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Thursday, 17 April 2008

Indonesia: Tapping the Islamic bond

(Jakarta Post, 16 Apr 08)

The Islamic bond (sukuk) law enacted by the House of Representatives last week will give the Indonesian government a stronger legal basis for tapping the savings of Muslims within the country and overseas who prefer sharia-compliant financial products.

The Christian-oriented Prosperous Peace Party, the only faction at the House which opposed the approval of the law, had no legitimate grounds for its stance, because the legislation serves the interests of around 90 percent of the Indonesian people.

Moreover, the sukuk law is not the first legislation based on sharia or Islamic laws. We have long had several sharia-based laws such as those regarding the religious court, weddings and the management of alms and haj pilgrimage.

The sukuk law serves only to provide alternative financial services and products to the conventional ones to meet the increasing demand of people who prefer sharia-compliant financial products.

An important principle behind Islamic finance is the desire to maintain the moral purity of all transactions. The funds intended for sharia-compatible investments should therefore not be mixed with those of non-Islamic investments.

In fact, as the world's largest Muslim-population country, Indonesia was rather late in providing legal protection for Islamic financial products. Malaysia, for example, issued in early 2002 what it claimed to be the world's first sovereign sukuk according to the tenets of Islam which forbid interest and investment in such notorious activities as gambling and drinking alcohol.

Now Malaysia is the top global sukuk issuer with over US$52 billion or 62 percent of world's total. Malaysia also boasts of having the most comprehensive range of Islamic products and services from everyday banking and family needs such as deposits, credit cards and insurance to sukuk and other wholesale capital, all under the regulatory and supervisory regime called the Islamic Financial Services Board.

The sukuk law will enable the Indonesian government to raise part of the Rp 117 trillion ($12.8 billion) it plans to seek this year from the international and domestic debt market through the issuance of Islamic bonds in the rich Gulf countries.

The Islamic financial landscape has steadily expanded around the world and is supported by more than 300 Islamic financial institutions in more than 75 countries, with estimated assets of US$700 billion.

In the Middle East alone, according to the analysts of Standard & Poor rating agency, the market for Islamic financial products -- banking, mortgages, equity funds, fixed income, insurance, project finance, private equity and even derivatives -- was estimated at about $500 billion and set to expand further as the petro-dollar gush to the Gulf Cooperation Council countries, including Kuwait, Saudi Arabia and the United Arab Emirates, has continued to increase.

The director general of government debt management said the Finance Ministry would set up a special company (special purpose vehicle) to issue Islamic bonds.

Judging from the experiences of other countries with already well-developed sharia financial services, the first measure the government must undertake is to appoint a sharia board, a move that would provide advice on the instruments and services offered by the institutions in their jurisdiction.

This initial step is essential for the future operations of the institution (special purpose vehicle), as it will help minimize sharia risk -- the risk that the terms agreed to in a contract do not effectively comply with Islamic jurisprudence and thus are not valid under Islamic law.

Another important aspect for the regulator is that its rulings and decisions must be consistent with those of the sharia boards of foreign supervisory agencies.

The government therefore must see to it that its sukuk conforms with the standards set by two multilateral institutions: the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), which issues internationally recognized sharia standards on accounting, auditing, and governance issues, and the Islamic Financial Services Board (IFSB), which issues standards for the effective supervision and regulation of Islamic financial institutions.

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