ISLAMIC FINANCE: Looking beyond the numbers

While the number of regulated Islamic funds in Luxembourg has remained steady at around 39 over the past three years, the figure masks a high level of product activity. Stefanie Eschenbacher reports.

Last year, Luxembourg saw the launch of a sharia compliant forestry fund, one of the new hybrid products that target both Islamic investors and those seeking green investment.

Sustainable Capital, the asset manager behind the launch, is in the process of liquidating this particular fund; the key seed investors from the Gulf decided to proceed with a direct purchase and ownership of the key plantation rather than investing through a fund structure.

A unit trust is now being set-up in Singapore to target investors based in Asia. The fund will have a separate sharia compliance board of Malaysian and Indonesian clerics for potential investors from these countries.

It is such innovative products as well as a whole lot of other activity that are often buried in official statistics.

The number of regulated Islamic funds in Luxembourg has remained steady at around 39 over the past three years, but the figure masks a high level of product activity. The Commission du Surveillance du Secteur Financier (CSSF), the Luxembourg regulator, says 17 new funds and sub-funds were launched; 17 funds closed, five of which were mergers within an umbrella structure.

At the end of December 2012, there were 19 funds structured as specialised investment funds (SIFs). These can only be marketed to institutional and qualified investors, but can draw a large amount of assets. Another 18 are structured as Ucits, and two are so-called part 2 Ucis that do not qualify as Ucits.

Eleanor de Rosmorduc, senior adviser at Luxembourg for Finance, says the slightly higher than expected ratio of SIFs may reflect a growing use of this vehicle in anticipation of the alternative investment fund passport.

The passporting facility will be introduced later this spring via the Alternative Investment Fund Managers Directive (AIFMD).

De Rosmorduc says the CSSF’s figure of 39 is “a conservative one”. It does not include some that are sharia compliant, but have not registered themselves as such for reasons of discretion.

Statistics of unregulated funds and structured vehicles were also unavailable at the time Funds Europe went to press.

There have been 16 sukuk listings on the Luxembourg stock exchange, with all but three now matured.  “Looking ahead, we anticipate new product activity in the sphere of the International Islamic Liquidity Management Corporation, of which the Luxembourg Central Bank is a member,” de Rosmorduc says.

Said Qaceme, senior manager, management consulting, at KPMG in Luxembourg, says the country is “really trying to position itself as a hub for Islamic finance”.

He says as the AIFMD approaches, there is pressure that managers are closer to their fund’s domicile. Substance is important, but the level of substance is still in question. “I do not see all the managers coming to Luxembourg,” he adds.

Qaceme estimates a larger proportion of assets are held in unregulated funds, with at least two Luxembourg-domiciled funds with more than €2.5 billion of assets under management.

While the Ucits structure might be interesting for certain investors, Qaceme says a lightly regulated SIF might suit high-net-worth individuals better.

He says while most Islamic asset managers are from the Middle East, Asia has the largest growth potential.

Jean-Marc Goy, counsel for international affairs at the CSSF, shares this line. Most interest comes from Bahrain, Dubai and Malaysia, he says. As supervisor, the CSSF is not in charge of promotional activities, but he says the minister of finance has “repeatedly underlined an interest to develop Islamic finance in Luxembourg”.

As the CSSF is a secular authority, Goy says it does not have religious experts to assess fund applications on religious principles. He and his colleagues evaluate whether a fund complies with Luxembourg’s legal and regulatory requirements.

When an application for a fund is submitted at the CSSF and it appears during discussions that the fund is “not acceptable” or amendable, Goy says the project will usually be withdrawn.

Danielle Berna-Ost, general secretary at the CSSF, says the approval process usually depends on the complexity of these funds, the quality of the application and the service providers involved. She says this can take weeks or, in extreme cases, up to one year.

Luxembourg is an international centre and aims to provide service for international investors.

De Rosmorduc says: “There are different interpretations of sharia law and if we set up a board we commit ourselves to one of them. It does not help a Saudi Arabian promoter if the decision of our sharia board is acceptable in Malaysia, but their fund cannot be distributed in the Gulf. We have to remain flexible.”

It is a question of tolerance levels. While a Malaysian Islamic fund would typically be able to invest in a shopping centre that, among other types of shops, hosts a supermarket which sells alcohol, this investment would be deemed unacceptable in the Middle East.

In Malaysia, as elsewhere, such problems are solved through a process of income purification, by which the profit from non-compliant activities is identified, set aside and donated for charitable purposes.

Islamic finance remains a niche sector, not only in Luxembourg but also elsewhere in the world. Asset managers launching Islamic funds not only face an additional layer of compliance and cost, they also need to make sure they attract enough assets to make their products economically viable.

Many have failed to gain a critical mass.

When the financial crisis hit, de Rosmorduc says, Islamic funds outperformed the market because they were not invested in banks. “But another crisis might hit another sector.”

In general, Islamic funds are not geared so they underperform in rising markets, but outperform in falling markets. Their attraction is not necessarily their performance, adds Goy.

Pierre Oberlé, business development manager at the Association of the Luxembourg Fund Industry (Alfi), says there were both international and local players that launched Islamic funds in Luxembourg last year.

He says many wanted to expand internationally, therefore, the Ucits structure suited them. In 2008, Alfi launched a working group in Islamic finance. Despite having stepped up promotional activities, Oberlé says Luxembourg is not well-known in the Middle East and Asia.

Qaceme categorises Islamic finance funds as sustainable and responsible investing (SRI) because they do not invest in weapons or adult entertainment. Such funds are also not allowed to use leverage.  

“Islamic funds should play a biger role now­ that the public has been disappointed with speculators,” says Qaceme. “There is a huge market within ethical, SRI funds and microfinance.”

©2013 funds europe



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