BLOG OF KNOWLEDGE

By Mushtak Parker Available at: http://www.arabnews.com/?page=6&section=0&article=128520

THE Luxembourg office of PricewaterhouseCoopers (PWC) in a report on Islamic finance published at the end of October 2009, has urged greater involvement and visibility from the Luxembourg government and regulators if it is serious about establishing the principality as a European Islamic finance hub especially for Islamic funds and sukuk.

Compared to regulators in the UK, Ireland and France, the Luxembourg regulators have never approached their counterparties in target countries such as Saudi Arabia, the UAE, Kuwait, Bahrain and Malaysia to seek cooperation on Islamic finance.

PWC, the international auditors and consultancy, has based its report on the recommendations and conclusions drawn from an Islamic finance meeting. The report suggests that Islamic finance is an important niche business for Luxembourg. Some 16 sukuks are already listed on the Luxembourg Stock Exchange. For instance, the $1.5bn Petronas EMAS sukuk issuance in August 2009 was listed in Luxembourg in preference to the London Stock Exchange.

In addition, there are more than 31 Islamic investment funds, mainly global equity and real estate funds, registered and domiciled in Luxembourg. The PWC report stressed that the future target of Luxembourg Islamic funds should be investors in Europe, although this will require an educational process to attract investors amongst Europe’s Muslim population of around 20-25 million. The report also stressed that Luxembourg should leverage its strong private banking industry, its good reputation and its cost-competitiveness as a financial center. As such, there is a potential for cross selling Shariah-compliant products to these investors.

In a rare foray into Islamic finance, Yves Mersch, governor of the Central Bank of Luxembourg, in a speech at the Islamic Financial Services Board (IFSB) in Kuala Lumpur earlier this year, stressed that “despite the current turbulences, the market practitioners of Islamic finance in Luxembourg remain optimistic that Islamic finance is likely to grow steadily in the next few years based on investors’ appetite for financial products based on sound ethical principles.”

Mersch warned that numerous challenges remain, however, including regulatory changes, legal certainty, illiquidity issues, liquidity management risk concerns, the need for harmonized regulation, regulatory disparity amongst national supervisors and a lack of level playing field. It is crucial to ensure that Shariah principles are able to accommodate the innovative products which would allow the integration of Islamic finance into the international financial system.

Mersch confirmed that market players in Luxembourg want formal recognition of Islamic financial products and accounting standards. “Our authorities have proved pragmatic, innovative and adaptive to the financial landscape. According to discussions currently being held at the national level, this will also be the case with regard to Islamic finance,” he declared.

Although the Luxembourg authorities have set up an Islamic finance Taskforce, bringing in various regulators, professional associations and market players, actual progress in the facilitation of Islamic financial products in Luxembourg remains slow and bureaucratic. It would be difficult to have full fledged Islamic banking operations in Luxembourg due to a legal and regulatory framework. For example, it is not possible for Luxembourg banks to provide bank accounts without any risk cap, which is typical for an Islamic bank. In addition, Islamic banking requires banks to have partnership accounts.

The PWC report also highlighted concerns from market players in Luxembourg about various risks associated with various Islamic financial products and practices, although some of these concerns betray some ignorance about Islamic finance. Islamic funds are almost all done through manual transactions. This leads to higher risk, for example accounting of revenues and purification of interest. Compliance issues such as eligible assets and investment restrictions are not monitored, as these are dealt typically by Shariah boards. There is also a perception of a lack of information sharing in relation to cleansing and eligible charitable organizations. The report calls for rules of charities should be demystified. However, the total amount of money purified is insignificant and money laundering risk is therefore limited as most of the Shariah compliant funds in Luxembourg are equity funds.

These latter points are unimaginable in markets such as Malaysia and even Turkey. Perhaps it reflects more on the inability of the fund managers and their lack of engagement in navigating through these issues. Sharing of information is a requisite in Islamic finance otherwise the transaction could be non-permissible because of Gharar (deception or non-disclosure), which is proscribed by the Shariah. Such concerns are not new and typical of some jurisdictions new to Islamic finance.

Fiduciary risk is not much different than for conventional funds with respect to OTC (over the counter) products. A large portion of sukuk is listed and managers have not yet invested in sukuk privately placed, thus mitigating risk to a certain extend. Assets are generally held by sub-custodians implying settlement and custody risk.

