Global Islamic Finance

GMALLOABYSAIAL 2I0S1L5 AMIC
FGILNOABNACLE ISLAMIC
2F0I1N6ANCE





contents

global islamic finance

2016

INTERNATIONAL INVESTOR WOULD LIKE TO THANK ITS 4 Introduction: Expanding
KNOWLEDGE PARTNER: the global footprint

7

7 STRATEGIC REVIEW:
PRIORITIES FOR THE NEXT
STAGE OF GLOBAL EXPANSION
The 2008 Financial Crisis and market
trends towards sustainable and
responsible investing have generated
increased interest in Islamic finance.
Industry thought leaders discuss the
strategic objectives and next steps
required for further global expansion.

DDCAP Group

Islamic Market
Intermediary

Real-time trading
platform technology
with 24 hour coverag

30 DDCAP Limited
Copyright © 2011 Hayes Davidson / Nick Wood
30 Business Intelligence: Positions itself as an intermediary i
the Islamic Financial Services Indust
Islamic Capital Market
providing structuring support, trade
Growth in Europe execution and value-added services

The expansion of the Islamic capital its global clients
DDCAP holds a unique market positio
market in the UK, as well as the
as facilitator across a diverse range
resilience of Sharia-compliant of Sharia’a compliant products, asse
classes and instruments in both the
invesDDtmCAPeLnimtiste,d has ledDDaCAgP (rDoIFwC) iLnimgitednumber Islamic primary and secondary mark
of European nations to look at Islamic8-10 Grosvenor Gardens
London DD&Co Limited
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finance.United Kingdom Dubai, United Arab Emirates Transactional Solutions
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e: [email protected] www.ddcap.co.uk

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34 perspective: Stimulating 42 Business Intelligence: Publisher and Editor-in-Chief
Private Sector Sukuk Galvanising Islamic finance Cory D’Abreo
Markets through sukuk Managing Editor
The private sector sukuk market must The successful deployment of Thomas Michael Edwards
be further developed to sustain the Cagamas’ working model has helped Regional Director, Asia
growth of the Islamic financial industry. stimulate sukuk market growth in Janice Lee
Michael J.T. McMillen presents an in Malaysia, while simultaneously Project Coordinator
depth analysis of the critical factors promoting home ownership in the Leba Sable
that must be addressed in order country. However, in order to expand Editors
to facilitate increased corporate the Islamic finance market, in Malaysia Alexis Psarras
issuances. and globally, educational efforts must Haley Moncrief
be bolstered. Production and Design Editor
49 Izabela Austin
Publishing Assistant
44 perspective: Towards 49 STRATEGIC REVIEW: Roselin Banu
Photographer
more ethical forms of HARNESSING THE POTENTIAL John Poh
Circulation Manager
finance OF THE HALAL ECONOMY Louise Powell
Though the convergence of the Islamic The burgeoning halal economy is
This publication is copyright protected.
finance and environmental, social and set for phenomenal growth, driven Copying any part of International Investor is
governance (ESG) investment markets by the surging Muslim lifestyle unlawful without the prior written permission
appears to be inevitable, certain of Capital Knowledge (Hong Kong) Limited.
space. The Strategic Review brought No part of this publication may be repro-
critical developments must occur for duced or transmitted in any form or by any
together high-level stakeholders to means nor held in any information storage
financial products to appeal to both or retrieval system.
debate how to facilitate the supply of
Islamic investors and conventional No warranty: whilst every reasonable ef-
40 halal products and services to meet fort has been made to ensure its accuracy,
ESG investors. neither Capital Knowledge (Hong Kong)
increasing demand. Limited nor any contributor accepts any
responsibility or liability for the accuracy of
40 Business Intelligence: 70 FOCUS: REINVENTING THE any part of the content in this publication.
Sharia-compliant ECONOMIC MODEL Readers should also be aware that external
investment is worth it The emergence of crowdfunding and contributors may represent firms that may
Contrary to industry perceptions, blockchain technology are reinventing have an interest in companies, funds and/
Sharia-compliant investment is the way business is done and funding or their securities mentioned in their contri-
providing Muslim and non-Muslim is secured. These alternative platforms, butions. No statement in this book is to be
investors alike with competitively in line with the Islamic Gift Economy construed as a recommendation to buy or
performing investment opportunities principles, offer increased access to sell securities in any entity or enter into or
based on sound principles and due funding and greater transparency, as exit an investment of any kind.
diligence with an emphasis on social well as social and financial benefits for
responsibility. the market and public alike. +44 (0)20 7193 2965
[email protected]
42

46 Business Intelligence:

OPTIMISING WORKING CAPITAL

VIA FINANCIAL SUPPLY CHAINS

In an increasingly competitive

business environment, RHB Bank is

providing SMEs with innovative and

interactive supply chain solutions to

facilitate access to financing, expedite

financial transactions and improve

42 interactions between distributors, 70

vendors and buyers.

introduction  global islamic finance

Introduction: Expanding the global

footprint

The rapid growth of Islamic finance is being carefully monitored around the world, espe-
cially in countries or jurisdictions that aspire to be global financial hubs. Islamic banking
has been steadily increasing its market penetration, with banking asset growth in many
Muslim-majority countries outpacing conventional banking assets. And the expansion of
global sukuk issuance has been nothing short of remarkable, with the instrument attract-
ing greater numbers of issuers and investors from a broad range of markets.
Today, Sharia-compliant assets are estimated at around US$2 trillion, compliment-
ed by an asset management industry with approximately US$60 billion of assets under
management (AUM). These figures are the product of compound annual growth rates
over the last five years of approximately 17 and 9.5 per cent, respectively.
As a result of the increasing interest in this alternative form of financing and strong
economic growth in countries with large Muslim populations not yet integrated into the
banking system, the market is predicted to grow even further. Mainstream estimates
suggest that the Islamic finance market could grow to over US$3 trillion by 2018, and the
Islamic asset management market may exceed US$75 billion AUM by 2019. Further-
more, the projected rise in Muslim consumer spending to US$2.6 trillion by 2020 feeds
into this expansion, with increasing demand from halal economy suppliers for Sharia-
compliant financial services.
While the numbers relating to Islamic finance growth are impressive, they pale in
comparison to total global conventional financial assets, estimated at US$294 trillion
according to a 2015 study by Deutsche Bank. Clearly, there is a significant amount of
work to be done before Islamic financial markets can start to make a dent in the global
financial universe, and many challenges must be faced in the short and medium term.
As with any burgeoning and exciting economic sector, there are many voices at-
tempting to adequately define the aforementioned challenges, as well as the order of
priority. Yet, herein lies a more fundamental problem: without greater cohesion, coop-
eration and consensus between stakeholders on what the challenges are and how they
should be addressed, many will either remain unovercome or the lack of concurrence
will result in a number of different, and sometimes opposing, solutions, which will further
fragment the market and obstruct the path towards global expansion.
In recognition of this issue, International Investor’s role in the market is evolving
beyond the provision of strategic business information, and into the area of industrial
development services.
A key facet of the value proposition we offer is our ability to successfully bring the
highest level public and private decision-makers together, in a neutral and secure en-
vironment, to productively collaborate on setting and executing strategies that result in
sustainable economic growth and industry-wide development.

4 INTERNATIONAL INVESTOR

global islamic finance  introduction

The primary mechanism we use to achieve these outcomes is an International
Investor: Strategic Review event. The following document contains the reports from two
such events, which examined the global growth of the Islamic finance market and the
halal economy, respectively.
At our Strategic Review event for the Islamic finance sector, entitled ‘Priorities for
the next stage of global expansion’, the discussion centred on the pre-eminent ques-
tions pervading the sector. One such issue was the role of Islamic finance in creating a
more equitable and sustainable economy, and how to develop broader recognition of the
industry’s alignment with these objectives. There was also serious discussion relating
to the specific steps required to advance certain strategic goals, including whether the
next stage of industry development meant divergence or convergence with the financial
framework already in place on a global level.
The Halal Economy Strategic Review, ‘Harnessing the potential of the halal econ-
omy’, facilitated a constructive debate touching on a number of defining issues for this
rapidly expanding sector. These included the development of Islamic e-commerce, and
how an industry that contains a plethora of SMEs can embrace and leverage the digital
economy; as well as the compatibility of conventional banking and financing models for
halal businesses, and alternative risk sharing structures, such as crowdfunding.
In addition to the insights provided by the participants attending our Strategic Re-
view events, this edition of International Investor: Global Islamic Finance offers more
detailed analysis and opinion from industry thought leaders. The topics covered in our
feature pieces include the European Islamic capital market growth, analyses of both
public and private sector sukuk market development, the benefits of Sharia-compliant
fund management, the convergence of Islamic finance and ESG Investing, the impor-
tance of Sharia-compliant financing solutions for SMEs, and the emergence of a global
sharing economy.
Industry development and growth can only be successfully achieved through close
collaboration, reciprocal contribution and strong commitment. This edition aims to pro-
vide perspective to all stakeholders, as well as communicate and facilitate ongoing col-
laboration between the public and private sector actors in the Islamic economy and the
global Islamic finance industry. The intention is to drive the achievement of cross-sector
industry goals, stimulate further discourse and, ultimately, illuminate the path towards
sustainable growth.
Finally, International Investor would like to take this opportunity to thank the partici-
pants of both our Strategic Review sessions, as well as those who contributed additional
content in what follows. We hope you consider the findings and material arising from
these debates both interesting and useful.

strategic review 5



global islamic finance  strategic review

STRATEGIC REVIEW: PRIORITIES FOR THE NEXT
STAGE OF GLOBAL EXPANSION

Islamic finance is becoming increasingly known for its AGENDA
innovative and sustainable qualities. As global recognition
increases, industry thought leaders must clearly define the ■■ Defining the value proposition and strategic
value proposition and the necessary strategic steps that will objectives of Islamic finance
facilitate a progression to the next level of development. ●● Creating a viable alternative
●● The need for a holistic approach
●● Promoting the inherent values: sustainability,
transparency, fairness and ethics

■■ Creating a balance between socially-responsible
and profit-driven goals
●● What does this mean for financial institutions?
●● Incorporating Islamic principles into products
and structures

■■ Industry development and potential blockages
●● Where is the corporate momentum?
●● Educating the decision-makers
●● Top-down and bottom-up approaches
●● Infrastructure and ecosystems: where
there’s a will, there’s a way

■■ The big question: convergence or divergence?
●● How to compete on a playing field defined by
conventional finance?
●● Ramping up Sharia-compliant asset
management
●● Adapting to the framework: expounding
specificities
●● Islamic finance as responsible finance
●● Promulgating important industry contributions

■■ Involving the small-scale investors
■■ Expanding the role of Sharia scholars
■■ Closing comments and concrete actions

strategic review 7

strategic review  global islamic finance

PARTICIPANTS DAUD VICARY STELLA COX
ABDULLAH Managing Director
President and Chief DDCAP
Executive Officer
International Centre for
Education in Islamic
Finance (INCEIF)

Daud has been in the financial services industry for more than Stella has been in her current role since 1998, having
four decades, with significant experience in Asia, Europe, Latin previously worked as an independent, non-executive director
America and the Middle East. Prior to his current position, he of a UK Islamic bank. In 2013, she was one of a small group of
was Global Leader of Deloitte’s Global Islamic Finance Group, non-ministerial industry experts within the UK Government’s
as well as acting CEO of Asian Finance Bank, an Islamic bank first Islamic Finance Task Force. Stella has worked on Islamic
based in Malaysia. Daud holds an economic and social history finance market development committees formed by several
degree from the University of Bristol, UK, and has co-authored overseas authorities and is also chair of the Islamic Finance
the book Islamic Finance: Why it Makes Sense. Market Advisory Group established in 2014 by TheCityUK.

MOHD IZANI GHANI DR NIK RAMLAH
Chief Financial Officer MAHMOOD
Khazanah Nasional Deputy Chief Executive
(since retired)
Securities Commission
Malaysia (SC)

Izani has a degree from the London School of Economics and Nik held numerous positions within the SC during her 22 year
Political Science and is a fellow of the Association of Chartered career at the authority. She worked in distinct areas ranging
Certified Accountants, as well as a member of the Malaysian from legal and regulatory reform, to product and market de-
Institute of Accountants. In the field of Islamic finance, he has velopment, and Islamic capital market investor education and
played a fundamental role in establishing ringgit-denominated enforcement. She subsequently retired from the SC in March
sukuk programmes for Khazanah Nasional, as well as in 2016. Nik currently sits on the board of the Securities Industry
issuances of landmark and innovative sukuk transactions in a Development Corporation and holds an LLM and a PhD from
number of distinct currencies. the University of London.

GERALD MICHAEL CHUNG CHEE LEONG
AMBROSE President and Chief
Chief Executive Officer Executive Officer
Aberdeen Islamic Asset Cagamas
Management Sdn Bhd
(AIAMSB)

Gerald joined Aberdeen Asset Management in 2005 and is Chee Leong has been in his current position since 2012 and has
currently CEO of AIAMSB, the group’s Islamic fund management almost three decades of banking experience, focusing mainly
hub. He previously worked as institutional sales director on financial system stability and the financial sector. Prior to
covering ASEAN equities at Kim Eng Securities in Singapore, joining Cagamas, he served as director of Bank Negara Malaysia’s
HSBC James Capel in London and BNP Paribas Securities, Banking Supervision and Risk Management departments, during
London. Between 1980 and 1987, he served as a submarine which time he conducted a number of assignments for the
officer in the British Royal Navy. Gerald holds a masters in land International Monetary Fund. Chee Leong holds a degree in
economy from the University of Cambridge. business administration from the University of Malaya.

8 INTERNATIONAL INVESTOR

global islamic finance  strategic review

PROF. RIFAAT AHMED DR MULYA SIREGAR PARTICIPANTS
ABDEL KARIM Deputy Commissioner
Chief Executive Officer of Banking Supervision
International Islamic Indonesia Financial
Liquidity Management Services Authority (IFSA)
Corporation (IILM)

Rifaat is a global leader in the Islamic financial services Mulya has held his current post since 2014, in which he is
industry at both the professional and the academic level. He responsible for overseeing banking research and regulation,
previously served as the inaugural secretary general at both licensing and information, and Sharia banking in Indonesia.
the Accounting and Auditing Organization for Islamic Financial Since 2012, he has been active in a number of global
Institutions and the Islamic Financial Services Board. Rifaat has organisations focused on financial system stability, including
garnered a number of prestigious international awards for his serving as co-chair of the ASEAN Banking Integration
extensive contribution to the Islamic financial services industry Framework, among other roles. Mulya holds a PhD and an a
over the last three decades. masters of science degree from Ohio State University, U.S.

SYED ABDULL AZIZ
SYED KECHIK
Chief Executive Officer
OCBC Al-Amin Bank

Syed has been in his current position since the bank’s inception
in 2008. He began his career in the banking industry in 1990
at Citibank Malaysia, prior to working at two other banks,
including in a senior management role at an Islamic bank.
Under his stewardship, OCBC Al-Amin was named Islamic Bank
of the Year for Malaysia in 2014 by the UK-based publication,
The Banker. Syed is currently a member of the Chartered
Institute of Islamic Finance Professionals.

ROUNDTABLE PARTNERS

DDCAP Group

strategic review 9

strategic review  global islamic finance

GLOSSARY Sharia IJARA
Often referred to as Islamic law, it encompasses the rulings A type of contract that refers to an agreement made by
contained in and derived from The Koran and the Sunnah, an institution offering IF services to lease a particular
which are the sayings and living example of the Prophet client an asset specified by the client for an agreed period
Muhammad. It is primarily concerned with a set of values against specified instalments of lease rental. Neither party
that are essential to Islam and governs not only religious may alter the contract without dual consent.
rituals, but also all aspects of daily life. There is extreme Ijara is classified into ‘operating ijara’, which does not
variation in how Sharia is interpreted and implemented include a commitment to transfer the legal title of the
among and within Muslim societies today. This is especially leased asset to the lessee at the end of the lease, and
prevalent for its financial laws. ‘ijara muntahia bittamleek’, which is completed by
passing the legal title of the leased asset to the lessee.
SUKUK
A sukuk is a financial certificate that represents the holder’s musharaka
proportionate, beneficial ownership of an undivided part of A type of contract that stipulates an investment
an underlying tangible asset relating to particular projects partnership between two or more parties, for example
or investment activities. In this structure, the holder an institution offering IF services and its clients. All
assumes all rights and obligations to the asset. In contrast parties contribute capital towards the financing of a
to a conventional interest-bearing bond structure with a particular business activity in equal or varying amounts
contractual obligation to pay bondholders interest and to establish a new project or share in an existing one.The
principal on particular dates, the issuer of sukuk sells an partners share the profits according to a pre-agreed ratio,
investor the certificate and the asset is then leased back while losses are shared in proportion to each partner’s
to the issuer for a predetermined return in the form of share of capital. Musharaka is often used by Islamic banks
rental charges. The issuer also makes a contractual promise to finance large projects.
to return the principal at a future date at par value by
buying their share of the asset. Sukuk must be able to link MURABAHA
the returns and cash flows of the financing to the assets A type of IF structure in which the institution offering IF
purchased, or returns generated from an asset purchased. services sells a specified kind of asset to a customer that
is already in the possession of the institution, or buys a
RIBA product on behalf of the client and resells the product to
Riba generally refers to charged interest, but can be the same client, at cost plus an agreed profit margin.
translated in many ways to mean interest rate, excess,
increase or addition. Technically, it refers to any WAKALA
increase or addition to capital obtained by the lender A contract of agency in which the customer appoints the
as a condition of a loan. Simply put, it covers earning institution or other party to perform a certain task or
money on money. Riba, in all forms, is strictly prohibited undertake business on their behalf, usually for payment
under Sharia law, as it is considered an unjust return that of a fee or commission. This kind of arrangement,
leads to unjust enrichment. This, in part, is due to the without provision for payment of a fee, cannot be
fact there is no productive or trade activity to create considered irrevocable, thus allowing an agent the right
the additional wealth. In Islam, money is seen as only a to terminate the agency at any time. Also known as
medium of exchange, it has not value in and of itself and al-wakala.
should not give rise to more money.

