Islamic finance starts thinking outside the box
Last week’s IFN Europe conference in London, organised by Islamic Finance News, was refreshing. Packed with practitioners prepared to ask difficult questions, we had the impression that “Islamic” finance was ready to work at adding something new to the word “finance”. An example was Dr Armen Papazian of Keipr, who argued for a change in the logic of money creation. There was also a running debate on Day 1 on the question of whether there is a real business case for corporate sukuk.
Create money, not debt
Professor Papazian focused on macroeconomics. One of the fundamental problems with our financial system, he said, is that these days money represents nothing but debt. This applies equally to Islamic countries: widely linked to the US Dollar, their currencies are backed by US treasury bills. “I am not here to tell you that you should be following shariah principles” he said, “what I am proposing is that the principles of Islamic finance have an answer to the problem”.
What he had to propose was the partial replacement of Treasury Bills by Public Capitalisation Notes (PCN). These notes would be issued by the Government Treasury and purchased by the Central Bank. The notes would be used to finance projects with real assets, representing partial ownership and the right to a pro rata percentage of profits.
Used directly to finance projects, PCN stimulate employment, driving consumption, tax revenue and bank deposits. The economy is stimulated, welfare improved and capital formed without the addition of debt. In short, it frees economic growth from reliance on debt and credit.
Dr Papazian justified his radical approach by quoting Albert Einstein: “We can’t solve problems by using the same kind of thinking we used when we created them”.
Who should be issuing sukuk?
“A huge amount of enabling work has been done at the regulatory and tax level”, said Neil Miller of KPMG, referring to the EU sukuk market; so why is nothing happening? His comment was echoed by several speakers, including the country presenters: “The toolbox is ready but we see very little demand” regretted Gilles Saint Marc, speaking of the French market.
In legal terms delegates agreed there was nothing intrinsically new in the design of a sukuk, since the underlying structures exist already in conventional finance. Unfamiliarity an issue, but the problem goes deeper than that.
“If I am a corporate and I raise money through a sukuk, will I get a better price?” asked a delegate, echoing the thoughts of half the room. The answer, said Badlisyah Abdul Ghani of CIMB, is “Not at first”. The first time you tap the market, you are unknown. Even in Malaysia the first sovereign issue paid a large premium, he continued, “but their sukuks are now paying less than sovereign bond issues. The question is, are you willing to invest to tap a new source of capital for the future?”
But therein lies the rub, as Shakespeare would say. Can issuers really tap a new market?
There is a fundamental misalignment between the yields expected by GCC investors and what European companies are prepared to offer. Mr Abdul Ghani suggested that European corporates issuing sukuk should ignore the Islamic investment market, at least at first. “Go to your usual investors who are comfortable with your credit” he recommended, quoting a recent corporate issue, only 6% of which went to Islamic investors. “They got extremely tight pricing; better than a conventional bond”.
Is this a catch 22 situation? The only reason to issue a sukuk is to widen your investor base. Demand is attributed to takaful and re-takaful companies and Islamic banks in search of liquid placements. But if demand really outstrips supply, as experts claim, why is this not pushing down prices?
Other problems exist beyond pricing: structural complexity leads to higher legal fees and a slower time to market. There is also the risk of the project itself, on top of the usual placement risk, and the fact that few sukuk are rated. Finally, some investors do not like asset backed deals because of the risk of ending up owning the underlying liability, such as a ship.
However, certain delegates took an entirely different view, arguing that sukuk were not suitable for sovereign issuers. “The UK can issue conventional debt at extremely competitive prices”, pointed out Rafael Dalmau of BNP Paribas: “the future for sukuk in Europe is corporate”. ER