Sukuk Investing _ Diversification_IFN

Sukuk &
Capital Market
November 2012
Features Chapters
Islamic PE
& VC: Still
Misunderstood?
Secondary
Markets
Stalemate?
Eastspring
Al-Wara’
Investments
The KLRCA:
Dispute
Resolution
PP17808/06/2013(032740)

November 2012 1
editor’s note
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The last year has seen unprecedented growth in the Gulf Sukuk market, with
major issuances spurring its primary Sukuk market, and new entrants such as
Turkey creating diversity in the issuance space. Although Malaysia currently
dominates the global issuance table, making up 60% of global Islamic issuances,
the challenge to attract cross-border investments and Middle East issuers still
remains a hurdle in the country’s bid to create a dynamic and internationally
attractive capital market.
For any capital market to be successful, clear laws and precedence are important
elements in attracting foreign issuers and creating a sustainable market. Past
defaults and the current global economic environment has further pushed the
need for transparency, proper regulations and clear-cut tax laws in order to attract
major issuers and to create investor confidence in the market. Diversity amongst
investors is also fundamental in avoiding too much concentration in one single
geographical area to mitigate risk from an issuer’s perspective.
Analysts have projected a continued rise in demand for Sukuk particularly in the
infrastructure and project finance space; in the GCC, Arab Spring countries and
Asia moving forward. Tapping the Sukuk market could help improve the capital
structure and liquidity profiles of GCC and Asian companies, particularly those
operating in capital-intensive industries such as infrastructure. It could also
provide such companies the longer-term funding they need via a different funding
source. This is expected to create more depth and substance in the Sukuk and
capital market space, and also ties in with the need to tether Islamic finance to
the real economy.
In this issue of Islamic Finance news Supplements, we take a comprehensive
look at the current Islamic capital market landscape; its issues and challenges,
as well as the meteoric rise in capital market issuances. We also examine the
secondary markets, which has seen development over the years, but still requires
much more attention in order to create more depth and sustainability. The private
equity and venture capital sector also take center stage in this issue; in which we
question the habits and intentions of Islamic investors who are eager to reap the
rewards but still shy away from risk.
We hope you will find this issue an informative and enjoyable read.
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consulting
Market resurgence
Nazneen Halim, Editor

2 November 2012
feature
25 The Islamic Fund Management Industry
– Back to Basics
The Islamic fund management sector is still
grappling with fundamental challenges that could
prove to be crippling to this nascent industry.
chapters
13 A Bright Path Ahead
The outlook is favorable for Sukuk issuance in
Malaysia this year and in the future, as issuance is
expected to continue to grow exponentially.
18 Sukuk Investing: Diversification for
Resilient Performance
The 2009 Dubai debt crisis erroneously gave the
global investment community a poor impression of
Sukuk (Shariah-compliant fixed income) investing.
22 Dispute Resolution: The Final Piece of
the Puzzle
With an eye on the growing complexity and
internationalization of the Islamic finance market, The
Kuala Lumpur Regional Arbitration Center (KLRCA)
has become the first organization in the world to
launch its i-Arbitration Rules; a dispute resolution
mechanism specifically formulated for Shariah
compliant transactions.
27 Diverging Models Shape The Growth
Prospects for Takaful
The growing need for insurance that complies with
Shariah law means that the global Takaful sector is
becoming an increasingly significant niche within the
wider insurance industry.
COVER STORY
4 Sukuk and the Islamic Capital Markets:
Moving Forward
As the Islamic capital market space sees new
entrants and Sukuk issuances gain momentum in
the Middle East and in emerging markets such as
Turkey and Hong Kong, Islamic finance players
look forward and seek to create a sustainable and
credible Islamic capital market to capitalize on the
influx of business.
interview
8 Addressing Relevance
Afaq Khan, CEO of Standard Chartered Saadiq
shares his views with Islamic Finance news on the
global Islamic capital market, and prioritizing for the
future.
featureS
11 Islamic Private Equity and Venture
Capital: Still Misunderstood?
Until issuers and investors alike accept risk sharing as
a fundamental aspect of Islamic finance, the Islamic
private equity and venture capital space will continue
to struggle.
15 Secondary Markets Stalemate?
Liquidity and the secondary market, or the lack
thereof, in the world of Islamic finance, has been an
issue of much debate for many years among industry
professionals.
contentscontents

4 November 2012
Cover story
Sukuk and the Islamic Capital
Markets: Moving Forward
As the Islamic capital market space sees new entrants and Sukuk
issuances gain momentum in the Middle East and in emerging markets
such as Turkey and Hong Kong, Islamic finance players seek to create
a sustainable and credible Islamic capital market to capitalize on the
influx of business. NAZNEEN HALIM explores the current issues in the
market and challenges moving forward.
Although Sukuk remains the buzzword particularly in Asia and
the GCC, industry players have begun to place more emphasis
on products and structures beyond the traditional debt capital
market instruments, looking to incorporate Islamic finance
into the real economy via project and infrastructure financing
structures, increasing trade finance and syndication activity,
and most importantly realizing the need to underpin Islamic
finance transactions to real and tangible assets.
For the last ten years, Sukuk has been one of the main drivers
in the industry. However, industry players have been urged to
take a macro perspective on the Islamic finance industry and
help it find place in the global economy. As a result, the Arab
Spring countries have taken center stage in the bid to venture
into new, untapped markets with an opportunity to directly link
infrastructure building and development to Islamic finance.
UsmanAhmed, the head of corporate and investment banking
at Citibank in the Philippines, believes that an important
driver of sustainability in the market is the integration of
Islamic finance within existing markets and the development
of new products. The global financial crisis has also served
as a wake-up call at the very least to the Islamic finance
industry as a whole, creating further need for regulatory
supervision, transparency in documentation and structures,
as well as sound capitalization in the banking and financial
system.
As an instrument that allows medium-term capital raising, the
popularity of Sukuk amongst capital market players—both
Islamic and conventional— has become more prevalent. The
growing desire for jurisdictions to issue sovereign Sukuk to
diversify their investor pool and attract liquidity from the Islamic
world is constantly reflected by the entry of new markets; with
the most recent being Turkey, which had issued its debut
US$500 million Sukuk, attracting over five times its initial
issuance target.
Malaysia leads the way
Malaysia is currently touted as the most favored destination
for issuers in the Sukuk market dominating 60% of the global
share worth US$100 billion. This is primarily due to its deep
and broad market with comprehensive regulations that ease
Sukuk issuances, a favorable tax regime, a sophisticated
investor base as well as support from all issuers, regulators
and investors. However, the lack of an available platform in the
Islamic capital markets outside of Malaysia and Saudi Arabia,
as well as cross-border transactions involving swapping the
ringgit to the currency of the issuer still remain a concern in the
market.
Cover story

November 2012 5
Cover story
From a foreign issuer’s perspective, Sabri Ulus, the head of
treasury at Bank Islam Brunei Darussalam, is full of praise for
the Malaysian Sukuk market, particularly due to its government
and regulatory support, as well as its “very sophisticated”
investor base. He added: “There are also many Islamic financial
institutions, regulatory organizations and standard-setting
bodies. GCC entities come to Malaysia and issue ringgit Sukuk
mostly due to the premium on cross-currency swaps, thus
reducing their costs if they issue in Malaysia. The tax regime
and regulatory environment is also very encouraging to foreign
companies to issue in the ringgit market.”
Afaq Khan (caricature below), CEO of Standard Chartered
Saadiq believes that clear laws and precedence are key to
the success of any capital market in attracting cross-border
issuances; a feat Malaysia has achieved over a decade of
fine-tuning its Islamic capital market laws. “It is always a big
concern for issuers when they want to come to a new market
to issue paper. Malaysia’s regulations make it easy for the
Middle East issuers to come to a new legal jurisdiction, and the
ringgit market remains the most liquid in the Sukuk industry,
so Middle East issuers are confident they can meet their issue
size requirements by coming to the ringgit market as opposed
to going to any other regional currency.”
However, he adds that the main drawback of the ringgit market
is its failure to meet the requirements of most international
issuers in terms of currency. “The need of the issuer isn’t
exactly in the ringgit currency, and it has to be swapped
back into the currency which the issuer can use in their day
to day business. Sometimes you will see Sukuk issuances
in the ringgit market go up, or some taper off. At the back of
this there really is no concern. It is simple economics; once
they (the issuer) swap into a currency they can use, can it still
be considered a competitive financing for them? That is what
drives the issuances from the Middle East to the ringgit market;
when it is viable for them to competitively tap
this liquid and growing market.”
Another fundamental to Malaysia’s
popularity as an up and coming
jurisdiction for cross-border deals
involving Middle East entities is
its legal system, which is based
on Common law. Saad Rahman,
the executive director for global
Islamic banking at Credit Agricole
explains: “Most cross-border deals
are based on English, New York
or Texas law. As an issuer, you are
looking for transparency of contracts,
proper enforcement, and to seek
satisfaction under the enforcement; and
you get that under English law more
than civil law. There is a precedence
which exists in more codified forms of
law. As an investor and issuer you want
robustness of the contract and a legal
jurisdiction that gives you comfort on
both sides when it comes to a cross-
border deal.”
Badlisyah Abdul Ghani (caricature
right), CEO of CIMB Islamic believes
that it is imperative for the industry
to take a step back and evaluate its
position in the market. “Outside of
Malaysia, the Islamic capital markets
in other jurisdictions need to be aware
of the need to chart greater growth in
the future, and to create a platform
that will ensure success. In my
opinion, the infrastructure in
the global Islamic capital
markets is already there: with
RegS and 144A regulations
in place, however, from a
jurisdictional perspective, it is
unstable to rely on the global
market at all times.”
He added: “The framework is
available and the liquidity is
there. But as a nation, you do
not have control over the global
market, which creates instability.
What we want as a player is to be
able to go into a particular jurisdiction and to do transactions
in the local currency. Because in the long-run, that would be
more stable for issuers in terms of ability to tap the currency
that they require in a particular jurisdiction. As CIMB Islamic
try and facilitate issuers and issue Sukuk globally, we always
advise the issuer to do it in their local currency first, then in US
dollars. Outside of Malaysia and Saudi Arabia however, there is
currently no local currency market.”
Change in mindset
It has been said time and again that Islamic investors are
incredibly risk-averse, which in reality goes against the main
tenets of Islamic finance which promotes the sharing of risk.
This has proven to be a major drawback for the Islamic capital
markets, especially in its bid to create a more equity-based
issuance and investment environment.
According to Usman, innovation and growth can only
be achieved if the industry moves beyond fixed-income
instruments and embodies the true spirit of Shariah financing;
which involves the willingness to take up equity-type risk. “In
the capital markets we have only just scratched the surface
by relatively integrating Islamic finance with fixed-income
instruments. However, we haven’t even explored truly asset-
backed securities, infrastructure financing and equity-linked
issuances. It is important to understand first what differentiates
Riba from profit. It is the risk related to ownership; and therefore
we have to take real risk, relate to ownership of assets.
“We are still very far from the true spirit of Islamic finance,
and that is exactly what is holding us back in terms of the
development of new instruments. The whole world will open
up to us if we are willing to take equity-type risk. Fixed-income
Sukuk should just be seen as a means to an end. Issuers
should be encouraged to do Sukuk issuances because then
their equity will become Shariah compliant, and if they do a

