Is a ‘game changer’ on the way?

MUSHTAK PARKER looks at new developments in the field of Islamic finance

It may be another sign of the growing maturity of the Islamic finance industry or complementary competition in a product area that is screaming out for diversification. But all the signs are that the industry’s short-term cross border liquidity management and financing challenge is attracting more takers.

On the one hand, you have the tried and tested Murabaha family instruments – the traditional vanilla Murabaha used primarily for trade finance; the much-misunderstood Commodity Murabaha (Tawarruq), which is the mainstay of managing short-term liquidity and in the case of retail customers, cash management; and the Syndicated Murabaha Facility, which is very popular especially amongst Turkish participation banks and financial institutions in the Gulf Cooperation Council (GCC) states, which raise such short-to-medium term funds for various reasons – to finance balance sheet activities, trade, small-and-medium-sized enterprises (SMEs) and so on. The global Murabaha market is estimated at about a $1 trillion.

On the other hand, you have the Sukuk, which has emerged in recent years as an alternative way for financial institutions to raise funds on a much longer-term basis, not only to manage liquidity but also to finance some of the above activities. According to various estimates, the total volume of Sukuk issued for the period January to July 2013 amounted to $65bn compared with $81bn for the same period in 2012, which was an extraordinary year because of two single significant issuances – the SR15bn 10-year Sukuk issued by the General Authority for Civil Aviation (GACA) in Saudi Arabia and the RM30.2bn by PLUS Berhad, the Malaysian national road agency.

This year the Sukuk market could see the beginnings of a potential game changer with the entry of the International Islamic Liquidity Management Corporation (the IILM), which was established in 2010 by central banks, monetary authorities and multilateral organisations to develop and issue short-term Shariah-compliant financial instruments to facilitate effective cross-border liquidity management for institutions that offer Islamic financial services.

The IILM at the time of writing was poised to issue its long-awaited debut Sukuk – a 3-months $490m short-term issuance backed by sovereign assets, and which is rated A-1 by Standard & Poor’s Rating Services. According to the IILM, its Sukuk will be tradable Shariah-compliant US dollar-denominated short-term financial instruments issued at maturities of up to one year; are money-market instruments backed by sovereign assets, excluding Saudi Arabia, of course, following the divestment by SAMA (the Saudi Arabian Monetary Agency) of its equity stake in the IILM in April this year; are tradable globally via a multi-jurisdictional primary-dealer network; and have strong global support as they represent a unique collaboration between several central banks and a multilateral development bank with the aim of enhancing the financial stability and the efficient functioning of Islamic financial markets. The IILM short-term Sukuk is primarily seen as a complement to the intermediate and long-term Sukuuk currently available in the market.

In July, a new kid on the block emerged. The Bahrain-based International Islamic Financial Market (IIFM) launched an Interbank Unrestricted Master Investment Wakalah Agreement, which, according to Ijlal Alvi, CEO of IIFM, is “a specific contract designed to be used between financial institutions for managing their liquidity through Shariah compliant interbank treasury transactions,” and which is a complement to liquidity management in the global Islamic finance industry based on commodity Murabaha transactions. Islamic financial institutions (IFIs) have traditionally used commodity Murabahah for their wholesale liquidity management purposes.

Challenging task

“Liquidity management,” explained Sheikh Abdullah Saoud Al-Thani, governor of the Qatar Central Bank, who is also the current chairman of the governing council of the IILM, at the recent London Sukuk Summit “has been one of the most challenging tasks faced by Islamic financial institutions. For institutions offering Islamic financial services, the limited availability of Shariah-compliant instruments in several jurisdictions continues to pose substantial challenges. The combination of supply and cost considerations has resulted in unnecessarily large holdings of cash by most Islamic financial service providers to meet their short-term liquidity needs. Addressing the limitations that constrain effective liquidity management practices will be critical not only to support the further development of Islamic finance, but, more importantly, to promote global financial stability.”

To what extent the IIFM’s Interbank Unrestricted Master Investment Wakalah Agreement will diversify the range of liquidity management solutions and other types of financing available to the global Islamic financial services industry remains a moot point. The agreement, for a start, is designed as a tool for managing liquidity and short term Shariah-compliant treasury activities, and is not intended to be used for normal financing of transactions.

