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Islamic assets not ‘immune’ to global economic downturn

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Points of Essence:

  • There have been misconceptions that Islamic finance does operate in its own league without any link to the conventional system. Sharia compliant assets differ although structurally and principally unique but they work in a similar way as conventional assets and the related economics are identical.
  • In equity business, the same volatility pattern is shared. Akin to conventional equities, the Islamic equity subscribes to investor sentiment, news flow, dividend distribution, volatility pricing, etc. Thus, the downturn in global equities caused by the subprime crisis affected the global sharia compliant equity asset class.

Mohamad Safri Shahul Hamid is Head of Islamic Structuring Asia and Manar Mahmassani is an analyst at German investment bank Deutsche Bank. They look at how Islamic financial investments and conventional ones compare in the global downturn.        – Editor

DUBAI, Oct 14, (RTRS): In the context of the current persisting credit crisis and worsening global macroeconomy, it is essential that any misconceptions in the markets about Islamic finance be addressed. Unlike its conventional peer, Islamic finance is based on productive activities: trading, leasing, partnership/joint venture etc. All these activities involve the use of assets or businesses that comply with Islamic law or Sharia. Islamic finance does not typically differentiate between ‘good’ or ‘bad’ performing assets – it does not claim that it offers safe(r) investment but rather, it provides investors with opportunities to put their monies into ethical investments.

With regard to sharia compliant deposits and investment assets, though relative performance can naturally vary, Sharia assets share a close correlation with their equivalent conventional assets. Money invested in Islamic financial markets is by no means “insulated” and we do not expect the global downtrend to be a trigger of demand for Islamic assets. Nevertheless, variables such as sharia structure, geographic/regional risk, and degree of business’ compliance with sharia can and do provide support and stability to Islamic financial instruments.

Sharia compliant assets differ from their conventional counterparts primarily in terms of underlying structure (inputs, cash flow mechanisms, determinants, tests, legal documentation, etc.) in order to abide by Sharia law. Yet ultimately, they function in just the same fashion as conventional assets and the related economics are identical. Indeed, as innovation and growth in the Islamic financial markets persist, almost all transactions that can be done conventionally can now be structured in Islamic format. For example, the sukuk market which started with plain vanilla issues has now seen complex trades structured in the form of exchangeable, convertible and hybrid sukuk.

And, in the last couple of years, the market has also seen the emergence of Islamic risk management tools including profit and currency swaps, fx options, etc. We believe that these developments will benefit the market as a whole. At the same time, conventional investors from across the globe are also playing an increasingly active role in the Islamic financial markets. Their growing participation in Islamic issues and trade flows make Islamic assets more and more vulnerable to how non-Islamic assets behave. Sharia compliant equities are only differentiable from the wider conventional pool subject to a series of qualitative and quantitative tests that need to be satisfied.

Just like conventional equities, the Islamic equity world remains exposed to investor sentiment, news flow, dividend distribution, volatility pricing, etc. Indeed, the downturn in global equities in the wake of the subprime crisis has had a considerable impact on the global sharia compliant equity asset class. In the Islamic financing, structured products and risk management space, specific business activities would need to be undertaken to achieve the required economics. This is usually based on a purchase and sale of real assets or via a particular asset management/co-investment agreement that comply with sharia.

By Mohamad Safri Shahul Hamid and Manar Mahmassani


Written by Suapi Shaffaii

October 15, 2008 at 11:54 pm

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