Sri Lanka: A stronger player in 2016?

With a costly bloody war in the past and a new president at the helm, Sri Lanka is charting a successful economic recovery with strong reforms in place that are building the case for a greater private sector development and bigger FDI flow. The fastest-growing South Asian economy is well-positioned to reap the benefits of a more robust economic growth this year and very likely so will its burgeoning Islamic finance industry, VINEETA TAN observes.

Sri Lanka has had regulations recognizing Shariah compliant banking transactions for over a decade now following the amendment of the Banking Act No 30 of 1988 in 2005 which allows commercial banks and specialized banks to offer Islamic finance products. It was also made mandatory by the Central Bank of Sri Lanka for these banks to maintain separate books of accounts as well as comply with the existing regulatory framework and prudential regulations imposed on conventional banking business.Market players have, however, lamented that the regulatory framework is not solid enough to support the Islamic financial community, citing a lack of documentation standardization and the absence of a level playing field as reasons. Nonetheless, the government seemed committed to bolster the industry and has reportedly indicated that it may issue a positive policy statement seeking to facilitate Sukuk transactions as well as other Islamic banking deals.

Banking and finance
The number of Islamic finance providers is growing in Sri Lanka. According to figures provided by Richard Pieris Arpico Finance, there are 44 participants in the local Shariah financial space including 16 in the banking and finance sector, four in Islamic insurance, nine in consultancy and advisory, four in education, three in software and IT, two in publishing and two in microfinance.In the banking and finance segment, Islamic banking window operations dominate in terms of numbers; there is only one fully-fledged Islamic bank — Amana Bank, which became a member of the IFSB in 2015. In the same year, Commercial Leasing Finance and Adam Capital joined the Shariah financial community.

After years of monopolizing the Takaful market (since 1999), Amana Takaful’s status quo was rocked in 2013 HNB Assurance entered the scene with a Takaful unit. Competition became greater in 2015 when two insurers launched Takaful windows: People’s Insurance and LOLC Insurance.Section 53 of the Regulation of Insurance Industry (Amendment) Act No 3 of 2011 requires composite insurance operators to split their life and non-life insurance business into two separate legal entities, which came into effect the 1st January 2015 and saw Amana Takaful segregate its operations into two separate business entities. As a result, all life insurance policies were transferred to Amana Takaful Life.

Other positive developments in the Sri Lankan Islamic finance space include the formation of the Association for Alternate Financial Institution in 2015 — a forum/platform to discuss issues relevant to the Shariah finance landscape and act as a collective representation of policymakers to facilitate accounting, tax and legal changes. The association has reportedly begun taking initiatives and lobbying the government to introduce Shariah compliant treasury bills/Sukuk to create an avenue for Islamic financial institutions to park their surplus funds in.The Republic is also said to be applying for an IDB membership — a calculated move taken in order to access greater funding.

The Islamic financial market of Sri Lanka may still be fragmented and may be in need of a better regulatory framework to level the playing field, and the industry still faces challenges in terms of human capital pool and product development; however, the country is exhibiting positive momentum as interest is swelling from the ground up, attracting market players to continue to explore and build their capacity in Islamic finance.The year 2015 has seen more players joining the fray as well as greater product diversification and 2016 is shaping up to be another interesting year for Sri Lanka with the possibility of new regulations in place as the government begins to position itself to tap the Islamic capital markets.

Negative interest rates and Islamic finance: Where ideology meets reality

Negative interest rates, which were once unbelievable by most economists, now do not seem abnormal. Zero interest rates do sound familiar as most of us would have studied it as part of economics; however, interest rates are now getting pushed into the negative territory. LOKESH GUPTA and NAFIS ALAM write.

The turmoil in financial markets has been observed globally due to tumbling oil prices, uncertainty due to China’s slowdown and US rate hikes. The fallouts due to the global downward spiral are surfacing and policymakers such as the central banks in Europe, Japan, Denmark, and Switzerland have already adopted the path of lowering interest rates to below zero and now it has gone negative. 

In layman’s terms, the plunge in interest rates signifies an increase in fiscal deficit, deflation (fall in prices) and weak economic conditions. Central banks opt to cut interest rates as a measure to make saving less attractive by charging commercial banks and depositors for keeping their money with banks. This means depositors will have to pay to keep their money with banks. This is intended to incentivize banks to lend money more freely to individuals and corporates to invest, inject into businesses, and spend money rather than paying a fee to the central bank. The increase in flow of money into the economy will boost industrial production and recovery. The effects of negative interest rates can be summarized as follows: 

  • Retail/corporate depositors will be charged for holding their money with banks
  • The central bank will charge commercial banks for reserves
  • A reduction in borrowing costs to stimulate lending and boost inflation
  • Increase in spending and investment elsewhere due to negative returns from deposits, and
  • Lower or negative yields on bonds.

If we compare the present market situation with the principles of Islamic finance, we can observe that this has been thought through and is well taken care of under the fundamentals of the Islamic financial system. 

