ENHANCING CAPITAL MARKETS COOPERATION AMONG IDB MEMBER COUNTRIES

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2 ISLAMIC DEVELOPMENT BANK ENHANCING CAPITAL MARKETS COOPERATION AMONG IDB MEMBER COUNTRIES Proceedings of the 19 th IDB Annual Symposium, Jeddah, Saudi Arabia Jumad Awwal 1429H (2-3 June 2008)

3 Coordinated by: Dr. Nosratollah Nafar Economic Policy & Statistics Department Islamic Development Bank P.O. Box 5925, Jeddah Kingdom of Saudi Arabia Telephone: Facsimile: nnafar@isdb.org.sa Home Page: The views expressed in this document are those of the authors/speakers and do not necessarily reflect the position, views and policies of the Islamic Development Bank or its member countries. ii

4 CORPORATE PROFILE OF THE ISLAMIC DEVELOPMENT BANK Establishment The Islamic Development Bank (IDB) is an international financial institution established in pursuance of the Declaration of Intent issued by the Conference of Finance Ministers of Muslim Countries held in Jeddah in Dhul Qadah, 1393H (December 1973). The inaugural meeting of the Board of Governors took place in Rajab, 1395H (July 1975), and the IDB formally commenced operations on 15 Shawwal 1395H (20 October 1975). Purpose The purpose of the IDB is to foster economic development and social progress of member countries and Muslim communities in non-member countries individually as well as jointly in accordance with the principles of the Shariah (Islamic Law). Functions The main function of the IDB is to provide various forms of development assistance for poverty alleviation, human development, forging economic cooperation, promoting trade and investment and enhancing the role of Islamic finance in the social and economic development of member countries. It also establishes special funds for specific purposes including a fund for assistance to Muslim communities in non-member countries. IDB mobilizes financial resources using Shariah-compliant modes and provides technical assistance to member countries, including provision of training facilities for personnel engaged in development activities in member countries. Membership The present membership of the IDB stands at 56 countries spreading across different continents and regions. The basic condition for its membership is that the prospective country should be a member of the Organization of the Islamic Conference (OIC), pays the first installment of its minimum subscription to the Capital Stock of IDB and accepts any terms and conditions that may be decided upon by the Board of Governors. iii

5 Capital Pursuant to the decision of the Board of Governors in their 31 st Annual Meeting held in Kuwait in Jumad Awwal 1427H (May 2006), the Authorized Capital of IDB was doubled from ID15 billion to ID30 billion and the Issued Capital was also increased from ID8.1 billion to ID 15billion. The Issued Capital was further increased to ID16 billion by the Board of Governors in their 33 rd Annual Meeting held in Jeddah, Kingdom of Saudi Arabia, on Jumad Awwal 1429H (3-4 June 2008); of which ID15.1 billion was subscribed with ID3.3 billion paid-up as of end- 1429H. Head Office and Regional Offices Headquartered in Jeddah, Kingdom of Saudi Arabia, the IDB has four regional offices in Rabat, Morocco; Kuala Lumpur, Malaysia; Almaty, Kazakhstan; and Dakar, Senegal. Financial Year The IDB s financial year is the lunar Hijrah Year (H). Accounting Unit The accounting unit of IDB is the Islamic Dinar (ID) which is equivalent to one SDR - Special Drawing Rights of the International Monetary Fund. Language The official language of the IDB is Arabic, but English and French are additionally used as working languages. iv

6 TABLE OF CONTENTS Preface... vii Welcome Address Dr. Ahmad Mohamed Ali, President, Islamic Development Bank. 1 Opening Statement H.E. Abdulrahman A. Al-Tuwaijri, Chairman, Capital Market Authority, Saudi Arabia, And Chair Of The Symposium... 3 The Big Picture: Capital Markets Cooperation - Challenges and Opportunities Dr. Huseyin Erkan, Chairman and Chief Executive Officer, Istanbul Stock Exchange, Turkey TECHNICAL SESSIONS Promoting Global Depositary Receipts (GDRs) Market in the GCC Region Mr. Mahmoud Salem, Managing Director, Head of Islamic Products, Depositary Receipts, Bank of New York Mellon, USA 15 Redirecting GCC-Based Mutual Funds To IDB Member Countries Mr. Nabeel Shoaib, Global Head, HSBC Amanah, UAE. 37 Mr. Michael Lee, CEO and Member Of The Board of Ithmaar Bank, Bahrain. 41 New Partnerships in Regional (Private) Equity Market Mr. Stephen Bishop, Senior Vice President, Treasury, Dubai Ports World (DPW).. 93 Engr. Sobhi A. Batterjee President & CEO, Saudi German Hospital Mr. Jean Paul Gilet, General Manager BRVM, Stock Exchange, Cote d Ivoire 107 Major Regional Equity Indexes Research Report Mr. Rushdi Siddiqui, Global Director, Dow Jones Islamic Market Indexes, USA v

7 Islamic Capital Market And Sukuk Overview Mr. Ijlal Ahmed Alvi, Chief Executive Officer, International Islamic Financial Market, (IIFM) Manama- Bahrain MINISTERIAL SESSION Inaugural Address H.E. Sheikh Ahmad Bin Mohammed Al Khalifa, Minister of Finance, Bahrain And Chairman Of The IDB Board Of Governors. 161 Keynote Address - Capital Markets: Building The Future H.E. Dr. Moeen Qureshi, Chairman And Managing Partner, Emerging Market Partner (EMP) Global 163 Major Conclusions and Recommendations vi

8 Preface The Islamic Development Bank (IDB) has been organizing annual symposia on various themes of interest to its member countries concurrently with the Annual Meetings of the Board of Governors since 1409H. The purpose of the symposia has been to generate and disseminate ideas to orientate and encourage best practices as a way of enhancing the bank s catalytic role in fostering economic and social development in member countries. Eighteen such symposia have already been organized. In line with this tradition, the IDB organized its 19 th Annual Symposium on the occasion of the 33 rd Annual Meeting of its Board of Governors in Jeddah, Saudi Arabia, from 2 to 4 June The theme of that Symposium was Enhancing Capital Markets Cooperation Among IDB Member Countries. Given the highly important and technical nature of the theme of the Symposium, we enlisted the services of top-class professional experts from both within and outside the IDB Group. This enabled us to become more focused and specific in choosing implementable and realistic issues for discussion at the Symposium, issues which could facilitate the channeling of liquidity to productive activities in member countries. The Symposium was designed, in particular, to serve as a forum to address key issues pertinent to promotion of capital markets cooperation among member countries with a view to accelerating long-term resource mobilization and improving resource allocation efficiency through diversified and competitive capital markets. The Symposium comprised a one-day Technical Sessions and a Ministerial Session. The Ministerial Session was chaired by H. E. Sheikh Ahmad Bin Mohamed Al Khalifa, Bahrain Finance Minister, Chairman of the IDB Board of Governors; while the Technical Sessions were presided by H. E. Dr. Abdulrahman A. Al-Tuwaijri, Chairman, Capital Market Authority of Saudi Arabia. The keynote address was delivered by H. E. Moeen Qureshi, Chairman and Managing Partner of the Emerging Market Partner (EMP) Global, former Prime Minister of Pakistan. The Symposium was facilitated by contributions from highly experienced resource persons, including Huseyin Erkan, Chairman and Chief Executive Officer, Istanbul Stock Exchange; Mahmoud Salem, Managing Director, Head of Islamic Products Depositary Receipts, Bank of New York Mellon, New York; Nabeel Shoaib, Global Head, HSBC Amanah; Michael Lee, CEO and Member of the Board of Ithmaar Bank; Stephen Bishop, Vice President, Treasury, Dubai Ports World; Sobhi Batterjee, President & CEO, Saudi German Hospital; Jean Paul Gillet, General Manager, BRVM Stock Exchange, Abidjan; Rushdi Siddiqui, Global Director, Dow Jones Islamic vii

9 Market Indexes; and Ijlal Ahmed Alvi, Chief Executive Officer, International Islamic Financial Market. The speakers focused primarily on identifying instruments and mechanisms to mobilize both domestic and external resources to speed up economic growth, reduce poverty in IDB member countries and transfer management skills to help local enterprises operate successfully and develop new business skills at senior management level, thus enabling them to survive and compete on international markets. They discussed (i) the possibility of developing Islamic mutual funds through inclusion of more companies from IDB member countries in the DJIM and FTSE, thereby providing them with opportunities to obtain long-term resources; and (ii) practical ways and means to create a harmonized mechanism for efficient sovereign Sukuk markets to enhance capital markets cooperation among IDB member countries. The keynote speaker, H.E. Dr. Moeen Qureshi, reviewed the experiences of the strategic alliances established at regional and international levels and drew for member countries the lessons they needed to harmonize their institutional and legal frameworks and policies and share their investor base. He stressed that (i) the path to capital market development in the emerging economies such as IDB member countries, needed to be charted very carefully; that (ii) it was neither necessary nor desirable to model capital markets in IDB member countries entirely along the lines of Western capital markets even though there were lessons to be learned from their experiences; that (iii) there was great merit in cooperation among the capital markets of the region; that (iv) the one area in which IDB member countries had comparative advantage is, without doubt, Islamic or Shariah-compliant financing; and that (v) the IDB is in a unique position to play a crucial role in capital markets development by mobilizing and spearheading collaborative effort on the part of member countries. As the Symposium generated a number of useful ideas, it is hoped that the deliberation would create greater awareness of the significant role which capital market plays in economic growth and the key factors that facilitate cooperation among capital markets in IDB member countries. Dr. Lamine Doghri Director Economic Policy and Statistics Department viii

10 Welcome Address H.E. Dr. Ahmad Mohamed Ali President, Islamic Development Bank In the Name of Allah, the Most Gracious, the Most Merciful Praise be to Allah, Cherisher and Sustainer of the World and Peace and Blessings be upon the Last of the Prophets and Messenger and upon His Family and all His Companions Mr. Chairman, Your Excellencies, Dear Brothers and Sisters, Assalamu Alaikum wa Rahmatullahi wa Barakatuh Your Excellency Dr. Abdulrahman A. Al-Tuwaijri, Chairman, Capital Market Authority, Your Excellency Dr. Huseyin Erkan, Chairman and Chief Executive Officer, Istanbul Stock Exchange, On behalf of the Islamic Development Bank (IDB), I would like to very warmly welcome you all to the 19 th IDB Annual Symposium on Enhancing Capital Markets Cooperation Among IDB Member Countries, organized in collaboration with the Saudi Capital Market Authority. It is indeed a privilege for the IDB that leading experts are participating in this Symposium to brainstorm on practical ways and means to accelerate the mobilization of long-term resources and improve the efficiency of resource allocation among member countries through diversified and competitive capital markets. Dear Brothers and Sisters, An efficient and sound capital market plays a critical role in enhancing productivity and economic growth through mobilization of savings and allocation of investment funds. However, as a consequence of low domestic savings and inadequate external capital flows, investment ratios in many member countries, particularly in Sub-Saharan Africa, are lower than in other developing regions. Helping member countries to close this financing gap in a sustainable manner is a major challenge for various stakeholders in regional and international capital markets. 1

11 We need well-focused and specific measures to facilitate the channeling of resources to productive activities in member countries. To this end, I strongly believe that capital markets cooperation will offer substantial opportunities to raise new capital and diversify the investor base in member countries so that the resultant resources could be put to optimum use, thereby boosting economic growth and development. The main objective of this Symposium is to provide a forum for experts and member countries policy makers to discuss key issues regarding areas of cooperation among key stakeholders in member countries, areas that can facilitate capital mobility. I wish to express my sincere gratitude to H.E. Abdulrahman A. Al-Tuwaijri, Chairman of the Capital Market Authority of Saudi Arabia for accepting to chair the intensive Technical Sessions of the Symposium which, I am confident, will achieve its targets, by the grace of Allah, through judicious conduct of its proceedings. I also thank the distinguished speakers for having so kindly agreed to participate in the proceedings, and for their various presentations which will address the various themes of the Symposium. Clearly, by so doing, they will share their wide and rich experiences with all the participants. I am confident that the recommendations emanating from the ongoing Technical Sessions, and the Ministerial Session to be held tomorrow will, Insha Allah, help us identify the areas of cooperation that would boost efforts at achieving capital mobility among IDB member countries. With these words, I once again welcome you all to the Technical Sessions of the Symposium and wish you every success in your deliberations. Wassalamu Alikum Warahmatullah Wabarakatohu 2

12 Opening Statement H.E. Abdulrahman A. Al-Tuwaijri, Chairman, Capital Market Authority, Saudi Arabia and Chair of the Symposium Excellencies, Distinguish Guests, Ladies and Gentlemen, It is a great pleasure for me to be with you today. I am indeed honored for opening this meeting on the vital theme of enhancing capital markets cooperation among the member countries of the Islamic Development Bank. Let me begin by paying tribute to the IDB for the invaluable work it has done to foster socio-economic development in its member countries. Since its establishment in 1395H (1975), the IDB has grown tremendously in terms of its membership, capital and operations. Through its lending programs and technical assistance initiatives, the Bank has played - and continue to play - an invaluable role in boosting economic development in its member countries. This meeting is a good example of how the IDB can help its member countries attain their economic potential through exploring opportunities for broader and deeper cooperation. Before addressing the subject of capital market cooperation, which is the theme of this Symposium, please permit me to say a few words about the important work we have been doing to develop the capital markets in Saudi Arabia. Cooperation among capital markets must be cushioned on the solid foundations of sound national systems, i.e. trading, settlement and regulatory systems. Our capital market reforms in Saudi Arabia are part of a broad economic reform strategy which aims to change the Saudi economy from one that is heavily reliant on the export of one basic commodity oil to a highly productive, diversified and knowledge-based economy. A well-functioning capital market is part of this strategy. It is needed to ensure the efficient allocation of economic resources and to provide the channel through which Saudi Arabia can attract both foreign and domestic investment to finance our economic development. We have, in recent years, undertaken extensive capital market reforms to help us achieve these objectives. 3

13 The first step in this direction was the formation of Tadawul, our stock exchange, in This structure provides the service for the trading, clearing and settlement of shares in Saudi Arabia, and is one of the most advanced trading platforms in the world. It offers a continuous, order-driven market, with up-to-the-minute price, volume and company information dissemination. It concentrates all local equity trading in one single market. Moreover, the Capital Markets Law and its various enabling regulations have, since 2003, created a regulatory framework in line with international best practices. Additionally, the Capital Markets Law established the Capital Markets Authority (CMA) which became operational in The CMA is a government organization with financial, legal and administrative independence. It reports directly to the President of the Council of Ministers and is governed by a board of five full-time members appointed by Royal Order. Our primary functions are to regulate and develop the Saudi Arabian Capital Market. Since 2004, the CMA has made rapid progress in developing our capital market. We have issued a comprehensive set of regulations based on international best practices in such areas as Corporate Governance, Mergers and Acquisitions, Real Estate Investment Trusts and Investment Funds. We have licensed ninety (90) firms, including major international firms like Deutsche Bank, J.P. Morgan and Merrill Lynch. In today s world, no sustainable and significant development can be accomplished without efficient capital markets. Capital markets, in essence, have become the spearhead of serious and material development efforts. Given the size of the Saudi market and the significant development it witnessed over the past few years, we believe that we are in a position to share our accumulated experience with the IDB and its member countries. We also stand ready to support the Bank s efforts at encouraging mutual actions among its member countries, as a way to achieve its long-term strategic vision of effectively serving the increasing developmental needs of its member countries, in which capital markets play an important role. Ladies and Gentlemen, There is wide consensus in academic and policy-making circles on the benefits offered by capital markets integration. Dynamic capital markets are important for growth and innovation. They can produce lower cost financial services; more efficient, broader and more liquid securities markets; greater financial innovation and lower costs of corporate financing, in addition to many other benefits. Seen from the regulator s perspective, what is important 4

14 is to manage this process effectively in order to get the most out of it and, at the same time, avoid any shortcomings that may be encountered in the due course. The focus of this Symposium is, and rightly so, on the opportunities for enhanced cooperation among the capital markets of IDB member countries. Many differences exist between our respective domestic legal systems in terms of the size and stage of development of our markets, our regulatory philosophies and market cultures. At the same time, however, we have many things in common and there are a great many benefits to be enjoyed from deeper cooperation. It has always been the policy of Saudi Arabia and its leadership to embark on any effort that could foster mutual cooperation among Muslim countries in all fields. High on the list of such effort, we believe, is the enhancement of capital market cooperation among Muslim countries. I look forward to hearing from our many distinguished speakers in the course of this day, about some of the opportunities on offer. Thank you for your attention. 5

15 The Big Picture: Capital Markets Cooperation-Challenges and Opportunities Dr. Huseyin Erkan Chairman and Chief Executive Officer, Istanbul Stock Exchange, Turkey I. A Brief Overview of the Islamic Financial Services Industry In line with the fast growth of the global financial market, both conventional and Islamic finance asset size increased tremendously in the last decade. To be more specific, the asset size in the Islamic financial services industry was estimated to peak at US$ 700-US$1,000 billion by the end of 2007, of which 30 to 35 per cent fled to the GCC countries. While the number of Islamic financial institutions worldwide has also swelled to over 300, spanning more than 75 countries, Muslim and non-muslim alike, the growth rate of the Islamic finance industry has stood at 15 per cent on the average in the past five years. One particular aspect of this growth is the listing of Islamic financial instruments on stock exchanges (20 to 25 per cent of the overall outstanding Sukuk is listed on various exchanges, including the Labuan International Financial Exchange, Dubai International Financial Exchange, the Hong Kong Stock Exchange and the London Stock Exchange). Despite this growth, the Islamic finance industry is still at its infancy in relation to the conventional financial sector. While the size of bank assets in the conventional and Islamic finance sector accounts for US$ 74.4 and US$ 0.6 trillion respectively, the debt securities and Sukuk market sizes stood at US$ US$69.2 billion and US$ 0.1 trillion respectively as at the end of In regard to Islamic financial instruments, the highest ever growth rate of 75 % was registered on the Sukuk market over the last 5-year period, reaching a global outstanding total of US$ 105 billion by the end of In this respect, some vital facts need to be carefully evaluated. Many international financial institutions such as Citibank, HSBC, ABN Amro, Standard Chartered Bank, UBS, Goldman Sachs and Nomura have Islamic Window operations, and several Islamic equity investment funds have been launched, tracking the indices created by FTSE and Dow Jones. Some non-muslim countries such as UK, Singapore and Japan also plan to make sovereign borrowings through Sukuk issuance in the second half of II. Importance of Regional Cooperation In the face of the afore-mentioned challenges and opportunities, Islamic countries need to take appropriate steps to develop their markets and 7

16 enhance cooperation among their capital markets. The importance of regional cooperation is on the agenda for a number of reasons: Some of the regional countries capital markets could benefit from other countries expertise and gain valuable insights; An expanded marketplace for investors and issuers from within and outside the region could be created; There could be more diverse offering of securities and a decreased risk environment for portfolio investments; and The regional capital markets could achieve rapid improvements in terms of market quality, integrity standards and innovative products and services. III. What ISE s Experience could offer to other OIC Member Countries The Istanbul Stock Exchange (ISE) has been very active in the international arena in terms of establishing close links with its regional and international counterparts. Thus, the ISE has quite valuable experience in promoting cooperation among capital markets in neighboring countries. To mention but a few such experience, the ISE serves as coordinator of the OIC Member States Stock Exchanges Forum, the first meeting of which was held in Istanbul in March Of the 57 OIC Member States, only 38 have functional exchanges, and 16 of these 38 countries are members of the Federation of Euro-Asian Stock Exchanges (FEAS), founded and chaired by the ISE. The aim of the Forum is to promote cooperation among the stock exchanges of the OIC Member States. To this end, at their first meeting, the stock exchanges came up with a number of proposals to be addressed in the years ahead. The focus of the proposals may be summarized as follows: definition and certification of securities; creation of regional market indices; cooperation among regulatory bodies and other capital market institutions (i.e. clearing, custody institutions); cooperation with existing federations; and organization of joint training and staff exchange programs. Two working committees, namely: the Technical Committee and the IT Committee, are set to fulfill all these tasks. The Technical Committee consists of 11 members and aims to accomplish the tasks listed hereunder: creating common indices; promoting the creation of Islamic Depositary Receipts (IDR); 8

17 cross-listing and cross-membership opportunities; exchanging staff and organizing training programs; and defining areas of cooperation (i.e. common trading platform). The IT Committee, on the other hand, consists of 8 members. It is responsible for assessment of the technological levels of the participating stock exchanges and for establishment of a data centre. The ISE is also the President of the Federation of Euro-Asian Stock Exchanges (FEAS). FEAS has 32 member exchanges and 8 affiliate members from 29 countries. Its mission is to create a fair, efficient and transparent market environment with little or no barriers to trade between its members in their regions of operation. On this score, harmonization of the relevant rules and regulations and adoption of new trading and settlement technology by the member securities markets will facilitate FEAS objectives of promoting member markets development and providing cross-border trading opportunities for the securities issued by FEAS member countries. The Table below summarizes some statistical data on capital markets in the FEAS region. Statistical Comparison/FEAS Region Number of Companies Traded 8,003 8,348 9,057 9,498 Market Capitalization (US$ million) 377, , ,455 1,065,337 Total Volume (US$ million Stocks) 273, , , ,733 Total Volume (US$ million Bonds) 314, , , ,517 Source: FEAS With its solid institutional framework, FEAS serves the needs of member stock exchanges in a variety of ways, namely: Promoting the mechanism for reliable, transparent and continuous trading and settlement; Creating greater awareness and visibility for the stocks issued in the region and investment opportunities; Helping to promote the listing of home market investment grade companies on the regional market and encouraging them to get involved in regional indices; 9

18 Providing network and updated information to the new members in the region, through meetings, web applications and publications and the joint work accomplished by FEAS, ISE and the OECD ( Best Practices for the Development of Stock Exchanges in Transition Economies, SME Financing: Alternative Sources of Finance ); Helping to create linkages among the regions intermediaries, data providers as well as settlement and custody institutions; Creating a centralized training hub for FEAS members to encourage research and regulatory implementation via bilateral exchange programs; and Promoting corporate governance. FEAS has a number of Task Forces that work on a variety of subjects such as Media, Regional Indices, Corporate Governance, Affiliate Members, FEAS Data Center and Research and Development. To sum up, through membership of FEAS, the regional capital markets will have strong networking opportunities and will gain insight through Bilateral Visit Programs. FEAS has been running this Program since 2002 with more than 70 visits concluded. It also has sustained links with the World Federation of Exchanges (WFE) and other international organizations. It offers updated information on the region and on other members, new products, markets and regulations and on training and research opportunities. IV. Turkey: Gateway to Europe, Asia and the Middle East The Turkish economy has a growing potential and offers valuable investment opportunities in a variety of sectors, namely: property projects, telecommunication and technology as well as infrastructure projects (public utilities, ports and highways). Net foreign direct investment flow to Turkey in accounted for a total of US$ 40 billion; one third of which came through the ISE. Turkish capital markets are also highly liquid and are attractive to foreign investors as a result of their enhanced market infrastructure. With total stock market capitalization of US$ 296 billion, the ISE ranked 9 th among emerging markets as at the end of It has a very liquid Bonds and Bills Market and represents the world s 5 th largest exchange traded bond market with a total trading value of US$ 479 billion as at the end of Foreign participation in the ISE Stock Market has similarly registered a stable trend, changing within a range of per cent in the last 3-year period, despite the global financial crunch facing the world economy. This trend testifies to the high-level investor confidence in Turkish stock markets. 10

