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Tuesday, 11 September 2012

The weakest link - short-term liquidity and how it impacts Islamic finance

Let me start off with a loaded question, what one word in Islamic finance is as important as Shari'ah, tax, accounting, regulation, and standardisation (STARS)?
Here are some clues:
Islamic finance has institutions called Liquidity Management Center (LMC) in Bahrain, Liquidity Management House (LMH) in Kuwait, and International Islamic Liquidity Management Corporation (IILM) in Malaysia, plus other similar organisations with different names.
The UAE Central Bank has been encouraging commodity Murabaha certificate of deposits (CDs) and expanded to repurchase (repo) offerings to address short-term UAE Islamic bank needs.
The Central Bank of Bahrain (CBB) has been issuing liquidity, addressing Sukuk Al-Salaam, short term, non-tradable securities.
Index providers have created Shari'ah-compliant liquid blue chips, similar to the Dow Jones Islamic Market International Titans 100 Index.
At many of the Islamic finance conferences, there are speakers and sessions dedicated to liquidity management risk along with credit, operational, market, and Shari'ah non-compliant risk.
Thomson Reuters launched the Islamic Inter-bank Benchmark Rate (IIBR), decoupling from LIBOR, an indigenous innovation for Islamic banks to manage their own short term liquidity.
The Islamic Financial Services Board (IFSB) released documents directed towards enhancing reliability and stability in the industry, through The Development of Islamic Money Markets (technical notes), earlier this year.
The Bursa Suq Al-Sila (in Malaysia) is a commodity trading platform, underlying is, say, palm oil, directed towards facilitating Islamic liquidity management.
Well if you haven't spotted the common thread, in a word it is liquidity and it goes with asset-liability matching. In Islamic finance, there has been a historical mismatch because of the lack of robust short-term money market instruments; primarily reliance on two party bi-lateral commodity Murabaha and Wakala agreements, to manage the liquidity, surplus and deficit of Islamic banks. 
The challenges associated with bi-lateral agreements includes counter-party credit risk, meaning that the lending entity may not be able to get its funds back with profit, if the receiving entity goes out of business. Obviously, the situation becomes more pronounced if subjected to external shocks, like the credit crisis in 2008, where liquidity freezes, hence, presenting fire-priced asset sales as the only alternative with the resulting 'systemic' risk to the niche industry.
The short-term liquidity challenge has also produced something called 'leakage,' where Shari'ah-compliant funds are placed in 'conventional' spaces. For example, the CEO of CIMB Islamic Bank, Badlisyah Abdul Ghani, stated during an interview in 2007 that, "there is nothing wrong with commodity Murabaha as a structure … what is not liked is when proceeds … are used for non-Shari'ah purposes … this leakage of Islamic funds is huge … We estimate it is over $1.2 trillion ... mostly invested in US Treasuries and non-compliant investment products …
There is continued chatter in the Islamic finance market place about authentic Shari'ah-based solutions, as today's offering, to address short term liquidity, is about either removing the Haraam elements or placing Islamic 'wrappers' on their conventional counter-part products.
However, it must be understood that Islamic finance is an immensely small sub-set (valued at $1.2 trillion) of conventional finance (valued at over $100 trillion) and of course much younger, four decades versus four centuries. And to be fair yes, Islamic finance needs to stop using its infancy as an excuse and to dissociate from the law of necessity, as Islamic finance solutions are gradually surfacing.
Let's also manage expectations accordingly on what issues Islamic finance can resolve today within this niche industry, before proposing it as a solution for the ills of conventional finance. Today, Islamic finance is more about incomplete product pushing at the national/country level, than providing holistic financial and financing solutions.
For example, conversations are invariably raised on the inefficiencies, such as the inability to achieve economies of scale/size or the lengthy time frame it takes to bring a Sukuk to the market in the GCC, associated with a lack of standardisation, hence, one possible reason that the conventional financial industry has not yet taken IF seriously. Thus, if we do not have a 'unified' and efficient approach to addressing some of our major issues like short term liquidity, then it is going to be a challenge for others to accept our advice regarding their concerns.
To grow Islamic finance to $2 trillion and cross-sell beyond its traditional markets, fundamental, not reactive, and foundational, not bi-lateral, approaches are needed and necessary. The thinking of 'if, it ain't broke, what you gonna fix,' is no longer applicable to addressing short term liquidity in Islamic finance.
To get to the end-goal of so called 'Islamic' purity, the industry, with guidance from regulators, has to go through interim tolerance parameters that are time consuming to avoid self-destructive destabilisation. Islamic finance has to, at one level, reflect its age and maturity, and not that of the more established conventional finance. In fast tracking solutions, the law of unintended consequences kicks in, where the solution actually creates more problems.
Thus, the alternative approaches in different geographies to, say, liquidity to asset-liability mismatch is the industry recognising a challenge and transparently offering suggestions to find a solution. This reinforces the fact Islamic finance, today, is fragmented and domestic in nature, i.e., pieces in a jigsaw puzzle.
With the recent 'conventional banking' scandals over alleged Libor manipulation and money laundering, this openness needs to be both acknowledged and commended!

