Islamic Finance Bulletin December 2013

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December 2013

Islamic Finance Bulletin

Gulf One Lancaster Centre For Economic Research

lums.lancs.ac.uk/research/centres/golcer


From the Editor As we reach year-end and peer into the prospects for 2014, it is clear enough that international markets are on the cusp of expecting some critical sense of change. Whether it is the extended buoyancy of global stocks, the nervous retreat of bonds and sukuk, the middling tendencies of oil and copper, or the receding attraction of gold, all eyes are on the balance of economic and policy outcomes in the US, and whether China’s pause and reorientation amount to a significant shift in gears. While we have documented the major trends and minor fluctuations one way and another in 2013, and perceived the dominance of these two leading influences, the new year will represent not only a turn of the calendar but a new phase for investors to get to grips with. At least they are armed with the facts to address the relevant concerns. This month we also host a contribution by Thomson Reuters on the Islamic economy, providing another baseline of understanding as perspectives on Shariah-compliant business opportunity are expanded, notably by Dubai, into non-financial spheres. Our in-house piece, meanwhile, addresses the commercial and strategic realities that have attended the funding programme of Emirates airline, considering both traditional and Islamic bond options to back its own particular expansion in a dynamic industry. We wish all readers season’s greetings and a prosperous outlook for the year ahead.

Contents HIGHLIGHTS (p.3) RECENT DEVELOPMENTS (p.4) VIEWPOINT (p.7) FEATURE (p.10) STOCK MARKETS (p.14) COMMODITIES (p.17) BOND AND CDS MARKETS (p.20) PERSPECTIVE (p.23) DIARY (p.24)

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Highlights Islamic Economy: A key event in the Gulf this year was Dubai’s pitch for leadership of the Islamic economy, stretching the view of Shariah-compliant opportunity beyond the financial field. Our viewpoint article explains the drivers animating segments such as travel and food, relating especially to population and consumption trends, emerging markets growth and trade, and such additional factors as the plans of conventional multinationals, and communications technology.

Oil: As cause and effect of the state of the world economy, oil has had a sideways feel for most of 2013. A lot of attention may be paid at this point to any signs of a breakout in prices reflecting interpretations of the net impact of the Federal Reserve’s tapering plans relative to underlying business conditions. Crude markets into December also reflected expectations of both global supply and demand fundamentals for 2014, and variations in US inventories.

Gold: By contrast with oil, gold’s direction has been clear for some time, and sentiment has anticipated the implications of revised Fed policy. The prospect of QE’s tapering has been taken to indicate a diminution of the monetary stimulus that in any case has failed to ignite an inflationary reaction that might motivate the precious metal higher. Without running yield to compensate for lack of capital growth, it has been the downside that is being thoroughly tested.

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Recent Developments in the Islamic Finance Industry Britain will issue ‘one-off’ Islamic bond Following last month’s initiative by the UK to become the first hub for Islamic finance in Europe, its plan to issue sukuk during 2014 is unlikely to be repeated, according to the head of the country’s debt-issuing agency. The government is planning to sell a £200m sukuk as clearly a symbolic and one-off transaction. No details have yet been given about the timing of the sale. The government is working closely with the Treasury as well as with experts in Islamic finance.

GOLCER perceives this move as being in line with

Britain first announced plans for a sovereign sukuk

the UK’s potential to become a hub for Islamic

five years ago, but no issuance materialised, since the

finance in Europe. It seems that Gulf still would

government then decided that the required structure

like to lead the sector, by operating several Islamic

was too expensive.

banking branches in the euro zone. The Islamic

Source: Reuters, December 5th

finance industry’s emergence in the region has

A clearer picture emerges with this update on the prime minister’s announcement, GOLCER suggests. We still consider this an important step by a Western country in terms of the industry’s growth, as the first and largest sovereign sukuk issuance outside a Muslim country. At the same time, it will bring potential benefits to London as a financial centre. Islamic banking to be deepened in Europe Private investors from some Gulf Arab countries, including a royal family from the UAE, plan to establish the first fully-fledged Islamic bank headquartered in the euro zone. It will be named Eurisbank, with an initial capital of 60 million euros ($80m). The bank will offer retail, corporate and private banking services, with branches in Paris, Brussels, the Netherlands and Frankfurt. Eurisbank will be owned by an unnamed country from the Gulf Cooperation Council (GCC) and other private investors. The founders of the institution plan to apply for a licence in January 2014, with expectations to obtain regulatory approvals by April. By reference, the European Central Bank and the Malaysia-based Islamic Financial Services Board worked during 2013 on a joint project study on Islamic finance in Europe. Source: ArabianBusiness.com, November 26th

been very slow, with some attempts by London and Luxembourg to market themselves as the hosts of Islamic bonds. This became more evident after the recent financial crisis, as European governments have since shown more interest in the sector. This tendency could be attributed to the claimed weakness of conventional finance as exposed during the credit crunch, together with an interest in attracting oil-rich funding countries. Dubai’s Expo 2020 win to boost sukuk Sales of Shariah-compliant debt by Dubai are expected to surge after the emirate’s successful bid for the staging of Expo 2020, with the aim to spur construction projects. Winning the Expo is likely to increase Dubai’s economic growth rate to 6.4% over the next three years, as reported by Barclays. Expectations are that Dubai will spend almost 6 billion euros ($8.1bn) on infrastructure projects during this period. Raising funds to cover such outlays would require the right financial structures, with sukuk tending to be the preferred route of the government. The emirate will speed up plans for a 5 billion dirham ($1.36bn) expansion of the city’s metro network, with a new purpose-built exhibition centre with themed pavilions to be constructed in the desert to the south of the city. Source: Bloomberg, November 27th

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GOLCER finds that the Expo win will give Dubai more

estimated to be worth $1.4trn in the next two to three

credibility, but it will have a tough financial target to

years.

meet in coming years, given its need to find cheaper

Source: Khaleej Times, December 12th

finance, i.e. lower borrowing costs. Still, however, a financial burden looms as the potential increase in spending raises the risk associated with further debt accumulation by Dubai entities. Australia to launch Islamic pension Melbourne plans to launch an Islamic pension fund in January, collaborating with some of Australia’s most well-known Muslim organisations. The purpose is to set up a $1.5trn private pension system. The fund has received regulatory approval, and has been developed with the Muslim Community Cooperative of Australia and the Islamic Council of Victoria (the governing body for the state’s Muslim community). Private pension schemes are also making inroads in majority-Muslim countries including Pakistan, Turkey and Malaysia, with early experience suggesting Islamic fund managers can benefit from such efforts.

