Money Laundering: Pulling out the rug – Turkey slips back

Money Laundering Bulletin

 Turkey has major gaps in its AML regime - Construction of the new Golden Horn Metro Bridge, in Istanbul (2013).

Conflict rages just over the border in Syria yet Turkey goes slow (even backwards with recent amendments of its customs code) on terrorist financing. So, what is the agenda? asks Paul Cochrane.

Turkey may be on the frontline of the so-called 'war on terror,' but its new customs code asks no questions of incoming cash, while its definition of terrorism has been criticised for contrasting with international standards. Furthermore, judicial independence and reliability of the rule of law in the country are both often in issue.

Turkey's geographical positioning has always made it a crossroads between east and west. The country is a conduit for the heroin trade flowing to Europe from Afghanistan, a gray market exchange and trade hub for (sanctioned) Iran, and an entry point for fighters joining the ranks of the Islamic State (IS) and other radical groups in conflict-ridden Syria and Iraq. The country has also experienced multiple terrorist attacks over the past 12 months, including a devastating attack in the capital Ankara in March this year which killed 32 people.

Free cash flow

Yet despite myriad of problems, and removal from Financial Action Task Force (FATF) ongoing monitoring in 2014, Ankara has enacted legislation that would seem to be a gift to money launderers, organised crime and terrorism financiers.

In April, 2015, the Ministry of Customs and Trade amended the 2013 Customs Code, making it two pages shorter (now four), and allowing any amount of cash to enter or leave the country – the previous limit was US$50,000. “Frankly, why does it matter if the money comes in cash or through a bank as long as it is money earned from exports? If this is dirty money, it will not be allowed to enter the country. There are no changes with regard to unrecorded cash,” said the Minister of Customs and Trade, Nurettin Canikli, arguing that the newer code represented a simplification, as the previous version, albeit had been in line with EU regulations, was “unclear".

Canikli's statement, though, is not supported by the new code's text, which reads: “Revenues from the export of goods and services, revenues with regard to transit trade, cash from foreign capital and other resources are free to enter the country through custom gates. [The value of] the items is not required to be declared and passengers cannot be forced to make declarations.”

With the economy slowing down and the Lira having dropped by over 20 percent against the US dollar since 2014, the move is seen as a way to foster the return of much-needed Turkish cash. “It is more of an effort to repatriate holdings abroad than help terrorists or money launderers but, regardless of the intentions, it does open the door to these types of transactions,” said Atilla Yesilada, Istanbul-based analyst at Global Source Partners Inc, an international business advisory service. “As IS has a pernicious and pervasive network in Turkey, I speculate that there's no way to distinguish between legal money coming into the country and cash to help IS and other [designated terrorist groups] like Al Nusra Front. From a domestic viewpoint, it's a big problem.”

The new customs code is but one sign of Ankara's lacklustre approach to anti-money laundering (AML) and countering the financing of terrorism (CFT). “They were on the FATF gray list for several years, and were removed because they enacted laws that codified the approach to terrorist financing, but at the end-of-the-day it was a bureaucratic manoeuvre, as it didn't necessarily make the place safer from a AML and CFT perspective,” said Jonathan Schanzer, the vice president for research at the Foundation for Defense of Democracies, in Washington DC.

Gateway to the Front

On several fronts Turkey is not playing ball according to international AML/CTF rules say experts, frustrating international efforts to curb financing to the likes of IS. Its border with Syria and Iraq is “like Swiss cheese”, said Yesilada, and the country is still an entry point for Islamic fighters, over four years after the conflict started in Syria in 2011.

“Even today for Westerners seeking to join IS, they get a one way ticket [to Turkey], and make their way east. Apparently crossing the border [into Syria] is not challenging. Border issues are among those tracked by FATF, and this one has gone rather undocumented. Turkey is due for an evaluation as the deficiencies are clear,” said Schanzer. However, FATF scrutiny will not happen any time soon – the country's next mutual evaluation report (MER) is slated for release in 2019.

Law and effect

CFT legislation that Ankara adopted to avoid an earlier threat of being expelled from FATF in 2013 – the Law on the Prevention of the Financing of Terrorism - included freezing and confiscation of assets, but the question of enforcement remains. The US State Department is among those with concerns – stating, in June 2015, that while the government “has issued freezing orders without delay (three to five days), it remains unknown whether any assets have actually been frozen”.

FATF and the US have also criticised Ankara for not having a wider and more international approach to combating terrorist financing. “Efforts to counter international terrorism are hampered by legislation that defines terrorism narrowly as a crime targeting the Turkish state or Turkish citizens,” stated the US State Department's 2015 country report.

A mute point

So it is odd that the Turkish government has avoided being flagged for its CFT deficiencies by FATF and other agencies. Some say this is because of Turkey's strategic importance to NATO, with the Incirlik air base being used for strikes against IS, and to the European Union (EU) in tackling the Syrian refugee crisis. “Because Turkey is a NATO country and not a basket case like Sudan or Iran, they are able to get away with quite a bit. There is a sense among Western policy makers that its a bit dangerous to air [concerns] and tackle them head on, so instead they kick the can down the road on illicit activities in Turkey,” added Schanzer.

Reporting, supervision, prosecution

Meanwhile, evidence that concerns about Turkey's AML and CFT regime are warranted continue to pile up. According to a 2013 report by the country's interior, justice and finance ministries, no judicial investigations into terrorist financing had ever been conducted. But following FATF's threat to demote Ankara from the gray to the black list, the finance ministry’s Financial Crimes Investigation Board (MASAK) has been a bit more active. In its latest report, on fiscal year 2014, 0.4% of all suspicious activity reports (SARs) were related to terrorism, while out of 623 judicial notices issued, 10 were related to terrorist financing, compared to 117 related to tax evasion and 83 to fraud.

“MASAK has fined banks for failing to have the necessary AML mechanisms in place, but not many, if any, individual convictions for financial crime have resulted from SARs or MASAK intelligence,” said a London-based financial crime researcher who focuses on Turkey and asked for anonymity. MASAK did not respond to interview requests from MLB.

Political influence

Disquiet over judicial inaction has also been fuelled by the dropping of a high-profile case that surfaced in December 2013, in which four ministers and the son of the then Prime Minister (and now President), Recep Erdoğan, were accused of being involved in a 'gas for gold' deal when an alleged US$13 billion was traded between Turkey and Iran, in breach of international sanctions.

“The judiciary has removed all the prosecutors and judges responsible for those trials from the profession. The parliament has also acquitted the four ministers named in the indictments,” said Yesilada.

Nor was any judicial action taken following a Turkish prosecutor's report in 2013 into some US$100 billion in illicit transfers from Turkey to Iran to circumvent the multilateral sanctions against Tehran. “The report was essentially scuttled,” said Schanzer. “The entire (judicial) process is completely devoid of transparency, so there are serious problems.”

