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Sukuk market poised to rebuild

One of the questions being asked amid the deepening financial crisis is whether a revival of the sukuk market might provide a source of funds for companies in an environment where bank credit is restricted and the IPO market likely to remain effectively moribund for some time. If global developments are any indication, the signs are encouraging—corporate issuers seem to be returning to the market in force.
     Global corporate bond issuance in January hit US$170bn for non-financial companies and the total for the year as a whole could come close to $450bn. Overall investment-grade debt issuance globally reached $825.6bn during the first quarter of the year, more than twice the $390.9bn raised during the corresponding period in 2008. The lower inter-bank and government rates in the wake of aggressive monetary easing are making it easier for corporations to issue debt instruments, while investors can take comfort in the fact that the premium on corporate as opposed to sovereign bonds is highest since the Great Depression. It should be noted, however, that government-guaranteed bonds issued by banks made up 33% of the global investment-grade issuance during the first quarter.
     Indeed, the sukuk pipeline is estimated at $39bn globally. The establishment of increasingly well-defined practices and widely accepted standards has enabled issuance to take off in recent years. In particular, the institutional and regulatory framework for a sukuk market has helped address the traditional concerns of investors and issuers regarding bonds as interest-bearing instruments. Moreover, the global financial crisis has, if anything, boosted the reputation of Shariah-compliant products and institutions. Although complaints about the lack of standardisation are numerous, and likely to persist, the products are typically fairly simple, transparent and low-risk in terms of their structure.

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Smoke signals

The Islamic approach to the environment is for the believer not to consider nature as a deity but at the same time not to tamper with or spoil it. The recommended relationship is one of harmonious benefit and use and a reverent, view and protective outlook towards other creatures and aspects of God’s creation. Numerous verses in the Quran state that Allah has appointed man as His vice-regent on earth and, as such, one of the duties specifically enjoined on the believer is to preserve His habitat and protect the environment from abuse.
     Islam calls on mankind to recognise the bounties of God and utilise them in a manner that satisfies human needs. Allah has given man the right to invest in and benefit from the environment but without unduly impoverishing it, over-using its resources and acting in a way that ultimately turns out to be against his own interests.
     God says in Sura 7:31 of the Quran: “O Children of Adam! Wear your beautiful apparel at every time and place of prayer. Eat and drink but waste not by excess, for Allah loveth not the wasters.” While private property is defended, individual rights are subject to the rights of others in the community to benefit from environmental resources such as water, forests, air and sunlight. These are held in common by all members of society. If one wastes or degrades a resource, he is accountable for its use and liable for its repair.
     Islam also condemns in the sternest possible terms spreading mischief and corruption on earth. And mischief is generally understood to be inflicted by man’s unwary interference with the natural laws and environmental balances, as Sura 2:205 recites: “When he turns his back, his aim everywhere is to spread mischief through the earth and destroy crops and cattle. But Allah loves not mischief.” In its own words, the Quran, along with all its commentaries, warns against any change in the animate or inanimate components that cannot be accommodated by the ecological systems without disturbing their own balances. It warns against the dire consequences of what today is known as pollution.

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Cushioning the blow

Financial stability has been identified as the ability of an economy to withstand shocks and create a sustainable environment for growth. The main aspects are GDP and its growth, monetary policy including interest rate policy, exchange rate policy, balance of payments, fiscal policy and government budget deficit/surplus. GDP and its growth in almost all GCC countries are heavily reliant on international oil price. With the exception of a few economies like UAE and Bahrain, most are non-diversified, such as Saudi Arabia. The predicted global recession for 2009 poses a detriment to GDP growth of these economies at market and real values.
     Monetary policy in GCC is closely linked to its exchange rate policy of pegging most of the regional local currencies to the dollar. This limits the scope of operations of monetary policy, as its main task is reduced to maintaining the parity between these domestic currencies with the dollar.
     There is thus limited scope of monetary policy to address other key issues such as inflation in the domestic economy. In recent times, the GCC has experienced high inflation. This inflation is partly induced by the heavy reliance on imported food and other necessary items in the face of a global food crisis in 2008 combined with rising oil prices.
     The high trend in oil prices in recent years has given rise to a boom that is, in part, expressed in the major infrastructure and real estate construction spree in the region. The inflow of international labour, resources and capital coupled with an optimistic forecast of global growth have led to an unwarranted expansion of various services which, in turn, have created a pressure on resources of the region in the short run. Regional central banks have limited monetary policy mechanisms at their disposal to control the demand driven, and to some extent, imported inflationary trends on these economies.

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And the winner is...

They may not be as glitzy and glamourous as the Oscars, but they are nonetheless treasured by those who work in Islamic finance. Indeed, it’s a rare month that passes without yet another industry award ceremony taking place. But which of these are gold medal events and which are wooden spoons all round? And who profits the most from them: the winners, the clients or the organisers?
With Islamic finance still being a relatively young industry, there’s not yet a clear consensus on which is the best gong to win.

