High finance

Amid continuing turmoil in global credit markets, Islamic finance is going from strength to strength. Arabian Business examines the rise of Sharia investment, and analyses the challenges ahead.

With the credit crunch and markets in the West tightening their belts, more and more attention is becoming focused on the Middle East as a source of potential revenue and growth.

And with a host of Sharia-compliant products on offer, both local and international finance houses are scrambling to secure their slice of a lucrative market.

"Islamic finance is kind of like going fishing and having a net which is able to catch all kinds of fish - if you're going fishing in the Middle East and you have Sharia-compliant financing prospects, then a lot more people will likely be able to take advantage of your products," says Oliver Agha, head of Islamic Finance at DLA Piper, the world's largest law firm.

If you've only got conventional financing products then you're limiting your business. It's like appealing to a larger audience, and from a very simple commercial perspective, that's why it's becoming attractive.

Islamic finance has grown by between 15 and 20% in each of the past three years, and since the inception of modern Islamic banking, the number and reach of Islamic financial institutions worldwide has risen from one institution in one country in 1975, to more than 300 institutions operating in more than 75 countries today.

Although Islamic banks are concentrated in the Middle East and southeast Asia, they are also niche players in Europe and the US. Islamic banking assets and assets under management now exceed US$1.7 trillion, and the Islamic finance sector is expected to reach US$2.7 trillion by 2010.

"Project financings that previously were done purely conventionally are now beginning to be done on an Islamic basis, sometimes partially and sometimes wholly," says Agha.

Across the board you're seeing Islamic financing coming into the fray - insurance for instance has grown tremendously and the premiums now are at US$2bn to US$3bn, and we expect that to go up to US$10bn in a decade.

"So in all respects as the market develops and matures, we're seeing a growth that's pretty substantial."

While Islamic finance is still a nascent industry, with a small share of the global market - about 1% - the sector is benefiting from a number of favourable structural and cyclical drivers: strong growth in the GCC and emerging market economies of Asia, positive demographics of young and rapidly growing populations, and a shift of preferences of savers and investors towards Islamic finance in Muslim countries.

There are also handsome returns to be had.

"We have found that Sharia finance doesn't just help you pick good sectors from the broad universe, but it actually helps you move a step further and pick good companies from within those sectors," Jahangir Aka, senior executive officer for SEI in the Middle East, and author of a new report entitled Sharia Investing: Beating the Credit Crunch, tells Arabian Business.

In the report released last week, The New York-based investment operations solutions firm emphasises the consistent outperformance of the MSCI World Index by the Dow Jones Islamic Developed World Index.

"Sharia-compliant structures have many screens and requirements that should be recognised as contributing to this outperformance," the report reads. "The oft-quoted aversion to the financial services sector is only one of those."

"It is a much tighter, far more regulated market [than conventional finance]," says Aka. "There are so many screens and filters, and if you're applying your Sharia guidelines and principles then you have to be doing a very, very high level of due diligence."

In addition, the leverage component of Sharia finance has played an important role in assuring the security of investments. The broad Islamic screen on equities demands low-leveraged companies, with acceptable debt-to-revenue ratio levels below 33%.

"As a result, what we have ended up picking, in terms of stocks, have actually been far, far better performers," Aka continues. "We've been managing mandates for different religions for a while, and we have been pleasantly surprised by the performance of Sharia-compliant structures.

Despite the success stories, there are challenges ahead for the Sharia finance industry.
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