Issue 12 2013

Financing the FutureAbu Dhabi’s financial sector is laying the foundation for diversified growth

PAGE 06 The vision of Global Marketplace Abu Dhabi

PAGE 16The growth potential of Islamic financial services

PAGE 20 Abu Dhabi’s banks are growing thanks to sound policies

16 | Feature Islamic Finance

The potential of Islamic finance

As Abu Dhabi seeks to diversify its income away from oil as part of its Vision 2030, the biggest oil exporter in the

United Arab Emirates is grooming itself to become a financial hub and expanding its Islamic finance sector.

Global Islamic banking assets with commercial banks grew nearly 20 per cent in 2012 to reach $1.55 trillion, and are projected to reach $2 trillion by 2015 according to Ernst & Young. The National Bank of Abu Dhabi (NBAD) saw a 5.1 per cent rise in net income from its Islamic financial services in 2012 to $1.66 billion. First Gulf Bank reported growth of nine per cent in its Islamic banking sector, while Union National Bank reported a 6.2 per cent increase. Abu Dhabi’s interest in developing its Islamic finance industry further is therefore well founded.

“Wealth creation due to high oil prices among Sharia-sensitive investors was the single largest contributor to the development of Islamic finance in the UAE,” says Ashar Nazim from the Global Islamic Banking Centre of Excellence at Ernst & Young.

“Realisation of the market demand from high net worth individuals for Sharia-compliant investments made setting up Islamic banks a necessity, and from there the requirement for Islamic assets drove the rapid development of Islamic finance in the UAE.”

Abu Dhabi Islamic Bank (ADIB), which began operations in 1998, is the biggest Islamic lender in the country by market value. The other Islamic bank based in Abu Dhabi is government-owned Hilal Bank, which began operations in 2008. Ill

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The Islamic financial services industry in Abu Dhabi has been growing steadily, but there is room for improvement, reports Dania Saadi.

The Economic Review | 17

With regards to product innovation, Islamic banks need to expand their range of products and address a bigger percentage of small and medium size enterprises, which form a big percentage of businesses in the UAE and Gulf as a whole.

Although Abu Dhabi’s Islamic financial services industry is nascent, local banks have catered to demand with innovative new products, including sukuk, Islamic insurance or Takaful, and expanding their presence. The UAE’s total sukuk issuance more than doubled in 2012 to reach $6.5 billion from $2.95 billion a year earlier.

ADIB is an innovator in the area of sukuk issuance. Last year it launched the world’s first Sharia-compliant hybrid perpetual sukuk to help raise its Tier 1 capital ratio and comply with the new banking standards of Basel III.

“Because it behaves like equity and is deeply subordinated, the Tier 1 hybrid sukuk is more attune to the principle of sharing risk and reward, which is one of the fundamental tenets of Sharia,” explains Alex Roussos, a counsel at law firm Norton Rose Fullbright.

Several Abu Dhabi institutions have utilised Islamic finance in projects such as Dolphin Energy, Zayed University and the Abu Dhabi Water and Electricity Authority. However, the capital’s Islamic banks still have room to grow in the space of sukuk and other financial products.

“With the impending requirements of Basel III on the horizon, there will be a number of financial institutions that will be looking to structure Islamic debt issuances for raising capital requirements,” says Baljeet Kaur Grewal, managing director of Kuwait Finance House Research.

“One other area is the innovation of retail sukuk that aims to expand access to smaller investors. This will be an important aspect of sukuk structuring that will allow greater demand in a time when bond yields are rising.”

Sukuk issuance could become more frequent as Abu Dhabi improves legislation for the industry. Currently Islamic banks hold a large percentage of sukuks, but greater liquidity in the secondary market trading of sukuks is needed to help encourage more investors to buy these instruments.

The Abu Dhabi authorities can

help in this regard by encouraging the setting up of institutions investing in sukuks, such as pension and saving funds.

“If you get to a situation where you have real institutional money accounts such as pension funds that are more motivated by generating total return rather than just earning coupon income, then you will get sukuks that are more tradable and create even better liquidity,” says Abdul Kadir Hussain, CEO of Mashreq Capital.