A general treasury pool currently usually comprises placements with banks and other financial institutions under Murabaha/Wakalah/Mudarabah contracts; investment in highly liquid Shariah compliant Treasury Bills, government securities and money market instruments; investment in listed Sukuk and similar instruments; and cash and cash equivalents pending investment allocations.

The Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) defines Wakalah as the act of one party delegating the other to act on its behalf in what can be a subject matter of delegation. Basically, the Wakalah contract is a non-binding contract for both parties (Muwakkil and Wakil), which means that each of the two parties has the right to cancel the contract. However, it may sometimes become a binding contract in certain cases.

There are several types of Wakalah contracts, but under the Interbank Unrestricted Master Investment Wakalah Agreement, an investor, explained a Clifford Chance Briefing, (the Muwakkil) appoints an Islamic financial institution as its agent or delegate (the Wakil) to invest its funds in a Shariah-compliant manner in exchange for a fee or a fee and a profit share.

Once the Muwakkil and the Wakil have entered into the Master Wakalah Agreement, they can enter into a series of Wakalah Investment Transactions under which a deposit in an agreed and certain amount (the Investment Amount) is invested in a pre-determined pool of assets (the Wakalah Pool) for an agreed and certain amount of time (the Investment Period) in relation to which there is an anticipated return (the Anticipated Profit Rate).

The Wakalah Pool may consist of a general treasury pool comprising of Shariah-compliant assets or, at the Wakil’s discretion, a segregated pool of assets both of which must be described under the Wakalah Investment Transaction. The Wakalah Pool can then either be managed on a segregated or co-mingled basis.

What consists of a general treasury pool needs to be clearly defined or elaborated in the Offer Notice. But here lies the anomaly. The general treasury pool will almost certainly include investments in Murabaha, the very instrument the IIFM seeks to complement or even replace.

New developments

Three recent developments strongly suggest that Murabaha, in particular Commodity Murabaha (Tawarruq) and Syndicated Murabaha, continues to entrench itself in the mindset of both regulators and market players and in market practice. This despite the continued buoyancy in the global Sukuk market, albeit at a slightly lower level than in the record year of 2012.

In the first development, Turkiye Finans Katilim Bankasi AS, a subsidiary of National Commercial Bank of Saudi Arabia, for instance, raised the equivalent of a record $500m through a dual tranche and currency Syndicated Murabaha facility in July, which, according to Derya Gürerk, CEO of Türkiye Finans, is the largest Syndicated Murabaha transaction in the Turkish market for the last few years, surpassing the $450m Murabaha facility raised by Albaraka Turk Participation Bank in September 2012 and the $382m dual currency Syndicated Murabaha raised by Asya Katilim Bankasi A.S. in May this year.

Investor demand for Syndicated Murabaha is as robust as ever. The latest Turkiey Finans transaction, which was lead arranged by ABC Islamic Bank (Bahrain), Al Hilal Bank (UAE), Emirates NBD Capital Limited (UAE), Noor Islamic Bank PJSC (UAE), Standard Chartered Bank (Middle East) and The Saudi British Bank (Saudi Arabia), who were also the bookrunners for the transaction, was launched at $250m equivalent but due to heavy demand was upsized and closed with $426m and €57m tranches, equivalent to about $500m.

In terms of tenor, too, the transaction set new benchmarks. The larger tranche has a 2-year tenor with a profit margin of 135 basis points plus LIBOR per annum; and the smaller tranche has a one-year tenor and a profit margin of 100 basis points plus LIBOR per annum, respectively.

 “This year, we managed to attract excessive demand in a relatively short period of time and concluded the deal by signing twice the facility amount we initially intended. The two year tranche of the deal distinguishes itself with its unique long-term tenor, a maturity that hasn’t been seen in the market for quite a long time now. This indicates confidence of the international financial markets into our economy as well as Türkiye Finans,” explained Derya Gürerk at the signing of the deal.

