Islamic Finance Bulletin June 2014

4TH ISLAMIC

BANKING AND

FINANCE

CONFERENCE

(IBF 2014)

23 & 24 JUNE 2014

Co-organizers

Supported by

Islamic Finance Bulletin

June 2014

lums.lancs.ac.uk/research/centres/golcer

Gulf One Lancaster Centre For Economic Research

From the EditorA few events in the past month, of varying kinds and degrees

of publicity, have caught the attention of this publication in

representing the current state and prospect of the Islamic

finance sector. Each is reviewed within this bulletin, as a

staging post for awareness of the industry.

First to mention would be the UK’s delivery of the sovereign

sukuk that was promised at WIEF last year. Only £200m

in size, it nevertheless marked London’s attempt to show its

commitment to sharing strategically in the Shariah-compliant

market, and was oversubscribed some ten times.

Second, the 11th annual summit of the standard-setting IFSB

in Mauritius coincided with a mid-term review of a ten-year

framework and programme to advance Islamic finance’s

proposition to its potential customers around the world, with

recommendations arising.

Third, Lancaster University itself hosted an Islamic finance forum

which assembled a multitude of parties from different sides

of the industry and discipline, to collaborate in developing a

deeper understanding of its issues and continuing constraints,

and ways to step forward.

Taken together, these instances exemplify aspects of the market

realities, institutional and theoretical challenges, and need for

cross-border efforts that characterise the range of topics that

can be found when studying this sector and its potential.

Meanwhile, trends in the financial and commodity markets,

also tracked here, tended to show the lack of volatility that has

become routine as bonds and equities have reached liquidity-

fuelled heights, while the global economy itself is still muddling

along in uncertain fashion.

Apart from natural investor concern that significant further

gains in stocks and fixed-income might be hard to achieve,

confidence was affected both in May but mainly in June by

geopolitical developments, especially the spreading conflict in

Iraq. Oil and gold were modestly affected too.

Lastly in this edition, we have continued also to provide a digest

of the regular news in Islamic finance, particularly as regards

its geographical growth, and this month feature Morocco in our

series of country-based reports.

Contents

HIGHLIGHTS (p.3)

RECENT DEVELOPMENTS (p.4)

FEATURE (p.7)

CONFERENCE COVER (p.10)

FEATURE (p.13)

STOCK MARKETS (p.16)

COMMODITIES (p.19)

BOND AND CDS MARKETS (p.20)

ISLAMIC BONDS (p.21)

Egypt: While tensions inevitably persist, the elevation

of former army chief Al-Sisi to the presidency has

corresponded with generally buoyant financial markets,

owing to perceptions of conducive stability. The

unexpected announcement of a capital gains tax on

investors caused a brief pullback in stocks, but that

was offset by MSCI’s decision to keep Cairo’s bourse

in its emerging markets index, a reflection of improved

national finances and firmer Egyptian pound. The

country’s eurobonds traded at lowest yields for nearly

four years, with international accounts reaching for yield,

alongside Saudi Arabia’s call for concerted support for

the local economy.

IBF 2014 Conference: This month’s 4th annual Islamic

Banking and Finance Conference, held at Lancaster

University in conjunction with Aston and Durham Business

Schools, had record attendance and constituted the largest

empirical research event in Islamic finance in the UK.

Delegates from around the world, representing the various

strands of the industry (researchers, regulators, market

practitioners) reviewed the challenges and outlook for the

sector, emphasizing the outstanding issues to study and help

resolve. In so doing, they epitomized the spirit of cross-

border co-operation vital to the sector’s potential growth

and provision of opportunity.

UK Sovereign Sukuk: The much-awaited debut

sukuk from the UK emerged in June, with very

positive investor reaction, although there was

some disappointment that local Islamic banks were

not mandated to distribute the issue. While only

modestly-sized at £200m, this debt-raising is seen

as both symbolic and practical in promoting Islamic

finance, and advertising its potential for corporates

seeking funding. The government had reached out

to investors through a roadshow across the Gulf and

Malaysia, with an approach that suggested that the

possibility exists of a recurrent sukuk programme.

Highlights

Recent Developments in the Islamic Finance Industry

Senegal sukuk heading South Africa

Senegal is now on its way to beating South Africa and Nigeria to market with sub-Saharan Africa’s biggest sovereign sukuk, and the continent’s biggest economies are expected to follow with debut Islamic bonds. This month Senegal opened its sale of 100 billion CFA francs ($208 million) of debt, tapping a global market that may this year surpass the record annual issuance of $46.5 billion in 2012. The sukuk issuance comes as Senegal plans to sell its second Eurobond, intending to raise $500 million by July. Worldwide offerings rose 27% to $24.4 billion in 2014 so far from a year earlier, as data compiled by Bloomberg show. Senegal has the second-largest economy in the eight-nation West African Economic and Monetary Union.

Source: Bloomberg, June 27th

GOLCER finds this to be one of the most interesting news items on sukuk issuance this year, given that the market is still relatively underdeveloped in sub-Saharan Africa. With countries making such initial offerings, this example shows the initiative to put underdeveloped countries in the African space in position as hubs of Islamic finance. Senegal is issuing sukuk bonds before more developed markets in North Africa (such as Morocco and Tunisia) do so. However, the development still poses challenges in the form of country-level regulations, auditing and personnel professionalism and training when it comes to trading these sukuk.

