Islamic finance awards 2010: Islamic finance joins the global mainstream


Dominic O’Neill
Published on:

Even while it began to grow in developed markets, Islamic finance faced key tests. Fears about the enforceability of sukuk contracts in the Middle East might have proved exaggerated, but critics of the industry’s mimicking of conventional finance remain.

Islamic finance awards

Islamic finance joins the global mainstream

Institutional Awards
Best international Islamic bankBest Islamic bank in the Middle East
Best Islamic bank in AsiaBest sukuk house
Best takaful provider Best project finance house
Best leasing house Best fund manager
Best assurance and advisory firmBest legal advisory firm
Most improved Islamic finance houseBest structured products house
Deal Awards
Deal of the year Best sukuk deal
Most innovative deal Best project finance deal
Outstanding contribution to Islamic finance
Badlisyah Abdul Ghani

ISLAMIC FINANCE, AND more particularly the sukuk market, might have passed its first big test – or at least confirmed its conformity to conventional risk.

Last year an Islamic bond defaulted for the first time in the Middle East, one of the product’s two core markets – and the market with the more stringent Islamic rules. This happened when Kuwait’s The Investment Dar (TID) missed a payment on a $100 million sukuk issued in 2005.

Less than a year later, this event might have ultimately demonstrated that Middle Eastern companies defaulting on sukuk would not exploit their adherence to Islamic principles of shared risk completely in line with the theory of Islamic finance. It seems to have shown that when things go wrong, investors in Middle Eastern Islamic instruments might not be left with much less, or with a far less absolute claim on collateral, than in the conventional market in the region.

Despite all its financing being Islamic, the restructuring of TID seems to have given way to an ordered process of consultations, and a fairly recognizable series of resolutions. By the end of the year, more than two-thirds of TID’s banks and investors, representing around 200 local, regional and international firms, had agreed to a restructuring plan. Islamic scholars had given their go-ahead.

Meanwhile, at the end of 2009, another Kuwaiti investment firm, Global Investment House, had completed its restructuring, a portion of which was Islamic (there was no sukuk, however).

Some industry insiders argue that these restructurings serve as models for other companies, especially in the Middle East, that have missed payments on their financing.

Indeed, by the beginning of 2010, the complicated restructuring of the troubled Saad group in Saudi Arabia, with its $650 million sukuk, was apparently making more progress. Investors in entities in Dubai World, the state-linked investment company, were similarly getting better news, or at least clearer news. This was apparently more evidence that debt-renegotiation processes in the Middle East were gradually becoming more standardized.

In the US, where bankruptcy law is more established, a court in Louisiana appeared, as Euromoney went to press, to be moving towards recognizing the rights of the investors to the underlying oil and gas assets of the $166 million 2006 East Cameron sukuk. This could be another happy ending for an Islamic finance industry that has sometimes worried how courts might interpret the rights of investors in sukuk.

The extreme volatility of the global capital markets over the past two years, as well as those scares that have been more specific to Islamic finance and to the Middle East, have promoted the development of Islamic asset and liability-management products – derivatives, in other words. In 2009, structuring and arranging hedging instruments against rate and foreign-exchange volatility became a much bigger part of the business in which Islamic bankers and lawyers were engaged.

A prime example of this was the large profit-rate swap, an Islamic equivalent of an interest-rate swap, that was attached to a $2.6 billion Islamic loan to the Saudi Arabian section of Kuwaiti mobile-phone operator Zain. For a notional amount of an equivalent of about $2.2 billion, this was the biggest profit-rate swap ever transacted, and the local-currency portion was the first profit-rate swap denominated in Saudi riyals.

Insiders say this focus on risk management will continue in 2010. A long-awaited introduction is expected this year of a standardized master agreement for over-the-counter Islamic derivatives trading. This would dramatically reduce the time required to negotiate Islamic hedging transactions. The master agreement is being formulated by the International Swaps and Derivatives Association in New York, alongside the International Islamic Financial Market, a Bahrain-based organization of Middle Eastern and Asian governments and central banks.

More risk-conscious Islamic banks and financial institutions are moving away from their former concentration on investments in real estate and private equity. This is helping to create more demand for money market-style securities, which is encouraging developed-market and investment-grade sukuk issuance.

"Sukuk is going mainstream," says Simon Eedle, global head of Islamic finance at France’s Calyon.