The Islamic financial system, which is also known as interest-free banking, provides pro-active measures to ensure that the economy does not reach the point of a spurting economy. The surprising fact is that the ‘pro-active’ measures followed under the Islamic financial system are ‘reactive’ measures followed by the conventional economy for recovery.

Interest is strictly prohibited under Islamic finance and it emphasizes the ethical, moral, social, and religious dimensions. The most fundamental pillar of Islamic finance is the profit-sharing feature and permissible (Halal) financial products and services, which must be in compliance with Shariah. The principles of Islamic finance focus primarily toward uplifting society through the concept of justice, equitable distribution of wealth, risk-sharing, no gambling and the sanctity of contracts and offering Riba (usury)-free products and services. 

Table 1 shows the aftereffects of negative interest rates, which lead to positive measures for economy recovery which has already been pre-defined under the principles of the Islamic financial system. 

Table 1: Aftereffects of negative interest rates

Positive effects of negative interest rates


Reactive measures in conventional financial system due to negative interest rates


Proactive measures stated under principles of Islamic financial system


No incentives for depositors depositing their money with banks.

Depositors will have to pay banks to safekeep their money. This is to discourage excess holding and to encourage spending.

Under Islamic finance, depositors are not entitled to any share of the profits for the money deposited in an Islamic bank. The Islamic bank act as a custodian and the money is deposited on the basis of trust and for safekeeping. The underlying contract is Wadiah Yad Amanah and Islamic banks can charge a safekeeping fee for Wadiah accounts.

This is to discourage savers from hoarding their money with banks and to encourage them to put it into productive investments.

Encourage loans to stimulate economic growth.

Commercial banks are disincentivized for holding excess reserves by central banks. This is to encourage more lending and investing at the margin to individuals and corporates where collateral, negligible interest rate terms and charges are more business-friendly.

Islamic banks emphasize on financial inclusion and offer financing under various contracts based on partnership and profit-sharing to promote equality and fairness, where collateral is the underlying physical asset. This is to facilitate easy access to finance for the poor and small businesses in areas such as agriculture, industrial production and other finance needs.

Money will flow more into productive investments such as equity and venture financing.

Interest-based lending promotes risk-shifting, risk-shedding and risk-transfer, whereby the risk is solely borne by the borrower. The borrower will have to pay principal and interest irrespective of profit and loss in the business. With the negative interest rate, the depositor will be more interested in doing investment in the form of a project financing, seed capital, private equity funding as there is a high probability of better returns in comparison to bank deposits or investment in bonds or securities. This in turn will promote a partnership model and will follow the risk and return principle, whereby partners share profit and losses based on pre-agreed percentages.

Creditors and debtors alike must share risk and return, ie the ‘no risk, no gain’ concept. Islamic finance emphasizes on a partnership and profit-sharing style of financing based on the Islamic contracts such as Mudarabah (trustee financing) and Musharakah (equity partnership). Profits are shared according to a predetermined ratio and the investor is not guaranteed a return and bears any financial loss. This provides financial support to entrepreneurs and productive enterprises to increase output and venture into new projects. This will generate more employment, increase in production and will contribute to economic development.

The time value of money will not be applicable due to negative interest rates.

Zero or negative rates mean that the money loaned has no value. It is lent out below cost. In the case of deposits, there will be negative returns, which breaks down the core principle, ie no potential earning capacity.

Money has no intrinsic value under Islamic economics. It can only be used to acquire goods or services and is not a commodity which can be directly exchanged for some other things. Money is just a medium of exchange. This is one of the fundamental reasons behind the prohibition of Riba (interest/usury). Therefore, Islamic finance permits financing based on contracts of exchange and contracts of investment partnership in compliance with Shariah principles.

From Table 1, it can be derived that a negative interest rate policy will influence the way lending and borrowing rates are charged in conventional financial markets. The objective behind such a policy is to deliberately boost aggregate demand and output by encouraging business and trade activities. The underlying principle behind the policy is that cash is not subject to a negative interest rate once it is withdrawn from the bank. This will create liquidity surplus in the market and will open channels for other sources of investment driven by equity and partnership models. This will uplift society, create social equity and narrow the wealth and income distribution between the rich and the poor. This is precisely what is preached and practiced under Islamic finance, ie there is an emphasis on fairness, transparency, equitable income and wealth distribution. 

The negative real interest rate ideology is a closer example of what Islamic finance intends to achieve. Islamic finance has already proven its stability during the subprime crisis, that the crisis would have been averted if Islamic financing principles were followed, ie financing the purchase of physical assets and not permissible to finance a debt. A negative interest rate does have its limitations. It does not wave a magic wand to do away with inherent business risks such as the flocking of non-performing loans due to easy loans and the economy sinking into recession. The success of a negative interest rate implementation in stimulating the economy is something that the future is going to decide. 

However, the current negative interest rate policy could also be an opportunity for Islamic financial institutions, where the expected outcome has already been taken care of under the principles of Islamic finance. The Islamic financial system is driven by profit-sharing, equity-sharing and asset-based financing and shares the same intended outcome as negative interest rates. This brings an opportunity for Islamic financial institutions to illustrate to the world that the fundamental operating principles of risk-sharing strengthen financial stability. This does not mean that Islamic financial institutions are risk-immune and not vulnerable to financial shocks; however, there are inbuilt checks in place as guided by the principles of Islamic finance to mitigate adverse financial risk and volatility. 

