Insulating Your Company From a Credit Crunch

by Cesar Bacani, 02 November 2010

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topics:
Corporate Finance Risk Management

tags:
diversification GE Islamic finance Shariah-compliant sukuk Toyota

I just got back from the Global Islamic Finance Forum in Kuala Lumpur. The impression I took away from it is that Asia’s companies are going to get inundated with proposals to raise capital from the Muslim world. The place was crawling with investment bankers – along with market representatives from Australia, Hong Kong, London, Luxembourg, Singapore, South Korea and other jurisdictions where there are actually few, if any, Muslim inhabitants.

Indeed, the Malaysian organisers were keen to reach out to what they call “conventional finance.” While US$1 trillion of the world’s wealth is estimated to have found a home in Islamic financial products, the bulk of the planet’s financial assets are still in the form of conventional interest-bearing instruments developed in Europe and North America. If it is to grow and remain sustainable, Islamic banking and finance must attract that kind of money, too.

Which is, in theory, good for Asia’s CFOs. Ever since the Asian financial crisis in 1997, the region’s money men have realised the importance of cultivating diversified investor and borrowing bases. That lesson was reinforced in the 2007-08 credit crunch, when Western banks and other financial institutions pulled in credit lines even as the capital and debt markets ground to a halt.

The proponents of Islamic finance like to point out that their sector proved resilient, although they acknowledge aftershocks from the conventional side. Islamic banks have exposure to property, equities, Islamic bonds (known as sukuk) and managed funds, whose market values sank along with confidence in financial markets.

But they never bought derivative instruments that mixed together U.S. subprime mortgages and triple-A paper, the toxic cocktail that brought down the likes of Lehman Brothers and AIG. Islamic precepts prohibit speculation and require investing in tangible business activities only.

Is Your Company Eligible?

So how can CFOs of non-Muslim companies access Islamic capital? First, you have to understand what kind of investments Muslims are allowed to make, and then make sure your company satisfies those requirements.

Ownership and management by Muslims are not required, which is why companies like GE and Toyota have been able to issue Islamic bonds. However, a company is required to possess the following qualities:

Engaged only in businesses that are allowed in Islam. There are really just a few forbidden business activities, among them production or sale of pork-related products, alcohol, pornography, gambling, and weapons.

Does not practice usury. The mere fact that a company charges interest on loans does not automatically disqualify it from accessing Islamic capital. What is objectionable is charging unreasonably high interest, particularly to those with limited borrowing options.

Not engaged in derivatives for speculation. A company that invests in futures contracts, currency swaps and the like is not automatically disqualified from accessing Islamic capital if the use of derivatives is to hedge risk, and not make money from transactions that do not refer to a tangible and/or identifiable underlying asset.

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