Malaysia, Emirates plan sukuk to fund aircraft

Malaysian Airline System Bhd (MAS) and AirAsia X Sdn are joining Emirates in planning sales of Islamic bonds as banks curb lending on Europe’s debt crisis.

MAS, voted Asia’s leading air carrier by World Travel Awards this year, may sell sukuk to partly fund an order for RM12 billion (US$3.8 billion) of aircraft due to be delivered by the end of 2014, chief executive officer Ahmad Jauhari Yayha told reporters in Kuala Lumpur on Dec. 7. AirAsia X, the region’s first long-haul budget service, may issue syariah-compliant debt to expand its fleet, CEO Azran Osman Rani said in an interview in the capital on Dec. 13.

The airlines are turning to Islamic markets on prospects European lenders will reduce credit next year due to the region’s financial crisis, according to Standard & Poor’s. Syndicated loans in Europe, the Middle East and Africa fell 31 per cent to US$184.4 billion this quarter from the previous three months, while global sales of sukuk rose 38 per cent to US$7.2 billion, according to data compiled by Bloomberg.

“Banks in Europe are less willing to provide financing for large asset purchases because of the region’s debt crisis and the need to preserve capital,” Hang Tuah Amin Tajudin, vice president of Kuala Lumpur-based OCBC Al-Amin Bank Bhd, the Islamic unit of Singapore’s Oversea-Chinese Banking Corp, said in a Dec 19 interview. “Sukuk is a good option as there’s still pent-up demand.”

Average yields on sukuk have dropped eight basis points, or 0.08 percentage point, to 4.09 per cent since reaching a seven- month high of 4.17 per cent on Dec 9, according to the HSBC/NASDAQ Dubai US Dollar Sukuk Index. Yields fell 65 basis points this year, following a 252 basis-point decline in 2010.

Yields on emerging-market bonds fell five basis points this month to 6.06 per cent and are down seven basis points since the end of last year, according to JPMorgan Chase & Co’s EMBI Global Sovereign Index.

“Sukuk may not necessarily be priced lower than conventional bonds but they offer the airlines a source of diversification,” Michael Oh-Lau, head of debt markets at Kuala Lumpur-based Maybank Investment Bank Bhd, said by e-mail on Dec 12. “The sukuk market opens doors to a wider group of investors.”

Islamic bonds are “naturally suited” to airlines given their structure and because aircraft can be used as the underlying asset to back the debt, said Badlisyah Abdul Ghani, chief executive officer of Kuala Lumpur-based CIMB Islamic Bank Bhd, a unit of CIMB Group Holdings Bhd.

Sukuk can be based on a sale and lease agreement such as Ijara, where the asset is rented out and final ownership is optional. Islamic bonds can also use Murabaha, a three-party transaction where a bank buys a product on behalf of the customer and sells it back at a mark up. There is also Istisna, a contract to make an item at an agreed price with the potential buyer making periodic payments.

“More airlines can be expected to look at the Islamic market for financing,” Badlisyah said in a Dec. 12 interview. “Ijara is a perfect Islamic structure for airlines.”

Selling syariah-compliant notes is an option for Emirates, the biggest international carrier, chairman Sheikh Ahmed bin Saeed al Maktoum said at the Dubai Airshow on Nov 15. Gary Chapman, president for group services, didn’t answer calls to his mobile phone this week seeking comment.

The company, based in the United Arab Emirates, sold US$550 million of floating rate dollar-denominated Islamic bonds in June 2005, the world’s first sale of sukuk by an airline. The price of the notes was 98.36 on Dec 20, compared with 94.12 at the end of last year, according to data compiled by Bloomberg.

Loans in Europe, the Middle East and Africa are poised for the worst quarter since the three months ended March 2010 and have climbed 8 per cent in 2011 to US$1 trillion from the year earlier period, data compiled by Bloomberg show. Global sales of Islamic bonds, which pay returns on assets to comply with Islam’s ban on interest, rose 68 per cent to US$26.4 billion, short of the 2007 record of US$31 billion.

