In this issue…
- Alignment of form with ethical values is the best way forward for Islamic finance
- Extending the institutional investor base in the Middle East insurance market
The Bank of Japan retained its benchmark interest rate (minus 0.1 %) on the basis that, according to its Governor, negative interest rates can actually serve as a useful tool against deflation in the economy. Across the Pacific, following a policy meeting, the Federal Reserve has not made it clear if or when it will raise interest rates again, insisting that it will closely watch watch developments in the economy. This follows the Fed lowering its expected rate hikes for 2016 from 4% to 2%, weakening the dollar and at least mitigating the challenges that emerging markets were facing as a result of the strong dollar – especially those suffering from a fall in commodity prices and those with dollar-denominated debt. Meanwhile, the European Central Bank introduced a rather larger-than-expected stimulus plan, which includes raising its quantitative easing program from USD 60 billion to USD 80 billion. Finance Forward will continue to follow the impact of key central banks’ actions on the MENASEA economies.
In other central banking news, Bangladesh’s central bank recently found itself the victim of a cyber heist to the tune of USD 101 million via the country’s official account at the Federal Reserve. The bank’s Governor, Atiur Rahman, resigned on March 15 after accepting the blame for what is, according to reports, one of the largest cyber heists to date.
The below article was originally published on the Salaam – Global Islamic Economy Gateway here to reflect key themes to be covered in the upcoming Responsible Finance Summit happening in Kuala Lumpur, Malaysia from 30-31 March 2016. The Summit is hosted by Bank Negara Malaysia, organized by RFI Foundation and co-organized by Middle East Global Advisors.
“The next wave…must be designed so that they not only create returns and social equality, but the funds themselves must also be structured so they are aligned with the values they support.”
The above quote is from an article by Kristi Mitchem, Executive Vice President at State Street Global Advisors, describing the transition point of environmental, social and governance (ESG)-focused investors. But for the words “of ESG vehicles” (replaced by an ellipsis), the sentiment is also one facing Islamic finance. The focus on structuring has allowed the development of a wide array of financial products to meet the needs of many investors, whether their values are based on religion or other ethical frameworks.
However, for as long as ‘business as usual’ is a binding constraint on responsible finance as a whole (including Islamic finance), there will be a limited ceiling for responsible finance. Estimates for managed assets globally that integrate some form of ESG is currently just above 30%; however, it is concentrated in developed markets and in the asset management sector. Islamic finance has reached a higher ceiling in many markets with some (like Kuwait and Saudi Arabia) reaching close to 50% of total banking system assets.
These are all tremendous achievements compared to what was thought to be the ceiling for responsible finance at the turn of the 21st century when Islamic banking was just in the early stages of what would become exponential growth. Socially responsible investing was still making the transition from exclusionary screening to positive screening and a greater focus on engagement.
All areas of responsible finance were affected by the Global Financial Crisis but in many ways, each emerged with a stronger ethical identity about what is the end purpose of responsible finance. For the traditional approaches to responsible finance, the message was clear—individual investors can invest according to their principles, but it is not until large institutions become active owners when change will actually happen.
For Islamic finance, the shift has occurred starting to move the industry away from a mindset where a Shariah compliant versions of conventional products are structured and this is determined to be sufficient for the financial institution to discharge its ethical responsibility. Instead, more considerations—driven by consumers and other stakeholders—are coming into play not just about the structure but about what the financing is being used to support.
This has come from a ‘positive’ and ‘negative’ approach. On the positive approach, asset managers like SEDCO Capital and Arabesque have become signatories to the United Nations-supported Principles for Responsible Investments. In doing so, they integrate environmental, social and governance factors into their investment approach as well as being Shariah compliant.
Another approach is in the capital markets space where Khazanah Nasional Bhd, the Malaysian strategic investment fund, has issued a sukuk where returns are linked with the performance of a school that the proceeds of the sukuk are financing. A similar approach is included in two sukuk issued by the International Finance Facility for Immunizations (IFFIm) – involving the World Bank – where sukuk are used to raise financing for immunization against disease.
In both these approaches, there is a specific social impact consideration that is built in (it is integrated into) the underlying business purpose of the financial products. This is in significant divergence from more common practices to separate the Shariah compliant business (like banking or asset management) from social impact (through Corporate Social Responsibility). While it is positive for companies to undertake charitable activities through CSR, it is not going to allow them to have a truly lasting social impact in a way that consumers (particularly the Millennials) expect them to.