The materials presented above are provided voluntarily. The information is made available in good faith and is derived from sources believed to be reliable and accurate at the time of release. Readers are responsible for making their own decisions about the accuracy, reliability and correctness of the information given. We do not accept any liability for any loss or damage incurred by reliance on the information provided. 

Lokesh Gupta is the head of consulting at RM Applications and Nafis Alam is an associate professor and director at the Center for Islamic Business and Finance Research at the University of Nottingham Malaysia Campus. They can be contacted at Lokesh@rma.com.my and nafis.alam@gmail.com respectively.

The Big Short

The movie ‘The Big Short’ has probably already aired in much of South Asia, Southeast Asia, and the Middle East by now. HUSSAIN KURESHI took time out to watch the movie last week and in this article, he won’t be writing a review for the movie or pretend to explain what MBS, RMBS, CMBS, ABS, CDOs, CDOs2 and subprime are all about, or what CDS are but what is fundamentally put to question is the credibility of not just the financial system, but the whole system at large.

In the world of finance, banks used to enjoy the credibility of churches, and bankers were thought to be the most trustworthy members of society as opposed to the gambling, speculating, non-moral (not immoral) beings that they are thought of today. The Securities and Exchange Commission of Pakistan (SECP) represented that wing of the government that oversaw capital markets and if they were not doing their job properly, then who is to say the FDA or any other authority was doing their job properly? 

If a banker could resign from the private sector and join a regulator and if a senior official at a regulator could resign and join the same companies he or she was regulating, then who is to say, for instance, a regulator of the automobile industry cannot overlook emission test results with the assurance of a senior post at a company after retirement? It’s probably no surprise the VW scandal hit us in 2015 causing considerable damage to the German economy. 

When the VW scandal broke, the entire infrastructure of the financial system was caught with its pants down, from the fraud conducted at the time of loan origination, to the lack of diligence by Freddie Mac and Fannie Mae, the lack of diligence on the part of regulators, and the overall ignorance of the general public regarding the complexity of the times they live in. What if this collusion between the government and private sector at the expense of citizens is commonplace in other industries too? Should the pharmaceutical industry, for instance, be the place for the world’s largest mergers to be taking place?

Where else does this corruption lie, where else has the fabric of credibility fallen and why do we still trust those very institutions that betrayed public trust? Why do pension funds continue to trust ratings assigned by the three rating agencies that offered ‘AAA’ ratings to subprime mortgage-backed bonds? Why do mutual funds bank with those very same banks that did not allow the value of CDOs and bonds backed by mortgages to fall in value when close to one million homeowners had defaulted? It’s because of the mere reason that they were holding these toxic assets on their balance sheets and would not let these assets fall in value until they were hustled off and sold to other customers, ranging from the Sultan of a Middle East state to a local teachers’ pension fund.

And has Islamic finance risen to the challenge to offer an alternative? Sadly no, especially when internationally floated Sukuk are rated by those very same agencies and these instruments are listed on those same dodgy markets. I recall hearing comments of jubilation on social media when the London Sukuk were issued, as if a great enemy of Islam had converted to the true faith. Silly rhetoric to say the least.

The movie ends like others on the subject, at the turning point where taxpayers’ money is used to bail out the banks. Quantitative easing was approved, money was printed to buy toxic assets which are now on the balance sheets of central banks to the tune of trillions and yet credit was not extended by these banks to businesses and households. There was no demand for credit as no one had faith in their financial future. 

Instead, money was again pumped into financial assets, equities, indices and the like and the overvalued assets created a bull market, giving citizens the illusion of economic prosperity. If I were a graduate with US$100,000 in loans, and I cannot get a job, I frankly don’t care where the S&P index is at, I’m still unemployed and working at McDonald’s does not count as being employed.

Hello bespoke tranche opportunity; the world of capital still chooses to ignore investing in the real economy and continues to be addicted to synthetic instruments. Well, another crisis in the making?

Hussain Kureshi is CEO of Millennia Global Research House. He can be contacted at husseinkureshi@gmail.com.

A new milestone for the Indonesian Shariah landscape

It is quite inexplicable that the penetration and growth of Shariah-based investments and the capital market in Indonesia is still very low, despite the fact that Indonesia has the world’s largest Muslim population. Malaysia, its neighbor whose population is only one-eighth of Indonesia’s 253 million, has Shariah mutual fund assets 10 times that of Indonesia’s. ALVIN PATTISAHUSIWA tries to find out more.

In 2014, Indonesia was ranked 9th in terms of total Shariah assets — with assets amounting US$40.4 billion — far behind Malaysia leading from the front, with US$415.4 billion. In terms of mutual funds, Indonesia was ranked 5th with a total net asset value (NAV) of US$898 million, while Saudi Arabia ranked first with a total NAV of US$23.4 billion. 

