Islamic Banking & Finance Page 28th December 2018

Sukuk Market and Sukuk Developments

Manzar Naqvi

Global Sukuk (Islamic Bond) issuance is expected to reach US$90 billion to US$100 billion in 2018 (one year), with more volume expected from Malaysia and Indonesia in the second half of the year, However the issuance of Sharia-compliant bonds in the Arabian Gulf region have slowed by around 15 per cent in the first three quarters of this year. Hence it is likely to remain lower than $95.9 billion on the back of tightening international liquidity and rising borrowing costs as the US Federal Reserve hikes interest rates.

Worldwide sovereigns, financial institutions and the corporate issuers in 2018 are expected to reach about $ 350bn to $ 400 bn worth of Shariah-compliant Sukuk.

In Pakistan 106 corporates including KE and Engro have issued Sukuk valuing Rs 1,224.819 billion till 2018 whereas Government has issued 3 years ijara based sukuk worth 385.4 billion and Sukuk in $ worth  $7.3 billion till 2018.

With these demands the sukuk market has to be exceptionally innovative. A basic requirement for Shariah compliance of any sukuk structure is that it shall be backed by tangible assets. Therefore, when the sukuk were first developed in 1990, Shariah (Islamic law) prescribed sukuk as requiring 100% tangible assets to provide fully backed assets to investors.

Since problem of insufficient physical assets always existed whenever issuers demanded to tap funds, therefore Shariah requirements and solutions offered by Shariah advisors always played a role in shaping the issued sukuk structure. The financial community adopted and refined the concept of sukuk and expanded its scope to incorporate a wide range of commercial and financial activities.

The Islamic capital market has become a global phenomenon with sukuk playing a substantial part in the industry. Of all Shariah-compliance financing methods, the one that has received most public attention to date is sukuk

The sukuk market’s growth is being fueled mainly by corporate, sovereigns and financial institutions. Although corporate find that sukuk is an alternative form of financing for businesses or projects, banks are turning to these financial instruments to sustain growth using stable funding sources and curb maturity mismatches.

The Islamic debt securities market was developed to meet diverse risk-return profiles and the needs of issuers and investors who looked for a type of asset that complied with Shariah. Conventional bonds or sukuk, both are financial vehicles attempting to mobilize the funds from surplus spending units to shortage spending units. A bond is a contractual debt obligation that pays holders a coupon of fixed or floating interest. Most conventional bonds are primarily concerned with the return on investment, not the actual object that is being financed. Hence the underlying asset for corporate bonds is money (debt). Its whole premise is to provide holders with interest in return for their capital investment. This kind of asset does not comply with Shariah, as they are in the form of interest-bearing loans. There is a blanket prohibition on interest under Shariah. Therefore, interest is fundamentally tainted with riba. Shariah-compliant transactions preclude making money with money because “no one should be able to earn an income from money alone”. In this sense, money itself may not be a source of profit because many scholars of Islamic economics argue money has no intrinsic value within Islam. The ultimate purpose of money, from their point of view, is to help fulfill basic needs, such as food, clothes and shelter. In this approach money must be seen (and used) as a means of exchange only, not as a basic need in itself.

Given that, use of money as a source of profit is forbidden by Shariah, the presence of underlying tangible assets in the sukuk transaction is required. The Council of the Islamic Fiqh Academy of the Organization of Islamic Conference (OIC) in 1988 defined sukuk as “any combination of assets (or the usufruct of such assets) can be represented in the form of written financial instruments which can be sold at a market price provided that the composition of the group of assets represented by the sukuk consist of a majority of tangible assets”. Meanwhile the Securities Commission Malaysia and SBP and SECP in Pakistan provide a guideline which states that an asset must be made available for sukuk to be issued in the case of sukuk bay bithaman ajil (deferred payment sale), murabahah (cost-plus financing), istisna’ (contract of exchange with deferred delivery) Salam and ijarah (lease).

