Islamic Finance Global Outlook and a European Perspective Anouar Hassoune, Managing Partner Luxembourg 4 March 2016
Introduction 1. Ethics 2. Growth 3. Stakes 4. Limitations «There has never been a prettier marriage to date than that of knowledge and patience» Prophet Muhammad (PBUH)
1. ETHICS
1. Islamic finance is a compartment ethical economics Morals and ethics These terms are no substitutes to each other. Let us ask Emmanuel Kant Question Scope Book What must I do? Morals The Critique of Practical Reason What can I know? Epistemology/arts The Critique of Judgement What am I allowed to hope for? Metaphysics The Critique of Pure Reason Morals answer the question «What must I do?». Ethics is the why of morals, their reason, their cause.
1. Islamic finance is a compartment ethical economics Let s explore the morals and ethics of Islamic finance SCOPE MORALS ETHICS Question What must I do? Why I must do it? Level Principles Values Content Prescriptive, normative Axiological Etymology/root Rome Athens Mode Acting Thinking Ethics precede morals. Morals must be legitimate. For this to happen, underlying values must pretend to be universalized.
1. Islamic finance is a compartment ethical economics Conviction Vs. Responsibility Such values, and the principles derived from them, are the prerequisite of trust: in Arabic, trust is translated as amanah, which shares the same root as imân (faith) as in Latin, fides means both trust and faith. Since Max Weber (The Protestant Ethic and the Spirit of Capitalism, 1905), one traditionally opposes: The ethics of responsibility: the necessity to rationally take into consideration the possible effects of one s acts in the fact of acting; and The ethics of conviction: which justifies and legitimates action by one s faith in beliefs supposed to be true ex ante and a priori. Islamic finance reconciles both approaches: conviction is the underlying element of values (ethics); whereas responsibility feeds its principles (morals).
1. Islamic finance is a principles-based finance Principles: the 5 pillars of financial Islam Riba: interest, usury Maysir: speculation, randomness, game of chance Gharar: excessive contractual uncertainty Banned sectors: alcohol, weapons, tobacco... Sources of Islamic law Coran (the Holy Book) Sunna (sayings and deeds of the Prophet) Ijma (consensus of Scholars) Asset-backing: any financial transaction must be backed by a real, tangible asset Profit and loss sharing: profits and losses from an economic activity must be shared between stakeholders Qiyas (analogy and balance) Ijtihad (rational intellectual effort) Page 6
1. Islamic finance is a values-based finance Ethics: the axioms of Islamic finance Value Object Axiom Reality Money Money is just a measure of value, but it does not have value per se. The real economy is the primary focus; notional inflation is not desirable. Responsibility Debt Debt is a sacred liability; it constitutes a responsibility and is not to be traded. Excessive indebtedness is discouraged. Co-ownership Regency on the world Human beings are not the masters, owners and commanders of Nature; they are only its regents. Equitability Social justice Participation finance, based on equity and mutualism, is encouraged; neither speculation, nor hoarding can be acceptable/permissible. Sequentiality Production and trade Production precedes trade: one cannot sale what he/she does not own. To serve the real economy Not to be served by it
Page 8 1. Islamic finance is a contract-based finance Name Summary Description Considerations Ijara Istisna a Murabaha Commodity Murabaha Musharaka Mudaraba An Islamic lease. An investor purchases an asset and leases it to the borrower for fixed monthly payments Variations include head-lease / sub-lease structure and usufruct Includes an obligation for the lessee to buy the asset at the end of the lease Specifically relates to construction and manufacturing (the asset to be financed not being in existence) The investor finances the work or construction in progress and then sells it to the borrower, payable in installments The sale of an asset on a cost-plus basis with a mark-up agreed by both parties added to the original cost price The investors purchase an asset from a third party and sells it to borrower on a deferred payment basis Popular for providing trade financing Investors appoint an agent to purchase a commodity from a commodity seller, which is sold onto to the borrower at the price + a mark-up on a deferred payment basis. The borrower then sells the commodity on the same day to a third-party vendor (to raise capital) and pays back investors at the pre-agreed mark-up on the agreed deferred payment date A contract where the borrower and investor invest capital to a joint venture, with both parties sharing risk and reward Profits can be allocated in any pre-agreed ratio, and losses are borne in proportion to capital invested A form of joint venture where one or more parties provide capital and other parties contribute their expertise with profit sharing agreed in advance The investors bears all losses if any, unless caused by negligence or violation of the terms of the contract Most widely accepted structured Requires the transfer of the beneficiary ownership of the underlying asset Tradable at secondary market levels Most Suitable for a Sukuk Debt-like instrument, tradable at par only When used with an Ijara can be tradable at secondary market levels, and suitable for a Sukuk Need of an asset to develop The underlying asset doesn t need to be a fixed tangible asset (commodities, oil, minerals, etc.) Debt-like instrument, tradable at par only Most suitable for short-term syndicated facilities Least favored structure by Sharia'a scholars No need for underlying asset, but use of proceeds has to be Sharia'a-compliant Debt-like instrument, tradable at par only Most suitable for short-term syndicated facilities Associated with equity-like risk by some investor Most suitable for project finance Associated with equity-like risk by some investor Most suitable for project finance
