Volume13.Issue11

‘One Belt, One Road’: China turns to Islamic finance to fund overseas expansion

With a slowing domestic economy, China is turning to overseas opportunities to sustain its growth ambitions and benefit from the rapid growth potential in neighboring countries. Its ambitious new trading initiatives are set to create enormous opportunities for development along its expansion routes — and Islamic finance is playing a major role in funding this development. LAUREN MCAUGHTRY looks at the latest opportunities — including the interesting possibility of sovereign collaboration on infrastructure Sukuk issuance.

An ambitious plan

China’s flagship expansion strategy is the ‘One Belt, One Road’ (OBOR) initiative, which seeks to resurrect the ancient Silk Route into a new Silk Road Economic Belt passing through Central and West Asia, the Middle East and Europe; while at the same time creating a Maritime Silk Road that links China’s ports with the African coast, through the Suez Canal and up into the Mediterranean. Passing through up to 60 countries across three continents, the strategy is supported by the highest levels of government and funded with deep pockets — including an initial US$50 billion Silk Road Fund from China to directly fund the initiative. The goal is to create opportunities for Chinese firms to explore new markets and investments abroad — but with China pumping significant sums into infrastructure and investment partnerships with member countries (including a recent US$55 billion commitment to infrastructure in the Middle East), the opportunities extend far beyond domestic benefit.

Islamic opportunity

The project aims to redirect China’s overcapacity and capital toward regional infrastructure development as well as to improve trade with ASEAN, Central Asia and Europe. And with a large proportion of the proposed route passing through Muslim-majority countries, including its regional strongholds in the GCC and Southeast Asia, Islamic finance is playing an increasingly large role in China’s OBOR funding strategy. Both state-owned enterprises and private firms are keen to explore Islamic opportunities to enter these markets, and deals that have been trickling onto the market over the past year could soon turn into a flood.

Sichuan Development Holding Company, an investment subsidiary of the Sichuan local government, has since 2015 been in talks to raise US$300 million in Islamic financing followed by a US$1 billion Sukuk program. The Sichuan province sits at the intersection of the land and maritime belts of the OBOR initiative, and has become the locus of activity and interaction with South Asia and the expanding Silk Routes.

“We are still working on the documentation and getting the Chinese regulators on board, but the Sukuk plans are still very much in play,” confirmed Bobby Tay, an advisor for Singapore-based Silk Routes Financials, who is advising on the deal, speaking to IFN this week. “There is also a lot of infrastructure work to be done on the roads in Sichuan and a lot of opportunity for Middle East and Islamic investors to get involved in infrastructure projects in China as we move along the OBOR route.”

In March this year, China confirmed that Islamic financing instruments would be used to fund some of the largest projects along the China-Pakistan Economic Corridor, part of the OBOR initiative, marking the growing importance of Islamic financing to the world’s second-largest economy. Worth approximately US$1.95 billion, the dual-currency multijurisdictional part-Islamic financing package will be used to fund the development of the Thar Block II coal mine and two associated 330 MW coal-fired power plants in Thar, Pakistan. The project, one of the first integrated coal mining and coal-based projects in the China-Pakistan Economic Corridor — a key component of OBOR — is expected to be commissioned in 2018.

Most recently, IFN can exclusively reveal that the Chinese government and its financial advisors are currently in talks with another South Asian country to issue a sovereign Sukuk for infrastructure development in order to facilitate the OBOR project. “We are currently in discussions with both parties, and hope to be able to confirm shortly,” commented Tay.

Attracting investment

But it is not just the OBOR strategy that is driving activity. “The Chinese want to attract OIC investment into China at one end, while at the other end they are investing a significant amount overseas so they want [to] open the channels of investment between one side and the other – and Islamic finance will play a major role in this,” explained Tay. Chinese brokerage Southwest Securities in 2015 signed a partnership with Qatar International Islamic Bank to develop a framework for Islamic transactions within China, while the leasing arm of banking behemoth the Industrial and Commercial Bank of China (ICBC) has also entered into an agreement with the Islamic Corporation for the Development of the Private Sector (ICD), a subsidiary of the supranational development agency the IDB. HNA Group, the owner of Hainan Airlines, recently announced a US dollar Islamic bond issuance to fund ship acquisitions in the first-ever Islamic financing deal from a mainland Chinese company; while Chinese property firm Country Garden Holdings is planning a RM1.5 billion (US$368.1 million) Islamic bond program in Malaysia. A railway project in the eastern Chinese province Shandong is also reported to be considering Islamic issuance to raise up to CNY30 billion (US$4.65 billion).

