As Asia and especially China plays an increasingly powerful role in the global economy, its import needs will surge as consumption outpaces production. With demand for investment avenues in staple areas such as food production and energy growing, MICHAEL STOCKFORD looks at how Hong Kong is encouraging conservative, risk-averse Islamic investors to get involved.
Most investors in the Middle East understand that capital flows to Asia need to be increased, not only as Asia’s share of world GDP (and therefore its global economic influence) continues to increase, but also for risk diversification purposes as an alternative from traditional reliance on western investment opportunities. Nowhere is this more apparent than with China which, depending on who you believe, will become the world’s biggest economy as early as 2016 (according to the OECD), but more likely much later than this as structural reforms slow the pace of growth and a stronger Chinese yuan dampens exporter competitiveness.
What is for sure is that if growth is to endure in China, even at a reduced rate, it will continue to accumulate and consume natural resources at a rapid pace. At the most basic level, its population of approximately 1.3 billion needs to be housed and fed and this means China will keep looking for basic minerals and foods to provide for its population. Iron ore, copper, coal, wheat, rice and soy beans are just some of the staples that China cannot produce enough domestically and so will naturally need to import.
But as populations live longer and consume more, seeking out these resources is becoming increasingly more difficult, especially as producing countries look to protect such resources for their own people. As recently as 2009 when many traditional food exporters in the developing world stopped exports to feed their own people, some food-importing countries faced price hikes and shortages, even riots in some cases. At the time a G8 statement noted: “Food security is closely connected with economic growth and social progress as well as with political stability and peace”. Quite dramatic.
If we accept that the long-term global trend for energy and food prices is up, even if the path is volatile as periods of over-production lead to corrections, then there is obviously money to be made by investing in these sectors. However, there is intense competition to tie up most, if not all, future energy and agriculture production at the project development stage and this is where private equity funds with their long-term investment horizon are natural vehicles for such investments.
But how do conservative, risk-averse Islamic investors share in these opportunities? Traditional private equity funds normally lock money up for a minimum of seven years and there is no control over what investments are made by the fund to ensure it adheres to Shariah principles. Even if a private equity fund could be made Shariah compliant there is still the issue of a lock up and investors currently do not like this, having been burnt during the global financial crisis when liquidity dried up and investors in such funds either needed to sell their ‘interest’ at a deep discount or seek other avenues to cover short-term cash flow issues.
But there is an alternative. The Hong Kong Exchange provides for what are commonly referred to as Chapter 21 companies, after the section in the listing rules that govern their operations. These are effectively investment vehicles (funds) but are listed and so have a liquidity option for investors who wish to gain access to private equity deals, which should be the preferred transactions for Chapter 21 companies, but may not wish to be locked in for the long run. Such vehicles also lend themselves quite nicely to Islamic principles as they have natural risk diversification and risk-sharing principles built into the stock exchange rules. For example such companies cannot invest more than 20% of its assets in an individual investment, nor can it own more than 30% of the issued share capital of that investment.
With these foundations in place it is relatively easy to add the specific Shariah restrictions into the constitutive documents of the company to make it completely Shariah complaint — industry classification, in particular precluding asset classes such as gambling and alcohol; the use of leverage, taking of interest and other financial restrictions, are all relatively easy to build in. Certainly agriculture and energy are two asset classes that can be utilized in an Islamic vehicle.
Like a private equity fund, a Chapter 21 company must have an investment manager, but unlike private equity funds this manager is required to be licensed by the Hong Kong Securities & Futures Commission. It is required to have a board with independent non-executive directors, a custodian, an auditor and audit committee and regular shareholder meetings. All in all there is far more internal and external oversight of a Chapter 21 company than there is a typical private equity fund, which should provide a degree of comfort to even the most cautious of investors. Add to this the ability to add a Shariah board oversight and it is easy to see why it may not be long before Chapter 21 companies, established specifically to act as a conduit for China’s thirst for resources, will be the investment vehicle of choice for Islamic investors looking to capitalize on the opportunities that will arise from this natural demand and supply equation.
Michael Stockford is the CEO of OP Investment Management in Hong Kong. He can be contacted at
[email protected]
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