Islamic finance needs the IILM. So where is it?

Euromoney, February 2012

Many in the Islamic finance community found in the global financial crisis an opportunity to boast or, at the very least, be a little smug. The problems in the western banking system were a vindication of Islamic finance, practitioners would say: anchored on tangible assets, no Islamic bank could ever have got messed up with CDOs and other derivatives. The safest way was the Shariah way.

To an extent, they had a point. But the smarter members of the industry recognised that, while Islamic finance came through the crisis in far better shape than its conventional equivalent, it was a long way from being bulletproof. In mid-2008, with the crisis in the conventional world intense, Euromoney asked Professor Rifaat Ahmed Abdel Karim – then Secretary-General of the Islamic Financial Services Board, the Kuala Lumpur-headquartered body tasked with bringing harmony of approach and financial prudence to the Islamic banking industry – if the turmoil in conventional credit markets created an opportunity for Islamic banking to prove its worth. We expected a gung-ho response and didn’t get one. “It would only provide that opportunity if the Islamic financial services industry can establish that it has an inherent resilience to a similar crisis,” he said. “I am aware of those who say it does, and I am aware of those who say it does not. The test will be when it takes place, and God forbid it takes place in the near future. But we should not be complacent.”

One suspects the reason Rifaat passed up any opportunity to gloat was because he could see cracks in the Islamic finance industry’s overall structure, and he was not alone. In October that year the Islamic Development Bank met in Jeddah, Saudi Arabia to establish a task force to work out exactly what had gone right and wrong for Islamic finance through the crisis, and what could be done about it. Dr Zeti Akhtar Aziz, Governor of Bank Negara Malaysia, and one of the leading advocates that the last thing Islamic finance should do was rest on its laurels, was appointed chair of the task force and chaired its first meeting in Kuala Lumpur in January 2009. The participation in that meeting of Shaikh Saleh Kamel, the Mecca-raised founder of the Al Baraka investment and finance group and a former Saudi Arabian finance ministry man, underlined the sense that a global initiative needed to be agreed.

The single biggest imperative that came out of those discussions was a way of improving liquidity, especially since Islamic finance was increasingly taking place cross-border. This is where Islamic finance may have dodged a bullet in the financial crisis: had there been any loss of confidence in inter-bank liquidity in the Islamic world, as had happened in the conventional, then Islamic banks simply did not have the instruments available in the capital markets to do anything about it. If anything, Islamic finance was even more vulnerable to a loss of confidence, and a drying up of funding, then the western investment banks had proven to be.

The institution that grew out of this realisation was the International Islamic Liquidity Management Corporation (IILM), established on October 25 2010. The idea was that this would create and issue short-term Shariah-compliant financial instruments to improve cross-border Islamic liquidity management. Its stated aim is to enhance cross-border investment flows, international linkages and financial stability. From the outset it enjoyed tremendous take-up from the Islamic world: its 14 founder members are the central banks of Indonesia, Iran, Kuwait, Luxembourg, Malaysia, Mauritius, Nigeria, Qatar, Saudi Arabia, Sudan, Turkey and the United Arab Emirates, plus the Islamic Development Bank and the Islamic Corporation for the Development of the Private Sector. Given Zeti’s spearheading of the initiative, it is no surprise that it is based – “hosted” is the official word – in Kuala Lumpur.

It’s a great idea. The world needs it. Islamic finance in particular needs it, and never more so than right now.

But where is it?

16 months on from its formal foundation, the IILM has still not conducted a single issue. It has not set a timetable for issuance. It issues no press releases and last appeared in anyone else’s in November when it joined the IFSB as an associate member. It is giving no interviews (and declined to comment in any way to Euromoney, citing timing and market sensitivities). World credit markets are in a state of continued flux with the problems in Europe, which has amply demonstrated the need for such an institution; the timing is probably rather sooner than Zeti and her colleagues would have hoped but in some senses it’s perfect. So where are the new issues?