Cross-border connections

Hong Kong is making a clear play to be the gateway for Chinese fundraising activity and cross-border investment flows, and is taking steps to facilitate this connectivity. As such, the Hong Kong government has already issued two benchmark-sized sovereign Islamic bonds and recently announced a third, in order to establish a precedent and create a yield curve for corporate issuance, enabling and encouraging Chinese mainland firms to raise Islamic finance from global investors using Hong Kong as a conduit.Yet while Hong Kong’s role is important, China is doing a pretty good job of expanding its access on its own — entering into new markets through partnerships and positions in overseas financial centers. Multiple Chinese banks are already working on raising their profile in key Islamic markets across the Middle East. The Bank of China, ICBC, the Agricultural Bank of China and China Construction Bank all have offices in the Dubai International Financial Center (DIFC), and have recently issued conventional bonds listed on NASDAQ Dubai. Chinese banks in the DIFC have doubled their balance sheet in the last 18 months, according to DIFC figures as of the 19th February, and China’s top four state-owned banks currently represent 26% of total assets booked at DIFC, at US$21.5 billion. The four banks have all upgraded their DIFC licenses to Category 1, expanding their presence from subsidiary to branch status. The next logical step for these Chinese banks will be to facilitate, manage and arrange corporate Sukuk issuance from Chinese entities, listed in in Dubai or perhaps Malaysia.“Dubai with its established Islamic finance framework offers global visibility, streamlined listings, prompt responses to issuer needs and wide access to investors — enabling a healthy Islamic finance network for Chinese firms looking to build their Islamic finance portfolio,” said the DIFC in its latest note on China-UAE trade. “In addition, Dubai’s exchange has successfully launched the Murabahah [cost plus] financing platform, which provides retail and corporate users with an efficient, fast and flexible alternative to traditional solutions, and a Shariah compliant repurchasing platform for short-term financing.”

African intent

But other GCC markets are also getting in on the act. Oman, for example, was the first GCC country to export oil to China in 1983, and is currently the country’s fourth-largest trading partner in the MENA region — while China is Oman’s top export partner and accounted for 43% of all exports in 2015. Omani and Chinese firms have in the past year signed construction deals for a power plant, as well as infrastructure projects including a port and facilities for shipbuilding and water management. There are more than 40 Chinese companies currently partnering or doing local business in Oman, and the two countries are also working together to enter new markets — in 2015, representatives from both countries entered into a partnership with the government of Tanzania to launch a US$10 billion port in Tanzania.China’s investment objectives in Africa are well-known, and the country is specifically seeking to raise Islamic capital from Asian and Middle East investors to fund its expansion plans. Already Africa’s biggest global trading partner, China’s ambitions to dominate African infrastructure investment have contributed to its Islamic finance ambitions — and as China and Africa seek to double their two-way trade to US$400 billion by 2020, the GCC and Dubai especially will serve as a vital strategic link in connecting Chinese companies with African markets, and vice versa.Chinese firms are also now pushing for involvement in the Islamic Republic of Iran, including tenders for multibillion dollar transportation and energy deals and the announcement just this week of a financing partnership between Iran’s Tejarat Bank and the Export-Import Bank of China to develop joint projects.With the ICD-sponsored China OIC Forum fast approaching in Beijing on the 22nd March, it could be the ideal opportunity for Islamic players to explore what the country has to offer.

Linking academia with Islamic finance

Since I last wrote this column I have visited both Singapore and the UK. A little later this month, I will be in Turkey and Pakistan and I will report in next month’s article on those trips. As promised, here are some updates on my recent travels.

In Singapore, I participated in a very interesting focus workshop on Islamic finance. Participants were varied: academia, regulatory authorities and practitioners from across Southeast Asia and the Middle East. The format allowed ample time for discussions with all the attendees and some interesting takes were made on such topics as accounting, microfinance, regulatory environment and liquidity management. The good news is that all of these will be distilled into a paper of record which will be published in a couple of months and will allow us to be measured against the suggestions that were made for improvements.

In the UK, I had the opportunity to mingle and meet with students, practitioners and academia. The overarching theme, particularly from the Student POV, was that of jobs and linkages between academia and the industry. The general feeling was “not enough is being done”. I was able to provide some input on the Malaysian experience and describe some of the similar growing pains and solutions that my adopted country has been through in the past.The challenge in the UK appears to be more one of clear communication between the various entities (as there are a number of worthy initiatives at play). What may be required are some organizational or governance changes to be made to ensure that strategies, the execution of plans and tactical changes are discussed and articulated on a broader stakeholder front.

I, for one, know that there are a lot of positive things happening in the UK and there are many capable professionals who are committed and working hard at it. This is probably more a case of joining up the dots than anything else.As I have mentioned in earlier articles, 2016 will be a challenging year, and I see nothing to change that outlook. We must remain focused and persistent.

As always, there is much to do and not a moment to lose!

