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January 14, 2008

The crescent moon is rising

By Nicholas Moody

Islamic finance is becoming increasingly familiar to non-Muslim ears across the world. Nicholas Moody speaks with several industry leaders on the current state of the business and finds a sector where demand for Sharia-specific knowledge is increasing.

Islamic finance has been gaining increasing exposure as an emerging global industry. But putting an accurate figure on the industry’s size is one area that is open to debate. A report from London-based lobby group International Financial Services, released this month, reveals the global market for Islamic financial services measured by Sharia-compliant assets is estimated to have reached $531 billion by the end of 2006, having grown by more than 10 percent a year from about $150 billion in the mid-1990s.

Ernst & Young (E&Y) Islamic finance director Ken Eglinton quotes a Standard & Poor’s report that estimated Islamic global assets are worth $500 billion with annual growth of between 10 percent and 15 percent. Eglinton notes that the report was released before last year’s credit crunch and suspects the figures would be smaller if the survey was conducted today.

Conservative estimates KPMG’s London-based Islamic financing and investment advisory director, Darshan Bijur, says the general estimates of the size of the global Islamic finance industry are conservative. He estimates the Middle East has around $2 trillion in sovereign wealth – although not all Islamic. In banking terms, he estimates around 45 percent of all banking in the Middle East can be termed Islamic, resulting in Islamic global assets that are closer to $1 trillion, and that the total business will grow to about $5 trillion in 25 years. Bijur bases this estimate on the increasing move by banks in the Middle East to become Sharia compliant and the interest in Islamic finance from large conventional banks.

“Very few people realise that 25 percent of the world’s population is Muslim and it’s true that a vast majority are very poor, but a small minority are exceedingly wealthy,” Bijur says. “Conceivably, you could say 25 years from now 20 percent of all banking in the world will be Islamic banking, in which case it’s a huge business – there’s no reason it should not be.”

The value of global advisory services for professional firms from Islamic finance is estimated to be about $500 million and growing at 10 percent to 20 percent a year. Again, Bijur questions these projections. “If it is purely auditing and tax, advisory as in internal audit, anti-money laundering and technology advice – that’s probably right. But the moment you bring in investment banking work, which is the kind of work that we do as well, for instance corporate finance and transaction support, then [the value] explodes. So $500 million is a fairly conservative estimate of what the accounting profession should be making out of this phenomenon, and it’s only likely to continue increasing rapidly,” he says.

Eglinton says Middle East oil wealth is the big driver in the Islamic finance market. “[There are] huge amounts of money from the Middle East trying to find productive homes, trying to find a diversification of risk. So there is a big appetite for OECD [Organisation for Economic Co-operation and Development] assets to be packaged up in ways that they can invest in. There’s a huge impetus to finding valuable investment opportunities,” he says.

Rising demand for qualifications

The growing push by Islamic and conventional finance institutions into this new area has created a strong demand for Islam-specific qualifications. Mohd Daud Bakar is chief executive of the International Institute of Islamic Finance, a Malaysia-based professional development business. The institute trains lawyers, bankers and accountants in Islam-specific topics, including accounting, auditing, Sharia principles, legal and risk management.

Bakar says demand comes from all over the world and has risen around 30 percent since last year. “Interestingly, the demand is not only from the new entrants into the industry like Hong Kong, Singapore and the UK but also from the established countries like Bahrain, Malaysia and Dubai,” he says.

Bakar points out that Islamic finance is multi-disciplinary: a commercial product based on religious principles. “For the product to be commercially viable it has to satisfy the legal requirement, the accounting treatment, the auditing standards plus the Sharia principle at the end of the day,” he says.

Bakar helped the Chartered Institute of Management Accountants (CIMA) develop its global qualification in Islamic finance in the UK recently. CIMA director of education Robert Jelly said the institute developed the qualification in recognition of demand in the UK and from the global business community.

The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) is an international body that prepares accounting, auditing, governance, ethics and Sharia standards for Islamic financial institutions and the industry. The Bahrain-based organisation was established in 1991 and now has more than 150 members. It offers two main qualifications: the Certified Islamic Professional Accountant and Certified Sharia Adviser and Auditor. It has issued 63 standards on accounting, auditing, governance, ethics and Sharia compliance since 2005.

Bakar says AAOIFI’s Islam-specific standards have been adopted in some countries such as Sudan and Bahrain, but other regions have opted for partial adoption of the standards to make them compatible with their own domestic regulations. “It is up to the regulatory authority of the country to make [the AAOIFI standards] binding and mandatory for banks and financial institutions to follow,” he says.

Financial reporting is an area that will be important for the further development of the industry. A 2007 KPMG UK report into the sector said the quality and transparency of financial reporting and disclosure in the Islamic finance industry currently “differs significantly from one regulatory jurisdiction to the next”. The report added that the people who were interviewed for the research believed that Islamic financial institutions in many countries “should have more rigour in their disclosure and financial reporting, especially to the general market”.

