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Islamic finance’s big opportunity

Capital markets are crying out for a shiny new funding machine free of the problems that have beset the conventional model. But Islamic finance must choose a different path from the one it has previously followed if it hopes to assume that function and wire in sustainable growth.

Practitioners of Islamic finance have within their grasp an opportunity unlike any their industry has known before or indeed may have again. Conventional markets in Europe and the US could remain in disarray for years to come. Growth rates are low, bank weakness endemic, political risk rife. Sovereign and corporate issuers face the possibility of a returning liquidity crisis.

There is an obvious funding gap that Islamic finance could fill and in so doing install itself as a credible alternative to the tarnished conventional model. It’s the capital markets’ very own Mac versus PC moment — the chance to offer users a reliable technology that works as it’s supposed to and isn’t prey to viruses.

But it is also appears more likely than not Islamic finance will waste this opportunity — unless it rewires its circuits, learns to interface and embraces compatibility.

The incredulity prompted by recent talk of countries like Hungary and France issuing sukuk — and even a solid corporate like GE in times past — provides apt illustration of the problem. “They are not Islamic, simply put,” said bank debt syndicate specialists. “Who in the Gulf is seriously going to do the credit analysis that is needed to make such an investment?”

It’s a fair question but one that should be framed literally rather than just rhetorically. A great deal of groundwork needs to be done to change perceptions on both sides, so that the two stubborn markets can turn towards each other.

The Islamic finance model needs a champion, or champions, to push its advocates to leave their comfort zone and to educate conventional markets, not only about the benefits of Islamic investment but also how to make its issuers more appealing. [For the record, GE’s sukuk issue tanked initially after launch in 2009, but has performed much better since investors realised there was a dearth of supply to choose from.]

In the absence of obvious will on the part of the GCC to take on such a role, Malaysia has found itself increasingly pushed to the front in the drive to expand the market. It could yet leave its Gulf counterparts trailing in the sand, unless they grasp the scale of the momentum the Asian country is gathering.

Malaysia for its part appears to recognise that it cannot do things alone. It has engaged with the GCC for both its recent issuance and investment in sukuk — cross-border investment is a growing trend between the two regions and banks are now talking of creating a currency swaps market.

But at the same time it is clear that Malaysia also sees its future strength coming from greater engagement with the conventional market. State-owned Khazanah Nasional’s issuance last week of a first ever sukuk into Hong Kong may be seen as a small step in the larger scheme of things, but it lays down a marker. What’s more, the company did the deal on its own terms — being prepared to delay the trade for better conditions, despite local fund manager objections.

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