The Impact of HSBC's Withdrawal of Amanah

It has been reported that HSBC bank will focus its Islamic financing operations in Saudi Arabia. HSBC have also decided to withdraw its Islamic banking operations in seven other countries, including the United Kingdom, and has already divested its assets in nearly 30 other countries. HSBC's reasons for getting out of the Islamic banking game in some countries is because of the pitiful state UK banks have been in since the global economic meltdown of 2008 and the restructuring efforts now underway to revive the industry. But HSBC, as a conventional bank, also could not really compete against the big Islamic banks. A case in point was HSBC's success in becoming the first Western global bank to sell $500 million sukuk, but still falling far short to become a significant competitor against the big Islamic banks.HSBC and similar conventional banks offering segregated Islamic services also faced criticism from scholars who complained the traditional institutions did not go far enough in serving Muslim clients. And Islamic banks often said they faced unfair competition from the large global players. It's unknown whether the bank's change in direction had anything to do with the scandal earlier this year in which a US Senate subcommittee determined that the bank violated regulations that led its affiliates to move drug trafficking funds and alleged terrorist financing to the US. HSBC acknowledged its failure in following financial regulations and promised to adhere to the rules. The bottom line is that dropping its Amanah services in the UK allows HSBC to cut costs and transfer its Amanah employees to the main operations. Ultimately,

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however, the move will deprive the UK's 2.87 million Muslims of banking based on principles that ban funds speculation, and interest on checking and savings accounts. Perhaps it's a prudent cost-saving measure for HSBC, but it certainly does little to maintain a loyal Muslim customer base. The wider implications of HSBC eliminating its Islamic banking services in the UK is whether conventional Western banks can serve Muslim communities with a relatively small customer base and either absorb the losses or earn some measure of a profit. There are few banks in the United States, which has a Muslim population of just 1 percent, that are inclined to open Shariah-compliant accounts. The Michigan-based University Bank's subsidiary, University Islamic Financial, has only a regional reach. And Standard Chartered Bank has offices only in California, New York, Texas and Florida. Ask a bank manager at JPMorgan Chase Bank or Bank of America for a Shariah-compliant account and you get only a blank stare in return. Yet even in Muslim countries conventional banks offering Islamic products and services continue to struggle. In addition to the UK, HSBC, once a pioneer among Western financial institutions in offering Islamic services, pulled out of Bahrain, Bangladesh, the United Arab Emirates, Mauritius and Singapore. Qatar had banned conventional banks from offering Islamic products to guarantee the "purity" of Islamic funds. And HSBC had only been offering Shariah-compliant services in Bangladesh less than two years before pulling out. Jaap Meijer, who is in charge of equity research for Arqaam Capital in Dubai, told reporters recently that HSBC's "Islamic activities in the affected countries were subscale so they decided to wind them down in an effort to reduce costs. Except for maybe the UAE, it's not likely to have a big impact on the Gulf region." And that's despite the fact that HSBC Amanah will retain 83 percent of its overall Islamic business revenue. In Malaysia, HSBC still must go head-to-head with Standard Chartered Bank, which enjoys a solid foothold there. But the British bank is competing well against Malayan Bank and CIMB Group Holdings. HSBC, operating through holding, Saudi British Bank (SABB), is also good position in Saudi Arabia. According to Bloomberg, HSBC helped sell $6.4 million sukuk in

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Saudi Arabia. It also served as the underwriter for SR 15 billion in a General Authority of Civil Aviation offering to fund the new Jeddah airport. HSBC is also well established in Oman, sharing much of the funding market with BankMuscat.By curtailing its Islamic funding operations elsewhere, HSBC can focus on Saudi Arabia and a select few other Muslim countries. However, missing from the picture is the low- and middle-income customers in non-Muslim countries who depend on Shariah-compliant banking. At the moment, there is no other conventional bank willing to step into the void left by HSBC, and Islamic banks have yet to demonstrate an inclination to reach out to non-Muslim countries

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Attracting the World of Enterprises for Islamic Banking Services

