Due to the continuing Eurozone crisis investment conditions continue to be challenging in both the mature and emerging markets. Prices for Shariah compliant equity have been falling in line with shares more generally, resulting in a reluctance to invest. Although 2012 will be a record year for Sukuk issuances, yields are low and barely compensate for the much greater default risk than was the case for the period prior to 2008 when there were no defaults. Real estate markets, significant for long-term investment, also remain weak, with much uncertainty over future prices.
In these circumstances it is not surprising that Islamic financial institutions are holding on to their liquidity and are reluctant to invest. Arguably it may be an appropriate time to invest in the emerging markets of Muslim countries, as although these are risky, the risks are no greater than in mature markets. Following its presidential elections, Egypt is an obvious destination for Islamic investment. The country has a young, well-educated population anxious to find employment. Investors who get involved in the Egyptian economy could be participating in a market with exciting prospects while at the same time supporting socially worthwhile endeavors.
Emeritus Professor, Durham University, UK
Banks are required to operate within the confines of the local laws and regulations, and product innovation is often a long and cumbersome process. In addition, many Islamic banks appear to have a tendency to invest in the same type of transactions and sectors over and over again. As long as the banks keep on placing money with each other using commodity Murabahah or invest in real estate, product innovation is unlikely to happen quickly. One of the opportunities that is often overlooked is to invest in, and lend to, local enterprises. It may not be as glamorous as being able to show a global reach, but it would benefit the local economy, allow for diversification, and has a strong potential to reduce risks.
DR NATALIE SCHOON
Principal consultant, Formabb
The question of finding a home for excess liquidity is one that has been doing the rounds for a good number of years now. Over the last five years, great strides have been made by the market to structure products that are suitable for investment such that I now question whether there is truly a lack of avenues to invest.
I believe that with the advent of Sukuk funds, Ijarah funds, trade finance funds and so on, there are now plenty of avenues to choose from. What I have found is that risk management techniques and the detailed knowledge of how these products operate are still lacking in some areas. It is normally said that if a message is not being understood, it is the problem of the deliverer not the recipient. I think that the task that lies ahead for the industry is one of education, both of the markets and of the products that give access to those markets.
Head of fixed income, Asset Management Group, National Bank of Abu Dhabi
Islamic institutions that have liquidity, yet feel there are no suitable instruments or platforms to invest in, face a peculiar dilemma.
For conventional banks, the natural home for such liquidity is the fixed income markets, whether it is the money market for shorter tenor liquidity, or the bonds market for longer tenors. Islamic banks do have access to a reasonable Islamic money market platform (which is of course priced at interest) yet have more restricted access to a liquid Sukuk market (again priced at interest).
By its very nature, liquidity needs to be invested in a manner that provides strong security for the protection of the capital, along with some parameters for assessing the returns. Debt products (interbank and bond markets) were designed for this very purpose, and that is one reason why Islamic banks have only considered Islamic versions of these debt products to manage their liquidity. It is clear that this is a short-sighted solution, because we are still relying on debt and interest at all stages in this scenario. Steps taken to deepen this market, to introduce some level of transparency, do not take us away from the fact that these are still debt and interest instruments that we are transacting and relying on.
In the short-term the industry, due to a proven lack of vision that we all have demonstrated over the years, may well focus on attempts to reduce transactional costs and improve the liquidity of money markets (e.g. the introduction of certificates of deposit) and Sukuk markets, but that has little to no impact on the deeper problem that we still interact in a very significant manner with interest and debt.
What is needed – and the sooner the industry grasps this, the sooner we can look to make positive developments — is an attempt to transform investments and aspects of the real economy into what is needed by the banks. For certainty of capital, the banks (investors in this case) should look to markets with long-term fundamentals and resilience. It is unlikely that countries where the Islamic banks are located (in meaningful numbers) can deliver these markets in the medium-term. So we have to look abroad to markets that can deliver these instruments.