  “There are a number of awards aimed specifically at Islamic finance institutions, and given that most are relatively new, time will tell which emerge as the most prestigious within the industry,” says Patrick Rochette, head of structuring and distribution at Bank of London and the Middle East. Picked up the title for “Best Islamic Bank in Europe” at the recent Islamic Finance News (IFN) Awards. Already the same names tend to come up over and over again when companies are asked which awards they care most about winning. Euromoney, the Kuala Lumpur Islamic Finance Forum (KLIFF), the International Islamic Finance Forum (IIFF) and IFN are the most commonly mentioned. Meanwhile, those organised by media groups with little expertise in Islamic finance were often seen as an effort to cash in clumsily on the industry’s boom. “You don’t put these ones high up the page,” as one person put it.      Understandably, no one is willing to criticise on the record—“we wouldn’t want to be seen to be putting anyone down” says one large banking group.
     Among winners, the reasons for a particular ceremony getting high marks can seem quite circular: the top ceremonies seem to be important because they are respected, and they’re respected because they’re big and thus important. So what really makes the difference? What helps lift it into the premier league?

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Market tension

The collapse of the securitisation market and ensuing market turbulence have cast doubts on this economic proposition of unbundling, transforming, and re-distributing credit risk via structured finance instruments. In view of sweeping fiscal intervention in the financial sector, a widespread retrenchment of mortgage exposures, and substantial liquidity injections by central banks to support inter-bank money markets, both the scale and persistence of the current credit crisis seem to suggest that pervasive securitisation—together with improvident credit origination, inadequate valuation methods, and insufficient regulatory oversight—can perpetuate market disruptions, with potentially adverse consequences for financial stability and economic growth.
     After having nearly ground to a halt last year, the market for securitised debt remains moribund and pricing depressed as banks dispose of non-core assets and raise capital to de-lever and bolster their imploding balance sheets. The complexity of securitisation structures, which once obscured actual loss exposures, perpetuated benign asset valuations, and incubated fallacious investor complacency, is now debilitating effective banking sector resolution in a time of systemic distress.
     As the global credit crisis continues to deepen, the soul-searching in conventional finance has directed attention to alternative modes of structured finance to fill the void of unmet credit demand. In this context, some investors—unsettled by excessive risk-taking and asset price volatility— have turned to Islamic finance as market ruptures caused by the headlong flight to safety during the initial phase of the credit crisis seem to have receded only slowly.
     Islamic securitisation, via Shariah-compliant investment certificates or sukuk, invites a comparison of conventional and Islamic finance principles as to their capacity to sustain efficient capital allocation and financial stability. Sukuk have been affected by the global financial crisis only recently in response to inflationary pressures in the Gulf countries, uncertainty about commodity prices, and the widespread economic downturn.

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Principles win in the end

With collapses of major financial institutions an almost weekly occurrence, it is clear that the models on which they have been based are seriously flawed. Of course, it’s easy to say that now—and the hindsight merchants, from opposition political parties to self-professed financial experts—are telling us all what we should have done differently. But there is one financial sector that has not been hit nearly as hard as the headline-dominating victims—the Islamic banking sector. The prudence, sense of security and commitment to the common good that are built in to its principles are, more or less, what may well be enforced on the Western banking sector unless it can really get its act together.If we try to excavate the basic principles of banking and business that prevail in the Western world today, we are led on a fascinating journey that ultimately takes us back to the heartlands of Islam 1500 years ago and detailed Quranic instructions on business practice.
     The Muslim conquest of what we now know as Spain and Portugal introduced the ideas to the European mainland, and the re-conquest of these lands by Christians during the European renaissance facilitated the spread of these principles throughout Christendom. As more ancient knowledge is unearthed, the deeper-rooted the principles seem.
     The limited liability company, for example, with its emphasis on partnerships, enterprise creation and avoidance of personal debt, would sound like a description of a Shariah mechanism to anyone who has ever studied Islamic economics! It takes into account the fact that some businesses will inevitably fail, and not necessarily through the misdeeds of the owners. And yet it is a standard structure in today’s business, offering respectability and an innovative spirit to companies. By being able to write off the debts caused by the collapse, enterprising individuals or partnerships can dust themselves down and try again if the business fails.
Magnify these principles to the national scale and entire countries can enjoy virtually the same benefits.
     We have seen the results of debt write-off on the developing world. Since many developing countries are saddled with virtually unserviceable debts owed to various developed countries, their freedom to develop is seriously curtailed by their need to meet their debt obligations. When freed of their national debts, developing countries that do not suffer from corruption and ill-management can start to thrive in remarkably short time spans. Again, this idea would not look all that unusual to a scholar of Islamic business and finance principles and history. Another example is the corporation as a non-personal legal entity that can borrow money in its own name, sue and be sued without necessarily directly affecting the individual or persons who founded, own, manage or are employed by it. Its principles would be perfectly at home in the Quran, as it allows enterprise without taking on large risks that could destroy a person financially.