GOLCER sees Islamic banking in MENA having some particular characteristics which are liable to make the industry in the region flourish. Banks in the region contain an ‘Islamic orientation’, given the majority Muslim population. MENA already accounts for more than the half of the global figure given for Islamic finance assets. Indonesia aims for insurance legislation Insurers in Indonesia, reflecting South-east Asia’s largest economy, are proposing a new law that will require the spin-off of their Shariah-compliant units. This move is expected to reshape Indonesia’s Islamic insurance market. A draft law is now with parliament, but remains under discussion and may not be stipulated this year. It will cover all areas including licensing, market conduct, and corporate governance for both takaful and non-takaful firms. Indonesia’s

Source: Reuters, December 20th

takaful sector has attracted global firms keen to

This initiative will target a small and scattered

capitalize on rapid economic growth in the world’s

Muslim consumer base that has yet to fully

most populous Muslim country, with 240 million

embrace retirement savings. GOLCER thinks it will

consumers.

be attractive also to other ethically-inclined fund

Source: Reuters, December 11th

investors. However, unlike counterparts in the

It seems that Indonesia’s step is an example that 2014

ethical sector in Western markets, Islamic pension funds globally still struggle for lack of scale and poor management, topics which still need to be considered by Islamic scholars. Next stage for MENA region Expectations for 2014 are that rapidly-growing Islamic-based finance will drive the next phase of economic growth across the Middle East and North Africa (MENA), as discussed in Euromoney’s Qatar Conference during December. The event provided

is bringing more support and promise for the industry worldwide and in general. Initiatives, regulations and accountancy rules appear to be accumulating. GOLCER thinks that such legislation will help the country’s nascent Islamic finance takaful market, which still lags behind neighbour Malaysia’s. It’s time for the industry to have a solid platform supporting Islamic banking, in order to allow fair competition with the conventional sector, which already has a long history of operation.

critical insight into the state of the global economy and the MENA region’s growing role as a centre for Islamic-based finance, with Shariah-compliant assets

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IFSB seeks to tighten oversight

GOLCER believes that, in advancing this initiative,

The Kuala Lumpur-based Islamic Financial Services

it’s time for Pakistan to build a long-term, healthy

Board (IFSB) is revising guidelines on the supervision of

prospect for its own Shariah-compliant sector, as

Islamic finance institutions around the world, helping

well as improve the regulatory environment, given

tighten regulatory oversight of industry practices.

that the industry is increasing in size country by

During 2013 the body issued separate guidelines on

country across the world.

liquidity risk management and stress testing, while it is currently reviewing a draft on capital adequacy. The 187 members of IFSB are likely to bring during 2014 more detailed guidance in response to the global financial crisis, following the trend towards tightening of regulation among conventional financial markets. Revised guidelines detail criteria for using sukuk as tier-1 and tier-2 regulatory capital, a practice pioneered in the past year by Islamic banks in the UAE and Turkey. The latest update by IFSB complements stricter Basel rules, agreed globally in an attempt to make banks safer after the 2007-09 credit crisis. Source: Reuters, December 6th GOLCER finds that guidelines provided by the IFSB, while important, lack additional clarification and details compared to the growing sophistication of the global Islamic banking industry. Still, IFSB represents one of the main standard-setting bodies for Islamic finance, and has been gaining prominence in several majority-Muslim countries. Pakistan’s Islamic banking committee As a marked forthcoming step in one of the largest Muslim-population countries, Pakistan’s Ministry of Finance has set up a committee to explore areas for promoting Islamic banking. This is not the first such initiative – for instance, regulators have already worked on a media awareness campaign. The aim is to expand Islamic banks’ share of the total banking sector to 15% by 2017. The committee will submit recommendations on ten areas by December 2014, covering legal hurdles to converting banks into Islamic ones and the changes required to remove those obstacles. Source: Reuters, December 11th

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Viewpoint Defining the Global Islamic Economy by Sayd Farook and Rafi-uddin Shikoh Four major Islamic market-based drivers are shaping

(ii) Large & fast-growing Global Islamic economies

the growth and prominence of the Islamic economy. These drivers are (i) demographic, (ii) Islamic values-

The 57 mostly Muslim-majority member countries

driven consumption, (iii) economic growth, and (iv)

of the OIC (Organization of Islamic Cooperation)

intra-OIC trade growth.

represented 8.9% of global GDP in 2012. These economies are also growing at a faster rate than the

In addition, four major global environment-based

global economy. The projected growth of the OIC

drivers are also facilitating this Islamic economy.

markets 2013 through 2018 is expected to average

These are: (v) global multinationals participation, (vi)

6.3%, compared to the global 5.3%, based on IMF

global markets seeking opportunities, (vii) growing

projections.

ethical consumption, and (viii) the revolutionizing communication technology.

(iii) Islamic ethos/values increasingly driving lifestyles and business practices

These drivers can be discussed in turn. Islam is seen by Muslims as a way of life. The (i) Large, young & fast-growing global Muslim

unique Muslim lifestyle consumer drivers are

demographic

centered around food (‘halal’ options), familyfriendly environments, accommodation of religious

The world’s Muslim population is expected to rise

practices, gender relation nuances, modest clothing,

from 1.6bn in 2010 (23.4% of global) to 2.2bn by

education, finances, and many other areas.

2030 (26.4%), according to Pew Research Center’s Forum on Religion & Public Life.

Many of these values have universal appeal, and thus many products and services do not have to

The ‘youth bulge’ among Muslim populations in the

be exclusively positioned for Muslims. An example

Arab countries is now a well-known phenomenon.

is that the majority of Islamic finance customers

Today, people under 30 make up about 60% of the

in Malaysia are non-Muslims, attracted by its risk-

population of these countries. While the Pew Report

sharing, ethical and non-interest based financing

projects that the ‘youth bulge’ is peaking, it also

models.

expects the global Muslim population to remain comparatively youthful for decades to come.

