Islamic finance

One of the last refuges of decoupling proponents is the idea that Islamic finance might offer a more stable alternative to traditional financial markets. True, issuance of sukuk – or Islamic bonds – fell by more than half last year, to $20bn. But difficulty raising money was inevitable as the financial crisis led investors to shun debt, Islamic or otherwise. Come the recovery, finance grounded in Sharia law – with its strictures against leverage and speculation – should thrive in a deleveraged world. Or so the argument goes.

Indonesia’s launch of a massively-oversubscribed $650m sukuk last month – the first global dollar-denominated sukuk issue of the year, and Indonesia’s first ever – has kindled hopes among sukuk boosters. Bahrain is expected to launch $1.5bn-$2bn of sukuk next month. As sovereigns return to the fray, analysts expect companies to follow. Investors should wait before diving in, however. It may ban leverage, but Islamic finance is beset by other uncertainties. One is how the claims of sukuk holders might stack up against those of other stakeholders in the event of default. Last week’s default on a $100m sukuk bond by Investment Dar, a Kuwaiti investment company that owns half of Aston Martin, the UK sports car maker, will be a critical test case. Courts must decide if sukuk – whose returns are based on an ownership claim on assets, rather than cash flows – should be lumped in with bonds, or be treated more like equity.

Islamic scholars, meanwhile, must reach an agreement on standards for what constitutes sharia-compliance. Uncertainty on both fronts partly explains why the spread on HSBC’s leading sukuk index remains at four times pre-crisis levels, compared with three times for its conventional Gulf counterpart. Until a more mature regulatory and legal environment emerges, investors who do not face religious restrictions on how they deploy their funds would be wise to stay on the sidelines.