What is revealing is that the above syndication comes a mere three months after Turkiye Finans issued its debut $500m Sukuk al-Murabaha, which was priced at 3.95 per cent per annum. Given the long gestation period in structuring, arranging and issuing Sukuk, syndicated Murabaha, according to Islamic bankers remain an attractive option.

Financing preference

Massoud Janekeh, director and head of Islamic capital markets at the Bank of London & the Middle East (BLME), maintains that “most Islamic banks prefer to use instruments such as Murabaha, Tawarruq and Ijara (leasing) for their financing, and I cannot see that changing in the short term. Contracts such as Musharakah and Mudarabah do not fit in with general bank financing regulations in most tax regimes”.

Similarly, Ufuk Uyan, CEO of Kuveyt Turk Participation Bank, which is a subsidiary of Kuwait Finance House and which reported increased net profits of TL146m in the first half of 2013 and a 16.8 per cent rise in total assets amounting to TL22.09bn compared with the same period in 2012, agrees that “the engine of growth of the Turkish economy in 2013 will be energy sector investments and exports”. Not surprisingly, Kuveyt Turk is in the process of launching a number of new export finance products to complement its Sukuk issuing programme and its Syndicated Murabaha transactions.

The international market is very familiar with Turkish risk, especially for transactions such as Syndicated Murabaha. This latest Turkiye Finans Murabaha transaction, for instance, not surprisingly attracted the participation of 28 banks from 14 countries across the world.

The diversity of the subscribing institutions to the Syndicated Murabaha is revealing and included ABC Islamic Bank, Al Hilal Bank, Emirates NBD Capital, Noor Islamic Bank, Standard Chartered Bank, The Saudi British Bank, British Arab Commercial Bank Plc, Citibank N.A., United Arab Bank, Türkiye Halk Bankasi (Bahrain Branch), BANK AUDI, Zürcher Kantonalbank, Qatar Islamic Bank, Ajman Bank, Dubai Islamic Bank, Boubyan Bank, United Bank Limited, Ahli United Bank, Bank of London and The Middle East, Sharjah Islamic Bank, Deniz Bank AG, Deutsche Bank, Bank Audi Saradar France, UBI Banca International S.A., Eurocity Bank AG, Banka Kombëtare Tregtare, Oberbank AG and BankMed Sal.

The proceeds of the facility, like those raised through the Sukuk, will be used to fund the balance sheet and financing activities of Turkiye Finans, especially of small-and-medium-sized enterprises (SMEs) and other companies in support of the growth of the Turkish economy. The bank recently reported net profit for first quarter 2013 of TL76.7m compared with TL71.1 for the same period in 2012. Similarly, total assets stood at TL14.95bn at end Q1 2013 compared with TL13.97bn at end Q1 2012.

At the same time, AlBaraka Türk Katilim Bankasi A.S. also mandated ABC Islamic Bank (E.C.), Al Hilal Bank PJSC, Barwa Bank, Emirates NBD Capital Limited, Noor Islamic Bank PJSC and Standard Chartered in July 2013 to arrange a $250m equivalent dual tranche and currency Syndicated Murabaha facility with tenors of one year and two years. The profit margins for the 1-year and 2-year tranches are 100 basis points per annum and 135 basis points per annum respectively, and the proceeds similarly will be used to fund the activities of the bank, especially trade finance and SMEs.

Transactions remain robust

The syndicated Murabaha and Ijara transactions in the Middle East and North Africa (MENA) region remains robust judging by the spate of such transactions closed so far this year.

