Dubai Islamic Bank introduces American students to principles of Islamic Finance

Dubai Islamic Bank recently conducted two workshops on the principles and foundations of Islamic finance for 44 senior finance professionals and Executive MBA students from Stetson University and Jacksonville University in Florida, United States of America (USA).

The DIB Academy in cooperation with Dar Al Sharia (DAS) Legal & Financial Consultancy, a subsidiary of DIB, conducted these sessions at their purpose-built premises, which were created specifically to enhance the learning and development function at the Bank.

Sohail Zubairi, CEO of DAS, presented sessions on Islamic finance principles to Executive MBA candidates that included C-level executives such as Chief Financial Officers, Chief Executive Officers, Managing Directors, Chief Operating Officers and other senior executives from a cross section of commercial and financial institutions.

Zubairi highlighted the basic difference between conventional and Islamic banking; Sharia perspective on current global financial crisis; economic philosophies of Islam; impact of interest/usury in the economic models; differences between risk capital and loan capital; reasons for Islamic banking's prohibition of trading in debt and risk guarantees; and the reasons why Islamic finance has remained relatively less affected by the global financial crisis.

'We are pleased to introduce candidates from prestigious universities in the USA to principles of Islamic Finance. Islamic finance has remained relatively less affected in these times of global economic crisis, greatly enhancing its attractiveness among customers worldwide. It is not surprising then to see such great interest among global management students for Islamic finance. As the pioneer of Islamic banking, DIB is committed to raising awareness and enhance understanding of Islamic Finance.' said Obaid Al Shamsi, Head of Human Resources, DIB.

The presentation by Sohail Zubairi also touched upon the pre-requisites of forming a contract in Sharia and he explained the investment contracts (Mudaraba, Musharaka and Wakala) and sale contracts (Bai Mutlaq, Bai Muajjal, Murabaha, Istisna, Ijara and Salam) in Sharia.

New Shariah Index Follows Letter Of Law

Standard & Poor's introduced a Shariah-compliant TSX index on Wednesday, looking to tap into the rapidly growing Islamic investor community in Canada and abroad.

The S&P/TSX 60 Shariah Index recategorizes equities on the S&P/TSX 60 and excludes all those that do not comply with Islamic law, which is based on the Qur'an. These include companies involved with alcohol, entertainment, pork- related products, tobacco and financial services. As well, companies with certain ratios of cash, leverage, and involvement in non-compliant business activities do not qualify.

Banks are excluded because investors are not allowed to profit from interest, which is considered an unequal distribution of risk.

Alka Banerjee, vice-president of global equities at Standard and Poor's, said there has been plenty of interest from asset managers already for the new index.

"It's still very young, maybe walking but not yet running," she said. "We'll find out over time what feedback is but we've gotten solid queries."

There are 25 companies on the new index with a combined market capitalization of $328.7 billion, or roughly 73 per cent of total Canadian equity market cap.

Commodities dominate the index, which is very closely tied to its parent. Top 10 holdings include EnCana Corp., Potash Corp. of Saskatchewan and Suncor Energy. BlackBerry maker Research in Motion is also represented.

Other excluded sectors are telecommunications, industrials and utilities.

The companies on the index are evaluated once a month by outside agency Rating Intelligence Partners, and then passed on to a panel of four Shariah scholars with financial backgrounds, all based in the Middle East.

The index maker uses the same logistics for its entire Shariah family, leading to economies of scale and the ability to create indices for any market, Banerjee said.

Standard and Poor's has 10 other Shariah indices covering 52 markets and 11, 000 securities around the world. There are specific indices for Japan, Europe and Asia. It also has 13 global benchmark and sector-specific Shariah indices.

The S&P 500 Shariah Index, measuring the U.S. equity market, was the company's first foray into such instruments and debuted with two others in December, 2006.

"Shariah indices have been around for a long time, but interest has only picked up in the last three or four years," Banerjee said. "We were very surprised at the strong response so we speeded up service."

While Standard and Poor's' other Shariah indices are already available, the retail market here remains "fragmented" and the company derives most of its sharia interest from the Middle East and South East Asia.

"The question is whether the demand for Canadian equities is in Canada or from outside Canada," Banerjee said.

Standard and Poor's also faces stiff competition from other index makers, such as Dow Jones and FTSE Group, which announced its own new Shariah index on the Stock Exchange of Thailand on Tuesday.

"Dow Jones was first . . . All major index providers have Shariah offerings but we have the deepest," she said.