10 INTERNATIONAL INVESTOR

global islamic finance  strategic review

Daud Vicary Abdullah, International Centre for sustainable and ethical, due to the foundational elements Daud Vicary Abdullah
Education in Islamic Finance (INCEIF): I would like to of Islam. Achieving sustainability is a process affected by President and Chief Executive
extend a very warm welcome to all the participants; numerous variables, but these elements and prohibitions Officer
there is certainly much to discuss, so I will forego a put the industry on a solid path. International Centre for
lengthy introduction. There are three broad areas that Second, Islamic finance must be linked to the real Education in Islamic Finance
we will cover during this discussion: the value proposition economy, real assets, real transactions, which, as you all (INCEIF)
of Islamic finance; the role of Islamic finance in creating know, is quite different from conventional finance. By
a sustainable economy; and issues related to creating a some estimates, the size of conventional financial assets
level playing field with conventional finance. is four times global GDP; the Islamic finance framework
Accordingly, I would like to begin by getting a sense would not allow this predicament. It is about financing,
of the current value proposition of Islamic finance not the financialisation of the economy.
and what participants identify as the industry’s core Finally, the numbers speak for themselves. Figures
strategic objectives. often cited suggest that the world’s two billion Muslims
are growing at double the rate of non-Muslims and that
Prof. Rifaat Ahmed Abdel Karim, International Islamic by 2030 Muslims will make up more than a quarter of the
Liquidity Management Corporation (IILM): Islamic global population. This, coupled with the relative size
finance is trying to provide a viable alternative to a of economies in the Middle and North Africa, Asia and
certain group of individuals who wish to adhere to their Sub-Saharan Africa, for example, shows that demand
faith. This objective may seem straightforward, but will certainly not be lacking.
it actually requires significant infrastructure being in
place. Thus, in order to provide the value proposition Dr Mulya Siregar, Indonesia Financial Services
to this group, Islamic finance must have the necessary Authority (IFSA): At the IFSA, initially we approached
infrastructure in accounting, prudential supervision, Islamic finance development from a legalistic
liquidity management and, of course, human resources, perspective, but quickly realised it would be more
among other areas. Industry development and advancing prudent to shift our approach to one based on value
the value proposition demand a holistic approach. orientation, i.e. engaging finance to achieve positive
socio-economic goals. In other words, we moved from a
Stella Cox, DDCAP: Of course, I certainly concur with prohibition orientation to a maqasid orientation, which
Professor Rifaat’s point. Currently, the key issue is that is aligned with the objectives of Sharia.
the infrastructure in some territories is rather more Building on this approach, it is important to point out
developed than in others. Yet, ultimately, the industry’s that Islamic finance should be ‘development relevant’
value proposition rests on its global footprint; it is the in order to be truly and meaningfully Islamic, rather
responsibility of involved jurisdictions to work together than ‘development neutral’. Moreover, a further shift
and collaborate with the objective of trying to move is needed from poverty-neutral to poverty-sensitive;
each one to an equal footing over time. it must be a clear industry aim to improve the lives
In terms of the holistic approach, while there has of citizens and reduce poverty. The latter is linked to
been an extensive focus on the prudential side, one another shift from debt orientation to equity orientation.
area that is rightly becoming more prominent and is In some areas, Islamic financial institutions have
certainly required to enhance the value proposition is a parochialistic approach, as opposed to aiming for
the development of human resources through structured universalism. Islam is not meant for any particular group
education and training. of people, but for all humanity. The principles of Islam
pertaining to finance are universal in nature: fairness,
Dr Nik Ramlah Mahmood, Securities Commission ethics, transparency and sustainability. Thus, we must
Malaysia (SC): When I hear ‘value proposition’, I think of execute these shifts in perspective to enhance the value
the inherent value of Islamic finance. First, it is inherently proposition of the industry.

strategic review 11

strategic review  global islamic finance

Chung Chee Leong Gerald Michael Ambrose, Aberdeen Islamic Asset primarily serve as an intermediary producing outcomes
President and Chief Executive Management Sdn Bhd (AIAMSB): From a fund that impact on all humanity. Now, these outcomes
Officer management point of view, while I agree with principles should be charity and corporate social responsibility
Cagamas like poverty-sensitive over poverty-neutral, as an focused, but there also must be profit.
industry we are entrusted with funds for augmentation, Chee Leong, Cagamas is primarily involved in
in many cases, to provide for our client’s future. There mobilising funds, how do you see this issue in the
must be some profit share available. context of your role and objectives?
Bonds issued under the Ihsan Sukuk Programme,
for example, have been quite difficult to sell to fund Chung Chee Leong, Cagamas: From the perspective
managers, as they cannot quite fathom a scenario in of a regular sukuk issuer, when we design a structure,
which, if the underlying project is a success, you get less including our current Multicurrency Medium Term Note
money back! There must be opportunities for investors (EMTN) programme, we would ensure that it is based on
to find returns. globally accepted Sharia principles, which in this case
is the wakala principle, in order to broaden the appeal,
NRM, SC: That is a very pertinent point: to what extent particularly to Gulf Cooperation Council investors. Thus,
should the design and development of Islamic finance, the demand factor is important.
going forward, be demand driven? How far should the
industry align itself with the requirements of fund  Many jurisdictions with huge Muslim
managers, for example? Clearly, it has to be to some populations ... are either underserved
extent, but is it all about what can be sold? or not served at all because of
It is a very delicate balance; we have to find the the lack or non-existence of Islamic
landing from somewhere. Hitherto, the design has been finance facilities
based on what sells and that is part of the problem. It
is the root of the accusations relating to the replication
and adaptation of conventional products.

DVA, INCEIF: You have both anticipated one of today’s Accordingly, we have been pondering how to structure
key discussion topics. Arguably, the perception is that our sukuk in a manner that is not only geared towards
the Islamic aspect of the industry is largely philosophical, meeting investor demand, but embodies the socially
but, operationally, it is in close proximity to conventional responsible remit of Islamic finance. Cagamas already
finance. Yet, this reality was born out of necessity and facilitates government policy by helping to provide
we are at a stage where this can begin to change. affordable housing, for example, but we are investigating
Accordingly, the debate must now focus on balance. the ways in which our instruments can better meet this
Clearly, undertaking socially orientated activities is dual purpose. If we take waqf funds, for instance, there
a central pillar of Islam and there are already financial are possibilities to invest these funds in the capital
instruments that facilitate this, such as zakat and waqf markets to provide further affordable housing.
funds, but where does finance fit in here? If the finance Having said that, there are still significant
part is a means to an end, are we, for instance, merely opportunities in the sukuk space. We are in contact with
looking at asset management driven by waqf? many jurisdictions with huge Muslim populations that are
The 2008 Financial Crisis was a fulcrum that either underserved or not served at all because of the
accelerated the search for alternative forms of finance; lack or non-existence of Islamic finance facilities. The
thus, spurring interest in Islamic finance. We must now Philippines is one example, and they have approached
articulate what that means for the various branches of Cagamas for help in designing instruments to meet their
finance, such as asset management. Some market actors demand. I think the multilateral agencies should certainly
contend that the financial services industry should assume the mantle in terms of Islamic finance promotion.

12 INTERNATIONAL INVESTOR

global islamic finance  strategic review

Regarding objectives, following Stella’s point, capital markets, trade finance, project financing, Syed Abdull Aziz Syed Kechik
enhancing awareness and understanding of Islamic working capital lines, so the next phase should include Chief Executive Officer
finance is very important. In jurisdictions that are a lot more development in wealth management. From OCBC Al-Amin Bank
not financial centres or are non-Muslim majority, our our bank’s point of view, the four main categories of
conversations with investors about sukuk often must wealth management products would be deposits, as well
begin with explanations. However, this can change. as the structured investment products, unit trusts and
For example, after the Hong Kong Government issued bankatakaful.
sukuk, understanding of sukuk by the Hong Kong
investors increased exponentially. Notwithstanding this While we have seen remarkable
development, investors in Japan, South Korea or Taiwan, developments on the asset side,
for example, still do not grasp sukuk fundamentals; there has been some lagging on the
it is either too complicated or they prefer to stick to liability side
conventional if they cannot secure a higher yield.
Thus, we must collectively instigate an industry-wide
communication strategy, especially in new markets.

Syed Abdull Aziz Syed Kechik, OCBC Al-Amin: As far as the consumer banking business is concerned,
Returning to the value proposition, two key points bear there must be more development and innovation here.
reiterating. First, Islamic finance creates an alternative
market for the Muslim community to undertake banking NRM, SC: I would just like to add that the Securities
in accordance with Sharia. Second, it creates the Commission (SC) is currently working on a blueprint
required market for the Islamic banking business that for Islamic funds and wealth management, which is
facilitates real economic activity. intended to cover asset management and private wealth
OCBC Bank has a presence throughout Southeast management. I fully agree that wealth management is
Asia, and Islamic banking, on regional basis, is a key the next area for development, hence our focus here.
focus for us. The decision to locate the company’s
Islamic finance centre in Malaysia was straightforward. DVA, INCEIF: Let’s bring Izani into the discussion.
The country has led the way in this sector and has Khazanah Nasional is clearly engaged, but what is your
painstakingly constructed the right ecosystem for strategy and agenda? How important are the ideas
further development. Consequently, we have put that Mulya highlighted in terms of your fulfilling the
significant weight behind our operations here. fundamental objectives of Islamic finance?
In terms of core strategic objectives, over the last 40
years the Malaysian Government has achieved the goal Mohd Izani Ghani, Khazanah Nasional: In 2005, Khazanah
of significantly increasing the market share of Islamic resolved to make Sharia-compliant transactions our
banking. It currently stands at approximately 25 per mainstream financing choice. We knew we were going
cent, but Bank Negara Malaysia announced in 2011 that to do a lot of financing and demand for capital from
the goal was to achieve a 40 per cent market share, in Khazanah would be high, so it was a tough call to make
terms of total banking financing assets, by 2020. That is up front; however, due to this commitment, we had the
a big challenge, but in order for the industry to continue determination to follow it through. This compelled us
to be relevant, this degree of scaling up is key. to devote the required resources, to take the difficult
Another focus should be on rebalancing. While we decisions, and, importantly, to innovate and explore in
have seen remarkable developments on the asset side, terms of structures.
there has been some lagging on the liability side; in This is borne out by our transactions. For our 2006 and
my opinion, there is too much focus put on the asset 2007 exchangeable sukuk, we designed a structure that
side. In Malaysia, all the products are already in place: fit our requirements. In both instances we encountered

strategic review 13

strategic review  global islamic finance

Mohd Izani Ghani problems relating to the need to restructure the easy to sell, but it would not be so impactful. Our aim was
Chief Financial Officer company’s non-Sharia-compliant debt, which also to draw out investors that wanted to give and integrate
Khazanah Nasional generated pushback from the underlying company’s a gift element into the bond. Accordingly, we took the
management. However, we were able to move forward decision to structure the sukuk in such a way that the yield
because of our ideological commitment. In fact, with our would be reduced if the schools met the required Key
PLUS exchangeable issuance in 2007, we went together Performance Indicators (KPIs). It was another innovative
with PLUS to meet the SC’s Shariah Advisory Council to structure that required resolute decision-making.
discuss steps towards purifying PLUS’s capital structure. Thus, in 2015, we issued the ringgit-denominated
sukuk priced at par to yield 4.3 per cent, in line with
 For the Ihsan Sukuk Programme, we our curve and slightly above the fixed deposit rates at
decided to design an instrument to target the time. In year five, there will be a KPI review and if
like-minded people, who want to give the targets are met, investors will face an 80 basis point
back to society reduction to 3.5 per cent.
Needless to say, it was a challenging roadshow, our
Since then, we have sustained our momentum, in first ever for a ringgit-denominated bond and for only
part due to our continued commitment to innovation. MYR100 million, a relatively trifling amount compared
The Ihsan Sukuk Programme is a good example of this. to our previous issuances. We convinced the foundations
In 2010, Khazanah started to look at the education and the corporates; the bank treasurers were the
sector. The public were unimpressed with the quality of most difficult to manage because they were decidedly
Malaysian schools, but the issue was not being addressed sceptical about being able to convince their own bosses
adequately, particularly by the private sector. Accordingly, to take the yield reduction, but some came around.
we set up the Yayasan Amir Trust Schools programme and,
beginning in 2011, started to fund a broad cross section GMA, AIAMSB: You are making fund managers sound
of schools using internal Khazanah funds. like the unacceptable face of capitalism! I think it is
After four years, the results were outstanding. One important to find ways to convince funds to invest
school in Johor moved up 2,000 places in the overall in these types of programmes. If we had principals,
rankings. The attendance at that school increased, the government-linked pension funds, for example, who
teaching improved, there is greater parent participation, would provide us with a remit to invest a percentage of
and that is just one example. Accordingly, we wanted our assets in these kinds of corporate social responsibility
to continue the development of the trust programme, (CSR) initiatives, we would be absolutely happy to do so.
but diversify the funding because Khazanah had been On the wealth management side as well, I think there
shouldering the entire burden. So, for the Ihsan Sukuk are significant opportunities, as many individuals would
Programme, we decided to design an instrument to target see it as a good investment.
like-minded people, who want to give back to society.
The social impact bonds, which had been launched MIG, Khazanah Nasional: One other important feature
in the UK, piqued our interest, but in this model a of the programme is the option to waive the principal
step-up yield was provided as an incentive. Thus, and give it to the trust at any stage during the seven-year
the government commits to pay for improved social tenor, which counts towards the giver’s tax exemption.
outcomes that result in public sector savings: reducing The implication of this for Khazanah is that the more
recidivism, for example. investors donate through this instrument, the more
Clearly, if Khazanah issued a sukuk with these terms internal funds are freed up for allocation to other CSR
we could raise significant funds; it would be ludicrously activities on an annual basis. Moreover, this structure
can be applied in a plethora of other sectors: affordable
housing or healthcare, for example. It is a channel that
allows people to give back to society and take decisions

14 INTERNATIONAL INVESTOR

global islamic finance  strategic review

about further giving, while stimulating social spending. Asset management is in focus with major firms, such Stella Cox
It has really caught the imagination, we have proven this as Aberdeen Asset Management, prioritising Islamic Managing Director
kind of structure can work; people are talking about it financial market strategy. Specifically in terms of DDCAP
and we hope that it will be replicated and used by other asset management, we see a lot of the potential in
countries and institutions. harnessing the growth in that sector to the development
of Sharia-compliant financial technology. Already in the
DVA, INCEIF: I want to get some perspectives from UK, Fintech has extended its reach to niche or focused
participants on industry development, globally speaking subsets of the financial industry. This is where we also see
and in their own markets, and how they see Islamic strong interest from Muslim entrepreneurs in the business
finance moving forward from the point at which it world, both within the UK and throughout Europe.
stands now. Moreover, are there any potential blockages
to development that must be addressed?  If we want to drive the European
Islamic capital market prospects forward,
SC, DDCAP: Fundamentally, in terms of direction, we must focus on the delivery of
development and forward progress, as I mentioned focused, professional education
in my opening remarks, it depends on where you are
located geographically. Another important consideration for the UK industry
The UK market supports five, wholly Sharia- is how to build on the financial architecture that has
compliant banks, as well as a Sharia-compliant insurance been implemented. There is already a Sharia-compliant
underwriting agency. I chair the Islamic Finance Market capital markets platform and the inaugural UK
Advisory Group (IFMAG) that sits within TheCityUK, a sovereign sukuk was issued in 2014, but I think there
private sector organisation that represents UK-based has been a lack of corporate momentum following these
financial and related professional services. TheCityUK developments. For example the Eurosukuk market has
works with the UK Government through its seat on the not materialised, which is a disappointment to many
HM Treasury-led Financial Services Trade and Investment observers. Although there may a be number of valid
Board (FSTIB). The FSTIB has nine different work reasons for this, we cannot set it aside and must still
streams: Islamic Finance is one. establish a clear pathway to achieve our objectives.
London is a leading global centre for professional In my opinion, this pathway must include a concerted
financial services so, unsurprisingly, we have many effort to educate senior, corporate decision-makers.
high-quality, professional financial advisory firms among A significant number of major UK and European
IFMAG’s membership. Thus, when we meet, we include corporations have been accessing Islamic finance for a
focus on the expertise we have in the UK across the long time through private market arrangements rather
legal, prudential, advisory and accountancy spectrum. than through public Islamic market issuance. However,
The front offices of our financial institutions are often the biggest problem in the European space is convincing
located in the core hubs for Islamic finance, as client the chief financial officer. Thus, if we want to drive the
connection is important, which enables conducive European Islamic capital market prospects forward,
discussion about the broad development of the industry we must focus on the delivery of focused, professional
when working groups and similar committee meetings education. This will bring us a little bit closer to meeting
are convened overseas. one of the core strategic objectives of the industry.
The UK Government has clearly set out its agenda.
There can be no argument that the UK is the Western DVA, INCEIF: I think there is general agreement about
hub for Islamic finance; no other European nation has the importance of delivering education. Often there is
made a concerted effort to authorise Sharia-compliant
banking institutions, for example. However, we cannot
be complacent and we need to continue to push.

strategic review 15

strategic review  global islamic finance

Dr Mulya Siregar an attempt to implement a one-size-fits all approach, situation. There was no government leadership at this
Deputy Commissioner of but it requires a multi-layered and nuanced strategy time; the progress was as a result of citizens petitioning
Banking Supervision that must be developed over time. members of parliament to act on their behalf. Thus,
Indonesia Financial Services We must also consider which markets to prioritise. I the Banking Act was amended to state very clearly how
Authority (IFSA) have had conversations with a number of well-respected Islamic banking should be operated and opened the
Islamic finance thought leaders that are adamant the pathway for more Islamic banks.
U.S. is the key target market for education. Yet, the In 2008, the government enacted the Islamic
ethical value arguments will not be enough there, it will Banking Act and the Sukuk Act, but there was still no
also require empirical evidence. top-down programme that targeted Islamic finance
development. Consequently, important changes took
GMA, AIAMSB: One related consideration is how this an inordinate amount of time to occur. For instance, it
form of financing compares with the competition. As took four years to convince the government to exempt
part of the efforts to convince target markets, clear murabaha transactions from double taxation; clearly,
arguments must be made relating to why Sharia- the bottom-up approach was not sufficient.
compliant finance, fund management or sukuk are The decision was then taken by the Indonesian
better options compared to other non-Muslim forms Central Bank and FSA to request that governmental
of finance that also pertain to the common good, like development planning institutions take the lead and
environmental, social and governance (ESG) investing devise an Islamic finance master plan. At first, they
or socially responsible investing (SRI). were reluctant, but they realised it was fundamental
to development and various government-led plans were
NRM, SC: In terms of potential blockages to development, put in place. However, even this was not enough to drive
while both the UK and Malaysia have vital top-down the necessary changes, so it was deemed necessary
governmental commitment, clearly demonstrated by to establish a National Islamic Finance Committee to
policy, markets must have organisations like Khazanah develop the industry, in the vein of Malaysia’s MIFC.
that are willing to drive the required changes and Consequently, it is unlikely we will have another four-
innovate structures and products. year wait to change regulatory obstacles because these
I am not underestimating the role of asset managers issues will be addressed at the top level first.
and fund managers; arguably, Islamic finance has My broad point is that it requires a combination of
reached this stage due to a certain degree of similarity both top-down and bottom-up approaches in order to
with conventional finance. However, if we are to take develop Islamic finance.
it to the next level, we must liberate the industry from
what has become a very restrictive playing field. Due MIG, Khazanah Nasional: It is also important that the
to familiarity and similarity, investors and practitioners industry operates with a global view. Khazanah faced a
refuse to think any further or engage with the kinds of frosty reception to the idea of issuing a Singapore dollar
products Khazanah is developing. sukuk in 2010, even though it provided a natural hedge
for our asset purchases in the country. We were asked
MS, IFSA: In Indonesia, Islamic banking really developed why we wanted to help Singaporeans! If we do not push
as a result of the people demanding Islamic banking the boundaries and take this to other markets, we will
services. Even then, only one article was included in not advance Islamic finance any further.
the 1992 Banking Act, which related to Islamic finance In order to do this, government support in the
allowing for the possibility of banks to operate based on particular jurisdiction is very important in order to
profit and loss sharing. implement the required infrastructure that allows the
This stimulated the foundation of Bank Muamalat issuer to play their role accordingly. We would not have
Indonesia, but there was no more progress after that until been able to undertake our renminbi sukuk without the
1998, when it was the citizens again who questioned the support of the Hong Kong Government, for example.

16 INTERNATIONAL INVESTOR

Copyright © 2011 Hayes Davidson / Nick Wood DDCADPDGCrAouPpGroup
Copyright © 2011 Hayes Davidson / Nick Wood
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strategic review  global islamic finance

Rof. Rifaat Ahmed Abdel Karim RAAK, IILM: Once a government or jurisdiction accepts the government can set the pace by forming policy, it
Chief Executive Officer the value proposition of Islamic finance, which is to is right that practitioners are expected to build on that
International Islamic Liquidity provide a viable, alternative means of finance, then through implementation and development.
Management Corporation everything should fall into place. They will see the
potential and implement policy to support development. CCL, Cagamas: If the relevant infrastructure is put in
In Malaysia, for example, the government and Bank place by governments or central banks, the market itself
Negara played an instrumental role in setting up INCEIF will incentivise Islamic finance practice and may not
to provide the required human capital for industry necessarily require other stimulants, like tax incentives,
development. Moreover, Bank Negara, the SC, MIFC, and for example. In the international market, a corporate
Khazanah Nasional are all providing sustained regulatory will have to pay a higher yield on a sukuk to generate the
and practical support, as well as the infrastructure required interest. However, if the same corporate issues
required to develop the industry. sukuk in the Malaysian market, due to the depth and
infrastructure within the Islamic financial ecosystem, it
 Once a government or jurisdiction will be able to pay a lower or the equivalent yield as a
accepts the value proposition of Islamic conventional bond.
finance, which is to provide a viable, While there may be some governmental incentives,
alternative means of finance, then encouraging transactions has more to do with the
everything should fall into place establishment of an adequate ecosystem.

The strategies can, of course, be different. In order SAASK, OCBC Al-Amin: From a retail perspective,
to establish themselves as an Islamic finance hub, as of 2013, Muslims constitute 61.3 per cent of the
Malaysia decided to build strategic practical and legal total population in Malaysia, yet even convincing this
infrastructure, as well as host international Islamic demographic to do Islamic banking is a big challenge.
finance institutions. The crux of this issue is cost: if Islamic banking is more
Each jurisdiction is trying to differentiate itself in expensive the majority will not consider it, despite
order to be a hub, which is why a top-down approach is so the religious aspect. This is compounded by the fact
important because it always begins with the unified and that Islamic banks have infrastructure costs that are
overall objective of providing a viable alternative means greater than conventional banks, due to the stage of
of finance. That is what will drive the industry forward. development, which limits our price competitiveness.
In Malaysia, the top-down approach from the
SC, DDCAP: It is absolutely correct that there has to be government has been critical to the retail business,
a mix of a top-down and bottom-up approach. In terms particularly regarding tax incentives. For example,
of infrastructure, the UK Government was able to roll the 20 per cent stamp duty discount offered by the
out an Islamic finance roadmap, initially with a priority government means the customer saves money with an
of financial inclusion and based on the premise that UK Islamic mortgage and the policy has even attracted
regulation did not preclude Islamic financial practice. non-Muslims. These kinds of incentives are of great
While our government could not and cannot incentivise importance during this period of growth for Islamic
Islamic financial products and services, some changes to finance, as they can really drive the market. Until the
the legal environment were certainly required to enable industry is large enough to achieve the economies of
it to grow. Importantly, where government could fix scale required to compete on a level playing field with
issues, such as with requisite amendments to legislation conventional finance, policy that facilitates growth
to level the playing field, they did so. However, while must continue until we reach the tipping point.

NRM, SC: Tax incentives are important to discuss; we
have been dealing with tax issues for as long as we have

18 INTERNATIONAL INVESTOR

global islamic finance  strategic review

been promoting Islamic finance and capital markets. established, and the country is the largest sukuk issuer. Dr Nik Ramlah Mahmood
Due to the structure of Islamic financial transactions, it It is the sum of these parts that creates momentum. Deputy Chief Executive
is important to remove the tax disadvantages and move (since retired)
towards tax neutrality. That is relatively easy and most DVA, INCEIF: Interestingly, Malaysia has created this Securities Commission Malaysia
jurisdictions will recognise the need to ensure parity. ecosystem, which has been very successful. However, (SC)
perhaps this progress has inadvertently increased the
Due to the structure of Islamic gap from those following because the specificities are
financial transactions, it is important to understood at multiple levels.
remove the tax disadvantages and move
towards tax neutrality SC, DDCAP: Education will play a key role here and
there has been a significant top-down focus in the UK
Malaysia went one step further and provided to develop the educational infrastructure to support
incentives, as the government was fully committed to Islamic finance, but this effort must be approached
Islamic finance. While the policy has been a significant from a holistic perspective. To this end, we are very
success and the decision has served both the industry interested in global partnerships to help development
and the country well, incentives like these may be and improve standards and consistency.
problematic for other countries because, arguably, tax In academic education, we are working to help the
incentives introduce a discriminatory element to the universities with their efforts to ensure that the content
regulatory environment. and delivery of individual courses and the qualifications
attached to them are consistent, as far as it is practicable.
DVA, INCEIF: As an extension of this discussion, we must This is also to the extent it is appropriate as there are
consider whether Islamic finance must divorce itself currently no formally agreed global standards. There
from conventional finance in order to make it more is also the practical issue of graduate employment and
sustainable, or if there is a structured path towards new entrants’ access to the industry. We try to support
convergence with conventional finance to be followed? this and are addressing it in our own way at DDCAP by
The latter would, in effect, require an admission that offering internships to students, which is one important
the industry will never be completely removed and, method of supporting human resource sustainability.
consequently, require agreement on what degree of A number of former members of the UK Government’s
differentiation is acceptable. Islamic Finance Task Force, who worked on the
preparations for the UK’s sovereign sukuk issuance, now
RAAK, IILM: In order to become a hub, you must cater sit on the advisory boards of various UK universities.
for the specificities of Islamic finance or, perhaps more Among them is the University of East London (UEL) that
importantly, be able to cater for those specificities. For evolved an Islamic finance education strategy and is
example, INCEIF has had and will continue to have the working quite closely with INCEIF, for example.
support of the Malaysian Government to cater for the The Chartered Institute of Securities and Investment
specificities of Islamic finance. offers the Islamic Finance Qualification, a professional
To be a hub, you have to take concrete steps. That qualification which, during the past ten years or so, has
is why the Malaysian Islamic finance ecosystem has become a global leader in its space.
increased exponentially since 2000, as a result of top-
down initiatives. The Islamic Financial Services Act has DVA, INCEIF: The governor of Bank Negara, Zeti Akhtar
been passed, the takaful industry has been developed, Aziz, has highlighted the importance and international
the educational framework has been laid, MIFC has been stature of INCEIF, which was heartening to hear. It is very
much a medium- to long-term play that is required to
build up the next generation and, as Stella mentioned,
ensure industry sustainability.

strategic review 19

strategic review  global islamic finance

Gerald Michael Ambrose Coming back to the issue of convergence or thinking required to advance the industry. It must be
Chief Executive Officer divergence: how do we navigate the need to compete on independent.
Aberdeen Islamic Asset a playing field that is defined by conventional finance? Of course, at present, there is a need for closer
Management Sdn Bhd Must we break completely free from it or operate in relations in order to find cost savings and offer
some level of parallel existence? If the latter is the case, competitive products, but at some stage there has to be
what are the immediate steps that must be taken in progress, especially in Malaysia. The industry here must
order to work in parallel with the conventional system? think very carefully about what must happen to lay the
groundwork for truly separate entities.
SC, DDCAP: From the perspective of an external observer, For example, currently the board members of
Malaysia has always been lauded in the international Islamic banks in Malaysia are mostly made up of
markets due to the manner in which it has successfully conventional practitioners; this will certainly not lead
implemented a framework in which the Islamic and to the innovation and the kind of mandates required
conventional financial systems operate in parallel, but to advance Islamic banking. This fact perhaps points
with the scope and coherence to co-operate when it is towards the establishment of an Islamic megabank as
necessary and appropriate. part of a solution.

SAASK, OCBC Al-Amin: I am of the view that the parallel One challenge is the lack of
operational model should continue for now. The key convergence between jurisdictions...
factor in this respect is to develop the right business due to differing views regarding
model for Islamic banking. Islamic banking windows what is permissible, particularly
worked reasonably well, but the concept is problematic in equities
as it encourages the perception that Islamic banking
is a subset of the conventional industry. When Islamic SAASK, OCBC Al-Amin: If we operate a dual system,
banks become separate legal entities it generates more issues related to cost and investment come into play,
competition and fosters development. but I agree that the ultimate goal has to be separation.
However, while the standalone, parallel model is Yet, to reach that stage will require a lot of progress in
successful in Malaysia due to the top-down approach and terms of scaling up the market itself.
the ecosystem, I am not sure it would work on the global
level. The costs are very high to set up a separate legal DVA, INCEIF: Moving on from banking, asset management
entity, which will always generate a significant question uptake is even smaller and Sovereign Wealth Fund (SWF)
mark for shareholders. Furthermore, even though the investment in Sharia-compliant stocks, for example, is
Islamic subsidiary will not have the same scale as its miniscule. Gerry and Izani, you both must have a view
conventional sister, it would still have to comply with on this, what is it going to take to ramp up Sharia-
the guidelines set out in the Third Basel Accord, as well compliant asset management or persuade SWFs to
as prudential standards and risk management issues, increase investment in this direction?
which is a real challenge. Even with the market vibrancy
in Malaysia, Islamic banks still have issues relating to GMA, AIAMSB: Aberdeen Asset Management has always
compliance management. invested in sukuk, even before Aberdeen Islamic Asset
Thus, shareholders will only authorise the establish- Management Sdn Bhd existed. However, it was judged
ment of these entities if they can ensure certain returns by the same criteria as conventional issuances: the bond
and extract additional value. that offered the best return for the credit rating would
be part of the portfolio.
MIG, Khazanah Nasional: From my perspective, as long
as Islamic banking remains under the parentage of a
conventional bank, it will restrict the kind of ideas and

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global islamic finance  strategic review

One challenge is the lack of convergence between noticeably when conventional bank and insurer equities
jurisdictions; we still have difficulty selling Sharia- did poorly, although it has underperformed in the long
compliant fund management services outside Malaysia, run. So Sharia-compliant funds may have defensive
due to differing views regarding what is permissible, merit, depending on your view of financials and the
particularly in equities. In the Middle East, for example, scope for another crisis. We have two such funds, which
some investors may find the fund management services are three years old, that have performed creditably
we provide unacceptable, due to the regulatory versus their conventional counterparts.
framework within which we exist. In Malaysia, there is a critical mass of Muslims, so you
Moreover, in the past, there was a fear of have the necessary principle-based demand that can
cannibalisation between the conventional and Islamic bring success, but, globally speaking, the major investor
business segments. The company manages a lot of concern will be performance.
funds for Middle Eastern SWFs; consequently, there
was concern that an Islamic fund with a two-year track SC, DDCAP: Outside of Malaysia, one of the development
record would simply take money from the conventional issues for Sharia-compliant fund management is that,
to the Islamic side. historically, Islamic funds have frequently not performed
as well as conventional funds. Before the 2008 Financial
NRM, SC: In terms of asset management and your Crisis, there were a number of attempts to bring Islamic
question regarding convergence or separation, from a funds to market, often by banks rather than the big
regulatory perspective, we operate on the principle that asset management firms. These were not successful for
all products and services must fulfil the objectives of a variety of reasons, among them that various ineligible
securities regulation as embodied by the International conventional stocks outperformed over a considerable
Organization of Securities Commissions (IOSCO), i.e. the period. Furthermore, certain investors were perturbed
protection of investors, a fair and orderly market, and by the impact of Islamic screening processes in niche
the avoidance of systemic risk. and narrow asset classes which resulted in much
While products or funds that claim to be Sharia- elevated volatility.
compliant should have an extra level of supervision in There was also a point when fund sponsors were
order to ensure their integrity, even guidelines that anxious to capitalise on their own perceived ‘demand’
seem specific to Islamic finance are in pursuit of the for Islamic funds, but were disappointed with the size
IOSCO objectives. Furthermore, we want the experience of assets under management because they consistently
to be seamless, so that someone who chooses an Islamic failed to define their target investor market.
product will be given the same level of assurance and Another hindrance to the development of this segment
disclosure that you would receive if you opted for a was the negative experience, particularly for many
conventional product. Middle Eastern investors, of redemption suspensions
and deferrals introduced by managers during the 2008
DVA, INCEIF: Having set this regulatory objective, from Financial Crisis. As investors were effectively prevented
a fund management business perspective, is there any from withdrawing their funds, it negatively impacted
empirical evidence to demonstrate that performance of perception and investment decision-making processes
an Islamic or Sharia-compliant fund is better than its for an extended period afterwards.
conventional counterpart, or is the draw solely related Finally, if we average out the assets under
to its ethical and socially responsible elements? management of Islamic funds across the board,
historically there have been limited examples of their
GMA, AIAMSB: Many Sharia indices are quite recent comparing favourably with conventional counterparts
and date from the early 2000s. Over the past eight in terms of size. Gerry is correct regarding the more
years or so the Dow Jones Islamic Market World Index recent performance achievements, which will adjust
has periodically beaten its conventional counterpart, perception over time, but our clients have not always

strategic review 21

strategic review  global islamic finance

been overly enthused and have expressed concerns Principles for Responsible Investment (PRI), which is C
about potential performance distortion caused by Sharia currently executing its Strategic Plan 2015-2018. M
screening, the extra cost of Sharia validation itself, as However, the Islamic finance industry must look at how Y
well as the increased fees fund managers sometimes it can integrate and contribute to these initiatives. The CM
charge because it is Islamic. These issues must be industry cannot take for granted that it will just fit in; in MY
confronted and addressed. order to claim that Islamic finance is responsible finance, CY
we must substantiate these claims with evidence. That is CMY
GMA, AIAMSB: For non-Muslim clients, I do not think you what we are in the process of doing at the RFI. K
can argue that Sharia fund management outperforms
conventional, which essentially means it must be DVA, INCEIF: What I am hearing is the increasing need to
promoted as a form of SRI or ESG investing. deal with the detail across the spectrum. The question
is, how would you take that globally?
DVA, INCEIF: Therefore, how important are opportu-
nities, discussed within the Responsible Finance RAAK, IILM: In order to expand Islamic finance on
Institute (RFI) and at the Ethical Finance Forum, for a global level, we must aim for integration because
example, to align more closely with the ethical and conventional finance dominates the current system.
responsible finance segments to build the critical mass Thus, in terms of regulation, it is vital to start with what
required, while pushing the idea that Islamic finance is is already in place, but clearly explain the specificities
not radically different and intrinsically equivalent? Is of the Islamic system to the conventional authorities.
that the approach to take? In this way, the industry can foster joint agreement
relating to policy and regulatory actions that will take
GMA, AIAMSB: Yes. Given the irrational fear of Islam that these differences into account.
has been promulgated by the coverage of events in the Accordingly, there must be a detailed understanding
Middle East, the term ‘Islamic fund management’ can regarding the implications of Basel III. The Basel
sometimes produce a negative reaction from clients. Committee on Banking Supervision (BCBS) has essentially
One possible way to rationalise these fears could be to deferred responsibility for reconciling Basel III with
highlight that the Koran is the earliest and original form Islamic finance to the Islamic Financial Services Board
of SRI. (IFSB). This is because the IFSB is the platform through
which Islamic finance regulators are involved and it
RAAK, IILM: The RFI was conceived as a mechanism can help the BCBS gain a better understanding of the
to highlight and study the closeness between Islamic specificities to which I have been alluding.
finance and responsible finance. Many have already For example, regarding capital adequacy, to enter
made this connection and the institute was established into a basic murabaha contract the bank is required to
to convince more people and promote this idea. first acquire the asset backing the transaction in order to
The single most important fact is that Islamic finance is be able to sell it. Hence, the bank is exposed to market
responsible finance, and if the Islamic finance world can risk for the period during which it holds the asset before
contribute to enhancing the visibility and perpetuation of the asset is sold or leased and transformed into a credit
both schools of thought, it is a worthwhile pursuit. Thus, risk. Even at the time of implementation, Basel II did not
events like this are an important part of the roadmap. cater for this transformation from market to credit risk.
Moreover, this framing will allow the Islamic finance We must consider issues relating to monetary policy,
world to broaden its vision and consolidate a new pathway for example, if a central bank decides to tighten or
linked with the increased interest and initiatives related loosen monetary policy using interest rates. To operate
to responsible finance. A number of supranational a dual system there must be an understanding of how
institutions have been implementing initiatives related these monetary transmission mechanisms apply to
to responsible finance, like the United Nations-supported Islamic financing. In order to develop a level playing

