A will but not the ways for Islamic finance hub

SCMP July 2 2008

It is a legitimate ambition for Hong Kong to play some intermediary role in the fast growing world of Islamic finance. But the way officials have gone about it suggests ignorance of the issues and a public relations-motivated desire to be seen to be active.

Last week I attended a seminar in Kuala Lumpur on Islamic Finance. Various financial and legal experts, mainly from the Gulf and Southeast Asia, were there for discussion on some of the finer points of sharia-based finance and prospects for its growth.

Representatives from Singapore and even Japan laid out the specifics of tax and regulatory changes that had been made to accommodate the concepts of sharia, which relies on asset-trading and share of profit rather than debt funding to give a return to investors. And then there was Hong Kong's belated attempt to jump on the Islamic bandwagon.

The director of the Investment Products Department of the Securities and Futures Commission spoke of Hong Kong's virtues for trading with China, but was vague about regulatory changes to accommodate sharia-compliant products.

The way this should work is that the private sector sees an opportunity to sell or trade sharia-based products here and the authorities follow up with seeing whether local tax and regulatory regimes can reasonably be adapted to facilitate it. Instead, this was an initiative by Chief Executive Donald Tsang Yam-kuen and the bureaucracy, seeking a part of the industry without first preparing the ground.

To support it has come the suggestion by the Airport Authority that it may make a sukuk issue. A sukuk - there are several types - is a security whose performance is very similar to that of a bond but which does not involve the payment of interest. For sure, there is an appetite for such issues particularly by Gulf countries. But such a sukuk will have to be issued offshore - until such time as Hong Kong can devise a way of removing tax obstacles without blowing a huge hole in its profits tax system.

There is obviously potential for sukuk issues by mainland companies wanting to tap this market, now growing at 20 per cent a year. However, the reality is that sharia-conscious investors in the Gulf are more interested in mainland equities and Hong Kong plays no role in determining whether or not these are sharia-compliant. It seems unlikely that Hong Kong, with only a small Muslim population, is going to be able to set up its own sharia-compliance board of experts as Malaysia and Singapore have done.

There is in theory at least the possibility that Hong Kong can develop a framework for sharia-compliant products which would appeal to China's Muslim population. However, while that community may be large in numbers it is mostly found in the poorer western regions and is not known for strict adherence to sharia. It is also evident that Islamic finance mainly thrives in Muslim countries with large surpluses and has failed to take root in populous nations such as Pakistan, Bangladesh and Indonesia.

Could Hong Kong become a centre for selling sukuk and related products to non-Muslims? Proponents claim they are relatively low risk due to their structure. Because of their aversion to leverage, Islamic financial institutions have not suffered much from the crisis that has hit western ones. On the other hand, because so many are based in oil exporters they could be hit by a collapse in oil prices.

Another problem is that interpretations of sharia-compliance vary widely, with Gulf definitions being stricter than Malaysian ones which some critics allege are legalistic devices created to mirror conventional products rather than reflecting the philosophy underlying sharia. Legal and tax issues aside, there seems to be a fundamental divide between sharia's aversion to gambling and get-rich-quick instruments and the natural instincts of Hong Kong and mainland investors.

ends