Shariah indices are one of the newest categories of socially responsible investments. These are usually funds or portfolios built on companies that match up with an investor's social, ethical and political beliefs.

Banerjee does not consider the index a straight SRI because it is directed at investors of a specific religion.

While a common complaint of SRIs is that they may limit growth potential, both the S&P 500 and Europe 350 Shariah indices have actually outperformed their secular counterparts over a five-year period from 2003 to 2008.

"We're not necessarily looking at outperformance. It's a strategy for better governance and religious beliefs."

This profit is likely because Shariah investors have avoided steep losses from financials, but even if the situation were reversed the Muslim faith prepares them for that risk. And that is the greater purpose of the index.

"A Shariah investor can be comforted to know what they're buying is compliant today and ongoing," she said.

From Canwest News Service

Plugging The Gap In Islamic Finance Carry Risks

The Islamic finance world is huge and growing hugely," says Chris Oulton, chief executive of Prime Rate Capital.

As yet, this upbeat description does not apply to money market funds, largely because the traditional short-dated instruments used in such funds are outlawed due to Islam's prohibition on interest.

But Prime Rate is endeavouring to help plug this gap by launching a Sharia-compliant money market fund, using Sharia commodity investments to mimic the characteristics of a Western money market fund.

The fact that Prime Rate's product will be just the second Sharia liquidity fund available in Europe, after last month's launch from the Bank of London and the Middle East, is testament to how slowly the Islamic asset management industry, as opposed to general Islamic finance, is developing.

Rushdi Siddiqi, global head of Islamic finance at Thomson Reuters, has a measured take on the situation. "This particular industry is young and there are growing pains." Questions of demand, performance and liquidity must all be resolved before Islamic asset management can be considered mature, he says.

An obvious question to ask is what Islamic asset management is, but finding an answer is not easy. While there is consensus on how to build a Sharia-compliant equity fund, extending that to other asset classes is not straightforward. For an equity fund, the manager simply needs to use a screen to exclude companies involved in activities deemed unacceptable such as alcohol consumption, gambling or pornography. Conventional financial stocks are excluded because of the prohibition on interest-bearing debt, which further precludes companies with too high a level of debt.

All of this is sufficiently well established that nearly $16 billion (Dh59 billion) was held in Islamic equity funds at the beginning of this year. "The key issue in terms of building out to other asset classes is going to be screening," says Siddiqi. "Equity screens don't work, so each vertical silo [asset class] requires its own screening proposition."

Sukuk, the Islamic equivalent of fixed income, for example, was rocked last year when a scholar on the Sharia committee of the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions (Aaoifi) was reported as saying 80 per cent of current sukuk structures were not Islamic.

This is a striking example of what Siddiqi calls "Sharia risk," the danger that a product thought to be acceptable will be rejected by influential authorities.

"It comes down to whether you know the scholar," says Tim Harvey, head of sales in Europe, the Middle East and Africa at ETF Securities, which has six products that are officially Sharia compliant.

In this context, "officially Sharia compliant" means a board of Sharia scholars has decided the products are acceptable, and Harvey can show statements or fatwas from the Sharia boards of HSBC Amanah and Al Qalam, a UK-based Islamic bank, to that effect. Any Islamic institution using the products however, would have to submit them to its own Sharia board for approval, although the names authorising the fatwa may be authoritative enough to be fast tracked.

Although there is no central authority, the scholars on Aaoifi's board carry great weight. Largely as a result of the uncertainty surrounding sukuk's Sharia status, issuance in 2008 was less than a third that of a year before. While this year may see a return to the levels of 2006 - about $27 billion, according to Ernst & Young's annual Islamic Funds and Investment Report - this is still a far cry from the $47 billion of 2007.

Another challenge is that sukuk are not immune to the problems of the global financial environment. Two Middle Eastern issuers and one US-based issuer of Islamic bonds have recently been unable to meet their obligations. In Western terms, they defaulted, but since the concept of sukuk is relatively new, there are no established ways to work out what to do in the circumstances.

Siddiqui is optimistic: "That's the industry growing up." Once the restructurings are worked through, he predicts, there will be better pricing because the downside is clearer to issuer and buyer.

On the positive side, he says, due to the uncertainty some investors are selling off their sukuk holdings at a discount, thereby creating a buying opportunity for new sukuk funds, such as that of HSBC Amanah.

Asset managers wishing to offer sukuk funds to investors also face a lack of effective secondary market. Most sukuk are bought on issuance and held until maturity, leading to difficulty in finding assets to buy and in pricing assets held.