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field and implement a monetary policy that works for prioritisation, or because some changes are just not
both conventional and Islamic, you have to cater for the going to happen due to prudential considerations.
specificities of the latter without creating arbitrage. However, London is the leading global financial
It is vital to work under the regulatory and supervisory centre, the markets are very, very deep and there
umbrella. Thus, the capital adequacy example from the should be no doubt that, as a jurisdiction, the UK can
Basel II framework is important. At the IFSB, we started contribute significantly to the connectivity of global
with the conventional framework and had common Islamic financial services and the flows that surround it.
starting points, which enabled forward progress. London offers a complete proposition that other Western
This realisation has informed our approach at the IILM. centres cannot currently provide, with the exception of
An important aspect of Basel III is High Quality Liquid the U.S., which is by no means yet an evolved centre
Assets, so we looked at what was required and developed for Islamic finance. Clearly, further detailed work is
our own version of an Asset-backed Commercial Paper required to identify how delivery can be achieved, and
programme, which was highly rated A-1 by Standard & this is apparently under review.
Poor’s, the credit rating agency. This has assisted the
IILM in the sense that the price of its short-term sukuk RAAK, IILM: The competition between the UK and
did not fluctuate over a period of time, thus meeting the U.S. for the title of leading international financial
conventional criteria. However, we adapted the centre tends to depend on the pool of human resources
programme to the Islamic finance specificities. The point available to sustain the financial industry. In terms of
is that we have again worked in the realm of conventional Islamic finance, I think neither the U.S. nor the UK can
finance in order to be able to integrate Islamic finance claim it has anything like what is required.
specificities into what already exists.
DVA, INCEIF: There seems to be somewhat of a
NRM, SC: The same approach has been taken within consensus that, rather than needing a step-change in
IOSCO. In fact, as early as 2004, a working group was Islamic finance to a point of divergence where we go
looking at the regulatory issues relating to Islamic away from conventional, we need to adapt the existing
products. The conclusion was that Islamic products could framework and integrate the specificities of Islamic
be introduced in any well-regulated capital market and finance as we move forward. Is that correct?
this was reaffirmed in 2008 because the objectives
remain the same. SC, DDCAP : I am still on the fence. Ultimately, we need
The SC also takes this approach. For example, in order to go for the latter option but we are not quite there
to issue a sukuk, the basic requirements relating to bonds yet, although there are some incredibly interesting
apply. The Sharia-compliant aspect of the guidelines developments occurring, which certainly highlight
is over and above the minimum that is required for all a more independent pathway. In terms of social
capital markets. We certainly would not have got this far responsibility, the Ihsan Sukuk Programme and the sukuk
if we had started with a blank sheet of paper. issuances from the International Finance Facility for
Immunisation (IFFIm) were really exciting.
SC, DDCAP: I understand where Professor Rifaat is coming Additionally, following the UK sovereign sukuk, the
from; the issue of detail is vital for global Islamic finance UK’s export credit agency, UK Export Finance (UKEF),
development. In the UK, I think there is a significantly added its guarantee to a sukuk brought to market for
deep understanding of specificities and they have been Airbus’ customer, Emirates Airline. This transaction
identified and addressed, as far as possible. However, was the first to include an export credit agency wrap
in some territories, understanding the issue and being and UKEF obligations rank pari passu with UK sovereign
able to take action are two very different things. There obligations. Furthermore, at US$913 million, it was the
are some aspects that have not been addressed either largest export credit agency-wrapped aviation sector
due to policy, unwillingness, for reasons related to transaction ever, conventional or otherwise.

24 INTERNATIONAL INVESTOR

global islamic finance  strategic review

Importantly, this is a transferable model. UKEF was bankers relayed to me that there is a significant part
involved because components of the underlying asset for of the country’s population, specifically Muslims who
the transaction, the Airbus A380-800, are manufactured cannot receive interest, that must deposit money into
in the UK. Thus, it can provide a workable capital the country’s banking institutions without seeing any
markets template going forward to assist corporate returns. They asked me what solutions Cagamas could
entities in the UK and elsewhere to reflect on the provide for this problem.
capability of Islamic finance to meet their needs.
Regarding the relationship between socially respon- While adapting the existing
sible or ethical financing and Islamic finance, while framework to meet industry
the industry must, in my opinion, retain its unique and requirements, Islamic finance can clearly
valuable features, there are potential, significant areas show relevant and distinct contributions
of collaboration. For example, a combination of the to the financial system
‘positive’ screening methodology from SRI, and the
‘negative’ screening undertaken in Islamic finance could From my experience, this situation is by no means
have wider merit. Analysis of financial ratios, a core exclusive to the Philippines and I think this highlights an
element of Sharia screening, is not as embedded in SRI interesting facet of development relating to engagement,
processes, for example. Therefore, in terms of exploring particularly with small-scale Islamic finance investors.
collaboration possibilities and providing thought leader- In fact, our equivalent institution in the Philippines is
ship on developing a collaborative approach from the very interested to learn about and issue sukuk, but there
Islamic finance perspective, it is a vital step forward. are challenges relating to sufficient underlying assets
infrastructure and legal and regulatory frameworks,
DVA, INCEIF: I absolutely agree. In fact, perhaps these which is the case for a lot of these nascent markets.
interesting case studies reveal a third way of reaching an
operational equilibrium that much faster. While adapting DVA, INCEIF: I have had discussions about a sukuk
the existing framework to meet industry requirements, issuance that would allow for the possibility of
Islamic finance can clearly show relevant and distinct MYR1,000 denominations and, crucially, enable greater
contributions to the financial system. participation. I know Khazanah has been thinking about
At the World Islamic Economic Forum 2015, I this for several years now, in relation to low-cost housing
moderated a panel, on which Izani also sat, alongside or affordable housing.
an entrepreneur from Ghana, who was using Sharia
constructs to deliver impact solutions, including medical MIG, Khazanah Nasional: Yes, retail sukuk is certainly
care, pharmaceutical logistics and water solutions, using a key point on our agenda, in addition to other
mobile phone technology. It is examples of effective mechanisms that have a social impact, as I mentioned
Sharia-compliant solutions like this, like the UKEF previously. In fact, we invested in a Filipino company,
wrapped sukuk, and like the Ihsan Sukuk Programme, the 8990 Housing Development Corporation, that
that must be promulgated. develops affordable housing using pre-cast concrete
Chee Leong, in your opening remarks you talked houses that can be built in ten days. The company
about strong potential for Islamic finance in new caters for people that are unable to obtain mortgages.
markets, including the Philippines. What must be done We are very interested in these kinds of concepts that
to develop these new jurisdictions? are easily transferable and can be imitated in Malaysia.
In terms of facilitating investment from small-scale
CCL, Cagamas: In the course of our efforts to generate investors in Malaysia, we plan to include a public
interest in our EMTN programme, I have had conversations
with many finance professionals in various different
markets. During a visit to the Philippines, a number of

strategic review 25

strategic review  global islamic finance

element to our social impact bond, so anyone can invest long-term money, whereas we are offering short-term
if they are passionate about education. money. Specifically, these deposits will play out in a
maximum of 12 months, whereas the sukuk has a tenor
NRM, SC: This is a very important angle. We have been of seven years. In fact, the two sukuk will complement
talking about sukuk and the bond market, which is high each other and investors can capitalise on both these
finance. It is vital that Islamic finance creates and offers opportunities.
opportunities for small-scale investors to participate as
well; otherwise, they will continue to keep their money DVA, INCEIF: They may also be able to secure a higher
under the mattress. return than depositing in a savings account. Average
returns for savings accounts have been 1 to 1.5 per cent,
 It is vital that Islamic finance creates but INCEIF has done a lot of research into the equities
and offers opportunities for small-scale market and, in the last ten years, irrespective of the
investors to participate as well country or the product, the returns have averaged
between 15 to 17 per cent. This situation is allowing
The industry must become more intimately involved people with small savings to secure access to a higher
with the people it represents. There has already been rate of return.
progress in retail sukuk, we have had the DanaInfra
Nasional sukuk to raise finance for the Mass Rapid SAASK, OCBC Al-Amin: Clearly, it is not just Islamic
Transit system expansion in Kuala Lumpur and the Klang banks that can offer these kinds of instruments and
Valley, but we must also foster the development of other it is an add-on to a basic suite of products. However,
investment products, like mutual funds. the conventional side is not taking advantage of the
This feeds into the importance of having an adequate potential and it is an example of how Islamic banks can
framework for screening listed companies because if innovate and differentiate themselves.
retail investors choose to go directly to the market, they Moreover, there is certainly the prospect of
must be able to easily identify Sharia-compliant stocks. developing this concept in relation to profit and loss
If you are talking about inclusiveness and serving the sharing. It is complex to undertake at the moment, but
community, you cannot forget the mainstream aspect of if the latter becomes a reality in the banking sector
Islamic finance. in the future, these kinds of products can become a
profit sharing investment account (PSIA) with a social
responsibility element, for example.

SAASK, OCBC Al-Amin: To link the previous two broad CCL, Cagamas: I would like to make two additional
points, from a retail perspective, we have been having points. Although Malaysia has a very developed bond
serious discussions about how we can differentiate and sukuk market, the country is lacking a retail
ourselves from the conventional banking system. bonds and sukuk space. Thailand, for example, has a
Initially, we wanted to have a wealth product, i.e. huge retail bond market compared to Malaysia. The
a time deposit with a waqf element. My team were regulatory authority, together with the other market
working on this for quite some time, but there are stakeholders, must seriously consider the best ways to
significant issues relating to waqf because of Malaysia’s stimulate this area in order to provide retail investors
federal system and the regulatory issues that emerge as with opportunities to invest directly into a sukuk.
a result. Thus, we shelved the waqf element because Regarding affordable housing, Cagamas is
it is not necessary as long as the related investment is investigating how to convince Malaysia’s state
philanthropic, which is the path we are following now. governments and religious government ministries
In terms of competition, I think there are distinct to standardise the legislation relating to waqf lands,
segments. The social impact sukuk from Khazanah is some of which have potential for development and

26 INTERNATIONAL INVESTOR

global islamic finance  strategic review

are currently idle, in order to unlock its potential to To these institutions, sustainable finance means the
be used for affordable housing. This issue connects green index and green bonds, plus environmentally
Islamic finance and affordable housing, and is a very friendly products, renewable energy and energy
useful and innovative initiative that would promote the conservation, as well as many other areas. In my opinion,
development of both. Islamic finance already encompasses these areas, as has
been alluded to in our discussion today. Islamic financial
 The role of Islamic finance is principles are embedded in these products and services.
inextricably linked with creating a We have been talking about convergence or
sustainable economy that works for divergence. I believe it is conventional finance that is
everybody converging towards Islamic finance, as a result of these
developments, which, significantly, have come about as
MS, IFSA: Connecting Islamic financial practice with the a result of pressure from the global population.
population is vital. This leads back to the discussion about
the role of the industry, which, from my perspective, is DVA, INCEIF: In terms of the UN SDGs, which are
inextricably linked with creating a sustainable economy laudable, and your suggestion that Islamic finance
that works for everybody, as well as the planet itself. already embodies the pillars and specifications outlined,
In 2015, the United Nations (UN) made the switch your comments draw another pertinent question into
from Millennium Development Goals to Sustainable focus relating to the role that regulatory authorities
Development Goals (SDGs). My assessment is that the or Sharia scholars may play in terms of expediting the
SDGs can be organised into three broad sections: goals achievement of these goals.
that pertain to sustainable economic development Should the regulatory bodies steer Islamic finance
issues, which include profit making; goals that pertain towards these kinds of developments or, if Islamic finance
to the social aspect, which ensure a business or project is really picking this up, should the Sharia councils and
does not have a negative impact on the population; and boards be more proactive in delivering these outcomes?
goals that pertain to the environmental aspect, which
are concerned with conserving the planet. Thus, we NRM, SC: It is a difficult issue; I am trying to envisage
can summarise the objectives of these goals as profit, how the role of Sharia scholars should change if we take
people and planet. Professor Rifaat’s point that Islamic finance is actually
The three objectives of the SDGs are being used responsible finance. If there were a realisation that the
as a reference to develop sustainable finance within role of a Sharia board should be more than just assessing
the UN and it is now being actively pursued by the UN what is prohibited and approving particular financial
Environment Programme, as well as a number of other products, and that it should take on a broader remit to
supranational organisations, including the World Bank look for positive elements, they would certainly have a
and the International Monetary Fund (IMF). In fact, prior larger role to play in the development of Islamic finance.
to the IMF’s 2015 annual meeting in Lima, Peru, we took
part in a sustainable finance group discussion, where DVA, INCEIF: I have actually sounded out a number of
we were heartened to discover that a large number of Sharia scholars on this and it would be a huge challenge
regulatory authorities are adapting their regulation to due to the extensive expertise they would require. It
include sustainable finance. Most notably, the China is reasonably clear whether a particular transaction
Banking Regulatory Commission, which is looking to structure is acceptable or not, but making adequate,
leverage sustainable finance to address a number of informed judgements on carbon dioxide emissions, for
environmental issues in the country. example, may be more difficult.
Accordingly, if the industry was to encourage this
change, there would need to be an agreed upon
framework on which the Sharia scholars could base

strategic review 27

strategic review  global islamic finance

judgements. In fact, I believe there are a number of Islamic banking is still behaving like conventional
standards and matrices that exist to aid investors banking because it operates as a profit-making
in evaluating and differentiating between financial organisation. Thus, the aspect we can change immediately
products described as sustainable, to which Sharia in order to create our own space is to promote the socially
scholars could refer. I like the idea of changing the responsible purpose of Islamic banking.
Sharia board paradigm to include the kind of positive Clearly, there is the potential to create different
screening that pertains to responsible finance. products like the PSIA, but currently it can only be a
small percentage of your total operation, due to the cost
GMA, AIAMSB: Surely the role of the Sharia adviser of adhering to the prudential standards and creating
should be to ensure that the financing system, as a the infrastructure required. Nevertheless, our aim in
whole, is halal. Thus, there should be a follow-up the future is to grow this part as quickly as industry
investigation, if necessary. development will allow.

MIG, Khazanah Nasional: Another aspect of this NRM, SC: The Islamic finance industry has got to this
would be the responsibility of the team presenting the stage because adaptation has worked. A degree of
proposal to the Sharia board; they must be truthful in closeness to conventional finance was necessary in the
their presentation. It is not just about saying what they beginning to ensure customers understand the products
expect the Sharia board want to hear. and it has brought us this far.
We must now decide how to take the industry to
DVA, INCEIF: There is an initiative in Malaysia, similar the next level. It seems the view is to detach a little
to the Financial Institutions Directors’ Education and differentiate ourselves. The way to achieve this
Programme training, to provide guidance to the Sharia is by making it widely known that Islamic finance is
scholars in order to enhance their understanding of the not a subset of socially responsible finance or impact
financial business. investing; in fact, Islamic finance is the confluence of
In fact, they are quite in favour of moving in that SRI, ESG and sustainable finance, and these concepts
direction. Many scholars feel they are being constrained are inherent in this form of financing.
by the fact the regulators are directing them to take The demonstration effect is also vital. We only
decisions on particular constructs solely based on the touched briefly on the IFFIm Vaccine Sukuk: this issuance
Islamic legal maxims. Nevertheless, if it is generally was arranged by the World Bank, not a Muslim country,
agreed that the Sharia scholars are expected to look at it had a social purpose and it was a resounding success.
the bigger picture, that is a positive step. The investor profile of the subscribers was diverse; it cut
I would like to focus the closing comments on broad across all the boundaries. These kinds of success stories
or specific actions that participants have identified to do a great deal to further the cause.
advance industry development, perhaps as a result of
today’s discussion. What are the key takeaways that will SC,DDCAP: From the perspective of DDCAP, the take-
inform your thought processes and deeds in terms of away is the need to continue to concentrate on joining
taking Islamic finance forward? up the growing footprint of Islamic finance. There is a
need to make a concerted effort to increase and support
SAASK, OCBC Al-Amin: The key issue is differentiating educational programmes, so awareness and knowledge
Islamic finance or, in our case, specifically, Islamic in the nascent markets can be elevated to the required
banking from the conventional system. levels as quickly as possible.
In practical terms, the demand is there, but people Beyond my work at DDCAP, I will certainly
will always look for the easily identifiable economic communicate the thought leadership aspects we
benefit. If we are better or equal, then consumers are have discussed here to my other spheres of work at
likely to take the decision to do Islamic banking. TheCityUK, at UEL and also with the RFI. My aim, in this

28 INTERNATIONAL INVESTOR

global islamic finance  strategic review

respect, is to help to join the dots as far as our industry passion, but in order to see your plans come to fruition
collaborations are concerned. you must also have patience.
Finally, in terms of the development of Islamic finance
in the UK, I am going to continue to encourage more RAAK, IILM: We must create and foster a greater
focus on social impact bonds and refer that discussion understanding of the specificities of Islamic finance. It
to other authorities, where appropriate. I think social is all very well to talk about the history of the industry,
impact certainly needs to be on the UK’s Islamic finance but it will not develop if the details are not seriously
agenda, as well as the agendas of everybody else! considered. That is how we can differentiate ourselves.

GMA, AIAMSB: I have learned a lot today, especially MS, IFSA: Primarily, it should be communicated
relating to the many ways in which Islamic finance can that Islamic finance is universal in nature, bringing
be used for good. The numerous projects that Izani fairness, ethics, transparency, sustainability, and, most
mentioned, which have a social component built in and importantly, profit.
reflect the inherent values of Islamic finance, are very In terms of the role of financial regulators: neutrality
interesting and important. is not enough. They must provide the infrastructure
for Islamic finance to develop and, where possible,
 It should be communicated that incentives to stimulate industry growth.
Islamic finance is universal in Lastly, the aim of any government effort to promote
nature, bringing fairness, ethics Islamic finance must be acutely and continuously
transparency, sustainability, and, most informed by the needs of the people.
importantly, profit
CCL, Cagamas: I will confine my comments to the sukuk
As a result of this discussion, I am certainly going to space. Although sukuk and bonds are quite similar in
speak to our clients about providing the leeway that will nature, we must ensure that the differences are made
enable us to undertake step-down sukuk financing! If clear to investors. Moreover, we must make significant
we were given permission to invest 3 per cent of the inroads into untapped markets in order to advance the
portfolio along socially responsible lines, for example, development of Islamic finance and sukuk.
we could begin to fund these kinds of initiatives. The other point is related to the practicalities of sukuk
Moreover, as the wealth management side of Islamic issuance. We must find a way to encourage potential
finance grows, there will be a number of clients with issuers to opt for sukuk over conventional bonds. One
whom institutions have a strong personal relationship of the critical issues inhibiting sukuk development is
and this will provide the space for more complete the availability of suitable asset classes on which the
explanations of the concepts that underlie sukuk issuance can be based, especially for structuring globally
issuance. Once it is clarified that sukuk is not only about accepted Sharia instruments. This must be addressed.
profit, but also about creating a fairer society, I think The answer could be to establish an entity that can
there will be increased interest. provide such facilities, but, whatever the case, it would
be very helpful if regulatory bodies could increase their
focus on encouraging more sukuk issuances and resolving
the dearth of underlying assets.