[Subhead] Building an institution

Naturally, there was a lot to do in getting such a multilateral institution off the ground. It made an important step when it appointed Mahmoud AbuShamma as CEO on a three-year term from February 1 last year. Mahmoud was former head of HSBC Amanah Coverage in Dubai, a job that gave him responsibility for key relationships globally for HSBC’s Islamic banking arm: governments, high net worth individuals, top corporate clients. He had also headed the formation of HSBC Amanah’s Islamic unit in Indonesia, and ran it for several years. Zeti, unsurprisingly, was made chair of the IILM’s governing board, with Yves Mersch of the Central Bank of Luxembourg became deputy (Zeti’s chairmanship has since rotated to Kuwait), and six scholars were appointed for the Shariah committee, including the near-ubiquitous Saudi Mohamed Ali Elgari and Malaysia’s pre-eminent scholar Mohd Daud Bakar.

With the infrastructure in place, attention turned to first issues, and with IILM itself making no formal comments, Bank Negara Malaysia became the main source of information. In March Zeti’s deputy, Datuk Mohd Razif Abdul Kadir, one of the bank’s key drivers of Islamic finance until his sudden death in August, said the first commercial papers from IILM would be issued by the end of the year with a minimum issue size of US$300 million. In July, by which time the institution had 20 staff and was installed in offices in Kuala Lumpur’s Intermark office complex, AbuShamma gave the only interview we are aware of to date in his tenure, to Malaysian official news agency Bernama. At that time he said the main challenge for the IILM was to find the common denominator among its founding jurisdictions, but again talked of a year-end issue if the infrastructure was ready.

Clearly, the first issuance did not come by the end of the year. Behind the scenes, some challenges were arising. Interviewed in November, Governor Zeti told Euromoney: “It has been a long process to get the rating and to get high quality underlying assets, and also to obtain all the parameters for issuance.”

These are clearly vital issues. The whole point of Islamic finance is that any security has to be underpinned by physical assets, and for the issuance to be credible, those need to be good assets. It’s still not clear what assets will be used. “The most likely structure will be istithmaar or ijara, both of which would probably be done using an asset-based structure,” says Blake Goud, an Islamic finance researcher who produces a web site on the subject called Sharing Risk. “The assets would likely be contributed by IILM members, most of which are central banks from OIC countries.” But there’s a challenge right there. “The central banks are not likely to risk that their assets could be taken by sukuk holders should the IILM default or otherwise fall apart,” she says.

A rating is also vital, and not straightforward to determine; the 14 founders cover a range of investment grade and non-investment grade jurisdictions and, again, the question of underlying assets will be fundamental to determining a rating. Zeti told Euromoney on November 15: “We’re about to get rated.” That was the day before IILM’s board was due to meet again, and at that time the mood was positive. “All the parameters will be proposed to the governing board tomorrow, and following that there will probably be a press statement,” she said. “The governing board meeting… will, we hope, approve the parameters for issuance. This involves the allocation of assets, high quality assets against which the issuance will be made, and all the primary dealers that will make the market will be appointed at this meeting.” She added: “We are very close.”

Interviewed the same day, the central bank governor of another founder painted a slightly different picture.  “We are still crossing the t’s and dotting the I’s. There are still issues even in terms of the rulings in the Shariah council on what we can and can’t do, and how it will be structured,” Malam Sanusi Lamido Sanusi, Governor of the Central Bank of Nigeria, told Euromoney. Far from being ready to go, IILM was still “going through the process of structuring IILM to get the kind of rating we would like to have,” and “still looking at the assets, trying to find out what are the eligible assets in different countries, and the rules and regulations around that,” he said. “It’s up and going but I think it will take a little time for us to be out there.”

Whatever happened at that meeting, it clearly wasn’t positive enough to lead to a press statement – not that day, and not in the more than two months since. Since there has been no announcement of a rating, that may be the hold-up, because clearly the institution can’t approach the market without one.

