Islamic finance - An opportunity for Malta?
Until a few years ago Islamic finance, also known as sharia-compliant finance, was considered as a relatively niche financial market that was of interest only to Muslim investors who required a market that conforms to the requirements of sharia...
Until a few years ago Islamic finance, also known as sharia-compliant finance, was considered as a relatively niche financial market that was of interest only to Muslim investors who required a market that conforms to the requirements of sharia law.
These requirements include a ban of lending at interest (riba), the necessity for certainty in financial dealings (gharar) and the prohibition of investment in activities that are prohibited by Islam, such as gambling and pornography.
Naturally, schemes were devised to circumvent some of these restrictions. A typical transaction aimed at the avoidance of the prohibition of interest works as follows - person A seeking finance from a bank in order to purchase goods from person B will enter into a contract with the bank whereby A will bind himself to purchase such goods from the bank at a fixed price and at a fixed date, if the bank purchases the goods from B. Naturally, the pre-determined profit on the deal will be the equivalent of the bank's interest on the transaction.
Over the last few years, Islamic finance has grown exponentially, and is today a significant financial market offering increasingly sophisticated and varied financial products that are attracting interest from non-Muslim investors.
I actually developed an interest in sharia-compliant investment while researching the subject of socially responsible investment, also known as ethical investment, as part of a thesis about the human rights responsibilities of multinationals.
It is interesting to note that non-Muslim investors are increasingly attracted to sharia-compliant investment as this is perceived as guaranteeing that the particular financial product will not be tainted by activities that may be repugnant to the investor.
The range of products has increased rapidly, and sukuk, or Islamic trust certificates, have been developed over the last few years in order to offer a product that, while being sharia-compliant, offers a similar performance to fixed income securities. Saudi Arabia has passed a law regulating sukuk in 2006.
However, Islamic finance has always been perceived as lacking a satisfactory regulatory framework, and this is a major obstacle to the global growth of this sector. Islamic scholars are required to determine whether a particular transaction is sharia-compliant or not, and these scholars do not always agree with each other. Critics such as Tarek el Diwany have also pointed out that the current system of leading Islamic scholars being paid considerable amounts of money by financial institutions in order to give religious judgments on products offered by those same institutions may lead to a conflict of interest and other critics have voiced concerns about the risks of insider trading.
There have been recent developments in this regard and the Islamic Financial Services Board (IFSB) was set up in Kuala Lumpur and commenced operations in 2003 as an international standard-setting body for Islamic finance. The board consists of 110 members including the World Bank and the IMF. In December 2005, the council of the IFSB adopted two standards: the guiding principles of risk management; and capital adequacy standard for institutions (other than insurance institutions) offering only Islamic financial services.
The City of London has rapidly become a leading centre for sharia-compliant products and London is now offering the first internationally recognised qualification in Islamic finance.
In 2005, the Dubai International Financial Exchange (DIFX) was the first to include sharia-compliant products within a regulatory framework based on international standards and the Malaysian government has created an academy in order to study sharia-compliant financial law.
Finally, one must consider whether there are any opportunities for Malta in this regard. The amounts of money involved are huge, even if one allows for the fact that there are different estimates in this regard. One of the more recent estimates is that the market currently includes assets in excess of $400 billion, and according to Standard and Poor's rating services the market has the potential to exceed $4 trillion.
Although not a Muslim country, Malta is viewed favourably by most, if not all, Muslim countries and is therefore theoretically ideally located to offer a EU jurisdiction to sharia-compliant investments with considerably lower costs than those incurred in London. The Malta Financial Services Authority has an excellent track record in creating a regulatory structure for new financial products such as trusts, professional investment funds and protected cell structures, and our professional workforce is also quick to acquire specialised knowledge in new fields.
It is probably too early to move in this direction as yet, due to the high level of uncertainty that still surrounds sharia-compliant investments. It may make sense to wait for international codification of regulatory, corporate governance and prevention of money laundering issues related to sharia-compliant investment before designing a Maltese legal structure to accommodate such products but there is a strong case for preparatory work to be done which will allow Malta to enter the market as early as possible and thus gain a competitive advantage over other jurisdictions, as we have done on other occasions.
Malta will also require the input of Muslim scholars and advisers with a thorough knowledge of sharia law working together with local professionals with an understanding of Western financial systems.
