Islamic Finance - The New Mainstream Alternative
by
Jeremy Hetherington-Gore, January 2008
IMPORTANT
WARNING:
The contents of this report have been compiled in good
faith by Investorsoffshore.com to provide assistance
to investors, but do not constitute investment advice
or recommendations. Investors should not rely upon the
information given in order to choose types or routes
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The
global Islamic finance industry is now worth more than
$1 trillion in terms of assets, having quadrupled in
the last three years. Moody's
recently estimated that the total issuance of sukuk
(Islamic asset-backed bonds) alone stood at US$82.3bn
in July 2007.
If
2006 was the year in which Islamic finance, a concept
virtually unheard of outside banking circles a decade
ago, finally crossed the border-line between slightly
exotic alternative territory and the mainstream, 2007
saw an explosion of demand for alternatives to western
banking products structured along ethically-aware Islamic
principles. In early 2007 Islamic finance received the
financial equivalent of the accolade when UK Chancellor
Gordon Brown announced that the Islamic finance industry
would be given the same tax treatment in the UK as other
investments. The move was applauded by tax and finance
experts, who say it puts the City of London at the forefront
of the nascent but rapidly growing global industry.
The British government is expected to announce the issue
of Islamic sovereign debt early in 2008.
Although
the size of the Islamic sector remains just a fraction
of global assets, given a world Muslim population of
around 1.5 billion people, the industry has enormous
potential, and this is a fact that is starting to be
recognised in boardrooms of some of the world’s
largest western-based banking, fund management and insurance
groups, many of which have now launched banking facilities
compliant with Shariah law.
What
Is Islamic Finance?
It's
almost no longer necessary to ask that question, but
for the record, under the guiding principle of Shariah
law, the goal of trade and enterprise within an Islamic-based
society is the sharing of wealth and prosperity within
the community through morally acceptable business activities.
Likewise, Shariah law dictates that risk in trade and
business should also be shared. This means that the
accumulation of wealth through the receipt of interest,
or riba, is prohibited, as interest income is deemed
effortless profit. It also means that investment in
certain business activities is forbidden on ethical
and moral grounds, such as those involving alcohol,
tobacco, pornography, armaments and gambling.
Whilst
trade along Islamic lines is as old as the religion
itself, modern Shariah banking didn’t really take
off until the 1960s with the launch of the Social Bank
in Egypt, a project later replicated in other areas.
In the intervening years, some countries, such as Pakistan
and Sudan, have made attempts to completely ‘Islamicise’
their financial systems, although the Islamic banking
and investment industry has been, until recently, confined
largely to the Middle East.
The
concept of a bank making a profit without charging interest
can be a difficult one to grasp for those of us brought
up in a western-style capitalistic environment. However,
numerous financial products and contracts have been
developed and are appearing on the market place all
the time, based on a number of structures which seek
to eliminate the need for interest, and share both profit
and risk.
Possibly
the most popular of these is the contract known as Murabaha.
Described as a cost-plus-financing contract, a Murabaha
contract can be used to finance a variety of purchases.
For example, in order to buy a house using this contract,
the prospective buyer agrees a sale price with the seller
and approaches a bank, which will buy the property and
sell it back to the customer at a higher price. The
house will be registered in the buyer’s name and
he will agree to pay back the amount in instalments.
This technique is also applied to the financing of other
purchases, such as cars or household appliances. Murabaha
contracts are also used to issue letters of credit and
to provide financing for trade.
A
similar method, known as Ijara, works in much the same
way, except that the bank will buy an asset and then
effectively lease it to the customer for an agreed period.
During the term of the lease, the buyer is required
to pay a form of rent, which is deemed by the bank to
be reflective of the risk that it is taking as part
of the transaction. This rent can be either fixed or
variable, depending on the specific contract terms offered
by the institution.
Another
popular method of financing under Islamic law is Musharaka,
which can be loosely translated to mean a partnership.
This is widely recognised as perhaps the purest form
of Islamic contract available within the modern banking
framework because it has more of a basis in the profit
and risk sharing principle. Within a personal banking
context, a Musharaka arrangement may see the bank providing
the funds to enable the customer to buy an asset, with
the bank and customer agreeing a profit or equity sharing
ratio for that asset. Losses are shared on a similar
basis.
There
are also variations on the above themes, such as Ijara-wa-iktana.
This is similar to Ijara, the difference being that
included in the contract is a promise from the customer
to buy the asset or goods at the end of the lease period
at a pre-determined price. Rentals paid during the period
of the lease constitute part of the purchase price and
often under these arrangements the final sale will be
for a token sum.
Ijara
with diminishing Musharaka means that an institution’s
equity in an asset may be reduced as the buyer makes
capital payments over and above the agreed rental payments
or lease payments. This means that the bank’s
ownership decreases and the customer’s equity
increases over time, until ownership is eventually transferred
entirely to the buyer.
Another
important tool within the Islamic finance framework
is the Mudharabah contract, which is used in the financing
of new business ventures. In short, under this arrangement,
one party known as the rabal-maal provides the funding,
while the other party - the entrepreneur or mudarib
- provides the effort and labour. Profit is shared at
an agreed ratio at the start of the contract; however,
in the event that the venture fails, any losses are
borne completely by the owner of the capital, whilst
the entrepreneur derives nothing for their efforts.
Instruments
have also been developed to serve part of the investment
industry that were previously off limits to the Islamic
investor, such as the international bond markets, in
which sukuks are fast becoming a visible feature. These
certificates bear a resemblance to conventional bonds,
but unlike their western counterparts, they are backed
by an asset, such as pools of ijara contracts. The asset
will be leased to the client to yield the return on
the sukuk and backing by real assets ensures that a
sukuk is also tradable in a Shariah-compliant secondary
market.
Location
Of The Islamic Finance Sector
Key
locations for the rapidly developing Islamic finance
sector are Dubai and Labuan, because they are sophisticated
low-tax centres in Islamic regions with concentrations
of wealthy investors, while London and the Cayman Islands,
as existing banking and investment fund centres, are
home to the highly skilled legal and financial professional
communities needed to bring Islamic products to market.
