With the global financial crisis having wreaked havoc on its financial and capital markets, Japan’s involvement in the Islamic finance market has been muted. But there are hopes the country will step up its involvement as its economy gradually recovers. CAMILLE KLASS looks at the state of Japan’s involvement in this market and what lies ahead.
Japanese involvement in Islamic finance may have dialed down in the last two years as a result of the global financial meltdown and the debt crisis in Dubai, but market observers say interest is very much alive. Both events hit business and investor confidence in Japan, even though they caused little damage to Islamic finance markets overall. Together, they put the brakes on what seemed from 2006 to 2008 to be Japan’s promising start in Islamic finance.
“The timing was pretty bad after the fourth quarter of 2008,” said a Bank of Japan executive, who asked to remain unnamed. “We were pretty much affected by the Lehman crisis. Output by small- and medium-scale enterprises (SMEs) fell from the demand side because of the impact of the turmoil and financing activities went down significantly.”
The worldwide recession hurt export-dependent Japan, causing key industries to suffer from shrinking exports; and whipped its financial and capital markets, as banks across the globe reeled from the damage to their balance sheets. Lehman Brothers’ collapse, in particular, sparked a downturn in the economy that especially hurt Japan’s SMEs, causing investor and business focus to turn inwards. “Since the onset of the global financial crisis (in September 2008), there has been greater focus on prioritizing finding solutions to severe problems,” said London-based Walid Sarieddine, head of Islamic finance at the structured finance department of Sumitomo Mitsui Banking Corporation Europe (SMBCE).“As such, little time and effort was left for new initiatives or new products.”
Between 2006 and 2008, Japan’s involvement in the Islamic finance market came in the form of government-owned Japan Bank of International Cooperation (JBIC)taking the helm to steer Japan’s participation in the market, Sukuk issuances of RM1 billion (US$312 million) by Toyota Group’s Malaysian subsidiary UMW Toyota Capital and RM400 million (US$124.9 million) by the Malaysian subsidiary of Aeon Credit Services, as well as fund manager Daiwa Asset Management’s launch of its FTSE Shariah Japan 100 index on the Singapore Exchange.
Commenting on the scaled down activity among Japanese companies, Etsuaki Yoshida, deputy head of JBIC’s Africa Office and Middle East, said:” I don’t see any really big progress with regard to development.” Coming from an active proponent of Islamic finance, the statement is telling, especially given that JBIC has yet to follow through on its 2008 plan to issue the first international Sukuk. Since Aeon Credit’s Sukuk in 2007 and UMW Toyota’s in 2008, no other Japanese entity has issued a Sukuk.
While Islamic financing may not have been a priority for Japanese companies, market observers say this doesn’t mean they have given up altogether on transactions relating to Islamic finance. “No indications have been given regarding any abandoning of the steps that have been made over the last few years to develop Islamic finance for subsidiaries of Japanese banks,” SMBCE’s Sarieddine said. “Overall, the stance is a slower one. It doesn’t mean at all that it’s a reversing one.”
SMBCE, for one, has an established Islamic finance desk in London, focusing on offering Islamic financing products primarily to its wholesale clients in the GCC/Middle East region and in Southeast Asia, especially in the area of project finance for infrastructure and energy developments.
Another Japanese corporation that has been involved in various types of Shariah compliant financing is financial services provider Mizuho Financial Group. The company says its involvement ranges from providing project finance as a multilateral agency (MLA) for projects in Saudi Arabia; providing support as an agent for a Japanese company’s Sukuk in Malaysia to providing revolving credit and bilateral Murabahah to Middle Eastern financial institutions. Through its asset management vehicle in London, it had previously established a Shariah compliant Japanese stock investment fund.
More recently, Mizuho says, it has been strengthening business relationships with Muslim countries such as Saudi Arabia and Malaysia. It set up a local securities unit in Saudi Arabia — the only one operated by a Japanese bank — which began operations in 2009. At the end of last year, Mizuho signed a memorandum of understanding with Malaysia’s Maybank Investment to form a strategic alliance in areas including Islamic finance. As a first step of this alliance, they jointly held a Sukuk seminar for Japanese companies in Tokyo in February.
In order to expand its Islamic finance business, Mizuho’s priority is to “utilize its vast customer base, far-reaching office network, strong advisory functions and other various strengths to increase money flow from trade and investment by its customers into Muslim countries, including Malaysia,” a spokesman said.