By Daud Vicary Abdullah, the president and CEO of the International Center of Education in Islamic Finance (INCEIF), The Global University of Islamic Finance.

IDB keen to collaborate with India

INDIA: The IDB has expressed its keenness to operate Islamic finance activities in India and is hoping to collaborate with the Reserve Bank of India to introduce Islamic finance to the country, according to the Press Trust of India. Khaled Mohamed Al Aboodi, CEO of the Islamic Corporation for the Development of the Private Sector, the IDB’s private sector arm, was quoted as saying that the plan can be done through the setting up of a special fund which allows it to undertake activities in non-member countries.The IDB is also planning to launch a US$1 billion fund to finance the construction of residential facilities for Indian Haj pilgrims in Mecca with the Indian Consulate General in Jeddah provided a draft MoU on this matter. Additionally, the IDB has set aside US$50 million for the launching of e-medical mobile units in rural India and is in the process of identifying NGOs which can act as partners for the initiative.

Separately, according to the Times of India, the IDB is likely to launch its first operations in India with a branch in Ahmedabad, a city in the state of Gujarat. 

SMEs play vital role in Italy’s economy

The Italian industrial structure is dominated by microenterprises and SMEs with SMEs estimated to number 35,000 (roughly 96% of the total number of Italian enterprises), nearly equally distributed over the country. This peculiarity of the Italian system has never hampered innovation and improvement. Small but highly specialized companies, focused on providing great quality products and services, have in fact allowed Italy to be one of the most developed and economically affluent countries in Europe and in the world. STEFANO PADOVANI explores.

Alternative financing opportunities for SMEs
According to the EU recommendation No. 361/2003, SMEs are those with a turnover between EUR2 million (US$2.2 million) and EUR50 million (US$55.1 million) (alternatively an annual balance sheet not exceeding EUR43 million (US$47.38 million)) and a number of employees between 10 and 50. Microenterprises are those below the aforementioned criteria.

As a consequence of the globalization of the economy and above all as a result of the enduring financial and economic crisis, Italy, as with other countries worldwide, has tried to help SMEs in continuing to play their vital role in the international economic scene, by fostering the accessibility to banks and alternative ways of financing. 

As a result of the turmoil in the banking sectors and the limited capability of banks to guarantee a continuing flow of resources to the economic system, and also as a result of the heavy burden of non-performing loans which impair them, alternative sources of financing end up playing a fundamental role. This may be divided into three main categories: debt and equity capital market instruments and direct lending.

‘Mini-bonds’ – a debt instrument shaped on needs of SMEs
In 2012, the Italian government started with law Decree No. 83/2012 and law Decree No. 179/2012 (‘Decreto Sviluppo’ or ‘Development Decree’) a reforming process which continued then in the following years with law Decree No. 145/2013 (‘Destinazione Italia Decree’) and law Decree No. 91/2014 (‘Decreto Competitività’).

The overall effect of the enacted legislation is a relaxation of the legal and tax restrictions on the issuance of bonds and similar securities by unlisted companies like SMEs. Such bonds are known in the market with the non technical name of ‘mini-bonds’.

In terms of timing, the issuance of mini-bonds requires between three and four months. The main steps are the following:

  • the preliminary feasibility analysis

  • the structuring of the issue with specific regard to the terms and conditions of bonds (eg duration, tradability, amount), and

  • the research of potential investors.

Mini-bonds issued by SMEs may also be listed on the ExtraMot Pro (the market segment of Borsa Italiana, the Italian stock exchange), which is exclusively dedicated to qualified investors, on the condition that the issuer has published the financial statements of the last two years, and a prospectus or an admission document stating details regarding persons in charge, the financial situation, the activity description, etc.

Furthermore, the reform has also introduced the possibility of issuing profit-participating mini-bonds, containing a participation clause which links the bondholder to the performance of the bond issue. Such instruments must have a maturity date of at least three years and contain a fixed income component in addition to the profit component, which in other words means that the bondholder position is always guaranteed by the reimbursement of the fixed income. In addition, the percentage of the annual profit of the issuer cannot be changed during the life of the bond and shall be paid within 30 days from the approval of the issuer’s annual financial statement.

The aforementioned decrees also brought about an amendment of the taxation applied to the mini-bonds for both the underwriters and the issuers, whereby they are not required to apply 26% withholding tax on interest and other income from bonds, similar securities, and commercial paper traded on regulated markets or multilateral trading systems of EU member states.

The Alternative Investment Market
As an alternative to debt instruments, SMEs can raise funds in the form of equity through the Alternative Investment Market (AIM) which was established in 2012.

