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SHARIA COMPLIANCE: An Islamic partner

HourglassLaunching a sharia-compliant fund can require a time-consuming search for religious experts to certify the fund's Islamic credentials. An alternative is to employ an Islamic advisory firm. George Mitton reports.

In March, Franklin Templeton Investments called a press conference in the company’s Dubai office to announce its entry into Islamic finance for retail investors. To indicate the significance of the launch, the company had flown out its emerging markets guru, Mark Mobius, to attend.

Sitting in the sunny room, the bald, slightly eccentric American explained the funds were an “enormous” opportunity to reach the world’s 1.3 billion Muslims. He confessed he would be disappointed if they did not attract hundreds of millions of dollars.

So far, so familiar; another global asset manager attempting to gain a chunk of the Islamic funds market, estimated by Ernst & Young to be worth some $60 billion (€46 billion).

Yet the product launch was notable for at least one reason: instead of going through the difficulty of assembling its own board of Islamic scholars, Franklin Templeton had done a deal with a Malaysia-based consultancy, Amanie Advisors, to outsource to them the responsibility for establishing its fund’s Islamic principles.

The result was that Franklin Templeton had become a manager of three Islamic funds without the expense of hiring its own Islamic finance staff.

A fund is considered Islamic if it accords with the principles of Islamic legal tradition, the sharia. Islamic funds cannot invest in companies that make money from arms, alcohol, tobacco, pork, gambling or pornography, nor in firms that have large amounts of debt.

Though it is by no means a new innovation – the concept of sharia-compliant investing goes back at least 40 years – there has been a recent flowering of optimism about Islamic funds. At the start of the year, Dubai announced its intention to become a hub for Islamic finance, while the UK government has established a task force to promote London as an Islamic finance centre.

It is natural that companies such as Franklin Templeton want to have Islamic products on the market. And yet the obstacles to launching Islamic funds have been high. To be recognised as sharia-compliant, a fund must have its investment strategy and documentation certified by a board of Islamic scholars. These religious experts must issue a judgement, or fatwa, and meet at regular intervals to reaffirm their decision.

Finding the right scholars and negotiating a price for their services is a challenge that can confound companies entering Islamic finance for the first time.

“If you’re talking about a new entrant, even if they’re a big company, they have no clue about the right scholars,” says Baiza Bain, managing director at Amanie Advisors. “We’ve had this conversation many times with fund managers, even big ones, making a first entry into Islamic finance. ‘We had no idea,’ they said. ‘We had to do months of research to see which scholar we could potentially employ. When we found scholars we wanted, we didn’t know how to contact them.’”

Finding scholars is difficult because there are simply not enough of them. There has not been a large enough rise in the number of Islamic financial experts to meet demand from the growing industry.

A second problem is that among the small pool of Islamic scholars, only a handful can be certain to command the confidence of the market. In the absence of a centralised body to attest scholars’ qualifications, investors tend to trust only those they recognise.

Competition for the most high-profile scholars, men such as Sheikh Nizam Yaquby, of Bahrain, or Dr Abdul Abu Ghuddah, of Saudi Arabia, can be fierce. It is said that some of the most sought-after scholars already sit on 50 or more boards. Scholars’ time is valuable and therefore expensive.

Sohail Zubairi, chief executive at Dubai-based Dar Al Sharia, an Islamic finance consultancy, estimates there are around 500 Islamic finance scholars working today, but says only about 20 are sought after because of their reputation. Sharia scholars, he says, are “a rare commodity”.

A balancing factor is that asset managers have some flexibility in arranging sharia boards, which can range in size from three to nine people. And there are ways fund companies can address the shortage of scholars. Zubairi says the best model “is to keep a senior scholar with some juniors he can nurture – an experiment carried out by Dar Al Sharia for some of our fund clients”.

Nevertheless, for a fund company that is new to Islamic finance, the challenges of putting together a board are intimidating, and these challenges do not end once a board is assembled. Board members’ time is so precious that an asset manager may only meet for an hour every three months. To make the best use of this time, the asset manager needs to prepare an agenda in advance, a task that requires some expertise in Islamic finance.

Sharia advisers can help with these problems by assembling a board on behalf of a client, letting its own board act for a client, or by helping clients prepare for their meetings.

“In the past four or five years, there has been a growing interest in this kind of sharia outsourcing,” says Hatim El Tahir, director of the Islamic finance group at Deloitte.

Tahir says that as well as reducing complexity for asset managers, outsourcing can cut costs, since clients can benefit from economies of scale. “I support having a sharia adviser,” he says. “Give it to the expert. It’s cost effective, it cuts down on administrative work, and you don’t have to hire someone to chase the scholars. These advisory companies will probably have a blend of experts within their board which can include Malaysian and Middle Eastern scholars.”

It is important to get the sharia board right because Islamic finance is not easy. Last year, HSBC announced it would pull back much of its Islamic finance coverage to focus on just Malaysia, Indonesia and Saudi Arabia.

Not all of the Islamic funds launched in recent years have been successes. The Allianz Islamic Global Equity Opportunities fund is one example of a product that closed due to lack of investor demand.

It is not that Islamic funds are hard to make. There are tools to help fund managers, such as Dow Jones’ Islamic indices, which list sharia-compliant stocks. But sharia-compliant funds can be difficult to sell if they are not certified by a board that has authority in the market.

Bain says he knows of one case of an Asian asset management house that pitched a so-called Islamic fund to a Malaysian pension fund. The fund was based on one of Dow Jones’ Islamic indices, but the fund itself did not have a sharia board. The Malaysian pension fund declined to invest.

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