These standards clearly underpin that sukuk must be asset-backed and subject to compliant contract. Income from securities must be related to the purpose for which the funding is used and securities should be backed by real underlying assets, rather than being simply paper derivatives. Since the issuance of sukuk is not an exchange of paper money for interest but rather an exchange of a Shariah-compliant asset, the asset itself must be halal (permissible) in nature and being utilized as part of halal activity. Shariah considerations dictate that the pool of assets should not solely be composed of debts from Islamic financial contracts (e.g. murabahah, isitisna’) but also comprise real assets (Krichene, 2012). Clearly, all Sukuk by definition must have an asset that is tangible, although some fuqaha allow for a portion of the asset to be in intangible form, all jurists require that there be an underlying asset (Bacha & Mirakhor, 2013).

While there are a number of other Islamic finance principles that must be borne in mind when structuring Islamic-compliant deals, Islamic scholars and practitioners view that the identification of the assets is the most essential. The prominent and influential Shariah scholar, Taqi Usmani (1999) emphasized that one of the most important characteristics of Islamic financing is that it is an asset-backed entity. Islamic finance is justified in that it restricts finance to funding of trade or the production of real assets. In fact, of all the rules that govern the structure of Islamic finance instruments, the rule that transactions must be real asset-based is the most striking (Hoor & Kreemer, 2014).Where the funds raised are used to finance a needed tangible asset, specificity of assets is important. That is, the assets being financed should be clearly identified.

To sum up, the necessity for the underlying asset is a clear requirement in all Islamic financial transactions. However, to what extent sukuk structures in practice truly behave according to their specific Shariah assets requirement has raised serious doubts among scholars. Many current sukuk issuances have an asset somewhere in the mix, but in most cases, actual cash flows from the issuances are not derived from that asset; they actually originate from the rest of the structure. Thus, the presence of an asset gives the sukuk the “form” of an Islamically permissible finance product, but not a “substance.”

Islamic Asset Management (AMC) in Reality

Muhammad Arif

Daily, we witness entry of new products by newly emerged Islamic Asset Management companies in the name of falah or using name of religion. But in the competitive world we must understand that only those products are going to succeed which in fact come for the service of customers.

Being in Pakistan we must understand that the Pakistani market is one of the most volatile markets of the world, which generates limitations for future investment decisions.

As regards an asset management company, it is a company that invests its clients’ pooled fund into securities that match its declared financial objectives. Asset management companies provide investors with more diversification and investing options than they could have been made themselves. Mutual funds, Hedge funds and Pension funds are also part of AMC.

The concept of asset management starts with investment management, where, Investment management is the professional management of various securities (shares, bonds etc.) and assets (e.g., real estate), to meet specified investment goals for the benefit of the investors”. Now the questions arises who are the investors? The investors can be: – Insurance companies, Pension funds, Corporations etc. or Private Investors (both directly via investment contracts and more commonly via collective investment schemes)

Now coming to Islamic asset management it refers to professional investment management of Sharia-compliant securities (equities, Sukuk and other securities).  The net effect of this investment approach is generating competitive investment returns and encouraging ethical business practices. However, very little of innovation and ground-breaking work entered the Islamic asset management space. Rather, it was the retail, corporate and investment banking sectors that benefited from the professionalization of Islamic finance industry. Asset management seemed to have been the poor step child, less exciting and less rewarding to the professionals than high-volume retail banking or highly compensated investment banking.

However in areas like pension funds, takaful (Islamic insurance) companies, corporate treasuries or retail investment for households, where banking institutions were not willing to work properly, Islamic mutual funds and other assets entered to fill in the gap.

In fact, over the last six years there has been a pell-mell rush into the sale of derivative-based structured products with a fatwa wrap. These products are by and large toxic waste, and the ongoing meltdown in global markets magnifies the underlying mistrust about their application in nearly all institutional and private client portfolios. Here the Sharia scholars cannot be blamed for these time bombs. They are hired only to say whether the investment violates the rules and norms of Islamic ethics and nothing more.

Now the chicken has come home to roost. Investors everywhere with asset management professionals have taken a serious look at what constitutes Islamic asset management and Islamic wealth management. They have developed quantitative models that start with a deep scan of the available universe of Islamic products, and then combine them in a format that achieves the desired results required by the Modern Portfolio Theory (MPT).

Many investors are seeking the golden egg, the one style of investing that is foolproof during all economic conditions. Unfortunately, no one has come up with that bird yet! There still remains more than abundant risk in the world, and avoiding risk occupies as much time of a professional asset manager as actually seeking profits.