The listing on the AIM, which is controlled by Borsa Italiana, is a way for Italian SMEs to raise equity funds among institutional and professional investors to sustain their growth and expansion. In terms of time, the entire listing process lasts between two and four months and it is endorsed by a nominated advisor, or global coordinator, appointed to guarantee support to the company willing to be listed and to give comfort to investors that all conditions and requirements of the listing process are met. One of the main steps of such a process is the drafting and publishing of an informative prospectus (‘Prospetto Informativo’), approved by the Italian Securities and Exchange Commission (CONSOB), containing all information with respect to the business, financial positions, economic prospective and corporate governance of the issuer.

The prospectus may be substituted by a ‘lighter’ admission document (‘Documento di Ammissione’), which does not need to be approved by CONSOB and which must contain financial data regarding the issuer’s business, risk factors, corporate structure, future strategies, if the offer: (i) is made only to some specific professional investors ex Article 26, clause 1, letter (d) of the Intermediary Regulation (‘Regolamento degli Intermediari’); (ii) is made to fewer than 150 professional investors, and (iii) is with regards to financial instruments amounting to less than EUR5 million (US$5.51 million). 

Direct lending
Law Decree No. 91/2014 has also broadened the turnout of those that can grant financing to SMEs by including Italian insurance companies, Italian securitization vehicles (SPVs) and alternative investment funds (AIFs).

With respect to insurance companies, the decree provides that borrowers must be selected by a bank or a financial intermediary ex Article 106, which must “retain a significant economic interest in the transaction”. The insurance companies must also be adequately capitalized and have an internal control and risk management system typical of any lending entity. Furthermore, they are admitted to the ‘Centrale dei Rischi’, which is the Italian centralized credit risk database of borrowers. 

The decree also sets forth the conditions applicable to securitization vehicles to be used for financing purposes. As it is for insurance companies, borrowers must be selected by a bank or a financial intermediary ex Article 106 that retain a “significant interest” in the transaction. Furthermore, (i) a bank or a financial intermediary must assist the securitization vehicle in order to identify potential borrowers; and (ii) only qualified investors are allowed to subscribe and purchase the notes issued by the securitization vehicle.

Lastly, AIFs are included among those entities that can provide lending directly. The Regulation on the Collective Management of the Credit (‘Regolamento sulla gestione collettiva del risparmio’) issued on the 19th January 2015 specifies that direct lending is reserved only to ‘closed-ended’ AIFs or funds exclusively reserved for qualified investors. 

In addition, other constraints are imposed: for instance, (i) the fund cannot grant loans representing more than the 10% of its total asset to the same borrower; (ii) the duration of the financing cannot exceed the duration of the fund’s term; and (iii) funds cannot apply a leverage in excess of 1.5 times. The same regime applies also to EU AIFs that want to lend money directly to Italian borrowers, as provided in Article 46-ter of law Decree No. 18 on the 14th February 2016. 

Relationship between Italy and Islamic investors 
In this historic phase during which growth tends to move from the west to the east, it would be a great opportunity for Italy to open its resources and expertise to Islamic investors and the country would be a perfect partner not only for sovereign funds, which are already active in Italy, but also for corporations, banks and financial institutions and family offices based in countries with a Muslim-majority population, to invest in. 

In particular, Italian SMEs operate in many sectors, such as industrial, retail, manufacturing, food, luxury, fashion, etc, which could be very appealing to Islamic investors, considering that many of them can be Halal-certified. Indeed, there are almost 250 Italian companies that have obtained such certification.

Islamic financial instruments and their implementation in Italy
Due to the possibility of a flawed bank lending, corporates are increasingly seeking alternative instruments to raise funds. In this context, Islamic finance could surely be an opportunity to take advantage of instruments like mini-bonds which are already provided by the existing tax and legal framework and which could be made Shariah compliant by combining them with Islamic finance contracts like commodity Murabahah contracts, or alternatively Musharakah or Mudarabah contracts. 

Furthermore, there is one particular type of mini-bond, which is the so-called ‘profit participating’ one, which is indeed based on the risk and profit-sharing approach, one of the pillars of Islamic finance, as it is remunerated mainly on the basis of the profits of the issuer.

Stefano Padovani is a partner and the head of banking and finance at NCTM Studio Legale Associato. He can be contacted at stefano.padovani@nctm.it.

Modaraba sector: Heading toward growth

The Securities and Exchange Commission of Pakistan (SECP) has recently issued a notification regarding the draft of amendments to the Modaraba Companies and Modaraba Rules, 1981 to obtain the opinions of stakeholders and the general public. The commission had also issued a draft Modaraba regulation which is still under consultation with all stakeholders of the sector. The proposed amendments to the Modaraba rules and regulations are aimed at updating the legal framework for the registration and flotation of Modaraba facilities in the country, seeking to provide a comprehensive framework for the operation and conduct of Modaraba companies and to enhance supervision by the SECP

Recently, the SECP took various initiatives to promote Islamic finance at the country level. Under the leadership of Zafar Hijazi, the chairman of the SECP, the commission has become very active in promoting Islamic finance. A major breakthrough was made through the establishment of a separate Islamic Finance Department in 2015, which will be responsible for Shariah regulation and compliance, product development and market awareness. The Modaraba Division within the SECP is headed by the newly appointed Modaraba Registrar, Shahid Mahmood, who is also actively working to further the growth and promotion of the Modaraba sector of Pakistan. The objective of these amendments is to support the growth of the Modaraba sector in a prudent manner by providing a conducive regulatory environment. 

