Investing in the big ‘wish list’

The World Bank and the Islamic development Bank are to explore ‘Islamic finance as a potential tool supporting efforts of countries to reach their development and financial stability goals’. MUSHTAK PARKER looks at the detail

Judging by the burgeoning number of transactions successfully closed and the utterings of senior officials and bankers in Saudi Arabia this year, it is easy to get the impression that the Kingdom is a natural fit with, and a developed market for, Islamic finance.

Economic recovery in a high debt and sluggish growth environment; job creation especially for the youth; and disaster management were not surprisingly the overriding concerns at this year’s 86th World Bank Group/International Monetary Fund (IMF) annual meeting held in Tokyo in October.

The meeting was originally scheduled to be held in Cairo, but the new Egyptian government of President Morsi requested an opt out because of security and economic concerns and deferred Egypt’s right to host the annual meeting to 2015.

But behind the scenes financial stability and the reform of the global financial system continued to reverberate with some interesting new strategies emerging, especially in the Islamic finance space. These include the use of the capital market to boost financing and investment activity across a wide spectrum of sectors.

The capital market is not only expected to play a bigger role in traditional sectors such as the debt market for corporates and institutions; for IPOs in raising funds; for asset management; and for private wealth management, but also in the growing SME and  agricultural sectors respectively.

At the forefront of some of these initiatives are the World Bank and the Jeddah-based Islamic Development Bank (IDB) Group. Dr Ahmad Mohamed Ali, IDB group president, addressing the prestigious development committee meeting of the IMF in Tokyo, emphasised that “the Islamic capital market and Islamic financial architecture remain central to the IDB. The group will support and encourage member countries to mobilise capital resources by launching Sukuk, which in the first half of 2012 alone reached US$66.4bn globally, representing a year-on-year growth of 40.1 per cent, mainly triggered by large sums of funds from sovereign authorities and central banks to absorb excess liquidity.”

In fact, the two multilaterals signed a Memorandum of Understanding (MoU) in Tokyo to finalise a framework for the development of Islamic finance to help foster financial stability and promote increased access to Islamic financial services in markets around the world.

Both World Bank managing director Dr Mahmoud Mohieldin, and Dr Ali emphasised that the MoU “will help us build capacities to develop institutions and instruments to support sustainable inclusive growth and help societies to achieve their development goals with emphasis on poverty alleviation and shared prosperity”.

Just a few weeks ago, Dr Mohieldin reiterated at the Global Islamic Finance Forum (GIFF) 2012 in Kuala Lumpur that the boom in world commodities such as oil and gas; quality improvements in the industry; the growth of Islamic finance windows at conventional financial institutions and the growth of  Shariah-compliant equity, Sukuk and other indices, all point to exciting opportunities for the Islamic finance industry going forward.

According to the World Bank, with total assets in 2011 exceeding US$1.2 trillion, Islamic finance could account for a substantial share of financial services in many countries in the coming years. Through their cooperation, the World Bank and IDB Group will explore Islamic finance as a potential tool supporting the efforts of countries to reach their development and financial stability goals.

Islamic banking assets and deposits, according to the World Bank, also grew faster than conventional banking assets and deposits in six key markets – Saudi Arabia, Turkey, UAE, Qatar, Malaysia and Indonesia, in the period 2006-10 – with Turkey, Qatar and Malaysia showing the largest growth differentials. The rationale underpinning the growth expectations include the huge surpluses generated by the commodity boom in several Muslim countries, which Dr Mohieldin emphasised, need to be allocated through financial intermediaries and sovereign wealth funds (SWFs).

Over the past three years, 10 major international conventional financial institutions have opened Islamic finance windows, which, according to Mr Mohieldin, “translates into Islamic finance products potentially being available in an additional 44,000 outlets/branches across more than 70 countries”.

However, there are also some key challenges the industry is faced with, including improving regulatory oversight; rebalancing tax treatment; strengthening insolvency frameworks; promoting standardisation; ensuring adequate liquidity for long-term financing and establishing sound risk-management practices.

The bank is keen that progress needs to be made on:

A  
improving regulatory framework and strengthening regulations in several markets and that “consensus remains to be established on a widely-accepted and comprehensive risk-based supervisory approach, essential for mitigating the risk of systemic failures”

B  
more work is needed on ensuring convergence between best insolvency practices on the conventional and sharia-compliant sides, especially the need for developing reliable mechanisms for dealing with Sukuk defaults and identifying parties’ rights, especially in the case of cross-border transactions.

The World Bank, he revealed, is collaborating with the Islamic Financial Services Board (IFSB) to establish widely-accepted Principles for Effective Insolvency and Creditor Rights System. It is also in the process of finalising the Supplement Corporate Governance Guidelines for Islamic Financial Institutions, and is in discussions with the International Islamic Liquidity Management Corporation (IILM) to foster liquidity in the global Islamic financial system.