19 Furthermore, Turkey stands as a corridor amidst the GCC countries, Europe and Asia, and offers valuable investment opportunities that appeal to both individual and institutional investors. It has a well-developed banking sector with 46 commercial and investment banks and 4 participating banks engaged mainly in interest free banking activities. It provides investment-friendly policies as it allows 100 per cent foreign ownership and free movement of funds, and has concluded tax treaties with 86 countries. Turkey offers very profitable investment opportunities including a booming property market, development of energy industry for the region, the growing need for infrastructure development and project financing for fast-growing companies. Turkey also provides a wide-range of capital market investment instruments including stocks, bonds, bills and ETFs. New regulations for structure warrants and asset-backed securities are in the pipeline. V. Future Prospects The ISE aims, in the coming years, to continue promoting capital markets cooperation among the regional member countries. To this end, the ISE will host the Second Stock Exchanges Forum meeting on October, 2008 in Istanbul. It plans to use that opportunity to invite representatives from the Islamic Financial Services Board (IFSB), the International Islamic Financial Market (IIFM) and the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). This would allow for enlarged participation in the discourse to promote capital markets cooperation among the regional exchanges. 11

20 TECHNICAL SESSIONS

21 Promoting Global Depositary Receipts (GDRs) Market in the GCC Region Mr. Mahmoud Salem, Managing Director Head of Islamic Products, Depositary Receipts, Bank of New York Mellon, USA Executive Summary The aim of this briefing is to provide an independent, robust analysis of the value and liquidity effects of depositary receipts (DRs) established by companies from emerging markets. The DR programs of 628 firms were analyzed, covering the period The key conclusions from the research are outlined below. Key Conclusions 1. Stock exchange-listed DRs (both ADRs and GDRs) add (on average) over 20 per cent of shareholder value in their first year of trading as the international markets welcome the greater financial disclosure, transparency and signal of superior governance Sub regional results include: 15% value added in Asia; 8% value added in EEMEA; 35% value added in Latin America; and 35% value added in BRIC countries. 2. OTC-traded DRs (both ADRs and GDRs) add over 30% of value on average. Sub regional results include: 25% value added in Asia; 30% value added in EEMEA; 40% value added in Latin America; and 50% value added in BRIC countries. 3. An upgrade from an OTC-traded DR to a stock exchange-listed DR program adds, on average, a further 60 per cent of value as investors respond to the higher reporting standards. 4. Delisting a listed DR program to the over-the-counter trading market destroys 20 per cent of value on average, as it becomes clear that the additional financial reporting will be withdrawn. 5. Listed DRs improve home-market liquidity by 40 per cent on average, as access to, and visibility in, the issuer s stock rises and is accompanied by greater and wider coverage by equity analysts. OTCtraded DRs improve home-market liquidity by 48 per cent on average. 15

22 Empirical evidence is presented that DR programs established by firms in emerging markets add significant value and improve home-market liquidity to the benefit of both issuers and investors. DRs additionally provide a strong signal of willing disclosure, greater transparency and superior governance, particularly important for emerging, less-regulated markets. I. Introduction The analysis presented in this report measures the value and liquidity impact on local shares of establishing, upgrading or delisting a depositary receipt (DR) program. The full history of DRs is analyzed, from 1980 to In this particular report, the focus is on emerging markets, as defined by the MSCI International Equity Indices (see Appendix for definition). Shown in Figure 1 is the number of DR programs by year over the last decade. For the purpose of this study, Level I DR programs are defined as DRs that trade on an over-the-counter (OTC) market and are exempt from most international reporting and accounting requirements. In contrast, stock exchange-listed DRs (Levels II/III) require international registration, reconciliation with U.S. generally accepted accounting principles (GAAP) or international financial reporting standards (IFRS) and annual reporting according to the particular stock exchange requirements. Figure 1: A Decade of Success in DRs Despite recent doubts expressed over the benefits of cross-listing, the dramatic increase in listings from emerging markets is clear from this graph. Subsequent sections of this report will quantify the shareholder value and liquidity benefits for these firms. 16

23 Figure 2 provides an illustrative overview of the empirical research presented herein. Figure 2: Analytical Framework In sections 2 and 3 of this report, the research focuses on the value impact of establishing a new listed (Levels II/III) or new OTC (Level I) DR program, respectively. Following these aggregate analyses, four regions from within emerging markets are evaluated separately: Asia, EEMEA (Eastern Europe, the Middle East and Africa), Latin America and the BRIC countries of Brazil, Russia, India and China. Section 4 focuses on the interaction between the listed and OTC DRs. Both the value impact of upgrading one s program (moving from Level I to Level II/III) and delisting one s program (moving from Level II/III to Level I) are analyzed. Finally, in section 5, the effect of establishing DRs on home-market liquidity is evaluated. II. Performance of Listed DRs This section focuses on the value impact on an emerging-market company of establishing a listed (Levels II/III) DR program. Using the methodology described in the previous section, Figure 3 shows the average value impact on share prices in the issuers local markets across 380 new listed programs. 17

24 Figure 3: Over 20% Added From Listed (Levels II/III) DRs The graph shows a modeled share price reaction (using local share prices), where market-wide influences have been stripped out and the returns are risk-adjusted. The dates on which the new programs started trading have been aligned to Event Day Zero; the graph reflects one calendar year. A degree of information leakage to the markets is evident as the additional value becomes apparent over the twenty trading days prior to Day 0. Investors anticipate the programs, and the positive market reaction is sustained through the year. By the end of the first year s trading, in an equally-weighted investment strategy, investors have added over 20 per cent (equivalent to over US$ 100 billion) to their portfolios. The next few graphs show the value reaction across selected regions in the emerging markets portfolio: Asia, EEMEA (Eastern Europe, the Middle East and Africa), Latin America and the BRIC countries (Brazil, Russia, India and China). It can be seen that 15 per cent of value is added to the Asian portfolio of new DR programs, equivalent to over US$ 40 billion in an equally-weighted investment portfolio. Particularly strong value was realized in India: Figure 5. Of the 84 new DR listings by Indian companies, 51 have been on the Luxemburg Stock Exchange. Across the EEMEA region also, the positive value effects are demonstrable in Figure 6 with a significant 8 per cent of value being added to portfolios, equivalent to US$ 1.4 billion. 18

25 Figure 4: Over 15% Added Across Asia Figure 5: Strong Value Added In India Figure 6: Significant value Impact Across EEMEA 19

26 The picture here is positive but more volatile; the volatility due, in part, to the smaller portfolio size under analysis. The results from Latin America are stellar with companies on average, increasing their value by over one-third. This is equivalent to US$ 72 billion in an equally-weighted investment portfolio. Figure 7: 35% Value Added Across Latin America Figure 8: Strong Value in Mexico 20

27 The New York Stock Exchange appears as the exchange of choice for Latin American companies, dominating the listings with 87 of a total 98 new programs from the region. Presented in Figure 8 is the value reaction to programs established by Mexican companies; equivalent to US$ 22 billion in monetary terms. Figure 9: 35% Value Added Across BRIC Countries 21

28 The final region selected for analysis is that of the so-called BRIC countries: Brazil, Russia, India and China. For these purposes, China is considered as mainland China and excludes Taiwan (and Hong Kong which is considered as a developed market). Shown in Figure 9 is the value reaction. A dramatic 35 per cent of value is added on average, to companies across these countries, equivalent to over US$ 36 billion. In Brazil specifically, 80 per cent of value is added (US$ 33 billion): Figure 10. It is clear that by signing up voluntarily to more stringent standards of reporting and disclosure, companies from emerging markets can make a strong signal of their willingness to embrace superior governance. These signals are not lost on the markets, and the companies are rewarded with higher valuations. III. Performance of OTC DRs Presented in this section is an analysis of firms local share-price performance following the establishment of an over-the-counter (Level I) DR program. Unlike their U.S.-listed counterparts, OTC programs are exempt from U.S. reporting requirements and from U.S. GAAP compliance. Shown in Figure 11 is the value reaction to 248 firms across emerging markets as they establish an OTC (Level I) program. The value impact is dramatic with approximately one-third of companies value being added in the year following establishment. In an equallyweighted investment strategy, this is equivalent to US$ 136 billion. The 22

29 following graphs show the value reaction in different sub-regions of emerging markets. Presented in Figure 12 is the value impact across Asia. A steady and sustained 25 per cent of value is added to firms, equivalent to US$ 9 billion. Figure 13 shows the powerful value effects in mainland China due to establishing an OTC DR program. Over 30% (US$ 3 billion) is added to an investment portfolio of such firms. Similarly, strong results are found in the region of Eastern Europe, the Middle East and Africa (EEMEA): Figure

30 Approximately 30 per cent of value equivalent to US$ 84 billion is added across this region by the establishment of a Level I program. Two countries notable in driving the value growth in this region are Russia and South Africa: Figures 15 and

31 Figure 16: More Volatile but Still Impressive in South Africa In Russia and South Africa, respectively, the value added to investors has been 90 per cent (US$ 221 billion) and 14 per cent (US$ 5 billion). Latin American firms demonstrated strong value growth in the year following establishment of an OTC program: Figure 17. Over 40 per cent is added on average to such an investment portfolio, equivalent to US$ 34 billion. 25

32 Both listed and OTC DR programs have proved to be popular and successful amongst Mexican companies, with OTC programs adding 14 per cent in value over the first trading year, equivalent to almost US$ 9 billion. The final region under consideration within the emerging markets is the BRIC region, which comprises Brazil, Russia, India and China. Shown in Figure 19 is the value performance across these countries following the establishment of an OTC DR program. 26

33 Firms from these countries add on average 50 per cent of shareholder value in the first trading year, equivalent to an impressive US$ 150 billion. Similar in percentage terms is the value reaction to Brazilian companies establishing an OTC DR program, value equivalent to US$ 11 billion in monetary terms. 27

34 IV. Impact of Upgrading and Delisting This section focuses on the interaction between OTC (Level I) DR programs and U.S.-listed (Levels II/III) programs. Specifically, the value effects of upgrading from a Level I to a Level II/III, and delisting from a Level II/III to a Level I program, are measured. Figure 21 illustrates clearly the value enhancement possibilities of upgrading one s program to meet more rigorous reporting and disclosure requirements, whereas Figure 22 is a stark warning to issuers considering delisting. Figure 22: 20% Value Destroyed By Delisting For U.S.-listed issuers wishing to delist but not incur such extensive value losses, there is now a premier level of OTC program, the International OTCQX SM program launched by Pink Sheets LLC. This tier of program enables issuers to retain the advantages of an OTC DR program (rather than terminate it completely) but distinguish themselves through specified disclosures. V. Evidence on Liquidity Improvement In this section, the impact on home-market liquidity of establishing a DR program is evaluated. Trading volume activity reflects the speed and intensity with which information about a firm is disseminated, digested and acted upon by investors. In the context of DRs, an increase of liquidity in 28

35 ordinary share trading would indicate that the firm is now more visible, with greater access to (and from) investors, and receiving more profile and wider coverage from equity analysts. Figure 24: OTC DRs Improve Home-Market Liquidity By 48% 29

36 The Trading Volume Multiplier is defined as the multiple of the previous year s average daily trading volume in ordinary (local) shares. Thus, a Trading Volume Multiplier of 1 indicates normal trading volumes and no significant impact on liquidity. Figures 23 and 24 illustrate the positive (above 1) impact on home-market liquidity of establishing a DR program, for listed (Levels II/III) and OTC (Level I) DRs, respectively. One reason cited for actual or potential delisting of a DR program is the widely perceived reduction in home-market liquidity when a DR exists. A common expectation is that, by concentrating all trading activity on the local market, liquidity in the security would increase. However, the research results suggest that such expectations usually are illfounded and that liquidity in the local shares is enhanced significantly by a DR program (listed or OTC) as the profile of the firm s stock rises. VI. Summary and Conclusions The research conducted demonstrates that, on average, there are significant value and liquidity advantages to be gained by emerging-market companies which pursue cross-listing. Furthermore, with the help of effective investor relations, it would appear that these advantages are sustainable over the long-term. Figure 25 shows the DR performance of emerging-market companies over the last four years against the S&P 500 Composite Index. An investment of US$ 100 million in the S&P 500 Composite Index over the last four years would be worth US$ 155 million at the end of the period. A similar investment in The Bank of New York Emerging Markets ADR Index would be worth US$ 341 million. DR programs have much to offer firms in emerging markets seeking to demonstrate their growing willingness to embrace robust standards of financial disclosure and reporting, heighten their visibility and expand their investor base. 30

37 A Glossary Of Terms Delisting: The downgrading of a DR program from listed (Levels II/III) status to OTC (Level I) status. Depositary Receipt DR) Listed (Levels II/III) Rs OC (Level I) DRs A negotiable receipt denominated in U.S. dollar and issued as a certificate that represents a set number of non-u.s. firm s publicly-traded shares in its home market. It is sponsored by a U.S. depositary bank. DRs that are listed on a U.S. exchange (NYSE, NASDAQ or AMEX) or an international exchange (including London and Luxembourg) and, therefore, require a higher degree of registration, accounting (US GAAP or IFRS) and annual reporting. Level II DRs are defined as a listing without capital raising in DR form. Level III DRs additionally raise capital. DRs that trade in the over-the-counter market and are exempt from U.S. reporting requirements and from complying with U.S. GAAP. 31

38 Upgrade The development of a DR program from one status to another for which additional requirements must be met. Pure upgrades represent those DR programs that are upgraded from OTC (Level I) status to listed (Levels II/III) status. Appendix For the purposes of the research presented herein, emerging markets are defined as the 25 countries included in the MSCI Emerging Markets Index plus the 8 MSCI stand-alone countries and the Gulf Cooperation Council (GCC) plus Sri Lanka and Venezuela. These 33 countries presented in Figure 26 capture 95 per cent of the listed and OTC DRs established by firms on all markets which could be considered emerging. 32

39 Figure 26: Emerging Markets Defined 6 MSCI International Equity Indices ---Country And Market Coverage Stand-alone countries GCC Countries: Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, United Arab Emirates. Sri Lanka, Venezuela 33

40 Presented in Figures 27 and 28, respectively, are the distributions by country of listed (Levels II/III) and OTC (Level I) DRs7. 6 Source: MSCI Barra 7 at 30 June

41 Oxford Metrica Oxford Metrica is an independent research and analytics firm in international investments that focus on risk, value reputation and governance the strategic aspects of financial performance. The firm connects financial and risk theory with real data to provide empirical, quantitative and practical analysis for clients worldwide. Oxford Metrica aims to provide evidence-based support for key management decisions. Oxford Metrica also provides research and analytics to several hedge fund managers, particularly those involving emerging markets and multimanager strategies. The Firm is ready to discuss the implications of its current report for companies that are interested. Further information can be obtained from the website at The Bank of New York Mellon The Bank of New York Mellon Corporation is a global financial services company focusing on helping clients to manage and move their financial assets; it operates in 37 countries and serves more than 100 markets. The company is a leading provider of financial services for institutions, corporations and high net worth individuals, and offers superior asset as well as wealth management, asset servicing, issuer services and treasury services through a worldwide client-focused team. It has more than US$ 20 trillion in assets under custody and administration and more than US$ 1 trillion in assets under management. The Bank of New York Mellon s Depositary Receipt business is conducted through The Bank of New York subsidiary, which acts as depositary for more than 1,270 American and global depositary receipt programs, in partnership with leading companies from 60 countries. With an unrivalled commitment to helping securities issuers succeed in the world s rapidly evolving financial markets, the Company delivers the industry s most comprehensive suite of integrated depositary receipts, corporate trust and stock transfer services. Additional information is available at Additional information is available at 35

42 Redirecting GCC-Based Mutual Funds to IDB Member Countries Mr. Nabeel Shoaib, Global Head, HSBC Amanah, UAE Your Excellencies and Distinguished Members of the Board of Governors of the Islamic Development Bank Honorable Guests and Colleagues, It is indeed an honor for myself to be here today at the IDB Board of Governors Meeting to speak to you on the topic of Redirecting GCC-Based Mutual Funds to IDB Member Countries. Mr. Chairman, My presentation today will cover four broad areas: 1. Introduction to Mutual Funds. 2. History and Development of Mutual Funds in the GCC. 3. Assessment of emerging IDB Member countries. 4. Redirect GCC funds investments in Emerging IDB Member Countries. Before I start, I would like to take this opportunity to thank and appreciate IDB for its pioneering work and contribution towards the economic development and social progress of its Member Countries and Muslims in non member countries. The programmes and initiatives undertaken, particularly its Africa program are really commendable. IDB can play a very important role in further enhancing cooperation among its members mainly in the field of agricultural development, water, Islamic finance and microfinance. We live in a world where there is an increasing realization that the public sector on its own cannot cope with the growing needs of the member countries. Therefore there is a shift to move towards public sector private sector participation and Islamic investment funds provide a wonderful medium to achieve this goal. For the Islamic financial instruments to realize their full potential, an infrastructure for the Islamic finance needs to be created. The Islamic finance in its modern form has come a long way from its rather humble beginnings in the early seventies. Today, Islamic finance markets have opened up in most, if not all of the, major Islamic Development Bank member countries. The sector is getting increased credibility and mainstream relevance as new players enter the market place. It must be pointed out that all of these 37

43 achievements have been made in the absence of Islamic finance friendly legislations and regulations both from a domestic and cross border perspective in most countries. Mutual Funds Characteristics A form of collective investment that pool funds from many small investors to invest in stocks, bonds, real estate and other securities. Investment decisions are taken by a professional investment management company, which is appointed by the fund. An investment management fee is paid to the investment manager: Investment Funds provide the following benefits compared to standalone investments Professional Management Diversification Reduction in volatility Liquidity Structured either as closed-end or open-end. The Islamic asset management market presents an important opportunity and is mainly centered around the GCC. The GCC investable assets will continue to grow across all investor segments. The industry players need to leverage the tremendous market opportunity in order to build the assets under management by both size and client base in a profitable manner. I believe that the growth is driven by the following factors: (i) Economic growth driven by strong oil prices and infrastructural investments, real estate and growing service industry (ii) Increasing demand for Shariah compliant investments and products, (iii) Lack of depth across products and asset classes, (iv) Regulatory reforms and developments. An increasing number of Islamic investment products are now available. However there needs to be more work done in terms of development and consistency. They are mainly private equity fund of funds, international real estate funds, Takaful, hedge funds and capital protected funds. The industry should be geared to meet varied product preferences that typically differ by investor segments namely institutions, high network individuals and mass affluent including retail. A successful investment product strategy for Islamic financial institutions should be able to: 38

44 Create innovative and high octane products that fulfill investors desire for Shariah compliance and competitive returns, Expand geographic reach of Islamic investing, Create door opening/signature for essential to sell fillers. Our priority at HSBC Amanah includes improving our range of products. At the moment we are focusing on asset management, products and Takaful A very important initiative for us. We believe that the asset management and Takaful business complement each other very well and by building synergies between them, we could significantly improve the scope and reach Shariah compliant investment business. It is estimated that there are around 400 Islamic funds, with the Middle East and Asia Pacific accounting for more than 2/3 rd of the market. It is estimated that the total GCC investable assets are around USD 2400 to 2800 billion, with Islamic assets estimated around 6% i.e billion dollars as per McKinsey. It is estimated that the industry is expected to grow at the 25% p.a over the next four years. The number of GCC wealth individuals with liquid wealth in excess of USD 50,000 is expected to increase to over 387,000 in 2007 from 311,000 in Additionally, analysis indicates that the total liquid wealth held by them is expected to grow to US$ 80 billion in 2007 from US$ 61 billion in Furthermore, there is a strong institutional demand segment in the GCC with the three largest investment authorities holding investments in excess of US$ 600 billions. The takaful industry, in particular, presents a growing focus for Islamic investment opportunities. In 2006, it is estimated that there were US$ 3 billion in global takaful premiums, 36% of which was based in the Middle East. It is important to note that around 70% of the Islamic funds are concentrated in the IDB member countries, with Saudi Arabia, and Malaysia leading the pack.equity funds remain the bulk of the funds making up 50% to 67% in most of the markets compared to around 40% on the conventional side. The fixed and balanced Islamic funds make up to 17% as compared to 40% on the conventional side. 39

45 It is important that the emerging IDB member countries leverage from the large pool of investable funds available within the GCC countries and develop the local markets and regulatory framework to attract and retain investments. I would recommend: Closer arrangements between the financial institutions of the IDB member countries, Measures from the regulators to develop their local capital markets (set up of MICF in Malaysia, Dubai International Financial Centre, the DIFX are some examples that we could take lead from). Strong secondary markets for mutual funds can play a key role in developing the business. Private equity fund raising activities can play important role and has witnessed robust growth. In my closing remarks, Islamic wealth management players will need to develop holistic business models that leverage intricate client relationships and implement efficient operational frameworks. This is increasingly important due to the fact that multinational institutions have entered the market to alter the competitive dynamics in the region. A broad set of factors critical for success need to be acquired by Islamic players like: Product innovations and sophistication - Alternative investment funds, Asset focused, Regional diversification, Operational and technological efficiency, Competitiveness with large global players entering the market, Develop marketing and distribution networks, Retention of quality human resources, Develop a leading Islamic asset management academy to teach and train And finally launch Islamic ETF family covering Islamic indices accessible to global investors. Thank you 40

46 Redirecting GCC-Based Mutual Funds to IDB Member Countries Mr. Michael P. Lee, CEO and Member of the Board, Ithmaar Bank - Bahrain 1. Introduction An increasing number of mutual funds are now domiciled in Islamic Development Bank (IDB) member countries, especially in the Kingdom of Bahrain and Malaysia. However, the majority of the funds generated through fund investment vehicles in these domiciles and, in fact, most other mutual fund centers, are directed towards investments in Europe, the USA and, to a far lesser extent, in IDB member countries. Moreover, in the latter countries, the funds are concentrated on investments in the GCC region and Malaysia, rather than in other IDB member countries. The map below clearly illustrates this situation. 41

47 In the GCC region and Malaysia, stock markets, while not yet generally as diversified in terms of types of listing as the most advanced capital markets, nor generally having the same degree of liquidity as in those markets, there has recently been a significant increase in the number and range of listings and of stock market reforms; for example, the highly regarded regulatory developments introduced by the Capital Market Authority in the Kingdom of Saudi Arabia. These IDB member stock markets, together with others such as those in Egypt, Turkey and Pakistan, offer the prospect of regional- or country-based open-end equity funds, sometimes alternatively characterized as unit trusts Open-End Mutual Funds Globally, open-end mutual funds are the major type of Investment Company. Such funds continually have fund shares (or units, in the case of similar unit trusts ) available for sale; and usually redeem outstanding fund shares when desired by the investors. Accordingly, the volume of fund shares outstanding fluctuates, reflecting new sales and/or redemptions. The prices of the fund shares generally reflect the net asset value per fund share of the underlying assets of the fund, comprising some cash (to provide liquidity for normal levels of redemptions) and the main income- or capital gainproducing assets of the fund, often listed company shares which are valued at quoted market prices daily, facilitating daily quoted fund share bid and offered prices for, respectively, the redemption of existing fund shares or the purchase of new fund shares. Generally, the fund s available cash will be sufficient to facilitate redemptions. However, in unusual circumstances, a fund may also have to liquidate part of its portfolio of listed company shares in order to accommodate large amounts of redemptions. The essence of the open-end fund is that the fund investor has the benefit of continuing liquidity (to meet the investor s unexpected cash needs) because the underlying investments of the fund, in which the investor has a share of the diversified risk, are themselves in the form of the liquid, quoted shares on recognized stock exchanges or markets. Stock market liquidity depends on the market s investor interest depth and breadth, occasioned by a wide range of quality company share listings, information transparency through stock exchange reporting/announcement requirements on listed companies (usually) quarterly financial results and on general economic, industry-specific or corporate-specific changes in 42