Moroccan parliament advances Islamic finance

The first house of Morocco’s parliament has now approved a bill to allow the establishment of Islamic banks and enable private companies to issue Islamic debt. The bill, however, still needs to be passed in a final vote in the second house in the coming weeks.

Source: Reuters, June 23rd

As highlighted in previous editions, GOLCER finds this a belated response by the government for the current calls by investors and practitioners to join the queue of MENA countries inviting participation in Islamic finance. Although Morocco has been seeking to develop Islamic finance for almost two years, in an attempt to attract Gulf money and fund a huge budget deficit, the delays witnessed to date can be accounted for by the sensitivity of the political elite to Islamism, which has been remarked upon repeatedly as holding back approval.

UK’s first sale of non-Muslim sovereign issue

This month the UK became the first non-Muslim sovereign issuer of Shariah-compliant debt, as it raised 200 million pounds ($339 million) in Islamic bonds, with investors bidding for more than 10 times the amount offered. The notes maturing on July 22, 2019 were sold at a profit rate of 2.036 percent, offering zero spread to the 1.75% gilt due the same year, according to data on the UK Debt Management Office page on Bloomberg. This instance follows Prime Minister Cameron’s much-publicised announcement in October 2013 of planning to sell securities that comply with Islam’s ban on interest (see Focus).

Source: Bloomberg, June 25th

GOLCER perceives the UK as now moving more seriously to validate the premier’s commitment late last year. We recognise these sukuk as helping London to establish itself as a global capital for Islamic finance, bracketed alongside Dubai and Kuala Lumpur. This government issuance will also encourage further private sector issuances of sukuk in the UK. We believe

Recent Developments in the Islamic Finance Industry

also that a very strong signal has ultimately been sent, albeit delayed, about the UK’s commitment to developing Islamic finance.

Sukuk issuance to have formal liquidity guidance

The Malaysia-based Islamic Financial Services Board (IFSB), one of the main standard-setting bodies for Islamic finance, has announced a plan to issue draft guidance by year-end on how Islamic banks may manage liquidity, as they tend to face a lack of short-term funding instruments. This guidance will enable financial institutions to use sukuk as a key tool for meeting the liquidity requirements of Basel III. Guidance from the IFSB would help Islamic banks manage their short-term funding needs. The guidance note would address the use of an alternative mechanism to help Islamic banks meet the liquidity coverage ratio (LCR) found in Basel III.

Source: Khaleej Times, June 25th

GOLCER believes this guidance is crucial for Islamic banks worldwide, particularly in the Gulf, which has been waiting for regulatory guidance on how debt instruments such as sukuk will be treated under Basel III, the directive which reflects stricter banking rules being phased in around the world. Basel III now offers an alternative liquidity arrangement for domains with limited high-quality assets which would be extended to markets where Islamic finance features prominently. However, the application of this guidance will be challenging for the majority of Islamic finance jurisdictions in terms of providing markets and assets guidance for banks in their efforts to international-level Basel rules.

Luxembourg planning sukuk bill

Luxembourg has expressed its hopes of adopting a bill before the summer holidays that would allow it to issue its first Islamic bond, especially with the AAA-

rated sovereign thereby opening the door to future sukuk issuance. The government has requested the Council of State, the legislature’s advisory body, to consider a revised bill on July 1st, so that it can securitise government assets to back a sukuk worth 200 million euros ($275 million).

Source: Reuters, June 25th

GOLCER considers Luxembourg’s initiatives as being motivated by the example of the UK’s recent issuance. It seems that the competition between European/Western countries to join Islamic finance will be fierce. Although Luxembourg tends to lose out to Britain in such cases, in terms of speed of actions and prospective timeframes, nevertheless repeat sukuk issuance could cement a stronger commitment to the Islamic finance industry by these countries than by other Western nations. We find that both countries, as are many others European nations, are working hard this year to boost their industry credentials to attract more business from cash-rich Gulf countries and tap into the growing market for sukuk.

Jordan studies sukuk issuance

Jordan’s government is currently studying a proposal to issue its first Islamic bond. The country’s sukuk programme may start as early as next year. A committee including the finance ministry and the central bank is looking at a proposal for a recurring issuance programme, although details such as the size, tenor and frequency of issuance have yet to be determined.

Source: Reuters, June 12th

GOLCER is unsure about the likely results of Jordan’s proposed issuance of sukuk, as the pressure to cut public debt and a preference for concessionary loans from aid donor countries could hinder the plan. Even though the country has an established Islamic banking sector,

issuance of sukuk has been slow, with legal limitations on the transfer of assets required to underpin such transactions. Jordan passed a long-awaited law at the end of 2012 allowing the government to raise funds through sukuk, but no issue has yet been materialised, while Jordon is increasingly using international bonds to help cover its budget deficit.

Focus: UK’s sovereign sukuk

The Financial Times reported that, according to arranging bank HSBC more than a third of the issuance went to UK investors, with the remaining bonds sold in the Middle East and Asia. Previously, British grocer Tesco issued a sukuk in 2007 through its Malaysian arm, and Ocado, an independent online grocer, borrowed £10m in a Shariah-compliant loan in 2009. The FT reported a banker’s claim that some of the UK’s largest property companies “have already expressed interest” in the idea of raising finance through Islamic bonds. It also quoted Humphrey Percy, chief executive of The Bank of London and the Middle East, remarking: “The issuance of a UK sovereign sukuk sets a precedent for the Western financial world, with the high demand hopefully encouraging further issuance from Western countries and corporates.”

