Islamic Finance: Islamic Sukuk By Goldman Sachs Causes Debate

A controversial plan by Goldman Sachs to issue an Islamic bond has ignited a wider debate on whether conventional banks in the West should be allowed to engage in Islamic finance.

At a major conference of Islamic scholars and bankers in London this week, much of the public and private discussion was devoted to whether growing Western interest in Islamic finance could damage the industry by compromising its religious principles.

Some participants argued investment banks such as Goldman should be banned from issuing Islamic bonds, or sukuk, because the funds they raised could help to finance other parts of their business that did not comply with sharia or Islamic law.

“A conventional bank, with the exception of multilateral development banks like the World Bank and the Asian Development Bank, should not be allowed to issue sukuk,” said Badlisyah Abdul Ghani, chief executive of CIMB Islamic, the Islamic unit of CIMB Group, Malaysia’s second biggest bank.

“The basic principle of Islamic finance is that you should only finance activities that are consistent with sharia, and conventional rib (interest) is not,” he told Reuters on the sidelines of the Euromoney Islamic Finance Summit.

Other participants said the industry could not bar conventional banks and should focus instead on ensuring that each of their Islamic transactions complied with sharia law.

“The fact that these sukuk are issued by Goldman Sachs or by another Western bank really makes no difference whatsoever as far as judgement of sharia is concerned,” Mohamed Elgari, a prominent Islamic scholar, said during a panel discussion.

“An institution has no religion and therefore cannot be judged on religious grounds. Our judgement is always on the structure of the transaction, and whether it is permissible or not and had the necessary sharia requirements.”

The debate could affect Western access to a fast-growing area of the financial world. Estimated at over $100 billion, global sukuk issuance is still dwarfed by trillions of dollars worth of conventional bonds. But Western banks are becoming more involved in Islamic finance as its pool of wealthy, conservative investors from the Gulf and southeast Asia makes it a stable source of funds during the global financial crisis.

HSBC’s Middle East unit became the first Western bank to issue a sukuk last May with a $500 million, five-year Islamic bond. France’s Credit Agricole said last October it was considering whether to issue a sukuk.

Goldman’s sukuk became controversial partly because for many investors, the U.S. investment bank embodies aggressive, sophisticated Western financial engineering.

It announced in October that it planned to issue a sukuk worth as much as $2 billion based on murabaha, a structure that instead of interest, which is banned by Islamic principles, uses a cost-plus-profit arrangement to pay investors.

Some Islamic finance analysts questioned whether the underlying structure of the sukuk was really murabaha, and suggested Goldman might use the proceeds of its sukuk to fund interest-based banking activities.

They also said the sukuk might violate a ban against pure monetary speculation if it traded between investors on the Irish Stock Exchange, where it would be registered, at levels other than par value.

The controversy has put the top authorities of Islamic finance in a difficult position. Big Western banks such as Goldman could help the industry grow by providing trading liquidity, trained personnel and access to Western investors. But the credibility of the industry could suffer if it is perceived to be manipulated by Western institutions.

Asked about the participation of Western banks, a top official of one of the international bodies which sets standards for the industry replied: “That’s a tough question — there is a sharia-compliant issue.

“It requires a seriousness of purpose and respect of Islamic finance, and if those two are not there, I am not sure how they would participate,” said the official, declining to be named because of the sensitivity of the issue.

He noted that Malaysia’s central bank, for example, stipulated Islamic banking activities could only be transacted by a licensed Islamic bank. But he added that this should not exclude Western banks from all involvement in the industry.

“Western banks can certainly participate in terms of underwriting and helping in structuring the products.

Most participants at the conference said there was unlikely to be any sustained, concerted push within the industry to exclude conventional or Western banks from areas of Islamic finance. Some big Western banks, such as HSBC, already operate well-established Islamic arms offering a range of services.

Any attempt to exclude conventional banks could also be thwarted by the industry’s decentralised structure.

Bodies such as the Malaysia-based Islamic Financial Services Board and the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) set standards which they hope banks will follow, but they cannot impose rules; that is up to national regulators in each country.

