Executive Magazine

Wealth begets more wealth for luxury brands and stocks

by Fadi Eid July 3, 2008

written by Fadi Eid

Luxury goods are in vogue like never before. In fact, 2007 was a record year for many manufacturers of luxury items. The share prices of these companies have also benefited, with luxury stocks having easily outperformed the Morgan Stanley Global Equity Index over the last six years. Many structural indicators suggest that this trend is set to continue.

The luxury goods industry continues to benefit from the fact that the rich continue to get richer. As a result, more and more money is spent on luxury goods. This phenomenon manifests itself strongly in the US, where the top 20% of earners account for 60% of total US income. Where assets are concerned the picture is even more extreme, with the wealthiest 1% owning 40% of total US assets. In the first three months of 2008, sales of high- end luxury goods in the US continued to display double- digit growth for most companies. At least, where high-end consumer goods are concerned, the anticipated slowdown in consumption has not been felt.

Not only is the luxury goods industry growing fast, it is also a very profitable business. This is hardly surprising given that luxury products tend to beautiful, of very high quality, but also very expensive. Consumers are evidently willing to pay a disproportionately high amount for the products of renowned luxury brands, not least because they are perceived to confer prestige and social distinction. Strong brands can thus dictate their prices. In historical terms, the prices of luxury goods have even risen faster than inflation, something that is only possible in very few industry sectors. As a result of the price-setting power enjoyed by luxury brands, the luxury goods business can be very lucrative, but here too, there are winners and losers.

Branding Is Key
What makes for a successful luxury brand? What luxury goods manufacturers represent good investment bets? For every company in the luxury goods industry, branding is the be-all and end-all. But owning a brand is just the beginning. There are countless examples of brands that have either been sold too expensively — and therefore never really made money — or successful brands that were not properly looked after, and even diluted. A successfully managed brand will display at least the following four characteristics.

First, a luxury brand must brook no compromises when it comes to product quality. Luxury consumers are prepared to spend large sums of money on brands, but in return they expect top quality when it comes to material, production processes and service. For example, the Kelly or Birkin handbags from Hermès will set the purchaser back more than 5,000 Swiss francs ($4,800). Despite these hefty price tags, these products have waiting lists. In return, the purchaser is assured of exclusive leather, painstaking hand-stitching and the right to have the bag repaired, even after many years.

Second, the brand needs to be clearly positioned. Every brand sends out a message that differentiates its products from those of other brands. Competition in the motorbike industry is strong. There are many manufacturers of motorbikes competing for the favor of bikers. But those who buy a Harley-Davidson acquire not just a motorbike, but also the Harley-Davidson lifestyle: freedom, independence and America. In this respect, Harley-Davidson has virtually no competition.

Third, successful brands are famous for their continuity. Consumers have expectations of the brands they buy. The Four Seasons hotel chain is renowned for its good service. All staff is subjected to a harsh training process designed to ensure that guests are satisfied in return. The hotel’s internal guidelines are very strict and highly client-focused. This is the only way the hotel’s high prices can be justified. The hotel’s guests can have high expectations, and will not be disappointed.

Innovation as sales argument
Finally, perhaps the most important of all the features of a successful brand is its ability to innovate. Consumers of luxury goods are quite sophisticated, and need to be continually seduced by new and attractive products to buy. After all, how many women nowadays actually need another new handbag? How many affluent men do not already own a watch? The proportion of new products in overall sales volumes is often considerable, depending on the brand and the product. The Porsche Cayenne, for example, launched just a few years ago, today accounts for more than a third of all Porsche models sold.

Hence the appeal of investing in luxury stocks. What are the opportunities and risks? The fundamentals appear outstanding. In Asia and the emerging markets, the number of consumers wanting to buy Western luxury brands is rising every day. The luxury product business generates so much cash flow that most companies have healthy balance sheets with very little indebtedness. The operating margin is often over 15%. Though among other things, this will depend on how much is spent on brand maintenance and marketing.

Luxury goods firms are currently spending large sums of money. Tapping into new markets requires great marketing expenditure, and this can often account for up to 40% of sales revenues. The smaller the brand, the proportionally greater the marketing investment. This is where large companies, which enjoy economies of scale, can benefit most.

The same is true of the opening of luxury boutiques, for which only the most expensive and most coveted locations can be considered. These investments in the future of brands are both necessary and good business. However, unexpected events such as the outbreak of bird flu or other unforeseeable crises can lead to short-term collapses in sales in the luxury goods industry, with consequences for profit margins.

Another risk — albeit more for the much more volatile luxury stocks than the luxury goods industry itself — is a further strengthening of European currencies against the dollar and the Asian currencies. The fact is that most luxury goods companies continue to manufacture the majority of their products in Europe, yet export them around the world. Exchange rate fluctuations can be compensated for through price adjustments over the long term, however. In recent years, investors in luxury goods stocks have made handsome profits. Given the healthy fundamentals of the luxury goods industry, it is only fair to assume that this will continue to be the case in future.

Fady Eid is General Manager for Credit Suisse (Lebanon Finance) S.A.L

July 3, 2008 0 comments

By Invitation

What is so Islamic about Islamic Banking?

by Nada Abdelsater-Abusamra July 3, 2008

written by Nada Abdelsater-Abusamra

The Islamic banking industry has grown impressively during a short period of time. In the early 1960s, the Islamic finance sector witnessed a steady growth in different aspects such as size, complexity of the transactions, and internal processes. It has been estimated that the sector is witnessing a 15% to 20 % annual growth rate (10% of which is in the Gulf region). One of the reasons pertaining to this growth — but certainly not the only reason — is the huge amount of petro-dollars following the rapid increase in oil prices.

Islamic finance now exists in more than 75 countries with more than 300 Islamic financial institutions and Islamic windows operating globally. According to McKinsey & Co, it is estimated that this sector will attain $1 trillion in assets by 2010. Currently, this sector is estimated at more than $500 billion in assets. The success of Islamic banking prompted many multinational conventional banks to offer Islamic financial services. For instance, HSBC, Citibank, and Deutsche Bank are already providing such services worldwide. So what is so different about Islamic banking and what is so “Islamic” about it? Is conventional banking non-Islamic? And is Islamic banking non-conventional?

Answering these questions warrants an in-depth analysis of Islamic Finance which is clearly beyond the scope of this article. This article aims at introducing, from a legal perspective, basic concepts of Islamic finance.

Some have questioned the rationale of distinguishing between Islamic and conventional finance with a skeptical approach advocating that there were no real differences between the two systems. However, the Islamic banking industry is different from conventional banking in several aspects of its core legal features even though some Islamic banking operations may ultimately lead to the same results as conventional banking operations.

