202 AN INTRODUCTION TO ISLAMIC FINANCE
CHALLENGES FOR DEVELOPING AN ISLAMIC
CAPITAL MARKET
Developing capital markets is not an overnight task. Today’s conventional
capital markets are the result of years of evolution, and this has enabled
them to cope with the unprecedented pace of innovation that has been evi-
dent in the last couple of decades. Islamic capital markets can learn and
benefi t from the rich experience of the conventional markets to reduce their
own development time.
Today’s capital markets do not operate in isolation but, rather, are part
of a complex system that comprises several different components: the state of
the regulatory system, the quality of supporting institutions, the design of the
incentive and corporate-governance systems, and market micro - structure
and practices. In addition, other factors like the breadth of the market
determined by the product range, the existence of reliable benchmarks for
performance evaluation, the culture of market players and the degree of
integration with external markets are also critical to the development of an
effi cient capital market.
The major challenges facing the development of Islamic capital markets
are discussed below.
Legislative and Regulatory Framework
The existence of a strong legislative and regulatory framework is essential
for capital markets. Laws to protect the rights of investors and mechanisms
to resolve disputes in an effi cient manner help in establishing the confi -
dence of the investors. This issue has become increasingly relevant given the
greater competition to attract cross - border investors.
The majority of Muslim countries in which there is a demand for
Islamic products lack a sound legal and regulatory system. In many cases,
amendments are made to local laws and regulations on an ad - hoc basis
to accommodate the needs of a transaction, but this style of operation is
ineffi cient as well as frustrating for the players in the market. The frame-
work should facilitate the smooth execution of transactions without cre-
ating any of the technical, legal or regulatory issues that recent sukuk
issues have raised. For example, an ijarah sukuk transaction requires the
owner of the operating assets to enter into a leasing transaction. While
the owners are often governments or their related public - sector bod-
ies, the relevant laws and regulations in the host country may not allow
these public - sector bodies to pledge or lease assets needed to structure
the transaction. This is a fundamental point: the host country’s policy
actions to promote such Islamic fi nance will be a key prerequisite for the
market to develop further.
The following suggestions are made in this respect: