Russia is enacting regulations and building infrastructure to enable Russian firms and eventually the government to issue sukuk- bonds compliant with Islamic law
This article originally appeared in Business New Europe
Cut off from Western capital markets, Russia is stepping up efforts to tap into the huge pools of capital in the Middle East by issuing Islam's answer to bonds, sukuk, which are not subject to Western sanctions.
Sukuk are especially attractive for Russia following its downgrade to junk status by rating agency Standard & Poor's in January. As the bonds are asset backed, the quality of those assets will be more important to potential investors than Russia's sovereign rating.
"Today, Russia has a low rating and is suffering from sanctions, but it is not the rating that will attract the investors but the quality of the assets and the returns the bond pays," Linar Yakupov, head of Russia's Islamic Business and Finance Development Fund, tells bne IntelliNews.
Russia's Islamic banking is still in its infancy, and the state has yet to launch a debut sukuk, but the government is actively working on putting in place the regulations that would allow for the issue of what is essentially a regular asset-backed bond with some special rules and restrictions.
"Islamic bonds are a mix of ethics and a structural product. They are broader than just the banking business and wider than the Middle East. It is a horizontal product," says Omar Shaikh, member of the board of the Islamic Finance Council in the UK. "It is a young market and still evolving. And it is not just for Muslims. Sukuk have attracted several billion dollars worth of investment and non-Muslim governments like the UK have issued them."
And Russia is already actively marketing itself; in December, officials from Moscow Industrial Bank, VEB, SME Bank and the Russian Direct Investment Fund (RDIF) were part of a trade mission to the Gulf region, where Islamic finance possibilities were high on the agenda.
And in the same month, Russia's National Rating Agency signed an agreement with the Bahrain-based Islamic International Rating Agency to jointly rate Russian sukukissuers. A few Russian firms have already got an Islamic bond rating, including an Islamic leasing firm in the Russian republic of Dagestan and a fish skin leather manufacturer in Ingushetia.
With a significant Muslim population of about 20m, Russia has already gone some way to developing Sharia-compliant Islamic financing structures.
The Autonomous republic of Tatarstan, one of the few predominantly Muslim Russian regions, has been a pioneer and already attracted some $8bn from the Middle East. It has done so well that at last year's KazanSummit, an annual event held in June, the Russian Ministry of Finance sent a deputy minister to see how it was done.
Kazan-based AK BARS Bank, the largest bank in the region and 18th largest Russian bank by assets, broke the ice by raising $160mn via two Islamic syndicated loans since 2011, and it hopes to tap the market for a for a third time this year.
From the mainstream Russian lenders, the state development bank Vnesheconombank (VEB), which is on the West's sanctions list, is leading the charge and has approached institutions in the Middle East for help. "VEB sets as its goal diversification of project financing instruments, and among those it considers Islamic finance tools," a VEB source told Reuters recently.
Russia's second-largest lender VTB Bank is also on the sanctions list and exploring sukuk deals for several clients. But to really get the ball moving, the Russian state needs to issue sukuk to set a sovereign benchmark to help price commercial issues – and that is still some way off. Tatarstan was hoping to issue the first regional government sukuk in 2011, but the deal failed to materialise.
Part of the reason is that the regulatory environment surrounding sukuk is a work in process, with a draft law to create the necessary regulation still at the first stage. The Association of Russian Banks in October asked the Central Bank of Russia (CBR) to start work on developing Islamic finance regulation, but there is still no timetable for when the law will be ready. Russia still has a steep learning curve ahead of it.
"People are afraid of introducing Islamic finance, as they don’t know it. In our country the new banking system was only introduced 20 years ago," points out Yakupov, the man who pioneered Russia's tie-up with the Islamic world in his previous job as head of Tatarstan’s regional investment agency.
"We have already been working on it for seven years and we will expand it when people understand the regulatory needs… The whole of the former Soviet Union sees Islamic finance as a way of attracting money from the Middle East and Southeast Asia; yes we can do that, but it is not the point. This is a new instrument, a new tool for government and business to use."
In this regard, the former Soviet republics of Azerbaijan, Kyrgyzstan and Kazakhstan are all well ahead of Russia. All of them are a lot closer to the Middle East, both commercially, geographically and culturally, and all have the regulations and Sharia-compliant banks already in place.
That's why the creation of the Eurasian Economic Union (EEU), which came into being on January 1, will also help spread Islamic finance to Russia, because the trade bloc unites the markets of Russia and Kazakhstan, allowing the freer movement of capital and making the sharing of regulatory frameworks easier, as well as increasing the pool of Muslim investors and Islamic-oriented companies.