The fact that the same result may be reached in both systems does not mean that both systems are identical. An expressive example was used by Professor Mahmoud Amin El- Gamal from Rice University when comparing an “Islamic finance contract” to a “marriage contract”. Whether the “marriage contract” is held under Islamic or civil law, this will lead in both cases to two persons being married and forming a family. In certain respects, “a marriage is a marriage” and “a “financial contract is a financial contract.”

Does this mean that Islamic marriage is identical to civil marriage only because both lead to the same result? The answer is “of course not.” In Islamic marriage (and similarly in Islamic leases), the contract must comply with additional requirements warranted by the sharia. As with marriage, the outer form of an Islamic lease (for example) may seem to a casual observer to be identical to a regular lease. However, recognizing the differences requires alertness to the legal requirements of sharia.

Fundamental principles
We shall now turn to some fundamental principles of Islamic banking including the prohibition of riba, the requirement to structure transactions according to Islamic compliant vehicles and invest in halal activities, the concept of Profit and Loss Sharing schemes, and the prohibition of gharar (uncertainty).

In Islamic banking, no interest (riba) is paid or charged for any transaction or service. In other terms, one cannot make “money from money.” According to Islam, prohibition of riba ensures justice, welfare and non-exploitation of the other party’s weaknesses.

However, an increase in business activity derived from invested money is not riba. Taken as a “trade” activity, investment is not only permitted by sharia, but it is also encouraged. This is taken from the hadith whereby “a man’s labor and every legitimate sale” are the best forms of income generation. This shows the necessity to clearly define what constitutes a “prohibited” interest (i.e. riba). In addition, the prohibition of interest is not the only “Islamic finance rule”. In fact the Islamic financial system is supported by other key principles consecrated by sharia such as risk sharing, trade, property of rights and the “sanctity of contracts”.

Second, investments of an Islamic bank must be channeled to approved (halal) sectors, and such by using Islamic structures of finance such as mudaraba, musharaka, bai- muajjal, bai-salam, and ajar among others.

Third, Islamic banking deals with the Profit and Loss Sharing (PLS) scheme. In fact, the financer or investor usually shares in the profits or losses arising out of the enterprise’s business where the money is invested with other contributing parties. This concept is derived from sharia, where Islamic finance is based on the belief that the provider and the user of capital should share the risk of business.

Fourth, gharar (uncertainty, risk or speculation) is prohibited under sharia. Consequently, the contracting parties should have perfect knowledge of the counter values intended to be exchanged as a result of their transactions. For instance, maysar (gambling) is prohibited by sharia law since it involves speculation and uncertainty. At this level, a distinction should be made between gharar and “risk” as such. In fact, according to Islamic principles not only is risk permitted but risk must be inherent to any profit. In other terms, reward must be accompanied by risk. For example, this is why investment in stock is permissible (market risk) while investment in bonds is not (credit risk).

In addition to the above, several points are worth noting when addressing the particularities of Islamic banks such as the principle of non-guaranteed investments as well as the most common Islamic vehicles.

Value of investment not guaranteed
Islamic banks neither guarantee the capital value of investment nor the return on investment except in the case of mismanagement or negligence. These banks mainly pool funds provided by the “depositors” (account holders) and therefore provide them with professional investment management (whilst conventional banks guarantee the depositors’ fund and provide them with a fixed interest rate). From this perspective and due to the application of the PLS scheme, Islamic banks may viewed as being in a better position than conventional banks in absorbing external shocks. This is because they have the ability to reduce the capital value of investment deposits in the case of loss, thus transferring part of the loss to the investment accounts of the investors.

As for Islamic legal vehicles, these include murabaha or mark-up financing, accounting for 75% of Islamic financial activities, where the seller adds a cost plus to the initial price of the acquired product. Another well-known instrument is mudaraba or profit sharing where the rabb al- mal (capital owner) provides the total amount needed to finance a project while the entrepreneur offers his labor and expertise. Another instrument is musharaka or equity participation where the bank enters into an equity partnership agreement with one or more partners to jointly finance an investment project. Profits and losses are shared strictly in relation to the respective capital contributions. Other tools include ijara (lease), salam (deferred payment), and sukuk (Islamic bonds).

The use of the above described Islamic legal vehicles is not limited to Islamic banking, nor should Islamic banking be viewed as the only component of Islamic finance. Islamic finance is much broader and forms part of a comprehensive financial and legal system. As such this system also encompasses financial intermediation, financial markets, funds, insurance, and other financial and non-financial transactions.

However, the legal and technical framework of these systems needs further elaboration and development. The implications of corporate governance, risks, systemic risks as well as other considerations need to be addressed by regulators and appropriate best practice Islamic standards have started to be developed.

In addition, capital market players (as well as regulators) need to take cognizance of the importance of Islamic finance compliance notably in the context of an IPO. In this respect Islamic Investment criteria (also referred to as sharia “filters” or “screens”) have been developed by Islamic law scholars as well as international financial institutions. The most widespread sharia “filters” or “screens” are the ones adopted by the Dow Jones Islamic Market Indices, Standard & Poor’s Islamic Indices, the Bahrain-based Accounting and Auditing Organization for Islamic Banks and Organizations (AAOIFI), FTSE’s indices, the Malaysian Securities and Exchange Commission, Meezan Bank of Pakistan and many other private and public institutions in Saudi Arabia, Kuwait, the United Arab Emirates and other Arab and Muslim countries including also Iran.

Nada Abdelsater-Abusamra is a corporate and finance attorney admitted to the courts of Beirut and courts of New York. She is a lecturer of law at the American University of Beirut and speaker on Islamic Finance in international conferences. She advises regulators as well as private and public financial institutions on Islamic Finance. Bassem Dagher is a legal counsel and holds an MBA from the American University of Beirut.

July 3, 2008 0 comments

Comment

Chary of the summer shop

by Riad Al-Khouri July 3, 2008

written by Riad Al-Khouri

The region’s rich are certainly getting richer, to the delight of the purveyors of luxury goods. As the jewelers of Paris and the watchmakers of Geneva will testify, the influx of rich Arabs into Western Europe each year turns the summer season into boom time; and the wealthy don’t care too much about the exchange rate of the euro, sterling, or the Swiss franc.

London in particular has long been the Mecca, as it were, of Middle East shoppers. However, in the globalized 21st century, if you can’t go to Regent Street, it will come to you — the latest example of this being the launch in Amman of a branch of the up-market UK toy store, Hamleys. Choosing the Jordanian capital for a first- ever outlet outside Europe, Hamleys opened in Amman in mid- June to considerable fanfare. This would have been hard to imagine a decade ago, when the price of oil was closer to ten dollars a barrel, but with hordes of Gulf Arabs and prosperous Jordanian expats now descending on Amman every summer, the British toy retailer will be doing a brisk business over the next few months. Come winter, however, Amman goes back to being just another capital of a middle- income developing country. No matter: as summer comes around again in 2009, affluent Arab consumers will return, a pattern also replicated in Beirut and Damascus.

