Volume13.Issue24

Man versus machine

Man versus machine

Technology is taking over the world, and the latest developments in asset management could cast fear into the heart of even the hardiest fund manager – while at the same time ringing good news for global investors, as costs plummet with the rise of robo advisors and their online, electronic advice on asset allocation. Our cover story this week explores what the impact has been so far – and what this could mean for the slow-growing Islamic asset management industry.

Our IFN reports this week cover a diverse range of topics, from standardization, collaboration between Russia and Pakistan to UAE entities tapping the Sukuk market with the UAE hoping to draw investment by raising Islamic finance professional standards. Our in-house analysis looks at Kenya and fintech while our IFN Correspondents come to you from Bahrain, Egypt and Hong Kong and China. Features are brought to you by MARKAZ on fintech, the Islamic Corporation for the Development of the Private Sector on Suriname and Guyana and a Takaful feature by Malaysia Insurance Deposit Corporation. We also have special reports from Youssef Aboul-Naja on leasing and RHB on Islamic factoring and of course our monthly column from Daud Vicary.

I hope all our readers are enjoying a pure and productive Ramadan, and we wish you all the best with all your endeavors during this Holy Month.

Ramadan Kareem.

Sovereign Sukuk: Housing sector a boon for issuance

Over the past week, the sovereign Sukuk space was ignited by the housing sectors in both Malaysia and Saudi Arabia, with the former officially unveiling its first Sukuk paper to drive the public housing market, while the latter’s Ministry of Housing is making plans to tap into the Islamic capital markets to finance the expansion of the overall housing sector in the Kingdom. DANIAL IDRAKI brings you the usual updates.

Malaysia
The Public Sector Home Financing Board (LPPSA) last week unveiled its maiden RM25 billion (US$6.12 billion) Sukuk/bond programs, comprising an Islamic commercial paper/Islamic medium-term note program and a conventional commercial paper/medium-term note program. The first issuance is expected in July and around RM7-10 billion (US$1.71-2.45 billion) to be issued this year, an arranger confirmed with IFN. Backed by the government, the three-year programs will be issued over several tranches to finance the provision of housing loans to civil servants. AmInvestment, CIMB Bank, Maybank Investment and RHB Bank have been mandated as joint lead arrangers for the program, while Affin Hwang Investment Bank, Bank Islam and OCBC Bank Malaysia will jointly manage the transaction.

Saudi Arabia
The Ministry of Housing is considering issuing Sukuk at the end of 2017 to help fund the Kingdom’s Real Estate Development Fund, Housing Minister Majed Al Hogail said during a recent press conference. Majed noted that the fund is the largest financier for the Saudi real estate sector and has a portfolio of around SAR190 billion (US$50.63 billion).

Indonesia
In its regular issuance series, the government of Indonesia plans to raise IDR4 trillion (US$299.2 million) via the auction of its sovereign Sukuk (SPN-S 01122016 and four project-based Sukuk series) on the 14th June 2016 to finance the 2016 State Budget, according to an announcement on the Ministry of Finance’s website.

Upcoming sovereign Sukuk

Country

Amount

Expected date

Oman

TBA

Second quarter

Hong Kong

TBA

TBA

Egypt

TBA

TBA

Iran

IRR60 trillion

2016

Nigeria

TBA

TBA

Jordan

JOD175 million

TBA

Pakistan

PKR79.1 billion

TBA

Egypt

TBA

2016

Kazakhstan

TBA

2016

Kenya

TBA

2016

South Africa

TBA

2016

Bangladesh

TBA

TBA

Hong Kong

US$500 million to US$1 billion

TBA

Ningxia Hui Autonomous Region

US$1.5 billion

TBA

Senegal

TBA

TBA

Niger

XOF150 billion

TBA

Luxembourg

TBA

TBA

Tunisia

US$500 million

TBA

UAE

TBA

TBA

Shandong Province

CNY30 billion

TBA

Sindh Province

US$200 million

TBA

Kuwait

KWD1 billion

2016

Maldives

TBA

TBA

Sri Lanka

US$1 billion

TBA

Germany

US$1 billion

TBA

Company Focus: KT Portfoy gunning for growth in real estate and pension funds

KT Portfoy, the portfolio management arm of Turkey’s participation bank Kuveyt Turk, may have only begun operations in January this year, but it already has big plans in the pipeline to grow its footprints in the domestic Turkish capital markets, as well as overseas in Europe. DANIAL IDRAKI speaks to Tayfun Ozkan, CEO of KT Portfoy, to find out the company’s growing Shariah compliant ambitions.

KT Portfoy currently manages six funds with assets under management (AUM) of TRY100 million (US$34.05 million), which include: a pension fund, two retail funds and three funds for qualified investors only. It became the first fund management company in the country to launch a US dollar-denominated fund with the global Sukuk fund for qualified investors, after legislation allowing hard currency fund unit issuances was enacted in September 2015. The fund, according to Tayfun, will invest at least 80% of its assets in both Turkish and foreign Sukuk, including sovereign and corporate issuances. KT Portfoy does not intend to take things slow at this point, and is looking at introducing a Shariah compliant real estate investment fund (REIF) in the next two years, targeting to have collective AUM of US$500 million once the REIF is introduced to the market, in addition to the growth prospects of the pension fund it manages.

Real estate investment fund
“KT Portfoy plans to grow its AUM as quickly as possible, and we would like to bring innovative products to the Turkish investment industry. We expect the lion’s share of growth coming from the REIF, and we gauge that it can be set up in two years’ time,” Tayfun told IFN. The REIF legislation in Turkey was enacted in July 2014, with currently six REIFs being granted authorization by the Capital Markets Board of Turkey (CMB), although they have yet to begin operations. 

KT Portfoy, for its part, has yet to apply for authorization from the CMB, but Tayfun is incredibly optimistic of the potential growth in this sector. “We have been discussing it for almost a year now, having been in talks with both potential investors and owners of potential investment opportunities,” he added.