(Equities.Com / 10 Sept 2012)

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Islamic finance industry urged to recognize individual achievements

LONDON — Prominent Saudi Shariah scholar and economist Dr. Mohammed Elgari has urged the global Islamic finance industry to pay more attention in recognizing the outstanding contributions of individuals and institutions to the development of the contemporary industry, which is now in its fourth decade. 

“For the past 37 years, the industry has not put much emphasis on the need to honor pioneers who have passionately devoted their expertise toward providing the Muslims, particularly, with an alternative to their financial transaction needs,” said Dr. Elgari in an interview with Saudi Gazette.

“We are aware that riba or interest is totally forbidden in Islam and it is a heavy obligation upon all of us to find solutions to the management of our daily financial needs that is free from riba. The process of developing Islamic finance is currently a very difficult one, given the fact that the market has reached a great level of sophistication and the needs and wants of the investors especially are very complex.”

Dr. Elgari, who is an adviser to the Saudi Arabian Monetary Agency (SAMA) on Islamic finance inter alia several other banks and financial institutions, will be in Kuala Lumpur on Sept. 19 to attend the Gala Dinner for the 2012 The Royal Award which is bestowed by Bank Negara Malaysia, the central bank, and the Securities Commission Malaysia (SC) under the patronage of the Malaysian King, Tuanku Abdul Halim, who is also the Sultan of Kedah State. 

Dr. Elgari, who has a doctorate in economics from the University of California at Berkeley, is one of several prominent foreign members of the Jury Panel of The Royal Award, which uniquely is non-commercial and perhaps more importantly is not deal or transaction driven. 

“I agree that this Award is Malaysia’s effort to develop Islamic finance internationally but it is not to glorify Malaysia’s achievements in the field. It is more of Malaysia taking the lead to place proper recognition to contributions made by an individual or individuals who has contributed to the development and enhancement of the global industry. The contributions that we are considering can come from various disciplines such as economics, Shari’ah, banking and takaful practises, overall markets and other related fields,” he explained.

He is confident that The Royal Award is on the right track as it would further boost the growth of not just true scholarship but also the industry. However, he has a message for the Islamic finance industry: “I have not seen such a great level of ikhlas or sincerity being shown by all level of players in their commitments to the development of Islamic finance.”

It is not open to competition being a non-commercial award. It, however, does recognize breakthroughs in major issues in Islamic finance. “How do we measure for example the monetary value to solutions given by tawarruq, for instance?” he asks. “It is unlike the commercial achievements where success measurement is made, such as in terms of sale-ability of securities or fee income earned. The breakthroughs do not provide just a solution to a specific issue faced by an issuer but one that is to be enjoyed by the ummah in general; capable of solving major issues and able to move the market or the industry in greater steps and providing an alternative solution to the financial industry as well,” he added.

The globalization and requirements of finance today needs are global in nature. This has further increased the complexity of the industry. As in the past, the objectives of seeking solutions have never been material-driven but more by the need to achieve al-falah or victory. This, stressed Dr Elgari, is the Islamic spirit that prevails in Islamic finance.

