Be Positive in Dealing With Decision To Establish Sukuk Market

No two people can disagree over the importance of the step taken by the [Saudi Arabian] Capital Market Authority [CMA] to launch a secondary Sukuk market which will stimulate the public and private financial sector in the issuance of Sukuk bonds. The establishment of this secondary market will transform Saudi Arabia into a major player in this promising market that studies expect will witness unprecedented growth in the near future. The International Monetary Fund [IMF] expects that that by 2010 Sukuk revenue will amount to US $200 billion. The public and private sector will be able to benefit from this revenue rather than seeking investment opportunities outside of Saudi Arabia. According to the McKinsey Competitive Report [issued by the World Islamic Banking Conference], Saudi Arabia is ranked second behind Iran with regards to assets from the Islamic banking industry.

The existence of a secondary Sukuk market is one of the important steps that will enable Riyadh to become one of the most important financial centres of the Islamic banking industry. This is a status that is long overdue and one that Riyadh fully deserves but has failed to achieve due to the previous lack of conviction in the Islamic banking industry on the part of some involved in the Saudi financial sector. This opened the door to some of the capital cities of the neighbouring countries, and even Western and Asian cities, to take over this role. The competition between Riyadh and these capital cities has become more complex, especially since these capital cities have preceded Riyadh in gaining a foothold in this sector. However despite this, Saudi Arabia's task is not impossible so long as efforts are combined and strategies are developed and plans are implemented to help achieve this objective.

Therefore I believe that the step taken by the CMA to launch a secondary Sukuk market must be supported by all parties interested in putting Riyadh on the map of the Islamic banking industry. If anybody has objections to or observations on this decision – whether these are juristic or technical – they should be brought to the attention of the CMA in a calm and rational manner. There should not be any loss of control or media incitement, as this will only result in the severance of dialogue and the CMA maintaining its decision, something which was proven in previous experiences with governmental bodies. These emotional methods [of objecting to a decision] have not led to any changes, and in fact the opposite has occurred with the governmental upholding its position and refusing to make any of the proposed changes.

For this reason, I urge the religious figures who are concerned with this decision [with regards to a secondary Sukuk market] to sit down with the CMA and discuss the details surrounding this, and whether it would be possible to modify or neutralize this. However only Sharia-compliant Sukuk bonds will be traded in this secondary market, and these Sukuk bonds could not have been issued except without the blessing of God and the CMA efforts that facilitated their issuance. The CMA is also the first Saudi Arabian financial regulatory body that specifically mentions Islamic banking in its charter, specifically in the chapters dealing with Islamic investment.

I believe that the timing of the launch of the secondary Sukuk market will encourage public and private institutes to issue Sukuk bonds which will help push this market forward, especially since trading in this market is limited to initial public offering [IPO], which we well know is within the provision of Islamic Sharia law. We know this because the majority of Saudi Arabian investors refuse to utilize any investment tool that is not compatible with Islamic Sharia law.

My words should not be misunderstood as a call to not distinguish between what is Halal [religiously permissible] and Haram [religiously forbidden] with regards to what is taking place in this market. Rather, I am requesting that the discussions that occur on this issue take place in a calm and rational manner away from slander and rebuke, which is something that has been advocated in the Holy Quran. ‘Invite [all] to the way of thy Lord with wisdom and beautiful preaching; and argue with them in ways that are best and most gracious: for thy Lord knoweth best, who have strayed from His Path, and who receive guidance,’ [Surat an-Nahl: 125]. This was also advocated by the Prophet Mohammed (PBUH) in the Sahih Muslim collection of Hadith [Prophetic traditions]. On the authority of Abu Massoud al-Ansari “A person came to the Messenger of Allah (PBUH) and said ‘I keep away from the morning prayers on account of such and such [a man] because he keeps us so long.’ I never saw the Messenger of God [PBUH] more angry when giving an exhortation than he was that day. He said ‘When any one of you leads the people in prayer, he should be brief for among them are the young and the aged, the weak and the sick.’ It was Prophet Mohammed’s nature to act in this manner [i.e. to speak in a calm, generous, and rational way], and this is something that we should emulate.