Discontinuance of such cases is widely considered to be politically motivated, part of the ruling Justice and Development Party's (AKP) consolidation of power within the country which, since 2013, has included overhauling the judiciary to remove supporters of political leader Fethullah Gulen. The state has also been increasingly heavy handed with academics and media outlets speaking out against the AKP; in March, the government seized control of Zaman, one of the country's leading private newspapers.

“The AKP has managed to have control over who it appoints. As a result you don't have the separation of powers in a democracy between the executive, legislative and the judicial branches. It doesn't necessarily exist in Turkey at the moment, so it's hard to talk of the rule of law. As a system, you don't see prosecutions in cases where the government or those affiliated are accused,” said the financial crime researcher.

Indeed, the overhauling of the judiciary extended to members of the police force as well as ministries and the central bank. On top of political meddling in the legal process, it has left government bodies without experienced personnel.

“The purging of people from institutions has hurt institutions somehow. In their defence, I'm not saying they're not functioning, but they've lost a lot of human capital, experienced people who were not with the AKP. Now there's no one to replace them,” said Emre Deliveli, an independent economist based in Turkey.

Photo from Wikicommons, by Arild Vågen

Child labor in agriculture on the rise in Lebanon

Executive magazine

The sun is rising over the Anti-Lebanon mountain range that borders Syria. Kowsa Ibrahim, a 12 year old refugee from Aleppo, is already at work pruning grape vines. She will work for the next several hours for 6,000 Lebanese Lira ($4), although she will not get that amount; an overseer, known as a “shawish,” will take 2,000 LL ($1.33) as a form of commission.

Kowsa prefers working the vines to collecting potatoes. “It’s better as there’s more shade. Potato work is out in the open fields under the sun, and it’s hard. I collect the potatoes in 20 kilogram sacks which I have to carry to the collection point,” she says.

Kowsa never had to do such back-breaking work in Aleppo, but for the past three years she has had to help support her family since fleeing Syria to Lebanon’s Bekaa valley. The war in Syria, now in its sixth year, has caused millions of refugees to flee their homes, putting significant strain on already stretched labor markets and services in neighboring countries.

“The number of working children has increased exponentially since the Syrian refugee crisis began. Because the country is struggling economically many families are relying on their children to contribute to their livelihood,” says Hayat Osseiran, a child labor consultant at the International Labor Organization (ILO).

In addition, international aid has been reduced. Last year, the World Food Program (WFP) was forced to cut its food voucher aid from $27 a month per refugee to just $13.50.

“It is a major problem, how can people live on that? But it is not only lowering the monetary amount, the targeted assistance program has been reducing the number of people it aids every year,” says Solange Matta Saade, Assistant Representative at the Food and Agricultural Organization (FAO) of the United Nations.

As a result of such cuts and the economic situation, refugee children are being forced to work as farm hands. But it is not just Syrian children working in the fields.

“We think only Syrians are being affected, but from 2009 to 2016, there has been an increase in the number of Lebanese child laborers,” says Carlos Bohorquez, a child protection specialist at UNICEF, referring to a study the agency carried out on child labor in the country. “There are three times more Lebanese (children) working than before, so the Lebanese are also being affected.”

Out of school, into the fields

There is a dearth of national data on child laborers, but an indication of the rise in their numbers can be gaged through school attendance.

“Last year there were around 10,000 Lebanese students that dropped out,” said Sonia Khoury, Director of the RACE project (Reaching All Children with Education) at the Ministry of Education and Higher Education (MEHE).

Among Syrian refugee children the numbers are even starker. Currently, out of the 482,034 school aged Syrian children, only 33 percent are enrolled in school. To bolster attendance among refugees, the MEHE’s RACE project implemented a second school shift in the afternoons to cater to the surge in students.

“Four months after starting the second shifts we lost 45,000 students,” says Khoury, attributing this to children being forced to work and the lack of affordable school transportation in the more rural areas. There is also a correlation between the picking season and school attendance.

“We are noticing 2,000 to 3,000 are absent during that time,” she adds.
However, the problem has moved beyond seasonal work. “Child labor in agriculture is classified as seasonal labor, but what we’re seeing now is that it is no longer the case as picking seasons vary, from potatoes to year-round greenhouses to picking flowers,” says the ILO’s Osseiran.

Hazardous work

It is not only the workload that Kowsa finds tough. She says she has been frequently exposed to pesticides. “I get a rash from the pesticides. Sometimes I get flu or breathing difficulties too as we get no protection,” she says.

Such exposure can lead to pesticide poisoning and long-term health problems, explains Rana Barazi-Tabbara, a public health lecturer at the American University of Beirut.

“For children it is especially dangerous as there will be immediate health effects from pesticide toxicity, which at the most acute level can cause vomiting and even death. In the long term, pesticides affect nearly all the organs in the body, from the neurological to the reproductive system, and results in cancer,” she says.

Raising awareness

Indeed, the ILO notes that agriculture is one of the three most dangerous sectors in terms of occupational safety and health, irrespective of the age of the worker, because – in addition to occupational diseases – it results in a high rate of work-related fatalities and non-fatal accidents, largely through use of motorized agricultural machinery.

To raise awareness of these dangers, the agency held a children’s funfair in the town of Saadnayel in the Bekaa, one of the areas with a high prevalence of child labor in agriculture.

“The fair was one of our ways to raise awareness, among both locals and refugees, on the very real dangers and risks children face when working in agriculture,” says Osseiran as the fair closes, which was held just ahead of World Day against Child Labor, marked globally on 12 June. “It also included artistic performances by working children and their parents, which provided them with a means to express some of the distress they feel due to their life of toil and hardship.”

Legal loopholes

Children have often been extra hands during harvesting time to pick olives and other cash crops in Lebanon. In fact, children as young as 10 are legally allowed to engage in family farming.

“Not all participation by children in agriculture is defined as child labor. It can be to acquire skills for the future, and is allowed as long as the children are not coming to harm, being abused, or their opportunity to get an education is denied,” says Faten Adada of the FAO’s Social Protection Focal Point.
Lebanon’s Decree No. 8987 of 2012 defines which forms of agricultural labor minors can engage in.

“It specifies which forms of hazardous work and which forms of agricultural work children should not be exposed to, which includes family farming. However, there is a loophole in the law that says that when a child is engaged in family farming they can work from the age of 10 onwards. We are working with General Security on closing this loophole,” says Nazha Shalita, Director of the Child Labor Unit at the Ministry of Labor.

Minimal enforcement

But with minimal enforcement of the Decree at the national level, children are openly working in the agricultural sector. “As children are working freely, and can be filmed doing so, it shows they are not worried about being caught,” says Adada.

An issue is that the inspection department at the Ministry of Labor has just 90 staff, while there are only around 45 inspectors to monitor labor practices nationwide. To Adada, such inspectors need to be bolstered not only in number but also at the technical training level to properly assess child labor practices, while they should be backed-up during inspections by the General Security. This is considered crucial to take on the shawish.

