Apr 28, 2015, 12:29 AM ETPanel

Great Ambition: Islamic Finance Goes Global

The global Islamic population is projected to rise from 23% today to 30% by 2050 (Pew Center), driving demand for financial services among a currently significant underbanked demographic.
Industry growth rates are estimated at 15% to 20% annually through at least 2019, with continued double-digit growth expected thereafter.
The sector is experiencing a shift from retail-focused products to institutional dominance, with approximately $1.5 to $2 trillion in total assets, 80% of which is concentrated in Islamic banking.
Demand for Sukuk (Islamic bonds) consistently outstrips supply, leading to oversubscribed issues and yields often lower than conventional fixed-income equivalents for issuers.

Prohibition of Riba: Earning money solely from money (interest) is forbidden, banning traditional lending models.
Asset-Backed Requirement: Transactions must involve tangible physical assets; nominal transfers of assets often occur in practice, though true securitization is less common.
Risk Sharing: The framework mandates shared upside and downside, theoretically acting as a circuit breaker against systemic debt crises caused by leverage.
Ethical Screening: Investments are restricted from sectors involving gambling, alcohol, and uncertainty (Gharar), appealing to ethical investors alongside religious mandates.
Scholarly Certification: Products require approval from panels of Islamic scholars, creating a bottleneck as the industry's 15-20% annual growth outpaces the supply of qualified certifiers.
Derivatives Limitation: Standard derivatives are generally prohibited due to the concept of uncertainty, though efforts to create "Islamic hedge funds" or swaps (e.g., fixed-rate conversions) remain controversial and limited in acceptance.

Malaysia: Identified as a primary hub with over 60% Muslim population; legislation began in the 1980s with the first modern Islamic bank (Pilgrimage Fund) and the first modern Islamic debt issuance by Shell in the early 1990s.
Bahrain: A pioneer in regulation as the first jurisdiction to issue separate laws for Islamic banks and the first central bank to issue a sovereign Sukuk in 2001.
GCC Dynamics: Oil price declines are pressuring government revenues, prompting an increased reliance on government-related entities to issue Sukuk to fund infrastructure.
Non-Muslim Jurisdictions: London and Hong Kong issued sovereign Sukuk (£200m and $1bn respectively) to set benchmarks and navigate tax/regulatory hurdles, though follow-on corporate issuance has been limited.
Infrastructure Opportunity: Long-term, stable cash flows make infrastructure (e.g., Emirates Airline fleet purchases) a prime sector for Islamic capital deployment in Asia and Africa.

High Sunk Costs: Issuers face significant initial legal and structural costs to ensure Sharia compliance, creating a premium barrier for first-time issuers.
Liquidity Constraints: Secondary markets are shallow outside Malaysia (which holds over $100bn in secondary debt), limiting the ability of fund managers to trade in and out of assets.
Tax Neutrality: The lack of tax exemptions on asset transfers (e.g., stamp duty) in many jurisdictions increases the cost of Islamic structures compared to conventional ones.
Form vs. Substance: Critics note that many Sukuk transactions, while legally asset-backed, function economically as senior unsecured bonds with claims against the issuer rather than the underlying asset.
Regional Standardization: Divergent interpretations between GCC and Asian "schools of thought" exist, though convergence is observed over time with scholars working across borders.

US Market Demand: Significant demand exists for Sharia-compliant real estate in the US, driven by GCC investors seeking US dollar-denominated income; advisors are based in London and the investor base is primarily Kuwaiti and Dubai-based.
Mortgage Gap: Personal loans and standard consumer credit equivalents are notably absent in Islamic finance, while mortgages and trade finance are established.
Sovereign Wealth Funds: Funds like Malaysia's Khazanah issue Sukuk for market development (e.g., Social Impact Sukuk) rather than immediate funding needs; Saudi Arabia is the second-largest issuer after the UAE.
Iran vs. Saudi: Saudi Arabia is a robust, active market with deep external demand; Iran remains a large ($450bn) but isolated market contingent on the lifting of sanctions.
Acquisition Structures: Large M&A deals (e.g., Kingdom Holdings' acquisition of hotel chains) often avoid Sharia compliance due to the complexity of screening out prohibited elements (alcohol/gambling) inherent in the target assets.

Islamic finance may become the primary financing model if interest rates remain negative globally, removing the traditional prohibition on interest in practice.
The convergence of regulatory standards and the expansion of non-Muslim central banks into Sukuk issuance will likely drive the sector into a global asset class within the next 5-6 years.
Tax neutrality reforms in major financial centers (UK, Hong Kong) are a prerequisite for attracting conventional global fund managers to the asset class.
The industry will continue to prioritize infrastructure financing as a primary vehicle for capital deployment in Asia and Africa to diversify away from traditional GCC and Malaysian markets.