48 conditions that might potentially affect a particular listed company s earnings prospects, on the imposition of international corporate governance standards, and on the availability of independent investment research and high quality brokerage as well as transaction execution services. In the stock markets with these features, the stage is set for individual stock liquidity, also dependent on the size and quality of the particular companies traded, and on the availability of stock for public trading (i.e. the volume not closely-held). Open-end mutual funds have many advantages for the listed or traded companies, the economies and the stock markets involved, as well as for investors. For example, where the funds are quoted locally, for the listed or traded company, the fund manager of a mutual fund is usually a wellinformed, sophisticated investor, who understands the risks of investment in the company, rather than a fair-weather friend; and mutual funds can, subject to general stock market conditions, become a valuable alternative source of additional demand for the company s stock. For the relevant economy and stock markets, mutual funds interest could lead to increased inward investment and, where the funds are quoted locally, to domestic savings participation, attracting investment from, respectively, foreign investors and nationals who would otherwise not have the necessary investment expertise or capacity (for example, if the foreign investor is in a different time zone from that of the relevant stock market). Through such funds, the individual, relatively small investor (although demand is not limited to that from such fund investors) obtains the advantages of access to a diversified portfolio of securities, which could extend across the globe. Risk diversification for the small investor (by geography, industries and companies) is only possible because such an investor can, through a mutual fund, buy a fractional share of a large portfolio. This also leads to savings on transaction and administration costs, owing to the economies of scale of managing large portfolios (negotiated brokerage charges, etc.). There is also the avoidance of the time and effort involved in otherwise, as company shareholders, responding to, or otherwise dealing with, many corporate events, such as rights issues, dividend payments, proposed takeover and merger transactions, etc; and investors receive periodic portfolio information from their fund manager in a digestible format. Finally, and perhaps most importantly, there is the benefit of enlisting the expert management of the fund manager who decides which equity securities to buy and sell in anticipation of, or in response to, changing circumstances. 43

49 In conventional products, there is a wide range of highly popular mutual funds, catering to a full range of investment objectives. These include, in the equities category, aggressive growth funds (higher risk, seeking maximum capital appreciation), growth funds (seeking long-term capital appreciation), growth and income funds (seeking capital appreciation combined with current annual income), income funds (seeking high-level of current income from dividends), international equities and sectoral funds such as precious metal funds (investing in gold and other precious metal companies). More recently, there have emerged international infrastructure funds, investing in companies engaged in the power, telecommunications and transport sectors, etc. Also, while there are some hedge funds which operate on a fund of funds basis, and similarly to open-end mutual funds, they are not discussed further herein. Their going short (selling securities that they do not own) presents Shariah issues that are outside our scope; and they are more typically akin to private equity funds, directed at sophisticated investors such as high net worth individuals and pension funds. Sometimes, also, they are closed for the first two years and then are open only for redemptions quarterly and on advance notice. Generally, with respect to advanced stock market investments, similar funds (excluding those activities that are haram, such as those involved in gambling, pork, alcohol or in riba such as conventional banking and insurance, etc.) are available on a Shariah-compliant basis. Their performance may be tracked against an Islamic stock index, e.g. the Dow Jones Islamic Index, the Al-Meezan Islamic Investment Index and the Malaysian Islamic Index. Shariah-compliant equity funds are available, for example, in respect of GCC and Malaysian securities markets, as well as in respect of advanced country markets outside IDB member countries. Openend funds may themselves be listed on a stock market. Conventional markets also offer open-end mutual funds addressing interestbearing bonds and a range of money market instruments having different levels of risk (e.g. government bonds and treasury bills, government-backed municipal bonds, corporate bonds and short-term money market securities such as commercial paper, bankers acceptances and certificates of deposit). Equivalent or similar fixed income and money market funds are not currently available on a broad scale in Shariah-compliant form, owing to the still early- stage development of the tradable Sukuk market (although some Investment Sukuk funds have already been established) and to the very limited availability to date of Shariah-compliant money market securities. 44

50 This issue will be covered in more detail below, when discussing the role of mutual funds in liquidity management. In the advanced conventional markets, the range of open-end mutual funds and the quality of their fund managers, combined with the other advantages listed above in respect of individual investors, have led to a massive growth in the number of mutual funds attracting institutional investors, such as bank trust departments, pension funds and insurance companies, as well as educational and other foundations Closed-End Funds Closed-end funds or investment companies (also sometimes in the alternative form of investment trusts), are closed in the sense that the number of fund shares outstanding is generally fixed at the outset. The fund shares do not have liquidity through use of the cash in the underlying asset portfolio or through sales of the company shares in that portfolio. Rather, liquidity is available through secondary market trading of the fixed number of shares in the closed-end fund itself. Whereas open-end funds are quoted on the basis of the net asset value ( NAV ) of the underlying investment portfolio, the closed-end funds are quoted on secondary market-determined fund share prices, based entirely on the sale and purchase of the fund shares themselves (and investors are paid dividends, interest and realized net capital gains received by the fund). Conventional closed-end funds may, however, have intermittent new issues of fund shares. Closed-end funds are usually traded on a stock market, and trade at a premium or discount of their underlying portfolios to the NAV: often, at a discount. I believe that I am right in saying that the latter possibility makes closed-end equity funds non-tradable if they are to be Shariah-compliant, as it is not permitted to buy fund shares at less than the pro rata value of the underlying net assets. Closed-end funds are usually in one of three forms diversified securities, dual-purpose (with income shares and capital shares, receiving dividends and capital gains, respectively) and specialized funds (for example, by way of industry or geography). I also believe that I am correct in saying that, under Shariah, a Murabaha fund should be closed-end and fund shares should not be tradable. This is because a Murabaha portfolio does not entail the ownership of physical assets. 45

51 In the conventional mutual fund market, there are real estate investment trusts (REITs), similarly structured to closed-end funds (which are often the format used for pooled real estate investments). REITs purchase and manage real estate and/or real estate mortgages Other Fund and Quasi-Fund Types of Investment In the USA, there is a particular fund variant called the unit investment trust (not to be confused with UK s unit and investment trusts, similar to openend and closed-end funds, respectively). These have a fixed portfolio of money market or bond securities for the duration of the trust, and the investor receives redeemable trust certificates. Interim redemption is possible for these unquoted certificates, like, for open-end funds, by liquidation of trust securities by the trustee and at prices reflecting the Net Asset Value per unit. Apart from open-end and closed-end funds per se, there are retirement and other family-related savings plans offered by insurance companies linked to such funds. During the savings period, periodic or single payments of savings are invested in a way similar to mutual fund investments. When the purpose behind the saving materializes (for example, retirement) the investor receives a lump sum and/or an annuity (an annual amount, sometimes inflation-linked). The amounts payable differ, depending on the success of the pro rata share of pooled investments during the investment/saving period. Family Takaful investment products are similar Redirection of Shariah-Compliant Funds IDB is interested in ways in which it can encourage investments from locally domiciled Sharia-compliant open-end and closed-end funds in the GCC countries to be redirected to some of the other 56 IDB member countries (see Appendix I), so as to foster economic development and social progress in the countries concerned. In this context, I shall not become side-tracked into referring to Shariah compliance issues that are outside the scope of my personal expertise when discussing redirection of mutual fund investment in the categories of Islamic funds which, reportedly ( Understanding Islamic Finance by Muhammad Ayub, 2007, John Wiley & Sons Ltd.), have been indicated by Shaikh Taqi Usmani, namely: equity funds meeting screening criteria such as those of the Dow Jones Islamic Market Index Criteria, which are, among other things, 46

52 that debt to market capitalization ratio should be less than 33 per cent, and be tradable because such funds represent ownership in corporate assets; Ijara funds, to purchase assets for leasing, with such Ijara Sukuk being tradable on the basis of market forces; commodity funds, purchasing commodities for resale; Murabaha funds or closed-end funds and, as indicated above, not tradable; and mixed funds, invested in equities, leasing, commodities, etc., and tradable, provided that the tangible assets comprise more than 51 per cent of the fund. It should be noted that the above established categories of Shariah-compliant funds operate on a Mudarabah and agency basis, respectively, with compensation to the fund manager being a pre-agreed share of profits or on agreed terms (including specified amounts or percentages of net asset values). In the redirection discussion, I shall also not become side-tracked into discussion of the Shariah issues relating to Investment Sukuk. Suffice it to say that approved Investment Sukuk structures, as Ayub points out, are akin to the conventional concept of securitization.. ownership of the underlying assets is transferred to a large number of investors through paper commonly known as certificates, Sukuk or other instruments representing proportionate value of the relevant assets. Sukuk can be made fixedreturn Sukuk through the provision of any third party guarantee. the price in secondary market trading depends on the nature of the security being traded.. pure debt securities do not have a secondary market.. However, there is the possibility of securitization of debts resulting from real trading transactions when they are pooled with other assets or instruments representing ownership in real assets. Again, as noted elsewhere by Ayub, the pool of assets being securitized should comprise Ijara in fixed assets being valued at more than 50 per cent of the total worth of the pool of assets underlying the Sukuk issue, in which case the Sukuk can be traded at any value on the secondary market. Whereas most of the redirection discussion herein focus on mutual funds comprising equities, rather than on Sukuk, since to date Sukuk funds are still in their infancy, it should be borne in mind that there is outstanding potential for the use of Sukuk in financing projects and real estate assets in the less developed IDB member countries, and that the general social, political, economic and legal factors conducive to investment in such countries apply to both Sukuk and equity mutual fund development. 47

53 It should also be borne in mind that the given title of this paper is somewhat misleading. I have already taken the liberty of tinkering with the title, in order to make clear that we are examining here the challenges of enhancing investment from the GCC, a region well endowed with surplus capital, to other IDB member countries. However, I would also point out that redirection is a misnomer if taken to imply that there should be less investment within the GCC itself, where the laudable reinvestment of oil and gas proceeds in domestic economies, diversifying these economies away from energy sector reliance, should be encouraged for the benefit of future generations in IDB member countries as a whole. Such improved selfreliance of the mainspring IDB member country economies indeed augurs well for future IDB capital replenishments and for expansion of the various forms of present assistance to, and investment in, less developed member countries (see Appendix I). Moreover, when attracting non-idb member country capital into the mutual funds investing in less developed IDB member countries, it may well make sense for such mutual funds to combine some of the equity and other Shariah-compliant investment instruments sourced in GCC countries with those of less developed member countries, so as to lower the overall perceived financial risk profile. Accordingly, redirection may be taken to mean here not redirection from investments made in the GCC economies themselves, but redirection from investments otherwise made in countries outside IDB membership. For the most part, such redirection under our consideration is towards the less developed countries in Africa, those outside the MENA region in which there is already significant and growing investment flows from the GCC to other MENA members. Less developed African countries are often rich in natural resources but lack the infrastructure to exploit them fully, although this situation is expected to be transformed, owing to the interest of China and India in sourcing raw materials from Africa for their burgeoning production. There is, indeed, much optimism that Africa represents the next big international investment opportunity. In foreign investors entering new emerging markets, international foreign direct investment often leads the way, from multinational corporations, trailblazer financial investors, be it high net worth individuals or institutions, and private equity funds. Mutual fund investors in equities require prior 48

54 stock market development, although other investment categories, such as Investment Sukuk, Ijara, commodity and real estate, do not have such requirements China and India as Attractive Investment Targets China and India (whilst not members of the IDB), provide good examples of countries which have, in the not too distant past, opened up their markets, in order to benefit from a higher degree of foreign investment. Amongst other things, welcoming foreign investment, be it direct or in the form of private equity or mutual funds, has led to rapid economic growth. Real GDP growth in India and China is strong compared to the rest of the world and is projected to remain so, as shown in the chart below. 49

55 In addition, China and India are projected to see an increasing share of world direct investment. The relevant figures are shown below: Share of flows (%) Share of stock (%) China World Inward Direct Investment: Source: EIU forecasts and estimates India World Inward Direct Investment: Share of flows (%) Share of stock (%) Source: EIU forecasts and estimates 2. Key Investment Drivers The following are the key drivers attracting foreign investment to China and India, some of which apply to particular IDB member countries or could apply to them, with policy reforms. Continued economic boom (despite difficulties in the US) albeit at a slightly slower pace: 50

56 - In China, real GDP growth is expected to slow slightly from a high of 11.4 per cent in 2007 to 9.8 per cent in 2008 and 9 per cent in In India, real GDP growth is expected to decelerate from its high of 9.7 per cent in 2006/07 to 8.7 per cent in 2007/08 to an annual average of 7.6 per cent in 2008/ /2013 Market size - population size and growth, especially of working age population; Strengthening domestic demand boosted by wage growth; Increasing market access; Increasing numbers of privately and foreign-owned and funded enterprises; Gradual liberalization of trade regimes; Governments committed to increased spending on health, education and rural welfare projects to improve living standards The Global Context and the Macro-Economic Environment The success of China and India in attracting foreign investment (including from mutual funds) illustrates the fact that emerging markets are an attractive way for mutual fund investors to diversify their portfolios, especially given the higher returns, albeit with higher risks, that often characterize such investments compared to investments in advanced economies. To mitigate emerging market risks, it is important that the basic macro elements that underpin a sound investment environment are present. IDB countries can help themselves to attract more capital from mutual funds, sourced in the GCC countries and elsewhere, by developing positive investment and business-friendly environments, which in turn foster positive market sentiment. When making investments, both the fund manager and initially the investor must make a decision as to whether they are comfortable with, amongst other things, the sector, location, risk exposure and such like elements of the proposed investment(s). The following list of indicators is likely to factor into the decision-making regarding i) where the fund will be domiciled, ii) the geographic focus of the fund, and iii) the location of individual investments. 51

57 Social & Political Economic Legal Population growth GDP growth rate Rule of law rate Mortality rate Population and market size Free and independent judiciary Level of education and literacy Inflation rate control System of precedent Physical Retail price stability Predictability of infrastructure business and financial regulations Technology, including telecoms and IT infrastructure Free trade and investment flows Strong and credible regulatory institutions Health and Foreign reserves sanitation Level of poverty Currency stability Employment rate Reasonable tax regime Political stability Level of, and commitment to, Good governance and absence of corruption, cronyism etc privatisation No recent history or current threat of expropriation Skilled and professional workforce Financial services, including insurance Facilities for expatriate professionals and other visitors Acceptance of foreign investment ownership (ideally up to 100 per cent, or at least allowing for foreign majority control) International-standard corporate governance and financial regulation Country investment grade rating (if possible) 52

58 It is acknowledged that such favorable factors are the product of a lengthy process in which numerous other factors, in addition to the ones listed above, will play a part, and that it is not possible for all factors to be in place in the immediate future. However, as a first step, countries can begin to put in place those mechanisms which allow the private sector, from both home and abroad, to take responsibility for infrastructure and industrial development and to prosper by adding value to IDB member countries economies in new and innovative ways. IDB is already providing excellent leadership in promoting social, economic and legal reforms in those member countries outside, as well as within, the group (i.e. the GCC and North African countries, as well as Turkey and Malaysia) which is already regarded as comprising attractive mutual fund investment destinations for GCC investors. In introducing private sector financial investment into emerging markets, private equity funds often lead the way, e.g. IDB s pioneering role in promoting private equity investment in infrastructure, through its successful, private sector-managed private equity infrastructure fund and the IDB Infrastructure Fund. This fund, which applies commercial investment principles, has resulted in successful investments in selective emerging markets in IDB member countries outside the GCC. As and when such private equity infrastructure funds, more of which have now been raised following IDB s exemplary leadership, list their investments on IDB member country stock exchanges, this will lead to increased potential for mutual fund equity investment from a broader range of investors investing in the form of open-end funds, in infrastructure growth in the emerging economies of IDB member countries. Infrastructure is a relatively low risk category for entry into an emerging market (given infrastructure assets relatively predictable cash flows, the relatively low level of technology risks, and the asset backing involved). Interestingly, although some infrastructure investments are highly leveraged, one international infrastructure fund of conventional listed equities managed from Australia, albeit including non-shariah-compliant companies, has an average debt/market capitalization ratio of around In any event, the advent of Shariah-compliant private equity infrastructure funds will naturally lead to more Shariah-compliant listed infrastructure companies, providing attractive investments for open-end mutual funds. While, in due course, listing of the infrastructure assets and companies should ideally be in the countries of the regions concerned, to reflect and strengthen their local and regional capital markets development (and, for those African countries which do not yet have highly developed stock 53

59 markets, listing in South Africa is one natural current possibility), such listings could, in the meantime, be in the GCC, e.g. on the Dubai International Financial Exchange (DIFX). Here, we should address a misconception about emerging market development that often arises when discussing inward international investment with the political communities. The development buzzword additionality is often invoked e.g. how can it be adding value, or providing additionality, if private equity infrastructure funds buy existing assets, rather than only investing in Greenfield projects? ; and, it might now be asked, how will it help emerging countries if international mutual funds just buy into the already-listed equities in or from the countries concerned?. A key point to grasp about foreign investment is that it has to have not only free access to, but also free egress or exit from, the emerging market. All investors seek the prospect of available exits for realization of capital appreciation as and when they choose. Accordingly, it is essential that private sector infrastructure investors (whether financial investors or strategic investors) have the opportunity to exit their investments. When willing sellers of investments are unable to sell, investor confidence is adversely affected, and invariably the sources of new capital for similar new projects then dry up or are reduced. Furthermore, when such investments are listed on a stock exchange or market, then, clearly, the more interest in the relevant equity securities from sophisticated investors, the better it is for continued interest in new issues by the companies which originally issued those equity securities. Open-end mutual funds are managed by sophisticated fund managers; and those funds, having incoming capital from new purchases of fund shares, are also able to purchase new issues of securities. Of course, fund share redemptions might also occur, leading to the need to sell underlying listed equities (this might argue for, generally, avoiding a mutual fund having too narrow an investment scope, e.g. for avoiding concentration on a single, high risk, high return sector or country). One obvious strong recommendation is that the IDB should continue to use its unparalleled prestige in Muslim countries and, from the Muslim countries in the global financial markets, to sponsor trailblazer private equity (and private sector-managed) funds that, in turn, pave the way for the listings of equities from the less well-developed economies of the IDB member countries and then mutual funds investing in such listed equities. Another recommendation in this regard is that, where IDB has established special expertise, such as in the small and medium-size business sectors in member countries through Islamic Corporation for the Development of the 54

60 Private Sector (ICD) (see Appendix II), IDB should consider joining forces, as it has already done, with a private sector fund manager to form a welldiversified open-end or, if possible and more appropriately, closed-end, mutual fund focusing on the development of SMEs in member countries, both within and outside the GCC: SMEs are critical to the growth of all economies, developed and emerging economies alike. The role of IDB s Investment Promotion Technical Assistance Program (IPTAP) (see Appendix II) is critical in helping to foster implementation of the key success factors for attracting foreign investment, including through mutual funds, as indicated above. Of course, other multilateral development institutions, such as the World Bank and the World Trade Organization, also provide plentiful advice on the importance of such key success factors, but detailed implementation is what counts in determining success. In promoting the key success factors, it is recommended that IDB support such private sector initiatives as the Mo Ibrahim Foundation (see Appendix III), which seeks to promote exemplary leadership and governance quality in African countries. It is recommended that IDB examine its own potential, perhaps together with trailblazer investment organizations and individuals, to sponsor similar initiatives and incentive schemes for the promotion of specific financial market, financial institutional and corporate governance standards in member countries/regions. Sometimes, leading individual and institutional investors could be the investment trailblazers (complementing private equity funds) for the mutual fund investors. Accordingly, it is recommended that IDB should track and publicize investments in the targeted IDB member countries by such individuals and institutions as HRH Prince Alwaleed bin Talal and HRH s Kingdom Holding Company, HH Shaikh Mohammed bin Rashid Al Maktoum, Vice President and Prime Minister of the United Arab Emirates and Ruler of Dubai and HH s Foundation, and by Dubai World (see Appendix III), as well as the GCC sovereign wealth funds. Trailblazing investments by such sophisticated investors lend substantial credibility to the investment potential of the countries and sectors concerned, and can lead to the eventual development of private equity funds and to mutual funds having similar investment targets. It is further recommended that, in regard to its own technical assistance to the targeted IDB member countries in developing the above key success factors, IDB s own efforts in promoting vis-à-vis investors the existence of such key success factors should include seeking updates on such matters from other interested and supportive Arab and other regional development 55

61 institutions (see Appendix III), as well as from the Breton Woods institutions. It is similarly recommended that IDB maintain dialogue with both the Overseas Private Investment Corporation (OPIC) and the Multi-lateral Investment Guarantee Agency (MIGA) (Appendix III), to help ensure that their support facilities for development of key success factors, where applicable, are extended to targeted IDB member countries. The benefits conferred under such facilities should then be made known to the GCC investment community, including fund managers, through IDB s promotional assistance. The impact on mutual fund investments might only be indirect, as currently these institutions are focused on assisting direct investment or private equity funds, by supporting emerging markets, e.g. by providing political risk insurance, often an important requirement for newcomers investing in emerging markets. I have already raised with OPIC the issue of providing direct Shariahcompliant financial support, which would require Charter amendments. However, the IDB maintaining dialogue with such important institutions which provide support to emerging markets could result in IDB designing similar facilities where needed, possibly in tandem with the support of other appropriate regional organizations also covered in Appendix III to OPIC and MIGA organizations (where not already provided by the Islamic Corporation for the Insurance of Investment and Export Credit (ICIEC)), so as to expedite the mobilization of mutual fund investments in the target IDB member countries from the GCC and non-idb member countries The Best Practice Checklist for Fund Registration/Regulation The IDB may wish to see the international development of mutual funds in countries outside the GCC and Malaysia, etc. as also providing an opportunity to upgrade the financial and capital markets infrastructure in IDB member countries, especially in relation to the domicile of the mutual funds themselves, as well as the domicile of the stock exchanges and markets in which the fund s underlying securities are quoted. To gain credibility as a legal registration and regulatory centre for mutual funds, it is recommended that IDB member countries seeking such a role adopt international best practice. The Cayman Islands is the leading domicile for establishment of mutual funds. For example, it is estimated that over 70 per cent of the world s hedge funds are registered in the Cayman Islands. There are many reasons 56

62 as to why the Caymans have become the international finance destination of choice. These include: Market access; Positive investor perception; Availability of quality professional services, including accountants, attorneys, administrators and directors; Swift turn-round time for fund establishment; Flexibility afforded by the range of structures used to operate investment funds; No specific statutory or regulatory constraints on the investment policies and strategies that may be adopted by a fund; Absence of prescriptive regime mandating the location of service providers; No restrictions on the issue of equity interests; Local infrastructure; High level technological sophistication, including IT and telecommunications infrastructure; Availability of listing on the Cayman Islands Stock Exchange; Single independent regulator; Efficient and free of time-consuming bureaucracy; User-friendly regulatory framework for fund managers and straightforward licensing and regulatory procedures; Well developed and sophisticated legal and court system derived from English law and supplemented by local legislation with ultimate appeal to the Privy Council in London; and Zero tax jurisdiction. 3. IDB Countries with Established Mutual Funds Frameworks Currently, among others, three member countries in particular have international-standard mutual fund management registration and regulatory regimes, as well as officials who are experienced in the implementation of international best practice: the Kingdom of Bahrain, the United Arab Emirates represented by the Dubai International Financial Centre, albeit itself of more recent vintage, and Malaysia. 57

63 3.1. The Kingdom of Bahrain The Kingdom of Bahrain ( Bahrain ) provides a good example of the successful importation and application of the Cayman Islands regulatory model into an IDB member country. The Central Bank of Bahrain (CBB) recently issued the first Module of Volume 6 (which regulates capital markets) of the CBB Rulebook relating to collective investment undertakings (CIUs) (the Module) which repealed the existing regulations relating to collective investment schemes. The Module, effective from 1 June 2007 (with a one-year transition period for existing CIUs), aims to reinforce Bahrain's reputation as the funds centre of the Gulf by allowing certain CIUs to be targeted, for the first time, at professional investors and by broadening the range of available products. CIUs are defined as "undertakings the sole object of which is the collective investment of capital raised from the public". CIUs operate on the basis of risk spreading, and holdings are repurchased or redeemed out of the sale of the assets of those undertakings. The Module applies to CBB licensees who carry out capital markets activities and all "relevant persons", which means any person who is offering CIU holdings to investors resident in Bahrain and any person acting as the operator, manager, administrator or custodian of a CIU. Relevant persons acting in any of the above capacities in Bahrain must be acceptable to the CBB. With respect to the administrator and custodian roles, the CBB would normally expect the relevant person to be a CBB licensee. However, the CBB will allow hub-and-spoke arrangements whereby the actual operations of the administrator/custodian are undertaken outside Bahrain, provided that a suitably licensed office is maintained in Bahrain. In the case of an exempt CIU, the CBB may consider non-cbb licensees on a case-by-case basis, but only where there is strong rationale for doing so (typically, where the service required is not available in Bahrain). The Module provides for retail, expert and exempt funds, and makes special provision for Shariah-compliant funds. Of the three basic types, only retail and expert funds attract supervisory oversight from the CBB. The Module reflects the different risk profiles of each CIU category. Retail CIUs are open to all investors and are subject to detailed regulation and supervision. They are subject to restrictions on concentration levels and on the types of financial instruments or assets that can be held by the fund. Expert CIUs may be offered only to "expert investors" who are individuals or institutions with unencumbered assets of at least US$ 100,000. The 58

