Islamic finance plays growing global role
Securities regulators are hopeful that the first Islamic bonds will make their debut in the Thai market in the first quarter of this year.
The Securities and Exchange Commission expects to finalise rules for sukuk instruments some time over the next several months.
Authorities hope that Islamic bonds will help draw capital from the cash-rich Middle East and other markets.
Dheerasak Suwannayos, president of the Islamic Bank of Thailand, notes that Islamic finance has posted massive growth in recent years, and now plays a key role within the global financial system.
Growth in the market has averaged around 80% per year over the past several years, with more than $80 billion in sukuk instruments outstanding.
According to the SEC, Malaysia is the largest market in the world, with some 59% of outstanding sukuk instruments as of September denominated in ringgits, followed by US dollars at 25% and Saudi riyals, UAE dirhams and Indonesian rupiah the rest.
Islamic finance comprises a wide range of instruments and financial structures aimed at bypassing Islamic prohibitions against the payment of interest. In many cases, financing is done through trustees, where a special purpose vehicle is set up to serve as an intermediary between investors and the entity seeking capital. Investors receive benefits through leases or profit-sharing arrangements rather than interest returns.
Mr Dheerasak said Islamic bonds are open to both Muslims and non-Muslims for investment, and that they typically offer greater transparency than conventional bonds.
Recent sukuk deals have even been able to secure funding at 25 to 50 basis points (hundredths of a percentage point) cheaper than conventional bonds, thanks in part to higher investor demand, said Mr Dheerasak.
"No one knows really how big the petrodollar market really is. We think it may be larger than the US dollar market," he said.
Mr Dheerasak said a sukuk bond is similar to a conventional bond in terms of yields and issuing procedures, with a key difference being that Islamic finance is generally structured as an asset-backed security and has restrictions in terms of the type of businesses permitted under Islamic law.
Sukuk bonds boast a major advantage for investors in terms of transparency, given that conventional bonds generally do not stipulate explicit claims on assets.
"Sukuk holders are owners. They share in the revenues generated from an asset. If a default occurs, the assets are liquidated and split among the sukuk bondholders," he said.
"But for a traditional bond, the investor is a creditor. In a default, they will have to queue up with other creditors in splitting any assets."
Islamic bonds may be structured in a variety of ways, but typically fall into one of four categories: Ijarah, or leasing arrangements; Murabaha, a transaction where the seller explicitly declares his cost-plus-profit margin; Mudharabah, a structure similar to a joint venture where profits are shared between a fund raiser and investor; and Musharakah, a joint venture where profits and losses are shared.
Ijarah represents the most common type of structure, accounting for an estimated 60% of the Islamic bonds outstanding in the global market.
Issuing a bond is similar to any other asset securitisation. A company seeking to raise funds may sell assets to a special purpose vehicle (SPV), which pays for the assets using funds raised from the sale of sukuk securities to investors.
Revenues from the assets are passed along to the investors, while the issuer retains use of the assets themselves. On maturity, the transaction is reversed, where the SPV sells the assets back to the original issuer, with the proceeds passed back to the sukuk investors.
The asset trustee is responsible for the issue of the sukuk instruments and its underlying assets. A sukuk trustee, meanwhile, is a professional trustee responsible for overseeing the interests of bondholders as well as monitoring the asset trustee to ensure that terms of the trust deed are being followed.
In Islamic finance a Shariah committee acts similar to credit rating agencies in conventional finance to ensure that the base assets, business and bond structures are in compliance with Islamic law, said Mr Dheerasak.
Malaysia dominates the Islamic finance market in Asia, while London is the main centre for European issues. But a number of global financial centres, including Tokyo, Hong Kong and Singapore have taken steps to support the development of Islamic finance as well.
"We have 9 million Muslims in Thailand out of a population of 67 million. Of this, 1.4 million live in the three southern border provinces," he said.
"Compare this with Malaysia, a country with 12 million Muslims out of a population of 22 million."
"We have a number of top international banks, banks with experience in Islamic finance such as Citibank, HSBC and Standard Chartered with offices in Thailand. I believe that we have strong potential to become an Islamic financing hub as well. It all depends on government policy."
Development of Islamic finance in Thailand has long been hindered due to the tax code, where returns from sukuk instruments are classified as rental revenues and subject to a 12% property tax. Transfers of land or property assets to a SPV is taxed as a land transaction. But a new trust law for capital market transactions will eliminate such obstacles, and clear the way for the issue of sukuk bonds.
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