Some quarters consider the current global financial crisis to be a blessing to the Islamic finance industry as there seems to have been a shift from the conventional capital market to Islamic. As for Malaysia, it sees several issuance of Sukuk despite the economic turmoil while some firms in the Middle East have postponed or are deferring plans to issue Sukuk, given the unfavorable conditions.
The current economic woes have also given many firms around the world reason to hold back on their capital raising plans, particularly through equity, with an increasing number preferring to do it by way of debt, issuing bonds or Sukuk, which have not been as severely affected by the current financial fiasco.
“The selloff in the equity market has not made it attractive for people who want to issue equity. Whenever there is market uncertainty, probably for now in Malaysia and around the world, they would go for private equities,” Abdulkader Thomas, CEO of Kuwait-based SHAPE Financial Corporation, told MIF Monthly.
He said an increasing number are attempting the debt market, with many firms preferring to issue Sukuk. “The Sukuk market would probably be more attractive partially because in the Sukuk space, there is a prospect of raising bonds in the Gulf and other Asian countries without worries about western financial institutions intermediaries.”
According to him, the Sukuk market in the foreseeable future — within the next year, at least — will see more conservative products. “There will be many more plain vanilla concepts. This is a time when everybody is unsettled. I think we have already seen the main innovation, a lot of Sukuk and warrants and equities that were attached to them and this is basically indicating that people are uncertain about risk and pricing.
“Early in the year, investors had a pretty strong risk-appetite and were willing to go for private equity risk in business and willing to take real estate risk in a number of positions in the emerging markets. I think investors are now jittery about the safety of financial institutions and the safety of financial networks,” he said. “They worry about the quality of regulators, so they retreat to more conservative ways to invest money. I think that will be the trend in the next one to two years, depending on how bad the economy is.”
While Thomas remains optimistic about Malaysia and its capital market, he is however “concerned about the impact of recession and the impairment in the international financial system on Malaysia or any other regional market space.”
‘Most dynamic Sukuk market’
Mohamad Safri Shahul Hamid, director and regional head of Islamic banking at Deutsche Bank, reckons Sukuk is still preferable because of its size and long tenure while corporate financing (bilateral) is a viable option. The current market conditions have made it difficult to raise money at the right price and some desperate issuers would end up with “expensive” money. He took note of private placements by Middle Eastern investors into Malaysian companies such as Bank Islam and Putra Perdana.
“The Sukuk market in Malaysia is the most dynamic in the world. Despite the current market conditions, we expect to see some activities in the primary ringgit Sukuk market as there is still liquidity among the ringgit investors,” Safri said. “Outside Malaysia, however, the global Sukuk market has been at a standstill for the last few months and we are not sure when recovery will take place.”
Safri said there are a few large Sukuk issues in the pipeline that are expected to hit the market between now and December, but suspects some of these could have been put on hold. He pointed out that Islamic syndicated facilities are another popular form of Islamic financing among clients outside Malaysia.
Islamic capital raising may be riding high at the moment, but challenges lie ahead for the Islamic markets, both local and international. One is the need for financial centers to continue innovating the products and services to support the growth of the Islamic capital market.
In Malaysia, Safri said, innovations in the methods to raise capital in the Islamic market can be seen with the emergence of Sukuk exchangeable, Sukuk convertible, hybrid Sukuk and structured financing such as acquisition finance. He expects to see products such as structured repo and structured financing being used to raise capital in the near future.
However, he concedes, there are chal lenges to innovating the Islamic methods of raising capital such as Shariah interpretation and acceptance, even though this problem is probably not as acute as it was some years ago. “We have been seeing Shariah convergence, especially between the Malaysian and Middle Eastern ways, in the last couple of years such as Khazanah’s Sukuk, about half of which was taken up by Middle Eastern investors. There are legal, tax and accounting issues and impediments, and there is also a lack of understanding among market players,” Safri lamented.
The LARIBA way
To Dr Yahia Abdul Rahman, chairman of American Finance House LARIBA, the most important thing about innovation is the opening up of the market.
“It is more to rebrand Islamic banking into rebate- or riba-free and not innovation in terms of names and trying to take some banking products and pick up Arabic names for it,” said Yahia, Shariah supervisor and founder of the LARIBA System.
“This way, you can really make a difference because frankly, when you look at market penetration in Malaysia and Pakistan, it is only 10% or 12%. We want market penetration of 30%, 40% and 70% and the only way to do this is by having a larger population.
“The good thing about the west is that they are open to new ideas while people in the East tend to be more conservative as they have been mistreated, abused and lost money through many different schemes.