[Subhead] What IILM can be

Nevertheless, assuming it’s not on ice indefinitely, IILM still has the potential to be a vitally important institution and one of the most interesting capital market stories of 2012. And despite the vacuum of information from IILM itself, we are gradually learning more about its structure.

“There will be regular issuance throughout the year, with each issue in the region of US$2 billion,” said Zeti in November (since she no longer has chairmanship of IILM – Kuwait does – Bank Negara can’t now comment on where the institution is up to). “This is to meet the requirements of Islamic financial institutions. It will be high quality short-term liquid instruments and will be in demand by funds managing portfolios – even conventional. It will be another asset class that will be attractive as a liquid instrument.” She said the first issuance could be smaller, “a pilot issuance to test the system”, but that later issues would have to be much bigger to meet the requirements they have identified the market.

“It will contribute towards better liquidity management,” she said. “We saw during this crisis liquidity became an important issue. With the internationalisation of Islamic finance, cross-border flows require short-term instruments to effectively manage, not only in stressful conditions but in normal times.”

For Zeti, the opportunity is there to create something to compare with US Treasuries for the Islamic world. “Almost the entire world uses Treasury bills,” she says. “They are highly traded, and can be used to manage the liquidity of any portfolio or any financial business. But for Islamic finance, there is no sovereign that issues short term paper of that nature, and therefore IILM was established.”

Speaking while still its chair, she clearly took great pride in its existence. “It took us two years of work in a taskforce,” she says. “It is a collaboration. One of the most significant aspects of it is that we have been able to collaborate and come up with something concrete that is going to be an important part of financial infrastructure for the development of Islamic finance. Given that it is a collaboration among central banks that come from different parts of the world including Europe, the Middle East and Asia [actually it includes Africa too], it has required consensus building on all the issues. It is a great achievement for Islamic finance.”

All of that is true. So we look forward to hearing from it. Hearing anything at all.

BOX: What are you doing here?

It’s illuminating to talk to the member states of IILM – particularly outside the obvious mainstays of the Gulf – to see what prompted them to be a part of it.

Nigeria, for example, is not a natural founding member of a facility like this; although it has a very high Muslim population, it has only just issued its first licence for an Islamic bank. But Malam Sanusi Lamido Sanusi, Governor of the Central Bank of Nigeria, says the financial crisis taught the country the benefits of Islamic finance and therefore of participation in IILM. “If you look at the financial crisis, our banks went into trouble largely through speculation in the capital markets,” he tells Euromoney. “A very simple way to look at it is to say that if you had a system that prohibited that kind of speculation, it would at least eliminate that risk.” And joining IILM as a founder? “It’s strategic more than anything else, to the extent that when we know we are going to have Islamic banks, and we do know we don’t have a local interbank market and local products for liquidity management, IILM offers us the opportunity to provide them with liquidity products out of other countries.”

And for Nigeria there’s a longer term possibility as well. “It’s also basically a recognition of the fact that with a Muslim population of 80 million, Nigeria is potentially the hub for Islamic banking in Africa. There are more Muslims in Nigeria than in many countries in the Arab world, so if we are able to build Islamic finance over the long term to where we want it to be, we should be in the forefront of Islamic finance countries.”

Turkey? Turkey isn’t even, strictly speaking, an Islamic state – it’s proudly secular, though as much of 98% of its population is Muslim. Luxembourg? Well, that has a lot to do with Yves Mersch’s enthusiastic championing of Islamic finance over the years, and his belief that Europe ought to embrace it.

Arguably the oddest name on the list of founders is Mauritius, since it is not even predominantly Islamic and has a population of just 1.2 million people, but again there is an angle. “We came to Islamic banking from the perspective of adding to the range of products we offer in offshore banking,” explains Rundheersing Bheenick, Governor of Bank of Mauritius. “We took care to ensure the whole population followed us. We didn’t emphasise Islamic banking.” IILM membership for Mauritius, it appears, is simply adding a string to its bow in terms of its offshore credentials.