Islamic Banking and Finance

Islamic Banking and Finance Trends, Opportunities and Challenges Sohail Jaffer, June 4, 2009 0

Contents 1. Overview of Islamic Finance 2. Capital markets 3. Sharia Compliant Investments 4. Takaful 5. Islamic Finance Challenges 6. Islamic Finance Opportunities 7. Conclusion 1

Islamic Finance Overview Faith based financing system providing alternative products to those available in the conventional financial markets Competitive alternative to conventional products attractive to Muslims and non-muslims Transparency and full disclosure Fairness with all parties involved Profit and loss sharing Real transactions 2

Islamic Finance overview Global Reach Islamic jurisdictions Secular jurisdictions Progressive juridictions Future directions Standardisation Transparency Neutrality Separation of Shari a from law and politics 3

Islamic Banking and Finance Overview 4

Growth of Islamic Finance 1975-1990 Commercial Banking Syndications Islamic Conglomerates Market exposure: 20m Onset of Islamic Banks (Malaysia, UAE, etc.) Inefficient Command SOEs in Iran and Sudan, and Pakistan 1991-2000 Hard Asset Private Equity Fund Management Islamic Indexes Market exposure: 100m Concentrations of Islamic Banks growing in GCC, Malaysia, Pakistan and Bangladesh Market Exposure: 900m Conversions, Islamic Windows & Subsidiaries of Mega Banks, Establishment of significant Islamic Banks in Non-Muslim states Muslim populated states getting interested Syria, Libya, Soviet bloc Timeline 1975-2010 Source: S. Farooq, BIBF Source: Dow Jones and Company, Inc. 5

Wherearewetodayin IslamicFinance? Private Equity Venture Capitalist Activities Risk Cost- Plus Leasing Real Estate Equity Islamic Financial Institutions IF Products Islamic Finance Conventional Fund Institutions Conventional Fund Products Conventional Funds 40 years 300+ years Timeline: Products/Returns/Players Source: Dow Jones and Company, Inc. 6

Screening: Common Shared Values 7

Key Characteristics of Islamic and Ethical Funds Clear definition of action limits Faith-based rules Supervisory Committee Sector Exclusion Best-In-Class Environmental filters Human rights Transparent corporate practice Restriction on investment mgt Financial screens Islamic YES YES YES YES NO NO NO NO YES YES Ethical NO NO NO YES YES YES YES YES NO NO The Performance of Islamic Equity Funds, Falaika 28/05/2008 8

Trends: Regional Champions Regional Champions emerging Islamic Mega Bank: Shaikh Saleh Kamel, chairman of Al Baraka Banking Group, to launch the world's biggest Islamic bank before the end of the year, with an initial public offering of $3 billion Al Baraka Banking Group will launch Islamic Banking in France NBK to launch a private banking arm in Switzerland Al Salam Bank and Bahrain Saudi Bank to merge creating a bank with a market value of USD 400 million Emergence of International Financial Centers DIFC MIFC BFH QFC 9

Trends: Global and Regional Brands Islamic Banking: Takaful: HSBC RBS Standard Chartered BNP Paribas Credit Agricole Aviva Zurich AIG ING Fortis Fund Managers Global Brands Deutsche Bank CAAM BNP Paribas Societé Générale Dexia ING Regional Brands Islamic Banking: DIB ADIB Al Rahji KFH Noor Takaful: Solidarity Takaful Malaysia Salama Fund Managers Shuua Capital NCB EIS 10

International activities of ING and Dexia Malaysia MENA - Malaysia Prices as of 29-Apr-2009 Fund Name ING Balanced Fund ING Dynamic Fund ING Equity Fund Unit Price (RM) Bid 1.6235 1.4744 1.6848 Offer 75% of Denizbank s shares in Turkey were purchased by Dexia for $2.43 billion 1.6235 1.4744 1.6848 ING Income Fund ING Global Equities Link Fund PB ING Baraka Commodities Fund PB-ING All Weather Fund ING Dana Suria Ekuiti ING Asian Debt Fund ING Asian Equity Fund 1.6855 1.0357 0.9801 1.0091 1.9901 1.0469 0.1423 1.6855 - - - RBC Dexia is a custodian for Sharia Compliant funds and Takaful Companies 1.9901 1.0469 0.1423 ING International High Dividend Fund 0.3171 0.3171 11

