Wealth & Finance Special Report: Islamic Finance

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Islamic Finance A Global Force

The Rise of Sukuk

Why Islamic finance is growing – and not just in the Middle East

Why this Islamic bond is the one to watch

Leading the Way in the Banking Industry Zaina Ahmed Karim and Mohamed Bouker from EY tell us why Islamic finance is flourishing

Nasri H. Barakat Arbitrator, Umpire and mediator l II&RCS, Inc.

In 1994, Nasri H. Barakat established his practice as a full-time commercial, insurance and reinsurance arbitrator and umpire. As president of II&RCS, Inc, International Consultants, he continues to provide arbitration and litigation support for complex international disputes, expert testimony, run-off and liquidation services to the insurance and reinsurance industry.

Mr. Barakat has more than 40 years of insurance and reinsurance experience in the U.S., Europe and the Middle East. He has participated as arbitrator, umpire and mediator in a large number of arbitrations involving commercial, insurance and reinsurance disputes.

Mr. Barakat is an ARIAS-US certified arbitrator and umpire. He is also listed on the “Roster of Neutrals” of the American Arbitration Association’s commercial domestic (AAA) and International (ICDR) panels, the USCIB, AIRROC and CPR panels. His extensive exposure to international commercial business includes major industry privatization of several Middle Eastern countries applying for admittance in the World Trade Organization (WTO).

His keen knowledge of the Islamic Sharia Law and abilities to fluently read, speak and write French, Arabic and English put him in a unique position to serve on certain international panels.

Prior to founding II&RCS, Inc., Mr. Barakat served as president of National American Insurance Company, vice-president of Chandler Insurance Company Limited (an Offshore Reinsurance Company) and vice-president of Old American Insurance Services, Inc. of Dallas, Texas. He also held executive and other positions with Republic Insurance Company of Dallas, Texas and ITT Hartford.

Mr. Barakat is a non-practicing attorney.

SERVICES Arbitrations Mediations Litigation Support & Management Reinsurance Inspections Insurance Inspections Expert Testimony Due Diligence Collections Liquidation Management Run-off Management

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CONTACT

353 East 72nd St., Apt. 4D New York, NY 10021 Tel: (646) 707-0157 Fax: (646) 224-8404 Cell: (214) 912-9848 Email: iircsinc@ipa.net nasrib@yahoo.com or nasrib@nhbarakat.com

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Islamic Finance

Contents 4 The Rise of Sukuk Why the Islamic bond is one to watch 6 Leading the Way in the Banking Industry Islamic finance’s continuing growth 10 A Global Force We look at Islamic finance’s worldwide appeal

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Islamic Finance

The Rise of Sukuk Last year, Britain became the first non-Muslim country to issue sukuk, an Islamic financial instrument equivalent to a bond or mortgage, leading to £2.3bn in orders. Hong Kong quickly followed and now Société Générale and Bank Tokyo-Mitsubishi, as well as the governments of Luxembourg and South Africa, are planning thieir own sukuk issues.

Dr Heba Abou-El-Sood from Cairo University and Dr Marwan Izzeldin from Lancaster University Management School tell us why the sukuk is one to watch

In June 2014, Britain became the first non-Muslim country to issue sukuk, an Islamic financial instrument equivalent to a bond or mortgage. Hong Kong followed Britain’s suit in September and the governments of Luxembourg and South Africa expressed their planned sukuk issuance by the end of 2014. Britain’s issuance has attracted above £2.3bn in orders while the Hong Kong issuance attracted US$4.7bn in orders. The huge market demand for sukuk has encouraged non-sovereign sukuk issuance to tap into the fast growing Islamic finance market of approximately US$2tn.