“Within a relevant framework of regulations, standards and corporate governance,” he concluded, “Islamic finance, based on its main principles and through continued investment in human capital, can play an ever-more important role in ensuring broadened financial access to support sustainable development.”

In Tokyo, Dr Ali, also drew attention to the use of Sukuk as a resource mobilisation and fund-raising tool and gave some hints as to the future direction in this respect for the multilateral development bank of the Muslim world.

The Sukuk market, according to the IDB, has already demonstrated its ability to intermediate funds effectively across borders, contributing towards the efficient allocation of funds in the global financial system and has emerged as a major instrument for international fund raising by multilateral agencies, sovereigns, government agencies, financial institutions and corporations.

Resource mobilisation is a major priority for the IDB given the increased demand for financing from member countries, especially the so-called Arab Spring countries, which are seeking financing aimed especially at promoting projects generating youth unemployment.

In fact, Dr Ali revealed that following a two-day OIC Extraordinary Islamic Summit held in Makkah, Saudi Arabia, in August, the bank’s main equity subscribers, especially Saudi Arabia, have agreed to another capital increase for the bank. The current authorised capital of the IDB is 30bn Islamic dinars (ID – one ID is equivalent to One SDR (Special Drawing Right) of the IMF) and the subscribed capital is ID15bn. Dr Ali did not say by how much the capital is set to increase and over which timeline.

The IDB relies on equity, callable capital and Sukuk (both international, local currency and private placements) to finance its import and export trade finance; development and project finance; technical assistance; private sector finance; and export credit and investment insurance activities.

Its latest Sukuk was issued in October through a private placement arranged solely by Credit Agricole. The US$500m 5-year Sukuk was priced at 3-months LIBOR plus 30 basis points and the size is much larger than for private placements of bonds and Sukuk in general in the MENA region.

The interesting thing is that the issuance comes under the IDB’s new US$6.5bn Islamic Trust Certificate Programme. According to Dr Ali, the bank plans to go to the market more regularly with sizeable volumes each year over the next few years. The IDB issued a US$800m Sukuk at a profit rate of 1.357 per cent and a final spread of 5-year MS (Mid Swap) + 40 basis points (bps) in June this year thanks largely to a spate of orders from central banks, regulatory authorities and government agencies. This brings the total volume of IDB Sukuk for 2012 thus far to US$1.3bn.

The increase in the frequency and volume of IDB issuances is designed to mitigate the higher cost of capital incurred by the IDB when raising funds through issuing commercial papers compared with other peer multilaterals.

The other interesting aspect of the IDB US$500m private Sukuk is that it was as a result of a reverse enquiry. Here investors starved of quality (usually AAA-rated papers) in the market (especially the conventional bond market) are keen to buy papers issued by a number of selected high quality issuers, of which the IDB is a sought-after one. The standing of the IDB commercial papers received its perennial boost in October, when international credit rating agency, Standard & Poor’s (S&P), for the 11th consecutive year, reaffirmed the IDB’s “AAA” Long-term Issuer Credit Rating; and its “A-1+” Short-Term Issuer Credit Rating with a “Stable Outlook”.

It is no secret that in the aftermath of the Arab Spring the IDB is paying much more attention in directing financing to its MENA member countries. The reasons are compelling.

The IDB Group is currently acting as the Secretariat of the International Financial Institutions (IFIs) Coordination Platform under the aegis of the Deauville Partnership, which was launched at the G8 Summit in May 2011 in Marseilles. This partnership brings together the G8 and nine international development partners to address and support country-owned economic programmes for the MENA region.

According to Dr Ali, the group has set up a dedicated team to handle all work related to the IFI Coordination Platform, and it is in the process of finalising proposals for  a number of initiatives and Sharia-compliant financing mechanisms to the other financial institutions in order to support countries in the Arab region with their transition.

In addition, another major priority for the IDB Group is supporting the formulation of an employment-focused development strategy in member countries.

In its latest report, the International Labour Organisation (ILO), for instance, paints a bleak picture of youth unemployment worldwide predicting that the global youth unemployment rate will reach 12.9 per cent by 2017, up by 0.2 per cent from its forecast for 2012.

“The unemployment hotspot,” warned Dr Ali in Tokyo, “still remains the MENA region, where the youth unemployment rate is projected to average above 25 per cent over the next few years and might even rise further if policymakers do not put in place adequate measures and strategies to address the problems, which include youth bulge, skills mismatch, outdated curriculum etc.”

Saudi Finance Minister, Ibrahim Al-Assaf, addressing the development committee meeting of the IMF in Tokyo, could not be more to the point. “The global crisis beginning in 2008 has highlighted the urgency of the employment challenge, given the large and possibly rising levels of unemployment around the world. The MENA region is a case in point, where high rates of youth unemployment have been a perennial problem,” he explained.