In the area of fund management, financial institution Nomura Holdings set up an Islamic asset management arm in Malaysia early last year to tap the funds of Islamic investors. “We saw a chance to create a niche for ourselves in Malaysia and realized that with the supportive environment that Malaysia provides for Islamic funds management … there is a whole load of opportunity that has not been seized previously,” said Nor-Regina Rahim, managing director of Nomura Islamic Asset Management.
Given Japan’s lack of a significant minority Muslim population, it’s no wonder Japanese companies are directing their energies on developing Islamic finance transactions outside Japan. “The focus of Japanese banks is clearly on international markets, especially on the Middle East and Southeast Asia, two strategically important regions for a number of large Japanese banks and also where there are sizeable markets for Islamic finance,” said SMBCE’s Sarieddine.
With Japan’s private sector involved in transactions outside the country, what of developments within? Aside from its desire to foster Islamic finance as an alternative to conventional financing, Japan is keen to act as a center for the intermediation of Islamic fund flows between Asia and the rest of the world and embrace Islamic investors flush with petrodollars to invest in its financial markets.
While there may be little impetus for the country to develop a domestic market for Islamic finance because it has few potential domestic consumers of Islamic products, Hooman Sabeti-Rahmati, a counsel at law firm Allen & Overy in Singapore, said there is good reason for Japan to be involved in Islamic finance from an international political standpoint. Japan, the world’s third largest importer of crude oil, depends on the Middle East for about 90% of its crude oil requirements.
“It makes sense for (Japan) to seek to access Middle East capital and, as a political matter, show a commitment to the Middle East and Muslim countries by taking the initiative in Islamic finance,” he said. “When non-Islamic entities do business with Islamic companies, it furthers their relationship with Muslim countries.”
A member since 2007 of the prudential and supervisory standard-setting Islamic Financial Services Board, the Bank of Japan is still studying the implications of Islamic finance for its domestic market. “We joined IFSB to observe developments that countries such as Hong Kong, Singapore and Malaysia are making in the field — and to ask what’s the significance of Japanese intermediation in Islamic finance and how can it create wealth, from a macro-economic perspective,” said a BOJ executive. “We are engaging in this kind of activity to keep ourselves aware, but we are not focusing on the operational part of it. We are still asking questions.”
With expectations of a further firming of the Japanese economy — Japan posted a 4.6% annualized growth in GDP in the fourth quarter of 2009 — market observers say demand for participation in Islamic finance remain high.
Indicative of that demand, So Saito, a partner and Islamic finance specialist at Tokyo law firm Nishimura and Asahi, said clients are approaching him for advice on Islamic finance transactions, primarily Sukuk.
“Clients want to issue Sukuk, even now,” said Saito. “They are interested in setting up Japanese SPCs (special purpose companies) in order to issue Sukuk that are backed by real estate. I have been asked how to go about a Sukuk issuance by Japanese corporations under the current Japanese civil and taxation laws; whether to use a trust and how to effect a transfer of real estate.”
While the private sector interest spells good news for the industry, market observers say challenges posed by existing legal and tax regulations stand in the way of taking Islamic finance to the next level. Referring to tax reforms, Saito said: “There are two main issues concerning tax: one is a lack of clarity, and the other is the lack of a level playing field.”
Whilst there is general agreement that providing a regime for Islamic finance in Japan would be a clear signal to the market that Japan has a role to play, clarifying the taxation treatment of those Islamic financial transactions that would appear most suitable for the Japanese market, particular from the perspective of Japanese withholding tax and classification of the component transactions — in particular, as to how a Sukuk would be defined and treated — is necessary before any market can be formed in Japan, market observers say.
“The relative importance of the market, how reform may be approached and implemented and the overall timing of any specific legal and taxation reform related to Islamic finance transactions in Japan is under informal review,” said Stuart Porter, a partner at Pricewaterhouse Coopers Tax in Tokyo.
While the removal of tax barriers by the regulator will help, Allen-Overy’s Sabeti-Rahmati cautioned that “amending tax laws is an invitation for people to seek to take advantage of loopholes created. So, it requires careful understanding of what one is doing and it will be slow going.”
What’s needed, though, are amendments to allow banks themselves, instead of just their foreign subsidiaries, the ability to deal in Islamic finance, encompassing all the kinds of financial products that banks are allowed within the conventional banking sphere, said Nishimura and Asahi’s Saito.