Author: Tasnim Nazeer Abstract: Attracting the world of enterprises for Islamic banking services discusses the various options available for Small and Medium sized enterprises (SMEs). It also ensures that all business professionals and those SMEs wishing to tap into the market are familiarised with the Shariah compliant principles and various methods of Islamic financing contracts. These contracts range from the successful and popular Ijarah contract through to Istisna, Mudaraba, Musharaka, Salam and many others which will be discussed comprehensively in this article. Global Islamic Finance Magazine aims to establish the various ways SMEs can successfully attract the numerous benefits of Islamic financial options and contracts which provide an ethical alternative to conventional methods of financing. The article also gives the reader vital information on the processes of each financial instrument from Islamic banks which is crucial to know when attracting SMEs to financing the Islamic way. Global Islamic Finance Magazine aims to equip you with the sound knowledge of the options for Islamic financing which are currently offered by many Islamic banks and financial institutions across the world and help you make the right decision in gaining support for your Small business Enterprise. Keywords: Small and Medium Enterprises, SMEs, Islamic Banks, Mudaraba, Ijarah, Musharakah, Salam, Istisna, Islamic Finance, PLS, Islamic Financial Transactions. Small and Medium Enterprises a Growing Market for Islamic Banking Services Islamic Finance and banking is growing at an unprecedented rate and is expected to reach to over $2 trillion dollars by 2012. Many countries from around the world are opening up Islamic financial institutions and fully fledged Islamic banks which cater for the demand of Shariah compliant products and services. One aspect of Islamic banking services is its attraction to small and medium enterprises as it presents them with an attractive alternative of financing for their businesses. Many Muslims and Non Muslims around the world find Shariah compliant financing an ethical option in comparison to conventional financing which is why there is a growing market for Islamic banking services around the world. It is clearly apparent that in order for any investment or transaction to be made by Small or medium enterprises the company would have to adhere to the principles laid out by the Shariah. This article aims to address those necessary financial instruments that need to be known by any potential investor or business associate when dealing with Islamic banking in SMEs. When an investor or business professional is considering Islamic finance options, it is important to ensure that the instrument used is suitable for the economic purpose that a company seeks to achieve and gain profits from. This article will address the main categories for Islamic financial transactions and also the various ways you can effectively target small and medium enterprises through the various Islamic Banking Services available or that you may potentially wish to offer in your company.

The Islamic Banking industry is providing unprecedented unique services for both Muslims and Non Muslims around the world and the future for Small and Medium Enterprises looks promising if they were to choose an Islamic financial institution.

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Understanding Islamic Banking for SMEs Global Islamic Finance Magazine aims to give you a comprehensive insight into understanding Islamic Banking transactions so that you can acquire the knowledge to implement and understand potential instruments for SMEs. There are specific main categories for transaction types which are as follows as in Figure 1: Transaction Categories and Sukuk Profit and Loss Sharing partnership instruments which are primarily compared with that of equity investments Transactions which have a fixed return structure or are predictable Sukuk Islamic Bonds and other contracts Financial instruments such as Foreign exchange letters for credit and guarantees in addition to agency contracts are also available Figure 1: Table by Tasnim Nazeer What is Partnership Contract in Islamic Finance? When looking into the Small and Medium enterprises it is important to understand about partnership contracts in Islamic banking and finance. There are two main types of partnership transactions: joint venture (Musharakah) and passive partnership (Mudarabah). The main difference between the two structures relates to what the partners contribute to the partnership. Joint venture Musharakah Partnerships Musharakah means sharing and is used in financial transactions to identify joint ventures or partnerships. More than two parties can be involved, and generally each provides knowledge and their expertise as well as a share of the capital. Knowledge coupled with expertise can take the form of management or advisory services or even doing the actual work itself. It is admissible for one of the partners only to provide capital, in which case he or she becomes a partner. The profit ratio is pre-agreed in the contract and reflects the level of capital provided, effort, skill and expertise the partners bring to the joint venture. Losses are borne by the partners in proportion to the capital they have provided. The liability of the partners is therefore unlimited and can provide scope for being an attractive partnership.

Figure 2: Diagram from Bank Negara Malaysia

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Figure 3: Diagram from Clayton Figure 3 exhibits the process and implementation of the Musharaka financial contract. As you can see the first partner puts in capital into the joint venture project and whatever the outcome of profit or loss from the project it is shared with both partners. The same is entailed by partner 2 as they equally put in the capital and take a share whether it is profits or losses. In terms of Musharaka with an Islamic bank the bank would put hold an increased ownership with the partner or customer at a lesser ownership. Diminishing Musharakah Diminishing Musharakah is a different partnership in which it is agreed between the parties at the very beginning of the contract that one partner will purchase units over a fixed period of time in the joint venture from the others at a pre-agreed unit price. At the start of the agreement, the project is divided into a number of equal units (shares) that are bought by one of the partners over the life of the transaction. In a diminishing Musharakah, the repurchasing agreement is part of the contract. The purchasing party will gradually own a larger share of the joint venture and, as a result, his or her share of the capital increases. With this increase in capital, the purchasing party will be liable for a larger proportion of any loss. Profit ratios will be revised either with each purchase or on a periodic basis as agreed between the partners. Mudaraba Partnerships with SMEs In a Mudaraba transaction only one partner contributes to the capital and the other who is the Mudarib or business will contribute to the expertise and skills side of the partnership. The business manager or Mudarib may have set conditions regarding the operations of the business on a day to day basis but this can be discussed at the time of contract with the investor. The passive partnership transaction may be used for private equity investments; it is also often used when clients wish to deposit money with a bank. When used for deposits, the bank contributes its skill and expertise in identifying appropriate investment opportunities.