However, he advised, jobs needed to be seen through the lens of family welfare and social stability. “We should not overlook that there exist important differences in cultures across the bank group’s vast membership and the way societies view families and family welfare. In developing countries, families, whether with single or multiple income earners, are the ultimate beneficiaries of jobs and, therefore, the most important stakeholders in the jobs agenda.

He added, “Choices about who in the family should assume the responsibility of earning income and looking after health, education and upbringing of children must be made by families themselves.”

He further urged reforming the education system to promote employability so as to make it more relevant to the needs of the private sector; and warned that there was a need for behavioural change, particularly in youth, with regard to “blue collar’ jobs.

The MENA region, especially those countries in transition (Arab Spring countries such as Egypt, Yemen, Tunisia, Libya) are projected to record a decline in GDP growth in 2012, from 4.7 per cent in 2011 to four per cent in 2012 and down further to 3.6 per cent in 2013. Likewise, growth in the countries in transition will decrease from an average of 6.6 per cent in 2011 to 5.4 per cent in 2012 and 5.2 per cent in 2013.

“The economic and financial prospects of these conflict-affected countries are at risk due to continued political and social instability as well as unfulfilled pledges by donors to support the transition period. In fact, some of these countries face serious balance of payments crisis as well as the daunting task of rebuilding their economies from the scratch, which requires technical and financial support to help them make progress. As many Western donor countries are in austerity mode, transition countries in the MENA region need to woo their rich neighbours to come to their aid,” advised Dr Ali.

In fact, in September at a donor meeting in Riyadh, donors pledged $6.4bn to Yemen, of which Saudi Arabia is providing $3.25bn, the World Bank $400m in new resources and the IDB $100m.

Dr Ali also visited Tunisia in September, where he signed two financing agreements worth $236m with Dr. Riyadh Bettaieb, Tunisian Minister of Investment and International Cooperation – a $209m part-financing facility for a power project in Sousse; and a $27m job creation vocational training program in Jendouba, Tozeur and El Kef governorates aimed at young Tunisians.

This is in addition to the $250m Youth Employment Support for the Arab Countries Programme launched earlier this year by the IDB and aimed at Egypt, Tunisia and Morocco. The MENA region has the world’s highest youth unemployment rate at more than 25 per cent costing the region an estimated $50bn each year. Accordingly, the IDB and the International Finance Corporation (IFC), the private sector funding arm of the World Bank Group, have launched a $50m MENA Regional Initiative under the IDB’s Education for Employment Programme to engage with the private sector to create new job opportunities for employment based education, and to enhance labour market skills of the youth.

There are important synergies between youth job creation and SMEs, often the backbone of many economies – both in the developed and developing countries. One sector that is getting additional assistance is the multi-billion-dollar halal industry, especially in developing high-impact products for export. The IDB is cooperating with the SME Bank in Malaysia to manage its $200m SME Development Fund, which is directed at financing the working capital of SMEs involved in the halal industry.

In Tokyo in his statement to the influential Development Committee of the IMF, Dr Ali implored the World Bank Group to consider the role of Islamic finance in contributing to financial stability; reconstruction and development; SME financing; microfinance and financial inclusion.

He urged the World Bank Group to consider using Islamic financial instruments and tools in its various financing activities.

“In this fast-changing, global development and financial landscape,” he explained, “Islamic finance has come of age providing ample opportunities and solutions to challenges facing countries worldwide. The fragile global economy needs a new financial strategy for the post-crisis era. While efforts are being made to fix the global financial system, it is high time to mainstream Islamic finance into the global financial system. Islamic finance, with its global footprint in 75 countries (where more than 600 Islamic financial institutions – comprising some 450 Islamic banks and about 200 conventional banks with Islamic windows – are located), is an ethical financing based on risk-sharing, which links the growth of credit to the growth of real sectors in the economy. Its financial products and services are opening new opportunities for businesses in the financial and non-financial sectors thereby creating new jobs.”

In the agricultural sector, there are new initiatives emerging based on the Islamic capital market that has the potential to make a huge impact on agribusiness, food security and hunger alleviation. Here the concept of the AgroSukuk is being pioneered by Malaysia and in which several MENA countries, including Turkey, Egypt, Morocco and Sudan, are interested.

The aim is for the major agricultural companies and agro-based industries to  raise funds from the capital market. The Securities Commission Malaysia is finalising the framework for the issuance of AgroSukuk. The Malaysian government also decreed in September that expenses for the issuance of AgroSukuk are eligible for a double tax deduction for a period of four years effective from year of assessment 2012 to 2015.

Even in the social sector, Islamic finance structures such as Murabaha (cost-plus financing) are starting to make an international impact. The IDB, for instance, has recently partnered with the Bill and Melinda Gates Foundation to finance polio eradication programmes in a number of countries.

Under this ground-breaking partnership, the IDB is extending the Murabaha financing facility, and the host governments where the polio eradication programmes are being carried out will reimburse the IDB with the principal amount, while the Bill and Melinda Gates Foundation will pay the IDB directly the corresponding mark-up on behalf of the respective governments.