As the global recovery begins to take hold and confidence
returns to financial markets, Islamic Finance has returned to
prominence. A number of entities, often from markets and
industries that had not previously considered Sharia-compliant
funding structures, are exploring the opportunities that Islamic
finance may present – most notably the UK government.
However, there is a perception that Islamic structures are costly
to implement and that without an extensive land-bank or other
inventory of assets available to an issuer, Islamic finance is not
a viable option. Recent developments in both the Sukuk market
and more broadly within Islamic finance may prove these assumptions
to be incorrect.
There continues to be a supply/demand mismatch in Sharia-compliant
asset classes arising from a lack of both assets and
diversification within the classes of asset that are
available. This has led to problems such as a
"hold-to-maturity" culture and the inevitable valuation
inaccuracies that this creates. However, there are also
benefits as commercial tension has put pressure on pricing and
driven down yields in favour of issuers. Abu Dhabi Commercial
Bank (ADCB) benefitted from this particular phenomenon in 2012 when
it converted its proposed conventional bond issuance to a Sukuk in
order to benefit from more attractive pricing.
Traditionally, Islamic finance has focussed on Sukuk and, owing to
the need to have real assets underpinning the issuance, issuers
have tended to be restricted to those with a land-bank to support
such issuance. Much of this was as a result of the Accounting
and Auditing Organisation for Islamic Financial Institutions
(AAOIFI) pronouncement in early 2008 which criticised a number of
Sukuk outstanding at that time. Criticism focussed on the
valuation mechanic used to calculate the repurchase price for the
assets underpinning the Sukuk and, therefore, the amount available
to redeem such Sukuk. AAOIFI was of the view that where Sukuk
are based on assets such as equity securities which have a
fluctuating market value, it is artificial to fix the repurchase
price for those assets five years prior to the date of re-purchase
(in the case of a five-year tenor). This contrasts with land
or moveable property which is always sold at the price agreed
between buyer and seller when required. The net effect of
this was to restrict issuers of Sukuk to those entities that had
land or other tangible assets available to them and to focus almost
exclusively on the Ijara (sale and leaseback)
structure.
However, a number of recent Sukuk issuances have employed more
creativity in the selection of assets to underpin the Sukuk
issuance and have successfully utilised intangible (but
nevertheless real) assets. Two noteworthy examples of this
are the Axiata Sukuk (which used airtime vouchers as the underlying
asset) and the FWU AG Sukuk (which used Intellectual Property in
and to a software programme as the underlying asset). These
issuances are indicative of a move away from some of the more
"traditional" Sukuk asset classes and show a greater
creativity by all parties involved. The effect of such
issuances should be that more companies may consider ways to use
the assets and/or cashflows available to them in their current
business to support the issuance of Sukuk and thus find the Islamic
capital markets open to them.
However, it would be wrong to focus solely on Sukuk as the only
instrument available within Islamic finance. The breadth of
offering within the Islamic finance sphere is growing allowing the
industry to explore new, innovative structures.
Sharia-compliant factoring arrangements have been successfully
implemented and there is a growing interest in Islamic risk
management (using the IIFM/ISDA Master Tahawwut Agreement) and
structured investment products. Risk management tools in
particular are assisting the Sharia-compliant market to mature and
to mitigate the risk profile of issuers – something that was
not previously the case. Developments have also been seen
within the traditional fields of Sukuk evidenced by the growth of
"Project Sukuk" (notably that issued by Sadara to fund
the joint venture between Saudi Aramco and Dow Chemical) and
infrastructure Sukuk (notably that issued by the MRT in Malaysia to
fund expansion to the Kuala Lumpur metro) which are linked to, and
intended to fund, long-term development projects.
It is perhaps worth considering why new structures and asset
classes are appearing to support Islamic finance offerings.
The reason for this may be quite simple: as industry professionals
gain an increased understanding of the requirements of the Sharia,
scholars have gained greater freedom to turn their attention to new
structures and asset classes. The growing understanding of
industry professionals is in turn helping to drive this process
forward through the development of more sophisticated products and
new asset classes to present to scholars for their
consideration. This should bring greater diversity to the
investment opportunities within the Islamic sphere and create
opportunities for issuers and investors that have not previously
considered Islamic finance as a means to raise capital.
It is important to note that Islamic financing techniques are not
limited solely to Sharia-compliant companies or investors. In
fact, it is estimated that two-thirds of Sukuk issued are purchased
by conventional investors and there is nothing to suggest that
broker/dealers treat Sukuk any differently to how they treat
conventional bonds. Certain types of company – those
that are involved in Haram (forbidden) activities –
are naturally excluded from Islamic finance; but for most others
there is no restriction. It should also be noted that there
is nothing in the Sharia that says that the making of profit is
forbidden; it merely restricts the means by which such profit may
be made. Conventional investors have become ever-more
comfortable with the contractual arrangements and economic returns
available within Islamic structures. The development of the
Islamic financial market and industry professionals operating
within it has led to a reduction in the costs associated with
structuring and documenting Sharia-compliant products, adding to
the benefits of more attractive yields driven by pent-up
demand. All of these factors may encourage more companies to
look to Sharia-compliant methods of financing.
Perhaps the biggest fillip for the industry has come with the
announcement that the UK government intends to issue a Sukuk by
2015. Whilst the UK government won't be the first
government in Europe to issue Sukuk (Saxony-Anhalt was in 2005) it
will be the largest and most significant to date. The
projected issue size may be relatively small (estimated at
£200m) for a government issuance, but it nevertheless
illustrates the commitment of the UK to develop Islamic finance
beyond its traditional jurisdictions and to encourage other UK
companies to consider Islamic finance as a viable option in the
future. In order to do so, companies may need to be creative
in identifying assets to be utilised within a particular Islamic
structure but, as we have seen above, the ground-work has been
laid.
As the Islamic finance industry continues to develop and confidence
returns to the world economy more generally, there are many
opportunities for issuers to raise capital by Sharia-compliant
means. Whether this occurs through Sukuk issuance or by other
Sharia-compliant structures any potential issuer will need to be
able to identify assets that will underpin the structure
selected. Greater creativity and a deeper understanding of
Islamic finance by industry professionals should enable potential
issuers to identify asset classes that they had not previously
considered and therefore allow them to give serious consideration
to Sharia-compliant funding opportunities.
Originally published in Corporate LiveWire
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