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An example of a Mudaraba Partnership process is identified in Figure 4 below:

Figure 4: Mudaraba Structure and Process Source: Clayton Utz

As figure 4 suggests the Investment Manager or Mudarib puts in the capital and management to the business enterprise who will give back a share in the profits to the manager. The Business enterprise will also give a share of profits or losses to the capital provider who has given the means of capital to the investment manager and this is how the process of Mudaraba works in SMEs if you are considering participating in this type of financial contract. Islamic Financial Instruments with Predictable Returns There are four main categories for Islamic financial instruments with predictable returns which involve: Istisna Ijarah Salam Murahaba This is a favoured method from Islamic financial institutions and banks as they do not have to rely on any third party for calculation. Small and Medium enterprises may be attracted by a Murahaba contract such as whereby there is a deferred payment sale or instalment of credits. Murahaba is mainly used for the purchase of goods for immediate delivery with payment to be settled at a later date. In its most basic form, this transaction involves the seller and buyer of the merchandise as shown in Figure 5.

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Figure 5: Murahaba an attractive option for SMEs Source: Clayton Utz

As part of the contract between the buyer and the seller in a Murahaba contract the price of the goods, mark up, payment date and delivery of products are agreed. The seller then takes immediate possession of the goods, against future payment. The buyer has full knowledge of the price and quality of the goods purchased. In addition, the buyer is aware of the exact amount of mark up paid for the convenience of paying later. In the context of trading, the advantage to the buyer is that he or she can use the goods to generate a profit and use this profit to pay the original seller. Ijarah and Other Leasing Options for SMEs Many Islamic Banks offer services for Ijarah leasing contracts that often will be attractive to SMEs. The Ijarah contract works by providing a lease in which one party (the lessor) allows another party called the (lessee) to use an asset against the payment of a rental fee. Three options may be possible for the Ijarah contract such as the following: Gift. In this case, the lessor has gradually paid for ownership of the asset, there is no further payment required from the lessee to obtain the asset. Against fixed payment. At the end of the lease, the lessee becomes the owner of the asset once he or she has paid the purchase amount agreed in the contract. Against market value. At the end of the lease, the lessee becomes the owner of the asset once he or she has paid the market value to the lessor.

Information from Islamic Banking PDF

Due to the fact that the financier owns the asset, they will responsible for bearing the risks of ownership in addition to profit which is generated on the lease and is regarded as profit derived from the asset and not only Riba (interest). Figure 6 shows the structure and process of the Ijarah system. Figure 6: Ijarah a Popular Contract for Islamic Banks

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Source: Clayton Utz Figure 6 outlines the structure of the Ijarah contract whereby the Supplier contacts the financier with the acquisition of the subject matter the financier then leases the subject to the customer who gives the financier a rental payment. The financier gives the payment of the purchase price to the supplier. The financier provides the sale on maturity for the Ijarah contract to the customer and in return the customer provides the purchase price on maturity under the Ijarah contract to the financier. The Ijarah contract has proved to be a popular and successful method of Islamic financing contracts in Islamic banks and Shariah compliant financial institutions and is yet another way of attracting Small and Medium enterprises given them a choice to hold less risks for their company without the worry of conventional financing which involves interest (riba). Islamic financial contracts provide businesses with the reassurance of their wealth and gives them a fair chance of profits or losses which will be incurred by both sides. Short Term Shariah Compliant Financing Options for SMEs in Construction and Agriculture Salam Contracts The Shariah compliant contract of Salam can be the best option for small and medium enterprises whose particular focus is on the construction and agriculture sector. It has been a very successful method of financing for these specific groups and involves an immediate payment which is made against a future delivery for the asset. As the purpose of the funding is to construct or produce the asset, the asset itself does not have to be in existence, and the seller does not need to have ownership. In its simplest form, Salam is a contract between a buyer and a seller. The buyer pays an immediate agree price to the seller and then the seller delivers the goods at a later specified date. It is a simple and straightforward concept that even conventional banks may use however the advantage over conventional counterparts and the main attraction of this Salam contract as it does not involve any interest as once again we know that according to Shariah law interest is strictly prohibited. This is a short term contract whereby the contract could last from one to three months. It is important that the type, quality and quantity of the product are specified in the agreement from the very beginning. It is the sellers obligation to deliver the goods at the specified date and if the seller cannot deliver the goods then they will have to recompense the money back to the buyer or business and buy back the goods. Istisna for SMEs providing a Long Term Solution Istisna can be used as a long term way of financing for a future asset. Istisna involves a contract which involves payment to the producer or contractor of the asset and does not have to be in full in advance. Payment is likely to be in various instalments in line with the progress made on the development of the asset and is, therefore, well suited to project finance and construction. The asset primarily needs to be manufactured, constructed or processed, and is of a significant size and capital outlay which should be discussed at the onset of the contract. Istisna is ideal for Small and medium enterprises which involve major construction, industrial projects or large equipment manufacture, such as ship or aircraft manufacture. The financier funds the manufacturer, acquires title to the asset upon completion and,

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typically, immediately passes this title to the purchaser on agreed deferred payment terms or a leasing agreement (Ijarah).

