The Fajr of Islamic Finance in Japan

Etsuaki Yoshida
Japan Bank for International Cooperation & Visiting Associate Professor, Waseda University

1. Introduction As is widely shared among people as common knowledge, Islamic finance is available to and offered by non-Muslims as well as Muslims. One of the characteristics of modern Islamic finance is that non-Muslim countries with a highly developed financial center are quite positive toward involving the Shariah compliant financial business into their financial systems. The United Kingdom and Singapore are good examples. One of the more recent characteristics in the industry would be that, unlike the aforementioned two countries with substantial amount of Muslim population on their islands respectively, jurisdictions with little Muslim population, such as Korea and Hong Kong, are also trying to step into the newly growing market. Japan is not an exception. Rather, the worlds second-largest economy is known among the industry people as a potential issuer of sovereign sukuk since around 2006, although the status remains potential. Japan's positive attitude toward Islamic finance in the recent days can be most characterized by the amendment in the banking regulation in December 2008 to allow Islamic financing. Still, it has a long story until we witnessed this symbolic event. I will discuss details of the amendment later in this article, after introductory explanation of Islamic finance development in Japan. In this paper, I try to explain how non-Japanese people can do Islamic finance business with Japanese institutions by showing the situation of 1

the Fajr, or dawn, of Islamic finance in the country.

2 Salient features about Japans Islamic finance 2-1 The recent growing interests As in many other non-Muslim countries, the growing interest in Islamic finance came with the rising oil price. Many seminars have been held, including the one held by Islamic Financial Services Board (IFSB) and Japan Bank for International Cooperation (JBIC) in 2007, and the one that Nikkei Newspaper organized in 2008 involving 500 audience. Newspapers and economic magazines reported the coming of the new trend in the international finance. This can be seen in the growth of Islamic finance articles shown in Figure 1. Figure 1 The number of newspaper articles including Islamic finance
# articles

200 180 160 140 120 100 80 60 40 20 0 00 01 02 03 04 05 06 07 08

Source: Nikkei Telecom The decrease in 2008 compared to the previous year can be interpreted that, the more Japanese come to know what Islamic finance is, the less introductory articles were written, as well as the fact that the sub-prime shocks, the financial crisis, and sharp fall of oil price affected activities of Islamic finance transactions. More than ten books were published in the Japanese language in these three years. Although many of them contain a lot of misunderstanding and wrong information, at least we can see that many publishers thought Islamic finance was a good topic for publishing. 2-2 Chronology of Japan-related Islamic finance The beginning of the relations with Islamic finance for Japan is difficult to detect through written materials, but an old book titled Islamic Banking: Theory, Practice and Challenges written by Fuad Abdullah Al-Omar & Mohammed Kayed Abdel-Haq in 1996 indicates that a Japanese bank, the then Industrial Bank of Japan, was Involved in Islamic trading, approximately in the 1980's in London. Not only this, but many Japanese firms were engaged in Islamic transactions, and this is often emphasized by many bankers, people at 3

energy companies, and those at general trading firms, or Sougou Shousha, that were based in London in those days. Yet, I must point out that "Islamic finance" in this context is slightly different from what it is now. Those people were engaged in Inah type of transactions. The "borrower" buys certain amount of goods, such as oil and gold to name just a few, with deferred payment, and sells them back to the seller, or the "lender" with payment on the spot to the borrower. The price of the spot payment is lower than that of the deferred one, and the differentials between the two is virtually traded as interest rate. This was considered Islamic, being the differentials on the surface taken as profit of trading goods, not as interest rate. This type of financial transactions are different from our modern Islamic finance in the sense that there was no screening by a Shariah board, the players that offered credit were not necessarily financial institutions (but oil traders or similar), i.e., it was not institutional. Still, I think the fact that some Japanese people were engaged in these Islamic trades is of help in some ways when the modern Islamic finance came to be introduced to Japan as new global phenomena in international finance. Along with the rise of the oil price, Islamic finance has come up to the scene in Japan around 2004-2005, and those with experience of Islamic transactions already had sense of it and explained it to other Japanese. In 1990's, there were some Japanese asset management companies that offered Islamic fund products to Muslim investors mainly in the Middle East. Nomura Asset Management sold Al Nukhba Asia Equity Fund. DIAM, the then Daiichi-life IBJ Asset Management, offered Middle Eastern Fund for Japanese Equities. These products were screened by Shariah board, and in this sense, we can recognize these as Islamic in the modern sense as well. Unlike today, this trend of selling Islamic products was only a regional phenomenon as they were sold only in the Middle East. major incidents related to Japan. Figure 2 Recent development of Islamic finance related to Japan Year 2001 2004 2004 2005 2005 2005 2006 2006 Institution Tokio Marine Tokio Marine Tokio Marine JBIC ARCAPITA Tokyo Commodity Exchange JBIC Bahrain Monetary Agency 4 Content Launched Takaful business in Saudi Arabia Set up Retakaful company in Singapore Started Takaful business in Indonesia Co-financed with Islamic to Bahrain Set up Islamic Fund for Japanese properties Signed MOU with BMA for Islamic trades Established Shariah Advisory group Held seminar in Japan We need to wait for the rise of oil price until we see Japan-related Islamic finance in the global context. It happened after 2004. Figure 2 shows