The deteriorating outlook for the airline industry and the clampdown on lending may encourage companies to turn to the Islamic bond market, Shukor Yusof, a Singapore-based aviation analyst at S&P, said in an interview on Dec 20.

Profits may drop 57 per cent this year and 49 per cent in 2012 as Europe’s crisis hurts bookings, the International Air Transport Association said in a Dec 7 statement. Companies may be unprofitable next year should the contagion “spiral out of control,” according to the Montreal-based agency that represents 240 airlines worldwide. Jet fuel prices have increased 14 per cent this year to US$119.40 per barrel.

“Many airlines won’t be able to raise funds from their traditional sources,” said Shukor. “It’s natural for the Emirates and the Malaysian Airlines to look at sukuk as they are from Muslim jurisdictions.”

Syariah-compliant bonds returned 6.7 per cent this year, according to the HSBC/NASDAQ Dubai US Dollar Sukuk Index, while debt in developing markets rose 7.9 per cent, JPMorgan Chase & Co’s EMBI Global Composite Index shows.

The difference between average yields and the London interbank offered rate, or Libor, was little changed this month at 286 and narrowed four basis points in 2011, according to the HSBC/NASDAQ index.

The yield on Dubai’s 6.396 per cent Islamic notes due in November 2014 fell two basis points to 5.89 per cent yesterday and has decreased from the year’s high of 6.64 per cent on Jan 31, according to data compiled by Bloomberg. The difference in yields between Malaysia’s sukuk and the Dubai Department of Finance’s debt narrowed three basis points yesterday to 316, data compiled by Bloomberg show.

The Bloomberg Malaysian Sukuk Ex-MYR Index of foreign- currency Islamic debt sold by companies in Malaysia climbed to 104.2280 on Dec 20, the highest level since Nov 17. The gauge has gained 5.8 per cent this year.

AirAsia X, the long-haul affiliate of Asia’s biggest discount carrier AirAsia Bhd, is looking at Islamic bonds as it may add at least another 60 aircraft to an existing order of 30 Airbus SAS planes, CEO Azran said.

Emirates is building the world’s biggest fleet of wide-body jets and signed an order for US$18 billion of planes on Nov 13 with Boeing Co.

“In today’s environment, you need a variety of funding sources,” Azran said in telephone interview in Kuala Lumpur. “The situation in Europe plays a part.” -- (Bloomberg: 22-Dec-2011)

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Alfalah Consulting Malaysia: www.alfalahconsulting.com

Dr Mahathir urges countries to achieve 50% market share for Islamic banking

Even in retirement he remains the most popular politician to the Muslim "man-and-woman-in-the-street". Now as an elder statesman, Mahathir Mohamed, the former Malaysian prime minister, continues to give advice whether on the global financial crisis, on the future of the Islamic banking industry, on the Islamic gold dinar, on the future of US dollar as an international trading currency, and on his celebrated spat with arch speculator and fund manager, George Soros, in the aftermath of the Asian financial crisis in 1998.

In an exclusive interview, Mahathir, albeit a bit more frail now, was his usual outspoken self, and he had a clear and present message for the Islamic banking industry - learn from the mistakes of conventional banking if the industry is to avoid the same fate. There definitely is a future for Islamic finance. It would not be spectacular; it would not be the cause of booms and busts.

"It would be steady and would not cause the kind of social and economic upheavals that we are seeing today. Islamic banking and the wealth of the Muslims will cause the rest of the world to link up with Muslim countries. Muslims will feel comfortable doing business without going against the injunctions of Islam provided that the abuses of the Riba banks are avoided there will not be the periodical collapse of the Islamic financial system. We are seeing how the Islamic banks have remained unaffected by the current crisis. Insha'Allah it will remain crisis-free in the future," he added.

