August 11, 2009 / 5:40 PM / 10 years ago

Insurers can end sukuk compliance woes, experts say

* Insurers could design products to reduce sukuk risks

* Could help create sharia-compliant sukuk structures

By Frederik Richter

MANAMA, Aug 11 (Reuters) - Islamic insurers can help rid the Islamic bonds market of crippling concerns over the compliance of structures with Islamic law, or sharia, industry experts and executives said.

Global issuance of sukuk fell 56 percent year-on-year to $14.9 billion in 2008, according to Standard & Poor’s, as the market was caught up in the global liquidity freeze but also due to a debate on whether the majority of Islamic bonds, or sukuk, were sharia-compliant.

Prominent scholar Sheikh Muhammad Tariq Usmani said in late 2007 that most Islamic bonds were not compliant with sharia as their guarantee to pay out bondholders at maturity contradicts the principle of sharing risk and returns.

Peter Hodgins, a lawyer specialising in Islamic insurance at law firm Clyde & Co said Islamic insurance, or takaful, products could help reconcile the need for sukuk to comply with these requirements and investors’ need to insure against risks.

“Takaful can be a solution to help out the sukuk market.”

Takaful firms could provide insurance for sukuk investors that takes over notional annual payments to bondholders if they fall below an agreed amount, he said, adding that there were discussions in the industry on such a product.

In Islamic insurance, customers contribute to a pool of funds which is used to indemnify participants who suffer a loss, while in conventional insurance the insurer takes on the risk for a premium.

“As the sukuk market evolves, there could be room for such a product,” said Nick Frei, chief executive of Bahrain-based Islamic insurer t’azur.

But he said pricing these products could be a challenge for takaful companies as the risk of sukuk was difficult to assess.

DEFAULTS LOOM

A $100 million sukuk issued by Kuwait’s Investment Dar TIDK.KW defaulted in May, and analysts have said more defaults could follow.

Allianz Takaful is offering a product insuring against shortfalls in payments of receivables, but it has not been made use of in sukuk yet, said its CEO Abdul Rahman Tolefat.

“We are in close contact with Islamic investment banks to sell them this idea, to be used in sukuk,” he told Reuters, adding that the product would not insure the sukuk themselves, but the underlying receivables, such as cash-flows from telephone bills or oil revenues.

The fledgling takaful industry is offering most of the products of their conventional peers, but has struggled to find long-term assets to invest their funds for products such as pension funds or education plans.

Bonds are an important asset class for conventional insurers, but most sukuk are issued with a tenure of only three to seven years.

Hodgins said takaful products for sukuk would allow issuers to issue longer tenures, which in turn would help the takaful industry to find long-term assets.

Ismail Mahbob, chief executive of Malaysia’s MNRB Retakaful said the use of takaful in sukuk structures should be explored, but said whether or not charging fees for a guarantee on returns is sharia-compliant was being debated.

“Research needs to be done on the right transaction principles and sharia rationale,” he said. (Additional reporting by Liau Y-Sing in Kuala Lumpur)

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