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April 30, 2008

The crescent moon is rising

By Nicholas Moody

Islamic finance is becoming increasingly familiar to non-Muslim ears across the world. Nicholas Moody speaks with several industry leaders on the current state of the business and what this emerging market can offer professional accounting firms in the future.

Islamic finance has been gaining increasing exposure as an emerging global industry. But putting an accurate figure on the industry’s size is one area that is open to debate. A report from International Financial Services London, released this month, estimates the global market for Islamic financial services, as measured by Sharia compliant assets, is estimated to have reached $531 billion by the end of 2006, having grown by more than 10 percent a year from about $150 billion in the mid-1990s.

Ernst & Young UK (E&Y) Islamic finance director Ken Eglinton quotes a Standard & Poors report that estimated Islamic global assets are worth $500 billion with annual growth of between 10 to 15 percent. The report estimated deposits of approximately $200 billion growing 8 to 12 percent and a sukuk (Islamic bond) market worth $70 billion. Standard & Poors forecasts it could balloon to $4 trillion over the next few years. Eglinton notes that the report was released before last year’s credit crunch and suspects the figures would be smaller if the survey was undertaken today.

PricewaterhouseCoopers’ (PwC) global Islamic finance leader Mohammad Faiz Azmi agrees that the commonly quoted statistic for global Islamic banking assets is around $500 billion. “If you are talking about sukuk that come out of the Gulf and Malaysia – about $57 billion were in sukuks at the end of Dec 2006. At the end of Dec 2007 the estimate is somewhere in the area of $80 billion,” he says.

But KPMG’s London-based Islamic financing and investment advisory director Darshan Bijur says the general estimates of the size of the global Islamic finance industry are conservative. He estimates the Middle East has around $2 trillion in sovereign wealth – although not all Islamic. In banking terms he estimates around 45 percent of all banking in the Middle East can be termed Islamic, resulting in Islamic global assets that are closer to $1 trillion. He estimates the total business will grow to about $5 trillion in 25 years.

Bijur bases this estimate on the increasing move by banks in the Middle East to become Sharia compliant and the interest of larger conventional banks in Islamic finance.

“Very few people realise that 25 percent of the world’s population is Muslim and it’s true that a vast majority are very poor but a small minority are exceedingly wealthy,” he says. “Conceivably, you could say 25 years from now 20 percent of all banking in the world will be Islamic banking, in which case it’s a huge business – there’s no reason it should not be.”

The value of global advisory services for professional firms from Islamic finance is estimated to be about $500 million and growing at between 10 to 20 percent a year. Again Bijur questions these projections: “If it is purely auditing and tax, advisory as in internal audit, anti-money laundering and technology advice – that’s probably right. But the moment you bring in investment banking work, which is the kind of work that we do as well, for instance corporate finance and transaction support, then [the value] explodes.

“So $500 million is a fairly conservative estimate of what the accounting profession should be making out of this phenomenon, and it’s only likely to continue increasing rapidly,” he says.

Eglinton says Middle East oil wealth is the big driver in the Islamic finance market. “[There is] huge amounts of money from the Middle East trying to find productive homes, trying to find a diversification of risk. So there is a big appetite for OECD (Organisation for Economic Co-operation and Development) assets to be packaged up in ways that they can invest in,” he says.

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Key regions Islamic finance activity for the Big Four accounting networks has tended to focus on several key regions; Malaysia; the Middle East – mainly Bahrain, Qatar, Dubai, Doha; Saudi Arabia and increasingly London.

Malaysia is estimated to have the largest Islamic finance industry in the world with both PwC and KPMG basing their leaders in global Islamic finance there. Azmi says part of the reason PwC’s Islamic leadership is based in Malaysia is it is slightly ahead of the curve in terms of Islamic experimentation. The country’s experience using conventional laws while operating dual economies, one Islamic and one conventional, is also seen as being more relevant to the global firm’s conventional clients, says Azmi.

Mohammed Amin, who head’s PwC’s London Islamic practice, agrees: “Malaysia is very actively involved in Islamic finance and has been a pioneer in the industry. It is a place that has focussed on it quite a lot and it has a lot of advanced government thinking.”

Although Bahrain has traditionally been a powerhouse of Islamic finance, Bijur says he can’t help but feel that the sun is setting in Bahrain and rising in Dubai. “Bahrain is stagnating and much of the growth and action is coming out of Dubai and Qatar while Malaysia keeps pushing the Sharia boundaries,” he says.

London is increasingly becoming the focus for Islamic finance on the international stage. Eglinton, who is based in London, says he has been operating for more than 10 years in the field. “What’s been interesting in this sector is how it’s changed so dramatically in the last three years. I think I’ve done more work in the last three years than I have done in the previous ten,” he says.

Bijur says both the Middle East and Malaysian industries have a strong regional focus but lack international spread. “The moment any of these guys [in the Middle East and Malaysia] have to do anything cross-border they have to be looking at London. They can’t do anything from within their regions with any other region without going via London, which works very well for London and for the profession here,” he says.

