Sukuk model grows in strength in spite of Islamic compliance doubts

Infighting will always be there, but so will sharia-based business, says James Swift

Muhammad Abdullah Al-Harith Sinclair
Muhammad Abdullah Al-Harith Sinclair

In November 2007 Islamic finance, which until then had been soaring on the back of a bullish economy and a climate of more liberal interpretation, hit its first snag.

Sheikh Muhammad Taqi Usmani, head of the religious board at the Accounting and Auditing Organisation for ­Islamic Financial Institutions – the body that sets standards for Islamic finance products – declared that around 85 per cent of the sukuk in issuance broke key principles of Islam and were not sharia-­compliant.

The media made a big fuss of the statement and, according to a number of Islamic finance lawyers, exaggerated its significance. The instruments Taqi Usmani was referring to made up only a small percentage of all Islamic finance transactions – probably less than 30 per cent and maybe as little as 15 per cent.

But before people had time to put things in perspective, the ­global financial crisis hit. ­Combined with the uncertainty that followed Taqi Usmani’s claim, it almost killed off sukuk.

“It almost brought things to a complete halt,” says Jawad Ali, ­managing partner of King & ­Spalding’s Middle East offices and global co-head of Islamic finance at the firm. “Four or five months after [Taqi Usmani] made the announcement the financial ­markets tumbled, so sukuk took a double hit and numbers dropped drastically, almost to the point where people questioned whether sukuk would survive and if it would ever come back.”

But it is coming back. A report issued by Kuwait Finance House in August stated that global sukuk issuance could reach $30bn (£19.3bn) in 2010, an estimate that is derived from a first-half result of $16.5bn (£10.62bn). This represents a great improvement on the $7.6bn recorded in the same period last year.

“It’s welcome news and shows that the market’s coming back, that the market has dealt with the ­structural issues that were ­criticised and that people have reached a compromise,” says Ali.

“We’ve closed three sukuk in the past four months and are ­pitching several other billion-dollar sukuk deals,” says Norton Rose head of Islamic finance Neil Miller, ­supporting Ali’s optimism. “The practice is alive and well and will come back, but it’s linked to the magic word ’confidence’.”

Islamic finance as a whole, of course, never really went away. Its ups and downs merely mirrored those of conventional finance, with some exceptions – shortly after Lehman Brothers went bust investors fled conventional funds for the perceived haven of sharia-compliant structures and all things Middle Eastern. Large restructurings, such as that of Dubai World subsidiary Nakheel (see box) and Kuwait Investment Dar, characterised the market and new-money deals were few and far between.

General Electric’s (GE) first sukuk, issued in December 2009 with Allen & Overy partner Roger Wedderburn-Day advising, was one of the first signs that things were picking up, albeit slowly.

It was an innovative deal that used a portfolio primarily made up of ownership interests in leased ­aircraft and showed that, not only was sukuk coming back, but it had grown.

“The way we see it, at the moment there are two principal trends,” says Clifford Chance ­partner Habib Motani. “One is the increase in globalisation, ­meaning people from around the world are looking to access Islamic investors. For example, GE ­recently issued sukuk to raise funds in a way that gave it access to Islamic investors, and Japanese companies such as Nomura have been looking to access that investor base too.

“The other significant trend is the increasing sophistication of products. The launch of the ISDA/IIFM Tahawwut Master Agreement is one example of this.”

As liquidity continues to be in short supply, governments across the world are legislating to make tax codes more sharia-friendly in a bid to tap Muslim cash.

London appears to be ahead of the pack in terms of non-Muslim countries. The 2009 Finance Act was just the latest adjustment in creating a level playing field for sharia-compliant investors in the UK. But in 2010 countries such as Australia, South Korea, Singapore, Hong Kong and France have also looked to encourage Islamic investors.

“There’s still so much cash in [the Middle East] – all you need to do is look at the price of oil,” says Ashurst international finance partner Abradat Kamalpour. “There’s enormous wealth [in the Middle East] and people want to use it in a sharia-compliant way. I think things are going to get more interesting in private equity and technology, and we’re also seeing a spike in sharia-compliant credit notes along with other more ­structured products.”

The ideological struggle between those who want Islamic finance to remain true to its ­spiritual roots and those who would take a more pragmatic approach – the divide which led to Taqi Usmani making his ­statement – still exists. It probably always will.

It is a situation that is not helped by the lack of cohesion among scholars in Gulf countries and the absence of a single regulatory body.

“There’s an undertone in the market that if you try hard enough then you can get people to approve anything, and that undermines the credibility of the market in its own eyes,” says Pinsent Masons partner Muhammad Abdullah Al-Harith Sinclair.

Others see the push and pull between the two schools of ­practice as a small but inevitable, even exciting, part of the practice area.

“The chatter’s constant,” says Miller at Norton Rose. “People are always talking about these issues. One of the most exciting things about the industry is that you have a lot of people who are passionate about doing things properly. If we do something that’s not ­completely compliant we take a look at it and try to do it better next time.”

It is easy to forget how new Islamic finance is as a global practice. “The longest anyone can say it’s been going on is since the 1970s, but it never really took off until the late 1990s or early 2000s,” says Pinsents’ Sinclair.

And while things are picking up slowly, the practice feels it has demographics on its side.

“Around 25 per cent of the world’s population is Muslim, and most of these people are in ­markets that are emerging,” says Miller. “But Islamic finance only accounts for around 1 per cent of finance deals. There’s only one direction the practice can go, and that’s up.”

Recent islamic finance deals

In December 2009 Ashurst, led by Islamic finance partner ­Abradat Kamalpour and restructuring ­partners Matt ­McDonald and David Von Saucken, advised creditors holding 25
per cent of Dubai World subsidiary Nakheel’s $3.52bn (£2.25bn) bond. The creditors were paid when Abu Dhabi agreed to put up $10bn in financing to Dubai.

Clifford Chance advised Kuwait Finance House (Malaysia) Berhard as lead manager on Nomura Holdings’ $100m
sukuk in July 2010.

The Clifford Chance English law team was led by partner and head of Islamic finance Qudeer Latif in Dubai and partner Reiko Sakimura in Tokyo. White & Case advised Nomura, led by Hong Kong partner Hallam Chow.

In August 2010 Hogan Lovells and Norton Rose acted on what was thought to be the first sukuk issue from Turkey. Norton Rose, led by associate Rizwan Kanji, advised Kuveyt Türk Katilim Bankasi, a Turkish subsidiary of Kuwait Finance House, on the $100m issue. Hogan Lovells, led by partner Rahail Ali, acted for Citigroup Global Markets and Liquidity Management House.

Allen & Overy, led by partner Roger Wedderburn-Day, and in collaboration with Abdulaziz AlGasim Law Firm, advised Saudi Electricity Company on a $1.87bn sukuk, issued to fund an investment programme to expand its generation capacity. The deal is one of the largest so far in 2010.