Figure 7 Ijarah Structure and Process Source: Clayton Utz The Ijarah process as outlined in figure 7 shows the manufacturer which provides the manufactured goods to the financier. The financier provides the price and commissions of goods to the manufacturer. The customer orders the goods and sale price where the financier provides the manufactured goods to the customer. Sukuk providing innovative bonds to SMEs Islamic Sukuk bonds works by the Sukuk holder owning a proportional percentage of the underlying asset. Sukuk can be listed on recognised exchanges and is, with a few exceptions, tradable. Under the process of Sukuk the special purpose vehicle (SPV) purchases an asset from the original owner on behalf of the Sukuk holders. The SPV is part of the group of companies selling the asset and hence raising the funds. For the benefit of the Sukuk holders and assurance that the SPV is bankruptcyremote, which means that insolvency of the original seller of the asset will not affect the SPV. In addition, the SPV should not be subject to any negative tax implications and will need to be established in what is known as a tax-friendly jurisdiction law. Similar to conventional bonds, Sukuk can be bought from the issuer or on the secondary market. . The Sukuk holder owns a proportional share of the underlying asset and has a financial right to the revenues generated by the asset. However, as mentioned before, the holder is also subject to ownership risk, which means that he or she is exposed to any risk associated with the share of the underlying asset. As the most renowned Islamic investment tool small business may consider using Sukuk however it might not be suitable for smaller businesses. The cost of setting up and managing the SPV, the legal documentation and issuance process can be prohibitive for relatively small amounts of funding and may be the reasons why Small business may incur more costs and therefore opt out from Sukuk whereas Medium and Large businesses may find Sukuk a more beneficial deal for them. When Small businesses or Medium ones are considering Islamic finance as an efficient funding option the company needs to take the business requirement into account. Figure 8 shows the various different ways Islamic financial instrument structures can be applied to SMEs.

Partnership contracts. Joint ventures or passive partnerships can be utilised for private equity participations.

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This means that the bank or Islamic financial institution will take a share of the ownership from the enterprise and shares in the profits and losses. Partnership transactions are mostly praised by scholars because they are designed to share risk and reward, which is in line with Islamic principles from the Shariah law. Deferred payment transactions. When an SME considers including a financial institution in a deferred payment transaction, the bank will then purchase the asset against a cash payment from the seller and subsequently sells on the asset to the buyer which will require a future payment of the plus a pre-agreed mark up to be paid on a pre-agreed date. The bank instructs the seller to deliver the asset direct to the buyer although ownership is transferred to the bank before the asset is passed on to the buyer. This transaction type is particularly suited for working capital and export finance. Leasing. Leasing transactions will be ideal and suitable when there is a need for a specific or particular asset such as vehicles or equipment however the enterprise or company prefers to rent or lease the equipment rather than owning it outright with all the associated ownership risk. The bank will then purchase the asset and acts as the lessor. The client is the lessee and pays for the use of the asset. Contracts such as Ijarah leasing can be used in this type of example. Production Finance. Production finance transactions in SMEs are mostly ideal for financing assets that need to be manufactured or built such as construction projects or agricultural ones. The bank in this case acts as an intermediary between the contractor and the ultimate buyer and facilitates the payments.
Information from Islamic Banking PDF The Future for Islamic Banks and SMEs Many Small and Medium enterprises are offered financial services from Islamic banks which provide excellent beneficial services which may provide an ideal alternative to conventional financing. An example of this is Bahrain Islamic Bank which has its own division especially dedicated for SMEs which handles all aspects of Islamic financing for Small and Medium enterprises. The National Bank of Abu Dhabi for example launched a specific service especially designed with SMEs in mind. A Spokesman for NBAD said in a statement that, This is a unique and exceptional promotion designed by NBADs Business Banking Group to allow the nations SMEs access to quick funds for that special project they have been contemplating, says Haitham AlRefaie, the Head of Business Banking Group at NBAD. NBAD is fully aware that SMEs are the UAEs engine of growth and we also understand the challenges faced by this very important sector. This is why we have designed this special campaign to help this critical segment of the UAE economy. (NBAD). The National Bank of Abu Dhabi had created various other initiatives to help Small and Medium Enterprises. The Bank had opened its first business centre in the Abu Dhabi Industrial City which already has other numerous SMEs in the city. It is also reported that in January 2010, NBAD became an administrator of the Khalifa Fund, which offers interest-free loans to SMEs which is a particularly attractive option in comparison to conventional alternatives for

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SMEs. NBAD has also reportedly sponsored and participated in the National Exhibition for Small and Medium Enterprises to support and facilitate the sectors growth.