Although
starting late, Hong Kong may also become a major player.
Chief Executive Donald Tsang told a December conference
that he is considering a mission to the Middle East
early this year, to help promote the development of
an Islamic bond market in Hong Kong.
"At present,
assets worth more than US$300 billion are being held
by some 300 Islamic financial institutions in 75 countries.
A further US$400 billion is managed by the Islamic business
units of international banks," Tsang noted.
The
focus will be on the bond market. The Hong Kong Monetary
Authority, in conjunction with the financial sector,
has set up a dedicated team to study related issues
such as taxation and legal and regulatory frameworks,
and to make recommendations for the early introduction
of Islamic debt offerings in Hong Kong.
2007:
A Watershed Year
A
round-up Of Islamic finance developments in late 2006
and through 2007 shows the growing size and maturity
of the industry:
-
In
December, 2007, KPMG launched its “Japanese Desk”
in the United Arab Emirates, which is said by the
firm to be the first of its kind in the UAE amongst
accounting firms with operations located there.
KPMG's initiative is intended to assist Japanese
companies already operating in the UAE and those
considering investment in the region. It will aim
to cater to their needs by providing J-Sox Services,
new business set-up support services, feasibility
studies, transaction support and Islamic Financial
advisory for Japanese Financial institutions and
companies planning to issue Islamic bonds. A significant
proportion of the Japanese companies operating in
the UAE are located in the Free Trade Zones with
a major focus on re-export, new investments, operations
in infrastructure, and real estate.
- European
Islamic Investment Bank Plc (EIIB), the first independent,
Sharia-compliant Islamic investment bank to be authorised
and regulated by the UK Financial Services Authority,
announced the launch of a Sharia-compliant real estate
fund. The EIIB Pan-European Islamic Real Estate Fund
is structured as a tax-efficient Sharia-compliant
fund which will directly purchase commercial real
estate assets in the office, retail and industrial
sectors in and around major cities in the UK and Western,
Central and Eastern Europe.
The fund takes the form of a closed-end fund with
a fixed term of five years plus up to two years wind-down.
With a target size of between EUR200 million to EUR500
million at launch, the fund may consider a listing
on a stock exchange after the initial capital is deployed.
Jeremy Beswick, Head of Asset Management, EIIB, announced
that: "The launch of this fund is a significant milestone
in the development of EIIB, representing an example
of EIIB's intention to offer sophisticated and differentiated
products to the Islamic investments marketplace. We
believe there will be significant investor interest
in this fund, which will deliver to investors a diversifed
commercial property portfolio including exposure to
the rapidly-developing markets in Central and Eastern
Europe."
The launch is part of the roll-out of EIIB's own Sharia
compliant investment fund range, covering the real
estate, hedge fund and private equity asset classes,
and including capital-protected structured products.
EIIB is also developing a number of derivative and
asset securitisation products, and expects further
new issue mandates in the coming months. EIIB will
also partner with other financial institutions, both
Islamic and conventional, to create bespoke Sharia-compliant
investment products according to demand.
- In
August, 2007, Dar Al-Arkan International Sukuk Company
listed a landmark US$1 billion Sukuk Al-Ijara on the
Labuan International Financial Exchange (LFX), marking
the first Saudi corporate Sukuk to list on the LFX.The
Sukuk was arranged by a consortium of international
banks on behalf of Dar Al- Arkan Real Estate Development
Company, a leading residential real estate developer
in the Kingdom of Saudi Arabia. The Sukuk has also
been listed on the Dubai International Financial Exchange
(DIFX). Launched in June, the Sukuk issue received
an overwhelming response from institutions across
the Middle East, South East Asia and Europe. It was
significantly oversubscribed, raising close to US$1.5
billion, with Dar Al-Arkan opting to close the issue
at US$1 billion.
The landmark 5-year issue, based on an Ijara structure,
marks the second Sukuk to be issued by Dar Al-Arkan.
In March this year, the company closed its inaugural
Sukuk at US$600 million, marking the first Sukuk to
be issued by a Saudi corporate in the international
capital markets. The inaugural Dar Al-Arkan Sukuk
is listed on the DIFX.
Majid
Al Sayed Bader Al-Refai, Managing Director and Chief
Executive Officer of Unicorn Investment Bank B.S.C.(c)
commented: "The listing of this second landmark transaction
for Dar Al-Arkan on the LFX represents a further important
milestone in the development of the Islamic capital
markets. We look forward to continuing to partner
with regional and international financial institutions
to expand the boundaries of the Islamic finance industry."
- In
February, 2007, Deutsche Bank published a White Paper
outlining an investment structure that facilitates
the issuance of Sharia compliant securities that offer
investors access to alternative asset classes. Deutsche
Bank said it had made public its procedures both in
the interests of transparency and in an attempt to
help alleviate some of the 'supply side' constraints
that exist in Islamic financial markets. These constraints
are mainly related to capacity - in respect of the
number of qualified bankers involved and their Islamic
structuring capabilities. In addressing these issues,
the market will be more able to develop in line with
customer demand.
Geert Bossuyt, Managing Director, Regional Head of
ME Structuring, Deutsche Bank, commented: "We are
confident that the structure will eventually be viewed
as a significant milestone in the development of the
Islamic finance industry as it provides Islamic investors
with exposure, in a liquid and cost-efficient way,
to new asset classes and pay-outs, removing one of
the main structuring barriers. The structure itself
is the result of close co-operation between academics,
bankers and, of course, scholars.
"Too often, 'innovation' is achieved by pushing the
barriers and/or misusing fatawa by taking them out
of their context. Innovation ideally should be the
result of a well documented and fundamental discussion
on Sharia. Deutsche Bank wishes to encourage the use
of academic resources to assist the industry in developing
new products as this has not been a feature of the
industry to date.
Bossuyt concluded: "We believe that those institutions
with the vision, creativity, innovation, courage and
commitment to develop the Islamic financial markets
will be recognised for their hard work and ideas.