Ultimately, therefore, the success of Islamic financial products offered by Western banks is likely to come down to whether investors choose to buy them. The Goldman case suggests they will.

Banking sources in the Gulf told Reuters this week that Goldman, which insists its planned sukuk obeys Islamic principles and will not be used to raise money for interest-based activities, was talking to potential Saudi Arabian buyers and was likely to have no problem in attracting enough demand.

A copy of the fatwa or Islamic ruling behind the Goldman sukuk, which was seen by Reuters, showed five sharia scholars had signed it. The AAOIFI’s guidelines stipulate that at least three scholars advising on a bond programme should approve it in writing before issuance.

However, the Goldman controversy could cause conventional banks to take more steps in future to allay potential concerns over whether they are following Islamic principles.

Aznan Hasan, one of the scholars who signed the Goldman fatwa, said there were no sharia-related problems with the sukuk. The intention to list on the Irish exchange is purely for tax purposes, he said. But he added that Goldman should consider more measures to address doubts.

“I personally think the issue now is what is the mechanism to ensure that it is not traded, and even if it is traded, that it’s traded at par, and they have to come up to us with a mechanism for that,” he told Reuters.

He said Goldman might issue an additional or complementary prospectus to address this aspect and describe how it would ensure proceeds of the sukuk were only used for sharia-compliant purposes. Goldman might also agree to issue a letter to its board of sharia scholars whenever it used the proceeds, or agree to quarterly audits, he added.

“If they can put all the mechanisms in there, then there shouldn’t be any problem,” said Hasan. “The murabaha is not a new one — there is nothing new in the structure.”

Another scholar, Sheikh Edam M. Ishaq, said the Goldman case might lead to institutional reforms in the industry and closer scrutiny of sukuk issues in general.

“There must be some regulatory body to monitor and ensure the compliance of these issues, otherwise sooner rather than later the attraction of sukuk as Islamic liquidity management instruments will lose a lot,” he said.

Goldman Sachs Sukuk Row May Dent Industry Lure: Islamic Finance

Dec. 21 (Bloomberg) — Goldman Sachs Group Inc., the fifth biggest U.S. bank by assets, has become entangled in a debate about how Shariah compliant its $2 billion Islamic bond program is, which may diminish the allure of Islamic debt.

Goldman Sachs’ sukuk program, blessed by eight of the world’s top scholars, is criticized by some Islamic advisers for not ensuring the debt will be traded at par value as mandated by Islamic law. Advisers including Riyadh-based Mohammed Khnifer of Edcomm Group Banker’s Academy in New York and Dubai-based Harris Irfan at Cordoba Capital have also said it’s unclear on how Goldman will use the funds it raises.

The debate highlights the struggle of Islamic finance’s standard-setting bodies to formulate rules that apply globally. Companies and governments aren’t bound by the regulations set by organizations including Manama-based Accounting & Auditing Organization for Islamic Financial Institutions and Kuala Lumpur-based Islamic Financial Services Board.

“The industry needs to welcome key global financial institutions if it wants to strengthen and further entrench Islamic finance globally in order for it to become a viable and competitive alternative,” Rizwan Kanji, a Dubai-based debt capital markets partner at King & Spalding LLP said in a telephone interview Dec. 15. “That said, new entities looking to Islamic finance as a source of financing should work hard to answer queries by the Islamic finance community.”

Islamic Bond Demand

Islamic bond sales, which jumped 68 percent to $26 billion in 2011, are still below 2007’s record $31 billion and are dwarfed by the $764 billion in bonds sold globally this year. Shariah restricts investors to transactions based on the exchange of assets rather than money alone because interest payments are banned.

Goldman Sachs set up a sukuk program based on a so-called commodity murabaha structure, or a cost plus mark-up transaction, that was approved for listing on the Irish Stock Exchange by the Central Bank of Ireland in October. Murabaha certificates can only be bought and sold at par value because they represent a future claim on the underlying assets.

“The commodity murabaha structure is already under fire from much of the Islamic community who consider it a shallow attempt to mimic conventional debt structures, and using such proceeds to fund conventional banking activities is ludicrous,” Irfan, managing partner of Cordoba Capital, an Islamic finance advisory company, said in an e-mailed response to questions Dec. 7.