However, market-tracking publication Global Capital.com found the timing of the issuance to result from “some strange misfiring of logic, [as] the government managed to announce a Middle East-focused roadshow late on Thursday” at the beginning of the region’s weekend. Moreover, it implied a mistake in that no UK Islamic bank got the mandate, even at sub-arranger level, although those banks may have more confidence in the government’s plans for the future, when they can offer “precisely the kind of hands-on specialist knowledge and attention that big banks have failed to muster for smaller borrowers in recent years”. That said, the government “should get plaudits for

taking the roadshow far and wide”, meeting investors in Qatar, Saudi Arabia, the UAE and Kuala Lumpur. “It should convince doubters that this is not a one-off.”

Reuters commented that the choice of arrangers in HSBC, Qatar’s Barwa Bank, Malaysia’s CIMB, National Bank of Abu Dhabi and Standard Chartered – “big institutions with considerable marketing muscle” – was “designed to ensure easy distribution and tight pricing”. The omission of Britain’s six fully-fledged Islamic banks, however, “could reduce the impact of the issue in developing expertise and depth in Britain’s Islamic banking sector”. The issue itself will use an ijara structure, a Shariah-compliant sale and lease-back contract, under which the rental income of three central government offices will underpin the transaction.

UAE news agency WAM said the sukuk offering was in fact 11.5 times oversubscribed, quoting leading local bank NBAD’s group CEO saying the growing market “provides a valuable and diversified funding source for clients across the West-East Corridor”.

Islamic Finance report card: Morocco by Rachel Latham and Andrew Shouler

Feature

Morocco has emerged from the Arab Spring with clear ambitions and moreover is better placed, economically and politically, than many of its North African neighbours to fulfil those aspirations. The development of Islamic finance stands among those objectives.

Having undergone what has been described as an evolution rather than a revolution, with a democratic transition initiated in the 1990s, the country has managed to avoid the levels of tur-bulence experienced in other parts of the region. It has also withstood the economic meltdown of its main trading partner, the eurozone.

As a consequence of this resilience, Morocco has gained the confidence of international markets. Proof of this is the recent successful is-suance of a €1bn 10-year bond, and the King-dom’s investment grade rating from S&P and Fitch Ratings.

So what are those goals, exactly? With a large budget deficit and high unemployment to attend

to, the government wants to encourage new industries, to attract increased inward invest-ment as well as expand export markets, with the focus turning towards sub-Saharan Africa.

One sector clearly earmarked for expansion is the financial industry, which is already one of the most prominent in Africa. The newly-formed Casablanca Finance City (CFC) is meant to become a regional financial hub for north and west Africa. Very much part of this vision is the creation a thriving Islamic finance sector.

The benefits of such a strategy appear to touch all aspects of Moroccan society. Of course, with a Muslim population of over 30 million, it is hardly surprising that a survey carried out by IFAAS consultancy found that more than 90% expressed an interest in Islamic financial products.On a global perspective, Morocco is a late-comer to this fast-growing sector, but there is now a sense of urgency, in common with the international impetus and domestic impera-tives.At the beginning of this year Morocco’s gov-ernment adopted a bill regulating Islamic banks and sukuk issues. A final vote by par-liament is expected ¬¬¬later this year. Once approved, the law will enable the formation of fully-fledged Islamic banks, whether subsidiar-ies of Moroccan banks or foreign entities.Until now only Attijariwafa Bank -- controlled by the royal family’s investment holding com-pany SNI, and one of the biggest banks in North Africa -- was the only Moroccan bank

to have offered Islamic finance products, and only for personal finance. Once the bill is passed, the bank will boost its Islamic business either in the form of a joint venture with a foreign partner or alone.Two other local banks, BMCE Bank and Banque Centrale Populaire (BCP), are also preparing to launch Islamic subsidiaries. There is also talk of new entrants to the market. The Egyptian–headquartered Faisal Islamic Bank is reported to have shown inter-est in operating in Morocco, as has Qatar Interna-tional Islamic Bank. Preparation is also under way for sukuk issuance, both sovereign and corporate. In June last year the multilateral Islamic Development Bank announced that it would support Morocco by buying its first sovereign sukuk, in place of offering the country more finance, thereby ensuring that there is a large institutional investor supporting the issue. There is also strong interest at the corporate level, with nine

out of ten institutions surveyed by the Moroc-can financial market authority (CDVM) last year saying they would be interested in issuing sukuk once the law allowed. In terms of alleviating poverty, zaqat and awqaf, Shariah-endorsed instruments, already a deeply rooted part of Moroccan culture will be boosted by the enhanced focus. Also in the area of microfinance, participatory banks – as Islamic banks will be called under Moroccan legislation - will bolster funding of small busi-nesses, which (with SME’s accounting for more than 95% of the total number of operating enterprises and 48% of total employment), is of considerable importance.