Pension funds
Besides the real estate sector, KT Portfoy has also set its eyes on the growth of pension funds. Currently, it is managing one out of the seven funds by Katilim Emeklilik, a collaboration between Kuveyt Turk and Al Baraka Turkey. “The pension fund that we manage has AUM of TRY43 million (US$14.64 million), but total AUM of interest-free pension funds in Turkey have reached TRY2.6 billion (US$885.42 million), and we hope to capture a 20% share of this pie. The company (Katilim Emeklilik) is almost two years old now, and they are growing fast. We hope to benefit from the pension funds’ growth as well,” Tayfun explained.

Searching for growth
While KT Portfoy’s five-month journey to date has been solely on a domestic route into the Turkish capital markets, it is already making plans to set up base in Europe, further signaling its hunger for growth in potential markets. Tayfun said that it is looking to set up a Luxembourg-based fund to support KT Bank in Germany — the first Islamic bank in continental Europe and also a 100% subsidiary of Kuveyt Turk. “The Luxembourg fund will also invest in Turkish assets,” he noted.

KT Portfoy’s growing presence hardly comes as a surprise, given the increasingly proactive role that participation banks (Islamic banks) are playing to raise the profile of Shariah compliant investments in Turkey. Although it may be too early to tell if KT Portfoy will be able to meet its goals over the next few years, its achievements in just a short five-month period, including the issuance of an inflation-indexed Sukuk, speak volumes of it growth ambitions.

State-backed bank taps US dollar private Sukuk market to meet balance sheet growth targets

After a three-year hiatus, state-backed Al Hilal Bank has tapped the Sukuk market again, raising US$225 million from private investors in a move it says made it the first UAE institution to execute a Shariah compliant private debt placement. VINEETA TAN has the details.

Priced at 3mL+160bps, the 2.5-year floating rate RegS facility forms a part of the Islamic bank’s existing US$2.5 billion trust certificate issuance program launched in 2013; the first issuance, worth US$500 million, is due in 2018. The offering is also the first senior unsecured dollar Sukuk since 2013 by any Abu Dhabi entity.

Al Hilal Bank’s strategy is to diversify its funding base and tenors. We aim to work toward raising funding for [the] medium term to enhance our funding profile and meet balance sheet growth targets,” commented Khaled Abdulla Alkhoori, CEO of Al Hilal.

Latest 12-month rolling data from Dealogic places the UAE as the third-largest Sukuk issuer globally, behind Malaysia and Saudi Arabia, with US$3.2 billion-worth of Islamic offerings. Data for private Sukuk issuance is scarce; however, UAE institutions have raised funding through the private route previously including DAMAC Properties which placed a US$100 million 18-month facility in 2015.

Matching the mainstream: Consistency is key

Islamic bonds have hit the headlines this month as media channels from CNBC to the BBC jump onto the bandwagon with predictions of mainstream success within the next five years. And why? Because a new trend for the standardization of transactions will make the sector easier to access and the process simpler to use and understand. LAUREN MCAUGHTRY looks at the prospects. 

The debate over standardization has long polarized the industry, with some believing it is the discrepancies in interpretation that are holding back global growth, while others argue that the beauty of Islam lies in its flexibility and versatility. 

Yet there is no denying that for the wider pool of potential issuers, conflicting interpretations of Shariah law across different jurisdictions are one of the barriers which, along with the perceived additional expense and time to market, can act as an impediment to Islamic issuance. “Standardization is one of our biggest challenges, and the necessity to standardize some of the contracts and structures, especially those that are used in the Sukuk market, remains imperative,” insisted Mohamed Damak, the global head of Islamic finance at S&P, speaking to IFN. 

It seems as if the figures could tell the same story. According to S&P figures, just 4,650 deals have taken place since 2005 and the market has been slipping since its peak in 2012. In the GCC, year-to-date figures show an increase in conventional bond issuance of around 120%, yet Sukuk issuance is in comparison down by around a third. “That is related to the expense of structuring Sukuk, putting it together and making it fly,” noted Mohamed. 

However, could all this be about to change? Moves are afoot to increase the pace of standardization – and the industry is throwing its weight behind the trend. At the 33rd Board of Directors Meeting of the International Islamic Financial Market (IIFM) (which included a workshop on liquidity management and Islamic hedging standards hosted by Saudi’s National Commercial Bank (NCB)), Abdulrazak Elkhraijy, the executive vice-president and head of Shariah Group of NCB, emphasized that: “We need to standardize the documentation for facilitating greater flow of funds between the market players within the domestic boundaries and across the borders while ensuring their enforceability in the various courts of law.” 

But it is not just standardization that is important. In order for the industry to grow further, Abdulrazak pointed out that there is also the need to develop and expand the range of Islamic products, develop IT solutions, establish a legal and regulatory framework and develop human capital. “Above all, [we need] more involvement of Shariah scholars to find comprehensive solutions to the complex financial products and transactions and provide the right guidance in accordance with Shariah principles,” he noted. 

Khalid Hamad, the chairman of the IIFM, agreed — but warned that the process could only happen with the support of the industry as a whole. “The full potential of [the] IIFM can only be realized when most of the market participants support this standard-setting organization created by several regulators,” he commented. 

The IIFM recently released standards on Islamic cross-currency hedging, and expects to complete standards on Islamic foreign exchange forwards, credit support arrangements and risk support arrangements by the end of this year. The agency also has plans to start work on a Sukuk standardization initiative that will address structure and documentation issues and provide comprehensive market guidelines with the support of industry stakeholders. Standards are also being developed on the Islamic capital and money markets as well as on trade finance and corporate finance. 

“I am hopeful of standardization being reached in the next few years,” concluded Mohamed. “People understand now this is critical for the industry. The good news is that some of the industry heavyweights are getting a bit more serious about standardization, and are working either jointly or separately to put together standard documents for Sukuk issuance. If the process becomes similar to the process for a conventional bond, then the people who are interested today will be able to tap [the market] much more easily.”

