As global growth returns and with the Sukuk market re-establishing itself, focus has returned to the problem presented by the dearth of liquidity management tools available to Islamic investors. BARRY COSGRAVE discusses.
There are too few short-term, liquid instruments available to investors looking for Shariah compliant products. The notable exception to this is the Bahrain government’s Salam program but the very fact that this is a unique offering is evidence of the problem. Islamic investors are essentially limited to investment in Sukuk and as such are positioned at a disadvantage to their conventional finance counterparts to whom a seemingly endless variety of investment alternatives are offered. At present, investors that might otherwise seek an Islamic investment opportunity are forced to turn to conventional finance in order to address a number of their financing needs. The end-goal for the industry must be to provide a full range of short, medium and long-term investment opportunities such that Shariah compliant products are seen by investors as the go-to option.
The International Islamic Financial Market (IIFM) recently launched its standard documentation for collateralized Murabahah transactions which is intended to provide a Shariah compliant alternative to the conventional repo transaction. This is another example of the excellent work undertaken by the IIFM in leading the push for standardisation of Islamic finance documents. As with the Tahawwut Master Agreement, the existence of this agreement alone indicates that Islamic finance is maturing and developing new instruments to address the numerous gaps in Shariah compliant products available to participants. However, much work remains to be carried out and market participants must build on these foundations to develop more innovative products for the industry to use.
Sukuk have dominated the Shariah compliant investment landscape and will continue to do so for the foreseeable future. Recent issuances by sovereigns outside traditional Islamic jurisdictions (notably the UK and Hong Kong) support the proposition that Islamic finance is again in growth mode. However, the same problems persist in that Sukuk are rarely traded and held to maturity by investors. This creates two problems: the absence of a liquid Sukuk market and lack of efficient market-based pricing. These two problems exacerbate each other creating a vicious circle that is hampering the industry. These two problems are further increased by the fact that a high percentage of newly-issued Sukuk are subscribed for by conventional investors which creates a more competitive environment for Islamic investors. Given the relative paucity of supply, Islamic investors are effectively encouraged to hold onto the Sukuk in which they have invested for fear that fresh Sukuk will not be available to them. As a result of this, secondary market trading is extremely limited and Sukuk are rarely seen as a liquid instrument.
At present, the only short-term Islamic investment of note is the government of Bahrain’s Salam program. This short-term Shariah compliant program uses Bahrain’s aluminium supply as its basis and is highly successful with each issuance regularly over-subscribed. However, this program is unfortunately all too rare. Five year Sukuk appear to be the must-have accessory for sovereign issuers in 2014, but what the market needs is for those issuers to also consider short-term instruments. If the right assets can be identified there should be nothing preventing sovereign issuers from issuing instruments similar to the Salam program. The fact that the Bahrain government’s program is so regularly and heavily over-subscribed would suggest that the risks associated with the success of such a program should be relatively low.
However, the industry cannot rely solely on sovereign issuers to push Shariah compliant hedging products have become increasingly popular and the structures used here can be transferred into new products such as structured investments that generate returns that may be benchmarked to the performance of certain indices or other assets. innovation, more can and should be done with the tools that are already available. Shariah compliant hedging products have become increasingly popular and the structures used here can be transferred into new products such as structured investments that generate returns that may be benchmarked to the performance of certain indices or other assets. The collateralized Murabahah project completed by the International Islamic Financial Market (IIFM) in recent months is a good example of the development of ever more sophisticated investment products. Given that standard form documents are generally issued in response to market activity and therefore naturally lag behind such activity, it is very positive that such a document has been prepared as it shows that innovation is continuing.
Whilst problems remain, there is certainly a sense that Islamic finance is moving forward into a new phase of development. The Sukuk market is now a developed one and as such the focus is shifting to more sophisticated instruments. Islamic finance has always suffered from a perception that it should be able to run before it can walk. Conventional finance has developed over decades to the position in which it stands today. Islamic finance does not benefit from this history and, whilst the lessons learned from conventional finance and the products developed does give Islamic finance a head start, this does not mean that the full suite of products will be available immediately. However, it is clear that good progress is being made and that the future is bright.
Barry Cosgrave is the senior associate at Shearman & Sterling. He can be contacted at
[email protected]
.