6 November 2012
Cover story
debt on a Shariah compliant basis, they will be able to tap into
a much bigger equity investor base that will come from the
Islamic finance market. Islamic investments have to be coupled
with risk-taking appetite.”
Market challenges and moving forward
The all-time low yields currently being experienced by Middle
East issuers is seen as a catch-22 amongst some industry
players. Although it has attracted an unprecedented number of
issuers to the market, some worry that the market will become
hollow once this low-yield run ends.
Sabri notes that: “As a treasurer, it is important to keep in mind
that although the cost of funding is very low today, it might not
stay the same for the next five to ten years. This is worrying
if you are tapping into the market with low-yield Sukuk. At
present, most conventional issuers are shortening their
borrowing from the market, because they can’t find investors,
and even if they can, the price of the conventional bond is very
high. For instance, Spain’s sovereign bond saw a pricing of 3%
compared to Turkey’s debut sovereign Sukuk; which was below
investment grade paper, but priced at 2.8%. On the other hand,
it is encouraging to see the Sukuk investor base evolve to almost
a 50-50 share between conventional and Islamic investors. We
are seeing conventional pension funds and banks subscribe to
Islamic paper mainly because for issuers, from a credit-rating
and cash flow perspective, Sukuk is more reliable than the
conventional or European issuances at present.”
Although the recent impact from Dana Gas’ inability to meet
its Sukuk repayment deadline on the 31st
October for its US$1
billion issuance has yet to be thoroughly explored, industry
players are clearly divided. On one hand, many believe that
Dana Gas’ standstill with its creditors is just a mere hiccup in
the Islamic finance capital market space, and on the other,
some worry that this might have a spillover effect into the UAE
Islamic issuance market and deflate any ambition of a market
resurgence in the Middle East.
Khalid Howladar, vice president/ senior credit officer at Moody’s
believes that the market was already primed on the Dana Gas
situation and a possibility of a default, in the several months
leading up to the standstill; thus eliminating the shock factor
which is usually the main reason for panic in the market. He
said: “Dana Gas has been in trouble for a while, so it’s not really
a shock. The market was already aware of the situation, unlike
the Dubai World/Nakheel Sukuk— which was a bit of a surprise
at that time. Broadly, the UAE market is recovering, and the
economy is much better. So this is just a small piece of bad
news in what is overall a much improved credit environment.
So, I don’t think it is that significant. In terms of the Sukuk
market, it’s not so much a negative signal about Sukuk, and
it’s more about the company, so I don’t think it would affect the
Sukuk market that much.”
In terms of its effects on the credibility of the UAE credit
market, Khalid believes that there are more pressing issues
at the moment, including Dubai Holdings’ current financial
woes: “There are still bigger problems outstanding such as the
companies of Dubai Holdings that are under restructuring. It
has been a year but there is still no resolution on that. That’s a
much bigger story and in terms of exposure in the market, that
will have more of an impact. This (Dana Gas) is relatively small
at US$920 million and the banking system is well capitalized
and liquid.”
The lessons to be taken from this nail-biting experience, Khalid
believes, are aplenty: “From an issuer’s perspective, companies
need to look at their capital structure and take on debt based
on solid cash flow projections. I think they need to take a more
conservative approach to future cash flow forecasting to ensure
that they can pay back all the debt borrowed and not be carried
away by the boom times. Investors on the other hand need to
study the company, their cash flows and the ratings they get,
and make sure they understand the risks in the bond… such
as, will the company be able to pay me back in bad times as
well as good times? People need to do their due diligence in
these investments to make sure that the company is in a strong
position to pay back the money that they borrow.”
As the market evolves and the industry becomes clearer of
its goals and objectives, market players are becoming more
perceptive of what investors want and what motivates bankers
to become part of the growing global Islamic finance movement.
“From an issuer’s perspective, their primary objective is to
tap liquidity, build a profile with investors they haven’t really
explored before, and ensure diversity of their funding base. At
the heart of every Islamic capital market issuance is the desire
to get core Islamic demand from issuing an Islamic finance
transaction. Sustainability has to be driven by the ability and the
increased participation of Islamic banks to anchor a transaction
that is issued in a Shariah compliant manner,” said Usman.
He added: “Transactions are substantially driven by demand
from non-Islamic banks and conventional investors, and that
should encourage more issuers to look at the Islamic market.
It is primarily a case of investor demand driving sustainability.”
According to Saad, it is important to bear in mind that the Islamic
capital markets is far from isolated from the conventional space,
and that Islamic finance exists in a greater credit model of global
liquidity. “We are still working in a very much conventional
environment and issues in this market have a direct impact on
the Islamic finance industry. For instance, in terms of Sukuk,
many times it is the conventional investor who drives the
pricing down, and although this is to the benefit of issuer, it
does not necessarily bode well for the Islamic investor looking
to come into the deal. Islamic finance cannot be a standalone
industry.”
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Cover story

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8 November 2012
interview
Addressing Relevance
Afaq Khan, CEO of Standard Chartered Saadiq shares his views with
Islamic Finance news on the global Islamic capital market, and
prioritizing for the future.
Standard Chartered Saadiq, ever since its inception in 2004,
has come leaps and bounds in the global Islamic banking and
finance space. The bank, which has successfully remained
on track in terms of fulfilling its clients’ needs and providing
them with a complete suite of Islamic products for end-to-end
solutions is also a major player in the Islamic capital markets
space; having been involved in landmark Sukuk deals this
year, including the Qatar Government’s US$4 billion issuance
and Abu Dhabi National Energy’s RM650 million (US$213.07
million) innovative cross-border transaction.
“This year we have had two significant milestones: we
launched a global private banking business recently, and
also launched the Islamic Euro Clearing Account in Turkey
in September this year. This has been very well-received
in the market, and we are constantly looking to expand by
products, businesses and geographies. Overall, the journey
has been very rewarding. We have a very cohesive, client-
centric mandate to serve our clients, to offer a complete Islamic
banking alternative product suite to meet the end-to-end
requirements of our clients,” Afaq said.
However, despite the bank’s many successes in arranging
major Islamic capital market deals throughout the year, and
a healthy deal pipeline moving forward, Afaq insists that the
bank’s priorities extend beyond Sukuk. “Although Sukuk is a
good proxy for the health of the industry, we should be very
careful. It is not the only proxy. Islamic banking is an alternative
to the entire conventional banking space. In the conventional
banking space, nobody says that if the capital markets are
down, then the entire banking system is down. The same
applies to Islamic banking. Trade finance and syndication are
also growing sectors.”
“Sukuk in itself is an instrument that allows medium-term capital
raising. As and when the clients need medium-term capital, they
currently have three options: to do bilateral financing, go to the
syndications market, or go to the Sukuk market. But that is only
a small part of it, clients are constantly doing treasury activities,
buying products, using Islamic banks, doing trade finance and
cash management activities too,” he added.
Afaq also warns that most of the Islamic capital market activity
moving forward hinges on the global economy, and to an extent,
the outcome of the Eurozone crisis. He said: “I am optimistic
for next year’s issuances, but a lot depends on what happens
to the global economy. This is because medium-term capital
is raised for expansion or new projects, for restructuring and
lowering cost of capital. And if everyone has refinanced and
lowered their cost of capital, then there is no need for them to
keep coming to the market.”
Although Sukuk is a good
proxy for the health of
the industry, we should be very
careful. It is not the only
proxy
interview

