Islamic Finance in Hong Kong - Laying the Groundwork

After months of delay, amendments to the Inland Revenue and Stamp Duty Ordinances were passed on 19 July 2013 to provide much-needed groundwork for Islamic finance - in particular sukuk issuance - to take root in Hong Kong. So what exactly can we expect from this sector going forward?

Islamic finance is derived from Shari’a, which bans the payment or receipt of interest. Consequently, the notes issued under sukuk transactions represent beneficial interest in an underlying asset or business, which, before the laws were changed, faced heavy tax burdens in Hong Kong.

As an international finance center, Hong Kong has been attempting to establish a sukuk market, which will broaden the range of financial products and services currently available.

“Many major financial centres have [already] recognised there is a sizeable market for Islamic products”, Malcolm Walker, Executive Vice President & Group Chief Audit Officer of the National Bank of Abu Dhabi, tells Hong Kong Lawyer. The bank is among the big fish that financial centres like Hong Kong and Singapore are targeting for their nascent Islamic finance products.

The legal industry in Hong Kong has been responsive to this new opportunity and top firms have already set up small departments to cater to this growing market, they told Hong Kong Lawyer.

One of the attractions of sukuk products, Mr. Walker adds, is that they can be structured for retail, commercial and corporate clients, rather than being limited to big market players.

Slow to grow

Several reasons have been suggested by Amirali B. Nasir, a partner at law firm Nasirs, as to why the sukuk market has been slow to take off compared to other markets that have already seen success.

These include “a lack of knowledge of issuers in Hong Kong, the false assumption that issuance requires a large Muslim population, and the lack of access to Shari’a scholars”.

He has suggested that in order for the sukuk market to develop successfully, the Hong Kong Government must “step up to the learning curve for Islamic finance”. In doing so, relevant governmental bodies such as the Hong Kong Monetary Authority should be proactive in promoting Islamic finance through “education of the professions, lawyers, accountants, marketing agencies, banks and government departments.”

Major players in the market looking to attract new Chinese clients include Malaysian, Middle Eastern and some Western funds. However, because Hong Kong allows transactions of a bi-partite nature, this would affect the potential interest of Middle Eastern funds unless the offerings are structured correctly, said Mr. Nasir.

Previously, if a company wanted to conduct an Islamic financial transaction using a property or business located in Hong Kong as its underlying asset, it would need to conduct the transaction in a more tax-neutral jurisdiction to avoid facing additional tax and stamp duty implications.

But since the returns are conventionally regarded as comparable to more conventional products like bonds, it did not make sense for investors to raise funds via sukuk offerings. While sukuk transactions have been conducted in Hong Kong before the legislative amendments were made, they involved assets based elsewhere.

Now that the relevant legislative groundwork has been laid to encourage Islamic finance activities, market players say, the next step is for Hong Kong to fine-tune the rules, and promote itself as a platform to link Islamic and Chinese yuan financing together, given the appeal of the PRC growth story to international investors.

“This is especially (true) given the fact that many investors are now actively looking for investment opportunities in Asia, particularly Mainland China, to diversify their investment portfolios”, said Peter Pang, Deputy Chief of the Hong Kong Monetary Fund, in March 2013, when he was addressing a workshop on Islamic capital markets.

Ultimately, the receptivity of market players will be the measure of determining the success of Islamic finance in Hong Kong, he added.

Room to grow

As reports have indicated, the global sukuk market is expected to more than double to reach nearly US$300 billion (HK$2.3 trillion) by 2016, as more non-Muslim jurisdictions tweak rules and regulations to tap into this market. Total assets in the Islamic finance industry are now estimated at US$1.3 trillion.

London and Kuala Lumpur are currently the big global centres for sukuk, and cities like Hong Kong want in on the action, and attract major Islamic banking players looking to expand in Asia.

The city faces stiff competition. In January, Dubai announced plans to become a global centre for Islamic business, and authorities outlined in October a broad strategy to help accomplish this, including developing the emirate as a centre for issuance and trading of sukuk, Reuters reported. Local firms such as Dubai Islamic Bank, Dubai Electricity and Water Authority and the Emirates airline have issued and listed sukuk in Dubai this year.

Other non-Islamic-related firms are also looking into sukuk as a new opportunity to raise funds. In August, Singapore’s Swiber Holdings, an offshore marine services company, introduced a new group of Islamic investors to the city's capital markets.

Almost half of the S$150 million (HK$940 million) deal went to investors from the small oil-rich state of Brunei, helping Swiber clinch pricing that was more competitive than conventional debt, Reuters reported.

“The latest deal is another piece of clear evidence that Islamic sukuk generates more competitive yields than conventional debt,” one debt syndicate banker told Reuters.

The next step in ensuring the development of the sukuk market is “for originators to appreciate what Hong Kong has to offer and what benefit there is to them”, says Mr. Nasir.
“This means that they will need material to understand the terrain in which they wish to launch their product,” he adds.

Mainland investment opportunities becoming accessible for sukuk transactions also begs the need for more information to understand how these new finance structures “can be used in Hong Kong to raise infrastructure finance”.
In essence, the key to a successful sukuk market in Hong Kong will be for the Government to promote, generate buzz, and provide sufficient information about this new opportunity to local market players as well as interested foreign players, specialists say. This means, among other things, more forums, talks, and receptions to push the potential of the sukuk market.

The fact that law firms and banks are bolstering their sukuk know-how is also encouraging, they add. Now all the city has to do is to complete that first Hong Kong-based sukuk deal. 


By Mercedes Chien