As a relatively young market, the Islamic finance sector has evolved in a fractured fashion. This has driven the establishment of the International Islamic Liquidity Management Corporation to tackle the lack of high-quality liquid instruments in the market. James King talks to acting CEO Abdoul Aziz Ba about the challenges involved.

Abdoul Aziz Ba

Immature markets are prone to teething problems when they expand. The process of ironing out operational, legal and regulatory uncertainties takes time and the experience of the Islamic finance industry has been no exception.

Swift growth in terms of core numbers, including total sharia-compliant assets and the number of institutions offering services in the market, has been accompanied by geographic expansion. With key centres of power emerging in Malaysia and the Gulf Co-operation Council (GCC) area, Islamic finance providers have used these geographic platforms to expand into the wider Middle East, Africa and south and south-east Asia.

Disjointed development

But as The Banker reported in its August edition, this growth has been somewhat dislocated. There has been, in a relative sense, minimal convergence between standards, norms and regulations in larger markets in Asia and the Middle East, for instance.

This lack of convergence is partly a result of the industry’s relative youth on a global basis. It is also a reflection of the different approaches to issues of sharia compliance, among other matters, adopted by different jurisdictions and scholars.

Slowly, however, growing co-operation among the industry’s leading markets is changing this. The standout example of this, the International Islamic Liquidity Management Corporation (IILM), is a case in point. Established in 2010, the IILM is a landmark institution established by the central banks and monetary authorities of Malaysia, Indonesia, Kuwait, Luxembourg, Mauritius, Nigeria, Qatar, Turkey and the United Arab Emirates, with an aim to tackle the deficiency of highly liquid investment-grade instruments in the market.

“The idea was to have an institution that would address some of the dysfunctions in the Islamic finance capital markets, globally. Central banks realised that Islamic lenders lacked a supply of liquid instruments to better manage their liquidity positions – specifically, excess cash,” says Abdoul Aziz Ba, acting chief executive of the IILM.

“The IILM is a pioneering institution because its genesis stems from various central banks having the foresight to address a particular problem in the industry. It serves as a good example for other markets,” he adds.

Using Islamic bonds

Islamic banks have, for many years, struggled with issues linked to liquidity management. Even today, sharia-compliant lenders in the GCC hold about 8.8% of their assets in cash or equivalents and a further 9.8% in placements at other financial institutions, according to research from Thomson Reuters. To address this challenge, some lenders have turned to the commodity murabaha, a cost-plus deferred sale of commodities, to manage their liquidity.

“Some Islamic banks have, traditionally, used commodity murabaha to handle their short-term liquidity needs. But this instrument isn’t tradeable and is not widely accepted in some jurisdictions. The IILM was created to provide Islamic banks with new options to manage their liquidity needs through the issuance of high-quality, short-term sukuk [Islamic bond] instruments,” says Mr Abdoul Aziz.

In January 2017, the IILM issued $1.11bn in short-term sukuk. The A1 rated transaction was structured in two tranches; a $260m two-month tenor priced at 1.21% and an $850m three-month tenor priced at 1.41%. This type of issuance has helped to fill a large void in the industry since, prior to the creation of the IILM, short-term instruments of this nature were largely transacted in local currency. In 2016, the IILM accounted for about 40% of all short-term sukuk issuances, according to research from the International Islamic Finance Market.

But the IILM’s rise to become one of the Islamic finance industry’s most important institutions has not been easy. For one, it has had to structure high-quality instruments in a way that is acceptable to different stakeholders around the world. This has been achieved while creating a new framework of market makers and lowering the volatility in the pricing of its instruments. The outcome of these efforts has been game changing for the industry.

“The combination of these three factors has led to a demand-driven and scalable programme of sukuk issuance. The IILM found a solution to a common problem by acting as an independent body that can listen to the market and investors. We spent a lot of time trying to understand the dynamics of the market. Our work is pioneering because we have brought a diverse group of global actors to the same table,” says Mr Abdoul Aziz.

To nurture a well-functioning and liquid market, the IILM has been proactive in developing a strong primary dealer infrastructure. “If you only take Islamic banks as dealers you might defeat the purpose because they will hold these instruments and potentially not sell back. The same goes for conventional banks. So we needed to have a combination of conventional and Islamic banks to be more efficient in terms of making available the instruments to the market. So I think we ended up finding the right balance,” says Mr Abdoul.

Only the beginning

For now, the IILM has focused on short-term and high-quality liquid instruments. But this could change as the organisation adapts to a changing market. Indeed, Mr Abdoul Aziz sees scope for further improvements to the Islamic finance landscape and in particular the deficiencies in the industry’s capital markets. “This is only the beginning of the journey. We have started by issuing sukuk with tenors of less than a year,” he says. “Over time, demand will change. We will come back and adapt with new structures and different tenors. We can address other dysfunctions in the Islamic capital market. Different types of instruments serve different types of needs.”

The Islamic finance industry’s rapid growth is presenting opportunities for new players to participate in the investment landscape. Though banks have, so far, been the key investors in the sukuk market, according to Mr Abdoul Aziz, change is afoot.

“For the time being, most ‘Islamic’ investors in the sukuk market have been Islamic banks. Over time, pension funds and money market investors from the Islamic market may become more active. The market will develop naturally because increased supply will help other investors to take positions in the Islamic market,” he says. “Money market players and pension funds need a viable secondary market for sukuk. And, assuming we can have more Islamic instruments included as part of various global indices, it won’t take long for this to occur.”

Challenges to progress

But with the industry’s additional growth and complexity, new challenges are likely to emerge. The case of Emirati energy company Dana Gas contesting the legality of its own sukuk under Islamic law is one such problem. Addressing this kind of challenge will be crucial if the Islamic finance market is to obtain a set of common standards and, in turn, become a truly interconnected, global structure.

“The more legal uncertainties that exist within an industry actually help it to mature. Standardisation of products and services is happening quite swiftly across the Islamic finance marketplace,” says Mr Abdoul Aziz.

But if the experience of the IILM is anything to go, then the future of Islamic finance is in good hands. Representing the kind of forward-thinking, cross-border co-operation required to support a nascent but expanding market, the organisation has quickly gained acceptance in core markets. This is because the IILM’s policy-driven approach and use of sharia scholars from around the world has been fundamental to its success. “This has helped us to achieve acceptance across all Islamic finance jurisdictions,” says Mr Abdoul Aziz.

As other international bodies, including the Accounting and Auditing Organisation for Islamic Financial Institutions, work to improve complementary aspects of the global market, it is clear that sharia-compliant finance is heading in the right direction. Easing the various regulatory, operational and legal standards between markets will take time but market participants can at least be confident that the right leadership is in place. The experience of the IILM is a testament to this.


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