December 2010

DECEMBER 26, 2010

I wrote a blog post a few weeks ago about the role social media can play in the industry’s growth if it were used more widely by Islamic finance institutions. To follow up on that post, I thought it would be useful to look at the other ways that Islamic finance can benefit from social media, primarily blogs.

There are a number of blogs focused on Islamic finance out there, including my own.  Some of them provide opinion and commentary on Islamic finance or provide readers with selections of academic and corporate research on the Islamic finance industry.  Others provide news updates on Islamic finance, for example by republishing articles on Islamic finance.  In addition, there are areas where people come together to discuss the Islamic finance industry like the LinkedIn groups.

My primary reason for writing this follow up post to my earlier post was that I believe there could be better use of social media by people within Islamic finance and those with an interest in the field that could serve to broaden the number of people with exposure to Islamic finance.  To someone without any exposure to the broad use of social media relating to Islamic finance, there appear to be few connections between the people who do participate in social media: analysis blogs have few comments, others have news, but no commentary and the dialogue that takes place on LinkedIn or the email listservs are largely invisible to people who have not joined the groups.

Someone who finds a blog either by being sent a link in an email or in a web search might read with interest, but not be able to tell whether the other readers (perhaps with greater experience in Islamic finance) support the opinion expressed by one author and would have trouble finding another place where the topic is discussed with ease.  Or, a regular reader of a blog might come across it and start a conversation in another forum.  However, unless the blogger is also a part of those forum, it is difficult for the blogger to react to criticism, clear up misunderstandings or even realize that something he wrote was wrong.

I am not suggesting that each blog should be a self-contained source of information and discussion on a topic; even if I believed that (which I do not), it would be futile to suggest moving towards that end.  However, there are some ways in which dispersed discussions can be counterproductive.  Specifically, if content and comments do not overlap in one place, it ultimately disrupts the conversation between bloggers and readers, one of the key differences between the blogging format and the opinion pages of newspapers (where there is more of a one way street from authors to readers with less dialogue).  It also removes the ‘social’ from social media.

There is no solution that I or anyone else in particular could or should dictate.  However, I have a few suggestions (speaking to everyone, but no one in particular).

1) If you find something wrong, or something you disagree with on a blog you read on Islamic finance, write a comment on the blog.
2) If you agree with a blogger or other commenter, but think they missed some aspect, write a comment on the blog.
3) If you see an interesting discussion somewhere else about a blog post that adds something to the point the blogger was making, write a comment on the blog with a link to the discussion.
4) If you think that a blogger misses something big with regularity, write a comment on the blog and start your own blog about that area.
5) If you want to write a blog, but cannot because you don’t have the time or are prohibited by the company you work for, drop a blogger an email and suggest topics that you see missing, but think are important.  The blogger may not write about everything you want or in the way you want it written, but most bloggers will consider ideas if they are something the blogger hasn’t thought of before that fit in with the subject of the blog.  
6) If you write a blog that provides news on a topic in Islamic finance, don’t be afraid to add your own commentary on the subject and post a link to it in a comment on related blog posts of other bloggers.

Social media is a relatively new area of communication and, particularly within new areas like Islamic finance, are still at an early stage.  However, for a young industry spread globally, they can be a valuable tool to introduce the industry to people who might not been exposed and to allow people involved with it to collaborate regardless of where they are located.  Social media has room to grow across the Islamic finance industry.  It cannot be just the financial institutions.  Consumers, researchers and practitioners must also add their voices to make social media more valuable to the industry’s growth and development.

DECEMBER 19, 2010

The news about the International Islamic Liquidity Management Corporation is coming out very slowly, with with sufficient regularity that it seems possible that they can actually launch within the next few quarters, as planned.  The big question is whether they have agreed upon a mechanism for the short-term sukuk and whether it will be widely accepted in the market.  The latest piece of news was the appointment of the CEO, Chairperson and Deputy Chairman.  The CEO (a former head of HSBC Amanah) and Chairwoman (Bank Negara governor Zeti Akhtar Aziz) were not surprising.  However, the Deputy Chairman, Yves Mersch, who is the governor of the Central Bank of Luxembourg, was a bit more surprising.  Luxembourg is the only European member of the IFSB, which led the establishment of the IILMC, and the appointment of the country’s central bank governor signals that Islamic finance in Europe is viewed as a growing part of Islamic finance.