“There is no single solution to any problem or issues, as we have seen, how products have evolved. Such as from the controversial bai’ inah to tawarruq. Though tawarruq is another debatable issue, but it is undeniably a progress. Ultimately we will find better solutions to the everyday problems in our life. The optimal solution will be something that we will strive for and the Award is such an incentive for the industry to keep on progressing and developing,” he explained. 

Deal-driven awards have been controversial especially in the Islamic finance space. While they purportedly profile the product, the institution and the issuer, there have been allegations that some of them are linked to sponsorships. 

According to Dr Elgari, The Royal Award does not recognize just any contribution but one that has become applicable globally — how it has been able to solve major issues or able to provide solutions arising from such issues; how it has removed the dependency on riba from practices; and how this has contributed to the entire value chain of Islamic finance as well the meeting the needs of mu’amalah or the daily transaction needs among human. 

“Issues in Islamic finance,” he further stressed, “need to be solved by overcoming the greater compliance needs to the Shari’ah. And this is not easy, as for the past decades the two stakeholders were talking in different ‘languages’. The successful interaction between them has been able to resolve many issues and today the Shari’ah community is being mainstreamed into the industry. This is something that we have not seen before. 

Thus, to Dr Elgari, The Royal Award looks at how great the contribution has enabled the interaction and how it has contributed towards resolving Shari’ah issues to solve the complex applications in financial operations or structures. This is not a small challenge. “What we are looking at is how significant it has been? It is a challenge now for the Jury as we need to be convinced, to be certain and to be satisfied that the achieved contribution is truly outstanding. We have the diversity of membership of the Jury Panel. Each member represents a specific area that constitutes a component of the major building blocks of Islamic finance. Most of the members have been involved in the development of Islamic finance since the early days — the early 80s and are still active until today,” he added. 

This year, The Royal Award has received 32 nominations for candidates who are influential in the field of Islamic finance and some are drivers of the industry. What is more surprising is that there are also non-Muslim candidates in this year’s nominations. 

Dr Elgari is admant that the selection process is very robust and rigorous. It covers both qualitative and quantitative aspects pertaining to the impact of the contributions by the candidates and also their characters. However the developed assessment matrix, he said, has enabled the recognition of the special skills and strength of the candidates and this enabled the Jury especially a systematic process on how to select the best from among them. Decisions are made on unanimous basis. 

Selections, explained Dr Elgari, are not based on votes or popularity of submissions but on merit. Records or achievements are cross-checked for their authenticity. Candidates are also checked for their integrity. There is thus no possibility absolutely for riggings or pre-planning. In fact the Jury Panel members are not even informed of the nomination list when they come for the first selection meeting. The discussions by the Jury Panel are not disclosed to any members of the Royal Award committees or even the organizers. Even the Jury Panel members are selected from various geographical locations and from both Muslims and non-Muslims.

Dr Elgari warns against likening The Royal Award for Islamic Finance to become the Nobel Laureate of Islamic Finance. “I would not agree that this is the aspiration of the organisers but who know perhaps as in the King Faisal International Prize a number of the science prize winners have gone on to win Nobel prizes. We cannot rule this out as the Award winners are also considered for among others the dedication and services to humanity.”

As to the future development of The Royal Award, Dr Elgari recommends a longer time frame be given to the selection process; probably interviews with the nominees and those involved with them so that more in-depth information could be obtained. Perhaps also at such a time, there should also be the implementation of an independent audit to verify that governance has been exercised.

(Saudi Gazette.Com.Sa / 10 Sept 2012)

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UAE: National Bank of Abu Dhabi Soars on Malaysia Islamic License Plan