Such sukuk funds are open-ended despite the difficulty of managing a fund that investors can redeem at any time, yet for which there is no market for the underlying assets. To manage this issue, many of these funds have high minimum investments to restrict them to the institutional or private wealth market, as well as swingeing redemption fees.

Not all Sharia investment requires religio-financial engineering: ETF Securities' Sharia products are exchange traded commodities, investing in physical metals, not designed with the Islamic market in mind.

"We knew many Muslim asset managers who work in global capital markets who said to us 'these products are Sharia compliant'," says Harvey. "Eventually we thought we should do something with that."

The company asked Al Qalam to check the suggestion a couple of years ago, and last year HSBC Amanah issued a fatwa saying the products passed muster. Now, Harvey is fielding an increasing number of enquiries from investors in the Gulf.
From Gulf News

AAOIFI To Screen Products

A key Islamic finance body which proposes industry rules to Islamic lenders said on Sunday it plans to monitor Islamic finance products in the absence of a sector watchdog.

The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) "will screen products and services offered by the industry for sharia compliance", it said in a statement.

The move is aimed to "homogenise the market", Mohamad Nedal Alchaar, secretary general of AAOIFI, told Reuters.

The fledgling Islamic finance industry relies for guidance on a patchwork of standard-setting bodies such as AAOIFI, opinions of Islamic scholars and national regulation.

"Although AAOIFI is not taking on a permanent role of industry watchdog, there exists a current huge gap in the market relating to credible sharia compliance screening of products and services," AAOIFI said.

AAOIFI describes itself as an autonomous corporate body that prepares accounting, auditing, governance, ethics and sharia standards for Islamic financial institutions and the industry.

But it provides product and auditing standards, which are mandatory in seven countries mostly in the Middle East.

Alchaar said AAOIFI would screen products of all Islamic financial institutions, including those which are not members of AAOIFI and in countries where its standards are not mandatory.

"It will be market-wide, regardless of the geographic distribution of products," he said, adding that AAOIFI plans to submit a proposal on its initiative to its board of trustees by the end of the year.

"We are not pretending we are going to be the industry's watchdog, it will be a temporary role because we see the need for screening," he said.

AAOIFI said it would highlight products it sees non-sharia compliant to providers and help them meet necessary requirements.

Alchaar said he expected banks to be open for AAOIFI advising them on products it finds not to be sharia-compliant as bankers were also interested in greater standardisation of products.

Varied interpretations of sharia, or Islamic law, has so far blocked the standardisation of rules across regions dominated by different schools of Islam.

Derivatives and short-selling are two areas that have divided Islamic financial markets.

The lack of standardisation is seen as a growth constraint as bankers need to design products for different markets and investors are reluctant to invest in products unless they are satisfied about it compliance with Islam.

The Islamic finance industry is catering to investors who would like to avoid paying or earning interest, which Islam describes as usury.

From Reuters

Bank Islam Makes Moves In Indonesia

Bank Islam Malaysia is seeking a controlling equity stake in Indonesia's PT Bank Muamalat, sources say

Bank Islam Malaysia Bhd is pursuing a stake in Indonesia's PT Bank Muamalat to expand into the world's most populous Muslim nation, sources said.

The oldest Islamic bank in Malaysia is ultimately seeking a controlling equity stake and the sources said it was already engaged in talks with several shareholders of the Indonesian Islamic bank.

It is believed to be close to cementing a deal with at least one of the shareholders.

PT Bank Muamalat is Indonesia's largest bank by branch network. It has some 230 branches nationwide and is represented by another 3,800-odd outlets through its collaboration with Indonesian post offices. The bank, which began operations in 1992, is Indonesia's first Islamic bank.

Its biggest shareholders as at end-2008, according to its website, are the Jeddah-based Islamic Development Bank with a 28 per cent stake; Boubyan Bank Kuwait (21.28 per cent); Atwill Holdings Ltd (15.32 per cent); and individuals Abdul Rohim (6.7 per cent) and Rizal Ismael (5.49 per cent).

Analysts contacted by Business Times were positive about a potential marriage between the oldest Islamic banks in both countries.

PT Bank Muamalat, besides being well run, has a strong capital base with a capital adequacy ratio of 10.83 per cent as at end-2008. It made a net profit of about 207 billion rupiah (RM73 million) last year and had a high return on equity of about 33 per cent.

It is one of the leaders in the Islamic banking industry, with total assets of about 13 trillion rupiah (RM4.6 billion) as at the end of last year.

