Investors are everything in the fiscal world. However, could it be that issuers and market makers have gone too far out of their way to gain mass appeal— to the point of compromising fundamental Shariah principles? NAZNEEN HALIM speaks to industry experts to get the lowdown on who really has the last say.

The general consensus across the board is what the market wants, the market gets. Industry players are ready to cater to investor appetite, at whatever cost. Although investors understand, and want Shariah compliant products— such as in the case of asset-backed and asset-based securitization, many say that they would prefer to have credit reliance on corporate balance sheets rather than asset risk. Market players also believe that investors are not willing to take the risk that comes with the true purchase of assets.

This is one of many predicaments currently faced by industry practitioners and regulators. Keeping to the true spirit of Shariah, while creating commercially viable products, and appealing to investors is a delicate balancing act which the market has yet to master.

Evolutionary glitches
The Islamic capital markets is currently in an evolutionary state, and as Davide Barzilai, Islamic finance partner at Norton Rose elucidates, there are two tiers of Shariah that co-exist in the system now. One, he says, is Shariah compliance, and the other is the essence of Shariah; or embracing the concept of a Shariah-based system.

“There has been a push off-late to say that the market is mature enough to go to the next level and keep to the spirit of Shariah; i.e. move away from fixed-income and reliance on debt into a quasi-equity system, where there is an element of risk sharing.

Quasi-equity is not the same as equity and shares— equity already exists. Therefore, practitioners and regulators should lead the market and create the demand for that type of product,” Barzilai said.

Matthew Sapte, partner and Islamic finance specialist at Denton Wilde Sapte also shined light on the approval process and the back and forth between market practitioners and Shariah scholars: “Scholars are not approving structures that perhaps they would have approved a few years ago. And to be fair, it was always made clear that Shariah pronouncements are given on an exceptional basis.

The problem facing the market right now is that a number of people have been trying to make the exception the rule, rather than maintaining the exception as just that. What we’re seeing is a renewed examination of structures— which is good.”

Based on Sapte’s experience, scholars have always approved structures on an exceptional basis and have always made it clear that the same exceptions do not spill over onto other transactions. “There used to be an expectation in the market that if they were able to do that (innovate a deal or product) the last time, they should be able to do it the next time. That is not the case. Scholars approve certain deals for a reason, and we must understand why they are approving such deals. Even if they come across a similar structure the next time, they will look at it with a fresh perspective.

Thankfully, we are seeing a manifestation of that now; new structures are being looked at by scholars as events happen that test various parts of Sukuk structures. People recognize that they could be done in a slightly different way next time—better perhaps. And that’s what the market is going to do. This is all part of an evolving market, and no different from the conventional financing market,” Sapte shared.

Now, the burning question is whether regulators and practitioners have the ability to drive demand for more Shariah-based products and break from traditional banking practice where products are driven by customer demand.

Investor influence— how much is too much?
According to industry players, there are instances where investors play a major role in the banks’ or issuers’ decision making process. “If you’re talking about a loan done in a Shariah compliant manner, your lender will dictate what that loan looks like. For instance, there are some people who won’t do a Murabahah and some who will.

For a Sukuk transaction that is publicly listed, arrangers will structure it with an eye on their target market. But ultimately, the investors do not have an influence on the structure because they are not at the table at the time.

But obviously the arrangers have an eye on where they’re going to market because the Sukuk has to be a success,” Sapte revealed.

At the other end of the spectrum, he says, there are Shariah compliant structured products which are tailored to a particular investor, and in that particular case, the investor will have a say on how the structure is put together.

Barzilai too, is staunch in his approach. He believes that it is on the banks’ onus to create their own demand to break away from customer-driven pressure.

“Regulators and governments can encourage and potentially create demand for new forms of investment to be more Shariah-based than Shariah compliant by way of regulation and example. Governments who control sovereign wealth funds can direct their funds accordingly to move in that direction.”

However, he warns that this is not something that can happen overnight. “It takes a very long time to create a system. I do not see anything wrong with having Shariah compliant products which meet the demands of fixed-income securities, and to an extent, having a certain level of Shariah compliant debt in the system. Even if it does not adhere to the ultimate goals of Islamic law, at least it’s going in one direction,” Barzilai added.

Post Taqi Usmani’s announcement in 2008 on the dubious Shariah compliance of Murabahah and Musharakah-based products, the market has seen an influx of Ijarah-based products.

Sapte believes in this case, investors have had some sort of influence: “Ijarah-based structures can be inflexible for certain Sukuk issuances— if you are looking to do an exchangeable or convertible Sukuk issuance, you can do well with an Ijarah-based structure. But it is a little more inflexible than Mudarabah or Murabahah-based.

The reason why Murabahah-based structures are more prevalent in Malaysia are ultimately driven by the Shariah requirements of the investors,” Sapte opined.

Market players however anticipate a potential finite limit to the amount of assets that can be put into an Ijarah structure, and will, at some stage, have to look at more joint-venture type structures and aim to structure them in a way that will meet investors’ needs.

A higher power
The market is seeing the early days of evolution, and it is evident that change is happening in pockets. There first needs to be a drive to create demand for more Shariah-based products on the government and regulatory level, and eventually let demand build on an investor level by building up the market.

However, the only way for any real change to occur is if key players in the Gulf, its ruling families, global governments and regulators will it.