November 2012 9
interview
What the market needs, Afaq says, are more players issuing
paper in order to expand the current issuer base: “The market
needs more players to issue paper. We were very excited that
the government of Turkey had recently issued a sovereign, and
I believe that Malaysia and Indonesia should become repeat
issuers in the market, and new counterparts should also look to
enter the Sukuk market. This is because banks have regulatory
limits on how much exposure they can have to each client as a
proportion of their capital. Therefore we need the issuer base
to expand.”
Islamic treasury: Area of focus
Based on the current issuer and investor trend, particularly
in the GCC and Malaysia, it is evident that there is ample
liquidity to be tapped in the market, and there is still much
Shariah compliant liquidity looking for Islamic assets to invest
in. However, this can only be engaged effectively with the
proper deployment of Islamic treasury products, including risk
management.
Afaq explained: “We are very focused on risk management,
because I believe it is very important to manage risk as the
industry grows in size and scale. In the real economy, Islamic
banking is exposed to these risks, and it is important to keep in
mind that derivatives are not for speculative purposes, and are
essentially restricted to hedging purposes. Risk management
is a very important catalyst to the growth of Islamic finance
as the product suite grows and the gap between conventional
and Islamic finance is breached. Innovation and product
development will remain a key growth driver for the next decade
for Islamic banking. For us to become relevant to the needs of
society and the economy, we must meet the needs of society
and the economy.”
According to Afaq, there are currently two types of treasury
products in the market; one is for the money-market, in which
Malaysia has taken the lead in terms of having a complete
product suite, and was generally a pioneer in this area with
support from Bank Negara Malaysia. “The progress is good
in this area, as a lot of other countries such as the UAE and
Pakistan have now started issuing money-market products,
and the International Islamic Liquidity Management Corporation
(IILM) has also begun work in this area. These are all important
initiatives.”
“Because we operate in the real economy, we are exposed to
the risks in the real economy whether it is exchange rate risk,
yield curve risk, etc.- these are facts of the economy. And this
is true from the perspective of the bank’s balance sheet and
our clients’ viewpoint; because our clients are also exposed
to these risks and need to hedge them. We currently have a
comprehensive product suite covering currencies, rates and
commodities hedging solutions. I believe these are important
for the corporates, because we are offering them end-to-end
solutions, and for Islamic banks, because they are growing
in size, and becoming material to the banking system in the
country. Therefore, they must have risk management tools
to manage the risk. For instance, Malaysia’s Islamic banking
sector currently stands at 20%, and there are aspirations to
double this figure. However, this cannot be done without risk
management tools. We are very focused on this, and it is
essential to the growth of the Islamic market, where we have
balanced growth, with business and risk going hand in hand,”
he added.
Industry initiatives
Afaq believes that the industry is currently already committed to
grow Islamic treasury and risk management products, with the
International Islamic Financial Market (IIFM) actively involved
in drafting standardized commodity Murabahah, and profit-rate
swap documents. “Standard Chartered was on the working
committee for these standards, and as the market grows, these
standards will start as best practice, and then the market will
use them as the base document and either adopt them or
tweak them based on local norms and local regulations. It is
a very good start. We believe that this whole area needs more
attention and more exposure.”
New frontiers
In terms of new markets, Standard Chartered has revealed
its aspirations to tap into the African Islamic banking space in
the medium-term. “The market is growing, and we are excited
about the market there. There has to be a change in regulations
in some markets, and we are currently studying the prospects
there. To successfully launch in the country, you need a
regulatory and legal framework in place. We are currently
talking to different stakeholders in Africa, and as Standard
Chartered is very client-centric, we will choose which products
to launch based on the feedback we receive from the clients.”
Afaq also believes that there is much potential amongst the
Arab Spring countries such as Egypt and Libya. There is a great
opportunity for these countries to rebuild, and Islamic banking
is looking for new markets. Therefore, it appears to be a perfect
match. What timeframe the regulations will be passed and how
welcoming they will be in terms of giving licenses remains to be
seen; but clearly there are opportunities due to their proximity
to the Middle East and a common language.”
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Afaq Khan
Chief executive officer
Standard Chartered Saadiq
Building One, DIFC Gate Precinct
Dubai International Financial Centre
Dubai, UAE
Email: afaq.khan@sc.com
Web: standardchartered.com
I believe it is very
important to manage risk
as the industry grows in
size and scale
saadiq

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November 2012 11
feature
Islamic Private Equity and Venture
Capital: Still Misunderstood?
Until issuers and investors alike accept risk sharing as a fundamental
aspect of Islamic finance, the Islamic private equity and venture capital
space will continue to struggle. NAZNEEN HALIM studies the prospects
of this virtually non-existent sector and its potential contribution to
the Islamic finance industry as a whole.
At present, industry experts unanimously agree that investments
in private equity and venture capital in the Shariah compliant
universe are almost zero. Despite the myriad of family-owned
businesses and start-ups in Islamic finance strongholds in the
Middle East and Asia, investments in Islamic private equity
have been dismal to say the least.
Opportunities in this sector also extend beyond these two
regions, into countries such as Germany where SME businesses
and start-ups are well-regulated and a common phenomenon.
Considering the continuous calls for Islamic liquidity and
investments to be channelled into real economic activity, and
for the sharing of risk and rewards in a Shariah compliant
transaction, it is ironic that this sector remains dormant as
private equity and venture capital investments are the perfect
fit for the Shariah compliant investment universe.
Amongst the most common structures prescribed for investing
in Islamic private equity and venture capital are Mudarabah,
Musharakah and Wakalah. These structures involve profit
sharing (Mudarabah), partnership between two parties
(Musharakah) and the use of an agent to act on behalf of the
principal (Wakalah). In a Mudarabah arrangement, a contract
is made between two parties to finance a business venture.
The parties are a Rab al maal (investor) who solely provides
feature

12 November 2012
feature
the capital and Mudarib (entrepreneur) who solely manages the
project.
Ahmad LutfiAbdul Mutallip, a partner of global financial services
and Islamic banking at Azmi & Associates, wrote: “This is akin
to a conventional PE/VC, where there exists a relationship
between the capital provider and the entrepreneur. If the venture
is profitable, the profit will be distributed based on a pre-agreed
ratio. In the event of a business loss, it should be borne solely
by the capital provider, to the extent of the capital contribution
while the entrepreneur will lose his time and effort. The key to a
Mudarabah structure is the fact that the entrepreneur cannot be
placed at risk to bear losses, unless proven negligent.”
In Malaysia, the Securities Commission issued guidelines
and best practices for Islamic venture Capital in March 2008,
solidifying the regulator’s support for the sector. The guidelines
specify the core requirements for establishing an Islamic venture
capital corporation or an Islamic venture capital management
corporation, and set out the best practices intended to assist
such corporations in carrying out Islamic venture capital
activities.
According to the guidelines’ core requirements, the
corporation must first be registered under the Guidelines for
the Registration of Venture Capital Corporations and Venture
Capital Management Corporations issued by the Securities
Commission. In addition, all activities of the VCC and VCMC
must be Shariah compliant, and an independent Shariah
advisor must be appointed to ensure adherence to the Shariah.
The Shariah advisor is also expected to disclose, on an annual
basis, and declare to the board of directors of the Islamic private
equity/ venture capital fund company that the Islamic private
equity/ venture capital fund company is managed according to
Shariah principles.
The Shariah advisor is also expected to endorse any investment
decision and to ensure that the activities of the investee
companies remain Shariah compliant right to the point of full
divestment.
According to Lutfi, the four key considerations involving
the investment into Islamic private equity/ venture capital
companies include Shariah compliant documentation, financing
and investment structures; Shariah compliant underlying
assets and investments; legal documentation, which includes
the powers of the Shariah advisor; and an express provision
and understanding between the parties involved that any profit
of the Islamic private equity/ venture capital fund company
shall be based on returns from investment of the fund, with no
guaranteed profit return and there should also be a provision for
reinvestment of profits into the Islamic private equity/ venture
capital fund company.
What is needed now to create some sort of momentum in
the Islamic private equity and venture capital space – apart
from a change of mindset amongst Islamic investors – is
regulatory support; particularly in ensuring transparency and
proper regulation of these companies, the creation of attractive
and innovative structures to encourage investments, the
establishment of legal and regulatory frameworks, as well as
guidelines specific to this sector across the board.
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consulting
The key to a Mudarabah
structure is the fact that
the entrepreneur cannot be placed
at risk to bear losses,
unless proven negligent
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November 2012 13
chapter
Malaysia maintained its pole position with 71% of Sukuk issued,
followed by Saudi Arabia with 15% .
In addition, global Sukuk issuance in the first quarter of 2012
reached US$43.5 billion, up by an impressive 55% from the
corresponding period last year.
According to Zulkifli Ishak, CEO of Eastspring Al-Wara’
Investments (formerly known as Prudential Al-Wara’ Asset
Management), Malaysia will continue to lead the market
as the world’s largest Sukuk center. The latest issue of
Malaysia’s sovereign Sukuk earned a strong response and was
oversubscribed by almost five times.
At the same time, there has been a marginal downside to Sukuk
in that there are default cases in Malaysia and other countries.
But these isolated cases are not likely to dampen sentiment for
Sukuk in future.
Elaborating on this, Zulkifli says: “Standing true to Islamic
principles, Sukuk are perceived to be ethically protected from
turning bad. However, when Sukuk defaults were scrutinized by
the practitioners and academicians, concerns were raised on
the reliability of their structures and Shariah supervision. This
has created the perception that Sukuk may not be any safer
than conventional bonds in terms of investor protection and the
treatment of defaults.”
On a brighter note, unlike the high profile default and near-
default cases in the Middle East, Malaysia’s Sukuk defaults
have received less criticism and scrutiny from global industry
players.
Some reasons for this are Malaysia’s robust supervisory
structure, established governance and disclosure standards;
and the highly developed legal framework and court system
which provide the necessary protection and comfort to investors.
A Bright Path Ahead
The outlook is favorable for Sukuk issuance in Malaysia this year and
in the future, as issuance is expected to continue to grow exponentially.
External economic shocks such as the Eurozone crisis are not likely to
affect the domestic Sukuk market due to ample liquidity, but will have
an impact on the international capital markets.
chapter