London calling Deloitte’s Islamic finance team is led out of London and the firm’s recently appointed Sharia scholar Mufti Hassan Kaleem says the UK city has all the advantages of a well established finance centre and can build on this to become a key hub for Islamic finance. “The principles-based regulation and the human capital in the city, in addition to government initiatives, provide the key ingredients for success,” he says.

The budding nature of Islamic financial business is reflected in the small size of Islamic finance teams within the main accounting networks. Staff typically work in their core services lines of audit, tax, consulting or corporate finance with only a few senior figures mostly committed to Islamic finance. Several of the firms operate virtual global Islamic teams, which share resources and experience but are spread through out the world.

KPMG operates as a global virtual team with strong businesses in Malaysia, Bahrain, the UK and reasonable business in the Middle East. “We have about 25 people in Malaysia who work on Islamic finance almost full-time – M&A, accounting, tax and other areas involved with Islamic institutions. In the Middle East we have about 8-10 people and in the UK we have about 10 people who are involved in various aspects but if I was to think of it in full-time equivalence it would be about six [in the UK],” Bijur says.

Ernst & Young has a specialist unit of full-time Islamic finance advisors based in Bahrain but most of its Islamic finance work is split on a geographical basis.

PwC created its Global Islamic Finance Team (GIFT) in February last year to establish where its experienced Islamic finance practitioners were based. It found expertise from Switzerland to Malaysia but emphasises the goal of GIFT is to take conventional services and make them Islamic friendly. Azmi says PwC has 10 to 20 partners involved in GIFT. “I can’t say that any one of the 20 are full-time Islamic but it’s more about making sure that we have partners around the world who have familiarity with the concepts and can explain it to the clients then ultimately deliver that service we want,” he notes.

All those interviewed by IAB stress that key participants in the emerging Islamic finance sector are often non-Muslim institutions with significant capital. “We have quite a number of significant financial services clients who are not Islamic but were moving into Islamic finance. [Setting up GIFT] wasn’t just aimed at the Islamic market per se, but it was also aimed at servicing our existing conventional clients who were foraying into it,” says Azmi.

Some of the biggest players in Islamic finance are traditional conventional banks, which is one of the reasons the sector is well positioned for growth, says Bijur. “HSBC, Deutsche Bank, Citibank, Barclays are the big boys in the Islamic banking space, especially on the corporate and institutional level,” he says. Elington adds: “A lot of the conventional banks have Sharia windows. They are obviously not Sharia compliant institutions because most of their business is completely non-Sharia but they set up a ring-fenced division and do the business through that.”

The increasing prominence of Islamic finance is highlighted by Deloitte’s appointment of a Sharia scholar Mufti Hassan Kaleem in November last year. Deloitte is the first Big Four firm to appoint a Sharia scholar but the other three say they will not follow suit. Amin says he does not think it’s necessary in terms of the way the business operates and can not see any benefits. Bijur says KPMG uses Sharia scholars on much the same level but describes Deloitte’s appointment as a red herring. “I think the important thing to remember is that when two Islamic institutions are doing business with each other, both institutions have their own Sharia boards – almost by constitution they do. All of them have their own conscience keepers and Sharia scholars. They don’t care about what somebody else thinks, they only care about what their conscience keeper thinks. So having some consultant with an advisor is by itself not very useful,” he says.

Positive forecast The Islamic finance experts all see increasing growth for the industry. Amin says there are two significant reasons why the Sharia-compliant sector will grow dramatically in the future. The first is the increasing economic growth among the 1.5 billion Muslims in the world in countries like Indonesia. The second is the increasing proportion of the financial system in the Muslim world that is becoming Sharia-compliant.

Bijur says the Islamic sector is a sunrise industry but at the moment the message is ahead of reality; there is activity but it is not of the scale that people are making it out to be. “I suspect at the moment, this business is at a slow burn stage,” he says. “Proportionally if we estimate the Islamic assets are about $1 trillion now with $500 millionish accountancy professional fee component, ten years from now I would not be surprised if it’s for $3-4 trillion with corresponding size of professional fees.”

Guiding principles Islamic finance is a form of finance that is consistent with Islamic law (Sharia) and adheres to a number of key principles that include:

  • Backing by a tangible asset, so as to avoid ‘speculation’ (gharar).
  • Prohibition of interest payments (riba).
  • Risk to be shared amongst participants.
  • Limitations on sale of financial assets and their use as collateral.
  • Prohibition of finance for activities deemed incompatible with Sharia law (haram), such as alcohol, conventional financial services, gambling and tobacco.

    Deloitte Sharia scholar Mufti Hassan Kaleem says it emphasises earning wealth through valid activities. He says Islamic finance is based on trading and creating valuable services and different modes of partnership. “What distinguishes Islamic finance from non-Islamic finance is that Islamic finance is always linked to genuine economic activity. It does not promote some thing which is destructive for human beings and does not create a bubble economy,” Kaleem explains.

    Source: Deloitte and International Financial Services London

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