According to a 2012 study by The Pew Forum, 87% of Muslims globally consider religion ‘very

By 2030, 29% of the global young population (15-29)

important’, and 93% fast in the month Ramadan. In

is projected to be Muslim. The implication presents

essence, faith as a key market attribute is already

significant economic challenges (job creation,

real and growing for Muslim consumers. The global

training and education) for the host economies,

Islamic finance market (on risk-sharing, ethical, and

as well as opportunities (young consumer market,

non-interest based financing models) has over $1.3

entrepreneurship engine).

trillion in assets, and continues to grow in the 1015% range per annum.

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economy sectors much global credibility and boost. Halal food consumption market is potentially over $1 trillion, representing 16.6% of the

(vi) Developed economies seeking growth markets

global food expenditure. Other emerging sectors include travel, clothing/fashion,

Developed economies are seeking new growth

pharma/cosmetics, media and recreation. In

markets. Asia in particular has been a region where

travel, many Muslim travellers are travelling

much of the focus is centered.

to ‘Muslim-friendly’ travel destinations (e.g. Turkey, Malaysia), given values-based affinity,

Political changes in the Asian markets, the ability

security, comfort (e.g. halal food, family-friendly

to broaden governments’ horizons with regards to

environments, prayer facilities, etc).

investments, and relatively easy and inexpensive communication are all factors that have led

(iv) Intra-OIC trade growth

developed economies to quadruple their direct investment within a decade.

There is a clear drive to develop intra-OIC trade, which is also facilitating development of the

(vii) Ethics and social consciousness globally

Islamic economy sectors.

influencing industries

Intra-OIC trade among the 57 mostly Muslim-

A growing global sentiment around ethical- and

majority member countries has grown to 17%

socially-conscious businesses is emerging. The

from 13% in 2000. In 2005 the OIC had set a

recent global financial crisis raised alarm bells

target of 20% Intra-OIC trade by 2015.

globally, with financial services regulators, business educators and consumers all reassessing the ethical

As an example, Malaysia’s trade with the UAE

focus of various business practices.

reached $8.0bn in 2012 increasing from $6.8bn in 2011, making the UAE Malaysia’s largest

In addition, various large-scale integrity issues in

trade partner. This growth is facilitating Islamic

the global food value chain as well as a growing

finance and halal food related-trade as well.

concern around inhumane animal treatment in food production, together with the environmental

(v) Participation of global multinationals

impacts of an increasingly crowded world and economies, are all having tangible impact on

The OIC countries are very much an integrated

government policies, education systems and

part of the global economy as suppliers and

consumer behaviours. These trends are also

consumers, as well as providers and seekers of

influencing the potential of Islamic economy

foreign investments.

sectors that have ethical and socially-responsible underpinnings.

This global interconnectedness is driving global companies -- ranging from banks globally

(viii) Technology and connectedness

(Deutche Bank, HSBC, Citi) to consumer product and retail companies (Nestle, Carrefour) -- to

Communication technologies are revolutionizing

not only participate but also lead in the Islamic

every possible area of our lives. The internet

economy development given their large scale

connected the world like never before, and now

and stature. Their engagement gives the Islamic

major global platforms of social media and mobile

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services are giving a big boost to develop the globally-

$2.47 trillion by 2018. In addition, Islamic financial

distributed, fragmented demand for halal food,

assets are estimated to be $1.35 trillion (total

Islamic finance and related lifestyle services. Muslim

disclosed), growing at 15-20% a year in most core

consumers are a big part of this digital revolution. The

markets.

cellular subscription base of Muslims globally is 1.3bn, 21% of the global figure.

While the size and potential of Islamic finance sectors have been established, it is the halal food and lifestyle sectors with their significant potential

Primer on the Islamic Economy

size that present a new set of opportunities. Key estimates include:

What do we mean by the Global Islamic Economy? •

Food market: $1,088bn of global Muslims’

The global Islamic economy has core sectors and

expenditure on food and non-alcoholic beverages

their ecosystems, which are structurally affected by

(2012) -- 16.6% of global expenditure, and expected

Islamic values-driven consumer lifestyle and business

to reach $1,626bn by 2018.

practices. •

Clothing & fashion market: $224bn in

These core sectors are primarily centered around

expenditure on clothing and footwear globally

financial services and food, but also include lifestyle

by Muslims (2012) -- 10.6% of global expenditure,

sectors of travel, clothing/fashion, pharmaceuticals/

expected to reach $322bn by 2018.

cosmetics, and media/ recreation. Other segments include education and philanthropy.

Tourism market: $137bn in expenditure

on tourism (not including Hajj/Umrah) globally The consumers of the Islamic economy are primarily

by Muslims (2012) -- 12.5% of global expenditure,

Muslims but also include others outside the Islamic

expected to reach $181bn by 2018.

faith who share similar values. The specific Islamic value-influenced consumer practices include the

Media & recreation market: $151bn in

consumption of halal (lawful) food, Islamic financing,

expenditure on recreation and cultural services

modest clothing, family-friendly tourism, as well as

globally by Muslims (2012) -- 4.6% of global

other services with special considerations on gender

expenditure, expected to reach $205bn by 2018.

interactions and religious practices. The demand also extends to business practices that seek Islamic

Pharmaceutical market: $70bn in

business financing, investment and insurance services.

expenditure on pharmaceuticals globally by Muslims -- 6.6% of global expenditure, expected to

The Islamic economy collectively creates value for

reach $97bn by 2018.

the consumers and economies involved. It also has a major potential to contribute to global well-being

Cosmetics & personal care market: $26bn in

through its underlying socially-conscious ethos.

expenditure, expected to reach $39bn by 2018.

The potential of the Islamic economy The authors are Global Head of Islamic Capital Markets,

In aggregate, the global expenditure of Muslim

Thomson Reuters, and Managing Director of Dinar Standard

consumers on food and lifestyle sectors is being

respectively.

estimated to be $1.62 trillion in 2012, and to reach

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Feature The corporate choice between bonds and sukuk by Rachel Latham and Andrew Shouler Early in 2013 the Ruler of Dubai made a

like bonds, and are rated like bonds by the same

commitment for the city-state to become the global

ratings agencies”, says Nigel Denison, head of wealth

hub of the $300bn market in Islamic bonds, part

management and treasury at Bank of London and

of the strategy to develop Dubai as central to the

Middle East.

global Islamic economy, integrating other segments such as halal food and cosmetic production.

They also offer flexibility, with a number of structures possible, with a lease-back approach commonly used.

