The Silk Road was ancient China's important channel for cultural, commercial and technological exchanges with the outside world. Analogously, the cocktail of renminbi development, the new regulatory regime in the post-financial-tsunami period, financial risk management and financial innovation, as well as much-talked-about Islamic finance in Hong Kong may yield a renaissance, a new Silk Road, in finance.

Promotion of Islamic finance in Hong Kong is part of the government policy as expressed in the 2007 Policy Address. The expansion of the renminbi bond market in Hong Kong provides huge investment opportunities for Islamic investors.

Although the troubles of Dubai World precipitated difficult times in the global Islamic finance market, the growth of Islamic finance has been stunning over the past decade. That is in part because of the investment made by the oil-rich Gulf Cooperation Council (GCC) nations in the Middle East. According to a Sovereign Wealth Fund Institute's report, the total assets under management of GCC nations reached approximately $1.4 trillion in March 2010, accounting for about one-fifth of global foreign exchange reserves.

Developing Islamic finance in the city is a wise move, judging from the huge business potential in that market segment.

However, Hong Kong faces two major challenges in developing Islamic finance in the city, namely, product innovation and human capital development. The government is working on a modification of the taxation framework, in areas such as profits tax, property tax and stamp duty, in order to facilitate development of Islamic bond (sukuk) markets. Financial innovation will be addressed in areas of Islamic structured products, Islamic Real Estate Investment Trusts listed in Hong Kong with exposure to the mainland's properties and Islamic ETFs.

Given a relatively small domestic Islamic community, education about Islamic finance is needed, especially for financial institutions. An understanding of Islamic beliefs and practices is a foundation in expansion of sukuk and takaful (Islamic insurance) markets. Core areas include Islamic commercial law, Islamic capital markets and instruments, sukuk, Islamic banking and takaful - the latter being an Islamic form of cooperative and mutual insurance conforming to Islamic moral and financial principles.

Islamic finance involves a combination of trade and specific investment principles in a fast-changing global financial system. The current Western financial system does not fulfill the requirements of Shari'ah rules and principles prescribed in the Qur'an and the traditions of Prophet Muhammad.

Major principles governing Islamic equity screening include core business activities, financial ratio analysis and non-Halal (lawful and permitted) income consideration. Types of prohibited core business activities under Shari'ah include interest-based financial products, conventional insurance, pornography, gambling, alcoholic beverages, pork production, tobacco products and armaments.

Financial ratio screening emphasizes a low level of debt ratio. For example, Islamic investors are not allowed to invest in any firm whose interest-bearing debt/equity ratio is greater than 33 percent; whose liquidity ratio is greater than 33 percent and whose receivables ratio is greater than 49 percent. Following the 2008 financial crisis, any first-year finance student understands that massively over-leveraged firms or economies might not be sustainable in the long run in a world with a bankruptcy risk. The debt crisis of Greece and demise of Lehman Brothers show that this theory really works. The third principle states that income from non-core activities should not be greater than 5 percent of the total revenue. For example, Islamic investors can invest in China Mobile, PetroChina, Hong Kong Electric and Esprit in Hong Kong.

The author is program director at University of Hong Kong SPACE. The views expressed are entirely his own.

(HK Edition 07/20/2010 page3)