Mahathir is perhaps one of the better qualified persons to talk about Islamic banking. Not because he is an expert in Islamic finance or Fiqh Al-Muamalat (Islamic law relating to financial transactions). It is because that he is the architect of the Islamic banking system in Malaysia. Not many people today realize that one of the first actions that Mahathir took when he came to office in 1981 was to set up a National Steering Committee to implement Islamic banking in Malaysia. The report of this committee on the viability and strategy of Islamic banking was the impetus for the creation and robust development of the Islamic financial industry in Malaysia. The rest is history.

He strongly believes that the Islamic system for economic and financial management has something to offer to the world especially in these dire times of financial crisis, sovereign debt and economic recession. Indeed, he urges countries to resort more to using Islamic finance in the aftermath of the global financial crisis and stressed that the industry is here to stay and definitely has a future in the global financial system.

"The Islamic financial system is not just about the proscription of Riba (interest) and Gharar (deception). It has certain codes, for example, if you lend money you have to do so with good intention and not in order to cheat your partner or to exploit him. Uncertainty and speculation in terms of gambling are not allowed in Islam. The Islamic system practically says 'No' to the speculative products of the financial market. Without these products the chances of economies collapsing would be much less," he maintained.

He believes that the Islamic financial system has much greater connectivity with the real economy and not the speculative one. But its development and evolution will take time. "When we started Islamic banking in Malaysia, there were very few Islamic banks around the world. We had to build the industry in Malaysia from scratch. Today Islamic banking is spreading everywhere and even the conventional banks have standalone subsidiaries or Islamic banking windows. We decided that instead of confining ourselves to one system, people should have a choice whether they wanted to use the conventional or Islamic banking systems. This has done us a lot of good. It does not disturb the process of doing business that much," he added.

With Malaysia's new 10-year Financial Master Plan (2012-2022) due to be launched later this week by Bank Negara Malaysia, the central bank, the Islamic finance industry is keen to see the provisions pertaining to the industry. The main objective of the 2012 Master Plan is the consolidation of the Islamic finance industry, unlike the previous one which concentrated more on the establishment of the industry and the achievement of certain targets of which the most celebrated one was achieving 20 percent market share for the Islamic banking industry by the year 2010. The new Master Plan avoids setting market share targets for the Islamic finance industry for the next decade.

In fact the market share of Islamic banking in Malaysia is currently 22 percent. Mahathir is not coy about wanting to see this market share increasing further "We started with nothing, and the growth to over 20 percent in less than three decades compared with three centuries of conventional banking is very fast indeed. I would perhaps like to see a 50:50 percent market share for both systems operating side-by-side. The Muslim world today is much richer than it has ever been," he advised. And he believes that this aspiration is both achievable and sustainable, provided the Islamic banking industry is properly governed. "There cannot be any playing around with products that are speculative and that are not really tangible. We must do real business. It is something that is doable not only by Malaysia but also some other countries," he added.

While it is a vindication of the Islamic banking system that Hong Kong, Singapore, Luxembourg and London all aspire to become centers for Islamic finance and capital markets, he warns that "if we are not careful the big conventional banks might become bigger in Islamic banking than the Islamic banks." As such the challenge for Islamic banks going forward is for them to study the needs of borrowers in greater detail and coming up with fair solutions for them.

He would you like to see Muslim sovereign wealth funds for instance direct more of their investment portfolios to the Islamic financial sector. But he concedes that would depend on whether the sector can offer products to absorb all this liquidity. But he is confident that over time people in the sector will manage this. "The Islamic world is flush with funds. We have to show that it is worthwhile for them conforming with the injunctions of Islam in terms of financial transactions and investment, without them losing much money."

Mahathir is an ardent promoter of the Islamic Dinar concept, which he maintains has been misunderstood. He is advocating the use gold merely to back bilateral trade between Muslim countries and between developing countries as a unit of accounting to be settled between central banks. This as opposed to gold as a means of exchange, which is Riba and uses gold as a commodity, and which is proscribed in Islam.

