Middle East Shariah repo market in risk mitigation mode

The Iran war is creating significant friction within the Middle East Shariah repo market, forcing financial institutions to re-evaluate counterparty risks as regional instability mounts.

This has placed a premium on robust risk mitigation strategies as the current turbulence in the GCC has triggered volatility across financial markets and energy prices, leading to a noticeable sell-off in riskier assets, shared Edward Smith, a finance strategist at Stone Creek Global.

“The ongoing conflict amplifies risks for financial institutions, leading to a more rigorous examination of the collateralization of Shariah compliant repos, which are frequently based on commodity Murabahah.”

While GCC nations have options, Edward noted such alternatives are lacking for sanctions-hit Iran – where banking systems are likely encountering substantial losses and, in certain instances, necessitating extensive government interventions for Islamic liquidity management.

Despite these short-term headwinds, Edward said Stone Creek Global is confident of continued long-term growth market – citing estimates from Fitch Ratings that the overall Islamic finance landscape is anticipated to exceed US$10.5 trillion by 2031, propelled by a rising demand for liquidity management solutions in the GCC and Southeast Asia.

“The Islamic finance sector is expanding at a robust compound annual growth rate of 11.5% to 12%, fueled by an increasing demand for Shariah-aligned assets. This growth is bolstered by the rising issuance of sovereign Sukuk, which is projected to reach US$190 billion to US$200 billion in 2026, serving as the foundational assets for repo-like liquidity management.”

Within the GCC, the UAE, Saudi Arabia and Qatar are seen as the principal catalysts and leading adopters of Shariah compliant repo transactions. These countries hold the largest Islamic banking assets and benefit from sophisticated regulatory frameworks that support these operations.

The main hurdles include that of standardization, where variations in Shariah interpretations across different jurisdictions imply that a structure sanctioned in one nation may not be recognized in another, leading to inefficiencies in cross-border transactions.

Edward also pointed to operational complexity with Shariah repos, which necessitate intricate documentation and multiple, concurrent transactions, in contrast to the straightforward title transfers seen in conventional repo.

“The relative scarcity of central counterparty clearinghouses for Shariah compliant transactions heightens counterparty risk and obstructs effective netting.”