The Shariah compliant investment industry is one of the fastest growing sectors of the worldwide financial system. As a growing number of institutions seek to tap this pool of wealth, new regional players are emerging to compete with the traditional Islamic fund centers of Malaysia and the Middle East. With the announcement this week of both the first foreign-licensed Islamic retail funds in Malaysia, and the development of a new platform for Shariah compliant funds in Luxembourg, we take an in-depth look at what each of these jurisdictions really have to offer.
Currently there are around US$53.2 billion Shariah compliant assets under management globally, with an estimated addressable universe of over US$500 billion. And as the sector develops so too does competition between financial centers jockeying to attract this potential wealth.
Although the two biggest fund centers remain Malaysia (22%) and Saudi Arabia (18%), which together make up over 40% of total global Islamic funds, several European jurisdictions including the UK, Ireland and Luxembourg are snapping at their heels. And as investor attitudes develop with their tastes becoming more sophisticated and their service expectations higher, the game is gradually changing. Gerald Ambrose, the managing director for Malaysia at Aberdeen Asset Management, explains that: “Investor attitudes have changed from ten years ago: there’s more recognition of the role of funds and portfolio planning.”
Priorities are shifting and each jurisdiction has its own set of advantages and disadvantages, which must be weighed up in the choice of fund domicile. “What makes a location competitive?” asks Marc Theisen, the managing partner at Theisen Law in Luxembourg and a founder of the new Luxembourg Islamic funds platform, Alliance for Luxembourg Finance (ALIF). “That’s the real question – whoever answers this will be the winner.”
Leader of the pack
Malaysia has long been a hub for Shariah compliant fund management, with a thriving retail market as well as a large institutional sector. The country has been a pioneer in the industry, introducing its first Islamic unit trusts in 1993. It was the first country to introduce Islamic real estate investment trusts (REITs) in 2005, and the first in Asia to launch Islamic exchange-traded funds in 2008. A mutual recognition agreement between the Securities Commission Malaysia and the Dubai Financial Services Authority (DFSA) to promote cross-border marketing and distribution of funds between the two financial markets has also driven development.
While the Islamic fund management space is dominated by institutional investors, which in 2011 made up over two thirds of the market, Malaysia has also been successful in developing its retail sector; with a unit trust industry comprising 169 funds as of October 2012 (compared to 433 conventional funds) held in 2,086,351 accounts with a total net asset value of RM34.47 billion (US$11.35 billion) and accounting for 12% of the total RM296.22 billion (US$97.55 billion) Malaysian market.
Much of this success stems from the consistent government and regulatory support given to the funds industry in a bid to establish the country as the leading Islamic international investment management center. Incentives include a liberalized shareholding structure, up to 100% foreign ownership of Islamic fund management companies (compared to 70% for conventional fund firms); and an active cross-border investment policy. From 2007 Islamic funds domiciled in Malaysia have been allowed to invest 100% of their assets abroad, and the sector has seen around US$2 billion in start-up funding channelled to Islamic fund management companies from the state Employees Provident Fund. The country also offers significant tax breaks, including income tax exemption on all Islamic fund management activity fees until 2016, and income tax exemption for non-resident Islamic finance experts.
Winning the business
And this effort has paid off, with Malaysia widely accepted as the global hub for Islamic fund management. This was underscored in January 2013 with the launch of two new Islamic funds from Aberdeen Asset Management, one of the world’s leading fund management firms. The Shariah compliant unit trust funds represent Aberdeen’s attempt to break into the lucrative retail market, and are the first in Malaysia from a foreign-owned Islamic fund licensee.
The Aberdeen Islamic Malaysia Equity Fund is managed from Kuala Lumpur while the Aberdeen Islamic World Equity Fund will be operated from Edinburgh, UK. Ambrose explains that: “Both funds will be managed in accordance with Aberdeen’s long-term stock-picking style, resulting in concentrated portfolios.” However: “While several other Shariah compliant Malaysian equity unit trusts exist, the Aberdeen Islamic World Equity fund is a genuinely international fund and will have no immediate exposure to Malaysia at all.”
Aberdeen Asset Management is a strong long-term supporter of Malaysia as a location for its Islamic funds, and Ambrose is emphatic regarding its attractions. “We have been really impressed by how Malaysia’s capital markets have progressed over the years and with these two new funds, have high hopes for continued success in asset gathering over the medium to long-term. We are confident that with the development of a track record, these products will attract interest from Muslim investors worldwide – indeed, if the experience in Malaysia holds true, for investors of all religious and cultural backgrounds.” He highlights Malaysia’s comprehensive regulatory framework for Islamic finance, along with its 30-year track record and Islamic banking assets of around US$65.5 billion growing at 18-20% annually. In addition, the country’s diverse and developing wealth management sector is also an attraction: “Few other countries offer Malaysia’s mix of Asian and Islamic influences in their private wealth management market, providing an example to the world.”
Over the years, Malaysia has also strengthened its position in the industry by issuing more licenses to foreign banks, a policy that is set to continue. “As such,” asserts Ambrose, “the country is set to maintain its position as the world’s leading Islamic fund center.”
Nevertheless, as the market develops the global landscape is inevitably shifting and the core fund centers are seeing challenges to their dominance. Ambrose explains that: “There has been a lot of change, especially in the way Shariah investments are being used to position the local funds industry internationally. While there has been mixed success in attracting money from abroad, the effort has helped to concentrate minds on what needs to be done at home to make the industry more dynamic.”
Pretender to the throne
While Malaysia is struggling to attract money from abroad however, a new player is rapidly rising through the ranks. Luxembourg has been developing its Islamic fund management industry for some time now and is already the favored domicile of much Muslim wealth, particularly from Middle East sovereign wealth funds, as well as being a popular stock exchange for Sukuk listing. It is the second-largest investment fund center in the world and the largest wealth management center in the Eurozone. Already home to over 41 Shariah compliant funds managing around US$5.3 billion (or 10% of the estimated global Islamic total), the country is the fifth-largest domicile for Islamic funds in the world. According to Razi Fakih, the deputy CEO at HSBC Amanah: “We chose Luxembourg as our domicile for HSBC Amanah’s Shariah compliant UCITS because of its brand and reputation as a fund center, its expertise and skills in fund operations, and its global reach for fund distribution.”
Paving the way
In 2012 the Association of the Luxembourg Fund Industry published a collection of best practices for the setting up and servicing of Islamic funds, and in January 2013 this was followed by the launch of ALIF, a Shariah compliant platform offering custody and administration services. A joint venture between Amanie Advisors, ADEPA Asset Management, KBL European Private Bankers and Theisen Law, the platform plans to offer a full range of services including Shariah supervision and monitoring, compliance monitoring, and liaison with regulatory authorities for the approval and creation of investment vehicles.
“The idea for this platform actually came when we sent the Luxembourg financial mission to Malaysia in 2011,” explains Theisen. “We noted that there was very positive feedback and a strong interest in Luxembourg from the fund industry, especially for Islamic funds.” The platform is intended to work on two levels: first to make Luxembourg better known outside Europe, and promote its advantages as an Islamic fund domicile; and secondly to give a one-shop service for banks and institutions.
A wealth of opportunity
“Generally there is an interest towards more regulated funds,” says Theisen. “Luxembourg is well regulated, it is very flexible and we have over 70 double tax treaties; and we are seeing strong demand from Asia and especially from the Gulf region because of this.” Luxembourg also benefits from its position as the second-largest overall funds domicile worldwide. “You have all the providers here already, and that’s important. You can leverage the European passport for funds. And the third advantage is that Luxembourg funds have a very good reputation and are well known in other financial centers.” In addition, Luxembourg benefits from its position in the Eurozone surrounded by countries such as France and Germany with large Muslim populations, thus is well positioned for up and coming European markets.
Nevertheless, it is not all plain sailing. Theisen explains that “although Luxembourg was in the pipeline for many institutions, the global situation is difficult and people take time to make up their minds”.