Malaysia takes the lead in setting best practices in the Takaful industry with pioneering framework

The global financial crisis and the subsequent period of financial instability, presented a set of challenges to regulators and policymakers. Countries looked to deposit insurers and insurance guarantee schemes to restore market confidence and avoid financial contagion via runs on financial institutions. In that respect, MOHD IZAZEE ISMAIL brings us a detailed look at a first-in-the-world framework by Malaysia’s deposit insurer designed to foster a sustainable and resilient Takaful industry with the aim of promoting financial stability.

Post-crisis, financial safety net players, including the Malaysia Deposit Insurance Corporation (MDIC), have taken steps to put in place robust measures to address the evolving financial landscape and better protect the interests of financial consumers.

Overview
In April 2016, the MDIC completed the differential levy systems framework for Takaful operators (DLST), a framework which provides incentives for sound risk management and levels the playing field between Takaful operators and insurance companies. Implemented this year, it also has the distinction of being the first differential levy system in the world for Takaful operators.

This follows the transition of the MDIC, whose key mandate is to promote financial stability, from the flat-rate levy system to a differential levy system framework (DLS framework) for insurance companies in 2013. The DLS framework was not applicable to Takaful operators and the MDIC continued to work on developing a suitable framework for Takaful operators, with an implementation date in 2016. 

Impetus for the implementation of a DLST framework
The growth of the Takaful industry and its increasing contribution to the financial sector emphasized the importance of implementing a suitable DLS framework for the 11 Takaful operators in the Malaysian Takaful sector. The industry has made significant strides in terms of business growth, maturity of operations and consumer awareness of Takaful and associated products.

In terms of the regulatory environment, international best practice stresses the importance of a robust regulatory and supervisory regime when implementing deposit insurance systems and DLS frameworks. Therefore, the role of Malaysia’s central bank, Bank Negara Malaysia (BNM), has been critical in setting strong prudential standards and providing effective supervision to facilitate the implementation of the DLST framework. Moreover, BNM has been a leader in implementing regulation for Takaful operators, including the Risk-Based Capital Framework for Takaful Operators (RBCT).

Accordingly, the implementation of RBCT in 2014 provided vital data for the DLST framework’s Free Capital Index (FCI), a capital measure, which is a fundamental aspect of the DLST framework methodology. This timely combination of a growing Takaful sector and robust regulatory regime provided the right conditions to implement the DLST framework.

The framework adopted by the DLST has a strong track record since 2008, when it was implemented by the MDIC for deposit-taking members and tested further in 2013 with the implementation of the DLS framework for insurance companies.

The implementation of the DLST framework is important to ensure a level playing field among Takaful operators and insurance companies, in terms of providing meaningful financial incentives for sound risk management. Well-managed Takaful operators now have the same opportunities to benefit from a lower levy rate as with well-managed insurance companies.  

In addition, the DLST framework is a world’s first, with no other jurisdiction applying a differential levy system for Takaful operators. The implementation of the DLST framework demonstrates Malaysia’s leadership position in promoting best practices in the Takaful industry.

Utilizing quantitative and qualitative measures to assess Takaful operators’ risk profiles 
Turning to the operational aspects of the framework, DLST incorporates both the quantitative and qualitative approaches with a 60% weightage assigned to quantitative measures while the remaining 40% is carried by qualitative measures. The rationale for the heavier weightage on quantitative measures is to ensure that the framework is objective, transparent and forward looking.

The quantitative criteria includes the FCI, a capital measure to assess capital management, and operational and sustainability measures to assess business performance and operational efficiency. Thus, a two-dimensional matrix approach is used with one of the dimensions being the FCI and the other composed of the operational and sustainability measures. The combined scores of the two-dimensions determine the position of a Takaful operator in the quantitative criteria matrix. The position of the Takaful operator in the matrix would determine the quantitative criteria score of the DLST, which carries a maximum score of 60%. The remaining 40% qualitative score consists of a supervisory rating which holds a maximum score of 35% and 5% for other information.

In the DLST framework, the primary component of the quantitative measurements is the FCI. Capital is important because it provides a crucial cushion against adverse changes in a Takaful operator’s earnings and asset quality. Moreover, a well-capitalized Takaful operator is in a better position to carry out its fiduciary duties to Takaful participants including covering the expenses of managing the Takaful business and providing an interest-free loan (Qard) if there is a deficit in the Takaful business.

In terms of the operational and sustainability measures, the objective is to comprehensively assess the ability of the Takaful operators to generate and sustain the income needed to meet their contractual obligations to Takaful participants while maintaining sound underwriting and investment practices.  

The operational and sustainability measures include business growth, investment yield, business diversification and business concentration, among others. So as to capture the differences between Family Takaful and General Takaful, the framework adopts specific measures to assess the General Takaful business and Family Takaful business.

Moving on to the qualitative criteria, the purpose is to provide important information on current and future risk profiles of the Takaful operators. The qualitative criteria gives a greater weightage of 35% to the supervisory rating as assessed by BNM, due to the direct supervisory relationship between BNM and the Takaful operators. The supervisory rating captures first-hand information about the Takaful operators by BNM which supervises and monitors the Takaful operators’ risk profiles, operational management and their risk management control functions.

The remaining 5% score within the qualitative criteria incorporates other information not considered by the quantitative and qualitative criteria as described previously. This other qualitative criteria would assess the Takaful operators based on their compliance with regulations, guidelines and any other regulatory requirements which may include supervisory concerns and intervention actions. This factor aims to capture any issues that may have a significant impact on the financial performance and/or reputation of the Takaful operators.

The DLST framework scoring methodology uses a matrix approach, whereby the sum of the respective scores from the quantitative and qualitative measures will determine the overall DLST score, ultimately translating into the levy category and levy payable by a Takaful operator. Each levy category carries a prescribed levy rate and minimum levy amount for the purpose of computing the levy payable to the MDIC for the respective assessment year. 

