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Saturday, 28 April 2012

Islamic finance: Mega bank, stock exchanges and trading platforms

ISSUES TO CONSIDER: An open letter to Islamic Development Bank president Dr Ahmad Mohamed Ali
DEAR Dr Ahmad Mohamed Ali, president, Islamic Development Bank (IDB) Group;

Asalaam Alaikum,

The Islamic finance world welcomes your comments on the Mega Islamic Bank with much excitement and great sense of anticipation. 

“…The ‘Mega Islamic Bank’ comes as an initiative of the Islamic Development Bank in its efforts to address the dearth of senior financiers, the absence of the Islamic tools of stock exchange and the absence of market liquidity between Islamic banks.” 

Dr Ali, the Islamic mega bank, working with IDB and industry stakeholders, needs to also include stock exchanges and trading platforms, both Islamic and OIC, as part of the conversation.

The objective is to make Islamic finance better ‘equity/debt’ balanced, conventionally efficient and syariah compliant complete. This may well bring in additional senior financiers, attract ‘under the mattress and conventional’ liquidity, and replace today’s product pushing with tomorrow’s investment tools determined by market liquidity. 

Work in Progress

The lack of enough qualified professionals, including scholars, is something leading academic and research institutions like Inceif, ISRA, etc, are working on. The issue of inter (Islamic) bank liquidity is something IILM and others are working on, and ‘…absence of the Islamic tools of stock exchange…’ are part of ongoing public-private sector initiatives. 

Dr Ali, you may ask, why stock exchanges and trading platforms also need to be part of the mega bank conversation? 

(Lets side-bar two points: (1) The capital charges associated with Basel lll for now, as we are at blueprint stage, and (2) Mega bank implies cross border, however, without another mega bank, are there counterparty (small) size risk issues, as the average Islamic bank’s paid-up capital is equivalent to the assets under management of an Islamic equity fund?)

Simply put, the need for ‘equitisation’ of Islamic finance for a better balance from the present debt bias via Sukuk, Murabaha syndicate loans, etc. As entities and individuals can be over-leveraged, they can also be Islamically over-leveraged, witness the recent bankruptcy reorganisation declaration by Bahrain-based Islamic bank, ArCapita, and Sukuk have defaulted and gone into bankruptcy, hence, no ‘divine put’ in Islamic finance.

Stock Exchange

In the developed world, stock exchanges, like Nasdaq NYSE-EuroNext, are well established and closely regulated, hence, there is confidence and trust for investor participation. In the 57 Muslim countries, which also happen to be emerging markets, some/many of the stock exchanges are often-time called ‘casino-capitalism’. It may be just one reason why there are more depositors than investors in the Muslim world. 

However, stock exchanges are the foundation of the capital markets, and such markets reduce reliance on bank financing, conventional or Islamic. Furthermore, it’s the risk-taking capital markets that are the financing foundation of knowledge-based economies. However, in the Muslim countries more needs to be done, as the largest economic sector is the (prohibited) conventional financial sector! 

Finance may be the lubricant of economies, but Muslim countries need less financial engineering and more intellectual property-led engineering (for knowledge-based economy) that Islamic finance needs to finance. Dr Ali, a collateral question becomes, beyond real estate, what value-add area(s) has Islamic finance financed in a Muslim country?

For example, the three largest economic sectors in a global Islamic index are technology, healthcare, and oil/gas, and innovation typically is from these areas. However, in OIC stock exchanges, these three sectors are either missing or have insignificant weighting representation in the capital markets. An Islamic mega bank will probably not be offering Islamic VC funds or funding SMEs, both contributors to knowledge and GDP/employment of economies, respectively. 

Dr Ali, the status quo cannot continue as the ‘Muslim man on the street’ is losing patience and confidence, (s)he is looking for VC, microfinance and SME financing and believes Islamic finance is only for the bankable. Furthermore, in Muslim countries there are more depositors than investors. A recent report by Ernst & Young on Islamic funds shows the assets under management to total banking deposits ratio (AUMs/Deposits) of US at 143 per cent and Saudi Arabia at 33 per cent and Malaysia at 10 per cent! 