Sharia itself has inherent flexibility and fewer constraints
than is often assumed by the financial services industry.
Fundamental research is the key to unlocking this
inherent flexibility, thereby allowing this market
to grow to its full potential."
- Bursa
Malaysia Berhad, the Malaysian Stock Exchange, in
collaboration with FTSE Group, the global index provider,
launched the FTSE Bursa Malaysia EMAS Shari'ah index,
designed to provide investors with a broad benchmark
for Shari'ah-compliant investment for the Malaysian
market. The index takes the constituents of the FTSE
Bursa Malaysia EMAS Index, which has been free float
weighted and liquidity screened, and overlays the
Securities Commission’s Shariah Advisory Council’s
(SAC) screening methodology to derive a highly investable
and transparent Shari'ah-compliant index.
The
new index will run parallel with the existing Shari'ah
index (KLSI) for nine months. The KLSI was deactivated
on 1 November 2007, making the FTSE-Bursa Malaysia
EMAS Shari'ah Index the singular benchmark index for
Malaysian Shari'ah-compliant investments.
Bursa Malaysia’s Chief Executive Officer, Dato’ Yusli
Mohamed Yusoff said: “The new index provides investors
with a clearer picture of quality Shari'ah investments
in the Malaysian market. It uses globally-adjusted
criteria that make it easier for institutional investors
to track our Shari'ah-compliant investment offerings
more effectively. This is critical to ensure our Shari'ah
market continues maintaining its competitiveness with
other international Shari'ah investment destinations.”
He added that the new index also represents a first
step towards the creation of more Islamic products.
“With the new FTSE Bursa Malaysia EMAS Shari'ah Index,
we can now work on creating a tradable Shari'ah index
which in turn allows us to introduce Islamic structured
products.”
- In
November, 2006, Walkers, an offshore law firm, reported
that their Dubai office had seen an increase in the
use of sukuk, Shari'ah-compliant bonds, with the Cayman
Islands emerging as one of the world's most favoured
domiciles for the vehicles. "While the sukuk market
is still very small compared to the conventional debt
market, there is enormous potential for growth from
both local investors and international markets," stated
Robert Varley, a partner in Walkers' Dubai office.
"As local institutions in the Middle East partner
with conventional Western banks to issue these types
of bonds with increasing frequency, it is certain
that banks outside the region are watching the sukuk
market with great interest," he added. "Recently Dubai
Civil Aviation announced that it would raise roughly
US$1.6 billion through sukuk to fund the first phase
of the new Jebel Ali International Airport. Almost
every day we see a new deal being developed," he added.
"Offerings
are hugely oversubscribed. The recent listing of Cayman
Islands-issued sukuk on both the London Stock Exchange
and the Dubai International Financial Exchange will
only strengthen that demand," he concluded.
Sukuk
that are developed and marketed in the Middle East
predominantly use Cayman-domiciled issuers over other
jurisdictions because of its established trusts law
regime, lower costs, relatively fast turnaround, and
flexibility in structuring. The Cayman Islands' strong
reputation in the world of global finance can also
make listing and rating Cayman-issued bonds much easier
compared to bonds issued from other jurisdictions.
Meanwhile, new regulations introduced by the Dubai
Capital Markets Authority and the launching of the
Dow Jones Citigroup Sukuk Index earlier this year
are helping to fill a number of gaps in the Islamic
market, says Walkers. General business and acquisition
finance, project finance, and securitizations have
all been funded with sukuk.
- In
July, 2007, DIFC Investments and Dubai Islamic Bank
(DIB) announced that they had initiated a project
to establish ‘Waqf Trust Services’, the first Islamic
trust services provider in the world exclusively offering
sharia compliant trust services, which will operate
from the Dubai International Financial Centre (DIFC).
The
company, which is awaiting approval from the Dubai
Financial Services Authority (DFSA), is set to operate
within the guidelines of the ‘Trust Law of 2005’,
enacted by Sheikh Mohammed Bin Rashid Al Maktoum,
Vice President and Prime Minister of the UAE, Ruler
of Dubai and President of the DIFC. The law is primarily
intended to ensure the proper succession and preservation
of lineage, while allowing families to manage their
wealth in such a way as to guarantee the rightful
disbursement of their inheritance and maintain a strict
adherence to Sharia’a guidelines.
Waqf
Trust Services will offer a diverse array of trust
services for both corporate and individual clients,
primarily encompassing the provision of tools to assist
clients in the protection of assets, succession planning
and the preservation of family wealth.
Saad
Abdul Razak, Group CEO of the Dubai Islamic Bank Group
and Vice Chairman of Waqf Trust Services noted: “Extensive
research was conducted to provide an indication of
the outlook for a new trust service provider in the
region, the results of which have formed the basis
of the business strategy for Waqf Trust. As such,
we are proud to be the first to introduce these specialized
Islamic trust services. Our aim, as it has always
been, is to find different ways to assist our clients
in managing their assets and together with DIFC Investments,
we look forward to helping our clients, and the region
as a whole, prepare for a prosperous future.”
Dubai
Islamic Bank was established in 1975 and is the world’s
first fully fledged Islamic bank. It currently offers
a wide range of Sharia’a compliant products and services,
including retail, corporate and investment banking,
within the UAE and internationally across Bahrain,
Egypt, Sudan, Lebanon, Pakistan, Iran, Turkey, Ireland,
Bosnia, the Bahamas and the Cayman Islands.
- In
October, 2007, Asian Finance Bank Berhad (AFB) and
AmanahRaya Investment Bank Limited Labuan (ARIBL),
entered into an agreement to launch the world's first
Islamic Marine Fund. A memorandum of understanding
(MoU) between the two institutions committed them
to an Islamic Forward Binding (AFB-i) transaction,
and pledges to jointly establish, sponsor, manage
and administer an Islamic Marine Fund, which expects
to raise $250 million.
AFB, an Islamic bank, is backed by a consortium of
leading Middle Eastern investors, namely Qatar Islamic
Bank (70%), RUSD Investment Bank Inc of Saudi Arabia
(20%) and Global Investment House of Kuwait (10%).