As seen in Table 1, Takaful operators will be classified into four categories based on their DLST score, with Category 1 being the best, representing the lowest risk category and Category 4 being the highest risk category. The levy rates are designed using a double-up approach from each category to provide an incentive for Takaful operators to improve their overall risk profiles.

Table 1: Categories of Takaful operators based on DLST score

Family Takaful business

Levy category

Levy rate

1

0.025%

2

0.05%

3

0.1%

4

0.2%

General Takaful business

Levy category

Levy rate

1

0.1%

2

0.2%

3

0.4%

4

0.8%

Toward a sustainable and resilient Takaful industry that promotes financial stability
The MDIC’s experience with differential premium and levy systems has shown that the double-up approach is an effective financial incentive that encourages financial institutions to adopt sound risk management practices.

Therefore, by linking the levy payable by Takaful operators to their risk profile as differentiated through the DLST framework, Takaful operators will have to improve the overall aspects of their business in order to achieve the best risk category and the lowest levy rate. 

The levy assessment process is fairer as a Takaful operator with a higher risk profile will pay more, while a Takaful operator with low risk will pay substantially less. 

The introduction of the DLST framework subjects Takaful operators to the same requirements as insurance companies. Moreover, the DLST framework assesses similar areas of the risk profile such as business performance, operational efficiency and capital management. This should also reassure financial consumers that Takaful operators are held to the same regulatory standards as insurance companies. 

Nevertheless, the DLST framework has been adapted to suit the Takaful operational model and business environment. A new indicator, the expense gap ratio, was introduced to capture the Takaful operators’ fiduciary duties to Takaful participants, particularly in managing the expenses incurred in the operations of the Takaful business.

Furthermore, the weightages adopted for the operational and sustainability measures along with the score ranges reflect the operating conditions faced by the Takaful industry. 

The DLST framework reinforces and complements the existing regulatory and supervisory framework by providing incentives for sound risk management in the financial system and minimizes excessive risk-taking.

Over the longer term, the DLST framework is envisaged to promote better managed Takaful operators with more resilient capital, sustainable income streams and more efficient operations. Therefore, Takaful operators will be in a better position to meet their obligations to Takaful participants.
This year was the first year of implementation of the DLST framework and the submissions received demonstrate the ability of the framework to differentiate Takaful operators while providing objective and transparent measures of their risk profiles. 

In summary, the introduction of the DLST framework is an important milestone for the TIPS and the MDIC in fulfilling the mandate to promote financial stability by differentiating Takaful operators and encouraging sound risk management practices. The implementation of the DLST framework further bolsters Malaysia’s leadership position in adopting best practices in the Takaful industry and sets the path for further innovation in this continuously evolving sector.

Mohd Izazee Ismail is the general manager of insurance, risk assessment and monitoring at Malaysia Insurance Deposit Corporation (MDIC). He is responsible for the analysis and monitoring of member institutions’ risk levels as well as the premium and levy collection function at the MDIC. He can be contacted at dlst@pidm.gov.my.

Suriname and Guyana lead the way for Islamic finance in South America

In this article, the Islamic Corporation for the Development of the Private Sector (ICD) takes a look at Suriname and Guyana, two countries in South America that are pushing ahead with Islamic finance.

Suriname’s foray into Islamic finance
Suriname, a former Dutch colony with a population of roughly 540,000, is a small country located in the northeast of South America. On the economic front, Suriname is heavily reliant on the extractive industries such as gold, oil and bauxite for their fiscal revenues. Due to the country’s high dependence on natural resource revenues, the economy has been largely affected by the recent decline in commodity prices and the dampening of domestic demand as a result of fiscal consolidation. Consequently, the government has prioritized economic diversification through broad private sector development in order to reverse Suriname’s slowing growth, and this is where Islamic finance has a role to play. 

While Islamic finance has aggressively expanded its footprint in its traditional markets of Asia and Africa, South America represents a new frontier. Indeed, Suriname aims to be an Islamic finance hub in a region where Islamic finance has been slow to take root. 

Since 1997, Suriname remains the only member country of the IDB Group from the western hemisphere and the Caribbean Community (CARICOM), positioning it to act as the natural link between countries in South America, the Caribbean and the Muslim world. Suriname now shares that status with Guyana, the newest IDB member country from the same region. 

In December 2015, the ICD – the private sector arm of the IDB Group – inked a cooperation agreement with Suriname’s Trust Bank to offer advisory support and technical assistance during all stages of Trust Bank’s integration process into Islamic finance. Indeed, this will make Trust Bank the first fully-fledged Shariah compliant bank not only in Suriname but the whole of the Caribbean and South America. This key milestone will hopefully pave the way for other financial institutions in the country to consider jumping onto the Islamic finance bandwagon. In the long run, it could also encourage Shariah compliant investors to do business in the country. 

Trust Bank’s bright potential in contributing to the economic development and wellbeing of Suriname through efficient, Shariah compliant means will benefit the country’s SME sector tremendously, where the major challenge is the lack of financing options available to local SMEs. As the asset-backed finance and risk-sharing nature of Islamic financial products aim to promote social and economic development through encouraging entrepreneurship, this bodes well for Suriname’s future. 

Meanwhile, the IDB and Malaysia recently partnered to spur the development and export of the agricultural sector in Suriname. The reverse-linking project is a tripartite cooperation (financing) between the IDB, the Malaysian government and the Surinamese government to enable Suriname to achieve self-sufficiency in rice production and increase its export of high-quality rice. Additionally, as part of the country’s multiyear development program, multiple government and private sector projects have been earmarked to benefit from further investment capital from the IDB Group. To date, Suriname has received financing from the IDB worth a combined US$149 million for 18 projects. 

