HOLY QURAN, ANYONE?

This might be a good time for investors to pick up a copy of the Holy Quran. Stocks and other investments that adhere to shariah, or Islamic law—though hardly unscathed—have fared better than the broader market - thanks largely to rules that forbid investing in collateralized debt obligations and other toxic assets that have caused the carnage in conventional financial circles.

A big part of the appeal of Islamic finance is its simplicity. Speculation is taboo under shariah, and there's a ban on assessing interest because the Prophet Mohammed s.a.w said debts must be repaid in the amount that was loaned. Money proffered must be backed by collateral, and if financial instruments are traded, they generally have to sell for face value, which deters banks from repackaging debt.

That doesn't mean Islamic finance won't suffer in an economic downturn. Because they must hold collateral, Islamic financial institutions tend to have more real estate assets than Western banks do. So far, shariah-compliant banks—mostly in the Gulf region—haven't suffered because housing prices there have held up relatively well. But if those markets were to dive, there could be trouble.

ISLAMIC FINANCE : THE BENEFITS AND POST CRISIS POSITION

Extracted from The Daily Mirror Financial Times

To encapsulate Malaysia’s almost 30 decades of expertise and experience in Islamic finance, the Malaysia International Islamic Financial Centre (or MIFC) was launched in August 2006; sukuk origination has been identified as one of the 5 pillars that will solidify the country’s position as an international Islamic finance hub. The other 4 pillars are: Islamic fund and wealth management; international Islamic banking; international takaful business; and human capital and thought leadership.

The sukuk market provides an avenue to channel excess funds and savings from resource-surplus countries, such as oil-rich Gulf nations, to the Asian region - given the latter’s massive infrastructure and other commercial funding requirements. There are still funding and investing opportunities, especially in real estate, financial services and infrastructure (power, oil and gas, and roads). More importantly, the sukuk market could convert Asia’s export surpluses into investment opportunities, rather than investing in the sovereign debts of advanced economies. The Islamic finance market can step into these areas that would traditionally have been filled by the conventional market.

Following the liberalisation of foreign-exchange administration rules in Malaysia, several foreign multilateral development banks and agencies, quasi-sovereign agencies and multinational corporations have joined local companies in tapping the domestic sukuk market for funds. There is no doubt that sukuk has become a global phenomenon, attracting increasingly more issuers from a larger pool of countries. Indeed, Shariah-compliant financing is set to continue providing issuers with non-bank alternatives to longer-term funding.

Under the MIFC, service providers are welcome to use Malaysia as a platform for Islamic financial activities, leveraging on the nation’s comprehensive system and conducive environment for Islamic financial activity. The incentives include new licences for conducting foreign-currency businesses, attractive tax incentives and facilitative immigration policies. These measures lead to operational cost efficiency, a shorter learning curve, less time to market, access to new markets and surplus funds. They have been designed to provide operational flexibility, cost efficiency and an encouraging environment for Islamic finance in international currencies, making Malaysia even more attractive to foreign investors.

What makes Malaysia an international Islamic finance hub?

The rapid and undeniable growth of Malaysia’s sukuk market has been nothing short of remarkable. As a pioneer in the Islamic capital market, Malaysia has set standards and provided leadership by example on many fronts, for instance:

The Malaysian Islamic capital market has all the hallmarks of a sound and efficient setting for fund-raising and investment activities, placing it ahead of other financial centres. Malaysia’s Islamic capital market effectively replicates the service elements that are expected in any established conventional capital market.

Principles of Islamic finance

The cornerstone of Islamic finance is based on the principle that funding is not provided for monetary returns. Rather, Islamic finance is based on contracts of exchange. Hence under such contracts, assets or services will be exchanged for monetary consideration, or for other assets. This gives rise to sale and purchase contracts or leasing contracts. Another positive development is the increasing interest in Islamic asset-backed securities and the ongoing research and development towards the use of the partnership-based contracts of Musharakah and Mudharabah in the sukuk market.

The encouraging response to the nation’s sukuk issuances, especially from Middle Eastern investors, has paved the way for Malaysia to further explore the international Islamic financial arena. There has been a notable shift from debt-based bonds, premised on cost-plus-sale agreements or cost-plus production agreements, to lease-based or profit-sharing sukuk, including the issuance of convertible sukuk, following the shift towards a wider variety of Islamic investors. It is only natural that products are tailored to meet the requirements and preferences of specific target markets. This is because each market regulator and institution has its own Shariah board; opinions on permissible structures vary from country to country as well as from one investor group to another. There is now a tendency for Shariah boards to comprise both local and internationally prominent scholars, qualifying them to address issues and operate across the different schools of thoughts.

On the national front, the shift in the types of sukuk has also been partly influenced by the additional tax incentives accorded to specific types of sukuk.

Islamic finance’s position in the capital market after the current financial turmoil

The Islamic financial market has undoubtedly also been afflicted by frozen credit markets and the current confidence crisis, along with the backlash from the global financial mayhem. Nonetheless, it has mostly escaped the direct fallout from the sub-prime crisis that had begun in the United States, thanks to the Shariah prohibition of investing in the kinds of instruments that had sparked off the current chaos. This is perhaps because of the “built-in antibody” that Islamic finance has in the form of its Shariah conformity, which has provided some degree of stability and resilience in facing the current global financial turmoil.

Once market conditions attain some semblance of normalcy, RAM Ratings expects it to be business as usual. Sukuk issuance is envisaged to resume its impressive growth, fuelled by massive investment and financing needs, notably of countries in the Gulf area and Asia. In this context, Islamic finance, and sukuk in particular, is an emerging asset class that will sit well with investors across the globe.

Moving forward, we also foresee Islamic ratings playing a catalytic role in advancing the growth and development of domestic sukuk markets, and in promoting cross-border issuance and investments, especially inter-regional flows between Asia and the Middle East. The Malaysian sukuk market has benefited from having a reference benchmark for credit risks, as the rating of Islamic securities in Malaysia - similar to conventional debt instruments - have been compulsory since 1992. Bonds rated by RAM Ratings account for 75% to 85% of the domestic sukuk market.