From asharq alawsat

Debt Management With A Conscience

THE world experienced two major financial crises within a decade: the currency and stock market crises of 1997-98, and now a crippling recession that began with the US subprime debacle caused by excessive lending to borrowers unable to make repayment.
Both originated in "asset bubbles" and unlimited creation of fiat money that loaded the market with the sale of debts, or bay' al-dayn, as it is known in the jargon of syariah law. Dealing in debts that lacked any asset base overwhelmed the financial system.

Transactions in derivatives and contra trading in stocks proceed largely over debts that are bought and sold through mere exchange of promises by speculators and hedge funds that take risks far in excess of their available assets.

It is different in Islamic finance, which is structurally averse to indulgence in debt-based transactions.

The capitalist banking and financial institutions, moreover, make profits but have no mechanism to share possible losses. A different scenario exists in Islamic finance, which favours equity financing, in which the parties involved share the prospects both of profit and loss.
Islamic finance transactions also proceed over underlying assets, trades and services that hold real market value. Pure unsecured debt plays a minimal role, essentially confined to an act of goodwill or qard hassan, without a commercial prospect.

The half-a-dozen or so contracts in use in the Islamic system proceed over trades and services, as in the case of musharakah and mudarabah, which consist of participation finance, profit and loss sharing. Banks and financial institutions that enter these contracts effectively become partners in a project and hold a stake in both its failure and success.

Islamic finance admittedly permits debt-based transactions, which are, however, limited to situations where only one of the two countervalues consist of a debt. For example, in bay's bi-thaman aajil, or deferred sale, only the price, but not the sale object, consists of a debt.

Since a sale takes place over a real asset, such as a building or a plant, the debt in question is asset-based and proportionate to the price of the sold item.

This is also the case in the forward sale of salam, in which only the sale object, but not the price, consists of a debt. All the contractual details of the debt in salam must be specified in writing to ensure commitment, proportionality and equivalence in the exchange of values.

Syariah law does not approve of a financing scheme in which both the countervalues consist of debt. A difference of opinion has thus arisen over the validity of istisna', or manufacturing contract, whereby an order is placed for the manufacture of goods, be it a house, ship or handicraft.

Nothing changes hands at the time of contract, and both sides of the bargain consist of debts payable in the future -- which is why Muslim jurists have considered istisna' as basically ultra vires. Yet istisna' has been exceptionally validated by consensus (ijma') because of the people's need for it.

A similar line of analysis can be extended to the entire range of contracts that represent the bulk of Islamic banking and finance transactions. Murabahah or cost-plus-profit sale, which is very common, may or may not involve a debt as it can be spot or deferred. Only when deferred does it involve a debt, in which case it would resemble bay's bi-thaman aajil.

The contract of wadi'ah or deposit, also widely practiced, does not involve either a debt or exchange of values and is therefore free of financial speculation and risk-taking.

Since syariah law proscribes the giving and taking of banking interest, or indeed of any unwarranted increase that violates the principle of equivalence in countervalues, syariah-compliant transactions are less vulnerable to interest-rate fluctuations.

The syariah is similarly averse to excessive risk-taking (gharar) that threatens due fulfilment of contractual obligations, especially in deferred and forward sales, which involve debt.

The applied rules of Islamic financing in Malaysia and elsewhere limit exposure to risk, in that a transaction is not permitted with a company or institution whose balance sheet consists of debt that exceeds 50 per cent of its total available assets. This is a major restraint that curbs asset bubbles of the kind that continue to plague contemporary finance.

These are some of the in-built elements of stability in Islamic finance that are generally absent in their conventional counterparts. Yet, the advantages of Islamic finance can only materialise when compliance with syariah principles is assured, which is not always the case. Many contract specifications are followed in form but not in spirit by the Islamic financial institutions.

For instance, the detailed requirements of delivery and possession are often ignored, and buying and selling take place in the same session. Murabahah is thus manipulated for the purpose mainly of securing the price differential, or mark-up, which is made payable at a later date, and the net result is not very different from earning interest on a conventional loan.

Similarly, the very commonly practised sell-and-buy-back transaction of inah often consists of a price differential in the same session and a quick profit-taking that resembles riba.

Formal compliance that amounts to effective non-compliance has thus aroused much criticism among Muslims, who go to Islamic banks often with pious motives to avoid the forbidden riba, but remain askance about whether the Islamic banks really measure up to their expectations.