The Goldman Saches successful sukuk issuance in September has motivated Société Générale and Bank Tokyo-Mitsubishi to follow the lead by the end of 2014.

at an agreed-upon, value paid in installments in a partnership-like structure (murabaha sukuk) or he can make monthly payments that comprise a rental portion and another portion that goes towards the purchase price until he owns the house (ijara sukuk). Non-Islamic financial institutions have to devise financial instruments conforming to Shari’a requirements and fitting the sukuk structure. The urging question has been whether the appeal to a growing market has been the sole motive for non-Islamic banks to issue Islamic Shari’a-compliant instruments.

Non-Islamic financial institutions have been devising sukuk instruments that are compliant with Islamic Shari’a rules where the possessor is entitled to part-ownership of an asset and then receives income either from profits generated by that asset or from rental payments made by the issuer. This structure is resolves the issue of receiving non-Shari’a compliant interest payments on lent money, as in a standard bond. Therefore, if a customer wants to buy a house, the bank will buy the house itself rather than lending money and receiving interest.

With Basel III banking regulations being phased in starting 2013, several Islamic banks have issued subordinated instruments, including those in the United Arab Emirates, Saudi Arabia, Turkey, and Pakistan to boost their regulatory Tier 1 and Tier 2 capital. Banks in Malaysia have started to use of investment partnership structures (murabaha) for their sukuk, which will be classified as Tier 2 capital on the balance sheet. Tier 1 capital constitutes core equity and disclosed reserves; and Tier 2 capital comprises supplementary capital of other reserves, provisions, subordinated debt, and hybrid instruments. Basel III regulations allow part of the minimum Tier 1 capital ratio to be in the form of additional Tier 1 capital, a layer of additional capital that is perpetual in nature.

The customer then has two options depending on the structure of the Islamic sukuk transaction.

He can either buy the house back from the bank

The main purpose of Tier 1 and Tier 2 capital is to absorb losses during economic shocks. With additional Tier 1 capital, Basel III is signaling oppor-

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tunities of using instruments that are potentially hybrid in nature and provide fixed rates of return.

While the growth of sukuk issuance has been targeting market opportunities, there have been massive opportunities for the capitalization of Islamic and non-Islamic banks to meet regulatory capital adequacy needs. Out of the total volume of sukuk instruments issued to date, 59% support the Basel III Tier 2 capital requirements while 41% support the Tier 1 capital. Recently, sukuk compliant to Basel III has formed an alternative source of finance for institutions that face difficulties in raising capital through stock issuance as financial instability depresses stock market prices.

After Basel III new regulatory capital adequacy rules, there has been a market gap for the supply of instruments that are potentially hybrid in nature (equity callable at the discretion of the issuer), subordinated to depositors, have no maturity date or perpetual, and offer fixed rate of return to sustain the perpetual nature. This unexploited market gap has been filled with globally growing sukuk instruments, boosting the regulatory capital of issuing banks and reinforcing the role of Islamic finance in the global banking industry.

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Islamic Finance

Islamic Finance: Leading the Way in the Banking Industry EY was the first professional services firm to establish a dedicated team to service clients in the Islamic financial services industry and is the only professional services firm to offer Shari’a auditing services. Partner Zaina Ahmed Karim and senior manager Mohamed Bouker explain more about this growing industry and how EY meets its changing needs In June 2014, Britain became the first non-Muslim country to issue sukuk, an Islamic financial instrument equivalent to a bond or mortgage. Hong Kong followed Britain’s suit in September and the governments of Luxembourg and South Africa expressed their planned sukuk issuance by the end of 2014. Britain’s issuance has attracted above £2.3bn in orders while the Hong Kong issuance attracted US$4.7bn in orders. The huge market demand for sukuk has encouraged non-sovereign sukuk issuance to tap into the fast growing Islamic finance market of approximately US$2tn.

