Digital innovation and sustainability — the two driving forces shaping the future of Islamic finance. What are the biggest themes and challenges surrounding these two, particularly within the context of asset management? Experts share their two cents at IFN Investor Middle East Forum 2024 in Dubai.
What is the incentive?
While the world is pushing out one innovation after another in this era of digital technological advancement, Islamic asset management may not be moving as quickly as one may hope.
“There has been some progress in this space especially with some digital wealth platforms — but it is still a long way to go,” observed Ali Allawala, Standard Chartered Saadiq’s head of Islamic banking of the UAE and head of wealth and retail banking of group Islamic banking.
At the essence of it all, the industry hopes digitalization can achieve two main things: the democratization of wealth — that is allowing the common man to invest; and to facilitate investments into various sectors of the real economy including start-ups to allow the opportunity of meaningful transfer of wealth.
Unfortunately, banks are generally more focused on deposit-taking and lending, not wealth management.
“Those who do wealth management focus on high-net-worth individuals which are very niche, and they generally go for typical products, hence, innovation takes a back seat,” opined Ali.
Umair Javed, the chief business officer of Fasset, concurred: “From our experience, we have seen that retail depositors of Islamic banks are more intuitive, more money-savvy and more keen to invest and grow their wealth — so I am absolutely bewildered that banks don’t have more wealth management products.”
There is a potential explanation: intermediation pays. So, what is the incentive for banks, which profit tremendously acting as intermediaries, to do something different, something innovative?
Unless of course, if one is compelled to do so; and, competition is often a big catalyst for change.
Stimulate competition and collaboration
In some markets in the Middle East, this competition drive has seen forward-thinking banks explore and cultivate new relationships to generate new revenue streams and enhance operations.
In this respect, Saudi Arabia stands out.
“Banks have innovation centers and collaborate with start-ups; start-ups believe that if you want to launch something, it’s better to go to the banks. The government also supports them through accelerators and different types of licenses,” according to Paula Tavangar, the chief investment officer of Injaz Capital.
But here is another issue: are there start-ups worthy of investments?
“We need to stimulate these companies to a level of growth that banks would get interest in, but I think it is quite tough for start-ups to get funding,” said Khalid Howladar, the chairman of MRHB DeFi, adding that most venture capitalists are secular in their investment, which may not necessarily bode well for Shariah start-ups. “What is also disappointing even from investors in this region is that they prefer global products as opposed to local … I feel that support for investment liquidity to support start-ups to scale to the level banks require is missing.”
Tokenization — the next big thing?
Regardless of their trade — banking, investment management or fintech entrepreneurship — the panelists all believe that the tokenization of assets is a game-changer for Islamic asset management, with the potential to create a new structure of economy and investing.
We are seeing blockchain technology being used to fractionalize assets including real estate and Sukuk, but we are still at very early stages.
“I am very encouraged and optimistic about where it’s going, especially DeFi [decentralized finance], and in digitalizing existing payments and cross-border transactions,” shared Saleh Al-Tamami, the co-founder and CEO of Mamun.
Then of course there is also the appeal of high-risk digital currencies, with their hard-to-believe returns and growth. Bitcoin for example — BlackRock’s Bitcoin exchange-traded fund (ETF) in less than five months since its launch in January very quickly almost eclipsed Grayscale’s Bitcoin ETF to become the largest cryptocurrency ETF in the world with about US$17 billion in assets under management (AuM); Grayscale as at the 14th May 2024 held about US$18 billion in AuM but it did start January with over US$26 billion.
“Obviously, Bitcoin has a controversial position in Islamic finance,” said Khalid. “But I think every Islamic asset manager should have a minimal allocation toward digital assets, whether it is half a percent of 1%. The fact is, it’s been around for 15 years and it’s proven it’s the best-performing asset for the last decade.”
Regulatory clarity or ambiguity?
When it comes to governing and regulating this new asset class, and technology, however, there seems to be differing opinions.
“Having regulatory clarity is extremely important,” emphasized Umair. “Having certain consensus and uniformity across the GCC would be helpful.”
Khaled on the other hand believes it is too early to impose strong rules. “You might standardize on the lowest common denominator and the highest; I think the benefits of decentralization at such an early stage is to let the market decide.” This could give birth to new innovations rather than replication of conventional models and structures.
Regardless of approaches, Saleh thinks: “It is incumbent on us as well as the larger players, and not just the regulators, to [drive this forward].”
Cost of doing nothing
Self-reliance, instead of depending on the regulators, is a belief also shared by ESG practitioners and advocates.
“You can’t just wait for regulations,” said Husam Abdel Al, the senior director of origination and head of sustainable finance, investment banking at Mashreq. “You can do nothing or move forward. What we are seeing recently is the realization that sustainable is good to do — it is not an expense, rather a risk mitigation exercise and an exercise for better returns.”
“There is certainly a cost of doing nothing that people do not acknowledge,” echoed Aruna Narayanan, the founder and chief impact enabler of Real Impact Solutions, adding: “As an asset owner, you need to play a more active role rather than passive.”
Missing parts
To be fair, there are exemplary regulators churning out guidelines and policies to facilitate this market such as Securities Commission Malaysia (SC) and the Dubai Financial Services Authority (DFSA). The SC for example released an SRI Sukuk Framework and taxonomy among others, while DFSA issued voluntary guidelines and disclosure rules.
As one can imagine, it is challenging attempting to regulate this burgeoning sector optimally due to its complex and dynamic nature.
Effectively, we are dealing with an industry with two parallel developing systems: sustainable and Islamic, according to Luma Saqqaf, the director of Middle East, Africa and India at UN Principles for Responsible Investment. For example, carbon credits — there is yet a global consensus on how they should be traded or generated. Work is still underway on crafting standards on both the supply and demand side.
“With Maqasid, as long as you cross out the sin list, or negative screening list, you should be fine, but we still have issues with structuring — we still do not have a uniform standard for issuing Sukuk globally even after so many years,” explained Luma.
Such ambiguity could hamper product development.
“We are on the highway, but, we have not reached the destination,” Prasad Dhake, the manager of markets, strategy and risk of the DFSA, described the regulator’s journey toward regulating the Islamic ESG sector.
Razvan Dumitrescu, the sustainable finance director at Emirates NBD Capital, also cautioned the industry on the potential impact of certain regulations, particularly the EU Sustainable Finance Disclosure Regulation.
“At some point, you might see some funds from Europe may not invest in our region anymore if you don’t have certain info available — I think we have to be mindful in terms of the development.”
Pushing for innovation
Innovation is hard. Islamic ESG innovation is even harder.
“It is difficult enough to come up with the filter for Shariah compliance and negative screening, then you add on positive screening with ESG, and on top of that, you are trying to find the alpha,” explained Sharifatul Hanizah Said Ali, the executive director of Islamic capital market development at the SC.
But we have seen several landmark offerings including Khazanah Nasional’s 2015 SRI Sukuk with a step-down coupon feature.
“What drives innovation would come first from the investor; then, as a regulator we try to encourage and facilitate what is needed for it.”
Practitioners have identified transition finance and carbon credits as high-potential asset classes for Islamic finance.
Razvan believes carbon credits could get an extra boost in the near future as the regulated and voluntary carbon markets could gradually converge.
“That can be an opportunity to be addressed during the next COP [Conference of the Parties of the United Nations Climate Change Conference], especially on Article 6 … that would provide extra momentum.”
Razvan is referring to Article 6 of the Paris Agreement which allows countries to cooperate with each other, on a voluntary basis, to achieve emission reduction targets, allowing governments to transfer carbon credits.