These institutions are, like their conventional counterparts, eager to lend as much as possible and gain as much profit as they can. The inner stability and resilience of Islamic finance will not hold, and the low risk element therein is bound to diminish unless the syariah principles that regulate such transactions are faithfully observed.

By Mohamad Hashim Kamali
The writer is chairman and CEO of the International Institute of Advanced Islamic Studies (IAIS) Malaysia

Shariah Sensitive Assets In GCC, Asia Top US$700 Billion

Shariah sensitive assets in the Gulf Cooperation Council (GCC) countries and Asia touched US$736 billion in 2008 compared to US$267 billion in 2007, said the third annual Ernst & Young Islamic Funds and Investments Report (IFIR) 2009.

In a statement Tuesday, Ernst & Young said that in computing the total asset size this year, the report included Awqaf and Endowments, Takaful operators in Malaysia, sovereign wealth funds in the Middle East and North Africa (MENA) and Asia, as well as the markets of Pakistan and Southeast Asia.

It said that although the Islamic asset management industry had a potential revenue pool of US$3.86 billion, the size of funds remained small with over 50 percent having assets under management of US$20 million or less.

Ernst & Young also stated that the largest concentration of Islamic funds remained in the Middle East and equity funds led the field of choice of asset type. Saudi Arabia held US$19.28 billion in total assets under management for Islamic funds while Malaysia US$4.579 billion, it said.

"The untapped markets in Asia and MENA are a source of growth for the Islamic funds due to their large Muslim populations. These markets, where Islamic finance is still in its infancy include Indonesia, Pakistan, India, Bangladesh, Turkey, Iran and Nigeria," it said.

Ernst & Young said that the average return from Islamic equity funds fell to minus 39 percent in 2008 compared to a 23 percent return in 2007. In the first quarter of 2009, the average return stood at minus 3.7 percent.

On Islamic fixed income funds, the average return dropped from three percent in 2007 to one percent in 2008 and the first quarter of 2009.

Meanwhile, Sukuk issuance slowed as spreads widened -- Sukuks worth US$15.5 billion were issued in 2008 compared to US$47.1 billion in 2007. The report estimated that US$27.5 billion worth of Sukuks would be issued in 2009.

"Last year, we highlighted the phenomenal rate of growth experienced in the Islamic asset management industry. The landscape has changed significantly now, yet the fundamentals of the Islamic fund industry remain strong.

"With almost US$50 billion in fund assets under management and a large, expanding and untapped Muslim population, there are likely to be considerable opportunities in the future.

"This is a time when strategic choices have to be made and market participants have to adapt to survive," said Ernst&Young Islamic Finance Services Group (IFSG) partner and its head of Assurance Services of Malaysia Abdul Rauf Rashid.

Sukuk - Where Next?

Turbulence in the financial markets during 2008 and the resulting collapse of the securitisation markets has made it increasingly difficult for companies to access these markets in order to raise additional finance. The Islamic securitisation market, often referred to as the Sukuk market, has not been immune to this economic downturn, indeed it has also suffered from controversy over the very nature of some Sukuk structures and suggestions that some Sukuk in issue were not Shari’a-compliant.

However, even with a struggling global economy, organisations throughout the world still need to raise finance to fund their activities, and in some cases their expansion plans. With a continuing lack of bank credit and with no sign of a recovery for the IPO markets, corporate issuers seem to be returning to the financial and securitisation markets and several of these prospective issuers have indicated that they are either planning or actively considering raising funds thorough the Sukuk market.

This article will seek to show that Sukuk structures continue to be a useful way to raise finance for both Islamic and non-Islamic organisations. Furthermore, if, as is expected, the Sukuk-based securitisation market (particularly for asset-backed transactions), recovers more quickly than the conventional securitisation market, will those involved in structuring non-Islamic securitisation transactions learn any lessons regarding the principles of sharing risk and reward and reflect this in conventional structures?

Sukuk
Many readers will be familiar with the general concept of Sukuk, but it is important to reflect on the basic principles in order to appreciate how the market for Sukuk may develop.

In Shari’a Standard No. (17) on Investment Sukuk, the Accounting and Auditing Organization for Islamic Financial Institutions, (AAOIFI) gives the following definition of Sukuk:

“Investment Sukuk are certificates of equal value representing undivided shares in ownership of tangible assets, usufructs and services or (in the ownership of) the assets of particular projects or special investment activity”.

