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Capital Agenda Insights, February 2011 - Islamic finance offers capital opportunities - EY - Global

Capital Agenda Insights, February 2011Islamic finance offers capital opportunities

2010 has seen Islamic financial assets rise by 8.9%, according to studies by The Banker and Maris Stategies, which value the industry at about $895 billion.

Growing hydrocarbon wealth in the Middle East and an increasingly devout generation of young Muslims are creating opportunities for multinational companies looking for new ways to raise capital in the aftermath of the global economic downturn.

Market overview

With four decades of history behind it, modern Islamic finance has evolved dramatically over the past 10 years and now comprises institutions ranging geographically from the Middle East and the Asia-Pacific region to Europe, and issuers ranging from major international banks to multinational companies.

2010 has seen Islamic financial assets rise by 8.9%, according to studies by The Banker and Maris Stategies, which value the industry at about $895b. From its bases in the Middle East and Malaysia, Islamic finance has been embraced by Europe, Africa, Asia and South America.

Countries have been approving institutions that provide Islamic financial services, and new initiatives and tax treatments are being developed to ease the path for expanding this source of capital. This is a market that is here to stay, and it's about time that it is seriously considered as an alternative approach to raising capital.

In the near term, activity is likely to remain focused on the expanding Islamic debt capital market, with a somewhat smaller scope for the introduction of new instruments such as Shari’a-compliant public-private partnerships.

Opportunities

The case for expansion of the Islamic finance sector is relatively straightforward: Islamic instruments have been more resilient than many conventional instruments during the global financial crisis, and they are likely to see growing demand from an increasingly wealthy group of Muslim investors.

Shari’a restrictions against excessive leverage contributed to the stronger performance of Islamic instruments during the darkest months of the financial crisis, compared with conventional instruments. For example,the Dow Jones Islamic Financial Index lost a modest 7% in 2008, compared with the S&P 500, which plunged 38.5% for the year.

While a range of Islamic profit-sharing and loan structures has existed for some time, the evolution of the Sukuk, or Islamic debt issuance market, has created a more easily tradable investment option for investors.

At the same time, the ongoing development of hydrocarbon resources in the Gulf region will continue to generate huge amounts of liquidity that will be looking for a home.

Challenges

The economic downturn has hardly left Islamic instruments unscathed.

Many investors in Islamic instruments are already overly exposed to real estate and related sectors that have yet to rebound from the downturn. The Sukuk market has also been affected, and while some recovery is in sight, sovereign issuers are outnumbering corporate ones.

Meanwhile, some of the principles behind Shari’a compliance, including those that prohibit Islamic funds from investing in sectors ranging from pork and alcohol to significant parts of the financial service sector, raise diversification issues. With industries such as gaming and alcohol off limits, Islamic fund managers need to be careful to avoid real estate developments that include gambling or alcohol retail outlets or even conventional banks.

More significantly, the overall lack of standardization in Islamic finance means that individual instruments often need to be structured in a piecemeal fashion, which makes them more costly at the outset.

Regional centers of activity still evolving

Currently, the bulk of Islamic capital raising is taking place in the Asia-Pacific region, which is home to 62% of the world’s Muslim population, and in the Middle East, which remains the largest source of Islamic capital.

Malaysia

Malaysia has dominated the Sukuk market for much of the past decade, helped by the government’s willingness to allow a 20% stamp duty exemption on Islamic financing instruments and to provide other tax incentives, which have boosted Kuala Lumpur’s profile in the sector.

Growth has taken off in the past five years, and the country is currently the largest issuer of Islamic debt in the world, with 60% of outstanding Islamic debt issues.

In 2008, Malaysian telecommunications holding company Binariang GSM Sdn Bhd raised US$3.56b in the largest Sukuk issue so far. Malaysia’s Petronas raised US$1.5b in a Sukuk issue during the latter part of 2009, and an arm of the government raised close to US$1b in June 2010.

Additional potential growth areas

The momentum of wealth generation and demand for Islamic instruments from the GCC countries in particular could see the geographical focus of Sukuk issuance move toward financial centers in Bahrain, London and Luxembourg in the near future; a Bloomberg report in December 2010 suggested that Saudi Arabia could overtake Malaysia as the largest issuer of Islamic debt as soon as this year.

Financial centers such as Singapore and Hong Kong are also positioning themselves to compete in the market, while others hoping to build up expertise include Australia, which has ambitions to become a financial hub in the Asia-Pacific region, and Paris, which is home to many of France’s 3.5 million Muslims.

Much will depend on how quickly prospective Islamic finance centers acquire the expertise and talent needed to develop the industry. Most institutions rely on having their own board of recognized Islamic scholars who also have expertise in the financial arena.

Islamic finance goes global

Islamic banks compete with conventional global banks that currently have the advantage of well-known brands, and, in many cases, have already set up Islamic “windows” via separate branches or Shari’a-compliant subsidiaries. Global brands have so far had an advantage over comparatively small Islamic banks, although it remains unclear whether the attachment to global brands will be sustained through the economic recovery.

Islamic finance is already being marketed beyond the traditional Muslim investor community. The appeal of Islamic instruments stems from the concepts on which they are based — for example, their emphasis on ethical and environmentally sustainable investments.

The potential reach of the market is evident from the range of high-profile issuers in recent years: in November 2009, GE Capital issued a $500m Sukuk, the first by a US company, while International Innovative Technologies raised $10min August 2010, the first Sukuk offering by a UK company.

In the end, of course, both Muslim and non-Muslim investors will make their investment decisions based on the potential returns, but the potentially widespread appeal of Islamic financial instruments suggests strong growth prospects ahead.

Other editions

Chew, Clark, Eglinton, Nazim

Contacts

  • Edwin Chew
    Mergers and Acquisitions,
    Asia-Pacific
    Transaction Advisory Services
    +60 3 7495 7805
  • Paul R. Clark
    Capital and Debt Advisory,
    Asia-Pacific
    Transaction Advisory Services
    +61 3 9288 8926
  • Ken Eglinton
    Islamic Financial Services, UK
    Transaction Advisory Services
    +44 (0)20 7951 2061
  • Ashar M. Nazim
    Islamic Financial Services, MENA
    Transaction Advisory Services
    +973 1751 2808

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