Present state of Islamic capital markets

2.4.1 Present state of Islamic capital markets

The need for vibrant and efficient capital markets in the area of Islamic finance cannot be over-emphasized. The IFSI can claim to offer a full-fledged financial system only when its capital markets have the depth and liquidity typically found in well-developed conventional markets. Since the IFSI itself is a new industry, it is not surprising that the capital markets segment is underdeveloped. However, the Islamic capital market is emerging gradually, as is noticeable from a number of significant developments.

i) Shari’ah-compliant stocks: The availability of Shari’ah-compliant stocks is most basic consideration in the development of Islamic stock markets. This need of the market has led to the development of the Shari’ah screening of stocks based on quantitative measures such as debt-to-asset, liquidity-to-asset and receivables-to-asset ratios as well as on fundamental subjective criteria such as Shari’ah compliance of the business line. Major Islamic stock indexes now include: the Dow Jones Islamic Market Indexes, the FTSE Global Islamic Index Series, Global’s GCC Islamic Index, the Kuala Lumpur Shari’ah Index and the Jakarta Islamic Index. The technology is expected to be gradually in common usage in major markets. As a result, real-time data on the indexes will enhance the market microstructures for the Islamic capital market.

ii) The market capitalization of the Global DJIMI as of 31 March 2005 was estimated to be US$10.65 trillion, and the Shari’ah-compliant universe comprised 1942 stocks. Since the Global DJIMI takes up only those stocks in which an international investor can invest and repatriate the proceeds, it excludes many local stocks. The Islamic capital market is not so global; it is rather segmented. By applying the DJIMI criteria to local markets of four IsDB member countries, a recent study conducted at IRTI found that 6.4%, 12%, 42% and 60% of stocks, respectively, in the four countries met the DJIMI criteria. The total annual market capitalization of the stock meeting the DJIMI criteria in three countries was calculated to be US$104 billion. This constitutes about 42% of total market capitalization in the three countries, indicating that Shari’ah-compliant stocks constitute a significant part of the stock markets in the countries concerned. This size is expected to grow through a wider application of the screening technology, as well as through formalization of product identification marks.

iii) Islamic alternatives to debt: The most prominent development in this regard has been the introduction of corporate and sovereign sukuk or trust certificates as well as pooled securitization as substitutes for conventional bonds. Recently, hybrid sukuk such as convertibles and exchangeables have also been issued. Table 2 lists Islamic capital market products in some IsDB member countries. Although there are significant differences across

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countries, broadly speaking, the products listed in table can be considered as the currently available Islamic capital markets instruments. Table 3 presents the principal instruments available in the conventional capital markets and their Shari’ah-compliant alternatives and highlights the gaps in the case of the Islamic alternatives.

iv) Legal framework and tax neutrality: In terms of the development of appropriate legal and tax framework, two significant developments are noteworthy. The first is the tax neutrality accorded to Islamic financial contracts in UK and Singapore - in particular, the coverage of sukuk in the later case. The second significant development is the enactment of Financial Trust Laws in Bahrain. A few other countries have also introduced securitization laws. These are expected to be highly supportive of the development of the sukuk market, as sukuk are trust certificates and there are no trust laws in most countries.

Table 2: Types of capital market products available (in various markets) Bahrain Malaysia Pakistan Sudan Saudi Arabia

Ordinary stocks Ordinary shares

Ordinary stocks

Ordinary stocks

Ordinary stocks

Preferred stocks Preferred

Preferred

shares/warrants

stocks/warrants Mudarabahs (or mudarabah sukuk )

Futures Single stock futures Index futures

contracts (if underlying asset is Shari’ah approved)

Bonds Bonds

Bonds and term finance certificates (TFC)

Ijarah sukuk Ijarah sukuk

Ijarah sukuk

Ijarah sukuk

(issued but not available in local market)

Partnership sukuk (participation term certificates)

Salam /Istisna’- Salam /Istisna’-

Salam /Istisna’-

based sukuk based sukuk

based sukuk

Special government

investment certificates

Central bank Musharakah certificates, government Musharakah certificates

Mutual funds Unit trusts (Islamic/

Mutual funds (Islamic/

Mutual funds

(Islamic/ conventional)

products Murabahah bonds (securitized debt), generally based on the Bai’ Bithaman Ajil principle

structures to structures to trap

structures to trap

structures to trap

trap liabilities liabilities for asset-

liabilities

liabilities

backed securities

Table 3: Capital market products

Types of Characteristics Current practices instrument

in the IFSI ♣

Equity Equity holders are the owners of the firm and are Accepted responsible for conducting its affairs

Preferred stock A hybrid security that combines features of debt Emerging and equity