At the other end of funding scale, the country should benefit from attracting overseas funds, reflecting closer ties with GCC countries and other parts of the Muslim world. The fact that Morocco is a latecomer does have its advantages, in that guidance is avail-able from the experiences of other countries. Perhaps of key importance is the topic of Sha-riah governance. The Moroccan framework is unique in this respect, in the sense that indi-vidual participatory banks are not permitted to have their own Shariah board, and instead their activities are to be endorsed by the state-authorized Central Shariah Board.Challenges remain, particularly in the likely uptake of the products the sector rolls out. While significant interest has been identified, it is usually qualified on the retail and SME side by the fact that potential demand is not irre-spective of cost.

Attijariwafa Bank’s managing director Ismail Douiri told Reuters in an interview earlier this year that Morocco has a very competitive banking market, and Moroccans are very price-sensitive, so he was not expecting a sudden, dramatic impact, as it is almost impos-

sible, he said, to have products with the same prices as those emanating from conventional finance, at least initially.

Price competitiveness will not be the only test facing this fledging sector. The training of in-dustry professionals, in particular the develop-ment of the expertise of local scholars, is a key requirement to ensure the long-term growth of the industry, as is the development of a stan-dardised Shariah framework and correspond-ing documentation. Having a Central Shariah Board, rather than individual banks pronounc-ing on matters (as is the case in some coun-tries), should assist in streamline the crossing of hurdles faced.

According to Ernst & Young, global Islamic fi-nance assets are expected to climb to USD 3.4 trillion by 2018 from about USD 1.7 trillion in 2013. The international backdrop, therefore, is enticing. With the advantage of learning from experiences elsewhere, a bright future for Islamic finance in Morocco is predicted by many.

The Moroccan Association of Participa-tive Financiers, for instance, estimates total investment in Shariah-compliant products to reach USD7 billion by 2018, assuming that all goes to plan with the passing of the Islamic Law this year. Thomson Reuters estimates that Islamic banking assets could potentially reach $8.6 billion by 2018 – ac-counting for around 5% of total banking as-sets, up from a current base of 0.5%, with a profit pool of between $67 million and $112 million in view for Islamic finance providers.

It is yet one more example of the welcom-ing prospect that the industry presents to those willing to invest the appropriate ef-forts.

Sources: Thomson Reuters, Ernst & Young, Clif-

ford Chance, The Banker, Bloomberg, Financial

Times

ConferenceReflections on the 4th Islamic Banking & Finance Conferenceby Vasileios Pappas and Andrew Shouler

The 4th Islamic Banking and Finance Conference was hosted this month by the Lancaster Univer-sity Management School (LUMS).

Co-organised by the El Shaarani Centre for Islamic Business & Finance (EIBF) at Aston Busi-ness School, the Gulf One Lancaster Centre for Economic Research (GOLCER) and Durham Busi-ness School, the well-attended event provided a forum for an exchange of views on key issues and challenges in the sector.

With a record attendance of over one hundred participants, it is the largest empirical research gathering in the field of Islamic finance in the UK. Delegates came from over thirty countries, including Malaysia, Australia, the USA, France, Algeria, Pakistan and Saudi Arabia, to name but a few. The discourse benefitted from the offer-ing of ideas from individuals involved within the many facets of Islamic finance, whether re-searchers, regulators, or practitioners.

The Dean of LUMS, Professor Sue Cox, gave an opening speech addressing the sustained growth of Islamic finance in the past five to ten years, and the substantial scope for future expansion. The fact that three institutions were collaborating in the UK to research this area of banking itself marked a notable step forward in reflection of the subject’s current resonance.

The keynote speech was given by Professor Thorsten Beck of Cass Business School and Tilburg University, explaining the role of Islamic banking in the modern world. It highlighted the results of a research study comparing the per-

formance of both Islamic and conventional banks from around 22 countries, with aspects of business orientation, efficiency, asset quality and stability. Islamic banks were revealed to be more capitalised but less cost-efficient, which could be due to differ-ences in the business model. As to lines of future research enquiry, those might include the drivers of the expansion of the industry, its role in financial in-clusion, and the type of customers who uses Islamic banking services, as well as the type of products offered, given a choice in the market between competing systems.

The series of presentations consisted of original contributions on topical matters, including Islamic finance’s specific contribution to economic growth, the requirements of risk management, the Islamic variant of microfinance, the regulation, supervision and comparative performance of Shariah-compli-ant institutions, and corporate social responsibility, as well as technical issues of their efficiency, stabil-ity and default risk. Also covered were investment-related matters of Islamic indices and stock market returns.

The topic receiving the best paper award had analysed the stock market reaction to 131 sukuk is-suances from eight countries over the period 2006-2013. It found that the type of sukuk and choice of scholars hired to certify these securities matter for the market valuation of the issuing company. In particular, the analysis revealed that Ijara (lease) sukuk structures exert a positive influence on the stock price of the issuing firm.

Another interesting contribution extended the empirical studies linking investor mood and finan-cial market behaviour, in particular the impact of psychological effects associated with Ramadan celebrations. Using data as far back as 1990, from seven predominantly Muslim countries, the results indicated that ‘herding’ activity is significant dur-

ing Ramadan in the majority of the markets examined, with the exceptions of Malaysia and Pakistan. The findings have important relevance to international investors dealing with these markets.