Forced labor

“We asked General Security to enforce the law, to have a reason to tell the shawish that it is not us (requiring no children to be employed) but the law. We need to show them the law is being enforced, and to get more inspectors for the ministry,” says Elie Massoud, Head of the Agriculture Department at the Chamber of Commerce, Industry and Agriculture in Beirut.

The shawish used to organize Syrian farm hands that came to Lebanon on a seasonal basis before the 2011 uprising. Once the Syrian conflict started, and the number of refugees rose to the government estimated 1.5 million today, the shawish moved into the informal refugee camps to capitalize on an abundance of cheap labor and their agriculture contacts.

“Those living in the agricultural camps pay no rent, and they are obliged to work for the shawish. If they don’t work, they have to leave,” says Riad Jaber, Co-Founder of civic organization Beyond, at the Fayda camps outside of Zahle.

“There are 15,000 refugees there – it’s about 10 camps grouped together, and each group has its own shawish. If there are at least 100 women and children going from their camp, the shawish will be making about $200 a day,” he adds.
Unless greater action is taken by the authorities and public awareness around the issue improves, children will continue to be exploited and exposed to hazardous working conditions while missing out on crucial schooling years.

“There should be a concerted effort by the Lebanese government, supported by international donors, to eliminate child labor in agriculture, among refugees as well as Lebanese host communities. Unless it is addressed, it will contribute to a ‘lost generation’ in terms of education and human development,” says Frank Hagemann, Deputy Regional Director of the ILO Regional Office for Arab States.


Photo by Tabitha Ross/ILO

Jordan's Pharmaceutical Sector Punches Above Its Weight

Zaatari Refugee Camp. ‘Bluntly, demand for pharmaceuticals did not reflect the 15% rise in the population. Refugees are buying in small quantities, and only the essentials,’ said Mohammad Shahin, Chairman of JAPM. 

Manufacturing Chemist

By Paul Cochrane in Amman

Jordan may be small in population terms, but it packs a hefty punch in the Middle East pharma manufacturing sector

With a population of just 6.6 million, Jordan may be a small country but it is one of the largest pharma manufacturers in the Middle East. A key reason for this is that production is export focused, particularly in the generics sector.

The country’s manufacturing sector, with an annual turnover of US$500m, had been steadily growing at 8–10% per year until 2012, according to the Jordanian Association of Pharmaceutical Manufacturers and Medical Appliances (JAPM). But since the ‘Arab Spring' of 2011, exports have slowed due to instability in the region, notably the conflict in neighbouring Syria.

Development is also being hindered because Jordan, unlike some of its regional competitors, notably Iraq and Iran, abides by the World Trade Organisation (WTO) Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) and data exclusivity. Since becoming a member of the WTO in 2000 and signing a free trade agreement with the USA in the same year, Jordanian companies have not developed any significant new medicines.

That said, Jordan’s domestic pharma market is growing. According to UK- based BMI Research, the total market, including imports, reached Jordanian Dinars JOD643m ($905m) in 2014, and is forecast to grow by 6.4% in 2015, to JOD683m ($962m). Samer Al-Ansari, Marketing Director for the Middle East and North Africa (MENA) at Hikma, one of the region’s leading pharma manufacturers and exporters, established in Jordan and listed on the London Stock Exchange, says the total market grew by 9.4% in 2014, while according to BMI generic growth was 10.5%.

Driving sales is burgeoning population growth, at 4.2%, further boosted by the influx of Syrian refugees: 937,830 were registered as of 2015, according to the United Nations High Commission for Refugees (UNHCR). Demand comes from the UN and other agencies supporting the refugees, and the market’s value is increasing due to the entry of patented products with high prices as well as an increase in generics, said Al-Ansari.

However, aid agencies import medicines and individual refugees have low purchasing power. ‘Bluntly, demand for pharmaceuticals did not reflect the 15% rise in the population. Refugees are buying in small quantities, and only the essentials,’ said Mohammad Shahin, CEO of the Jordan Sweden Medical and Sterilisation Company (JOSWE), and Chairman of JAPM.

The Jordanian healthcare sector is heavily supported by the government, with the ministry of health providing insurance to 40% of the population, followed by state health services organisation Royal Medical Services (RMS) covering 27.5%, according to the Jordan Journal of Pharmaceutical Sciences (JJPS). Government healthcare spending is on the rise, projected to go from JOD1.86bn ($2.62bn) in 2014, to JOD1.97bn ($2.78bn) in 2015, a 6.2% increase, according to BMI Research.

In 2016, compulsory health insurance is scheduled to be introduced to cover all Jordanians. If such a move happens, it is expected to be a boost for pharmaceutical sales. ‘The goal is to have local insurance companies support the private sector, but so far it has been only discussions, nothing has been agreed on yet. But you see that Jordan is moving towards the privatisation of healthcare, and wants to boost medical tourism,’ said Al-Ansari.

Jordan has 16 pharmaceutical firms, which manufacture mostly generics or branded generics, bulk antibiotics and cancer-related treatments. The market is dominated by Hikma, followed by Dar Al Dawa, Arab Pharmaceutical Manufacturing, JOSWE, Pharma International and United Pharmaceutical Manufacturing. ‘Local companies supply around 20% of total domestic consumption, and the rest is imported,’ said Shahin. More than 70% of Jordanian pharma production is for export, to more than 65 countries, primarily in the Middle East, Africa and Asia.

Regional instability has had a negative impact on exports, affecting the country’s overall economy, which is expected to grow by just 2.5% in 2015, according to the International Monetary Fund. ‘Our export markets are challenged to Iraq, Syria, Egypt and Saudi Arabia, as well as to Yemen and Sudan. You can anticipate issues in one or two countries but not four surrounding countries all having problems,’ said Hana Uraidi, CEO of the Jordan Enterprise Development Corporation (JEDCO).

Financing has also been complicated by the instability, while credit lines are under pressure. ‘It’s hard to get extended credit lines as insurance companies are seeing Jordan as higher risk, so traders have to pay up front, and we have a cash problem. If we take out loans it affects overall costs and profits. Before, we thought the situation would calm down after two or three years, but the government is now forecasting problems for 10 years,’ she added.

The closure of the Syrian border has hit the pharmaceutical sector particularly hard, as it was a major transit route for exports to Lebanon, and on to Turkey and northern Iraq, while the western Iraqi border has also been closed due to the presence of Islamic State. Companies are managing, however, to export to Kurdish Iraq and Baghdad, avoiding areas controlled by IS, while the central Iraqi government is still delivering drugs.

‘Overall exports are down by around 10–15% on 2014. It is not only neighbouring countries that have affected us, the whole region is affected, and in certain countries it is not clear who is in control. Payments are another problem,’ said Shahin. JOSWE expects a drop of 10% in its sales this year, with its business evenly split between local sales and exports.