14 November 2012
chapter
A default occurs due to the breach of binding obligations under
the original terms of the agreement between the issuer and
the Sukukholders. Both contractual parties must fulfill their
obligations under the contract or agreement. The level of
investor protection provided by a Sukuk structure is a factor
in credit assessment, but from a rating perspective, assessing
the issuer’s inherent credit strength is fundamental to the final
rating outcome. In other words, the financial and operating
outlook of the Sukuk issuer highly affects the final rating on the
Sukuk itself.
The Accounting and Auditing Organization for Islamic Financial
Institutions (AAOIFI) guidelines emphasize the difference
between Sukuk and conventional bonds. These guidelines
show that Sukuk does not represent a debt owed to the
certificateholder by the issuer, so that the owners share the
returns and the losses.
De-mystifying Sukuk
The most common Sukuk issued in Malaysia are Sukuk
Musharakah and Sukuk BBA. Sukuk BBA were the Sukuk most
issued in Malaysia in 2004, before the Malaysian Sukuk market
got dominated by Sukuk Musharakah beginning 2006.
Sukuk are not similar to bonds because the latter represents a
debt obligation of the issuer. It is created to service the need
for working capital or to re-finance existing debt, normally to
be used in the transportation sector, especially in the shipping
and aircraft sectors, real estate, construction, and also for
petrochemical projects.
Despite the wide variance in ratings, the default rate for
Malaysian Sukuk in 2009 was relatively low at 0.46% . Between
1997-2010, there were 24 cases of Sukuk default. Most were
mainly structured based on Murabahah and BBA contracts – 12
on Murabahah, 11 BBA, and only one on Ijarah.
Industry experts maintain that Sukuk defaults in Malaysia will
not pose a significant threat to the local capital market; however,
they may have a slight impact on the overall reputation of
Malaysia as the hub for global Islamic finance.
“We are optimistic about the performance of Sukuk in Malaysia
and the rest of the world. And we will highlight the positive
points of diversification to our investors,” concluded Zulkifli.
According to Securities Commission Malaysia, total outstanding
global Sukuk amounted to US$243 billion as at June 2012,
with Malaysia continuing to be in the forefront of the market.
www.MIFforum.com
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www.MIFtraining.com
consulting
Zulkifli Ishak
Chief executive officer
Eastspring Al-Wara’ Investments Berhad
(formerly known as Prudential Al-Wara’ Asset Management Berhad)
Level 12, Menara Prudential, Jalan Sultan Ismail, 50250
Kuala Lumpur, Malaysia
Tel: +603 2072 8808
Web: www.eastspringinvestments.com.my
chapter

November 2012 15
feature
Secondary Markets Stalemate?
Liquidity and the secondary market, or the lack thereof, in the Islamic
finance industry, has been hot on the lips of industry players since the
inceptionoftheIslamiccapitalmarkets.Alacklustersecondarymarket
has had an effect on the overall growth of the industry, particularly in
the long-term, NAZNEEN HALIM discovers.
The Islamic investor is known for his penchant to buy-to-hold
papers to maturity, which is perhaps one of the main reasons for
the current tepid movement in the secondary markets. Driven
by the mechanics of supply and demand, pricing in the Islamic
secondary market has also been relatively disappointing as the
buy-to-hold mentality and a limited diversity of Sukuk investors
have inhibited efficient price discovery.
Despite efforts from central banks such as the Central Bank of
Bahrain and Bank Negara Malaysia to drive secondary market
growth – through the issuance of short-term paper and the
establishment of the International Islamic Liquidity Management
center, which is meant to facilitate more efficient and effective
global liquidity management solutions for Islamic financial
institutions and to create greater cross-border investments; the
money market has yet to truly yield the results of these efforts.
In a paper by the IMF entitled: “Islamic bond issuance – what
sovereign debt managers need to know” it was suggested that
the development of a liquid secondary market will depend on
Shariah compliant short-term liquidity facilities and Sukuk as an
interbank money market instruments. It said: “Given the current
short-term nature of bank liabilities, the creation of money
market instruments, and asset securitization with shorter
maturities should help to encourage a secondary market for
Sukuk. Although Islamic banks are currently one of the largest
buyers of Shariah compliant products (with long maturities),
they would benefit most from issues at shorter tenors.
feature

16 November 2012
feature
Short-term Sukuk could serve as money market instruments for
liquidity management purposes. Malaysia and Bahrain are the
only Muslim countries that have developed an active interbank
market. Since 2001, the Central Bank of Bahrain has issued
short-term Sukuk of either three- or six-month maturities (in
addition to medium- and long-term notes). In the GCC, 20%
over-subscription for these Sukuk indicates the substantial
demand for a Shariah compliant interbank market. In Malaysia,
similar considerations apply to Government Investment Issues
(GII) and Bank Negara Malaysia Negotiable Notes (BNNN).
Alternatively, banks can resort to asset securitization in order to
transform the proceeds from Islamic contracts into customized
capital market securities with variable maturities. One such
transaction was completed in July 2005 by Cagamas, the
National Mortgage Corporation of Malaysia, when it issued the
first Islamic mortgage-based securities as Mudarabah bonds
with varying returns and maturities, ranging from three to 20
years.”
A silver lining to have emerged this year is the increased
utilization of Sukuk for the funding of project finance and
infrastructure development in Asia and the Arab world. Issuers
are also beginning to look into new, previously untapped
markets to access Islamic liquidity and plug the demand gap for
more Shariah compliant paper linked to the real economy. An
industry player based in Dubai revealed that at present, there
is simply not enough Shariah compliant paper in the market
to fulfil investor appetite, and that issuances from highly-rated
issuers and sovereigns are still few and far between. “The
outcome of this is that Islamic investors are unable to purchase
enough Sukuk, and this supply and demand imbalance has
caused Sukuk-holders to feel unwilling to trade out of a position
for fear of not finding another Sukuk of similar credentials to
invest in,” he said.
A difference in opinion amongst scholars with regards to the
Shariah compliance of Islamic paper and their acceptability
has also been a reason for the lack of cross-border trading
across jurisdictions, causing a lack of diversity amongst
investors and creating a homogenous and largely domestic
trading environment. Dominic Harvey, project finance partner
at Vinson & Elkins, and Barry Cosgrave, finance associate at
the same firm wrote in a paper: “Barriers to secondary market
trading are not the result of a lack of effective valuation alone;
there are also other considerations relating to differences of
opinion among scholars as to the acceptability or not of certain
structures. It is possible that certain investors shy away from
secondary market trading because of a lack of clarity as to the
acceptability or not of the transaction structure employed. Were
a scholar to rule against a particular structure, and a secondary
market trade to be sought to be unwound, it would cause huge
complications both on a practical level and from the point of
view of market reaction.”
A lack of mark to market (MTM) valuations for Sukuk, which
became apparent over the last few years as a result of the
restructuring activities in the Middle East has also impacted
the Islamic secondary market. Harvey and Cosgrave wrote:
“As balance sheets became distressed over the past few
years and options to restructure were being explored, one of
the factors that caught a number of restructuring advisors from
conventional markets off guard was this lack of MTM valuation.
This led to difficult conversations with certain creditors when
‘hair cuts’ were being discussed.
A lack of MTM valuation also impacts secondary markets as
it does not establish any sort of profit-making opportunity for
traders. Without effective valuation of Sukuk there is no way to
establish a market and as a result trading does not happen.”
The growth of the Islamic secondary market requires a
collective effort amongst all the stakeholders of the Islamic
finance industry; from central banks propagating high-quality
short-term paper and encouraging the growth of the inter-bank
money market, bourses working to encourage trading through
Shariah compliant trading platforms, standardization and
agreement amongst scholars to create universally accepted
papers to increase investor diversity on a global scale, and
the creation of effective risk management tools to engage the
otherwise risk-averse Islamic investor.
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consulting
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18 November 2012
chapter
Sukuk Investing: Diversification for
Resilient Performance
The 2009 Dubai debt crisis erroneously gave the global investment
community a poor impression of Sukuk (Shariah-compliant fixed
income) investing. Having fully recovered from this, the Sukuk market
performance has proved resilient for the past two years. Sukuk
investing not only enhances potential returns relative to conventional
fixed income investing but also reduces portfolio volatility.
This article will shed light on how Sukuk investing offers
diversification benefits by examining the investment universe,
sector weightings and country spread. It will conclude with
a case study of how investors who have limited themselves
to investing in the conventional fixed income asset class can
definitively add value to their portfolios by allocating a portion
to the Sukuk investment universe.
The Dow Jones Sukuk Index (DJSI), designed to measure
the performance of global Sukuk, comprised merely seven
constituents when it was first introduced in October 2005. At
that time, the index lacked breadth and depth in comparison
to the conventional bond index, the World Broad Investment
Grade Bond Index (WBIG). The 2008 global financial crisis and
2009 Dubai debt crisis were the first real tests for Sukuk. The
combined headwinds proved damaging to the nascent Sukuk
market and several issuances slumped to their lowest level
during these crises. However, in spite of the challenges, or
because of them, the Sukuk investment universe has staged
a strong comeback since 2009, and has reestablished itself
as a vibrant and attractive new asset class today. The DJSI
has not only improved from the unimpressive performance of
its five and seven-year returns, but it also went on to produce
superior returns by outperforming the conventional index
over a two-year time period as at the end of September 2012.
Table 1: Annualized returns of DJSI and WBIG
Annualised Returns
2-year 5-year 7-year
Dow Jones Sukuk Index 6.27% 4.87% 4.63%
World Broad Investment Grade
(WBIG) Bond Index
4.52% 5.55% 5.17%
Source: Bloomberg and CIMB-Principal Islamic Asset Management as
at end-September 2012.
Repeat of the Dubai debt crisis unlikely
With Dubai and state-controlled Dubai corporates being early
entrants as issuers in the Sukuk market, Dubai’s 2009 crisis
reverberated forcefully into the Sukuk space. With the onset
of the global financial crisis that adversely affected economies
everywhere, Dubai’s real estate market declined after a six-
year boom. On the 24th
November 2009, state-controlled
Dubai World rattled financial markets by announcing that it
was seeking to delay payments on US$59 billion of debt1
. The
collapse of the real estate market in Dubai severely affected
the mortgage sector and hence, the broader Dubai economy.
Uncertainties surrounding how the Sukuk securities would fare,
caused many global investors to flock to what they viewed as
the comparative safety of conventional fixed income.
However, investor fears in the 2009 Sukuk market proved to
be unfounded. Dubai did not actually default on its public debt.
In fact, Dubai received financial assistance from Abu Dhabi,
the ‘patriarch’ of the UAE. In similar fashion to what investors
had seen related to the global banking firms a year earlier, Abu
Dhabi stepped in to support Dubai with a US$20 billion bailout2
.
Following the extension of financial support to Dubai from
Abu Dhabi, the Government of Dubai made concerted efforts
to strengthen its banking system by implementing a scoring
system to evaluate individual borrowers’ creditworthiness.
In addition, the Gulf Cooperation Council (GCC) banks have
made a variety of efforts to strengthen their balance sheets
to protect against declines in loan recovery rates and asset
prices. The banks’ tier 1 capital adequacy ratios have steadily
increased over the last four years and were in the region of
15% at end-2011. More importantly, equity forms the bulk of the
banks’ capital base, and their equity-to-assets ratios are high,
ranging from 10% in Bahrain to 16% in Qatar3
.
250
200
150
100
50
0
9/30/2005
9/30/2006
9/30/2007
9/30/2008
9/30/2009
9/30/2010
9/30/2011
9/30/2012
Source: Bloomberg
Chart 1: Sept 2005 — Sept 2012 (7 years)
DJSI
WBIG
Dubai crisis