"The future of Islamic investment banking is likely to be firms with better fee-generating capacity"

Anouar Hassoune, Moody’s Investors Service

Anouar Hassoune, an Islamic-finance specialist at Moody’s Investors Service
Anouar Hassoune, an Islamic-finance specialist at Moody’s Investors Service, points out that independent Islamic investment banks have found it more difficult to access funding since the beginning of the crisis, which has compromised their ability to do new business, even if it has not pushed them into restructuring. "Islamic investment banks that are backed by the larger commercial banks are achieving more prominence. The future of Islamic investment banking is likely to be firms with better fee-generating capacity," he says. The result might be less activity by the kind of small, ambitious, and lightly regulated but risky Islamic banks in Bahrain, for example, some of which basically acted like private-equity firms, with a strong inclination towards property.

Last November’s $500 million GE Capital sukuk was therefore a landmark deal. The International Finance Corporation’s $100 million five-year sukuk, issued at roughly the same time, was also important for the development of an increasingly safe pool of Islamic assets.

Being corporate, and not officially government-guaranteed paper, the GE Capital sukuk cannot be given a zero-risk rating by banks for their regulatory capital requirements. But in practice, in December, for example, banks might have viewed the GE Capital sukuk as far more secure than the Islamic instruments guaranteed by the emirate of Dubai, which was at the centre of the Gulf property bubble.

GE Capital says it intends to issue more Islamic instruments. More sukuk is expected from oil companies, utilities and other corporate stalwarts in the west.

Yet despite all this newfound caution, on-balance-sheet Islamic bank assets are estimated to have grown around 20% in 2009 to about $820 million. If assets in Islamic funds and insurance are included, the industry’s asset base is expected to breach the symbolic mark of $1 trillion in 2010.

Talk of the creation in 2010 of an Islamic mega-bank through a coalition of institutions might not even be completely unrealistic. However, this mega-bank, which was originally broached by Sheikh Saleh Al Kamel (the Saudi patriarch behind Al Baraka Banking Group in Bahrain) might be more likely to have paid-up capital of around $1 billion or $1.5 billion, instead of the $10 billion previously suggested to the press.


The internationalization of Islamic finance is not restricted to the developed world. The governments of Kazakhstan and South Korea are considering issuing sukuk. One lawyer tells Euromoney he is working on an Islamic financing in Russia. In several African countries Islamic banks are being established and Nigeria was planning a summit on Islamic finance in Abuja in February.

But as Islamic banks grow and become more mature and conservative, and as new Islamic banks are established, the demand increases for Shariah-compliant investments – especially of the more secure type. At the same time, the financial crisis has made corporations around the world even more aware of the importance of Middle Eastern and Muslim petrodollars.

In fact, the biggest buyers of sukuk are usually institutions from outside the Islamic world, and from developed markets. But issuers can build a bigger order book by not excluding Islamic investors, and governments are keen to develop growth industries. Countries and companies issuing in an Islamic format can also increase their profile in the Middle East, which can give them a commercial advantage in a rich and fast-growing region.

Business-savvy governments understand this. Sources tell Euromoney, for example, that Ireland, Italy, and Spain are all implementing or considering regulatory and legislative reform to make Islamic financing easier. In September, France, which has 4 million Muslims, changed its civil code to help the structuring of Islamic financial products using the French equivalent of trusts – despite the French state’s usually vehement secular stance. There has been talk of an unnamed French financial institution issuing Islamic debt, as well as rumours that Italy’s UniCredit might open an Islamic window.

Islamic banks performed relatively well early in the sub-prime crisis because Shariah rules had prevented them investing in the blatantly interest-carrying structured finance products. But after Lehman collapsed – and as global and regional funding dried up, equity prices crashed, and property bubbles burst – Islamic finance joined the crisis.

It is relatively easy to comply with Shariah rules when investing in property and when investing in assets where property is the underlying collateral. Some argue that this predilection for property in Islamic investing added fire to the Middle East’s property bubble, especially in Dubai. They say it left some Islamic financial firms particularly exposed to the regional downturn.

From another perspective, however, the main cause of the credit events of the past year was not the firms’ having accessed or invested in Islamic finance. In most cases, some argue, it was simply attributable to the conventional failure of having over-extended in a bull run – of managers having imagined the good times would never end.

Nevertheless, the question still remains whether such investment bubbles could be better avoided if adherence to Islamic principles was more, not less, strict. Regardless of the rights and wrongs of either structure, there is certainly a feeling in the market that sukuk needs to be more clearly and more consistently marketed as being either a risk against the issuer (and therefore more asset-based) or against the underlying project (and therefore asset-backed).