The emirate itself raised $1.25bn in January in a mix

If an income-generating asset is present, receivables

of conventional fixed-interest instruments with a

can be securitized. Otherwise, other structures can

$750m Islamic tranche.

be utilized, such as profit-sharing. Issuers mainly are sovereigns, Islamic banks and corporations.

Global sukuk issuance reached $140bn in 2012, up 64% from $85bn in 2011, according to Zawya. Issuers from the UAE accounted for $6-7bn of that total.

With yields on a downward trend, issuers were able to lock into low (US$-related) rates for the medium term, although investment banks questioned whether the market’s price gains of the previous two years would continue, given that inflation

“Sukuk trade like bonds, clear like bonds, settle like bonds, and are rated like bonds” In the first half of 2013, $61.2bn of sukuk issuance was placed. Yields in the GCC jumped 43% in Q2, to 4.2%, but subsequently receded to around 3.9%, according to the HSBC/Nasdaq Dubai Index.

and interest rates may rise in tandem with global economic recovery.

The Islamic Development Bank, based in Saudi Arabia, issued $1bn of sukuk in June. Al Hilal Bank

Currently the nominal value of sukuk listed on Dubai exchanges is estimated at $10.6bn, the third largest

of Abu Dhabi in October issued $500m of sukuk, oversubscribed twelve times.

in the world. Non-Muslims can both buy and issue sukuk, and Over ten years total sukuk issuance had soared from $5bn in 2003, according to Ernst & Young, providing an equivalence of financial instrument with conventional bonds, while structured to meet

“European governments have indicated a desire to issue sukuk to tap the additional pool of Islamic liquidity”, says Khalid Howladar, senior analyst at Moody’s.

Shariah’s requirements. “Overall, we believe the demand for sukuk worldwide “Sukuk trade like bonds, clear like bonds, settle

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is $800bn to $1 trillion, says Ashar Nazim, Islamic


financial services leader at Ernst &Young. “The supply

option in terms of securing an alternative source of

is $250bn. So you can imagine, demand is three times

funding. Capital market products generally allow for

or more what supply is today.”

deviation from the commercial bank route, which has been constrained in recent times.

Still, the fact that supply doesn’t keep up with demand means buy-and-hold investors predominate, so that

Several airlines, such as Turkish Airlines and Malaysia’s

sukuk remain somewhat less liquid than conventional

budget carrier Air Asia, have indicated that they

bonds.

are exploring the possibilities of financing new fleet acquisitions and expansion through Shariah-

Sukuk yields used to be correspondingly higher than for conventional bonds, but that differential has either closed or even overlapped as liquidity has improved.

In the Gulf region Islamic bonds are not only meeting refinancing requirements, but also funding massive infrastructure spending. Prominent examples include

compliant methods.

“Bankers say sukuk are ideal for the aviation industry because of the nature of the assets and the structure and tenor of the securities.”

the power & water sector (names like Saudi Electricity, SEC, and Dubai Electricity & Water Authority, DEWA),

In March this year Emirates Airlines and Malaysia

and events like the 2022 FIFA World Cup in Qatar.

Airlines sought funds to finance fleet acquisition and expansion. Both companies had issued Islamic

Demand for sukuk in the GCC is likely to continue

papers previously.

growing at double-digit rates in the next two years, rating Standard & Poor’s says. SEC broke fresh ground

Saudi Gazette reported that an estimated sixty

with its 30-year maturity issue this April, “illustrating

transactions valued at nearly $10bn have been

that the market is broadening and innovating”.

completed for various airlines and airline leasing companies over the last three decades, with “very

As for sector suitability, bankers say that sukuk are ideal for the airline and aviation industry because of the match between the long-term nature of the assets,

familiar and comfortable” documentation involving Shariah-compliant structures related to purchasing, maintenance and insurance.

with a regular income stream from passenger traffic, and the structure and tenor of the securities.

By the time Emirates launched its $1bn amortising sukuk in March, it had already tapped global debt

Similarly, airport infrastructure may be implicated too. Kuala Lumpur International Airport and the international terminal at Istanbul’s Ataturk Airport involved large Islamic financing tranches.

It’s also said, though, that sukuk are not necessarily a better financing option but are simply a different

markets (in January) for a $750m amortising bond, which Reuters reported “received a muted response due to weak market sentiment at the time”. It had also issued two smaller export credit agency-backed deals this year.

The March sukuk, maturing in 2023, carries an

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average weighted life of five years and was launched at

ER and two Boeing 777 freighters. “We have pretty much

300 basis points over five-year mid-swaps, at the tighter

the same strategy for the next financial year as this year.

end of the nominated range, and was sold to investors

It’s going to be a diversified structure,” the spokesman

in MENA, Europe, Asia, and offshore US accounts.

confirmed.

Clearly, it seemed the decision was strategic for

Based at one of the busiest airports in the world (with

Dubai, not just a corporate financing matter. Emirates

over 32m passengers passing through in 2013H1, up

chairman and CEO Sheikh Ahmad Bin Saeed Al

17%), Emirates has witnessed astonishing growth.

Maktoum told media the aim was “to confirm our support to the initiative of Dubai becoming the world capital of Islamic economy.”

At this year’s Dubai airshow, it again rewrote the record books with an order for 150 Boeing 777X, comprising 35 Boeing 777-8Xs and 115 Boeing 777-9Xs, plus 50

Market conditions deteriorated in the spring, however,

purchase rights; also an additional 50 Airbus A380

with speculation over the US Federal Reserve’s reduction

aircraft.

of its bond-buying programme (QE), which provoked an alarming reaction in emerging-market debt.

Together, these orders, excluding purchase rights, are worth an estimated US$ 99bn at list prices, truly a vast

Average yields on global corporate sukuk increased

sum. “We believe business will come,” said Tim Clark,

46 basis points to 4.62% in the two months following

President of Emirates.

the Fed’s tapering declaration in June (HSBC/Nasdaq Dubai Corporate US Dollar Sukuk Index). The yield on Emirates’s $1bn sukuk increased 31 basis points in that

Snapshot of Emirates airline

period to 5%.