Some of this petro-largesse trickles down to the poor, and a considerable swathe of the local population ends up benefiting for one financial quarter, in what has become the Arab Levant’s annual summer boom. However, this should be a complement to business during the rest of the year, not a substitute for nine months of relative slump. Capital cities — and societies as a whole — cannot depend for their livelihood on such a pattern of business, which is potentially unstable in the absence of solid infrastructures and high standards. Faced with shoddy service or rickety infrastructure Gulf Arabs, and to a lesser extent Levantine expatriates, will eventually head elsewhere. There is no shortage of convenient leisure destinations; places from Malaysia to Morocco — and Turkey nearer by — have become magnets for tourists, many of them from GCC states. So the hoteliers and boutique owners of Lebanon, Syria, and Jordan, not to mention policymakers, had better get their acts together to keep their customers.

The other problem with these sub-regional summer booms is what economists call the demonstration effect. Put simply, when a Jordanian living on the equivalent of a few hundred dollars a month sees lots of richer people around him between June and September spending that amount in an hour, envy sets in. In an ideal world, the poorer Jordanian would work harder and make enough to buy the luxuries he sees around him. In fact, with an attitude left over from the bad old days of the late 20th century, he often begs, borrows, or steals to acquire these things before he has managed to be more productive, thus leading to lower savings and a pattern of buying that is wasteful.

Waste was not a big problem back in the 1970s, when newly prosperous Arab states like Jordan created a pseudo- welfare state, subsidizing such basic items as bread or sugar. From the 1990s, that changed, but a shift in the way people perceive work and productivity has not yet happened. For many in the region, the old oil boom brought with it poor attitudes to work, and conspicuous consumption; the new regional prosperity of the past half- decade threatens to do the same, except that the state is no longer there to cushion things through subsidies of basics like food or electricity. That is because Jordan and the rest of the non-oil Arab economy has had over the past decade or so to cope with changing the roles of the public and private sectors by reducing handouts.

Such a process is difficult, but the alternative is to go back to old patterns of waste and sloth. Mindsets that saw poorer Jordanians and others in the Levant sponging off the state may now be converting into similar attitudes towards the affluent. That in turn is promoted by the pressure to consume. I am not saying “Hamleys go home” since my young children would never stand for it; neither in a free market do I want to ban the sale in Beirut of Zegna ties. However, a closer look by regional policymakers at the rest of the economy would be good. Summer shopping and tourism are fine, but cannot alone spearhead sustainable growth. In fact, they could end up creating new problems.

Riad al Khouri is visiting scholar at the Carnegie Middle East Center, Beirut; and senior fellow of the William Davidson Institute, the University of Michigan

July 3, 2008 0 comments

Banking & Finance

IPO Watch – Selling from home

by Executive Staff July 1, 2008

written by Executive Staff

The United Arab Emirates has finally decided to go ahead with a new commercial law that would allow family owned firms to go public and list on the country’s two stock exchanges by floating between 30% and 50% of their shares in an IPO, rather than the current requirements of 55%. The move by the UAE has received high accolades and analysts say this will encourage more family businesses to raise capital by going public. In the past, family businesses were reluctant to use this route because most did not want to give up controlling stakes in their companies. The new law will allow them to maintain majority control while giving them access to liquidity on the stock markets.

The timing for this is very important at this juncture as the IPO market in the region continues to experience substantial upward movement and new records are expected to be set at the end of 2008. Coupled with the region’s bull markets which are being driven in part by a growing middle class seeking new investment opportunities, investors are expected to make the best of these changes by buying bargain-priced shares of undiscovered “family” companies.

For the month of June the IPO market continued to experience new announcements, the biggest being that a unit of Kuwait’s Global Investment House known as Global MENA Financial Assets Ltd. said it seeks to raise over $500 million by floating some of its shares on the London Stock Exchange. The company said the move is part of its strategy to “tap economic growth in the Middle East.” The sale is expected to take place around July 18 and the shares would be sold to “institutional and professional” investors in the GCC.

In the UAE, Drake & Scull International said it plans to raise $326 million in an IPO by offering 55% of its shares to the public. HSBC and Al Mal are the joint lead managers and the IPO will run from July 1 to July 10. Drake & Scull will offer 55%, or 1.198 billion shares, at AED1 ($0.27) each. Meanwhile, the Abu Dhabi-based investment and merchant banking firm, The National Investor, said it is seeking to borrow $400 million and plans an IPO of 30% of the company’s shares soon after.

In Saudi Arabia, Abdul Ghani El Ajou and Sons Holding Trading Company said it will float about 30% of its shares in early 2009. The company did not provide details about the amount it seeks to raise but analyst say the multiline Conglomerate is set to generate a lot of interest when the IPO is launched. Moving to Kuwait, the oil and gas firm, Kuwait Energy, said it plans to offer 25% of its shares to the public in early 2009. The company did not provide details as to the value of the offering but said that it plans to list on the London stock exchange by mid-2009.

In the Levant, the Amman-based Al Israa for Islamic Finance and Investment said it plans to offer 25% of its shares to the public in an effort to raise around $10 million for administrative restructuring. The IPO launched on June 26 will close on July 9.

Observers say the concept of family-owned and joint stock businesses, which have been the model of choice used by the global community for the past few hundred years, has proved itself to be an efficient and dynamic mechanism for wealth creation and capital raising, and that the global financial markets such as Saudi Stock Exchange, Dubai Financial Market and DIFX are the best ways for corporations to raise essential investment capital. According to a recent survey more than half of the family businesses in the GCC agreed that going public is essential for “their survival.” The remaining 50% will now be even more encouraged to choose going public when the adoption of the new laws take place.

July 1, 2008 0 comments

Capitalist Culture

Lebanon – Wealth or war

by Michael Young July 1, 2008

written by Michael Young

This month Lebanon commemorates the second anniversary of the July-August 2006 war, and moreover, the dilemma it created for the country. Druze leader Walid Jumblatt defined that dilemma more than a decade ago as being a choice between Hanoi and Hong Kong; in other words, between Lebanon as a haven for open-ended resistance and militancy, or as a liberal economic system that would seek out peaceful transactions through free markets.

That dichotomy has been often repeated, to the extent that it has almost become a cliché. However, clichés often provide insight into reality, and it was noticeable that in a speech on May 26, the Hizbullah leader Hassan Nasrallah, returned to that dichotomy. He told his audience: “Some put the government and the resistance in front of two choices: Either Lebanon is Hong Kong or Lebanon is Hanoi. In other words either Lebanon is destroyed or it is the pearl of the East, yet with its land occupied, its sovereignty confiscated, its dignity trampled upon, and its security exposed to the Israelis.”

