European Islamic finance: still waiting in the wings
Global Islamic finance assets have remained flat at around 1 trillion dollars, of which 6% is held in investment funds. This is the topline figure of the shortly-to-be-published 2011 edition of Ernst & Young's Islamic funds report, which has become a reference in the industry. It was also the only figure leaked by E&Y, at an Islamic finance seminar they hosted within the framework of the Luxembourg AIF Club. This did not dampen a debate on how to expand the market.
Ernst & Young challenges the exuberant annual growth forecasts bandied about in the industry. The investment sector has remained flat for several reasons, reported Pierre Weimerskirch. Assets are linked to the real economy and the price of real estate, neither of which is in good health. Three other weaknesses make the industry vulnerable : lack of cross-border activity, lack of innovation and lack of institutional investors.
As at December 2010, assets under management in shariah compliant investment funds stood at $58bn, up 7% on the previous year. This was almost all due to market performance. Problems cited by Pierre Weimerskirch include the fact that bank personnel are unwilling to promote investment funds to their clients (in this aspect, the market strongly resembles Germany 20 years ago), and the fact that customers are not demanding them. The ratio of non-bank assets to bank deposits in Saudi Arabia, for instance, is 1:01 ; compare this to a ratio of 1:1.4 in the USA.
What’s in demand - and what isn’t
The long term growth potential for Islamic finance remains very large, but forecasts must be realistic, continued Weimerskirch : « Sovereign wealth funds may convert 5%-10% of their assets to Islamic finance, but this could take 5-10 years. The products with the highest immediate potential are takaful (insurance) and waqf (endowments), because the assets of both are 100% shariah compliant. »
Dr Mohd Daud Bakar, president of Amanie Advisors, Malaysia, defended a more optimistic view, pointing out that growth in the Malaysian takaful market in 2010, at 20%, had outstripped the conventional market. What is more, he said, 70% of takaful was sold to non Islamic investors.
This level of cross-cultural acceptance may be difficult to reproduce any time soon in Europe. Experience in the UK - where several Islamic banks are operating - indicates that the retail market may not be an easy nut to crack : many Muslims are wary of the products that are being promoted to them. «Education and a competitive return will be crucial to success» commented Bilal Khan, executive director of the Islamic Finance Educational Council of the UK. «We need to normalise the idea of Islamic finance in the business community by offering short courses in this discipline as part of the standard business curriculum.»
An area where demand has proven disappointing in Luxembourg is private equity. These funds are too illiquid for Islamic investors, commented the experts.
The sukuk (Islamic bond) market is more nuanced. Following a dramatic fall off in 2008 and weak recovery in 2009, business volumes bounced back with $45bn of sukuk issues in 2010 and another $40bn in the first half of 2011. Recovery has been spurred by sovereign and quasi-sovereign issuers, which represent 80% of issuers in the last three years (compared to 80% corporate issues prior to the financial crisis). However, Luxembourg has failed to win its share of this business and has lost market share to London.
What next for Luxembourg?
A number of ideas were put forward to help kick-start the European Islamic finance sector in general, and Luxembourg in particular :
- Focus business development effort on individual institutions;
- develop a European standard interpretation of shariah law, to halt fragmentation and achieve scalability. Shariah scholar Bilal Khan spoke of creating a new generation of « shariah professionals » competent to handle compliance;
- bolster Luxembourg's position as a wealth management centre for Gulf clients by adopting the draft law on trusts and foundations;
- spearhead a euro sukuk market.
Fit in or fail
Clearly, Islamic finance has to become part of the normal business scene if it is to succeed in Europe.
Where investment funds are concerned, a number of factors are holding up progress: large European retail banks have not taken the plunge, depriving the market of distribution; EU KYC ("know your customer") standards must be accepted by non-EU promoters as part of the procedure for doing business in Europe; pricing must be in line with conventional products (high start-up costs and high TERs must be tackled; 70% of shariah compliant funds are under $100m in size) and concern must be laid to rest that performance will not match that of conventional funds.
Two of these factors were tackled by the final speakers.
Clive Lang of Astongate explained the function and advantages of using an open platform to bring funds rapidly and cheaply to the market. Shariah compliant platforms are available in Luxembourg.
A team from the university Paris-Dauphine tackled the question of comparative performance in the area of equity funds. The study suffered the statistical constraints common to any emerging investment sector: short track records and small samples. Nevertheless, the results contribute credible academic evidence to support the view that shariah compliant funds are a good place to be during turbulent markets. In this, the results are comparable to academic studies that have been made on the performance of SRE investments. ER