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islamic finance
The
Battle
over
Islamic
Finance Gulf and Asian centers are competing
for leadership. Some cooperation could
really help the industry grow.
By MarkTownsend
I n t h e a f t e r m at h o f t h e g lo b a l
financial crisis, the prospects for Islamic finance
appear brighter than ever. The industry boasts
an estimated $1 trillion in assets, and Islamic
banking — untouched by subprime-mortgage-
backed securities and other toxic assets that
devastated manyWestern institutions — contin-
ues to grow at a rate of about 20 percent a year.
Financial centers from Bahrain and Dubai in the
Persian Gulf to Malaysia and Singapore in Asia
are moving to improve their regulatory frame-
works in a bid to win a bigger piece of the pie.
Yet much of the industry’s potential remains
untapped. And the competition itself may be
part of the reason, bankers and analysts say.
A lack of consistency in the interpretation of
Islamic law by scholars who decide if a product
complies with shari’a principles is holding back
the development of a vibrant capital market
and asset management business. The industry
must resolve differences between the secular
element of contracts frequently based on Eng-
lish common law and a shari’a board’s inter-
pretation of the same contract if conventional
money managers are to see long-term value in
Islamic finance, an essential element for future
growth. Among other things, shari’a bans the
charging of interest and requires that loans be
structured on a profit-sharing basis.
“There is a need for standardization and
uniformity,” says Arul Kandasamy, head of
investment banking at Abu Dhabi Commer-
cial Bank. “We cannot rely on shari’a scholars,
as they have a vested interest in retaining the
status quo. Governments and regulators have
primary responsibility for resolving this situa-
tion.” Similar concerns temper the optimism
of Mohieddine Kronfol, managing director of
Algebra Capital in Dubai. “Shari’a-compliant
assets are more than $1 trillion, but legal and
market infrastructure as well as corporate gov-
ernance standards are current and very relevant
challenges facing Islamic finance,”he says.
newscom.com
Investors gather around the monitor displaying
the latest prices at the Dubai Financial Market
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islamic finance

The Islamic fund management business has total assets of just was the first central bank in the world to develop and issue sukuk.
$52 billion, a fraction of the $22 trillion handled by conventional The central bank has also moved to address the shortage of trained
money managers, according to a recent report by accountants Ernst professionals in the industry by establishing the Waqf Fund for
& Young. Most of the funds have less than $100 million under Research, Education and Training in 2006. The Bahrain Institute for
management, the threshold needed to achieve profitability, the firm Banking and Finance recently launched a master’s program in Islamic
says. The small size of the funds also limits their ability to match the finance in conjunction with DePaul University.
variety and quality of conventional investment funds, it adds. “Bahrain is an important regional financial center and offers a
The market for sukuk, or Islamic bonds, shows signs of recovering well-established legal and regulatory framework and good ancillary
from the blow dealt by Dubai’s near default last year, but the market services to support the financial services sector,” says Ikbal Daredia,
remains a fraction of the size of the conventional fixed-income who heads capital markets, institutional banking and the Malaysian
market. Sukuk issuance totaled $5.6 billion in the first five months arm of Unicorn Investment Bank in Bahrain.
of this year, up slightly from $5.3 billion in the same period of 2009. Bahrain officials say they are eager to work with other financial
The Dubai property developer Nakheel came close to defaulting centers to establish common standards and help overcome the
on its $3.52 billion sukuk — the largest ever — before Abu Dhabi fragmentation that is holding back the growth of Islamic finance.
stepped in to bail out Dubai. The company’s debt problems raised Fund managers in particular identify the lack of connectivity and a
doubts among investors about the ability of sukuk holders to transparent screen-based trading platform as significant barriers to
seize control of assets backing the bonds in the event of a default the growth of the Islamic fund business.

“
— doubts that have yet to be resolved,
bankers and analysts say. The region’s
credit problems continue to weigh on
the sukuk market. Gulf corporations are
facing a wall of debt coming due, with
$145 billion outstanding and $28 billion
scheduled to mature in 2012, the bulk
of it for companies in the United Arab
Emirates, according to Moody’s Inves-
tors Service. It’s little surprise, then, that
Malaysian entities are dominating the
sukuk market, accounting for slightly
more than half of global issuance this
year through May.
