Islamic finance supplement - Khalid Howladar

The vice-president in Moody's Middle East and Islamic structured finance group, talks Shariah compliance and risk in Middle East markets


Q: You have been holding your Middle East credit conference for 10 years. How long have you been active in the region and why did you wait until this year to open your regional office?

A: We've been active there for over 20 years with over 80 issuers rated to date. Demand for ratings in new markets evolves over time - banks and financial institutions are usually the first to seek them and they are quite often a necessity for the larger ones that engage in the global financial system. Larger corporates looking to tap the capital markets come next and this is the current stage in the Gulf. These local corporates have global ambitions. Large international bond or sukuk issues get the borrower's name out there and supply expansion-funding in a region that recently awakened from a monogamous love of equity finance.

As for the office timing, it's primarily driven by market demand. Go to any regional event and ratings crop up in many unrelated sessions. Risk awareness is developing and the breakneck pace of innovation and growth means investors can't keep up. Objective and credible ratings are one very important piece of information to help people make investment decisions in the local market.

Servicing local issuers from Cyprus and London was becoming impractical given the sheer volume of rating interest now emerging from the region, but as well as bringing Moody's to the Middle East it was important to bring the Middle East to Moody's. For the foreseeable future the bulk of our analysts will still be in Europe, but having seasoned analysts on the ground, as we have in Dubai, was key to bringing better local knowledge and understanding back into our credit committees. Qualitative analysis is a key part of rating and being 'local' is a way to improve this.

Q: As the market develops, do you anticipate opening more offices in other relevant regions?

A: Again, it's a function of demand and potential. If issuers show sufficient interest in our ratings and need us there, then it makes sense. We've planned well thus far when you consider already we have a total of 10 corporate ratings this year, up from last year, and more financial institutions in addition to the 43 we already cover. Securitisation too is set to emerge in sizable volumes in 2007. We've been very active in the region over the last few years, in preparation for our presence through conferences, publication of topical research and local meetings with a variety of market participants. We've been promoting credit risk awareness and done our part to educate investors. Also, it's not always clear in new markets that participants know how exactly we do what we do, so we make a real effort to demystify our processes and bring some transparency.

Q: Do you apply different criteria when rating Islamic financial institutions? What extra considerations apply when you look at local banks?

A: We have a hefty paper on the subject but simplistically we feel that risk is universal. I had one senior GCC central banker tell me that 'risk has no religion' when asked about supervision of Islamic banks. Other opinions suggest quite strongly that such firms need their own special ratings, accounting standards and regulations - unlike most areas of finance you need to be sensitive to these opinions as you're dealing with people's beliefs.

It's correct that their efforts to comply with Shariah mean that they can operate very differently to conventional banks but ultimately it is the ability and willingness of the borrower to pay on their rated obligations that is the key concern for us. Indeed the collection of risks in an Islamic institution may be different from the norm but even in 'conventional' banking there is tremendous variation in their risk profiles. No two banks are the same and require a very specific analysis irrespective of their Islamic nature. At Moody's we feel from a credit perspective one can almost be agnostic. It's still important, however, to understand the source of the differences and how, for example, operationally, the institution's strategy may be affected by the need to run an ethical business according to the precepts of Islam.

Q: Do you co-operate with Islamic scholars when rating Islamic institutions and Shariah compliant issues? Is there consensus between them, or is there a danger of the market being destabilised by disparity of opinion?

A: Co-operation is probably not the right word, but ideally given the influence they have over the organisation, we would look at it more from a corporate governance perspective. It's important to note that it is not like one has a 'ten commandments' of unambiguous financial rules. Shariah draws upon many sources and it is driven more about principles of justice and fairness and seeks to prevent exploitation. As such, there is still much discussion as the demand for compliant structures continues to grow. It is unlikely and even undesirable that one will ever have complete harmony but, where there is profit involved, it's likely the Islamic financial markets will evolve with the different opinions that people hold.

Q: Do you agree that issuance brought to finance large infrastructure projects is contributing to a bubble in any key markets or territories?

A: I'm not sure that the vast funding required for infrastructure projects is an issue. Indeed the windfall of the oil boom is in many instances being invested in a far more productive way, that should yield long term benefits to the region which is a marked difference from prior 'booms'.

What is more of an issue is that you don't have enough issuance of financial assets to help soak up this excess liquidity. As a result a lot of it currently finds its way into real estate, consumer and corporate lending. Our financial institutions group is well aware of these issues and is watching the environment closely, although the local banks are pretty strong right now and despite a massive equity correction that may have destroyed confidence and affected banks more seriously in other regions, the gulf economies are still growing at record rates.

Q: Where do you anticipate growth in the medium to long term, in terms of both credit assets and territories? Is Saudi Arabia a 'sleeping giant' in terms of international borrowing?

A: Saudi Arabia was already the largest sovereign borrower in the Gulf. It has over half the regional GDP, the largest companies and the most sizable population. It may be slow to start but regulatory, financial and legal reform are proceeding apace to help improve and encourage capital markets.

Financially, debt capital markets are pretty immature compared to equity markets. Recent corrections and the high cost of equity finance are helping to focus the region on fixed income and should encourage a lot more issuance and help balance the markets.

Q: To what extent do you consider event risks specific to the Middle East, such as the oil industry and political instability in certain parts of the region?

A: Our sovereign risk group looks at all risks when assigning ratings and our Gulf ratings are all in the single-A or double-A range reflecting strong economic fundamentals. There is a paradoxical relationship in that a small amount of instability actually benefits local government finances through increased oil prices. Our rating outlooks are positive or stable, indicating that the current regional tensions alone are not sufficient to impair the creditworthiness of the neighbouring countries.

Q: As the sector and Sharia'ah-compliant products gain status internationally, do you anticipate issuance from non-Islamic borrowers?

A: Of course. There is a strong economic angle - it is not just about morals. Over half of the jumbo multi-billion dollar issuances have gone to non-Islamic investors. We've seen German states, Japanese, Chinese and UK agencies entities issue or signify their intention to issue sukuk.

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