Syria was not an export market for Jordanian manufacturers prior to the conflict as the country was practically self-sufficient in pharmaceutical production. But although the Syrian sector has been ravaged by war it has started exporting to the Arab Gulf and north Africa, according to Shahin, which has detracted from Jordan’s export competitiveness due to low prices.

Looking ahead, it may be generics that really underpin the Jordanian pharma sector’s success. WTO membership and its US trade deal have forced the country’s pharma sector to be transparent about producing generics and original research is still at an emerging stage due to a lack of investment, according to a 2015 article in the JJPS. The Jordanian Scientific Research Support Fund inked four agreements with public and private universities to develop pharmaceutical and medical research projects, worth $479,660 in September 2015, but it is not expected to cause any major upturn in the overall sector given the large investments elsewhere in the world.

‘We had hoped when we signed the WTO and IPR agreements that there would be a transfer of technology and know-how from multinationals to the local industry, but it’s been an unfulfilled promise,’ said Shahin.

Currently, local producers engage in contract manufacturing for global majors, which contributes to less than 5% of the sector’s overall revenue, according to the JJPS. The rest of production is generics under licence, with most licensing agreements still in effect signed before 1999.

Heightened competition

Due to data exclusivity and a lack of diversification, there is heightened competition among manufacturers, while JAPM estimates that few companies are operating at more than 40% of installed capacity. ‘Pharmaceutical companies are all making the same product, and each product has 15 or 20 competitors, while some have 50 or even 100 if we include imports as well,’ said Shahin. Such products include second-, third- and fourth-generation generics. To bolster business, JOSWE has started producing generics not in the market, but few others have followed the same route.

‘JAPM is trying to advise companies not to add more similar generic products but to create variety and products not in the market,’ added Shahin. The overcrowded generics market has led to a domestic price war, with companies trying to sell the same generics at a price 20% lower than the originator drug.

Companies are also having to make their generic products known in the market. ‘In the EU or the US you can sell a generic by its scientific name, but in the Middle East and North Africa (MENA) it is branded generics, so you have to build up a brand name,’ said Al- Ansari.

The fact that the writ of TRIPS does not run across Jordan’s region is a problem: ‘You find firms in such countries registering more products than us as they are not as strict in protecting IPR agreements,’ said Shahin. Egypt, for instance, has no TRIPS-Plus provisions, mandating more data exclusivity in its IPR law, yet it has had more foreign investment in its pharma industry, boosting competition for Jordan.

Price controls in Saudi Arabia to protect domestic production, and protectionism in Algeria to encourage pharmaceutical manufacturing are also affecting Jordanian exports.

The JJPS noted that data exclusivity related to TRIPS affected Jordanian exporters, as they ‘will be out of their export markets for at least seven years – five years’ protection due to data exclusivity, one year registration time in Jordan and at least one year registration in the export market’.

Meanwhile, exports to Africa have been affected, added Shahin, by changing rules and prices in certain markets, as well as the need to compete with cheaper imports from India and the Far East.

To bolster sales and enter more stable markets, Jordanian pharmaceutical companies are preparing for EU accreditation. Hikma is already in the EU market, but it is easier for US products with Food & Drug Administration (FDA) approval to enter than Jordanian products, said Al-Ansari.

But while its MENA business has been affected by the regional unrest, Hikma has continued to expand its portfolio globally. In 2014, it acquired the US’s Bedford Laboratories, and in 2015 bought the US’s Roxane Laboratories Inc and Boehringer Ingelheim Roxane Inc. Last September, the company acquired Egypt’s EIMC United Pharmaceuticals.

Hikma’s generics business, which sells non-injectable products in the US market, generated revenue of $216m and accounted for approximately 15% of group revenue. ‘If there is potential and a need we’ll bring some products (from the newly acquired companies) from the US to Jordan,’ said Al-Ansari.

Photo Credit: US State Department photo/ Public Domain

Hot Air in the Saudi Desert: a Kingdom in Descent?

Counterpunch, 5 May 2016

The Kingdom of Saudi Arabia (KSA) is in financial dire straits. Since the plunge in oil prices, the kingdom has been hemorrhaging money left, right and center. It has provided billions of dollars to shore up counter-revolutionary governments around the Middle East, especially Egypt, it is heavily involved in the Syrian conflict, and is burning through some $6 billion a month waging war on impoverished Yemen. The country needs oil to be $104.6 a barrel, according to the Institute of International Finance, for its budget to break-even; the current price is around $45.


Finances have become so tight that from being the second largest importer of armaments worldwide in 2010–14, deputy Crown Prince Mohammed bin Salman (MbS) has said the kingdom aims at sourcing up to 50 percent of arms from local producers to help diversify the economy. It is as much of a pie-in-the-sky idea as turning KSA over the next several years into a knowledge-based economy.

What is also indicative of the financial difficulties ahead is that commercial banks have tightened lending to anyone outside of the government, with the state the primary borrower, according to a senior financial officer in Riyadh. “There is a liquidity crunch at the banks, and it is the government that is borrowing, so companies are suffering,” he said.

Stories abound across the Middle East – the whole region’s economies are intrinsically linked to Gulf petro-dollars – of salaries and contracts not being honored due to cash-flow problems within the KSA government and at major companies. Indeed, Saudi construction firm Binladin Group laid off over 12,000 Saudi employees this week, and a further 77,000 foreign workers were given the given the boot.

According to the same source – and not reported in the media – state-owned petrochemical giant SABIC has been laying off workers as well. With government investment drying up, as for oil giant Aramco, funds are instead being diverted to minerals and gold vehicle Maaden, which had been sidelined when oil prices were high, and now a priority in these low oil price times.

To try to mitigate such economic pressures, Riyadh is planning a Thatcherite sell-off of major government entities to drum up more cash. It is causing a lot of excitement and comment in the financial pages, as top of the pile is the plan to float an initial public offering (IPO) of up to 5 percent of Aramco, supposedly the world’s largest oil producer and valued at some $2 trillion. The plan ties in with MbS’ recently announced ‘Vision 2030‘ to diversify the kingdom’s economy away from hydrocarbons, which account for 70 percent of government revenues and 90 percent of exports. MbS even stated that the economy would be weaned off oil by 2020; a curious date, as it is the same as the IMF have predicted the kingdom could be effectively bankrupt.

The problem is that KSA will not have diversified by then, or most probably by 2030. As one analyst put it, MbS is “pulling the wool over everyone’s eyes” by implying the country can stay afloat without oil. Indeed, hydrocarbon revenues are critical to enable diversification in the first place. And if oil revenues are not readily available, which they are not, then private funding is needed, but that too is now limited at commercial banks. Furthermore, Riyadh has talked of weaning the economy off oil for decades, yet the most notable financial success in that effort has been in petrochemicals, a spin-off industry of oil extraction.