Indonesia’s Islamic-based investment industry is relatively young (less than 20 years). That may be one of the reasons for such a low Islamic capital market penetration and growth. The story of Indonesia’s Shariah capital market reach a milestone with the launch of a Shariah mutual fund in 1997, followed by the launch of the Jakarta Islamic Index in 2000. In 2001, the National Shariah Council of the Indonesian Ulama Council (Dewan Syariah Nasional – Majelis Ulama Indonesia) issued a Fatwa (an Islamic legal pronouncement) regarding Shariah mutual fund guidelines. In 2002, Shariah bonds were issued for the first time. 

In the last 10 years, a noticeable increase in Shariah-based investments and capital market activity was visible, but not yet at the level that Islamic finance’s potential has to offer. At least three things were identified: 

  • An upturn in supply and demand 
    Shariah products in Indonesia enjoy only a small chunk of market share when compared with the conventional capital market products. It calls for more favorable regulations and encouraging incentives for financial institutions and companies to decide to issue Shariah-based products. 

  • Readiness of the resources 
    There is an obvious gap in understanding the Shariah capital market. Many capital market professionals lack knowledge of Shariah principles, while many Shariah practitioners have not paired up their expertise with capital market knowledge. 

  • Promotion and education 
    Promotion and education are expected to upgrade market participants’ understanding of the Shariah capital market. Furthermore, the Shariah capital market needs to be featured on the world stage to attract global investors. 

Given the magnitude of Indonesia’s Shariah capital market’s potential, along with its existing challenges, we believe the Indonesian financial industry will welcome Otoritas Jasa Keuangan (Indonesia Financial Services Authority)’s initiatives to declare the year of 2015 as the ‘Year of the Shariah Capital Market’. 

In November 2015, OJK refined its regulations on Shariah mutual funds, as well as started to accommodate domestic investors’ interests in offshore investment access. Through this initiative, Shariah mutual funds may invest more than 50% in offshore instruments. This initiative — together with the commitment of adequate promotion and education — is expected to bear fruit. To make it even better, these initiatives will also coincide with the period of macroeconomic improvements in Indonesia, which are expected to continue in 2016. 

As a reference, Indonesia’s capital market performance (both conventional and Shariah) in 2015 was not as good as that in the previous year. In 2014, all US$898 million of Indonesia’s Shariah mutual funds generated a 12% average yield, and ranked fourth-highest highest in the world after India (40%, with total assets of US$40 million), Pakistan (19%, with total assets of US$990 million) and Egypt (15%, total assets of US$242 million). 

The dynamics and volatilities of the financial markets will continue. However, we believe that 2016 is the year of economic recovery for Indonesia. In the long term, Indonesia and other emerging markets in Asia will play an important role in the world’s further growth. 

Asia’s contribution to the world GDP is expected to increase from 28% in 2010 to more than 50% in 2050. With a large population at the productive age, increasing income and the increasing size of the middle-class population, Asia is a consumer as well as a producer. Asia is very diverse and one cannot see it from a single investment point of view, with the countries in this region providing different opportunities. 

Alvin Pattisahusiwa is the director of Investment Manulife Aset Manajemen Indonesia (MAMI). He can be contacted at alvin_pattisahusiwa@manulifeam.com

Company Focus: Guidance Investments

Investors are moving away from riskier avenues as markets continue to rage with volatility, seeking lower but more stable and consistent returns from safer avenues. This week, VINEETA TAN casts an eye on an investment manager which is taking advantage of the current risk-averse sentiment while balancing it with exciting opportunities in key growth markets in Asia.Guidance Investments — launched in 2013 — may be young as a stand-alone company; however, it carries the strength of its parent group the US-based Guidance Financial Group which has built a repertoire in the Shariah compliant space over 15 years of being in business, leveraging on Capital Guidance (its parent)’s 50-year strong history as a strategic and long-term investor in Asia, Europe, the Middle East, North Africa and North America.Anchoring itself in one of the most advanced Islamic financial economies of the world — Kuala Lumpur — Guidance Investments has made a name for itself through landmark transactions including launching the first Islamic Asian private equity fund, pioneering a Shariah compliant China real estate development fund, rolling out the first-ever MENA hospitality fund and completing the first Malaysian ringgit-denominated Sukuk issuance by a Saudi Arabian company.With a strong focus on Asia, the firm recently invested US$50 million to acquire four additional properties in Southeast Asia as part of its Guidance Southeast Asian Real Estate Partners LP — Southeast Asia’s maiden Shariah compliant fund focused on logistics and industrial sectors in Malaysia, Singapore, Thailand and Indonesia.“We are highly optimistic about the performance of these Southeast Asian markets as key growth markets,” shared Pius Ho, the managing director of the real estate investment program at Guidance Investments. “These markets are characterized by several elements that contribute to their attractiveness — a young and urban population, industrialization growth, and growth in middle-income retail markets.”Generating US$100 million for the fund in the last quarter of 2015 — from a broad range of investors including government-related institutions in Southeast Asia and the Gulf — the firm is optimistic that it will be able to hit its next target closure of US$150-200 million this year, with an additional offering of US$200 million in 2017.“To date, we have closed a total of four properties and have invested 70% of our initial capital of the fund which is a significant milestone,” enthused Ho.“Malaysia will remain a key market for the fund, and in particular we see good investment prospects in Penang, the Klang Valley and Johor as we focus on areas around ports, the main transshipment zones and distribution hubs within these areas,” chimed David About, the firm’s director of Asian real estate. The fund expects to yield a return of an average 6-7% per year over a seven-year horizon from both annual rental income and the increasing value of the properties over time.Including this logistics fund, Guidance Investments has a growing portfolio of nine Islamic international investment funds across different segments such as private equity, real estate and fixed income, working independently and in partnership with global strategic partners.

