Islamic asset management is one of the fastest growing sectors of the global fund management industry. In 2002, the Islamic banking sector was worth $145 billion. Now, that figure stands at roughly $1 trillion, and looks set to grow exponentially. PricewaterhouseCoopers estimates Islamic banking will grow at a compound annual growth rate of 15% to 20% until 2015. Much of that growth is driven in asset management, by the issuance of sukuk products, which are bond like obligations.

In 2007, new issuance for global sukuk reached a record $47 billion, up 70% from the prior year, according to a report compiled by State Street. Though 2008 and 2009 saw a slowdown, issuance has since picked up and analysts expect 2012 to be buoyant. As State Street points out, massive infrastructure projects in the GCC region, estimated in excess of $1.6 trillion, will require huge amounts of funding. Sukuk issuance has not been limited only to the GCC region, either.

Last year saw the issuance of a $2bn sukuk by the Malaysian government, whose five and ten year sukuk Wakala was oversubscribed by 4.5 times, attracting an excess of $9bn, according to news reports.

“It was a much welcome development in the market. It provides the market with the building blocks for a yield curve,” explains Raphael Dalmau, head of Shari’ah-compliant portfolio management at BNP Paribas Investment Partners in Singapore.

The nature of sukuk issuance has changed as well. “In the past, the real estate and construction sector dominated the sukuk market. Today however, we are departing from that trend with a greater participation of the financial and industrial sectors. In the future, we can expect a wider sector diversification, including new sovereign names,” says Dalmau.

 Interestingly, sukuk issuance appears to be succeeding where conventional fundraising is struggling. “We found that Islamic deals were closing and conventional deals were not. What we were hearing from clients is that sukuk were pricing more attractively than conventional bonds,” says Farmida Bi, partner at the law firm Norton Rose, in London.

In contrast, equity issuance has not been as strong, although this is hardly surprising, given the slowdown in equity world-wide over three years. Industry practitioners believe that things will pick up. “People are still a bit shy of equities. I suspect that this may rebound a little this year. Corporate earnings are relatively strong for a lot of companies,” says Rod Ringrow, senior executive officer for the MENA region, at State Street in Doha.

Islamic Funds

The growth of Islamic funds has eased as well. In 2007 there were 173 funds launched, and in 2008 that figure fell to 78. In 2009, it fell sharply again to 29, according to Ernst & Young. However, this is in line with the conventional asset management space, which has seen a significant slowdown since the recession began. Islamic equity funds returned 10% in 2010, less than the 15% return on the global equity index, according to TheCityUK. This was also less than the 22% average of 2009.

Equity funds make up the largest segment of the market at 35% of funds. Alternative funds and feeder funds make up 6%, fixed income 14%, money market 14% and commodities 12% (See Table 1).

 New Markets

However, analysts point out that Islamic finance currently makes up only 1.5% of global banking assets, meaning that there is huge potential for future growth in a sector that is only 40 years old.

Despite the fact that volumes have not grown a great deal since 2007, there are a number of factors that will support the growth of the industry, according to Francis Dassou, senior manager for product solutions at HSBC Amanah Securities Services. “The Muslim population which is estimated to be nearly 26% of the world population, their increasing income per capital and the mounting wealth in the GCC region [are some]. If we combine these factors to the growing interest for Islamic finance expressed by conventional fund centres and global asset managers, this industry has the main ingredients to grow,” he says.

 There are an estimated 1.5 billion Muslims in the world. With the GCC home to between $1000bn and $1200bn of wealth, it is not surprising that Bahrain, Qatar, Dubai, and Abu Dhabi are all vying for regional dominance.  In Asia, Malaysia stands miles ahead as the leading centre, while in Europe; the UK is attempting to set itself up as a dominant hub. The UK amended its tax law in 2007 to make sukuk coupons tax deductible, which means that they are now equivalent to interest and no longer viewed as rental payments, says State Street. The UK is the third sovereign outside of the Middle East to issue Shari’ah-complaint paper after Malaysia in 2002 and the German state of Saxony-Anhalt, which issued a five year sukuk in 2004. 

Islamic asset management is gathering pace. There are about $400 billion internationally that is being managed using Islamic investment solutions, and new Islamic asset managers are appearing in the GCC and Asia Pacific.  Besides that, the Islamic asset management industry has grown moderately in many countries in Southeast Asia (e.g. Brunei, Singapore and Indonesia),

 Of the challenges in creating a wider market for Islamic products, according to Datuk Noripah Kamso, Chief Executive of CIMB-Principal Islamic Asset Management, says: “The interest in Islamic investing that we see today has nothing to do with it being faith-driven, but due to the change in trend for investors’ monies to be invested responsibly in an ethical form. However, challenges remain. In the Saudi Arabia for example, there are very strict interpretations of what is permissible/halal. Shariah-compliant products are for everyone (not for Muslims only) and they are competitive in terms of performance, innovation and diversity.

