Against the backdrop of improving economic growth, Islamic finance in the UAE maintained its gradual growth which outpaced the growth in conventional finance assets in 2021. Although Sukuk issuance slowed, the overall momentum in Islamic finance continued unabated particularly with the ongoing growth in the Takaful sector as well as in Shariah compliant fund management.

Review of 2021
Some of the key developments during the year 2021 were a) introduction of new Shariah compliance rules and b) increased focus on environmental, social and governance (ESG) within the Islamic finance framework.

In early 2021, the Higher Sharia Authority (HSA), housed under the Central Bank of the UAE, introduced regulatory changes that required Islamic banks and Islamic windows of the conventional banks to comply with AAOIFI Shariah standards.

Although these changes affected various aspects of Islamic banks’ daily operations, the biggest impact was seen on issuing, arranging and investing in Sukuk. According to Fitch Ratings, the new regulatory requirements for Sukuk included stricter tangibility ratio requirements with new dissolution triggers such as tangibility and delisting events and associated put options, as well as partial-loss events.

Under the new standard, issuers are required to maintain the tangibility ratio above 50% throughout the Sukuk’s life, rather than just at issuance. If the tangibility ratio falls below 33%, it could trigger the exercise of put options by investors.

Such events, in turn, could reduce issuers’ liquidity and potentially affect their credit ratings, according to Fitch. That said, the changes have so far been seen in Sukuk issued by corporates and financial institutions, and less so in sovereign Sukuk, largely because sovereign Sukuk structures do not contain Murabahah (deferred sale payments), which are considered intangible assets.

The HSA also issued guidance on the London Interbank Offered Rate (or LIBOR) transition. Given the prohibition on speculation under the Shariah guidelines, the current lack of forward looking rates under the new Secured Overnight Funding Rate (or SOFR) mechanism has presented a few challenges which are currently being addressed.

During the year, the UAE Ministry of Climate Change and Environment launched the UAE Sustainable Finance Framework 2021–2031. We note that sustainable finance has several parallels with Islamic finance as the goal to uphold one’s ethical values and promote social welfare through investment has some origins in Shariah law. The year 2021 saw increased focus on ESG financings and most Islamic banks increased their ESG-related lending.

In the Islamic capital markets, Sukuk issuance in the UAE and in the wider GCC region slowed in 2021 compared with 2020 as the rise in oil prices reduced the government’s budget deficit and consequently the government’s need for funding from the capital markets.

Nevertheless, NASDAQ Dubai remained the most active listing exchange for Sukuk in the region. Recently, it listed a US$500 million Sukuk facility from Emirates Islamic after registering a US$1.7 billion Sukuk facility by the IsDB.

On the banking front, in 2021, UAE Islamic banks’ operations suffered from low profitability, modest financing growth and elevated financing impairment charges amid subdued economic conditions.

The real impact on asset quality became a bit harder to estimate as the true impact was masked in the short term by financing deferral programs and regulatory flexibility for banks in recognizing impairments amid the COVID-19 pandemic.

Although Islamic insurance still represents less than 30% of the total insurance market in the UAE, Takaful premiums recorded an annualized growth of circa 6.8% between 2017 and 2020.

Much of the boost in the later years was fueled by the government making health insurance mandatory in the country. The recent adoption of risk-based capital regulation and the continued embracing of digitalization are further positive developments in the Takaful sector.

However, on the negative front, the profitability of the Takaful sector was hit hard by COVID-19-related claims. As per Moody’s Investors Service’s estimate, Takaful players’ profitability in the first half of 2021 was down by more than 35% from 2020 levels.

On the Islamic asset management front, several new avenues have opened up within Islamic investment, such as charitable trusts, private equity, exchange-traded Sukuk funds, Shariah compliant mortgage investment funds, Halal mutual funds, etc. Such wide offerings are likely to appeal to a broader consumer base, thus improving demand prospects for Islamic instruments in the UAE.

Preview of 2022
We expect 2022 to bring more of the same things that hallmarked 2021. Looking at the ambitious energy targets announced by the government under the UAE Energy Strategy 2050, there will be plenty of new projects in sustainable energy generation, all of which will require significant investment and capital.

Green and sustainable Sukuk, which will appeal to both the core Islamic investors in the region and the wider pool of international ESG investors, may offer a unique source of diversified capital for issuers and therefore we may see heightened activity in this space.

Conclusion
The UAE government’s goal of making the country a hub for Islamic finance is being well executed with a continued focus on launching new Shariah compliant products and the adoption of newer technologies.

Anita Yadav is CEO of Global Credit Advisory. She can be contacted at [email protected]