A new world of opportunities
Islamic finance is no longer a niche market. Most investment banks now have departments looking into tapping the region’s wealth, and the success of the sukuk market over the last few years merely demonstrates the huge potential for financing activities in the region, writes Han-Nee Tay.
The Islamic market is a hugely attractive one for any financial institution. After oil prices hit a record high of US$147.27 level on July 11, it is easy to imagine the vast amounts of money corporates and individuals have made in the oil-rich region of the Middle East over the last few years.
It is a fact that the rich are getting richer in the region. Last year, the number of high net worth individuals (HNWI) in the Middle East increased by 15% from the year before, compared to the global average rise of just 6%, according to the World Wealth Report, released by Capgemini. This group’s share of the world’s money increased by 17.5% in the same period. As such, investment banks have been ploughing into the market, looking for ways to expand their businesses. Islamic finance is fast becoming mainstream, to the extent that its terminology is increasingly understood by all in the investment banking business.
“Most foreign banks now have Islamic finance teams,” said Kashif Raza, director of capital markets and syndications at Millennium Capital, a subsidiary of Dubai Islamic Bank. “The concept of Islamic finance is no longer alien. These days, anyone sitting in an office in Canary Wharf is likely to know what an “ijara” is. The terminology is no longer alien.” (For those that still don’t know, an “ijara” refers to a lease agreement whereby instead of receiving interest, which is forbidden under Sharia law, a bank makes money by charging rent on an asset leased to a client.)
Despite the different economic and financial fundamentals in the region, the Middle East is not immune to the credit contagion that has spread throughout the world. In recent years, the sukuk market has been booming, as both Islamic institutions and non-Islamic institutions sought to tap the region’s wealth. But issuance in the sukuk market has all but come to a standstill as the credit environment worsened throughout the world. Issuance in 2007 leapt to US$23.1bn from US$9.9bn a year ago according to Thomson Reuters data, a surge of 133%. By the end of August this year, only US$8.1bn of sukuk has been issued, and bankers are not expecting to see the market come back to life this year, although fundamentals remain solid.
On the other hand, the syndicated loans market has shown some resilience, although issuance is also down on the last year. In 2007, syndicated loans issuance reached US$21.4bn, up threefold from the year before, (again, using Thomson Reuters data). In the first eight months of this year, US$12.7bn of syndicated loans was sold. Part of the reason for the better performance in this market is that the pricing levels have been more attractive for issuers than those in the sukuk market.
Sukuk deals that were priced at around Libor +33bp in April 2007 were now trading at around Libor +190bp. Spreads in the loans market have widened at a slower pace. For example, the government of Dubai used to borrow at a margin of around Libor +10bp but since the credit crisis, has only been able to tap the market at around Libor +55bp. As a result, bankers said they expect to see more issuers tap the loans market before the end of the year.
“Syndicated loans give issuers the ability to use their relationship muscle to get a few banks in,” said Raza. “It’s more relationship-driven, so they can shield themselves from the market environment. What they get is a relationship price rather than a market price. What we have witnessed is an abundance of Islamic syndication being done.”
In terms of sectors, real estate continues to draw interest. Despite the overall sluggishness in the bonds market, investors are still keen to look into real estate deals. Standard Chartered, Dubai Islamic Bank and Badr Al Islami managed to offload into the market an AED1.1bn (US$299m) five-year sukuk from Tamweel PJSC, the largest real estate finance provider late in July. The Capgemini report said the Middle East is the region with the greatest exposure to commercial real estate. About one-third of all real estate investments made by Middle Eastern HNWI are in the commercial sector.
Bankers said that the potential in the region is huge. Deutsche Bank director of global markets structuring Harris Irfan said that there are at least 30 Sharia-compliant structures that could be used, but the market so far has only employed a handful. One area he singled out for growth is in private equity: given that economies such as that of the Middle East, north Africa and south Asia are still growing while the Western world is teetering at the brink of recession, private equity could certainly help to restructure, streamline and improve businesses.
“Economically, we're at a different point in the cycle,” said Harris Irfan who is also the chief executive officer of Dar Al Istithmar, a joint venture between Deutsche, Russell Wood and Oxford Islamic Finance offering Sharia advisory services to financial institutions. “There’s massive shareholder value waiting to be unlocked out here. There's a huge amount of real economy work that can be done. We've barely scratched the surface of it.”
But the key to unlocking the wealth in the Middle East is to find solutions to meet with Sharia principles. While there has been tension between Sharia scholars and investment banks in the past, bankers said that it is an education process for every party. On the part of the investment banks, they have to be sensitive to the needs of the region and be attuned to what constitutes Sharia-compliance – and what does not. For the scholars, they have to learn the workings of investment banks and find ways to make use of the capital markets to ensure that Islamic institutions, firms and individuals benefit from part-taking in global financing.
“This is a new industry and a new area, so we all have to go through an education process,” said Ghazanfar Naqvi, head of Islamic products at Standard Chartered. “Within the bank, we have to educate our colleagues. It’s a process of making people aware of how the structure works and how it would be treated vis-à-vis the regulatory and the balance sheet aspect. We consult the scholars on the structures and they educate us on the Shariah aspects.”