Western banks including are looking to Islamic trade finance as trade grows between Europe and the Gulf, while Islamic banks are also building ties with conventional and western banks in order to leverage trade opportunities between OIC countries. This week we take a look at the exciting world of Islamic trade finance and the tantalizing prospects for growth and collaboration within this rapidly growing market.
Bank of America Merrill Lynch recently suggested that it hopes to launch Islamic trade financing soon, according to comments made by its head of regional sales for global transaction services, Chris Jameson: with a focus on Middle Eastern clients seeking to expand internationally and potentially linking with a local Islamic partner. As the global markets begin to emerge from recession the big international banks are once again turning their eyes towards the Islamic market, taking advantage of their size and global network to offer opportunities that the smaller and often more local Islamic banks are unable to offer.
As a result, some of these banks are breaking rank and taking an “if you can’t beat them, join them” approach. Last September Dubai Islamic Bank announced that it would work with Deutsche Bank to bring its letters of credit to Europe. “Trade flows have become a critical component of growth, as has the provision of trade finance activities for businesses,” said CEO of Dubai Islamic Bank, Adnan Chilwan.
Irresistible opportunities
In 2008, emerging economies accounted for just a third of world trade, but over the next three years they contributed almost 60% of the growth in imports of goods and services and 52% of the growth in exports, according to a 2013 report from the Malaysia International Islamic Finance Center (MIFC).
Global trade by the 57 OIC member states stood at US$2.1 trillion in 2011 with an intra-OIC trade rate of 17.8%. According to AAOIFI, total trade finance among the OIC country members (including Saudi Arabia, Malaysia and Turkey) and as at the end of 2012, OIC trade had grown to US$4.2 trillion, with an intra-OIC trade rate target of 20% by 2015. Trade between the GCC and Southeast Asian economies is growing by 25% per year, according to Kuwait-based Asiya Investments; while trade within Asia is expected to quadruple from US$5 trillion in 2012 to US$20 billion by 2020.
Trade in the MENA region is expected to increase by a compound annual growth rate of 131% between 2012-26 according to a recent report from KFH Research, compared to a corresponding figure for the increase in global trade during the same time period of just 86%. The report highlights the potential for Islamic finance in global trade, especially given its low starting point. Industry estimates suggest that Islamic trade finance transactions currently make up only around 1.5% of total world trade finance flows, with Shariah compliant instruments and transactions supporting around US$250 billion in trade and around
Islamic trade finance transactions are roughly 1.5% of total world trade finance value.
Filling the Asian gap
However with the European banking sector currently struggling with an economic slowdown and the upcoming Basel III capital adequacy rules implementation, Asiya Investments highlights a shortage of US dollar funding, particularly for medium-sized companies in Asia. According to a March 2013 survey from the Asian Development Bank (ADB) there is a US$1.6 trillion gap in the US$4.6 trillion global trade finance market. In Asia out of US$2.1 trillion trade finance proposals received in 2012, US$425 billion were rejected.
“Dramatic shortfalls in meeting financing needs of importing and exporting companies are exacting a huge toll on job creation and economic growth in the region,” said Steven Beck, the head of trade finance at ADB. “These trade finance gaps need to be addressed to give developing Asia a boost to create jobs and alleviate poverty.”
This could represent a significant opportunity for Islamic firms to step into the breach: either by promoting their own trade finance products or by partnering with conventional western banks to provide them with on-the-ground access to attractive local markets. The Asia region accounted for 69% of total Islamic Trade Finance Corporation (ITFC) approvals in 2013, compared to 26% in the MENA region and 5% in sub-Saharan Africa, suggesting that Asia continues to offer the most tempting opportunities in the sector.
“GCC investors are eager to step up their exposure to the growing Asian economies as many of them are currently under-allocated to the region,” said Mohab Mufti, CEO of Asiya Investments Dubai. “While they are intrigued by the opportunities, most are looking for ways to expand their exposure to Asia via lower-risk strategies. Currently there is a shortage of opportunities which offer both attractive income streams and lower risk profiles, especially for those investors who require their investments to be Shariah-based.”
Trade finance funds
A solution to this demand is access to Islamic trade finance funds, and a multitude of new funds have sprung up in the past year to leverage the growth in the sector. In May last year Asiya Investments launched the US$20 million Asia Islamic Trade Finance Fund, focusing on small Asian manufacturers. Based in Hong Kong, the fund has a target return of double the Zakat rate (5%) and offers an attractive diversification at a return higher than money market funds (around 0.5-1.5%) and Sukuk (around 3% average). Ahmad Al Hamad, the group managing director of Asiya Investments, commented at the launch that: “The fund comes at a time of continued growth within the Asian continent as well as growing cross-border trade between the GCC and emerging Asia.”
In November 2013 the Rasmala Trade Finance Fund was launched by EIIB-Rasmala, a joint venture between the UK-based European Islamic Investment Bank and Dubai-based Rasmala Group (Rasmala Investment Bank). The fund is domiciled in the Cayman Islands and has a target size of US$100 million and a target return of 4%. At its launch Eric Swats, the head of asset management, highlighted the focus on diversification and stable income from Islamic investors. “Our latest fund will cater to the increasing demand for low risk, income-orientated Shariah compliant investment products. The Rasmala Trade Finance Fund will provide investors with a low-risk alternative investment opportunity to obtain attractive and stable returns.”
Growing the universe
As the sector grows, its accompanying services are now developing and more firms are entering what is an increasingly attractive market. On the 10th January UK-based financial services group UMEX launched a new ESG (environmental, social and governance) and Shariah compliant trade finance service focusing on the Halal sector, which it claims “has been largely underserved in the UK and Europe due to the fact that most Islamic financing models are managed by a handful of Islamic banks and a few mainstream banks in UK and Europe”. The service will provide businesses with a range of trade finance instruments for enhancing cash flows, improving liquidity whilst meeting their market needs, and fulfilling their full commercial value chain obligations. Initially launched in the UK, the firm plans to expand to other EU countries as well as the UAE, Mauritius and Malaysia in the spring of 2014.
European opportunity
One of the reasons for the launch of the UMEX product and a driving factor in the increased interest in trade finance is the urgent financing requirement from small and medium-sized businesses, especially in Europe, as the major European banks pull back from supporting cross-border trade finance within the SME sector. A recent study from the Institute of International Finance in collaboration with Bain & Co found that new lending decreased by 50% between 2007-12. In the conventional market, interest rates have a huge impact on SME ability to access credit: with firms in peripheral EU countries paying up to three times more than those in Germany and thus being “starved of credit”. In the UK, the volume of new loans to non-financial firms between 2007 and June 2013 fell by 20% while in other EU countries the loss was even greater. According to data from UMEX, Ireland saw SME lending drop by 82%, Portugal by 45%, France by 37%, the Netherlands by 32% and Italy by 21%.
Islamic trade finance offers a viable alternative to this, and thus has the chance to step into the breach left by conventional banks in foreign markets as well as domestic. Demand for Islamic trade finance is not only driven by a desire for religious alternatives to the conventional, but is also stimulating interest from conventional clients due to convenience, low risk levels, secure ownership structure and ethical proposition.
With the ever-growing opportunities and an operational platform that is finally sophisticated enough to keep pace with demand, it looks as if 2014 could be the year for trade finance. But more importantly, could this be the year that Islamic institutions leverage their own unique strengths to show the conventional sector the advantage of collaboration rather than competition?