Interest in the Islamic asset management industry’s Shariah compliant financial instruments extends beyond the Muslim Ummah. Smart investors have grasped that the principles governing Islamic finance were attractive to other investor groups; the concepts of honesty, fairplay, trust and shared equity championed by Islam are also shared by non-Islamic societies. They call this new practice ‘ethical investing’, but the ethics of our Shariah compliant financial world are centuries-old.
Institutional asset managers seek to combine Shariah principles with a reliable, competitive return on investment and defined business practices — occasionally termed ESG principles. Although Islamic finance companies are ahead of this curve, the search for new ESG-related financial instruments has produced growth in Islamic managed assets.
That market (Islamic banks, Sukuk and Takaful) reached an estimated US$3 trillion of assets in 2021. Assets under management (AuM) in Islamic funds increased substantially with an annualized rate of 13% over the five years to the end of the third quarter of 2021 (compared with 11% for non-Islamic mutual funds globally over the same period) (ibid) — 84% growth in Islamic funds in cumulative terms, compared with 68% for all mutual funds.
Saudi Arabia and Malaysia remain the preeminent Islamic fund domiciles worldwide, accounting for two-thirds of industry assets. Saudi Arabia-domiciled funds had US$41.5 billion AuM in 2021, against US$35.5 billion in Malaysia. The UAE and Indonesia followed, the latter with a compound annual growth rate of 11.7% since 2017.
Review of 2022
A challenging year
As the COVID-19 pandemic eased, financiers left established asset locations for emerging markets, though conflict in Ukraine has complicated this trend. The Islamic asset management sector demonstrated resilience and innovation, as Shariah compliant investment firms sought new ways of attracting capital and recovering forward momentum.
Leading examples include Qatar Insurance Company and QInvest bank combining in an Islamic asset management venture in April, and Labuan FSA’s new International Digital Asset Centre, leveraging its Islamic financial services legislation, trust law and digital delivery schemes to attract fintech companies and digital asset holders.
In western Asia, Saudi Arabia — the largest global incubator of Islamic financial assets at US$800 billion (28% of total global Islamic assets) — focused on open banking to enhance innovation and competitiveness, improve efficiency and develop its digital economy. Its Vision 2030 objectives encompass fintech and digital developments through its Financial Sector Development Program (FSDP), including a ‘Global Award for Islamic Finance’ to inspire advances in the Islamic finance industry, and open finance training programs at its academies.
In neighboring UAE, while bank assets rose to US$950 billion in July 2022, Islamic assets were broadly steady, increasing 2.3% during the first seven months of 2022 (US$3.65 billion). Total Islamic bank investments reached US$26.3 billion in July, a 14.4% rise during 2022, and a 17.1% leap year-on-year.
The use of Islamic financial products against conventional options narrowed to just 1% in 2022 (ibid) (61% of customers had conventional products, against 60% with Islamic products) — confirmation that consumers increasingly choose Shariah compliant solutions, reflecting the UAE’s Islamic banks’ reputation as reliable and trustworthy.
Preview of 2023
What we hope to see
We expect more innovation in Shariah compliant institutional asset management offerings, including non-Islamic fund managers offering tailored structures to permit Shariah compliant investors to access their funds as asset managers minimize risk in troubled times. Shariah–ESG strategies also offer advisory opportunities for Islamic fund managers.
The trend of non-Islamic institutions offering Shariah compliant options will continue. ‘Offshore’ jurisdictions such as Jersey (Channel Islands) have become Islamic exchange-traded fund (ETF) hubs. Luxembourg’s multiple commodity ETFs (notably gold) claim Shariah compliant status; its Islamic mutual funds can be sold in the EU and third-world countries, tapping into global demand for Islamic investment products.
Positive movements on two perennial challenges to Islamic asset management — bankruptcy regulations and the standardization of Shariah compliance laws — would be widely beneficial. Some jurisdictions have updated their bankruptcy laws, but their practical application among secular legal systems is often untested.
The UK CFA asked (ibid): “How would bankruptcy courts treat Sukuk defaults compared to (regular) bond defaults, whether investors will have full recourse to the issuers, and if Sukuk certificate holders will be able to enforce their contractual rights in local courts?”
On regulation, Dr Mohamed Damak, the senior director and global head of Islamic finance at S&P Global Ratings, suggested that mandated regulatory compliance with AAOIFI standards in the GCC had slowed some Sukuk issuances. He considers standardization to be critical for the sustained growth of Islamic finance — not a new proposal, but an important and valid one.
Are AAOIFI and similar regulations too onerous, especially an institutional response to those seeking easier paths to attract funds to a Shariah compliant home? Regulators and boards of Islamic financial institutions will decide which interpretations to apply; having stricter regulations does not necessarily equate to funds seeking alternative locations, though it can increase operational costs.
Conclusion
Islamic institutional asset managers across the Ummah and beyond have an exciting future, with a flight to asset quality, reliability and an ethical investment basis. Discussions should continue between financial practitioners, experts in Shariah-related aspects of investment and asset managers on standardizing Islamic financial products. Ensuring a continued focus on risk, sharing, social equity and ‘doing good’ will demonstrate the ongoing value of our Shariah-guided practices across the globe, reinforcing the advantages of Islamic institutional asset management.
Pankaj Gupta is the co-founder and co-CEO of Gulf Islamic Investments. He can be contacted at [email protected].