By SARA HAMDAN
Published: October 28, 2010
DUBAI — Until recently the issuance of Islamic bonds, or sukuk, was confined to the Muslim world. But now a number of international borrowers are tapping the markets, including Nomura Holdings in Japan and Europe's first corporate borrower, International Innovative Technologies.
The $100 billion Shariah-compliant bond industry prohibits the generation of interest and investments in areas that go against Islamic moral codes. As their use spreads beyond the Gulf and Malaysian markets where they originated, some analysts are warning that regulators must watch closely to prevent money laundering in the developing market segment.
“It is good that sukuk and Islamic finance are gaining acceptance internationally, but regulators must be careful in doing this because they may not necessarily have experience in regulating this market,” said Khairum Nizam, assistant secretary general of the Accounting and Auditing Organization for Islamic Finance, based in Bahrain. “The challenge is to make sure new jurisdictions are well informed, where sukuk is fairly new and not tested, to provide all necessary disclosures, transparency and anti-money laundering mechanisms.”
The ratings agencies Moody’s and Standard & Poor’s say they expect to see a rise in the number of sukuk issues by new players over the next 12 months, including issues by borrowers in Singapore, Australia, Luxembourg, Thailand, Hong Kong, France and Russia.
In August, International Innovative Technologies, based in Britain, made the first sukuk offering by a European corporate borrower. Totaling a modest $10 million, the sukuk, which will be listed on the Cayman Islands Stock Exchange, will mature in 2014. It followed a $100 million sukuk issuance in Japan by the investment bank Nomura Holdings in July.
Kuveyt Turk Katilim Bankasi, a Turkish Islamic lender, raised $100 million through three-year Islamic bonds in August and announced plans a month later for a second sukuk issuance of a similar size in 2012. Similarly, Kazakhstan, which last raised debt overseas in 2000, and the Philippines state-owned Al Alamanah Islamic Bank, both say they are planning debut Shariah-compliant debt sales by the end of this year.
“We are seeing the market opening to non-Islamic issuers who are intending to diversify their funding access and investor base, in Europe and even the U.S.,” said Emmanuel Volland, a senior director at Standard & Poor’s based in Paris. “Aside from differing sukuk structures, one issue as the sukuk market goes global is the interpretation of Shariah law in different countries. To have a global definition of Shariah compliancy for sukuk is extremely challenging when scholars come from different schools of thought.”
Differing interpretations of Shariah law for financial products caused widespread confusion in February 2008, when a religious scholar said that nearly 80 percent of sukuk in the market were not actually compliant. While no fingers were pointed at specific debt issuances, analysts say the comment caused substantial disruption in the market, even before the financial crisis hit. As debt markets dried up over the course of 2009, the sukuk market struggled with at least $10 billion in delayed sukuk and defaults of high-profile issuances including Dubai World and Nakheel. Global sukuk sales fell 23 percent to $10.9 billion in 2010, according to data compiled by Bloomberg.
“Given the failure of some sukuk in the past year or so, there is a call for new regulation,” said Hatim El-Tahir, director of the Islamic Finance Knowledge Center for Deloitte & Touche in Bahrain. “Investors need more information for their own protection. This is still a young industry and lack of regulation will cause difficulty for investors and for cross-border investments in sukuk.”
While the Islamic Financial Service Board and the accounting and auditing organization have defined standards for sukuk, defaults over the past year have shown that new guidelines must be set as problems arise, particularly as sukuk start to generate global attention.
“There isn’t a global standardized contract and documentation process relevant for this product; whether in London, Luxembourg or the D.I.F.C., there is no consensus of countries abiding by one set of rules,” said Dr. Tahir, referring to the Dubai International Financial Center. “The standards are developed here, but not every issuer is following these.”
He added that ideally, they would all have to abide by guidelines set by the accounting and auditing organization and the financial service board to ensure that they followed best practices.
Analysts say regulatory weaknesses are understandable in what is still a young market.
“Yes, it is underregulated, but it is just a normal evolution of the market as it goes from phase one, where rapid growth often ignores poor practice, to maturing in phase two, with better regulation and industry-wide standardization on a global scale,” said Mohieddine Kronfol, a fund manager at Algebra Capital in Dubai.
As conventional debt markets have developed momentum this year, sukuk issuance has expanded too.
Global sukuk issuance topped $13.7 billion in the first half of 2010, nearly twice the $7.1 billion reported a year earlier, according to a report by Standard & Poor’s.
In the past three months, Saudi Electric Co. issued $1.8 billion in three large sukuk offerings; Dar Al Arkan sold $450 million worth through sukuk; Qatar Islamic Bank sold $750 million in sukuk, the first international sukuk issuance by a Qatari financial institution; and in late October, the Saudi-based Islamic Development bank raised $500 million through sukuk sales as part of a $3.5 billion program.
Still, analysts say, further growth risks being hampered until proper regulations are in place to allow the development of a diversified institutional investor base.
“Non-bank institutional investors are growing in the Gulf, but it’s still not where it should be,” said Raphael de Ricaud, head of Islamic finance at Rothschild based in Dubai. “We need more of these companies in the region, and we also need the existing ones to be more informed about these products. And at the end of the day, it’s about managing risk.”
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