ISLAMIC BANKING AND FINANCE:

WHAT’S 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
 OVERVIEW OF ISLAMIC BANKING
SECTOR
 Centers of Islamic Finance

 Malaysia

 Persian Gulf

 United Arab Emirates (Dubai)

 Bahrain

 England ????
 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
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)

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
 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
History of Islamic Banking (V)
 Conventional International Banks with
Islamic Windows:

 Citigroup
 HSBC
 Deutsche Bank
 UBS
 ABN AMRO
 Standard Chartered Bank
 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
 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
Role of Islamic Finance in World
Credit Markets
 Demand Side

 Sovereign Debt

 International Agencies

 Corporate Debt

 Project Finance

 Consumer Debt
 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
 International Agencies
 International Agencies Have Issued Sukûk
in recent years:

 Islamic Development Bank: $400 million

 World Bank: $200 million
 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 S&P
 Listed on London Stock Exchange
 Previous issuance by same issuer listed on Luxembourg
Stock Exchange
 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 S&P

 Average tenor 3 years

 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
 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
 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
 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
 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
 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 region’s
infrastructure
 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
 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
 Opportunities for Canadian
Issuers
 Canadian Issuers, public and private, may
consider tapping the Islamic capital markets

 Because of Islamic finance is asset-based, Canada’s

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
 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
 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
 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