Among ideas put forward of immediate note in the UK, one attractive example was a proposal on Islamic student loans, seeking to enable access to university education for Muslims who wish to abide by Shariah rules but cannot afford the UK’s £9000 pound/year fee. This piece of research may have important policy implica-tions, as it could help engage the segment of Muslim students in the UK that are currently ex-cluded from education due to being religiously restricted from borrowing from the conventional sources operating on an interest basis .

As to the global context, Islamic banking is now practised in more than twenty countries, with a steadily growing suite of services and instru-ments available including bonds, equity indi-ces and insurance. The annual growth rate is estimated at this point at around 16%, relatively unaffected by the global financial crisis. Cur-rently Islamic finance products, which total in excess of $1.2 trillion, are offered by 350 institu-tions worldwide.

A central theme in Islamic finance has been its revealed, relative resilience compared to conventional counterparts, as there is grow-ing evidence that the constraints applied by Islamic banks protected them to an extent from the shocks of the international credit crunch. It is that finding that has especially attracted the attention of market participants and research-ers to the Shariah-compliant banks, and their liquidity buffers, leverage ratios, managerial efficiency and bespoke financial products.In respect of the UK, which aspires to become an important hub for the development of Islamic

finance and currently is home to more than four times the number of banks offering Islamic financial services in any other country in Western Europe, there is over $19 billion held in Islamic assets here, and pioneering tax law reforms have been brought in order to support further growth of the sector.

With the continuing rapid growth and interest in the sector, the Islamic Banking and Finance Conference promises to become a focal point for academics, ad-ministrators, advisory bodies and practitioners alike. More than anything, the event will facilitate what has become observed as the necessity of inter-connect-edness, on a cross-border basis, to seek resolution of the issues that remain outstanding in the sector, and help enhance awareness of its offering.

FeatureStrategies for the Islamic Financial Services IndustryReflections on the Mid-Term Review (MTR): A Joint Initiative by IRTI and IFSB by Hylmun Izhar

The most anticipated Mid-Term Review (MTR) of the 10 Year Framework and Strategies was recently launched in conjunction with the 11th IFSB (Islamic Financial Services Board) Summit, hosted by the Bank of Mauritius.

Its 13 core recommendations were firstly published by the Islamic Research and Train-ing Institute (IRTI) of Islamic Development Bank (IDB) in collaboration with IFSB in March 2007.

The main idea was to systematically study, dis-cuss and propose policy responses for the or-derly development of the Islamic Financial Ser-vices Industry. The 10Y framework document could ultimately provide a general blueprint or guideline for new and existing Islamic finance jurisdictions in designing and developing their national plans and major initiatives as part of their financial sector development policies.

A number of leading specialist and practitio-ners had prepared technical papers on vari-ous themes that were presented in a technical workshop jointly organised by IRTI and IFSB in 2005 in Dubai, hosted by the Dubai Finan-cial Services Authority. Subsequently, IRTI and IFSB jointly organised a policy dialogue on the same theme in Malaysia, facilitated by Bank Negara Malaysia. A drafting committee was formed, which held three meetings and final-ised a draft document.

At its final meeting in August 2006 in Kuala Lumpur, the drafting committee reviewed all the comments and the feedback received and reached a consensus on the revised document.

Contents of the Mid-Term Review

The Mid-Term Review of 2013 was aimed at assessing the impact of macroeconomic events, to monitor progress in implementing the rec-ommendations, and to propose additions or modifications to the recommendations to guide the industry.

In conducting the MTR, IRTI and IFSB were supported by a number of prominent research institutions, and have engaged with leading regulators, market players, academicians and Shariah scholars through various intensive dis-cussions during the roundtables held in Qatar, Malaysia and Turkey whereby IRTI and IFSB had an opportunity to obtain further insights from the key stakeholders and the panel of Review Committee.

The key findings were as follows:

Firstly, the industry has shown growth and re-silience, with growing market share and profit-ability, an expanding number of institutions, and numerous industry-level initiatives under way, reflecting customer confidence in the sec-tor, whose con¬cept is proven in many markets.

Secondly, macroeconomic events or external factors have brought both challenges and op-portunities to the sector, which has not been im-mune to the effects of the global financial crisis, by way of the economic impact, the approach to financial regulation, the strength of partners

and counter¬parties, and the value of assets and in-vestments. Nevertheless, some countries have acted as important centres of growth as the global econ-omy has stumbled. Political developments in recent years have also made several countries more open to Islamic financial services. Technological innova-tions such as branchless financial services are now available, and can allow the industry to broaden its future reach.

Thirdly, the development of the industry has varied by sector, while estimates of its total asset size and growth rate vary significantly (either near or well above USD 1 trillion). As a key example, Islamic microfinance has transitioned from a concept with isolated case studies to a fledgling sector across multiple markets. Moreover, although the market values of certain Shariah-compliant instruments have shown mixed performance due to overall capital market challenges, and Shariah-related challenges remain, the breadth and sophistication of such instru¬ments has improved.

Inevitably, modifications on the original document have been made, in order to reflect the current sta-tus of the Islamic Financial Services Industry (IFSI).

Three additional recommendations aim for the fol-lowing --

a) to develop an understanding of the linkages and dependencies between different compo-nents of Islamic financial services, to enable more informed strategic planning to be under-taken;

b) to foster and embrace innovative business models, including new technologies and deliv-ery channels, in offering Islamic financial ser-vices;

c) to strengthen contributions to the global dia-logue on financial services, offering principles and perspectives to enhance the global finan-cial system.

