Asiamoney, July 2008
In May, the Monetary Authority of Singapore made a low-key but significant announcement. Speaking to a room full of Islamic finance specialists at a conference in Amman, Jordan, MAS managing director Heng Swee Keat explained that Singapore would develop a program of sovereign-rated sukuk issues.
It might not sound much in the telling, but that’s a big deal. Sukuks are the Islamic equivalent of bonds, and they represent a growing global market, already over US$100 billion in size, with issuers from sovereigns down to corporates all over Malaysia and the Middle East. But despite lots of conjecture, they’ve never yet been issued by a non-Islamic sovereign. Singapore’s announcement is, one could argue, the tipping point where the conventional world’s capital markets not only acknowledge the importance of Islamic finance, but join in.
In fact, the non-Islamic world has been watching developments in Islamic finance closely for some time. For a start, numerous multinationals headquartered outside Malaysia or the Middle East have built big businesses in this area, most obviously banks like HSBC, Citi, UBS, Deutsche and BNP Paribas. But additionally, world centres of finance – both the established order and those aspiring to join it – have increasingly come to realise that Islamic finance is something they ought to accommodate and, if possible, become a hub for.
London has been an early mover in this area, streamlining tax practice and changing regulations to become a better environment for Islamic finance to take off. For years people have been talking about the UK issuing a sukuk in its own name, although today’s credit environment has delayed that venture for the time being.
In Asia, Islamic finance has become yet another field of battle between Hong Kong and Singapore. The Jordan conference, hosted by the Islamic Financial Services Board, featured senior delegations from both states. They took it seriously: Singapore’s team featured Heng himself; Vince Cook, chief executive of the Islamic Bank of Asia, the Singapore-based Islamic bank part owned by DBS; Lawrence Wong, who heads listings for Singapore Exchange; Gerard Lee, chief executive of Fullerton Fund Management, a manager which has greater significance for being a wholly-owned subsidiary of Temasek; and representatives of Singapore’s tourism agencies. Hong Kong pitched up with Eddie Yue, the deputy chief executive of the Hong Kong Monetary Authority; Martin Wheatley, head of the Securities and Futures Commission; Lawrence Fok, chief operating officer of Hong Kong Exchanges and Clearing; and James Lau, CEO of the Hong Kong Mortgage Corporation, among others. One imagines Jordan has rarely attracted such a gathering of the great and the good of Asian finance.
In many ways Singapore has made the most headway so far. Seeing the volume of trade with the Middle East – it has doubled, to US$37 billion, in the last four years – Singapore decided some time ago that it needed an Islamic finance industry to help cater for increasing demand for Shariah compliant financing. The idea is to leverage off Singapore’s strengths – wealth management, trade finance, capital markets – and make sure that Shariah products are among the suite being offered.
On the regulatory side, the MAS built Islamic finance into the existing regulatory and supervisory framework, and reviewed its regulations and tax positions to ensure a level playing field between conventional and Islamic approaches. For example in 2005 additional stamp duties incurred by qualifying Islamic financing arrangements for immovable property were remitted; and banks were permitted to offer Murabaha financing in Singapore. The following year income tax and GST treatments for Shariah compliant financing arrangements, and also for sukuks, were clarified so that those structures would not be disadvantaged compared to their conventional counterparts. Since then Murabaha investments have been permitted, and retail investors in them have been given the same regulatory protection under Singapore’s Banking Act as any conventional depositors. Most recently, in the February budget, a 5% concessionary tax rate was announced on income derived from qualifying Shariah compliant financial activities, including lending, fund management, insurance and reinsurance.
One of the biggest steps came with the formation of Islamic Bank of Asia in Singapore in June 2007. The bank focuses on Shariah-compliant commercial banking, corporate finance, capital market and private banking services and logged over half a billion dollars of deals, including 20 cross-border capital transactions, in its first year of business.
IB Asia is not an entirely Singaporean entity: DBS is and will remain its majority shareholder, but 22 different Middle Eastern investors from prominent families and industrial groups in the Gulf were represented in the company at its launch. Its chairman is Abdulla Hasan Said, who is also economics affairs advisor to the prime minister of Bahrain; the bank has since opened a representative office in the Bahrain Financial Harbour complex.
