Islamic finance regulators are working to reduce the role of scholars, blaming delays and excessive fees for stifling growth in the industry.
Bankers and officials from Bahrain to Indonesia are standardizing documents and bond structures to limit impediments caused by varying interpretations of Shariah law. It can take up to 12 weeks to arrange a sukuk sale, compared with eight for a non-Islamic debt offering, according to law firm Clifford Chance LLP. A well-respected expert can charge between $500 and $1,000 an hour in the Middle East, according to two scholars, who declined to be named due to the sensitivity of the issue.
Islamic finance institutions require rulings from scholars, known as fatwa, before they can market any securities or funds in an industry whose assets are set to double to $3.4 trillion by 2018, according to Ernst & Young LLP. Their reputations can heavily influence the success of a product, according to Bank Negara Malaysia’s Shariah Advisory Council, driving demand for a select group of experts and leading to inflated earnings.
“These old gangs are still sitting there in the top firms, issuing fatwa without understanding the consequences,” Ishaq Bhatti, an associate professor who teaches Islamic finance at La Trobe University in Melbourne, said in an Aug. 6 e-mail interview. “The dollar value they earn they don’t contribute to the product’s development.”
Flexibility Needed
Scholars pass religious decrees on whether a financial product conforms with Islamic tenets such as a ban on interest payments. While Malaysia and Indonesia have centralized Shariah boards to approve structures, it doesn’t stop bond issuers from seeking outside endorsement.
Sheikh Bilal Khan, the co-chairman of Dome Advisory Ltd. in London that specializes in areas such as Islamic finance and private equity, said the fees demanded by scholars depend on the complexity and nature of the transaction, declining to be specific on amounts earned.
“The industry is already standardized,” Khan said in a phone interview yesterday. “Bringing standardization has a disadvantage. The transaction is more rigid in the market. If you want to innovate a market, you want flexibility.”
Shariah finance is looking to shed its image as an opaque and fragmented business as it enters new markets. The U.K. sold its first sovereign sukuk in June and Hong Kong plans to follow suit later this year. The governments of Luxembourg, Kenya and the Philippines are also planning debut issues.
Differing Interpretations
The International Islamic Financial Market, a standards-setting body in Bahrain, is developing common templates for structuring sukuk to reduce delays caused by differing views between scholars, Chief Executive Officer Ijlal Ahmed Alvi said in May 6 interview in Jakarta.
Islamic bonds are issued under various principles and are usually backed by an underlying asset, with opinions differing among regional jurisdictions as to their acceptability.
Indonesia’s government is reducing sales of Ijara sukuk because some scholars say the structure the country uses isn’t fully Shariah-compliant. This type of debt is typically backed by a property that a bank purchases on behalf of the customer and leases it back at a mark up. Malaysia switched to the more globally recognized Murabaha contract, a three-party arrangement, for local-currency notes in July 2013.
Middle Eastern investors say the bai al-inah structure, or a sale and buy-back agreement previously used by Malaysia, is too similar to interest-based lending, Winson Phoon, a Kuala Lumpur-based fixed-income analyst at Maybank Investment Bank Bhd., wrote in a June 2 research note.
Transaction Costs
“Due to the lack of standardization, there is indeed too much reliance on scholars,” Murat Unal, chief executive officer of Funds@Work AG, a consulting company near Frankfurt that produced a 2011 report on Shariah scholars, said in an Aug. 6 e-mail interview. “The more international standard-setters agree on standardization, the less there will be a need for scholars.”
Issuers seeking Islamic funding for the first time are faced with a higher fee than if they tap the conventional market, with a $500 million sukuk costing between $20,000 and $100,000 more, according to Clifford Chance.
“Standardization will help to reduce costs on a transaction,” Qudeer Latif, the Dubai-based global head of Islamic finance at Clifford Chance, said in an Aug. 6 phone interview while on a trip to London. “The conventional market is able to issue much more quickly and at a lower cost on the basis that there’s already accepted standard form documents.”
Religious experts are regarded as the sole authority on whether an offering meets the standards of Islam and their sanction is crucial for Shariah-compliant investors, according to Union Investment Privatfonds. Scholars need to be experts on the Koran, commercial law and finance.
Quality Seal
“For Shariah-compliant financial institutions and funds, Shariah scholars are extremely important,” Sergey Dergachev, who helps oversee about $10 billion in emerging-market debt at Union Investment in Frankfurt, said in an Aug. 7 e-mail interview. “Fatwa from a well-recognized scholar is something like a seal of quality and a seal of true compliance with Shariah.”
The central bank of Malaysia, the world’s largest sukuk market, has forbidden scholars from sitting on more than one Shariah advisory board for each type of institution since 2010. Most countries don’t impose such limits.
Islamic bond offerings worldwide increased more than fourfold over the last decade to $26.9 billion so far this year, compared with $43 billion in 2013 and a record $46.5 billion in 2012, data compiled by Bloomberg show. As the $1.7 trillion Shariah finance industry gained greater global prominence, the pay of scholars has increased accordingly.
Setting Standards
The number of hours an Islamic expert has to spend on a sukuk issue depends on the complexity of the structure and a standard transaction would involve about 20 hours of work, one of the scholars who declined to be named said.
“Particularly if the transaction is in big volume, they want a well-known scholar to endorse it so they don’t mind paying,” Mohamad Akram Laldin, deputy chairman of Bank Negara’s Shariah Advisory Council, said in an Aug. 7 interview in Kuala Lumpur. “They know that people are not going to question the credibility of this scholar. This scholar signs off, people know that he knows his stuff.”
As a scholar’s approval is key to determining the success of a product, the industry has sought the services of a select pool of experts. The 20 most-active individuals each advised 31 institutions on average, according to a 2011 report by Funds@Work.
“The lack of standardization creates a need for scholars, which objectively seen are not needed for standard solutions,” said Funds@Work’s Unal. “A central Shariah board at the central bank level could easily take care of it or an international standards setter.”
(Bloomberg / 12 August 2014)
---Alfalah Consulting - Kuala Lumpur: www.alfalahconsulting.com
Islamic Investment Malaysia: www.islamic-invest-malaysia.com
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