More clarity needed on Islamic bonds

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There was a certain amount of consternation in the international markets for Islamic bonds last week on the back of an agency article that suggested the bottom was falling out of the sukuk business and that this would impact on the big infrastructure projects where the UAE leads the field increasingly funded by these instruments. Some clarity is needed.

The article - which was picked up round the world and was still repercussing in the local press at the weekend - highlighted the recently depressed state of the sukuk market (issuance down 50 per cent so far this year) and attributed this fall to a ruling in February by Bahraini-based Islamic scholars that the vast majority of sukuk products were not shariah-compliant.

I remember at school learning the fallacy of the argument summed up in the Latin phrase "post hoc, ergo propter hoc" - after the fact, therefore on account of the fact, meaning that because one event follows another chronologically there must be a causal relationship between them. It would be absurd to suggest, for example, that because the Russian invasion of Georgia followed the close of the Beijing Olympics that the latter caused the former. I think the author of the sukuk article fell into that trap.

That was kind of understandable. The Accounting and Auditing Organisation for Islamic Financial Institutions is the closest the sukuk industry has to a central regulator under its chairman Sheikh Mohammad Taqi Usmani, and he did say that up to 85 per cent of sukuk products were potentially non-compliant. As the figures show, there has been a subsequent (though not necessarily consequent) downturn in the market.

But it is not that clear-cut. For one thing, while Usmani and his organisation are recognised authorities on sukuk, advising global financial institutions like HSBCHSBC and Dow Jones, they are not the only experts in this field. Other institutions like Citigroup, Royal Bank of Scotland, and Société Générale also have their in-house shariah experts. London and Hong Kong, both of which have ambitions to be global centres for sukuk, retain well-paid shariah advisers too.

As one financial expert said: "In times of distress the first thing investors sell are the credits they don't fully understand," and there you have it in a nutshell. International investors' enthusiasm for sukuk has dried up at least partly because they cannot get to grips with the basic concept, and for this the absence of a unified voice on the industry is greatly to blame.

The other big reason seems so obvious I hesitate to point it out, but the world has changed dramatically since the Bahraini body's February statement. In the wake of the subprime-fuelled credit crunch, international financiers are suspicious of all financial instruments, even plain old-fashioned fixed interest debt. With asset values in doubt and spreads widening across all markets (including the UAE) it appears as though debt is just getting harder to sell. World finance is going through a trauma from which it will take years to recover.

It would be a shame if this credit-crunch contagion were to seriously or permanently tarnish Islamic finance, which until the beginning of this year was deemed almost invulnerable to the financial squeeze affecting the rest of the world. There is still a huge pent-up appetite for these products, especially in the Asian markets where sovereign wealth funds are looking for ways to tap into the huge pools of liquidity in the Gulf.

The economic fundamentals of this region, which generates most of the sukuk business, have not changed. There is still dynamic growth and solid fiscal realities. Most Gulf government budgets balance at an oil price of $40-$50 a barrel, so there is plenty of leeway even with the oil price taking a breather at the $105 level. HSBCHSBC, the biggest trader in the secondary market for sukuk, is recommending them as a raging buy at current spreads. That seems like pretty sound advice to me.

By Frank Kane

© Emirates Business 24/7 2008