November 2012 19
chapter
Global Sukuk makes a high quality recovery
The DJSI has recovered completely from the crisis. The index
has matured with respect to both the quality and quantity of
its constituents. This has led to markedly lower volatility given
the higher creditworthiness of the investment universe. The
returns volatility of the DJSI has fallen significantly to 2.08%
for the two-year period compared to the five and seven-year
periods of 10.13% and 8.58% respectively. At 2.08% the return
volatility in the Sukuk space is less than half of that in the
conventional space over the same period, which registered
at 5.16% for the WBIG. This lower volatility is coupled with a
tripling of the number of constituents in the index, meaning that
a severe fluctuation of any one constituent has less singular
effect on the overall index.
Table 2: Returns volatility of DJSI and WBIG
Returns Volatility
Dow Jones Sukuk Index 2.08% 10.13% 8.58%
(WBIG) Bond Index
5.16% 6.29% 5.99%
at end-September 2012
A further examination of the DJSI’s returns reveals a significant
increase in the Sharpe Ratio, a measure commonly used to
better analyze performance by taking risk into consideration.
A portfolio with a higher Sharpe Ratio is considered to have
exhibited better performance as the Sharpe Ratio measures
how well the return of an asset compensates the investor for
the risk taken.
The Sharpe Ratio for the DJSI is 2.96 over the most recent two
year period, versus 0.47 and 0.53 over the five and seven-year
periods respectively. In contrast, the Sharpe Ratio of the WBIG
remained similar over the two, five and seven-year periods
at average of 0.86. Therefore in examining the quality of the
Sukuk index performance while considering both return and
risk, we find that its superior performance is further enhanced
with lower volatility and a higher Sharpe Ratio.
Table 3: Sharpe ratios of DJSI and WBIG
Sharpe Ratio
Dow Jones Sukuk Index 2.96 0.47 0.53
(WBIG) Bond Index
0.87 0.87 0.85
Sukuk investing offers an enlarged investment universe
Unlike Shariah compliant equity investing, which is a subset of
global equity, Sukuk is a unique investment space that enlarges
the existing conventional fixed income investment universe
to grant conservative investors attractive opportunities in a
completely separate class of fixed income assets.
The number of constituents in the DJSI has tripled in two
years, largely due to active participation by governments and
corporations that have facilitated numerous Sukuk offerings.
The number of constituents in DJSI has increased from 13
(in June 2010) to 36 (as at the end of September 2012)4
. In
addition, the constituents of the DJSI have similar ratings to
those of the WBIG. Both indices require a minimum quality of
‘BBB-‘ or ‘Baa3’ by the rating agencies5
.
Moving forward, we anticipate that more issuers will participate
in the Sukuk market. Today Sukuk investors are seeing several
first time issuers come to issue in their market. For instance,
the Republic of Turkey issued a US$750 million benchmark
issuance in September with Citigroup and HSBC included as
bookrunners. Further, following on the sovereign issuance,
Turkey’s Sukuk market is gathering even more momentum as
companies from the national airline to the biggest telephone
operator plan Sukuk offerings6
.
Sukuk investing offers strong international
diversification
The performance of the DJSI has remained resilient despite
political unrest in pockets of the Middle East. The stability of
the index is a reflection of the geographical diversification it
offers. The sovereign representation of Sukuk issuers in the
DJSI leads with Malaysia, and is followed by Saudi Arabia,
Qatar and Indonesia.
Table 4: Percentages of sovereign debt in Dow Jones Sukuk Index
Country Percentages
Malaysia 17.08%
Saudi Arabia 16.21%
Qatar 13.60%
Indonesia 6.04%
Dubai 5.53%
Abu Dhabi 3.60%
Total 62.06%
Source: Bloomberg and CIMB-Principal Islamic Asset Management
In addition to the benefits of diversification, these jurisdictions
have strong macroeconomic fundamentals and offer exposure
to oil and gas-related revenue streams which offer deep
reserves support to issuers. In addition, more than 60% of the
investment universe of DJSI is comprised of investment grade
Sukuk from countries which may not register significantly, if at
all, inside the conventional index.
Sukuk investing offers Shariah compliant exposure to
financials
Investment exposure to the financial sector is considered a
proxy for the growth of an economy since banking prospers
with an economic expansion.
However the Shariah compliant equity portfolio will typically
filter out the financial sector, as they tend to be conventional
banking and financial services entities. Shariah-sensitive
investors who want exposure to the financial sector can still
access the sector through the Sukuk asset class. Below are
the sector weightings of both indices:

20 November 2012
chapter
Table 5: WBIG and DJSI Sector Weightings
Weightings (%)
Sector Dow Jones
Sukuk Index
World Broad Investment
Grade (WBIG) Bond Index
Government and
governments
sponsored
53.47 68
Financials 29.42 5.33
Utilities 6.30 2.31
Industrial 5.53 6.35
Energy 5.28 1.00
Collaterised (MBS
and Covered Bonds)
0 17
As shown in table 5, financials constitute the second-largest
sector of about 30% in the DJSI. This is also an investment
opportunity for conventional investors who want to diversify
the quality of their overall portfolio’s exposure to the financial
sector as they can gain exposure to Islamic banks such as QIB
Sukuk Funding (Qatar), IDB Trust SVCS (Saudi Arabia) and
Abu Dhabi Islamic Bank (UAE).
Case study: Sukuk investing as a diversification
strategy
The benefits of diversification with Sukuk securities is not
just theoretical, it is demonstrable. For example, one can
examine the results of the following two scenarios to determine
if investing in Sukuk serves as a good diversification strategy
without compromising investment returns:
1. One portfolio which tracks the conventional index com-
pletely, and
2. A second portfolio which is split, whereby 20% tracks the
DJSI and 80% tracks the conventional index
For the two-year period ending the 28th
September 2012, the
annualized returns of the second portfolio resulted in a slight
enhanced return of 4.88%, versus 4.52% in the first portfolio.
In addition, the second portfolio’s Sharpe Ratio was increased
significantly to 1.14 versus 0.87.
Table 6: Two-year returns and Sharpe ratios improved with
20% Sukuk allocation
Annualized
returns
Sharpe
Ratio
Portfolio 1:
100% tracking the World Broad
Investment Grade Bond Index
4.52% 0.87
Portfolio 2:
20% tracking the Dow Jones
Sukuk Index and 80% tracking
the World Broad Investment Grade
Bond Index
4.88% 1.14
Given low yield markets worldwide, a 36 basis points differential
in and of itself is not an insignificant improvement. Equally as
important, the improvement in the Sharpe Ratio shows that the
strategy can generate alpha or additional returns that better
compensate for risk.
Conclusion
As one can see, investment exposure to Sukuk can offer
diversification benefits. In addition, prices of Sukuk generally
hold up well by virtue that they are often treated as a ‘buy and
hold’ investment. This grants an additional layer of insulation
against volatility relative to conventional fixed incomes. With
additional information and enhanced knowledge, investors
are becoming more comfortable with Sukuk investing. One of
the most convenient and easiest ways to access the Sukuk
asset class is via a fund which invests in diversified portfolio
of global investment grade Sukuk such as the Al Hilal Global
Sukuk Fund. Launched in early 2012, the Al Hilal Global Sukuk
Fund has delivered a strong performance of 4.3% in only six
months since its March debut. The fund invests in a diversified
portfolio of Shariah compliant Sukuk issued by sovereign,
quasi-sovereign and corporations and aims to generate regular
income as well as capital appreciation.
There are clear signs that the Sukuk market is maturing and
spurring a growing interest in gaining investment exposure to
the asset class. Over the two-year period, we found similar
investment results with lower volatility compared to the
conventional fixed incomes. These similar investment results
also showed a clear improvement in the Sharpe Ratio over
the conventional index. Closer examination of the Sukuk
investment space revealed further diversification benefits for
investors who have until now only invested in the traditional fixed
income space. From its ability to enlarge the total fixed income
investment universe to offering international diversification with
credit quality and Shariah compliant financial sector exposure,
there is evidence which shows that diversifying a portion of
one’s overall investment portfolio to Sukuk investments away
from traditional fixed income will show an improvement in the
Sharpe Ratio without diminishing investment returns.
www.MIFforum.com
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consulting
Endnotes:
1
Source: Dubai World Seeks to Delay Debt Payments as Default Risk
Soars
2
Source: After Crisis, Dubai Keeps Building, but Soberly from the NY
Times on the 29th
September 2010
3
Source: Middle East Credit Compendium 2012 by Standard Chartered
Bank dated 2nd
May 2012
4
& 5
Source: Bloomberg
6
Source: Sukuk Taking Flight as Airline Readies Debut Sale: Turkey
Credit by Bloomberg dated 3rd
October 2012
CIMB-Principal Islamic Asset Management
Level 5, Menara Milenium, 8, Jalan Damanlela,
Bukit Damansara
www.cimb-principalislamic.com.my

November 2012 21
chapter
Ramlie Kamsari
Deputy Chief Executive
Email: ramlie.kamsari@cimb.com
Michael S. Zorich, CFA
Chief Investment Officer
Email: zorich.michael@cimb.com
CIMB-Principal Islamic Asset Management (CIMB-Principal Islamic) is a dedicated Islamic global institutional asset management house,
combining the strength of 2 credible shareholders. The joint venture between CIMB Group and Principal Global Investors allows CIMB-
Principal Islamic to leverage on the compelling global Islamic credentials of CIMB Group (via CIMB Islamic) while Principal Global
Investor’s lends its expertise in global asset management.
CIMB-Principal Islamic won Best Overall Islamic Asset Management Provider of the Year 2012, Best Islamic Asset Management Company
in Asia, and Best Institutional Solutions Provider of the Year 2012 by Islamic Finance News Awards - Islamic Investor Poll 2012. At the
International Takaful Awards 2012 (London), the company was awarded The Best Asset Management House in Asia for the third year in
a row and also earned the Islamic Asset Management House of the Year by The Asset’s Triple A Islamic Finance Awards 2012.
Headquartered in Kuala Lumpur, Malaysia, the firm is strategically located in the world’s first country with a complete Islamic financial
system operating in parallel to the conventional banking system. This allows the firm to leverage on Malaysia’s comprehensive Islamic
financial infrastructure and its adopted global regulatory, legal and Shariah best practices.
Ramlie Kamsari,
Deputy Chief Executive
Tel: +603 2084 2289
E-Mail: ramlie.kamsari@cimb.com
Level 5, Menara Milenium, 8, Jalan Damanlela,
Bukit Damansara
www.cimb-principalislamic.com.my
Michael Zorich is the chief investment officer of CIMB-Principal
Islamic Asset Management (CIMB-Principal Islamic). He is
responsible for establishing and implementing investment
strategies for the firm’s clients and overseeing the performance of
both global Islamic equity and global sukuk portfolios.
A seasoned fixed income professional with a strong credit
background, Zorich has worked in tandem with portfolio managers
in the management of multi-sector portfolios. Previously, he was
managing director, special assets, for Principal Global Investors
(PGI) Fixed Income.
As the head of special assets group, he was responsible for
negotiations with distressed companies and the oversight of the
analysis, valuation and restructuring of all distressed debt in PGI’s
fixed income portfolios. Zorich joined PGI in 2001. Prior to that, he
was a senior associate at PrimeSolutions Capital Corporation.
Zorich is a Chartered Financial Analyst (CFA) and a member of the
CFA Institute. He obtained his Masters in Business Administration
(MBA) from Carnegie Mellon University and his Juris Doctor (JD)
from the University of Pittsburgh, School of Law. He is a member
of the Pennsylvania Bar and has a Bachelor’s Degree in Business
and Communications from the University of Pittsburgh.
Ramlie Kamsari is the deputy chief executive of CIMB-Principal
Islamic Asset Management (CIMB-Principal Islamic). As the head
of global sales & marketing, he also drives and oversees the global
institutional sales of CIMB-Principal Islamic’s full range of Islamic
funds to institutional investors in Europe, Middle East and Asia.
His responsibilities include implementing successful sales efforts
which targets relevant institutions and third parties, as well as
identifying new business opportunities and driving transactions
through to the close.
Since joining CIMB Group in 2004, he has held several senior
positions, including CEO and head, institutional sales of CIMB
Futures and CEO and director of CIMB Insurance Brokers. He
was also director and head, Islamic equity markets & derivatives of
CIMB Investment Bank.
Ramlie has extensive experience in the global financial industry,
spanning over 18 years across major financial markets and
covering the areas of global sales, advisory services and deal
executions of capital market products, derivatives products, risk
transfer solutions, and most recently, Shariah investment products.
In Singapore, his previous stints include Barings Futures, Daiwa
Co. and Refco Investment Services. Prior to joining CIMB Group,
he was vice president and head of global services at FIMAT, the
global derivatives trading division of Societe Generale. He holds a
Bachelor of Commerce from the University of Western Sydney and
a Graduate Diploma in Financial Management from the Singapore
Institute of Management.
Profile

22 November 2012
chapter
Dispute Resolution: The Final Piece
of the Puzzle
With an eye on the growing complexity and internationalization of the
Islamicfinancemarket,TheKualaLumpurRegionalArbitrationCenter
(KLRCA) has become the first organization in the world to launch
its i-Arbitration Rules; a dispute resolution mechanism specifically
formulated for Shariah compliant transactions. Islamic Finance news
speaks to Sundra Rajoo, director of the KLRCA on this cutting-edge
idea and its role in pushing the industry to new heights.
The Islamic finance industry is fast attaining a globalized status;
taking a more international approach in the structuring of
products and contracts, and through the proliferation of cross-
border transactions amongst issuers and investors. Although
Malaysia is considered to be one of the most sophisticated
jurisdictions in terms of regulations and resolving contractual
disputes for Shariah compliant transactions, based on Bank
Negara Malaysia’ Shariah Advisory Council’s rules established
by the Central Bank Act 2009 and the Shariah council
established by the Securities Commission under the Securities
Commission Act 1993, the country’s dispute resolution
capabilities can still be considered insular, as the judgment of
the courts are only enforceable in Malaysia.
Although the practice of alternative dispute resolutions for
Islamic finance contracts are becoming more common in civil
and common law courts, the system is far from impervious to
further dispute. Issues with ambiguity concerning the language
used in the contract, and in some cases the constitutional
limitations imposed on judges to interpret laws derived from
religious sources have all become prevalent issues in the legal
decision making process.
chapter

