BUSINESS SCOPE

Specialist audits to ensure compliance

An emerging business in the sector is independent Shariah-compliant audits, reports Tan Su Lin

Complying with the Shariah doesn’t stop after a product receives a rubber stamp from the Shariah board. While approved by scholars in the boardroom, a bank may inadvertently adulterate the transaction through non-compliant procedures. This discrepancy has created the need for verification procedures. “The primary responsibility is with the Shariah advisor of the bank who makes a statement that the bank is Shariah-compliant,” says Mohd Faiz, global Islamic Finance Leader at Pricewaterhouse Coopers Malaysia. “Shariah advisors either en-gage staff to check the service complies with their issued fatwas throughout or they outsource the work,” explains Mr Faiz, global Islamic finance leader at PricewaterhouseCoopers. “External auditors don’t do this themselves, but can do so like an internal audit, with help from Shariah advisory firms.” Shariyah Review Bureau (SRB) was founded to provide reviews and analyses of corporate activities to verify their conformity to issued fatwas.

“What motivated us to develop Shariyah Review services are the trends and challenges facing the Islamic finance industry,” chief executive Mr Yasser Dahlawi says of the company, now in its third year of operations. “Developing an Islamic financial system requires the reinforcement of significant Islamic financial infrastructure, including the legal and Shariah infrastructure and the regulatory and supervisory framework. Significantly, a strong Shariah infrastructure is essential to ensure that Islamic financial instruments and strategies are Shariah-compliant.” When an institution is found to be in breach of Shariah rules, a purification process is typically called for. Far from being ritualistic, Mr Dahlawi describes this as simply identifying and segregating gains realised through non–Shariah-compliant sources or means. These gains are then donated to charity. SRB hopes it can plug the gaping hole in the Islamic financial services industry in the Middle-East where it is estimated that only seven to eight scholars are spread between 80 per cent of the industry’s needs. But with only so few scholars to go around, wouldn’t the same individuals be serving on the SRB as well? “Our scholars are members of other boards including banks, however, their role with SRB is different. Considering the limited number of scholars and the high demand on them, one of our goals is to reduce the pressure on Shariah boards’ supervisory role,” Mr Dahlawi says.

Of course, the success of any kind of audit depends on the strength of human resources. “The critical success factor is having staff to do it and having credible people setting the work plan and reviewing the results,” Mr Faiz says. Although Shariah audits have not been made mandatory, Mr Dahlawi believes such legislation will be passed because he sees a gap between issued fatwas and their respective implementations. “Even though there is no legislation requiring a Shariah-compliance audit, we expect demand to grow, and we expect more attention from central banks in the GCC region.”

Substance versus form still an issue after 15 years

Islamic financial services has plenty of work cut out for it if it wants to be seen as a true alternative to conventional finance. At least that’s what delegates at last month’s FT Global Islamic Financial Services Summit would have come away thinking. A straw poll of 200-odd delegates at the conference found more than 60 per cent regarded Islamic finance in its current state as merely a “wrapper” for conventional finance. Encouragingly, more than half agreed the industry has set a clear vision of where it wants to be. Substance versus form and Shariah-compliant versus Shariah-based made up a good part of the lively discussions. As one round-table speaker put it, the debate is still running after 15 years. The question is whether the industry can move from taking conventional product structures and tweaking them to gain Shariah approval, to bringing original Shariah-based products to market. For all its existential pondering, the industry is still teeming with activity. Industry leaders believe there is fundamental demand for Shariah-compliant financial services, with the industry on the cusp of innovation. A study of the global industry by The Banker and Cambridge consultancy Maris Strategies predicts the next big wave of Islamic banking expansion will be to the vast number of unbanked in the Muslim world.

Indices give sukuk broader coverage

Investors can benefit from indices that track movements of international sukuk, reports Tan Su Lin

Fixed income investors frequently moan and groan about the lack of a vibrant secondary market for them to buy and sell sukuk and how this limits liquid-ity management. Despite its drawbacks, the global sukuk market is gaining depth and diversity with the increasing number of private and sovereign issues. With interest in sukuk far from diminishing, the Dubai International Financial Exchange (DIFX), in collaboration with HSBC, launched a group of indices to help investors value their portfolios. The family of indices include those that exclusively track price movements of conventional Middle Eastern bonds and international sukuk. For sukuk, HSBC-DIFX has created the SKBI, which tracks global sukuk issued in dollars, euro, sterling and yen. While other sukuk benchmark indices such as the Dow Jones Citigroup Sukuk Index, have been established for more than a year, the DIFX hopes the SKBI will become the benchmark of choice for most investors. With 10 sub-indices, the SKBI offers more depth and range to investors. The Dow Jones-Citi Sukuk Index lists 11 component issues and is limited to issues denominated in dollars, with a minimum of US$250m. By contrast, the SKBI casts its net wider. Moreover, the DIFX boasts the highest value of listed sukuk in the world—US$13.8bn. Of course, much of this comes from two colossal issues: a US$3.5 bn sukuk musharaka by port operator PCFC Development FZCO and the US$3.52bn sukuk Ijarah by Nakheel Development.

As with any new index, the SKBI is touted as a tool that will contribute to market liquidity. Armen Papazian, head of innovation and development at the DIFX, says the exchange is looking into the possibility of having separate indices. “DIFX and HSBC are open to suggestions. We will take into account the demands of investors.” Yet, observers are quite clear on what the market really needs to gain momentum. According to Mr Papazian, a large number of small and medium issuers and investors are crucial for a healthy sustainable market. Right now, those numbers are absent. “The way to bring the small and medium players into the market is to have cheaper, faster and standardised sukuk issues,” says Mr Papazian. Giath Shabsigh, the International Monetary Fund’s chief of Middle East and Central Asia division of the monetary and capital markets department, outlines the fundamental problems with the sukuk market, including the lack of plain-vanilla or standardised issues. With the absence of Shariah-compliant mortgage backed securities in large volume, he says that this hinders the ability of Islamic financial institutions to manage liquidity. For the industry to move forward, Mr Shabsigh says that the sukuk market needs to be integrated with the conventional market.

While that may take some time, institutions such as the DIFX are committed to the development of the industry. Mr Papazian says: “We are the largest sukuk market in the world. We take a strategic view and we intend to contribute to its growth.” The global credit crunch that plagued financial markets this summer has undoubtedly clouded the outlook for new debt issues. At the time of writing, at least two more Islamic debt issues were in the pipeline. Bookrunning for the Ras Al Khaimah Investment Authority US$500m government-backed sukuk began in November. The sukuk will be listed on both the DIFX and the London Stock Exchange. The Rakia sukuk offers a test bed of investor appetite for debt issues in a perplexing market environment. Gulf sukuk issues this year could more than double to US$35bn from US$17bn in 2006.

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