Wherever one falls in this debate, what is of particular interest is the way it has been formulated, so that capitalism, open markets, and striving for prosperity are antithetical to the idea of resistance — or rather of resistance defined mainly as the pursuit of armed struggle.

That approach is surprisingly narrow in this day and age, where power is not exclusively of the gun. The notion of “soft power,” in other words influencing others and shaping their behavior through persuasion and attraction, is now so widespread, so essential a product of globalization, that it too has become a cliché. And what kind of soft power does Lebanon have that might advance its “resistance” against Israel and liberate the Shebaa Farms?

Perhaps more than we know. Recent signs intone that the United States may push Israel to withdrawal from the Shebaa Farms. The US and the United Nations have an incentive to act on this front precisely because of the Hanoi-Hong Kong duality. If the Shebaa Farms can be neutralized, the reasoning goes, this may oblige Hizbullah to disarm, advancing a more attractive model for Lebanon. Their incentive is to react to, but also bolster, Lebanon’s soft power — to show why those things that make Lebanon appealing to outsiders are worth preserving. And if Lebanon offers beaches, good quality education, shopping, economic development, cosmopolitanism, and peaceful prosperity, then what better way to confirm that those attributes mean something in the world than for the UN, US or anyone else to show that it is a strategic priority for them to prevail in Lebanon?

In other words, Lebanon has soft power precisely because the influential in the world are willing to make its more liberal model triumph over the more martial alternative of perpetual resistance — aka Hanoi.

The problem with Hizbullah’s model is, simply, that it is rather grim. No one would deny that the party fought courageously until 2000, when the Israeli army was forced to withdraw from Lebanon. But after that the contradictions between Hong Kong and Hanoi sharpened. With most Lebanese expecting a de-escalation in Hizbullah’s activities, instead the opposite happened: the party accumulated more arms. From liberator of the south, it built up an arsenal suggesting it wanted to liberate Palestine itself. Here was a promise of endless Hanois.

The Hizbullah model is popular in the Arab world. After more than half a century of humiliation in confronting Israel, many see in Hizbullah a fighting force that works. But this lasts for as long as the fighting remains limited to Lebanon, where, not surprisingly, militancy is less popular, perhaps because the country is demolished every time serious shooting starts. Perhaps too because Hong Kong will always be much more appealing than Hanoi, since it offers an infinite number of possibilities and variations beyond the use of weaponry.

Hizbullah’s critics ought to define better how soft power can achieve the goals Hizbullah claims to be pursuing. They ought to show how being Hong Kong need not necessarily be a tale of land occupied, sovereignty confiscated, dignity trampled upon, and security exposed.

But on Hizbullah’s side, the party must really do better than simply dismiss the liberal capitalist model, Hong Kong, as a byword for perdition. Whatever Hizbullah does, the Lebanese, and we suspect most other Arabs, will always prefer an approach that promises more than open- ended conflict. With liberal capitalism you can be who you want, say what you want and make money if the opportunity allows. An ideology of war, in contrast, means what you build might soon be destroyed, what you want to be may be not be allowed and the opportunities you seek might disappear when the rockets fall.

Nasrallah is right. There are only two choices — and I suspect a majority of Lebanese have already chosen.

Michael Young

July 1, 2008 0 comments

Financial Indicators

Global economic data

by Executive Staff June 22, 2008

written by Executive Staff

Interest rates on government borrowing (as a %)

Interest rates are determined by three factors: the price that lenders charge for postponing consumption, the risk that the borrower may not repay the capital and the fall in the real value of the capital that the lender expects to occur because of inflation during the lifetime of the loan. The interest rates shown here refer to government borrowing and the risk factor is very low. To an important extent the interest rates in this table are driven by the expected rates of inflation. From 1993 long-term interest rates fell for a few years but edged upwards again in 1994/1995. Since then they have been falling steadily in most member countries, but have starting to rise again in 2006. For the 20 member countries in the table for which data are available for the full period from 1993 to 2006, long-term interest rates averaged 6.9% in 1993 but only 3.8% by 2006. For many countries the long-term interest rates recorded in 2005 were historically low. The most striking feature of the table is the reduction in the variance of interest rates among countries. The convergence of long-term interest rates is mostly explained by the increasing integration of financial markets — one aspect of globalization — was particularly pronounced among members of the euro area. Japan and Switzerland are exceptions; their interest rates have remained low but are not converging to the OECD average.

Investment Rates (in gross fixed capital formation as % of GDP)

The total investment rate now averages 21% for the OECD as a whole but rates are substantially higher than this in Korea, Spain, Iceland and Australia and well below 20% in Sweden, United Kingdom, Germany and Norway. For the OECD as a whole, total investment rates are largely unchanged compared to 1993-1995. Particularly sharp falls occurred in Korea, Turkey, Japan and Germany, although in Korea and Japan, investment rates remain well above the OECD average. Total investment rates are now much higher than at the beginning of the 1990s in Ireland, Iceland, Spain and Greece. Investment in machinery and equipment accounts for more than 30% of GFCF in most OECD countries, but investment rates tend to be higher than this in countries with a significant manufacturing base, such as Japan and Switzerland. Over the period shown, the machinery investment rates have fallen in most countries, with particularly sharp falls in Luxembourg, Korea, Ireland and the Netherlands, reflecting higher growth of service activities. Rates grew most in Greece and Iceland. Investment rates in dwellings were particularly high at both the beginning and the end of the period in Norway and Portugal. Ireland, Spain and the Slovak Republic recorded substantial increases over the period, but a number of countries recorded large falls: Turkey, Luxembourg, Germany, Japan and Austria. In the short term, rates of investment in dwellings are sensitive to the business cycle, but, over the long run, investment rates in dwellings reflect population growth rates either through natural growth or immigration, and rising affluence, as is evident for Ireland and Norway.

Migration (as net migration rate per 1,000 inhabitants, annual average 2000-06 or latest available period)

Since 1993 Poland is the only OECD country among the countries shown in the table that has shown negative net migration on a systematic basis. Among countries showing significant increases in population (>0.5% per year) over the 1995-1999 period as a result of international migration are Australia, Canada, Spain, Ireland and Luxembourg. Since then Iceland, Italy and Switzerland have joined the list. Former emigration countries (Ireland, Italy, Portugal and Spain) thus figure prominently among high net migration countries, a trend which is likely to continue. There are nonetheless a number of countries where net migration is currently contributing less to population increase than was the case five to ten years ago. These include Greece, Denmark, the Netherlands and Germany. Those where it is contributing more are the four former emigration countries Ireland, Italy, Portugal and Spain as well as Austria and Switzerland. Indeed, all but eight OECD countries are showing a larger contribution to population growth from net migration in recent years. With the retirement of baby-boomers in the near future, to be replaced by smaller entering labour force cohorts, labour supply needs may well increase and OECD countries see a continuing rise in net migration.

