Securitization under Islamic Philosophy: An Innovative Industry in a global dynamic market

by Fathelrahman A.M.Salih

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Introduction:

As it organized by Islamic teachings and orientations, the whole business and financial institutions should pursue their line of business in a way that comply with shari'a (Islamic rules) principles. The major ruling aspects are, the prohibition of interest -based transactions, adhering to Halal (Lawful activities) and Haram (Sinful activities) rules, the whole business should be carried with some degree of risk, i.e. the free-risk type of investments is not found under Islamic business environment. That means the rewarding system under Islamic philosophy is based upon risk taking considerations, and no room for gaining without exposing to some sort of business risk.

So, the Islamic financial and business institutions should structure their line of business alongside to prescribed guidance, esp.  the areas of sources and uses of finance .

The fact that Islamic institutions have a growing participation in securitization line of business is due to their achievements that they made during last three decades, and the hope of capturing the huge type of benefits that will accrue to them, when they embark on such global market.

This article segmented into four parts. After this introductory part, we visualize the expected benefits that Islamic institutions will realize from structuring their finance activities. Part two, focuses carefully on the Islamic frameworks that bound securitization process. In part three we elucidate major trends in securitization movements for Arab & Muslim countries. The last part will present conclusion remarks on opportunities and potentialities for Arab & Muslim economies.

Why Securitization is appreciable for Islamic Institutions?

As we know that global securitization market has been driven by several factors. The major among which are the case that the cost of capital is tending to be tremendously increasing esp. in those countries who has a low credit rating class (where major Arab countries listed). In addition to capital regulatory requirements imposed by monetary and supervisory bodies. So it's inevitably for institutions there to resort to another innovative,  cheaper sources of capital, and the securitization can help actively in this connection. Also, alongside with the growing convergence of capital markets through global financial dynamism,           and ongoing technological advancement, the barriers among such markets were removed, so severe competition for efficient type of capital has been aggravated made the reliance upon new sources is inevitably art for business survival.

Another important dimension that made securitization very appreciable industry for Islamic institutions is that it can be viewed as a viable bridge for those institutions to money market environment. This merit, and others, allows Muslim investors to deal successfully in money market instruments, and permitting corporate institutions to mange their A/L actively. Considering the fact that bond issuance and trading are important means of investment in the modern economic systems, Muslim jurists are striving to find alternatives. As Islamic jurisdiction prohibit dealings through interest-based transactions, so all financial and credit dealings under Islamic philosophy tend to relate finance to assets, ABS become islamically possible to be structured as long as it conveyed to Islamic principles. Therefore, the use of securitization will bring in much needed liquidity to theses institutions by enabling them to free part of their capital which is tied-up with these illiquid assets into short, partnership-based unpre-determined rate of return instruments. Obviously, we can't ignore the huge benefit that realized to the macro economy form the evolvement of securitization process. 

Islamic framework for Securitization:

According to the above mentioned constrains that bound the working of Islamic entities, there are several regulatory issues that organize securitization process, such issues include,

The type of assets to be securitized:

 As securitization is evolved tremendously in non-Islamic world, the ABS generated there does not necessarily conform to Islamic principles (Interest -bearing credit and receivables, etc.) So according to prescribed guidance, the assets to be securitized might include leasing contracts -can be used in different business lines - equity ownership, morabaha and other sales contracts, in addition to current tangible assets that generate systematic cash flows, which acceptable to be traded by Islamic investors.

The securitization structure: 

The structure of securitization under Islamic philosophy in its features does not differ greatly from that of conventional type. The major player composed of the originator, trustee, Servicer, SPV investment bankers, Credit Enhancer and rating agency. Without keeping close specifications of their functions in securitization process, we confine merely to describe the differences in their roles under Islamic philosophy as follows:

      1.      The securities that issued by SPV are claims on assets held by the issuer SPV. Such that claims are closely attached to the ownership of such assets. 

      2.        Accordingly, ABS does not guarantee a pre-determined rate of return but variable one alongside with the performance of the assets under securitization.

      3.        The credit enhancer provide that required credit (if needed) could be either part of the fund generated from asset cash flows, or collateral pledged to support assets, or guarantee in order to obtain sound credit rating.

      4.        The pass - through securitization structure can be visualized as closest arrangement that satisfy Islamic principles.

      5.      The transfer of assets from an originator to an SPV should be in true sale basis, in some securitization cases that related to productive investment project, the originator has a right to compete in the repurchasing of the assets underlying after selling it to an SPV, when securitization deal is finalized .This always done in securitizing government productive assets where the public interest dictate the retention of Govt. ownership to specific strategic venture .

General trends around securitization in Arab and Muslim world:

The major securitization experiences in Arab and Muslim countries is adopted under the case of financing specific-contained project through securities (with variable return according to the asset performance, for short duration backed by the expected flows of such specific project.

As the most Arab and Muslim countries are banking -based economies rather than financial-based economies, this made securitization and financial instruments transaction very rarely used. So, at first glance to Arab and Muslim financial statistics we can realize that their ratio of market capitalization to GDP is almost not more than 10 % generally, where in an emerging market tends to approach more that 50% Probably the securitization would be in Arab region as low as compared to that of advance economies. Such situation, can be attributed to several factors, the important among which are: 

       ·  As Islamic entities conduct their major part of businesses in Muslim world. Being a regulating-driven process, securitization, however, is prevalent only in countries with developed regulatory framework with adequately institutional settings, like that of most advanced countries, in addition to few emerging countries i.e. Malaysia and Taiwan.  While Islamic institutions, therefore can easily securitize the assets they own in most developed economies, they may not easily do the same with the bulk of their assets in Muslim world due to insufficient organizational arrangements

       ·  In addition to that securitization process require availability of sophisticated credit and financial information on the underlying assets, and existence of proper accounting standards which might not be adequate under Arab region.

       ·  Most of Arab and Muslim countries are creditably unrated, and this might jeopardize their chances in promoting securitization products esp. abroad.

        ·  One of the main factors that hinder spreading of securitization know-how practices in Arab economies, is the poor financial structures and consciousness among individuals and institutional bodies.

Conclusion:

Securitization and structured finance is an inevitably financial technology that any institutions should adopt for their survival. This rule can be generalized to Islamic financial and business institutions where they're working, always in a risky environment. In spite of that, major Arab and Muslim countries are striking progressively toward setting the relevant institutional and regulatory structures for locating such new dynamic technology. 

 

Fathelrahman A.M.Salih-

Financial Investment Bank

Khartoum - Sudan