united arab emirates

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Islamic-Bond Market Becomes Global

This year, a new trend was observed in the International financial market with the borrowing of the Texas-based energy firm East Cameron Partners from the Middle East Market to raise cash for their projects instead of approaching the banks or the domestic bond market. The result is the first bond backed by U.S. assets that adheres to Islamic laws against paying or charging interest.

There is a marked difference between Islamic financing and conventional financing. Islamic financing is strictly adhered to Shariah, or Islamic law, which calls for ethical and equitable financing, and bans speculation.

Conventional bonds issued by companies or governments pay a fixed annual interest rate for the life of the bond which can be as many as 10 or even 30 years, after which the principal is repaid. Some bonds are backed by assets such as mortgages or credit-card receivables. If the issuer defaults, the assets are sold to recoup some bondholder losses.

“Sukuk” is the Arabic name for Islamic bonds.Sukuk are similar to asset-backed bonds, but instead of a fixed annual interest rate, payouts to investors over the life of the bond are derived from leases, profits or sales of tangible assets such as property, equipment or a joint-venture business. These leases, profits or sales can be structured to deliver the equivalent of a fixed annual interest rate, yet they technically aren't the forbidden "interest" payment.

Islamic bonds are increasingly being used in the Middle East Western and Asian companies and governments to tap a well of petrodollars. According to this trend, A great number of of Persian Gulf-based borrowers are following suit to raise cash overseas, particularly for large infrastructure projects needed to diversify their sources of economic growth.

Resultanly, the Islamic finance market is experiencing a swift global expansion and this trend is helping in building bridges between Muslim and non-Muslim nations.

According to London 's Islamic Finance Information Service, $16.9 billion in sukuk was issued between January and October this year, 43% more than the total in 2005. Analysts say there is easily $10 billion in the pipeline for the next few months.In the first half of 2006, new sales of international bonds and short-term notes totaled $1.2 trillion, according to the Bank for International Settlements.New rating and hedging tools are expected to help the Islamic bond market expand faster.

An Islamic bond would be easily placed with conventional investors, which can widen the investor base, whereas the opposite isn't true.

In the Middle East, The marketing of the Islamic bonds have been successfully observed. Malaysian borrowers, including state-owned investment company Khazanah Nasional, have marketed Islamic bond deals in the Middle East . So has the Pakistani government, selling $600 million in bonds in 2005. In Japan, Bank of Tokyo-Mitsubishi UFJ Ltd., the core banking unit of Mitsubishi UFJ Financial Group Inc., is allying with Malaysian bank CIMB Group Bhd. to sell financial services, including potential Japanese corporate sukuk.

The Muslim Communities of the Gulf Region has history of looking close home to raise capital for centuries. Recently, there is a remarkable change in this traditional trend. Now they are looking farther a field for Shariah-compliant funds to finance projects aimed at transforming the region into a tourism and business hub.

Dubai Ports , Customs and Free Zone in January sold 11% of its $3.5 billion sukuk -- the largest ever -- to European investors. Around half went into the hands of non-Islamic investors.In Future, the other Gulf region countries (Bahrain , Kuwait , Qatar , Saudi Arabia , the United Arab Emirates and Oman ) are going to follow suit this financial borrowing trend.

Infrastructure is a perfect use of sukuk because funds are raised that are to be used for a specific project. Assets that are created can generate a return" to pay bondholders. That’s why, the property sector is considered very important one in the Middle eastern region.

Some Islamic borrowers are preferring to list their deals outside their home jurisdictions. Mr..Gerard Scully, head of debt listing at the Dublin exchange, which last month got its first sukuk listing said, “Listing on a European exchange like the Irish Stock Exchange makes secondary trade easier from a regulatory point of view for European institutions”. The London and Luxembourg exchanges also list sukuk.

The global expansion of the Islamic bond Market gives people the chance to learn something positive about Islam, and it counters negative issues in other areas.Cross-border sales of sukuk are prompting greater harmonization in the way the bonds are structured.

The Middle East's interpretation of Shariah is not favoured in all other muslim countries.Malaysia in the past has favored bond structures that don't comply with the Middle East's interpretation of Shariah, notably the deferred payment sale principle of bai' bithaman ajil -- whereby a bank buys an asset on behalf of a customer and sells it later at cost plus a profit margin. In recent years, however, the Malaysian government has offered tax breaks to encourage the use of more globally accepted structures in a bid to become an Islamic financing hub.

One is called the lease-based, or ijarah, structure. Say a petrochemical company wants to raise $350 million. It would sell a plant to a special-purpose company set up for the deal and then lease it back for five years. Investors or banks would lend the company the $350 million. Instead of interest payments, the investors would get proceeds from the lease payments. After five years, the special-purpose company returns the plant to the parent company, and the principal $350 million is returned to the investors.

Another globally accepted structure is called musharakah, a joint venture. The venture's partners buy Islamic bonds and receive payments over the loan period based on the plant's profit.

In September, Malaysian toll-road operator Plus Expressways set a precedent by swapping outstanding 4.7 billion ringgit ($1.3 billion) in bai' bithaman ajil debt for Persian Gulf-compliant funding to make the company eligible for inclusion in global Shariah stock indexes.

The use of credit ratings will futher encourage the cross-border investment opportunities.For this purpose, Shariah Quality Ratings has been developed by the year-old Islamic International Rating Agency. It is actually designed to help Islamic investors better judge the standard of Shariah endorsements of an instrument or issuer.

Another catalyst for growth should be global standards for Shariah-compliant derivatives -- financial products designed by investment banks to hedge the risk of Islamic debt. New York 's International Swaps and Derivatives Association and Bahrain 's International Islamic Financial Market are engaged in talks aimed at agreeing on such basic standards.

Islamic investors have some problems in order to survive in the modern financial market. i.e., Adherence to Shariah prevents Islamic investors from using conventional hedging tools -- interest-rate swaps, forwards or options -- to offset fluctuations in interest rates and currencies. The few tailor-made hedging tools now in use have concentrated such risk into the hands of a small number of investors. Global standards would help spread it more evenly, bankers say.

Badlisyah Abdul Ghani, head of CIMB's Islamic division, says, “For the Islamic market to exist in the proper manner, it must have all the relevant products that befits the financial market. For every single conventional product, you want to have the equivalent Islamic product,"