ARIBL is a wholly-owned subsidiary of Amanah Raya
Berhad, and has been granted an offshore banking licence
by the Labuan Offshore Financial Services Authority
(LOFSA).
In a joint statement, the banks said the the AFB-i
is a contractual obligation by two contracting parties
to pay, on a forward value date, the price of commodities
purchased on the transaction date, in order to facilitate
the exchange of currencies between the two contracting
parties. The transaction is based on the shariah contract
of Bai Muajjal, in which the bank's customer purchases
assets with a deferred payment at a specific time
in the future, and the delivery of the assets on spot
basis.
AFB and ARIBL also sealed an understanding to develop
an Islamic Marine Fund to invest in completed and
non-completed marine vessels covering dry bulk carriers,
tankers, anchor handlers, crew boats, equipment barges
and other support vessels for marine activities, both
on the local and international arenas. The Islamic
Marine Fund is designed as a 'core plus' marine fund,
investing in performance-proven vessels that show
characteristics for capital and income enhancement
through re-deployment strategies. The
fund is a fully-fledged investor-managed fund based
on the Ijarah-backed structure, the first of its kind,
and is expected to generate an internal rate of return
(IRR) of 12-15%.
"The
Islamic Marine Fund will provide opportunities for
institutional and sophisticated retail investors globally,
to participate and take advantage on the growth of
the marine sector. Through this fund, investors will
have access to a diversified portfolio of Shariah
compliant marine vessels that could potentially generate
attractive medium to long-term returns" announced
Datuk Abdul Latif Abdullah, Chairman of the Islamic
Marine Fund.
London's
Growing Role
Already
in 2005, the UK's RICS (the Royal Institution of Chartered
Surveyors) was able to publish a report saying that
London had become a major centre for Islamic banking
and investment.
Based
on research commissioned by international property consultants,
King Sturge, the report said that London was securing
its position as a major centre for Islamic banking and
investment due to the availability of relevant expertise
and a flexible, well developed regulatory environment.
The
report detailed how Middle Eastern investment in European
real estate reached £827m in 2001, an increase of 225%
on the previous year. 90% of investors cited the UK
as their favoured location for Shari'ah funds because
of its political environment, legal and institutional
frameworks, human capital and expertise. London’s wide
range of skills in particular puts its commercial property
industry in the strongest position to take advantage
of the growth in Shari'ah compliant real estate investment.
Like
“ethical funds”, Islamic investment funds require careful
portfolio and stock selection to ensure compliance with
Shariah law. Shariah property investment funds also
prohibit renting properties to organisations engaging
in business relating to pornography, gambling, arms,
pork, tobacco, cinema and alcohol consumption.
The
commercial and industrial property sectors are reported
as the most popular investment by Shariah funds, with
three quarters of respondents already investing in industrial
property. A growing trend is the market’s move into
property investments in leisure and care for the elderly
which are compatible with Shariah principles and somewhat
reflective of developments in other ethical funds.
According
to Angus McIntosh, Partner & Head of Research at King
Sturge international property consultants: ‘UK business
is now familiar with ethical funds but there is a real
need to find out more about the growing opportunities
for Shari'ah compliant real estate investment and the
nature of the market as this area represents a crucial
opportunity for many UK businesses.’
The
most important factor considered by Shari'ah compliant
funds when buying and selling property was tax status
(cited by 65% of respondents), followed by the availability
of specialist expertise (61%), the regulation of investment
and risk assessment regulation (both 47%) and the transparency
of transactions (41%).
According
to Ali Parsa, author of the report, and director of
research at London South Bank University’s Property
Surveying and Construction department: ‘The research
indicates the likelihood of a substantial increase in
the funds available for Shari'ah investment as a result
of growing wealth in Muslim countries and communities,
and that most of the new investments will be through
some form of Shari'ah compliant funds.’
UK-based
HSBC has launched a number of Shariah-compliant products
through its Amanah Finance division. The bank is also
seeking to establish a firm foothold in the US market,
offering Islamic banking services through 300 branches
in the New York area. Other institutions, such as the
UK’s Lloyds TSB and the US-based bank Citigroup,
have also stepped into the market.
However,
new ground was broken in 2004 with the launch of the
Islamic Bank of Britain, the first in the UK to concentrate
solely on offering Shariah-compliant banking services
to the country’s 1.7 million Muslims (although
it must be pointed out that one doesn’t necessarily
have to be of the Muslim faith to take up Islamic banking
services). Its product offerings include mortgages,
current accounts, savings accounts and personal finance.
The bank is also planning to launch its own credit card.
Brown's
2007 budget introduces two key measures to encourage
growth in Islamic finance, namely a new regime for sukuk
(Islamic securitisations) giving comparable tax treatment
to conventional securitisations, and guidance clarifying
the treatment of diminishing musharaka (partnership
share) and takaful (insurance) products.
Commenting
on the move, Darshan Bijur, Director, KPMG Islamic Finance
Advisory, said this new legislation has created the
framework for London to emerge as undisputed global
leader in the Islamic finance industry.
“Sukuk
will be the equivalent of Eurobonds, and the likely
exponential growth in UK Sukuk issuance will ensure
that Islamic finance moves from niche to the mainstream,"
he observed. “It will cost the UK next to nothing, and
opens up the way for UK companies to access Islamic
finance, and the Middle East wealth that has been generated
by oil."
Peter
Muir, tax partner at Deloitte, says that the Chancellor
should be applauded for his reforms, which will benefit
both the Muslim and non-Muslim investment communities.
"The
UK is the only country which is changing legislation
to create a level playing field for both individuals
and companies investing in Islamic finance products,"
he noted. "Reform of sukuk (Islamic bonds) is the latest
addition to the suite of specific legislation that gives
certainty to the taxation of Islamic financial products.
Before this reform was introduced, there was ambiguity
around how capital gains tax, income tax and capital
allowances would apply to these products."