2006 2007 2007 2008 2008 2008 2008 2009

Tokio Marine JBIC Aeon Credit Malaysia Tokio Marine Toyota (Malaysia) Nikkei Financial Services Agency SMBC / BTMU(Malaysia)

Established Takaful company in Malaysia Joined IFSB as a first Japanese institution Issued Sukuk Takaful license was given in Egypt Issued Sukuk Held a big Islamic finance seminar Changed the banking regulation Set up Islamic Banking teams Source: Various sources

We're all aware that Islamic finance has developed as a global trend. In this sense, Japan, albeit with little Muslim population, is not an exception.

2-3 Details of the recent legal amendment and its background As mentioned in the beginning of this chapter, there was a change in the Japanese banking regulation to accommodate Islamic banking with its financial system. A clause was added to the Ordinance for the enforcement of the Banking Act. Note that this, however, is not a situation of all or nothing, i.e., it is wrong to interpret that Islamic finance was completely prohibited before the amendment and is totally allowed after it. Although there is no official translation in English, the added clause (17-3-2-2) in the Ordinance goes as follows; A transaction that is deemed equal to money lending, though it is not money lending (, is included in the business domain of a banks subsidiary) This can be done if the following two conditions are met according to the clause; The transaction is the one that must not involve interest rate due to the religious constraint. The transaction should be authorized by those who have expertise in the religious discipline. Here are some explanatory notes. Islamic lending is not considered as money lending, because money lending should involve interest rate by definition. Regarding those who have expertise in the religious discipline, it of course means Shariah scholars. In order to fully understand the content of this amendment, it is necessary to know why this happened. In Japan, Islamic banking was considered to be difficult to be offered by a bank due to the existing Banking act. Article 10 (Scope of Business) says that, A Bank may conduct the following businesses: followed by business offered by a bank such deposit and loans. Article 11 admits activities related to banking business. Below is Article 12; 5

A Bank may not conduct business other than the business conducted under the provisions of the preceding two Articles and the business conducted pursuant to the provisions of the Secured Bonds Trust Act (Act No. 52 of 1905) or other laws. By this Article, an Islamic transaction that involves goods trading, such as those using Murabahah, Ijarah, and Istisna concepts, is considered to be out of the scope of a banks business. However, as interest in Islamic finance gradually grew up in Japan in 2006, there was a call from the financial industry for Islamic financial business, and this led to the amendment. Note that this clause has a couple of important points. First, it stipulates the business domain of a bank's subsidiary and in this clause Islamic finance is explicitly included into the business domain of a banks subsidiary. Although there is no word of "Islamic", it is just to avoid the name of a specific religion. Still, a bank itself is not allowed to offer goods-trading type of Islamic financing, according to the majority of legal experts. Second, financial institutions other than banks are allowed to offer Islamic products regardless of this amendment. Asset management companies sold Islamic equity funds, and a general insurance company was engaged in Takaful business even before this amendment. Third, the business domain of other financial institutions is not mentioned in this clause, and hence, it was not made clear if, for example, how (and by what type of financial institutions) Islamic products should be dealt. This raises a question. Are Sukuk dealt as bonds, or trust beneficiary rights? If the former, banks are not allowed to do Sukuk business, while they can handle Sukuk if the interpretation is the latter.