Secondly, investments would need to be separated into three elements — one would be for investors who desire capital protection above all else (i.e. the banks and Takaful firms), one would be for investors who wish to take some reasonable amount of risk, and a third would be for investors wishing to take more risk. It is not that difficult to break down an investment into these kinds of tranches. What is key here is that these investments must be real investments delivering real returns from real markets, not the tranching of credit default swap, credit risk, and debt that we have seen for too long in the conventional markets. These create risk and are de-linked from the real economy.
In short, banks do need to transform from entities that have liabilities (deposits, capital market issuance etc) they fund with interest — which means their assets must also deliver interest, just more of it — to entities that truly manage money and risk of the real economy.
Without making this step, Islamic banks will continue to have available to them solutions that are spin-offs of the conventional markets, which will naturally be based on debt and interest. This is a voluntary decision. Any developments along these lines are not really developments at all, but further steps that take us away from the real solutions our Islamic banks require.
CEO, Siyam Capital
This is an interesting question, and in the course of my research at the University College London’s Institute for Security & Resilience Studies (ISRS), I have come to the conclusion that Islamic finance is a contradiction in terms insofar as it is based upon a dollar monetary system which is backed by debt.
There is in fact a Shariah compliant financing mechanism which pre-dates the dawn of the modern banking system in 1694 when the (then private) Bank of England first began to privatize sovereign credit.
This is ‘stock’, which is not to be confused with shares in ‘joint stock companies’. Stock consists simply of undated credit issued at a discount and redeemable in payment for value provided. In fact the origin of the phrase ‘rate of return’ has nothing whatever to do with a fixed interest rate and is simply the variable rate over time at which ‘stock’ may be returned to the issuer against value received.
Interestingly such ‘stock’ is — in effect — now re-emerging in the form of exchange traded funds redeemable in payment for (in this case) gold bullion. My research and development has been focused upon such instruments based upon the use value of productive assets, such as energy and land rentals.
Managing partner, Wimpole International
For Indonesia, there is a high demand for infrastructure project funding and long-term Islamic instruments (i.e. Sukuk) are perfect for such projects. The issue is to engage the legislators and the tax office to create a conducive requirement for infra Sukuk. A Sukuk law akin to the sovereign Sukuk law would greatly help achieve this.
Partner, Roosdiono & Partners
The challenges faced by Islamic financial institutions are fundamentally the same as those faced by conventional financial institutions, whether they be banks, insurance companies (Takaful operators) or asset managers. All of them need to find investible assets which have the right characteristics in terms of yield and risk.
There are two factors which increase the challenge for Islamic financial institutions compared with conventional financial institutions:
1. Islamic financial institutions are often smaller than their conventional counterparts. This matters for Islamic banks and Takaful operators, and means that they have lower equity which in turn means that they are less able to take on financial risk. As a concrete illustration, the only stand-alone retail Islamic bank in the UK has been ‘deposit rich’ for many years, but unable to provide much customer finance, for example house purchase finance, due to its low level of shareholders’ equity.
2. Islamic financial institutions are unable for religious reasons to invest in many assets which are available to their conventional counterparts. At its simplest, interest-paying assets are excluded, but also the equity of many quoted companies is also excluded, either because they carry on prohibited businesses or because they earn or pay unacceptable levels of interest.
To address the first issue, Islamic banks and Takaful operators need to increase in size, for example by merger. The Islamic banking industry contains too many banks for its overall size, and regulators should encourage mergers.
To address the second issue, Islamic financial institutions need to become more innovative at structuring investible financial assets which can be issued by companies regardless of whether the issuing companies are owned by Muslims or by non-Muslims. Provided they can offer finance at attractive terms, they will find people willing to issue the investible assets required.
Islamic finance consultant and former UK head of Islamic finance at PwC
The economic cycle has not favored Islamic product development. The discipline is a costly one to fund, often requiring legal, marketing, and personnel costs that are hard for even the largest institutions to champion in a poor earnings environment. Once we enter a more stable economic growth trajectory and there is a higher degree of financial intermediation taking place, institutions may be more willing to put their carefully crafted budgets at risk.
