ISLAMIC BANKING AND FINANCE:

1
ISLAMIC BANKING AND FINANCE

• WHATS IN IT FOR CANADIAN COMPANIES?
• Mohammad Fadel
• Canada Research Chair in the Law and Economics of
  Islamic Law
• University of Toronto Faculty of Law
• October 16, 2006

2
OVERVIEW OF ISLAMIC BANKING SECTOR

• Centers of Islamic Finance
• Malaysia
• Persian Gulf
• United Arab Emirates (Dubai)
• Bahrain
• England ????

3
History of Islamic Banking

• Local Islamic banks formed in the 1970s in Muslim
  countries such as Malaysia, Pakistan and Dubai
• Originally emphasized joint-venture structures
  akin to private equity
• Quickly evolved to provide short-term credit
  facilities by using the murâbaha structure

4
History of Islamic Banking (II)

• With increase in scale, Islamic banks began to
  branch out to more complex financing schemes,
  including
• Retail banking, including, deposit taking and
  consumer lending
• Bonds (sukûk)
• Medium- and Long-term leases (ijâra)

5
History of Islamic Banking (III)

• Impact of 9/11 Reverse Capital Flight
• Perception of hostile climate in many Western
  jurisdictions, in particular, the United States,
  led to repatriation of dollars by Arab investors
  to Middle Eastern banks
• Islamic banks, along with conventional banks in
  the region, benefited from this reverse flight of
  capital
• Increase in Oil Prices Led to Dramatic Increase
  in Liquidity in the Gulf

6
History of Islamic Banking (IV)

• Conventional Banks Open Islamic Windows
• Conventional banks began to respond to requests
  from Muslim clients to offer products that
  complied with Islamic law
• As the size of the potential market became clear,
  conventional banks responded with the creation of
  divisions dedicated to Islamic banking

7
History of Islamic Banking (V)

• Conventional International Banks with Islamic
  Windows
• Citigroup
• HSBC
• Deutsche Bank
• UBS
• ABN AMRO
• Standard Chartered Bank

8
History of Islamic Banking (VI)

• Almost all regional banks have followed the
  international banks in creating Islamic windows
  and some have converted, or are in the process of
  converting, to the Islamic banking model

9
Size of Islamic Banking Sector

• No precise measure of size of deposits held in
  Islamic banks or Islamic divisions of
  conventional banks
• Ranges from a low of 250 billion to a high of
  750 billion
• As much as 300 billion held in Islamic
  investment funds awaiting investment
  opportunities
• Arab investors hold approximately 800 billion of
  assets in European banks, with a growing trend to
  invest that money in Islamic products

10
Role of Islamic Finance in World Credit Markets

• Demand Side
• Sovereign Debt
• International Agencies
• Corporate Debt
• Project Finance
• Consumer Debt

11
Sovereign Islamic Debt

• In recent years, several Islamic Countries and
  their instrumentalities, as well as non-Islamic
  countries, have issued sovereign debt in the form
  of sukûk
• Department of Civil Aviation, Dubai 1 billion
• Qatar 700 million
• Pakistan 600 million
• Malaysia 600 million
• German State of Saxony-Anhalt 100 million
• Bahrain 79.5 million

12
International Agencies

• International Agencies Have Issued Sukûk in
  recent years
• Islamic Development Bank 400 million
• World Bank 200 million

13
Islamic Corporate Debt

• Private Issuances of Sukûk
• DP World 3.5 billion 7.5 sukûk, convertible
  into equity at the time of a qualifying initial
  public offering
• National Central Cooling Company 200 million,
  rated BBB- by SP
• Listed on London Stock Exchange
• Previous issuance by same issuer listed on
  Luxembourg Stock Exchange

14
Islamic Corporate Debt (II)

• Global issuance of sukûk has exceeded 20 billion
• Dow Jones Citigroup Sukûk Index
• Comprised of seven sukûk
• 2.8 billion aggregate principal amount
• Each issue rated at least A by SP
• Average tenor 3 years

15
Islamic Corporate Debt (III)

• Biggest challenge thus far is limited secondary
  trading market for sukûk
• Demand for sukûk has far exceeded supply
  offerings typically oversubscribed, even after
  substantial upsizing of the offering at times
• DP World offering originally contemplated for
  2.8 billion but was upsized to 3.5 billion to
  meet excess demand no road show needed to market
  the offering