Enabling SMEs to invest in their business contributes to a healthy market generally, benefitting all players. Abu Dhabis ambitious development plan envisions a special role for SMEs in the Emirates progress. NBAD in its commitment to support Abu Dhabi Vision 2030 continues to advance the objectives and goals of this blueprint, such as SMEs, Mr. AlRefaie says (NBAD). Many other Islamic fully fledged banks along with major Islamic financial subsidiaries have opened up services for SMEs to cater for the demand of Shariah compliant methods of financing. If your business is currently a registered Small or Medium Enterprise and you are seeking to find out more about Islamic financial banking services this article intends to put you in the right direction in establishing the major components and financial instruments in adherence to the Shariah. As discussed there are many options depending on your specific requirements for financing such as Ijarah, Musharaka, Mudaraba, Istisna, Salam contracts and other short and long term production options. It is important to be sure from what you want out of your business and what your business wants to achieve in order to make the right decisions in collaborating with an Islamic financial institution. There are many options to utilise and it is worth investigating various options more thoroughly with your chosen Islamic financial provider. Many Islamic banks around the world have dedicated services for SMEs such as Emirates Islamic Bank, Bahrain Islamic Bank, Abu Dhabi Islamic Bank and the National Bank of Abu Dhabi amongst many others. The Shariah compliant methods of financing for Small and Medium enterprises is not only confined to Muslims alone but also welcomes applications from Non Muslims wishing to adhere to Shariah financing rules in dealing with their wealth in their businesses. In all contracts it is important to familiarise yourself with the terminology used in Islamic Finance as this article has explained about the various instruments involved in Islamic financial investments. Many investors around the world continue to praise Islamic financial methods and often find that there are fewer risks associated with Islamic finance than if they were to take up financing options with a conventional bank. As Shariah compliant Islamic instruments such as Sukuk Islamic bonds become a universal and globally renowned method of financing many SMEs become familiarised with the terms and conditions and find the options increasingly attractive. Saudi Arabia and Malaysia have been actively encouraging the financing of SMEs by the banking sector in an effort to stimulate the private sector and to boost rural and inner city poverty alleviation policies. In Malaysia for example Bank Negara, the central bank has provided financing for SMEs as the Islamic banking sector continued to increase from RM3.5 billion. "The small business sector makes up 80 percent of the Saudi market, stressed Ibrahim Al-Buloushi, head of NCBs small business group (Islamic Banking). The banks aim was to expand the national economic structure which would consequently provide the support it needs to increase and generate income and activate the economy to create more jobs and investment opportunities worldwide. The reasons why SME financing should be a natural niche for Islamic banking, stresses Dr. Adalet Djabiev, CEO of Badr-Forte Bank in Moscow, which is Russian sole Islamic bank, is that it deals directly with the real economy; creates employment; involves the productive use of resources especially capital and finance; and contributes directly toward the alleviation of poverty. (Islamic Banking). The Islamic Banking industry is providing unprecedented unique services for both Muslims and Non Muslims around the world and the future for Small and Medium Enterprises looks promising if they were to choose an Islamic financial institution. If you are an Islamic financial institution wishing to target the SMEs in attracting your services then proper marketing and promotion of the various ranges of options available to SMEs for support with funding can further help to spur growth and profits.

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New Shariah Board model suggested by Islamic scholars

A new model of Shariah Board has been proposed by some Islamic scholars as a solution to diverse range of problems prevailing in Islamic Finance sector across the globe. A group of Islamic scholars has suggested a new model of Shariah Board as the present shariah boards are open to conflicts of interest. They have suggested creating partnerships between the boards and Muslim depositors in order to protect the boards from pressure exerted by bank managements. Shariah boards, composed of experts in Islamic financial law, supervise Islamic banks activities and products to make sure they conform to religious principles, such as bans on interest and pure monetary speculation. Traditionally, banks appoint prestigious scholars to their shariah boards and pay them handsome fees and retainers. This has left the system vulnerable to conflict of interests. The scholars are being paid by the institutions which they are supposed to be supervising impartially. A group of scholars in South Africa, led by Durban-based Ebrahim Desai, a senior figure in the citys Muslim community, has proposed that Muslim depositors in each bank fund a shariah compliance body that would be created separately from the bank. The body would then hire a shariah board to supervise the bank. In this way, the scholars on the board would not be appointed by or report to the banks management and would not have a direct financial relationship with the bank.