“The cost of structuring and issuing
“We need to work with other countries
to get appropriate regulatory structures for
Islamic finance in place,” says the Economic
Development Board’s Ahmed. “We are
There is a need for working with others, of which Malaysia is
standardization and a big player, to develop the Islamic banking
equivalent of Basel II.”
uniformity. We Dubai had sought to challenge Bah-
cannot rely on rain’s leadership in the Gulf with a raft
shari’a scholars, as of sukuk issues in 2006 and 2007. Nas-
they have avested daq Dubai is one of the world’s largest
exchanges by listed value of sukuk, with
interest in retaining 20 issues worth a total $16.3 billion. The
the status quo. emirate faces an uphill climb to regain
— Arul Kandasamy momentum, however, following the recent

”
sukuk remain high relative to conven- Abu Dhabi Commercial Bank debt crisis and the restructuring of Dubai
tional” bonds, says Nasser Saidi, chief World’s $23.5 billion in borrowings.
economist of the Dubai International Giambattista Atzeni, corporate trust
Financial Centre. “The lack of unifor- business manager for the Middle East and
mity and certainty is also curbing and inhibiting innovation.” North Africa at Bank of New York Mellon Corp., notes that Dubai
Notwithstanding the problems, countries across the Gulf region has focused on international sukuk issues, many dollar-denominated,
and Southeast Asia are targeting the industry for growth and hoping while Bahrain has concentrated on local currency offerings “and has
to establish themselves as major centers for Islamic finance. “From a great track record in government deals.”
our perspective, the exciting thing is, so many countries are focused The emirate still has some ways to go if it is to become a serious
on Islamic finance,” says Afaq Khan, the Dubai-based CEO of Stan- regional contender, says ADCB’s Kandasamy. Most of Dubai’s sukuk
dard Chartered Saadiq, the Islamic banking subsidiary of Standard offerings have been real estate plays, and the emirate’s regulatory
Chartered Bank.“That can only be positive for industry growth.” framework lags behind that of Bahrain, he says. “Bahrain has taken
For many years, Bahrain has led the Gulf region by devising sup- the right steps to close the gap with Malaysia, but its small domestic
portive Islamic and tax regulations that have boosted its reputation as market will constrain further growth,”says Kandasamy.
a leading banking center. Bahrain has 28 Islamic financial institutions, There are 12 Islamic funds domiciled at the Dubai International
the largest such concentration of any country, according to Kamal Financial Centre, with combined assets of $580 million. High costs
Ahmed, chief operating officer of the Bahrain Economic Development are one key barrier to growth, officials acknowledge. Late last year
Board. Total assets in Bahrain’s Islamic banking sector jumped by the Dubai Financial Services Authority issued a report on collective
nearly 50 percent last year, to $24.5 billion. As recently as 2000, assets investment funds that raised eyebrows when it stated that the DIFC
totaled just $1.9 billion. Bahrain is also home to 47 Islamic investment was the most expensive financial center in the world.
funds with total assets of $2.15 billion, according to Ernst & Young. By many measures, Saudi Arabia is rapidly becoming the biggest
The country regards a strong regulatory environment as a com- Islamic financial center in the Middle East, although its market is
petitive advantage. The highly regarded Central Bank of Bahrain almost entirely domestic in focus. The kingdom boasts 174 Islamic
regulates the sector; its forerunner, the Bahrain Monetary Agency, funds with a total of $22.7 billion in assets, according to Ernst &
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Young. There has been a major trend finance operations,” says Mohamad
toward Islamic banking, which was Nedal Alchaar, secretary general of the
virtually unheard-of in the country a Accounting and Auditing Organiza-
decade ago, notes Paul Gamble, head tion for Islamic Financial Institutions, in
of research at Jadwa Investment in Bahrain. “Nevertheless, in the long term
Riyadh. “New banks launched in it will benefit the Islamic finance sector
recent years are 100 percent Islamic, to have its own benchmark index.”