Furthermore, a 3-pillar framework has been introduced, namely Enablement, Performance, and Reach, and Key Performance Indicators (KPIs) developed to help address weaknesses and monitor progress in a more focused manner.

Progress made on the original recommendations has been mixed. For instance, many countries have adopted international standards specific to Islamic financial services; however, many have not yet fully done so.

A stronger Implementation Plan is to be un-dertaken by a range of stakeholders, amongst which it is suggested that the role of central banks and governments are especially impor-tant. Twenty Key Initiatives have been synthe-sised and prioritised. These are classified in line with the three pillars of the framework – Enable-ment, Performance, and Reach; summarised in the accompanying chart.

Enablement Integrate Islamic finance in national development plansIntroduce national Islamic financial services master plansEnhance regulatory implementation and enforcementHarmonise, where possible, regulation and regulatory frameworks across bordersAdopt and strengthen national Shariah governance frameworksWhere mandates overlap, align the positions of industry bodiesLink Islamic financial markets across bordersForm a “Technical Assistance and Linkage Network”Form regional working groupsFoster information-providing institutions that support the provision of Islamic finance Incorporate Islamic finance data in statistical and official reporting

Performance Institute centralised R&D for Islamic financial products in addition to the decentralised R&DEstablish diversified financial institutionsDemonstrate the industry’s distinctive value propositionFund public infrastructure projects to build Islamic capital markets

Reach Revitalise zakah and awqaf for greater financial inclusion and make them an integrated part of Islamic financial systemEnsure that regulations allow for the use of new technology to provide affordable servicesEngage with newly-opened marketsFoster the financing of a wider set of economic sectorsBrand Islamic financial services for wider markets

Conclusion

The world consists of a diverse group of nations; which span a range of regions, cultures and stages of economic development in which Islamic law, common law, and civil law jurisdictions are ad-opted.

In conducting the Mid-Term Review, it was ob-served that diverse views were particularly salient in regards to: (a) whether countries should have specific laws for Islamic financial services or rather fit Islamic structures into a single set of financial services laws; (b) whether countries should adopt national-level Shariah boards or retain Shariah governance solely at the institutional level; (c) whether central banks should allow conventional institutions to offer Islamic financial services; (d) whether the adoption of international standards specific to Islamic finance is essential; and (e) whether product standardisation should be a policy objective or not.

While diversity of use in these areas is appreci-ated, a key underlying theme is that a supportive public policy stance is essential for enabling the industry to reach its full potential. Different coun-tries have been successful under various models; each choice brings benefits and drawbacks. Nevertheless, a strong and supportive public policy stance can help contribute to greater con-fidence that energises the private sector.

The MTR therefore does not seek to prescribe specific approaches to the choices above. It does, however, urge various jurisdictions to deliberate carefully on these matters and form well-considered strategies. The MTR also in-dicatively suggests that Islamic financial services offer benefits to the people and economies of the public at large, and advocate thoughtful strate-gies on how best to avail of these benefits.

Hylmun Izhar, PhD is an economist at IRTI-IDB

GCCMost of the GCC’s indices gained again in May, bringing the collective advance to nearly 20% in the year to date. Qatar was best-performing ahead of its inclusion in MSCI’s emerging market index, while the twin UAE bourses were comparatively volatile -- reflecting a certain degree of disquiet among international benchmarks -- having made greatest progress during 2014 so far. Investor sentiment remained generally positive in the aftermath of the earnings season, with economic growth still well supported by oil prices firmly in three-digit territory, lifted partially by the Ukrainian case, and subsequently geo-strategic Middle East issues. The conflict and turmoil in Syria and Iraq nonetheless prompted a drop in Gulf stocks in June, taken by analysts to be only a correction as renewed buying quickly reappeared, although book-squaring was expected ahead of the quieter Ramadan period.

Egypt / MENA

Egypt’s stock market too was affected by MSCI’s index deliberations, as the compiler declared it was no longer considering downgrading the country to frontier status. The announcement in late May was followed by a sharp bounceback

for shares which had slumped upon news of a 10% capital gains tax to be imposed. A key consideration in the agency’s decision was the accumulation of foreign reserves in the past year, and corresponding appreciation and stability of the currency. Merger plans between Beltone and EFG-Hermes investment banks also gave a fillip, as did Saudi Arabia’s call for Egypt to benefit from an international aid effort upon the accession of former army chief Al-Sisi to the presidency. Elsewhere, Turkey’s Borsa Istanbul retreated from its improvement over several weeks as violence surged in Iraq, given the impacts on trade and oil prices.

South East AsiaMost Asian stocks were well supported by the combination of a strengthening US

Stock Markets

economy in tandem with the retention of very accommodative monetary policy, recovering ground previously lost. Better signs from China imparted confidence too. The Thai market featured, reaching peaks this year despite the imposition of martial law, as the new military rulers set about restoring order, for instance in ensuring cash flow at state firms. Foreign funds that initially were driven away found themselves drawn back, in league with domestic investors. Other bourses were influenced by incidental factors, such as Malaysia’s robust growth data for Q1, softer GDP numbers relative to expectation in the Philippines, and Indonesian interest rates being held steady rather than easing as hoped.

