MIDEAST DEBT-Conventional banks' sukuk to push limits of Islamic finance

Sept 14 (Reuters) - Islamic bond programmes from a trio of big conventional banks are set to expand the boundaries of Islamic finance, helping open the market to first-time issuers while testing the banks' ability to win over industry purists.

Since June, France's Societe Generale, Bank of Tokyo-Mitsubishi UFJ (BTMU) and Goldman Sachs have set up sukuk programmes, aiming to tap the pool of cash-rich Islamic investors.

They are treading a fine line, having to reconcile the fact that their businesses mostly depend on conventional banking practices - interest payments, and to some degree monetary speculation - which Islamic principles forbid.

An abortive plan by Goldman to issue sukuk in 2011 showed the obstacles which conventional banks can face in the market. Some in the industry accused Goldman of failing to follow Islamic principles, and it never went ahead with that issue.

But if the three banks are successful and become regular sukuk issuers, they could help to widen Islamic finance beyond its core markets in the Middle East and southeast Asia.

Governments in non-Muslim countries are already issuing sukuk; Britain and Hong Kong made debut issues earlier this year, while South Africa and Luxembourg are next in line. The entry of conventional banks into the market may be needed to prompt significant numbers of Western companies to issue.

"It builds credibility in an industry that is attracting many new participants," said Khalid Howladar, Moody's Investors Service's global head of Islamic finance.

"Key financial institutions represent volume issuers in mature markets. They will improve liquidity and encourage more global investor participation."

Year-to-date, sukuk issuance totals $88.9 billion through 475 deals globally, up from $76.4 billion through 574 deals a year earlier, according to Zawya, a Thomson Reuters company.

But the market remains stubbornly reliant on sovereign and quasi-sovereign issuers, who represent a combined 77 percent of the total; most corporate sukuk come from Malaysia.

Only a few companies from non-Muslim countries have so far issued sukuk, including GE Capital, which in 2009 raised $500 million through five-year Islamic bonds backed by interests in a portfolio of aircraft, and Japanese brokerage Nomura Holdings, which in 2010 issued $100 million of two-year sukuk in Malaysia.

CREDENTIALS

HSBC is the only non-Islamic bank to have issued sukuk, through a $500 million deal in 2011. Market acceptance of that deal was ensured in part by the fact that HSBC operates a major Islamic retail brand, HSBC Amanah.

SocGen and BTMU, Japan's largest lender, do not have Islamic retail banking brands. So they have been building their Islamic credentials by establishing strategic relationships with heavyweight Islamic financial institutions.

BTMU, which set up its $500 million multi-currency sukuk programme in Malaysia in June, signed in April a cooperation agreement with the Jeddah-based Islamic Corporation for the Development of the Private Sector (ICD), the private sector arm of the Islamic Development Bank.

Last week, BTMU extended $100 million in murabaha financing to the ICD, marking the first time that the ICD had raised cash from a non-Islamic financial institution. Murabaha is a common cost-plus sale arrangement in Islamic finance.

The participation of conventional banks in Islamic finance is positive as long as they ensure adherence to sharia principles in a way that is acceptable to the market, the ICD said in a statement to Reuters.

"The recent murabaha agreement marks the first step along this path and we fully expect the relationship to grow, develop and strengthen over the coming years."

SocGen, which also set up a sukuk programme in Malaysia in June, offers sharia-compliant commodity hedging tools to corporate clients. Last year, it helped Dubai-based cable manufacturer Ducab migrate most of its commodity hedging needs into Islamic equivalents.

"We know there are many similar companies to Ducab within the region and we do hope they will gradually move into sharia-compliant programmes," said Dubai-based Mohamed Virani, SocGen's head of Islamic products.

"It's a natural progress in the evolution of the Islamic finance market as it develops and matures."

DIFFERENT TACK

The biggest leap could be for Goldman, which is viewed by some in Islamic finance as a symbol of Western financial engineering. Though it insisted that its 2011 sukuk plan obeyed sharia principles and had enough certification from Islamic scholars, it is taking a different tack with this year's plan.

While the 2011 plan was a $2 billion programme of one-year sukuk, the current plan appears smaller; lead managers said the issue would be benchmark-sized, meaning at least $500 million, and the tenor would be longer, at five years.

Goldman sought advice for its latest plan from two of the same scholars whom it cited for its 2011 scheme, Abdul Sattar Abu Ghuddah and Mohammed Elgari, a source familiar with the plan said. This time, however, Goldman has also revealed the banks arranging the issue: Abu Dhabi Islamic Bank (ADIB), Emirates NBD, National Bank of Abu Dhabi and Saudi Arabia's National Commercial Bank.

The involvement of four top Gulf banks, including ADIB which has a sharia board led by the prominent scholar Taqi Usmani, may go a long way towards removing the misgivings which dogged Goldman's 2011 plan.

Goldman has also changed the structure of its sukuk plan. While its 2011 scheme was based on murabaha, its current plan has a hybrid structure and envisages operating only 49 percent though murabaha and 51 percent through a structure called wakala.

Under wakala, certificates are issued by an originator to buy assets which are given to an agent, who charges a fee for managing the assets, Some scholars favour wakala over murabaha because of its clearer link to the assets backing the sukuk; the HSBC issue in 2011 was wakala, as are the issuance plans of SocGen and BTMU.