2. GROWTH
Page 10 2. Islamic finance is fast-growing industry Growth of global Islamic financial assets ($bn) Composition of global Islamic financial assets 2500 2094 2000 1799 1584 1500 1000 500 0 1234 1086 985 822 694 2007 2008 2009 2010 2011 2012 2013 2014 Conventional CAGR = 2.8% over the same period of time 80% = banking assets: the industry is not disintermediated enough 1% = takaful: Islamic insurance is much underdeveloped 72% in the Middle East, 23% in Asia: the industry remains geographically concentrated, around 2 hubs = the Gulf and Malaysia $2 trillion seem a lot in absolute terms: in relative terms though, it is not 1,200$ per Muslim; global financial assets stood at $294 trillion, meaning the global market share of Islamic finance was only 0.71% at YE2014. Conclusion: there is still a long and tedious way to go Global Islamic financial assets grew 17% per annum, on average, between 2007 and 2014, to reach $2 trillion at year-end 2014 Sources: The Banker, IFSB, Zawya
Page 11 2. Sukuk: the Islamic bond market is dynamic, but does not function in isolation If historical trends were prolonged, sukuk issuances and outstanding sukuk amounts should be 3 times larger than what they are today But sukuk do not function in isolation: no man is an island, and credit risk has no religion
2. Sukuk investors: who are they? Sukuk investor base: truly a global community The sukuk asset class allows for a better diversification of funding sources The investor community includes a wide scope of accounts, i.e. conventional fixedincome buyers AND Islamic investors Such aggregation represents an enlarged pool of demand and tends to create pricing tension at the time sukuk are issued US Entirely conventional investors Increasingly looking at Sukuk asset class Middle East Europe Predominantly conventional, familiar with Sukuk asset class Many conventional investor interest for Sukuk given supporting markets Some Islamic banks and Sukuk funds Retail demand from GCC accounts in Swiss private banks Largest market for Sukuk, dominated by bank investors Some two-thirds of worldwide Sharia'a compliant assets Islamic investors represent an estimated third of the investor pool Conventional investors prefer Sukuk with additional capacity available Asia Second largest Islamic market Mostly dominated by Malaysian investors, but growing in Singapore and Indonesia Conventional investors, extremely familiar with Sukuk asset class Many conventional investor interest for Sukuk given supporting markets Significant Islamic funds managed out of Singapore and Hong Kong
Page 13 2. Islamic finance and its territories: international, yes global, no UK Turkey Kazakhstan South Korea Japan Hong Kong Sukuk legislation passed Treasury considering short-term benchmark issuance Sukuk legislation passed First corporate issue completed Sukuk legislation passed Looking to complete debut Sovereign issue Regulators keen to promote Islamic products Draft Sukuk law submitted to national assembly for review Bill submitted to parliament to allow issuance and trading JBIC considering quasisovereign issuance Announced plans to issue sovereign Sukuk Wants to establish a large and liquid secondary market Germany Thailand In 2004, the Federal state of Saxony-Anhalt became the first European Sukuk issuer Considering Sukuk issue to tap into GCC liquidity France Malaysia Keen for development of Islamic finance Looking at draft legislation to allow Sukuk issuance Several sovereign issues Invested in large secondary markets and knowledge centres Tax benefits for Sukuk Egypt Singapore Sukuk legislation passed Considering debut Sovereign issue Sukuk legislation passed Sovereign Sukuk issuance Bahrain Jordan UAE Saudi Arabia Pakistan Indonesia Sovereign and quasisovereign issuance Established one of the largest secondary markets for Sukuk Ministry examining options for Sukuk issuance Large issuances by sovereign, quasisovereign and corporate institutions Wants to be global centre Announced plans to issue sovereign Sukuk International and local sovereign Sukuk issaunce Central Bank established a dedicated Islamic Banking unit Extensive tax and legal reforms Sovereign Sukuk issuance
Page 14 2. Islamic banking intermediation: core QISMUT vs. frontier EMEIA Core Markets QISMUT : Qatar, Indonesia, Saudi Arabia, Malaysia, United Arab Emirates, Turkey Frontier Markets- EMEIA: Europe (including Russia), Maghreb countries, Egypt, Iran, Africa
3. STAKES
Page 16 3. Credibility: based on its principles, the Islamic financial industry has come of age Measure of success profitability High The Islamic financial industry is at a critical step within its development cycle Rapid growth Maturity Decline Medium Take-off Innovation Core demand Low 1960 1970 2000 20xx Development cycle of the Islamic financial industry $10 bn $20 bn $350 bn $140 bn
3. Institutionalization of Islamic finance: the trend goes unabated Page 17
Page 17 3. European stakes: the continent is more mature, but Islamic finance remains embryonic France: uncoordinated and isolated initiatives. No inprinciple objection, but only a pure player can succeed. Belgium and the Netherlands: very shy supply. A French or Luxembourgish entrant is the only one capable of boosting both markets. Luxembourg: a special case. Active and ambitious, ordered and patient. The European solution is likely there. Germany: a Turkish lab. Supply is restrictive and shy. Ultraniche market... for the moment Southern Europe: peripheral; nothing material is happening there. UK: well equipped, if not already saturated.