Rest of the World

US equity indices maintained their form in the period covered, backed by easy-money alongside the sense of economic pick-up, including buoyant housing figures, a better jobs report, and firmer inflation. In Europe traders adopted the theme of recent times that bad news is good news, insofar as signs of economic weakness will be met by the persistence of cheap credit and the authorities’ promotion of liquidity-based stimulus. The European Central Bank signalled its intent not only to keep interest rates low, or negative, but to bring forward other extraordinary measures if necessary, suggesting to investors that there might be currency relief to come. Russia and India (where for the first time in thirty years an overall government majority resulted from a general election) stood out among emerging markets.

Sources: GIC, Reuters, Bloomberg, broker reports

Islamic or Shariah compli-ant indices exclude indus-tries whose lines of busi-

ness incorporate forbidden goods or where debts/

assets ratios exceed 33%. The increasing popular-ity of Islamic finance has

led to the establishment of Shariah compliant stock

indices in many stock markets across the world, even where local Muslim populations are relatively

small, such as in China and Japan.

Volatility is a measure of un-certaincy of market returns. It is calculated as the standard deviation of the returns in the reported month. The formula for the standard deviation is:

σ=E[(X-μ)2]1/2

Islamic Stock Indices

Conventional Stock Indices

Evolution of Islamic Stock Markets in May 2014 for GCC, Far East, Middle East North Africa (MENA) and Rest of the World markets. Prices represent the closing price of the respective index at 30/5/2014. Percent-age Month-to-Month (MTM) Change and percentage Volatility. Source: Datastream

Evolution of Stock Markets in May 2014 for GCC, Far East, Middle East North Africa (MENA) and Rest of the World markets. Price represent the closing price of the respective index at 30/5/2014. Percentage Month-to-Month (MTM) Change and percentage Volatility. Source: Datastream

CommoditiesOilGeopolitical concerns, particularly over Ukraine, lifted oil prices in May, as well as the delayed return of Libyan exports and the re-emergence of Asian demand. These factors broadly offset the impression of sluggish global economic growth and the record high reached in US inventories. Overall, the markets were roughly sideways, exhibiting the lowest levels of volatility in a decade. In June traders’ attention was seized by the Iraq insurgency, both for its political fallout and its potential to disturb the country’s crude supplies, though situated some distance yet from the conflict zones.

Gold/Precious MetalsGold turned softer again during the period, as US Federal Reserve pronouncements that inflation pressures remain muted were taken on board, with the key measure still below the 2% target. Hedge funds reduced long positions, as money reverted to equities in the face of diminishing worries about economic slowdown. Analysts expected a slide in prices until a possible seasonal rebound in the third quarter. Events in Iraq induced safe-haven buying again, however, and Fed chairman Yellen’s remarks that interest rates would persist low gave further encouragement, although a range-bound trend still seemed set.

Copper/Base MetalsDuring May copper prices gained as fears receded of retrenchment in the Chinese economy. Industrial data strengthened, matching an improvement in counterpart US figures that also boosted confidence. Sentiment deteriorated in June, though, when an investigation was initiated by the authorities into fraudulent trading of copper in China, part of a crackdown on the shadow finance sector. Experts took the

potential curtailment of funding transactions as a bearish signal for dealing. Underlying motivation of prices depended, however, mostly on the continual variation of economic statistics, which lacked direction.

Sources: OPEC, Reuters, Bloomberg

GCC

Bonds in the Gulf space benefited through May and into June from the helpful backdrop from US Treasuries, whose progress has surprised analysts this year. In most recent weeks, however, the regional troubles in Iraq took some hold of sentiment, and yields moved higher. Risk appetite diminished somewhat, and attention was drawn back to new issuances. Liquidity generally has been light enough that prices have been well bid when confidence is in place, with underlying local demand tending still to outstrip supply, although financials such as RAKbank and Commercial Bank of Qatar have come to market to take advantage of low borrowing costs. Corporates such as MAF and Qtel, meanwhile, have faced a certain amount of profit-taking, having rallied.

Egypt / MENA

Egypt’s international bonds have continued to climb on the back of an extended period of political stability, despite simmering tensions in the country. Likewise, the firmer standing of the pound and national finances have given comfort to investors that a better platform is in place for investors’ trading, especially with the specific call from Saudi Arabia that more support should be given from the region to aid the Egyptian economy. Invest AD reported Egypt 2020 bonds trading at roughly 4.75%, the lowest since December 2010, and 2040 bond yields down to 6.85%, the lowest since November 2012. International accounts have taken greater notice as well, encouraged to seek rewards again in emerging markets, with benchmark market yields having become so low.

Malaysia / South East Asia

Asian bonds were motivated in the period covered by investors’ renewed search for yield, with G3 monetary settings all very easy still,

Bonds and CDS markets

Credit Default Swap Markets

Sovereign Bond Markets

Evolution of Bond Markets in May 2014 relative to the previous month. The table reports the price index on which the MTM Change is calculated (month-to-month) and the Yield of sovereign bond maturities typically between 6 months and 25 years. Data as at 30/5/2014.