National Bank of Abu Dhabi PJSC climbed the most in almost a year after the largest lender in the United Arab Emirates by market value said it plans to seek an Islamic banking license in Malaysia.
The shares jumped 4.4 percent, the most since Oct. 30, to 8.83 dirhams at the close in the emirate. The benchmark ADX General Index (ADSMI) advanced 1 percent.
The Abu Dhabi-based lender wants to expand after starting non-Islamic commercial banking operations in Southeast Asia’s third-largest economy in July, Leong See Meng, chief executive officer of National Bank of Abu Dhabi Malaysia Bhd, said in an interview in Kuala Lumpur Sept. 7. Malaysia’s Islamic banking assets rose 21 percent to 359 billion ringgit ($115 billion) in July from a year ago, driven by government incentives for Shariah-compliant products, according to central bank data.
“Investors liked the news that NBAD is venturing into Islamic banking in Malaysia,” said Nabil Farhat, a partner at Abu Dhabi-based Al Fajer Securities.
National Bank of Abu Dhabi was among five foreign institutions, including Indonesia’s PT Bank Mandiri, which received central bank approval in 2010 to begin non-Shariah banking operations. “There are opportunities across the board,” Leong said.
National Bank of Abu Dhabi already offers products that comply with the religion’s ban on interest in the United Arab Emirates, including savings accounts, treasury instruments and trade financing.

(Bloomberg Business Week / 09 Sept 2012)

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Turkey seeks advice on its proposed sovereign sukuk

The announcement by the Turkish Treasury a few days ago that it had mandated Citigroup, HSBC and Liquidity Management House (LMH), the investment bank subsidiary of Kuwait Finance House, “to explore opportunities for a possible Lease Certificate issuance in the international capital markets” could not be more Turkspeak. 

In reality the mandate is to advise and structure the proposed debut sovereign Sukuk Al-Ijara of the country, the first time that secular Turkey would raise funds from the international market through the issuance of Islamic leasing certificates (Sukuk Al-Ijara). 

In this respect, according to the Treasury, a series of investor meetings (road shows) organized in important financial centers in the Middle East and Asia started Monday which will continue till Thursday.

Ankara has been contemplating for the last five years whether to issue a sovereign sukuk, which has over the last decade become an internationally recognized and acceptable financial instrument through which funds can be raised either through a primary issuance or through a securitisation exercise. 

Hitherto, the AK Party government of Prime Minister Recep Tayyip Erdogan has been cautious not to be seen overtly to promote Islamic or participation banking as it is classified in Turkey. But thanks to the subprime crisis, the precipitant global financial crisis and the resultant Eurozone sovereign debt crisis, even the secular bastions in Ankara, Istanbul and Izmir started questioning the excesses and vagaries of market and casino capitalism. While the lessons learnt from the Turkish financial crisis in 2001 stood local banks in good stead to counter the worst effects of the global financial crisis in 2008, the country’s exports to the Eurozone did suffer. But it is to the prowess of the Turkish private sector that the loss of the Eurozone business was quickly mitigated to a growing extent by seeking new markets in Asia, Africa, Latin America and nearer home, for instance, in Kurdish-controlled Northern Iraq, where Turkish businessmen have a lead start on others. 

Turkey’s staunchly secular media started arguing the merits of raising funds through sukuk especially to attract Middle East and Asian investors to the country. This in effect has helped the Erdogan Government to pave the way for starting the preparatory work towards the issuance of a debut sovereign sukuk.

The government in February 2011 passed vital legislation to facilitate the issuance of leasing certificates (Sukuk Al-Ijara) including tax neutrality measures consistent with equivalent conventional products. 

Turkey traditionally, save for a couple of recent years, has raised funds from the IMF or through issuing Eurobonds to meet its external borrowing requirement, which in 2012 was targeted at US$4.5 billion. According to Treasury figures, Ankara has already raised US$4.6 billion in 2012 in this respect, so technically the country does not need to raise additional funding for this financial year. As such, proceeds from the proposed Sukuk will go towards the funding requirements in fiscal year 2013.

Emad Al Monayea, CEO of Liquidity Management House, one of the mandated lead arrangers for the Turkish sukuk, in a recent unrelated interview stressed that the pricing for sukuk has become so tight that it is a very attractive instrument through which funds could be raised currently. However, he cautioned that new issuers may have to pay a slight premium to attract investors. However, Turkish risk is familiar to European, Middle East and now Asian investors. 

For Liquidity Management House, a sister institution of local Turkish participation bank, Kuveyt Turk Participation Bank – both subsidiaries of Kuwait Finance House – the Turkey sovereign sukuk mandate is yet another triumph. It comes on the heels of another important recent mandate it won as part of a six-member consortium to advise and structure on South Africa’s debut sovereign Sukuk Al-Ijara.