These included a $265m Syndicated Murabaha arranged by the International Islamic Trade Finance Corporation (ITFC), the trade finance fund of the Islamic Development Bank (IDB) Group, for the Egyptian General Petroleum Corporation to finance the import of crude oil from ITFC member countries; the QR800m Murabaha facility arranged by Qatar Islamic Bank (QIB) for NBK Holding; the three-year QR345.8m equivalent Dual Currency Syndicated Murabaha arranged by Qatari investment bank, Qinvest, for the local Al Jazeera Finance; the $100m Revolving Murabaha arranged by QIB for Qatar First Bank; the $100m Syndicated Murabaha arranged by a consortium of banks comprising Emirates NBD Capital Limited, Barwa Bank, JP Morgan Ltd and Noor Islamic Bank PJSC for the International Bank of Azerbaijan; the $50m Syndicated Murabaha arranged by the Islamic Corporation for the Development of the Private Sector (ICD), the private sector funding arm of the IDB Group) for Pt Mandala Multifinance tbk in Indonesia; the SR1.04bn Murabaha facility arranged by Saudi Hollandi Bank for Abdullah A. M. Al-Khodari Sons Company; the AED302m Syndicated Murabaha lead arranged by Abu Dhabi Islamic Bank (ADIB) for Emirates National Factory for Plastic Industries L.L.C. (ENPI); the $150m Syndicated Ijara arranged by ADIB Egypt for the Egyptian marine services company, Maridive and Oil Services Ltd; and the $150m Structured Murabaha arranged by Standard Chartered Bank for Construction Products Holding Company (CPC), the industrial arm of Saudi Binladin Group.

The second development sees the proaction of some regulators such as the UAE Central Bank, Central Bank of Oman and Bank Negara Malaysia (BNM) guiding their market place to instruments such as Commodity Murabaha and Diminishing Musharakah.

In Malaysia, for instance, most of the Islamic banks have been practising the concept of Bai Bithaman Ajil (BBA), which is a deferred payment product, for home financing.

This, says Mohd Reza Shah, CEO of Bank Muamalat, the second Islamic bank to be established in the country, “has drawn a lot of criticism from practitioners and the public, especially when it is seen as more debt financing, as opposed to the more authentic product such as Musharakah Mutanaqisah, which encompasses a diminishing partnership contract. But there is no incentive to move towards Musharakah Mutanaqisah because the BBA is a tried and tested product and is making money”.

But, last December, BNM intervened and, according to Mhd Reza Shah, said, “Yes you can do BBA, but if you want to do BBA these are the new procedures.” That, he added, “really shocked the market, and brought about the change away from BBA in Malaysia. Today, you can still do BBA but it is so strict that we don’t want to do it any more, so we’ve moved to Tawarruq (Commodity Murabahah) now in terms of the product offering.”

In fact, Tawarruq is now an established product in Malaysia based on transactions on Bursa Suq Al Sila, the commodity trading platform based on Palm Oil and Olefins contracts, at the Bursa Malaysia, the national stock exchange.

The third development is the increased engagement especially in the largest such market, Saudi Arabia, by Islamic banks and intermediation firms involved in the Commodity Murabaha brokerage business and others in educating their clients – both institutional and retail – about the efficacy and Shariah legitimacy of Commodity Murabaha (Tawarruq).

Bid for direct dialogue

The aim is to demystify Islamic finance and Tawarruq by forging a direct dialogue between the institution and its Shariah Supervisory Board (SBB) and a bank’s clients’. The National Commercial Bank (NCB), for instance, held such a meeting between its Shariah Board and its customers and employees in April this year in Jazan. NCB has been holding such meetings in key cities in the Kingdom for the last two years.

One British financial institution, DDCAP Limited, one of the largest intermediation and commodity brokerage firms serving the Islamic finance space for almost two decades, recently held such a dialogue at the Riyadh Marriot Hotel to introduce its SSB to its Saudi-based client banks. The interactive dialogue comprised presentations by senior DDCAP executives and the chairman of the company’s SSB, and a lively questions and answers session with client banks, which included several technical queries relating to the mechanism and processes involved in commodity-based Tawarruq and Murabaha transactions.

DDCAP, which is majority owned by ICAP Private Group Limited (IPGL) and headed by Stella Cox, managing director and CEO, who in turn has over two decades of experience in Shariah-compliant commodity trade facilitation and intermediation, in fact has an all-Saudi Shariah Supervisory Board comprising three prominent Shariah Scholars, namely, Sheikh Abdullah Bin Suleiman Almaneea (chairman), Sheikh Dr Abdullah Almutlag (both are Members of the Council of Senior Scholars in Saudi Arabia and Advisors to the Royal Court) and Sheikh Dr Mohamed Ali Elgari, one of the leading Shariah advisories in the Islamic finance world.