64 minimum investment is set at US$ 10,000 or the equivalent. Whilst they are subject to diversification and asset class requirements, this type of fund is less restrictive and may invest in, amongst other things, real estate, commodities, unlisted securities and hedge funds. Retail and expert CIUs must be initially authorized by the CBB and regulated by the CBB on an ongoing basis. Exempt CIUs are only required to be registered with (as opposed to authorized by) the CBB and are largely unregulated. They can be offered only to "accredited investors" who are individuals or institutions with unencumbered assets of at least US$ 1,000,000. The minimum investment is US$ 100,000 or the equivalent. They are to be marketed only to investors who are able to understand and bear the inherent risks of investment in such a CIU. Exempt CIUs are not subject to any restrictions on investment policy or leverage limits. To avoid supervisory duplication, the Module provides that overseas domiciled CIUs which are already approved by the "home" regulator in certain "recognized jurisdictions" are simply required to register with the CBB, prior to being marketed in Bahrain. The list of "recognized jurisdictions" includes all European Economic Area member states, the USA, the Cayman Islands and British Crown dependencies. The Module further provides guidance on, amongst other things, the anticipated contents of the prospectus, the investments which a CIU may make, borrowing and lending by a CIU, valuation and record keeping by a CIU and on the reporting and auditing requirements for a CIU. As at December 2007, over 2,483 funds (2,360 offshore and 123 locally domiciled) were registered in Bahrain, accounting for an 18 per cent growth over the previous year. Investments in CIUs as at December 2007 stood at a total of US$ 15.6 billion (US$ 11.1 billion invested in offshore domiciled funds, and US$ 4.5 billion invested in locally domiciled funds). In view of the Kingdom of Bahrain s experience in registering and licensing mutual funds, it is recommended that the other GCC countries consider recognizing CBB-licensed funds, provided, of course, that the role of such funds in their jurisdictions complies with their securities regulations. Such mutual recognition could expedite access to GCC capital, for IDB member country focused mutual funds from outside the GCC. 59

65 Both the Kingdom of Bahrain and the Dubai International Financial Centre (covered immediately below) share the vital advantage of being Englishspeaking, zero tax locations Dubai, United Arab Emirates (UAE) The Dubai International Financial Centre (DIFC) established in 2004, is a 100-acre financial free zone inside the UAE, with its own financial services regulator - the Dubai Financial Services Authority (DFSA), its own securities exchange - the Dubai International Financial Exchange (DIFX), and its own system of codified civil and commercial laws. In addition, there is a commodities exchange - the Dubai Mercantile Exchange (DME). The DFSA is an independent body responsible for regulating all financial and associated services conducted in or from the DIFC, as well as for licensing, authorizing and registering businesses to conduct the services in question. The DFSA's regulatory framework is based on the best practices and laws of the world's leading financial jurisdictions. The DFSA regulates the full range of financial services, including banking, securities business and insurance, as well as ancillary activities such as trustee services, money services, custody and insurance intermediation. There are also regimes for regulation of exchanges, clearing houses and alternative trading systems, like in the United Kingdom. Notwithstanding the fact that the DFSA regulates the full range of financial services, the DIFC is designed as a wholesale financial centre, primarily accommodating financial institutions, companies, other businesses and high net- worth individuals. In this context, firms authorized by the DFSA are prohibited from carrying on financial services for retail investors and, prior to accepting an individual as a client, a DIFC-registered firm must satisfy itself that the individual meets certain minimum requirements, similar to those required under Bahrain law for the accredited investor category (described above). To the extent that DFSA-licensed funds may be mutual funds, it is also recommended that such funds (as with those licensed by the Kingdom of Bahrain s CBB) be recognized also by other GCC countries. 60

66 3.3. Malaysia Malaysia is an important funds centre in Asia and exhibits many of the characteristics that encourage investment into a country including, amongst others, the following: Stable economy and government; A legal system which is based on English common law and Islamic law; A young population; Low unemployment rate of 3.1 per cent; Increasing workforce it is estimated that Malaysia will have the biggest increase in Asian workforce (ING Real Estate); Membership of many international bodies and organizations including, but not limited to, the Asia Pacific Economic Cooperation (APEC), Organization of the Islamic Conference (OIC), World Trade Organization (WTO) and the Food and Agriculture Organization (FAO); Perceived undervaluation of the Malaysian Ringgit, which encourages investment; Good strategic location - close to Australia, Singapore, China and Hong Kong; Good education and literacy rates compared to other Asian countries 88.7 per cent of the population over the age of 15 can read and write; Several languages widely spoken, including English; Availability of both traditional and Shariah-compliant funds; and Promotion of Shariah-compliant finance by the government. Again, given Malaysia s experience with licensing mutual funds, it is further recommended that consideration be given to GCC countries recognizing such licensed funds Is IDB Member Country Jurisdiction Essential? While any of the above registration and licensing centers could be considered for the mutual funds (subject to the type of target investor) directed to the less developed member countries of IDB, most of such countries are in Africa, and it might be that an African jurisdiction, e.g. one of such internationally-acceptable jurisdictions as Mauritius, makes particular sense for funds with an African focus. Again, perhaps GCC countries might consider recognition of funds licensed in these jurisdictions. 61

67 Moreover, international investors from outside IDB member countries might well be interested in investment in a diversified pool of African assets and, accordingly, it is best to be open-minded about the registration and licensing centre for a mutual fund, which might occasionally be the Cayman Islands or another UK-related jurisdiction, or even the United States. In any event, in order to maximize the near-term prospects of increasing the flow of mutual fund investment from the GCC to the less developed IDB member countries, it is recommended that we adopt an open mind on the registration, licensing and regulatory centre for the mutual funds, and not insist that the only applicable registration, licensing and regulatory centers should themselves be located in IDB member countries. 4. Opportunities and other Recommendations 4.1. Opportunities for Investment in IDB Member Countries Set out in the following sections is an overview of various industry sectors energy, infrastructure (in particular, power), agriculture, real estate and asset leasing which, it is recommended, should provide specially attractive investment opportunities in certain IDB member regions and countries. The suggested sectors have been chosen either because of the natural resources of a country or region, the reduced financial risk associated with a particular type of investment, or the increasing requirements and high demand for such investments in a particular country or region. Such investments could provide opportunities where there are listed or quoted equities for open-end funds, or even where such equities do not exist (e.g. real estate for closedend funds). Whereas we shall, towards the end of the paper, briefly address some technical issues relating to Shariah-compliance with respect to the mutual funds focused on money markets, here in looking at targeted equity and Ijara (leasing) investment opportunities, we assume that the form of the mutual fund itself will be Shariah-compliant. As indicated above, apart from investments in the form of equity or Ijara, the following sectors may also provide opportunities for Investment Sukuk mutual funds. 62

68 Energy industry Oil / Gas Coal Petrochemicals Electricity Other energy Oil refining Oil field services Rig fabrication & refurbishment Pipelines Shipping Exploration and Production Distribution Storage Mining -related services Commodity Specialty Generation -Independent Power Plants - Captive power Transmission & Distribution Biodiesel Waste to energy Alternative Renewables LNG Liquefaction Gasification LNG terminals LNG shipping Energy Investments The energy industry offers several opportunities for investment in different sub-sectors. The following diagram shows the major sub-sectors in the energy industry. Worldwide energy consumption is expected to increase by over 50 per cent between 2004 and Growth is expected to occur across all sectors, as demonstrated in the following graph: There are opportunities for energy investment in some non-gcc IDB member countries in terms of improved transport links, energy infrastructure and investment in energy companies of all types. As both institutional and individual investors in the GCC region are familiar and comfortable with energy industry risk, it is recommended that mutual funds target the energy sector in other IDB member countries. 63

69 The Commonwealth of Independent States (CIS) region which includes some IDB member countries, is likely to become a key player in the energy world, owing to its plentiful resources of oil and natural gas. There are several key investment drivers for the CIS region including the following: Increasing importance of the CIS region as an energy centre; Increased demand for energy driven by population growth and quality of life expectations; Opportunity to utilize better and improved existing transnational distribution networks; Opportunity to enhance existing international export-focused distribution networks; Aging of Soviet-era sourcing, generating, refining, storage and distribution systems and equipment; Considerable government assistance (tax holidays, etc.) The Ithmaar-Kazyna Regional CIS Energy Fund L.P. Ithmaar Bank B.S.C. is launching a private equity fund with a leading partner in Kazakhstan, Kazyna Capital Management, which is the fund of the funds subsidiary of Kazyna, the Sustainable Development Fund of the Republic of Kazakhstan. The fund intends to make equity and equity-related investments in the CIS region. The sector will focus on the companies engaged in the management and/or marketing of value added energy (including natural gas, oil and coal and their respective derivatives). For this purpose, management means the companies engaged in refining, storage, control and distribution of energy in its various forms, and marketing companies means the companies engaged in the pricing, packaging, promotion and delivery of energy in its various forms to the consumer. Whereas such private equity funds are not usually open to mutual fund investors, it may be possible to have some of the limited partners sell-down, to a closed-end mutual fund, part of their private equity fund interests at fair market value once the private equity fund has become fully invested. Also, as indicated above, such private equity funds often list individual fund assets, upon initial public offering, thereby creating assets suitable for openend mutual funds. 64

70 Infrastructure Investments Infrastructure generally refers to the large-scale public systems, services and facilities of a country or region that are necessary for economic activity. It is typically separated into two broad subsets of economic and social infrastructure. Economic infrastructure includes transport assets (including roads, railroads, bridges, tunnels, seaports, airports and other logistics facilities), water and wastewater facilities, electricity generation, transmission and distribution facilities as well as communications facilities; whereas social infrastructure encompasses, for example, education and healthcare facilities, courts and public administration buildings. Infrastructure assets generally involve large-scale investment, have relatively long operating lives and are financed and managed on long-term basis. The role of government as the provider of public services is increasingly being supplemented or supplanted by private sector participation. The private provision of these assets could take many forms, from joint ventures, concessions and franchises through to delivery contracts. As this trend continues, the private sector is increasingly being introduced to design, build, finance and/or maintain infrastructure assets in return for long-term contracted payments from the government or direct access to the revenues generated from the asset. Infrastructure projects and companies, particularly in the power sector, offer attractive opportunities for private equity investors because they typically operate under government licenses and concessions, and often have longterm contractual arrangements for the sale and pricing of their services. Such arrangements tend to mitigate financial risk and create the potential for relatively predictable cash flows. Moreover, the combination of the significant capital cost and the requirement for government licenses creates high barriers to entry, while the essential nature of the service provided by infrastructure assets leads to reliable demand, or take or pay agreements in countries where seasonal climatic conditions create extremes of high and low capacity utilization and/or where the government wishes to subsidize the price of power supply. The substantial burden placed on existing infrastructure in many of the emerging markets of IDB member countries has resulted in congested roadways, ports and airports, and inadequate or insufficient schools and hospitals; while the need to modernize telecommunications facilities, improve water treatment facilities and meet energy and power shortages is also evident. 65

71 The scale of investment in infrastructure required globally, both in developed and developing economies, is immense. A review in November 2006 (Deloitte Research) has estimated that the combined infrastructure investment requirement of all regions of the world exceeds US$ 1 trillion per annum. Set out below is a diagrammatic presentation of the infrastructure required on a global scale. Owing to their relatively low risk, infrastructure investments, especially in the power sector, make a particularly suitable asset class for mutual funds, closed-end (when such investments have not yet been subject to IPOs) and open-end (when the infrastructure assets or companies are already listed or quoted) Agriculture Investments Crop diversification programs, financing and research are some of the ways in which IDB countries can attain self-sufficiency in food grain production. There are vast untapped opportunities for Islamic banks in agriculture financing, whereas the banks presently focus more on consumer and corporate financing. Agricultural development can be a major contributor to poverty reduction and economic growth. Increasing 66

72 agricultural productivity is key to improved food security for both the rural and urban poor. Given the prospects for financing agriculture in IDB member countries, it is recommended that IDB encourage GCC-based Islamic banks and other GCC institutions and investors to consider establishing private equity funds focused on developing agribusiness in the less developed IDB member countries, an initiative which could, in turn, create future opportunities for mutual funds. We indicate hereunder some of the challenges and opportunities in agribusiness, heightened by the current widespread food price crisis affecting all countries, particularly emerging market countries. Agriculture in Africa A major reason as to why Africa lags behind other regions is the underperformance of its agriculture, which accounts for 30 per cent of GDP and employs 75 per cent of the population (Commission for Africa, 2005). In a study carried out by the World Bank in 2004, it was noted that, if the development community were to choose one activity with which to address the first Millennium Development Goal of reducing extreme poverty and hunger in Africa, that activity would be to produce more food. Agriculture in Pakistan According to the Economic Survey of Pakistan (2005), 65.9 per cent of the total population lives in rural areas and 44.8 per cent of the total labor force is directly employed in agriculture. Overall, the sector accounts for 23 per cent of Pakistan s GDP. Agriculture in Bangladesh Agriculture is the single largest productive sector of the Bangladesh economy. It comprises approximately 30 per cent of the country's GDP and employs around 60 per cent of its total labor force. The performance of this sector has an overwhelming impact on the country s key macroeconomic objectives such as employment generation, poverty alleviation, human resource development and food security. Agriculture in Yemen With its wide ranging arable climatic zones, Yemen has the greatest potential for agricultural development in relation to any other nation in the Arabian Peninsula. Agriculture is an important part of the economy, accounting for 17 per cent of GDP in 2001, and over 64 per cent of the workforce. 67

73 Agriculture in Egypt Agriculture is a vital sector of the Egyptian economy. It contributes nearly one-sixth of the GDP, employs roughly one-fourth of the labor force and, through agricultural exports, provides a substantial proportion of the country s foreign exchange. Egypt successfully implemented land reform programs as a result of which its agriculture is geared overwhelmingly to commercial rather than subsistence production. Huge capital has been invested in canals, drains, dams, water pumps and barrages, plus investments in skilled labor and in commercial fertilizers and pesticides. Strict crop rotation, in addition to government controls on the allocation of cropping areas to specific crops, the varieties planted, the distribution of fertilizers and pesticides, as well as on marketing, contribute to high agricultural yields (see Appendix III on the role of one leading GCC investor, HRH Prince Alwaleed bin Talal, in supporting the creation of this exemplary success story) Real Estate Investments One of the main challenges facing the housing sector in IDB member countries, many of which have fast-growing, young populations, is the lack of affordable housing and, in some areas and/or countries, the lack of available housing stock. The absence of appropriate financing options is one of the major reasons as to why many people are unable to own property. It is recommended that laws and regulations be modified to allow for a greater degree of private sector participation in real estate development and financing. IDB countries could work to develop mortgage markets with a wide range of Shariah-compliant financing products, including REITs. In relation to international standards, the growth of residential real estate financing industry in Islamic countries has been slow over the last two decades, and many economists predict that this could result in a housing crisis in some Muslim countries. These States have a shortage of strong financial institutions and mortgage bankers, and have not developed asset securitization markets. Primary and secondary markets attract real estate broker and real estate sales associates, mortgage brokers, title companies, closing agents, appraisers, credit reporting agencies, private mortgage insurance companies, insurance companies and more. Already, however, we are seeing many initiatives being successfully undertaken for REITs and for real estate closed-end funds focusing on upmarket residential and commercial developments in IDB member countries, both in the GCC and in other IDB member countries. There could be interesting opportunities for similar developments, e.g. tourist-related, in 68

74 some of the African member countries, in addition to the opportunities in North Africa where GCC mutual fund investor interest has already become manifest Leasing Assets Shariah-compliant equipment leasing funds provide opportunity to encourage economic growth and attract foreign companies. Such funds invest in leases of equipment for viable businesses, allowing domestic and foreign companies to free up their resources and divert them to their core business. Ithmaar Bank s associate, First Leasing Bank (FLB) in Bahrain, is a proven example of how this business model can be introduced into new markets relatively easily and profitably. FLB provides solutions for most asset classes including industrial, manufacturing, medical, printing and publishing, construction, telecommunications, IT, transportation, and marine and special purpose real estate. FLB has also expanded to other companies in the region and is currently the only provider in the region that specializes in this service. Worldwide, equipment leasing is a US$ 600 billion market which includes industrial companies that set up their own leasing specifically to finance their own equipment use (referred to as captive leasing companies), companies that set up their own leasing companies to finance both their inhouse equipment and the leasing needs of other companies, independent leasing companies that specialize in equipment leasing, and banks that are involved in different forms of leasing. Pooling such leases into Shariah-complaint closed-end mutual funds is expected in due course; and whereas this action would initially be expected to concern private sector leases in the GCC region, it is recommended that IDB consult with member country governments on the scope of a (private sector managed) IDB-sponsored Ijara equipment (leasing) mutual fund for government sector lessees. 5. Liquidity Management IDB member countries and their banks must have successful tools for managing their liquidity, if they are to drive economic growth. Open-end funds are highly desirable as short and medium-term investment vehicles to manage liquidity because they provide a higher degree of flexibility than closed-end funds and are able to provide instant liquidity as 69

75 their units are saleable at any time. Investors are also able to diversify their investments by allowing assets to be allocated across many different types of holdings. Brunei recently took steps to meet the growing demand for new and flexible ways of investing in a Shariah-compliant manner. The Brunei Investment Agency launched the investment company, BICB Capital, in January The company will offer open-end Sharia-compliant investment opportunities. In Bahrain, the Liquidity Management Centre (LMC) was establish with the support of some of the largest and highly respected leading Islamic financial institutions in Muslim countries. The LMC aims to satisfy the increasing need for short to medium-term tradable investment opportunities and to develop an active secondary market for such instruments. LMC launched an open-end short-term Sukuk program in January 2004, which has now grown to approximately US$ 100 million. The Sukuk provides monthly entry and exit points for investors, high liquidity and underlying asset security/collateral in the form of a performing portfolio of various Sukuks. The Central Bank of Bahrain also offers various debt instruments to manage its liquidity needs, for example: 1. Monthly issuance of a three-month maturity Al Salam Sukuk; 2. Monthly issuance of short-term Shariah-compliant Ijara Sukuks for a maturity period of six months; and 3. Ad hoc issuance of long-term Ijara Sukuks for a maturity period of 3 to 10 years. It seems that a promising prospect would be the creation of mutual funds based on the Mudarebah, Musharakah certificates and Ijara leases, as well as on Sukuk, because, according to Ayub, stocks/securities/certificates and Sukuk can be traded on the market depending on market signals, provided that there is compliance with the Shariah rules relating to: (i) instruments representing physical assets and usufructs (encompassing all the above as negotiable at market price); and (ii) instruments representing debts and money, subject however to constraining negotiability rules on Hawalah (assignment of debt) and Bai al Sarf (exchange of monetary units), with mixed pools applying the negotiability principle of the dominant type (i) or (ii). It would seem that the best recommendation to improve liquidity would be to encourage more IDB member countries governments to issue Investment Sukuk including for short periods, to enable these government securities to 70

76 form the basis of well-diversified Sukuk-based mutual funds, which could become tradable. However, I have to end this section by emphasizing that any such possible solution to the liquidity issues in Islamic finance and banking would need to be preceded by the closest possible scrutiny by Shariah scholars. I am very much a novice pupil in this area and, after 35 years in the domain of international finance, it is quite humbling, challenging and, indeed, exciting for me to have the opportunity to become engaged in learning about the issues involved in what is rightly seen as the most ethical approach to the financing ever practiced, and one from which, in light of the most recent failings of the conventional banking system, the whole global finance profession has much to learn. 6. Conclusion Redirecting investments from GCC-based mutual funds to other IDB member countries will play a crucial role in the success of economic development and social progress in the less developed IDB member countries. A positive investment environment is the primary determinant of the number and value of investments made in a country or region. IDB member countries could take a number of steps to foster an investor and business-friendly environment. The increasing presence of positive investment indicators will encourage the redirection of funds. In this regard, it is suggested that investments in certain areas (including energy, infrastructure, and power and agriculture in particular) will be of utmost benefit for both the countries in which the investments are made and for the investors, in terms of the lower levels of risk and the reasonable returns associated with these types of investment. The IDB could play a positive role in encouraging investment in its member countries in many ways, which include serving as the sponsor of targeted funds in certain regions through continued promotion of countries as investment destinations and providing arenas for such promotion action, offering technical assistance to governments and intermediaries, providing or arranging insurance to mitigate the risks associated with investment in certain countries and, finally, incentivizing member countries through various initiatives geared to improving transparency and corporate governance. A more detailed set of detachable recommendations follows. 7. Recommendations 1. Recognize that redirection should not be from GCC investments within the GCC region but from GCC surpluses that are otherwise invested outside IDB member countries. 71

77 2. Recognize that, with regard to equity investments in the less developed emerging economies, the trailblazers are likely to be multinationals direct investment, direct private equity from high net worth individuals, investment institutions (including development funds/development banks from the GCC) and from private equity funds. Accordingly, we should encourage such trailblazers and ensure that their investments are publicized as a way to create positive market sentiment among pension funds, smaller financial institutions as well as high net worth and other individuals - investor types that usually make up the fund shareholders in open-end mutual funds. Trailblazer investments should result in initial public offerings (IPOs) of emerging market infrastructure projects/companies, regional joint ventures with prominent GCC companies, and of emerging market SMEs, the listed or quoted stock market securities of which can form the basis of subsequent investment by open-end mutual funds. Meanwhile, we should also consider encouraging closed-end, non-tradable mutual funds to participate, at an earlier stage, in the maturation process, by purchasing at fair market value a portion of private equity fund interests once private equity funds are bulked up with assets. 3. Recognize that confidence-building, leading to mutual fund creation for emerging market country investment, requires macro-preconditions whereby key social, political, economic and legal success factors should be in place for attracting, retaining and growing foreign investment, especially from mutual fund investors. Pro-private sector and foreign investment policies, currency stability, political, corporate and financial sector good governance policies, etc. are key. IDB already helps to promote awareness of implementation of such policies but could join hands with other development institutions and private individuals to provide incentives for such policies to be adopted and implemented. IDB has a key ongoing role to play in encouraging the introduction and upgrading of such policies, and ensuring that implementation is given recognition by publicizing progress for the attention of GCC investors. 4. The IDB could also strengthen its dialogues with such international agencies as the International Finance Corporation (IFC), OPIC and MIGA to ensure that less developed IDB member countries potential investees are given the benefit of political risk guarantees as well as other guarantees when appropriate, and that their facilities are, wherever possible, provided in a Shariah-compliant way. Where 72

78 needed support to attract international investment is not available from these international sources, IDB s own capacity to step into the breach could be possibly augmented by the support of GCC and Arab regional development agencies and banks, and/or by support from a fund to be created and supported by economically stronger IDB member countries and prominent high net worth individuals. 5. Mutual fund listings and those of their underlying corporate investees need not be in the local markets of the less developed member countries themselves, although that would be a long-term goal. They could well be on a GCC stock market or exchange, such as DIFX or the Bahrain Stock Exchange, or even in Mauritius, for African mutual funds. 6. Also, to attract earlier than otherwise interest from non-idb member country investors, it could make sense to combine in one mutual fund both listed or traded GCC stocks and listed stocks from emerging market member countries. 7. Whereas it might be preferable to have the mutual funds established in, and under the law and regulation of, an IDB member country, of more importance at this stage is to have the funds in jurisdictions acceptable to both GCC and non-idb member country investors. So, at this stage, a flexible approach should be adopted, e.g. openness to funds registered in the Cayman Islands. 8. However, several IDB member countries are already advanced in implementing international best practice in registering, licensing and regulating mutual funds. Examples are the Kingdom of Bahrain (the Central Bank of Bahrain), the DIFC (DFSA/DIFX), and Malaysia. It would be helpful if established mutual funds jurisdictions and regulatory centers, such as the Kingdom of Bahrain, were automatically recognized by (other) GCC countries, thus expediting the placement of mutual funds from emerging markets of IDB member countries in the GCC. 9. In accelerating access to GCC (and other international) mutual fund investors, it is important to focus mutual funds scope on those geographies and sectors that make the most sense for early understanding and acceptance of the risks involved by such investors. Generally, it makes sense to have familiar but, nevertheless, broad categories that may be regarded as relatively low risk (or at least better understood risk) by such investors and for fund assets to be diversified 73