The Dubai government-owned airline, launched in

However, Emirates continues confidently to expand. A company spokesman revealed this year that the Dubai carrier will need an average of $5.3bn a year over the next five years to finance 119 aircraft deliveries. The company could access the sukuk or non-Shariahcompliant bond market early next year, he said. The market volatility that arose in mid-year “is not ideal”, he admitted, but it “has not stopped us from issuing bonds in the past.” Still, the availability of funds might become a headache. “If the banks are having their own problems or the bond markets collapse -- that will affect us,” he conceded. Other options for funding are commercial debt, operating leases and export credits. There are no known plans for an IPO. Cash raised for next year will finance the delivery of 21 aircraft including ten Airbus A380s, nine Boeing 777-300

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1985, currently flies to 137 destinations in 77 countries. Reporting its 25th year of consecutive annual profits, Emirates group announced net profit of $845m for the year to March 2013, up 34% year on year. Group revenues grew 17% to $21.2bn. The airline carried a record 39.4m passengers, up 16% on the previous year. At the group’s cargo business, contributing 15% of the airline’s revenues, tonnage rose 16%, while revenues grew 8%. Profits have surged in the last two years, with more routes and more passengers, but the latest results show the airline to be affected by the fuel and exchange rate issues that have hit other large global players. For the half-year period to September 2013 the company only marginally improved net profit to $475m, despite a 15% rise in passengers to 21.5m.


Financing analysis

demand for sukuk. An issuer such as Emirates airline,

A recent teaching note by Emir Hrnjic, Harun Kapetanovic

with a large issue of U$ 1bn and strong and recognizable

and David Reeb for the Richard Ivey School of Business at

credit profile, would be able to aim to reduce its cost of

the University of Western Ontario contained the following

finance by using a sukuk structure.

remarks on the $1bn Emirates issue --

Analysts differ on the best alternative as to the financing

In June 2012 Emirates repaid a $550 million sukuk bond

of further aircraft orders. Some have favoured repeating

used to finance plane purchases in 2005. In February and March 2013 it raised $1bn in sukuk at a profit rate of 3.875%, and $750m from 12-year amortizing regular bonds

the sukuk issue, some appeared focused on exploring other types of sukuk, and others have leant towards conventional financing arrangements. Big decisions

at a coupon of 4.5%.

remained for the treasury department.

Sukuk bonds are essentially equity-based securities

[Yet], Emirates is a privately held company with a variety

with promised profit rates (in negative profit years, sukuk bondholders still receive payment based on the expectation of future profits), which requires special

of financing options available. In addition, it should be underscored that its treasury function has a strong track record with external capital markets due to successful

accounting and tax rules to make them competitive with

prior issuances.

conventional bonds.

Its decision should not therefore be confined to which

From this perspective, it seems that Emirates’s sukuk has

debt instrument to use or whether to use bilateral bank

higher risk than conventional bonds, and should have

financing; rather, it should include the option of raising

had higher (not lower) yield. [In fact] the sukuk had a

equity as well.

lower yield. This difference seemed at odds with several

A primary decision is the choice between equity and

conventional finance theories. This lower financing cost

debt. Capital increases using the equity path would

might have been one of the key reasons for issuing sukuk

include going public (IPO), private sale and capital

bonds.

increase from the same shareholder. Debt-like options

Sukuk bonds seek to replicate conventional bonds and

include the choice between conventional bonds, sukuk

receive similar accounting and tax treatment in Islamicfriendly markets. However, the equity-based nature of the sukuk bond provides substantial difficulty in providing the

bonds, or lease agreements. Arguably, issuing sukuk bonds provides an additional source of funding that does not entail providing voting rights to external capital

same priority as senior conventional bonds. Moreover,

markets.

bankruptcy courts could potentially invalidate any stated

In respect to sukuk structures, an asset-intensive industry

rule that gave an equity-based security the same priority as

such as airlines allows the deployment of a variety of

a conventional bond.

asset-based structures. The motivation behind issuing

During the crisis in 2009, it seems that Dubai credit was

a sukuk as opposed to issuing a conventional bond

‘too big to fail’. Government-related entities (GREs) that

[involves] diversity of investor base and funding method.

were central to the local debt crisis are closely linked to

The lack of credit rating has not impeded the company’s

(owned by) the ruler of Dubai and/or Government of Dubai.

ability to raise funds. For 2014 Emirates plans to issue

Possible default would have set a negative precedent,

regular bonds and up to $4.5bn of sukuk. Issuing in both

[with] a ripple effect in the investor community. However, it

markets would continue (despite the different costs of

is not clear that Islamic bonds would be more favoured in

capital), owing to different demand curves and investor

the event of a bailout.

interests.

A firm issuing both conventional and Islamic bonds would

Sources: Reuters, Bloomberg, Financial Times, Saudi Gazette,

be able to achieve better pricing with sukuk by favouring

Gulf News, Gulf Times, Dow Jones, Emirates press release,

Islamic financial institutions (IFIs) and their inherent

Harun Kapetanovic (Dubai Dept of Economic Development)

Page 13


Stock Markets GCC Gulf bourses mostly maintained their form through November, spurring gains for the year to 25% on an aggregate basis. Qatar’s index was bestperforming, having been softest in prior months, driven by real estate, banks, transportation and industrials. Saudi Arabia’s Tadawul index also recovered some vigour, turning its attention from disappointing Q3 results towards better outcomes expected for Q4. In a further switch of trends, both UAE markets were hesitant by comparison, keeping watch ahead of Dubai’s ultimately successful Expo 2020 bid. Kuwait, meanwhile, continued to underperform, by some distance on the year. Investors were sidelined by the suggestion of measures to be taken against speculation. Oman and Bahrain were relatively sideways on the month.

MENA The persistence of political wrangling provoked weakness in the Egyptian market, offsetting some of the relative buoyancy achieved in quieter conditions in recent months. Disputes among the 50-member panel writing another constitution for the country led to premier El Beblawi declaring a charter referendum for the new year. The government also enacted a toughening

Page 14

of legislation surrounding public protests, adding to nervousness and uncertainty. During December, however, the central bank’s unexpected cut to interest rates lifted the mood, in the wake of modest quarterly growth data in the last quarter. Reflecting that renewed thrust, key lender Commercial International Bank jumped over 6% to its highest level since 1997.