“It’s a good platform for Bank Islam to tap the biggest Muslim population in the world,” said Vincent Khoo, head of research at UOB-KayHian in Kuala Lumpur.

For Bank Islam to grow, it needs to explore mergers and acquisitions, its managing director Datuk Zukri Samat said last week.

The bank operates primarily in Malaysia, where competition is set to become more intense as more foreign banks are allowed in under Malaysia’s financial sector liberalisation.

He said the bank was “actively” looking for a potential merger partner to expand in the region, but declined to say in which markets it was looking.

"If we think we can do it locally, we’d like to … but our focus and priority is always South-East Asia,” he had said. Bank Islam is 51 per cent owned by BIMB Holdings Bhd and 40 per cent owned by Dubai Investment Group.

It recently moved to raise RM540 million from the sale of preference shares to strengthen its capital. Earlier this year, Bank Islam was reported to have been studying a merger with Maybank Islamic Bank but the plan was said to have been put on hold as the two needed to focus on strengthening their respective capital base.

From Busines Times

Sukuk Defaults Expose Islamic Finance Soft Spot

First defaults of sukuk are set to expose the vulnerabilities of Islamic finance, with most investors expected to have no better legal redress than conventional bondholders as underlying assets have not been truly transferred to them.

The current financial and economic crisis is a first for the US$1 trillion (RM3.5 trillion) Islamic finance industry, which over the past few years has been spoilt by cheap oil money, and legal provisions and protection clauses in sukuk worth billions of dollars are being tested for the first time.

Islamic bonds, or sukuk, are structured as profit-sharing or rental agreements and their returns are derived from underlying assets. Islamic finance caters to investors who would like to avoid paying or earning interest, prohibited by Islamic law.

Kuwait’s Investment Dar said in May it had defaulted on a US$100 million sukuk registered in Bahrain and in the United States a court case is ongoing on the East Cameron Partners Sukuk by bankrupt Texas-based East Cameron Gas Company.

Despite its earlier billing as a safer alternative to traditional banking due to its requirement for assets to underpin deals, Islamic bondholders may not have any more legal safeguards than conventional counterparts in case of default.

With rare exceptions, sukuk issuers have created special purpose vehicles (SPV) to pool assets underlying the issue, but they have not been securitized for a true sale to investors.

“Secular, non-Sharia courts upholding those structures are more likely to consider sukuk holders to have contractual rights as opposed to proprietary rights and as a result rank them as creditors rather than equity holders,” said Muneer Khan, partner and head of Islamic finance at law firm Simmons and Simmons.

A US$650 million sukuk issued by troubled Saudi group Saad, which is undergoing debt restructuring, for example is seen as an asset-based, rather than an asset-backed, sukuk. Yields of the sukuk jumped to above 70 per cent in mid-June, as investors feared a default of the issue.

Most sukuk are structured as asset-based instruments, rather than asset-backed securitisation where “you always have a claim for that particular asset that has been sold to you as the investor”, said Megat Hizaini Hassan, an Islamic banking lawyer in Kuala Lumpur.

CHASING ASSETS

“Everybody is chasing the same assets if they have not been transferred to the name of the sukuk holders,” said Samer Amro, senior associate at law firm Dewey LeBoef.

Other uncertainties are likely to arise from sukuk defaults, including a debate about how courts will interpret repurchase clauses which are structured to follow a controversial ruling by prominent jurist Sheikh Muhammad Taqi Usmani in late 2007.

Taqi had ruled that repurchase guarantees found in most sukuk contradict Islamic laws, as they violate the principle of sharing risks and returns.

“If you’re looking at the newer structures where the repurchase obligations are left to be determined at the time of repurchase, there may be some issues there,” said Megat Hizaini.

“You don’t really know how the courts will treat it in the situation,” he said.

Islamic finance is governed by scholars’ rulings, national regulators and its own standard-settings bodies such as Bahrain-based AAOIFI, the Accounting and Auditing Organisation for Islamic Financial Institutions.

“In the Middle East, it’s going to put to the test many of the legal protections that were originally built into the sukuk,” said Mohammad Faiz Azmi, global Islamic finance leader at PriceWaterhouseCoopers, adding that countries in the region typically do not have bankruptcy laws as sophisticated as in Europe.

“When these sukuk start to default, it would be very apparent which jurisdiction has a more robust system than others,” he said.


HURDLES TO TRUE SUKUK
Corporates with perceived higher risks that are facing high borrowing costs and a sluggish regional IPO market could use true sukuk sales with full ownership transfers as an avenue to the capital markets.