Muir
added: “Gordon Brown seems to have taken a personal
interest in ensuring Islamic products are brought into
a level playing field. This is intended to meet the
financial needs of the Muslim community as well as,
increasingly, non-Muslim investors in these products."
"From
a capital markets perspective, the reforms are a boost
to the City of London, improving its global competitiveness
in the Islamic finance market. Notably, the measures
reach out to a potentially much wider group of international
exchanges who can be given tax recognition in the UK
in relation to ‘sukuk’ bonds.”
Mohammed
Amin, tax partner, PricewaterhouseCoopers, said that
Sukuk have become increasingly important in the Muslim
world, as companies prefer to obtain finance directly
from international investors.
"While
London-based lawyers and bankers regularly structure
and market sukuk for companies from Muslim countries,
until today tax uncertainties have precluded them being
issued from the UK," he stated. “The changes announced
should enable the City of London to become the global
centre for international sukuk issuance and trading,
in the same way as it dominates the eurobond market.
There should also be scope for mainstream UK companies
to issue sukuk to both Islamic and conventional investors.”
Under
Shariah law certain investment practices commonplace
in the world of conventional finance are prohibited,
the charging of interest a notable example. This is
because Shariah law dictates that risk in trade and
business should be shared and the accumulation of wealth
through "effortless" profit is frowned upon. Islamic
finance doctrine also states that investment in certain
business activities deemed unethical are forbidden,
such as those involving the selling of alcohol, tobacco,
pornography, armaments and gambling services.
UK
City Minister, Kitty Ussher hosted two meetings of the
Islamic Finance Experts Group in 2007, in August and
December. The focus of the initial meeting was the Government's
feasiblity study into issuing sovereign sukuk.
The
second meeting focused on how to improve access to and
awareness of retail Islamic finance products. Speaking
after the meeting, Kitty Ussher announced that:
"The
UK is at the forefront of developments in Islamic finance
and London continues to seize new opportunities. We
have made tremendous inroads in the wholesale markets,
where it is estimated that the market is worth more
than GBP250 billion worldwide and growing at 15 percent
a year."
"But
there is also an important domestic market which we
want to be accessible and open. There are nearly two
million Muslims living in the UK and, thanks in part
to legislative changes introduced by this Government,
the Islamic mortgage market is now worth over GBP500
million. Going forward, the Government and industry
want to continue to do all we can to see the retail
market flourish and ensure that everyone - regardless
of faith - has equal access to competitive financial
products."
The
Government's aims for Islamic finance are to continue
the growth of the global wholesale Islamic finance market
in the UK, as part of the city competitiveness agenda
being pursued by the Chancellor's High-Level Group on
City Competitiveness; and to create a level playing
field in alternative finance and investments, such as
Islamic finance, in the retail market.
The
Role Of Offshore Jurisdictions
Offshore
jurisdictions have played a major role in the development
of Islamic finance markets, particularly Labuan and
Dubai.
Kuwait
Finance House, a leading Islamic banking group, announced
in December, 2005, its intention to break into the South
East Asian market through a new base in Labuan, which
it hopes will come on stream in 2006.
Jamelah
Jamaluddin, deputy chief executive of Kuwait Finance
House in Malaysia, said that the group sees potentially
lucrative investment opportunities in real estate, infrastructure
assets and power plants within the region.
"We
want to position Malaysia as a regional hub for KFH
in this part of the world which includes Thailand, Singapore,
the Philippines, to a certain extent China and India,
and maybe Australia and New Zealand," Jamelah stated,
adding that KFH is also attempting to make inroads into
the Indonesian market.
KFH's
Malaysian operation will initially focus on investment
banking, and will later branch out into commercial and
retail banking, providing consumer credit products such
as mortgages, car financing, credit cards and insurance.
Kuwait
Finance House was incorporated in the State of Kuwait
in 1977, and is listed on the Kuwait Stock Exchange
with a market capitalization of US$1.95 billion as of
31 December 2001. The Government of Kuwait owns 49%
of the equity, and the general public holds the remaining
shares.
AMBB
Capital (L) Ltd, a wholly owned subsidiary of AmBank
(M) Berhad, Malaysia's sixth largest bank with total
assets of $13.7 billion, said in July, 2005, that it
would list $200 million in Hybrid Securities on the
Labaun International Financial Exchange (LFX).
The
bank announced that it had completed the book building
process in relation to the issue of the 'Fixed-to-floating
Rate Step-up Non-cumulative Non-voting Guaranteed Preference
Shares,' or Hybrid Shares, with AmMerchant Bank Berhad,
BNP Paribas and Credit Suisse having been appointed
by AmBank as the joint lead managers and joint bookrunners.
The
Hybrid Securities are guaranteed on a subordinated basis
by AmBank and will be listed on the LFX and the Singapore
Exchange. They are open to international institutional
investors.
The
initial book size was set at $150.0 million, but was
twice oversubscribed, leading to its increase to $200
million.
"The
Hybrid Securities issued by AMBB Capital has garnered
strong demand from international investors and the attractive
pricing for the Hybrid Securities demonstrates international
investors' confidence in AmBank's Business model," commented
Mr Cheah Tek Kuang, Chief Executive Officer of AmBank.
The
LFX is an offshore exchange wholly owned by the Kuala
Lumpur Stock Exchange (KLSE). It was officially launched
in November 2000 and it is seen as one of the key components
in promoting Labuan as an offshore financial centre.
In
August 2005, the total market capitalisation of Labuan
International Financial Exchange (LFX) had reached $12.09
billion, and the exchange accepted its 34th listing
with the debut of Eucalyptus Investment Holdings Limited's
$30 million variable rate guaranteed secured bonds.
AmBank,
with total assets of RM51.6 billion ($13.7 billion)
as at 30 September 2005, is the sixth-largest Malaysian
bank by assets with over 170 branches nationwide.
Emirates
Islamic Bank said in July, 2005, that it had launched
a new real estate investment fund which will investment
in property along the principles of Shariah law.
The
new fund, which is registered in Jersey and managed
by Belgravia Asset Management, will investment mainly
in property based in the United Arab Emirates.