Returning to the launch of the IILMC, although I think it will be launched on schedule, I think it would be beneficial for its own success if the guidelines of the new sukuk were launched in advance of the IILMC itself in order to provide the industry with a period to comment on the structure.  Were the IILMC a private company, the secrecy (or at least vagueness with regards to comments on the structure) would be justified by a fear of another group launching a competing product.  However, the strength of the IILMC will not be created by its structure, but by the backing provided by the IFSB member governments.

For this reason, releasing the details of the sukuk would serve to prepare the market for its first issuance and also solicit comments that could limit the ‘bugs’ that come with new products.  Creating a short-term sukuk market is too important to not try and create the best framework for public comment.  In essence, the best way to find problems with the structure or identify adverse market reactions is to use an open source model: release the structure, the documents behind it and let those who are interested enough to dig through them do so.  Besides generating feedback it would also generate interest in the structure and might increase the number of Islamic finance institutions who are early adopters.  In spite of the need for the short-term sukuk, there are going to be some institutions who adopt a ‘wait-and-see’ approach letting other Islamic financial institutions be the first to invest in the new sukuk.  This will slow the widespread adoption of the IILMC sukuk as a liquidity management tool.

DECEMBER 12, 2010

The last post I wrote this week on the blog was about the need for more coordinated Islamic finance advocacy and I think the post can be expanded to describe the point I am making, as well as provide a mechanism by which it could succeed to make Islamic finance more accepted by regulators as well as by the general public.

The main point is this: Islamic finance is growing rapidly, even if the statistics on that growth are murky at best.  This growth has been worldwide, from Muslim majority countries in the GCC and Malaysia and in countries with relatively small Muslim populations like South Africa, Japan, South Korea, France, Germany and the United States.  This growth has been demand driven in some countries and more supply driven in others.  Some countries’ regulators are proactive in accommodating Islamic finance by changing the tax laws and financial regulations to remove impediments to Islamic finance caused by additional costs vis-a-vis conventional finance that are strictly a function of the tax laws and regulatory environment.  Others, including France and South Korea have been hostile to the growth of Islamic finance and have struggled to make the changes necessary to put Islamic finance on an equal footing with conventional finance.  Some, including the United States, have opted for more quiet cooperation within the existing (and quite flexible) regulatory framework.

However, despite the generally accommodating stance from regulators, politicians and the general public have been more skeptical towards Islamic finance.  Some Islamophobic groups have cast aspersions on the industry insinuating it is connected with terrorist financing while even where this is absent, most non-Muslims have not had enough exposure to Islamic finance to determine whether it would be a good alternative to conventional finance.  Therefore, there needs to be a widely targeted education and advocacy group for Islamic finance of all types–from retail banking to mutual funds to investment banking.

The reason it has been so far lacking, I believe, is that the costs are specific–from hiring the right people to speak for the Islamic finance industry to publishing advertisements to coordinating dialogue with national regulator–but the benefits are not able to be captured by the institution that expends the costs.  In this way, Islamic finance advocacy is a “public good” as economists define it.  It is both non-rival (one institutions’ use of the goodwill or regulatory system does not limit the ability of other institutions to benefit) and non-exclusive (so those who do not contribute to creating the goodwill can nonetheless benefit).

As with the traditional public good, there needs to be an institution working for these benefits that is not necessarily working for one specific institution, but is rather working for (and funded by) the industry as a whole.  Each institution would be expected to contribute to the costs of the advocacy effort.  All institutions will benefit, so all institutions should contribute based on their ability to pay.  One way to do this would be to create an organization (either on a national level or internationally) that is funded by member institutions who pay based on their total revenue or total capital.  Such an organization would have to be operationally independent from all institutions, even if it relies on member institutions for funding; the important point is that it not be working on behalf of one institution’s needs to the detriment of assisting other member institutions’ needs.

This won’t happen overnight–it will take time to develop the capabilities of the institution, as well as to convince Islamic financial institutions that the costs of membership are worthwhile–but it is vital if the industry is to expand its reach outside of the Muslim population and even reach deeper within the Muslim population to those who may now be skeptical about whether Islamic finance is different from conventional finance.