“A couple of years ago a combination of things came into being,” says Vince Cook, IB Asia’s CEO. (Cook previously ran capital markets and corporate banking for Qatar National Bank, and before that was Barclays Capital’s MD in the Gulf.) “One was an initiative from Bahrain looking to build a joint venture approach between what they saw as an increasing Middle Eastern influence in Asia, making it easier for entities to bring equities, capital and a degree of governance structure back into the Middle East. This happened to coincide with Singapore’s similar wish to build closer ties from the same people.” The Islamic Bank of Asia grew out of those discussions. “The idea is to be at the forefront of these new market-based ideas and introduce opportunities in Asia to our Middle East investors,” he says. “And at the same time we’ve had DBS realising that for them to continue to thrive as a regional bank, they needed to build experience and competence in the Middle East. It’s a very convenient coming together of minds.”
It’s against this backdrop that the new sukuk announcement comes. Sovereign sukuks are seen as both practically and symbolically important. They create a benchmark for other issues to price off, thus developing a curve for issuers and giving predictability and comfort to investors. But they also demonstrate loud and clear that the state itself believes in this style of issuance. For example, Indonesia’s relatively stagnant development of Islamic finance is sometimes attributed in part to its lack of a sovereign sukuk issue; the clarification of laws earlier this year to allow one to be launched, and the suggestion that one will follow this year, have revived interest in the sector in Indonesia dramatically.
Singapore’s approach is an interesting one. Unlike most sukuk programs, this one will work on reverse inquiry: the MAS will issue according to the needs of financial institutions in Singapore conducting Islamic finance. Also, initially, the securities will be priced against the liquid Singapore government securities market, to provide a transparent price discovery mechanism. The idea is that as the Singapore dollar sukuk market deepens, it will then develop its own pricing benchmarks.
Why reverse inquiry? “We decided on this approach after consultations with financial institutions in Singapore,” Heng tells Asiamoney. “The reverse inquiry approach allows us to be more responsive to the needs of institutions. It’s a more flexible arrangement that just issuing on a regular basis. It’s very much market driven. As the need for instruments grows, demand will increase and we can respond more readily to changes.”
Singapore is already home to a number some sukuks and other Islamic securities. In April 2007 MBB Sukuk Inc, a special purpose company established by Maybank, raised $300 million in a corporate bond with Aseambankers, HSBC and UBS as bookrunners. A year earlier, the exchange teamed up with the FTSE Group and Yasaar Research, a Shariah consultancy, to launch the FTSE SGX Asia Shariah 100 Index, made up of 100 compliant stocks from Japan, Singapore, Taiwan, Korea and Hong Kong. The idea was that this index could be used as a basis for exchange traded funds and over the counter trading instruments.
Lawrence Wong at Singapore Exchange tells Asiamoney more are likely to come. “Things like the business trusts [an investment vehicle similar to a REIT, but used for infrastructure or transportation assets] lend themselves to Islamic product,” he says. “We’re working on a Shariah-compliant product in China.” Heng says he will “be glad to see the first Shariah ETF launched in Singapore in the near future.” There are also several Shariah mutual funds offered in Singapore.
Outside of the big public institutions, though, does anyone care? Singapore does have a significant Muslim population in proportional terms (13.6% of its citizens and permanent residents are Malay), but it’s still less than one million people. If Islamic finance is to fly in Singapore, it will be by targeting Middle Eastern institutional flows. Lee at Fullerton admits “at this point of time Fullerton is not known as a provider of Islamic finance products,” although it has established a partnership with EFG Hermes, probably the most powerful local investment bank in the Middle East. “But we do forsee that there will be demand from this part of the world [the Middle East] to invest in Asian capital markets,” he says. “And to the extent that there is money emanating from the Islamic world there will definitely be demand for Islamic compliant products. It would be music to my ears to talk to you in a year or two about such deals.”
If Singapore, with only a slice of its population Muslim, seems an odd place to base an Islamic finance business, Hong Kong looks stranger still. Eddie Yue acknowledges the fact. “We are aware Hong Kong faces a lot of challenges in building Islamic finance,” he says. “The Islamic community in Hong Kong is not big. But we are confident that development of Shariah compliant financial markets can take off even in an environment in which the Islamic community is relatively small.”
