Islamic finance demand rising, but depth lacking

By Will Rasmussen

DUBAI (Reuters) - Gulf Arab companies face constraints in using Islamic finance because of its lack of depth but will increasingly use it for debt and private equity as demand grows among Muslims, regional business leaders say.

Western companies are looking to Islamic debt to tap Middle East petrodollar wealth and Gulf Arab firms are using Islamic financing as they spend oil windfalls on acquiring firms in Europe, the United States, and Asia, speakers at the Reuters Middle East Investment Summit in Dubai said this week.

"The beauty of Islamic finance is that it can coexist with Western finance," said Peter Barker-Homek, chief executive of Abu Dhabi National Energy Co. (Taqa), which is planning to raise as much as $2 billion this year by selling Islamic bonds to finance acquisitions.

"It is an alternative investment base that is deep but isn't as deep as conventional finance."

Secondary trading in Islamic bonds, or sukuk, is nearly nonexistent, with most bought and held to maturity. Sharia law bans payment of interest, allowing money to be earned only from physical assets. This makes it difficult to trade debt or receivables for anything other than par value.

But as the sophistication of Islamic markets and products grows, Muslim investors will increasingly shun conventional finance and a greater proportion of petrodollars will be invested along Islamic principles, summit participants said.

Islamic financial institutions, including non-bank operations such as insurance firms, manage more than $800 billion, according to data cited by the Islamic Development Bank in its 2005-2006 annual report.

Gulf firms are raising sharia-compliant money to fund takeovers of Western companies. British luxury car maker Aston Martin, for example, was acquired earlier this month for $925 million by a consortium including Kuwait's Investment Dar, which invests according to Islamic law.

GROWING DEMAND

The world's 1.2 billion Muslims are increasingly insisting that their money be invested according to Islamic principles, which bans alcohol, gambling, and pornography.

"Once you see Islamic finance producing similar returns and products to conventional products, you will see a shift," said Atif Abdulmalik, chief executive of Bahrain-based private equity group Arcapita. "You used to pay a premium. The legal fees used to be prohibitive. Now it's mainstream."

Gulf-based private equity firms, many controlled at least in part by governments, are moving to Islamic finance despite the restrictions it places on investments.

"There isn't a history of sharia-compliant private equity, and you have to do an extra amount of work to set it up properly," said Keba Keinde, CEO of Dubai-based Millennium Finance Corp, controlled by Dubai Islamic Bank.

"In terms of finding leverage Islamic finance has made progress in adding depth."

Millennium will manage funds that will invest $10 billion over the next five years in sectors including energy, media and telecommunications.  Continued...