The fact that the Goldman sukuk is predominantly wakala may remove one objection to its 2011 plan: that the sukuk might be traded at prices other than par value. Trading wakala structures is relatively uncontroversial, according to scholars.

Hybrid formats have been used in the past by the likes of the Islamic Development Bank, Abu Dhabi Commercial Bank and Qatar International Islamic Bank, combining different Islamic structures among which at least one is tradeable to ensure the sukuk can be bought and sold in the secondary market.

Another objection to Goldman's 2011 sukuk, which the U.S. bank said was unfounded, was that the proceeds might be used in interest-bearing finance. Documentation for the current sukuk plan, seen by Reuters, does not appear to address that issue directly, though it says proceeds would be used in the commodities business of J. Aron & Co, a Goldman unit.

"The thing they have to be most careful with is the use of the proceeds. They are a conventional bank, so they need to show that the proceeds are going to sharia-compliant purposes," said Shamsiah Mohamad, senior researcher at the Malaysia-based International Shari'ah Research Academy. 

(Reuters / 14 September 2014)

---
Alfalah Consulting - Kuala Lumpur: www.alfalahconsulting.com
Consultant-Speaker-Motivator: www.ahmad-sanusi-husain.com
Islamic Investment Malaysia: www.islamic-invest-malaysia.com

City sukuk opens door to more Islamic finance in Hong Kong

The launch of the Hong Kong government's first sukuk last week is seen as paving the way for private firms to follow suit in promoting the city as a centre for Islamic finance, now a global business worth US$1.3 trillion and expected to double by 2017.

The government's US$1 billion, five-year sukuk offered on Thursday was oversubscribed 3.7 times with US$4.7 billion in orders received. It attracted a mix of mainly international institutional investors, with 36 per cent from the Middle East, 47 per cent from Asia, 6 per cent from Europe and 11 per cent from the US. The bonds will be listed in Hong Kong, Malaysia and Dubai.

Amir Ahmad, a Dubai-based partner with international law firm Pinsent Masons, said the Hong Kong government-issued sukuk was popular with Middle East investors because of its high credit rating.

"This is the first time to have a government entity with AAA credit rating issue a sukuk in US dollars," Ahmad told the South China Morning Post.

"Many Islamic investors have strong demand for high credit rating sovereign bonds which comply with the Islamic religious investment law but the supply is limited. This is why the Hong Kong government issue is popular."

He said the buyers from the Middle East are mainly institutional investors such as banks, fund managers and pension fund companies.

"The Hong Kong government issue is a milestone as the successful launch of the first Islamic bonds in Hong Kong would help encourage other companies to follow suit," Ahmad said.

"We are looking forward to seeing more Islamic bonds issued by other Hong Kong and mainland companies in future."

While other issuers may not have Hong Kong's high credit rating, he said other Islamic bonds could still attract buyers as long as they offered good pricing for investors.

Ahmad added that although Hong Kong is far from the Middle East, it still could be an ideal global Islamic finance centre due to its active market and sound banking and legal system.

A change to the tax laws last year to provide fair tax treatment for Islamic bonds and conventional bonds was an important step for the city to promote Islamic finance.

In 2007, Financial Secretary John Tsang Chun-wah announced a plan to secure part of the Islamic finance pie. However, the city had no sukuk issue until the government offering last week, largely due to the tax issue.

Taxation had been the obstacle in Hong Kong because the special structure of sukuk, which must conform to sharia law, does not allow Muslims to accept interest payments, so the bonds were structured as assets or property.

That meant they were subject to stamp duty, income tax and profit tax. Ordinary bonds pay interest, which is not taxable in Hong Kong.

"The tax law change in 2013 has allowed the sukuk to be treated as conventional bonds in terms of tax payment. This has provided a level playing field for sukuk issuance in Hong Kong," Ahmad said.

"If the Hong Kong government and other companies continue to issue Islamic products, Muslim investors will come," Ahmad said.

A banker involved in the deal said the offering showed that the city has the ability to be an Islamic finance centre.

"Hong Kong does not have many Muslim followers but if the city can attract Islamic followers to trade here, we can also be an Islamic finance centre. The government bond issue has taken the first successful step," he said.

The challenges ahead, the banker said, include whether there would be enough issuers in Hong Kong willing to deal in Islamic bonds.

"The Islamic religions have restrictions which exclude some companies from issuing sukuk, including supermarkets and retailers who sell pork or related products as well as those involved in the entertainment business," the banker said.

"Even if the companies are qualified to issue sukuk, they may prefer to issue conventional bonds which do not have any restrictions."

Ben Kwong Man-bun, a director of brokerage firm KGI Asia, said the sukuk would have difficulty attracting local retail investors.

"For many retail investors in Hong Kong, it is much easier to buy in the stock market than trade in bonds," Kwong said.

"The timing is also not good for bond offerings as interest rates could go up and this would hurt bond prices. Sukuk are not likely to attract many retail investors to trade even after they are listed on the local stock market."

(South China Morning Post / 15 September 2014)

---
Alfalah Consulting - Kuala Lumpur: www.alfalahconsulting.com
Consultant-Speaker-Motivator: www.ahmad-sanusi-husain.com
Islamic Investment Malaysia: www.islamic-invest-malaysia.com