DECEMBER 5, 2010

The Banker has a fantastic article on the liquidity management tools currently available to Islamic banks.  At the end of the article, it briefly covers an effort by Geert Bossuyt, formerly the head of Islamic finance at Deutsche Bank now with Dar al-Istithmar, to establish an independent Islamic commercial paper (CP) facility for Islamic financial institutions.  The article offers few details about the CP facility he is developing, which is based on using a single SPV owned by a charitable trust (to make it independent) using a double-wa’d structure.

The Dar al-Istithmar website provides a little more details, although just in the form of a transaction diagram.  From what I can gauge, it is the same structure used by Deutsche Bank for their Al-Mi’yar platform (which I wrote about in a 2009 post).

Source: Dar al-Istithmar.

The structure uses the wa’ad Shari’ah wrapper, which has attracted criticism in the past, although depending on what returns are being swapped, it may not be as controversial as when it was used for generating returns from conventional hedge funds inside of a Shari’ah-compliant wrapper.  Here is my best guess on how the product works:

The independent issuer SPV is established and issues its CP certificates to the investors (Islamic financial institutions).  The proceeds of these funds are invested in a Shari’ah-compliant asset, whether that is a basket of Shari’ah-compliant stocks, commodity murabaha contracts or any other asset that is Shari’ah-compliant (the diagram says “Shari’a compliant shares”, suggesting stocks).  The SPV then enters a dual wa’d undertaking with a counterparty to swap the returns of the Shari’ah-compliant asset (presumably) with the returns on conventional money market funds.  The dual wa’d would have to be structured to ensure that only one side of the dual wa’d will be exercised (otherwise it would run into Shari’ah-compliance questions).

At this point, the SPV generates a return that is equivalent to a conventional money market fund to pay to the holders of the CP certificates it issued.  The counter-party is receiving a stream of returns based on whatever the Shari’ah-compliant assets are invested in, which it can separately hedge using conventional hedging tools (unless it is an Islamic financial institution itself).  The investors can hold their CP certificates as long as they have surplus liquidity and if they need liquidity, they can sell the CP on to other investors, who will then receive the stream of money market returns from the SPV.

The risks to the investors and to the SPV is that its swap counterparties are unable to fulfill their side of the swap.  If one counterparty became insolvent, the SPV might have difficulty continuing operations because the payments expected by investors would have to be generated by the investments of the SPV.  This would likely have a destabilizing impact on the entire platform because it is likely that there would be some general financial market stress, which would lead to lower asset values for the assets held by the SPV.  This would probably be accompanied by greater cash needs for the investors in the Shari’ah-compliant CP (and a general desire to hold more safe assets with limited counterparty risk).

If doubts became widespread about the counterparties of the SPV, it could trigger a ‘run’ on the SPV to redeem shares (if that is possible) or at least pressure on the price of the CP in the secondary market, which would be akin to the problems facing the conventional money market funds that came close to ‘breaking the buck’ or falling below the $1 net asset value.   These problems could be mitigated if not entirely avoided if the counterparties to the platform were one or many central banks of countries viewed to be stable (US or EU for example), although any central bank that had access to the Fed swap lines during the recent crisis would probably suffice (or a multilateral institution like the Islamic Development Bank with a AAA rating and many member countries who could support the bank in its role as the dual wa’d counterparty).

There are always going to be risks that contagion develops for money market products unless they are somehow guaranteed by “reliable” sovereigns.  Developing a structure for money market funds will be a tricky business.  The current setup of ad hoc bilateral commodity murabaha also creates the same type of counterparty risk, so whether the replacement structure uses a  network of commercial counterparties or sovereign counterparties, the success of each product should be viewed on how cost competitive it is to conventional liquidity management tools, as well as how much it reduces counterparty risk over bilateral commodity murabaha.  Finally, there will also be an impact of the structure on how widely used it is.  The more controversial a structure, the less likely it will be to gain wide acceptance unless it offers something compelling on the other metrics.  What is undoubtedly positive is that liquidity management has moved the the fore for new product development.  This is probably the best legacy of the financial crisis for Islamic finance.