Open Letter to IDB President: Mega Islamic Trading Platform

By Rushdi Siddiqui, Global Head of Islamic Finance, Thomson Reuters

Dear Dr. Ahmad Mohamed Ali, President, Islamic Development Bank (IDB) Group:

Asalaam Alaikum:

The Islamic finance world welcomes your comments on the ‘Mega’ Islamic Bank to effectively compete against well capitalized conventional financial institutions.

“…The ‘Mega Islamic Bank’ comes as an initiative of the Islamic Development Bank in its efforts to address the dearth of senior financiers, the absence of the Islamic tools of stock exchange and the absence of market liquidity between Islamic banks.”

However, $1 billion, with $500 million in paid capital by the three founders (IDB, Dallah Albaraka and Qatar Government), is smaller than three existing Islamic banks, which have never addressed themselves as ‘mega.’ The three include Saudi Arabia’s Al Rajhi, Qatar’s Mashraf Al Rayan and Kuwait’s Kuwait Finance House (KFH). Furthermore, it seems the ‘mega’ story may be incomplete without Malaysia’s participation.

Dr Ali, the Islamic ‘mega’ concept needs to be applied another IDB backing for attracting global liquidity and the cross sell of Islamic finance. The conversation needs to include an IDB backed ‘mega’ screen-based trading platform for both Islamic and non-Islamic from OIC countries.

The objective is to make Islamic finance better ‘equity/debt’ balanced, conventionally efficient and Shariah compliant complete for ALL investors, traders, and asset managers.

Work in Progress

Dr Ali, you may ask, why a ‘mega’ trading platform also need to be part of the mega-bank conversation?

Simply put, for building and connecting communities involved in Islamic finance. We hear repeatedly of nearly 700 Islamic financial institutions (does not include halal food companies) that are dispersed and fragmented in 90 countries. Now, what if we put all their (1) offerings (menu) in real time along with (2) news (country macroeconomic, industry, company, product, etc.) and (3) information on entity’s risk and compliance, and (4) let communities (treasury, sukuk, equity, takaful, scholars, lawyers, etc.) communicate on secure and trusted platform, then (5) standardization moves faster and (6) transactions volume increase to reach (7) $2 trillion and beyond in few short years rather than nearly 40 years it took to reach $1 trillion.

The above is also mitigating, measuring and monitoring ‘risk’ in/of finance as more information is available in real time, hence, better information intermediation will result in more players who bring their liquidity. The Islamic depositors may provide cheaper funding for Islamic banks, but growth will come more from the capital markets innovations (read: not Islamic financial engineering) and real economy linked transactions.

Stock Exchange

In the developed world, stock exchanges, like of Nasdaq NYSE-EuroNext, are well established and closely regulated, hence, there is confidence and trust for investor participation. In the 57 Muslim countries, which also happen to be emerging markets, some/many of the stock exchanges are often-time called ‘casino-capitalism.’ It may be just one reason why there are more depositors than investors in the Muslim world.

However, stock exchanges are the foundation of the capital markets, and such markets reduce reliance on bank financing, conventional or Islamic. Furthermore, it’s the risk taking capital markets that are the financing foundation of knowledge based economies.

For example, the three largest economic sectors in a global Islamic index are technology, healthcare, and oil/gas, and innovation typically is from these areas. However, in OIC stock exchanges, these three sectors are either missing or have insignificant weighting representation in the capital markets. An Islamic mega bank will probably not be offering Islamic VC funds or funding SMEs, both contributors to knowledge and GDP/employment of economies, respectively.

Dr Ali, the status quo cannot continue as the ‘Muslim man on the street’ is losing patience and confidence, (s)he is looking for VC, microfinance, education and SME financing and believes Islamic finance is only for the bankable. Furthermore, in Muslim countries there are more depositors than investors. A recent report Ernst & Young on Islamic funds shows the assets under management to total banking deposits ratio (AUMs/Deposits) of US at 143% and Saudi Arabia at 33% and Malaysia at 10%!

