The open-door policy that Luxembourg brings to all its business partnerships resulted in a series of firsts in the European Islamic finance sector: the first country to authorize an Islamic insurance company (1983), the first to list a Sukuk facility (2002), the first central bank to join the IFSB (2010) and the first eurozone market to raise a sovereign issue in euros (2014). Today, the Luxembourg financial center is well established in Islamic finance, notably in the Shariah compliant fund and Sukuk areas. What have been the key developments in the last 12 months and what could 2021 look like?
Review of 2020
The most prominent development in Islamic finance in Luxembourg in the last 12 months has certainly been Luxembourg hosting the second Sukuk Summit of the IsDB in November 2019 and the commitment by the IsDB and the European Investment Bank to commit US$1 billion each in a five-year, joint program of green Sukuk to be invested in Africa and the Middle East.
The Luxembourg trade mission to the UAE in January 2020 headed by the Hereditary Grand Duke of Luxembourg, and led by the ministers of finance and economy, was an occasion to reinforce the link in Islamic finance between the two countries.
Luxembourg has seen a continued interest in Shariah compliant investment funds in 2020. Luxembourg is the number one investment fund center in Europe and the second in the world in terms of assets under management. The majority of funds domiciled in Luxembourg are Undertakings for Collective Investments in Transferable Securities (UCITS) funds, which are allowed to market their shares freely in all EU member states and are accepted in many non-European countries. This is especially the case in Asia, Latin America and increasingly in the Middle East. This makes Luxembourg the ideal location for the domiciliation of Shariah compliant funds intended for international distribution to retail or institutional investors. Because UCITS funds are designed primarily for retail investors, their main concern is safety, and their rigorous investment policies are consistent with Shariah law’s prohibition of Gharar (uncertainty).
In addition, more flexible structures such as the Specialised Investment Fund or the Reserved Alternative Investment Fund, which allow for a wide variety of different investment strategies, can be used for Shariah compliant private equity, property or other alternative investment schemes mainly aimed at institutional or high-net-worth investors. Over the last 12 months, service providers in Luxembourg have reported a steady flow of new Islamic finance-related projects both in the UCITS and alternative areas.
While Shariah compliant funds still remain a niche market segment, over the past few years the concept of responsible investing has gained a lot of traction with both investors and asset managers globally. Environment, social and governance (ESG) integration and Islamic finance share complementary investment approaches with many common principles, such as being a good steward to society and the environment. The IsDB green Sukuk facility mentioned earlier is an example of the growing link between sustainable finance and Islamic finance.
Preview of 2021
A turning point in the development of responsible investing in Europe was reached when the European Commission presented its Action Plan on Sustainable Finance in March 2018. Things have accelerated since then and are set to develop at an even faster pace in the coming years. A recent study forecasts European ESG assets to reach between EUR5.5 trillion (US$6.4 trillion) and EUR7.6 trillion (US$8.85 trillion) by 2025, making up between 41% and 57% of total mutual fund assets in Europe by 2025, up from 12.7% at the end of 2019 (2022: The growth opportunity of the century, PwC study, October 2020).
This study also showed that investment into ESG will bring a fundamental restructuring of the investment landscape. About 77% of the 300 institutional investors stated that they intend to stop purchasing non-ESG products within the next 24 months.
Responsible investing is increasingly driven by the growing recognition that ESG factors play a material role in determining risk and return, as well as shaping the industry. Next to the established specialized investment managers, mainstream asset managers have entered or are entering the market. This follows a similar trend as Islamic finance a decade ago when global players started launching Shariah compliant funds while initially only specialized players, mostly from the Middle East and Southeast Asia, offered Shariah funds.
Investment funds are a major tool for sustainable finance. Innovative capital structuring allows funds to combine private and public financing and thus to leverage public money for financially sustainable climate investments for example. Luxembourg has strengthened, over the years, its position as the number one domicile for responsible investing funds in Europe. Today, Luxembourg is the leading global ESG domicile with 21.2% of the ESG assets under management in the world (2022: The growth opportunity of the century, PwC study, October 2020).
I am confident that in 2021 the increased focus on sustainable finance in Europe will lead to a renewed growth of Islamic finance on the European continent. Luxembourg, with its leading position in sustainable finance, its unparalleled expertise in fund structuring and administration as well as its recognition of Islamic finance, will play a key role in this regard.