We need to get out of Islamic because it is limited. We need to approach everyone with an open heart. If you are really a good Muslim, you should be able to serve other markets, the non-Islamic ones, to the best of your ability,” Yahia said.
He said LARIBA plans to develop portfolios that can be matched to certificate deposits (time deposit) as people are taking their money out of the stock market and putting them into the certificate deposit, for as long as 30 days or three months.
Dr Mohd Kamal Khir, CEO of Institut Bank-Bank Malaysia (IBBM), said preferred methods in raising capital in the local Islamic market include Islamic venture capital and private equity participation. These are different as they require substantial due diligence and expertise in the area of investment, not to mention the actual high-risk participation of investors in the fund seekers project.
“While other methods in the market are highly regulated, under these (preferred) methods, the terms and conditions are cemented through agreements between the parties involved. For example, in Islamic venture capital, where the Mudarabah contract is applied, the investor will bear the total loss for losses in the injected capital but the investees will only bear losses for their time and effort. In keeping the balance, usually the investor is given a greater share in the project,” Kamal said.
According to him, the market will soon see innovative Shariah-based methods for raising capital such as Musharakah Mutanaqisah (diminishing partnership) and Ijarah Mausuffah Bizzimmah (forward lease).
Kamal cited two factors that could give momentum to Islamic banking. Firstly, the profit-sharing basis subject to certain conditions, in which the bank provides the return on a pre-agreed profit-sharing ratio with the bank: This means the higher the profit, the bigger the returns — especially on investment- or deposit-based products.
Secondly, the underlying agreement in Islamic banking is at all times asset-based. It is a bank requirement to have the transaction based on underlying assets which may include commodities, properties or even everyday utensils like kettles or irons, as is the practice by some financial institutions.
Meor Amri Meor Ayob, chief operating officer of Bond Pricing Agency Malaysia, said the market has seen various types of Islamic structures, namely Bai Bithaman Ajil, Al Qardhul Hasan, Bai Bi Al-Taqsit, Bai Dayn, Bai Dayn-Murabahah, Bai Inah, Ijarah, Istisna, Mudarabah, Murabahah and Musharakah. The combination concepts include Bai Bithaman Ajil-Bai Inah, Mudarabah-Murabahah, Murabahah-Bai Dayn, Murabahah-Musharakah and Murabahah-Ijarah, said Meor Amri.
“Now, you don’t have Musharakah alone but a combination of Musharakah and Ijarah issues, which is sophisticated in itself. It is the same as in the western debt market where people started optionality. You can then create a structure that specifically caters to a certain type of investor. You have to innovate for the investors. Innovation is the key to market development,” Meor Amri said.
He said debt/equity-like transactions appear to be the way forward. “Pure debt or pure equity has its plus and minuses. Combining the best of both sources of funding will appeal to potential investors,” he said.
Meor Amri added that recognition must be given to innovators who innovate the products. “Such a reward system will promote innovation and remove fear of ‘intellectual property theft’, he said.
According to Meor Amri, access to information is among the factors that is slowing innovation. “Due to the fact that guaranteed returns are prohibited by Shariah, investors prefer sophisticated products on the market, especially here in Malaysia, that are given capital protection rather than guaranteed returns subject to the terms and conditions laid down by the institutions,” he said.
Real growth to come from capital market
Daud Vicary Abdullah, chief operating officer of Asian Finance Bank, said the market was seeing a lot of activity, particularly via the Sukuk structures.
“Now, it is really an issue of securing the acceptability and for the international regional market to look at it, especially on the tax issue. To me, it is not the innovation on the product structure, as a lot has been done on that. It is an innovation around the tax structuring and ensuring that there is a level of tax attractiveness around us,” he said.
“Otherwise, you are not going to get the cross-border transaction. At the moment, there is an interesting transition point where a lot of products on the capital market side are within the geography. But what about cross-border? You must look at the risk and currency profiles as well as the risk management aspect and the tax. The issue of innovation in Islamic products is how you deal with the underlying tax structure.
“We are trying to do cross-border business, the Islamic structures are there. Until the taxation issues are really resolved, we are not going to get this cross-border flow which will support the growth of the industry. The real growth of the industry is not going to come from the retail business but from the capital market, the asset management side, the wealth management or high net worth individual, where there are tax implications. We have to find a way to resolve this,” he emphasized.
Some Islamic finance experts, however, believe that while innovation is needed in the industry, a balance must be struck when it comes to creating innovative products. Highly innovative products are not necessarily good.
What the Islamic finance industry needs is original Shariah-based products and not the replication of conventional products. Innovation must be a genuine response to investor needs that meet Shariah principles. |