The standard makes it clear that Sukuk must be backed by assets that are subject to a Shari’a-compliant contract, e.g. an Ijara contract, sets out 14 examples of Sukuk structures and distinguishes investment Sukuk from shares, notes and bonds.

Furthermore, the Standard makes it clear that the Sukuk documentation must demonstrate:

* That any income arising must derive from the underlying activities for which the funding has been used, and not simply comprise interest,
* The Sukuk must be backed by real underlying assets and these assets must be halal (allowable) in nature and be being utilised as part of a halal activity, and
* There must be full transparency as to rights and obligations of all parties.

Thus a large part of the conventional securitisation market – for example, mortgage-backed securities – would be prohibited because the income element (though not the principal) of the cash flow would be characterised as riba. Similarly, CDOs and other such instruments could not be allowed as an asset class as these represent “Debt” rather than an allowable commodity or activity. However, investment in tangible assets, used for productive purposes, and reaping the rewards arising from those assets is a core principle of Islamic finance and it is this principle on which Sukuk securitisation structures are founded.

Whilst AAOIFI standards are not compulsory from an international perspective, they are generally binding in six Middle Eastern countries, together with the Dubai International Financial Centre. Furthermore, it is difficult to imagine how an issuer would be able to obtain a fatwa from a recognised Shari’a Supervisory Board if the structure did not comply with Standard 17, thereby making adherence with the standard obligatory from a business perspective.

AAOIFI resolution on Sukuk
In late 2007 Sheikh Muhammad Taqi Usmani, as Chairman of AAOIFI, issued a statement (that was subsequently heavily misquoted) in which it was claimed that many of the Sukuk structure in existence at that time would fall foul of basic Shari’a principles, in particular, many appeared to violate the principle of risk and profit-sharing by promising to pay back capital. Subsequently, in February 2008, AAOIFI issued a statement setting out six core principles for structuring and implementing Sukuk transactions, noting that it was these principles that were often being disregarded in the larger or volume-based Sukuk structures.

A key feature of the AAOIFI resolution is to be found in the final paragraph. This calls for Islamic financial institutions to:

“decrease their exposure to debt-related operations and to increase their operations based on true partnerships and the sharing of risk and reward”

Whilst there is still much debate as to whether Sukuk can be used to raise debt for an institution (i.e. where the underlying structure is asset-based), it is clear that the resolution endorses the use of Sukuk to finance the acquisition of actual assets on behalf of an Islamic entity and in particular where the financing is structured as a traditional asset-backed securitisation.

The Markets
The growth of the Sukuk market in the 21st century, albeit from a very small base, seemed unstoppable, with an approximate cumulative doubling each year from 2002 through to 2007, see chart below.
Global_sukuk_issuance_Islamic_securitisation_market
The chart shows the dramatic decline in new issues during 2008, but it is impossible to determine how much of this decline was attributable to global economics and how much to restraint arising from concerns over the validity of Sukuk structures following the AAOIFI announcements. Similarly, many of the Sukuk issued previously would have had a 3 to 5 year tenure and therefore were repaid in 2008, with market conditions preventing these from being rolled over.

So what are the factors that will drive the resurgence of the Sukuk market. First and foremost is a need to finance the large number of construction and infrastructure projects throughout the GCC. Historically, the financing for many such projects benefited from direct or indirect governmental guarantees, but this was one of the concerns that led to the original AAOIFI statement as Sukuk holders are supposed to bear the risks of ownership and not be immune to affects of changes in the profitability of the venture; it remains to be seen as to how such support can be built into a structure whilst still giving an element of risk. Similarly, private companies throughout the region have been starved of finance and whilst these companies will need to demonstrate that they either have a strong track record or a good business case, together with a pool of appropriate assets to securitise, the entrepreneurial spirit of the region, coupled with pent-up demand for Shari’a-compliant investment products is likely to make such corporate Sukuk structures an attractive proposition for both regional and international investors.

International institutional demand for Sukuk cannot be understated, with both Islamic and non-Islamic or Western institutions participating in many of the large quasi-governmental Sukuk issues of 2006 and 2007. Similarly, several counties in the West have made various announcements as to their own plans to issue Sukuk, most notably the UK Treasury whose plans for a Sukuk have been on/off for the past three years.