Sovereign Sukuk: All eyes on Indonesia

The sovereign Sukuk space may have been hushed this past week but Indonesia wrapped up the period with a bang. VINEETA TAN brings you the latest updates.Indonesia made a lot of noise this week with its highly successful retail Sukuk sale — the largest the Republic has seen since tapping the consumer market seven years ago. Raising IDR31.5 trillion (US$2.37 billion) from its three-year offering — a 43.41% hike from its previous sale — the program attracted a total of 48,444 individual investors, marking an impressive 63% jump from the government’s previous retail Shariah sale.This success follows yet another successful Shariah securities auction involving financial institutions: the latest auction in February broke its IDR4 trillion (US$300.4 million) target as a total of IDR9.85 trillion (US$739.73 million) in bids were received and it is likely the government will overachieve its IDR4 trillion target again for its auction on the 8th March (results were not available at press time).The country could also welcome a quasi-sovereign issuance this year (or early 2017) as state-backed mortgage company Sarana Multigriya Finansial is reportedly planning to issue IDR200 billion (US$15.02 million)-worth of Shariah asset-backed securities in collaboration with Bank Tabungan Negara.Upcoming sovereign SukukCountryAmountExpected dateHong KongTBATBAEgyptTBATBAMalaysiaTBAMarch 2016Indonesia (retail Sukuk)IDR25-30 trillion10thMarch 2016IndonesiaUp to US$2 billionMarch 2016IranIRR60 trillion2016NigeriaTBAMay 2016Emirate of SharjahTBAFirst quarter of 2016JordanJOD150 millionTBAIndonesiaTBA2016PakistanTBASecond quarter of 2016EgyptTBA2015/16 fiscal yearKazakhstanTBA2016KenyaTBA2016South AfricaTBA2016TurkeyTRY1.8 billionFebruary 2016BangladeshTBATBAHong KongUS$500 million to US$1 billionTBANingxia Hui Autonomous RegionUS$1.5 billionTBASenegalTBATBANigerXOF150 billionTBALuxembourgTBATBATunisiaUS$500 millionTBAUAETBATBAShandong ProvinceCNY30 billionTBASindh ProvinceUS$200 millionTBAKuwaitTBATBA

Green, the way to go?

Ethical/socially responsible investment (SRI) finance seems to be the market buzzword these days and while SRI and Islamic finance are often lumped together, there are, however, key differences between the two that often enough, public relations engines leave out. This week, we take a hard look at the ‘green’ movement, asking where the material benefits for the Islamic finance industry are and where the much-hyped green Shariah issuances are.Continuing our line of hard questions, this week our IFN reports explore Indonesia’s new hedging rules and its ability to ramp up Islamic forex, Afghanistan’s recently minted Islamic banking regulations and what it means to the war-torn country as well as Pakistan’s clarion call for Shariah pricing disclosure. Our IFN Correspondents bring you latest market developments from Malaysia, Jordan and Egypt while our IFN analyses take a closer look at Sri Lanka and Islamic leasing. Our special reports delve deeper into the hot topic of negative interest rates as well as what our industry can learn from the blockbuster hit ‘The Big Short’. We bring you features on Kazakhstan, leasing and the Indonesian asset management industry, and round off with ‘A Letter from Amin’.It’s a bumper issue this week and we hope you find it an enjoyable and informative read.

Sustainable financing: Is the grass really greener?