Guyana becomes newest member of the IDB; opening its doors to Islamic finance
The third-smallest country on mainland South America, Guyana has a population of roughly 800,000, with about 10% of the population being Muslim. Like Suriname, Guyana too, is well-endowed with natural resources, and generates a large share of its economic activity from the extractive sectors. In March 2016, Guyana became the second CARICOM member and the 57th member of the IDB

Historically, Guyana had been dependent on bilateral support from China, India, the Inter-American Development Bank and the Caribbean Development Bank. By gaining IDB membership, Guyana will now have access to the US$2 trillion global Islamic finance market which represents an appealing alternative to traditional financing sources. Indeed, Islamic finance will greatly assist in financing the government’s development agenda and attract liquidity from both Islamic and conventional investors in local and international markets. 

After years of social and economic progress, South America is currently facing challenging times where numerous countries are suffering the economic repercussions of the substantial decline in commodity prices. Access to traditional sources of liquidity is proving harder to come by, requiring a financing strategy that steps outside the boundaries of what is conventional in the region. 

The introduction of Islamic finance will likely expand the sources of capital available to South America, which is crucial given its numerous economic and development challenges. With its strong resource mobilization potential, especially for infrastructure development and project financing, Islamic finance can help catalyze long-term sustainable economic development in a region with significant untapped opportunities. As Suriname and Guyana lead the way for Islamic finance in South America, key issues which need to be confronted in order for the industry to flourish are: a) developing an ecosystem to build confidence in the system, and (b) the widening knowledge and awareness gaps in Islamic finance.

Islamic finance brings with it opportunities to create financial inclusiveness in a country through much-needed private sector initiatives such as SME financing and equity participation SME funds. Typically, SMEs make up more than half of any economy and SME funding programs have been seen to accelerate both the economic and developmental impact in any country. Both equity and financing programs have been successfully tested in other member countries and can be made available to Suriname and Guyana to suit local requirements.

Is robo-advisory a threat to Middle Eastern wealth managers?

Financial technology or fintech refers to the use of technology, usually in the form of software applications or digital platforms, to deliver financial services to consumers. An important feature of fintech is its disruptive nature, as it tears down existing business models and creates new and efficient means of providing services to consumers, usually by cutting down processes and middlemen. M R Raghu Mandagolathur delves further.

Fintech has yet to find its feet in the GCC, despite several digital transformation drives initiated by the regional governments, but is soon expected to overhaul the financial services industry, especially in payment systems, lending, insurance, remittances, and advisory functions. Among these up-and-coming financial technologies, robo-advisory is expected to be a major disruptor, and could potentially upend the investment advisory segment of the financial services industry.

Who are robot advisors?
Robot advisors (automated investment services) are a set of algorithms that are programmed to provide wealth management services without the help of human financial advisors. They are typically low-cost services, require low minimum balance and currently popular among the younger tech-savvy generation. Robot advisors require customers to fill out a set of questionnaires with their goals and appetite for risk. Once that is completed, it makes decisions to construct a portfolio, invest in exchange-traded funds, rebalances and reinvests the gains. Human intervention is required only when the portfolio needs to have new risk-tolerance parameters or the asset allocation should be changed. This new breed of investment advisory services currently has close to US$100 billion of assets under management in the US market which has a total size of close to US$30 trillion. 

Suitability of robo-advisory for the Middle East and Islamic finance
The GCC and the wider Middle East market have largely been served by private bankers. According to the BCG’s 2015 Global wealth report, private wealth in the Middle East and Africa region increased by more than 7% to surpass US$8 trillion in 2014 and is expected to reach US$13 trillion by 2019. Privacy of wealth is also of paramount importance in the region as a result of which private banking has been the most preferred route for investors in the region. Western private bankers command about 70% of the assets as of June 2015 with regional banks developing their own private banking offerings. A recent survey of high-net-worth individuals by Emirates Investment Bank found that 59% preferred to use a local bank as their main banking partner.

Saudi Arabia and the UAE are expected to be the two major markets with total private wealth of US$2 trillion and US$1 trillion respectively. The wealth of the Middle East and Africa accounts for 5% of global wealth in 2014 which is expected to increase to 6% by 2019. The growth and distribution of private wealth in the Middle East and the GCC region are more suited toward private banking in the region. However, with the GCC region waking up to regulate ‘briefcase banking’ of foreign funds, it would open up opportunities for local banks, asset managers and online fund distribution. With both local and foreign banks competing against each other for market share, the effective use of technology could help banks and wealth managers to maintain their squeezed margins. 

Robo-advisory in its current iteration does not have the capability to service the varied needs of high-net-worth individuals and ultra-high-net-worth individuals (UHNWIs) of the region. These investors typically have complex investment requirements spread over multiple countries which is one of the reasons that private banking is preferred. Challenges include taxation, international regulation (money laundering, know-your-customer norms), estate planning and such which the automated robot advisory services in their current phase are ill-equipped to handle. 

While we can certainly rule out the possibility of robot advisors gaining enough knowledge to service UHNWIs and upper-high-net-worth individuals, the lower-high-net-worth individuals and the mass affluent segment can prove to be ideal markets for the technology. Individuals in these segments mostly would have some sort of investment advisory relationship with the regional banks which can be explored and built on. For instance, a local bank tying up with globally recognized robo-advisory services can turn around the rules of the game very quickly in the Middle Eastern market a few years down the line. While the thought of robo-advisory completely taking over one’s investments is a remote possibility, it can be mellowed down via a hybrid model. The hybrid model involves automated recommendations which are then supplemented by more personal advice from a finance professional. This segment which balances the best of both worlds is expected to grow to US$16.3 trillion worldwide over the next nine years globally (to the year 2025). 

Sukuk have become a popular investment avenue among Islamic investors globally as well as in the region. S&P expects Sukuk issuance to reach US$50-55 billion in 2016. The size of Sukuk market is testament to the popularity of these investments and the complex nature serves as an ideal place for innovation.