Fortis / Maybank Takaful: Strategic alliance Maybank Fortis Etiqa joint-venture in 2001 between Malaysia s largest local bank, Maybank (70%) and Fortis (30%) in 2005, Mayban Fortis is the second largest insurer in Malaysia acquisition of Malaysia National Insurance and Takaful Nasional: rebranded as Etiqa in 2007 Etiqa will be the single master brand for all conventional and takaful businesses under Mayban Fortis to become the No.1 insurer in Malaysia by 2009. Etiqa is a leading provider of takaful products in Malaysia with a market share of 54 per cent in 2006. It is also ranked second and third in the life and general insurance businesses respectively. 12

Contents 1. Overview of Islamic Finance 2. Capital markets 3. Sharia Compliant Investments 4. Takaful 5. Islamic Finance Challenges 6. Islamic Finance Opportunities 7. Conclusion 13

Capital Markets overview Islamic Finance Islamic Fund Management Takaful (Insurance) Sukuk (Bonds) Islamic Banking Capital Markets Commercial Banking 14

Islamic Banking and Finance: Major Instruments 15

Islamic Banking and Finance: Major Instruments Source: Pricewaterhousecoopers 16

Islamic Debt like instruments Ijara Ijara is the Arabic word for rent- providing goods and services for temporary use for a fee. An ijara contract is an agreement whereas a lessor (mu ajjir) leases a physical asset or property to a lessee (musta jir) who receives the benefits associated with ownership of the asset against payment of predetermined rentals. Ijara is for a known time period. Utilized by banks to provide customers with short to medium-term financing leases The asset is owned by the bank and is leased to the user. Typically the lessor is required to obtain insurance. Source: Pricewaterhousecoopers 17

Source: Pricewaterhousecoopers 18

Islamic Banking and Finance: Major Instruments 19

Islamic Banking and Finance: Major Instruments 20

Islamic Banking and Finance: Sukuk Overview Sukuk is a Shariah compliant capital market instrument By nature, it is analogous to conventional asset backed securities (with several exceptions) Business activities/assets that would be used as underlying assets backing the Sukuk would need to be Shariah-compliant. The proceeds of the Sukuk must be used for Shariah-compliant purposes only Sukuk can be issued under various structures The primary subscriber can resell the Sukuk in the secondary market; the secondary market buyer will be the new pro-rata beneficial owner of the underlying assets Source: HSBC Analysis (17 November 2008) 21

Islamic Banking and Finance: Sukuk Overview Sukuk vs. Conventional Bond Parameter The Issuer Investor Base Base Administrative Cost Cost Financing Cost Cost Islamic A Sukuk issuer shall be engaged in business activities which are permissible under Shariah Sukuk issues enjoy a wider investor base from both sets of investors Islamic (Islamic banks, takaful cos, Islamic asset management cos) & conventional Additional fees: legal and Shariah advisory fee A larger pool of Sukuk investors creates more demand, hence may help to achieve slightly more competitive pricing (Malaysia s s experience) Conventional An issuer of conventional bonds is not limited in its business activities Conventional bonds can only tap the conventional bond investors No additional administrative costs associated with conventional bond issues A comparatively smaller pool of conventional bond investors will mean that there is less demand for the paper. Source: HSBC Analysis (17 November 2008) 22

Sukuk A significant development in Islamic Banking Corporate and Sovereign Sukuk Issuance Global Sukuk Issuance Leader issuance volume Source: Bloomberg Source: HSBC Analysis (17 November 2008) 23