79 among a wide range of individual underlying investments, as is typical in the mutual fund model. Accordingly, it is recommended that early focus be given to energy investments (especially investments in the power sector which has relatively low risk), other infrastructure investments, real estate investments and leasing assets. SMEs, about which IDB has valuable experience, are another important category, albeit of higher risk, and it is essential to develop credible agribusiness investment opportunities, probably in joint ventures with international specialists, e.g. from Egypt, and from non-idb member countries. 10. While the above sectors appear the most promising for mutual funds, be it open- or closed-end funds, in target countries, it would probably make the most sense to combine in the scope of mutual funds many such countries (and even in some cases the whole 56 IDB member country universe), in order to provide attractive risk diversification, rather than focusing on the development of single country-only funds. Nevertheless, pan-african funds appear attractive, given the growing recognition that, with the interest of the high growth economies of China and India in sourcing raw materials from Africa, the continent offers the next big opportunity in international investment. 11. IDB itself is a trailblazer and its sponsorship of pioneering private equity funds in the investment categories mentioned in 9 and 10 above would foster, as with the IDB Infrastructure Fund, growing interest in such sectors and in the target countries/regions, and could lead to IPOs and attractive investment track records, which in turn would facilitate earlier interest than otherwise by mutual fund managers targeting investor interest from within the GCC and outside IDB member countries. 12. As regards the use of mutual funds to facilitate the development of much needed short-term liquidity in IDB member countries and among Islamic financial institutions, the IDB could encourage member country governments to lease assets, on an Ijara basis, from a private equity or mutual fund, and/or could also encourage them to issue Investment Sukuk, structured in a way that will enable it become Shariahcompliant for trading on the market depending on market signals, instruments of which could perhaps then be, subject to Shariah scholars rulings, the subject of liquid mutual funds. 74

80 APPENDICES Appendix I IDB Member Countries Afghanistan Indonesia Palestine Albania Iran Qatar Algeria Iraq Saudi Arabia Azerbaijan Jordan Senegal Bahrain Kazakhstan Sierra Leone Bangladesh Kuwait Somalia Benin Kyrgyz Sudan Brunei Lebanon Surinam Burkina Faso Libya Syria Cameroon Malaysia Tajikistan Chad Maldives Togo Comoros Mali Tunisia Cote d Ivoire Mauritania Turkey Djibouti Morocco Turkmenistan Egypt Mozambique Uganda Gabon Niger United Arab Emirates Gambia Nigeria Uzbekistan Guinea Oman Yemen Guinea-Bissau Pakistan 75

81 Appendix II Existing IDB Initiatives 1. IDB Infrastructure Fund (IDBIF) The IDBIF has committed to infrastructure projects in IDB member countries over US$ 750 million of equity capital commitments (including recycled commitments) for successful investment in, and management of, such projects. The IDBIF is performing well ahead of initial targets and expectations, with most of its investments now exited or listed. 2. Islamic Corporation for Development of the Private Sector (ICD) The mandate of ICD is to support economic development in ICD member countries (which include 45 IDB member countries) through provision of finance to private sector projects in accordance with the principles of the Sharia and through promotion of private sector development. ICD also provides advice to governments and private organizations to encourage the establishment, expansion and modernization of private enterprises. Projects financed by ICD are selected on the basis of their contribution to economic development, taking into consideration such factors as creation of employment opportunities and contribution to exports. The ICD also attracts co-financiers for its projects, provides advice to governments and private sector groups on policies to encourage the establishment, expansion and modernization of private enterprises, development of capital markets and best management practices, and enhances the role of the market economy. It operates to complement the activities of IDB in member countries and those of national financial institutions. 3. Islamic Corporation for the Insurance of Investment and Export Credit (ICIEC) The ICIEC acts to encourage exports from member countries and to facilitate the flow of foreign direct investment to member countries by providing and encouraging the use of Shariah-compatible export credit and investment insurance as credit and country risk mitigation instruments. ICIEC's objective is to widen the scope of trade transactions from the member countries of the Organization of the Islamic Conference (OIC), facilitate foreign direct investment flows into member countries and provide reinsurance facilities to export credit agencies in member countries. The ICIEC fulfills these objectives by providing appropriate Islamic Shariahcompatible credit and country risk insurance and reinsurance instruments. 76

82 4. Investment Promotion and Technical Assistance Program (IPTAP) The IPTAP is an IDB group member organization with the task of strengthening such institutional structures in member countries as could facilitate an investor s entry into a given country, and of building the capacity of countries to attract foreign investment. It achieves this by providing member countries with appropriate and affordable avenues to publicize their investment potential and opportunities, offering the means by which potential investors could obtain more accurate information on their target countries/sector, and by setting up mechanisms for activities coordination among member countries, governments and intermediaries. 77

83 Appendix III Initiatives by other Organizations and Individuals 1. Kingdom Holding Company (KHC) and HRH Prince Al Waleed Bin Talal The KHC, headed by HRH Prince Alwaleed Bin Talal, is based in the Kingdom of Saudi Arabia and is one of the world's largest and most diversified private investment companies with holdings in a large number of Saudi Arabian, Middle Eastern and international companies. Kingdom Agricultural Development Company (KADCO) The KADCO, a private Egyptian company, was created by HRH Prince Alwaleed bin Talal to develop as much as 100,000 acres of agricultural land in southern Egypt, an initiative known as Tushka Project. The Tushka Project is one of the pillars of the Egyptian government s multi-billion dollar South Valley Project - an immense infrastructural plan designed to irrigate over 500,000 acres of desert land to foster urban and agricultural development. The South Valley Project involves the construction of a 43- mile (70 km) canal that diverts water from Egypt s Lake Nasser, the reservoir formed on the Nile River by the Aswan High Dam, to four separate parcels of land - the first being the Tushka site. KADCO partnered with Sun World, a subsidiary of Cadiz, to undertake the project. The combined company benefits from the amalgamation of Sun World s proprietary product development and licensing program and its farming and water infrastructure development expertise, with KADCO s significant land and water resource holdings in Egypt. Pan-African Investment Partners II Fund (PAIPF) The PAIPF, a private equity fund whose biggest investor is HRH Prince Alwaleed bin Talal, is raising funds to invest US$ 500 million throughout Africa. HRH Prince Alwaleed bin Talal has already committed US$ 250 million to PAIPF, which is seeking to raise a similar amount from institutional investors. The fund will have a 10-year life span and is targeting about 10 investments, cost of which ranges from US$ 20 million to US$ 75 million per target in sectors with strong growth in terms of income and consumer spending, such as telecommunications, financial services as well as manufacturing, mining and energy services. 78

84 HRH Prince Alwaleed bin Talal was also the biggest investor in a previous fund managed by the same management firm, which has offices in Johannesburg, Accra, London and New York. The previous fund, launched in 2003 with US$ 123 million, made five investments and has so far sold two of them at a combined exit multiple of 3.3 over an investment period of less than three years. 2. Sheikh Mohammed bin Rashid Al Maktoum Foundation In 2007, His Highness Sheikh Mohammed bin Rashid Al Maktoum, Vice- President and Prime Minister of the United Arab Emirates and Ruler of Dubai, launched the Mohammed Bin Rashid Al Maktoum Foundation, a major initiative to promote human development and provide hope and opportunities by investing in education and knowledge development. The foundation was launched with an endowment of US$ 10 billion from His Highness Sheikh Mohammed bin Rashid Al Maktoum. The money is targeted to improve the standard of regional education and research, stimulate job creation, encourage innovation and entrepreneurship and bridge the knowledge gap in Arab and some other countries. The Foundation will source and manage a wide range of initiatives including the establishment of high-quality research programs and research centers, and the provision of scholarships to students to attend leading universities and institutes. It will also support research in universities across the region. The Foundation will, in addition, provide leadership programs for youth in government, the private sector and in non-governmental organizations. Scholarships and research grants will also be accorded to authors and researchers in the region. Furthermore, the Mohammed bin Rashid Al Maktoum Foundation and the United Nations Development Program (UNDP) have launched a new partnership to promote creative knowledge generation and investment in education, with emphasis on the need to bridge the widening knowledge gap by investing heavily in education and on promoting open intellectual enquiry. The agreement represents the first partnership between UNDP and a private foundation in the region, and is a major step forward in UNDP s initiative to work with all sectors of the Arab society, including governments, the private sector, the civil society and foundations. 3. Dubai World Dubai World is a holding company for the government of Dubai, which operates a highly diversified spectrum of industrial segments and plays a 79

85 major role as a growth engine that powers development both locally and internationally. Dubai World's investment spans four strategic growth areas, namely: transport and logistics, dry docks, maritime and urban development, and investment and financial services. Dubai World Africa oversees the regional development and portfolio of investments in the African continent. Dubai World's African business model currently includes over 30 investment projects such as marine terminals in Djibouti, Dakar and Maputo, and wildlife reserves in Rwanda and South Africa. Examples of such projects are the 20-year management contract for the terminal in Djibouti signed in 1999, with the government of Djibouti as a joint venture partner- a project in which Dubai World has invested over US$ 1.1 billion - and the US$ 800 million joint venture investment between Jafza - a subsidiary of Dubai World - and the Senegalese government. Dubai World is also partnering with the Senegalese government in a multi-billion dollar development of its trade and transport infrastructure. Dubai World Chairman, Sultan Ahmed Bin Sulayem, recently said that the conglomerate will invest US$ 1.5 billion in emerging African economies over the next five years. 4. The Arab Fund for Economic and Social Development (AFESD) The AFESD is an autonomous regional Pan-Arab development finance organization, membership of which consists of all the States members of the League of Arab States. Its function is to offer assistance towards economic and social development in Arab countries through: (i) financing development projects (providing loans on concessionary terms to governments and public corporations, providing loans and guarantees to private corporations and enterprises, participating in the equity capital of corporations, and establishing and administering special funds) with preference accorded to Arab development and joint Arab projects, (ii) encouraging the investment of private and public funds in Arab projects, and (iii) providing technical assistance services for Arab economic and social development. The AFESD seeks to assist member countries in this capacity by eliminating development constraints, upscaling absorptive capacity and achieving higher rates of growth and by fostering economic integration and cooperation among member countries. Recently, AFESD s lending program intensified its support towards promotion of Arab countries efforts at implementing high priority economic and social projects. Top priority was given to projects in the transport sector aimed at developing road networks and airports, followed by energy sector 80

86 projects with the objective of upscaling Arab countries potential for electricity generation and improving power transmission networks. Attention has also been accorded to water and wastewater projects, educational projects, social development funds and administrative rehabilitation projects. These projects aim to assist member countries in providing basic infrastructural services, developing current projects and promoting social development in these countries. Furthermore, the Fund has continued to offer grants to enable its member states to achieve their goal of providing institutional support and capacity building, undertaking feasibility studies and preparing projects, in addition to developing educational and health services, supporting training and information systems, carrying out population censuses and implementing emergency programs in some countries. 5. The Arab Bank for Economic Development in Africa (BADEA) BADEA is a financial institution funded by the governments of the States members of the League of Arab States. The Bank was created with the aim to strengthen economic, financial and technical cooperation between Arab and African countries, make Arab- African solidarity a concrete reality and rest this co-operative venture on the foundations of friendship and equality. To this end, the Bank was mandated to: (i) assist in the financing of economic development in non-arab African countries, (ii) stimulate the contribution of Arab capital to Africa s development, and (iii) help provide the technical assistance required for the continent s development. BADEA achieves the above objectives through offering project and technical assistance loans as well as export financing for foreign trade between Arab and African countries. In recognition of the role of trade in strengthening Arab-Africa cooperation, BADEA has contributed US$ 10 million to the capital of AFREXIMBANK and allocated a further US$ 100 million to finance Arab exports to African countries, of which US$ 50 million was entrusted to IDB for management. 6. The Abu Dhabi Fund for Development (ADFD) The ADFD, under the generous leadership of His Highness Sheikh Khalifa Bin Zayed AL Nahyan, President of the United Arab Emirates, provides economic assistance in the form of concessional loans, grants or contributions to project capital and equity participation, supports regional and international efforts aimed at achieving development goals in developing countries and encouraging fair participation in the distribution of world 81

87 resources. ADFD s main goals are to reduce poverty, and promote social equality and sustainable growth. ADFD s activities focus on the following sectors: electricity, water, transport, telecommunications, healthcare, agriculture and education. It has, since its establishment in 1971, provided AED 13 billion for 197 developmental projects. In addition, the ADFD has managed the loans and grants accorded by the Abu Dhabi government, and played a central role in the design, implementation, oversight and appraisal of the projects financed by the government. The subsidies provided by the Abu Dhabi government and managed by ADFD covered around 61 financing operations accounting for a total of approximately AED 10 billion. 7. Kuwait Fund for Arab Economic Development The object of the fund is to assist Arab and other developing countries in their economic development. The fund, amongst other things, provides loans and guarantees, offers grants by way of technical assistance, and contributes to the capital stocks of international and regional development finance institutions. The fund s operations focus primarily on agriculture and irrigation, transport and communications as well as on the energy, industry, water and sewage sectors 8. Mo Ibrahim Foundation The Mo Ibrahim Foundation is an African telecommunications sector initiative of a highly successful private equity fund founder chairman. The Foundation was established to: Stimulate debate on good governance across sub-saharan Africa and the world; Provide objective criteria by which citizens could hold their governments to account; Recognize achievement in African leadership and provide a practical way in which African leaders could, after leaving office, build positive legacies in the continent. The Foundation has established two major initiatives in support of improved governance in sub-saharan Africa. There are: 82

88 1. The Mo Ibrahim Prize for Achievement in African Leadership, awarded annually in recognition of a former executive Head of State or Government who has demonstrated exemplary leadership. 2. The Ibrahim Index of African Governance, a comprehensive ranking of sub-saharan African countries according to governance quality. It was created in recognition of the need for a more comprehensive, objective and quantifiable method of measuring governance quality in sub-saharan Africa. The Index assesses national progress in five key areas, which together constitute a holistic definition of good governance: Safety and security ; Rule of law, transparency and corruption; Participation and human rights; Sustainable economic development; and Human development. 9. Overseas Private Investment Corporation (OPIC) The OPIC is an independent US government agency whose mission is to mobilize and facilitate the participation of US private capital and expertise in the economic and social development of less developed countries and areas, and countries in transition from non-market to market economies. In total, OPIC does business in over 150 countries. OPIC assists U.S. companies by providing financing (from large structured finance to small business loans), political risk insurance and investment funds. OPIC complements the private sector in managing the risks associated with foreign direct investment and supports US foreign policy. The Office of Investment Policy (OIP), arm of OPIC, ensures that all OPICsupported projects: apply consistent and sound environmental standards; apply consistent and sound worker rights standards; observe and respect human rights; have no negative impact on the US economy; and encourage positive host country development effects. OIP achieves the above objectives by conducting analysis in the following four areas: i) environment, ii) worker rights, iii) human rights, and iv) economic issues. In addition, OIP monitors all OPIC-supported projects to ensure that they are in compliance with OPIC statutory and policy requirements. 83

89 One of OPIC s top priorities is to bolster its developmental efforts. To ensure that every project receiving OPIC support has a beneficial net impact on the economic and social development of the project s host country, OIP conducts a development impact analysis. The analysis uses objective measurements to demonstrate the developmental impact of OPIC-supported projects. Factors that are considered when conducting the host country development analysis include: Leveraging private capital; Demonstration of social policies and corporate social responsibility; Support for developmental infrastructure; Increased availability of goods and services of better quality or at lower cost; Development of skills through training; Transfer of technological and managerial skills; Foreign exchange earnings or savings; Human capacity building and job creation; Encouragement of private ownership; Host country tax revenues; Stimulation of small and medium-sized enterprises; and Infrastructure improvements. OPIC Investment Funds Of particular interest amongst OPIC s numerous initiatives are OPIC s investment funds. The OPIC investment fund model is a successful template for investment in developing countries and emerging markets and provides a useful starting point for consideration of some of the important factors relating to the structuring of such funds and the investments that the funds ultimately make. OPIC investment funds mobilize private capital for direct equity investment by qualified fund managers in private companies located in developing countries and emerging markets. OPIC is one of the largest providers of private equity capital to emerging markets. In FY07, OPIC s funding commitments to almost 40 private equity funds located across 53 developing countries and emerging markets were approaching US$ 3 billion The advantage of private equity is that it brings not just capital but expertise, experience and networks to the companies in which investments are made, all directed to the goal of building value and generating growth, resulting in better productivity, reliable financial controls, improved corporate governance, modern business practices and improved health and safety. Through its private equity funds, OPIC seeks not only to provide immediate benefits to the countries and companies in which the funds invest, but also to 84

90 demonstrate to the billions of dollars represented by private institutional investors currently sitting on the sidelines in regard to investing in these countries, that emerging markets private equity is an attractive asset class. OPIC s Private Equity Fund Structure OPIC mobilizes risk capital for emerging markets by providing (through a guaranty program) credit extension to private equity funds. OPIC s support is combined with the equity funds raised from private sector institutions and invested in private companies on these markets. OPIC is thus a creditor of the funds it supports, providing in most instances one-third of the fund s total capital and receiving debt returns on its investment. The structure of the debt is typically analogous to that of a zero-coupon loan, with most of the interest expense capitalized until the fund liquidates its investments. OPIC-supported funds are typically organized and structured like other private equity investment vehicles, i.e. as limited partnerships or limited liability companies. OPIC supplements private equity capital by lending long-term debt (typically with a 10 to 12-year maturity) to a fund. OPIC receives commercially-based fees and a small profit participation component as compensation for the financing provided to the fund, and the program is structured to ensure that fees and profit participation will fully cover costs and a modest return. In addition, OPIC s terms allow the fund manager to make distributions on pro rata basis along with the equity investors, subject to certain covenants being met. OPIC utilizes an open, competitive process in selecting fund managers, a process initiated periodically through the publication of a call for proposals in private equity trade journals and on OPIC s website. In general, the funds are organized by experienced sponsors of previous investment vehicles who raise the funds equity capital through private placement of equity interests with sophisticated institutional, corporate and other qualified investors. Funds are typically managed by an affiliate of the sponsor(s) with a proven track record in direct equity investments, portfolio management and relevant regional or sectoral experience. The fund manager is expected to add value to the portfolio investments by providing management expertise, improved marketing and access to international manufacturing technologies, and to implement a coherent strategy for the eventual liquidation of investments. The fund manager typically becomes a voting member of the board of directors or other governing body of any company in which a fund invests. 85

91 OPIC Investment Funds in Africa OPIC recently provided US$ 250 million in financing for establishment of two private equity investment funds designed to support the growth of businesses in sub-saharan Africa. Establishment of the funds fulfils an important objective of the Africa Growth and Opportunity Act. It has been reported that up to US$ 100 million of support would go to the establishment of the first fund, a fund managed out of Washington D.C., and targeting investments in infrastructure and related industries in Africa, including telecommunications, oil and gas, power, transport and agribusiness. The fund could also invest in the media, financial services and manufacturing sectors. It has also been reported that OPIC would provide up to US$ 150 million towards establishment of another fund, to be managed from South Africa. The fund s aim is to promote the expansion of mediumsize enterprises in sub-saharan Africa, with emphasis on South Africa and on the manufacturing and services sectors. It is also intended to support South Africa s efforts at encouraging black economic empowerment, and promote opportunities for women and low-income individuals through an arrangement with an investment firm which supports rural development and women-owned businesses. Set out in Appendix IV is a full list of OPIC s investment funds across Africa. By Region and by Sector: 86

92 OPIC Investment Funds in Asia OPIC has committed up to US $90 million in investment guarantees for the establishment of two private equity investment funds with the aim to support the growth of businesses in Asia. The combined target capitalization of the two funds stands at between US$ 250 million and US$ 300 million. The first fund is to invest in the credits of small and medium-size enterprises (SMEs) in Asia. Through the purchase and restructuring of these credits, and for recapitalization of these businesses, the fund will enable companies to restructure their balance sheets and allow banks to redeploy capital in the form of new loans. The fund's activities are expected to substantially enhance each target country's financial infrastructure. The fund is to focus its investments on South Korea, India, Indonesia, Malaysia, Thailand and the Philippines, with a target capitalization of US$ 100 million. OPIC selected as fund manager a privately-owned firm founded in 2001, with offices in New York, Hong Kong, Seoul and Singapore. The second fund will pursue expansion, management buy-outs/buy-ins and private investments in public equities, privatizations, consolidations and infrastructure investments. The fund will, in particular, seek investments in high-growth sectors such as pharmaceutical products, health care, manufacturing, consumer goods, retail, oil and gas and financial services. The fund s capitalization target is US$ 150 million; it will target investments in Pakistan, Bangladesh, India and Sri Lanka. To manage this fund, OPIC 87

93 selected a UK-based fund management company that focuses on managing capital primarily in Africa and South Asia. 10. Multi-lateral Investment Guarantee Agency (MIGA) As a member of the World Bank Group, MIGA's mission is to promote foreign direct investment flows into developing countries to help support economic growth, reduce poverty and improve people's living standards. Since its inception in 1988, MIGA has issued nearly 900 guarantees worth more than US$ 17.4 billion for projects in 96 developing countries. MIGA acknowledges that concerns about investment environments and perceptions of political risk often inhibit foreign direct investment, with the majority of flows going to just a handful of countries, leaving the world's poorest economies largely ignored. MIGA addresses these concerns by providing three key services: political risk insurance for foreign investments in developing countries, technical assistance to improve investment climates and promote investment opportunities in developing countries, and dispute mediation services to remove possible obstacles to future investment. The political risk insurance that MIGA offers complements the activities of other investment insurers; it works with partners through its coinsurance and reinsurance programs. By so doing, MIGA is able to expand the capacity of the political risk insurance industry to insure investments and to encourage private sector insurers to engage in transactions that they would not have otherwise undertaken. MIGA's technical assistance services also play an integral role in catalyzing foreign direct investment by helping developing countries, particularly governments and other intermediaries involved in promoting investments, to define and implement strategies to promote investment. MIGA develops and deploys tools and technologies to support the dissemination of information on investment opportunities. MIGA offers a suite of online investment information services, which complement country-based capacity-building work. MIGA uses its legal services to eradicate or mitigate possible impediments to investment. The dispute mediation program helps governments and investors to resolve their differences, and ultimately to improve the country s investment climate. 88

94 MIGA's Operational Strategy Focuses on Certain Key Areas: 1. Infrastructure development - given the estimated need for US$ 230 billion a year solely for new investment to cater for the rapidly growing urban centers and underserved rural populations in developing countries. 2. Frontier markets - high-risk and/or low-income countries and markets represent both a challenge and an opportunity for MIGA. Whereas these markets typically have the most need and stand to benefit the most from foreign investment, they are however not well served by the private market. 3. Conflict-affected countries - these countries tend to attract considerable donor goodwill once conflict ends, but aid flows eventually start to dwindle, making private investment for reconstruction and growth, critical. With many investors wary of potential risks, political risk insurance becomes essential to moving investments forward. 4. South-South investments - investments between developing countries contribute a growing proportion of foreign direct investment flows. However, the private insurance market in these countries is not always sufficiently developed, and national export credit agencies often lack the ability and capacity to offer political risk insurance. 89