November 2012 23
chapter
In a bid to create an effective and internationally enforceable set
of rules for Islamic commercial transactions, and to increase the
fluidity of cross-border transactions, the KLRCA’s i-Arbitration
rules were launched as a set of procedural rules which cover
all aspects of the arbitration process, allowing for the resolution
of disputes from any contract or agreement containing Shariah
issues.
The rules, which are the first in the world to adopt the United
Nations Commission on International Trade Law (UNCITRAL)
Arbitration Rules, ensures international recognition, while
taking into account Shariah principles. Essentially, it is the
first set of arbitration rules that cater to both conventional and
Shariah compliant transactions and contracts.
The rules are also based on the 1958 United Nations
Convention on the Recognition and Enforcement of Arbitral
Awards, or the New York convention – the defining element
within the i-Arbitration rules, according to Sundra. “The New
York convention is a convention in which countries enter into
and they agree to enforce foreign arbitral awards. This makes
arbitration different from litigation, where the foreign court ruling
of one country cannot be enforced in another country. It is so far
the most successful convention in the history of mankind, and
on the last count, involved 146 participating nations. Basically,
if you are a serious business nation, you are already part of
it. Our main challenge in structuring the rules was how to
make it compliant with the New York convention to ensure its
enforceability on a global level.”
“The most elegant ideas are usually the most simple,” Sundra
revealed; referring to the additional component- Rule 8, which is
activated in the event of a dispute involving a Shariah compliant
transaction. “The approach that the center has taken is that we
have to provide an avenue when an item of such significance
comes along, and see how it will be resolved in the arbitration.
Rule 8 comes into effect when there is a Shariah dispute. The
Shariah component is submitted to a Shariah Advisory Council
or expert for an opinion, and when the opinion comes back, it
is applied. For example, in a dispute involving Islamic financial
instruments, parties and the arbitral tribunal may agree to refer
the matter to Bank Negara Malaysia’s Shariah Advisory Council
or the Malaysian Securities Commission’s Capital Markets Act-
whichever is deemed relevant. In the instance of a situation
involving a Shii’te dispute for example, the parties and the
tribunal can appoint their own Shariah expert, as provided in
the UNCITRAL Rule, under article 26. Therefore, parties will
always be able to choose which Islamic school of thought
(madhab) to apply to their dispute. ”
Long-term view
It is the internationalization of the Islamic finance market which
spurred Sundra and his team at the KLRCA to formulate a
dispute resolution mechanism based on international laws and
acceptability before incorporating the Shariah element. “It is a
cutting-edge product. It took us two years to come up with this,
to deal with expert opinion and how it all ties together. A lot of
people will start with Shariah as a base, but we decided to work
from the New York convention and then incorporate the Shariah
element.”
“These rules can be used even when there is no Shariah
component involved. Rule 8 only gets activated when a Shariah
component comes into play. In Item 6 of Rule 8, it states that
the ruling of the relevant council or the Shariah expert may
only relate to the issue or question so submitted by the arbitral
tribunal; and the relevant council or Shariah expert shall not
have any jurisdiction in making discovery of facts or applying
the ruling or formulating the decision relating to any fact of
the matter which is solely for the arbitral tribunal to decide.
Therefore, they (the Shariah council) can only decide on the
Shariah component. It is the arbitral tribunal, not the Shariah
Advisory Council or expert, who is the final determinant on
the matter as the tribunal cannot delegate its powers to make
decisions.” he added.
“In the recent International Bar Association (IBA) Conference
in Dublin, the question of how people are dealing with Shariah
issues was raised, and to be honest, there is no experience
outside of Malaysia except in limited pockets such as Dubai
and Bahrain. The Malaysian system is so far the most
comprehensive,” Sundra explained.
Sundra believes that the best way to resolve disputes,
particularly from a business point of view is through arbitration:
“From my understanding, what is not forbidden is allowed in
Shariah. Most of these Shariah compliant products are the
ones that are allowed and not forbidden. And when you have
those products, you are marketing to the world at large and
therefore, there needs to be a dispute resolution mechanism
because people will have disagreements. And for business
people, resolution of those disagreements or disputes is best
done through arbitration.”
“For the first time, there is a viable dispute resolution mechanism
for Shariah-compliant products. The Islamic world has not
really explored international commercial arbitration, and after
a certain point, there is a dichotomy between a religious and
secular dispute system. In all honesty, business people do
not want to go to the Shariah court, and prefer a legal secular
system. A great deal of thought and care would have gone
into putting together the complex and sophisticated Shariah-
compliant deals and products, but if a business dispute arose,
they would have to go to conventional arbitration. With the
KLRCA i-Arbitration Rules, there is now an option for a dispute
resolution mechanism that is Shariah-compliant, thereby
putting the last block in place for a complete Shariah compliant
transaction,” he concluded.
www.MIFforum.com
www.MIFmonthly.com
www.MIFtraining.com
consulting
Sundra Rajoo
Director
Kuala Lumpur Regional Centre for Arbitration
No.12, Jalan Conlay, 50450 Kuala Lumpur
Tel: +603 2142 0103
Email: sundra@klrca.org.my
Web: www.klrca.org.my

November 2012 25
feature
The Islamic Fund Management
Industry – Back to Basics
The Islamic fund management sector is still grappling with fundamen-
tal challenges that could prove to be crippling to this nascent industry.
NAZNEEN HALIM explores.
Although there are no current definitive figures, the size of
global Islamic assets is estimated at around US$1.2 trillion,
and is expected to grow at a rate of 10-15% in the next three
years, according to industry forecasts. Despite standing at only
0.5% of conventional assets, Islamic assets are still looking
to be managed and marketed effectively in order to mobilize
the sector and to create an efficient global Islamic fund
management industry. According to the 2011 Ernst & Young
report on Islamic Funds and Investments, Islamic funds’ assets
under management grew by 7.6% from 2010 to US$58 billion
in 2011; with Sukuk, commodities and capital protected funds
featuring as the investment modes of choice for the Islamic
investor.
However, it is hard to ignore the gap between total Islamic assets
and total assets under management, particularly in high growth
areas such as Asia and the Middle East. According to Raja Teh
Maimunah, the managing director at Hong Leong Islamic Bank,
Malaysia and Saudi Arabia still remain the top jurisdictions
for the Islamic fund management industry, particularly due to
regulatory efforts in providing screening services, especially
in Malaysia. “Only Malaysia has a list of screened equities -
and apart from Malaysia and Saudi Arabia, the Islamic fund
management industry is still small and insignificant,” she said.
“There are Shariah compliant equities in the Middle East which
you simply do not have access to. And it becomes expensive
to buy equities outside of Malaysia. From my experience in the
Middle East, we had to hire experts to screen the stock; thus
adding to the cost of the fund by 25 to 50 basis points (bps).
We had to hire screening consultants to seek equities for us
to invest in. Additionally, the channels for asset management
are still difficult to access outside of equities. In the fixed
income arena for example, the Sukuk market is still very much
concentrated in Malaysia. Apart from the ringgit market, there
is some activity in the MENA region. Investors are currently
focused on equities and fixed-income products, whilst most of
them post-crisis have moved to cash,” said Raja Teh.
A recent comparison done between the asset allocation for the
feature

26 November 2012
feature
conventional and Islamic markets by AmIslamic showed an
almost identical breakdown in terms of investment preferences
amongst conventional and Islamic investors - 25% in emerging
market equities, 35% in global equities, 15% in global bonds,
20% in emerging market bonds, and 5% in alternative assets.
The difference between the Islamic and conventional market lies
in the need for investments in Shariah compliant alternatives,
and the Islamic fund management industry will continue to
struggle as long as there is a lack of Shariah compliant solutions
in the market.
In the equities space for instance, the report by AmIslamic said:
“It is not possible to have an Islamic version available for every
conventional (non Islamic) investment product/ strategy out
there. For example, a typical equity asset allocation includes
an allocation to Smart Beta and when it comes to the Islamic
space, there are almost no Islamic Smart Beta funds available.”
On the fixed income side, the report commented: “A global
Sukuk fund will have significant exposure to emerging markets
and minimal exposure to developed markets as there are hardly
any Sukuk issues from developed markets. Therefore, it is not
possible to get a global Bond fund’s geographical allocation
with a global Sukuk fund. One of the solutions is to seek other
alternatives that replicate the payoff of a Sukuk (periodic
return and lower risk). We have developed an equity-based
solution that exhibits lower volatility and yields periodic income
(high dividend) to replicate the payoff profile of a Sukuk fund.
This solution supplements the allocation to global Sukuk and
addresses the geographical coverage/diversification issue.”
Monem Salam, the president of Saturna Capital, highlighted
the challenges currently facing the Islamic asset management
industry: including limited opportunities in the cross-border
space, higher fees and lack of competitiveness with the
conventional markets: “Most Islamic funds are currently
domiciled in Malaysia, and there is very limited opportunity for
cross-border distribution of funds. The Malaysian Securities
Commission is working hard to facilitate this with Dubai and
Hong Kong, but there are many other markets fund managers
are interested in. The opening up of other markets has to be
done on a regulatory level. Second, fees tend to be much
higher across the board in Asia compared to those in the west;
particularly the US and Europe. If you can access an Asian fund
in Europe which you can buy at less than a 1% expense ratio,
then why would you come to Asia to buy the same product at
1.5 – 2%? We have to be competitive on a global level in terms
of fees. Although the cost of running funds is a lot cheaper in
Asia, expenses are lower in US and Europe.”
In terms of Islamic exchange-traded funds, education still
remains a key issue, says Mahazir Othman, CEO at i-VCAP.
“The Islamic ETF market is still underdeveloped, and
education is still a main concern. There also needs to be
more understanding on how investors actually use Islamic
ETFs in their portfolio to enable them to meet their investment
objectives. The current mentality in Asia is: ‘Why do we need
to go beta when we can do our own stock-picking?’ and most
Asian investors are stock-pickers. Another challenge is product
depth. There are currently not enough Islamic ETFs in the
market for investors to asset allocate their portfolios using this
instrument. It is important to get managers to roll out more
products to address this challenge.”
The ongoing debate on the use of derivatives to hedge risk in
the Islamic finance space has also brought about challenges
in the Islamic fund management industry; with the divide
between the proponents of derivatives and those who disagree
becoming more apparent. From a fund manager’s perspective,
Monem believes that it is possible to avoid the use of derivatives
all together, simply by picking the best stocks to invest in. “It
depends on the mandate of the portfolio. When we look at the
fundamentals of derivatives and their purpose, it is essentially
to transfer the risk from you to someone else. Islamic finance is
about sharing risk, whilst derivatives are about transferring risk.
In Islamic finance, the gains and losses are shared.
“The way you can fundamentally do that is by going back to
the fundamentals of investments – i.e. plain vanilla structures.
We have managed to provide our clients with high returns and
low volatility investment products without derivatives, simply by
buying companies that pay you back in dividends so you can
utilize the gains in your portfolio, and by holding cash if you
don’t like a certain investment. If you stick to the fundamentals,
you will realise that the use of derivatives simply add cost to
your portfolio and lower your returns - and that doesn’t really
help. In the conventional space for instance, normal indexes
actually outperform hedge fund indexes, so what is the point of
doing that (derivatives) except for someone lining their pockets
with money?” he added.
It is absolutely vital for the Islamic industry to develop effective
products with competitive returns to enable the efficient
management of Islamic liquidity, in order to create a robust
investment environment and attract more investors to ensure
the health and sustainability of the Islamic capital markets.
www.MIFforum.com
www.MIFmonthly.com
www.MIFtraining.com
consulting
Investment preferences amongst conventional and Islamic
investors
Emerging market
equities 25%
Global equities 35%
Global bonds 15%
Emerging market
bonds 20%
Alternative
assets 5%
There are Shariah compliant
equities in the Middle East
which you simply do not
have access to