MIG, Khazanah Nasional: The most important thing is DVA, INCEIF: That is a very interesting discussion, but
that the participants here today actually do something unfortunately it will have to wait for another day. It
as a result of this discussion. We must take action in has been a real pleasure to chair this Roundtable. I look
order to move the industry forward. What I have learned forward to continuing these discussions with you all in
over the years is that the catalyst for taking action is the future. Thank you very much indeed.

strategic review 29

business intelligence  global islamic finance

DDCAP Group Islamic Capital Market
Growth in Europe

The UK has witnessed continuous development of a strong Islamic
capital market. Europe is now following suit and seeking to expand
its Islamic finance footprint.

The Islamic Finance Market remain in the sovereign and quasi-sovereign
domain. However, there are strong indica-
The Islamic financial market has continued to tions that, with increasing awareness, the
market will also anticipate demand from the
outgrow its conventional counterparts, even corporate sector, including in Europe, where
during theDDgClAoPbGarolupeconomic slowdown. The overall liquidity has been tightened in the
conventional markets, with other forms of
worldwide demand for Islamic financial ser- funding re-appraised as a result.
Unsurprisingly, the traditional sukuk mar-
vices, mIselasmuircedMabrykeStharia-compliant assets, kets of Malaysia, Saudi Arabia, Bahrain, and
increasedIntbeyrm12edpiearrycent in 2014 to reach a Dubai, which have been somewhat subdued
in recent years, still represent, collectively,
record US$2 trillion, tripling since the 2007 to the highest levels of sukuk issuance in the
world. Notably, Dubai has recently surpassed
2008 pReeraiol-dt,imdeestpriatdeinthge effects of the 2008 Malaysia in sukuk issuance, largely due to
FinanpcliaatlfoCrrmisiste(csehenofilgo.gy1). the Malaysian central bank’s, Bank Negara
Malaysia (BNM), decision to stop issuing short-
Inwdiethed2,4 hthoeurdceomvearnadgefor Islamic capital dated sukuk, or sukuk with up to three-month
maturities. This was based on BNM’s belief
market products, such as sukuk, is predicated that there was sufficient liquidity in the coun-
try’s Islamic capital markets.
toenrninaPovtsieivtDisoentDsoiCttrsoseAl’fPacsdoLaennisimnvitreeirentmetefddiiooarrny ainal more resilient al- Their issuances, moreover, were being pri-
finance offerings, marily used by foreign banks to manage their
liquidity needs, and therefore, doing little to
whicthhe IsmlamaicnFyinanpcioalsSietrvicleesdIndutsotry the 2008 Financial improve the liquidity needs of the domestic
Crisiespxe.rocvuAitdioisnngaasntdrurvcaetluusreiun-agldtsdu,epdpbsoerart,vnticrkeasdsetoand other financial market. According to Standard & Poor’s, this
London is an important centre for the growing sukuk market institutionists glhobaalvcelientsbeen subsequently com- reduction in issuance by BNM resulted in a 42.5
per cent reduction in the global value of is-
pelleDDdCAPthooldsdaiuvneiqruesimfayrketapnosditionextend the list of suances in the first half of 2015 compared to
secuorafisStfhiaaecrilisait’aatdocroemaceprlomiasnsteapddriovdeurescetlsir,gaansigsbeelt e by regulators for the same period in 2014. Nonetheless, given
Copyright © 2011 Hayes Davidson / Nick Wood The DDCAP Group positions itself inclucsliaossnes ainnd itnhstreumirenltisqinubiodthitthye buffers. the growing familiarity and utilisation over dif-
as an intermediary in the Islamic WIsilatmhiicnprimtahryisandcsoecnontdearxy mt,arksetukuk have recently ferent jurisdictions, sukuk are likely to become
financial services industry, providing a key component of the financial landscape in
structuring support, trade execution played an increasingly active role in the both developed and emerging markets.
and value-added services to clients
across the globe Iesxlatemnitc,DafDinr&easnCucoletLoismfptaithceeed.inTchreisastinregnddemisa, ntdoanadn GROWTH IN THE UK AND EUROPe
intereAssstet fanrdoCmommsoodivtyeFarceiliitagtinon issuers, multilateral Historically, the speed of development of the
Islamic capital market in terms of sukuk issu-
agencies and corporations seeking to diversify ances has generally been driven by the domi-
nant jurisdictions of Malaysia and member
their sfueinkfTDfuareanDkDnciscrGateiiccsinIttvisoIgLneunvailaelmysnSnt.moecilueteIetnenitoddnvassessaatnopdrslamtafnaodnrmaigsetsouelmirqsaunindaoigtwey states of the Gulf Cooperation Council (GCC).
more In recent years, there has been a gradual and
view sustained effort in Europe to promote Islamic
finance, particularly in the UK, Luxembourg
liquidity, provide asset and infrastructure fi- and Ireland.
In this regard, the UK has arguably been
DDCAP Limited DDCAP (DIFC) Limited nancing in the real economy, and as a means the most pro-active, due in part to London’s
pre-eminent status and role in global finance.
8-10 Grosvenor Gardens Suite 39, Level 3 of ensuring portfolio diversification to poten-
London Gate Village 4
SW1W 0DH P.O. Box 506683 tially achieve a certain degree of insulation
United Kingdom Dubai, United Arab Emirates
from the volatility of other asset classes.
t: +44 207 863 1250 t: + 9714 401 9844
e: [email protected] e: [email protected] Ovewr wtwh.eddlcaaspt.ctoh.rueke years, the Islamic
capital market sector has been dominated

by sukuk in real terms, with their issuances

54423_DDCAP_Advert_190x254.indd 1 surpassing US$100 billio25n/08/2a01n5 d17:0t6 he addition of

sovereign issuers from both Muslim and non-

Muslim jurisdictions.

Regarding issuance statistics, the first ijara

sukuk issued outside the Islamic world was by

the UK government in 2014 in the amount of

GBP200 million, followed by issuances from

the governments of Luxembourg of EUR200

million, Senegal of XOF100 billion, Hong Kong

of US$1 billion and South Africa of US$500

million. The vast majority of sukuk issuances

30 INTERNATIONAL INVESTOR

global islamic finance  business intelligence

1. GLOBAL SHARIA-COMPLIANT ASSETS (US$ IN BILLIONS) 2. OUTSTANDING GLOBAL SUKUK BY EXCHANGE
2500 AS OF JUNE 2015 (US$ IN BILLIONS)

2,200

2000 2,000 25.1

1,790 36.7

1500 1,460

1,220

1,025 25.7

1000 780 850
620
500 460 26.6

0 2007 2008 2009 2010 2011 2012 2013 2014 2015 Dubai Exchange Bursa Malaysia
2006 Irish Exhange LSE

Source: TheCityUK Islamic Finance Report 2015 Source: Nasdaq Dubai Report

Additional factors include the UK’s historical that in June 2015, there was a change in the Not only was it the first instance of sukuk
links with the core Sharia finance markets of dynamics of their listings in the traditional certificates being guaranteed by an export
the GCC and Malaysia, as well as its require- centres of Malaysia, Ireland and London. credit agency (ECA); it was also the largest
ment to meet the needs of the country’s Accordingly, Dubai’s two exchanges, Nasdaq debt capital markets offering, conventional
own Muslim population. The UK was recently Dubai and Dubai Financial Market, registered or Islamic, in the aviation sector, with an ECA
identified as an important destination for total current listings of US$36.7 billion, guarantee to date; and, finally, it was the first
Islamic finance, receiving an index value of ahead of Malaysia’s Bursa Malaysia and the time that sukuk had been issued to raise fi-
16.2 in the 2014 ICD Thomson Reuters Islamic Labuan free trade zone listing US$26.6 billion, nance prior to delivery of an aircraft. This has
Finance Development Report, well above the the Irish Stock Exchange (IE) totalling US$25.7 had a demonstrable effect on the issuance
global average of 10.3. This figure represents billion, and the LSE with US$25.1 billion re- of buyer credits, with ECA providing backing
the value given to important global centres spectively (see fig. 2). for exporters wishing to offer medium-term
of Islamic finance based on their offerings in The UK government issued its sovereign funding to markets within member states of
terms of education and research, governance, sukuk with a number of objectives in mind. the Organisation of Islamic Cooperation (OIC)
corporate social responsibility and awareness. One objective was to open up alternative as part of their overall project bids. Given
The UK was the highest ranked non-majority sources of funding at an all-in cost equivalent that the UKEF guarantee ranks alongside that
Muslim country. to conventional gilts, thereby ensuring value of the UK government, this issue further re-
The sukuk market is an essential part of for money to the UK public and taxpayer. inforced the commitment of the government
the Islamic finance market, and London, as a Another objective was the provision of a High to deepen the Islamic capital market, by en-
major hub for international bonds, is an im- Quality Liquid Asset (HQLA), which could be couraging regular or recurrent issues by major
portant centre for the issuance and trading of utilised by domestic Islamic banks as part of European and international issuers.
sukuk. The outstanding value of international their regulatory liquidity and capital require- The second development was initiated in
bonds issued in the UK at the end of 2014 was ments. A further objective was to set a prec- late 2014 by means of further innovation. This
US$3.3 trillion, representing approximately edent that demonstrated to the corporate involved the International Finance Facility
15 per cent of the global total, second only to sector that the UK had implemented a proven for Immunisation (IFFIm) tapping the inter-
the U.S. London is also the leading centre for platform and infrastructure to enable sukuk to national capital markets to raise finance in
international bond trading with an estimated be issued comparably to conventional bonds. order to accelerate the availability of funds
70 per cent of secondary market turnover. As a result, this now paves the way for for immunisation programmes and health sys-
As the first Western sovereign to issue, in sukuk to become an instrument of choice for tems via the international organisation Gavi,
2014 the UK government sold GBP200 million raising corporate finance. This process has the Vaccine Alliance.
of sukuk with a 5-year maturity and profit been a work in progress in the UK for more IFFIm currently has nine sovereign donors,
rate on the sukuk set at 2.036 per cent, in than 15 years and has been supported with including the UK, which has pledged GBP1.63
line with the yield on conventional gilts with a programme of legislative reform targeted billion, or 46 per cent of total pledges over a
similar maturities. This debut sovereign sukuk at providing a level playing field for Islamic 23-year period. In addition to the UK, several
was oversubscribed by a factor of eleven, with financial instruments. other European governments have contrib-
strong demand and orders amounting to ap- Thus, two major developments followed uted donations. In late November 2014, IFFIm
proximately GBP2.3 billion from both domestic shortly after the UK sovereign sukuk issuance. issued its inaugural sukuk, raising US$500 mil-
and international investors. The sukuk was al- The first was seen as a key milestone in the lion for Gavi. Deemed to be the first bench-
located broadly with investors, including cen- annals of sukuk development in the UK, as UK mark-sized sukuk primarily focused on social
tral banks, sovereign wealth funds, and local Export Finance (UKEF) announced the provi- impact, it provided institutional investors
and foreign financial institutions. It was listed sion of guarantees for Sharia-compliant fi- with a socially responsible investment op-
on the London Stock Exchange (LSE), which is nancings involving British exporters. In March portunity that will help vaccinate and protect
a key global venue for the issuance of sukuk, 2015, it was announced that UKEF would tens of millions of children against prevent-
having been involved with 57 listings with a provide a guarantee in support of the US$913 able diseases. This sukuk was listed on the LSE
total value of US$51 billion. In terms of global million sukuk issued by Dubai’s Emirates Air and was oversubscribed, with global interest
sukuk listings, a Nasdaq Dubai report revealed Line. This was a ‘triple first’ in its own right. shown from multiple investors.

strategic review 31

business intelligence  global islamic finance

A supportive architecture underpins the Conclusion Limited, which is a private holding company
UK Government’s ambition to become a key The future development of the sukuk fund focused on partnering with experienced man-
global player and leader in Islamic finance market, from a European perspective, will agement teams to build fast growing busi-
in the Western world, acting as an enabler certainly depend on the volume of new, ness in financial services and other sectors.
to ensure this objective is realised. For ex- global sukuk issuance by all types of market DDCAP Limited (DDCAP) positions itself as an
ample, the presence of numerous leading players including sovereign, supranational intermediary in the Islamic financial services
law firms and professional service companies and corporate issuers. However, given the industry, providing structuring support, trade
based in the City of London, which specialise ever-growing cross border reach and sukuk execution and value-added services to clients
in all aspects of Islamic finance, has greatly becoming mainstream in Europe, as a result across the globe. Its primary markets include
added to the UK’s ability to offer advisory of the enabling financial architecture that is the GCC, Southeast Asia, Europe and the US.
and structuring services to Islamic financial already in place or in development, the pros- Through its unique position in the market,
market participants around the world. pects of further issuance, listings and wider DDCAP is able to provide physical asset fa-
Notwithstanding the UK’s long established market development is promising. The Islamic cilitation services to over 300 third-party
position, Europe has become an important capital market and its sukuk funds subsector institutions including central banks, govern-
listing destination for international sukuk, for have traditionally been referred to as, pre- ment institutions, Islamic banks, conventional
both Asian and Middle Eastern issuers, who dominantly, a feature of the Southeast Asian banks and managers of Sharia-compliant
are seeking to widen their investor base and and GCC markets. There are now growing funds. Additionally, its wholly owned mer-
simultaneously promote secondary market signs that both are finding a complementary chant trading company subsidiary, DD&Co
activity in sukuk markets outside their domi- and expanding platform in Europe. Limited (DD&Co), has originated commodity
ciled countries. Moreover, in the UK and across Europe, for a large number of structured and syndi-
This feature has often been absent from the demand for infrastructure development cated transactions for entities in various ju-
sukuk markets in industry hubs, where the se- continues to grow rapidly and the require- risdictions, including Dubai, Hong Kong, Kuala
curities tend to be held to maturity. European ment for alternative and efficient sources of Lumpur, London and Riyadh.
exchanges including the LSE, the IE and the funding for significant national projects is a DDCAP’s multi-award-winning Asset
Luxembourg Stock Exchange have been able priority agenda item. This has resulted in the Facilitation Platform allows its customers to
to attract Islamic issuers by offering efficient Islamic financial industry becoming an impor- purchase commodities via a secure electronic
and transparent listing processes and market tant and growing focus of numerous interna- portal as an alternative to the other trans-
liquidity profiles. tional governments. actional methods that remain available. The
Regarding funds, Europe has seen a steady In the UK, Islamic finance has already platform is functional 24 hours a day to re-
growth of Islamic funds domiciled within the played an important role, as illustrated by solve the time zone issues faced by customers
EU. There were approximately US$14 bil- its inclusion in the financing arrangements across numerous jurisdictions.
lion in Assets under Management (AUM) in and solutions utilised in the development In addition to being approved by DDCAP’s
the EU as of 2014, according to the Malaysia of infrastructure and infrastructure-related own Sharia Supervisory Board (SSB), it has
International Islamic Financial Centre’s projects around London. For example, it has also been endorsed by other internationally
report on Islamic Finance in Europe. This ac- been used to provide development finance recognised Sharia scholars. SSB is comprised
counts for approximately 20 per cent of the for The Shard, London Gateway and the of esteemed Sharia scholars including its
global aggregate of Sharia-compliant AUM, up Olympic Village, as well as the re-develop- chairman, Sheikh Abdullah Bin Suleiman
from 12 per cent in 2012. ment of Chelsea Barracks and regeneration of Almaneea, Sheikh Dr Abdullah Almutlag and
Generally, the appeal of European domi- Battersea Power Station. Sheikh Dr Mohamed Ali Elgari. In September
ciles for fund management lies in the attrac- Islamic finance is a core work stream of the 2015, DDCAP was proud to announce the ad-
tive combination of tax benefits, regulatory UK Financial Services Trade and Investment ditional appointment of leading Malaysian
sophistication, operational efficiency and Board (FSTIB) established by the Chancellor scholar and professor Dr Mohamad Akram
diversification. Each of these factors con- of the Exchequer in 2013. Consequently, Laldin to the DDCAP SSB, reflecting DDCAP’s
tributes to the universe of choices for fund TheCityUK, which sits on the board of the ever-increasing footprint in Southeast Asia.
and asset managers seeking to satisfy their FSTIB, inaugurated the Islamic Financial
customers’ preferences. More importantly, Market Advisory Group in 2014. STELLA COX
in cases where these factors are lacking in Chaired by DDCAP Managing Director Stella Managing Director
other asset managers’ immediate local or Cox, the group is tasked with providing a cen-
regional markets, European markets offer an tral point for UK thought leadership in Islamic [email protected]
advantageous alternative for their investment finance. Currently, the domestic footprint
portfolio needs. of the projects deemed relevant to Islamic DDCAP Limited
Accordingly, traditional fund management investment and funding is growing. With the
domiciles in Europe, such as Luxembourg, the proactive support of the UK government, it 8-10 Grosvenor Gardens
Channel Islands and Ireland, have tended to is ultimately likely to result in the country’s London SW1W 0DH
be among the favoured locations for the in- Islamic capital markets providing a financial UK
corporation of Islamic funds and offer the pro- platform for regeneration, development and
vision of ancillary services for local regulatory project funding across the United Kingdom. +44 207 863-1250
requirements. The distribution of many of www.ddcap.co.uk
these funds has largely come from London and About The DDCAP Group
other core, Islamic financial hubs, in which The DDCAP Group was founded in 1998 and
there is extensive experience from local and is headquartered in central London, with
international firms available to ensure suc- a presence in the Middle East. The group
cessful distribution on a global basis. is majority-owned and controlled by IPGL

32 INTERNATIONAL INVESTOR



perspective  global Islamic finance

perspective: Stimulating Private

Sector Sukuk Markets

The impressive growth of Islamic finance in recent years has been spurred on by significant rises
in global sukuk issuances. Despite the clear gains, underdevelopment in private sector sukuk markets
must be addressed by the industry and will require substantial reform.