95 Appendix IV: List of African Funds Assisted by OPIC Fund Name Fund size countries or region Status Primary investment focus *Africa Catalyst Fund US$300 million Fundraising Pan-Africa Investing in a portfolio of mezzanine finance, public and private equity, public debt, convertible bonds and private loans to provide growth capital to small- and mid-size enterprises in Africa *Africa Healthcare Fund Africa Telecommuni cations Media and Technology Fund *AfricInvest Fund II US$100 million Sub-Saharan Africa US$100 million East Africa US$175 million North Africa and Sub- Saharan Africa Fundraising Fundraising Fundraising Loans, equity or hybrid investments in smalland mid-sized private healthcare delivery businesses in Sub-Saharan Africa Equity investments in East African technology, media and telecommunications companies Equity investments in small- and mid-sized enterprises focusing on various industries including manufacturing, information technology, education, healthcare, tourism and transport and distribution *Atlantic Coast Regional Fund US$150 million West and Central Africa Fundraising Investments in growth equity companies in West and Central Africa, with a core focus in Angola, Cameroon, Côte d Ivoire, Democratic Republic of Congo, Gabon, Ghana, Nigeria and Senegal *Capital Alliance Property Investment Company US$200 million West Africa Fundraising Multi-product real estate fund investing in residential, commercial, retail, mixed-use and hospitality development projects and companies ECP Africa Fund II, PCC US$523 million Sub-Saharan Africa Investing Equity investments in industries including telecommunications, oil and gas, power, transport, agribusiness, media, financial services and manufacturing Ethos Fund V GEF/Africa Growth Fund US$750 million South Africa and other countries in sub-saharan Africa US$150 million Pan-Africa Investing Fundraising Equity investments in various industry including manufacturing, consumer products and services companies Fund targeting the consumer goods and services sector, including companies engaged in logistics support, distribution and transportation, light manufacturing and agroprocessing 90

96 Helios Sub- Saharan Africa Fund US$300 million Pan-Africa Investing Equity investments in various industries, including financial services, telecom, manufacturing, infrastructure and other service industries. InfraCo Sub- Sahara Infrastructur e Fund *Millennium Global Africa Opportunities Fund US$300 million Pan-Africa US$300 million Anglophone East Africa and Francophone West Africa Fundraising Fundraising Fund targeting greenfield development opportunities within the infrastructure sector, including: power, water, sewage, and transport Investing in a wide range of public and private, debt and equity strategies in Africa, focusing on the natural resources, telecom, energy, infrastructure, financial and manufacturing sectors South Africa Work Force Housing Fund ZAR1,120 million (US$240 million equivalent) South Africa Fundraising / Investing Equity investments in individual housing development and in companies that contribute to the development and affordability of residential housing at any point along the value chain, including development and housing finance companies, mortgage banking companies and secondary mortgage market makers *Standard Africa Development Fund US$300 million Pan-Africa Fundraising Invest in a wide range of public and private debt instruments in Africa 91

97 New Partnerships in Regional (Private) Equity Market Mr. Stephen Bishop Senior Vice President, Treasury, Dubai Ports World (DPW) Excellency, Distinguished Guests, It is very kind of you to invite me here to talk to you today. I am very happy to be working in particular with IDB and also with all your member countries. We already partner with nine members of your august group, which represent 45 per cent of your capital, and we hope that our good relationship will continue, with all of you making progress. DP World is the fourth largest terminal operator in the world. We run 43 terminals in 23 countries, and last year we moved just over 48 million TEUs, or twenty foot equivalent container units. That is more than 100,000 containers a day, which put end-on-end will would circle the world six times. We employ 30,000 staff around the world. Given our development plans today, we will have doubled our capacity by DP World is a member of the Dubai World group of companies, which has invested in a lot of different activities. Specifically, however, what this means for us is that we are able to partner with other group companies, notably Jebel Ali Free Zone or Jafza. They invest in logistics and business parks around the world. Other associated enterprises such as DC World or Dubai Customs also offer their expertise on customs systems and related services that support customers and countries alike. The port industry is a very good industry to belong to. Just to give you a little bit of background: historically, the port industry growth accounts for 3 to 4 times the GDP of countries all over the world. I am sure the commercial people in your organization and countries will know that ports are generally enablers for the trade that goes on in your countries. Containerization, introduced first in 1956, has since grown tremendously. While quite a large portion of world trade today is containerized, still considerable containerization is yet to occur, particularly in the developing countries. Let me give you just a small example. Jebel Ali port moved just over 10 million TEUs last year in its own right, i.e. twice the number of containers handled in the whole of India. So, there is an awful lot of growth to come in developing countries as well as in countries with higher developed curve. 93

98 The move to containerize products can happen quite dramatically. Our CEO gives a very good example of timber which was traditionally very much a bulk product, but now has a high value. In the past, losses or damage of around 10 per cent were acceptable. Not any more. When a commodity becomes more valuable, transportation by container gives you more security. Consequently, containerization of a product previously moved as a bulk product is becoming increasingly attractive. I spoke about the growth of the container industry. In 1956, Americans put the first box on a ship which was sailing around the US coast. It took 36 years, that is up to 1982, for the first 100 million containers to be moved around the world; it took just another 7 years for the next 100 million; and then only another 5 years for the next 200 million containers. So you can see that the exponential growth of this particular industry has been phenomenal and this trend has continued. Industry experts suggest that by about 2015, volumes will double again. World growth is the product of countries such as yours countries that want to trade and are therefore providing us with the ability to move boxes to your port. We expect the majority of trade to come from South and East Asia. Europe obviously is a traditional area. Its growth rate is more stable and much more based on lingering stable growth, whereas the tight economies of the Asian and Pacific region mean that trade will grow much more quickly. Just a remark about the capacity side of our business: a port is essentially full when you talk about 85 per cent capacity utilization of the port. You can see from the slide at the right here, that quite a number of locations around the world are close to capacity, and it is interesting to note that the world added another 50 million TEUs, approximately, of additional volumes in So, there is an incredible shortage of capacity across the world. The capacity shortage comes from developing areas; and so, we are very keen to invest in these countries where capacity shortage means that we shall be able to partner with local port operators or port owners to be able to develop the ports in their part of the world. The particular development of DP World has come about through the vision of one man - H.E Sultan Ahmed Bin Sulayem. He started expanding the business back in 1997 through Dubai Ports International known as DPI, which is where the business I now work for really started, with just a few ports outside the Middle East base. Two major acquisitions occurred with CSX in 2005 and P&O in We extended our reach to 43 countries as 94

99 shown by this particular slide. Our future commitment is to have 11 expansion projects and 13 development projects around the world, thereby extending our reach even further. So, this is a very dynamic industry and is very exciting to work for. The previous speaker talked about Africa and the opportunities available in that continent. Africa is seen very much as a potential growth area alongside South America, but Africa in particular is for us a region of strong focus. This is where the Dubai World model comes to the fore. DP World has invested in terminals in Senegal, Egypt and in other North African countries; and our sister companies such as Dubai World Africa, Istithmar World and Jafza also invest alongside us. As I mentioned, Jebel Ali is our biggest port. It is the one port where it all started. As you can see, in 1977, the port was basically nothing more and nothing less than The Creek, a miniature of a port sitting next to one of His Highness s palaces. The Ruler then said ok, build the ports and they will come; and that long-term approach is what has been adopted on numerous occasions. The bottom right corner shows a satellite picture of our Jebel Ali port as at last year. So, in 30 years, we have moved from nothing to the seventh largest port in the world, the largest between Rotterdam and Singapore. You can see how Dubai has put together a master plan for the development of these activities; and this is what we try to replicate around the world. Here are the port and the free zone, a 46-square kilometer piece of land with over 6,000 companies, accounting for 30 per cent of Dubai s GDP. The two structures are bound by a symbiotic relationship. The development of the Dubai logistics park next door will double the size of the free zone and upscale business activity flow to the port. There are just three things I would like to bring to your attention regarding the development and use of private equity, by which I mean private sector equity, and where we as a company are investing: we invest in operational expertise, we invest in capital and we invest in people. 95

100 On the operational front, we were the first to use cranes that pick up four boxes at a go - a major innovation and one that obviously improves our productivity quite tremendously. We pride ourselves at the fact that we are able to improve productivity quite quickly in the ports we move into, implementing efficient practices and systems. On the capital front, we embraced the idea of using Shariahcompliant products, and we have used these three examples here over the past year and a half or two years. We try to use a range of products. The one we like the most, of which I am sure you may be aware, are the mudarabah structures because, obviously, it gives us much more flexibility to use Islamic finance in the most efficient manner for both our investors and ourselves. We do not use musharakah products or estate products which are much more geared to assets security. Finally, we invest in people, irrespective of where they come from. We have huge demand for talented people throughout the world. This business is growing fast and we need to be able to attract the best; we need to attract people from around the world. We do that partly through internal promotions and training, which means that we use the best of our resources. We have a graduate trainee program which caters for 30 graduates from GCC countries alone, moving them around the world to give them a good chance of becoming our next leaders. Our latest initiative is called the gold program, whereby we take 40 to 50 top talents and give them intensive training to enable them become future leaders. So, in summary, we would like to bring to the table our expertise, our balance sheet strength and, above all, we would like to bring our ability to operate efficiently and effectively for the benefit of both you and us as partners forging ahead together. Thank you. 96

101 New Partnerships in Regional (Private) Equity Market Engr. Sobhi A. Batterjee Shares His experiences and thoughts on the Healthcare Industry The Batterjee family was the first to bring medicine to Saudi Arabia in early 1040s. The driving spirit at the time was the belief in the following verse from The Holy Quran الماي ده ومن احياها فكا نما احيا الناس جميعا 32 (And if anyone saved a life, it would be as if he saved the life of all mankind. Al- Maidah (32). This belief is deeply rooted even now and continues to be the guiding philosophy for the Group. The SGH Group started in 1988 with a capital of US$ 15 million. The Group has now grown to a US$ 1.5 billion institution and Number 1 healthcare brand in GCC, Pan-Arab and Levant regions. The SGH Group has now five world class tertiary care hospitals in KSA and Yemen, with over 1,600 beds, treating over one million patients annually and performing over 100,000 operations. Twelve hospital projects in Dubai (UAE); Cairo (Egypt); Hail (KSA); Addis Ababa (Ethiopia); Khartoum (The Sudan); Kashmir (Pakistan); Syria, Morocco, Nigeria, Chad. etc are in various stages of construction and planning. The Group is developing Not-for-Profit Hospitals for the poor in association with Prof. Mohammad Yunus (2006 Nobel Peace Prize Laureate)/Grameen Bank, IDB (Islamic Development Bank), GE and CCC. The Group has started the largest private Medical University of the MENA region in strategic partnership with Tubingen University of Germany. The Group has a network of SGNAs (Saudi-German Nursing and Allied Sciences Training Institutes) across Saudi Arabia. The SGH Group has also established many Not-for-Profit institutions like Charity Blood Bank, Saudi Entrepreneurship Development Institute (SEDI), Health Management Research and Training Institute (HMRTI) and Family Business Academy (FBA). The corporate vision of the Group is to design, finance, construct and operate 30 world class hospitals, create 50,000 jobs by the year 2015, and become the dominant regional player in private medical education by establishing 5 medical colleges by the year The SGH Group/Engr.Batterjee have received many prestigious awards for their contribution to the healthcare industry. The awards include: 97

102 Mohammad Bin Rashid Al Maktoum Award for Arab Management in the Best Arab Management Personality category (2006); National Medal of Cedar-Grade Knight, by the President of Lebanon (2007); Best Client of the Year from ICD-IDB (Islamic Development Bank) ; Saudi Achievement Award for Corporate Social Responsibility (CSR) by Arabian Business (2007); Healthcare Industry CEO Award, by the Middle East Excellence Awards Institute presented by Hon. Dominique de Villepin, Former Prime Minister of France (2008); SGH Group is among the 50 most admired companies of the GCC in a survey conducted by the Arabian Business in 2007, the one and only Healthcare Company on the list; Millennium Development Goals Award by MDG-UN and The Arab- African Initiatives, in Cairo (2007); Al-Eqtisadiah of Arab News Group published a list of top 100 Saudi companies in 2007 and the SGH Group was in the 66 th place on the list; E&Y Middle East Entrepreneurs of the Year finalist (2007); Specialist Achievement Award for Hospital Development in Middle East organized by ECRI, USA and Arab Health (2004); Arab Health Education/Training Award 2008 (for initiating an excellent evidence-based medicine project); The SGH ranked as No.1 Healthcare Brand in Pan-Arab, GCC and Levant regions in a survey conducted by PARC for Gulf Marketing Review (2005). Future of Healthcare and its Financing A recent study by McKinsey indicates that by 2025, healthcare in GCC will increase by 240 per cent, and healthcare provision will stand at about US$ 60 billion. Healthcare Infrastructural Levels (Should Improve In Arab World) # Per 1,000 Population US Germany GCC Average Source: McKinsey & Company # of Physician # of Beds # of Hospitals

103 From the above scenario, it is clear that private hospitals have to take the initiative to provide medical services and bridge the qualitative and quantitative gap in the healthcare services in the Arab World and more so in other Islamic nations. The SGH Group is benefiting from tremendous interest and support from governments, financial institutions, corporate bodies and individual investors, and they participate in the Group s ongoing projects across the MENA region. Initially, the bankers were rather reluctant to participate in healthcare, but the scientific approaches to this industry have changed their views. Some of the strategic partners of the Group are as follows: The Group s Strategic Partners Islamic Development Bank (IDB); Islamic Corporation for the Development of the Private Sector (ICD); Saudi Fund for Development (SFD); The International Finance Corporation (IFC) - member of the World Bank; The Arab Fund for Economic and Social Development (AFESD); The Yemenia (national air carrier of Yemen); Retirement Fund of the Ministry of Interior, Government of Yemen; General Corporation for Social Security, Government of Yemen; Global Investment House, Kuwait; Olympic Group, Egypt; and Islamic Finance Company, UAE. The SGH Group believes that, apart from its importance from the social perspective, the healthcare industry offers the infrastructure required for other industries to trigger economic growth; and so, it is the wish of the SGH that all nations of the Islamic world should be given priority in terms of quality healthcare facilities. The SGH Group is trying to secure maximum project finance from financial institutions as well as local governments long-term support to establish more hospitals in as many Islamic nations as possible. The success and significance of the Public-Private Partnership (PPP) have already been proven worldwide and the Group believes that this partnership constitutes the best formula for development in all sectors in Islamic countries. The SGH Group is working towards PPP (Public-Private Partnerships) models in healthcare and has successfully established two hospitals, one at Sana a-yemen (300-beds) and the other at Hail-KSA (150 beds). The Group 99

104 plans to build more hospitals based on this model in nations like The Sudan, Bangladesh, Chad, Pakistan, Mauritius and others. Private Sector Role The SGH Group is being approached by various development agencies and international funds which intend to establish hospitals in poor countries. However, some of these institutions have continued to pursue the policy of channeling the financing for projects directly to governments. They fail to understand or appreciate that, if they were to channel such credit to the private sector, they would not only achieve their social objective for the project, but also actually achieve such objective much faster and in sustainable manner. This is because the private sector would invariably repay the loan which could be used to fund more projects, whereas the experience of funding government projects has, in most cases, been unsatisfactory. Financial institutions should also pay more attention to promoting Export of Services including Healthcare Services which has significant impact on economic growth and development. Transfer of knowledge Many organizations in Islamic countries have excelled in their respective areas of competence, perfected business models and systems, operate methodologies with regional significance and emerged as strong brands. Through innovative approaches and hard work, they have created robust internal competencies that are sustainable and better suited to meet regional requirements. They have already proved their capabilities which are truly world-class. These Centers of Excellence deserve to be showcased to the Islamic world. The SGH Group believes that development agencies like the Islamic Development Bank, the World Bank, the African Development Bank and the Asian Development Bank can play a crucial role in promoting such Centers of Excellence at regional level and in other Islamic nations, thus enabling these organizations to actualize their true global potential and, at the same time, achieve regional development. In the Islamic world, a number of organizations have demonstrated such global potential in every area of industry like healthcare, services, construction, IT, manufacturing, retail, pharmaceuticals, education, etc. Islamic countries have an abundance of leadership capabilities, technical competence, funds, increasing market demand, etc., and only need to build the right structures and frameworks for them to bloom. A number of working 100

105 models could be instituted in selected areas, and then can be replicated to cover all industry disciplines across Islamic countries. The SGH Group appreciates the developmental role that IDB is playing by providing assistance/soft loans to the less privileged member countries. Currently, we are seeing a growing private sector role in economic development in the Islamic world. In the future, we see the IDB going to less privileged member countries with many Centers of Excellence identified in all Islamic countries and in various industries. Some of the Strengths of the SGH Group Strong leadership with defined Mission, Vision and Targets; Transition from family business to public company; Corporate governance; Scientific management; Medical facilities all world class; Professional staff and multinational work force; Advanced IT systems (HIS, ERP, Balanced Score Card, HR Portal, CARE (Audit & Risk Management System); Wide network of hospitals, regional brand name and positioning; Quality-oriented services, ISO accredited, JCI accreditation in progress; German visiting professors and programs; Specialized hospital construction division. SGH Group Strategies Operational Strategies Focus on patient needs and expectations; Employ and train committed and competent staff; Bring in international expertise; Use state-of-the-art technology; Apply dynamic and professional management techniques; Network of hospitals to leverage operational efficiency, patient convenience, client convenience and enhanced clinical quality assurance; Adapt and adopt the best industry practices and maximize IT applications. 101

106 Corporate Strategies Position the Group as the dominant player in the areas of healthcare and health education; Equity participation of strategic partners; Introduce corporate governance best practices; Consolidate and establish itself as the largest Healthcare Joint-Stock Company outside the USA. Medical Education The single major bottleneck in healthcare growth is the unavailability of healthcare professionals. For example, there is serious shortage of doctors and other medical professionals in countries like KSA where less than 17 per cent of the doctors are Saudi nationals. A solution to this problem is made more difficult because any educational institution established to train doctors and other healthcare professionals should be attached to a quality teaching hospital. Healthcare education has two segments. The first is a degree program for doctors. It is absolutely necessary for a country to have sufficient numbers of physicians in proportion to its population. A study carried out by KPMG revealed that Saudi students even exit to countries like Syria for their medical education. Graduates trained in many of the regional countries do not meet the quality standards that Saudi Arabia would like to maintain. There is acute shortage of capacity in the field of medical education in our region. Saudi Arabia has only 1.5 doctors per 1,000 persons, whereas in Germany the ratio is 3.6. The other segment of medical education is a diploma program for paramedics and graduates of allied health science disciplines like nurses and laboratory technologists, and graduates in radiology, anesthesia, medical records and others. Programs in these disciplines are necessary to ensure sufficient number of support personnel for healthcare. The programs offer excellent employability and career opportunities for young Saudis. A strong healthcare education base is necessary for creating a sustainable healthcare industry in Saudi Arabia comparable to international benchmarks. I believe that the best, and probably the only, way to address the current challenges in healthcare education, is through the public-private partnership model. 102

107 The SGH Group has established its first medical college in Jeddah. It is the largest private medical college in the Middle East and the Arab world with capacity for over 4,000 students. The SGH has, since the past four years, also been operating a network of Saudi-German Nursing and Allied Healthcare institutes. It has done extensive work with the University of Tubingen, Germany, on medical college systems and curricula using the Problem-Based Learning methodology, internationally recognized as the most effective. The SGH will be able to leverage such extensive experience and its German networks to create more healthcare education models alongside other public and private sector investors in many Islamic Nations, inshaallah. Healthcare is the largest employment-generating sector world-wide, and the trends in healthcare development in the Middle East are highly encouraging. We should take advantage of this opportunity and create the necessary infrastructure, and thus benefit from the current trends. Medical education projects are therefore of very high social significance, and will offer guaranteed employability and career development for thousands of Arabs and Muslims. We are confident that our medical education ventures in Arab and Islamic nations will receive support from other financial and development institutions. Many Private Equity Funds and serious investors from the GCC countries have expressed interest in our healthcare education initiatives aimed at building medical colleges and institutes of allied medical sciences. Doing Business with the Poor (Social Business) The SGH Group believes that we can successfully integrate seemingly contradictory concepts through innovative approaches. Doing business with the poor can combine social good and financial viability. The SGH Group s concept of doing business with the poor rests on three solid pillars: 1. Philosophical; 2. Social; and 3. Business. The philosophical pillar is the guiding philosophy as explained above. The SGH believes that quality healthcare is not a luxury nor a privilege reserved for the few who can afford it; rather, it is the right of every human being. A person should not be denied access to quality healthcare just because he/she is economically underprivileged. The SGH Group has taken that responsibility upon itself and will do its utmost to achieve this goal. 103

108 The social pillar is informed by the fact that the world, unfortunately, has more than 4 billion people living below the poverty line. Two billion of these people, who reside in Africa alone, earn less than 2 dollars a day. Business houses normally target the rich in marketing their products and services. Institutional humanitarian initiatives like contributions and donations have been ineffective. For example, General Electric had donated CT scanners to hospitals in Africa, and diesel generators to certain institutions and others. Experience in this regard showed that, after some time, these equipment broke down due to poor maintenance and improper use; besides, other support systems required to optimize the use of these assets were not in existence, with the result that within a short space of time, these wellmeaning contributions were simply wasted with no tangible benefit to the poor. Charity only addresses isolated, short-lived relief and does not offer a sustainable model. It is always better to teach people how to fish and afford them the tools to fend for themselves, rather than give them fish each time. Offering charity to the poor is not only ineffective in the long run; it also undermines the very self-respect of the poor. The Grameen Bank of Bangladesh, led by the Nobel Prize winner Prof. Mohammed Yunus had successfully cracked the success formula here. Grameen Bank gives small credits to the poor with absolutely no guarantees or collaterals, to make them financially independent. Their recovery rate is an incredible 99.6 per cent, which is much better than the recovery rate from credits given by commercial banks. This is because the poor have self esteem, appreciate the Grameen Bank s initiative in helping them to have a permanent livelihood, and would not renege on the moral responsibility to repay the debt that would perpetuate this noble cause and help many other poor people in need. The poor reciprocates the good will and trust that the Grameen Bank had shown and would not let this initiative fail. This is not the case with charity. The poor does not need sympathy; they rather need recognition that they are also self-respecting individuals who can contribute to the economy and the society, but only need timely help and support. General Electric used to spend US$ 30 million on charity every year. Recognizing the ineffectiveness and lack of sustainability of charity contributions, GE and the SGH Group signed an MoU to work together in promoting 10 not-for-profit hospitals in Africa. Creating sustainable platforms to provide services on a sustainable basis to the poor is definitely a better and more effective way of helping the poor. 104

109 The business pillar of doing business with the poor is underpinned by the fact that a large number of people are not targeted by organized companies. This is a totally ignored market segment which, by itself, can open up huge business opportunities. All that is required is to develop an innovative business model and pursue same with commitment and drive. Organizations and business leaders need to think laterally and come up with innovative models, whereby the entire chain of facility design and set up, production, packaging, marketing, sales, distribution, etc would have to be reengineered very differently from the conventional practices. Economic objectives and social good are not mutually exclusive, and can be achieved simultaneously. Our society has no shortage of people and institutions with good intentions. If there is transparent and efficient structure and platform, they will participate. We know of doctors, nurses and other medical personnel working for free for part of the day to help the poor and needy. There are suppliers willing to provide consumables at reduced price and cost, and even make some free contributions. We only need to create a vehicle that is effective, ensuring that the well-meaning contributions are not drained or diluted without resulting in the social good that was the primary goal. Healthcare is about life and quality of life; it is closer to the heart for all people than other services like banking. A not-for-profit hospital can offer services at low cost. The cost itself will be much less compared to that of a fully commercial establishment, and that too can be paid in installments with no third party guarantee or securities in cases of medical need and the person concerned is not in a position to raise sufficient cash even at the subsidized rate. The situation today is that almost everything from a car, television to house, etc. can be purchased and paid for in installments. However, if a person has a problem with his heart, there is no such option to obtain services and pay in convenient terms. Governments are also supportive of such initiatives backed by credible corporate entities, and usually provide free land for the facility, as well as tax exemptions, subsidized utilities, etc. The SGH Group believes that many organizations would definitely consider active participation in such an initiative by providing their services for the healthcare not-for-profit projects free of charge and, in some cases, at a cost where third parties are involved. Initiatives of this kind by any corporate house would also have positive impact on core company operations and its brand equity. Society would perceive the company as engaged in projects that contribute to social good as a good corporate citizen and a humane organization, with immense benefit to its brand equity. 105