The primary objective for setting up the SSB, according to Lawrence Oliver, director and deputy chief executive officer of DDCAP, is a “desire to further demonstrate DDCAP’s on-going willingness to subject the substance and integrity of its business and service provision to regular Shariah review and validation at the highest level”.

The specific mandate of the DDCAP SSB is to review exclusively from a Shariah perspective the company’s Islamic commodity trade services and processes.

Sheikh Abdullah Bin Suleiman Almaneea, chairman of DDCAP’s SSB, addressing the Company’s client banks’ meeting in Riyadh, emphasised the real time operational aspects of the board’s Shariah governance process. During the inaugural visit of the SSB to DDCAP’s head office in London in March this year, for instance, the board conducted a thorough review of DDCAP’s documentation, systems and procedures.

Sheikh Almaneea also confirmed that as part of the Shariah governance process, the Shariah Supervisory Board members also visited the London Metal Exchange and actually travelled to an LME approved warehouse operator in order to gain a better understanding of the processes and procedures that support DDCAP’s ability to supply physical commodity assets to the Islamic financial marketplace.

Upon completion of their review, the SSB issued a Fatwa to DDCAP supporting the substance of and the processes and procedures conducted through its services related to commodity-based Tawarruq and Murabaha transactions.

Business consolidation

To further consolidate its business and Shariah-compliant product credentials, DDCAP has gone that extra mile by not only establishing a SSB, but also appointing a full-time Shariah liaison director, Dr Fareed Hamed, a seasoned Saudi Islamic banker  based in Jeddah.

DDCAP’s wholly owned subsidiary, DD&Co Limited acts as a commodity facilitator and counterparty for the Islamic transactional requirements of its clients, and is a member of the London Metal Exchange (LME) and the London Platinum and Palladium Market (LPPM).

Commodity Murabaha (Tawarruq), which is widely used to facilitate short-term liquidity management for institutions and cash management for individuals, has in recent years come under greater scrutiny, especially in relation to the physical ownership of a particular commodity at any given moment in the transaction chain, and in relation to the nature of the involvement of any third party in the transaction, to ensure that the Shariah investment process is fully compliant.

The LME, explained Lawrence Oliver, director and deputy chief executive officer of DDCAP, is the oldest financial exchange in the world, having been established in 1877. “The LME has the largest physical, OTC (over the counter) environment of any world commodity market and is, therefore, ideally suited to supporting the transactional volume requirements of the Islamic marketplace,” he added.

The LME has approved more than 700 warehouses and storage facilities in about 40 locations across Europe, Asia and the US. As a further measure to ensure its independence and uphold prudential governance, the LME neither owns or operates the warehouses nor owns the commodities or metals contained therein.

Other than overseeing the business and good conduct of the exchange and its members, the LME’s role is to oversee the LME related activities and operations of the warehouse operators and warehouses to ensure their compliance with market standards. On an annual basis, the LME’s own audit teams visit the warehouses to test and ensure adherence to its stipulated rules.

According to Lawrence Oliver, “whilst DD&Co will always endeavour to ensure its available commodity capacity provides scope for exceptional and occasionally sizable additional customer commodity supply requirements, there have been occasions when the company has been asked to facilitate supply of a specific commodity and has declined due to underlying commodity market conditions”. DD&Co’s internal risk management controls and stipulations, emphasised Oliver, “prohibit short sales by DD&Co thus ensuring Shariah adherence at all times”.

“Any commodity supplied by DD&Co to customers,” he added, “is owned by DD&Co at the point of sale (ie DD&Co has unfettered title to the commodity) and available for physical delivery if requested. DD&Co’s supplies of commodities are classed as actual or physical, meaning that all commodities it supplies are fully identifiable (type, class, quality, location) at the point of sale.

“Upon allocation of a commodity to a specific customer, DD&Co’s policies and procedures prohibit the supply of the physical commodity to any other customer whilst the transaction is in process. Furthermore, DD&Co effects sales of commodity only in whole amounts and relevant market ‘lot’ sizes for, without such controls being in place, it would not be possible to effect true, physical delivery.” n