The Goldman Saches successful sukuk issuance in September has motivated Société Générale and Bank Tokyo-Mitsubishi to follow the lead by the end of 2014.

at an agreed-upon, value paid in installments in a partnership-like structure (murabaha sukuk) or he can make monthly payments that comprise a rental portion and another portion that goes towards the purchase price until he owns the house (ijara sukuk). Non-Islamic financial institutions have to devise financial instruments conforming to Shari’a requirements and fitting the sukuk structure. The urging question has been whether the appeal to a growing market has been the sole motive for non-Islamic banks to issue Islamic Shari’a-compliant instruments.

Non-Islamic financial institutions have been devising sukuk instruments that are compliant with Islamic Shari’a rules where the possessor is entitled to part-ownership of an asset and then receives income either from profits generated by that asset or from rental payments made by the issuer. This structure is resolves the issue of receiving non-Shari’a compliant interest payments on lent money, as in a standard bond. Therefore, if a customer wants to buy a house, the bank will buy the house itself rather than lending money and receiving interest.

With Basel III banking regulations being phased in starting 2013, several Islamic banks have issued subordinated instruments, including those in the United Arab Emirates, Saudi Arabia, Turkey, and Pakistan to boost their regulatory Tier 1 and Tier 2 capital. Banks in Malaysia have started to use of investment partnership structures (murabaha) for their sukuk, which will be classified as Tier 2 capital on the balance sheet. Tier 1 capital constitutes core equity and disclosed reserves; and Tier 2 capital comprises supplementary capital of other reserves, provisions, subordinated debt, and hybrid instruments. Basel III regulations allow part of the minimum Tier 1 capital ratio to be in the form of additional Tier 1 capital, a layer of additional capital that is perpetual in nature.

The customer then has two options depending on the structure of the Islamic sukuk transaction.

He can either buy the house back from the bank

The main purpose of Tier 1 and Tier 2 capital is to absorb losses during economic shocks. With additional Tier 1 capital, Basel III is signaling oppor-

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tunities of using instruments that are potentially hybrid in nature and provide fixed rates of return.

While the growth of sukuk issuance has been targeting market opportunities, there have been massive opportunities for the capitalization of Islamic and non-Islamic banks to meet regulatory capital adequacy needs. Out of the total volume of sukuk instruments issued to date, 59% support the Basel III Tier 2 capital requirements while 41% support the Tier 1 capital. Recently, sukuk compliant to Basel III has formed an alternative source of finance for institutions that face difficulties in raising capital through stock issuance as financial instability depresses stock market prices.

After Basel III new regulatory capital adequacy rules, there has been a market gap for the supply of instruments that are potentially hybrid in nature (equity callable at the discretion of the issuer), subordinated to depositors, have no maturity date or perpetual, and offer fixed rate of return to sustain the perpetual nature. This unexploited market gap has been filled with globally growing sukuk instruments, boosting the regulatory capital of issuing banks and reinforcing the role of Islamic finance in the global banking industry.

SPA Ajibade & Co. Legal Practitioners, Arbitrators and Notaries Public Suite 201, SPAACO House 27A Macarthy Street Onikan, Lagos, Nigeria Tel: +234 (1) 4609051; 472 9890; 740 8536 Fax: +234 (1) 460 5092 Email: lagosoffice@spaajibade.com Web: www.spaajibade.com Principal Partner: Chief S. P. A. Ajibade Managing Partner: Dr. B. A. M. Ajibade, SAN Partners: Olayimika Olasewere; Kalu Abosi; Oluwabukola Iji Number of Associates: 17 Other offices: Abuja and Ibadan

S. P. A. Ajibade & Co. is a leading Corporate and Commercial Law firm based in Lagos Nigeria.

Since its establishment in 1967, it has been at the forefront of developments in commercial practice in Nigeria and has continuously rendered sound technical advice and tailored solutions to the specific needs of its clients and its local and international partners across Africa, Europe and the Americas. S. P. A. Ajibade & Co. has advised a wide range of clients on various transactions spanning acquisitions, direct investments, divestments and capital issues.