The retail market for Sukuk is slowly opening up although demand seems to outstrip supply because of the lack of Sukuk available through the secondary market, which makes it difficult for retails investors to acquire Sukuk. Several institutions have established Sukuk funds to allow retail investors to participate in Sukuk issued by number of different institutions, but to date these too seem to be having difficulty in acquiring appropriate assets due to the lack of supply.

The similarity between Sukuk and traditional asset-backed securitisation structures will be readily apparent. However, as demonstrated in the points raised above, there is much more to establishing a Shari’a-compliant securitisation transaction than a simple rewording of conventional transaction documentation.

The call for a “back to basics” approach contained within the AAOIFI resolution on Sukuk had a negative impact on the issuance of Sukuk in 2008. Whether this will affect the ability of institutions to create innovative Sukuk structures going forward is an unanswered question, but in the author’s experience, provided the basic tenets of Shari’a Law are adhered to, the Scholars will generally accept such innovation.

From Global Arab Network

MCCA Announces Islamic Bank Ambition

Local Islamic banking co-operative, the Muslim Community Co-operative (Australia) Ltd (MCCA) is confident of securing a banking licence in three years to become Australia's first Islamic bank.

MCCA managing director Chaaban Omran said the co-operative would work with the Australian Prudential Regulatory Authority (APRA) to transition its current registrable superannuation entity (RSE) licence into a banking licence.

"We are (currently) regulated by ASIC (the Australian Securities and Investments Commission) and are the holder of a RSE licence.

"The way the supervision will work will be a modification of that particular licence," Mr Omran told business leaders at an Islamic banking and finance conference in Melbourne.

"If we get enough momentum from the industry it may be less than three years," he said.

In four years MCCA plans to have a presence in the investment banking sector, he said.

MCCA was established in 1989 and provides property finance and is now setting up a superannuation investment mandate and plans to build funds around that mandate.

"The investments are the most critical thing for us," Mr Omran said, adding that MCCA was also planning to launch a range of equity investment funds.

"We have a lot of challenges. Apart from capital requirements, there are issues to do with how we manage cash for example because APRA requires a certain level of funds to be invested.

Mr Omran said there are around 500,000 Australian Muslims forming a market worth $1.3 billion.

MCCA complies with Shariah Islamic law that prohibits all forms of interest charges.

Islamic banks are governed by a supervisory board of Muslim clerics to ensure compliance with Shariah law as well as banking regulations in the countries in which they operate.

Islamic finance does not recognise the concept of caveat emptor ("let the buyer beware") in which risks can be transferred to unsuspecting buyers of products and services, says PricewaterhouseCoopers' head of Islamic finance, Mohammed Amin.

Shariah-compliant finance is innovative, ethical and has been tried and tested throughout the centuries, Mr Omran said.

"We're not dealing with a new concept. The only difference is that the awareness has not been raised in Australia."

UK Aims To Make London Center For Islamic Finance

The UK government remains committed to Islamic finance and will continue to work with other authorities and with industry to establish and maintain the UK as a global gateway to Islamic finance, said Sarah McCarthy-Fry, exchequer secretary to the UK Treasury in London last week.

McCarthy-Fry, who is the minister responsible for leading Islamic finance policy at the UK Treasury, was giving the keynote address at the inaugural session of the 2009 London Sukuk Summit held on July 2-3. "In these difficult times for international financial markets," she added, "new opportunities for growth and development become increasingly important. The Islamic finance market presents huge long-term opportunities for London and for the UK. Islamic finance is an opportunity that we want to see realized for the benefit of Britain as a whole -- strengthening London's position -- not just as one of the world's leading financial centers -- but as the world center."

Perhaps equally important is the reassurance from the exchequer secretary that the decision not to issue a sovereign Sukuk by the UK Treasury at this time, "in no way reflects a diminished government commitment to Islamic finance in the UK. I hope that other progress, including the measures announced in the recent Finance Bill (2009), will pave the way for the Islamic finance industry to grow, and that corporate Sukuk products will thrive as alternative source of funding for UK and overseas firms."

