The growth of Islamic finance has been phenomenal, with it now gaining significant global exposure. By 2015, the figure is expected to reach $5trn. Islamic finance spans not only the Islamic world but, increasingly, secular countries are finding it attractive due to its similarities with socially responsible investing and ethical finance.
Indeed, the concepts of partnership and mutuality, which are integral to Islamic finance, are being seen as a welcome alternative to the traditional greed witnessed at the height of the global financial crisis.
The most innovative capital markets instrument is the sukuk, which has evolved rapidly using a suite of different types of Islamic contracts. Spanning 1996–2001, the early years of sukuk development were mainly based in Malaysia with GCC participation nonexistent except for Bahrain. Sizes were relatively small and the use was primarily for medium to long-term financing. The government sector saw the highest number of sukuk issuance, while the financial sector accounted for the largest issuance in value. Pricing was unavailable and five Islamic contracts were used: murabaha (real estate), salaam, istisna’a, ijarah and mudarabah.
The boom phase ran from 2002 until 2007. Dominated by US dollar and corporate issuance, this led to significant growth and innovation with 430 issues representing value of $72.3bn. Europe witnessed its first sukuk in 2004 and the first in the US took place in 2006. The real estate and construction sector was the largest in terms of value. Ijarah sukuk grew in popularity by number but musharaka held the largest share by value. Domestic financing dominated but a shift towards international issuance took place. The absence of an Islamic pricing benchmark prevailed. Between 2008 and 2010, deteriorating global markets and a drying up of liquidity – particularly in the GCC – caused a slowdown of the sukuk market.
Issuance now shifted back to sovereigns rather than corporates. However, conditions improved quickly in 2010 as shown by a higher number of corporate issuances. The industry was also impacted by the Audit and Accounting Organisation for Islamic Financial Institutions’ (AAOIFI) announcement that some sukuk issuance was non-Shariah compliant. Sukuk tenors gradually spread over a broader maturity range. With tenors of less than six months’ duration, the objective of liquidity management for Islamic banks and the establishment of a yield curve was reinforced.
As for the future, challenges will continue, but the number of jurisdictions developing legislative and regulatory initiatives should enhance their ability to explore the sukuk market for the first time. The market will mature with a broader investor base, encompassing both institutional investors and fund industry managers and there should be greater diversity of sukuk issuances across different jurisdictions. There is likely to be greater commitment of institutional and cross-border investors to long-term funding (mega energy and infrastructure projects in the GCC markets). The ijara and murabaha contracts will continue to dominate.
Eventually, there should be the establishment of a yield curve. Finally, signs of a maturing market will be evinced via greater understanding of disputes and defaults in Islamic capital markets.
Shariah is not a codified system but rather a set of core principles, which are open to interpretation. It is this very inconsistency, and indeed the divergence of scholarly opinions, that has led the DFSA to adopt a Shariah-based approach to Islamic regulation, which uses systems and controls to ensure that appropriate Shariah practices are followed. The result is a practical regime that bridges the gulf between conservative and liberal interpretation.