There has also been significant talk of Saudization – the hiring of Saudi nationals instead of foreign workers. That too has been a failure, with just over 40 percent of Saudis making up the labor market (just under 30 percent are employed by the state). Even with the requirement for firms to hire Saudis, the private sector has been loath to do so, as any off-the-record discussion with managers will tell you. “I’ve hired some Saudi women, as they are likely to stay around, but men? No. When I’ve hired Saudi males it’s a challenge to maintain them, and often they will not even show up. They’re also not easy to fire. It is a headache, and counter-productive,” said one manager at a Saudi conglomerate. Firms end up employing foreigners to do the work Saudis are supposed to do. The same applies for all the dirty and sweaty jobs in summer temperatures typically above 104 Farenheit. Yet KSA will need as many as 6 million additional jobs by 2030 to cater to the burgeoning population.

“The government is no longer in a position to hand out jobs willy-nilly. It has to be through the private sector, but that needs radical change in the educational system, which will take years, as it is heavily focused on academia, like Islamic studies or math, not vocational studies like plumbing. This is the issue, and jobs need to be filled by Saudis, or else there’ll be huge unemployment,” said a London-based analyst.

Incentives to work in the private sector also need to be overhauled, with the unemployment program providing some 2,000 Riyals ($533) a month, which is more than the salary for many jobs. Such benefits are in jeopardy, but that is something Riyadh cannot afford to renegade on, as government fiscal support is essential for the monarchy to stay in power. Even when the government has tried to reduce expenses, like cutting subsidies for water and electricity back in December – prices rocketed by up to 1,000 percent for water – the public backlash caused Riyadh to back-track, with the utilities minister saying in March that citizens could get permits to dig their own wells due to the higher prices; he was sacked in April.

The biggest challenge lies with MbS’ plans. Privatizing part of Aramco would force the country, and the company, to be more transparent, something the Saudis have balked at since Aramco was nationalized, while no updated oil estimates have been published since it was un-incorporated from Delaware in the 1980s.

Indeed, for there to be any investor confidence in the Aramco IPO, oil reserves will need to be published, yet just the nine-member executive committee know the true figures, according to a source at Aramco. Furthermore, if a US Embassy cable from 2007, leaked in 2011, is anything to go by, Saudi Arabia overstated crude oil reserves by up to 40 percent. Sadad al-Husseini, a former vice president and head of exploration at Aramco, was forced to tell the media following the revelation that he had been “misrepresented” by the US diplomats, and he “did not question in any manner the reported reserves of Saudi Aramco.”

Such concerns about actual reserves, and what oil price to base the IPO on – $45 a barrel, or an optimistic $100? – is likely to result in a dual listing, in KSA and in London or New York. In any case, only big players are likely to get a cut of the action, as to gain access to the Saudi stock exchange, the Tadawul, foreign investors have to have around $5 billion in assets under management.

Key to the whole Vision 2030 malarchy is MbS, the son of aging and reportedly unwell King Salman. Speculation is rife as to how long King Salman will live, and – the multi-billion dollar if – MbS will replace him on the throne. MbS has certainly annoyed many in the Saudi establishment, as well as among the legions-strong royal family. He has also annoyed the wealthy by repeatedly stating they should contribute to the country’s transformation, and has imposed a White Land tax, on undeveloped land, which was long used as a form of patronage and speculation. If MbS falls from grace, what will happen with the Vision and privatization plans? As it stands now, it will all be hot air. But trouble is undoutedly brewing as oil prices remain low, problems abound within the kingdom and the wider region, and by even the most optimistic outlook, diversification efforts will flounder.

If and when - to bank Iran: Anti Money Laundering and Combatting the Financing of Terrorism

www.moneylaunderingbulletin.com 

 

The international agreement limiting its nuclear ambitions signed, Iran is 'open for business'. But US sanctions remain largely in place, adding to Western banks' caution in dealing with the Islamic Republic, so long a pariah state. The biggest challenge, says Paul Cochrane, will be to reintegrate the country's financial institutions into the international system when they have spent years adapting to and circumventing sanctions.

Financial sanctions were imposed by the United States following the revolution in 1979, and ramped up during the Clinton and George W. Bush administrations. Multilateral sanctions, imposed by United Nations Security Council resolutions (UNSCRs) and the European Union (EU) from 2007 onwards, especially in 2011, hit Iran even harder, narrowing an already limited window to operate in the international financial system.

“One of the Iranians' primary objectives was that the financial sanctions originating from the EU and UNSCRs were removed within the comprehensive nuclear deal, whereas they were less concerned about US financial sanctions as Iran has lived with those for over three decades, and the systems to move around US sanctions have been well oiled within the country,” noted Emad Kiyaei, executive director of the American Iranian Council. The Iranians' objectives have been largely met. The EU and UNSCR's sanctions have been significantly eased, although crucial designations remain concerning terrorist financing and human rights. Attention now turns to bring Iran's outmoded financial and compliance machinery up to current international standards.

The Financial Action Task Force (FATF), in October 2015, stated that it “remains particularly and exceptionally concerned about Iran’s failure to address the risk of terrorist financing and the serious threat this poses to the integrity of the international financial system”. The body warned that if Iran fails to take concrete steps to improve its CFT regime, it will consider calling on all countries and jurisdictions to strengthen counter measures against it. The message was repeated at the February 2016 plenary.

FATF's hesitation to act is not surprising – it voiced the same concerns in June 2014, with an October 2015 deadline that passed without any action - but reform is clearly needed. “Iran's banking sector is in a difficult situation given they have shouldered the majority of the burden of the strangling sanctions. Major reforms are required, with many Iranian economists agreeing that the banking sector is a ticking bomb in terms of deficiencies and shortcomings,” said Ali Vaez, Senior Iran Analyst at the Brussels-based International Crisis Group.

Private enterprise

Part of the problem is that smaller banks in Iran are almost designed to be sanctions-busting institutions. The more recent sanctions, especially those imposed on the Central Bank of Iran (CBI) and major state banks, forced change on the domestic financial system. “One phenomenon, witnessed under the (EU and UN) sanctions was the mushrooming of private banks. The Iranians needed ways to get around sanctions, so a lot of smaller banks were basically a part of a game of cat and mouse that allowed Iran to survive the storm of sanctions,” said Vaez.

The  fledgling institutions developed ties with small and medium-sized banks in Asia, particularly Malaysia and India, but also Russia, the United Arab Emirates (UAE) and Oman, to indirectly access the international system. Creative ways to move money proliferated - through trade-based money laundering (TBML) and barter, including the “gold for gas” deals with Turkey, which surfaced in 2014. Smuggling increased, empowering factions like the Iranian Revolutionary Guard Corps (IRGC) to take a direct role in the black market; so corruption spiked to keep trade alive, diverting it through non-official channels.