Evolution of CDS Spreads in May 2014 relative to the previ-ous month. The index reported here represents the average ba-sis points (bp) of a 5-year CDS for protection against sovereign bonds. Data as at 30/5/2014. MTM Change refers to the change relative to the previous month.

with Europe’s stance becoming even easier, and US benchmark prices having climbed again. Currency volatility’s decline was a sign of sanguine sentiment, leaning towards risk-taking. Regional countries’ economies were also expected to benefit from signs that China is allowing the yuan to appreciate again, impacting on relative competitiveness. At the same time, the continuation of stronger economic data, e.g. manufacturing output, in Malaysia caused yields to firm, with suspicion that the central bank would have to consider raising interest rates. A better credit outlook expressed by agencies on the Philippines underpinned confidence.

Global Benchmarks

By mid-June US Treasuries had settled at elevated levels, the result of a combination of forces. The Federal Reserve has continued to promise accommodative policy, despite the economic upswing, as inflation remains apparently under control. Foreign accounts, including central banks, have bought into the persistent appeal of liquid dollar fixed-income, partly as the response to safe-haven need in the face of global political and security flashpoints. The European Central Bank’s declared intent to keep downward pressure on interest rates, and implicitly to weaken the euro, meant that the bund yield discount was reaching its limits. Regulatory pressures have added to demand for bonds, while improving budget figures have limited the need for additional supply.

Source: Invest AD, Emirates NBD, Bloomberg, broker reports

Islamic Bonds (Sukuk)

The tone in secondary trading essentially switched from May to June, as the rally in emerging-market and frontier credits was reversed upon developments in Iraq and US yields trending higher. International funds showed nervousness, and regional accounts in the Gulf absorbed only part of the selling pressure.

Focus was mainly again on the primary market. New names were well received and recent offerings traded well following a typical dip immediately upon issuance. Kuwait Finance House’s monitor described May’s total in the GCC as “monumental”, demonstrating once again the region’s continuing appetite relative to supply. As documented in last month’s edition, Dar Al Arkan, ICD and IILM featured in that period.

In June Emaar Malls sold a 10-year, $750m debut sukuk, which met with strong investor demand and picked up upon trading. The order book exceeded $5bn; pricing was at a profit rate of 4.56%.

Saudi Telecom Co (STC) completed a 2bn riyal ($533m), 10-year debut sukuk issue, almost twice oversubscribed, with a floating profit rate of 70 basis points over 3mth Saibor.

Saudi Investment Bank (Saib) also raised a 2bn riyal, 10-year sukuk, as a reserves-boosting measure. The subordinated Islamic bond, adding to Tier 2 supplementary capital, allows the bank to buy back the paper at mid-term. Pricing was at 145 bps over 6mth Saibor.

Similarly, Banque Saudi Fransi completed a 2bn riyal capital-enhancing sukuk, priced at 140 bps over 3mth Saibor. It too has an option for the bank to repay investors after the fifth year, and was priced at 140bps over 3mth Saibor.

Saudi Arabia’s National Petrochemical Co (Petrochem) issued a 1.2bn riyal debut sukuk, with a

5yr lifespan, priced at 170bps over 6mth Saibor.

Abu Dhabi’s Al Hilal Bank also issued a $500m capital-boosting sukuk, as again high demand helped reduce the borrowing cost, with guidance revised tighter. The perpetual transaction can be bought back by the lender after the fifth year. Order books were worth around $5bn.

Beyond the Gulf, activity was not so forthcoming, but had interesting features.

Public Islamic Bank, the Shariah-compliant arm of Malaysia’s third-largest lender, issued the first tranche of a 5bn ringgit sukuk programme. The 10-year murabahah issue has an annual return of 4.75%, with proceeds heading for working capital and general corporate purposes.

Hong Leong Islamic Bank Bhd successfully issued the first, RM400m tranche of its subordinated Sukuk Ijarah, part of a RM1bn programme. It was priced at 4.80%, with a bid to cover ratio of nearly three times.

Pakistani conglomerate Engro Corp raised 1bn rupees ($10m) from the retail market, as part of a 4bn rupee programme set up earlier this year, said to be a rare example of a retail offering of sukuk.

Most recently, the UK issued its much-anticipated sovereign sukuk, with orders exceeding £2bn, some ten times the planned issue amount. The five-year offering has been launched as part of an effort to boost London’s position as a centre for Islamic finance rather than essentially for funding needs. The profit rate was set at 2.04%, in line with conventional gilts of similar maturity.

Sources: KFH, GIC, Reuters

Research TeamGerry Steele

[email protected]

Vasileios [email protected]

Marwa El [email protected]

Marwan IzzeldinDirector

[email protected]

DISCLAIMER

This report was prepared by Gulf One Lancaster Centre for Economic Research (GOLCER) and is of a general nature and is not intended to provide specific advice on any matter, nor is it intended to be comprehensive or to address the circumstances of any particular individual or entity. This material is based on current public information that we consider reliable at the time of publication, but it does not provide tailored investment advice or recommendations. It has been prepared without regard to the financial circumstances and objectives of persons and/or organisations who receive it. The GOLCER and/or its members shall not be liable for any losses or damages incurred or suffered in connection with this report including, without limitation, any direct, indirect, incidental, special, or consequential damages. The views expressed in this report do not necessarily represent the views of Gulf One or Lancaster University. Redistribution, reprinting or sale of this report without the prior consent of GOLCER is strictly forbidden.

Andrew ShoulerEditor

[email protected]

Islamic Finance Bulletin June 2014

Documents

Transcript of Islamic Finance Bulletin June 2014