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"We seek a neutral and balanced position," Desai said, adding that freed of subjection to bank managements, shariah boards would be able to play more strategic and powerful roles in governance. "This would be in line with the larger interest of the Muslim community in upholding shariah law by maintaining the ultra-independence of the shariah supervisory board," he added. Emraan Vawda, a colleague of Desai, argued that by their nature, banks were illsuited to policing their own activities. He said, "Commercial concerns in the overwhelming majority of Islamic banks far outweigh genuine commitment to Islamic values and precepts." The proposal is likely to meet with considerable skepticism in the Islamic finance industry. Desai said that many institutions have approached him to discuss his proposal but he declined to name them, saying the talks needed to be kept confidential. One potential issue is whether depositors would be willing to fund the shariah compliance bodies; to compensate for this expense, they might demand higher returns on their money placed with the bank, which the bank might not be willing to provide. Banks themselves might be reluctant to give authority over their activities to a separate body, while highly paid Islamic scholars might prefer to continue working for bank managements rather than being subject to groups of depositors who could prove more awkward and demanding. One shariah board member in Dubai, who declined to be named because of the sensitivity of the issue, said that the scholars in the South African group are not experienced in the financial world and are instead mostly community-based. Such scholars can command great influence within their communities and give products informal endorsements to win mass appeal, but they cannot necessarily rule on the finer points of financial contracts, he added.

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Brave New World: Innovation in the Islamic Finance Industry

As a relatively new industry, Islamic finance is constantly changing and evolving. Innovation plays a big part in the growth of this phenomenon worldwide. The innovation of products, services, instruments, mechanisms and markets contribute to the industrys ever-growing competitiveness within the mainstream financial system worldwide. There are several issues surrounding innovation in Islamic finance that this article aims to examine and address. How can innovation be balanced with Shariah authenticity? What innovations should be made? What is this bank-based industry doing in terms of capital market development? What is the way forward for Islamic finance innovation? Innovation and Authenticity When Dr. Shamshad Akhtar delivered the keynote address, Islamic finance: authenticity and innovation-a regulators perspective at Harvard Law School in April 2008, she covered a number of hot topics that are still contentious issues to this day. The then Governor of the State Bank of Pakistan rightly highlighted that, in Islamic finance, authenticity and innovation are not diametrically opposed to one another; rather one leads to the other. She also emphasises that the trend of Islamic finance engineering and re-engineering has facilitated proliferation of Islamic products. Lastly, Dr. Akhtar makes the point that there is scope for unleashing financial innovation in Islamic finance to an even greater extent, in order to promote financial stability. Whilst remaining positive about Islamic finance throughout, Dr. Akhtar does claim that a number of Islamic products have been designed as conventional product equivalents. This a real point of controversy in Islamic finance at present, for many Shariah scholars and other industry experts believe this so-called Islamisation of conventional products is merely flooding the market with poor imitations of haram instruments. These products, they argue, are

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neither Shariah-compliant nor original. If employed with care, derivatives can enhance efficiency in IFIs through risk mitigation, thereby making them more competitive as well as appealing to customers. However, their application in Islamic finance is highly controversial for reasons of speculation and uncertainty, two practices forbidden under Shariah. Saudi Gazette cites the Moodys report Derivatives in Islamic Finance as saying the imitation of conventional derivative instruments prevents Islamic finance from fully developing its own innovation phase. Moodys vice president, senior credit officer and author of the report Anouar Hassoune elaborates, If employed with care, derivatives can enhance efficiency in IFIs through risk mitigation, thereby making them more competitive as well as appealing to customers. However, their application in Islamic finance is highly controversial for reasons of speculation and uncertainty, two practices forbidden under Shariah. The Shariah legitimacy of derivatives is in such dispute that some countries have completely banned these instruments-despite the fact that others are willing to implement them, albeit on a limited scale (Saudi Gazette). Just as some countries are more willing than others to accept Islamic derivatives, so more experts are more willing than others. Prominent Saudi Shariah scholar Mohamed Elgari believes derivatives are an innovation that could actually be useful to Islamic finance. Speaking at the Amani-Falaika Islamic Finance Symposium held in Dubai in early 2010, the scholar stated We should not look at derivatives, like anything else in life, in black and white terms. In moderation, they could be useful, especially to reduce risk on a Shariah basis. In principle, derivatives are possible in Islamic finance.

The word innovation in Islamic finance is developing into a misnomer or battleground between liberal and conservative interpretations. It is reminiscent of the dot.com bubble where anyone who did not buy into the concept was deemed to be a dinosaur destined for destruction. We must guard against euphemistic language that tricks us into circumventing the rules, particularly when the financial rewards are tempting.