The Modaraba sector of Pakistan plays a significant role in the promotion of Islamic finance in the country. The concept of Modaraba was introduced in Pakistan in the early 1980s as the first Islamic Shariah business model with a statutory framework and proper regulations. The concept of Modaraba transformed into an Islamic financial institution and Modaraba facilities were allowed to operate as corporate entities under the regulatory framework issued by the SECP. The Modaraba model in Pakistan with a corporate status is a unique business model all over the world. It provides the general public access to a Halal business/investment and skilled managers and is able to carry out a multitude of Shariah compliant businesses in various categories.

Several good changes have been recommended to the rules and regulations for a better regulatory environment that supports compliance, risk management and business as follows: 

  • The introduction of the concept of an annual general meeting from an annual review meeting.
  • The introduction of a new definition for financial services Modaraba facilities.
  • The introduction of a capital adequacy ratio.
  • There must be two independent directors for deposit-taking Modaraba facilitites.
  • The enhancement of the minimum mandatory reserve requirement.
  • A proposed maximum capping deposit generation of up to four times of equity.
  • The minimum credit rating for deposit-taking changed from ‘BBB’ to ‘A-’.
  • The rationalization of exposure on a single customer/group. 
  • The definition and category of ‘Key Executives’ have been further broadened.

Acquiring an existing Modaraba facility or to float a new Modaraba facility by big business groups and individuals has been an increasing trend in Pakistan. As such, two new Modaraba entities – Sindh Modaraba (a subsidiary of Sindh Bank) and Awwal Modaraba (a subsidiary of Pak Brunei) have started their business operations and more new entrants are expected to join and further strengthen the sector.

The proper implementation of the regulatory framework with evolving guidance will go a long way in enabling the sector to excel further. It is expected that the dynamic approach of the regulator in addressing issues in the competitive environment will assist Modaraba entities in setting new milestones in coming years.

Muhammad Shoaib Ibrahim is CEO and the managing director of First Habib Modaraba. He can be contacted at shoaib@habibmodaraba.com.

US: The next 240 days

Warren Buffett in his highly anticipated annual letter to his Berkshire Hathaway shareholders, published at the end of February 2016, encouraged them to be optimistic, despite the best efforts from those on the presidential campaign trail to convince voters that the model for achieving the American Dream is broken. Buffet stated that: “For 240 years, it’s been a terrible mistake to bet against America, and now is no time to start.” He added: “America’s golden goose of commerce and innovation will continue to lay more and larger eggs.”

But where does that leave the next 240 days or so of 2016 and are Islamic investors similarly optimistic?

Judging by Qatar’s activities, 2016 seems very positive for US real estate investment. After opening its US office in New York in September, the Qatar Investment Authority (QIA) in the following month wasted no time in acquiring a major joint venture stake in a Manhattan mixed-use development with a projected value in excess of US$8 billion.

Continuing to implement its plans to invest US$35 billion in North America by 2020, and following Qatar Airways commencing direct flights between Doha and Los Angeles in January this year, the QIA recently acquired a four-asset office portfolio for more than US$1.3 billion in the City of Angels.

Looking positive so far, and from our own perspective, just as many investors see gold as a safe haven, many Islamic investors continue to be attracted to real estate as ‘gold with income’. Meanwhile, with the dollar still the international default currency, the US is attracting much of this interest.

Our own 90 North closed a significant (for us at least, but regrettably not, compared to the QIA) US$123 million acquisition of Saint Gobain’s North American headquarters outside Philadelphia in February, with a further purchase scheduled for the end of March. The recipe is simple, with modern properties let to investment grade tenants on long leases and investors comparing this to what they’re earning on cash deposits.

So, the outlook for the next 240 days looks fairly positive for US real estate investors, and I really hope that Donald Trump’s ambitions when seen in the context of the US’s 240 years of history do not put too many Islamic investors off.

Philip Churchill is the founder and managing partner at 90 North Real Estate Partners. He can be contacted at pchurchill@90northgroup.com.

