West looks to the East for growth as Islamic finance comes centre stage
As the Muslim population is expected to rise twice as fast as the non-Muslim population, financial products to service this market could be in line for dramatic growth
WITH WESTERN financial markets still suffering the after-shock of the collapse of Lehman Brothers and the resulting credit crunch and Eurozone sovereign debt crisis, attention is now turning to the Middle East.
While Dubai may have been caught up in the global asset bubble, the region has emerged largely unscathed from the recent crises, paving the way for dramatic growth in Islamic finance. But what is Islamic finance and what does it mean for Irish investors?
WHAT IS ISLAMIC FINANCE?
In short, it involves the application of Sharia law, the moral code of the Islamic religion, to financial services.
According to Farmida Bi, partner and Islamic finance specialist with UK law firm Norton Rose, the following are the main rulings of Islamic finance:
Riba: this is the prohibition against charging interest, but also applies to usury or unjust enrichment
Gharar (uncertainty): there must be full disclosure when it comes to investments, such as certainty as to the subject matter or price of a contract
Maisir (speculation or gambling): this refers to obtaining something easily or becoming rich without hard effort
Unethical investment: under Sharia law, certain products are prohibited such as alcohol, armaments or pork, as well as activities such as gambling, entertainment and hotels.
HOW DOES THIS WORK IN PRACTICE?
The principles of Sharia law are applied to financial services in varying ways. With regards to deposit accounts for example, rather than earning interest, savers share in the profits and losses made by the institution from the use of this money. From an Irish context, this “return” would be liable to DIRT, much in the same way as if it was interest.
When it comes to mortgages, as it is against Islamic law to receive or pay interest, prospective homeowners may enter into a lease agreement with their lender.
HOW BIG IS IT?
The UK Islamic Finance Secretariat has estimated the value of Sharia-compliant assets to be in the region of about $1.3 trillion. While this may only account for about 1 per cent of the global financial system, it is growing at a rate of about 15-20 per cent a year, up from about $150 billion in the mid 1990s.
The main centres for Islamic finance are largely concentrated in the Middle East and Gulf region, with Malaysia another hub.
Andrew Quinn, head of tax at Maples and Calder, puts this growth down to a number factors, such as “greater sophistication in the Arab world” and the opening up of countries in this region, both economically and politically, since the Arab Spring. Moreover, the Muslim population is expected to grow twice as fast as the non-Muslim population up to 2030.
But it is yet a burgeoning industry, which is largely dominated by banking. As of the end of 2010 for example, Islamic banking assets represented 83.4 per cent of overall Islamic assets, followed by Sukuk (11.3 per cent) and Islamic funds (4.6 per cent).
WHY AM I HEARING SO MUCH ABOUT IT HAPPENING IN IRELAND?
Despite the fact that Ireland still has a relatively small Muslim population – at about 50,000 according to the 2011 census – Ireland has nonetheless emerged as a major global centre for Islamic finance.
Earlier this year Taoiseach Enda Kenny said the Government was “determined to ensure that the IFSC is a centre of excellence for Islamic finance”.
About 20 per cent of all Sharia funds located outside of the Middle East are now based in Ireland, while the industry here services about €2.5 billion worth of funds. In 2010, the Government published extensive tax legislation in the Finance Act to facilitate a wide variety of Islamic finance, such as debt capital markets, securitisation and investment funds. Moreover, Ireland has double tax treaties in place with 67 countries including Turkey, Malaysia, the UAE, Bahrain and Kuwait.
More recently, it has positioned itself in the debt space, with Goldman Sachs listing a $2 billion sukuk on the Irish Stock Exchange late last year. The Sharia-compliant bond acts as a trustee and seller of “murabaha” trust certificates. Murabaha is a contract whereby the seller must disclose its profit to the buyer.
But despite the hype, Islamic finance still remains a small segment of the overall international financial services market in Ireland, given that the total funds industry is worth about €2 trillion. “It’s a reasonable number but is growing,” notes Quinn.
