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The Sukuk In Africa: Financing Africa’s Future

The Sukuk In Africa: Financing Africa’s Future

It’s simple. No interest on investments but the lender and borrower share the returns.

This form of financing, known as Islamic finance, confronts the lifelong convention in finance of receiving interest on a loan.

The global financial system depends on the founding concept that money itself is a commodity that needs not be invested into an underlying commodity to have value. That said, money can be leveraged to create greater returns through the application of derivatives. Critics artfully label these leveraged and speculative winning, or more euphemistically, returns making money out of nothing. This can ultimately have catastrophic results.

Islamic finance theoretically eliminates the speculative nature of conventional finance. In prohibiting the “unjustified enrichment” and “speculation or excessive risk,” Islamic scholars pushed three principles:

  • Prohibition of interest.
  • Profit and loss sharing (riba).
  • No speculation (gharar).

These, for practical purposes, distinguished Islamic finance form all other counterparts. Prohibition of interest or riba generally translates that lending money should not generate “unjustified income.” Profit and loss sharing accordingly emphasizes a partnership where partners shares profits and losses on the basis of their invested capital. Gharar simply means no speculation.

Islamic finance in the West

In June 2014 and September 2014, the U.K. and Hong Kong became the first and second non-Muslim states to issue sukuks. Britain’s £200 million (US$323 million) sukuk fetched more than £2.3 billion in orders.

Hong Kong’s $1 billion issuing fetched $4.7 billion in orders, approximately two thirds of which came from the non-Muslim world. And investors did not bid up the sukuk for the sake of do-goodness. Instead investors were jumping at the opportunity to cash in on a five-year dollar denominated asset that, at 2.005 percent provided return 23 basis points above a five-year U.S. treasury bond.

Islamic finance and the sukuk in Africa

Islamic finance in Africa is in its early stages but the potential, due in part to the demographic realities of Africa, is garnering a huge amount of attention from financiers on the continent. Nearly half of the African countries have populaces where Muslims account for 40 percent or greater of the total population.

Several countries in Africa are planning sukuk (the Islamic equivalent of a bond) debuts, including Egypt, Kenya, and Tunisia. These issuances follow first-time issuances by Senegal and South Africa in 2014. Senegal launched a four-year US$168 million sukuk in June 2014. The issuance raised eyebrows not solely because it helped to address Senegal’s long-term funding needs, particularly for infrastructure, but also because it demonstrated Senegal’s desire to be the Islamic finance hub in Africa.

Finance Minister Alioune N’Diaye’s comments did not hide the country’s motives, especially in beating economic heavyweights Nigeria and South Africa to the punch.

“We have an Islamic bank in Senegal, the Banque Islamique du Sénégal, we have the advantage of a good relationship with the Islamic Development Bank (IDB) and we are the first country to explore these opportunities in the region,” N’Diaye said. “We have a population of 95-percent Muslim people as well. It has been a long time in planning, but we think that we can be a hub for Islamic finance in Africa.”

Following Senegal, South Africa issued a US$500 million 5.75-year sukuk in September 2014. Cote d’Ivoire, Niger, and Nigeria have since made debuts in 2015 each respectively north of US$200 million.

Financial and legal challenges

Islamic finance is arguably a watershed opportunity for supporting infrastructure projects in Africa. To issue sukuks, the issuer needs to have physical assets that the sukuk backs. Africa provides a massive landscape, infrastructure need and infrastructure financing gap. Arab leaders, if their growing presence at African forums on infrastructure and investment are any indication, are more than willing to share in the profits of infrastructure projects in Africa.

But, as is the general case in emerging markets, the legal framework is running to catch up to the eager financiers. West Africa has led the way, albeit after the Arab-dominated North Africa, in changing laws to permit sukuks and protect sukuk investors. Cote d’Ivoire, Niger, Nigeria and Senegal got to the market with sukuk bonds.

Southern Africa still relies more on conventional bonds to raise financing but was nevertheless a first mover when it permitted sukuks in 2011.

East Africa however is moving slowly to get to a Shariah-compliant legal framework for sukuk bonds. Kenya maintains an ongoing partnership with the Qatari government to build capacity and develop a regulatory framework for issuing sukuks. The Kenyan treasury must change the Banking Act, notes National Treasury Secretary Henry Rotich, with aspiration of attracting capital both from the richer Middle East and holders of low-yielding bank accounts in the country.

Ugandan officials have already outpaced their Kenyan neighbor by approving the Financial Institutions (Amendment) Bill 2015 which opens the door for sukuks.

Could Islamic financing fund oil infrastructure in the future in Uganda at a cheaper price than conventional financing?

It is the potential of such ideas that drives legal entities to find a solution to the regulatory deficit in the local financial environments of many African countries. Shariah law, at least, provides a foundation and does not require reinventing the wheel.

Kurt Davis Jr. is an investment banker focusing on the natural resources and energy sectors, with private equity experience in emerging economies. He earned a law degree in tax and commercial law at the University of Virginia’s School of Law and a master’s of business administration in finance, entrepreneurship and operations from the University of Chicago. He can be reached at kurt.davis.jr@gmail.com.