Malaysian base

Islamic finance activity is focused on several key regions: Malaysia; the Middle East, particularly Bahrain, Qatar, Dubai and Saudi Arabia; and, increasingly, London. Malaysia is estimated to have the largest Islamic finance industry in the world and both PricewaterhouseCoopers (PwC) and KPMG base their leaders in global Islamic finance there. PwC’s global Islamic finance leader, Mohammad Faiz Azmi, says part of the reason PwC’s Islamic leadership is based in Malaysia is that it is slightly ahead of the curve in terms of Islamic experimentation. The country’s experience of using conventional laws while operating dual economies, one Islamic and one conventional, is also seen as being more relevant to the global firm’s conventional clients, says Azmi.

Mohammed Amin, who heads PwC’s London Islamic practice, agrees. “Malaysia is very actively involved in Islamic finance and has been a pioneer in the industry. Malaysia is a place that has focussed on it quite a lot and it has a lot of advanced government thinking,” he says.

Although Bahrain has traditionally been a powerhouse of Islamic finance, Bijur says he can’t help but feel that the sun is setting in Bahrain and rising in Dubai. “Bahrain is stagnating and much of the growth and action is coming out of Dubai and Qatar, while Malaysia keeps pushing the Sharia boundaries,” he says.

London is increasingly becoming the focus for Islamic finance on the international stage. Eglinton, who is based in London, says he has been operating for more than ten years in the field. “What’s been interesting in this sector is how it’s changed so dramatically in the last three years. I think I’ve done more work in the last three years than I have done in the previous ten,” he says.

Islamic Finance leading countries for Sharia-compliant assets

Importance of London Bijur points out that both the Middle East and Malaysia have a strong regional focus but their industries lack international spread. “The moment any of these guys [in the Middle East and Malaysia] have to do anything cross-border, they have to be looking at London. They can’t do anything from within their regions with any other region without going via London, which works very well for London and for the profession here,” he says.

Deloitte’s Islamic finance team is led from London and the firm’s recently appointed Sharia scholar, Mufti Hassan Kaleem, says the UK city has all the advantages of a well-established finance centre: “The principles-based regulation and the human capital in the city, in addition to government initiatives, provide the key ingredients for success.”

Deloitte is the first Big Four firm to appoint a Sharia scholar but the other three networks say they have no intention of following suit. Bijur says KPMG uses Sharia scholars on much the same level. “I think the important thing to remember is that when two Islamic institutions are doing business with each other, both institutions have their own Sharia boards – almost by constitution they do. All of them have their own conscience keepers and Sharia scholars. They don’t care about what somebody else thinks, they only care about what their conscience keeper thinks. So having some consultant with an adviser is by itself not very useful,” he says.

All those interviewed by TA stress that key participants in the emerging Islamic finance sector are often non-Muslim institutions with significant capital. “We have quite a number of significant financial services clients who are not Islamic but were moving into Islamic finance. [PwC’s Global Islamic Finance Team isn’t] just aimed at the Islamic market per se but it was also aimed at servicing our existing conventional clients who were foraying into it,” Azmi says.

Some of the biggest players in Islamic finance are traditional conventional banks, which is one of the reasons the sector is well positioned for growth, says Bijur. “HSBC, Deutsche Bank, Citibank, Barclays are the big boys in the Islamic banking space, especially on the corporate and institutional level. They don’t have a stronger business on the retail level but on the corporate and institutional level they are very strong,” he says.

Eglinton says: “A lot of the conventional banks have Sharia windows. They are obviously not Sharia-compliant institutions because most of their business is completely non-Sharia, but they set up a ring-fenced division and do the business through that.”

Bright future

The Islamic finance experts all see increasing growth for the industry, although some projections are tempered. Amin says increasing economic growth among the 1.5 billion Muslims, and an increasing proportion of the financial system in the Muslim world that is becoming Sharia compliant are two significant reasons why the Sharia-compliant sector will grow.

Bijur predicts: “Proportionally, if we estimate the Islamic assets are about $1 trillion now with $500 million-ish accountancy professional fee component, ten years from now I would not be surprised if it’s for $3 to $4 trillion with corresponding size of professional fees.”

Guiding principles Islamic finance is a form of finance that is consistent with Islamic law (Sharia) and adheres to a number of key principles that include:

  • backing by a tangible asset, so as to avoid ‘speculation’ (gharar);
  • prohibition of interest payments (riba);
  • risk to be shared among participants;
  • limitations on sale of financial assets and their use as collateral; and
  • prohibition of finance for activities deemed incompatible with Sharia law (haram), eg, alcohol, conventional financial services, gambling, tobacco.

    Deloitte Sharia scholar Mufti Hassan Kaleem says it emphasises earning wealth through valid activities. He says Islamic finance is based on trading and creating valuable services and different modes of partnership. “What distinguishes Islamic finance from non-Islamic finance is that Islamic finance is always linked to genuine economic activity. It does not promote some thing which is destructive for human beings and does not create a bubble economy,” he explains.

    Source: Deloitte, International Financial Services London

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