Eastern Promise - Walid Sarieddine, WestLB

Western financial institutions urgently need to get up to speed with the requirements of Islamic finance if they are to tap into a huge capital reserve. Walid Sarieddine, head of Islamic Finance for WestLB, tells Jim Banks about the opportunities available.

International organisations, notably those based in Europe and the US, are growing more interested in Islamic finance structures, helping to fuel the current 15% annual growth rate in the global Islamic finance market.

Western banks and corporates are excited by the liquidity of petrodollars, particularly at a time when credit markets are tightening. To access that liquidity, they must invest under the principles of Shariah law. At the same time, many investors in the Gulf Cooperation Council (GCC) region – Kuwait, Oman, Qatar, Saudi Arabia, Bahrain and the UAE – seek outbound investments, including acquisitions in Europe, the US or Asia, which require Shariah-compliant structures.

The bridge between Western corporates and GCC investors, therefore, rests on a greater understanding of Islamic finance, and how Shariah law shapes a transaction such as a loan or a lease.

However, as Walid Sarieddine, head of Islamic Finance for WestLB, explains: ‘If you have a conventional loan or bond, no Islamic bank or investor can touch it because it is not Shariah-compliant.

Using Islamic finance can open up your loan to potential new investors. Banks like us can reach a wider audience with syndicated paper.

‘On the qualitative side, we can also create more visibility for our products and services in regions like the Middle East, where markets will grow.’

To derive the benefits of added liquidity and enhanced presence in growing markets, a company must understand how transactions work when the concept of interest is ruled out, as Shariah law requires. Return must be determined by exposure to risk and as such requires all parties to determine a different means to generate reward for investment.

UNDERSTANDING THE BASICS OF ISLAMIC FINANCE

The sukuk market comprises listed instruments that can be sold if needed and which have fewer covenants on borrowers, just like bonds. However, they must be based on identifiable assets and cannot bear interest, with returns linked to the performance of the assets purchased.

Over the last three years, the market for sukuk has expanded remarkably, particularly for products listed in Dubai and Bahrain. Increasingly, companies in the GCC region – and their sukuk – are rated, making them available to investors worldwide. Of the $28 billion total Islamic financings in 2006, $17 billion was in the form of sukuk.

Murabaha is similar to a loan, but with profit replacing interest. One party might, for instance, buy commodities of a given value and sell them to its counterparty, which can then sell them on. In effect, a loan has been made, but it is registered as a sale of commodities, with an agreed element of profit, which can be set at, for example, Libor plus an agreed number of basis points. Proceeds from Murabaha will have to be used in a Shariah compliant form.

Sarieddine explains: ‘Documentation for Murabaha is to a large extent based on conventional documentation and, as such, benefits from LMA standards. It is typically governed by English law, so it is easy for any FD in Europe to use.’

The volume of Murabaha and ljarah – the equivalent of a sale and leaseback deal – transacted around assets in non-Islamic countries is growing sharply. This has prompted banks such as WestLB to change their perspective on Islamic finance, no longer viewing it as part of a regional strategy, but as a product category in its own right on the international stage.

Shariah-compliant instruments are becoming increasingly available from European financial centres. The UK Government, for instance, is keen to develop London as a global gateway for Islamic finance. Work on legislation is well underway on issues such as tax equivalence with conventional investment structures.

WHAT EVERY FD SHOULD KNOW

The growing accessibility of Islamic finance structures in Europe and the US comes at a time when an appetite for them is growing among all parties. The calibre of outbound investments by GCC investors clearly indicates their desire to invest in more foreign assets. The purchase of UK car manufacturer Aston Martin by a consortium led by an investor from Kuwait, in which the Islamic finance team at WestLB arranged the entire debt funding in a Shariah-compliant structure, is a good example.

And in 2004, the German state of Saxony Anhalt issued a $100 million sukuk and MTC arranged a £405 million commodity-based Murabaha to pay off part of a bridge loan, while in 2006, East Cameron Partners issued a $165 million sukuk in the US.

Sarieddine says: ‘There is liquidity among GCC investors, who now need asset diversification and are looking to invest abroad. This is a long-term trend.’

The lesson for finance directors is that they may very soon need to be conversant in the language of Islamic finance, particularly if they want to further diversify their funding sources. Sarieddine adds: ‘For large, international companies based in Europe, it is hard to ignore Islamic finance, not least as an established source of fuel for international debt markets. It provides a source of liquidity that did not exist four years ago, and offers more diversified funding.’

The actions of the UK Government suggest that Islamic finance will be an increasingly important element in the global financial markets, with the liquidity and diversification it offers. For Sarieddine, this should be enough motivation for finance directors to start familiarising themselves with Shariah-compliant structures.

He says: ‘If HM Treasury, the government and the Financial Services Authority are working on it, then surely it makes sense for FDs in large organisations to be interested.’

One crucial question those finance directors will no doubt ask is ‘will it cost more?’ Sarieddine says ‘hardly’. He explains: ‘Islamic finance does not require changes to your corporate setup or assets, as there are many structures already available and more are expected as legislative changes are introduced. A manufacturing company with lots of assets can do a familiar sale and leaseback, and plain vanilla Murabaha structures use commodity markets to set up financing that you can pay back with profit.’

KEEPING PACE WITH CHANGE

While Islamic funds currently account for just 1% of global banking assets, approximately one sixth of the world’s population is Muslim. There is, therefore, huge scope for growth in the market.

One possible pinch point appears to be the relative scarcity of recognised Shariah scholars, who are required to issue a fatwa, or deed, for any Islamic finance transaction. Such scholars usually have a degree in jurisprudence and often a background in banking.

However, Sarieddine does not see this as a problem: ‘The number of scholars may be small compared to the size of the markets, restricting the speed of the transactions, but the liquidity remains the same.’

And in Malaysia, for example, fatwa are the responsibility of a government agency, which has improved efficiency and boosted the volume of transactions. Sarieddine says: ‘We may see a form of centralisation in GCC countries, and I feel this will happen sooner rather than later.’

As the market evolves, Islamic finance will only become more accessible and more appealing to Western organisations.

Sarieddine urges, ‘It is an opportunity to be seized. By any measure, the GCC is the biggest single source of project finance banking in the world.’

It is clearly an opportunity waiting to be taken, and those that get up to speed on the specifics of Islamic finance can only benefit from the huge reserves of capital waiting to be tapped.