QUERY: is it in the best financial interest of (Islamic) banks (in Muslim countries) to maintain the status quo: maintain and expand the number/percentage of depositors over investors?

OIC Exchange Situation

Dr Ali, today, there are a number of challenges with OIC country stock exchanges, possibly due to embryonic nature state of development and continued reliance on bank financing. However, let’s assume that your stock exchange comment is for both Muslim and non-Muslim country stock exchanges with listed Shariah compliant companies and products. The reality of the situation is most (85% market capitalization) of the compliant companies, in a global Islamic index from an index provider, are in the G-20 (non-Muslim) countries. There are 42 stock exchanges amongst the 57 Muslim countries and some of the challenges include:

1. Foreign investor restrictions, including currency restrictions and soft currency

2. Small free float

3. Illiquidity

4. Largest economic sector weighting is the prohibited interest based conventional financial sector

5. Let set aside issues related in insider trading, front running, etc., not an uncommon phenomenon in the emerging markets.

Furthermore, to date, there is no OIC stock exchange, GCC stock exchange or Arab stock exchange, CIS stock exchange, etc. Finally, the market has not accepted the conversion of Dubai Financial Market (DFM) into an Islamic stock exchange a few years ago, as. To date, very few, if any, non-UAE public listed Islamic financial institutions, Islamic Exchange Traded Funds (ETFs), etc., have listed on DFM.

Step 1: Trading Platform

Notwithstanding some of the abovementioned challenges with OIC stock exchanges, they are important building bloc foundation for asset class trading platform. The listing of companies and investment products are the ‘content’ placed on platforms, with work flows, for trading and investing for global investors. Thus, OIC stock exchanges, mostly a domestic play, become global on platforms like Thomson Reuters Eikon or Bloomberg terminals. Put differently, a platform would supplement, not replace, OIC stock exchanges.

Dr Ali, today, Islamic finance is over the counter (OTC), and it needs to move to the transparent screen based platform. Platforms are about multiple price discovery and liquidity, connecting communities, better understanding counter-party risks, etc., however, ‘products and tools’ continue the never ending standardization conversation. At the end of the day, the market, as a whole, will decide on product standardization (for the time) via market liquidity.

Dr Ali, your institution working with private sector information providers, needs to establish a scalable blueprint that prioritize asset class platforms, both Islamic and OIC, with global reach over products and tools. Why both Islamic and OIC, as latter implies conventional? For the simple reason of transitioning to Shariah compliance/based, as majority of financing/investing in the OIC is conventional. To get to purity, one needs to go through the interim tolerance parameters and ensuing time period.

For example, today, compliant listed products may come from non-OIC countries like India (200 million Muslims), Sri Lanka, US, France, Australia, Hong Kong, Singapore, etc., and they would be on the trading platform. The market traction of such products may just help with Islamic finance movement in those countries in a meaningful manner and eradicate prejudices, biases, and fear mongering.

Thus, it is possible to have, say, listed equities on the trading platform that allow users to use any rule book, like IdealRating offering, for Shariah screening. This would have all information, news, data, analytics, purification and Zakat (formulas for) calculation, etc., about listed companies and listed products at the end of the user’s fingertips, hence, conventional efficiency for information intermediation.

Benefits of Platform

This level of efficiency should result in cross sell of Muslim country (i.e., emerging market) opportunities to non-Islamic investors, provide better transparency and accountability for listed companies and products, and direct order flow to the exchanges for order execution (no cannibalization issues).

In conclusion, Dr Ali:

Islamic Mega Bank + OIC Stock Exchange Content + Housed on Trading Platform = Compete effectively in conventionally efficient manner, while providing balanced growth of Islamic finance to move beyond the country shores and for all of man-kind!

The IDB needs also to back a ‘mega’ screen based trading platform.

Respectfully Submitted and Wasalaams

Rushdi Siddiqui

The opinions expressed are the writer’s own.