16
Islamic Finance and Project Finance

• Infrastructure projects in the Gulf region
  largely financed on a corporate basis until the
  mid-1990s
• Sadaf, a joint venture between Shell Oil and
  Saudi Arabian Basic Industries Corporation
  (SABIC), first important project finance
  transaction in Gulf region, closed in 1995
• Project Finance now preferred structure for
  infrastructure investment

17
Islamic Finance and Project Finance (II)

• Islamic sources of capital traditionally played
  minor role in project finance in Gulf
• In recent years, however, no deal gets done
  without a substantial Islamic tranche
• Financing needs exceed capacity of commercial
  banks and export credit agencies
• Desire of project hosts to diversify sources of
  capital and take advantage of local capital to
  the extent feasible

18
Islamic Finance and Project Finance (III)

• Rabigh Refinery and Petrochemicals Project,
  Kingdom of Saudi Arabia
• 9.9 billion total cost, of which 5.8 billion
  was debt
• 4.1 billion equity split 50-50 between Saudi
  Aramco and Sumitomo Chemical
• 2.5 billion loan provided by Japan Bank for
  International Cooperation
• 1 billion loan from Saudi Public Investment Fund
• 1.7 billion commercial loan
• 600 million Islamic tranche

19
Islamic Finance and Project Finance (IV)

• YANSAB Project
• 5 billion greenfield petrochemical project
• 3.5 billion debt
• 1.067 billion, 13-year tranche from Saudi Public
  Investment Fund
• 850 million, 12-year Islamic tranche
• 700 million export credit agencies tranche
• 533 million 12-year commercial bank tranche
• 350 million working capital facility
• ABN AMRO was sole arranger, underwriter and
  bookrunner on deal

20
Islamic Finance and Project Finance (V)

• Future Demand for Project Finance
• Last two years saw 40 billion of project finance
  in gulf region
• Saudi Arabia estimates it will invest 90 billion
  in domestic power generation over the next
  fifteen years
• Other states in the gulf also investing heavily
  in infrastructure projects, particular
  petrochemical
• There will be a continuing demand in the region
  for capital to invest further expansion of the
  regions infrastructure

21
Opportunities for Canadian Banks

• Deal flow shows no sign of abating
• International banks have shown an ability to
  compete successfully
• Because of the size of new deals, Islamic banks
  need to partner with international banks to take
  advantage of their larger distribution networks
• Success of sukûk issues means that conventional
  market investors have grown comfortable with
  their structure and will invest in them so long
  as credit profile meets investors needs

22
Opportunities for Canadian Banks (II)

• Success in penetrating markets for arranging
  credit could lead to mandates in upcoming equity
  offerings
• Future opportunities to advise in connection with
  an inevitable consolidation of banks in the Gulf
  region
• Opportunities for wealth management of wealthy
  Islamic investors
• Merrill Lynch identified 300,000 U.S. dollar
  millionaires in the Middle East

23
Opportunities for Canadian Issuers

• Canadian Issuers, public and private, may
  consider tapping the Islamic capital markets
• Because of Islamic finance is asset-based,
  Canadas mining industry is a natural fit with
  the structures so far developed in Islamic
  finance
• Because of high-liquidity of Islamic banks and
  Islamic investment funds, issuers who tap this
  market may be able to obtain relatively favorable
  pricing relative to the conventional market

24
Opportunities for Canadian Infrastructure Firms

• Because of infrastructure boom in Gulf region,
  large premiums have been paid on Engineering,
  Procurement and Construction contracts
• Successful competition for infrastructure
  projects inevitably requires support of export
  credit agency
• Export Development Canada would have an important
  role to play in promoting Canadian firms
  expertise in the region

25
Conclusion

• Islamic finance and conventional finance are
  quickly converging in the Gulf region
• As conventional investors gain more comfort with
  Islamic structures, cost differential between
  Islamic products and conventional products have
  almost disappeared
• As a result, Islamic products may be more
  practical because they appeal to both Islamic and
  conventional investors

26
Conclusion (II)

• It is not too late for Canadian banks to compete
  for business in the Islamic finance arena
• To do so successfully, they will need to
  establish a presence in the region, as have their
  competitors