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ISLAMIC BANKING AND FINANCE:ISLAMIC BANKING AND FINANCE:

WHATS IN IT FOR CANADIANWHATS IN IT FOR CANADIAN

COMPANIES?COMPANIES?

Mohammad FadelMohammad FadelCanada Research Chair in the Law and Economics of Islamic LawCanada Research Chair in the Law and Economics of Islamic Law

University of Toronto Faculty of LawUniversity of Toronto Faculty of LawOctober 16, 2006October 16, 2006

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OVERVIEW OF ISLAMIC BANKINGOVERVIEW OF ISLAMIC BANKING

SECTORSECTOR

Centers of Islamic FinanceCenters of Islamic Finance

MalaysiaMalaysia

Persian GulfPersian Gulf

United Arab Emirates (Dubai)United Arab Emirates (Dubai)

BahrainBahrain

England ????England ????

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Historyof Islamic BankingHistoryof Islamic Banking

Local Islamic banks formed in the 1970s inLocal Islamic banks formed in the 1970s inMuslim countries such as Malaysia, PakistanMuslim countries such as Malaysia, Pakistanand Dubaiand Dubai

Originally emphasized jointOriginally emphasized joint--venture structuresventure structuresakin to private equityakin to private equity

Quickly evolved to provide shortQuickly evolved to provide short--term creditterm creditfacilities by using thefacilities by using the murbahamurbaha structurestructure

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HistoryofIslamic Banking (II)HistoryofIslamic Banking (II)

With increase in scale, Islamic banksWith increase in scale, Islamic banksbegan to branch out to more complexbegan to branch out to more complexfinancing schemes, including:financing schemes, including:

Retail banking, including, deposit taking andRetail banking, including, deposit taking andconsumer lendingconsumer lending

Bonds (Bonds (sukksukk))

MediumMedium-- and Longand Long--term leasesterm leases (ijra)(ijra)

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HistoryofIslamic Banking (III)HistoryofIslamic Banking (III)

Impact of 9/11Impact of 9/11 Reverse Capital FlightReverse Capital Flight

Perception of hostile climate in many WesternPerception of hostile climate in many Western

jurisdictions, in particular, the United States, led tojurisdictions, in particular, the United States, led torepatriation of dollars by Arab investors to Middlerepatriation of dollars by Arab investors to MiddleEastern banksEastern banks

Islamic banks, along with conventional banks in theIslamic banks, along with conventional banks in the

region, benefited from this reverse flight of capitalregion, benefited from this reverse flight of capital

Increase in Oil Prices Led to Dramatic Increase inIncrease in Oil Prices Led to Dramatic Increase inLiquidity in the GulfLiquidity in the Gulf

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Historyof Islamic Banking (IV)Historyof Islamic Banking (IV)

Conventional Banks Open IslamicWindowsConventional Banks Open IslamicWindows

Conventional banks began to respond to requestsConventional banks began to respond to requests

from Muslim clients to offer products that compliedfrom Muslim clients to offer products that compliedwith Islamic lawwith Islamic law

As the size of the potential market became clear,As the size of the potential market became clear,

conventional banks responded with the creation ofconventional banks responded with the creation ofdivisions dedicated to Islamic bankingdivisions dedicated to Islamic banking

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HistoryofIslamic Banking (V)HistoryofIslamic Banking (V)

Conventional International Banks withConventional International Banks withIslamicWindows:IslamicWindows:

CitigroupCitigroup HSBCHSBC

Deutsche BankDeutsche Bank

UBSUBSABN AMROABN AMRO

Standard Chartered BankStandard Chartered Bank

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Historyof Islamic Banking (VI)Historyof Islamic Banking (VI)

Almost all regional banks have followedAlmost all regional banks have followedthe international banks in creatingthe international banks in creatingIslamic windows and some haveIslamic windows and some haveconverted, or are in the process ofconverted, or are in the process ofconverting, to the Islamic banking modelconverting, to the Islamic banking model

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SizeofIslamic Banking SectorSizeofIslamic Banking Sector

No precise measure of size of deposits held inNo precise measure of size of deposits held inIslamic banks or Islamic divisions ofIslamic banks or Islamic divisions ofconventional banksconventional banks

Ranges from a low of $250 billion to a high of $750Ranges from a low of $250 billion to a high of $750billionbillion

As much as $300 billion held in Islamic investmentAs much as $300 billion held in Islamic investmentfunds awaiting investment opportunitiesfunds awaiting investment opportunities

Arab investors hold approximately $800 billion ofArab investors hold approximately $800 billion ofassets in European banks, with a growing trend toassets in European banks, with a growing trend toinvest that money in Islamic productsinvest that money in Islamic products

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RoleofIslamic Financein WorldRoleofIslamic Financein World

Credit MarketsCredit Markets Demand SideDemand Side

Sovereign DebtSovereign Debt

International AgenciesInternational Agencies

Corporate DebtCorporate Debt

Project FinanceProject Finance

Consumer DebtConsumer Debt

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Sovereign Islamic DebtSovereign Islamic Debt

