Talks over the Trans-Pacific Partnership stumbled and one of the sticking points deals with the Japanese auto supply chain which includes non-TPP countries like Thailand. The Japanese auto industry believes that strict rules about origin could harm it which show the complications of a regional approach to trade negotiations. While the TPP is touted as covering 40% of global trade, it does not include China or India, both of which are likely to be key players in future world trade. The absence of such key economies for the world and for the MENASEA region led Finance Forward to resume reading the 360,000 Google search results for “WTO talks collapse” and wonder whether to look forward to global treaty talks resuming if the TPP also fails.
Regrouping to build takaful markets in the UAE
In its report released last week, Standard & Poor’s rating services highlighted the challenges confronting the GCC Takaful industry in light of the regulatory changes made for the insurance industry in the Gulf. The recent regulatory changes include the doubling of the minimum capital requirements in Oman; more stringent solvency measures in Bahrain; and enhanced liquid asset requirements in the UAE and Kuwait.
In the long run the new regulatory requirements are expected to positively affect the financial strength of this sector; however in the short-term regulatory enhancements are likely to boost competition in an already over-crowded market leading to increased costs for both the local and foreign players.
The change does not affect takaful markets uniformly and it spells trouble for takaful operators in smaller markets for which the UAE serves as an example. Takaful operators will increasingly find it difficult to cover their operating expense and earn a market rate of return for shareholders after paying higher commissions to generate their takaful contributions. An extra challenge comes because the operating expenses will be proportionally higher relative to their smaller base of shareholder revenue highlighting their lack of scalability.
Consider the 7 largest takaful operators in the UAE for which there is data in Zawya Islamic. These operators generated gross policy contributions totaling $582 million and paid commissions of 14.1% of the gross policy contributions. The 7 largest takaful operators in Saudi Arabia (the far biggest GCC takaful market) generated $5.5 billion in gross policy contributions in 2014 and paid out just 5.0% in commissions.
If a representative takaful operator cedes 20% in contributions to retakaful and then received a 35% fee of net takaful contributions, in the UAE a takaful operator would receive 14% of gross policy contributions compared with 23%, about 40% less. In addition, because the takaful operators in Saudi Arabia will have a much larger overall pool of contributions (by a factor of 10), UAE operators have to spread fixed expenses over an even smaller base earned takaful contributions. Given the disparity between the market and it is no wonder that each operator (and insurer) in the UAE tries to make up the difference from volume which has driven underwriting surpluses into deficit for the insurance market as a whole.
The UAE Takaful market is inundated with issues pertaining to operational efficiency, scarcity of competent human capital and severe competition from conventional insurance. The UAE market also suffers from lack of innovations and undifferentiated product strategies. Some of the factors that limit the growth of insurance industry in UAE are structural. Many residents of the UAE are transient and carry their insurance coverage in their country of origin. As a result, life insurance/family takaful products which are longer-term and more profitable for insurers and takaful operators are not sold. In addition, many residents refrain from taking life cover mainly for religious reasons and even though they have an opportunity to use takaful, choose instead to stay uninsured.
Motor and health-insurance, where competition is most intense, commissions highest and underwriting surpluses absent account for a big chunk of the UAE takaful market. For the market to become healthier, family and other product need to repackaged and pitched to the un-insured population as something unique. Drastic measures need to be taken to make Takaful companies sustainable and compete with conventional insurance companies. Takaful operators should focus on finding lower-cost distribution channels to target the un-insured Muslim populace if they want to push the sector towards financial sustainability.
Leveraging impact investors to expand an SME development fund in Jordan
Social impact bonds (SIBs) are just beginning to transform how private capital can be attracted to social development projects, as well as ways in which charitable funds can be mobilized in a way that is more financially sustainable by attracting government support if it meets extra-financial goals. These bonds have been adapted to also fit within a Shariah compliant structure. The first, issued by Malaysian sovereign wealth fund Khazanah, is an SRI (socially responsible investment) sukuk to fund schools which requires investors to forego profits if certain benchmarks are met by the schools, providing the typical pay-for-success structure that SIBs deliver.
The mechanism of reducing the coupon on sukuk based on measurable social impacts makes Khazanah’s sukuk unique but also opens up many possibilities for alternative social financing structures. One such structure could be used in Jordan to leverage the government’s investment in a Governorate Development Fund (GDF). The GDF was established in 2012 with JD 150 million ($212 million) to invest in SMEs in underprivileged areas with an anticipation of becoming financially sustainable by taking minority stakes in businesses that generate an economic development and job creation benefit.
Jordan Enterprise Development Corporation (JEDCO), which administers GDF was reported to be in negotiations with the private sector and also approach donor countries and international financial institutions for funds. To date, however, the GDF has shouldered a big share of the financing with data released by JEDCO on July 21 indicating that JD 36 million was disbursed for GDF investments with total value of JD 73 million according to calculations by Finance Forward.
With the program being expanded to include Shariah compliant financing products (and amidst the backdrop of the government’s debut sukuk offering), it is an opportunity to question whether the program which has made investments expected to create just over 4,500 jobs, could be scaled up more rapidly by accessing impact investors. Currently, JEDCO serves as the “GDF ‘Fund Manager’ and […] the anchor investor by representing the government interest” to attract other (presumably private or multilateral/donor) capital.
The businesses that the company invests across the sectors in “services, manufacturing, industrial and agro-business sectors” and receives equity (generally 25-49% of the investee company). The Islamic financing option is designed to diversify funding methods to include “murabaha, leasing [ijara] and istisna’a”. Presumably, this will leave a mix of assets available including non-tradable (murabaha and ijstisna’a) and tradable (equity of Shariah compliant businesses and ijara).
Wakala is a common form of sukuk (used, for example, in APICORP’s recent sukuk program) for financing entities whose main assets are financing receivables. So long as 51% of the assets are in tradable form, the sukuk is tradable. If there are more tradable assets than needed, it is common for the total share used to be lowered to 51% using commodity murabaha to fill the remaining 49%. This gives issuers the greatest flexibility in the size of their issuance while still staying within commonly accepted limits to ensure the sukuk is tradability.
The assets created by GDF under both the existing equity investments as well as the planned Shariah compliant investments could be used to structure a JEDCO sukuk. To make it more marketable to impact investors, it could incorporate pay-for-performance metrics where the coupon is reduced based on the number of jobs created. To enhance the unique structure to include more risk-sharing features, the sukuk could be designed to absorb losses if there are significant business failures among the SMEs funded by the program.
By doing so, it would offer something unique to the market (an SRI sukuk focused on SME development and employment growth) but the GDF and by extension Jordan’s government would also receive tangible benefit by attracting (impact) investors willing to bear more risk and potentially provide less risky source of financing (compared to conventional bonds) in a way that increases the funding JEDCO can use to fund productive businesses.