In Yue’s view, Hong Kong’s practical and logistical assets will outweigh its apparent lack of relevance to Shariah financial services. “Hong Kong’s relatively small population has never been a factor in undermining performance in conventional capital markets,” he says. “We are not positioning ourselves as a market for supply and demand of Islamic products from a domestic angle. Instead, our objective is to make Hong Kong a platform for international intermediation activities for Islamic finance. What we can offer are location, a highly developed financial services industry, liquid capital market, robust and efficient financial infrastructure and a business friendly operating environment.”
Hong Kong has succeeded in attracting some interesting deals. Much the most significant came in March, courtesy of Khazanah Nasional, the investment arm of the Malaysian government. Using a vehicle called Paka Capital, Khazanah raised US$647 million through a US$550 million exchangeable sukuk and a US$97 million stock placement; the sukuk is exchangeable into ordinary shares of Parkson Retail Group, a Chinese property group listed in Hong Kong. The sukuk itself is also listed on the Stock Exchange of Hong Kong, as well as the Labuan International Financial Exchange.
The real significance of this deal, apart from Hong Kong hosting its listing, was that it ushered China into the realm of Islamic finance. It was marketed as giving Islamic investors exposure to China’s growth story through a sukuk for the first time.
China has long been talked about as a market for Islamic finance. People tend to bring up China’s large Muslim population, in provinces such as Xinjiang in the country’s far west, but perhaps the more important point is the wealth of Middle Eastern capital that wants to get exposure to China in a way they are sure complies with Shariah principles.
Another sign of this growing interest came in May when Dow Jones Indexes launched a new product, the Dow Jones Islamic Market China Offshore Hong Kong Index. This represents the performance of companies that have been screened for Shariah compliance, whose primary operations are in mainland China, but who trade in Hong Kong (so H-shares and red chips). Like Singapore’s index devised with FTSE two years earlier, it is designed to be a reference point for other investment products, such as mutual funds and ETFs. Incidentally, an Islamic China index doesn’t look that much different to a mainstream China index: since there’s nothing unIslamic about telecommunications or oil, the top five components are China Mobile, China Unicom, CITIC Pacific, CNOOC and PetroChina.
This continued engagement of China with the Islamic world is really Hong Kong’s ticket to launch an Islamic finance industry, and it knows it. “We have the versatility and talent to be a conduit to facilitate capital flows between the Middle East and China,” says Yue.
Hong Kong, though, hasn’t yet got as far as Singapore in streamlining the tax and regulation. “We are conscious greater effort has to be made to establish a level playing field in the conduct of Islamic businesses versus conventional,” Yue says. He says the Hong Kong government is conducting a review of tax laws to make sure Islamic finance is not disadvantaged. It’s also hitting the road trying to build relationships with the established centres of Islamic finance: Yue arrived in Jordan fresh from negotiating a memorandum of understanding with Dubai International Financial Centre Authority to foster co-operation between the two jurisdictions on Islamic finance. Wheatley says Hong Kong is “in the relatively early stages of trying to come to grips with all the elements of Islamic finance and the legislation that is necessary,” but adds: “I don’t think there is any change we would need to make in securities regulation. It’s complex tax issues rather than broader legislative issues.”
Markets like Hong Kong may also have a role to play bringing liquidity to the sukuk markets, which up to now have enjoyed very little secondary market trading. “I think Hong Kong definitely has a very advantageous position to provide genuine liquidity,” says Anita Fung, treasurer and head of global markets for Asia Pacific at HSBC. “We have the infrastructure, the payments and settlement system, active participants, investors, issuers, investors, intermediaries… if you make $200 million you just push a button and you can transfer it. It would provide liquidity to Islamic products.”
From the perspective of Islamic countries themselves, the participation of markets like Hong Kong and Singapore is welcome. “The most countries we bring into this, the better service we give to customers and the better competition we get,” says Professor Rifaat Ahmed Abdel Karim, secretary-general of the IFSB. And he notes a shifting balance. “If we look at the members of the IFSB, I see we have 11 from Asia. Asia is becoming very forceful on this.” And if even its non-Muslim countries start becoming big issuers of Islamic product, it’s going to be more forceful still.