Sukuk issuances have shifted from using a single Islamic finance contract to hybrid structures which involve more than one Islamic finance contract. Other innovations in the area of Sukuk include perpetual, retail and insurance-linked issuances. Given the complex nature of Islamic finance, individual investors might not be able to choose their investments effectively – an area where investment automation satisfies the dual requirements of religious compliance as well as ideal asset allocation. 

M R Raghu is the managing director of Marmore MENA Intelligence, a research house focused on conducting MENA-specific business, economic and capital market research. Raghu is also the senior vice-president of the research unit at MARKAZ (Kuwait Financial Center). He can be contacted at RMandagolathur@markaz.com.

Islamic factoring agreement: Practical in Malaysia’s environment

A factoring agreement is a transaction where a company sells its account receivable, normally on a discounted basis, to a financial institution. The terms factoring and receivable financing are often used simultaneously although there is a slight difference between the two. AHMAD MUKARRAMI AB MUMIN and AIZUL AIMAN MUSA write.

Factoring refers to a sale of receivable accounts to a financial institution without recourse. The purchaser assumes all credit and collection risks. A receivable financing, on the other hand, is where the receivables would be assigned/pledged against the financing given and there is no transfer of ownership on the receivables; here, the receivables are given to a financial institution with recourse.

One way or another, both instruments would allow a company to receive a cash payment in advance rather than waiting for the receivables to be fully paid.

From the Shariah perspective, receivables or debt (Dayn) can result from a range of cases, including product payment, Qard (loan) payment, Mahr (dowry) payment which has not been given after the marriage Aqd (contract), rental, compensation for crime committed, compensation for damages, money to be paid for a divorce (Khulu) and for purchase orders which have not yet arrived (Muslam Fih).

In the Islamic financial market, the debt usually comes from Muawadhat Maliyyah contracts (exchange contracts) such as Murabahah, Bai Bithaman Ajil, Ijarah, Ijarah Muntahiya Bil Tamleek, Istisnah and others.

The Islamic financial market poses at least three Shariah concepts used by Islamic financial institutions in structuring a receivable financing or Islamic factoring agreement. The Shariah concepts used are: 

However, each Shariah concept has its own advantages and disadvantages as shown in the following. 

Islamic factoring via Bai Dayn
Bai Dayn refers to the sale of debt. In this structure, the company will sell outright the receivables to the bank on a discounted basis. For example, the amount of the receivables is RM100,000 (US$24,453.6) and the company sells the receivables to an Islamic financial institution with the price of RM95,000 (US$23,230.9). The Islamic financial institution will disburse the RM95,000 to the supplier as payment of the purchase price of the receivables. At the maturity date, the Islamic financial institution will receive RM100,000 from the purchaser. 

In Malaysia, by using this structure, Islamic financial institutions could obtain an ad valorem stamp duty under the Malaysian Stamps Act 1949, First Schedule (32)(c), since it reflects the practice of a conventional factoring agreement.

However, this structure may create controversy among Shariah scholars since Bai Dayn is a contentious Shariah contract in terms of it permissibility. 

The Shariah Advisory Council of Securities Commission Malaysia, for example, allows the practice of Bai Dayn based on the views of some of the Islamic jurists who allow this concept, subject to certain conditions. At the same time, we can see several resolutions that confine the practice of Bai Dayn, such as the resolution from the International Islamic Fiqh Academy and AAOIFI which limits the usage of Bai Dayn only on certain scenarios.

Islamic factoring via commodity Murabahah and Hawalah
Commodity Murabahah, which is guided by the concept of Tawarruq, can be defined as a transaction that consists of two sale and purchase contracts. The first involves the sale of an asset by a seller to a purchaser with the price equal to cost plus mark-up on a deferred basis. Subsequently, the purchaser of the first sale will sell the same asset to a third party for a cash consideration and on a spot basis. Hawalah, which is also embedded in this structure, is a transfer contract of which a party can transfer either their right or their debt to another party.

In this structure, the company will enter into a commodity Murabahah transaction with an Islamic financial institution and will transfer the right to receive the receivables (Hawalah) to the Islamic financial institution as a commodity Murabahah payment. For example, say, the company’s outstanding receivables amount is RM100,000. The company will enter into a commodity Murabahah transaction with an Islamic financial institution for a Murabahah selling price of RM99,000 (US$24,209) (cost) + RM1,000 (US$244.54) (profit). The company will then transfer the right to receive the receivables amount, ie RM100,000 to the Islamic financial institution as a commodity Murabahah payment. So, the Islamic financial institution will disburse RM99,000 (cost price) to the company and at the maturity date, will receive RM100,000 from the receivables.

Similarly, it can also be done by the company entering into a commodity Murabahah transaction with an Islamic financial institution for a Murabahah selling price of RM100,000 (cost) + RM1,000(profit). However, the Islamic financial institution will only disburse RM99,000 and the RM1,000 will be regarded as upfront profit payment. The company will then transfer the right to receive the receivables amount, ie RM100,000 to the Islamic financial institution as the balance of the commodity Murabahah payment. At the maturity date, the Islamic financial institution will receive RM100,000 from the receivables. 

This is the most common structure used in structuring Islamic receivable financing due to its worldwide acceptance by Shariah scholars. However, since the structure would involve a commodity trading platform, it may incur additional charges such as a brokerage fee. Therefore, Islamic financial institutions need to identify the best commodity trading platform to facilitate the commodity Murabahah transaction and also to identify which party will bear the additional charges.

Islamic factoring via Bai Dayn Bil Al Sila 
Bai Dayn Bil Al Sila (BDBS) is a transaction where the debt is sold to the new creditor and the payment made to the original debtor is made in the form of commodities (ie crude palm oil, plastic resin, rubber, etc). Commodities can be traded at any price agreed by both parties and not necessary to be equal with the amount of debt, as it is not money. Diagram 3 explains how the transaction of BDBS is undertaken to facilitate the sale of receivables.