Kuwait’s triumph however is Malaysia’s disappointment. Malaysian banks such as CIMB Investment Bank and Maybank Investment Bank have once again lost out both in this Turkish mandate and the earlier South African one. The Malaysian International Islamic Financial Centre (MIFC) initiative has painstakingly spent much resources over the last few years to foster greater cooperation between Malaysia and Turkey especially in the Islamic finance space. This was translated into several MoUs, roadshows, seminars. For Kuala Lumpur, the absence of any Malaysian banks as mandated lead arrangers for both the Turkish and South African mandates must be a major disappointment, and perhaps questions the approach of Malaysian financial institutions to the Middle East markets. 

Kuveyt Turk in fact paved the way for Turkish corporate sukuk issuance with two offerings to date – a 3-year US$100 million Sukuk Al Ijara in 2010 and a 5-year US$350 million Sukuk Al-Ijara offering in November 2011. That latter issue, according to Ufuk Uyan, CEO of Kuveyt Turk was “the first Sukuk to be realized under the provisions of the new Capital Markets Board (CMB) legislation on Lease (Ijara) Certificates, which is the Turkish Participation banking version of Sukuk issuance, and for which also the taxation aspects of asset based securities or Sukuk were equalised to bring them to a level playing field to that of conventional bond issuances.” The proposed Turkey sovereign sukuk will be similarly based on the provisions of the above law. 

Once again using the Kuveyt Turk issuance, the pricing for the Turkish sovereign Sukuk according to bankers involved in the transaction is expected to be competitive. 

Its US$350 million Sukuk was priced at par with a profit rate of 5.875 percent with a spread of 447.5 basis points over MS (Mid Swaps). The good news for the Turkish Sukuk market was that the pricing for the Kuveyt Turk Sukuk was tight and far more competitive than the pricing for then equivalent bonds issued by Turkish conventional banks such as Akbank and Isbankasi which were priced 50 basis points and 20 basis points more respectively.

With Moody’s Investors Service, the international rating agency, a few days ago upgrading its outlook for Turkey’s proposed sukuk issuance to positive and assigned it a “Ba1” investment grade rating, the price guidance for the proposed Turkish sovereign Sukuk similarly is expected to be competitive.

The business case for a sovereign Turkish Sukuk is solid. It will set the benchmark for a spate of anticipated corporate issuances being lined up - both US-dollar denominated and Turkish Lira-denominated issuances. It will familiarize Islamic investors with the Islamic debt and capital market in Turkey. It will contribute to the government funding gap in fiscal year 2013. It will allow Islamic banks and participation banks to diversify their Sukuk holdings. It will allow local Turkish participation banks and funds to invest in Treasury Islamic leasing certificates, something of which they have been bereft thus far. It could be a vehicle for Turkish participation banks to park their reserves in Islamic instruments at the Treasury. It will diversify the base of true sovereign issuers which include Malaysia, Pakistan, Indonesia, Bahrain, Qatar, Dubai, Singapore and Brunei. And perhaps more importantly it could be a useful and competitive alternative source of raising funds to finance the country’s ongoing infrastructure, housing and energy spend which has been exacerbated by a young, dynamic and growing population. 

Turkey is the 17th largest economy in the world; it has a population of 70 million of which the average age is 29, which is the youngest in Europe; it is the 16th largest steel producer in the world; and the country averaged a GDP growth rate of 10.3 per cent for the First half of 2011.

The timing of the Turkish sovereign sukuk, which according to bankers in Istanbul is expected to be in the region of a 5-year US$1 billion to US$1.5 billion S registration US dollar denominated Sukuk Al-Ijara, is also opportune given that there is a surfeit of liquidity in the market chasing investment grade and AAA rated Sukuk issuances. 

Perhaps a Turkish sovereign sukuk will also spur on other major sovereigns in the region especially Saudi Arabia, Kuwait, Iran, Egypt, Morocco to go to the market with debut true sovereign sukuk offerings as opposed to quasi-sovereign issuances.

(Saudi Gazette.Com.SA / 11 Sept 2012)

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