Islamic finance is an intriguing option for China and Hong Kong. However, it is currently just that. NAZNEEN HALIM explores what makes these financial centers tick, and how far they have come in terms of creating a viable Islamic market.

Necessity is the mother of invention. But in the case of China and Hong Kong, there is really no necessity to create an Islamic market. Having flourishing markets in commodities, and accruing trade volume and human capital, these titans have long placed themselves among the big boys. And this is not expected to change anytime soon. However, even giants see the need to diversify, and Islamic finance is, at the very least, their passport into the Gulf.

China: Republic of hope
China, with its immense population, is also home to a vast array of cultures, spanning thousands of regional languages and tribes. The district where China’s first Islamic bank is being developed, for instance, is home to the Hui people, who are majority Muslim and therefore aware of the value proposition of Islamic finance. The younger generation of Chinese Muslims’ knowledge of Islam has however become very much diluted despite the government’s liberalization on religion and its practice.

It’s still extremely early days for Islamic finance in China, and the decision to grant an Islamic banking license to a national bank has been said to be a purely political decision based on the unrest among the largely Muslim Uighur community last year. The bank, which is located in an autonomous Muslim district, has just concluded its first phase of development and is now well into the second. Middle East trade with China is also seeing a healthy high, with foreign direct investments growing, with China Investment Corporation’s strategic global acquisitions in terms of oil and gas, coal, natural resources and minerals to fuel the economy.

Daud Vicary Abdullah, global Islamic finance leader at Deloitte, among the few who have been mandated to set up China’s first Islamic bank, believes that China is now sitting on a very interesting precipice. “China is however taking its time; not because they are slow but because they can afford to,” he said. China’s unique political landscape has also played to the tune of Islamic finance’s growth because of its single-party system.

He equates the up-and-coming bank’s set-up to a “blank sheet of paper with another blank sheet of paper on top.” This being the republic’s first Islamic bank also means that there is virtually no point of reference in areas such as taxation, governance, fractional reserve accounting, accounting standards and the like. And that is just on a macro-level.
Daud and his team however believe that working on the micro level is just as much of a challenge as the macro level due to the sheer amount of issues that needed to be addressed during the first phase of development: “We carried out a gap analysis of issues surrounding people, processes and technology. However we are lucky that the bank’s management is very eager and committed to this cause.” He added that a large proportion of the bank’s employees are Muslim, which has, to an extent, eased the learning process.

Starting from scratch
As far as the Chinese government is concerned, Daud says, they have ticked a box and said “here is your license”, and are now just waiting to see developments. “However, the situation that this bank in China currently faces is different from a start-up in Malaysia. I helped set up two Islamic banks in Malaysia, and there is extreme disparity in the infrastructure in place. In Malaysia, the banks were set up in an environment that WANTED Islamic finance. The central bank and government had regulations that were favorably disposed to growing Islamic finance. The only issues I had then were micro. The regulators were supportive, and we were able to talk to interact with people who knew what was going on.”

After the completion of the first phase, the bank in China is ready to enter its second phase of development which includes regulations, legislation, tax, capital adequacy and reserve accounting.

“We also need to develop interaction with regulators, and remind them that this is good for them. Of course, you never dive straight in and tell a regulator what to do — definitely a bad move. You have to go in and persuade them that this is good for business, and stress on the need to create a level playing field. If you don’t, the experiment will fail, subject to price pressure,” Daud added.

“There is no point in playing the Muslim card with the regulators. You have to emphasize that Islamic finance is good for business,” stressed.

Interestingly, the up and coming Islamic bank in China is only available to Muslims. This rule was apparently set by the Chinese regulators. The products which have been allowed are also confined to Wadiah, Murabahah and Mudarabah for now.

Daud however does not see this as a hindrance, and is actually very optimistic: “A year ago we had nothing. The bank is privileged to be given this opportunity. They have a license to open an Islamic window, are allowed to offer three products, and have a substantial Muslim population to play with.

“What needs to be addressed now is how do we move from here? They have to figure out what other products they may need, and try to persuade the regulators to permit this. There is a huge opportunity to grow the product range, but we also need the regulators to expand the marketplace and eventually allow Islamic banking for everyone.

“The Chinese regulators themselves are looking for advice and help, but at the end of the day, they will make up their own mind. They will listen, but they are not going to be told how to run their own country,” Daud concluded.

Hong Kong: Aspirations docked?
For two years now, Hong Kong has shown relative enthusiasm over Islamic finance, with the Hong Kong Monetary Authority (HKMA) actively seeking participants to create a decent Islamic finance capital market and signing a MoU with the Central Bank of Malaysia for the mobilization of Islamic finance.

However, that apparently is the extent of it. Rudi Prenzlin, chief financial officer at Hong Kong Islamic Index, elucidated that although the government has finally realized the need to revamp tax regulations to level the playing field for Islamic finance, only some changes are slated to be made before summer.

“What these proposed changes are I cannot say, but what is pretty telling is that the Financial Secretary did not make the further development of Islamic finance a priority for Hong Kong during his budget speech for this year. This is a first, at least since October 2007, that this was left out in a major speech by either the chief executive or the financial secretary,” he revealed.

Hong Kong’s regulators have also approved its first Shariah compliant credit union, which secures a retail banking angle to those looking to start such activities.

“As the treasurer of Amwal Credit Union, I can only say that Islamic finance in Hong Kong requires both sides of the balance sheet to work. Deposits are required to the same extent as loans. Most of what is talked about in Hong Kong only deals with the asset side of the balance sheet, that is, Sukuk, but very little thought is given to the source of the funds that is being lent out,” Prenzlin added.

In terms of indexes, the two most prominent Islamic indexes are the Dow Jones Islamic Titans Index and the Hong Kong Islamic Index which has outperformed the Hang Seng Index by 2% year-to-date and has, since its inception in late October 2006, outperformed the Hang Seng in excess of 17%. The fact that half of the constituents are mainland Chinese companies listed in Hong Kong is believed to have had a positive impact on the index’s performance.

However, the market is said to be actively seeking Middle Eastern investors in the form of banks. Prenzlin is however skeptical of Hong Kong’s success in pulling such investors due to competition from China.

“Hong Kong does not have a good history in attracting, and more importantly keeping, Middle Eastern investors. Plus, China is now the Arab world’s most important trading partner. Most of this trade, however, is not routed through Hong Kong and is something that has passed the territory by.

“Building a long-term relationship with the Arab world should be priority for all finance professionals in Hong Kong. There is a reason London is able to maintain the lead in international finance, even Islamic finance. The Arabs, the biggest source of Islamic funds, are comfortable there. It’s a place they know well. Hong Kong is a strange place and we have not gone out of our way to make the extra effort,” a near-exasperated Prenzlin said.

In a nutshell, Hong Kong has all the necessary elements in terms of regulations and experience to make Islamic finance work but ultimately, it is the relationships with the Islamic investors that are sorely lacking.