Islamic Banking and Finance: Sukuk - developments Differences in underlying asset :Wide range of sukuk structures debt-based, equitybased, asset-backed structures Sophistication of structures:new innovative and complicated Sukuk especially Hybrid Widening range of Assets Tangible assets (real-estate, aircraft, production plants and machinery) IPR, cash-flows requires Shariah scholar approval Secondary Market Restrictions on trading in Debt (Malaysia vs. GCC) GCC foreign ownership and controls Market beginning to see some level of secondary trading Singapore issued in January 2009 its first sovereign Al Ijarah Sukuk worth $134m to attract petro dollar investment and promote Islamic finance in Southeast Asia's financial capital. Comments Sector Country Sukuk Predominately driven by and distributed into the local Islamic accounts with some additional follow-on demand from Asian and European Islamic funds Middle East (60%) Europe (25%) Asia (15%) Banks (80%) Funds (15%) Other (5%) Source: HSBC Analysis (17 November 2008) 24

Islamic Banking and Finance: Sukuk - developments Singapore issued its first sovereign Al Ijarah Sukuk worth $134m in January 2009 Indonesia offered ist second sukuk in 2009 Malaysia established Financial Guarantee Institution The Islamic Development Bank (IDB) to issue a US$500m global Sukuk BNP Paribas on behalf of Darahim Capital of Bahrain issued a US$40m Darahim Sukuk Basket - a 3-year Note (January 2009) 25

Islamic Banking and Finance: Sukuk - developments UK Budget provisions facilitating sukuk issuance. Turkish and Jordan government paves the way for the issuance of theirs debut sovereign Sukuk. Hong Kong to facilitate tax neutrality between Islamic financial products and equivalent conventional ones. According to the Oliver Wyman 2009 Report Next Chapter in Islamic Finance, Exponential growth in Islamic Finance expected to reach $1,200 billion in 2012. 26

Contents 1. Overview of Islamic Finance 2. Capital markets 3. Sharia Compliant Investments 4. Takaful 5. Islamic Finance Challenges 6. Islamic Finance Opportunities 7. Conclusion 27

Islamic Banking and Finance: the Funds The mandates for Islamic funds are widening and becoming more global. In 2002, 45 % of Islamic funds were mandated to Asian securities, whilst 32 % more were focused on GCC regional securities. In 2007, 33 % of Islamic funds ran Asian mandates of which only 24 % were GCC funds. As research and analysis has widened and the index providers have started to create new series and subsets of Shariah compliant indices, so other markets come into play In 2007, 2 % of Islamic funds were Emerging Market funds. 28

Sharia Compliant Mutual Funds Improved coverage across asset classes and geographical mandates: 2008: over 500 Sharia compliant funds in the world Forecast: the number will reach 1,000 funds by 2010, CAGR of 24 % for the period 2007 to 2010. Equities remains dominant: allocation of 52 % for the Sharia compliant universe ( 42 % in conventional universe) Fixed income is underdeveloped: 7% for the Sharia universe (22 % in conventional universe) 29

Sharia Compliant Mutual Funds promoters/managers Regional International 30

Contents 1. Overview of Islamic Finance 2. Capital markets 3. Sharia Compliant Investments 4. Takaful 5. Islamic Finance Challenges 6. Islamic Finance Opportunities 7. Conclusion 31

Definition of Bancatakaful «Bancatakaful is defined as the delivery and distribution of a suitable range of tailored bankable protection and long term savings and pension products designed to meet the lifecycle needs of the customer base of a bank or other financial institution.» ANNUITIES LIFESTYLE SPEND RETIREMENT PLANS LIFE INSURANCES Customer Life Cycle Demand Driven STUDENT LOANS CAR LOANS SAVINGS MORTGAGES 32