Everyone is talking about the Islamic/ethical crossover and the potential for sustainable financing, clean energy and green Sukuk — but so far no concrete issuance has been forthcoming, and very little has actually happened in the market. What are the actual parameters of the ‘green’ movement and where is the material benefit for the Islamic finance industry? Is it really a commercially viable opportunity for Islamic practitioners — or just a convenient promotional tool to publicize corporate social responsibility? LAUREN MCAUGHTRY asks the hard questions.High demandGreen bonds are big business. Since 2007, the overall green bond market has seen compound annual growth of 50%, 2015 saw around US$42 billion in conventional green bonds come to market according to Moody’s Investor Services which has predicted another record year with over US$50 billion in expected issuance for 2016 and growth expected to continue well into next year. In January alone, total global green issuance reached US$6.7 billion (according to Renewables website SeeNews); on the 25th February, Luxembourg celebrated the listing of its 100th green bond; and so far this year players as diverse as the European Investment Bank, the UK’s Swindon Borough Council, New York’s Metropolitan Transportation Authority, technology giant Apple and China Industrial Bank have all tapped the green bond market — with deal sizes topping US$1.5 billion.This all sounds great — so is the Islamic finance industry getting on board to make sure it doesn’t miss out? In theory — absolutely. Last year we saw headlines galore, and optimistic announcements from all over the world. GCC governments have set ambitious clean energy targets that should be perfect for building up the green Sukuk market: the Climate Bonds Initiative (CBI) claimed to expect at least two green Sukuk issuances by April last year, while at the UN global warming conference in November last year the IDB also confirmed it would look at green Sukuk — and players from across the Islamic markets have paid lip service to the concept.But in practice on the other hand ... very little has actually happened. “We know that issuers are certainly looking at it,” Lee Irvine, a counsel with Latham & Watkins in Dubai, told IFN. “[But] one of the big challenges for the issuance of a green Sukuk [facility] is that the market for such green instruments is still yet to mature.”Public promotionSo what needs to be done? In February 2016, the CBI and the World Business Council for Sustainable Development announced a new partnership designed to drive the development of the green bond market and address global sustainability challenges through a combination of credit enhancements, government guarantees, tax incentives, pension fund mandates and regulatory steps such as preferential risk weighting for green bonds in bank capital requirements. Surely this would be an obvious move for governments not only to build their Islamic finance capabilities but meet their clean energy requirements, garner positive publicity and diversify away from hydrocarbons amid the ongoing oil price volatility.“It makes sense that a GCC sovereign or quasi-sovereign would be one of the first issuers of a green Sukuk [facility], and that would be great for the green Sukuk market — it would help open up the market and help set the price for these instruments,” said Irvine. “We are missing that benchmark in the green Sukuk space right now, and that is what we need, to establish it as a viable and acknowledged financing instrument and develop it as an asset class in its own right, rather than just a branding exercise.”Thus far however, only Malaysia has stepped up with any kind of socially responsible Sukuk issuance, with Khazanah’s inaugural sustainable and responsible investment (SRI) Sukuk in May 2015 — and that raised money for education, not renewable energy or ‘green’ causes per se, nor has it been followed by any further issuance, despite the much publicized SRI investment platform and ‘ethical’ Sukuk guidelines issued in 2014.So in the dearth of state support, could the private sector take the lead? The Gulf recently saw one of its biggest commitments to date in the form of the 10-year commitment to sustainable financing from the National Bank of Abu Dhabi (NBAD). “The bank has developed a US$10 billion target to lend, invest and facilitate in sustainable businesses: which is both a statement of strategic intent and a direction of travel,” explained Nathan Weatherstone, the head of renewable energy and sustainable business at NBAD, speaking to IFN.The definition of the projects is wide. NBAD last September became the first UAE bank to sign up to the UN Equator Principles, and the new financing strategy will adopt a similar definition to the International Capital Market Association (ICMA)’s green bond principles and will include renewables, clean transportation, energy, water efficient real estate, sustainable water and waste management systems, energy efficiency, decarbonizing technologies and climate change adaptation.Islamic opportunityBut how much of this activity will be Islamic? “That’s an interesting question,” said Weatherstone. “Is there any reason why they shouldn’t be structured in a Shariah compliant manner? No. We believe that a lot, if not all, of the activities we are looking at are capable of being structured to use Islamic finance.”So what might prevent NBAD, or anyone else, from going down the Shariah compliant route? Realistically, it becomes a question of competitiveness — both in terms of pricing, depth and liquidity, expertise in the market and — crucially — tenor. “A lot of these projects are infrastructure-based by nature. Traditionally, tenors in Islamic finance have not been so competitive with conventional finance,” pointed out Weatherstone. However, he stresses the business aspect. “We do see this sector being driven by commercial realism — 20% of our corporate clients are already active in the sustainable sector, and with the trend toward the removal of widespread state subsidies for things like electricity and the ever-increasing cost competitiveness of clean technologies, I have no doubt that other institutions may choose to follow our lead.”Size mattersAnd of course, there could be other opportunities for the Islamic market to benefit — although this may take time. “Bonds and Sukuk are great ways to refinance renewable energy projects, but it’s a difficult road to walk down on a first financing,” pointed out Jeremy Crane, CEO of Yellow Door Energy and board member of the Clean Energy Business Council MENA. “Green bonds in most cases are used for refinancing in markets that are large and relatively liquid. The Islamic world has relatively limited renewable energy penetration — relatively little has been built to date, so it requires projects to be built and then refinanced before we can go down the green Sukuk route.”Another problem is that the projects need to be big — and many of the smaller energy investment firms simply don’t have the scale or capacity. “Our portfolios just don’t really line up well for this,” agreed Crane. “We target smaller projects and you need to do at least US$100 million to make it worthwhile — that really means a major utility issuance.”Identity crisisThe major issue however, especially for the Islamic industry, is that of parameters. The ‘Islamic/ethical’ crossover is an idea that has gained significant traction recently — but the boundaries are blurred and while a good catchphrase or useful PR tool, the theory behind it doesn’t always hold up. Just because something is ‘ethical’ doesn’t mean it is Islamic — and just because an investment is Islamic does not make it ethical. The same holds true for green Sukuk and the sustainable financing trend. What constitutes a ‘green’ Sukuk and why? What parameters are there, what definitions exist that make an issuance ‘green’?There are multiple different agencies, such as the Climate Bonds Initiative, the ICMA Green Bond Principles and the UN Equator Principles — but these guidelines are all voluntary and the standards vary, which makes it harder for investors to evaluate their benefits and the impact.For the Sukuk market it is even more challenging, because you need tangible assets — and no one seems to have really explored yet how this might work. With green bonds, the underlying principle is simply that the proceeds must be invested for green purposes. But with Islamic transactions, there is also an underlying Shariah requirement for assets to structure the transaction — do these also have to be green? Surely a fossil fuel company backing a ‘green’ Sukuk issuance with a coal-fired power station is hardly environmentally friendly, for example?Conversely, what if the underlying assets are accepted as ‘green’ — for example, a solar power issuance using the solar panels as the underlying assets sold and leased back as part of an Ijarah structure with the rental going to pay the investors — but the proceeds are then used for non-green purposes? Would this still count as a green Sukuk? “That’s probably the biggest challenge,” agreed Irvine. “From a structuring perspective, we can structure a Sukuk [facility] utilizing the assets a company has available. But what is going to be interesting is how we are going to go about the verification process for a green Sukuk. This is something that we don’t believe the verification agencies have considered yet, simply because until now, there hasn’t really been a need to consider it.”Market driversThe problem is that as yet, there isn’t a clearly defined standard for certifying green Sukuk — and that is impeding progress. “Creating a standardized green Sukuk [issuance] would make it a lot easier for everyone to access the market. Standardization would be very useful — and it would certainly accelerate the market,” agreed Crane. “The thought has always been that investors are willing to accept a slightly lower coupon for green projects. All bonds around the world get different labels put on them — municipal bonds, treasury bonds and so on — we categorize them. Putting the green label on is a category that will bring with it certain attributes that hopefully will drive a lower yield threshold for the industry.”And there could be a number of advantages to issuing green Sukuk over green bonds, both from a public relations/corporate image perspective as well as a general commercial stance. “Why Islamic [issuance] over conventional? You open up to a wider pool of investors. From a pricing perspective, this wider pool of investors typically means you get better pricing,” pointed out Irvine. “The same analogy applies to green Sukuk: you open yourself up to a wider pool of investors, including those that have the stated aim of investing in sustainable projects.”Market demandThere is certainly demand — with a large pool of money already looking to invest in this sector. NBAD might be the first GCC bank to commit funds, but multiple other banks have already taken the same step. Barclays in November 2015 pledged to invest a further GBP1 billion (US$1.42 billion) in green bonds, after hitting a previous GBP1 billion target. HSBC has also announced plans to invest US$1 billion in green bonds to boost its investment in clean energy and transportation, while Zurich Insurance Group has already met a reported US$750 million of a US$2 billion mandate. These might be conventional institutions but, as Irvine points out: “Investors are interested — and while they are predominantly after yield, if they can invest in a green Sukuk [issuance] with a similar yield, why not choose that?”However: more standardization is needed, parameters must be defined, and goals must be identified in order to progress. Yes, there is demand and yes, there is potential. But it is not enough to simply jump on the green bandwagon in order to boost corporate image. For the sector to succeed, it is time for green Sukuk to be treated seriously as a commercial asset class — rather than pandered to as a promotional public relations exercise.