For many, true authenticity means true innovation, not the mere mimicking of conventional products already in existence. Others argue that Islamic finance products must be seen to be equal to their conventional peers in order to remain competitive with them. Despite the logic of this, it cannot be denied that innovation is a vital

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component of competitiveness. Developing products unprecedented in the marketplace is an obvious way of capturing that segment of the consumer market that has hitherto been unable to find a product to meet their demands. However, some analysts believe there is no such connection between the terms innovation and authenticity and that innovation is in fact used as euphemism for everything thats supposedly inauthentic about the Islamic finance industry. Islamic finance expert and author Toby Birch candidly expresses his viewpoint thus: The word innovation in Islamic finance is developing into a misnomer or battleground between liberal and conservative interpretations. It is reminiscent of the dot.com bubble where anyone who did not buy into the concept was deemed to be a dinosaur destined for destruction. We must guard against euphemistic language that tricks us into circumventing the rules, particularly when the financial rewards are tempting. Dr. Akhtar believes that the relationship between Islamic finance and conventional finance can be seen as positive, indeed helping Islamic finance to innovate and therefore flourish as an industry. While Islamic finance offers its own ideology, approaches and modalities, legal and contractual structures and risk management perspectives, conventional finance has steered the global financial markets for ages backed by the well tested policy, legal and regulatory prescriptions, tools and structures etc. It is inevitable that this has resulted in juxtaposition and transposition of the two disciplines to foster innovation and benefit the two fields of finance mutually. This argument that Islamic finances mutual dependence on conventional finances established legacy is actually positive in terms of both innovation and competitiveness is a valid one, if one believes it is possible for such a relationship to exist without Islamic finance crossing the line into the territory of copying haram products and services. Dr. Akhtar ultimately concurs that this is a balance that is important to get right. While Islamic finance converges and conforms to basic principles of finance, to ensure its acceptability and originality this should be achieved without compromising its ideological and spiritual distinction and uniqueness which is critical to public confidence in the system. At the Amanie-Falaika Islamic Finance Symposium, Farhan Al-Bastaki of the DIFC suggested that the industry needs to listen more to its clients in order to create innovation as opposed to merely Islamising existing conventional products (Parker). He applied this point to the Islamic funds segment of the industry in particular, urging it to take note of what clients and end users need and want. He also stated that listening more would bring about greater consistency of Shariah compliant funds documentation. By promoting the unification of funds