 “One of the most challenging aspects when it comes to penetrating overseas markets is to manage “image risk”. You will be surprised that even within the Gulf Cooperation Council (GCC) for example, investors in different countries have different interpretations of the Shariah principles. At first glance they may be sceptical of our products. But after some education and seeing the benefits, this challenge can progress positively. If this question were asked 6 years ago, I will not be able to show empirical evidence of the benefits and the resilient track records of Islamic equity investing. The conundrums and the black swans that have brought about a volatile equity market has given Islamic investing the opportunity to prove that despite the bull and bear markets globally, it is resilient and grants comparable risk returns (if not outperformance) in the long term to the conventional investment.”

 New markets are opening up all the time. Oman, for instance, has been working to develop Islamic banking regulations for the country, with Bank Nizwa to be the first bank granted authorisation to roll out Islamic finance products, which intends to do in the third quarter of 2012. The bank recently raised $156 million through an IPO. In Asia, Singapore has raised its profile with the launch of the city state’s first Shari’ah-compliant real estate investment trust (REIT), following a change in the tax law. The Sabana Shari’ah Compliant Industrial REIT raised $664m in a listing on the Singapore exchange.

 Badlisyah Abdul Ghani, chief executive officer of Kuala Lumpur-based CIMB Islamic, known for his pioneering work on many Islamic structures, notably the first ijarah sukuk, says that there is plenty of demand for REIT structures. “Even in Malaysia, we are seeing more and more interest by corporates and issuers to do REITs. Investors are hungry for quality assets and the demand for REITs is there, on the Shari’ah-compliant side. The biggest challenge for REITs is tax. Once the tax regime is conclusive to Islamic REITs, I think there will be more,” he says.

 However Piers Wheeler, head of institutional business in the Middle East for AMP Capital, believes it will be a while before the sector takes off. “I’ve heard people talk about Islamic REITs for a long time. It hasn’t really happened yet. A lot of REITs are considered beneficial with regards to mitigating tax leakage but there is no tax in the Middle East, so from that perspective it’s unnecessary.”

Other potentially interesting markets include Turkey, Korea, Hong Kong, Australia, South Africa, and the US. Offshore centres are also poised for growth, with many eyes on Bermuda. “We are a captive centre of the world and we are one of the three largest reinsurance markets. We have a pretty strong wealth management industry, so Bermuda is very interesting,” says Belaid Jheengoor, senior manager at PricewaterhouseCoopers. He argues that Bermuda is capable of creating a great deal of innovation. “You don’t have to deal with issues such as taxation. The legislation is very flexible,” he says.

 Growing Pains

But Islamic fund management still has plenty of challenges to deal with before it can become a truly global enterprise. Issues of standardisation and harmonisation have been discussed to death amongst practioners, but for good reason. In 2009, the industry watched with interest as Blom Bank sued Investment Dar Company for $10.7 mn, seeking the principal it had invested in a Wakala transaction, plus a five percent return. Dar said it would not pay as the fixed return constituted interest, which was not permitted the company’s own charter. At the time, Moody’s warned that the legal wrangling could hurt the industry a great deal.

Earlier, Goldman Sachs created waves with its proposed $2bn sukuk programme. At the time, according to news reports, the product was deemed unacceptable for Islamic investment by Abu Dhabi Islamic Bank, although ADIB did not make any official comment.

 “I think even someone like Goldman Sachs is not materially safeguarded from criticism in Islamic finance, if they are coming at it purely from a position of making money,” says one commentator. Other controversies remain over less mainstream products, such as Islamic hedge funds, with scholars divided over whether the products are truly Shari’ah-compliant or not.

But not everyone sees standardisation as a critical issue. “We can’t really expect too much standardisation in the sukuk market. Structures are still fluid and usually are put in place a direct response to market and the investors’ needs. If investors do not find a product attractive they simply just don’t buy it,” says Giambattista Atzeni, MENA business manager for BNY Mellon Corporate Trust.

