Once again rising to prominence at a time when the dominance of conventional financial markets has been shaken by the global economic crisis, developments over the past few years have allowed Islamic finance to blossom into a recognised alternative market for property investments. The financial meltdown has served as a useful reminder of the attractiveness of what should be a safer, more stable alternative to conventional financial models, because issues such as excessive leverage are not allowed to play any part in a Shari’a-compliant product.
Although the biggest opportunities lie within the oil and gas rich nations of the Gulf region, Malaysia has made much of the early running in developing investment-grade Islamic products, including Islamic real estate investment trusts (REITs) in the country. According to DH Flinders, an Asia-Pacific corporate advisory practice that focuses on real estate, financial services, and small capital sectors, Malaysia’s early actions have proved vital to its current status.
Executive director of the group, Stephen Hawkins, says that there is already a foundation in place with Shari’a law and an awareness of Islamic REITs. “Malaysia has Shari’a guidelines and Shari’a REIT guidelines, so there’s already a formal structure that provides fund managers and operators a structured environment to work within,” Hawkins says of the country’s structure. “It also provides the regulators with an environment to regulate and investors will be able to see clearly how things will be structured and run in this market,” he adds.
Guidelines for Islamic REITs were laid down by the Malaysian government as long ago as November 2005 through the Securities Commission (SC), which made Malaysia the first jurisdiction to introduce such measures. There are now two Islamic REITs in a total market of 13 REITs in the country. “Malaysia has an advantage over the rest of the region because it has taken the time to put those guidelines in place,” says Hawkins.
Yet on a global level, he believes that there is still a large, untapped market for Islamic REITs which is yet to be exploited, especially given the first signs of property recovery in some of the worst-hit Middle Eastern markets.
“From an international perspective, there are lots of Shari’a investors in the Middle East that look to countries like Malaysia that have established guidelines. There’s an opportunity to provide more investment products to those investors to give them choice,” he reflects.
A key factor driving the expansion of Islamic product offerings in Malaysia has been the country’s ability to drive down the cost of structuring such products without having to sacrifice on returns. One of the active players, Deutsche Bank in Malaysia expects more products to introduce a volatility target overlay to avoid excessive risk-taking, such as by using monthly rebalancing to ensure the target volatility is maintained. Islamic credit-linked notes are also expected to play a bigger role in the overall portfolio management industry in the near future.
Singapore too has made no secret of its desire to be the principle Shari’a hub in Asia and Monetary Authority Singapore (MAS) has over the last few years facilitated the development of Islamic finance in Singapore’s financial markets. Several sizeable cross-border transactions have been achieved, including the world’s first Shari’a-compliant data centre fund (Securus Data Property Fund); the listing of the world’s largest Islamic REIT (Sabana Shari’a-Compliant REIT) on the Singapore Exchange, as well as Khazanah Nasional’s SGD1.5bn sukuk — the largest Singapore dollar sukuk to date.
The spread of Islamic finance in South-East Asia is likely to gather momentum, especially in countries such as Indonesia and Brunei, where banks are seeing increasing investor interest in Shari’a-compliant alternatives to conventional financing.
There is a big prize on offer, even given the current constraints on the market. According to consultancy Ernst & Young, global Islamic finance will hit $1.1trn in value this year, a significant jump up from $826bn in 2011. However, a closer look at recent developments reveals a mixed picture.
While the Middle East's oldest Shari’a-institution Dubai Islamic Bank (DIB) achieved a 2011 net profit of $272.7m, an increase of 27.8% on the previous year, rival Emirates Islamic Bank (EIB) lost $122m dollars in 2011, after a profit of $16.2m a year earlier. Moreover, Kuwait Finance House, which specialises in real estate financing, at home and abroad, surprised the market in late March reportedly announcing that it was divesting non-profit making operations.
Elsewhere, in October last year Dubai Bank, another Islamic lender, was taken over by the United Arab Emirates (UAE)'s largest bank, Emirates NBD, upon the orders of the Dubai government. Dubai Bank posted a net loss of $79m in 2009 and since then it has not reported figures.
The stories go on and on. Bahrain-based private equity investor Arcapita Bank, which has a range of real estate investments in Bahrain and Dubai, is working with advisers ahead of imminent debt repayments totalling $1.1bn for the Manama-based group. The Shari’a-compliant group, which has many wealthy Gulf nationals as shareholders, is in talks with a coordinating committee of lenders, including Royal Bank of Scotland (RBS), plus advisers, including accounting and consulting group PwC and law firm Clifford Chance.