Qatar’s strong start to a testing year

Perhaps it is no longer a hidden fact that 2016 will be a difficult year for the Qatari market. With more governmental or quasi-governmental entities announcing reductions or cancellations of projects, staff redundancies and consolidations within departments, it is likely that business opportunities will be significantly fewer than previous years with huge growth numbers. Banks (including Islamic banks) have also suffered the wrath of the economic downturn, with lending in Qatar decreasing generally, despite the recorded growth of bank assets to QAR1.11 trillion (US$304.53 billion) by the end of 2015. AMJAD HUSSAIN writes.

However, amid the negative speculation and forecasts for this year, Islamic banks in Qatar have remained active in the market and are still keen on issuing Shariah compliant instruments. A prediction has been made by the Qatar Central Bank that bonds and Sukuk worth over QAR15 billion (US$4.12 billion) will be issued in 2016 in Doha.

Qatar Islamic Bank (QIB) has remained very active with respect to Sukuk issuances, with its shareholders approving the board’s recommendation concerning its Sukuk programs. Additionally, the board has approved an extension of the QAR3 billion (US$823.06 million) remaining from the additional Tier 1 capital perpetual Sukuk that were previously approved and also approved increasing the QIB Sukuk program to US$3 billion instead of US$1.5 billion.

Additionally, Ooredoo (the leading telecommunications company in Qatar) announced that it is seeking to raise over US$1.5 billion through bonds and loans in 2016 and is in talks with banks over the matter, according to Reuters. Quoting unnamed sources, the telecommunications firm is looking to raise funds to refinance the existing US$1 billion revolving credit facility (RCF) maturing in March 2017 and is exploring options in Islamic financing or conventional RCF and in the US dollar or a combination of currencies. Ooredoo is also planning a benchmark-sized bond issuance and is open to issuing in Islamic and/or conventional formats, in dollar or a combination of currencies.

Barwa Real Estate Company announced that it has entered into a number of Islamic financing arrangements in recent weeks. The company announced on the 14th January 2016 that it has entered into a Shariah compliant financing arrangement with Masraf Al Rayan, worth US$444.3 million for a term of five to seven years which will be used to refinance an existing Islamic financing liability of Barwa Real Estate, and which fits into the company’s strategy to refinance its existing financing liabilities in order to strengthen its overall financial position. Additionally, the company announced on the 17th January 2016 that it has secured a US$157.1 million Shariah compliant facility for a term of five years to finance its financial liabilities.
 
Ezdan Holding Group (a leading real estate development company in Qatar) announced that the board has agreed to recommend the issuance of Islamic Sukuk through many stages (worth up to US$2 billion), once the required approvals have been obtained. The matter has now been put to the shareholders to approve during the annual general assembly meeting in March.

Elsewhere, QInvest announced that it has provided a five-year US$30 million Murabahah mezzanine finance facility to Crescent Capital to fund its acquisition of a 100% stake in Akocak HPP, an operational 81 MW hydroelectric power plant in Turkey. QInvest reported that it structured and invested in this transaction, which is the first of its kind, alongside Garanti Bank, Turkey’s leading energy and infrastructure financier and the sole senior lender for the dual-tranche funding package of US$100 million.

From a regulatory standpoint, Sheikh Abdullah Saud Al Thani, the governor of Qatar Central Bank, recently announced in a press release that the bank has sought the assistance of a unified Shariah Compliance Committee (in cooperation with the Islamic finance institutions in Qatar) to achieve the following objectives: 

  • The issuance of a unified procedures manual relating to Islamic financial instruments, which establishes the legal and Shariah compliance guidelines governing each instrument in a manner that achieves and maintains the required transparency and market discipline along with a basis of adjudication and dispute resolution.

  • Providing Shariah opinions (Fatwa) with respect to Islamic financial instruments.

  • Providing a general framework to monitor and regulate Shariah compliant transactions.

  • Preparing research papers and studies for the purpose of promoting and developing the Islamic finance industry.

In light of recent developments in the market and the drive of the Qatari government and the Qatar Central Bank to find alternative sources of income to oil and gas, the role of Islamic financing as an alternative means to fund projects will certainly be a pivotal one. It is encouraging to see that despite a cautious start to the year, there is a strong drive to push ahead.

Amjad Hussain is the partner at K&L Gates. He can be contacted at Amjad.Hussain@klgates.com.

Will Indonesia’s development needs revive the country’s Islamic banking sector?

Standard & Poor’s Ratings Services believes the deceleration of Islamic finance growth in Indonesia that started in 2015 will continue in 2016 as there are three main challenges for the sector this year: Indonesia’s sluggish economy, which could subdue new business for both Islamic and conventional banks; Indonesia’s Islamic finance market is small in absolute terms and relative to the wider financial industry, so it lacks the capacity to benefit fully from the country’s large corporate entities and infrastructure projects and lastly; the regulatory framework is still developing and there is a scarcity of staff qualified in this area. MOHAMED DAMAK, IVAN TAN and KYRAN CURRY put Indonesia’s Islamic banking sector under the microscope.