We are currently advising on the merger and business combination of two brewery businesses in Nigeria that will create the largest company in the sector. We are also advising on the merger and business combination of various insurance businesses in Nigeria in which an international insurance company holds equity interest. We advised SRM Partners Limited in its acquisition of the entire shareholding of Nigeria’s largest bank, First Bank of Nigeria Plc. in and take over of, First Registrars Nigeria Limited in 2013.

We have recently been involved in some of the more important capital debt issues in the Nigerian Capital market.

We are currently acting for the Government of Oyo State in its N55Billion sub-national debt issuance programme. We recently acted for two state governments in their respective sub-national debt issuance programmes namely the Ekiti State Government N25 Billion Bond (Tranches 1 and 2), the Ondo State Government N50 Billion Multiple Series Bond and the Rivers State Government N250 Billion Multiple Series Bond.

We have also advised clients and led corporate restructuring transactions either to meet regulatory requirements or the emerging business strategy of the clients. We have also rendered advice to the Nigerian Securities & Exchange Commission on regulatory compliance issues.

We advised Broad Communications Limited in its divestment of its entire shareholding from Airtel Networks Limited in 2013. We were retained in 2010 to advise Broad Communications Limited in its involvement with Bharti Airtel’s multi-billion dollar acquisition of Zain Africa.

Reputedly, one of the largest ever cross-border deals in the emerging markets.

S. P. A. Ajibade & Co maintains a very vibrant commercial dispute resolution practice and is currently conducting litigation and arbitration before various courts in Nigeria and arbitration tribunals in Nigeria and abroad.

Areas of practice: Commercial Dispute Resolution; Capital Markets Law and Practice; Corporate Finance; Corporate Structuring and Re-Structuring; Insurance and Banking; Real Estate and Succession; Intellectual Property Law; Entertainment & Media.

Languages spoken: English, French, Yoruba, Hausa and Igbo.

Adding value throughout the entire transaction cycle.

URS is a fully integrated global engineering, construction and technical services organisation. With over 20 years’ experience of providing commercially focused environmental, health, safety, technical and operational due diligence in support of multi-billion Euro industrial transactions, URS’ award-winning team is perfectly positioned to guide clients through the process of identifying, quantifying, managing and mitigating risk.

From initial due diligence and deal negotiation to post-closure business integration and investor exit strategy, we support and add value to the entire investment and operation lifecycle. URS is proud to have been named

Acquisition International’s UK Mergers & Acquisitions Due Diligence Provider of the Year 2013.

For further information, please contact: transactions.uk@urs.com

URSGLOBAL.COM

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Islamic Finance

Islamic Finance: A Global Force

The Islamic financial industry is flourishing – and not just in the Middle East.

Barry Cosgrave, senior associate in the finance group at Shearman & Sterling LLP, tells us why

Having suffered an inevitable slowdown during the global financial crisis, Islamic finance is once again on the rise, with growth now being seen outside the traditional heartlands of the Middle East and South East Asia and taking on an ever more innovative and global flavour.

Shari’a scholars which has led to consequential efficiencies in implementing Islamic structures.

Whilst there has been a noticeable improvement in access to liquidity since some of the bleaker days of the recession, it is no secret that capital is still hard to come by for a number of businesses.

The announcement by the United Kingdom government of its inaugural £200m Sukuk issue (Sukuk is the Islamic equivalent of bonds) is perhaps the most high-profile example, but first of a kind issuances by FWU AG in Germany and Tilal Development Company in Oman, as well as innovative structures employed in the Axiata Sukuk in Malaysia and the Sadara Sukuk in Saudi Arabia clearly illustrate that the Islamic finance industry is moving forward.

Islamic investors in the Middle East remain cash rich but lack asset classes in which to invest.

Whilst the Islamic finance market in South East Asia has traditionally been domestic, Middle Eastern investors tend to be more outward looking, which drives overseas investment. However, those investors that need to invest in line with Shari’a principles have often found a lack of assets in which to place their funds, resulting in a stockpiling of cash resources.