Tawarruq Contracts

Edcomm’s Khnifer, a sukuk structurer and strategist, drew parallels between Goldman Sachs’ Islamic bond structure and the reverse Tawarruq contract, which was banned in 2009 by the Jeddah-based unit of the 57-member Organization of Islamic Cooperation. International Islamic Fiqh Academic hasn’t deterred issuers in Malaysia from using Tawarruq.

He also says Goldman’s program doesn’t ensure the commodity murabaha certificates are only traded at par, as per shariah law, especially since the program is listed on the Irish bourse.

Goldman Sachs says it has done its due diligence. The bank is “entirely confident” in the certification of its program as Shariah compliant, New York-based spokesman Michael DuVally said in an e-mail Dec. 7.

The bank, which hired Dubai-based Islamic finance advisory Dar Al Istithmar Ltd. to help set up the program, said it plans to use the funds it raises ”for its general corporate purposes and to meet its financing needs,” according to details offered in the program. It didn’t specify whether the money would be used in compliance with Shariah law, which would prevent it from paying interest and investing in businesses associated with gambling or alcohol.

Scholars Approve

Scholars involved in overseeing the sukuk program deemed it to comply with Shariah guidelines, Chairman of Dar Al Istithmar’s Shariah board, Hussain Hamed Hassan, said in a Dec. 19 e-mailed statement. Hassan sits on more than 15 boards, including Dubai Islamic Bank PJSC. Additional scholars mentioned in Goldman Sachs’ program include Mohammed Elgari and Sheikh Abdullah Bin Sulaiman Al Manea.

The sukuk structure is “a Murabaha, pure and simple,” Asim Khan, London-based managing director and head of structuring at Dar Al Istithmar, said in an e-mailed response to questions. A listing on the Irish Stock exchange would offer tax benefits, added Khan, whose said his comments reflect his own views rather than those of his company.

With Islamic bond sales increasing globally, investors may yet overlook the controversy and buy the bonds. South Africa invited banks Dec. 6 to submit proposals for the sale of its first Islamic bond, and Senegal plans to start investor meetings before year-end for the possible sale of sukuk.

Appetite for Goldman

“There will be an appetite from the market as Goldman Sachs is still one of the largest financial institutions in the world,” said Hakim Azaiez, head of capital markets in the Middle East and North Africa at London-based Dinosaur Securities. Still, “if its main aim is to achieve lower funding costs through this deal, then this won’t offer much value for investors as there will be comparison with its conventional bonds,” he said in an e-mailed response Dec. 19.

The yield on Goldman Sachs’ 5.375 percent dollar bonds maturing March 2020 jumped 88 basis points in 2011 to 5.79 percent today, according to Bloomberg prices. The average yield on Islamic bonds in emerging markets has fallen 65 basis points so far this year to 4.09 percent yesterday on the HSBC/NASDAQ Dubai US Dollar Sukuk Index. The debt returned 6.7 percent in 2011, compared with a loss of 0.1 on Goldman Sachs’ debt.

The yield on Dubai government’s unrated 6.396 percent sukuk maturing November 2014 dropped 59 basis points so far this year to 5.98 percent today, lowering the extra yield investors demand to hold Dubai’s sukuk over Malaysia’s 3.928 percent debt maturing in June 2015 26 basis points in the period to 312, according to data compiled by Bloomberg.

‘Fine Mess’

“We got ourselves into this fine mess, and have no one else to blame,” Safdar Alam, chief executive officer of Manchester, U.K.-based Solum Asset Management, said in an e- mailed response to questions Dec. 15.

On the one hand the Islamic finance industry encourages issuers to use structures as debt instruments “in clear contradiction of one of the most prominent facets of our industry — the prohibition of Riba” or interest, he said in an e-mailed response to questions Dec. 15. “Then on the other hand we disagree with how some entities use this product, because it is not ‘right’ or ‘good’, according to a definition of those words I am not familiar with.”