• Dr Muscat Azzopardi is a partner at Muscat Azzopardi and Associates, Advocates, and may be contacted on jamesma@ma-advocates.com.
These requirements include a ban of lending at interest (riba), the necessity for certainty in financial dealings (gharar) and the prohibition of investment in activities that are prohibited by Islam, such as gambling and pornography.
Naturally, schemes were devised to circumvent some of these restrictions. A typical transaction aimed at the avoidance of the prohibition of interest works as follows - person A seeking finance from a bank in order to purchase goods from person B will enter into a contract with the bank whereby A will bind himself to purchase such goods from the bank at a fixed price and at a fixed date, if the bank purchases the goods from B. Naturally, the pre-determined profit on the deal will be the equivalent of the bank's interest on the transaction.
Over the last few years, Islamic finance has grown exponentially, and is today a significant financial market offering increasingly sophisticated and varied financial products that are attracting interest from non-Muslim investors.
I actually developed an interest in sharia-compliant investment while researching the subject of socially responsible investment, also known as ethical investment, as part of a thesis about the human rights responsibilities of multinationals.
It is interesting to note that non-Muslim investors are increasingly attracted to sharia-compliant investment as this is perceived as guaranteeing that the particular financial product will not be tainted by activities that may be repugnant to the investor.
The range of products has increased rapidly, and sukuk, or Islamic trust certificates, have been developed over the last few years in order to offer a product that, while being sharia-compliant, offers a similar performance to fixed income securities. Saudi Arabia has passed a law regulating sukuk in 2006.
However, Islamic finance has always been perceived as lacking a satisfactory regulatory framework, and this is a major obstacle to the global growth of this sector. Islamic scholars are required to determine whether a particular transaction is sharia-compliant or not, and these scholars do not always agree with each other. Critics such as Tarek el Diwany have also pointed out that the current system of leading Islamic scholars being paid considerable amounts of money by financial institutions in order to give religious judgments on products offered by those same institutions may lead to a conflict of interest and other critics have voiced concerns about the risks of insider trading.
There have been recent developments in this regard and the Islamic Financial Services Board (IFSB) was set up in Kuala Lumpur and commenced operations in 2003 as an international standard-setting body for Islamic finance. The board consists of 110 members including the World Bank and the IMF. In December 2005, the council of the IFSB adopted two standards: the guiding principles of risk management; and capital adequacy standard for institutions (other than insurance institutions) offering only Islamic financial services.
The City of London has rapidly become a leading centre for sharia-compliant products and London is now offering the first internationally recognised qualification in Islamic finance.
In 2005, the Dubai International Financial Exchange (DIFX) was the first to include sharia-compliant products within a regulatory framework based on international standards and the Malaysian government has created an academy in order to study sharia-compliant financial law.
Finally, one must consider whether there are any opportunities for Malta in this regard. The amounts of money involved are huge, even if one allows for the fact that there are different estimates in this regard. One of the more recent estimates is that the market currently includes assets in excess of $400 billion, and according to Standard and Poor's rating services the market has the potential to exceed $4 trillion.
Although not a Muslim country, Malta is viewed favourably by most, if not all, Muslim countries and is therefore theoretically ideally located to offer a EU jurisdiction to sharia-compliant investments with considerably lower costs than those incurred in London. The Malta Financial Services Authority has an excellent track record in creating a regulatory structure for new financial products such as trusts, professional investment funds and protected cell structures, and our professional workforce is also quick to acquire specialised knowledge in new fields.
It is probably too early to move in this direction as yet, due to the high level of uncertainty that still surrounds sharia-compliant investments. It may make sense to wait for international codification of regulatory, corporate governance and prevention of money laundering issues related to sharia-compliant investment before designing a Maltese legal structure to accommodate such products but there is a strong case for preparatory work to be done which will allow Malta to enter the market as early as possible and thus gain a competitive advantage over other jurisdictions, as we have done on other occasions.
Malta will also require the input of Muslim scholars and advisers with a thorough knowledge of sharia law working together with local professionals with an understanding of Western financial systems.
• Dr Muscat Azzopardi is a partner at Muscat Azzopardi and Associates, Advocates, and may be contacted on jamesma@ma-advocates.com.