Djibouti sees Islamic finance sector expanding, aims for sukuk

Nov 2 (Reuters) - Djibouti expects to see new entrants in its Islamic finance sector and the government plans to work on a framework to allow the use of sukuk, or Islamic bonds, to fund infrastructure projects, its central bank governor said. 

Djibouti, a country of less than a million people located on the Horn of Africa, is a relative newcomer to Islamic finance, having introduced sector-specific legislation in 2011, but authorities hope it can increase banking penetration in rural areas while also attracting foreign investment. 

The government has established a national sharia board to help oversee the sector, appointing five members to the independent body last week, central bank governor Ahmed Osman said in an interview. 

The move could help Islamic finance by improving consumer perception of the industry and providing greater clarity on contracts which follow religious principles such as bans on interest and gambling. 

The government is in discussions with the Saudi-based Islamic Development Bank to secure a technical mission to help establish a framework to issue sukuk for either the government or state-owned enterprises, said Osman. 

"We will be looking a lot at sukuk in the next few years," said Osman, adding that there are around 10 projects which could be financed via sukuk - ranging from railways, pipelines to new roads. 

One likely candidate is the state telecom operator due to the availability of assets to structure a sukuk, Osman said on the sidelines of the International Islamic Banking Summit Africa, which the central bank is hosting this week. 

The central bank has avoided double-taxation of Islamic contracts through temporary exemptions, but it is in discussions with the Ministry of Finance to make those exemptions permanent, Osman added. 

NEW ENTRANTS 

The central bank is also in discussions with two lenders seeking to open Islamic windows of their own. Currently three of Djibouti's 10 banks are Islamic: Saba Islamic Bank, Salaam African Bank and East Africa Bank. 

The sector is attractive due to its faster growth - estimated at around 16 percent versus 10 percent for conventional banks - but also for its low levels of bad debt. 

"Islamic finance is more secure, as there is a direct link between financing and the underlying assets," Osman said. 

Islamic banks held 16.2 percent of banking assets and 14.3 percent of deposits as of September, central bank data shows. 

Their non-performing loans reached 3.1 percent of total lending as of June, compared to 19.5 percent for conventional banks. 

SOURCE: Reuters/2 Nov 2016

Why African Sukuk Still Faces An Uphill Battle

Growth in African Sukuk Shows Positive Momentum, but Structural Challenges Remain
Many African countries are working to develop their legislative and regulatory frameworks to establish Islamic finance and sukuk as a sustainable funding alternative. With Africa’s demand for infrastructure financing solutions and its significant Muslim population, such an opportunity might be well received.

Islamic finance is already present in more than 20 African countries, with Sudan having a fully-fledged 100% Islamic financial system. However, the size of the Islamic finance industry in Africa is still small in relation to the industry as a whole. Fitch estimates around USD1bn of sukuk total issuance from the whole of Africa in 2016 compared to USD21.74bn in 1H16 across the Gulf Cooperation Council, Malaysia, Indonesia, Turkey, Singapore and Pakistan.

When considering the reasons Why? Africa is less developed in its Islamic financial system, two common themes emerge. The first theme is the complexities of sukuk. Second is the emerging capital market infrastructure of African countries.  Both factors pose significant challenges for sukuk in general, particularly in establishing a legal structure and legislation that is acceptable to governments, investors and the Sharia boards. Also, structuring sukuk compared to issuing a traditional Eurobond remains a relatively complex and time consuming process.

Two main examples of these sukuk complexity challenges can be tax neutrality for sukuk and the ability to establish a special purpose vehicle (SPV) that acts as a single issuer for the sukuk. Although this is not Africa-specific, taxation is often challenging for sukuk due to their asset-backed/based nature. What this means is several asset transfers for a sukuk transaction, creating a dense tax load for issuers when there is not special sukuk legislation in place.

Regulations often need to be amended to provide some sort of exemption to taxable gains on the transfer of assets and tax on rental income earned by a sukuk issuing SPV. This is also true for withholding taxes linked to the transfer of underlying assets in sukuk transactions.

In most African countries, there are no specific comprehensive sukuk laws, though some initiatives have now materialized. One example is South Africa, which has introduced Islamic compliant financial structures with further amendments to the Taxation Act to widen the definition of sukuk. This comes following the issuance of its sovereign sukuk during 2014.

Regarding the second theme of the nature of Africa burgeoning capital markets, there are encouraging signs. That said, the development is still modest relative to their potential and compared to more developed countries. There are numerous limitations and challenges in developing bonds and sukuk alike. However, the regional/local currency sukuk market is an area where we have seen increased sukuk activity.

The choices in issuance are usually domestic versus international and the currency denomination of their sukuk (or bonds) are local versus foreign. These two features are often interlinked, as many issuances are denominated in the currency of the market in which they are issued.

Africa has seen success in issuing sukuk in sub-Saharan Africa, and West Africa in particular in the West African CFA franc (XOF), which minimises exposure to FX risk for domestic issuers and investors.

The continuation of sukuk activity this year is a positive development that allows the sukuk footprint to widen and foster greater acceptance of this instrument globally. Reuters reported that in 2016, Togo’s initial sukuk was XOF 150 billion (USD255 million). 

This comes after Senegal launched its second XOF200 billion (USD341.5 million) sukuk towards the end of June and Côte d’Ivoire’s second phase of its XOF300 billion (USD510 million) sukuk program. Similarly, it has been reported by Reuters that Nigeria has convened multi-agency meetings to organize its maiden sovereign sukuk issuance, expected by in 2017.

With global financial reform, we have seen the transformation of banks’ willingness and ability to lend. This, combined with recent events and uncertainties globally like about interest rates increase and appetite of investors to emerging market, has highlighted the limitations of heavily relying on foreign investments alone and regional and local currency could make this complex process easier.

Conclusion  Challenges lie ahead for the sukuk market despite continued momentum. The time needed to tackle these obstacles will in turn lead to a longer time frame of Islamic finance implementation and potentially higher costs in relation to more conventional forms of funding until a standardised framework is established. 

However, several important trends could provide the necessary impetus for the development of Islamic finance in Africa. This includes growing government support for Islamic finance, increasing acceptance of Sukuk and Islamic finance more broadly and existing large investment and financing requirements in Africa.

Furthermore, Islamic finance could enable African sovereigns to broaden their investor base while providing some diversification away from traditional Eurobond investors and towards regional/local market participants. 

As African governments tap the Islamic finance market, it is anticipated that other issuers such as state-owned companies and African banks could, in time, benefit from this additional source of funding.

SOURCE: ProshareNG/15 Oct 2016