The
fund is open to both institutional and individual investors
with a minimum investment of US$100,000. Minimum top-up
investments are set at US$25,000. In addition to capital
growth, the fund will target an income distribution
of 7% per year, which will be paid on a bi-annual basis.
“The
UEA has been one of the market leaders for property
development and innovation in the region," commented
Mr Ebrahim Fayez Al Shamasi, CEO of Emirites Islamic
Bank.
"The
success of residential and commercial developments over
the last three years has proved the increasing popularity
of this asset class amongst investors in the Middle
East," he added.
A
substantial market is developing in both sovereign and
corporate sukuks and some US$30 billion worth of certificates
have been issued to date. Although the market is still
in its infancy, on the sovereign front, sukuks are beginning
to attract the attention of non-Muslim issuers and investors.
International
law firm, Walkers announced in January, 2006, that it
had opened the first fully transactional office for
an offshore law firm in the Dubai International Finance
Centre (DIFC). The office is staffed jointly with a
combination of regional lawyers and leading attorneys
from London who specialize in Islamic finance and Middle
Eastern issues.
"As
the formation of investment funds, private equity funds,
and Sukuks – a type of Islamic bond – continues to soar,
the need to provide global counsel has grown too," the
firm explained in a statement.
"Walkers
recognizes that having counsel in Dubai doing the transactional
work in the same time zone and same culture is vitally
important to getting the job done. Walkers’ expertise
in investment funds, structured finance, and international
insolvency matters coupled with a presence in the Cayman
Islands, London, the British Virgin Islands, Hong Kong
and now Dubai, means that the firm can offer worldwide
clients an even broader range of products and services,"
Walkers added.
According
to a survey by McKinsey & Company, more than 75 percent
of the top 30 global asset managers are now active in
Dubai. The MAN Group plc, a leading hedge fund group
that has operated in the Gulf Cooperation Council region
(GCC) for more than 20 years and was part of the McKinsey
survey, reported an upswing of institutional investments
in hedge funds.
"Also
driving the need for greater offshore legal expertise
in Dubai are the international entities who invest in
the GCC region through British Virgin Islands companies
and regional investment in United Kingdom commercial
real estate,” observed Mr Palmer.
“With
Walkers’ strong presence and experience in those jurisdictions,
we can now provide a complete suite of offshore legal
service to our clients in Dubai," he added.
The Dubai International Finance Centre (DIFC), a financial
free zone that promotes economic development in the
United Arab Emirates (UAE), has a strong regulatory
framework based on best practices of the world’s leading
financial centres.
Companies
in Dubai recognize multiple benefits from the jurisdiction,
including zero tax on income and profits, 100 percent
foreign ownership, no restrictions on foreign exchange
or capital/profit repatriation, operational support,
and business continuity facilities.
In
March, 2007, Dubai
Islamic Bank listed a $750 million Sukuk on the Dubai
International Financial Exchange (DIFX) after selling
the Islamic securities to investors in the Europe, Asia
and Middle East, cementing the DIFX's position as the
leading exchange for the listing of these Islamic instruments.
The
Sukuk was the first ever issued by the bank, which specialises
exclusively in Islamic financial services.
Saad
Abdul Razak, group Chief Executive Officer of Dubai
Islamic Bank announced that: “The DIFX is a perfect
venue to list our first Sukuk. It is established as
the largest exchange in the world for Sukuk and its
international stature gives our listing high visibility
in the marketplace, both in the region and globally.”
Per
E. Larsson, Chief Executive of the DIFX, added: “This
listing by a prominent Islamic financial institution
reinforces the central role played by the DIFX in the
growth of Sukuk as an attractive asset class. It raises
the value of Sukuk on the DIFX to $8.38 billion, which
is more than the value on any other exchange.”
Forty-five
per cent of the Sukuk issue was placed with investors
in the Middle East, 30% in Europe and the balance was
placed in Asia.
The
Sukuk was issued by DIB Sukuk Company Limited, a company
incorporated in accordance with the laws of, and formed
and registered in, the Cayman Islands. The Sukuk issue
is rated A1 by Moody's and A by Standard and Poor's.
The lead managers and bookrunners for the issue were
Barclays Capital, Citigroup and Standard Chartered Bank.
Hamed
Ali, Executive Officer of the DIFX, noted: “The DIFX
intends to strengthen its focus on Sukuk. The total
value of Sukuk issued globally in 2006 was $27.1 billion,
more than twice as much as in 2005, as issuers turn
increasingly to this Islamic asset class as an effective
way to raise capital.”
Also
in March, the Dubai Financial Services Authority (DFSA)
entered into a mutual recognition agreement to facilitate
cross border distribution of Islamic investment products
with the Securities Commission of Malaysia (SC).
The
agreement was signed by Dato’ Zarinah Anwar, Chairman
of the SC, and David Knott, Chief Executive of the DFSA
at a ceremony in Kuala Lumpur, witnessed by the Second
Finance Minister of Malaysia, Yang Berhormat Tan Sri
Nor Mohamed Yakcop.
David
Knott announced that: "The DFSA is delighted that, as
a result of this joint initiative, DIFC domestic Funds
will be the first foreign funds permitted to be sold
into Malaysia. This arrangement is a positive step for
both jurisdictions, and is intended to facilitate the
cross border flow of Islamic capital market products,
as envisaged when this initiative was first announced
in August 2006.”
“The
DFSA is committed to assisting both the Dubai International
Financial Centre (DIFC) and the Dubai International
Financial Exchange (DIFX) in their objective to promote
innovation and growth of Islamic capital markets in
the Middle East,” he added.
This
is the first mutual recognition agreement entered into
by both regulators, and is a significant milestone for
both the SC and the DFSA in the area of cross-border
regulation of Islamic investment funds, and the development
of deeper and broader investment markets. Under the
mutual recognition framework, Islamic funds that have
been approved by the SC may be marketed and distributed
in the DIFC with minimal regulatory intervention, following
the inclusion of Malaysia on the DFSA’s list of Recognised
Jurisdictions. Similarly, Islamic funds which have been
registered or notified with the DFSA will be able to
access Malaysian investors. Supported by a bilateral
memorandum of understanding, both regulators will work
closely in the areas of supervision and enforcement
of securities laws to ensure adequate protection for
investors.