“An expansion of the investor base from just Islamic banks to institutions like insurance companies and pension funds can help. Regulators can help by coming up with regulation that force Takaful companies to maintain a certain percentage of their capital in sukuks.”

With regards to product innovation, Islamic banks need to expand their range of products and address a bigger percentage of small and medium size enterprises, which form a big percentage of businesses in the UAE and Gulf as a whole. There is a whole gamut of sectors Islamic finance can target in Abu Dhabi and elsewhere in the UAE.

“There are a whole host of products that are available in other Islamic hubs which are less developed in the UAE. This includes trade and lease financing products for businesses,’’ says Wes Schwalje, Chief Operating Officer of Tahseen Consulting.

“Wealth management, retirement and healthcare financing, and debt financing for households are not as developed as elsewhere globally. Also many equity financing and capital market products – which would facilitate economic diversification into high-value added industries, attract foreign direct investment and funds from international capital markets - are still underdeveloped.”

Trade finance is another area where Islamic banks in Abu Dhabi can develop their offerings, especially as the UAE is a major regional trading hub. To expand trade finance and connect with other banks, they need to invest in technology that will take advantage

18 | Feature Islamic Finance

of the young tech-savvy populace and improve their links globally.

“Islamic banks in the UAE should take part in trade finance by offering the best products. For example, the Murabahah contract is a good fit with financing trade, and its short term nature helps with the need for liquidity in the sector,” says Grewal. “Similarly, small and medium sized enterprises (SMEs) are the backbone of any country. It is estimated that there are approximately nine to 11 million SMEs across the Middle East. Recognising this business opportunity a few banks in the region have launched funds, which specifically cater to the cross-border trading requirements of SMEs.’’

Islamic banks also have to engage more stakeholders in the process, including lawyers, sharia scholars and experienced bankers. There needs to be a greater clarity in terms of the legality of Islamic products on offer, and a requirement for an Islamic centre for dispute resolution where cases regarding Islamic financing disputes can be handled by judges well versed in Islamic law.

“Islamic banks need to spend more efforts on research and product development to meet market needs; some products have inherent issues under UAE law,’’ says Oliver Agha, partner and

head of Islamic Finance & MENA practices at law firm Holland and Knight. “What is needed is to include industry experts and lawyers at the Sharia board level of product development to ensure the structure being developed meets legal and industry acceptability.”

The UAE government has issued several federal Islamic banking and capital market legislations, which help govern the Islamic finance industry. The UAE central bank has also aided Islamic banking. In 2011 it issued a collateralised Murabaha facility to help Islamic banks better manage their liquidity, which is a major issue globally for the Islamic finance industry. Abu Dhabi has also announced a new financial centre free zone, similar to the Dubai International Financial Centre (DIFC), which is expected to include Islamic capital.

“An Abu Dhabi-based financial centre focused on Islamic finance will be able to offer a unique alternative to the DIFC for Islamic institutions,’’ says Kuwait Finance House’s Grewal. “The centre will play a role in developing the internationalisation of the industry, with more Islamic capital flows expected to be generated throughout the region.”

The free zone would have to come up with specific laws to help further develop the Islamic finance industry. Such laws should include guidelines for sukuk issuance and trading, among other legislation, lawyers said.

“What we would like to see is a clear set of guidelines and specific legislation issued at Federal government level and by relevant free zones that promote and regulate the issuance of sukuks by UAE and free zone-incorporated entities – whether to international or domestic investors,’’ said Norton’s Roussos. “This would give issuers and investors alike more clarity about certain key issues relating to sukuk instruments, including how the underlying assets are treated on enforcement and what recourse

What is needed is to include

industry experts and lawyers at

the Sharia board level of product

development to ensure the

structure being developed meets legal

and industry acceptability.

The Economic Review | 19

investors have to the originator, which in itself would help the development of liquid local sukuk markets.”

One of the major challenges of developing an Islamic financial centre in Abu Dhabi is a talent shortage. This is a global issue in Islamic finance, but it is more acute in the Gulf due to the fast pace of growth.

