SCREENING

Beneath the veneer

The sub-prime crisis presents a compelling window of opportunity for Islamic finance both to showcase the merits of asset-based or backed financial intermediation as well as to deploy savings into real investments. Islamic finance operates in the same macro “conventional” tax, regulatory and legal environment, and it has the same vulnerabilities of liquidity and confidence. Islamic banks—within their capacity of amanah (trust)—need to undertake a customised stress-test exercise consistent with the uniqueness of the home country.
     The methodology must not be seen as initiated or heavily lobbied by Islamic banks, as this will erode confidence and contribute to allegations of opaqueness. The stress-test must be transparent, comprehensive and flush out the impaired Islamic assets.
The test should apply to all Islamic commercial banks in the gcc and include takaful operators. A seal of approval would confirm the positive spin of cheerleaders of Islamic finance and objectively showcase that the model works better or differently in a crisis from its conventional counterpart.
     Has the industry been able to build on the success of other asset classes and positive (sustainability) screening? What about screening of the publicly listed companies in Muslim countries with stock exchanges?
     To date, we don’t have Islamic real estate investment trusts (reit) indexes or commodity indexes, and yet real estate is an important asset class for Gulf investors, and the latter provides the foundation for murabaha contracts. Despite the launch of an Islamic sustainability index in 2006, no funds, exchange traded funds, or structured products have been launched off it yet. Sustainability has become a powerful phenomenon in non-Islamic investing, hence, an ideal opportunity for building bridges.

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INDICES

Symbiotic relationship

The relative stability of Shariah-compliant investment products has not gone unnoticed. Owing to its lack of speculation, the industry is attracting new fans daily. The Islamic funds market has grown 20% per year since 2003, according to figures from State Street. Assets under management by financial institutions stand at more than $600 billion.
     Shariah-compliant indexes have helped significantly with this stability. The Dow Jones Islamic Market World Index was launched in 1999. Between 2006-2008, other large mainstream index providers, such as ftse, msci, and Standard & Poor’s, followed suit, offering healthy competition and different approaches. Islamic indexes have offered investors transparency, standardisation, investability, and low-cost solutions, and have also helped with the development of products such as exchange traded funds (etf), which are poised for major growth globally.
     Like any religion, Islam is multi-faceted and open to many interpretations, and conservative approaches to finance vary between the Middle East, South East Asia, and North Africa. While indexes may differ in part of their approach and their regional, country, and industry focuses, they are largely in agreement over debt ratios and financial screening, offering different perspectives on investment criteria and dividend purification.
     Financial screening is a key feature of a Shariah-compliant index. Generally, index providers prohibit investment in alcohol, pork, tobacco, weapons, gambling, pornography, and certain leisure and entertainment businesses. None invests in conventional finance.

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ANALYSIS

Contentious reference rate

The question of reference rates of returns for Islamic finance has plagued the industry for a long time and will continue to do so unless there is a viable alternative. The key contention of those who oppose the use of the London inter bank offer rate (libor) argue that utilising it as a reference rate for pricing Islamic instruments means that we are using a benchmark that is utilised to price money in the conventional financial markets, because libor usually represents the base rate of interest, on top of which a margin is added.
This, in their opinion, is forbidden.
      According to Islamic commercial jurisprudence, commodities such as gold and silver or currencies do not have any intrinsic value in and of themselves and are only measures of value. Therefore, earning an additional amount of money on the money invested based on libor or any other benchmark rate is considered forbidden by all schools of Islamic thought. However, the key difference with Islamic transactions is that they do not earn money on money.
     Rather, assets are bought and sold, leased or invested in to earn returns. That said, a large portion of corporate financing and sukuk issuances utilise the libor as a reference rate to price their financing, whether it is through an ijarah (lease) contract, a murabaha (full disclosure cost plus mark-up sale) contract or even a musharaka (profit sharing) contract.
     The opponents of such practice argue that this is like utilising the casino industry’s return on assets to price the expected returns from a halal (permissible) asset, say, a telecommunications company. This is clearly abhorrent at face value.
     However, according to some scholars, this practice is not necessarily haram (impermissible). They argue that pricing Islamic transactions utilising any benchmark does not make a transaction haram or halal. What matters is that the transaction itself must be Shariah-compliant and the underlying assets that are the subject matter of trade must also be Shariah-compliant.

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