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Growth drivers In some countries with majority Muslim populations (Turkey, Egypt, Pakistan, Indonesia) the takaful market is at an embryonic stage. Untapped markets: insurance penetration is below 2% of GDP in the Middle East Region The global takaful industry is growing at 20% per year, far outstripping the 2.5% annual growth for conventional insurance premiums Moody s has predicted that global takaful premiums will rise to $7bn by 2015. Source: PWC, Takaful: Growth opportunities in a dynamic market* 2008 35

Untapped market potential Potential customer base: world s 1.5 billion Muslims Bulk of the world s Muslim population is young: 60% of the global Muslim population is under 25 years of age. The potential to be a customer for 40 years or more. Takaful products must be price competitive with conventional insurance products; Takaful is inherently ethical and is obliged to invest in sustainable investments. Further, it distributes the annual retakaful surplus back to the policyholders. Source: PWC, Takaful: Growth opportunities in a dynamic market* 2008 36

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Contents 1. Overview of Islamic Finance 2. Capital markets 3. Sharia Compliant Investments 4. Takaful 5. Islamic Finance Challenges 6. Islamic Finance Opportunities 7. Conclusion 38

Islamic Banking and Finance Challenges Pre global crisis Product Innovation Cross Border distribution Corporate Governance Global Sharia Standards Differentiated customer service 39

Islamic Banking and Finance Challenges Post Global crisis Funding costs expected to rise, liquidity to shrink Regulator are expected to introduce tougher consumer lending guidelines Retail lending volumes are expected to slow down even temporarily as banks adjust to new realities Source WIBCR 2008-209 McKinsey 40

Contents 1. Overview of Islamic Finance 2. Capital markets 3. Sharia Compliant Investments 4. Takaful 5. Islamic Finance Challenges 6. Islamic Finance Opportunities 7. Conclusion 41

What s driving the demand? As far as the Sukuk market is concerned, Moodys expect more (August 2008 Islamic Finance Notable Trends): Complexity and diversity Issuance volumes and widening gaps in terms of issuer creditworthiness Securitisation, structuring and subordination Liquidity 42

What s driving the demand? As far as IFIs are concerned, Moodys expect more (August 2008 Islamic Finance Notable Trends): Geographic diversification Operating diversification New entrants and competition De-correlation with oil prices 43

What s driving the demand? Product penetrations are low and indicate sizeable headroom for growth GCC population is still young with sizeable underserved segments Customers are seeking more tailored segmented proposition but banks are currently fosuced on a few Beyond topline, banks have opportunities to improve profitability through other efficiency levers Source WIBCR 2008-209 McKinsey 44

Contents 1. Overview of Islamic Finance 2. Capital markets 3. Sharia Compliant Investments 4. Takaful 5. Islamic Finance Challenges 6. Islamic Finance Opportunities 7. Conclusion 45

Notable Trends There are many reasons why new Islamic financial institutions (IFIs) have been mushrooming across the board: i) booming and profitable market naturally attracts new entrants because excess demand needs to meet additional supply; ii) retail banking in the Middle East was discovered in the 1990s and there's still a lot to do, where IFIs can offer attractive solutions; iii) governments have been very supportive of the Islamic financial industry. Asset-backed, infrastructure, and project finance is naturally in line with the principle of Islamic finance, just like mortgage lending. 46

Overview of the Global Islamic Market Islamic Financial Marketplace Sources of Funds Islamic banks have EU footprint through UK More than two thirds of Islamic funds are from the Middle East SE Asian Islamic Marketplace experienced rapid expansion 1.3 billion Muslims (20% of population) Fastest growing and one of the most active religions Source: 47

Islamic Banking and Finance: Fast track growth in Europe Islamic retail products appeared in the UK in the 1990s In 2009, with over $18 billion in Shariah compliant assets The UK comes 8th in The Banker s league table of Islamic assets worldwide In 2009, the UK hosts: 5 Islamic banks: (Islamic Bank of London and the Middle East (BLME) will focus on London Stock Exchange listing in 2010; Islamic Bank of Britain,...) over 20 conventional banks with Islamic windows, 1 stand-alone Shariah compliant insurance provider; at least 9 fund managers providing opportunities for investment in Shariah compliant funds 1 Shariah compliant hedge fund manager; the exchange upon which almost half of all global sukuk by value are listed 48

