A tale of two Shari’ah

According to Standard & Poor’s and other similar sources, the global Islamic finance industry is set to double in size from its current value of QR4.9 trillion by 2015. Moreover, according to exchange data, a total of QR510 billion in sukuks were issued in 2012 globally (a 64 percent increase from 2011), taking the outstanding sukuk market to an unprecedented high of QR874 billion.

It is little wonder then that Islamic finance centres in the Middle East and in Asia are seeking to cast themselves in the role of primary guardian of the code of finance defined by Shari’ah principles. There are many similarities in the way in which Islamic finance is practiced. For example, all of them forbid investing in activities that can be deemed speculative, involve uncertainty, entail the payment of interest, or are involved in prohibited businesses.

However, there are also some key differences, which have long-term ramifications for the development of this financial sector. One such broad-based regional difference lies in the basic school of Islamic thought that governs the regions and their corollary approach to finance, highlights Yusuf Battiwala, Islamic Finance specialist at Allen&Overy in Dubai. While Saudi Arabia follows the stricter Hanbali school Battiwala says, Malaysia, home to the largest Islamic bond market in the world, adheres to the less conservative Al Shafi`i school of Sunni Islam, while much of the remaining Gulf Cooperation Council (GCC) steers more of a middle course, following the Mâliki approach.
In practical terms, underlines Gregory Man, senior lawyer specialising in Islamic finance for Clifford Chance in Hong Kong is that, for example, a financing structure for a murabaha-type sukuk that may be able to be traded at an amount other than par in Malaysia, may not be considered as having sufficient tangibility in the underlying assets to make the sukuk tradable at an amount other than par in the Middle East.

There has been some controversy over such structures, particularly of the commodities type (Tawarooq) in which a bank buys and takes title to the relevant commodity assets from a third party broker, and then sells the assets to the borrower at cost plus a specified profit. In the Middle East, Islamic scholars highlight the risk of the commodities never changing hands and of there being no tangible commodities at all, just cashflows between banks, brokers, and borrowers, thus negating the basic tenet of Shari’ah pertaining to tangible underlying assets underpinning all transactions.
A wider adjunct to this, says Khairul Nizam, assistant secretary general of the Accounting Auditing Organisation for Islamic Financial Institutions (AAOIFI) in Bahrain, was evident in 2008, when the organisation stated in February of that year that the repurchase undertakings found in around 85 percent of apparently Shari’ah-compliant bond and equity fund structures that were based on mudaraba and musharaka violated the Islamic duty to share risk as well. Following this, the issuance of these two types of bonds fell through the year by 83 and 63 percent.

Nizam adds that having already produced 44 Shari’ah standards over the past few years to carefully demarcate what is precisely Shari’ah-compliant and what is not – in addition to another 40 standards on accounting, auditing, ethics, and governance – it appears that there is a broad-based move across the globe back to true Shari’ah-compliant banking and tradable assets.
Interestingly, in this regard, Malaysia continues to lead the way in the issue of sukuk, and Islamic equities products, by some margin (with around 80 percent of Islamic finance products in Malaysia held by non-Muslim investors), while Saudi Arabia continues to dominate straightforward bank deposits, concentrated almost entirely within the Muslim community.
Responsibility for imposing such regulatory frameworks also differs. “If you offer an Islamic REIT, in principle the underlying assets should be covered on a takaful basis, and it is here there appears to be a difference as to what sort of overseeing body provides the guidance,” Marcel Omar Papp, Head of Retakaful (Islamic Reinsurance) for Swiss Re Retakaful, in Kuala Lumpur, tells The Edge.

In the Middle East, guidance broadly comes from the AAOIFI, while in Malaysia specifically, and in Asia more generally, such guidance comes largely from central banks, their associated bodies (monetary authorities, for example, in the case of Hong Kong), and Shari’ah boards. This more insular operating environment in Asia, Papp adds, finds further resonance in the fact that Asia’s Islamic finance sector is currently much more focussed on individual domestic markets than is the case in the Middle East. “In Malaysia the vast majority of sukuk issuances are sold into the deep local ringgit-denominated market, whereas in the Middle East, especially in the GCC, the majority of major sukuk offerings are geared towards international investors.”

So, where does Islamic finance in Asia and the Middle East, specifically countries such as Qatar, go from here? As it looks increasingly towards making more international-oriented sukuk offerings, thinks Man, then Asia’s interpretation of Shari’ah finance is likely to move more towards the Middle East’s, if only on the basis that a level legal playing field will be required for international investors.