Far East Asian markets were slavish followers of economic trends in China and the prospects for tapering of US economic stimulus, but there were variations related to particular domestic issues. Thailand’s political troubles stood out, with an anti-government protest movement amassing at government offices, determined to


oust prime minister Shinawatra, who eventually dissolved parliament and called a snap election. Upbeat trade data out of China helped boost Vietnam to a six-month high, and Malaysia’s main index reached an all-time peak upon impressive export statistics. Still affected by the devastation of typhoon Haiyan, the Philippines saw stocks settle at a three-month low. Otherwise regional accounts were subdued in trading volumes ahead of the year-end, but also waiting especially for indications of the Fed’s monetary policy stance in response to latest jobs numbers.

Rest of the World Global equity markets were broadly positive overall, essentially heartened that the US’s QE programme would continue while leaning to determined support for the economy and financial assets. The announcement of Janet Yellen as new Fed chair underscored the point. US stocks hit all-time highs, boosted by Q3 GDP data exceeding forecasts and, for instance, the housing sector illustrating faster activity. European bourses were helped by an ECB rate cut, seeking to ward off deflation in the eurozone, collectively still in some difficulty. Japanese indices approached 6-year highs in mirror image of yen competitiveness, with Abenomics still on trial. Emerging markets, meanwhile, generated negative returns, in line with doubts over the potential withdrawal of stimulus in the US. Latin America proved most exposed in this regard.

Sources: GIC, Global Investment House, Emirates NBD, Bloomberg, Reuters, broker reports

Page 15


Islamic Stock Indices Islamic or Shariah compliant indices exclude industries whose lines of business incorporate forbidden goods or where debts/ assets ratios exceed 33%. The increasing popularity of Islamic finance has led to the establishment of Shariah compliant stock indices in many stock markets across the world, even where local Muslim populations are relatively small, such as in China and Japan.

Evolution of Islamic Stock Markets in November 2013 for GCC, Far East, Middle East North Africa (MENA) and Rest of the World markets. Prices represent the closing price of the respective index at 29/11/2013. Percentage Month-to-Month (MTM) Change and percentage Volatility. Source: Datastream

Conventional Stock Indices

Volatility is a measure of uncertaincy of market returns. It is calculated as the standard deviation of the returns in the reported month. The formula for the standard deviation is: Ďƒ=E[(X-Îź)2]1/2

Evolution of Stock Markets in November 2013 for GCC, Far East, Middle East North Africa (MENA) and Rest of the World markets. Price represent the closing price of the respective index at 29/11/2013. Percentage Month-to-Month (MTM) Change and percentage Volatility. Source: Datastream

Page 16


Commodities Oil In Brent and related series the price dip seen in November was more than unwound in the remainder of the month and into December as confidence grew in the prospects for the world economy -- particularly in respect of the US and China -- and therefore crude demand. Oil generally was initially subdued by a series of stockpile numbers that suggested the market would be well supplied, then by the news that sanctions on Iran might be eased and its exports restored. The scale of build-up in US inventories weighed especially on WTI, but prices snapped back when it seemed pipeline delivery to the Gulf Coast might act to drain the excess. Signs of a stronger American consumer were offset, though, by concerns for counterpart Fed tapering.

Natural Gas While scope exists for price reaction to inventory movements and to chart indicators, analysts confirmed that gas would trade very much in line with weather forecasts, or, precisely, in inverse relation to predicted temperatures. In much of November warmer conditions across much of the US meant that both residential and commercial demand sagged, as did that from electric generators. Forecasts of a colder front during December then boosted prices again, beyond the $4 mmBtu level. But technical indicators pointed to overbuying, and heating requirements were expected to drop later in the month as milder conditions were predicted again. The prospect of frigid weather early in January thereupon prompted another uptick.

Gold In recent weeks gold could not contain its slide, except when offsetting easing of the US dollar, and prices are heading for their first annual decline for 13 years. The pervading notion that

Page 17


the Fed will soon enough begin tapering its stimulus programme upon economic recovery gathering momentum has curbed interest in precious metals. A budget accord in the US had similarly softening effect. As it turned out, tapering talk was validated in mid-December, and gold’s enduring purpose as a safe haven was thereby undercut. Market participants may hope only that the experimental monetary strategy will still tend to prod inflation out of a comfortable zone if the determined policy stance overreaches.

Copper/Base Metals In common with the world economy of which it is supposed to be a barometer, copper maintained a moderate tendency in the same period, with the speculative element flipping from long to short positions. Equally, similarly to many other markets, downward influence came from the general expectation of Fed tapering, while the counterpart factor of the US economic rebound steadily developing kept some upward tilt to prices. Stockpiles in Shanghai and London diminished with an improvement in orders, while robust manufacturing data out of both China and the US also lent firmness, as did a strike at a Chilean smelter.

Sugar/Agriculturals Whereas agriculturals likewise kept a sideways range, sugar continued to suffer, experiencing what was described as a rout. A third straight annual decline beckoned, and a fourth year of surpluses. Production surges from Thailand, India, Australia and Brazil have followed with a lag the incentive of the higher prices of 2011, and bumper crops have arisen this year. A global glut has resulted, as consumption, though growing, has not kept the same kind of pace. Brazil’s pledge to extend its currency intervention plan in favour of the real fuelled sales of the sweetener in US dollar terms. Likely conversion of sucrose for ethanol output may restrict the slump.

Edible Oils

impetus this year has been sustained, with government initiatives in Indonesia and Malaysia to promote biofuel keeping stocks in check. However, if crude oil prices should themselves ease back, then the demand for the ‘green’ substitute would be trimmed. The weather was supportive in recent weeks, though, as monsoon floods impeded both harvesting and transportation. Palm oil prices were nevertheless restrained by the narrowing discount to the rival soybean, whose fulsome crops had impact.