Provisions for various reliefs involved in Sukuk issuances are included in the 2009 Finance Act which is expected to be adopted by the House of Commons next week and should get Royal Assent on July 21. The measures in detail comprise:

• Relief from stamp duty land tax where transactions are undertaken as part of the issue of Alternative Finance Investment Bonds (AFIBs) -- the name for Sukuk in the UK legislation.

• Relief from tax on capital gains in respect of these types of transactions and

• Clarification of how the capital allowances regime will interact with these changes.

Bankers in the UK and those from abroad attending the summit were encouraged by the minister's remarks and by the fact that the UK Treasury will soon publish details of a consultation on the measures to facilitate corporate Sukuk issuances out of the UK.

In fact, the market may be witnessing a race, albeit a slow one, to launch the first benchmark Sukuk in the European market. While the UK clearly has the lead through its enabling legislation in the last three finance acts regarding tax and capital gains reliefs and the current corporate Sukuk consultation, other EU countries such as France and Luxembourg have publicly announced that they too are interested in raising funds in the wholesale Euro market through a debut benchmark Sukuk issuance.

France recently similarly introduced tax and other neutrality measures to facilitate Islamic finance products in France including Sukuk and Murabaha. Luxembourg, says Marc Theisen, Senior Partner of Theisen Schiltz, a leading local law firm involved in Islamic finance, is also keen to issue a Sukuk, and any outstanding legislation needed could be introduced fairly quickly.

Luxembourg is host to almost 40 registered Islamic funds and about 15 Sukuk listings on the Luxembourg Stock Exchange. As such, it is very familiar with the tax and other requirements relating to Islamic financial products.

The Islamic finance market in fact is keenly awaiting the issuance of a benchmark Eurosukuk, which bankers stress could be the single biggest boost to the Islamic capital markets this side of 2010.

However, according to McCarthy-Fry, London has made much progress in the Islamic wholesale banking space in the last few years. The recent $750 million government of Bahrain sovereign Sukuk is now listed on the London Stock Exchange, bringing the number of Sukuk listed on the said exchange to 19 with an estimated total value of around $11 billion, a figure exceeded only by the Sukuk listings on the Nasdaq in Dubai.

The UK government has also taken significant steps to support the future issuance of corporate Sukuk in the UK.

The Treasury at the same time believes that future progress in the Islamic finance space in the UK must be led by the industry, but it recognizes that more needs to be done to create a level-playing field for Islamic finance in relation to equivalent conventional finance products.

"Our door remains open to consider other ways in which we can support the Islamic finance industry.. In Britain we have community and commitment; skills and scale; expertise and connections around the world," declared the exchequer secretary.

"We want the future of Islamic finance in the UK to be a collaborative effort from all involved. With the expertise and dedication in this industry, I am very optimistic that, working together, we can ensure Islamic finance and trade are major elements in London's success in the decades ahead."

From Arab News

Islamic Insurance On The Rise

Demand for Islamic products has driven the rise of Takaful, say experts. Chakib Abouzaid does not like playing the part of the outcast. Nor does he want his burgeoning business of takaful, or Islamic insurance, to be marginalised as something separate from the large global insurance providers that now dominate the scene.

“Takaful is not a ghetto and I don’t like to work in a ghetto,” says Mr Abouzaid, the chief executive of Takaful Re in Dubai, the first takaful reinsurer of its size in the world. “Takaful companies are mature companies. We are also part of the insurance industry and I think we are contributing to the development of the insurance industry.”

In many ways he is right. According to a report last October from Swiss Re, the world’s second-largest reinsurer, the takaful sector grew at an annual average of 25 per cent between 2004 and 2007, adjusted for inflation. The rest of the insurance industry grew at slightly more than 10 per cent a year in that period.

But takaful’s fast expansion has not come without growing pains. It still makes up a mere sliver of the global insurance pie, and only in the past five years has it begun to gain ground in the GCC, riding on the development of Islamic finance as a whole.

Figures on the industry are scant but one estimate last year said there was US$500 billion (Dh1.83 trillion) in Islamic bank assets worldwide, a small portion of the global figure. But Accenture, the global management consultancy, forecasts that household Islamic savings will amount to $24bn a year by 2020.

“Takaful penetration is still marginal,” Mr Abouzaid says. “It is still very small but definitely we are contributing to increase the penetration.