The Arab Spring itself, however constructive from a political point of view in some geographies, has further caused both issuers and investors to turn inward. The biggest frontier in the realm of Islamic product development is the economic hinterlands of the US, Europe, and East Asia; at least from a GCC or Southeast Asia perspective. Ultimately, the amount of capital chasing local opportunities in these core Islamic geographies will cause local returns to compress, making a case for greater international diversification and asset allocation policies.
The near-term challenge may be simply putting liquidity to work in routine products, given the difficult economic environment at hand. Poor economic prospects in the OECD countries, falling growth in Brazil, China, India, and Russia and the weak oil prices are a difficult combination for risk managers to look beyond.
DOUGLAS CLARK JOHNSON
CEO, Codexa Capital
The simplest approach is to break the answer down by asset class:
Equities — there are plenty of Islamic equity funds available, and it is worth noting that the Islamic indexes have outperformed their conventional equivalents over the last few years as they do not include conventional banks and insurance companies.
Property — favored asset class for middle eastern investors, both in terms of direct investments and Shariah compliant property funds ( For example, Bank of London and the Middle East (BLME)’s Light Industrial Building Fund). Good yields are available, though the investor has to be prepared to stay invested for five years, and so forego liquidity.
The criticism of shortage of products can only really be leveled at the fixed income space, and this is therefore an area where BLME has focused its asset management product development.
Although the Sukuk market is much smaller than the conventional bond market, by combining Sukuk with Islamic money market (commodity Murabahah) and leasing products (Ijarah) BLME has been able to develop funds that perform at least as well as their conventional equivalents — e.g. BLME’s US dollar Income Fund , which last year was ranked number three out of more than 800 money market funds by Lipper, and now the BLME High Yield Fund which according to a data provider is one of the best performing Sukuk funds available.
CEO, Bank of London and The Middle East
The short and medium-term strategy to develop more Islamic products cannot be developed without a clear vision of what Islamic finance should look like in the long-term. Today that vision is clouded by too many ‘new’ products that are just conventional remakes in questionable garb.
In the long-term, I perceive an Islamic financial industry that no longer defines itself by comparing its products to those of conventional finance. It is successful and commercially viable because it is true to its Shariah precepts and serves the needs of its clients: it has a strong ethical basis with a secure foundation in real commercial transactions rather than artificial derivative constructs. It is therefore also attractive to both Muslims and non-Muslims alike.
The short and medium-term strategy is for the leadership of Islamic finance to set an example today, to be a model of what the industry could become and thus inspire the new generation of participants in this industry. Islamic finance today is attracting more and more of the best and the brightest. These new participants will find a way to take advantage of short and medium-term opportunities if someone holds up to them an inspiring and attractive long-term vision and if our industry can give them the tools to innovate and progress.
In the long-term, people will look back at the current era and recognize huge changes in world finance, ones that have already occurred and more importantly, the big ones yet to come. It is a time and opportunity for extraordinary structural change. If we give our industry the support it needs for long-term development, if our leaders can set an example of where that long-term leads, the new generation of Islamic financiers will find a way to get there. More than anything we need leadership.
Of counsel, Agha & Co
Exchange traded funds (ETFs) are an ideal way for Islamic investors to gain exposure to a wide range of Shariah compliant products in a straightforward transaction. The London Stock Exchange (LSE) has a suite of Islamic ETFs, based on indices covering the US, Europe, Asia and emerging market economies. The products give investors access to a diverse selection of companies and markets, while offering the peace of mind that any investment does not conflict with their religious commitments. LSE’s ETFs see the most trading activity of any exchange in Europe. They are subject to continuous, intraday trading and are supported by dedicated market makers. The flexibility this creates means they are suited to long or short-term investment.
Press officer, London Stock Exchange Group