 Legal Frameworks

Another challenge involves individual country’s legal systems. Oliver Agha, partner of Agha & Shamsi, a Shari’ah-compliant law firm based in Dubai, argues that legal and regulatory frameworks in countries are, for the most part, unable to provide a proper structure for Islamic finance. In some instances (and in Islamic jurisdictions) Islamic finance is not even treated on par with conventional finance. “Our experience in litigating complex Islamic transactions reveals that judges may be at a loss to properly adjudicate complex modern-day Islamic transactions. As a result, there is confusion among Islamic financiers, consumers, and other stakeholders about what exactly they can expect in court when things turn sour,” he says.

Agha is also a board member of the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) and secretary general of the World Islamic Finance Institute, a body created to develop best practice in the industry. He believes industry associations, while doing their best; still have a long road ahead. “There is, unfortunately, a lack of overall vision and such disparate endeavours which lack a cohesive, cogent, and comprehensive approach to the key issues facing the industry.”

He also points the finger at governments, saying they need to work harder at integrating Islamic finance. “I wished I sensed more urgency from governments. I’m not sure how aware they are of the cost of not addressing Islamic finance issues. It’s going to take a lot of time,” he says.

 Murat Unal, member of the board of Funds@Work, the research based strategy consultant, identifies the problem as a critical one also.  “How do you implement a system from a legal perspective that can’t be enforced? When something happens in the UK, and it goes to a local court, chances are that the judge presiding will be telling you that he has no idea what you are talking about, and judge by conventional standards. So enforceability is a big issue,” he says.

For his part, Abdul-Ghani points out that 95% of products in Islamic finance are standardised. “What is more important to me is that each jurisdiction have the infrastructure and relative framework from the perspective of legal, regulation, and legislation of the business. There is no point standardising products if products cannot exist,” he argues.


Another key concern is that of scholar education. Shari’ah scholars sit on the boards of most investment companies. And yet, their positions are extremely concentrated, leaving them open to criticism of conflicts of interest. Funds@Work has been compiling summary reports into scholar board concentration since 2009.  The consultant revealed that the top five scholars (out of 176) made up at least 30% of the entire universe of almost 956 board positions. (See Table 2). As Unal points out, there are over 400 other scholars, apart from the most visible 20 or so, that could be used instead. They are as educated, and capable, of making decisions. Unfortunately some scholars have become “brands” with many fund managers saying they will simply not launch a product without them, (though in many cases, most of their oversight function is addressed by their teams, rather than the scholar in question.) “The scholar will come in at the last minute and sign on the dotted line. What else can they do, when they are sitting on so many boards? It’s impossible for them to do otherwise,” notes one industry commentator.Scholars in turn  say that the criticisms are unfair, and that they are besieged by so many requests for their services.

 Politics of Religion

At the macro level, Islamic finance faces one massive challenge, and that is the perception of Islam in non-Muslim countries. France, for instance, is vying to become a centre of Islamic finance. It is also however, the country which banned the burka.

In 2005, First Islamic Investment Bank and its subsidiaries changed its name to Arcapita. Though the firm insisted that it had not changed because of anti-Islamic sentiments in the regions in which it was operating, the name change did result in some controversy about whether it was done to hide the company’s Middle Eastern origin.

 “It’s a question of labelling and branding at the end of the day,” says Zaha Rina Zahari, the industry heavyweight and leading figure involved in Islamic finance in Malaysia. A problem, she suggests, is the fact that for some, terrorism has become synonymous with Islam. “I don’t like the way the media says Islamic terrorist. A terrorist is a terrorist. When you have problems in Northern Ireland, they didn’t say ‘catholic terrorist with the IRA.”

 Norton Rose’s Bi points out that now, more than ever, people across the world should be getting exciting about what Islamic finance stands for. “There has never been a better opportunity to construct an alternative form of capitalism based on sharing risk and reward in a genuine activity that supports the cash flows, to ensure fair behaviour. All those requirements are the tenets of Islamic finance,” she says.

However, there could be a branding issue. “The word ‘Islamic’ is a problem in the West. But I do wonder, on the flip side, whether it is a benefit in Muslim majority countries. If you are setting up an Islamic bank in Pakistan or Indonesia, it is likely to draw more investors than its conventional neighbour,” says Bi.

 So should Islamic finance re-brand itself for non-Muslims? “If you talk to any Islamic banker or scholar, they will tell you that Islamic finance is for all mankind and not just Muslims. The retort to that is, why don’t you change its name and call it participation banking? There are those that argue that Islamic finance doesn’t need the crutch of Islam to support it. If it is not meant just for Muslims and for mankind, then does the name of it needs to be revisited to capture the essence of what it is?” asks Rushdi Siddiqui, head of Islamic finance and OIC countries at Thomson Reuters. Given the multiple challenges the industry already faces, it is a question that will probably remain unanswered for some time.