The report also stresses that default risk must also be taken into account since the emergence of the first occurrences of sukuk defaults earlier this year, which include East Cameron Gas Sukuk, the Investment Dar Sukuk, and the SAAD/Al-Gosaibi Sukuk. In terms of valuation risk, the report stressed that there is no clarity on valuation parameter for investments to be obtained by counterparties or the Shariah board. The report also identified a number of compliance risks. Participants, for instance, mentioned that no Shariah compliance checks are made as it is not a market practice and it is the responsibility of the Shariah board.

A service fund administration can send a report to the board of directors but will not check if investments are Shariah-compliant. Shariah compliance is part of the investment policy and should be checked by the manager from an eligibility an d risk spreading point of view. The question remains, however, if asset managers have the knowledge to check such compliance issues. It is, however, difficult to put the compliance checks in a system in comparison with conventional funds as compliance rules might be non-standard (changing) and are somehow based on judgment. This requires more flexibility than for a conventional fund.

Good advice is always certain to be ignored, but that’s no reason not to give it By Agatha Christie

Best Regards
ZULKIFLI HASAN
DURHAM, UK

International Conference on Shari’ah and Common Law, Kuala Lumpur, Malaysia

By DALJIT DHESI Available at: http://biz.thestar.com.my/news/story.asp?file=/2009/11/13/business/5101869&sec=business

The accelerated development of Islamic financial markets and increased liberalisation are the two important trends which have increased the integration of Islamic finance into the international financial system, according to Bank Negara governor Tan Sri Dr Zeti Akhtar Aziz. In her keynote address entitled “Islamic Finance: A Central Bank’s Perspective” at a seminar on Islamic finance in Rome on Wednesday night, she said: “The development in the Islamic financial markets has contributed to the availability of a wide spectrum of Islamic financial instruments that ranged from instruments to manage liquidity, to structures for financing of mega investments.”

Her speech text was released to news organisations yesterday.

“The higher level of foreign participation in the Islamic financial markets has resulted in the increase in cross border flows in the international Islamic financial system thereby, enhancing international financial linkages between financial systems,” she said. Liberalisation, Zeti added, had also brought greater foreign institutional presence in Islamic financial systems, resulting in greater diversity of players and strengthening further international financial linkages.

Malaysia had very much been part of this process, she noted. In 2003, the Islamic financial system was liberalised to allow for increased foreign presence. In 2007, the sukuk market was liberalised to allow the raising of funds by eligible corporates from any part of the world in any currency. This year, the first foreign currency sukuk of US$1.5bil was successfully issued by Petronas, which was significantly oversubscribed by investors from Europe, the Middle East and Asia.

As part of an international collaborative effort, Zeti said a Task Force on Liquidity Management was set up by the the Islamic Financial Services Board and the Islamic Development Bank early this year to develop solutions to enhance the efficiency of Islamic financial institutions in managing liquidity at both the national and international levels. Another area of international collaboration is in the promotion of value-added investments in human capital to ensure the sustainable growth of the Islamic financial industry.

The International Centre for Education in Islamic Finance (INCEIF) in Malaysia was set up by the central bank with programmes for practitioners and post-graduate studies to ensure the continuous supply of talent in Islamic finance. At present, INCEIF students come from more than 60 countries, including Britian, Canada, France and Japan, South Korea and the Middle East. “Equally important to innovative development is a deeper understanding of syariah and knowledge of Islamic finance and for a greater convergence in the theoretical understanding and practical considerations in resolving the contemporary issues faced by Islamic financial industry players,” Zeti said.

An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today By Laurence J. Peter

Best Regards
ZULKIFLI HASAN
DURHAM, UK

Dubai, UAE

By BETH GARDINER, Wall Street Journal Education Available at: http://online.wsj.com/article/SB125745015996431565.html

As Islamic finance grows into a thriving and increasingly lucrative sector, business schools around the world are adding courses, concentrations and specialized degrees to train students in structuring investments that comply with Quranic law. The vast wealth of the Muslim world, buoyed by high oil prices, and a Muslim population increasingly interested in investing its money in ways that accord with religious principles have driven a boom this decade in specialized Islamic financial products.

When a sector grows so quickly, “the very first thing that there is a shortage of expertise,” says John Board, director of the ICMA financial studies center at the University of Reading’s Henley Business School in Britain, which has enrolled about 10 students in the first year of its masters’ in investment banking and Islamic finance.

