Financial crisis-related restructurings
and bankruptcy are putting the $1 trillion Islamic finance
industry's financial instruments to their first major test.
Here are some questions and answers about the structural risks
analysts say are inherent in common 'sukuk', which are usually
referred to as Islamic bonds.
WHAT ARE SUKUK'S MAIN STRUCTURAL RISKS?
Islamic finance has five 'pillars':
1. The ban on interest.
2. The ban on uncertainty or speculation.
3. The ban on financing sectors deemed haram, or forbidden
-- such as weapons, pork or gambling.
4. The profit and loss sharing principle -- parties share
risks and rewards.
5. The asset-backing principle -- each transaction must
include an identifiable underlying asset.
Current risks are focused on 'pillar number five' -- asset
securitisation -- and vary according to which of two general
types an investor chooses: 'asset-based' or 'asset-backed'
sukuk.
ASSET-BASED, ASSET-BACKED: WHAT'S THE DIFFERENCE?
The difference lies in ownership and sale of assets.
Asset-based sukuk allow the inclusion of assets that may
not be legally recognised as being owned by the investors.
The assets fulfil sharia compliance in form. But they may
not ensure that investors can recover capital, through sale of
the asset, for example, in the case of originator bankruptcy.
Asset-backed sukuk stick more closely to the ideal of
granting the investor a share of a concrete asset or business
venture, and a share of the risk commensurate with such
ownership.
In this case, sukuk securitisation is structured around
investors' rights, or legal ownership, of a plot of land,
building, or other asset.
WHY ARE THESE RISKS SHOWING UP NOW?
The widespread loss of liquidity and lack of investor
confidence wrought by the post-September 2008 global financial
crisis sent ripples through the world of Islamic banking, due
to originator insolvency, defaults and debt restructurings.
WHO HAS BEEN CAUGHT OUT?
A court case is still proceeding over whether investors in
sukuk issued by U.S. energy firm East Cameron own the assets
that underpinned the issue, reflecting the risks that sukuk
holders face.
The sukuk, an asset-backed musharaka securitised by ties to
two Gulf of Mexico gas fields, crashed into uncharted legal
territory with the bankruptcy of its originating company East
Cameron Partners in October 2008.
East Cameron argued sukuk investors have no rights to the
oil and gas assets as they were not part of a 'true sale' but
rather a 'secured loan'.
WILL SUKUK BE RESHAPED TO SAFEGUARD INVESTORS?
Perhaps. New, hybrid structures may evolve to attempt to
minimise risks. But as with most Islamic finance issues, there
is a diversity of opinion about the best development path to
take.
Differing legal systems, levels of institutional
transparency and sharia interpretations in centres from Dubai
to Jakarta will likely complicate moves to establish legal
precedents and to set and enforce new standards.
The influence of global industry bodies, such as AAOIFI,
and the likelihood of banks enforcing their standards is also a
matter for debate.
Source: Reuters, Moody's Investor Services 'The Future of
Sukuk: Substance over Form?', May 2009
(here
20Finance), Standard & Poor 'Islamic Finance Outlook 2009'
(here
ance_Outlook_2009.pdf)
Link: http://www.reuters.com/article/bankruptcyNews/idUSKLR28939220091105
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