Telephone access (as number of telecommunication access paths per 100 inhabitants in 2005)

Access to communications networks continues to expand in all OECD

countries. At the end of 2005, the total number of fixed and mobile telecommunications paths had increased to more than 1.5 billion. This represented a 8.8% increase over 2004 and an average increase of more than 8.5% in each year since 1997. Growth was not occurring across all access paths. The number of cellular mobile communication subscribers continues to climb. An additional 97 million mobile subscribers were added in 2005. By way of contrast, some segments of the fixed connection market have begun to decrease. The number of fixed access lines decreased in both 2003, 2004 and 2005 and will most likely continue to do so over the coming years. By 2005, all but two OECD countries — Mexico and Turkey — had more than one telecommunications access path per inhabitant and seventeen countries reported more than one and a half per inhabitant, those being Spain, Aust-ria, Australia, Portugal, New Zealand, Germany, the Netherlands, Greece, Norway, Switzerland, Finland, United Kingdom, Denmark, Italy, Sweden, Iceland and Luxembourg.

Among the five non-OECD countries shown here, growth has been spectacular in China, which had less than one access path per 100 inhabitants in 1991 but 60 in 2005. The Russian Federation has now the highest number of paths per 100 inhabitants among these countries. In spite of steady growth over the period, there were only about 13 access paths per 100 inhabitants in India in 2005. A growing trend toward liberalization, and the consequent use of prepaid cards in competitive markets, has helped drive the growth of mobile communications in both OECD and non-OECD countries. In 2004 the total number of cellular mobile users in non-member countries overtook the total for the entire OECD area.

June 22, 2008 0 comments

Financial Indicators

Regional equity markets

by Executive Staff June 22, 2008

written by Executive Staff

Beirut SE: Shuaa (1 month)

Current Year High: 3,399.69 Current Year Low: 1,761.53

The Beirut Stock Exchange had a stellar awakening in May and the BSI closed at 1999.36 points on May 23. The shares of Solidere flew to highs unprecedented in the company’s history as soon as Lebanon’s conflicted political opponents reached an unexpected agreement on May 21 to elect a president and downtown Beirut was released from the stranglehold of an 18-month demonstration. Solidere moved limit up at 15% on the news and the three major banking stocks added between 8 and 10%. On May 22, the traded value of Solidere shares exceeded $50 million — way above the BSE’s average daily trading values in the past year — and the stock jumped another 15% to close at $35.70.

Amman SE (1 month)

Current Year High: 9,330.70 Current Year Low: 5,560.56

Glad tidings also from the Amman Stock Exchange as a second straight month of gains pushed the ASE index above 9,000 points by May 7 and to a pinnacle of 9,330.70 points on May 14 before softening to 9,179.20 points by its May 22 close. The four sub-indices moved largely in step with the general index. Year to date, the ASE index gained 22.1%, driven by a phenomenal 79.3% climb of the industrial index. The ASE’s P/E ratio reached 26.73x, the second highest in MENA. Arab Bank reported 41% higher first-quarter profits and Q1 profits of Jordan Phosphate Mines soared 84% from a year ago. The Jordanian Securities Commission approved the planned initial public offering of what will become the Hashemite Kingdom’s first mortgage lending specialist.

Abu Dhabi SM (1 month)

Current Year High: 5,054.35 Current Year Low: 3,327.86

The newly rebranded Abu Dhabi Securities Exchange (ADX) traded sideways in May. The general index closed at 4,961.14 points on May 22, compared with 4988.86 on Apr 30. Top sub-sector was the industrial index which added 12.7% over the period, followed by construction with 4.3%. The consumer and telecom sectors were notable underperformers, with losses of 7.5% and 3.9% on the month. Arkan Building materials made news by announcing a deal with Aldar Properties which made it a major supplier to Abu Dhabi’s biggest developer. The market authorities announced in early May that they converted the eight-year-old name of Abu Dhabi’s securities trading place from Market (ADSM) to Exchange to signal its willingness to offer increased sophistication and to attract more foreign listings.

Dubai FM (1 month)

Current Year High: 6,291.87 Current Year Low: 3,968.09

The Dubai Financial Market slipped back in May as its positive momentum from the previous month fizzled out. On May 22, the general index closed at 5,696.61 points, down from 5,815.53 points on May 1. Sectors generally moved range bound with the overall index, except for the materials sub-index. Materials showed quite a bit of volatility throughout the month and closed 5.45% lower on May 22 when compared with the beginning of May. Year to date, the DFM lost 3.97% underperformed its peers in Abu Dhabi and elsewhere in the GCC with the exception of Saudi Arabia. Emaar Properties share prices again weakened slightly and closed at $3.13 on May 22. Fellow real estate firm Deyaar pulled out of a development deal in India, continuing to make negative headlines following an embezzlement case in April. Deyaar shares nonetheless traded in the general range of its sector and the overall market in May.

Kuwait SE (1 month)

Current Year High: 15,057.70 Current Year Low: 11,348.60

The Kuwait Stock Exchange roared into May with a mini-rally that drove the index to a new historic peak of 15,057.70 points on May 7. The KSE closed a tad lower at 14,957.50 on May 22. Real estate and insurance were the bourse’s top gainers in May, adding 6.2% and 4.2%, respectively. The banking sector index dropped 4.4%. In terms of first quarter results, banks led KSE listed companies in terms of total earnings per sector with $1.1 billion, followed by investment firms with $1.06 billion. In year-on-year comparison, however, the highest-gaining sector was real estate with a 43.3% increase in profits. Banking sector profits were 26.7% higher than in Q1 2007 whereas profits in the investment and insurance sectors dropped by 52.3% and 41.6%. The KSE was closed during a three-day mourning period in mid May after the death of its former emir, Sheikh Saad Abdullah al-Sabah.

Saudi Arabia SE (1 month)

Current Year High: 11,895.47 Current Year Low: 6,861.80

May was a moderately unfriendly month for numbers on the Saudi Stock Exchange, which continued to hold the red lantern for MENA stock market performance in 2008 to date. At its close on May 21, the TASI stood at 9,672.62 points, compared with 10,066.16 points at the end of April. On the year-to-date trajectory, the TASI’s loss of 13.45% to May 21 exceeded, by almost 10 percentage points, the loss of the DFM index, which was the period’s second worst performer among the region’s major exchanges. SSE trading volumes were unexciting as investors were said to put funds aside for the June trading debut of Inma Bank and for a rights issue by Riyad Bank. Another newcomer, Zain Saudi Arabia, achieved good trading volumes in its second month on SSE.