The restrictions imposed on Iran “led to the most comprehensive and innovative web of ML and circumventing ventures on a national level in the history of sanctions. The mechanisms for breaking sanctions have been institutionalised,” said Kiyaei. “A major cause of corruption, nepotism and cronyism is due to the reliance on so many players to circumvent the sanctions. It's a chronic problem, which does not bode well for a more transparent regulatory system to be put in place.”

Compliance - a culture of workaround

Any change in the short term will be difficult. The CBI brought in a formal AML regime in 2008, but a compliance culture has not been embedded in financial institutions - unsurprisingly, since many were previously encouraged to break rules to work around the sanctions. “There is now a mentality of constantly moving around restrictions, be it government-imposed sanctions on how to lead your life – censorship - or sanctions on the central bank, financial institutions and the economy. This has created, from an anthropological point of view, a crazy society, a tendency towards circumvention,” said Kiyaei.

Furthermore, there appears to be little political room to force through economic and banking reforms. “The difficulty is that (President Hassan) Rouhani almost exhausted his political capital to bring about this nuclear agreement, so there's less appetite for structural reforms,” said Vaez.

If there was any doubt about the scale of the task he faces, Iran was ranked number one in the Basel Institute on Governance's AML Index 2015, as well as in 2014, with the caveat that it was boosted to the worst spot by lack of data on the sector available from the CBI and the local financial sector (see my MLB article on Iran in 2014). Gauging the true extent of Iran's AML deficiencies is therefore difficult: with its well-entrenched siege mentality, the government in Tehran is not tuned into transparency.

“When you cut off Iran from the world, the world is cut off from Iran, so when a major part of the economy goes into the shadows then regulatory transparency measures are almost impossible to implement. What is interesting is that the Iranians are obsessed with statistics – the data is actually pretty decent - just access to it from outside entities is deemed a national security issue at a time of sanctions, and there's an access problem as there's no presence of Western (financial services) outfits,” added Kiyaei.

Iranian financial institutions have also encountered obstacles when trying to access lists of designated individuals and entities under sanctions, because - in a cold irony - the relevant software could not allowed to be traded under the EU and US sanctions. While this has been lifted, restrictions remain in be sold to them under EU and US sanctions. Although this bar has been lifted, restrictions remain on sale of software with possible nuclear or military application.

“The Iranians wanted access to the Bankers Almanac (for due diligence in correspondent banking) but the software vendors were accused of breaching sanctions. The Iranians have been going around in circles as they can't buy information to do AML checks,” said Nigel Kushner, CEO of W Legal Limited in London. “I'd be surprised if the majority of banks have any reputable screening in place.”

Unacceptable risk

Iranian financial institutions are struggling for re-acceptance by their peers overseas, which might also act as a discouraging break on moving to adopt international standards and take compliance seriously. Iran has been readmitted to SWIFT, the secure payments messaging network used by banks globally, but its banks still need to find correspondent banks to handle their transactions.

The newer “private banks haven't necessarily got the knowledge or track record which some counterpart banks are looking for, so they will suffer in that aspect. Many (Western) banks are taking the line: the money we will make is not worth the exposure. I've not seen any signs of clearing banks jumping back into the Iranian market, and an additional issue at the moment in London is Iranian banks can't find a clearing bank,” said Kushner.

  

Similarly, Western banks are reluctant to enter Iran amid ongoing uncertainty over sanctions - whether they might "snap back," as envisioned in the Joint Comprehensive Plan of Action; the country's domestic environment; and substantial past fines for violations by US regulators. “Big banks remain reluctant to re-engage in the Iranian market out of fear the (nuclear) deal is not as sustainable as it appears given opposition (by certain political factions) in Tehran and Washington DC, while banks paid huge fines for previous work with Iran so are very risk adverse,” said Vaez. 

Some of the fines are fresh in the corporate memory: in November 2015, Deutsche Bank was fined US$258 million, and in October 2015, France's Credit Agricole was fined US$800 million by the New York State Department of Financial Services for violating sanctions on Iran and Syria. In 2014, France's BNP Paribas was fined nearly US$8.9 billion for violating US sanctions against Iran, Sudan and Cuba.

These fears are reinforced by US government statements that it is not yet time for business-as-usual with Iran. In addition, past recommendations and regulatory settlements restricting trade with Iran often still stand. “In 2011, the US said Iranian banks were a source of concern for ML, so foreign banks will have to do enhanced due diligence, and secondly, many of the large UK clearing banks have been fined by US enforcement agencies over the past several years and entered into settlement agreements. In many cases they're not to have any dealings with Iran or Iranian banks, and the US said (in January) the easing of sanctions does not supersede these agreements. So some banks have their hands tied behind their backs,” said Kushner.

Image via Wikicommons.

Shaky foundations – Money Laundering and Real Estate Compliance

Money Laundering Bulletin

Tourist accommodation and high-end residencies are considered convenient vehicles for laundering illicit money.

Real estate has only recently started to come under the regulatory AML spotlight shone on other sectors, says Paul Cochrane, and not before time.

Money laundering into real estate (MLRE is the acronym in AML circles) has not garnered the same attention as the drug trade, sanctions enforcement or combating the financing of terrorism (CFT). Indeed, as Louise Shelley, founder and director of the Terrorism, Transnational Crime and Corruption Centre (TraCC) at George Mason University, Virginia, USA, observes, there has been surprisingly little research done globally on MLRE compared to other sectors.

“We have so little data on MLRE in general. We don't know how much is related to corruption, transnational crime or terrorism. I think the problem is as bad or worse than a few years ago,” she said. Shelley recalled how, in her testimony to the US House of Representatives financial services committee's task force to investigate terrorism financing in September (2015), she stressed that "if there are no reporting requirements in this area, then there's an enormous loophole that can be used." (1)

Regulatory oversight

The US is not alone in not treating MLRE as an AML priority. At the Financial Action Task Force (FATF) plenary in Brussels in October (2015), MLRE was suggested as a future typology topic, but was turned down. Instead half of the meeting was spent on ways to curb Islamic State (IS). “This doesn't mean MLRE is not an issue but it is seemingly not a priority,” said a senior source from European AML body Moneyval. The latest FATF 'Guidance for Real Estate Agents' was published in 2008 (2). “A big issue is that FATF has not really focused on this, never issuing best practices or a risk-based approach for real estate agents,” he added.

Building a picture

Meanwhile, the scale of MLRE could be eye-watering, based on the limited research available. “Real estate accounted for up to 30% of criminal assets confiscated in the last two years, demonstrating this as a clear area of vulnerability,” stated FATF in its June 2013report 'Money Laundering and Terrorist Financing Vulnerabilities of Legal Professionals'. Shelley's research has shown that in Colombia between 1997 and 2004, some US$10 billion was laundered into real estate, with only a fraction of the amount confiscated. Her studies have also shown high rates of suspected MLRE in Turkey and the United Arab Emirates (UAE). She highlighted tourist accommodation and high-end residencies as convenient vehicles for laundering illicit money, with cash-based economies particularly vulnerable.