This
follows an earlier announcement, on 15 August 2006,
of a joint initiative on regulatory alignment to facilitate
Islamic finance transactions between the DIFC and Malaysia,
which is now complete. The agreement today marks a significant
liberalisation effort on the part of the SC and DFSA
to encourage the bilateral flow of Islamic funds between
the two jurisdictions.
Dato’
Zarinah said: “By entering into a mutual recognition
arrangement with the DFSA, it demonstrates our mutual
intention to accelerate the growth of our respective
investment management industries through the trading
in each other’s markets of mutually recognised investment
products that are acceptable to both authorities. The
mutual recognition framework will provide many benefits
to market participants including lower regulatory cost
as well as an enlarged investor base. It will also provide
investors in each jurisdiction with greater choice of
Islamic investment products. This arrangement with the
DFSA is also in line with the Malaysia’s aspiration
to evolve its role as an international Islamic financial
centre."
In
N ovember, 2007, the Dubai Financial Services Authority
(DFSA) received the accolade of 'Best Regulator for
Islamic Funds', which was awarded during the recent
5th Annual Islamic Funds World Conference.
The
award was co-presented to the DFSA and the Malaysian
Securities Commission (SC), at the Master of Islamic
Funds Awards luncheon in Dubai, which took place on
13th November 2007. The award was co-sponsored by Dow
Jones and Standard & Poor's, and recognises the DFSA’s
efforts to facilitate cross-border marketing of Islamic
investment funds.
In March
2007, the DFSA and the Malaysian SC entered into a mutual
recognition agreement, allowing Islamic funds that have
been approved by the SC to be marketed and distributed
in the Dubai International Financial Centre (DIFC) with
minimal regulatory intervention, following the entry
of Malaysia onto the DFSA's list of Recognised Jurisdictions.
Similarly, Islamic funds which have been registered
or notified with the DFSA have access to Malaysian investors.
David
Knott, Chief Executive of the DFSA commented: "We are
delighted to be recognised again for innovations that
facilitate the growth of Islamic Finance. This award
further exemplifies the DFSA's strong commitment towards
taking a leadership regulatory role and establishing
the DIFC as a Centre promoting innovation and growth
of Islamic capital markets in the Middle East."
In
December, the DIFC welcomed Tokio Marine Group to its
growing portfolio of financial and management service
providers.
A leading
Takaful insurance services provider with operations
in the UAE and Saudi Arabia, Tokio Marine Group will
expand across the Middle East North Africa (MENA) region
through its new company, Tokio Marine Middle East Limited
(TMME). Registered with and located within the DIFC,
Tokio Marine Middle East Limited is regulated by the
Dubai Financial Services Authority as an insurance management
services provider.
Takaful is
a form of insurance that conforms to the principles
of Islamic finance. Using the Shariah principle of Ta'awun,
or mutual responsibility, the takaful industry rests
on the same foundations of profit and risk sharing as
other areas of Islamic finance. At a basic level, it
provides mutual protection of assets and property in
the event of loss or damage, based upon joint risk sharing.
Nasser Al
Shaali, CEO of the DIFC Authority, commented: "Takaful
services are increasingly sought after in today's dynamic
business environment and are of particular relevance
to the region. DIFC is further consolidating its leading
role in Islamic Finance with the addition of Tokio Marine
Group, through its new company. The inception of a company
dedicated to Takaful services also illustrates the DIFC's
increasing focus on socially responsible financial services."
Tokio Marine
entered the Takaful industry in 2001 through its conventional
financial operations in Saudi Arabia, and subsequently
became the first foreign company in the Kingdom to introduce
property and casualty Takaful products. Recognising
the potential in opening markets to new licenses, Tokio
Marine Group established Tokio Marine Retakaful company,
based in Singapore, in September 2004. In 2006, the
Tokio Marine Group took a 35% stake in the new joint
venture with Hong Leong of Malaysia for US$29m, to form
Hong Leong Tokio Marine Takaful Berhad.
"We are pleased
to establish this company with the objective of seeking
new business opportunities and expanding the Group's
existing business in the Middle East and North African
markets," announced Hisato Hamada, President and CEO,
Tokio Marine Group. He continued: "We are committed
to providing products and services that are fully aligned
with our customers' cultural and social values."
Hamada added:
"Tokio Marine with its long history of a local presence
believes that with its diverse portfolio, backed by
conventional and Takaful expertise, is well placed to
take advantage of opportunities that open up in the
MENA region. The Group has set its goals to establish
or acquire a number of operations in the MENA region
to better serve the indigenous insurance needs. TMME
will help the Group to achieve these goals."
TMME will
be a technical and management services provider, instituting
products, systems and procedures for the existing and
new ventures fully or partially owned by the Group.
"Tokio Marine
Group is committed to finding socially responsible ways
of bringing insurance solutions to its customers. These
solutions are in complete harmony with its environment
and culture," continued Ajmal Bhatty, Chief Operating
Officer and SEO of the Company. "Takaful may be a system
that has its roots in the Islamic Shariah, but because
of its ethical nature it has proven to be of benefit
for everyone. Not only does a Takaful customer benefit
from the surplus of the business when it does well,
but he also gains the satisfaction of knowing that his
contributions and premiums are only channeled towards
ventures that are socially and environmentally responsible."
"The
biggest challenge and potential for the region lies
in the development of Family Takaful which is life insurance
in compliance with Shariah principles. The cultural
mind-set against conventional life insurance has been
one of the main reasons why development of life insurance
has been slow. With strong professional approach and
innovative takaful solutions, the regional markets should
be able to realize the excellent potential that exists
in Family Takaful with its related savings and pensions
products," he concluded.
In
parallel with Dubai's distribution role, the Cayman
Islands have emerged as the jurisdiction of choice for
the listing of Islamic financial products.
