Remember the halcyon days of August 2008, before the collapse of Lehman Brothers and the onset of the financial crisis? Although there were already rumblings of problems ahead in global credit markets, it looked as though the world financial system was facing a gentle correction, rather than the vast destruction of value that occurred between September of that year and the following February. In the Gulf, the buzzword as I remember was "insulated". Even as signs of the growing crisis loomed ever larger, government and central banks across the region repeated that word like a lucky charm: because of its energy revenue and financial liquidity, the Gulf would be "insulated" from the global problems.
We now know that the financial hurricane that swept the world was so intense that even the Gulf's vast pools of liquidity could not fully compensate for the devaluation of global assets. Maybe the region's policymakers underestimated the strength of the coming crisis, or perhaps the region's financial resources were not so resilient after all. Whatever, the Gulf, like the rest of the world, has experienced a serious impairment of value which will take years to recover.
But back then, there was another reason for the Gulf's economic self-confidence: the growth of the Islamic financial industry. When the crisis began in earnest, we were again told that the region would be spared the worst effects of the downturn because it had developed a less risky financial system based on real value and backed by tangible assets. Unlike the artificial and almost surreal world of collateralised debt obligations (CDOs) and the other exotic financial instruments, Islamic finance was backed by physical assets and the real revenue stream generated by those assets.
Well, wrong again; the tangibility of assets under a Sharia-compliant system did nothing to halt the decline in asset values that spread inexorably from the West to the Gulf. In particular, the industry showed that Sharia systems were just as prone to sudden declines in prices as anything dreamt up by the West's CDO merchants. In some parts of the Gulf, property prices are down as much as 50 per cent from the heyday of 2008, and would-be investors and end-users are just as excluded from Sharia-compliant finance as any first-time buyer in the West denied a starter mortgage.
The other area where a financial nemesis came to haunt the Islamic industry was the corporate bond market. Sharia-compliant corporate debt, or sukuk, was seen as the next big thing in world finance, a growing market designed to tap demand in the Muslim world for products adhering to the basic principles of Sharia law. The industry boomed in 2006 and 2007, and conventional financial centres such as London and New York were suddenly keen to have a "sukuk capability" in their portfolios.
But, as we have seen with the controversy over the Nakheel US$3.6 billion (Dh13.22bn) sukuk last year, and ongoing doubts about future redemptions from the indebted Dubai developer, sukuk were as prone to the financial downturn as any conventional bond. In fact, because of investor confidence that they were fully backed by assets or government guarantee, the possibility of default had arguably worse consequences for regional financial markets.
The decision last November by Dubai World to restructure its debts was so traumatic for global markets partly because of bad timing (the eve of a Muslim holiday) but mainly because the notion that the Nakheel sukuk would not be paid on time had never entered the minds of investors. The lesson is that Islamic financial instruments, from mortgages to corporate bonds, are just as vulnerable as conventional ones to financial market volatility. To counteract that vulnerability the Islamic industry will have to fall back on some of the techniques of conventional markets.
The Bank of New York Mellon, the American financial institution which acts as an administrator to many of the world's corporate debt issues, has just produced a thought-provoking paper in which it argues that the time has come for a more rigorous approach to investor relations (IR) by sukuk issuers. "The adoption of sukuk IR can improve the quality of due diligence, foster an open dialogue between stakeholders and contribute to an ongoing process of disclosure beyond what is nominally contained in a prospectus," says BNY Mellon's strategic business development manager Giambattista Atzeni.
He says there are already benchmarks for quality in the administration of sukuk in the region, such as the Dh4bn issue by the Abu Dhabi property company Sorouh in 2008, or the $600 million bond issued in London and Dubai by the US company GE last year. Surely it can be only a matter of time before sukuk issues are subject to the same meticulous monitoring and scrutiny as their conventional counterparts. That would go at least part of the way to avoiding another Nakheel situation, and help the Islamic finance industry restore its image as a risk-averse, high-value business.