Michael J.T. The state of sukuk This piece seeks to identify some of the critical fac-
McMillen, partner The success story of Islamic finance since 2002, and par- tors that must be addressed in order to close the gaps
at Curtis, Mallet- ticularly since the 2008 Financial Crisis, is the growth and develop private sector sukuk issuance. Three cat-
Prevost, Colt and resilience of the sukuk markets, which are the egories of critical factors are considered: bankruptcy,
& Mosle LLP largest component of the Islamic capital markets. within which the issues relating to special purpose en-
and Adjunct Global sukuk issuances from 2002 until 7 November tities (SPEs), true sales, and substantive consolidation
Professor of Law 2008 totalled US$88 billion; issuances bottomed out at are considered; collateral security; and systemic legal
at the University of US$38 billion in 2009, surged to US$140 billion in 2012, structures, processes and procedures.
Pennsylvania Law and then plateaued at US$116 billion in 2013 and 2014.
School, reflects on The final figure for 2015 is expected to decrease to ap- Context
corporate sukuk proximately US$55 billion, due to the discontinuance Two fundamental topics that inform an understanding
market development of short-term sukuk issuance by Bank Negara Malaysia of the aforementioned critical factors are the nature of
(BNM). Historically, BNM has accounted for almost 40 per sukuk and the necessity of ratings, which are the primary
cent of total global sukuk issuances. determinant of marketability of private sector sukuk.
In 2014, sovereign issuances comprised 63 per cent
of the total global market, with corporate issuances Sukuk as securitisations
making up 22 per cent, and quasi-sovereign issuances It cannot be overemphasised that sukuk are securitisa-
16 per cent. In fact, these figures reveal little about the tions, not bonds, which, simply put, are usually obli-
true state of the markets and may be misleading. For gations payable out of the issuer’s general revenues
example, the ‘corporate’ category includes issuances by regardless of profitability. The widespread practice
corporates based in Malaysia, financial institutions and of referring to sukuk as ‘Islamic bonds’ confounds the
supranational bodies, such as the Islamic Development discussion and directs it away from rigorous inquiry
Bank (IDB) and Islamic Liquidity Management Corpora- regarding the critical factors impeding private sector
tion. In 2014, issuances from Malaysian institutions con- sukuk markets.
stituted 69 per cent of the total. Sukuk may be structured as securitisations of a
Globally speaking, there are only a handful of non- single asset, a pool of assets, or a whole business, in
financial corporate issuances outside Malaysia and each case using different structures and contracts.
corporate issuances are primarily from Malaysian and The Accounting and Auditing Organization for Islamic
Turkish financial institutions. Additionally, a sampling Financial Institutions (AAOIFI), in its widely-accepted
of ‘corporate’ issuances revealed that a significant Sharia Standard No. 17 - Investment Sukuk provides for
number were ultimately dependent on revenues from 14 permissible sukuk categories by asset class and ac-
a sovereign entity. In all cases, parsing the information tivity using nine different contracts.
is difficult because of the absence of transparent, de-
tailed reporting. Classification criteria are not revealed Ratings
and categories are not subdivided or broken down into The critical factor in developing a private sector sukuk
constituent elements. In short, detailed information is market is the ability to have the private sector issuer
not freely available and opacity is increasing. or issuance rated by an international rating service.
To summarise the situation, essentially all sukuk are Ratings services publish and apply a myriad of detailed
sovereign or ultimately dependent on sovereign credit. ratings criteria that relate to specific assets, structures
Moreover, there have been very few non-financial pri- and entities. Ratings principles apply to all types of
vate sector sukuk issuances, clearly highlighting that, corporates, governments, securitisation structures and
the private sector is not realising the benefits of sukuk. asset classes. Specific methodologies and assumptions
Without diminishing the contributions that sukuk have apply to certain types of issuers, issues, asset classes,
made to sovereign infrastructure development, an ap- markets and regions.
propriate conclusion is that there are gaps in the sukuk Standard & Poor’s Ratings Services has published
success story and the Islamic finance industry must pro- criteria setting forth its methodology for rating sukuk.
ceed with the arduous undertaking of developing private Indicative of the lack of true securitisation sukuk, this
sector sukuk issuance. methodology relates exclusively to structures involving

34 INTERNATIONAL INVESTOR

global islamic finance  perspective

sponsor, usually originator, contractual support for peri- This opinion is delivered to specific transaction par- There have been
odic payments by the SPE issuer of and on the sukuk, as ties and some third parties, such as a ratings service, very few non-
well as the repurchase of the securitised assets on ma- and only addressees may rely on the opinion. The rem- financial private
turity of the sukuk. While this structure is pervasive in edies opinion covers three distinct, but related, mat- sector sukuk
current sukuk markets for both sovereigns and financial ters: it confirms that an agreement has been formed; it issuances, clearly
institutions, it is of limited assistance to private sector confirms that the remedies provided in the agreement highlighting that
issuers, whose entity credit is inadequate to achieve will be given effect by the courts; and it describes the the private sector
higher ratings. extent to which the courts will enforce the provisions of is not realising the
There are five key areas in the analytical framework the agreement that are unrelated to breach. benefits of sukuk
for structured finance securitisation ratings: the credit Private sector sukuk transactions also include legal
quality of the securitised assets; legal and regulatory opinions addressing the following matters, among
risks; payment structure and cash flow mechanics; others: SPE considerations; true sale of securitised
operational and administrative risks; and counterparty assets; lien-free transfer of assets; non-consolidation of
risks. The focus of this piece is on some of the critical assets in bankruptcy; the collateral security structure;
legal and regulatory risks, such as bankruptcy matters enforceability of transactional documents; choice of
and, in certain transactions, collateral security matters. governing law; enforcement of judgments and awards;
In each case, the ratings service seeks to obtain comfort tax status of the SPE; fraudulent conveyances; and
regarding these risks, and others, by obtaining the ap- preferential transfers. The ratings services have specific
propriate legal opinions. requirements pertaining to some of these matters.

Legal Opinions Bankruptcy
Obtaining satisfactory legal opinions on critical aspects Special Purpose Entities
of the securitisation is critical to securing the rating, The first bankruptcy-related critical factor relates to
as well as satisfying a transactional closing conditions SPEs. The focus of a ratings service is whether the
precedent. The opinions are usually rendered by the is- entity that owns, or holds, the payment rights (secu-
suer’s outside counsel or opposing outside counsel and ritised assets) and is obligated to make payments on
include third-party opinions. This practice is intended to the sukuk is ‘bankruptcy remote’, meaning that it is
assure the independence and integrity of the opinions, unlikely to be involved in either a voluntary or involun-
including through due diligence inquiries. tary bankruptcy proceeding.
There are four general categories of required legal The criteria used to make the bankruptcy remote-
opinions, each rendered under the relevant applicable ness determination focus on six characteristics, each of
law. The two of relevance here are opinions addressing which must be addressed in either or both the organ-
the validity, binding effect and enforceability of the rel- isational and transactional documents. The fundamental
evant documents, termed ‘enforceability’ or ‘remedies’ characteristic is that the SPE’s objects and powers are
opinions; and specific matters of substantive law, such restricted to ensure that it performs only the bare ac-
as, true sale, substantive consolidation, liens, fraudu- tivities necessary to effect the sukuk transaction and not
lent conveyances, and others. others that might give rise to claims of persons or entities
A remedies opinion addresses issues relating to that are not sukuk holders. There should also be limita-
whether the provisions of an agreement will be given tions on SPE indebtedness and sponsor bankruptcy filings
effect by the courts. The essence of the opinion is that to minimise the likelihood that creditors and sponsors
each of the contractual ‘undertakings’ is enforceable. may cause SPE involvement in a bankruptcy proceeding.
The undertakings are: the ‘obligations’ provisions; the Additionally, the entity should have an independent
‘available remedies’ provisions; and the ‘ground rules’ director, or equivalent, whose vote is required for filing
provisions. The standard wording of the opinion is that, of voluntary bankruptcy petitions and certain other
“the agreements are valid and binding obligations of the matters to avoid interlocking directorates and reduce
[entity], enforceable against the [entity] in accordance the likelihood of such petitions; there should be prohibi-
with their terms”, although there are likely to be excep- tions on merger, consolidation and similar transactions
tions to this generalised statement. to provide comfort that the SPE’s bankruptcy-remote

strategic review 35

perspective  global Islamic finance

Substantive legal status will not be undermined by these transactions; and The situation is dire in most jurisdictions within the
reform of bankruptcy the entity should agree to abide by certain separate- Organisation of Islamic Cooperation (OIC). Bankruptcy
laws in OIC ness covenants to provide comfort that the SPE will act laws are relatively rudimentary in most OIC member
countries is vital in independently, which reduces the likelihood of a court states and are insufficient in terms of true sale and
order to stimulate ‘piercing the corporate veil’, characterising the SPE as similar concepts. Even if the transactional structure
private sector sukuk an ‘alter ego’ of another entity, or invoking ‘substan- complies with rigorous true sale principles, lawyers are
tive consolidation’ concepts. Finally, security interests unable to render true sale opinions because the substan-
in securitised assets should have been created to reduce tive law of true sale is insufficiently developed. Thus,
incentives of parent entities, parent creditors and other substantive legal reform of bankruptcy laws in OIC coun-
SPE creditors to file the SPE into bankruptcy. tries is vital in order to stimulate private sector sukuk.
Before moving on to the next concept, due to the
True Sale industry interest in the topic, the distinction between
It is often observed that defining ‘true sale’ is the holy asset-backed and asset-based structures, referred to
grail of the securitisation market. In private sector is- above, is worth further consideration. In a properly
suances, it is necessary to demonstrate that there has structured sukuk transaction involving an asset transfer
been a true sale of the securitised assets. The inability that is not a true sale, but that includes a first prior per-
to make the true sale demonstration or to obtain the fected security interest or security right in the trans-
related legal opinion supporting a true sale are the ferred asset, the asset ownership transfer is postponed,
leading inhibitors to private sector sukuk market de- pending the occurrence of a default or other event or
velopment. A complexity is that there are slightly dif- circumstance that allows realisation upon the security
ferent true sale principles under bankruptcy, collateral interest or security right. The asset-based arrangement
security, and tax laws, and more than one set of rules becomes an asset-backed arrangement if the default,
may have to be satisfied. event or circumstance occurs. If it does not, the trans-
True sale relates to the nature of the transfer of the action runs its course and the analytical focus shifts to
assets from the asset originator to the SPE that issues how the sukuk is retired, and whether the sukuk retire-
the sukuk. The essence is whether, in an originator bank- ment effects a transaction that is equivalent, for Sharia
ruptcy, a creditor of that originator will have recourse purposes, to an impermissible repurchase of the asset
to the assets that underlie the sukuk. If the SPE owns by the originator at something other than fair market
the assets, i.e. there was a true sale, the sukuk holders value at the time of the transfer.
will be repaid out of those assets in accordance with the
terms of the sukuk and the originator bankruptcy will be Substantive Consolidation
inconsequential to the sukuk holder. Another set of bankruptcy considerations is subsumed
Failure to establish a true sale results in an inability in the amorphous ‘substantive consolidation’ concept.
to obtain a true sale legal opinion and, in turn, a rating. This is the judicially imposed equitable remedies con-
If a true sale is absent, the rating will be based on the cept that two or more legally distinct entities might be
rating of the originator as obligor, taking cognisance of combined into a single debtor with a common pool of
all its liabilities and competing creditors. The assets, assets and a common body of liabilities, with the third-
although held by the SPE, will be considered those of party liabilities of the subject entities being satisfied
the originator, and the issuance will be treated not as from the single asset pool. Substantive consolidation
‘asset-backed’, but as ‘asset-based’. Thus, the sukuk might occur even if asset transfers into an entity were
holders will be deprived of their payment streams and true sales. In the sukuk context, the entities that might
the securitised assets. be substantively consolidated are the originator and the
The critical issue is whether the SPE has assumed issuer SPE.
sufficient risks relating to the value, and the burdens Substantive consolidation significantly affects credi-
of ownership, of the assets. To the extent that the origi- tors and their recoveries. It effectively denies them the
nator continues to participate in asset value, the risks benefit of their bargain and their freedom of contract
assumed by, and the true sale position of, the SPE are di- to obtain that bargain: a transaction based on risk as-
minished. Among the many factors considered in a true sessments, and risk and monetary allocations, that are
sale analysis are whether or not the originator has an premised on recourse to the assets of a specific debtor
interest in either or both the cash flows and the residual in competition only with other permitted, and limited,
value of the asset, and whether or not the originator creditors of that debtor. It abrogates asset partitioning
may reacquire the asset at other than fair market value concepts and limited liability concepts, as well as struc-
at the time of reacquisition. If the originator has such tural subordination.
rights, the transaction is probably not a true sale and A condition to rating is a legal opinion to the effect
the sukuk holders are at considerable risk of sacrificing that there will be no substantive consolidation. That
their payment stream to a creditor of the originator. opinion is essentially impossible to render in most OIC
Most contemporary sukuk fail the true sale tests. jurisdictions, given the state of development of the
Repurchase obligations at other than fair market value law. It is frequently impossible even to determine if the
are commonplace, as are violations of other true sale concept exists, let alone parse the nuance of when the
criteria. While this is of little consequence in sovereign concept might be applied. This should also be an area of
offerings, and of lesser consequence in financial institu- focus for structural legal reform initiatives, if sufficient
tion offerings, it is fatal to the development of private clarification is to be achieved for purposes of obtaining
sector sukuk markets. ratings on private sector sukuk.

36 INTERNATIONAL INVESTOR

global islamic finance  perspective

Collateral Security are relevant to development of private sector sukuk due There are a number
Some securitisation transactions involve collateral secu- to the effect they have on the predictability and cer- of deficiencies in
rity elements, such as mortgages, security interests or tainty of designated outcomes, as well as the ability of the systemic factors
security rights, because they are structured to involve counsel to render legal opinions. Systemic factors affect of particular Islamic
one or more transactions that are not true sales. For ex- ratings, pricing, and a panoply of risk-related business finance jurisdictions
ample, it may be uneconomic, impermissible or impru- matters. At present, predictability and certainty are
dent to transfer the title to an asset from the originator relatively low for these matters.
to the SPE at transactional inception, due to high tax There are a number of deficiencies in the systemic
impositions, restrictions on transfers of certain types of factors of particular jurisdictions. They include the
property, legal requirements to inform every obligor on permissibility of ex post facto legislation; the fact that
the transferred assets, and other constraints. Or the rel- Sharia is comprised of general principles, rather than
evant security interest laws may mandatorily encompass specific requirements, and that application in specific
the securitised assets. transactions is difficult to determine; issues relating to
In an asset transfer to the SPE, the granting of a secu- inconsistency and interpretative differences between
rity interest in the assets that serve as collateral for the Islamic jurisprudence schools regarding particular Sharia
sukuk will not provide adequate comfort that the sukuk principles; a lack of transparency as to the Sharia prin-
will be paid in a timely manner or receive the full value ciples as a result of the foregoing factors and the infancy
of the collateral if the originator-transferor becomes of modern Islamic finance; a lack, or often absence, of
involved in a bankruptcy proceeding. For example, in binding precedent concepts and published decisions
the instance of an automatic stay, or a similar process, with their rationales; de novo consideration of each
which would delay payments, the originator may be case and each issue set without regard to other deter-
permitted to use the assets in a sale or as collateral for minations; a great degree of discretion in courts in these
another financing, or the SPE may be required to return jurisdictions; and a number of uncertainties regarding
the assets to the originator’s bankruptcy estate. the availability and application of remedies.
The customary structural protection against this is Moreover, additional systemic factor deficiencies
the appropriate use of one or more SPEs. Additionally, relate to the application of choice of law principles being
the ratings services and the opining legal counsel will unclear and uncertain; the unwillingness to enforce for-
analyse each asset transfer in the structure to deter- eign judgments and foreign arbitral awards, and related
mine if it is a true sale, a secured loan or something questions regarding whether Sharia law may constitute a
else; the nature of each party’s property rights in the public policy exception to enforcement; and, finally, the
assets; and whether any entity that is unrated or not significantly extended time frames for determinations of
bankruptcy remote retains any interest in those assets. disputes and enforcement of remedies, which are often
True sale opinions are usually required for at least the so long as to preclude effective remedies.
initial transfer to an SPE. If the assets are involved in The lack of certainty and predictability that result
subsequent loan arrangements and serve as collateral, from these deficiencies often precludes the rendering of
for example in multi-tier structures, security interests necessary legal opinions, the willingness of ratings ser-
or rights must constitute first prior perfected security vices to provide ratings, and the markets from accepting
interests or rights, and legal opinions will be required unrated products, such as private sector sukuk.
with respect to those interests or rights.
Collateral security laws are significantly underdevel- Suggestions
oped in most OIC jurisdictions and lawyers have gen- The prospect of developing private sector sukuk mar-
erally been unable to render opinions as to SPE status kets may seem daunting, given the substantial reform
and perfection and priority of security interests or rights needed. However, I am not of the opinion that Islamic
that are necessary to obtain ratings on sukuk. While such finance stakeholders should forsake all hope until both
ratings have been unnecessary for sovereigns, quasi- substantive and systemic reforms have been imple-
sovereigns and financial institutions to date, they will mented, which could take years, if not decades.
be critical for private sukuk market development. Accordingly, I will make two suggestions regarding
Efforts are already being made to develop collateral how to proceed. The first entails formal and informal
security regimes for OIC jurisdictions. Examples include initiation of coordinated programmes for substantive
the laudable efforts of the United Nations Commission legal and systemic reform. Admittedly, this is a longer-
on International Trade Law (UNCITRAL), the European term and more arduous undertaking that requires coor-
Bank for Reconstruction and Development (EBRD), and dinated political, social, legal and religious efforts.
the World Bank. Each is examining the modification of The second suggestion involves a change in vision and
its model laws in order to be Sharia compliant, while orientation, and seems achievable in the near term. I
also remaining in harmony with modern international propose an immediate focus on private sector sukuk
practices. This is encouraging from a long-term perspec- issuance in and from jurisdictions where ratings are cur-
tive and it may provide some short-term guidance to rently achievable; market acceptance of securitisation
jurists, even prior to the adoption of these laws in the is broad and deep; and other critical criteria are already
longer term. satisfied. The main objective here is to prime the pump
and build a large and sustainable transactional flow in
Systemic Factors the shortest possible time frame. Another objective is to
The general structure, processes and procedures of the provide a proving ground for the private sector. The pa-
relevant legal systems, termed here ‘systemic factors’, rameters should allow accelerated achievement of both