110 The SGH Group is currently in the final stages of developing many Not-for- Profit Hospitals for the poor in association with many like-minded institutions. It has, in this regard, signed an MoU with Prof. Mohammad Yunus (Nobel Peace Prize Winner in 2006) of Grameen Bank, IDB, GE and CCC. To promote strong and lasting social integration, organizations need to make such contributions to the society at large, rather than focusing on a narrow consumer base. At the end of the day, the effectiveness of the business would be judged from the perspective of what difference it has made to the society. A strong and sustainable difference in society cannot be achieved if the vast social segment comprising the poor population is ignored. Like-minded organizations and individuals need to join hands and unleash their synergy to make this happen. 106

111 New Partnerships in Regional (Private) Equity Market Mr. Jean Paul Gillet General Manager BRVM, Stock Exchange, Côte d Ivoire I am going to speak in French. I apologize to the English-speaking audience. I believe however that there are some partners and participants who have enjoyed listening to a little bit of French. First, I thank you all especially the organizers and the IDB for inviting me to this very important seminar, to this very important meeting, the presentations of which have been quite interesting. I hope you will find my presentation also interesting. This morning, some speakers talked about entrepreneurship and investment. As for me, I am going to talk about one of the mechanisms that help to link the investor to the entrepreneur. Such mechanisms are less advanced in Sub- Saharan Africa, and it is important, in my view, to popularize the mechanisms and show that developed financial markets, capital markets and stock exchanges also exist in the Sub-Saharan region. The regional stock exchange is a relatively recent development and is specially organized given the fact that most financial markets are national. However, in this case, we have a regional financial market that brings together many countries. So, I will first of all explain to you the way it is organized, which is very unique, and then we will see how it conducts business. The regional financial market is based on the UEMOA organization (the West African Economic and Monetary Union), a union that brings together 8 Sub-Saharan African countries, namely: Benin, Burkina Faso, Côte d Ivoire, Mali, Niger, Guinea Bissau, Senegal and Togo. In fact, some of these countries were mentioned this morning and, as a proof, the previous speaker recalled the recent agreement concluded between the Port of Senegal and Dubai Port to develop the port and business in Senegal, Dakar port in particular. UEMOA is a geographical region of 80 million inhabitants with high population growth rate and a fast and ever-growing GDP that stands at an annual average 3.9 per cent. I will not dwell on the missions of the stock exchange and its classical role, which is obviously to build savings and contribute to growth and development. 107

112 It is important to note that our organization s operation is based on the most modern practices i.e. separation of the supervisory authorities and the market players. It is important to know, when it comes to investing in a given region, how the financial market is organized. It is a public entity while all other key entities such as stock exchanges, depositors and stock exchange firms are private players that can have ties with other major investors, partners and international stock exchange firms. Advantages of a Stock Exchange The regional stock exchange is a private entity represented by 7 branches, i.e. representation per country, and comprising 20 stock exchange firms that help investors to buy stocks - 3 in Senegal, 4 in Benin, 9 in Côte d Ivoire, 1 in Mali and 1 in Niger. So, each country has a representative who helps investors to access the stock exchange and to invest and work in listed companies. To be listed on the stock exchange, a firm should be of limited liability, should command a modicum of respect, comply with the requirements, have two years at least to be in the second compartment or five years if it wants to be in the first compartment, have stock exchange capitalization of a minimum of 200 to 500 million CFA francs and - this is most important - disseminate 20 per cent of its capital to the public. We have noticed that, so far, and for almost 10 years since the stock exchange started business, only a few new firms have come forward to register for listing. This is one of the major problems facing our financial market which is hardly known by investors and entrepreneurs. It is not part of corporate culture for entrepreneurs to lay their capital bare; nor is it the practice of governments, which are, in general, at the helm of the economies of the region, to facilitate access to the financial market for their firms. Unfortunately, privatization is ongoing; the public sector is pulling out of public affairs but firms have not come over to get listed on the stock exchange. This is a developmental factor that helps a large number of investors to invest in such firms. To break the ice, we have set up a prelisting mechanism designed to help firms to gear up for listing for a period of two years, with the assistance of a listing sponsor through a management and intermediation firm. Such a firm will undertake to do its best to help officially list enterprises within a maximum period of two years. We believe that such a mechanism, which is less costly and easy to access, would help remove psychological barriers, thus enabling new firms to come forward for listing. 108

113 You can invest in the regional exchange regardless of the part of the world you come from, because all investments are possible and without restriction at entry and exit. There are no value added taxes and it is fully modern because it is quite recent; it was established 10 years ago with an electronic notebook. Deals are struck with cash and fixed by comparing purchase and sale orders; the deals are not arranged by mutual consent; they are concluded with daily variation limits of more or less 7.5 per cent; and shares are determined daily at AT +3 in accordance with international standards. We have a system of monitoring and I patiently waited for the ADRs and GDRs since we are holding securities. Indeed certificates are held by a key depositor, who helps to ensure the full flow and settlement of securities, manage a stock exchange operations guarantee fund and obviously with the duty to ensure transparency and dissemination of information, which listed firms are required to do. From statistical standpoint, a major increase in stocks has been noted over the past 4 months, i.e. over 100 billion CFA francs. Since the beginning of the year, we increased capitalization by 18 per cent. Last year i.e. 2007, the increase was 75 per cent. A total of 38 listed firms are represented. This is how our capitalization increased since the start of the stock exchange in Another leading stock we have listed with Ecobank Transnational is SONATEL, a national telephone company of Senegal. We also have a number of agri-foodstuffs stocks which were recently traded internationally. Some Asian players had shown interest and bought equities in palm oil producing companies. You can see that our index and capitalization have increased over the past two years. The involvement of international players in our market is the main cause for the take-off and vibrancy of our stock exchange over the past few years. The purpose of this seminar is to highlight the scale of investments among UEMOA countries and thus stimulate financial markets development and increase corporate returns and investments. The breakdown of the capitalization is currently as follows: The Number 1 major bloc is represented by Senegal with the SONATEL stock; The Number 2 major bloc is represented by Togo with a major stock, i.e. Ecobank Transnational, which exists in a good number of African countries; 109

114 The third major bloc has something to do with history because it was recovered from the Abidjan stock exchange together with 34 Ivorian stocks. As I indicated earlier, the number of listed firms has hardly increased in the past 10 years. Yes, there have been some problems in the region, especially the socio-political upheaval in Côte d Ivoire. Well, this is being ironed out. We are hopeful that, in the next 3 to 5 years and beyond, many new firms would emerge. In Côte d Ivoire, I can mention Côte d Ivoire Telecom; in Burkina Faso, Onatel which is somehow equivalent to SONATEL of Senegal, and other firms, which should remain confidential for the time being when it comes to advertisement. However, they are on the waiting list of firms expected to join the stock exchange. We invite investors of the sub-region to closely monitor, in the coming months, the events that would unfold at the West African regional stock exchange and to liaise with various economic operators to take advantage of the opportunities generated by the development of such a market. Such a general index is not the making of one or two stocks weighing in on all other stocks, but rather the making of all the stocks including our 38 stocks. About 30 out of the 38 stocks have appreciated. Their results are improving, development potentials are huge and investors have started exploring the market, and thus showing interest in the stocks. There is also an indicator that is very important for a financial market, i.e. the increase in trade volume. One can see that this trade volume increase has translated into an increase in indices because in 2002/03, the indices were at an all-time low. Since 2005 however, the indices have risen and the level of transactions has significantly gone up. The difference between 2007 and the beginning of this year is a clear indicator. In 2007, we recorded 88 billion CFA francs worth of trade; by late April 2008, we recorded over 60 billion CFA francs, meaning that we realized over 100 per cent increase, which is significant, and the figures keep mounting. To ensure that the transactions are sound, the regional stock exchange has a Central Trustee which serves as guarantor when it comes to transactions. There are 86 items (see illustration below) that are in the custody of the Central Trustee, i.e. over 122 billion CFA francs reserved for economic operators after various distribution. I thank the IDB. 110

115 Major Regional Equity Indexes Research Report Mr. Rushdi A. Siddiqui, Global Director, Dow Jones Islamic Market lndexes, USA How can emerging capital markets become less volatile and behave more like the developed capital markets? The objective of any capital market is to create an atmosphere of stability resulting in confidence that induces listings (both investment products and corporate securities) and in the ensuing liquidity. The transformation from emerging to established capital market does not happen overnight, partly because of the events or conditions outside the control of capital-market proponents, and partly because the events and conditions within their control take time and persistent effort to achieve. The events and conditions beyond market players control include, but are not limited to, the following: geopolitical uncertainties in the Gulf Cooperation Council (GCC) countries and in the Middle East (which would include issues relating to Palestine/Israel, Iraq, Iran, Syria and Lebanon)- and internal strife arising from religious differences and tribal rivalries; capital flight, which is a direct result of the geopolitical uncertainties; and dominance of family-owned companies, which account for the bulk of each country's GDP but are not listed on the exchanges and, thus, are not part of the "opportunity set" into which investment capital flows. The event and conditions within market players' control include, but are not limited to, the following: improved regulations on periodic disclosure of audited financial statements (with penalty provisions), prohibition of insider trading, and a taxing regime that rewards long-term investors with lower rates on capital gains and "punishes" short-term traders with higher rates; greater emphasis on investor education on the benefits of diversification and the fundamentals of asset allocation, the creation of low cost index funds; and an index construction that reduces the volatility bandwidth. This chapter will focus on (1) defining an index, (2) a sample of indexes and their construction, (3) the impact of an index on the markets, (4) the benefits to a company in terms of its inclusion in an index, (5) the investment products that can be created with an index, (6) index construction as it relates to emerging markets (including a case study of DJ DIFC Arabia Titans 50), and (7) the role of an independent index provider in relation to the role of a stock exchange as an index provider. This chapter 111

116 aims to provide an overview of how indexes and the creation of indexes not only reflect the maturation of capitals markets by enhancing disclosure, transparency and accountability, but also help capital markets to evolve into stable investment environments by providing a benchmark for investments. What is an Index? In today's environment in which an abundance of various asset classes are rapidly broadening index offerings, indexes as investment benchmarks have taken on new characteristics: Stock market index - It is the most basic index which consists of a number of publicly traded stocks, the composite market values of which are measured over time and expressed as an index value. This index can also be used to represent the characteristics of its component stocks all of which bear some commonality such as: trading on the same stock market exchange, belonging to the same industry or having similar market capitalizations. A composite stock market index, acting as a proxy for the aggregate price changes of all of the stocks that comprise it, can be used to track both the direction of prices and the volatility of those prices. Stock market indexes are often updated frequently throughout each trading day so that trends in market price movements can be seen, thereby enabling trading decisions (i.e., buy, sell or hold at any particular time) to be made. Market index - a market index measures the price movements of a particular group of financial securities or other investment vehicles. Examples of a market index include stock market indexes, and bond and commodity market indexes. Recently, index providers also have begun measuring alternative asset classes, such as hedge funds and currencies. Frequently, indexes are used as performance benchmarks to measure relative performance of particular investments (for example, shares in a company) and investment managers (for example, mutual funds) to enable investors to make informed decisions on where and how to invest. Examples of Indexes and their Construction The main methods used to construct an index are set out below by reference to examples: (a) Dow Jones Industrial Average To provide an overview of the importance of indexes to capital markets, we will consider the Dow Jones Industrial Average (DJIA). The DJIA's most unique feature is that it is a price-weighted index (i.e. a stock's weight is 112

117 determined by share price only). To calculate the DJIA, the sum of the prices of all 30 component stocks is divided by a divisor. The divisor is adjusted in case of stock splits, spin-offs or similar structural changes, to ensure that such events do not in themselves alter the numerical value of the DJIA. When companies are replaced as a result of these corporate events, the individual weightings are adjusted so that the value of the average is not directly affected by the change. The initial divisor was the number of component companies, so that the DJIA was at first a simple arithmetical average; the present divisor, after many adjustments, is less than one. Some critics claim that the DJIA fails to represent the true conditions of the U.S. stock marketplace because higher-priced components have more influence on the index than lower-priced components. While a $1 change in the price of any component stock has the same effect on the DJIA's value, the same percentage move in two stocks of unequal prices will have different impacts on the index. Another criticism is that the DJIA's 30 stocks - which are selected by senior editors of The Wall Street Journal - do not adequately represent the overall U.S. stock market. In addition, because the 30 stocks in the DJIA do not open at precisely the same rime as the start of trading, the DJIA's opening price is determined by the prices of those few components that open at the start of the day and the previous day's closing prices of the remaining components. As a result, some critics claim, the DJIA's opening value is not indicative of the condition of the market at the beginning of the day. (b) Standard and Poor's 500 Index Standard & Poor's 500 Index (S&P 500) is a market capitalization-weighted index, which means that each of its 500 stocks is weighted (or valued) by its market capitalization (all shares outstanding multiplied by the price of one share) as a proportion of the total market capitalization of the index. The S&P 500 measures the change in the collective market value of all the 500 stocks that comprise the index. The index's performance over time is based on price changes and the changes in the number of outstanding shares. To replicate the performance of this (or any other) index, an investor would purchase and hold all the component stocks in the same proportion (called the stock's weight ) in which they are held in the index. Yet, the S&P 500 is not a passive benchmark. Its components are selected by a committee which can delete and add stocks to the index as long as the total number of the stocks stays at 500. Usually, the committee deletes a stock when the company concerned fails to meet certain financial performance measures, and adds a new stock to make up for those that "disappear" in corporate mergers and acquisitions. 113

118 Table 1: Top 10 Weighted Companies of the S&P 500 Company Float Adjusted Market Index Weight Cap ($Million) Exxon Mobil Corp % General Electric % Citigroup % Microsoft Corp % Bank of America Corp % Procter & Gamble Co % Johnson & Johnson % Pfizer, Inc % American Int l Group % Altria Group, Inc % Source: Standard & Poor s. For more information, visit Data as of 12/29/06 Table 2: Top 10 Weighted Companies of the DJIA Company Price (USD) Index Weight International Business Machines Corp % Boeing Co % Altria Group, Inc % 3M Co % Exxon Mobil Corp % American International Group Inc % Johnson & Johnson % Procter & Gamble Co % United Technologies Corp % Caterpillar Inc % Source: Dow Jones Indexes. For more information, djglobal@dowjones.com. Data as of 12/29/06 The above two Tables demonstrate that the methodologies applied by the DJIA and the S&P 500 produce different sets of stocks that have the greatest influence on the respective indexes. Only three companies feature among the top 10 of both the DJIA and the S&P 500. (b) Equal Weighted Indexes Equal weighted indexes are not passive benchmarks as they do not represent a buy and hold strategy. Each stock has an equal weight in the index irrespective of the company's size or share price. When the price of one stock changes, the index is no longer equally weighted. Rebalancing such indexes to equal weighting is usually effected monthly or quarterly. While such periodic rebalancing eliminates concentration in one or more particular component stocks, it increases brokerage costs if one is seeking to buy and 114

119 hold stocks in the same weights as the components of the index, and makes the index's performance difficult to replicate with a low degree of tracking error. As a result, equal weighted indexes are not typically used to benchmark a portfolio manager's performance. An equal-weighted index gives greater weight to smaller stocks (by market capitalization) and stocks with market values that are closer to their book values, which is a company's total assets minus intangible assets (such as patents and goodwill) and liabilities - in short, what are typically referred to as "value stocks." This type of index tends to perform well whereas smaller stocks do better than large capitalization stocks and "value" stocks outperform "growth" stocks. In summary, an equal-weighted equity index seeks to represent an overall market behavior. (d) "Fundamental" Indexes Fundamental indexes are becoming increasingly popular. Investment professionals are seeking ways to avoid the tendency of market-cap indexing of overweight large growth stocks increasingly turning to fundamental indexes. Dow Jones Indexes, Research Affiliates and Wisdom Tree have launched fundamental indexes that have exchange-traded funds based on them, and other index providers are busily researching their own entries to meet demand. In fundamental indexes, stocks are weighted by such fundamental factors as aggregate earnings, sales, book value and dividends. Investment professionals, however, continue to debate just how much of the fundamental indexes' return is due to the exposure to fundamental factors. Some also contend that the expenses, fees, tax and transactional costs incurred in the design and execution of fundamentally weighted portfolios seeking to track fundamental indexes can offset any "excess returns" benefits compared to funds based on cap-weighted indexes. Index Construction as it Relates to Emerging Markets The construction of the Dow Jones DIFC Arabia Titans 50 lndex is an example of how indexes relate to the maturation of emerging markets. In 2004, Dow Jones teamed up with the Dubai International Financial Center (DIFC) to launch the index, which comprised the most liquid stocks from the United Arab Emirates, Kuwait, Qatar, Egypt, Morocco. Jordan, Oman, Lebanon, Tunisia and Bahrain. The index represents established Arab markets that have proven to be accessible to international investors. Indeed, the GCC region is a wealthy emerging market region because of its connection to petrodollars; and with petroleum prices expected to remain above the per barrel production cost of the GCC countries, the wealth will likely continue. 115

120 The benefits of a regional market index such as the Dow Jones DIFC Arabia Titans 50 Index are that it offers investors the opportunity to benefit from such wealth. The components are among the largest stocks in the represented countries and, therefore, tend also to be the most actively traded. As a result, the index can be replicated easily and relatively cost-effectively. Because the components represent a significant portion of the float-adjusted market capitalization of the broader Arab markets, the index tends to closely track the performance of these markets. The components are large and, thus, typically stable, and so the index's component turnover tends to be low. To further reduce turnover, buffers are applied to the cutoff values that determine stocks' inclusion and removal during the review process. In other words, the Dow Jones DIFC Arabia Titans 50 Index is a blue chip index, tracking the stocks of high-quality companies that are considered to be relatively stable investments, in good financial condition and firmly entrenched as leaders in their industries. The criteria to classify a blue chip are relatively subjective, but, generally, include the following: an established track record of stable earning power over several decades; an equally long record of uninterrupted dividend payments to common stock holders; a history of regular increases in the dividends payable to each share; strong balance sheets with moderate debt burden; credit ratings in the bond and commercial paper markets; large size relative to businesses as a whole in terms of revenue and market capitalization; diversified product lines and/or customer base; competitive advantage due to cost efficiencies, franchise value or distribution control. The Dow Jones DIFC Arabia Titans 50 Index may be compared to a composite index - which is a much broader measurement of a particular market (usually that of an entire country). A composite index includes all the stocks in a given market, be it a stock exchange or a market sector - thus encompassing the entire "opportunity set" from which investors choosing to be in this market must select to form their portfolios. These composite indexes thus constitute effective benchmarks for investors, whereas a bluechip index is a subset of the entire market and, therefore, may not be a credible benchmark. However, that does not seem to be the case for the Dow Jones Arabia Titans 50 Index. Since its inception on 31 December 2000, the index has increased by per cent. During the same period, the Dow Jones Wilshire 116

121 Emerging Markets Index rose by per cent and the Dow Jones Emerging Markets Index has gained per cent. The returns are certainly different, but not markedly. The similarity in the degree of return indicates that blue chip Arabian stocks can serve as a measure of overall market performance. However, the most accurate measure remains a broad benchmark or a composite index - given the fact that it also includes the performance of smaller companies. Table 3: Top 20 Companies Weighted in the Dow Jones DIFC Arabia Titans 50 Index Name Country Float Adjust Market Cap (USD) Weight Orascom Telecom Holding Egypt % Maroc Telecom Morocco % Arab Bank PLC Jordan % Emaar Properties UAE % Orascom Construction Industries S.A.E. Egypt % Mobil Telecommunications Co. (MTC) Kuwait % K.S.C National Bank of Kuwait S.A.K Kuwait % Attijariwafa Bank Morocco % Kuwait Finance House K.S.C Kuwait % Telecom Egypt Egypt % Vodafone Egypt Telecommunications Egypt % Co. Ahli United Bank Bahrain % Group ONA Morocco % Egyptian Company for Mobile Services Egypt % (Mobinil) Industries of Qatar Co. Qatar % Agility Kuwait % Banque Marocaine du Commerce Morocco % Extérieur National Industries Co. S.A.K. Kuwait % Housing Bank for Trading & Finance Jordan % Sudan Telecommunications Co. UAE % Source: Dow Jones Indexes. For more information, djglobal@dowjones.com. Data as of 12/29/06 Other reasons as to why the Dow Jones DIFC Arabia Titans 30 Index does not completely measure the wealth of the GCC region include: 1) the fact that the energy sector is not adequately represented in the index because few energy companies located in that region are listed; 2) the fact that the index has a bias for the financial sector (nearly 44 per cent of the index tracks financial firms); and 3) the index does not include Saudi Arabia, one of the largest markets of the GCC region. 117

122 Thus, it is at times difficult for index providers to capture the true pulse of a region. One of the biggest challenges is accessing the data and the corporate actions needed to construct a viable index. The Dow Jones BRIC 50 Index is a blue-chip measure, for instance, that includes 50 of the largest and most actively traded stocks in Brazil, Russia, India and China. The China portion of the index comprises offshore stocks, H-shares and U.S.-listed ADRs/ADSes. The description of the wide array of indexes, their diverse purposes and their construction, impact on their performances. For example, large companies dominate any market-capitalization-weighted index. Therefore, a rise in the share price of such companies results in an increase in the index; and a decline of the share prices of such companies results in a decrease in the index. Equal-weight indexes help minimize this downslide, but have their own vulnerabilities. Capping the weights of very large components can reduce the concentration of an index in a few stocks, but it also increases the weights of the smaller components, the prices of which tend to be more volatile. On the other hand, such an increase in exposure to smaller components might help index performance in the long-term because smaller stocks tend to outperform large stocks in the long-term. However, whatever the methodology, the construction of indexes inevitably increases the amount of information disclosed on a regular basis, and thus offers a measure of transparency to developing markets. Impact of the Index on the Markets Indexes measure markets; but they also affect markets. An index distills the prices of diverse securities in a market to one statistic, revealing the net effect of all factors that are present on that market. Such factors include investor sentiment specific to the companies in an index, as well as broader factors - war, peace, economic expansion and recession - that can influence index component prices. An index is also an indicator of economic expansion or retraction. Additionally, an index can affect investor sentiment. If an index value increases, investors may gain confidence in the health of a particular market and increase their stakes in it. Increase in investments in turn further increases an index and, conversely, a decrease in investments results in a significant or sudden decline in the index. For investment professionals, indexes can be instrumental in risk control and asset allocation. An index helps professionals to compare market levels at various points in time. An index also helps to pinpoint the sources of 118

123 investment return (i.e., growth or value, large or small, sector and country) in a procedure called performance attribution. In other words, an index is a measurement tool: it can be used to compare the performance of a fund/portfolio against a corresponding index, assess a manager's performance and facilitate investor decision-making on hiring and retaining talented and firing under-performing managers. Moreover, because an index provides a basis for investment vehicles, index-based products create more opportunities for investors. Islamic Indexes The first Islamic index created by an index provider was the Dow Jones Islamic Market Index (DJIM) launched in The DJIM s credibility led it to have its own independent and established Shariah Supervisory Board. The DJIM differs from other index providers that more recently launched Islamic Indexes and outsourced this crucial Shari ah screening function to "Islamic consulting" firms. The current DJIM Shariah Board members include Sh. M. Taqi Usmani (Pakistan), Sh Abdul Sattar Abu Ghuddah (Syria), Sh. Nizam Yaquby (Bahrain), Sh. M. Elgari (Saudi Arabia), Sh. M. Daud Bakar (Malaysia) and Sh. Yusuf Talal Delorenzo (US). Market acceptance of the index resulted from the Dow Jones brand. The DJIM screens have been adopted by the Auditing & Accounting Organization of Islamic Financial Institutions (AAOIF['')-Standard 21. Hence, the index has resulted in a financial industry standard. The DJIM measures the performance of a global universe of investable equities that have been screened for Shariah compliance consistent with Dow Jones Indexes proprietary methodology. All other indexes in the DJIM family are created as subsets of this benchmark. Industry Screens Alcohol, pork-related products, conventional financial services, entertainment, tobacco, weapons and defense are covered by these screens. Financial Ratio Screens All of the following should be less than 33 per cent: Total debt divided by trailing 12-month average market capitalization; The sum of a company's cash and interest-bearing securities divided by trailing 12-month average market capitalization; and Accounts receivables divided by trailing 12-month average market capitalization. 119

