Kaouther Jouaber «Islamic Finance should account for 1300 billion dollars by 2020»

The university of Paris Dauphine (Paris 9) has launched a new higher education masters specialized in Islamic finance. It has a BAC + 5 level (Five years of study after the French baccalaureate). Kaouther Jouaber, lecturer at the university of Paris Dauphine and co-head of the masters, has shared his time with us to answer our questions on the subject during the inaugural conference that took place on the 18th of November at the Palais Brongniart in Paris.

Can you explain briefly what Islamic finance is all about?

Islamic finance is a kind of alternative and ethical finance which makes use of specific techniques in financial structuring. It is similar in many respects to conventional finance but very different at the same time. For instance, it has the same aims in terms of financial performance. Its specific nature comes from the fact that it applies a set of rules and principles that are dictated by Muslim ethic. Among those is the sharing of profits and losses, the prohibition of usurer interest, the obligation to back every investment with a tangible asset or better still the prohibition of activities judged as illicit in Islam. Islamic finance therefore imposes specific constraints especially in terms of risk and investment traceability. This type of finance consequently consists in structuring products that meet this double financial and ethical constraint.

What are the reasons which have lead Dauphine University to launch this new Masters?

Thanks to this training programme, Dauphine meets the request expressed several times over by finance experts. The training available to fulfil this need remains very limited in France. The demand is very strong especially from non Islamic institutions who wish to train their staff in the various approaches of their Islamic bank clients. It is moreover one of the main conclusions drawn by the report carried out by Elyès Jouini and Olivier Pastré at the request of Paris Europlace. As proof of this, during our short recruitment campaign which took place between the end of June and the beginning of September 2009, we received almost 200 applications. This figure is very close to the number received by well established Masters. The applicants come mainly from finance and insurance professionals who work in well known financial institutions.

How is Islamic finance currently doing after the financial crisis that we have just experienced?

Some recent developments in the financial economy are very strongly questioned by the current crisis and this has consequently highlighted Islamic finance in a way that was unseen a few months ago. The capital managed or likely to be managed according to Islamic finance principles are expected to growth at a rapid and durable pace. Besides, the fact that the philosophy of Islamic finance resides in long term investing and on the sharing of financial risk makes it very well suited model for the times we are currently living in.

What amount (in billions of dollars) is currently represented by Islamic Finance? What is the percentage when compared to conventional finance? What are the growth perspectives?

We can consider Islamic Finance as representing an 800 billion dollar market (similar in size to the “Paulson Plan” and almost as much as the “subprimes”). The specialists have estimated that this market should be worth 1300 billion dollars by 2020 with a two digit growth rate.

The sukuk is flagship product of Islamic finance. It is closely related to a bond but how does it pay the investor considering that the interest rate is not allowed? Does the investor receive a share of the turnover of the company issuing the Sukuk or a share of its profits?

The sukuk is an illustration of the concept of profit and loss sharing in Islamic Finance. The difference between a Sukuk and a common bond is that the sukuk is backed by a tangible asset. It provides the investor with the ownership of an asset that has been identified prior to the issue. Sukuk holders benefit from the asset’s usufruct on a prorata basis of their investment. Consequently, their return depends on the performance of the underlying. It can be fixed if the revenue of the underlying is fixed as well. It is the case regarding the asset class which is part of the Murabaha category. However, it can be variable when the return of the underlying is not constant such as when dealing with assets known as Ijara. Moreover, most of the Sukuk structuring uses an ad hoc entity which holds the underlying and exposes the investors to a credit risk.

Is there a secondary market for Sukuks? Are they liquid products?

There is a secondary market but it is not systematic. Sukuks are effectively listed and can display some degree of liquidity. Malaysia is considered as the most liquid market. Elsewhere, the lack of liquidity can be explained by a much bigger demand than supply and by the fact that Sukuk holders are long term investors and refrain from selling them thus preferring to keep them until their maturity. The Sukuk market, like the other markets, has suffered from the 2008 crisis. The question regarding product conformity issued under religious principles and the doubts expressed regarding some sukuk issues have also negatively impacted this market. However, specialists continue to believe in the long term development of this market. These products provide financing solutions that are hard to go without nowadays. The creation of Sukuks is now possible on several western markets including NYSE Euronext. The Luxembourg bourse has been issuing them since 2002. More than 15 are traded on it.

In conventional finance, financial product valuation requires mathematical models. Is it also the case for some Islamic products? What about the price of a sukuk on the secondary market? Do we require mathematical models associated to financial analysis?

Islamic financial products are most of the time valued through the same mathematical models used for conventional products. Several reasons can explain this. First of all, it is true that Islamic finance is more than 30 years old but research is only beginning. Models are starting to take shape but their implementation is not generalized yet. Then, from a financial perspective, financial institutions do not necessarily wish to display a distinction between Islamic and conventional products so as not to blur risk perception by investors. Besides, investors are more comfortable when the products display features that look familiar to them. Overall Islamic products represent a legal innovation but not necessarily a financial one. Moreover, financial analysis remains very important for Islamic products. The most well known rating agencies carry out ratings in addition to specific agencies most notably in Malaysia. Rating criteria remain similar to what is applied on other financial products.

How do we analyze the performance of an Islamic product? How do we link this performance to the Libor or Eonia rate?

In finance, the performance of a financial product is measured according to benchmarks. Islamic finance does not escape this rule. The methodology used remains close to classic ones in terms of performance measure. The Ijarest Sukuk for example is often analyzed with reference to the Libor, a rate of interest, despite the fact that it generates revenue linked to a tangible asset. Literature nowadays proposes other solutions to measure performance and suggests the use of macroeconomic indicators such as GDP growth.