A letter from Amin

As befits the home of the world’s leading international financial center, for over a decade the UK has been the pioneer among Muslim minority countries in facilitating the development of Islamic financial institutions. Its general policy has been to adapt tax and regulatory law and practice with the goal of establishing a ‘level playing field’. Islamic financial institutions should not be treated any worse, nor any better, than conventional financial institutions.Where the UK has led the way, many other Muslim-minority countries have followed. Some have adopted the UK’s general principles while others have virtually copied the UK’s legal drafting. The UK’s goal of levelling the playing field has not yet been achieved. Sadly, the complexity of the issues involved and the other demands upon the time of legislators and regulators mean that this is an ongoing process which will take many years to complete.All conventional banks have some common treasury management requirements. As many of their liabilities are repayable on demand, banks need to hold a significant proportion of their assets in a form that is safe from credit risk and can be accessed quickly while still earning some interest. They normally achieve this by holding deposits with the country’s central bank. Indeed, most central banks require commercial banks to hold specified levels of such deposits for regulatory purposes. From time to time, some banks find that they are unable to finance themselves from regular customer deposits and interbank deposits. They therefore need to be able to borrow from a ‘lender of last resort’. This function is a key role of the central bank.Islamic banks have exactly the same treasury management requirements as conventional banks. While Islamic banks do not deposit money at interest or borrow at interest, they need to be able to carry out transactions with the central bank which have equivalent economic effect and which are Shariah compliant.In the UK, Islamic banks have operated for the last 10 years without such Shariah compliant facilities being offered by the central bank, the Bank of England. This has made managing their treasury functions much more difficult than would have been the case if they had the type of access to the Bank of England, outlined previously, which conventional banks have.In February 2015, speaking at the University of Warwick, Dame Nemat Talaat Shafik, the deputy governor for markets and banking at the Bank of England, said: “The bank will commence work in the second half of 2015 to assess the feasibility of establishing a Shariah compliant facility. By providing an additional highly liquid asset for Islamic banks, such a facility would be a significant step forward in their liquidity management capabilities.”A year later, this work has moved a step forward. In February 2016, the Bank of England issued a consultation paper titled ‘Establishing Shariah compliant central bank liquidity facilities’ which is available from its website. This proposes two alternative models intended to allow Islamic financial institutions to make the equivalent of deposits with the central bank in a Shariah compliant way. While enabling such deposits will be the initial goal, the paper also sets out two alternative models which might be implemented at a later date for the Bank of England to act as a lender to Islamic banks. The deadline for responses is the 29th April.By Mohammed Amin, an Islamic finance consultant and former tax partner at PwC in the UK.