3 Transactions by Japanese players 3-1 Major examples of Japanese financial institutions offering Islamic business After the legal amendment in December 2008 as shown in the previous chapter, Japanese banks started to move. Sumitomo Mitsui Banking Corporation Europe established an Islamic finance team and is offering Islamic services out of London. They hired some non-Japanese experts from European banks, to strengthen this business. Bank of Tokyo-Mitsubishi UFJ also set up a unit of Islamic banking in its Malaysian entity and doing local business. Note that all these are possible because they are subsidiaries of each bank. Mizuho Financial Group has not made institutional change. However, Mizuho Corporate Bank have done a couple of Islamic transactions, including arranged an Islamic syndicated loan in Saudi Arabia, to the Ma'aden Phosphate Project, through its Dutch subsidiary. Arabia (at the time of writing). Although there is nothing to do with the mentioned legal amendment, securities firms are also on the move. Nomura started a team for Islamic structuring. Its asset management arm established a solely Islamic firm in Malaysia. Daiwa launched an Islamic ETF (exchange traded fund) listed on Singapore Exchange. Both Nomura and Daiwa have dealt with Sukuk underwriting in their London-based firms. 3-2 Examples of Japanese Sukuk issuers and other users Not only the sell side, but the buy side of financial services is also on the move. For example, there are a couple of Japanese corporations that have issued Sukuk. Aeon Credit Service (Malaysia), a credit card and loan service provider, became the first Japanese sukuk issuer when they did it in 2007. The Musharaka-backed sukuk was a MTN/CP program, denominated in Malaysian Ringitt. The sukuk proceedings are used for their Islamic financing, including personal loans and motorcycle loans that are Shariah compliant. Toyota followed this movement. Its subsidiary, the then UMW Toyota, established a Sukuk facility denominated in Malaysian Ringitt, also to finance their auto-loan business. In Pakistan, a local entity of ORIX Leasing issued sukuk. In this sense, the sukuk issuance by Japanese corporations is so far targeted for their local business: not for a global business. If we include Islamic borrowings, not only issuing sukuk, we can see more examples. Sumitomo Chemicals joint project with Saudi Aramco, Petro Rabigh, raised several billion USD of funds including Islamic tranches. Trading companies in Malaysia are using Islamic financing for their daily operations. Also, the Group is in the process of establishing an Islamic capital markets business entity in Saudi

4 Analysis: toward more Japan-related Islamic business 4-1 Why Japan lacks track records Despite the growing interest in the nation and its economic position in the global context, it seems Japan has not yet seized the opportunity of Islamic finance business substantially. If we turn our eyes on other financial centers, all of these, such as UK, US, Singapore, Hong Kong, have Islamic business in their markets. According to my analysis, there are three major reasons: lack of appropriate knowledge, lack of networking, and geographical & historical shortcomings. The last cannot be changed right away, and I will discuss the first two and consider solutions to each point for more Japan-related Islamic transactions. (1) Lack of appropriate knowledge As the Islamic finance industry gets more globalized, it has come to be known in a deeper and wider manner among the Japanese. Many seminars were held, many articles appeared on papers and magazines, and more than ten books were published in the Japanese language, as introduced earlier. Although the quantity of information is big, it seems the quality of information is not sufficient. Since Islamic finance was very new to most of the Japanese, a lot of wrong information was conveyed to the people by those with only fragmentary knowledge. Consequently, Islamic finance was somewhat misunderstood among the people in the country. This implies there is a big room for education business by international experts. (2) Lack of networking Some professional Japanese bankers are already well informed and ready to offer Islamic transactions in their respective business fields. However, even those players are not well involved in Islamic transactions, and it seems one of the reasons for this is lack of communication with Islamic finance community in the market, both with clients and with co-financiers. One of the backgrounds for this is that Japanese financiers tend to offer financial services mainly to Japanese customers, even in overseas markets, although the situation is coming to change. This is a good comparison with US and European banks that tend to be outstanding on a global customer basis including stepping into local markets. Through these businesses, they soon face with demands for Shariah compliant services, while Japanese banks stay away from this demand. This lack of contact points, or networks with Islamic communities, is considered to be another major reason for less developed Islamic business among Japanese. 8