We think Indonesia offers local Islamic banks significant medium-term growth opportunities. The country is home to the world’s largest Muslim population, and banking penetration remains low. In addition, there are significant shortcomings in transportation, energy and other critical infrastructure that could lead to investments of more than US$40-50 billion per year for the next few years.

In its ‘Infrastructure Plan 2015–2019’, the government announced ambitious plans to expand capital spending in a vast range of areas, including transportation, water and irrigation systems, roads, drinking water, waste management systems, telecommunication and information, electricity, oil and gas and renewable energy, education, prison, health and housing.

The government raised infrastructure spending by about 50% in its revised 2015 Budget to IDR290 trillion (US$22.19 billion or about 2.4% of the 2015 GDP). It has foreshadowed raising this by a further 25% per annum through to 2017, including through US$3 billion in capital injections into its state-owned enterprises to boost their own capacity to borrow to fund capital spending. It has also promised tax incentives and reforms to land acquisition and project approvals to improve the environment for greater private sector participation in its infrastructure investment plans.

However, the slow pace of capital spending to date is a reminder of the weak project execution capacity in Indonesia as compared to other emerging markets, and private-sector investment remains muted. We believe some of the funding for infrastructure projects could come from domestic Islamic banks, or from bilateral and multilateral Islamic financial solutions or Sukuk. In this regard, we view the government’s efforts to strengthen the foundation for future growth of Islamic finance as a positive step.

Growth likely to remain weak…
After five years of significant growth, the Islamic finance industry in Indonesia stagnated in 2015. Islamic banking assets increased by about 33.5% on aggregate between 2010 and 2014, but stayed almost flat in the first half of 2015 compared with 5% growth for conventional banking assets (see Chart 1). This setback stems primarily from Indonesia’s subdued economy, owing to weak domestic consumption, low private-sector investment, and moderating trading partner growth. GDP growth in Indonesia averaged 4.7% in the third quarter of 2015 compared with 5.5% on average over the past five years. Moreover, we expect activity to expand by only around 5% in 2016.

We expect this less supportive operating environment to persist in 2016. China represents about 10% of Indonesia’s exports, so a faster-than-expected slowdown of activity there can further delay the revival of the Indonesian economy. Exports to China had already fallen by 25.5% in the 12 months to the 30th November 2015, according to Bank Indonesia. What’s more, the Indonesian government has increased public sector spending to aid long-term growth, but the execution of its ambitious capital program is far behind schedule.

Islamic banks’ contribution to the banking system’s total assets stood at a meager 4.5% in mid-2015. Having said that, due to Islamic banks’ lack of scale and higher exposure to retail and SMEs than the system average, they have suffered more from Indonesia’s economic slowdown than their larger, conventional counterparts.

On a positive note, the effect of deceleration in Indonesia has not yet spread to other areas of the country’s Islamic finance industry. The government and a few other entities were quite active in tapping the Sukuk market in 2015, with total issuance reaching US$7.9 billion for the year, making the country the second-largest Sukuk issuer after Malaysia (see Chart 2). We believe this reflects Indonesian companies’ efforts to diversify their investor bases, as well as the government’s push to attract additional sources of financing for infrastructure projects.

However, this performance could falter in 2016, since we foresee liquidity tightening in the Sukuk market as the US Federal Reserve continues to increase its interest rates and the drop in oil prices affecting investors in major oil-exporting countries. We think the government’s move to front-load its Sukuk issuance could help it overcome these hurdles.

…but there are solid possibilities for new business
We believe Indonesia’s Islamic finance industry has healthy prospects for future growth. However, unlocking that potential will require aggressive reforms to level the playing field for Islamic banks vis-a-vis their conventional counterparts.

The Indonesian authorities have extended a significant amount of support for the development of Islamic finance through a dedicated roadmap targeting an increase of Islamic banks’ market share to 15% by 2023 from 4.5% in mid-2015. In addition, to ensure the swift execution of this strategy, a new committee to identify and implement the necessary reforms was created. 

The reform agenda includes, among other objectives, enhancing the quality and the quantity of human resources through dedicated training programs and a research center, strengthening the capitalization of Islamic banks, and harmonizing regulations and supervision.

On the retail and SME side, we are of the view that Islamic banks could help the country boost its banking penetration rate which remains lower than in other parts of the region. According to World Bank estimates, only 36% of Indonesia’s population uses banking services as of year-end 2014, compared with 46% on average for South Asia and 81% for Malaysia. This gap is mainly due to the relatively low income levels in Indonesia, with GDP per capita estimated at US$3,410 in 2015, and low financial literacy. Furthermore, it reflects Indonesia’s vast land mass and the poor connectivity between its islands. Specific Islamic products, such as low-income banking or SME financing, could help boost financial inclusion in Indonesia by offering customers products aligned with their needs and beliefs.