Leasing: One of the most versatile products in the Islamic suite

Ijarah, or Islamic leasing, is one of the most popular contracts in Shariah compliant finance across the globe, and its versatility makes it popular across a diverse range of products and transactions — from structuring Sukuk to offering auto finance or extending SME assistance. One of the easiest entry points to the market, Islamic leasing companies have sprung up across many emerging Islamic finance markets, assisted by supranational development agencies supporting their growth and market development. LAUREN MCAUGHTRY looks at the latest news in the sector.RegulationIn January, the International Accounting Standards Board (IASB) issued a new accounting standard for leasing, ‘IFRS 16 Leases’, replacing ‘IAS 17 Leases’, according to a statement. The new standard, to be effective on the 1st January 2019, is expected to solve issues pertaining to companies’ transparency on lease assets and liabilities and also improve comparability between companies. The IASB also published a separate Effects Analysis, which outlines the costs and benefits of the new standard.Middle EastIn January, Kuwait’s Warba Bank acquired the equipment leasing portfolio of US-based ATEL Capital Group. The Kuwaiti Islamic bank initially invested US$8.2 million in ATEL’s diversified portfolio of operating leases, with the acquisition enabling the bank to provide Shariah compliant financing solutions to ATEL’s customers.Last December, EFG-Hermes Leasing, a wholly-owned subsidiary of investment bank EFG-Hermes, announced plans to add Islamic leasing facilities in the first quarter of 2016, and is reportedly currently working on securing a Shariah compliant credit line from a Gulf-based Islamic bank. Also in Egypt, state-run insurance firm Misr Insurance, which is also looking to launch a Takaful offering, in November 2015 started talks with the regulator, the Egyptian Financial Supervisory Authority, to establish a new leasing firm whose seed capital will be contributed by a subsidiary of Faisal Islamic Bank of Egypt (Archer Capital) and the Egyptian Gulf Bank. The proposed leasing firm will have an expected capital of EGP50 million (US$6.29 million), although no further announcements have yet been made. In September 2015, Arab Investment Bank also announced the proposed launch of the first Islamic financing leasing company in Egypt, in collaboration with the IDB, and with an initial capital of around EGP100 million (US$12.57 million). However, no news has since been released.Europe and the USAlso in January, US-based entrepreneur FreshBox Farm, a provider of digital farming solutions, announced that it was looking to offer Shariah compliant leasing investment solutions to the Middle Eastern and Asian markets; and has appointed Shariyah Review Bureau to advise and manage the Shariah compliance of its leasing and investment plans.Bank of London and The Middle East is seeking to bolster its leasing footprint in the UK through a partnership with Renaissance Asset Finance signed in March, which it hopes will help the bank to access the smaller ticket sizes in the market, expand its client base and diversify its business to provide a tailored SME leasing service.FinancingIn January, Oman’s Al Osool Properties signed a financing agreement based on forward Ijarah with Bank Muscat to develop its latest premium ITC project, The Pearl Muscat. In September 2015, Jabal Omar Development secured an Ijarah financing facility of SAR8 billion (US$2.13 billion) from two local banks: SABB and Samba Financial Group. According to a bourse filing, the 12-year syndicated facility will be used to repay a SAR2 billion (US$533.13 million) bridge loan and also to fund the completion of certain stages of its project in Mecca.AviationIran in February announced plans to launch an international aircraft leasing company in the next fiscal year (beginning the 20th March 2016) to upgrade the Republic’s ageing air fleet, according to Mehr News Agency quoting the minister of roads and urban development, Abbas Akhoundi, who hopes to establish the company in cooperation with foreign companies.In June 2015, Kuwait Airways secured an Airbus A330-200 aircraft under a Shariah compliant leasing deal facilitated by Warba Bank. The aircraft is part of an inaugural transaction for International Airfinance Corporation (IAFC) of five of the same aircraft to be leased to the airlines. IAFC is the fund manager of the US$5 billion Aircraft Leasing Islamic Fund.


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