More recent cases show MLRE is a serious concern. In 2014, an international drugs trafficker was convicted by a Miami, Florida court for laundering over US$14 million in narcotics proceeds by buying high-end real estate and luxury vehicles. (3)

In the UK, a report released by Transparency International-UK in February (2015) stated that, between 2004 to 2011, more than UK£180 million (US$276 million) worth of property was brought under criminal investigation as the suspected proceeds of corruption. (4)

Political recognition

Such exposure has prompted the UK to start taking MLRE more seriously. In a speech in Singapore in July (2015), Prime Minister David Cameron said that with “UK£122 billion [US$187 billion] of property in England and Wales owned by offshore companies we know that some high-value properties – particularly in London – are being bought by people overseas through anonymous shell companies, some of them with plundered or laundered cash.” (5) There are more than 100,000 property titles in Britain registered to overseas firms according to Cameron and the TI-UK report.

This concern may be heightened by FATF's explicit reference to MLRE exposure in its standards. Recommendation 22 states that “customer due diligence and record-keeping requirements set out in Recommendations 1, 11, 12, 15, and 17, apply to designated non-financial businesses and professions (DNFBPs)... including the buying and selling of real estate.” Meanwhile Recommendation 20 states that real estate agents are another gatekeeper in terms of assessing risk and carrying out due diligence.  

No laughing matter

But there is recognition that the real estate sector has generally not been abiding by the Recommendations. "Whenever I go to do evaluations it borders on the comical when we meet real estate agents. The level of due diligence is far behind any other gatekeepers,” said the Moneyval source. “I'd say the biggest vulnerability is that those involved in real estate transactions, usually the agent or a notary, don't see the risk or appreciate it. What we see in Moneyval countries is that they don't really conduct any due diligence, especially on sources of funds.”

How many, sorry, few reports?

In the UK suspicious activity reports (SARs) from the real estate sector accounted for 0.05% of overall filings from October 2013 to September 2014, according to the National Crime Agency (NCA). “Our judgment is that the level of reporting is too low by the government, private sector, and the National Association of Real Estate Agents,” said Nick Maxwell, Head of Advocacy and Research at TI-UK. He chalked this down to a lack of awareness in the sector, not least since anyone can set-up as a real estate agent.

The UK's Office of Fair Trading issued fines against three real estate agents for almost UK£250,000 (US$384,593) in March 2014, but since HM Revenues & Customs took over responsibility for AML enforcement, in April 2014, there have been no further sanctions. 

“There's not been any action yet [by HMRC], so there's little reason for real estate agents to fear sanctions to improve standards. It is not just real estate agents but also professional enablers, as transactions include lawyers, accountants, and financial service providers, which should be covered by AML regulations,” added Maxwell. “But with hundreds of millions being laundered, if you compare that to the fines, it is questionable if fines are a deterrent.”

No cases in Eire

In Ireland, MLRE has not surfaced as a prevalent issue. “I never encountered an instance of money laundering through real estate deals. There have been fairly well documented incidents of mortgage fraud, but actual laundering schemes, I've not personally seen that,” said Shane Martin, a Regulatory Compliance Director at Walkers, an international financial law firm in Dublin, and a former regulator at the country's central bank. 

Obstacles to change

Opposition to regulation plays its part.“The agents know the problem, but if the sector was better regulated and required to report SARs, it would mean a lot of real estate deals would come apart, especially foreign deals, as laundered money usually goes into more expensive property,” said Shelley. “In the US, it would need Congress to enact legislation, and if justified in terms of national security, there may be some change.”

Jurisdictions have also been turning a blind eye to MLRE due to the capital inflows. Dubai, in the UAE, is a case in point. A compliance officer at an Arab bank, who asked not to be named, said that MLRE was a primary cause of the 2008-9 financial crisis in the region, and is an ongoing problem. “Of course it is happening. It is known and the talk of the town, but that is it,” he said.

Company registers

That said, some jurisdictions are getting more serious about MLRE, partly due to the heightened international focus on corruption, tax information-sharing, and transparency of company ownership. In the UK, the Land Registry is slated to publish data later this year on foreign ownership of real estate in England and Wales to heighten transparency about beneficial ownership in the sector. In the US, 17 non-governmental organisations sent a letter to the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) asking to repeal certain provisions granted to the real estate sector in the Patriot Act in 2002. (6).
Media exposures about shell companies driving up property prices in New York have also had an impact (7). This was followed up in July by New York City requiring new disclosure requirements on shell companies buying or selling property (8) and on January 13 this year, FinCEN imposed Geographical Targeting Orders that will require certain US title insurers, which play a central role in most property transactions, to report the beneficial ownership details of companies used to pay "all cash" for high-end residences in Manhattan, New York and Miami-Dade County, Florida.(9)

“New York's decision on beneficial ownership came at the same time as Cameron's announcement, and these [together with the FinCEN orders] are promising policy developments. We are seeing an era of secret ownership of property coming under pressure,” said Maxwell.

The Fourth EU Money Laundering Directive (4MLD) – to be implemented by July 2017 – also fosters increased transparency of property ownership, requiring EU member states to hold information on beneficial owners of all corporate and other legal entities in a national central register. How such requirements are applied will be key to any success. “The CEPI-CEI (European Council of Real Estate Professions) recognises the need to have strong rules in place at a European level. It is vital that those rules are proportionate to the risk involved and do not represent an unreasonable burden on professionals working in the sector,” said a spokesperson.

But even if real estate agents file more SARs and carry out effective due diligence, supervision at the national level remains an issue.“In many countries there are not enough resources to supervise the financial sector, so who will supervise the real estate sector? Another issue is that the new methodology of FATF is very focused on higher risk areas, so if the real estate sector is considered to not pose significant risk, then resources will not be allocated,” said the Moneyval source. Some countries are also deregulating real estate agencies. “If they don't know the number of agents nationally, how can they know what the market looks like to supervise it?”