QUERY: Is it in the best financial interest of (Islamic) banks (in Muslim countries) to maintain the status quo: maintain and expand the number/percentage of depositors over investors?

OIC Exchange Situation

Dr Ali, today, there are a number of challenges with OIC country stock exchanges, possibly due to the embryonic nature state of development and continued reliance on bank financing. However, let’s assume that your stock exchange comment is for both Muslim and non-Muslim country stock exchanges with listed syariah-compliant companies and products. The reality of the situation is most (85 per cent market capitalisation) of the compliant companies, in a global Islamic index from an index provider, are in the G-20 (non-Muslim) countries. There are 42 stock exchanges amongst the 57 Muslim countries and some of the challenges include:

1. Foreign investor restrictions, including currency restrictions and soft currency
2. Small free float
3. Illiquidity
4. Largest economic sector weighting is the prohibited interest-based conventional financial sector
5. Let’s set aside issues related with insider trading, front running, etc, not an uncommon phenomenon in the emerging markets.

Furthermore, the capital markets compartmentalisation within the Muslim countries, due more to politics than economics, is both a speed-bump and pothole to one seamless offering. 

To date, there is no OIC stock exchange, GCC stock exchange or Arab stock exchange, or CIS stock exchange, etc. Furthermore, the market has not accepted the conversion of Dubai Financial Market (DFM) into an Islamic stock exchange a few years ago, as to date, very few, if any, non-UAE public-listed Islamic financial institutions, Islamic Exchange Traded Funds (ETFs), etc, have not listed on DFM. 

Trading Platform

Notwithstanding some of the above mentioned challenges with OIC stock exchanges, they are important building bloc foundations for asset class trading platforms. The listing of firms and investment products are the ‘content’ placed on platforms, with work flows, for trading and investing for global investors. Thus, OIC stock exchanges, mostly a domestic play, become global on platforms like Thomson Reuters Eikon or Bloomberg terminals. Put differently, a platform would supplement, not replace, OIC stock exchanges.

Dr Ali, today, Islamic finance is over the counter (OTC), and it needs to move to the transparent screen based platform. Platforms are about multiple price discovery and liquidity, connecting communities, better understanding counter-party risks, etc., however, ‘products and tools’ continue the never ending standardization conversation. At the end of the day, the market, as a whole, will decide on product standardization (for the time) via market liquidity. 

Dr Ali, your institution, working with private sector information providers, needs to establish a scalable blueprint that prioritise asset class platforms, both Islamic and OIC, with global reach over products and tools. Why both Islamic and OIC, as latter implies conventional? For the simple reason of transitioning to Shariah compliance/based, as majority of financing/investing in the OIC is conventional. To get to purity, one needs to go through the interim tolerance parameters and ensuing time period.

For example, today, it is possible to have a screen-based OIC Trading Platform for, say, listed equities that allow users to use any rule book, like IdealRating offering, for syariah screening. This would have all information, news, data, analytics, purification and zakat (formulas for) calculation, etc., about listed companies and listed products at the end of the user’s fingertips, hence, conventional efficiency for information intermediation.

Benefits of Platform

This level of efficiency should result in cross sell of Muslim country (i.e., emerging market) opportunities to non-Islamic investors, provide better transparency and accountability for listed companies and products, and direct order flow to the exchanges for order execution (no cannibalisation issues). 

In conclusion, Dr Ali:
Islamic Mega Bank + OIC Stock Exchange Content + Housed on Trading Platform = Balance Growth of Islamic finance to move beyond the country shores and for all of mankind!

Respectfully submitted and Wasalaams.
Rushdi Siddiqui
The writer is Thomson Reuters’ Global Head of Islamic Finance based in New York

(Business Times / 24 April 2012)
Alfalah Consulting - Kuala Lumpur: 
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