In this structure, for example, the Islamic financial institution will first purchase a commodity from Broker A worth RM99,000. Subsequently, the Islamic financial institution will exchange the commodity worth RM99,000 with the receivables from the company worth RM100,000. The company will then sell the commodity to Broker B at the price of RM99,000. Hence, the company gets RM99,000 and the Islamic financial institution will receive RM100,000 from the receivables at maturity. 

Similar to commodity Murabahah Tawarruq, a BDBS contract is acceptable by Shariah scholars globally. Unlike Bai Dayn, payment for receivables in a BDBS contract is made in the form of commodities, not currencies. However, this structure will encounter the same issue as commodity Murabahah Tawarruq where it will incur additional charges and again the Islamic financial institution needs to identify the party that will bear the cost. On another note, a BDBS contract alone may possess disadvantages where it limits the Islamic financial institution in marking-up the selling price. This is because the Islamic financial institution will only purchase the commodity to be traded with the receivables based on the price which is equivalent to or less than the amount of the receivables. Should the Islamic financial institution purchase the commodity where the price is higher than the amount of the receivables and exchange is made, the Islamic financial institution will be at loss since it will only get the amount of the receivables at maturity that is lesser than the commodity purchase price.

Conclusion
Receivable financing or a factoring agreement is an essential product in the Islamic financial market. By having this product, it may provide certain businesses a channel for them to manage their receivables and cash flow. Furthermore, it will help Islamic financial institutions to expand their business by targeting segments such as the suppliers and their sub-suppliers. Despite the pros and cons, receivable financing has become an instrument that puts Islamic financial institutions at par with conventional financial institutions in providing not only a competitive product but one that is also Shariah compliant. 

Ahmad Mukarrami Ab Mumin is the head of the Shariah Division at RHB Islamic Bank and Aizul Aiman Musa is the head of the Shariah Research Section at RHB Islamic Bank. They can be contacted at ahmad.mukarrami@rhbgroup.com and aizul.aiman@rhbgroup.com respectively.

The rise of the robots: A revolution in fund management?

The global wealth management industry is a US$30 trillion business, with managers charging up to 1-2% despite frequently failing to beat the market. And although the Islamic sector accounts for a tiny proportion of the whole, fees are even more of a challenge in this high-competition, low-volume market. As a new trend starts to tread on the heels of traditional managers, LAUREN MCAUGHTRY asks if machine could ever truly overtake man as a preferred choice for cost-effective asset allocation?

Robo advisors are one of the biggest trends in the conventional wealth management space this year, with claims of major disruption to the industry as online firms charging significantly lower fees deliver electronic, software-based investment options that offer transparent model portfolios and allow the middle market investor to maximize their returns. 

So what do robo advisors actually do? In essence, almost anything. They can provide automated assessments of a user’s risk appetite, and automated portfolio creation, services and products. They can offer electronic advice to replace that of a traditional wealth advisor, as well as services such as diversified portfolio allocation, electronic portfolio management and rebalancing. They can be accessed from anywhere simply using a smartphone or laptop, they are available 24/7 and they charge a fraction of human managers — typically around 15-35bps. 

A key point to highlight is that robo advisors do not aim to beat the market. They do not even aim to beat the best managers. Instead, they aim to exploit the current inefficiencies in the existing system to smooth and improve overall performance — delivering returns very close to the market and thus outperforming most human fund managers who, data suggests, are less successful. 

A report from S&P Dow Jones Indices in 2014 found that 86% of active large-cap fund managers failed to beat their scorecards in 2014, while nearly 89% had underperformed benchmarks over the past five years and 82% over the last decade. While specific data is not available for the Islamic fund management industry, there is no reason to believe that the trend would significantly diverge from the wider market — making robo advisors a compelling attraction especially for the large mass affluent market seeking cost-effective and relatively simple investment advice. 

A growing trend
And the market is expanding fast. Research from MyPrivateBanking estimated robo advisory assets under management of up to US$14 billion in 2014 in the US alone, and expected to grow to US$255 billion within five years. More than 200 robo-advice platforms now exist in the US with activity also picking up in Europe, as the biggest players in the world look to gain first-entry advantage. 

Blackrock recently bought US robo advisor FutureAdvisor while Aberdeen Asset Management (which has an Islamic arm) was pipped at the post by Schroders to acquire online wealth manager Nutmeg in 2014, and in late 2015 retaliated with the purchase of Parmenion Capital Partners, a UK firm providing risk-graded portfolios to UK financial advisors through a digital platform. 

Charles Schwab has developed its own low-cost exchange-traded fund (ETF)-based service, while Vanguard offers a hybrid ‘robo-human’ model that already has over US$21 billion in assets under management and charges just 33bps for investors with portfolios of over US$50,000. 

It is clear that the conventional industry is embracing the trend — perhaps to mitigate the disruption that this new technology has the potential to cause. But what effect could robo advisors have on the Islamic space? 

“The impact could be profound,” predicted Muneer Khan, a partner at Simmons & Simmons Middle East. “As the technology develops, which will happen rapidly, more and more aspects of the wealth management service life cycle will be covered. This technology will be particularly useful for the ‘mass-affluent’ segment.

A possible trend
Currently, there is limited activity in the Islamic space. “It’s still very much in the planning stage,” agreed James Stull, a partner with King & Spalding Middle East. “The people I have spoken to who are interested in this are currently talking to partners about development or looking at examples in the US or UK — I am not aware of anyone in the region who is actively doing this yet on an Islamic level.” 

Yet there is certainly plenty of potential. “It should be easy enough to set up a robo advisor that can select stocks on a Shariah compliant basis that meet Shariah standards, and this could open up the universe to a broader range of Islamic investors,” he continued. “This could absolutely have an impact on Islamic funds — and a similar impact as it has had on the conventional space: by bringing costs down and allowing access for people who might not otherwise have been able to invest.”

It could also have positive implications for portfolio diversification and wider market access. “Robo advisors could be very applicable to the equities asset class, particularly when you are looking outside the region,” pointed out Stull. “For someone sitting in the Gulf who wants exposure to wider markets, this is cost effective, quick and easy so there is a big opportunity for growth.”