“It adds some credit-enhancement, it adds credit-worthiness,” said Rizwan Khan, a senior associate at law firm Norton Rose.

But the paperwork involved in registering ownership transfers in the Gulf Arab region and restrictions on foreign ownership of land make true sukuk sales difficult.

Issuers have to register the SPVs, to which asset ownership would have to be transferred, in Bahrain or the Cayman Islands, as regulatory frameworks in other Gulf countries like Saudi Arabia and Kuwait do not fully cover sukuk structures.

This turns the SPV into a foreign buyer, limiting the pool of assets.

“This is not going to change unless laws are enacted, in particular on the ownership issues,” Khan said.

From Reuters

Financial Partnerships

In theory, Islamic banking is based upon the concept of making financial profit by taking risks through financial speculation, financial partnerships and other financial transactions that are permissible under Islamic law whilst at the same time avoiding incurring debt that represents a high risk both to the individual and to the market in general.

Such debts leads to wealth being amassed by the privileged few who are capable of offering sufficient guarantees of financial solvency whereas the overwhelming majority of middle class professionals and small and medium enterprises cannot afford to incur such debts and are therefore unable to finance their own projects and achieve the desired growth and development. This type of debt would in any case suffocate the majority of small and medium businesses and ultimately lead to serious financial loss.

Small and medium businesses account for around 90 percent of companies worldwide, as well as providing between a reported 40 and 80 percent of employment. According to a study published by the Arab Orient Centre for Strategic and Civilization Studies, small and medium businesses account for around 85 percent of Britain's gross domestic product [GDP] and around 51 percent of America's GDP. In addition to this, between 1979 and 1995 around 75 percent of employment in the US was in the small and medium business sector.

Financing designs and products by continuously incurring debt will also ultimately kill off the spirit of creativity and inventions [by doing away with the concept of competition and financial solvency]. Financing is the umbilical cord that nurtures this, and since [much] financing is now obtained by taking out loans and thereby incurring debt, money inevitably end up with the privileged few when this umbilical cord is severed.

This manner of financing is warned against in the Holy Quran, "What Allah has bestowed on His Messenger (and taken away) from the people of the townships - belongs to Allah- to His Messenger and to kindred and orphans, the needy and the wayfarer; In order that it may not (merely) make a circuit between the wealthy among you. So take what the Messenger assigns to you, and deny yourselves that which he withholds from you. And fear Allah; for Allah is strict in Punishment." [Chapter Al-Hashr; Verse 7].

However the practical application of Islamic Banking has violated this, changing from a financial system founded on partnership to one based on debt. In some Islamic Banks, assets from Murabaha constitute as much as 92 percent of the overall financial portfolio. The Islamic banking system has also switched from operating via [Shariaa-compliant] rates of profit and has adopted interest rates, something that brings the Islamic Banking system closer to the conventional banking system. Islamic banking tools are also now used in risk management and credit policies; this makes the system vulnerable to the economic defects that are inherent in such practices in precisely the same manner as the conventional banking system.

Islamic banking has therefore ceased to be a safe haven for investors. It has become exposed to the risk of bad debts as the system is set up only to offer loans to a small number of individuals with substantial financial solvency as well as large corporations who are able to provide financial guarantees. These loans are provided without really examining the feasibility of the projects being funded or even knowing whether this financing is granted via Tawarruq or Murabaha. These kinds of financial practices do not occur when financing is provided via partnership or speculation.

Sukuk have also become vulnerable as a result of failures in meeting their financial obligations as a result of the legislative chaos that the Sukuk market is currently encountering and also because in many cases the assets being transferred to Sukuk-bearers are not genuine. In addition to this, Sukuk companies are now also including a contract where in the case of financial default the customer is obliged to immediately pay the value of the Sukuk in full. This only serves to increase the rate of default on Sukuk, and has therefore raised the risk that Sukuk bonds are exposed to. Islamic Banking has also become more liable to risk from individual bankruptcy as a result of the expansion seen in granting consumer credit based upon Tawarruq.

Islamic Banking has moved away from the values and principles that it was originally based on, and the Muslim community is no longer reliant upon this financial system to contribute to its progress and development. The damage caused by debt on the Islamic Banking system is therefore clear for all to see. Islamic Banking is no longer a system built upon partnership in profit and loss coming from actual financial activity that creates job opportunities and genuine products. Unfortunately, Islamic Banking is no longer a financial system that can make a difference to the world. Islamic Banking has crossed the line.