Muscat SM (1 month)

Current Year High: 11,489.62 Current Year Low: 6,042.93

The ascent of Omani stocks slowed in May when compared with the Muscat Securities Market’s strong growth phases in February and April this year. Entering the month at 11,210 points, the MSM index nonetheless still had enough breath to inch up to a new year high of 11,471.56 points on May 22. With its 26.96% gain since January 1, the MSM leads the GCC bourses in this regard. While the banking sector trailed the market, the services index added 2.71% during May and outperformed the general index by almost 1 percentage point. Among services sector gainers was the Salah Port Services Company which climbed more than 19% to May 22 after announcing on April 30 that its first-quarter results were more than doubled from a year ago.

Bahrain SE (1 month)

Current Year High: 2,889.22 Current Year Low: 2,295.98

The Bahrain Stock Exchange had a positive month on the balance. After losing some 34 points in the first week of May, the index came back and gained almost 80 points to close at 2885.09 points on May 22, a level very close to the year high of 2889.22 which it had reached in March. The banking sector did well and improved 7.41% in course of May. The hotels and tourism sector remained buoyant also above the general index’s performance whereas the sub-indices for insurance and for investment firms shed 1.33% and 1.88% respectively, underperforming the market. Among GCC bourses, the BSE showed some of the most attractive valuation ratios in May. It’s average price to earnings ratio stood at 11.83x on May 22, almost 5 percentage points lower than the GCC average of 16.67x and 9 percentage points below the Doha bourse fairly expensive 20.99x.

Doha SM: Qatar (1 month)

Current Year High: 12,289.40 Current Year Low: 7,244.63

The Doha Securities Market took the trophy of being the best performing GCC bourse between May 1 and May 22. Its 6% net gain included a 2.6% drop on the last two days of the review period when profit taking caused the DSM general index to recede from its May 20 year high of 12,289.40 points. All four sub-indices stayed on positive ground and the banking sector led the market’s movement with a net gain of 7.2% while the industrial sector was its laggard with net gain of 2.2%. DSM heavyweight Industries Qatar got a buy nod from analysts on the strength of its $20 billion expansion program. After an 8-week uptrend in its share price, IQ traded at P/E ratio of 16.71x on May 22 but was still below the DSM P/E ratio of 20.99x which is the highest in the GCC and the third highest in MENA.

Tunis SE (1 month)

Current Year High: 3,031.70 Current Year Low: 2,436.94

The Tunindex closed at 2,963.55 points on May 23, down 18.36 points from 2,981.91 on April 30. However, share price movements displayed some intra-month volatility with a 142-point slide from a year high of 3031.70 points on May 9. Of market heavyweights, beverage maker SFBT hovered in a range of $11.51 to $11.73 after announcing 2007 results of $38.2 million. Banque de Tunisie shed almost 17% in an intra-month decline but maintained its position as the market cap leader on the Tunisian Exchange, which it had taken over from SFBT in spring. BT appointed a new management team in mid May as part of corporate restructuring activities.

Casablanca SE All Shares (1 month)

Current Year High: 14,925.99 Current Year Low: 11,271.35

Companies on the Casablanca Stock Exchange traded sideways in the review period as the index moved from 14,387.79 points at the end of April to 14,451.08 points on May 23. While this trading range was about 3% off index peaks reached earlier in 2008, the sheltered Moroccan stocks remained quite a bit dearer than stocks on other MENA bourses. At market ratios of 35.18x for price to earnings and 7.02x for price to book value, these CSE cost indicators are each more than double the regional average P/E and P/BV ratios. In company news, Morocco’s largest bank, Attijariwafa, expanded further into Africa by acquiring leading Senegalese bank, Compagnie bancaire de l’Afrique de l’Ouest (CBAO).

Cairo SE: Hermes (1 month)

Current Year High: 103,313.60 Current Year Low: 67,011.50

Share values on the Cairo and Alexandria Exchanges contracted significantly in May 2008, as the close of the EFG Hermes Index at 92,331 points on May 22 represented a net loss of 9.8% when compared with the start of the month. While earlier downward fluctuations of CASE stocks were influenced by global markets, the negative movement last month was home made and incorporated the reactions of a surprised market to announced and rumored government action. Seeking to fund salary increases for cash-strapped public sector employees, the government revoked tax exemptions and fuel cost subsidies for energy-intensive corporations and started taxing profits from bonds and T-Bills. The stocks of large energy-intensive companies lost favor with investors due to the sudden loss of advantages; heavyweight Orascom Construction dropped 12.7% from May 1 to 22. The levy on bond returns sparked rumors that capital gains would also be taxed, to which investors responded by selling shares to take profits quickly. On the positive side, CASE authorities announced their intention to improve the bourse’s appeal by completing a campaign to banish hundreds of non-rule compliant companies before the end of 2008.

June 22, 2008 0 comments

Banking & Finance

Money Matters by BLOMINVEST Bank

by Executive Staff June 22, 2008

written by Executive Staff

Regional stock market indices

Regional currency rates

Dubai to introduce 3-5% VAT in 2009

Dubai Customs Authorities (DCA) will be introducing a 3-5% Value Added Tax (VAT) in the first quarter of 2009. This will replace the existing 5% customs duty. A spokesman for the DCA dismissed reports by the IMF expecting 2% inflation as a result of the new measure, highlighting that real inflation will be around the acceptable 0.5% range. He further stressed the positive economic growth that other countries experienced as a result of adopting the VAT system. DCA predicts other Gulf Cooperation Council nations to follow suit after signing unilateral free zone trade agreements with the US.

GCC investing in $18B of iron ore processing factories

The Gulf Cooperation Council Countries (GCC) are investing $18 billion to build 46 iron ore processing factories. The move is seen as vital in meeting the excess demand for steel following the construction boom that Gulf countries are witnessing. This has caused a supply shortage over the past five years. Moreover, diverse industrial projects are driving the demand for iron products of all kinds. Saudi Arabia is spearheading the drive to build iron factories with 17 new plants, followed by the United Arab Emirates (UAE) at 16, Oman with 6, Bahrain at 4 and Qatar with 3. Out of the top ten industrial projects requiring iron derivatives, four are in Saudi Arabia, three in UAE, two in Qatar and one in Oman.