3. Focus: Luxembourg has made its position very clear Page 17
3. with a well-designed action plan Page 17
4. LIMITATIONS
Page 22 4. Several limitations are undoubtedly constraining the industry s evolution Too much banking, not enough disintermediation Islamic asset management is far underdeveloped ($64 bn at YE2014) Takaful has not picked up yet($20 bn collected premiums in 2014) Sukuk: a resounding success, but sovereigns and local currencies still dominate the ballgame Liquidity management is a continuous challenge for Islamic financial institutions Yesterday the industry was driven by supply, today it is driven by demand: are services up to the challenge of quality, price-competitiveness and comprehensiveness? Innovation capabilities are weak Islamic investment banking is lagging behind Rather a collection fragmented domestic markets; not an integrated regional/global market Legal uncertainties when it comes to Shari ah interpretation remain Not enough Shari ah scholars; not enough experts Is Islamic finance green enough?
Page 23 4. Some heavy trends are forcing the industry s evolution Human capital Innovation
Page 21 4. From industrialization to behavioral change Regulators will have to adapt Build regulations that empower Islamic finance Help emerge an ecosystem that ensures equitable competition Strengthening impact on the real economy and society at large The initial phase of the industry was focused on debt instruments in the perspective of replication Equity instruments must now be fostered in order to set foot internationally Attract human capital The industry needs new talents to engage in to a new wave of creativity The industry must, in a proactive manner, institutionalize training Engagement and sponsoring Enhance academic research in order to better define its prospective vision and direction Regulators, practitioners and scholars must better coordinate their efforts Support Islamic financial institutions expansion Current players tend to have a limited scope, but have started to discover new frontiers Cross border ties and the interconnection of business lines are definitely a strength The industry s industrialization will to a large extent depend on better coordination
ABOUT THE SPEAKER
26 ANOUAR HASSOUNE Managing Partner of Euris Group Anouar Hassoune is currently the Managing Partner of Euris Group s Advisory practice, focusing on tailoring Islamic financial solutions to clients. A university professor in Islamic finance, entrepreneur, former banker, Anouar also sits on several companies boards. Anouar used to be the Head of Research and Strategist for MENA at The Bank of Tokyo- Mitsubishi UFJ, and the driving force behind BTMU s Islamic Window. Prior to that, Anouar used to be a Vice President & Senior Credit Officer for Moody s Investors Service, one of the leading rating agencies globally. Before this position, he used to be a credit analyst at another wellknown rating agency, namely Standard & Poor s. For both rating agencies, Anouar was responsible for the rating coverage of banks in the Middle East and North Africa, and served as global head of Islamic finance. Anouar is also one of the Managing Partners of Emerging Markets Ratings Ltd. (United Arab Emirates) and West Africa Rating Agency (Senegal). His academic background includes a master s degree in Business Administration from Paris-based HEC Business School, a master s degree in Political Science from the Paris Institute for Political Studies (Sciences Po Paris), a post-graduate degree in Economics from the University of Paris 1, as well as the Agrégation certification in Business and Finance earned at the French Ecole Normale Supérieure. He teaches Islamic finance and applied economics within various leading Universities and Business Schools in France, including HEC and the University Paris Dauphine. anouar.hassoune@euris-group.com +352 691 26 23 88 Visit: http://euris-group.com/