Again, this is a business opportunity for Islamic finance experts in global markets. Japanese bankers will be happy to welcome offers of assistance or collaboration in Islamic business. 4-2 Some ideas for doing Islamic finance business with Japan (1) Matrix Below are some ideas how Islamic finance can be applied to Japan-related transactions. In order to clarify scopes of business, let me introduce 2x2 matrix composed of retail-wholesale axis and domestic-overseas market dimension as shown below. Figure 3 Business domain matrix and rough ideas for business Retail Domestic - little Muslim population - growing demand for unit trust Wholesale - potential onshore sukuk issuers - outbound investment by Japanese institutional investors - inbound investment to Japan Overseas - Takaful - Retail banking unlikely as in conventional business - corporate finance - sukuk - investment & asset management - project finance in the Middle East Source: Authors own First, let us think about domestic-retail market. There is little Muslim population in Japan, with less than 0.2% according to muslimpopulation.com. This means that demand for Islamic products from religious motivations is not likely to be substantial. So, the need for banking, personal asset management, and insurance is not highly expected. Still, judging from the huge household financial assets, which amount to 14 trillion USD, investment products such as unit trusts can be a good idea along with the trend that more individuals have come to invest in capital market products, not only deposits. Islamic products can be considered as one of investment products regardless of their religious nature. Or, Islamic products may be held by those who would prefer socially responsible investment assets, because both kinds have many aspects in common, such as exclusion of alcohol and tobacco related equities, as pointed out by many people. Second, domestic-wholesale market. It has two main groups. One is Japanese borrowers and investors that may utilize Islamic products. As we see in the previous chapter, some Japanese firms have already raised funds in an Islamic manner through their local entities. This may spread to onshore, i.e., Japanese entities may issue sukuk. In order for this to be realized, 9

appropriate legal and tax treatments are of course necessary. Still, it is sure that there is huge potential demand, and they are not sure how Islamic transactions should be treated in terms of legal and accounting framework. The other group is on investors side. There are some Islamic investments from overseas into Japan. To assist these transactions will be a good business for those who operate domestically. Also, Japanese institutional investors are interested in holding Islamic assets. The third area is overseas-retail markets. The example of Tokio Marine, offering Takaful products in Saudi Arabia, Indonesia, and Malaysia, fits this category. This field is, unlike domestic markets in Japan, full of potentials given the existence of huge Muslim population. Lastly, wholesale business in overseas markets. This is the category with biggest possibility, given the fact that Japanese major banks and securities firms tend to focus on wholesale business, staying away from retail business that usually requires much higher initial cost. As shown before, Japanese banks and securities firms have the track records of Islamic wholesale transactions, which can be categorized to this area. Although Japanese financial institutions overseas business tends to target Japanese clients there, it is also true that Japanese financiers have come to explore local clients to expand overseas business. Offering Islamic financial services can be a key to success in countries with Muslims and business with Islamic financial institutions. Especially, those who try to survive in the Middle Eastern markets cannot stay away from Islamic demands. (2) Education and awareness among bankers Although I think a lot of Japanese bankers have basic understanding on Islamic finance, I must admit that it looks the level is not high and wide-spread enough. In this sense, I believe better and more practical skills should be needed, and this at the same time is a good business opportunity for education service providers in the world. As many of you may think, one of the difficulties in doing education business is language. A solution would be to have alliance with educational institution. Especially, Waseda Graduate School of Finance, Accounting and Law launched a class of Islamic finance in its regular curriculum since April 2008. The Graduate School held two seminars on Islamic finance. One was jointly with UK government with the presence of Lord Mayor, and the other was co-organized with Kuwait University. These can be seen as good collaboration between the school and foreign parties. For development of knowledge among people, one of the most major ways would be Islamic Finance Qualifications offered jointly by Securities and Investment Institute in UK and Banque du Liban. Although IFQ is not widely is known in Japan unfortunately, there are a couple of holders of the Qualifications. Introducing IFQ to the nation will be another good 10

way for improving peoples awareness. 5 Concluding remarks Japan has just started to catch up the global trend of the Shariah compliant financial business. This is not an easy task considering the religious background in the nation. However, we are surely seeing the Fajr of it in the country of rising sun, and with assistance from overseas professionals, I hope we will welcome a shining day in the near future.

11