"It is not so much an Islamic dinar but using the most stable of metals, gold, as a backing for currency. We are not talking about the physical movement of gold which would expose us to all kinds of dangers. We can use the value of gold. There are some people who have the wrong perception that the gold dinar could be used like ringgit for the purchase of all goods both in the country and abroad," he added.

To him the use of the US dollar as an international currency is over-rated and its days are indeed numbered. "I have said this a long time ago that East Asia should have its own trading currency. Not like the euro which is used domestically. This would purely be for the settlement of trade," he added.

But he knows the staying and pulling power of the greenback. When Mahathir was prime minister, his government pioneered the Bilateral Payments Arrangement (BPA) with countries such as Chile and Iran, to the chagrin of the International Monetary Fund (IMF) which thought it was against the spirit of the free market and financial liberalization. People hailed it as a good and a cost effective bilateral payment settlement system for emerging countries. But the BPA proved to be unsustainable.

"Everybody says the BPA is a good system. But governments are loathe to doing away with a system of using US dollars as payment for trade. Of course the US would not like this. If you don't use US dollars, their value will certainly go down. We can use our own currencies or a basket of currencies. If this is backed by gold then there won't be the volatility in the appreciation or depreciation as we have seen in currency exchange rates," maintained Mahathir. 

He is only half surprised that the world is in this financial meltdown and crisis because people have been writing books predicting that these things would happen. He admits that he did not think that it would happen on the scale that it has happened.

The crisis is a question of abuses in the financial, the banking and the monetary systems. The conventional banking system has served the developed economies very well by financing industry and services thereby enriching themselves through doing real business. However, these economies could not compete any longer with the emerging economies of the East and Latin America in the post-war years. This, he explained, necessitated a switch to the financial markets with the promise of huge capital gains from investments in the share markets of the world. This also spurred on financial innovation in derivative products including collateralized debt obligations (CDOs), short selling, hedge funds and currency speculation, which bore no relation to real economic activities.

Capitalism, he added, has given many nations prosperity, but when capitalism is combined with unbridled greed, the result is what we are seeing today. In the Western financial system the abuses are made possible because the system allows unlimited money to be created by the banking system. Loans by the banks have a guaranteed return. There was no risk for the banks, but new ways of guaranteeing returns were invented so that more money could be created and lent by the banks. The greedy played on the greed of people.

The idea that the market should regulate itself is wrong. "The market is about making money. It is not interested in regulating. The more money it makes the happier the market. Governments must exercise some degree of control over what is happening in the financial market. At the moment there is no control at all. One day of currency trading can amount to $4 trillion," he advised.

He has a message for his immediate successor then Prime Minister Abdullah Badawi and the current incumbent Prime Minister Mohd Najib Abdul Razak.

He is completely satisfied with the stewardship of his legacy of managing the economy. "The present prime minister is trying his best. The world has been going through a very traumatic period and this has also affected our economy. Some of our trading partners are now very poor. The US and Europe used to take 40 percent of our exports but they are now poor. We need to find new markets. We are less affected because we did not dabble in derivatives and short selling. This is bad for business and the economy," he added. (ArabNews/18Dec2011)

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Sukuk market is the fastest growing segment of international finance

"The sukuk market is the fastest growing part of Islamic finance. Indeed it is one of the fastest growing segments in the global financial market. Having attracted interest from the business community worldwide, it has helped place Islamic finance as a viable industry and as an asset class that is not confined to Muslim countries but as part and parcel of the international financial market," says Muhammad Al-Bashir Muhammad al-Amine, who is currently group head of Shariah compliance at Bank Al-Khair (formerly Unicorn Investment Bank) in Bahrain, in the introduction of his book titled “Global Sukuk and Islamic Securitisation Market - Financial Engineering and Product Innovation”.

