It is not often someone can credibly lay claim to have played a pivotal role in creating a whole market, but one man who can is Rafe Haneef.
The sukuk bond market would not exist without him. He developed the concept while working at HSBC in 1999 and spent a further two years trying to convince rating agencies, stock exchanges, clearing houses, Islamic scholars, issuers and investors that sukuk would work.
Together with Stephen Williams, then HSBC’s head of Asian debt capital markets, the two were team managers of the Federation of Malaysia’s groundbreaking $600 million issue in June 2002.
Today, the global sukuk bond market has grown to annual issuance of $35 billion, with $291 billion in outstandings and Haneef is now CEO of Group Islamic Banking for CIMB, an Association of Southeast Asian Nations [Asean]-focused bank headquartered in Kuala Lumpur, Malaysia.
Here he recalls the hard work of getting Islamic bonds off the ground and how Islamic financing, if practiced holistically, could not only wean the world off debt and the many crises it engenders, but also provides a whole new model for a more equitable form of capitalism.
Haneef's interview is one in a series we are running with key figures in Asian financial markets to celebrate FinanceAsia’s 20th anniversary.
I went to a talk recently where Greek economist and former finance minister Yanis Varoufakis concluded that debt is to capitalism what hell is to Christianity: you cannot have one without other. How is your worldview different?
Islamic finance can help to change the nature of capitalism itself. Under Islamic law, debt is an exception, a benevolent act.
For example, in conventional finance I could lend you $10,000 and then you’d re-pay me say $12,000, which includes a premium for my trouble, or a lot more premium than that if your repayments got later and later or smaller and smaller. This model allows debt to flourish.
Under Islamic principles, I’m encouraged to lend to someone in real need as a benevolent act. But I am not going to merely lend you $10,000 for you to buy a car because there’s no financial benefit to me.
But instead, I could buy that $10,000 car for you and then sell it to you for $1,200. This model maintains the relationship between the real economy and the financial economy.
There’s a link between the asset in question and the payment for it.
How does that model create a more equitable form of capitalism?
When holistically applied, Islamic finance is a more responsible form of financing. The higher objective also embraces more risk sharing between the savers and users of funds.
At the moment, the world is far too skewed towards debt finance rather than equity. It’s more attractive because the cost of debt is cheaper than the cost of equity: there’s no dilution and in many instances there are also tax benefits.
The Islamic approach is to push more risk sharing and equity participation. So ultimately profits are split between a buyer and seller rather than almost completely absorbed by the financial intermediary.
This model sounds very similar to the ethos behind the sharing economy?
Yes it is. If you believe the sharing economy is based on risk sharing then it is, by default, Islamic since that’s what Islamic finance is all about.
It all boils down to one thing: information. If I’m the entrepreneur, I need sound information about who will give me money.
If I’m a service provider, I need to know where my clients are. This is what Uber does. In the past, taxi drivers had no way of knowing where their customers were. Uber’s platform is a good example of knowing exactly who and where your customers are.
In the financial world, P2P platforms are doing this. Banking itself will probably be the last industry to get Uberised but it will happen. There’ll be a huge number of changes in financial intermediation over the next 20 years.
How might it happen?
Banks will become more involved in investment intermediation rather than directly lending money to clients themselves. For example, they might pool groups of entrepreneurs into different portfolios, graded according to risk.
They could then sell chunks of these portfolios to different investors who would share the upside and the downside.
This is something, which will happen progressively. The whole infrastructure also needs to change.
For example, why should a corporate get tax relief for interest payments to banks but no tax relief is available when profits are distributed to risk-sharing investors?
How far advanced is it in Malaysia?
About 60% to 70% of debt capital market instruments are Islamic. In Dubai it’s more like 40%. I think the ratio needs to get to 60% to 70% across the Islamic world before we see fundamental change.
The banking industry is still lagging behind for understandable reasons. In Malaysia, it’s about 27% at the moment.
Conventional assets are still significantly higher because these kinds of products are easier to execute. If you want a conventional loan, it’s very easy to just come in and sign a standardised document. With Islamic finance, for example, you have to go out and buy an asset first, then lease it.
I’m confident that by 2020, 40% of Malaysian banking assets will be Islamic. The fundamental shift will occur once they hit the 60% to 70% mark.