So why has this growth not yet occurred? One reason is because currently robo advisors are concentrated in the ETF space, and this has simply not yet taken off in the Shariah compliant market. Schwab Intelligent Portfolios for example, the online advisory service from Charles Schwab, combines robo advice with smart beta to beat the market: allocating around 60% to alternatively weighted ETFs. 

“One of the things that makes robo advisors work is the low fee structures in their ETF models,” explained Monem Salam, a director of Saturna Capital and the president of Saturna in Malaysia. “However, there is currently a dearth in ETFs in the Shariah space out of which you can actually build a model portfolio, so fees will remain high just because of the fund structures throughout most of the Muslim world.” 

These high fees make robo advice difficult to launch — because no matter how low the robo advisory fee might be, it is still an addition to the existing fund cost. “Yes there is potential there, but there are steps along the way that need to be taken first,” warned Monem. “The fee structures have to come down on the funds, then you have to have an explosion of ETFs and then the cost bases on these ETFs must be so low that you can justify having a robo advisor. I think it is a good thing, and it should happen — but right now there is just not enough product out there yet to do it in the Shariah space. The first step toward a robo advisor is to be able to go on your website and have a survey that finds out your goal, time horizon and so on. Then you move on to asset allocation, and here you can even recommend certain allocations. That’s already there, but that is not a fee model: that is a straightforward process that you don’t need to charge a fee for. The next step is a robo advisor, and that advisor does charge a fee, and makes recommendations on ETFs with an active rebalancing on a regular basis. ” 

A question of fees
It will come as no surprise that fees are the major stumbling block to the growth of the Islamic funds sector — this has been a challenge long recognized by the industry. And although most Shariah screening is done electronically already and several fund managers (such as UK-based Arabesque) already use a computer-based quantitative strategy for stock selection, this has not yet had an impact on fee reduction. Until that happens, little is likely to change. 

“There is currently a debate within Islamic investment whether to have a small amount of assets and charge a lot, or charge a little and let the assets grow. Right now I don’t think anyone is willing to take the risk and let the assets grow — they are pretty comfortable charging high and keeping the assets where they are,” commented Monem. “That’s one of the reasons why Islamic investment assets have plateaued over the last few years, and a lot of the growth is market growth rather than real asset growth.” 

A positive outcome
However, others are more positive as to the potential impact of the online revolution. “If something becomes more cost-effective, then it opens the doors up and I think it’s good for the industry and good for growth,” noted Stull. “We will see investors come in who weren’t willing to invest at the higher prices and this could be a boon for the Islamic funds industry.” 

Islamic funds might charge higher fees for advice now, but if the entire process could be mechanized then what reason would there be to charge these fees, other than a deliberate choice to maintain high barriers to entry? “I am a lawyer not a banker, but I would like to think that robo advisors could bring fees down to be equal to conventional counterparts,” said Stull. “It is essentially a computer, an algorithm, picking securities and making adjustments. It is a program, and I would think there would be no difference in price, as you are not relying on extra active expertise. It might take more expertise to create or launch that algorithm with the Shariah element but once it is up and running there is no reason why it could not be comparable.” 

And if the application is currently concentrated on ETFs, it has the potential to apply to a wider range of funds and assets. “This technology could certainly help to streamline processes and enhance efficiencies, and Shariah compliance processes could be built in,” agreed Muneer. “With the right collaboration between the asset managers, technology developers and Shariah advisors, robo advice could be adapted to deliver many Islamic wealth management services.” 

A disruptive influence
It seems inevitable that this new segment will disrupt the industry — not least because the growth of stand-alone robo advisors will force incumbents to react fast to launch their own offerings or risk losing customers. The conventional industry has already jumped on board — when will we see the Islamic industry follow? 

If Shariah compliant fund managers fail to follow this trend, they could lose out on even more customers as the market congregates toward the best price and the most efficient service. And after all, with the increasing sophistication in online and electronic services, what is to stop a conventional wealth manager from offering a simple Shariah robo advisory product and drumming the existing players out of business altogether? 

The target market for robo advisors is not high-net-worth-individuals or family offices, but the mass affluent, mid-career professionals with little time and low tolerance for high fees, yet a reasonable quantity of investable assets. With a rapidly growing middle class and increasing sophistication in financial services, the trend applies perfectly to the developing Muslim world. 

“Enhanced efficiency and productivity must be key objectives for the growing Islamic wealth management sector, as they are in the wider industry,” pointed out Muneer. “This technology, if deployed in the right way, could help to achieve these goals. This could in turn help to make the Islamic wealth management sector more competitive.” 

A slow burn
So why has no one yet taken the plunge? “Some of the smaller first-time managers have mentioned robo advisors as something they might look at, perhaps in partnership with someone else,” said Stull. “It is the smaller players who are exploring it, because they are looking for any kind of advantage they can get in terms of cost.” And while the barriers to entry may be high, they are no higher than in the conventional space. 

“A lot of the interested parties I have come across aren’t so worried about the impact on compliance of robo advisors,” Stull pointed out. “Most of them will have a Shariah board that approves the process — while the manager of the fund itself may not be a Shariah scholar. So in the case of robo advisors it would be a similar situation — the Shariah board would review and approve the underlying algorithm or program and then investors would be comfortable with that approval.”

However, as with human advisors, robo advisors will need control, oversight and audit. “This will especially be the case for Islamic wealth management services, due to the additional Shariah compliance requirements,” warned Muneer. “For the time being, and while the technology develops, there will remain a significant level of human advisor interaction in the Islamic wealth management space, with complementary robo advice services being added as they are developed.”

There is always a challenge with something new that people don’t understand. As people learn more about it the trend will grow, but it might have a slow start. “We are still in a wait-and-see phase, we haven’t yet seen anyone take the plunge,” confirmed Stull. But surely, if the Islamic asset management industry wants to survive, it can only be a matter of time? 

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