The book is the latest analytical offering on the subject of sukuk and was published by Brill under its Arab and Islamic law series. The claims in the above paragraph are in contrast to the outrageous claim on the cover of the book that "The sukuk market is the fastest growing segment of international finance".

Much of the literature on the contemporary Islamic finance industry has had the unfortunate tendency of excessive eulogizing of the virtues and values of the Islamic system of financial and economic management based on descriptive rather than empirical and philosophical analysis. At the same time the style also bordered on exaggerated claims about the Islamic finance industry and its role and impact on the global financial system.

To be fair, some of the literature on Islamic finance and economy in the last decade or so has shown a remarkable improvement and in some cases have even threatened to offer a valuable alternative to the cornucopia of literature on the political economy, finance, development and the market - written largely from a neo-liberal or purely Keynesian or monetarist capitalist point of view.

While Al-Amine's “Global Sukuk and Islamic Securitization Market - Financial Engineering and Product Innovation” does not necessarily fall into any of the above categories, it is important to put some of his initial claims in perspective. The sukuk market may or may not be the fastest growing component in Islamic finance. There has been very little empirical research done on this and much of the statistics are extrapolations from aggregate figures issued by some individual securities regulators ort professional associations or by some information, data and news outlets.

The base figure at the same time for sukuk originations is very low - there are about $120 billion to $150 billion of sukuk outstanding in the world today of which over 60 percent are from Malaysian issuers. Compare this to the several trillion dollars each conventional bond market and the hedge fund market.

At the same time, the commodity Murabaha and Tawarruq market remain the single largest markets in the Islamic finance industry with an estimated $1.2 trillion of funds invested.

Similarly, the interest from the business community worldwide has been at best curiosity of a potentially interesting new fund-raising asset class, but in reality this interest has translated into a peripheral acceptability of and involvement in the sukuk market. How many Western or non-Muslim  corporate/multilateral/quasi sovereign sukuk issuances, for instance, have come to the market? Hardly enough to count on both hands - Saxony Anhalt, East Cameron Partners, International Innovative Technologies (IIT), GE, Nomura, IFC, World Bank, Shell Malaysia and Tesco Malaysia. This is hardly the stuff of sukuk as a wild fire accelerant of global finance.

The point I am trying to make is that sukuk market dynamics is as complex as other asset classes whether in Muslim jurisdictions or non-Muslim ones. These relate to a cornucopia of issues - regulatory framework, enabling legislation, ratings, Shariah structures, purchase undertaking, guarantees, especially third party Sukuk guarantees, SPVs (special purpose vehicles), trust laws, court procedure (in case of defaults and recourse to law especially for different creditors), listings, secondary market, arbitration clauses and so on.

As such, any analysis will have to start from the basic proposition of the dynamics of the issuer jurisdiction, and these vary dramatically from country to country. Most Muslim jurisdictions for instance do not have Sukuk legislation in place, let alone tax neutrality or even the basic Islamic banking laws in place. Saudi Arabia, the world's largest Islamic finance market in terms of assets and liquidity, does not have a dedicated stand alone Islamic banking law in place, although its Sukuk law was designed in tandem with the debut sukuk offering of SABIC (Saudi Basic Industries Corp.), the world's largest exporter of petrochemicals, the SR3 billion SABIC I Sukuk issued in 2006. At the same time there are serious barriers to entry for investors in Saudi public Sukuk offerings because these are by law restricted to Saudi nationals and in the odd exception extended to GCC citizens.

These should not detract from Dr al-Amine's prodigious effort contained in 10 hefty chapters. These cover the growth of Islamic finance; concept and development of the sukuk market; Shariah basis for sukuk structures; sukuk structures; Global PLS sukuk structures; Securitization and sukuk; governing law in sukuk structures; Shariah convergence; risk factors in Sukuk Structures; and rating sukuk. These chapters contain valuable information and analysis, although the author could have been more forthcoming and thorough in the frankness of his conclusions and projections.