In recent years, several Islamic Countries andIn recent years, several Islamic Countries andtheir instrumentalities, as well as nontheir instrumentalities, as well as non--IslamicIslamiccountries, have issued sovereign debt in thecountries, have issued sovereign debt in the

form ofform ofsukksukk::

Department of Civil Aviation, Dubai: $1 billionDepartment of Civil Aviation, Dubai: $1 billion

Qatar: $700 millionQatar: $700 million

Pakistan: $600 millionPakistan: $600 million

Malaysia: $600 millionMalaysia: $600 million

German State of SaxonyGerman State of Saxony--Anhalt:Anhalt: 100 million100 million

Bahrain: $79.5 millionBahrain: $79.5 million

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International AgenciesInternational Agencies

International Agencies Have IssuedInternational Agencies Have Issued SukkSukkin recent years:in recent years:

Islamic Development Bank: $400 millionIslamic Development Bank: $400 million

World Bank: $200 millionWorld Bank: $200 million

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Islamic Corporate DebtIslamic Corporate Debt

Private Issuances ofPrivate Issuances ofSukkSukk::

DPWorld: $3.5 billion 7.5%DPWorld: $3.5 billion 7.5% sukksukk, convertible into, convertible into

equity at the time of a qualifying initial public offeringequity at the time of a qualifying initial public offering

National Central Cooling Company: $200 million,National Central Cooling Company: $200 million,rated BBBrated BBB-- by S&Pby S&P

Listed on London Stock ExchangeListed on London Stock Exchange Previous issuance by same issuer listed on LuxembourgPrevious issuance by same issuer listed on Luxembourg

Stock ExchangeStock Exchange

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Islamic Corporate Debt (II)Islamic Corporate Debt (II)

Global issuance ofGlobal issuance ofsukksukkhas exceededhas exceeded$20 billion$20 billion

Dow Jones CitigroupDow Jones Citigroup

SukkIndex Comprised of sevenComprised of seven sukksukk

$2.8 billion aggregate principal amount$2.8 billion aggregate principal amount

Each issue rated at least A by S&PEach issue rated at least A by S&P

Average tenor 3 yearsAverage tenor 3 years

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Islamic Corporate Debt (III)Islamic Corporate Debt (III)

Biggest challenge thus far is limited secondaryBiggest challenge thus far is limited secondarytrading market fortrading market forsukksukk

Demand forDemand forsukksukkhas far exceeded supply;has far exceeded supply;offerings typically oversubscribed, even afterofferings typically oversubscribed, even aftersubstantial upsizing of the offering at timessubstantial upsizing of the offering at times

DPWorld offering originally contemplated for $2.8DPWorld offering originally contemplated for $2.8billion but was upsized to $3.5 billion to meet excessbillion but was upsized to $3.5 billion to meet excessdemand; no road show needed to market the offeringdemand; no road show needed to market the offering

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Islamic Financeand ProjectIslamic Financeand Project

FinanceFinance Infrastructure projects in the Gulf regionInfrastructure projects in the Gulf region

largely financed on a corporate basis untillargely financed on a corporate basis untilthe midthe mid--1990s1990s

Sadaf, a joint venture between Shell Oil andSadaf, a joint venture between Shell Oil andSaudi Arabian Basic Industries CorporationSaudi Arabian Basic Industries Corporation(SABIC), first important project finance(SABIC), first important project finance

transaction in Gulf region, closed in 1995transaction in Gulf region, closed in 1995 Project Finance now preferred structure forProject Finance now preferred structure for

infrastructure investmentinfrastructure investment

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Finance (II)Finance (II) Islamic sources of capital traditionallyIslamic sources of capital traditionally

played minor role in project finance in Gulfplayed minor role in project finance in Gulf

In recent years, however, no deal gets doneIn recent years, however, no deal gets donewithout a substantial Islamic tranchewithout a substantial Islamic tranche

Financing needs exceed capacity of commercialFinancing needs exceed capacity of commercial

banks and export credit agenciesbanks and export credit agencies Desire of project hosts to diversify sources ofDesire of project hosts to diversify sources of

capital and take advantage of local capital to thecapital and take advantage of local capital to theextent feasibleextent feasible

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Finance (III)Finance (III) Rabigh Refinery and Petrochemicals Project,Rabigh Refinery and Petrochemicals Project,

Kingdom of Saudi ArabiaKingdom of Saudi Arabia

$9.9 billion total cost, of which $5.8 billion was debt$9.9 billion total cost, of which $5.8 billion was debt

$4.1 billion equity split 50$4.1 billion equity split 50--50 between Saudi Aramco50 between Saudi Aramcoand Sumitomo Chemicaland Sumitomo Chemical

$2.5 billion loan provided by Japan Bank for$2.5 billion loan provided by Japan Bank forInternational CooperationInternational Cooperation

$1 billion loan from Saudi Public Investment Fund$1 billion loan from Saudi Public Investment Fund $1.7 billion commercial loan$1.7 billion commercial loan