1. Testimony of Louise Shelley - http://financialservices.house.gov/uploadedfiles/hhrg-114-ba00-wstate-lshelley-20150909.pdf

2. http://www.fatf-gafi.org/media/fatf/documents/reports/RBA%20Guidance%20for%20Real%20Estate%20Agents.pdf

3. https://www.irs.gov/uac/Examples-of-Narcotics-Related-Investigations-Fiscal-Year-2014

4. 'Corruption On Your Doorstep: How Corrupt Capital Is Used to Buy Property in the UK,' Transparency International-UK - http://www.transparency.org.uk/our-work/publications/15-publications/1230-corruption-on-your-doorstep

5. Tackling Corruption: PM speech in Singapore - https://www.gov.uk/government/speeches/tackling-corruption-pm-speech-in-singapore

6. Letter to the US Treasury on Money Laundering -http://graphics8.nytimes.com/packages/pdf/20150311_towers/letter-to-treasury-on-money-laundering.pdf

7. http://www.nytimes.com/news-event/shell-company-towers-of-secrecy-real-estate?action=click&contentCollection=U.S.&module=Collection&region=Marginalia&src=me&version=newsevent&pgtype=article

8. http://www.nytimes.com/2015/07/21/nyregion/new-disclosure-rules-for-shell-companies-in-new-york-luxury-real-estate-sales.html 

9. http://www.nytimes.com/2016/01/14/us/us-will-track-secret-buyers-of-luxury-real-estate.html?_r=0

Islamic Finance: Closer to the spotlight

Accounting and Business

While there is clearly a demand for more socially sustainable banking, Islamic finance experts are calling for a slow and steady approach to developing the sector. Paul Cochrane reports

Oman has introduced a new Islamic banking regulatory framework and amended laws to level the playing field with conventional finance.

Despite its high profile, Islamic finance is arguably still stuck in third gear. Valued at more than US$2 trillion worldwide, and having grown exponentially over the past decade, the niche financial sector nevertheless has yet to achieve the critical mass that will take it to the next level and challenge conventional finance more effectively.
Islamic finance is ethical finance. By eschewing debt, interest and speculation, the sector is trying to harness populist sentiments that oppose the darker side of conventional finance and which have been in full flow since the global financial crisis.
Omar Shaikh, executive board member of the Islamic Finance Council UK, says: ‘There seems to be an increasing narrative around ethical finance and Islamic finance converging. This is particularly poignant against the background of the financial crisis and ongoing banking scandals. Unfortunately it does not seem to be a one-off blip, as mis-selling, rate fixing and other scandals are repeatedly occurring, yet there seems no material systematic change in the banking framework. Considering this and the ongoing austerity measures, society is still hurting from the banking crisis, and people are eager to see a more socially conscious form of banking.’
In the wake of the sub-prime financial crisis, Islamic finance has garnered significant attention as an alternative financing model. Its instruments are considered better suited to financing infrastructure projects in cash-strapped, debt-averse developing countries, while its more ethical principles are fast colonising a growing niche in conventional finance.
Indeed, Turkey, which last year held the presidency of the G20 group of major economies, organised a meeting in Istanbul in May along with the Global Islamic Finance Development Center of the World Bank to discuss how Islamic finance can contribute to global economic recovery. Discussions are also under way between the Islamic Development Bank and China to use Islamic financing in the recently launched Asian Infrastructure Investment Bank (AIIB).
However, the instruments and mechanisms needed to allow the sector to capitalise on its virtues are not yet there. Shaikh says: ‘The current environment is certainly an opportunity for Islamic finance, but perhaps an opportunity that has come too early.’
The International Centre for Education in Islamic Finance (INCEIF), a university set up by Malaysia’s central bank to develop human capital for the sector, is actively researching ideas in the Islamic finance space. The goal is to have potential frameworks available when the timing is more opportune. Obiyathulla Ismath Bacha, professor of finance at INCEIF in Kuala Lumpur, says: ‘We are coming up with prototypes of how Islamic finance should be. The next issue is to apply them in practice, which has not happened yet as commercialisation has not taken place.’
Malaysia has grown into one of the world’s Islamic finance hubs because of its willingness to innovate. Bacha says: ‘The Malaysian position is “let’s experiment and keep to the spirit of sharia, although not necessarily to the letter”. That model has worked well, and that’s why we’re pioneers.’
One of the most crucial developments is Malaysia’s Islamic Financial Services Act, introduced in 2013 to provide a stronger legal platform to develop the sector. It set up a comprehensive regulatory framework covering the various Islamic financial contracts for products and services. Bacha says the law came into effect last year, and is seeking to change the way Islamic finance is carried out. It could become a global benchmark for the sector.

Tighter sharia compliance

He adds: ‘I’m sure there will be mis-steps that need corrections along the way, but if all goes according to plan, in 10-odd years the Islamic finance topography will be totally different. What has been happening until now is pseudo conventional banking that has come in for a lot of criticism, and it’s easy to see why.’
Islamic finance institutions have come in for criticism for not following sharia principles closely enough and for lack of transparency. This is attributed to the relatively recent arrival of the sector, which has only developed since the 1970s. As a new industry, needing to bring depositors on board, it could not be radically different from conventional banking because of the financial risks involved. However, as the sector has matured, it has started moving away from the path of least resistance and more in a sharia- compliant direction.
Such diversity has meant a lack of standardisation at a global level. As anyone who has ever been to an Islamic finance conference will confirm, this issue is well recognised, and invariably the subject of a keynote speech. But with the sector having grown by 17.6% between 2009 and 2013, and forecast to grow by an average of 19.7% a year to 2018, according to EY figures, not all observers agree that formal standardisation is needed to ensure growth. Instead, they believe the focus should be on making the sector truly sharia-compliant, while allowing for diverse solutions from that base.
Samer Hijazi FCCA, director in KPMG’s financial services practice, in London, says: ‘So much has been said about standardisation, but I’m not 100% sure it is that great an issue. The dealings between [the Islamic financial hubs of] the Gulf, the UK and Malaysia have not caused that much trouble. What I’d like to see is greater standardisation around governance and compliance frameworks, and what compliance and regulations are going on in the background, so that investors are confident they are dealing with a truly Islamic finance institution.’

Levelling the playing field

Shaikh sees such an approach helping align Islamic finance structuring and models across the board. The UK’s issuing of a sovereign sukuk (an Islamic bond) is an example – it was announced in 2007 but did not happen until 2013 when the necessary structures were in place and the regulatory framework amended. Another example is Goldman Sachs’ first US$500m sukuk, announced in 2012. Its structure was initially contentious and the bond didn’t float until two years later after issues had been resolved. When these sukuks finally floated, they were both heavily oversubscribed, indicating the interest in long-term structured returns.
Elias Moubarak, head of finance at law firm Trowers & Hamlins in the UAE, says: ‘Penetrating a market that doesn’t encourage that product means a tough sell. That’s why Islamic finance needs support at a policy level to create a level playing field. As we see policymakers react, we should see a regulatory regime develop that encourages socially sustainable investments.’
Such progress is afoot. Oman introduced a new Islamic banking regulatory framework and amended laws to level the playing field with conventional finance in 2012. The Gulf state issued a sovereign sukuk last year.
Hijazi thinks a slow and steady approach is best. While opportunities for greater Islamic financing abound, and there is clearly demand for more socially sustainable banking, he thinks the sector should consolidate further and strengthen its foundations before rolling out new instruments and services. ‘I wouldn’t want to go down the innovation route over the next 12 months,’ he says, ‘but get houses in order and go for innovation down the line.’


Photo of Muscat by Paul Cochrane