Promoting Shari‘ah-Compliant Investments via Exchange-Traded Instruments
Modern Islamic financial markets began their journey with the establishment of interest-free banking practices. But while Islamic banking served its purpose, markets began looking for alternative solutions for fund raising and insurance through Islamic finance a decade later. Today, Islamic financial markets have flourished throughout the Middle East, Europe and Asia, with assets of approximately US$1 trillion[i] and the industry is expected to grow at an annual rate of 25 percent.[ii]
In Malaysia, the Islamic capital markets have been developing at a rapid pace since the 1980s. Malaysian regulators have played a key role in the development of the Islamic capital markets, including through the issuance of local and global benchmark Islamic instruments. The growth in size and scope of the Malaysian Islamic capital markets were accompanied by changes to the institutional and regulatory framework as well as to the market infrastructure and tax framework. These initiatives helped deepen the domestic capital markets and provided financing to both the private and public sectors. Malaysia is aiming to leverage upon existing achievements to strengthen its position as a global Islamic capital markets hub.
DEVELOPMENT AND GROWTH OF ISLAMIC CAPITAL MARKETS
The positive development in Islamic banking nurtured the search for fund-raising through Shari’ah-compliant instruments. The booming demand for Shari’ah-compliant structured products was triggered by the discovery of oil in the Gulf region. From basic interest-free banking products and services, Islamic financial markets now offer nearly all the products and services conventional markets offer such as money market and capital market instruments. These products not only cater to investors who are looking for Shari’ah-compliant investments but acts as a Shari’ah-compliant funding avenue for businesses to expand.
In acknowledging the need to cater to investors seeking Shari’ah-complaint investments, private funds and investors have begun screening their investments based on Islamic laws and principles. This has led to the development of Shari‘ah screening methodologies by various Shari‘ah authorities, regulators and index providers and the creation of Islamic indices facilitating stock selections and investments. The Shari‘ah-screening method incorporates financial ratios to measure the financial condition and gearing levels of companies.
The world’s first Islamic index was introduced by Dow Jones in February 1999.[iii] The Dow Jones Islamic Market Index tracks selected stocks from various countries based on its global universe of the Dow Jones World Index. The index is measured based on a basket of stocks which are in compliance with Islamic principles for example, shunning unethical or highly-indebted firms, or those engaged in gambling, alcohol sales and other prohibited activities. The creation of these indices has positively facilitated the selection of Shari‘ah-compliant investments and enabled the establishment of Islamic investment funds.
Shari’ah-compliant equity investments are a relatively new phenomenon. Malaysia’s stock exchange, Bursa Malaysia, which was established in 1973 (then known as the Kuala Lumpur Stock Exchange - "KLSE”) created its first Shari‘ah index in 1999 called the KLSE Shariah Index. Today, Bursa Malaysia has two Islamic indices, namely the FTSE Bursa Malaysia Hijrah Shariah Index and FTSE Bursa Malaysia EMAS Shariah Index, which were developed in 2007.
Apart from plain-vanilla equities, the Islamic capital market offers listed Islamic Real Estate Investment Trust or i-REITs and Islamic Exchange-Traded Products or “i-ETPs. The development of exchange-traded instruments provides diversification to investors looking for alternative asset classes.
Figure 1: Islamic ETFs by Countries
The successful development of equity investment instruments triggered the development of an alternative fixed-income market, which led to the introduction of the Sukuk market. The global issuance of Sukuk was spearheaded by the launch of the Malaysian Government Sovereign Sukuk in 2002. Today, the Sukuk market is part of the global debt market. Islamic Venture Capital and Private Equity have also emerged as alternative equity instruments[iv]participants seeking Shari’ah-compliant mezzanine investment. with increasing number of
Figure 2: Global Sukuk Issuance 2005-2010 (USD ‘billion)
Sukuk is heading the charge in the overall Islamic financial market growth. Sukuk issuances grew by 70.9% from USD19.6 billion recorded in 2008 to USD33.5 billion in 2009. The Sukuk market recorded stronger growth in 2010, where global Sukuk issuances reached USD50.5 billion, a 50.7% increase from 2009.[v] The issuances for the first half of 2011 stood at USD47.1 billion.[vi]
Islamic funds have seen an increasing growth trend since 2003. However in 2008, like its conventional counterpart, Islamic funds were affected by the global financial crisis resulting in equity funds posting a negative return of approximately 40 percent.[vii]
Global Reach and Other Progress in Islamic Capital Markets
Besides Muslim countries, several jurisdictions e.g. in the U.K., U.S., Luxembourg, Germany, Russia, Japan, Singapore and Hong Kong are facilitating the growth of Islamic financial markets as part of their broader financial markets. They are understood to be looking at issuing sukuk, establishing funds and many other Islamic capital market initiatives.
These markets are moving towards enabling Shari‘ah-compliant instruments to be offered and some have made notable progress in terms of legislation and tax framework; while many others are expected to participate soon.
The modern Islamic financial market, which started about four decades ago, is a rapidly growing industry. This industry’s staggering growth has been attributed to the sound political, economic, Shari’ah regulatory framework, market and tax environment. Islamic financial markets have a bright future given that the industry is still young and developing. With interest from all over the globe, the industry’s growth is expected to be sustained.
In terms of the Islamic capital market, the opportunity to offer a wide range of exchange-traded Shari‘ah-compliant investments is aplenty. In the spirit of Islamic finance and global cooperation, partnership and ventures to promote and offer diversified investable instrument should be further encouraged and incentives should be given. The re-packaging of Shari‘ah-compliant investments and ethical-based investments should be looked into as both have similar investment fundamentals and objective.
[i] Hurriyet, Islamic Finance Assets May Top One Trillion Dollars, retrieved on 22 July 2011, at http://www.hurriyetdailynews.com/n.php?n=islamic-finance-assets-may-top-...
[ii] Standard & Poor’s, Islamic Finance Outlook 2010, at www2.standardandpoors.com/spf/pdf/media/Islamic_Finance_Outlook_2010.pdf, retrieved on 8 August 2011
[iii] CPI Financial, First Islamic Indexes by a Global Index Provider, at http://www.cpifinancial.net/v2/pdf/awards/IBF_a_08/best_index_provider_D..., retrieved on 9 August 2011
[v] International Financial Services London, Islamic Finance 2011, at www.thecityuk.com/research/our-work/reports-list/islamic-finance-2011/, retrieved on 1 August 2011
[vi] KFH Research, Global Sukuk Report 1H2011
[vii] Ernst & Young, Islamic Funds and Investment Report 2009
Figure 3: Global Asset of Islamic Funds (USD ‘billion)