Analysts are particularly concerned about the health of a number of Bahrain-based financial institutions’ health, given the rising cost of borrowing after the pro-democracy uprising damaged confidence in the economy and political stability.
Elsewhere, while Islamic financing may be finding greater acceptance it has failed to make the deep inroads in the Muslim world that were originally anticipated, thanks in part to complications around Shari’a definitions and also because of the difficult investment market. While Ernst and Young expects Islamic finance to keep growing at a per annum rate of circa 15%, many Islamic retail investors enjoy much smaller growth rates on their Shari’a-compliant portfolios than they had expected or had been used to in the past.
Indeed, although the breadth and cost-efficiency of Shari’a-compliant structured products have greatly improved, they are sorely missing a standardised platform and as a result a fragmented and relatively young market has been burdened by the problem that compliance rules often differ from region to region.
This confusion is hampering market development and restricting the range of Shari’a-compliant platforms that can be used to create structured products.
One of the major challenges the Islamic industry faces is a lack of consensus regarding the interpretation and application of Shari’a principles, as well as market participants' ongoing preference for bespoke contracts over standardised versions. The lack of a ‘doctrine of precedent’ with regard to scholarly decisions has also led to regular inconsistencies in interpretation, and subsequent delays have been caused by ensuring Shari’a consistency and approvals.
In Malaysia, one of the least restrictive Islamic markets, the bai’ ’inah concept allows investors to buy and sell the same asset and create products which would be considered interest-bearing in the Middle East, where interpretation of the compliance strictures is far more rigorous. However, despite its proactive stance, Malaysia remains predominantly a domestic market which is denominated in ringgit, limiting the interest from outside investors, while Middle East products are more usually US dollar denominated and offer the potential for broader appeal.
Simon Gray, director for supervision at the Dubai Financial Services Authority in Dubai, reflects: "The scope for growth is tremendous, but much will depend on how Islamic finance copes with its own infrastructure. One hoped that Islamic finance would come into its own after the global financial crisis, but it has yet to make a massive impact."
A more integrated infrastructure between Islamic and conventional markets is developing elsewhere in Asia, with countries such as Singapore paving the way for an Islamic finance sector based on a single licensing and supervisory framework for both conventional and Islamic finance.
A spokesperson for MAS explains: "The Singapore Islamic finance sector has achieved several milestones in recent years as a result of the authorities working closely with the industry. These include the launch of the FTSE SGX Asia 100 Shari’a Index, the FTSE Japan Shari’a Exchange Traded Fund on the Singapore Exchange and the listing of the world's first Shari’a-compliant Industrial real estate investment trust. The prospects for the industry are good as more institutions consider Shari’a-compliant structures."
There are also signs that other corporates are becoming more interested in Islamic-backed real estate vehicles across the MENA region. In March of this year, Tecom Investments, a diversified conglomerate and a member of Dubai Holding, paid AED170m for a 25% stake in Emirates Real Estate Investment Trust “in addition to liquidity for pursuing new development opportunities," it said in a statement.
Emirates REIT—the first REIT to be established in the UAE—was created in November 2010 with Dubai Islamic Bank and Eiffel Management and is a Shari’a-compliant real estate investment vehicle. Tecom CEO Abdul Latif Al Mulla says of the deal: "While we will benefit from the liquidity and exposure to increasing values in a resurgent local property market, we will also help Emirates REIT take a step forward in its vision of launching an IPO. It is essential that developers come forward to form strategic partnerships with Emirates REIT to lay the foundation for a professionally managed real estate market in the UAE."
Hawkins stresses the need for a global market where real assets have regained popularity: “One of the underlying principles of Islamic finance is the need for an underlying asset, something real and tangible as opposed to bundled complex derivatives and other such instruments, the misuse of which caused the global financial crisis in the first place. Therefore, more tangible physical real estate, such as a building, has become more attractive to investors.”
Yet to exploit that change in priorities fully, Islamic financing needs to create a more transparent assessment methodology and agree to a more uniform scholarly approach, which will allow products to be delivered to market more quickly. Despite the political turbulence of the Arab Spring and the deep fall in valuations across some of MENA’s most over-inflated nations, there is a sense that the region is in a comeback cycle. If Islamic financing wants to be the dominant player in any resurgence those holding the reins need to act quickly.