Yemen invests $1.34B in new oil field exploration

Yemeni oil companies increased oil exploration investments by 10% over the past year. The initiative is to countermeasure the aging oil fields that have caused a drop in oil production in 2007 compared to 2006. The oil exploration companies conducted hydrocarbon surveys on a surface of 3943sqm and drilled 138 new oil wells that increased daily production of oil and gas by 80,000 barrels and 77 million cubic ft respectively. Investment by foreign companies in oil exploration grew by 110% from 2006 to reach $189.6 million in 2007. Yemen produced 116.5 million barrels of oil in 2007 with an average daily production of 3,196 barrels, representing a drop of 12.5% from 133.3 million barrels in 2006. The Yemeni government’s share of oil production also decreased by 18% to 73.6 million barrels. Oil exports in 2007 accounted for 36.7 million barrels valued at $2.6 billion. This contrasts with 50.9 million barrels of oil exports in 2006 estimated at $3.2 billion. Nevertheless, oil reserves increased by 4.8% to 10.9 billion barrels in 2007 from 2006 and the static reserves increased 3.4% to 695 million barrels by the end of 2007. The government also finalized the tendering for the oil exploration of 25 regional areas including gas reserves in maritime fields.

June 22, 2008 0 comments

Islamic Banking & Finance

First deposits

by Executive Staff June 22, 2008

written by Executive Staff

Syria’s embryonic Islamic banking sector is up and running. In late 2007 the country’s first two sharia-compliant banks opened to the public and a further five have received preliminary licenses and are in the process of setting up shop. All are hoping to tap the finances of a population increasingly keen to express its Muslim identity in the last country in the MENA region to liberalize its banking sector, and the early indicators suggest they will find much success.

Cham Bank became the country’s first Islamic financial institution in August 2007 when it opened its services to the public from its branch and headquarters in Damascus. The bank, a $108 million joint venture between a number of key investment firms from Kuwait, Saudi Arabia and Syria, reportedly took $100 million in the first six months of operations.

The Syrian International Islamic Bank, a $108 million venture between Syrian and Qatari investors, opened to the public in mid-September and was the only Islamic firm to have published audited figures by the time of this publication. At the end of 2007 — after two and a half months of operations — the bank recorded assets of $254 million and customer deposits of $84.1 million. The bank had a total investment portfolio of $31 million. As an Islamic institution, SIIB does not extend credit but shares the investment risk with its clients.

SIIB general manager Abdel Qader Dweik said the bank had taken $261 million in deposits from its two branches in Damascus and Aleppo at the end of March 2008, its first six months of operations. “The results have exceeded all expectations and we plan to expand considerably throughout 2008,” Dweik said. “We feel the country is ready for Islamic banking services.”

SIIB’s end of year figures provide the first indicator of the potential market size of Islamic banks in the Syrian market. The figures are impressive when compared to traditional banks such as the Syrian Gulf Bank which began operating around the same time and recorded deposits three times less than the SIIB at $26.5 million and loans of $12.4 million.

Untapped market

Independent analysts have predicted Islamic banks could eventually snare up to 50% of Syria’s banking market. “There is a gap in the market that can only be filled by Islamic institutions,” Abdul Kader Husrieh, general manager of Ernst & Young Syria, said. “That gap is large and has waiting to be filled for some time now.”

A further five Islamic banks have been licensed and several will commence operations this year. These include Bank of Baraka-Syria, a $108 million venture of the Bahrain-based Al Baraka Banking Group; Dubai Islamic Bank, a $216 million venture in partnership with the state-owned Real Estate Bank; Noor Financial Investment Company, a $216 million venture being backed by the Kuwait-based Noor Investment Group and the Pakistan-based Meezan Bank; Tadhamon International Islamic Bank, a $108 million affiliate of the Yemen-based Hayel Saeed Anam Group and the Global House Group of Bahrain which recently outlined plans to launch Syria’s largest Islamic bank with a capital of $540 million in partnership with a number of large financial institutions from the Gulf and several Syrian businessmen.

On paper, Islamic banks have a number of advantages. Unlike sharia-compliant institutions in other countries, Syrian firms are entering the market at the same time as their commercial rivals, allowing them to sidestep the challenge of having to promote a relatively new concept in competition against well established commercial firms — a challenge Islamic banks in neighboring Jordan and Lebanon have struggled to overcome. Syrian authorities have also granted Islamic banks a wider range of investment activities than their commercial rivals, including being able to enter as partners into trade, industrial or other ventures. Given the difficulties commercial firms have experienced in providing long term credit, being able to act as an investment partner opens up new lending opportunities commercial firms can not access.

Challenges to growth

Not that it is all smooth sailing. Like other Islamic financial institutions around the world, public awareness about Islamic products remains low. A lack of qualified staff also looms as a major hurdle for Syrian firms. To put in place a long term remedy, Cham Bank has approached a number of universities in Syria in a bid to see them add sharia-finance courses to their business and economic faculties.

The higher cost often associated with Islamic banking also looms as an obstacle. While the newest members of Syria’s private banking sector say they plan to unveil competitive products, the experience in other countries has been one where customers have had to pay a premium for banking services that are deemed legitimate under Islamic law. Whether price-sensitive Syrians will be willing to do so remains to be seen. “What part of the Syrian personality is more dominant,” Jihad Yazigi, editor of The Syria Report, asked. “Is it their religious side or is it their trading side?”

June 22, 2008 0 comments

Islamic Banking & Finance

Dr. Ahmad Jachi – Q&A

by Executive Staff June 22, 2008

written by Executive Staff

With Islamic banking gaining momentum throughout the Middle East, questions about its regulatory framework are increasingly asked. Executive interviewed Dr. Ahmad Jachi, First Vice-Governor of the Central Bank of Lebanon and Chairman of the Islamic Banking Committee, about the issue.

E What is the view of the Central Bank on regulating Islamic banking in Lebanon?

The duty of the Central Bank is to safeguard the currency, economic stability and basic structure of the banking system as well as the development of the monetary and financial market. Therefore, the bank’s approach to the regulation process resides in creating a level playing field for a sound and stable Islamic financial system, one that is viable and well integrated in our financial system.

E What is the legislative framework for Islamic banks in Lebanon?

The promulgation of Law 575 in 2004 allowed the Central Bank’s Central Council to license Islamic Banks in Lebanon. The Central Bank started by establishing a special Islamic banking committee, chaired by its First Vice-Governor. This committee is in charge of defining the regulatory framework for Islamic banks. It outlined the banking, financial and other activities that were to be provided by Islamic institutions and set the ground rules for the protection of depositors and customers as well as the preservation of an adequate level of liquidity and capital. The commission examined the standards issued by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and reviewed the Islamic banking legislation and practices in several countries in order to gain from their experiences before setting proper practices in Lebanon. Commission members were in majority part of the Central Bank staff.

E What is the regulatory framework for Islamic banks in Lebanon?