$600 million Islamic tranche$600 million Islamic tranche

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Finance (IV

)Finance (IV

) YANSAB ProjectYANSAB Project

$5 billion greenfield petrochemical project$5 billion greenfield petrochemical project

$3.5 billion debt:$3.5 billion debt: $1.067 billion, 13$1.067 billion, 13--year tranche from Saudi Public Investmentyear tranche from Saudi Public Investment

FundFund

$850 million, 12$850 million, 12--year Islamic trancheyear Islamic tranche

$700 million export credit agencies tranche$700 million export credit agencies tranche

$533 million 12$533 million 12--year commercial bank trancheyear commercial bank tranche

$350 million working capital facility$350 million working capital facility

ABN AMRO was sole arranger, underwriter andABN AMRO was sole arranger, underwriter andbookrunner on dealbookrunner on deal

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Finance (V)Finance (V)

Future Demand for Project FinanceFuture Demand for Project Finance

Last two years saw $40 billion of project finance inLast two years saw $40 billion of project finance ingulf regiongulf region

Saudi Arabia estimates it will invest $90 billion inSaudi Arabia estimates it will invest $90 billion indomestic power generation over the next fifteen yearsdomestic power generation over the next fifteen years

Other states in the gulf also investing heavily inOther states in the gulf also investing heavily ininfrastructure projects, particular petrochemicalinfrastructure projects, particular petrochemical

There will be a continuing demand in the region forThere will be a continuing demand in the region forcapital to invest further expansion of the regionscapital to invest further expansion of the regionsinfrastructureinfrastructure

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OpportunitiesforCanadianOpportunitiesforCanadian

BanksBanks Deal flow shows no sign of abatingDeal flow shows no sign of abating International banks have shown an ability toInternational banks have shown an ability to

compete successfullycompete successfully

Because of the size of new deals, Islamic banksBecause of the size of new deals, Islamic banksneed to partner with international banks to takeneed to partner with international banks to takeadvantage of their larger distribution networksadvantage of their larger distribution networks

Success ofSuccess ofsukksukk issues means thatissues means thatconventional market investors have grownconventional market investors have grown

comfortable with their structure and will invest incomfortable with their structure and will invest inthem so long as credit profile meets investorsthem so long as credit profile meets investorsneedsneeds

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Banks (II)Banks (II)

Success in penetrating markets for arrangingSuccess in penetrating markets for arrangingcredit could lead to mandates in upcomingcredit could lead to mandates in upcomingequity offeringsequity offerings

Future opportunities to advise in connection withFuture opportunities to advise in connection withan inevitable consolidation of banks in the Gulfan inevitable consolidation of banks in the Gulfregionregion

Opportunities for wealth management of wealthyOpportunities for wealth management of wealthyIslamic investorsIslamic investors

Merrill Lynch identified 300,000 U.S. dollarMerrill Lynch identified 300,000 U.S. dollarmillionaires in the Middle Eastmillionaires in the Middle East

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IssuersIssuers

Canadian Issuers, public and private, mayCanadian Issuers, public and private, mayconsider tapping the Islamic capital marketsconsider tapping the Islamic capital markets

Because of Islamic finance is assetBecause of Islamic finance is asset--based, Canadasbased, Canadasmining industry is a natural fit with the structures somining industry is a natural fit with the structures sofar developed in Islamic financefar developed in Islamic finance

Because of highBecause of high--liquidity of Islamic banks and Islamicliquidity of Islamic banks and Islamic

investment funds, issuers who tap this market may beinvestment funds, issuers who tap this market may beable to obtain relatively favorable pricing relative toable to obtain relatively favorable pricing relative tothe conventional marketthe conventional market

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Infrastructure FirmsInfrastructure Firms

Because of infrastructure boom in Gulf region,Because of infrastructure boom in Gulf region,large premiums have been paid on Engineering,large premiums have been paid on Engineering,Procurement and Construction contractsProcurement and Construction contracts

Successful competition for infrastructureSuccessful competition for infrastructureprojects inevitably requires support of exportprojects inevitably requires support of exportcredit agencycredit agency

Export Development Canada would have anExport Development Canada would have animportant role to play in promoting Canadianimportant role to play in promoting Canadianfirms expertise in the regionfirms expertise in the region

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ConclusionConclusion

Islamic finance and conventional finance areIslamic finance and conventional finance arequickly converging in the Gulf regionquickly converging in the Gulf region

As conventional investors gain more comfortAs conventional investors gain more comfort

with Islamic structures, cost differential betweenwith Islamic structures, cost differential betweenIslamic products and conventional productsIslamic products and conventional productshave almost disappearedhave almost disappeared

As a result, Islamic products may be moreAs a result, Islamic products may be morepractical because they appeal to both Islamicpractical because they appeal to both Islamicand conventional investorsand conventional investors

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Conclusion (II)Conclusion (II)

It is not too late for Canadian banks toIt is not too late for Canadian banks tocompete for business in the Islamiccompete for business in the Islamicfinance arenafinance arena

To do so successfully, they will need toTo do so successfully, they will need toestablish a presence in the region, asestablish a presence in the region, ashave their competitorshave their competitors

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