Tahseen Consulting projects that $71 billion could potentially enter the Islamic banking system in the UAE by 2015. This would create approximately 7,800 new jobs at local Islamic banks if current asset concentration ratios remain similar. The firm also forecast that another 500 jobs would be created by 2015 in other Islamic financial services segments.

“Talent attraction and development is the single most worrisome challenge to the evolution of Islamic banking, not only in the UAE but globally,” says Tahseen’s Schwalje. “To meet this growing demand for employees trained in Islamic finance the UAE will need to significantly broaden its education and training options to ensure the availability of human capital does not stall growth of the sector.’’

Although Zayed University and Hamdan Bin Mohammed e-University, offer in-depth Islamic finance and economics courses, there is a need for more institutions that offer programmes targeting new entrants and senior level leaders, rather than just courses aimed at mid-level employees, he added.

Some analysts believe Abu Dhabi requires a regulator to help supervise Sharia boards, similar to Malaysia’s own authority.

“There have been discussions about a central Sharia governing body to bring greater harmonisation to the industry, as well as new guidelines being issued on specific matters such as sukuk issuance and trading, that will provide a greater level of certainty to investors and issuers,” says Nazim. “However, substantial work is still required to create an inclusive legal and regulatory framework that involves Sharia-compliant businesses in financial services and other sectors.”

Abu Dhabi’s Islamic finance industry also has to expand beyond the UAE to help create scale and develop international links that will allow it to expand in areas such as trade finance, financing for small and medium sized firms, and other vital sectors.

Banks in Abu Dhabi have already taken up this challenge. ADIB, which operates in the UK, Qatar, Saudi Arabia and Sudan, became the first UAE lender in 2012 to open a branch in Iraq. Hilal Bank, which mainly operates in the UAE, opened a branch in Kazakhstan in 2010. It was the first Islamic lender to operate in the energy-rich central Asian country, which is fast embracing Islamic finance.

“Lack of scale is the biggest factor challenging the industry,” says Ernst and Young’s Nazim. “In the short term this requires transforming operations to be more flexible and responsive to new segments and markets. In the medium term, one has to look at expanding regionally and building institutions that are able to serve cross-border needs of the top-end of their business clientele.” ◆

One of the major challenges of developing an Islamic financial centre in Abu Dhabi is a talent shortage. This is a global issue in Islamic finance, but it is more acute in the Gulf due to the fast pace of growth.

Left: Zayed University and Hamdan Bin Mohammed e-University, offer in-depth Islamic finance and economics courses.

Welcome | 25

Cover Illustration by Tarak Parekh

The Economic Review is a quarterly publication issued by the Abu Dhabi Council for Economic Development.

Chief Editor and translator Dr. Hadi Al Taie

Production Dima Al Bawardi

Coordination Noura Al Obaidli

Abu Dhabi Council for Economic Development is a statutory body, established in May 2006, to facilitate economic diversification and growth through creating greater understanding, cooperation and engagement between the public and private sectors of the Emirate of Abu Dhabi.

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Special thanks to:

His Excellency Sultan Bin Saeed Al Mansouri, the UAE’s Minister of Economy and chairman of the capital markets regulator Securities and Commodities Authority (SCA); Abdullah Al Turifi, Securities and Commodities Authority; Madhi Mattar, Finance House Capital – Abu Dhabi; Essa Kazim, Dubai Financial Market; Rashed Al-Baloushi, Abu Dhabi Securities Market; Dr. Giyas Gokkent, National Bank of Abu Dhabi; Imelda Dunlop, Pearl Initiative; Ala’a Eraiqat, Commercial Bank; Tariq Qaqish, Al Mal Capital; Stephen Forster, Al Tamimi & Co – Abu Dhabi; Mohammed Yasin, National Bank of Abu Dhabi; Hamad Abdullah Al Mass, Abu Dhabi Department of Economic Department; Ashar Nazim, Ernst & Young; Alex Roussos, Norton Rose Fullbright; Baljeet Kaur Grewal, Kuwait Finance House Research; Abdul Kadir Hussain, Mashreq Capital; Wes Schwalje, Tahseen Consulting; Oliver Agha, Holland and Knight