However, it can be stated unequivocally here that Islamic asset management is no different than conventional asset management at this point of time when it comes to constructing a portfolio that will have a high probability of achieving an investor’s goals. To do that, an investor seeking professional investments with competent fatwa does not need to sacrifice anything: not performance, not transparency and not pricing.

The process starts by choosing an asset manager who understands Sharia. For many bankers, the entire concept of socially conscious investing is perfectly acceptable, but the idea of Sharia-compliant investing is strange and exotic. It is not. Sharia is not rocket science, understood only by a rare qualified few. It is the guiding principles of a faith with over a billion adherents. Surely such a popular and common religion does not exist based on mysteries and secrets. The moral precepts of Sharia are abundantly clear to anyone who wishes to pick up a copy of the Holy Quran. Bankers familiar with Islam will find nothing strange in Sharia, in particular when it comes to Sharia compliance of investment products.

The community of generally accepted Sharia scholars makes it easier for the novice investment manager to achieve a balanced and professional portfolio allocation. By choosing assets that have been granted a fatwa by that group of Sharia specialists who closely follow financial markets, any investor or asset manager can start the process to assemble a portfolio allocation that meets both Sharia and MPT standards. Being careful means diversifying the assets in hand. A Muslim investor who wants to achieve the same objectives can do so, as long as he seeks the aid of a dedicated professional who understands both Sharia compliance and MPT. Proper security selection can now be made at every level of the allocation spectrum, from cash to fixed income to stocks to alternative investments, all with respectable fatwa from notable Sharia scholars. While presently there is a dearth of professional managers in Islamic asset management sector, with the high demand this trend is likely to change.

Islamic banking, like other areas of professional practice, has witnessed some very creative, innovative expressions of human ingenuity. From nothing we have seen the development of world-class Islamic retail, corporate and investment banking in little more than a generation. Yet, this did not extend to Islamic asset management.

Segment of Islamic finance facing an upswing in volume and activity is the Islamic fund and wealth management sector. As a result of the growing demand for Shariah-compliant investment options and the growing volume of investable Islamic financial assets, as per the end of the first quarter of 2017, total global Islamic assets under management were $70.8bn, up from $47bn in 2008. The number of Islamic funds stood at 1,535, compared to 802 funds in 2008.

Malaysia and Saudi Arabia have the largest market share of the global Islamic funds and wealth management industry, together holding more than 67% of total Shariah-compliant assets under management (AuM). Saudi Arabia contributed a 35.6%-share of $25.2bn and 209 Islamic funds at end of the first quarter of 2017, while Malaysia has the most number of Islamic funds globally with 388 funds managing a total AuM of $22.6bn. Interestingly, Jersey ranked third in the ranking with AuM of $8.35bn owing to funds domiciled in this jurisdiction largely comprising of high-volume commodity funds, including gold. Luxembourg, Pakistan, the US and South Africa followed with $2.9bn, $2.6bn, $2.3bn and $5.66bn of AuM, respectively. Kuwait, Indonesia, Ireland, Singapore, Canada, Egypt, Pakistan and the UAE are other notable players.
Most of the growth of the Islamic funds and wealth management industry stems from the fact that global fund and asset managers increasingly notice the potential of this sector of the Islamic finance industry. Since it is now also accessible to institutional investors, as well as non-Muslim investors – from affluent persons to high-net-worth individuals to family offices –, they began using it as a new way to diversify investments or to put surplus funds into “alternative” investment variants. The global Islamic funds and asset management industry remains poised for growth and should increase in volume by more than 8% to $77bn by 2019.

In terms of types of Islamic funds and invested assets, money market funds are leading as per AuM by 38,6%, followed by equity funds, commodity funds, bonds, real estate, mixed assets, and, to a very small extent of just 0.2%, alternative investments.

Hopefully, over the next few months and years, new Islamic investment products will be introduced to the market. Now coming to Pakistan we also see a race going for new products. Overall industry has grown from Rs 160 billion in 2006 to Rs 678 billion with 244 funds in 2018. Out of this Islamic Asset Management occupies Rs 318 billion in 2018 i.e. 47% of the whole market. This is quite above to Islamic Banking assets against total Market assets i.e. 13 % as of Dec 2018.

The industry now forms as part of the emerging development in the wealth and management industry, a result of the growing interest from large and established fund managers tapping into this window of opportunities.