“In the past three or four years, all the new insurance companies in the Gulf area have been takaful companies. Nobody is starting a conventional company. It’s a very simple strategy: if some segment of the population is reluctant to buy conventional insurance, why not provide takaful insurance?”

Like many Islamic finance products, takaful first took hold in South East Asia, thanks to strong government support. In Malaysia, overall insurance penetration in 2006 amounted to about 5.4 per cent of GDP, well above the figure for the GCC. Insurance penetration in the UAE was just 1.53 per cent in 2006.

According to figures from 2005, Arab countries accounted for just 24.7 per cent of total takaful contributions, while countries in the Far East – including Iran – accounted for 75.1 per cent.

But takaful is growing in the region, thanks to government encouragement and rising oil prices that are helping spread wealth through the region.

Saudi Arabia’s co-operative companies law, passed in 2004, required firms to operate along Islamic principles. Iran’s companies are also legally bound to use Sharia-compliant financing, which has helped takaful penetration rates to rise there.

Yet central among its hurdles is the underdevelopment of the reinsurance industry of which Mr Abouzaid is a part.

Insurance companies, especially new ones, cannot survive without a mechanism to offload the risks they take on to larger companies with larger asset bases to absorb claims. That is where reinsurance comes in.

In the takaful sector, however, there are not enough large reinsurers to underwrite all the risks takaful companies take when they sell products.

Re-takaful has developed rapidly, industry insiders say, but most takaful companies still reinsure contracts using conventional, non-Islamic means.

“We’re looking to create that capacity or to find that capacity, and in the absence of finding that capacity in the market we have to rely a lot of times, and I’ll state it as unfortunate, we have to rely on conventional reinsurance,” says Abdallah Kubursi, the head of AIG Takaful, which is also based in Dubai and which started three years ago.

Conventional insurance is incompatible with Islam because of Sharia’s prohibitions on overly uncertain transactions that involve a strong element of luck. Conventional insurers also put large pools of money in interest-bearing investments, which are prohibited by Islamic law.

This state of affairs does not sit well with the Sharia boards that oversee takaful companies. But for now, Sharia scholars recognise that takaful-based reinsurance is not always available. They are pushing takaful firms to do their best to switch to re-takaful as capacity grows.

“It is not purely Sharia-compliant to reinsure using conventional reinsurance,” says Michael McMillen, an Islamic finance expert. “However, these are early years in the growth of the takaful business and Sharia-compliant re-takaful is not always available.

“Thus, the Sharia scholars with whom I have spoken on this matter have permitted reinsurance with conventional reinsurers in the short term. As re-takaful becomes available, use of those re-takaful providers would be required.”

The development of re-takaful in the past three years, helped along by the emergence of companies such as Takaful Re, which was capitalised with $250 million when it started in 2005, is proceeding apace.

Insiders say that for many types of risks, the capacity is already there in the re-takaful market. Motor takaful, for example, is almost completely covered by re-takaful companies.

Capacity is still lacking, though, when it comes to large, extraordinary risks.

“When you look at lines of business like financial lines, crisis management, sabotage … kidnap and ransom, directors’ and officers’ liability insurance, and so on, a majority of the re-takaful companies out there today do not really have capacity for those lines of business,” Mr Kubursi says.

For takaful to succeed in the long run, these issues must be worked out. It is unclear how long Sharia boards will tolerate the use of conventional reinsurance.

But takaful is growing so quickly in the GCC that it has become difficult even for large global insurers to ignore. Many global banks and financial institutions have been busy making partnerships with takaful providers to include Islamic insurance among the coverage they offer.

Last week, Mashreqbank began offering a takaful-based savings scheme to its customers, and Dubai Bank announced a partnership to offer takaful products with Salama, an Islamic insurer based in Dubai.

Practitioners say the industry in the UAE could be helped greatly by a formal endorsement from the Government, or by laws that require companies to use takaful instead of conventional insurance.

At the pace at which it is now growing, though, it may only be a matter of time before takaful becomes a global force, whether the Government helps or not.

“In the Middle East we are still fighting, because there is a difference in terms of maturity between Malaysia and the Far East and the GCC,” Mr Abouzaid says.

“Now we are working to convince the Sharia boards and the management of the companies to switch to re-takaful because, in fact, they have no choice.

“From a Sharia point of view, they have to limit their use of conventional insurance to the strict minimum.”

From The National