IS IRELAND FACING OTHER COMPETITION FOR THIS BUSINESS?
Given the potential growth prospects for the industry, it is not surprising that other centres in Europe are also trying to cash in. Luxembourg for example, is also aiming to position itself as a centre for offshore Islamic funds and debt issuance, while Switzerland is looking to cover the private banking angle.
London is also very active in the sector. Most major UK banks now have opened “Islamic windows”, which are treated as independent departments within the banks, in order to reassure customers that they fully respect Sharia law.
Moreover, the UK is home to the first wholly Sharia-compliant retail bank in the West, the Islamic Bank of Britain.
ARE ANY PRODUCTS AIMED AT THE IRISH MARKET?
Despite the growing Muslim population in Ireland, as of yet there are no specific Sharia-compliant products available here.
According to the Irish Banking Federation (IBF), the most likely area of activity will be mortgages. However, according to a spokesman for the IBF, this is currently constrained by demand, which is subdued in line with overall mortgage market demand. Moreover, to facilitate an Islamic mortgage product, legislative change will need to happen in relation to taxation matters such as stamp duty, tax relief at source, etc.
CAN I INVEST IN SHARIA PRODUCTS EVEN IF IM NOT MUSLIM?
Given the all-important diversification benefits that can be had by spreading your investments, exposure to the Middle East might be a good thing for some investors. According to Quinn: “There is nothing to stop a non-Muslim investor from investing” in Sharia products and he notes that it can help an investors’ diversification.
Moreover, Sharia-compliant funds might appeal to investors with specific ethical concerns, given that they don’t invest in gambling or alcohol-related stocks, and short-selling is banned.
For Irish investors, exchange-traded fund (ETF) specialist iShares offers the MSCI Emerging Markets Islamic Index, which offers exposure to stocks from the MSCI Emerging Markets Index, which comply with Sharia investment principles.
However, given that other opportunities exist to invest in the region, if you’re looking for exposure to the Middle East it might be easier to do so through a traditional investment product. For example, Rabodirect has an “Emerging Europe, Middle East and Africa” fund managed by Fidelity you could consider, while the iShares MSCI GCC Countries ex-Saudi Arabia ETF is another option.
Indeed depending on market conditions, being able to short-sell can be a better option for a fund. For example in the year to March 31st, the Dow Jones Islamic Market USA Index, which tracks Sharia-compliant stocks was up by 7.43 per cent. The SP 500 on the other hand, grew by 8.54 per cent. When looked at over a five-year period however, the Sharia index slightly out-performed the SP 500.
COULD ISLAMIC FINANCE BE A SOURCE OF NEW FUNDS FOR IRELAND?
With traditional credit lines squeezed in the West, countries in the Gulf Co-operation Council (GCC), such as Bahrain, Kuwait and Saudi Arabia, offer the possibility of a new form of funding from wealthy investors in this region such as sovereign wealth funds and family offices.
As a result, European companies have increasingly started to look to this region for funding by issuing sukuk bonds that are Sharia-compliant.
In 2010, International Innovative Technologies (IIT), a maker of industrial milling machines located in the northeast of England, launched this market when it funded its expansion plans by raising $10 million through a private sukuk.
Global giant GE has also raised $500 million through a sukuk which it listed on Dubai’s Nasdaq. Indeed HSBC recently forecast that global sukuk issuance will jump by 50 per cent this year. Moreover, in a time of much volatility on the debt markets, many sovereigns have also considered this route. The UK has repeatedly considered it, although continues to rule it out on the basis that it does not offer “value for money in the current low interest rate environment.
For Ireland however, it could prove a source of much-needed funding whenever it gets back to the debt markets. Indeed two weeks ago, Tánaiste Eamonn Gilmore told the International Fiscal Association conference in Dublin that the Government was “open to considering such an option in the future”.