Islamic banking an antidote to crises should be promoted

The global economy would not have to wrestle with so many ongoing problems had the world adopted and effectively used Islamic financial tools, which are relatively more resilient against shocks, Finance Minister Mehmet Şimşek declared at a meeting in İstanbul on Saturday.

Şimşek was speaking at a symposium on Islamic finance and the participation banking model. Underlining that the importance and role of participation banking in maintaining stable economic growth have so far been underestimated by many, the minister attributed the recent problems in world markets to such ignorance.

“We can all see from today’s crisis that an economic system supported by a banking model that gives priority to interest income is vulnerable to external shocks. … Participation banking, on the contrary, is a reliable model that contributes relatively more to the non-financial economy. This makes the real sector stronger,” Şimşek said.

Participation banks have not transferred money to what he called “speculative fields” but rather shared the profits directly with their customers. With assets totaling $30 billion, participation banks extend 84 percent of this money as loans while other banks in Turkey only share 63 percent of their assets. According to the minister, if Turkey is to consider the reform of its financial structure, participation banking would be the best model to adopt as it will increase the country’s resilience against external shocks.

Şimşek said many countries have now started to benefit from Islamic financial tools in their own financial systems. He emphasized that the Islamic banking model should be promoted. In meeting such preferences as not paying or being paid interest on loans and of not getting involved in any kind of investment in companies that sell goods or services considered forbidden in Islamic teachings, Islamic financial institutions have grown considerably over the years not only in Islamic countries but also in the West.

Şimşek underlined that such leading Western banks as Citibank, HSBC and Goldman Sachs have also made a place for this model in their systems. “We need to change the negative image of participation banking in Turkey for the better. … This will benefit not only the country’s economy but also entrepreneurs,” he opined.

Şimşek said the capital adequacy ratio (CAR) of participation banks in Turkey was 14.3 percent as of September, an encouraging figure, and added that the share of Turkey’s four participation banks in total bank assets reached 4.4 percent in September — an 80 percent rise over the figure in 2005.

Additionally showing participation banks’ growing appeal to Turkish customers, the number of such banks increased to four with 685 branches across the country from only two banks with two branches in 2005. The participation banks, like all other banks in Turkey, operate under the prevailing Turkish Banking Law, regulated and supervised by the Banking Regulation and Supervision Agency (BDDK).

Goldman sets up $2 bln Islamic bond programme

Oct 19 (Reuters) - Goldman Sachs has registered a $2 billion Islamic bond programme, providing further evidence of conventional borrowers looking to sharia-complaint funding sources as market volatility makes raising debt finance more difficult.

The investment bank has set up the Cayman Islands-registered Global Sukuk Company Limited special purpose vehicle to issue murabaha-structured sukuk, according to a base prospectus filed with the Irish Stock Exchange.

Murabaha is a cost-plus-profit arrangement which complies with Islamic law.

“In the current environment it is unsurprising to see borrowers turning to markets in which they believe liquidity is still available,” Chavan Bhogaita, head of markets strategy unit at National Bank of Abu Dhabi, said.

“(Goldman Sachs’ decision to tap sukuk) is simply a reflection of the very challenging environment in which we currently find ourselves, and the relative strength of the sukuk market at present given that we are seeing solid demand for assets in this space.”

The Islamic bond, which will be listed on the Irish bourse, could be denominated in UAE dirhams, U.S. dollars, Saudi riyals or Singapore dollars but a time frame for issuance was not provided.

The sukuk market has been largely resilient despite a global financial downturn that has dried up bond issuances.

HSBC’s Middle East unit became the first Western bank to issue a sukuk in May. The $500 million Islamic bond priced at 155 basis points above midswaps, carrying a maturity of five years.

Goldman does not have an established presence in the Islamic banking sector, unlike HSBC through its HSBC Amanah brand.

“Islamic investors are generally not comfortable providing funding for conventional banks unless it has a very large and dedicated Islamic business,” one Islamic banker said.

“You’ll find there are large Islamic investors that aren’t comfortable with it and tell us that they don’t want to see their money being used in a conventional business.”

Dar Al Istithmar Limited, which has offices in the U.K. and Dubai, is the sharia adviser of the programme.