Hong Kong: Islamic Finance Getting There Little by Little
Bryant Edwards, Craig Nethercott and Nomaan Raja
Latham & Watkins
With the platform for an Islamic finance offering in Hong Kong almost complete, what are the prospects for the growth of the Islamic finance sector in Hong Kong? Bryant Edwards, Craig Nethercott and Nomaan Raja ask whether the region has the capacity to foster an Islamic finance sector.
The Arabic exclamation ‘shwaya – shwaya’ (or ‘little by little’) comes to mind when one reviews the progress of Hong Kong towards establishing itself as an Islamic finance hub in Asia. Since 2007 Hong Kong has been focused on the need to develop a fiscal environment to encourage and sustain an Islamic finance offering. Meanwhile, the global sukuk market has continued its rapid growth with the value of sukuk issues in 2012 said to have reached over US$121 billion.
In his 2007 Policy Address the then HKSAR chief executive identified the introduction and development of the Islamic bond market in Hong Kong as a key government initiative. Hong Kong’s position as a global financial centre is undoubted; however Malaysia has, to date, grown to be the most active centre for Islamic finance in Asia and globally. Singapore has also made advances in extending its platform as a financial centre to Islamic finance, but sits far behind Malaysia.
Although Malaysia’s current lead for sukuk issuance is undoubted, commanding 60-70% of the global
Sukuk issuance, its position as the global centre for international, as opposed to domestic, issuance is still not confirmed. The recent multi-currency issuance by Sime Derby suggests that Malaysia could extend its status to the centre for international sukuk issuance. With Malaysia’s presence established, the question arises does Hong Kong have the regulatory platform and a market dynamic that can establish Hong Kong as an attractive and active centre for Islamic finance activity.
Fundamentally taxation, prudential regulation and a concentration of willing investor and issuer market participants are all necessary to develop a sustainable platform for Islamic finance in a financial centre. A critical mass of professionals such as scholars, lawyers and accountants is also required. Once the regulatory platform is established, the professionals will certainly follow the opportunities presented by the market.
Hong Kong has made significant strides in establishing its platform for an Islamic finance offering, but the last pieces remain to be put in place. The Hong Kong Monetary Authority (HKMA) as long ago as 2008 publicised its approach to the prudential regulation of Islamic finance activity. The HKMA, like other regional regulators, confirmed a substance-over-form policy for Islamic structures.
However, the taxation treatment of Islamic finance structures currently remains unresolved and a barrier to activity. It has long been recognised by the HKMA, the Hong Kong Stock Exchange and the Financial Services and Treasury Bureau that without an equalised taxation treatment of conventional and shariah compliant structures, an Islamic finance platform will struggle to gain traction in Hong Kong.
The introduction of the proposed Inland Revenue and Stamp Duty Legislation (Alternative Bond Scheme) (Amendment Bill) 2012 (the bill) to the Legislative Council at the end of 2012 is a significant and necessary step for the development of the Islamic finance sector in Hong Kong.
The bill proposes to exempt certain qualifying sukuk structures (termed ‘alternative bond structures’ or ABS) from profit, property and stamp duty exposures that may attach to the necessary structuring associated with sukuk issuance. The bill seeks to place sukuk and conventional bonds on a level playing field for the purposes of taxation.
The proposed legislation subdivides the sukuk structure into two elements, namely the ‘bond arrangement’ and the ‘investment arrangement’. The bond arrangement is the structure between the sukuk issuer and the sukuk investors. The investment arrangement is the structure between the sukuk issuer and the originator of the sukuk. Four qualifying structures (termed ‘investment arrangements’) are contemplated by the bill, namely (1) lease arrangement (Ijarah), (2) profit sharing arrangement (musharakah and mudarabah), (3) purchase and sale arrangement (murabahah) and (4) agency arrangement (wakalah).
The legislation recognises that the sukuk market is dynamic and additional structures (or investment arrangements) may be developed. The legislation permits the financial secretary to expand the coverage of the tax exemptions to additional structures.
An unusual feature of the proposed legislation is the contemplated limit on the maturity of the sukuk (or ABS) to 15 years. The briefing paper published with the bill noted that 90% of global sukuk issuance had a maturity of 15 years or less (with half being of a shorter maturity term). Again, it is proposed that the financial secretary would be empowered under the legislation to extend the maturity limit via subsidiary legislation.
With the platform for an Islamic finance offering in Hong Kong almost complete, what are the prospects for the growth of the Islamic finance sector in Hong Kong? The question is frequently asked: does Hong Kong, like Malaysia, enjoy an investor/issuer market dynamic to foster an Islamic finance sector?
To date, few banks have established Islamic windows in Hong Kong for Shariah compliant lending and other Islamic finance activity has been limited. However, Hong Kong sits as the South East Asian financial gateway to mainland China and, with Beĳing expanding the use of its currency overseas, it is in pole position to connect the Chinese market with Shariah compliant issuers and investors. The dim sum bond market has picked up again following a recent dip and some banks are predicting that sales of dim sum debt could reach RNB360 billion (US$57.89 billion) in 2013.
With the ever-increasing trade flows between the Middle East and Asia, Hong Kong sits as an important entry point along the New Silk Road of Middle East and Asia commerce. Middle Eastern issuers are seeking to diversify their funding beyond domestic markets and similarly Middle Eastern investors, following trade flows, increasingly see Asia as opportunity for diversity of investment.
With the last pieces of the regulatory and taxation platform falling into place and the privileged position that Hong Kong enjoys with respect to the China market, Hong Kong is well situated to find its own unique place in the global Islamic finance industry. The market is waiting to see whether Hong Kong will now take a fair bite out of the dim sum sukuk market.
Bryant Edwards and Craig Nethercott are partners based in Hong Kong and Dubai respectively while Nomaan Raja is an associate based in Dubai at Latham & Watkins.
This article first appeared in Islamic Finance News (23 January 2013, Volume 10, Issue 3, Page 20 - 21). For more information, please visit www.islamicfinancenews.com.