What has led to this increase in activity? The growth in Islamic finance is down to certain key factors which probably fall into three main categories: the continued strong cash position of Islamic investors; the de-mystifying of Islamic finance products; and the growing familiarity of Islamic finance professionals with the needs of

Traditionally, Shari’a-compliant instruments have been viewed with a great deal of caution by conventional investors. Much of this was down to a simple lack of understanding of what were perceived to be mysterious structures with complicated names.

However, as an increasing number of Sukuk have run through the maturity cycle, it has provided an

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illustration of how Islamic instruments bear many of the characteristics of conventional finance products.

Finally, Islamic finance has become increasingly popular as the cost of structuring and documenting Shari’a-compliant business has decreased.

Much of this comes down to Islamic finance professionals having gained an increased understanding of the requirements of scholars, which has led to a corresponding decrease in costs. This increased understanding has also complemented the general de-mystifying of the industry.

Increasingly Islamic instruments are being employed in innovative ways even where the structures themselves are tried and tested. The SAR7.5bn Sadara Sukuk is a good example of this: the financing formed a part of a larger financing package which closed in two phases with the Sukuk forming phase one and a combined conventional and Islamic finance package forming phase two. The use of Sukuk was aimed at tapping into the vast liquidity that Saudi Arabia has but which its institutions have struggled to deploy in an environment where Shari’a-compliant assets are hard to come by.

The debunking of the Islamic finance mystique is well illustrated by the number of conventional institutions that invest in Sukuk. It is estimated that around 60% of Sukuk are subscribed for by conventional institutions who regard Sukuk no differently to other fixed income investments. As a result, Sukuk are as attractive to conventional investors as they are to Islamic ones. The problem has traditionally been the comparatively high costs associated with entering into Shari’a-compliant structures. However, as industry professionals gain an ever-increasing insight into the requirements of Shari’a the burden on scholars has reduced. This has allowed scholars to turn their attention to more innovative asset classes to underpin Sukuk and to look at new structures to address products such as hedging and risk management, feeder funds and structured investments.

Islamic finance continues to be an important part of the global financial industry and the increase in its popularity has tracked a general increase in the growth of ethical investment products. It is worth noting that a number of the asset classes in which Islamic investors are prohibited from investing

(for example tobacco manufacture, the gambling industry and arms production) are the same as those which ethical investment funds avoid. There are obviously some Shari’a-specific prohibitions but the majority of those prohibitions are shared.

If an investor is looking for an ethical alternative to conventional investments then Shari’a-compliant structures can provide a solution. An increase in the breadth of the Islamic finance offering will only help with this.

The question is often asked as to whether the global financial crisis could have been prevented by a purely Shari’a-compliant investment environment?

It is, of course, impossible to say, but it should be remembered that the Islamic finance industry has not been free of problems. There have been a number of high-profile defaults on Islamic instruments and insolvency-type situations for Islamic companies. However, these scenarios may be expected during times of heightened economic stress and tight liquidity. What is important to note is that Islamic finance structures have performed no worse than their conventional counterparts.

What, then, of the challenges facing the Islamic finance industry going forward? The call for standardisation continues although at a more muted level. With the growing prevalence of Islamic finance structures, documentation and approach has undergone an organic standardisation to complement the more manufactured version evidenced by the ISDA/IIFM Tahawwut Master Agreement (an agreement, published in 2010, designed to govern the legal and credit relationship between two parties embarking on a bilateral trading relationship involving Shari’a-compliant hedging transactions).

The main challenge for the industry will be to drive innovation through the development of a more diverse range of financial products. Islamic finance is still too reliant on Sukuk as its major asset class and there is a particular need for short-term investment instruments similar to the Central Bank of Bahrain Salam programme. Sukuk will always remain the key Islamic investment tool but more variety will be needed in order to maintain growth.

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