The
introduction of a new Arabic language facility by the
General Registry in Cayman in March 2007 will trigger
more valuable business from the Islamic region, according
to international law firm, Ogier.
Ogier
partner Gray Smith, who practices Cayman law from London,
observed this week that the move demonstrated Cayman’s
recognition of the Middle East as an important area
for new business.
“We
can now use both Arabic and English names on all documents
when setting up a company and can also open bank accounts
in both names. Previously we had to use only an English
translation. The same ethos was applied to Chinese characters
a few years ago and that was of huge benefit in Hong
Kong, where both English and Chinese are used widely,”
he explained .
Mr
Smith went on to add that Cayman law particularly lent
itself to Islamic finance structures because of its
flexibility. It has become a centre for “sukuks” – bond
issues that are Shari’ah compliant, prohibit interest
payments and require tangible assets or equity as collateral.
“It’s
straightforward, the processes are relatively easy and
it’s very flexible, allowing for the drafting of articles
and agreements that comply with the restrictions of
Islamic law. Cayman is also a lighter regulation jurisdiction
and a widely recognised international finance centre
which suits Middle East companies looking for investments,”
he revealed.
The
Ogier partner also predicted further inflows of money
into the Middle East as clients are increasingly marketing
their funds outside the region.
“The
inflow to Middle East funds is a new growth area. Furthermore,
the establishment of the Dubai Finance Centre will enable
the listing of Cayman funds on the Dubai Stock Exchange
and dual listing, in Cayman and the Middle East or the
Middle East and the UK,” he stated.
Islamic
Insurance
The
world of insurance, which by its very nature runs counter
to Shari'ah principles because its profits are derived
through effectively gambling on uncertain outcomes,
was an area that until recently Islamic investors either
had to tolerate or abstain from altogether. However,
this problem has been overcome with the development
of the takaful insurance industry. Using the Islamic
principle of Ta'awun, or mutual responsibility, the
takaful industry rests on the same foundations of profit
and risk sharing as other areas of Islamic finance.
On a basic level, it provides mutual protection of assets
and property in the event of loss or damage based upon
joint risk sharing.
Takaful
Re Limited, an Islamic insurance company, was licensed
by Dubai Financial Services Authority (DFSA) in January,
2006, to operate from the Dubai International Financial
Centre (DIFC).
Takaful
Re is dedicated to offer Shari’ah compliant reinsurance
and related services to the growing Takaful & Islamic
insurance markets. Takaful Re will offer reinsurance
capacity in all major lines of property, marine and
family Retakaful business.
Because
profits in the conventional insurance industry are effectively
derived through gambling on uncertain outcomes the world
of insurance has been largely off limits to those wishing
to invest along Shari'ah principles. However, this problem
has been overcome with the development of the takaful
insurance industry.
Using
the Islamic principle of Ta'awun, or mutual responsibility,
the takaful industry rests on the same ideal of profit
and risk sharing as other areas of Islamic finance.
On a basic level, it provides mutual protection of assets
and property in the event of loss or damage based upon
joint risk sharing.
With
an authorised capital of US$500 million and paid-up
capital of US$125 million, Takaful Re has plans to focus
on retakaful business in the Middle East, North Africa
and other Islamic countries.
“This
is a significant announcement for DIFC, especially when
we already have some major international insurance companies
located here," commented Dr. Omar Bin Sulaiman, Director
General of the DIFC Authority.
”The
DIFC is committed to actively promoting the growth and
development of the Islamic insurance industry in accordance
with Shari'ah principles. The Takaful market is one
of the fastest growing in the world. It is expected
to grow at nearly 20 per cent per annum to reach US$7.4
billion in global annual premiums in 15 years. Firms
domiciled in the DIFC will complement the regional market
and help it grow. By providing the ideal environment,
both in terms of regulations and infrastructure, the
DIFC aims to maximise this potential," Dr. Omar Bin
Sulaiman added.
Meanwhile,
Mr. Khalid Ali Al Bustani, Takaful Re Chairman, commented
that: “We are pleased to associate ourselves with the
DIFC which is renowned internationally. For Takaful
Re, to be in the DIFC is a commitment for integrity,
transparency and efficiency."
Regulation
Of Islamic Finance
Regulation
and interpretation of Shari'ah law are two key issues
in the Islamic finance industry. Before an institution
can offer such products to the public, they must first
be scrutinised and approved by a panel of Islamic scholars.
However, this is by no means a clear cut issue, and
the opinions of individual scholars can vary. Indeed,
there are many academics in the Muslim world who have
been quite critical of contemporary Islamic finance
culture, and who have taken issue with certain forms
of financing, notably Murabha and Ijara contracts which,
it has been argued, are too similar to conventional
forms of financing, and which do nothing to share risk
and profit, the central tenet of Islamic capitalism.
To
ensure a degree of quality control over the Islamic
finance industry, regulating institutions, such as the
Malaysian-based Islamic Financial Services Board (IFSB),
have been set up to police the emerging industry. The
IFSB serves as an international standard setting body
of regulatory and supervisory agencies and its core
mission is to guard the integrity and stability of the
Islamic financial services industry across the spectrum
of banking, capital markets and insurance. The board
also provides guidance for institutions offering Islamic
investment products and liaises with other rule-making
bodies in the industry.
Whilst
modern Islamic finance may not be as pure as some scholars
and academics would like, the development of financial
products to cover the whole gamut of the finance and
investment industry, and the creation of the regulating
institutions to oversee them, is evidence that the industry
in its current form is likely to be here to stay. And
the fact that the new industry has really only scratched
the surface of potential demand for Shariah compliant
and more ethically aware capitalism means that the Islamic
banking and finance is likely to continue growing apace
for some years to come.
In
December, 2007, Deloitte appointed Mufti Hassan Kaleem
as Shariah scholar in its Islamic Finance practice.
The appointment makes Deloitte the first Big Four firm
to appoint a Shariah scholar, who will ensure that products
and transactions are fully compliant with the princ |