strategic review 37

perspective  global Islamic finance

The Islamic finance market segment growth and higher levels of product so- tionships and balances, vested interests, and carefully
industry must do phistication. Crucially, the initiative must be structured guarded institutional fiefdoms, not to mention budgets.
more than merely to serve an integrative function involving both Islamic To date, political will and consensus have been sought
participate; it must and conventional finance. with respect to substantive legal principles, but seem
lead the reform In order to advance this proposal, it is first neces- not to have been diligently pursued with respect to sys-
initiative sary to identify the criteria for selecting an appropriate temic reforms.
jurisdiction. Current widespread availability of ratings The required will, consensus and commitment are
for comparable arrangements is a fundamental prereq- not just secular. All segments and levels of the Islamic
uisite. A sophisticated and well-developed legal and finance industry must participate. Doctrinal stan-
regulatory regime and related infrastructure are critical dardisation should be achieved where that is feasible
foundation elements. A large and diverse market for without denigration of legitimate religious interpretive
both securitisable assets and absorption of securitised positions. One of Islam’s particular strengths lies in its
products is important. Extensive experience with secu- diversity of thought and interpretation, and should not
ritisation techniques and a well-developed institutional be forsaken for economic convenience. There are ways
infrastructure are essential. High levels of market and to achieve consensus on structural forms that accommo-
technical sophistication are highly desirable. Existing date divergent interpretations of principle, and efforts
liquid markets, both primary and secondary, are an im- should be directed towards achieving this consensus.
perative if the liquidity and capital issues of the Islamic Thus, sustained cooperation is paramount. The industry
finance industry are to be served. The jurisdiction should has already demonstrated its cooperative capabilities,
not suffer from the systemic impediments previously including within initiatives implemented through the
identified. Finally, predictability and certainty relating IDB, AAOIFI and the Islamic Financial Services Board.
to critical factors should be at the highest levels with Consequently, there is a greater sense of optimism with
respect to all relevant factors. respect to potential achievements by industry actors
Taking the criteria outlined above, my suggestion is and initiatives.
to focus on private sector sukuk issuances from the U.S. Yet, the Islamic finance industry must do more than
and similar markets. The U.S. securitisation markets are merely participate; it must lead the reform initiative.
massive, and support trillions of dollars worth of issu- The industry has the requisite technical knowledge
ances of a variety of assets. These markets and the base and, at many levels, the position and credibility to
of securitisable assets are broad and diverse. Rated pri- positively influence political, social, institutional and
vate sector issuances are commonplace, both from indi- other actors. It should seek to integrate participants and
vidual companies and from pooling vehicles. The legal coherently shape the reform process from inception in
and regulatory infrastructure, the market mechanisms areas such as bankruptcy and collateral security, rather
and the institutional frameworks are existent, devel- than labouring over piecemeal disjunctive amendatory
oped and refined. The securitised product, in this case processes, as has so often been the case in developed
sukuk, can be sold and traded throughout the world. areas, such as banking.
Both primary and secondary markets are highly liquid. Nevertheless, the path will be long and arduous.
Predictability and certainty parameters are satisfied. The suggestions made in this Perspective are intended
to satisfy immediate needs, while also laying the base
Conclusion and providing an impetus for further development of the
The benefits and ideals of Islamic finance mandate that necessary substantive and systemic reforms. There is an
more than sovereigns and large financial institutions opportunity to tap into and harness already existing and
participate in the funding opportunities afforded by refined securitisation markets, processes and institutions
sukuk. Private sector involvement is imperative, and in order to make the benefits afforded by sukuk available
must occur at the earliest practicable time. to the private sector. This can be done at the same time
Furthermore, substantive legal reform must take as developing the liquidity and secondary market ele-
place in critical areas. However, this challenge may not ments that have thus far eluded the Islamic finance in-
be as daunting as it first appears: suitable models, tech- dustry. It is an opportunity that should not be neglected
nical expertise, and a wealth of experience exist and can or squandered.
be harnessed for the task. The initiatives of UNCITRAL,
EBRD and the World Bank, among others, may lead the ➥ Dr McMillen teaches Islamic finance at the University of Pennsylvania
way. Sharia-compliant versions of their model laws will
greatly assist OIC jurisdictions that undertake reform Law School and The Wharton School. Views expressed in this Perspective
initiatives. Even the existence, without adoption, of are the author’s own. Copyright 2016 Michael J.T. McMillen; all rights
compliant model laws will provide jurists with insights reserved.
into resolving contemporary financing issues in compli-
ance with Sharia, and in harmony with international
practices and procedures.
The more challenging process may be effecting
change to systemic structures, processes and proce-
dures. This will require strong, sustained and diligent
leadership that is sensitive to the politically charged
intrusion of the reform process on existing customs,
prerogatives, sociopolitical alignments, intergroup rela-

38 INTERNATIONAL INVESTOR



business intelligence  global islamic finance

Sharia-compliant
investment is worth it

Aberdeen Islamic Asset Management Sdn Bhd is promoting the ethical
and financial benefits of Sharia-compliant investment, which have
more in common with SRI than most mainstream investors realise.

Malaysia is a hub for Islamic finance Industry perceptions ‘Chinese walls’ are weak in the face of con-
Every single investment is a leap of faith. For tinuing conflicts of interest; and transaction
Sharia-compliant investment may many choosing to invest in Sharia-compliant costs for bank customers are often excessive.
offer a solid hedge against the next products, that is especially true given their Therefore, for investors who are appre-
financial crisis religious convictions. hensive about the reliability and stability
In recent years, there has been a boom in of conventional global banking and finance,
demand for both equities and fixed income, Sharia-compliant investment may offer a solid
such as sukuk, and the profile of Sharia- hedge against the next crisis. In fact, had
compliant products has risen. However, Sharia precepts operated in 2008, they may
misperceptions remain. well have prevented the last one.
First, it is often thought that performance One of the reasons for this is because Sharia
will suffer in Sharia-compliant investments, principles prohibit the paying or receiving of
owing to their religious component, which im- fixed interest. Adherence to this concept,
poses restrictions on what securities investors referred to as riba, would have reduced the
may buy. likelihood of speculative and risky behaviour
Second, a commonly held belief is that among over-leveraged banks and insolvent
Sharia-compliant investments are only really borrowers in the run-up to 2008.
for Muslims and therefore irrelevant for main- In the same way, Islamic restrictions on
stream investors looking to build genuinely debt would have prevented the asymmetries
diversified portfolios. of a system where risk-taking rewards certain
Last, managers of Sharia-compliant funds individuals while requiring taxpayers to cover
are sometimes deemed to lack not only suf- any losses incurred.
ficient financial expertise, but also knowledge
relating to Islamic practices and Sharia law. SOUND PRINCIPLES
To understand fully the advantages of Another common misperception is that
Sharia-compliant investments, it is important Sharia law dictates where investments can
to address these issues one by one. and should be made. In reality, Islam makes
no distinction between the spiritual and the
COMPETITIVE PERFORMANCE secular; Sharia law merely stipulates where
Claims that Sharia-compliant funds underper- investments cannot be made.
form when compared to conventional invest- For example, in terms of investments,
ments are not true. Comparisons between Sharia places particular emphasis on haram,
two commonly used indices, the MSCI AC or ‘forbidden’ industries. Haram extends to all
Global Equity and the MSCI AC Asia ex Japan products and services considered addictive, in-
Equity and their Sharia equivalents, show that cluding alcohol and gambling. Accordingly, all
under certain conditions, the Sharia one can income generated from the manufacturing and
hold its own (see fig. 1). marketing of pork, prostitution or pornography,
Crucially, the performance of Sharia in- among other industries, is also forbidden.
dices is largely determined by one factor: Rather than simple moral prohibitions, the
the performance of bank stocks. When bank frame of reference of Islamic finance governs
stocks do well, Sharia indices underperform, personal conduct including individual respon-
and vice versa. sibility to society and the notion of serving
Clearly, banks are a major component the common good.
within conventional indices. Yet, eight years This social awareness is exemplified in the
on from the last financial crisis and regulators concept of gharar, which seeks to eliminate
still concede that some banks are too big to ambiguity and deceit in Sharia contracts, in-
fail; capital inadequacy remains a problem cluding fraudulent acts or other undesirable
in the wake of undemanding stress tests; consequences. From a financial perspective,

40 INTERNATIONAL INVESTOR

global islamic finance  business intelligence

1. ANNUAL PERFORMANCE OF CONVENTIONAL AND SHARIA-COMPLIANT FUNDS (%)

40 80
30 60
20 40
10 20

0 0
-10 -20
-20 -40
-30 -60
-40 -80
-50 -100

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

MSCI AC World MSCI AC World Islamic MSCI AC Asia Pacific ex Japan MSCI AC Asia Pacific Islamic ex Japan

Source: Aberdeen Asset Management; Factset; MSCI; 29 February 2016

this means that investment cash flows must tional transparency, in addition to ensuring Furthermore, the EPF announced that it
be tied to real assets. investee boards respect the rights of their will offer all members the option of a purely
The principle of gharar is similar to con- minority shareholders. Sharia-compliant pension from 2017. This
temporary ideas behind socially responsible The objective of AIAMSB is to invest over is set to increase its investments in Sharia-
investment (SRI). Under the premise of SRI, the long term. To that end, it first looks at compliant stock, thereby providing a signifi-
investments are based not only on financial downside risks, such as what could go wrong, cant boost to the industry as a whole.
return but also on their contribution to the with the aim of buying only those companies Indonesia is also now looking to improve
social good. that have strong balance sheets and cash flow. take-up of Sharia-compliant products. In 2015,
In recent years, SRI has become embedded Moreover, a group of external Sharia the country’s financial services authority re-
in the investing of public institutions in the scholars is responsible for screening all AIAMSB laxed its rules to allow domestic-approved
West, whether by means of SRI-specific, ESG investments. In fact, because of Aberdeen’s Sharia mutual funds to invest at least 51 per
(environmental, social, and governance) man- fundamental and comprehensive approach, cent, and up to 100 per cent, of underlying
dates, or otherwise. few adjustments are necessary to make con- assets overseas; conversely, conventional
However, the affinity between Sharia- ventional model portfolios Sharia-compliant. funds remain bound by a 15 per cent cap.
compliant investment and SRI has not yet This is significant because as long as this dis-
been noticed by mainstream investors. EDUCATION MATTERS crepancy between conventional and Islamic
Nevertheless, their converging investment Clearly, there are fewer investment options segments exists, Sharia-compliant funds will
concerns and approaches could be incorpo- available for Sharia-compliant funds than offer advantages in terms of diversification.
rated more widely into awareness raising of there are for conventional funds. This results Sharia-compliant funds, far from repre-
the potential of Sharia-compliant investments. in certain sectors being under-represented, or senting a restricted choice in terms of perfor-
indeed, as is the case with regard to banking, mance, diversity and expertise, offer investors
DUE DILIGENCE COMES FIRST absent altogether. a sound and potentially profitable alternative.
The final misconception relating to Sharia- However, AIAMSB believes that the pur-
compliant investments, in which fund man- chase of multiple stocks alone does not make GERALD AMBROSE
agers are said to lack the required expertise, a portfolio diversified. Rather, it contends Chief Executive Officer
is being addressed by Aberdeen Islamic Asset that risk can be mitigated by running a con-
Management Sdn Bhd (AIAMSB). centrated portfolio and having extensive [email protected]
AIAMSB was awarded its Islamic fund man- knowledge of every single holding.
agement licence in Malaysia in 2009 and is a Promoting its expertise requires AIAMSB ABERDEEN ISLAMIC ASSET MANAGEMENT
wholly owned subsidiary of Aberdeen Asset to focus on educating investors about the SDN BHD
Management Sdn Bhd (AAMSB), which itself attractions of Sharia-compliant investments. Suite 26.3, Level 26, Menara IMC
is part of a global investment management However, financial literacy across Asia re- Letter Box 66
group. AIAMSB manages funds on behalf of mains weak and the situation is made more 8 Jalan Sultan Ismail
both retail and institutional clients. challenging by the incentive structure which 50250 Kuala Lumpur
Both companies have a common investment governs how funds are bought and sold. Malaysia
approach, grounded in careful due diligence Malaysia serves as a benchmark for a
that involves visiting prospects and talking to way forward in this regard. In recent years, +60 3 2053-3800
their senior management before any invest- the Malaysian government has taken steps www.aberdeen-asset.com.my
ment is made. The purpose of this is to forge a to increase the amount that the Employees
deep understanding of the strategy and opera- Provident Fund (EPF), as the State agency re-
tions of these entities. sponsible primarily for the administration of
There is a particularly strong emphasis on private sector workers’ pensions, can invest
good governance, accounting and organisa- in Sharia-compliant investments.

strategic review 41

business intelligence  global islamic finance

Galvanising Islamic finance
through sukuk

To replicate the success of the Islamic capital market in Malaysia on a
global scale, Cagamas is using its strategic positioning to promote the
benefits of increased sukuk issuance and further regulatory incentives.

Sukuk has been critical to the progress of Islamic finance A thriving Islamic finance industry system in Malaysia and is strategically placed
Islamic finance in Malaysia has made signifi- to engender the growth of its Islamic capital
Cagamas forms a key part of cant progress since its inception more than market. In fact, it is one of the largest sukuk
the Islamic finance ecosystem 30 years ago, and now constitutes a compre- issuers in Malaysia, having issued both unse-
in Malaysia and is strategically hensive and sophisticated market. Over the cured sukuk and Islamic Residential Mortgage-
placed to engender the growth course of the past three decades, the coun- Backed Securities (IRMBS) totalling MYR46,485
of its Islamic capital market try’s financial regulators, including its central billion, as of December 2015 (see fig.1).
bank, Bank Negara Malaysia, and the body Since 1994, Cagamas has helped to stimu-
responsible for regulating and developing its late the growth of the sukuk market by cre-
capital markets, the Securities Commission ating and establishing a pricing benchmark
Malaysia, have implemented a series of infra- for the private debt securities segment. It has
structural reforms to boost the growth of the also taken the lead in terms of innovation,
sector and shape an environment conducive through the use of crude palm oil as an ac-
to progress. These efforts have included the ceptable underlying asset to facilitate sukuk
introduction of measures that are key to issuance. In addition, the pioneering efforts
the rise to prominence of Malaysian Islamic of Cagamas in the sukuk space have bolstered
finance, for example the application of tax the confidence of other issuers, encouraging
incentives and the creation of a harmonious them to further develop their offerings.
legal and regulatory framework. From the perspective of Cagamas as an
Islamic finance in Malaysia has reached issuer, the type of sukuk used for issuance
a level of development in which minimal purposes depends on investor demand, among
regulatory incentives are required to provide other factors. Fundamentally, Cagamas
further impetus to the sector. The market matches its issuances with the assets it pur-
itself is providing a form of incentivisation chases. Thus, the issuance of sukuk depends
by enabling industry players to capitalise on on the assets that Cagamas plans to acquire.
the opportunities available. This is primarily To achieve its objective of strengthening
due to the presence of the wider business the Islamic capital market in Malaysia,
ecosystem as well as multiple market players, Cagamas prioritises innovation and continu-
including asset managers, takaful companies ously seeks to introduce sukuk structures that
and Islamic banks. are viewed favourably by investors. This is
Furthermore, the presence of this eco- exemplified by the introduction of the com-
system and the magnitude of the players pany’s first Islamic multicurrency medium-
involved have the potential to incentivise term note (MTN) initiative, the Islamic
issuers to consider issuing sukuk, especially Euro MTN programme in 2014, valued at
considering the fact that issuance provides US$2.5 billion.
more favourable yields that are lower com- Additionally, the role of Cagamas in pro-
pared to conventional bonds. This differs moting home ownership is being facilitated
from new markets, such as Morocco, Nigeria, by the development of affordable housing
Oman and South Africa, where sukuk issuance through linkage to the capital market, thus
requires paying a slightly higher yield than complementing the efforts of the main in-
conventional bonds. stitutions financing these projects. To foster
additional home ownership, Cagamas is ex-
Fostering capital market development ploring the possibility of utilising waqf land.
As Malaysia’s national mortgage corpora- Thus, the company is looking to help stimu-
tion, Cagamas is mandated to promote home late efforts to standardise rules regarding
ownership and provide liquidity to financial estate management by the distinct state
institutions in the country. The company religious councils, since such standardisation
forms a key part of the Islamic finance eco- would facilitate the overall process.

42 INTERNATIONAL INVESTOR

global islamic finance  business intelligence

1. CAGAMAS SUKUK ISSUANCES, 1994-2015 (MYR IN BILLIONS)

8 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
7
6
5
4
3
2
1
0

1994-1999 2000

Sukuk (IRMBS) Sukuk (unsecured)

Source: Cagamas Berhad

Bolstering Islamic finance abroad this potential would enable additional Muslim local regulators and market players address
Cagamas is recognised internationally for its communities and investors to access domestic- this matter to enhance the offerings available
promotion of home ownership and the devel- based Sharia-compliant products and services. to individuals interested in sukuk investment.
opment of the Islamic capital market. As a In turn, the emergence of Islamic finance in At the international level, greater aware-
result, it is frequently used as a point of ref- these underserved markets would require the ness and understanding of the needs of
erence by central banks from distinct coun- presence of adequate Sharia-compliant assets Muslim communities and investors is vital in
tries interested in learning about its working in order to facilitate sukuk issuances. order to foster greater access to and partici-
model. The Cagamas model is well regarded Despite the widespread lack of Islamic fi- pation in the financial market. Increasing this
by the World Bank as a successful secondary nance options in Muslim communities around participation could potentially help tackle the
mortgage liquidity facility. the world, global Islamic banking assets con- challenges of eliminating extreme poverty
Cagamas’ advice has been sought by tinue to grow (see fig. 2) and governments and expanding shared prosperity.
external parties regarding Islamic finance are beginning to realise the importance of As a consequence, Cagamas envisions
solutions in the area of Sharia-compliant in- implementing Sharia-compliant alternatives boosting Islamic finance education in coun-
vestment. Through its activities in the Islamic to conventional finance. tries that are neither financial centres nor
finance sphere, including the publication have Muslim-majority populations.  Efforts to
of the textbook, Islamic Financial System: Challenges ahead increase knowledge of Islamic finance and the
Principles & Operations, Cagamas has sought Malaysia has an advanced Islamic finance financial needs of Muslim communities will
to promote the Malaysia International Islamic sector as well as solid bond and sukuk markets. play a crucial role in the emergence of com-
Financial Centre’s (MIFC) initiative of Malaysia Nevertheless, its retail sukuk and bond space panies and institutions with a similar working
as an international Islamic finance centre. is relatively new and improvements therein model to Cagamas. With this scenario in
Consequently, there is significant poten- will help the country contend with regional place, all industry stakeholders will be better
tial for the establishment of Islamic financial competitors, such as Thailand, which oversees equipped to facilitate the consolidation and
services in a number of countries. Fulfilling a robust retail bond market. It is crucial that growth of the global Islamic capital market.

