Britain recently confirmed its intentions to press ahead with plans to issue government bonds, that are compliant with Islamic law, in a bid to become the first non-Muslim nation to do so.
But the UK faces stiff competition from Japan: the latter’s giant state-owned development and export financing body, the Japan Bank for International Cooperation (JBIC) is also vying to issue the first sovereign-rated Islamic sukuk bond outside the Muslim world.
The decision by the UK Treasury and JBIC to tap the Islamic market reflects strong demand by investors for Sharia-compliant bonds, despite the global crunch on conventional credit.
For Japan’s part, the move represents a push by the government to establish a significant presence in the fast-developing Islamic finance market and to stake a claim for Tokyo as rival Islamic finance centre to Dubai, Kuala Lumpur and Singapore – and now, possibly London.
Tokyo began to take notice of Islamic finance last year when the government decided that Japan needed to bolster its financial services industry, and that Islamic finance should be part of the plan. JBIC’s initiative could put Tokyo firmly on the Islamic finance map – if it can get its semi-sovereign sukuk launched ahead of the UK.
Who gets there first “depends upon the vision of government, and on executives of banks and other financial service industry players,” says Tadashi Maeda, a senior executive at JBIC.
At present only JBIC can do Islamic finance business in Japan, because it is incorporated under a special law. The general banking law in Japan does not specifically permit Islamic finance at present, and banks generally assume that they can only carry on activities that are legally prescribed. But changes in the banking law are in the pipeline, and these will probably allow banks to do Islamic business through special subsidiaries, says Maeda.
Big news
Davide Barzai, an Islamic finance expert at UK law firm Norton Rose says it will be a considerable feather in Japan’s cap if JBIC can succeed in getting its sukuk launched. “Any sukuk that is sovereign or has a sovereign link, would probably be given a sovereign rating, and that is big news for the Islamic market,” he says. “The market needs more sovereign-rated issues. Banks need that kind of high quality capital, and there is not enough of this type of paper in the market.
“We know that the UK has reaffirmed its political will to have a [sovereign] sukuk issue so, for JBIC’s issue, if it is seen as a sovereign sukuk and if they get there first, then it really could make them the number one,” adds Barzai. “The main thing is that both countries are thinking about it. Hopefully they will both do it, and that will be a boost for the whole Islamic finance industry in Malaysia and in Europe.”
Mohamed Amin, head of Islamic finance at PricewaterhouseCoopers agrees that Japan, may be close to an international coup. “No one has actually issued a Sharia-compliant bond in London yet,” he says.
“What is available in London is secondary market trading of sukuk, where the originator is actually in the Middle East. When Dubai Ports took over P&O, they issued a sukuk [through] a UK bank, and UK lawyers designed it, but it did not involve UK real estate. It involved Middle Eastern real estate. The UK government is very keen to get to a situation where you create a sukuk using UK land, issued by UK registered companies,” he says.
A Kuwait bank, Boubyan Bank, recently completed a property deal which should also help facilitate development of Islamic finance in Japan. The bank bought three office buildings in Tokyo for 4.38 billion yen and has leased them back to their owners. The buildings will be vested in a global, open-ended real estate fund and could serve as underlying assets for Islamic transactions in future. The deal creates a useful precedent for Japanese institutions to follow as Islamic finance takes off in Tokyo, analysts say.
JBIC is looking to issue its sukuk in Kuala Lumpur, currently seen as the Islamic finance capital of Asia. What is unusual is that the JBIC issue would be denominated in US dollars rather than Malaysian ringgit, and it would be compliant with stringent Islamic standards of the Persian Gulf rather than the more liberal standards of Malaysia. “If it can do it, JBIC will be respected by the Sharia-compliant industry,” says Maeda.
“Japan would then be not just a buyer of oil but would be able to strengthen strategic ties with Middle East oil suppliers,” Maeda says, in his capacity as director-general of JBIC’s energy and natural resources finance department. “This would be the first time for Japan to play such a strategic role.”
Also, he notes, Japan’s legions of high net worth individuals are looking for new assets to invest in, and sukuk bonds (for example, to finance infrastructure in Asian countries) could provide one such vehicle.
The global market for sukuk (financial certificates) more than doubled in 2007 from 2006, to exceed $60 billion, and it is on course to top $100 billion in the next few years, says Standard & Poor’s. Meanwhile, the Islamic commercial banking sector has reached more than $500 billion and is growing at an annual rate of 10-15% – far outpacing growth in the conventional banking sector, according to the Singapore-based Islamic Bank of Asia.
Some way to go
JBIC still faces hurdles to getting its role as an Islamic finance pioneer accepted. “If the issue is in US dollars, we have to get the approval of the Sharia Board says Maeda. “We are trying to make this the most cutting-edge sukuk.
“Our original structure is based upon the structure that is allowed in Malaysia. In the Persian Gulf most of the sukuk are based on leasing or Ijarah. The underlying asset of a sovereign sukuk in the Persian Gulf is basically real estate – the headquarters of the central bank for instance. The problem with this kind of structure is the lack of liquidity or secondary markets. Most of the investors to a sukuk Ijarah are buy-and-hold investors, and this is an obstacle to fostering a secondary market.”
JBIC wants to issue a sukuk where the market value of the underlying asset is fully represented by the bond or note itself, he explains. “This is very close to the western notion of Roman Law,” says Maeda, whereas “in the Sharia, the value of the underlying asset will not be represented fully on the note. The right [to the asset] does not fully belong to the person who subscribes to the sukuk.” The JBIC model is allowed in Malaysia but that restricts potential investors to Malaysia. “Some Sharia scholars are opposed to my idea, so we are in a debate.”