124 Because in most Muslim countries, the conventional financial sector is the largest, there exists a situation of Shariah-compliant capital flight. Given the fact that Shariah-compliant investors cannot invest in conventional banks, insurance and consumer finance companies as a result of the prohibitions on riba (interest) and gharar (uncertainty), such investors as are interested in investing in the financial sector are left with a universe of companies (excluding Islamic banks and Takaful operators) that fail the leverage screen (debt/market capitalization being lower than 33 per cent). In addition, many of the remaining companies have a small free float (or foreign investor restrictions). Figure 1: Dow Jones Islamic Market World sector Weights Chart Consequently, many Shariah-compliant investors have to identify qualifying companies in Europe, US and Asia, thus resulting in a situation of Shariahcompliant capital flight. This phenomenon is not confined to equities; it also applies to other asset classes such as real estate, leasing, acquisitions, commodity, private equity and venture capital. Dow Jones Indexes is not the only index provider targeting the rapidly expanding Islamic banking and investment sector in the GCC region. FTSE and S&P also offer Islamic indexes. Achieving another first, however, Dow Jones Indexes launched the Dow Jones Citigroup Sukuk Index in Dow Jones Indexes was also the first to launch an Islamic index that incorporates positive screens: the Dow Jones Islamic Market Sustainability Index in These indexes launches 120

125 contribute to the development of the Islamic capital market, and possible additions of alternative asset class Islamic Indexes (e.g. REITs and commodities) will add depth and breadth to the market. The potential of a six-country GCC regional index reflects the possibility of a GCC Union - akin to the European Union - creating a specific capital market around a common history, language, culture, religion and currency. Dow Jones Indexes has launched an Islamic index for Kuwait - the Dow Jones Islamic Market Kuwait Index - and other country Indexes are in the pipeline. The key issues in the constructing of such indexes include: 1) an adequate number of listed compliant components in the designated region to create a well balanced index; 2) the fact that in regions where the debt culture is the norm, the major sector is conventional finance; and so, a large part of the market for an Islamic index is eliminated. Figure 2: Dow Jones Islamic Market World Country Weights Graph Top 9 Countries Measured by Market Cap Percentage 121

126 Figure 3: Dow Jones Islamic Market World Country Weights Graph 9 Countries Measured by Market Cap Percentage Recently, there was an implicit recognition of Shariah-compliant capital flight and an attempt was made to rectify it. For example, the Dubai Financial Market (DFM) announced that it would be the first Islamic stock exchange. It remains to be seen, however, whether the market will accept the DFM as an Islamic stock exchange. Benefits of Inclusion in an Index Indexes benefit not only the markets they measure, but also the companies that are included in the indexes. Most noticeably, the component companies gain exposure from the indirect marketing of the index-by-index providers and index-linked investment product purveyors. For example, a news coverage of how stock performance of a particular component company affects the performance of an index and the corresponding peer groups raises the visibility of the companies included in the index. Such publicity increases the potential of the component companies to attract investment for future share offerings. Companies have demonstrated that they are very aware of such benefits. For example, Emaar (listed on DFM) has mentioned in its promotional literature that it is included in the DJ DIFC Arabia Titans Index. Indexes also benefit emerging market stock exchanges, particularly if the stock exchange concerned co-brands with the index provider. Such indexes raise the profile of the stock exchange. Products Created off an Index Another significant way indexes benefit capital markets is that they serve as a basis for investment products. Index-based investment vehicles offer 122

127 investors a means to access the average return of particular markets. Indexbased financial products include: (a) Mutual funds: Mutual funds use indexes to build and manage their portfolios. Fund managers that actively pick the stocks to include in a particular mutual fund use indexes as benchmarks to measure the effectiveness of their techniques. Other fund managers use indexes to create funds that simply track the performance of an index. "Closet indexers" are those fund managers who say they are actively managing the holdings of a particular fund, but in fact are mostly picking the stocks that comprise an existing index. Broad market indexes are not the only indexes underlying funds. Consider the Dogs of the Dow, a contrarian strategy that chooses the ten most out-of-favor stocks, based on stock dividend yield, in the DJIA. The strategy calls for the investor to hold these high-yield Dow Dogs for a year, equally weighting them initially, and then to repeat the process the following year by selecting ten new dogs. With a growing number of funds based on indexes, a high volume of investor dollars will flow into a small population of stocks, i.e. those that are part of the indexes. Indeed, the investment management community relies on the due diligence of index publishers that is conducted when indexes are built. As a matter of fact, the standards that are included in index methodologies provide useful screens for stocks. (b) Structured notes: Structured notes are financial products that appear to be fixed income instruments, but could contain embedded options on indexes and do not necessarily reflect the risk of the issuing credit. Structured notes can be simple - "plain vanilla," as "Wall Streeters" call them, or may include highly leveraged exotic options. The risks inherent in structured notes are not obvious and, therefore, create pricing challenges. In other words, the value of structured notes can be affected by embedded derivatives, namely: caps, floors and call features. Structured notes are often used to expose portfolios to asset classes or markets in which investors cannot directly invest due to investment mandates and regulatory restrictions. In short, structured notes isolate and redirect specific risks. Additionally, they could offer a potential for returns greater than market rates. c) Exchange Traded Funds (ETFs): ETFs funds typically track an index and can be traded like a stock. Because ETFs comprise shares that are in fact bundled securities, they can be shorted. ETFs are more tax 123

128 efficient than mutual funds. Additionally, they tend to have low operating and transaction costs. The popularity of ETFs has grown tremendously. In its 2006 year-end review, Morgan Stanley predicted that ETF assets under management are expected to surge from the current US$ 574 billion to over US $2 trillion by Institutional investor global demand for ETFs rose 27 per cent in 2006, and by ^145 per cent in the past six years. During 2006, 79 ETFs were launched - more than double the 119 launched in 2005 and more than five times the 52 launched in (d) Futures: Futures are a standardized, transferable, exchange-traded contract that requires delivery of a commodity, bond, currency or stock index at a specified price on a specified future date. Because the holder of a futures contract has an obligation to buy the underlying securities, the risk to the holder is unlimited; and because the payoff pattern is symmetrical, the risk to the seller is unlimited, too. Futures are distinguishable from generic forward contracts because they contain standardized terms, trade on a formal exchange, are regulated by overseeing agencies, and guaranteed by clearinghouses. To ensure that payment will occur, futures have a margin requirement that must be settled daily. (e) Options: Options are the right, but not the obligation, to buy (for a call option) or sell (for a put option) a specific amount of a given stock, commodity or currency. As for index, or debt at a specified price (the strike price) during a specified period of time in the case of a security that cannot be delivered, such as an index, the contract is settled in cash. For the holder, the potential loss is limited to the price paid to acquire the option for the buyer; in which case, the upside is unlimited. Investors sometimes purchase or sell derivatives - futures and options - to manage the risk that accompanies the underlying security, to protect against fluctuations in value, or to profit from periods of inactivity or decline. Role of the Independent Index Provider VS. Sstock Exchange as Index Provider There is a common misperception by some institutions that index providers will make inroads into the franchise of a stock exchange if the former is allowed to construct and disseminate a local (country) index. The role of a stock exchange encompasses a wide variety of responsibilities including, but not limited to, listing companies stocks and other investment products (such as mutual funds), providing a trading platform for stocks and products, ensuring that market activity is in accordance with regulations, and periodic 124

129 reporting by listed stocks. The role of an index provider, such as Dow Jones Indexes, is that of an independent entity that develops methodologies to construct indexes that represent the performance of the broad market or segments of the market and follows published rules in maintaining the indexes. Some financial institutions such as HSBC, Shuaa; Capital, National Bank of Abu Dhabi (NBAD); and EFG Hermes have created rules-based index. However, these indexes are perceived by some investors as not independent of these firms asset management arms. In addition, competitions of the financial institution offering the index may not want to use the index to avoid promoting their competitor or its brand. Dow Jones & Company, Inc All rights reserved "Dow Jones," Dow Jones Industrial Average", DJIA. 'The Dow". "Titans", Dow Jones Islamic Market Indexes, Dow Jones-DIFC Arabia Titans 50 Index are service marks of Dow Jones & Company, Inc ("Dow Jones"). The Dow Jones-DIFC Arabia Titans 50 Index is calculated and distributed by Dow Jones pursuant to an agreement between Dow Jones and the Dubai International Financial Centre. DIFC is a service market of the Dubai International Financial Centre and is used under license by Dow Jones. The Dow Jones Wilshire Emerging Markets Index is calculated and distributed by Dow Jones pursuant to an agreement between Dow Jones and the Wilshire Associates Incorporated (Wilshire). "Wilshire" is a service mark of Wilshire Associates Incorporated and is used under license by Dow Jones. Investment products based on the indexes referenced in this document are not sponsored, endorsed, sold or promoted by Dow Jones; and Dow Jones does not make any representation regarding the advisability of investing in such product(s) or any component thereof. Inclusion of a security in the Dow Jones Islamic Market indexes, Dow Jones Wilshire Emerging Markets Index or DIFC-Arabia Titans 50 Index does not in any way reflect an opinion of Dow Jones, Wilshire or DIFC on the investment merits of the company. 125

130 Table 4: Dow Jones Industrial Average /S&P 500 Index Performance Year D JIA Yearly S&P 500 Yearly Performance Performance % 12.40% % 27.25% % -6.56% % 26.31% % 4.46% % 7.06% % -1.54% % 34.11% % 20.26% % 31.01% % 26.67% % 19.53% % % % % % % % 26.38% % 8.99% % 3.00% % 13.62% All information hereunder is as at 20 February The information in this paper is subject to change. Each of the Dow Jones-DIFC Arabia Titans 50 Index and the Dow Jones Wilshire Emerging Markets Index have been launched in Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and United Arab Emirates. The historical information, comparisons, assertions and conclusions contained in this paper with respect to such indexes as pertain to a time period that predates their respective launch dates are based on back-testing; that is, calculations of how the index might have performed in the past, if it had existed at that period. Back-tested performance information is purely hypothetical and is provided in this document solely for information purposes. Back-tested performance does not represent actual performance, and should not be interpreted as an indication of actual performance. Past performance is not indicative of future results. Index returns do not represent fund performance. Index performance returns do not reflect management fees, transaction costs or expenses. 126

131 Islamic Capital Market and Sukuk Overview Mr. Ijlal Ahmed Alvi, Chief Executive Officer International Islamic Financial Market (IIFM) Bahrain 1. Market Analysis This paper has been written against the background of the Islamic marketplace, which is estimated as follows: Total financial assets by Standard Chartered stand at US$ 700 billion; Liquid assets account for US$ 30 US$ 50 billion; Of this, 20 per cent is allocated to Investment funds; Over 65 per cent Interbank assets is allocated to secured Murabaha. Despite the high international level of free cash, there are still very few universally accepted Shari ah compatible and standardized financial instruments available for liquidity management outside Malaysia, due to the immature international capital marketplace. This presently makes secondary trading, especially in any zero weighted instruments, almost impossible in the GCC, which accounts for over two-thirds of financial assets. Figure 1: Total Global Sukuk Issuance 127

132 Again, outside Malaysia, there are no Islamic equity exchanges, and international Islamic equities rely on indices run by firms such as Dow Jones, indices of which have become the de facto market standard. With the world equity market estimated at around US$ 30 trillion, stocks which comply with accepted Shariah screening criteria are estimated at around 30 per cent on average (about 60 per cent to 70 per cent in the GCC markets) amounting to a total market of US$ 9 trillion in the region. 1.1 International Sukuk Market Sukuk started as a recognized Islamic financial instrument about eight years ago. The $100 million Bahrain sovereign issue in 2001 and two Malaysian international issues, the $600 million sovereign benchmark and the Guthrie $150 million corporate issues in 2002 resulted in the international Sukuk market development. As could be seen below, the overall issues up to March 2008 including Malaysian domestic issues, total nearly $106 billion. Figure 2: Total Global Sovereign & Corporate Sukuk Issuance Size in US $ Millions Total Global Sukuk Issuance Sovereign & Corporate Sukuk Best estimate including both International & Domestic issues Total Sovereign Issued Corporate Issued Year It could be seen that while sovereign issues showed no significant growth, growth resulted from international corporate issues which have been growing annually at about 150 per cent up to 2005, peaking at 400+ per cent as at December

133 1.2 Geographic Distribution International sovereign Sukuk geographic distribution, illustrated below, shows that to date there are nine issuing countries, if the Saxony and IDB issues were to be included as sovereign. Table 1:.Total Global Sovereign Sukuk Issuance Year US $ Millions Bahrain ,124 Saudi Arabia 1,333 1,333 Qatar UAE 1,000 3,520 3,425 1,731 9,676 Pakistan ,073 Malaysia ,315 3,777 5,842 Indonesia Brunei Germany Total issued ,180 1, ,147 9,794 2,260 22,625 Table 2: Total Global Corporate Sukuk Issuance Year US $ Millions Bahrain ,082 Kuwait 200 1, ,203 Saudi Arabia , ,552 Qatar UAE ,775 7,292 13,182 Pakistan Malaysia ,072 4,949 8,747 13,733 22,752 2,480 57,760 Indonesia Brunei USA Sudan Cayman Islands Total issued ,537 5,624 11,040 21,019 36,893 3,143 83,

134 Listing - Corporate issues are generally listed on local, rather than international exchanges with the two largest listed on the DIFX. There are some exceptions such as the Tabreed and Wings issues which have been listed on either Luxembourg or London. However, nearly all the sovereign issues have been listed on Luxembourg and many are dual listed regionally on LFX, DIFX or Bahrain SE. Maturities - these range from three months (Bahrain Salam Sukuk) to ten years, the average being between four and five years approximately. Price basis - of the issues analyzed, 50 per cent were floating and the other half fixed in some way. However, nearly all the sovereign issues except most of those in Bahrain have been floating. If the Bahrain fixed issues are excluded, the percentage of fixed issues falls to nearly 40 per cent. Of the total 17 benchmark issues, only 29 per cent were fixed rate with even less (10 per cent) of the sovereign benchmark issues being fixed. This is in stark contrast to the conventional market where 95 per cent of all issues are fixed rate Malaysian Market A thorough analysis of this undoubtedly successful parallel Islamic and conventional Malaysian market environment was conducted. The country was forced by the Asian crisis into developing a capital market. To implement this, they studied the developed markets and took a well-defined master plan approach from which, we believe, there are many lessons to be learned Overview In 1983, Malaysia adopted a parallel approach to Islamic and conventional finance and that country is currently the undisputed leader in Islamic capital markets. Malaysia s comprehensive approach is based on a Shari ah analysis that drives debt to a form of hybrid between real asset-backed security and corporate bond. To be included in the Islamic debt scheme, the underlying debts must be linked to a permissible Islamic contract; meaning that the contract must relate to permissible property sold, used or constructed. The contract itself must be a confirmed debt in which both ends of the obligation are completed, which means that the Salam and Istisna contracts do not directly fit this application. When the debts are traded, they are priced at discount or premium to par and do not carry coupon. The Malaysian system has allowed for the development of an Islamic promissory note as an affirmation of debt and as a tradable instrument. The 130

135 traded security is deemed to flow with the underlying contract, which itself is traded according to the local theory of Bai al-dayn. Here lies the primary difference with the dominant Islamic scholarly view whereby non-malaysian scholars require that the security attaches to ownership of assets and then a Shari ah permissible contract would be executed. As a result, the theory governing Sukuk trading outside Malaysia is that the actual asset and its attendant obligations may be traded. Table 3: Malaysian debt instruments compared with mainstream Islamic views Sukuk Compared to the Conventional The distinction between the Malaysian and mainstream Islamic approach is germane to an analysis of the distinctive nature of Sukuk when compared with traditional fixed-income instruments. The Islamic preference for assetbased financing and risk-sharing mechanisms creates built-in safeguards that protect both institutions and investors. In an Islamic finance culture, there is a strong aversion to high levels of debt, interest and speculations. This essentially implies financial prudence and encourages greater asset orientation, which some may consider as collateralization; and transactiondelimited risk sharing Sukuk as an innovative Islamic product may be structured and issued to achieve exactly these qualities. But first, how does the Sukuk stand up to conventional fixed-income products? 131

136 Landmark Sovereign Sukuk Since the Malaysia sovereign Sukuk issuance, countries members of the Organization of the Islamic Conference (OIC) have become increasingly active issuers on the international markets. The sovereign Sukuk issued following Malaysia s lead are enjoying widespread and positive acclaim among Islamic investors as well as global institutional investors, who are not traditionally active with Islamic structures or on Islamic regional markets. On the one hand, many OIC countries and their agencies are asset-rich and cash-poor. Therefore, sovereign Sukuk are an ideal method to monetize existing assets. On the other hand, OIC countries fall into two very different tax regimes. The Arabian Gulf States tend to be low or no-tax States, whereas the poorer OIC countries may have extensive but unenforceable, tax regimes. Therefore, sovereign Sukuk or state-sponsored Sukuk allow both groups to generate cash without raising taxes or otherwise alter their tax regimes. An additional benefit is that sovereign Sukuk gives central bankers their first tool to truly manage domestic money supply and the credit extension of Islamic Banks under their jurisdiction with a uniquely Islamic instrument. Starting with the Asian financial crisis, Malaysia had to broaden the spread of credit risk by moving away from the distressed area of straight bank lending and instead move towards a deeper market by issuing conventional and Islamic capital market instruments. At the beginning of 2006: Total capital market instruments outstanding were running at US$ 114 billion with 28 per cent being accepted in Malaysia as islamically compliant; and Total bonds accounted for 95 per cent of GDP. 132

137 Figure 3: Asian Bond Markets and Domestic Bond Markets, 2005 However, up to mid-december 2006 there have only been some 70 international issues totaling approximately US$ 21 billion. One third of these were sovereign (in Europe, sovereign issues accounted for over half of all issues) and two-thirds were corporate/institutional. Of the total 17 benchmark issues, only 29 per cent were fixed rate with even less (10%) of the sovereign benchmark issues being fixed. This is in stark contrast to the conventional market were 95 per cent of all issues are fixed rate. The reason for this present predominance of floating rate issues appears to result primarily from the self interest of liquidity-rich Islamic banks looking for assets, paucity of issues along with a very shallow investor base. Outside Malaysia, only Bahrain (and recently Brunei) has regular issues of fixed rate short tenor (91-day) Sukuk which could be used for bank liquidity management. Continuous government issues with regular and planned auctions are fundamental to market development. The same is the case for benchmark fixed rate issues with a wide spread of maturities, which could be used for infrastructure funding. The low total volume issued to date, the scarcity of fixed rate instruments and the lack of a diverse investor base makes the Islamic bond market onesided, with most buy-and-hold investors leaving the secondary markets being quite inactive. For example, the LMC only executed 36 trades over a year and a half up to the end of

138 With respect to issues, other fundamental aspects of a developed bond market presently missing from the Islamic market are benchmark fixed rate issues extending yield curves out to long maturities (even SABIC at 20 years was an FRN) and cost effective hedging instruments. 2. Sukuk Capacity Building Legal framework is a key part of the infrastructure. Under Shariah, a company owned by a natural person has to be established and then contracted to perform the duties required for him to become a de facto trustee. This requires restrictive covenants to represent the investor s best interests; and ownership by nationals leads to questions concerning foreign control, ownership, collateral and nature of capital flows. However, most Islamic markets are not governed by Shariah courts, but are subject to a local version of the civil code that is not particularly supportive of capital markets, especially in the areas of trust law and SPV structures. In most markets, specific amendments still need to be made to local code, trust law, banking and securities regulations. Islamic capital market is essentially a segment of the wider global securities market, and Islamic capital market products and services can be introduced and developed within any existing well-structured securities market. Specific Shari ah aspects can be addressed at either regulatory or issue level. Reviews of the Clearing and Settlement systems for Sukuk show that many of the international Sukuk are scrip less issues with a global certificate lodged with Euroclear/Clearstream, thereby enabling orderly settlement. Further work needs to be done with regard to establishing more Euroclear accounts and a primary dealer network for those houses that are not able to meet Euroclear requirements. The conventional settlement system is wholly Shariah compatible, given that it solely provides a means of payment of cash against title or notes held by a central depositary. There is currently no need to establish a separate Islamic clearing system, as international Sukuk are efficiently cleared through these international mechanisms. Establishing an independent and solely Islamic platform could even be seen as detrimental to market progress as it may restrict the flow of funds from the mainstream conventional marketplace. The only problem that may arise is in the unlikely event of late payment. This could be resolved by agreement with Euroclear to change their penalty mechanism or to work through a suitably capitalized interposed Special Purpose Company to settle any claims on behalf of Islamic institutions. 134

139 A Central Counterparty (CCP) is a financial institution that acts as an intermediary between security market participants. This reduces the amount of counterparty risk to which the market participants are exposed. CCPs must have adequate risk management systems, including sound margining policies, collateral management procedures and strong capital cushions. As CCPs are associated with individual countries, exchanges and markets, this presents significant national differences in legal and tax jurisdictions, settlement procedures as well as asset classes. These differences create huge barriers to efficient cross-border clearing and settlement, and place very significant additional risk and cost on CCP members and participants who operate in more than one national market. Through the involvement of major banks, many global Sukuk issues have already been widely accepted internationally. However, the local market and cross-border infrastructure are still developing. These open areas range across legal frameworks, regulations and guidelines with many either purely or partially market practice driven. About 90 per cent of the capital market turnover in conventional markets is attributable to bonds and only 10 per cent to stocks, while in the GCC, for example, it is the other way around. Bonds fulfill an important function in the economy. They provide stable long-term financing for companies and governments alike and offer investors an important alternative to stocks. Bonds offer a more predictable flow of income and are often negatively correlated with the stock market to play a vital role in balancing the portfolios of private and institutional investors, like pension funds. Pension funds in particular need the fixed income provided by the bond market to calculate their future liabilities. Thus, developing local mutual and pension funds must go hand-in-hand with the logical first step, i.e., the development of a GCC bond market. Asian bond markets (which include Malaysia, Indonesia and Brunei) have valuable lessons for the other Islamic capital markets. The Asian crisis of 1997/ 98 revealed serious problems of over-reliance in the banking sector for financing and currency, and maturity mismatches on the balance sheets of these banks. Following this hiatus, the bond market in Asia developed by leaps and bounds. Asian Development Bank statistics illustrate the balance typical of countries domestic financing profile. It could be seen that on average bond markets occupy about one-third across Asia with Malaysia now running at 26 per cent. 135

140 Figure 4. Asian Domestic Financing Profile The GCC bond market is yet underdeveloped in comparison to traditional bank and equity financing. High oil revenues put the region's governments in a comfortable position as they do not need to issue debt in order to finance fiscal deficits. GCC governments currently do not need to issue bonds to finance budget deficits, and neither do Hong Kong and Singapore; but both countries are issuing bonds across the yield curve to provide a benchmark for their corporate bond sector and add stability to their economies. Corporations in the GCC had easy access to equity finance during the stock markets boom. Thus, the market is characterized by a lack of benchmarks, a limited variety of issues and low liquidity. The recent floating rate government Eurobond Sukuk for Qatar and Bahrain lack the longer maturities needed to form a benchmark across the yield curve. Whilst Bahrain has promulgated a trust law, the legal issues surrounding UAE property law are still in the process of being sorted and most Sukuk issues there have succeeded only because of sovereign guarantees. 136