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Opalesque Exclusive: Developments in Islamic Finance (2)

Posted on 19 December 2008

Benedicte Gravrand, Opalesque London, reports for Opalesque’s free daily Islamic Finance Briefing (subscribe here). See yesterday’s part 1 of the article here.

Some experts on Islamic finance gave their views on the current developments: Dr. Mushtaq Shah, CEO of Ratings Intelligence (, a London firm which provides services for investors who wish to invest in stocks in accordance with Islamic principles, and Farmida Bi and Neil D Miller, partners at the law firm Norton Rose’s Banking team in London ( and specialists in Islamic Finance contributed. Norton Rose now has three offices in the region in Bahrain, Dubai and Abu Dhabi as well as an associated office in Riyadh with the Law Office of Abdul-Aziz Al Assaf.

New products in Islamic finance: note issuance platforms, structured products, alternatives, ETFS
According to Dr. Shah, we continue to see a wide range of products being developed along the risk/reward spectrum. The return on cash equivalent Islamic products is quite low so investors are looking for new products. In addition, global property (which used to be very popular with Islamic investors) is not looking very attractive and the illiquidity is an issue. On the Sukuk side, there are now almost exclusively Ijara type structures after the AAOIFI ruling, but at least the market is active again. Money continues to flow into equity mutual funds, albeit with capital protection. And there are more alternatives in the Shariah space (both hedge funds and private equity), though demand so far is limited.

Norton Rose believes that in the current market environment, it is difficult to talk definitively about what investors are willing to buy. In the past there has been demand for a wide variety of investment classes, although real estate has been a consistent favourite. The growing range of Shariah compliant indices such as the Dow Jones Islamic and the FTSE Islamic have also made equities more readily accessible and over the past year we have seen a wide range of structured notes trading or linked to equities.

In previous years, investment funds have provided convenient vehicles for investors and these remain a popular method. However, in the past 18 moths or so Norton Rose has advised on several note issuance platforms and structured investment products, including one of the first Shariah compliant hedge funds that has delivered a scholar approved arrangement that achieves the economics of short selling. Several Islamic ETFs have also been launched, although Norton Rose believes the Barclays Global iShares product they helped the banks to launch on the London Stock Exchange in December 2007 was probably the first of its type.

Investors-base becoming more institutionalised, most demand comes from Muslim majority countries
A recent Terrapinn survey, which was conducted amongst more than 820 institutional investors and fund managers from around the world and the Middle East, showed that more than half of international institutional investors, or 53%, were looking to allocate to Middle East-based hedge funds.

Investors “are looking for liquid assets that can provide a better return than compliant cash alternatives, but not with too much risk,” Shah says. And at the moment, most of the demand is coming from the private sector. In the Mid East, this amounts to private banking clients and in the Far East retail.

“However, there are signs that institutions (SWF’s, pension funds) in the Far East are starting to look at Islamic investments” he continues. “The ME institutions are a little behind, but we expect a SWF or pension fund to start making Islamic investments in the next 18 months. Once one has done it, they will all be forced to. This will really change the market and make it more institutionalised. We will see big flows into the area.”

Norton Rose observed that Islamic investors traditionally look for strong returns but may relinquish some of the return for a good periodic cash flow. It is difficult to predict whether sectoral and risk appetites will change in the new year. There are some arguments to suggest that investor portfolios do need to broaden when and where they can in equities not least because of the lack of fixed income and/or cash investments that are available.

The demand for Islamic products comes from Muslim majority countries, according to Norton Rose, with demand led out of the Gulf States and Malaysia. The pressures driving these demands are various. In some cases, Government and quasi Government sponsors will often require Shariah compliant financing solutions for major infrastructure developments etc. There is also demand from an increasingly sophisticated regional investor community which varies from high net worth individuals at one end of the spectrum to retail consumers at the other. The demand for sukuk however was driven largely by conventional investors looking for debt-like returns but wanting to invest in the region.

Sell-side and buy-side relationships
With regards to the sell-side and buy-side relationships, Shah says that on the sell-side (investment banks), the structured products/derivative desks are providing all sorts of products that can be “white labelled”, such as index tracking products with capital protection, passive product with volatility targets… On the client servicing side (prime brokerage for example), banks are gearing themselves to provide compliant solutions. This should [give] the cost of the product to the end client and improve efficiency. On the buy-side (fund managers) a number of big name Western managers are either looking to do Shariah compliant products or in the process of launching them.

Norton Rose believes that at present, investors are divesting real estate assets in particular, in order to meet cash flow obligations elsewhere. On the buy side, certain investors are looking for, and investing in, assets and regions where they see good valuations at present- and potential for growth e.g.: green technologies and emerging markets such as North Africa, China and India.

Fund flows come from individuals and from governments
Norton Rose argues that what external observers fail to realise is that the (vast) majority of funds generated in the Muslim world (much of which stems from oil revenues) has been managed either conventionally or not at all. The money that then starts to be managed Islamically generally represents amounts that belong to individuals who have then chosen (for religious reasons) to manage their financial affairs in a way that reflects their faith (i.e. in accordance with the Shariah) and/or it may be pools of cash that Governments, quasi Government entities and/or large corporations that have similarly decided (for religious reasons), should be managed in this way.

So far as the Islamic windows of conventional banks are concerned, Norton Rose adds, when they were providing credit to Islamically financed projects, it was on the basis of the demand for such financing coming from regional sponsors, so it made sense to respond to that demand and inject funding in a structured way that responds to these requirements. In this respect, the flow into Islamic finance has been in two directions but for completely different reasons.

According to Dr. Shah, counting the money coming into Islamic finance is hard to figure out, but taking the number of banks that are either converting to 100% Islamic or opening up Islamic arms, the growth in assets seems to be 20% + per annum.

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