Islamic wealth management, avoiding future crises, Moody's says Islamic finance could reach $5 trillion

The Islamic wealth management report from Bank Sarasin raises one point which I believe is true across the Islamic finance industry: the diversification of assets is not nearly as expansive as in conventional finance and in many cases leaves investors with too much exposure to real estate. It also is too focused on transaction-based compensation for Islamic bankers. The emphasis is placed on deals and there is too little focus (and compensation based on) the long term needs of Muslim investors. As an asset manager myself, I have watched the Islamic finance industry expand, particularly in the issuance of sukuk, with much of the focus on new financial products that expand the financial structures used in conventional finance. That is not necessarily problematic because good diversification relies on different asset classes from which investors can choose. However, when the focus is on creating a diverse set of structures and not on the types of investments, there will be an unmet need. For example, the equity asset class has been the easy part with Islamic indexes being around for over 10 years now. However, there remains a shortage of fixed income-like products that is only partially filled by sukuk (for example, there is still no fixed income-substitute within the United States). A lot of the other structures being created have still focused on property finance. There can be many different ways created to provide investors with exposure to real estate markets, but that still only addresses one asset class. It may create diversification (e.g. geographical) within that asset class, but a focus on real estate markets as a predominant investment area leaves asset managers struggling to create a diversified portfolio for Muslim clients (whether or not they are exclusively focused on Muslim clients). Perhaps the (nearly) global property bust will will make other areas more attractive, but it may just create a new area where activity is concentrated. That would be a shame and would harm the investors that are the source for the Islamic finance business.

The CEO of Fajr Capital, Iqbal Khan, said that Malaysia can provide an example for reform within the Islamic finance industry, particularly to separate the utilitarian and financial intermediation roles to prevent the problems that arose during the credit crisis. Mr. Khan said that there should be a separation to prevent the need in a future crisis for Islamic investment banks to be bailed out the government to preserve the basic payment systems within the banking system. Those payment systems could then be backstopped if necessary but ""Everything else - Mudharabah-based, asset-based, unit trust and investment fund - goes into separate business. These two, never the twain shall meet, they have to be kept separate". I believe he is absolutely correct. The flaw with the universal banking model and allowing the investment banks and commercial banks to merge (in the U.S., this was through the Gramm-Leach-Bliley Act) forced the government to bail out all or none of the banks and the combination of the two into large financial holding companies meant that in order to keep the payment systems intact, the investment banks had to be bailed out lest their losses endanger the institutions as a whole, which led to the crisis within the 'boring' areas of the credit markets unrelated to the investment banks' operations.

Moody's says that Islamic finance assets could grow to $5 trillion without providing a date by which this could be reached. They said assets were $950 billion in 2009, which is higher than previous estimates from other groups which were in the range of $800-$850 billion. Moody's says that Shari'ah-compliant derivatives, if 'employed with care', could provide a useful purpose for hedging purposes. The recent IIFM master agreement on Islamic derivatives includes a requirement that they only be used for hedging, not speculation. Moody's VP and Senior Credit Officer Anwar Hassoune cautioned that "IFIs aim to utilize derivative instruments to hedge against risk and to improve risk monitoring practices. However they are keen to do so in a Sharia-compliant manner, rather than imitating conventional derivative instruments, in order to avoid losing their special status as Sharia-compliant banks, which makes them very attractive to a large population of Muslims." Moody's warns that IFIs have weak asset-liability, investment, and liquidity risk management. An article published by the Wharton School at the University of Pennsylvania discusses the role of ratings agencies within the Islamic finance industry, specifically within the sukuk market.

Other News

• An article in the Financial Post (Canada) discusses the recent UFANA conference in Toronto (at which I was a speaker).
  
• $4.67 billion in sukuk were issued in the first quarter of 2010 according to Zawya, compared with $0.63 billion in the same period in 2009. Malaysian issuers accounted for 53% of all new issues, Indonesia for 33.5% and Saudi Arabia with 9.6% from the Dar Al Arkan sukuk of $450 million. Malaysia is planning a US dollar-denominated sukuk.
  
• An opinion column in the Kuwait Times asks whether Islamic banking has enough focus on providing a competitive and quality product to ordinary people.
  
• A GCC-based VP at iShares offers an interesting view of the current state of Islamic indices.
  
• Just as private equity has faced significant headwinds over the past 2 years, so has the Islamic private equity industry and things are just starting to get back to doing deals.
  
• The New York City Bar is planning a seminar on Islamic law including a portion of the seminar covering Islamic finance.
  
• Indonesia's efforts to expand the share of its banking system made up by Islamic banks is described in an article from the Oxford Business Group. The government is planning a 5 trillion rupiah sukuk (555 million) issue on April 13.
  
• Standard Chartered's Islamic finance window has avoided Islamic hedge funds based on a concern that the arbun structure used to create short-selling-equivalent has not been widely accepted among Shari'ah scholars.
  
• An article describes what AAOIFI does and what it is working on now.
  
• Sudan, which has been largely cut off from capital markets since US economic sanctions were imposed in 2007 because of the genocide in Darfur, is issuing $300 million in sukuk.