Although palm oil usually eases during this season in the northern hemisphere (as it tends to solidify), its

Page 18

Sources: OPEC, Reuters, Bloomberg


Bonds and CDS markets GCC Gulf bonds were caught between international prompts, as signs of economic recovery in the US and Europe diverged, while the strength of activity in China and Japan continued uncertainly. However, regional trading outperformed that of emerging markets. The market was fragile among sovereign CDS, with spreads widening across the space. That was notable in the case of Dubai, whose credits benefited from the winning Expo bid but whose funding requirements in the next few years were estimated at elevated levels. A defensive mood spread ahead of year-end, as players took to the sidelines, conscious also of the pipeline of supply that could become difficult to digest, although liquidity remained solid enough. Egypt / MENA Central Bank of Egypt’s surprise rate half-point rate cut barely affected the country’s foreigncurrency debt yields, signalling both an economic weakness that needs to be corrected to improve national finances, but also a lack of inflationary pressure. Donations by Gulf states have otherwise given the authorities some room for manoeuvre, allowing sufficient confidence for locals to invest in government securities, bringing domestic yields tumbling. S&P’s rating upgrade in mid-November also helped, and the Egyptian pound found reasonable stability below 7/$. All eyes became trained on the public vote on a new constitution scheduled for January. Malaysia / Far East Asian bonds have suffered conspicuously over the rumours and shifting timeline of the US Fed’s monetary tapering, as the impact of concerned speculation compounded the revealed reaction

sovereign bonds is held by overseas accounts. Asia’s bond markets have reacted very poorly both to US benchmark yields and their implications for the dollar. Malaysia’s quickening inflation rate added to the

of regional markets earlier in the year when the

pressure.

move was initially suggested. Malaysia’s ringgit

Global Benchmarks

experienced nine straight weeks of decline, the longest for eight years. Some 30% of the country’s

Beyond the short end, interest rates rose right across

Page 19


the US yield curve in November, responding to

Sovereign Bond Markets

stronger economic data, particularly the payrolls report. The market believed the improvement increased the chance of the Fed curtailing its QE programme. However, incoming chair Janet Yellen quelled fears at her confirmation hearing. When the Fed announced in mid-December a tapering from $85bn of bond purchases to $75bn per month, prior discounting of the decision mollified the market reaction. The policy pointer given that no precipitative rate hike would be seen also sweetened sentiment. In Europe the policy manipulations of the ECB, in tending to the needs of the struggling eurozone, continued to create a mixture of comfort and doubt in the market, with a background of deep uncertainty over the plausibility of lasting economic recovery and the technicalities of any banking union as proposed and apparently required. Source: GIC, InvestAD, Capital Economics, Bloomberg, Financial Times, broker reports

Evolution of Bond Markets in November 2013 relative to the previous month. The table reports the price index on which the MTM Change is calculated (month-to-month) and the Yield of sovereign bond maturities typically between 6 months and 25 years. Data as at 29/11/2013.

Credit Default Swap Markets

Evolution of CDS Spreads in November 2013 relative to the previous month. The index reported here represents the average basis points (bp) of a 5-year CDS for protection against sovereign bonds. Data as at 29/11/2013. MTM Change refers to the change relative to the previous month.

Page 20


Islamic Bonds (Sukuk) While in the secondary market mainstream bonds and their

tenor of ten years, and carries a half-yearly profit of

Sharia-compliant equivalents both depended on the mixed

6-month Saudi Interbank Offered Rate (SIBOR) plus

economic and policy news from the US especially, on a total

1.55%.

return basis sukuk slightly outperformed the conventional.

Saudi British Bank (SABB), an affiliate of HSBC Holdings,

HSBC’s Nasdaq-Dubai GCC USD Sukuk/Bond TR Index

completed a 1.5bn riyal ($400m) capital-boosting

(GCCB) finished flat in November, though spreads widened

sukuk issue. With a lifespan of seven years, it contained

by 4bps, yielding 4.02%. The USD Sukuk TR Index (SKBI)

a clause allowing redemption at five years, and was

ended marginally up, while the GCC Conventional USD

priced at 1.4% over 6-mth Saibor.

Bond TR Index (GCBI) were marginally down. The primary market was moderately active, and issues were

Sources: GIC, Invest AD, Bloomberg, Reuters, broker

well bid.

reports

Saudi real estate company Dar Al Arkan appeared with a three-year $300m (SAR1.1bn) sukuk that was issued at a profit rate of 5.75%, the second tranche under its sukuk programme. Qatari telecoms firm Ooredoo launched a $1.25bn, five-year sukuk, the firm’s maiden Islamic bond. The benchmarksized issue has a profit rate of 3.039%. The proceeds were for general corporate purposes, including re-financing existing indebtedness. Saudi-based water and power project developer ACWA Power raised a 1.77bn riyal ($471.9m) Islamic loan (5-year revolving credit facility) from four local banks to help finance investments including acquisitions and act as a bridge to a sukuk issue next year. No pricing was given but the statement compared it favourably with that for regional peers and with recent issuances by Saudi and regional government-related entities. ACWA is expanding rapidly across the MENA, hoping to at least double its power generation capacity and water production capabilities. Aldar Properties, Abu Dhabi’s property development, investment and management company announced its completion of a $750m capital-raising via a 5-year sukuk. The transaction, the company’s first foray into the capital markets since the merger with Sorouh, was priced competitively at a spread of 290bps over US$ mid-swaps for a fixed profit rate of 4.348%. It was integral to the firm’s debt strategy, focused on reducing the cost of borrowing, extending its maturity profile and lowering leverage levels. Saudi Hollandi Bank privately placed a 2.5bn riyal ($666.6m)

Source: HSBC Nasdaq Dubai

Sukuk is the Arabic name for financial certificates, but commonly refers to the Islamic equivalent of bonds. Since fixed income, interest bearing bonds are not permissible in Islam, Sukuk securities are structured to comply with the Islamic law and its investment principles, which prohibits the charging, or paying of interest. Financial assets that comply with the Islamic law can be classified in accordance with their tradability and nontradability in the secondary markets.

tier-2 sukuk to support the bank’s capital base. It has a

Page 21


Perspective Islamic finance & economy’s motorway has potholes to be fixed by Andrew Shouler

By contrast with financial markets which have been

financial crisis in favour of socially-conscious business;

shaped in 2013 very significantly by US monetary

and the impact of communication technology in aiding

impetus, real economies and sectors depend over

connectedness.

time on less artificial, more structural drivers. Islamic finance & economy has been quite well focused this year as one such segment of activity worth watching seriously.