On the investment side, we think that – at this stage – Islamic banking’s contribution to financing the country’s needs is limited because of the sector’s small size. A move toward consolidation could create fewer but stronger banks capable of providing cost-effective infrastructure financing.

Wholesale funding sources, through bilateral/multilateral financing and Sukuk issuance, could offer another avenue for the country to obtain infrastructure funding. Indonesia is one of the founding members of the Islamic Investment Infrastructure Bank, which is expected to be established in 2016 jointly with the IDB and other countries. 

In addition, in 2015, the Indonesian government raised US$2 billion in international Sukuk markets through issuance that was not only oversubscribed by 3.4 times, but also attracted significant interest from Middle Eastern investors. About 49% of the Sukuk proceeds were allocated to assets to be constructed during the life of the Sukuk, while the remaining funds were channeled to existing assets to ensure the transaction’s compliance with Shariah

We think Sukuk issuance could prove to be a win-win situation for the country, since it will help Indonesia attract investors that cannot invest in conventional instruments. For investors, Indonesia provides diversification opportunities in a country whose creditworthiness shows some promise.

Mohamed Damak is a director and the global head of Islamic finance of financial services research, Ivan Tan is a director of financial services ratings and Kyran Curry is a director of sovereign ratings at Standard & Poor’s Ratings Services. They can be contacted at mohamed.damak@standardandpoors.com, ivan.tan@standardandpoors.com and kyran.curry@standardandpoors.com respectively.

Mohebi taps the Islamic debt market with debut Sukuk

Marking its first Islamic finance deal, Mohebi Logistics in November 2015 floated its debut issuance of Sukuk worth AED400 million (US$108.87 million). Speaking to Abu Dhabi Islamic Bank (ADIB), the sole lead manager and bookrunner for the deal, NURUL ABD HALIM provides an account of the transaction.

The Sukuk were raised to meet the financing needs for the construction and development of Mohebi’s new warehouse and logistics center in South Dubai. According to ADIB, a flexible structure was considered for this facility to provide the bank with a tradable instrument. Since the assets were being developed over time, the Istisnah-Ijarah structure was employed for this Sukuk as it is well-suited for construction financing. 

Commenting on the challenges, ADIB referred to the structuring of the Sukuk: “The facility is being built on leasehold land [of] which [the] value was below the financing amount, thus an Istisnah [structure] was introduced to allow for the construction of the asset.” As such, ADIB added: “[The] ADIB team and Mohebi along with DWC [Dubai World Center] regulators worked together to amend their financing framework to facilitate Islamic financing in the DWC freezone.”

On the unique feature of the deal, the structure used for the purpose of this Sukuk, which historically has been used in the loan space, was formulated with guidance from the ADIB Shariah team. Under the Istisnah-Ijarah contract, the structure allows for the Sukuk size to be upsized on each drawdown linked to the construction of the project. The structure has also paved the way for companies to issue future Sukuk especially for project finance-type transactions. 

Mohebi Logistics is one of the largest vertically-integrated supply chain management companies in the Middle East.

 
AED400 million (US$108.87 million) Sukuk Issue
 
 
18th November 2015
 
   
Issuer Mohebi Logistics (LogiInvest)
Obligor Mohebi Logistics
Size of issue AED400 million (US$108.87 million)
Mode of issue Private placement
Purpose Construction and development of Mohebi’s new warehouse and logistics center in Dubai South
Tenor Nine years
Payment Semi-annual
Currency AED
Maturity date 18th November 2024
Lead manager(s) Abu Dhabi Islamic Bank (ADIB)
Bookrunner(s) ADIB
Governing law UAE
Legal advisor(s)/counsel White & Case
Listing Unlisted
Underlying asset(s) Warehouse and logistics center which is being constructed
Shariah advisor(s) ADIB
Structure Istisnah-Ijarah
Tradability (Tradable post 30% completion of asset)
Investor breakdown N/A

KASB’s Islamic bankers retained

PAKISTAN: More than 150 senior employees of KASB Bank had been removed from their positions between December 2015 and January 2016, while many others are being forced to resign, according to an official of BankIslami, as reported by Pakistan Today. The retrenchment exercise began after the central bank of Pakistan, the State Bank of Pakistan, imposed a moratorium on KASB in November 2014 for a period of six months, ending in April 2015, as the bank failed to meet its paid-up capital requirement, with BankIslami later acquiring KASB in May 2015 with the approval of the central bank. However, employees of KASB which had been given Islamic banking training are secured for now, added a senior official from BankIslami.

Pages

Subscribe to RSS - Volume13.Issue11