2. ISLAMIC BANKING ASSETS GROWTH TREND, 2008-2014 (US$ IN BILLIONS)

2,000 2008 2009 2010 2011 2012 2013 2014 CHUNG CHEE LEONG
1,800 President & Chief Executive Officer
1,600
1,400 [email protected]
1,200
1,000 CAGAMAS BERHAD
Level 32, The Gardens North Tower
800 Mid Valley City
600 Lingkaran Syed Putra
400 59200 Kuala Lumpur
200 Malaysia

0 +60 3 2262-1800
www.cagamas.com.my
GCC MENA (excl.GCC) Sub-Saharan Africa Asia Others

Source: Central Banks; IFSB; IFIS; Bloomberg; KFHR; and EY

strategic review 43

perspective  global Islamic finance

perspective: Towards more ethical

forms of finance

The global banking crisis called into question the ethical standards of the financial sector, and prompted
many investors to shift their attention to forms of finance that better align with their morals and beliefs.
Two recent Islamic finance transactions illustrate just how such alignment can succeed.

Michael Bennett, Islamic finance and ESG investing sukuks issued by the International Finance Facility for
Head of Derivatives News of malfeasance in the banking sector has been Immunisation (IFFIm).
and Structured a fairly common occurrence since the 2008 Financial IFFIm is an international organisation that acceler-
Finance in the Crisis. Incidents ranging from structured product ates the availability and predictability of finances for
Capital Markets mis-selling, to LIBOR rigging, to allegations of money the immunisation of children, as well as the related
Department at the laundering for criminal organisations all raise troubling strengthening of the local health services, in low-income
World Bank, reflects questions about the ethical standards of certain banks countries around the world. These actions are carried
on the second and bankers. Accordingly, the growing interest in more out in collaboration with another international organisa-
Vaccine Sukuk ethical forms of finance in recent years is not surprising. tion called Gavi, the Vaccine Alliance. Gavi was created
issuance by the Islamic finance and investment funds that follow in 2000 to address the problem of stagnating, and even
IFFIm environmental, social and governance (ESG) standards declining immunisation rates, in low-income countries.
are two areas of ethical finance in which assets have Since its creation, Gavi funding has been responsible for
increased at particularly sharp rates in recent years. 500 million additional children being immunised; the
Importantly, both areas involve investors using their mortality rate for children under five years of age has
money in a manner that conforms to their morals and declined by 28 per cent over the same period.
beliefs, unlike conventional finance, which has tradi- Backed by financial support from nine sovereign
tionally been driven solely by efforts to maximise risk- governments, namely the UK, France, Italy, Norway,
adjusted returns. Australia, Spain, the Netherlands, Sweden and South
Both Islamic finance and ESG investing have deep Africa, IFFIm raises funds on the international capital
historical roots. The principles of Islamic finance are markets, which are subsequently channelled to Gavi.
drawn from the Holy Quran, the Sunnah and centuries The World Bank acts as Treasury Manager for IFFIm and
of scholarly interpretations of those sacred texts. handles all funding activities, under the direction of the
Similarly, ESG investing can be traced back to religious IFFIm’s volunteer Board of Directors.
writings, such as those of Anglican minister and theo- IFFIm was established in 2006 and immediately
logian John Wesley. Nevertheless, these two forms of began issuing bonds. It issued its first sukuk in December
finance have only emerged as well-developed, globally 2014, which was a three-year, US$500 million issuance,
relevant investment strategies in recent decades. making it the largest debut sukuk ever by a suprana-
Investing in an ethical manner is not necessarily an tional entity. It became known as the ‘Vaccine Sukuk’,
altruistic activity in which returns must be sacrificed. since the proceeds were used primarily to finance the
In fact, investing in companies that engage in unethical purchase of vaccines, and introduced the concept of
behaviour often leads to poor returns, as illustrated ESG investing to the sukuk market.
by the sharp decline in the equity and bond prices of Despite the philanthropic purpose of IFFIm, in-
Volkswagen following its emissions scandal in September vesting in the Vaccine Sukuks was not regarded as a
2015; investors in BP Petroleum stock learned the same simple act of charity by the investors. The sukuks were
hard lesson at the time of the Gulf of Mexico oil spill rated Aa1 by Moody’s, primarily due to the strength
in 2010. The securities of companies with poor envi- of the financial support IFFIm receives from its nine
ronmental, social and labour records often make for sovereign donors, and the profit rate of the sukuks was
under-performing investments in the medium to long consistent with such a well-rated obligation issued by
term. Investing in an ethical manner, therefore, can be a supranational entity. Moreover, the Vaccine Sukuks
both consistent with the investor’s beliefs and a highly marked the first time that most sukuk investors had
effective investment strategy. ever considered a transaction that provided both eco-
nomic and social returns.
The vaccine sukuks IFFIm’s inaugural sukuk was warmly received by
As the outstanding volumes of both Islamic and ESG the market and won numerous awards, including the
investments continue to expand, the convergence prizes for innovation in Islamic finance from Euromoney
of these two markets begins to appear increasingly and achievement in transformational finance from
inevitable. One recent pair of transactions that dem- the Financial Times. The success of the issue and the
onstrates how this convergence can occur is the two strength of the demand, which attracted more than

44 INTERNATIONAL INVESTOR

global islamic finance  perspective

US$700 million in orders, led IFFIm and the World Bank Convergence: a concept proven Investing in an
to return to the sukuk market in September 2015. There are two critical developments that must occur ethical manner can
While the marketing of IFFIm’s debut sukuk primarily in order for financial products to appeal to both be both consistent
involved introducing the ESG concept to sukuk inves- Islamic investors and conventional ESG investors. with the investor’s
tors for the first time, with the second Vaccine Sukuk First, Islamic investors must increase their awareness beliefs and a highly
the issuer also made a concerted effort to introduce of securities that use proceeds in a clear and socially effective investment
the sukuk product to conventional ESG investors. beneficial manner. Second, ESG investors must un- strategy
The second Vaccine Sukuk was joint lead managed by derstand the nature of Islamic structures. These two
Standard Chartered Bank, who also acted as global co- developments will certainly take time to materialise
ordinator, alongside Emirates NBD, Maybank, National and require substantial educational efforts from both
Bank of Abu Dhabi and NCB Capital. In addition to this issuers and intermediaries.
strong lead manager group, IFFIm brought in Morgan In the case of the Vaccine Sukuks, such efforts
Stanley and Crédit Agricole, two international banks proved particularly advantageous for IFFIm. The
with a dedicated ESG focus, to act as co-lead managers second Vaccine Sukuk was a three-year, US$200
and focus on attracting conventional ESG investors to million issue that was 1.6 times oversubscribed. It
the transaction. achieved an impressively diverse order book, with
The co-lead managers, in conjunction with the global 65 per cent being placed in the Middle East, 18 per
coordinator, marketed the transactions to institutional cent in Asia and 17 per cent in Europe. As with the
investors in the UK and continental Europe with an inaugural transaction, the order book included both
ESG focus. This particular approach not only involved investors who had purchased IFFIm securities in the
educating investors about the nature of sukuks, but past, as well as those who were participating in an
also explaining the underlying transactions, which are IFFIm transaction for the first time.
required to ensure the structure is Sharia compliant. In aggregate, the two Vaccine Sukuks raised
The economics of the Vaccine Sukuk mirrored those US$700 million, on orders of well over US$1 billion, in
of a floating rate note, and the name-recognition and less than one year. Such a high level of demand from
life-saving mission of IFFIm were well known in the both traditional sukuk investors and conventional
ESG market. Nevertheless, the structure of the sukuk investors, including those with an ESG focus, proves
itself was new to most of the investors. In particular, that the convergence of these two areas of ethical
conventional investors needed to understand the use of finance is a distinct possibility.
a special purpose vehicle (SPV) issuer in the structure.
The structure used for the Vaccine Sukuks is called ➥ Although in Arabic ‘sukuk’ is a plural form of the word ‘sakk’,
a ‘commodity murabaha’, and a separate SPV issuer
was created for each transaction. The issuer issued the for the purpose of clearly identifying that two separate sukuk were
sukuk certificates and used the proceeds raised from issued by IFFIm, in this Perspective the plural term ‘sukuks’ is used.
the investors to enter into a series of commodity pur- The findings and conclusions expressed herein are those of the author
chase and sale transactions with IFFIm. The payments and do not necessarily reflect the views of the World Bank or its
from IFFIm to the SPV issuer in respect of these com- affiliated organisations.
modity transactions form the basis of the profit rate
payments made by the SPV on the sukuk.
Many conventional investors equate an SPV-issued
security with an asset-backed securitisation (ABS),
and in some cases have restrictions on the purchase
of ABS paper. While the structure of the Vaccine Sukuk
shared certain similarities with an ABS, the credit risk
borne by the investors belonged to IFFIm, the AA-rated
obligor. A critical aspect in marketing the transaction
was ensuring that conventional ESG investors clearly
understood this element of the structure.

strategic review 45

business intelligence  global islamic finance

OPTIMISING WORKING CAPITAL
VIA FINANCIAL SUPPLY CHAINS

The provision of accessible financing solutions is vital for the
development of Malaysian SMEs. RHB Banking Group has introduced
two innovative offerings to support the growth of this segment.

RHB is providing tailored, customer-focused solutions Every Cent Counts For SMEs greater interaction between users and entities
Small and medium-sized enterprises (SMEs) in critical to their operations, including banks.
FSC delivers convenience to Malaysia represent a fundamental part of the RHB understands the importance of
customers by overseeing their national economy, as the largest contributor to meeting its customer requirements, and to
entire supply chain, from invoicing GDP growth. The Malaysian Government, under this end, the platform functions as a financial
to settlement its SME Master Plan 2012-2020, aims to support community built around the needs of the prin-
the competiveness and growth of this vital cipal client, enabling them to interact with
sector and increase the contribution of SMEs suppliers, buyers and distributors in a closed
to the country’s GDP, employment and exports. trading ecosystem. Moreover, membership of
In the context of the present highly volatile this community enhances the capabilities of
and competitive business environment, acces- larger companies in assisting smaller organ-
sible, reliable financial solutions are critical isations to access financing.
to ensuring SME success. Challenges, such as The web-based financial ecosystem solution
difficulties in securing increasingly expensive runs on a secure platform and offers visibility
financing from financial institutions, under- for transactions made therein. In turn, this
score the importance of these solutions. improves efficiency and helps to mitigate risks
for members of the supply chain trading com-
Offering Innovative Solutions munity. Significantly, FSC also facilitates billing
In response to this crucial need and in support and payment processes between members of
of the bank’s continuous efforts to enhance the customer’s supply chain community. In
the viability of SMEs, RHB Banking Group (RHB) addition, transactions are made in real-time,
has introduced two innovative products: the thus further improving efficiency and allowing
Financial Supply Chain (FSC) platform, and users to benefit from added savings.
Flexible Trade Finance-i (FTF-i). These prod- Additional advantages of the innovative all-
ucts are aimed at assisting SMEs to grow their in-one financing platform include: its provision
businesses at a reasonable cost and provide a of an avenue for cash payment transfers and
seamless experience for customers. funding requirements via financing requests
on outstanding approved invoices; and its
Financial Supply Chain Platform delivery of cost savings for members who,
FSC is an end-to-end trade process and infor- for example, incur less charges by making
mation system that helps to improve cash flow business-to-business (B2B) cash transfers that
and working capital for clients. It provides a the system considers as internal transfers.
more structured trading system for members Importantly, FSC also treats financing as a pre-
across the supply chain and the product of- payment of a trade settlement, rather than
fering is targeted at delivering financing solu- as borrowing. This form of off-balance-sheet
tions to Malaysian SMEs that lack collateral financing, therefore, improves working capital
to support their working capital needs. The management for platform users.
provision of such a cost-efficient platform en- Furthermore, and in full realisation of the
ables increased growth in the SME community increasingly digital reality in which companies
and positively impacts the Malaysian economy operate, FSC facilitates the management of
as a whole. invoicing and billing data, integrating invoicing
At present, companies must contend with maturity email alerts and immediate financing
challenges relating to a disconnect between and invoice settlement into the platform.
supply chains and financial service providers. Similarly, FSC offers increased operability,
FSC delivers convenience to customers by allowing users to interact with cash manage-
overseeing their entire supply chain, from ment and general ledger systems. In addition,
invoicing to settlement. By leveraging infor- it facilitates working capital management, risk
mation technology, the platform facilitates mitigation and cash flow objectives with a full

46 INTERNATIONAL INVESTOR

global islamic finance  business intelligence

FSC Platform Vendors/Suppliers Payments can be made via financing. This enables the principal, Distributor Financing
Vendors/Suppliers acting as buyer, to: The distributor financing solution focuses on
delivering bank financing to local buyers, such
• Receive a consistent supply of goods by supporting supplier as distributors, dealers and agents on pur-
financing needs chases made from the bank’s customer, who,
in this instance, acts as the principal whole-
• Avoid booking financing as borrowing, which remains as a payable saler. All requests for financing are managed
• Maintain maturity or extend credit days up to the financing maturity date via FSC, which connects the wholesaler with
its local customers.
Vendor/Supplier financing scheme Electronic trading allows the payment and settlement of sales by cash Benefits to the principal wholesaler in-
Buyer transfers or financing. This enables customers to: clude a reduction of day sales outstanding, an
improved cash flow position, increased sales
Principal • Monitor delivery and acceptance of invoices and business growth and reduced buyer or
Seller/Wholesaler • Monitor and track all receivables and payables outstanding distributor payment risk. The buyer benefits
Receivable financing scheme Distributor financing scheme • Execute electronic payments on approved invoices from a possible extension to the payable
credit term, improved liquidity of working
Seller allocates Distributors The bank prepays the principal, or in this case, the seller. capital, greater visibility of supply chain
lines to buyers Programme lending lines This enables the vendor/supplier to: trade flows and improved business growth
• Receive financing supported by the credit standing of strong buyers with an additional sales limit.
Buyers • Receive non-recourse financing subject to a credit evaluation on the buyer
Strong players • Obtain lower financing costs, as risk is based on buyer credit standing
• Use of off-balance sheet financing to improve working capital requirements

spectrum of open account financing proposi- them to function as the buyer, seller or whole- Award-winning Solutions
tions, as well as streamlining the payment and saler. By means of this arrangement, RHB RHB Islamic Bank is a leading innovator in the
reconciliation processes. offers three types of supply chain manage- Islamic banking sector and remains committed
ment solutions: vendor/supplier financing; re- to delivering innovative and cost-effective
Flexible Trade Financing-i Product ceivable financing; and distributor financing. solutions to its customers. Its primary focus is
Among its portfolio of offerings, RHB has de- to continuously enhance its range of products
veloped FTF-i, a new product that supports Vendor/Supplier Financing and services to meet ongoing market needs.
FSC by facilitating financing schemes for The vendor/supplier financing solution en- In recognition of its commitment to deliv-
suppliers, distributors and receivables. This ables the bank’s customer to act as a principal ering flexible financing solutions to customers
product is used to finance import and export buyer. This solution is focused on financing in the form of the FSC and FTF-i products, RHB
businesses, goods, services, charges and pay- local and foreign vendor and supplier invoices Islamic Bank received the Most Outstanding
ments, as well as any other local and foreign that have been approved and accepted by the Islamic Consumer Financing Products award
trade transactions that cannot be financed buyer. The buyer is able to connect with ap- at the Kuala Lumpur Islamic Finance Forum
under the normal Islamic trade instruments. proved suppliers through the FSC platform and (KLIFF) in December 2015.
The all-in-one product solution is ad- all financing requests can be managed online. The provision of FSC technology, in con-
ministered under the Sharia principle of Benefits to the principal buyer include the junction with innovative financing solutions,
Commodity Murabaha, via the Tawarruq possible extension to its payable credit term, enables RHB Islamic Bank customers to con-
arrangement. This refers to the process of improved liquidity of working capital, greater solidate their standing in their respective
purchasing a commodity for a deferred price visibility relating to supply chain flows and a industries. In fact, the platform represents
and selling it to a third party for a spot price strengthened relationship with suppliers. The RHB’s commitment to its customers, as both
in order to obtain cash. vendors or suppliers enjoy benefits including a service provider and as a strategic financial
FTF-i offers flexibility to customers by ac- non-recourse financing, reductions in day partner, in their respective journeys of devel-
commodating financing needs across a number sales outstanding, no collateral requirement oping and expanding their businesses.
of sectors, including transportation, ticketing and improved cash flow management.
and tour agencies, construction, logistics and IBRAHIM HASSAN
other service-related industries. Receivable Financing Managing Director
The innovative product, moreover, provides The receivable financing solution facilitates
support through all stages of a transaction, financing for the customers of the bank’s prin- [email protected]
from pre-shipment to post-shipment financing, cipal customer, who, in this instance, acts as
as well as for costs relating to the delivery the principal seller. This solution allows the RHB ISLAMIC BANK
of goods. In this respect, the offering takes bank to finance customers of the principal Level 11, Menara Yayasan Tun Razak
a holistic approach to financing, providing seller by purchasing the latter’s receivables 200 Jalan Bukit Bintang
coverage in terms of freight and transport against invoice details that have been ac- 55100 Kuala Lumpur
charges, custom duties, port charges, takaful cepted and approved by the selected buyers. Malaysia
premiums and additional charges which may This can be undertaken with or without re-
not be incorporated as part of the value bill. course to the principal seller. +60 3 2171-5000
Benefits to the principal seller include a re- www.rhbgroup.com
Strategic Supply Chain Solutions duction in day sales outstanding, improved cash
Customer satisfaction is a key priority at RHB, flow management and visibility of the supply
and in support of providing customers with a chain trade flow. The buyer, in turn, benefits
hassle-free and seamless experience, the FSC from a possible extension to the payable credit
and FTF-i systems are designed to operate term, improved liquidity of working capital and
around a principal bank customer, allowing increased visibility of supply chain trade flows.

strategic review 47