In Lebanon, only fully fledged banks are allowed to operate in the field of Islamic finance, if they have a minimum capital of $20 million and a share value of $100. Islamic banks provide all banking, commercial and investment services and operations, including the establishment or participation in new or ongoing ventures. Deposits have a minimum term of six months and are protected by the deposit guarantee law. Investments and placements in Lebanon must account for at least for 50% of the bank’s total assets. The Central Bank has also stressed the establishment of a Corporate Governance Committee, whose primary responsibility is to safeguard stakeholders’ interests. Islamic banks will also be monitored by an independent sharia auditor and will have to publicly disclose their sharia board annual report. In addition, Islamic banks will have to feature monetary and special reserve requirements on deposits and investments.

E What is the role of the Sharia Supervisory Board (SSB) and what is the background of its members?

The Sharia Supervisory Board is usually comprised of scholars versed the interpretation of Islamic law and its application within Islamic financial institutions. The role of the SSB is to ensure and certify that all contracts and agreements related to the institution’s financial transactions are sharia-compliant. In Lebanon, each Islamic bank will have its own Sharia Supervisory Board, which usually consist of three scholars specialized in sharia who have deep knowledge of financial and banking operations. This consultative body reports to the respective board of directors and the general assembly.

E Do Arab central banks do oversight on sharia-compliant products?

There is no unified practice among the Arab central banks vis-à-vis the centralization of SSBs. Countries like Bahrain and Sudan have established centralized SSBs, which in turn supervise the SSBs of Islamic banks. Other countries, like Lebanon and the UAE, do not have a central SSB. Moreover, there is no standardization regarding the supervisory authority’s model. Some countries have created a separate supervisory authority drawn on the FSA model overseeing Islamic banks’ operations, such as in Lebanon, Bahrain and Sudan, while in others, like Saudi Arabia, the supervisory authority is still part of the central bank.

E How are Islamic products usually benchmarked? Is this done from a perspective of absolute returns or risk-adjusted returns?

Islamic financial instruments co-exist with conventional financial instruments in an open market structure governed by demand and supply. Although sharia-compliant finance is centered on return on investment rather than on interest rate, the competitive forces in an open market would eventually mediate between both systems to create a level playing field and hence comparable ‘rates of return’. Islamic banks are faced with the same classes of risk and risk exposure as their conventional counterpart. Credit risk, market risk, operational risk and legal risk are inherent to any financial operation regardless of its nature, whether conventional or Islamic. However, IFIs are faced with some additional types of risk such as reputation risk and sharia-compliance risk. Displacement risk — as a result of lower yields given by the Islamic banks as compared to the conventional ones — is also important for IFI stakeholders.

E How are the different Islamic funds structured to comply with sharia principles?

In order to be sharia-compliant, investments need to go through a set of conditions or filters. The main filters are related to the company’s business activity, whether or not it is in accordance with sharia requirements, the interest component of company revenues, whether the company borrows and lends frequently on interest basis and the leverage of debt to equity and whether the sale and purchase of shares is backed by debt.

The role of any fund’s Sharia Supervisory Board is to screen and accept asset classes underlying the investment vehicle, which is usually done twice a year. For instance, the SSB of the Dow Jones Islamic Fund has developed a two-step process whereby companies are subject to both an industry and a financial screening. The industry screening rejects companies dealing with non-sharia-compliant products and services such as alcohol, pork, defense, pornography, entertainment, insurance and conventional banking.

The financial screening excludes companies with unacceptable levels of debt or interest income and is subdivided in three applied filters. Companies excluded are those with a total debt divided by trailing 12-month average market capital greater than 33%. Investment is also prohibited in companies whose sum of cash and interest-bearing activities divided by trailing 12-month average market capital is greater than 33% or whose account receivables divided by total assets are greater than 33% .

E Doesn’t the prohibition of speculative behavior in Islamic finance contradict the basic principles of financial investment?

It is true that gharar, which is translated to ‘speculation’, is prohibited. However, the true meaning of gharar is any element of uncertainty in any business or contract. This is quite different from financial speculation as we know it. Therefore, I do not see any salient contradiction between financial speculation and sharia.

E What about prohibition of riba? Aren’t Islamic financial products usually more expensive than conventional ones?

In some cases, structuring new Islamic financial products entails relying on the expertise of lawyers or sharia scholars. This may account for the incremental fee faced by investors or depositors who pay the price of an added level of expertise.

E How is due diligence implemented on the different Islamic instruments?

Islamic financial instruments are in general asset-based or asset-backed. The intermediary role of an IFI is to ensure the financial prudence necessary to preserve its depositor’s investment. Due diligence for IFI is mainly done on utilizations and sources of funds. It takes into consideration the quality of the client and project at stake, its inherent risks and default probability, as well as, the liquidity and quality of the underlying asset. The IFI should inform its stakeholders of the placement target of their funds, the expected rate of return and tenure along with any change in the investment portfolio. Profit calculation, allocation and distribution schemes should be clearly disclosed, besides the SSB qualification of the investment scheme.

E Are there any special ratings for Islamic financial products and how accurate are they?

Some of the Islamic financial institutions as well as Islamic products such as sukuk are currently rated by Moody’s, S&P and Fitch. The different types of liabilities are being addressed by the different rating types. For instance, Moody’s bank ratings comprise the Bank Financial Strength Rating (BFSR), the baseline credit assessment, the local and foreign currency deposit ratings. Fitch and Moody’s do not believe, however, that a separate rating methodology or rating scale is needed as they deem their rating criteria and methodologies flexible enough to cover the specificities of sharia-compliant issuers and issues. It is worth noting that their analysis does not extend to whether or not a transaction, security or issuer is in compliance with the sharia. The Islamic International Rating Agency (IIRA) is the single institution that offers in addition to credit rating, sharia quality rating and corporate governance rating.

E Do you think that the Islamic financial market is at risk of facing a crisis comparable to the subprime one?

Investment share of the Islamic financial institutions in the structured products is very negligible; therefore their exposure to the current subprime crisis is very limited.

E What type of growth are you forecasting for Islamic products in the next year?

Fueled by the oil boom, the Islamic finance industry witnessed in the past decade a strong growth rate varying between 15 to 20%. While investors request liquidity, capital protection and profit on their investment, some investors are also seeking sharia compliance as well. The industry is currently driven by a high demand, exceeding the supply, and there are no signs that this trend will slow down as witnessed in the sukuk market boasting a compound annual growth rate of 121% from 2001 to 2007. Additionally, some 150 Islamic funds and funds of funds are available in the GCC and global market with a total capitalization of $10 billion as of 2005. All indicators seem to point to a faster expansion of the sector as through financial engineering, new contracts can be designed in compliance with gharar and riba prohibitions. Moreover, many Western banks and fund managers are entering this new field, relying on their financial acumen and the sharp know-how of strategic asset allocation.

June 22, 2008 0 comments