Even with this effort, there are a number of gaps - nothing on regulatory and legal frameworks (or the lack of them) which is an essential prerequisite to the development of an onshore sukuk or Islamic capital market. There is very little discussion of credit enhancement in sukuk structures through third party guarantees such as the initiative being contemplated by ICIEC and by Danajamin, the Bong and Sukuk Guarantee Agency in Malaysia.

Even in the governing law in sukuk structures, the examples used are curious - the Shamil/Beximco and TID/Blom Bank cases - these involved Murabaha and Wakala arrangements and not sukuk. Instead the legal issues raised by the default of the East Cameron, TID, IIG and the SAAD/AlGosaibi Sukuk issuances should have been covered in this chapter.

The East Cameron does get a cursory treatment in the Chapter on Securitization and Sukuk although the underlying issues are not discussed adequately especially the structure, the legal and the Shariah aspects. For instance, how come the lawyers for East Cameron Partners in the Chapter 11 Bankruptcy proceedings requested a ruling "that the sale of the ORRI (overriding royalty interest) was in essence a secured loan and not a 'true sale'". Surely this raises questions or at least an analysis of the Shariah basis of the structure and whether indeed the scholars were provided the relevant and complete information prior to them approving the Shariah basis of the structure. If not, investors and creditors may have been liable to claim compensation on the basis that the transaction was fraught with Gharar in that there may have been improper disclosure relating to the transaction.

The author rightly concludes that the growth of Islamic finance had outpaced that of the conventional industry in several countries and regions (the Middle East and Southeast Asia) in recent decades. This growth, he says, is likely to continue "at a furious pace in the coming years as the present size of the industry represents only a very small percentage of the overall global financial market place." His optimism is underpinned by his prediction that "this change will perhaps take place rather more quickly than many may expect," although he does not offer the reasons for this optimism, especially at a time when many Muslim countries are faced with volatility partly precipitated by the so-called Arab Spring events.

To the author, the holy grail of the future development of Islamic finance is the sukuk market, although the underlying assumptions on market growth and the involvement of the West are over-optimistic and empirically unproven and at best ambiguous. In his mitigation, Al-Amine rightly warns that "for the sukuk market to develop we need a robust market infrastructure in the region ns where Islamic finance is witnessing its rapid growth." At the same time this will also depend on developing a strong bond market in these regions; the Shariah legitimacy and authenticity of sukuk structures; a better engagement and discourse on sukuk structures by AAOIFI and the OIC Fiqh Academy, perhaps moving towards a more scientific way of issuing and developing fatwas in Islamic finance complete with market consultation and method of articulating these opinions and therefore paving the way to new ideas; the development of legal frameworks which are sustainable and based on internationally recognized standards and practices; and the potential role of sukuk in facilitating liquidity management, the strategy, for instance, on which the International Islamic Liquidity Management Corporation (IILM) has embarked upon.

Securitization, says Al-Amine, is expected to play a positive role in the future development of the sukuk market and seems to be the best way for the future of sukuk structuring because of the securitization condition of 'true sale' and legal transfer of ownership rather than just beneficial ownership. "These conditions shifts the risk of sukuk from the originator of the sukuk to the underlying asset. These principles ware more in line with Shariah principles than those followed so far in unsecured sukuk where the risk of the sukuk is fundamentally based on the creditworthiness of the originator," he maintains.

The author could have been more critical of the approach of the international rating agencies in rating not only sukuk but also Islamic finance products and institutions per se. They have stubbornly refused to design separate rating criteria to accommodate the specificities of Islamic finance in contrast to the Malaysian rating agencies RAM Rating Services and Malaysia Rating Corporation (MARC), which between them rate the largest number of sukuk issuance sin the world.

This book I believe is a valuable contribution to the literature on sukuk and Islamic finance, especially for regulators, market players, advisories, researchers, academics and students alike, although the author should be a little bit more discerning in some of his choices of references, especially media articles and reports by some institutions. (ArabNews/23-Dec-2011)

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