Europe: Investment and Retail banks in progress 3 Middle East banks are submitting their applications to the French authorities: the Qatar Islamic Bank (QIB) the Kuwait Finance House, Al Baraka Islamic Bank, from Bahrain. Crédit Agricole and Nomura plans launching sharia compliant funds domiciled in Luxembourg. Société Générale has done a couple of sharia compliant products in Reunion BNP Paribas has a long standing presence in Bahrain and plans importing its investment banking experience into the French market 49

Islamic Banking and Finance: Fast track growth in Europe Example of cooperation between Luxembourg and the GCC region In January 2009, Deutsche Bank launched Al Mi yar, a first-of-its-kind platform aimed at facilitating the issuance of Shariah compliant securities. The idea of Al Mi yar came about due to the Islamic investment space still being undersupplied, let alone underdeveloped. Domiciled in Luxembourg,the platform was developed by DB with Luxembourg Financial Group as its Shariah investment manager and DB s Trust & Securities Services group providing the settlement framework. 50

Luxembourg attractive to institutional investors The Luxembourg Stock Exchange was the first European stock exchange to enter the sukuk market, having listed sukuk since 2002. In September 2008, 14 sukuk with a combined value of USD 5.5 billion were listed and traded on the Luxembourg Stock Exchange. In September 2008 there were 31 shariah compliant investment funds held in 17 Luxembourg domiciled investment vehicles. Several large funds are in the process of being launched. Luxembourg is recognised globally as a world class financial centre; it is the second largest investment fund centre in the world after the Unites States, with almost EUR 2 billion under management. 51

Sample of Sharia Compliant funds domiciled in Luxembourg 52

Conclusion joint ventures/strategic alliances with more experienced GCC operators/providers European FIs like BNP, Credit Agricole, DB moving in to the regional GCC and SE Asian Sharia compliant mkts. NCB has an investment banking and asset mgt alliance with Goldman Sachs and plans to establish a UCITs sharia compliant funds family in Europe. Nomura has also established a Sharia compliant funds family in Lux. Increasing competition now between DIFC, Bahrain, Lux and Dublin to attract this business. Lux can offer an Islamic Banking and Fund admin experise, create a Training academy, provide Islamic research funding and facilities, legal fund structures for Private Equity, Real Estate and multi-mgr funds UNTAPPED POTENTIAL FOR ISLAMIC FINANCE IN EUROPE 53

Contact details Sohail E Jaffer s.jaffer@fwugroup.com Mobile phone: +352-621-326-495 Mr Jaffer is a Partner, Head of International Business Development for white label bancatakaful and Sharia compliant investments within the FWU Group. From June 1998 until June 1999, he was Senior VP within the International Mutual Funds Group of Scudder, responsible for international product development. From January 1989 until May 1998, he was VP with Citibank London with the Financial Institutions Group responsible for structured products including alternative investments until 1996, then joined Citibank s Alternative Investment Strategies (AIS) Group as Director and was also a member of Citi s Hedge Funds Policy and Strategy Committee. Mr Jaffer is currently a Regional Advisory Council Member (EMEA) of the Alternative Investment Management Association (AIMA), was a Council member of AIMA for the period 2001 to September 2008 and past Chairman for the period 1997 to 2000. He has written extensively on alternative investments and has edited several Euromoney publications on hedge funds, multi-manager strategies, 4 Islamic books on retail banking, asset management, insurance (takaful), wealth management and a recent CPI publication on investing in the GCC markets. He is also a member of ALFI s Asset Management Advisory Committee, Middle East working group and of their Hedge Fund Committee. He is also a member of MIFC's Strategic Focus Group (SFG). MIFC is the Malaysia International Islamic Finance Centre. 54