November 2012 27
chapter
What’s fueling the growth of Takaful globally?
Global Takaful growth was about 20% in 2011, although actual
rates varied widely between regions. Sharp spikes in growth
in countries such as Saudi Arabia were triggered by regulatory
action to expand compulsory insurance covers, particularly
medical insurance. For Asia, the family sector was boosted by
the customers’ needs and growth of agents and bank channels
distribution.
Is such growth sustainable?
We expect to see generally strong growth over
the long-term, however, we don’t anticipate
that the sector will sustain 20% growth over
the next few years, given the stuttering global
economy and the relative maturity of some
of the larger Takaful markets. Nevertheless,
Takaful has developed most fully in countries
that have relatively high economic growth
rates, and where the state follows Islamic
principles. Economic growth can support
greater personal wealth, leading to an
increase in insurable asset risk. In addition,
if sufficient wealth is created, we expect the
longer-term family (life) insurance sector will
also expand, especially in the GCC region.
How does the Takaful market in Asia
compare to that in the Middle East?
Takaful has developed most in the Gulf Cooperation Council
(GCC) region and Southeast Asia, but individual countries in
each region have taken different routes to develop the sector.
Malaysia is the most well-established Takaful market, which is
reflected in its size and relative sophistication. It contributes
over 17% to global contributions and has grown five-fold over
the past decade. In Malaysia’s Takaful market, family business
was about 63% of total contributions - the remainder comprised
general business. Most family business is linked to mortgage
lending (about 47% of total family contributions in 2011),
which perhaps reflects linkages between Takaful companies
and banks. For general business, mirroring the conventional
market, motor is the dominant business line, accounting for
55% of total general contributions in 2011.
The market in Saudi Arabia is larger but less seasoned. All
insurers have to operate to a cooperative model broadly
comparable with the various Takaful models used elsewhere.
While the country has seen very high growth recently, the main
source of growth over the past five years has been regulatory
action to introduce compulsory medical and motor insurance.
As a result, over 50% of global Takaful sector contributions
derive from Saudi Arabia. We do not expect the industry to
maintain the growth levels it saw after these changes, but it
is likely to remain high relative to global levels.
Is the investment approach similar between
Asian and Middle East Takaful companies?
Afundamental requirement ofTakaful companies
is to provide a fully Shariah compliant service
to both fund members (policyholders) and
investors. Southeast Asia makes greater use of
Sukuk for Islamic finance than the GCC region.
Its more developed market provides meaningful
volumes for the Takaful sector to invest in. In
Malaysia, more than half of Takaful insurers’
portfolios are invested in Sukuk, with the
remainder invested in cash & equivalent,
equities and other assets.
In contrast, a shortage of Shariah compliant
rated instruments in the GCC region means that Takaful
companies tend to invest in equities and real estate at a higher
portfolio than in Malaysia. Such investments can carry high
levels of value volatility and illiquidity and can drag on Takaful
companies’ balance sheets. However, the Sukuk portfolio for
GCC Takaful operators is increasing, reflecting the increase in
Sukuk issuance in recent years.
Many Takaful companies, particularly in the GCC region,
were set up during the boom years of the early 2000s. The
historically high investment valuations that operated when
they purchased their assets subsequently resulted in realized
losses. The current low investment yields strain bottom-line
results further. In our analysis, we consider the limited range of
acceptable instruments in which Takaful companies can invest
Diverging Models Shape The
Growth Prospects For Takaful
The growing need for insurance that complies with Shariah law
means that the global Takaful sector is becoming an increasingly
significant niche within the wider insurance industry. In the following
Q&A, Standard & Poor’s Ratings Services (S&P) compares the Takaful
markets in the Middle East and Asia, and discusses the outlook for the
sector amid the global economic slowdown.
Connie

28 November 2012
chapter
of the companies involved will sustain their profitability over
the longer term, particularly in the GCC region. However,
developments in Malaysia - the largest Takaful market in
Southeast Asia - appear much more healthy and sustainable.
They are supported by more sophisticated regulatory oversight
and the stronger investment profile of the industry.
How is the global economic slowdown affecting the growth
of Takaful?
The worldwide slowdown in economic activity will ultimately
depress growth in economies that provide resources for
manufacturing; this happens to include many of the resource-
rich countries where Takaful is developing. For insurers, this
constrains growth, partly by reducing demand for insurance,
but also by limiting investment yields.
Globally, the current low investment yields have hurt insurance
providers and markets. Insurance, Takaful included, is an
asset-rich business. Fierce competition in the economies
where Takaful is developing is putting underwriting margins
under pressure, especially in the high-volume, low-margin
retail lines that form the bulk of Takaful business. Meanwhile,
yields on Shariah compliant instruments and investments
are increasingly depressed. Providers will therefore need to
maintain their underwriting profitability to succeed.
What are the growth prospects of Takaful versus
conventional insurance?
Over the next 12-18 months, S&P expects Takaful company
contributions in the GCC region to significantly outgrow
premiums in the local conventional insurance industry, as
well as the global insurance industry. Global
insurance premium growth is expected to be
little more than 2% in 2012; by contrast, in its
World Takaful Report, Ernst & Young estimates
that gross Takaful contribution for 2012 will grow
to US$12 billion, a year-on-year increase of
24%.
In Southeast Asia, we anticipate that tightening
regulatory requirements in Malaysia could
depress the strong growth momentum the
industry has built up over the short-to-medium
term. That said, tighter solvency calculations
are likely to strengthen the financial profiles of
Takaful operators and operators will also benefit
from revised risk management practices in the
long term.
www.MIFforum.com
www.MIFmonthly.com
www.MIFtraining.com
consulting
Connie Wong,
Managing Director and Analytical Manager for Insurance Ratings,
Asia-Pacific, Standard & Poor’s
Kevin Willis,
Director, Insurance Ratings, Standard & Poor’s
to be a constraint that places downward pressure on their risk-
based capital position.
Is there potential for cross-border Takaful
activity?
To date, the primary Takaful sector in
Southeast Asia and the GCC region has
tended to comprise local operators that rarely
engage in cross-border activity. This reflects
the relatively small operational scale of the
sector and its still-developing status.
However re-Takaful companies, which
provide protection to the primary Takaful
sector, are operating in increasingly diverse
geographical areas. We see Southeast
Asian-based re-Takaful companies
competing and working with GCC-based re-
Takaful companies to develop and service
the growing capacity needs of the primary
sector in Africa, Southeast Asia, and the GCC region. As local
companies become increasingly mature and financially robust,
we expect cross-border activity in the primary sector to grow.
We also expect to see some consolidation in the more over-
populated insurance markets.
What is S&P’s key concern for the Takaful market?
We remain concerned by widespread use of high-risk
investment strategies by Takaful providers, and by the sector’s
lack of global standards in areas such as accounting standards
and Shariah compliance. In our view, it is unclear how many
chapter
Willis

July 2012
Features
ChapterThe Size
Issue
Decree 57: A Much
Needed Innovation
Market
Games Resolving Disputes
The Civil Law
Chokehold
GUIDE
February 2012
May 2012
Features
Chapters
On the
Horizon
Effective
Engagement
The Global IslamicDebt Market: Has itreached a plateau?
Takaful and
Waqf: An idealpartnership?
The Takaful andre-Takaful industry
Deals of the Year
Handbook
Deals of the Year
Handbook
Case studies
SATORP Sukuk Salik One
syndication
Danga Capital
Yuan Sukuk
First Sukuk in
Jordan
March 2012
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