These are ideas with a certain credibility, whose collective merits should bring weight to the sector in the course of time. Yet, there is still the matter of delivery, and the presence of constraints. Buttonholed by Laurent Marliere,

Whilst the positive attributes of the industry have

CEO of Islamic legal consultancy IsFin, I was reminded

been much trumpeted, however, there has equally

that particular themes have become ingrained as snags

been an acknowledgement, at well-attended forums

impeding development.

in key centres such as London and Dubai, that negative strains persist that may still dampen its prospects. Anecdotally, this fact became particularly apparent by engaging with the content and delegated representation at Dubai’s Global Islamic Economy Summit in November. A handbook for the event gave a rosier view than certain opinions expressed in the lobbies. In their literature in support of the forum, Thomson Reuters and Dinar Standard undoubtedly gave an impressive, comprehensive account of the opportunities for the Islamic dimension across a range of economic sectors, indicating its genuinely massive potential. Authors Sayd Farook and Rafiuddin Shikoh, of the two organizations respectively, listed eight factors favourably motivating the Islamic market in the years ahead. Four of those were related to trade and growth, namely: the demography of the world Muslim population; consumption trends directed by Shariahcompliant values; the economic growth profile of the relevant countries; and the intra-regional trade prospects of the OIC states. Four ancillary factors were: the emerging presence of globalized companies in the Islamic space; the interest of investors in the growth markets of developing nations; growing sentiment since the global

Page 22

Thus, while Islamic finance “prides itself on ethical governance”, it remains troubled by a “lack of maturity, and conflicts of interest”, he said. Most obviously, its standards, and the control and the certification of Shariah-compliant products, are not evolved internationally. That expert scholars are found only in very limited numbers “leads to an unhealthy concentration of expertise”, he added. On the aspect of reputation, Marliere was very critical about professional migrants from conventional banking whose independence and motivations are doubtful. That brickbat was tempered, though, by the observation that Islamic finance too can harbour unhelpful inconsistencies, such as when “the advisor happens to be the certificatory body as well”, an element that may feature in efforts to organize the industry. Other frailties of the sector he mentioned are very familiar, like the inadequacies in risk management or limitations of existing marketing. So the conjuring that Islamic finance & economy has to perform is – unsurprisingly, and often the way -- to convert potential into delivery. Plans may well come to fruition, but to do so will require not only the willpower of those in positions of authority who may help facilitate market appetite, but the imagination to find ways of overcoming bumps in the road.


Call for PaPers 4th Islamic Banking and Finance Conference (IBF 2014) 23rd to 24th June 2014 Venue: Lancaster University Management School

Keynote Speaker

Thorsten Beck Professor of Banking and Finance, Cass Business School The constraints applied by Islamic banks rendered them more resilient in the recent financial crisis compared to their conventional counterparts. This has attracted the attention of market participants and researchers to their liquidity buffers, leverage ratios, managerial efficiency and bespoke financial products. Islamic banking products are now offered in more than twenty countries and their expanding suite includes bonds, equity indices and insurance. The sector is estimated to exceed $1trillion in value, while growing at about 15% per annum. Among many issues still subject to debate is the purity of Islamic finance in practice, given the need to compete and to operate with customers whose expectations have been formed by conventional banking practices. EIBF centre at Aston Business School in collaboration with GOLCER Lancaster University Management School is organising a conference on Islamic Banking and Finance. The conference aims to provide a forum for an exchange of views on recent developments and to identify key issues/challenges underlying the paradigm of Islamic Banking and Finance in the 21st century.

Original contributions are invited on any of the listed topics: • • • • •

Financial risk and stability Transparency, governance and corporate social responsibility Earnings management and impression management Performance, efficiency and convergence Mutual funds

• • • •

Risk Management, Accountability and auditing Competition Microfinance and SMEs Behavioural finance

Conference Organisers: Dr Omneya Abdelsalam (Aston University), Dr Marwan Izzeldin (Lancaster University)

Special Issue

Journal of Economic Behaviour and Organisation (JEBO) Ana Timberlake Best paper Research Award: £500 Co-editors for the JEBO Special Issue Omneya Abdelsalam, Aston University Mohammed El-Komi, American University of Cairo Ana-Maria Fuertes, Cass Business School Stergios Leventis, International Hellenic University Gerald Steele, Lancaster University

Scientific committee Omneya Abdelsalam (Aston University), Nathan Berg (University of Otago), Rachel Croson (University of Texas at Dallas), Mahmoud El-Gamal (Rice University), Mohamed El-Komi, (American University Cairo), Meryem Fethi (Leicester University), Ana-Maria Fuertes (Cass Business School), Mohamed Shahid Ibrahim (Bangor University), Marwan Izzeldin (Lancaster University), Jill Johnes (Lancaster University), Stergios Leventis (International Hellenic University), Kent Mathews (Cardiff Business School), Khelifa Mazouz (Bradford Business School), Philip Molyneux (University of Bangor), Andrew Mullineux (University of Bournemouth), Steven Ongena (University of Zurich), Vasileios Pappas (Lancaster University), Mohamed Shaban (Leicester University), Mustapha Sheikh (Leeds University), Gerald Steele (Lancaster University), Emili Tortosa-Ausina (Jaume I University), Mike Tsionas (Lancaster University)

For paper submissions please email Marwa Elnahass: islamicfinance@aston.ac.uk Conference Abstract Submission 31st March 2014

Important Dates

Conference Full Paper Submission 27th April 2014

Submission for JEBO Special Issue 1st October 2014

Special Issue Publication October 2015

TIMBERL AK E St atis tics

Econometrics

For ecas ting

Global Forum on Islamic Finance 2014 Conference Developments and The Way Forward March 10-12, 2014 Lahore, Pakistan

Organised by Department of Management Sciences COMSATS Institute of Information Technology (CIIT) http://gfif.citilahore.edu.pk/ Page 23


Marwan Izzeldin Director m.izzeldin@lancaster.ac.uk Andrew Shouler Editor a.shouler@lancaster.ac.uk

Research Team Gerry Steele g.steele@lancaster.ac.uk Vasileios Pappas v.pappas@lancaster.ac.uk Marwa El Nahass m.elnahass@lancaster.ac.uk

DISCLAIMER This report was prepared by Gulf One Lancaster Centre for Economic Research (GOLCER) and is of a general nature and is not intended to provide specific advice on any matter, nor is it intended to be comprehensive or to address the circumstances of any particular individual or entity. This material is based on current public information that we consider reliable at the time of publication, but it does not provide tailored investment advice or recommendations. It has been prepared without regard to the financial circumstances and objectives of persons and/or organisations who receive it. The GOLCER and/or its members shall not be liable for any losses or damages incurred or suffered in connection with this report including, without limitation, any direct, indirect, incidental, special, or consequential damages. The views expressed in this report do not necessarily represent the views of Gulf One or Lancaster University. Redistribution, reprinting or sale of this report without the prior consent of GOLCER is strictly forbidden.


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