The key for financial institutions is to better understand the values that their wider stakeholders share and then identify where their activities can be changed to support these values in a material way. The stakeholders financial institutions should consider include their depositors, their communities (represented by individuals, NGOs and governments), as well as their shareholders.
If financial institutions step back and look deeper into what social impact their important stakeholders share, and identify ways to integrate these values into their day-to-day business, it can lead to more positive change. I hope that the Responsible Finance Summit, which will be hosted by Bank Negara Malaysia, will move the conversation forward on how all segments of the responsible finance universe can achieve this end goal.
The below article was originally published on the Insurance Day’s 14 March 2016 Special Report on the Middle East North Africa by Blake Goud, Chief Research Officer of Middle East Global Advisors. The piece reflects some of the key themes of the 11th annual World Takaful Conference happening in Dubai on April 11-12. WTC is the world’s pre-eminent platform for the global Islamic insurance industry with past partners including the Dubai International Financial Centre.
Domestic insurers face significant challenges when making their investment decisions and the limited options available to insurers has consequences for the financial markets. Regulations governing insurance globally is reactive in how it incorporates the issues and challenges faced by insurers. However, by looking at new regulations, in the context of the results of a survey of Middle East and north Africa (Mena) region insurers conducted by Middle East Global Advisors, it is possible to identify some of the particular challenges facing the industry.
The survey identified two self- reinforcing problems created in insurance markets that act as a drag on financial market development: cross-border investments and real estate allocations.
Lack of support
On cross-border activities, we found there was a severe lack of cross-border regulatory support, which makes insurers based in the Mena region highly concentrated on their home markets. With the region having relatively undiversified economies and small insurance markets, the ability to expand
their cross-border activities is important as a way to encourage better diversification of risks because otherwise the larger markets face excessive competition while smaller markets are underserved.
The regulations governing the insurance business across markets is different enough to limit cross-border activity in insurance markets which introduces strong single-country exposure in the in- vestments that each insurer holds which leaves them more vulnerable. This is particularly important to some of Mena countries, where the intensity of the competition has driven aggregate underwriting profitability down significantly, forcing insurers to rely more heavily on investment income.
Insurers’ exposure to real estate investments is also a function of limited financial market depth. While most insurers in developed markets hold a signi cant share of their assets in fixed income, insurers in the region hold a much larger allocation to real estate.
The survey did not ask specifically about existing asset allocations but did ask about changes expected in asset allocation. More than 38% of respondents, the highest level for any asset class, told us they expected to reduce their exposure to real estate. Our survey found the asset classes where an increase was most likely were emerging market fixed in- come, alternative assets and cash.
When we compare these survey results with some of the regulatory changes in the region, including those from the United Arab Emirates’ (UAE) Insurance Authority, there is a common thread around the high real estate expo- sure issue. Addressing this issue, and opening markets to more cross-border expansion for insurers, the region can help encourage the development of deeper financial markets.
The UAE Insurance Authority’s regulations limit insurers’ real estate exposure to 30% (com- pared to single-digit percentages for most global insurers). In designing the phase-in for the new rules, there is added flexibility built in for insurers to get underneath this relatively high cap. There is an extended window – three years rather than two – for insurers to comply with the 30% cap and a special exemption available to the Insurance Authority to allow some insurers to maintain up to 40% of their as- sets in real estate, even after the phase-in period ends.
The thresholds and phase-in requirements contained in the new regulations – designed to be in line with the Solvency II regulations that applies to European insurers – are not problematic on their own but re ect the issues in the market. By providing a formalized timeline that requires a shift away from real estate, it will put even more pressure to see greater financial market development in the Mena region.
Mena’s regional financial markets are limited by their lack of an institutional investor base and tend to be quite volatile as a result. The lack of institutional investors is due to the absence of private pensions, limited life insurance penetration (in part because of concerns that conventional insurance violates sharia precepts) and the focus of sovereign wealth fund assets outside their home markets (for reasons related to diversification).
Requirements for insurers to dedicate more of their invest- able assets into local equities and fixed income will not, on their own, create vibrant financial markets, but along with market opening to foreign institution- al investors (particularly in the UAE, Qatar and Saudi Arabia), it will contribute to creating a larger institutional investor base.
Parallel moves in the regulatory framework that encourage more cross-border regional insurance companies to develop can enhance the size of local insurers and move more of the insurance company assets into the region and create more active financial markets.
Blake Goud is chief research officer at Middle East Global Advisors