Growing demand for Islamic finance products
Islamic finance has been practised for more than 1,000 years, as Muslim traders in the Middle East conducted commercial activities according to the laws permitted by their faith.
Two main factors account for the surge of interest in Islamic finance in the last decade:
– High oil prices since the 1970s have allowed individuals and corporations in the Middle East and other oil-producing countries to accumulate considerable funds, all searching for higher yield investment products.
– Globalization and the ease with which commerce can be conducted in this internet age has led to international fund managers becoming aware of this huge reservoir of Islamic wealth that they can tap. It has enhanced their creativity in originating investment products that would appeal to Islamic investors.
Today there is a surge in demand for Islamic products in the global market estimated at around US$400 billion, and growing at a rate of 15% annually.
Singapore’s position on Islamic financial services
Singapore is well positioned to offer Islamic financial services. Over the years it has built a solid infrastructure as an international center for capital market and wealth management activities. Singapore’s success in this area can be attributed to:
– its political stability;
– its sound financial policies and freedom to repatriate funds overseas;
– its transparent regulatory environment; and
– its strong legal and judicial system.
This has led to the concentration of a pool of talent to support the vibrant financial services industry. In 2004, the Singapore debt market grew by 20% to S$123 billion (US$77.46 billion) and assets under management rose to almost S$600 billion (US$377.85 billion).
In his keynote address at the International Islamic Enterprise Forum on the 29th September 2005,
Mr Heng Swee Keat, managing director of the Monetary Authority of Singapore (MAS), said:
“As a major financial centre, Singapore can play two useful roles to support and complement the efforts of other regulators and the industry.
First, we can add breadth and depth to the range of Islamic products to complement those offered by other centers. Given our multi-ethnic and multi-religious make-up of our society, Singapore has the cultural software to facilitate and integrate different practices.
Second, as a global financial centre, Islamic financial products will add to the suite of conventional financial products that Singapore already offers. The depth and liquidity of the Singapore market is the source of its strength.”
Islamic finance activities in Singapore
The MAS has assured the financial market that it will make such changes to the regulations as may be necessary to accommodate and facilitate the development of Islamic finance. This has given impetus to the development of Islamic finance products in Singapore. Let us examine the impact in relation to some Islamic finance products.
Murabahah
Under a Murabahah arrangement, a financial institution would purchase goods required by a customer, and sell them to the customer at a marked up price, usually on a deferred payment basis. Murahabah is commonly used in trade finance and short-term financing. It is acceptable under Shariah law because there is no payment of interest.
Banks in Singapore are prohibited from engaging in the business of buying and selling non-financial assets. The banking regulations were amended in September 2005 to carve out an exemption from this restriction, by specifically allowing Murabahah transactions. Within two months of the change, Singapore launched its first Murabahah facility – a US$96 million facility offered by the Singapore branch of Standard Chartered Bank for Baitak Asia Real Estate Fund, a joint venture between Singapore-based Pacific Star and Kuwait Finance House.
With effect from June 2006, banks in Singapore can also offer Islamic murabaha investment products.
Sukuk
Sukuk refers to an Islamic investment certificate backed by a cash flow of assets. By way of an example, in January 2005 Pakistan International Sukuk issued US$600 million in trust certificates. The funds raised were used to acquire real property rights over a highway which was leased back to the Pakistan Government. The revenue stream from the rental payments were used to make periodic distributions to the Sukuk-holders. The Government gave an undertaking to re-purchase the property at the same price at the end of the trust period, and the proceeds will be returned to the Sukuk-holders in 2010.
A similar transaction, if it had been effected in Singapore in the past, would have the following drawbacks:
– The periodic distributions would be subject to income tax.
– A second set of stamp duty (at 3% of the transaction value) would become payable on the repurchase of the real property.
Singapore made the following tax changes in 2005 and 2006 to facilitate Sukuk issues:
– Periodic distributions on Sukuk trust certificates now enjoy the same tax exemptions as interest payments. Individuals (both resident and non-resident) receive them free from Singapore income tax. Where the issue is arranged by a Singapore financial institution, subject to certain exceptions, non-resident corporate investors receive them free of income tax and other investors pay tax at a concessionary rate of 10%.
– No stamp duty will be imposed on the second real estate transaction.
With these favorable tax changes, international investors will find it attractive to arrange Sukuk issues out of Singapore. In October 2005, the Bahrain-based Gulf Finance House was reported to be interested in securing the necessary licenses to conduct capital market activities out of Singapore under a Shariah compliant framework. Singapore-incorporated DBS Bank has secured a license to operate in Dubai and has commenced operations in June 2006.
Mudarabah
This is a contractual arrangement between investors and a fund manager (mudarib) who manages the pooled investment funds. Profits are distributed to the investors after the deduction of the fund manager’s agreed share of the profits.
The 2006 budget aligned the tax treatment of the profits distributed to the investors by a qualifying financial institution. They will be treated in the same way as interest for tax purposes. While some fine-tuning is still necessary, it is hoped that the favorable tax treatment will provide a boost to the growth of the wealth management industry.
To date, three property funds have been launched: the Baitak Asia Real Estate Fund, ARC Capita and Residences Japan, a joint venture between CapitaLand and Bahrain’s ARC Arcapita, and Al Islamic Far East Real Estate Fund by ARA Asset Management and Dubai Islamic Bank.
Over the last two years, Singapore has also modernized its trust legislation and introduced an array of trust vehicles, such as the business trust, to further enhance its position as a leading wealth management center. Islamic finance products can benefit through the use of these sophisticated trust structures.
Islamic Real Estate Investment Trusts (I-REITs)
Singapore has a thriving REITs market, with ten REITs listed on SGX, having a total market capitalization of approximately S$12.5 billion (US$7.87 billion) as at May 2006. As part of Singapore’s vision to position itself as Asia’s REITs hub, several attractive tax and stamp duty exemptions are available for conventional REITs. These include:
– stamp duty waiver on the transfer of Singapore real estate into listed REITs (or those about to be listed); and
– distributions made to individuals will not be subject to tax, and those made to certain other qualifying unit-holders will be taxed at a 10% concessionary rate up to 2010.
The Islamic finance industry would do well to leverage on this favorable infrastructure to launch a Shariah compliant REIT in Singapore.
Shariah compliant stock indices
The Singapore Exchange Securities Trading, together with FTSE Group and Yassar Research, launched the FTSE SGX Asia Shariah 100 Index in February 2006. This index tracks 100 Shariah compliant stocks from Japan, Singapore, Taiwan, Korea and Hong Kong and will encourage the launch and management of Islamic unit trusts and exchange-traded funds in Singapore.
This is the first of a series of Shariah compliant indices to be launched. In launching the index, Mr Hsieh Fu Hua, CEO of the stock exchange, said that “offering Islamic indices on SGX is key to our development as an Asian Gateway.”
Conclusion
In conclusion, let me quote from the keynote address of Mr Ong Chong Tee, deputy managing director of MAS, at the Asian Bankers’ Summit 2005:
“As a major international financial center, we are well placed to contribute to capacity-building and understanding of Islamic financial products, leveraging on the expertise and talent base in conventional products. Singapore’s open markets, efficient infrastructure and transparent regulations will remain attractive to both conventional and Islamic financial services players.
Our aspirations in Islamic finance can be described as an affirmation of our position as an international financial center. One that is a full service center with a broad range of intermediaries and products, including Islamic ones that can meet the interest and demand from investors in Middle East and the rest of the world.”
The views expressed in this article are the author’s own.