· Hong Kongs Legislative Council is considering a bill that will ease taxes on transfers of underlying assets of Islamic finance products, giving them equal treatment to conventional instruments;
· But Hong Kong lacks cultural connections and a large shariah-compliant investor base. Investors might instead be looking to invest in China;
· The bill only covers assets located in Hong Kong. To include assets in China, China would need to amend its relevant laws for equal tax treatment of shariah-compliant products;
· Hong Kong is competing with Singapore, which is closer to large Muslim-majority countries like Malaysia and Indonesia, as well as Malaysia itself, which boasts the worlds largest Islamic finance market
Hong Kongs Legislative Council is considering a bill that will ease taxes on the transfer of underlying assets in shariah-compliant products, allowing the city-state to build an Islamic finance market. But the move is unlikely to raise its profile as an Islamic finance centre.
Although Malaysia is a widely recognised Islamic finance centre buoyed by a steady flow of domestic issuers, Hong Kong and Singapore are both vying to be destinations for international corporates looking to raise Islamic financing.
Singapore has already passed a similar law and has seen a few issues, including Axiatas dim sum sukuk in September 2012. But Hong Kongs law may not spark a significant volume of Islamic finance deals.
Latham & Watkins Craig Nethercott said there were similarities between Dubai and Malaysia, and to a lesser extent Singapore - underpinning those markets is a cultural preference for shariah-compliant financing.
Where does Hong Kong find its unique spot in that market? "In competition with those Islamic finance centres, the hope is that Middle Eastern interests will see Hong Kong as a gateway into the Chinese market," said Nethercott.
A debt capital markets banker agreed, noting that the move would ensure Hong Kong had both the full suite of conventional products as well as Islamic finance products.
Who will issue sukuk?
But it may be difficult to find issuers. The draft bills provisions only include Hong Kong assets, or shariah-compliant portfolios with Hong Kong shares. The laws do not apply to PRC-based assets.
The banker predicted that the first issuer would probably be government-linked, as there is little incentive for a corporate private issuer to take that step.
Although many have predicted that an investment-grade Chinese real estate developer might be the first corporate to issue a Hong Kong sukuk ijarah (sale-and-leaseback structure), it would need to hold significant Hong Kong assets in order to do so.
Hong Kong doesnt have a natural investor base for shariah-compliant products. As Nethercott said, it lacks a cultural closeness to the Islamic finance market.
The city-state has seen Islamic transactions in the past, most notably a shariah-compliant loan facility for Noble Group that represented the first Islamic funding transaction completed by a Hong Kong-based borrower.
Regardless, Hong Kong will still have to contend with Singapore as an Islamic finance destination for international corporates.
Singapore is ahead of where Hong Kong is in terms of equality between conventional bonds and sukuk, said Nethercott. The trading and other connections with Malaysia and Indonesia probably makes them an interesting one to watch but they havent had enough traction in the sukuk market and arent yet a threat to Malaysian dominance.
Although some say that Indonesia is a jurisdiction to watch, sources told IFLR it is likely to remain a domestic market.
On the other hand, Malaysias Islamic finance market is much more developed than both Singapores and Hong Kongs. But its currency controls create complications for foreign investors. Practitioners have suggested that Malaysia open up the euro, pound sterling and US dollar-denominated markets to become a true global Islamic finance centre.
Nethercott agreed that the dominant Islamic finance market in Asia was Malaysia.
"If the Malaysian market further develops its ability to attract international investors, itll be out of sight from the perspective of its regional competitors its so far ahead," he said.
FULL TEXT OF THE INLAND REVENUE AND STAMP DUTY LEGISLATION (ALTERNATIVE BOND SCHEMES) (AMENDMENT) BILL 2012: http://www.legco.gov.hk/yr12-13/english/bills/brief/b02_brf.pdf
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How the global Islamic finance market developed http://www.iflr.com/Article/3125125/How-the-global-Islamic-finance-market-developed.html
Sabana reit convertible paves way for Islamic finance growth http://www.iflr.com/Article/3101391/Sabana-reit-convertible-paves-way-for-Islamic-finance-growth.html
Axiata sukuk signals use of new assets in Islamic finance http://www.iflr.com/Article/3101307/Axiata-sukuk-signals-use-of-new-assets-in-Islamic-finance.html