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documentation, we can provide a great deal of confidence in the market. Shariah scholars must focus on whats good for the industry, by which I mean they should focus more on the various areas of agreement among them, rather than their points of philosophical difference. Dr. Akhtar makes the point that it is the Shariah principles upon which Islamic finance is based that makes it potentially innovative as an industry. The ethical, sustainable characteristics of Islamic finance lead to the industry offering the global financial system new ethical and equitable perspectives [] Application of these IF-guidelines and principles to well tested tools of conventional finance itself ought to be treated as innovation. This is a point not often addressed in the debate on Islamic finances relationships with its conventional counterpart-rather than becoming less innovative because of its borrowing from conventional finance- Islamic finance can actually help conventional finance to innovate by giving it new, Shariah-based ideas and inspiration. Proposed Innovations Goud (2009) agrees that focus needs to be shifted away from the development of products mimicking conventional counterparts and towards innovations that are necessary. He not only proposes innovating alternatives for controversial instruments such as commodity murabaha or Tawarruq, which are considered by some to be too similar to interest-based products, he also calls for the creation of more standardised types of sukuk, which, he says could be priced competitively with conventional debt. Such an emphasis on competitive pricing would indeed add fire to the case for innovation leading to increased competitiveness of products. Goud further explains what the right sukuk structures could do for the market by stating they could reduce structuring costs and encourage issuers to bring sukuk into the market. With the prominence of sukuk in the headlines in recent years, it is easy to forget that the first sukuk was only issued in 1990, by Shell MDS (Aidham, 2009). Since then, sukuk has been a symbol of innovation in Islamic finance and now several variant structures have been used for sukuk issues. Arguably the main innovating nation of sukuk, and Islamic finance in general, is Malaysia. The South-East Asian country has charted many firsts, including the first issues of baibithaman ajil in 1990, mudaraba sukuk in 1994, ijara sukuk in 2001, sovereign sukuk in 2002, musharaka sukuk in 2005 and exchangeable sukuk in 2006. Why is sukuk so suited to innovations? The fact of the exchangeable sukuk, issued by Khazanah, gives us a clue. It demonstrates the robustness of sukuk structures, showing they
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can break away from the requirement of a tangible underlying asset, so characteristic of the structures used for previously issued sukuk. Malaysias innovative work with sukuk seems to have paid off for its Islamic finance industry, which is thriving. Malaysia has set an example of how beneficial it can be to innovate sukuk, therefore the world must follow if Islamic finance overall is to be strengthened. However, we must again tread carefully when designing sukuk with the purpose of increased market competitiveness in mind. Certain varieties of sukuk have features that are similar to those of conventional bonds (Aidham). One such feature is the certainty of an obligation to pay a determinable amount on a particular date, despite the fact that the underlying Islamic contract employed on its own does not create such an obligation. Attempts to create sukuk with these debt obligation features lead to structures that embed additional purchase undertakings by the issuer, or lending obligations to the issuer by an obligor. This could render certain contracts, such as musharaka and mudaraba, questionable in terms of Shariahcompliance. Such concerns were partially the basis for AAOIFIs 2008 statement, which provided more detailed guidance on the Shariah standards it has issued on sukuk. Despite the controversy surrounding AAOIFIs statement, the reasoning behind it is sound enough, in terms of introducing a greater degree of standardisation and regulation. Aidham argues that legal advisers must play a key role in the structuring of sukuk, as their specialist knowledge is vital. [Merely] a general understanding of Islamic contracts may be insufficient to efficiently structure and document the sukuk as structures get more innovative. The Moodys report states that product innovation could also aid the much-needed development of Islamic finance institutions risk monitoring capabilities. The report explains that in order to minimize the inherent risk factors in financial transactions, there is a greater need to invent a range of products and hedging instruments that could unleash much-needed innovation in structured products (Saudi Gazette). As hostile as Birch is to certain alleged innovations in Islamic finance, he does propose what he sees as a potentially true innovation for the industry. He believes that Islamic finance transactions should be based more on venture capital than on debt financing (Arabian Banking and Finance). As it is, Islamic venture capital and private equity form only the most miniscule parts of the industry as a whole, so this is one proposed innovation that is unlikely to come about overnight. Capital Market Development
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Dr. Akhtars speech addresses the progress Islamic finance has made in terms of capital market innovations. She rightly identifies and expands upon a number of significant developments: Islamic benchmark: Its introduction of Islamic sovereign paper has provided an alternative to LIBOR. Recent initiatives include: a. The Malaysia International Islamic Financial Centre (MIFC) initiative, under which that government launched in May 2010 a benchmark US dollar denominated Global Sukuk b. Short Term Sukuk from Bahrain, Brunei, Singapore, Malaysia and Pakistan c. Sudan Government Investment Certificates based on pool of Ijara, Salam and Murabaha Islamic investment indices: These indices track the performance of the top publicly trading companies involved in activities compliant with Shariah. Examples include the Dow Jones and FTSE Islamic indices. Islamic equity funds: These include Shariah-compliant equity and hedge funds, commodity, leasing and trade related funds. Development of derivatives and its equivalents As discussed above, a debate that is ongoing to this day is whether or not setting price at a future date is permissible according to Shariah. Some scholars argue that it is not permissible; others argue that with flexible interpretation forward trades are permissible in Islam.

Industrys effort to engineer and re-engineer financial innovation has been impressive, but authenticity demands that industry continues its efforts to innovate
Looking Forward to Further Innovation Which way now for Islamic finance innovation? Dr. Akhtar concludes that the industrys effort to engineer and re-engineer financial innovation has been impressive, but authenticity demands that industry continues its efforts to innovate. How can this continued process of innovation be guaranteed? As Dr. Akhtar points out, the enhancement of the legal, regulatory and supervisory infrastructure is key, as is the support of proper governance framework. As abovementioned, Islamic finance has a role to play in the innovation of conventional finance through Shariah-based principles. One such principle is Profit-and-Loss Sharing. Products development based on this principle is one example of why implementation of the right framework is so important to Islamic finance and its innovation of both itself and conventional finance. The development of such financial,
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legal and regulatory infrastructure, as Dr. Akhtar states, will help manage principal agent/entrepreneur relationships-central to the profit and loss sharing behind mudaraba, for example-whilst dealing with investment account holders concerns. Goud points out that it is possible for innovation to increase profitability without adding any type of broader benefit; to ensure Islamic finance innovations benefit the world of finance as a whole through the introduction of Shariah principles, such innovations must be well thought out and structured within a good regulatory and supervisory framework. Innovation may bring to mind images of creativity and imagination and indeed, these are at heart of innovation. However, for innovation to be effective and not counterproductive, in the case of Islamic finance at least, it must also have structure to it. Innovation is vital to Islamic finance in terms of authenticity, but to avoid the innovation of products and services that are not authentically Shariah-compliant, Islamic finance must plan its processes of innovation, contextualising them within a solid framework.

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