TodayÆs sukuk: yesterdayÆs Eurobonds

When I started in this business, global investors considered cross-border activity to be M&A deals between Germany and France, or, more radically, an investment toehold in a market like Malaysia. The concept has expanded dramatically over the past two decades. We now talk routinely about sukuk issues by European corporations, the potential role of petrodollars in building public infrastructure in the developing world, and what to do with burgeoning wealth in Southeast Asia.

Perhaps the first question we should ask ourselves is, why do we care about cross-border flows? Is this purely an academic exercise? Or is there something more at stake?

I think we care because such flows have a direct wealth-creation benefit at the national level.
Consider the dispersion of wealth across the Islamic economies, ranging from $428 per head in Bangladesh to almost $58,000 per head in Qatar. Malaysia sits in the middle of the pack at about $6,000 per capita GDP.

By comparison, the dispersion of wealth across the OECD countries ranges from about $5,500 per head in Turkey to $92,000 per head in Luxembourg. I find quite interesting the median in these numbers. Between Bangladesh and Qatar, the median is $3,000, while across the OECD, the number is $38,000.
The transmission mechanism of heightened cross-border flows should have a direct wealth-creation benefit on the Islamic world, particularly in countries with increasingly investor-friendly regimes. Such activity would move so-called frontier markets to the forefront of global investorsÆ attention.

One of the challenges here is relatively immature capital markets seen in many, but not all, Islamic economies. Granted, many local capital markets have grown in stature and depth as pools of liquidity have become available through petrodollar recycling and more prudent national-account management. But as a group, Islamic equity markets lag developed markets.

A fresh paradigm for the Islamic world is newfound wealth associated with current-account surpluses. Consider the current-account balances as a percentage of GDP in both Saudi Arabia and Malaysia, two key economies for this audience. Throughout the 1980s and most of the 1990s, both countries usually exhibited current-account deficits. But since then the tables have turned, with Saudi ArabiaÆs trade surplus some 31% of GDP and MalaysiaÆs surplus around 15% The shift from deficit to surplus has largely to do, respectively, with robust oil prices and ôrecovery policiesö in the wake of the Asian currency crisis.

I should mention that these surpluses have served the interests of the United States, given its ongoing deficit funding needs. Demand for US paper has kept US interest rates relatively low, and this in turn has supported economic activity domestically and globally. The impact on the dollar of these potentially volatile capital flows is a major debate now. ItÆs posted high on my own investment-strategy ôwall of worry.ö

Cross-border flows can take many forms: debt, equity, direct foreign investment, and remittances, but IÆll focus on capital markets.

In the case of equity, a breakdown of the Dow Jones Islamic Market World Index û a generally accepted measure of sharia-compliant equities û shows the US is the largest ôIslamicö equity market.

Transparency and disclosure standards in the United States suggest that Islamic investors can benefit from a ôwhat you see is what you getö framework. Suffice it to say that some Islamic investors may be irrationally avoiding portfolio opportunities in the US by invoking a cultural demonstration associated with geopolitics.

Although I was not working as a qualified investment professional in the 1960s, my studies in capital-market history suggest that the early development of the Eurobond market may be akin to what weÆre seeing in the sukuk market, albeit with slightly different nominal data. The trend is surprisingly similar.
The sukuk market is still relatively small compared to the Eurobond market. sukuk issuance in 2006 was estimated at $24 billion, whereas Eurobond issuance was almost $1 trillion in the US dollar segment alone, among issues with over one-year of maturity. By these numbers, the sukuk market is still quite tiny.

But as my colleague John Weguelin at the European Islamic Investment Bank has suggested, the upward momentum of the sukuk business exhibits the sort of vigor we saw in the Eurobond business decades ago. Indeed, sukuk may prove to be the definitive Islamic cross-border instrument.

Allow me to close with three simple observations:

1) Like the conventional business, Islamic finance is poised to benefit from translating investment ideas into investment practice. Creative cross-border work may extend the boundaries of Islamic finance briskly and effectively.

2) Despite unprecedented enthusiasm for the business in the Gulf and Middle East, the form and structure of Islamic finance remains largely unknown in conventional circles. That is unfortunate. There are far too many myths in circulation across the London-New York-Hong Kong nexus.

3) The breadth of the Muslim community suggests that Islamic finance can play a key role in globalization, providing the most opportunities for the largest possible proportion of humanity.

Douglas Clark Johnson is CEO and chief investment officer of Calyx Financial LLC, a Wall Street-based developer and marketer of offshore investment products for Islamic investors.