And there is stiff competition not only from established jurisdictions in Asia and the Gulf but from neighboring Eurozone player. The UK has a thriving Islamic funds industry, while Ireland has also seen considerable success. In 2008 the Irish Financial Services Regulatory Authority established a dedicated regulatory unit for the authorization of Shariah funds in Ireland, while the Central Bank of Ireland has set up a Shariah advisory team for the approval of Islamic funds and the Irish Stock Exchange has also set up a unit on which to list Shariah compliant products. As of October 2012 the Irish Shariah compliant funds industry was estimated to have reached around US$3.26 billion, or 0.2% of the total US$1.59 trillion in Irish-domiciled assets. It has succeeded in attracting several key providers, including an Irish UCITS fund range from Malaysia-based CIMB-Principal Islamic Asset Management in August 2012. Noripah Kamso, then-CEO of CIMB-Principal Islamic Asset Management, said at the launch: “Ireland is right for us as we believe it will provide global flavor to our products and be the passport for international investors beyond Europe.”
In December Saudi Arabia’s NCB Capital became the most recent addition to Ireland’s fund stable, with the launch on Ireland’s UCITS platform of its first two Shariah compliant funds not registered in Saudi Arabia.
However, despite the promising progress European domiciles still face barriers to development. “The biggest challenge for Islamic finance is the cost factor,” explains Theisen. “From a legal or tax perspective Luxembourg is the best, but it is known that costs are relatively high and this is holding it back. We have to convince people that our pricing is not a disadvantage in order to be able to compete.” Higher salaries and higher overall costs in Luxembourg – and indeed in most Eurozone jurisdictions – can make it harder for Shariah compliant funds to compete with the conventional.
Luxembourg is also struggling to attract Asian investment, with most of its investment flow coming from the Gulf. Primarily, Theisen believes this is a question of location, with the Gulf just a few hours away compared to a 14 hour flight to most Asian financial centers. However, with the strong interest in Ireland from Malaysia, there is an argument that perhaps Luxembourg could be doing more to attract Asian investors. “We do need to sell our product in the Asian market. But it is not so easy and it takes time – you can’t change the world in a couple of months.”
The main attraction to European domiciles for Asian and Gulf funds is undeniably the Undertakings for Collective Investment in Transferable Securities (UCITS); a set of EU directives that allow collective investment schemes to operate freely throughout Europe on the basis of authorization in any single EU member state. But while this is key for those looking to attract European investors, it is less important for regionally-focused fund managers.
“I think Malaysia will continue its dominance in the Shariah compliant asset management space,” says Barry Williams, the Singapore-based head of product development for Southeast Asia at State Street Corporation, one of the world’s leading providers of financial services to institutional investors. “The reason funds are going out to Europe and to Luxembourg is because of the UCITS funds. Whether you agree with it or not, having a UCITS title on a fund does give it a lot more credibility, if you are looking to attract European investors. I think that’s the only reason they are pushing into Luxembourg and Dublin.”
Show me the money
One of the most interesting factors to consider when looking at the popularity of domicile locations is the end destination of its investments. While institutions are increasingly flocking to European jurisdictions to incorporate their funds, is this money actually being invested in crisis-hit Europe or is it flowing straight back into the higher growth areas of Asia and the Middle East? Theisen thinks not, asserting that: “A large part of the money is kept in Europe, where there are many investments in projects and in real estate.”
This may be less surprising than it sounds. According to Ernst & Young, the most favored asset classes continue to be equities, real estate, Sukuk and alternatives. While equity issuance has unsurprisingly faltered, real estate is an enduringly popular asset class for Islamic investors and Europe is offering rich pickings.
Sukuk, meanwhile, has enjoyed record growth and Sukuk funds are performing strongly. Ambrose notes that: “There has been a move towards Sukuk issuances with longer duration, as currently most global issuance is in five-year maturities. Ideally, a Sukuk fund of this nature would be liquid, diversified across various durations, and take advantage of higher returns on longer dated Shariah compliant instruments and higher portfolio returns.”
A bigger cake
While Malaysia has a headstart in Islamic fund management, helped by its large Muslim population and established Islamic banking sector, the industry remains in its early stages and the field remains wide open for new jurisdictions to make their mark. Shariah compliant funds account for less than 0.01% of the total US$58 trillion global asset management industry and as the industry expands established domiciles such as Malaysia and Saudi Arabia will doubtless encounter increasing competition.
“There will be more wanting slices of the cake, but the cake will be growing faster,” concludes Ambrose. — LM