In both Muslim and non-Muslim countries, experts in the field say, there’s great demand for practitioners trained to deal in the sometimes complicated products required to turn a profit while obeying strictures like a prohibition on interest. B-schools say the boom is so great that they’ve even had trouble finding faculty with the required expertise in both financial practice and the principles of Sharia law. Both large international banks with Islamic finance divisions and specialized Islamic institutions are seeking the business of oil-producing countries’ massive sovereign funds and of wealthy Muslim individuals. The schools are eager to train prospective and current employees in both full-time masters’ programs and executive-education courses.

Universities in Muslim countries, particularly Malaysia, have added and expanded Islamic finance programs in recent years. Outside the Muslim world, Britain has sought to position itself as the main center for such work, with at least 22 banks providing some Islamic finance products and 55 British educational institutions, including business schools and private trainers, offering courses in the field, says Ruth Martin, managing director of the Securities and Investment Institute, a London-based professional body.

Lebanon’s central bank initiated a joint effort by the Securities and Investment Institute and Beirut’s Ecole Supérieure des Affaires to create an Islamic finance qualification, Ms. Martin says. The certification, started in 2007, is now being offered by more than 30 business schools in countries including Kuwait, Pakistan, Saudi Arabia and Britain, she says.

Bank Negara Malaysia, Malaysia’s central bank, started the Islamic finance university INCEIF in 2006 to help train practitioners. “We do find a number of Malaysians who work in this area are being snatched like hotcakes by the Middle Eastern countries,” says Datuk Dr. Syed Othman Alhabshi, the school’s dean.

In Saudi Arabia, the first cohort of students begins studies in March at the women’s university Effat in a new executive Islamic financial management degree course run by the Ecole Supérieure des Affaires and Erasmus University’s Rotterdam School of Management in the Netherlands.

Cass Business School is among the many British institutions with new programs in the area. The executive M.B.A. it offers in Dubai has given students the option since 2007 of specializing in Islamic finance, and corporate clients also send staff for a shorter-term overview of the field, says Zaher Barakat, who teaches in the program.

One of the central tenets of Islamic finance is its prohibition on the payment of interest, which has inspired a variety of alternatives to mortgages and other loans, as well as creative ways of helping those with capital earn a return. Techniques like leasing, equity sharing and profit-and-loss sharing offer vehicles through which an investor can, for example, finance a new plant and then lease it to a manufacturer, rather than lending the money to buy it.

Sharia law also requires clarity and openness in all transactions, involving detailed audit trails so that all parties have full information about the sources of the funds involved. Debt cannot be classed as an asset to be sold to a third party, and investments in areas like alcohol, gambling and weapons are forbidden. Islamic bonds and insurance follow their own sets of rigorous rules.

Proponents note that the prohibition on interest charging and the selling of debt shielded the sector from exposure to subprime mortgages and some of the complex debt-backed instruments at the center of the financial crisis. “There is a lot of reduction in risk,” Dean Alhabshi says. “Sharia requires Islamic financing to be asset-based, or at least asset-backed.”

And while its inherent conservatism has meant in the past that the potential for profit is lower in Islamic finance, many say that has begun to change. Environmentally conscious investments now earn as much as conventional portfolios, says Mr. Board of the University of Reading. “The same will become true of Islamic products,” he says. “It’s almost there now; that differential is getting smaller.” Finance isn’t the only area where business schools have spotted opportunity in the Muslim world.

At Oxford’s Saïd Business School, associate fellow Paul Temporal is researching marketing and branding to Muslim consumers. Almost no study has been done of consumer behavior and decision-making in the Muslim world, hamstringing local and international companies hoping to sell there, he says. “It’s a quarter of the world’s population and represents a huge opportunity, but how do we get to them and how do they behave?” he asks. Based on the results of Mr. Temporal’s research, Saïd plans to offer executive education to companies that are based in the Muslim world and need branding expertise. It also hopes to reach large international corporations that want to sell in Muslim nations but lack the cultural understanding to market effectively.

“Education is what survives when what has been learned has been forgotten”.
B. F. Skinner (1904 – 1990), New Scientist, May 21, 1964

Best Regards
ZULKIFLI HASAN
DURHAM, UK

Cape Town, South Africa