What’s your view on Islamic windows? Bangladesh has blocked its conventional banks from setting them up.
I think it’s much better to start off with an Islamic window that grows into an Islamic subsidiary and then eventually becomes the parent. It’s a much better approach than creating two separate banks, although there are some examples of banks doing it well.
What banks will find is that over time it will become too expensive to have two kitchens so to speak, especially when regulatory costs are increasing all the time.
At the end of the day we’re all marketing to the same customer base. In 20 years times I see a lot of banks defaulting to Islamic products because they’re easier to manage as opposed to having two kitchens targeting the same customer segment.
In its annual stability report this year the IFSB (Islamic Financial Services Board) called for more stress testing and disclosure now the market is become so systemically important across the world. Do you agree?
I definitely agree that all banks should be subject to higher stress testing. But I don’t see the logic of Islamic banking being held to higher stress tests than conventional banking.
If Islamic products have the same risk profile as conventional ones then why do they need more disclosure and stress testing?
Isn’t that one of the chief criticisms of the sukuk bond market? There has been too much reverse engineering of conventional products into Islamic products rather than creating new products, which promote financial inclusion?
I understand the argument, but if you examine the history of how sukuks came into existence, I think it’s very clear the structure we came up with was the necessary one to get it over the line and accepted by the market.
It had to appeal to conventional and Islamic investors; otherwise it would never have worked.
So how did it come about?
I was at a different bank back then (editor’s note: HSBC). The bank saw many Muslim countries were turning to Islamic financing and wanted to be part of its development.
It was also clear the growing wealth of these countries was massively outstripping their GDP creating excess liquidity we could try and tap into.
The big challenge was how to create an instrument that was compliant with Islamic principles or Sharia law yet recognizable to investors in non-Islamic countries.
When I started, there were already very small trade-based Islamic instruments out there. They were typically $50 million to $100 million in size.
But we realised there was a perfect fit with project finance since it’s asset-backed.
The first big deal we did was a project financing for a power project in Bahrain in 2001. The client was buying turbines from a Swiss company and we managed to get Swiss export credit agency (ECA) on board.
Then in 2002, I worked on an aircraft financing for Emirates backed by the French, German and British ECAs. So the industry swiftly evolved from trade to power, then ECAs and finally larger ticket items such as airplanes and ships.
At this point, it dawned on us that we needed a tradeable instrument and that’s when I came up with my concept paper.
We took it to more than a dozen governments. About a year later, Malaysia came back and said they were happy to run with it.
We tested the structure in Jersey through a roughly $100 million aircraft leasing transaction for a Greek buyer. It was sold to about 10 investors.
A special purpose vehicle (SPV) owned the project assets on behalf of the investors, who were issued trust certificates, and then leased them back to the project owner.
Our first pitstop was the rating agencies, in this case Fitch. We showed them the structure and asked if they would rate it like a conventional bond. They said yes.
The next challenge was to get it classified as a global bond. We talked to Luxembourg Stock Exchange. They said that as long as the payment profile is the same as a conventional fixed income then they agreed to list it.
Next we went to the clearing houses: Euroclear and Clearstream. They said if it behaves like a bond then we’ll treat it like a bond.
Finally we worked without lawyers to structure the trust certificate as a Reg S instrument.
How did investors react it? I was told the Islamic scholars in Jeddah had their doubts.
Yes, that happened during the roadshow for Malaysia’s debut bond. They’d initially been fine with it when we worked with them pre-launch, but then they started to have doubts.
The big challenge was getting everyone comfortable with declaration of trusts. Under English common law it’s very clearly defined: trustees hold assets on behalf of a beneficiary.
It’s not at all well-defined and hence well-understood under either civil or Islamic law. Under sharia law, the investors have to own the underlying assets and they struggled to understand the concept of beneficial ownership.
We also needed to persuade everyone to bring conventional investors on board. But we successfully argued that they would be the ones who’d trade the deals and create a fully functioning securities market.
And why did you call it a sukuk?
It’s the plural of sakk, which was a kind of cheque during the time of the Umayyad Dynasty, where the civil servants were partly paid with sukuk certificates, which were transferable for bushels of wheat etc. Some of the soldiers then sold these certificates on the open market for cash.