By: Chris Wright
Imagine a global industry in these volatile and bruising times where it is considered a disappointment that growth might drop to single digits this year for the first time in more than a decade.
That industry is Islamic finance, a system based on a set of Islamic principles that includes sharing risk in financial transactions. Standard & Poor’s estimates the sector now has more than US$2 trillion in assets. It has grown at between 10 and 20 per cent almost every year of this century to date, but may finally be slowing down as it achieves critical mass.
Mohamed Damak, global head of Islamic finance at S&P, sees headwinds on the horizon: the declining oil price, denting economic performance in key Islamic markets; rapid changes in global regulatory frameworks, both in banking and insurance; and the fragmented nature of the Islamic finance industry.
“Still, Islamic finance will have the impetus to continue progressing and maintain growth,” he says.
“We expect the industry will be worth US$3 trillion sometime in the next decade.”
That means Islamic finance, even if it’s slowing down, will continue to enjoy a headier pace of growth than China’s economy, global banking or very likely any Western stock market this year. Indeed, the jury is still out on whether it’s even slowing at all: Daud Vicary Abdullah CPA, president and CEO of the INCEIF Global University of Islamic Finance in Kuala Lumpur, believes that in the six most important markets for Islamic finance – Malaysia, Qatar, Indonesia, Saudi Arabia, the UAE and Turkey – Islamic banking assets are still expected to grow by an average 19.7 per cent each year until 2018.
Toward an Australian industry
This vibrant future is one reason it’s well worth Australia considering what it might achieve in the Islamic finance sector. It’s true that Australia lacks a sufficiently large Muslim population – just over 2 per cent of the national headcount – to be an obvious candidate for a successful industry.
However, Islamic finance experts point to two important factors beyond the country’s population base. One is that Islamic finance products, properly created, can be useful to anyone, not just Muslims. The other is that if Australia aspires to be a true regional financial hub, it must be accommodative to any area of the financial world that a customer in the Asia-Pacific might need.
“The Australian Government has said that we want to be a financial services hub for this part of the world – and, as such, developing a competitive sharia-compliant product offer is important to us,” says Alex Malley, chief executive of CPA Australia.
The UK example
In this ambition, the UK is instructive. Its own Islamic finance industry has developed along two separate tracks. A homegrown set of institutions serves the approximately 5 per cent of British people who are Muslim, with the usual mainstream services such as sharia-compliant equivalents of mortgages, car loans and insurance.
Beyond that, though, the UK Government is working to encourage an industry. In 2014, it went so far as to issue its own sukuk (the Islamic equivalent of a bond) at a sovereign level, not because it needed the funds but because it recognised that doing so might galvanise an Islamic capital market in London.
The British capital unashamedly wants to be home to every feasible form of finance, be it a metals exchange or a clearing centre for the Chinese renminbi or Islamic securities. The UK Government does what it needs to do in order to attract that money.
There are steps to take beyond launching a sukuk. The UK – and other jurisdictions with the same idea, such as Luxembourg – have worked to level the playing field, particularly by reducing any danger of double taxation for Islamic securities. This is a common problem when Islamic structures meet a conventional mainstream regulatory environment.
“We have some problems like that in Australia, including double taxation, and it would be very useful if it changed,” says Almir Colan, founder of the Australian Centre for Islamic Finance. While noting that some exemptions do exist, he adds that regulations are important.
“They give a signal,” he says. “By the time a big bank approves anything, it has gone through 10 different teams for every different compliance issue. They are not going to go through that where there is uncertainty.”
On the other point – that sharia products aren’t just for Muslims – the international capital markets provide the clearest illustration of potential. It is commonplace for sukuk issues from the Middle East or from Asian sovereigns to have as much as half their distribution to conventional investors who couldn’t care less about religious compliance but just like the risk profile and the yield (or the sharia equivalent of it).
Partly for this reason, sukuk tend to price more cheaply than conventional issues in the Gulf now, which in turn gives issuers more reason to follow the sharia-compliant route and attracts more investors, creating a virtuous circle.
“The growth of Islamic finance and its adoption, advocacy and promotion by Muslim-minority countries and by non-Muslim industries is a testament to its benefits, fairness and equitable approach to business and enterprise, where risk and reward are shared in equal measure,” says Vicary.
Malaysia is the world capital of sukuk issuance, as well as being the country with the most sophisticated regulatory environment. According to the Securities Commission Malaysia, Islamic assets made up 17.9 per cent of that country’s fund management industry as of June 2015.
Vicary expects sharia-compliant financing to reach 40 per cent of total financing in Malaysia by 2020. The total outstanding sukuk in Malaysia were worth RM580.71 billion (US$137.9 billion) in June, representing 53.7 per cent of all outstanding bonds from Malaysia. In recent years, the country has accounted for more than half of all global sukuk.
This, too, has lessons for Australia. Not all sukuk issuers in Malaysia are Malaysian; not all fund managers running assets there in a sharia-compliant way are Malaysian either. The Malaysia International Islamic Financial Centre was launched in 2006 with exactly this objective – to use the country’s homegrown expertise to attract international capital to be managed or raised there.
Attracted by seed capital provided by Malaysian pension scheme Employee Provident Fund, international fund managers have set up sharia-based operations through the centre. These firms include Aberdeen Asset Management, BNP Paribas Investment Partners, Principal Financial Group (in partnership with CIMB), Franklin Templeton Investments and Nomura Asset Management.
The retail side shouldn’t be ignored. History shows us that even in the most pious of Muslim states, notably Saudi Arabia, it’s not really institutions that tend to implement sharia investment practices. Saudi’s central bank, SAMA, doesn’t do so, for example. It’s ordinary mums and dads who provide much of the capital.
In fact, companies have offered simple Islamic home financing in Australia for these needs for more than 20 years. “We estimate that maybe A$4 billion of sharia-compliant home financing has been done in Australia, though most of that was in the last 10 years,” says Colan.
He believes the segment is now taking off, with fund managers taking the idea more seriously.
“I think different sectors have different potential,” he says. “Obviously there is great potential for anything that younger people need: home financing, business financing, insurance.”
Certainly, a small Muslim population should not be seen as a reason not to try to build an industry in Australia.
“When we see the energy and commitment being applied to the Islamic finance sector in Malaysia, and more broadly in Indonesia and elsewhere, I can’t help but feel Australia’s modest uptake is something of a missed opportunity,” wrote Alex Malley in Malaysia’s New Straits Times in November.
“So, too, is the potential for enhanced business, finance and cultural linkages in key Asia-Pacific and Middle Eastern markets that would come with a deeper engagement in sharia-compliant finance.”
What’s the difference?
Sharia-compliant finance differs from the mainstream in two key ways. One is straightforward: Islamic investors must avoid certain sectors, including pornography, alcohol, gambling or armaments.
The other is an avoidance of the concept of interest, and that’s where things become more complicated.
Many sharia-compliant structures look, superficially, just like their conventional counterparts. However, they are built in such a way that the outcome is not just interest – that is, money turning into more money without having done anything along the way – but profit.
What’s the difference? A key point is that in order to generate a return, the money must have served some purpose, perhaps being invested in a business or building. Also, whatever underlies these transactions must be real and tangible – hence lots of derivatives are ineligible in Islamic finance. There is also meant to be an equal sharing of risk and reward among parties to a transaction.