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Thursday, 3 July 2008

Credit crunch sparks interest in Shariah compliant finance

3 July 2008

The nervousness precipitated by the US credit crisis has failed to dissipate on the financial markets. In 2008, concern about the quality and market value of some banking assets has prompted major financial institutions in the US, Europe and the UK to begin capital raising. Now a greater degree of caution within the banking sector is making it more difficult and costly for borrowers to gain access to finance. The mood has intensified interest in Islamic finance. Its appeal was initially defined by religious affiliation, but has now spread beyond the world's 1.6bn Muslim community. There is a great deal of investor interest in states rooted in Islamic culture, which apply the principles of Islamic law or shariah with varying degrees of stringency.

The Gulf states, for example, earned $1.5 trillion in oil revenue between 2002-2006. They have financial institutions with limited or zero exposure to the troubled US mortgage market, and have organisations that wish to raise capital using debt instruments closely linked to underlying assets. This is a market with plenty to invest, and borrowers with strong ratings - appealing features in the current market.

There are structural differences in the products offered in conventional western-type and shariah-compliant markets. Conventional bonds commit the issuer to pay investors interest on the sums invested on specific dates. Shariah principles require that financing should be used for the trading or construction of identifiable assets, and do not allow the payment of interest. There are now many forms of shariah-compliant Islamic bonds or sukuk in existence, which differ from conventional bonds in that they represent partial ownership of underlying assets. The shared ownership principle, and emphasis on real assets, is of particular interest at a time when there has been concern about the degree of leverage used in some financially-engineered products. Since the credit crunch intensified in August 2007, global issuance of sukuk is estimated at $30.4bn. According to Moody's Investors Service, issuance could expand by 35% in 2008.

"The growing importance of shariah-compliant finance reflects an important global transfer of liquidity, prompted by the oil boom. It also illustrates how emerging financial markets are increasing their depth and range," says Andrew Marshall, Head of Emerging Market Research at Gartmore Investment Management. "We also note that issuers are moving away from pricing in US dollars, with more issuers choosing the UAE dirham, Saudi riyal or Malaysian ringgit."

There is, however, a level of complexity that results from the fact that products must comply with principles on risk-sharing laid down more than a millennium ago. Even so, the UK is keen to benefit from this expanding market. In March 2008, the government introduced tax concessions for sukuk in its annual budget, and UK Treasury Minister Ed Balls has indicated that the UK could issue its first sukuk bond this year.

Gartmore Investment Management has an experienced, award-winning Emerging Markets team headed by Chris Palmer, Head of Global Emerging Markets. Its Global Emerging Markets portfolios contain selected overweights (relative to its benchmark) in banks with experience of shariah-compliant finance, including the Indonesian Bank of Central Asia and Bumiputra-Commerce Holdings of Malaysia.
Alfalah Consulting-Kuala Lumpur: 
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