as are virtually all the local investment Malaysia’s success is spurring imita-
companies,” he says. Saudi entities are tion in Asia, most notably by neighbor-
also beginning to wade into sukuk in a ing Singapore. The city-state is targeting
big way, a potentially significant devel- Islamic finance in a bid to expand its
opment for that market. Saudi Electric- financial center. The Monetary Author-
ity Co. raised $1.9 billion in May with ity of Singapore is extending its existing
a sukuk priced to yield 95 basis points regulatory framework to the shari’a-
over the Saudi interbank offered rate. compliant sector. “Our approach is to
Notwithstanding the efforts of the treat conventional and Islamic financial
Gulf countries, Malaysia continues to products similarly, as long as they share
claim the world’s largest Islamic capital similar risk characteristics,” a spokes-
market. The country has integrated the person for the central bank says.
Islamic sector into its broader financial Recent regulations by the MAS allow
system, providing institutions as well as Singapore-based banks to enter into
intermediaries a deep market in shari’a- Istisna financing transactions, a shari’a-
compliant equities, sukuk, exchange- compliant method of financing con-
traded funds, real estate investment struction projects. The move appears
trusts and derivatives. At the end of designed to allow the country’s banks to
2008 (the most recent figures available), participate in an expected surge of financ-
Malaysia’s Islamic banking assets had ing for major infrastructure work in the
reached $72.5 billion, according to the Gulf Cooperation Council, a bloc that
Malaysia International Islamic Finan- encompasses Bahrain, Kuwait, Oman,
cial Centre. The country boasts 184 Qatar, Saudi Arabia and the UAE. “The
Islamic funds with assets totaling $5.1 GCC are heavily investing in infrastruc-
billion, according to Ernst & Young. ture, with $2 trillion of infrastructure
Shari’a-compliant companies make up investment over the coming five to
63 percent of the Bursa Malaysia’s 1.06 seven years,”notes the DIFC’s Saidi.
trillion-ringgit market capitalization. Afaq Khan (top), CEO of Standard Chartered Although Islamic finance is grow-
Malaysian entities accounted for Saadiq, and Ikbal Daredia, head of capital markets ing at an annual pace of about 20
and institutional banking for Unicorn Investment
53.4 percent of global sukuk issuance Bank, agree that Islamic finance is on the rise percent, it remains a very small part
in the first five months of this year, of the overall market. Singapore has
according to Dealogic. The govern- 13 Islamic funds managing a total of
ment itself has led the way by issuing a $1.25 billion sukuk, the $760 million in assets, compared with $610 billion in assets run by
largest ever by a Malaysian borrower, in May. conventional fund managers.
“Local investors’ demand and established market infrastructure Elsewhere in Asia, Hong Kong has begun to look at Islamic finance
has supported issuance, while local players such as Petronas and with greater seriousness. It could be a shrewd move. The growing
Khazanah have successfully issued large cross-border sukuk, raising trade relationship between China and the GCC, particularly in
capital abroad,” says BNY Mellon’s Atzeni. Kandasamy of ADCB energy, offers a rich possibility for Islamic finance projects. “Hong
agrees that Malaysia’s depth and sophistication give it a firm lead Kong has talked about strengthening its credentials as an Islamic
over the Gulf centers. “Malaysia has the best capability due to its financial center,” says Ben Simpfendorfer, chief China economist at
advanced regulatory environment, strong government support and Royal Bank of Scotland in Hong Kong. “This shouldn’t be interpreted
large pool of educated professionals to support growth,”he says. as competing with Malaysia and Singapore. Hong Kong is hoping to
For the Gulf to match the depth of the Malaysian market, it will profit from Islamic bond issuance by mainland Chinese corporates.”
need to establish more common standards to increase trading activity With so much competition for leadership in Islamic finance, will
and attract new investors, industry experts say. Adopting a benchmark there be enough business to go around? A little more cooperation
index like LIBOR would immediately improve transparency and to address some of the industry’s shortcomings could help grow the
liquidity and create clarity for conventional investors. “There is a market for everyone. ••
consensus among scholars and market practitioners that a conven-
tional benchmark index such as LIBOR can be applied to Islamic Comment? Click on Global Markets at institutionalinvestor.com.