Clare Nuttall in Almaty and Ben Aris in Moscow -

A landmark deal is expected this year with the first ever sovereign Islamic bond from Kazakhstan. This sukuk, a Sharia-compliant security, is only the latest, and most concrete, example of the growing interest amongst Arab investors to get involved in the development of the fast growing markets of the former Soviet Union.

With its cultural similarities and physical proximity, Central Asia is a natural destination for the conservative and slow-moving investors of the Middle East, who were already moving into the region before the global economic crisis struck in 2008. But since valuations have been reset at a lower level by the meltdown, this interest has intensified and things are starting to more quickly.

Bearing down

Arab investors' interest in the region was piqued by the boom in the middle of the last decade. The Union of Arab Banks began approaching regional governments to find out more information, but as the sub-prime mortgage crisis gathered pace in 2007, it stepped back again. However, having done the ground work, the first investors jumped in toward the end of 2010 as it became clear the crisis was in retreat.

At the end of November, the Mubadala Development Company, Abu Dhabi's sovereign wealth fund manager, signed off on a commitment of $100m to Russia's Verno Capital to invest in Russia and the Commonwealth of Independent State (CIS) in the first ever major commitment by an Arab investor to the Russian market. "Mubadala is a world-class investor and our partnership offers both organisations the opportunity to capitalise on the dynamic potential of the Russian and CIS markets," says Dimitri Kryukov, founder of Verno Capital. "At the same time, Mubadala is at the vanguard of a new class of investors into Russia. We believe this vote of confidence is a signal to top emerging market investors around the globe."

Abu Dhabi is emerging as a centre for Arab money looking at the former Soviet Union and the flow of investors is two way. Two years ago, the Pharos Financial Group, set up by Russia-veteran Peter Halloran, opened an office in Abu Dhabi. "We had no business there, but Abu Dhabi was the natural choice for a fund, as it is governed by international, not sharia, law," says John Papesh, a managing director with Pharos. "We have since moved our headquarters to Abu Dhabi and the investments in our Eastern European funds are building steadily."

Bridging the Gulf

Islamic interest in Russia is clearly building, but it remains early days yet. The Islamic finance market in Kazakhstan, however, is racing ahead thanks to a push by the government, from President Nursultan Nazarbayev downwards.

Al Hilal Bank from Abu Dhabi was the first Islamic bank to set up in Kazakhstan. The bank's registration process was fast-tracked, enabling it to obtain a license in just one year. As of February, Al Hilal had extended facilities worth around $25m, somewhat less than originally planned. The chairman of its Kazakhstan operations, Prasad Abraham, says the main focus is on government-related projects, big ticket items that can't be agreed overnight, and that several other projects are under discussion. "Separately, we have a mission to identify opportunities for [United Arab Emirates] investors in Kazakhstan. We will act as a bridge to bring Kazakh projects to the attention of UAE investors," Abraham tells bne.

"At the state and private sector level, the UAE is interested in investing in Kazakhstan, in projects to help the UAE to diversify or where there are synergies between the two countries - such as in oil and gas. Agriculture is also interesting. However, no sectors are ruled out completely, provided they make economic sense," he says.

An agreement on the creation of a second Islamic bank was signed in July 2010 by Almaty-based investment house Fattah Finance, the Development Bank of Kazakhstan and Malaysia's AmanahRaya Financial Group.

After legislation on Islamic finance was adopted in early 2009, the following year the Kazakh government and the Islamic Development Bank drew up plans to turn Kazakhstan into a regional centre for Islamic finance for Central Asia and the CIS by 2020. "The tone from the top is very clear: Islamic finance should be encouraged to grow and blossom," says Abraham.

A milestone for the sector will be the issue of a sovereign Kazakh sukuk. This was originally expected in 2010, but has been held up since changes to Kazakh law are needed. "We hope a sovereign sukuk will be issued in the near future because it is very important as a benchmark and will also create liquidity for the market," says Zaratkazy Nurpiissov, chairman of Fattah Finance's board of directors, which regards the issuance of a sovereign sukuk essential before any from corporations can be issued.

Other countries in the majority-Muslim countries of Central Asia and Azerbaijan have taken more tentative steps towards Islamic finance, and are opening up to investment from the Middle East and Malaysia. Iran is one of the largest investors in Tajikistan, and Qatar's state investment company Diar is targeting the real estate sector. Malaysian oil and gas companies are active in both Turkmenistan and Uzbekistan, while building ties elsewhere in the region.

Plans to grow Azerbaijan's Islamic finance market were developed at a conference in Baku in 2010. Kauthar Bank already operates along Islamic principles, and the International Bank of Azerbaijan plans to launch Islamic banking services.

Ecobank, Kyrgyzstan's only Islamic bank, carried out a three-year pilot project between 2008 and 2010. According to its chairman, Nurbek Shermukhamedov, the experiment was successful. Ecobank continued to increase deposits even during the April 2010 revolution and June 2010 ethnic violence. However, the recent political turmoil in the country has put future development of Islamic finance on the back burner.