Innovative sharia-compliant products are sparking global interest, and in the constrained financial climate they are catering to customers' growing risk aversion. Writer James Gavin
Islamic investors have become used to a wider array of products to place their money over the past year, as fund managers attempt to penetrate an untapped market with some innovative new instruments.
Whether traditionally structured equity and real estate funds - still the most popular - or the more esoteric products that have emerged more recently from financial institutions, such as Islamic hedge funds, the choice is wider than ever.
The surge in interest from overseas institutions in the Islamic space is largely a by-product of the Middle East's huge spurt of wealth creation that followed the dramatic rise of oil prices from 2002 onwards.
Demand is set to grow, experts say. The market for Islamic investment products is growing by 15% to 20% a year and equity fund assets alone are forecast to jump from $15bn to $53bn by 2010, according to the FTSE Group.
Islamic communities across the globe have always preferred to save and invest their capital in an Islam-compliant manner, but this has not always been possible as sharia compliant avenues were not always available in which to channel them.
Once investment houses realised the possibilities offered by Islam-compliant investment funds, and the profitability that could be delivered, they moved with alacrity to fill the gap.
Product engineering
Sometimes providers have little alternative but to engineer their product slate in an Islamic fashion. "Certainly in Saudi Arabia, a lot of clients say it is now almost a necessity to provide products that are sharia compliant," says Mark Stanley, assistant manager of Ernst & Young's advisory services and part of the Islamic Financial Services Group in Bahrain.
The 120 sharia-compliant mutual funds in Saudi Arabia account for a majority of Saudi assets under management in the kingdom.
Then there are attempts to tap the Middle East's investor base. "A number of Western product providers have recently shown an interest in restructuring their existing products to become sharia-compliant, particularly when they are asset-backed types of instruments," says Mr Stanley.
The activity is not just the result of Western institutions in pursuit of quick profit. Islamic banks are also becoming more creative in their product offerings. They carry four main asset classes within their investment portfolios, property, equity, sukuk and managed funds.
The Islamic fund space has gradually expanded, starting in the Gulf region. According to an Ernst & Young study, there were fewer than 500 sharia-compliant funds two years ago, but this could double in number by 2010.
Most Islamic investment strategies are focused on equities, an emphasis that has left the fund universe skewed against fixed-income sectors. Difficulties in structuring economically viable and truly sharia-compliant fixed-income-oriented mutual funds has left the Islamic space vastly different than that of the US, where bond and equity funds follow an asset allocation model of in the ranges of 60/40 to 70/30.
Financial climate
The worsening financial climate of the past six months may cause interest in Islamic fixed-income funds to pick up. "Fixed income is an area that is under-represented in the sharia-compliant space. From an investor's perspective, it makes sense to have a balanced portfolio, with some money in equities, and some in fixed income," says Saqib Masood, Saudi-based head of Islamic product development for HSBC Asset Management.
Diversification is the watchword: "Asset managers at Western banks have long acknowledged that you have to diversify portfolios if you are going to ride out the tougher periods, and this current crisis has forced a reassessment of concentrations, particularly in real estate," adds Mr Stanley.
Structural obstacles need to be surmounted. For example, Islamic funds of funds have found it difficult to place fixed-income funds. The inflationary spike that afflicted the Middle East last year also eroded the appeal of products whose returns were typically about 5% to 6%, well below many Gulf states' consumer price indexes.
Sukuks also carry large minimum investment levels, which put off retail investors. With the sukuk market illiquid, Islamic banks found it difficult to attract buyers at satisfactory prices. This may stymie the take-up of this asset class, although income generator types of products may draw more interest from customers.
Whether fixed-income or equities, neither class is likely to witness significant new product innovation so long as investors are bent on being cautious. Simpler solutions may prove more attractive to the average investor.
Wider interest
High-net worth individuals (HNWIs) have shown some interest in hedge funds and private equity funds, given their greater investment exposure to these strategies in the conventional space, but this demand has yet to seep into the wider retail sector.
Last July, Barclays Capital and the Dubai Multi Commodities Centre Authority (DMCC), an agency of the Dubai government, announced the launch of sharia-compliant hedge funds on the Al Safi Trust, a comprehensive sharia-compliant platform comprised initially of single-strategy alternative investment managers
Sunday, July 5, 2009
Insurance
The AIG and Lehman debacles have convinced regulators globally that a central clearing counterparty is critical for the future of the credit default swaps market. But many market participants feel that the idea is flawed. Writer Michelle Price.
The collapse of insurance behemoth American International Group (AIG) on September 16 2008 was the biggest financial catastrophe never to happen, or so it was billed at the time. When the financial superpower experienced a paralysing liquidity shortage, leaving it unable to meet its obligations to its trading partners – with whom it had racked up a net notional credit default swap (CDS) exposure of $372.3bn – the US regulators galloped in to prevent what they feared would be a financial and economic apocalypse.
The near fatality of AIG, combined with the demise of Lehman Brothers, shone a light on a sizeable yet opaque over-the-counter (OTC) CDS market that had hitherto escaped regulatory oversight, convincing many that both regulatory and infrastructural change is urgently needed. Discussions on the matter have turned to the well-established central clearing counterparty (CCP) model, found to be successful in the stock, futures, commodities and a number of derivative markets. By enthroning a central clearing and, in time, exchange infrastructure, the obscure CDS market will become transparent, with information on pricing and risk exposures visible to all. In the event of a default, the CCP would absorb any collateral losses and fund the resetting of positions, thereby buffering the wider market and its participants from the systemic chaos of recent months.
Persuaded by this paradigm, the US authorities, led by the New York Federal Reserve, have vigorously campaigned for the creation of a CDS CCP facility, while Senator Tom Harkin, chairman of the Senate Agricultural Committee, has introduced a bill requiring OTC derivatives to be traded only on exchanges. In Europe too, plans are now afoot to set up a CCP infrastructure, in what has been presented as an open-and-shut case in favour of the long-lived model. But as market participants descend into the detail of the proposition, its suitability for the OTC CDS market is growing ever doubtful.
A tempting opportunity
For the clearing agents and global exchanges, of course, the clarion call for a central clearing infrastructure is good news. Recent market developments offer a tempting opportunity for such parties to take a large slice of the high volume that has so far remained all but beyond their purview. For the exchanges in particular, using their clearing businesses to secure a grip on the CDS marketplace is one strategy by which they hope eventually to promote the full on-exchange trading of such instruments.
Four major contenders are vying for this foothold, including CME Clearing, a joint-venture between the Chicago Mercantile Exchange and hedge fund monolith Citadel; Liffe, NYSE-Euronext’s futures and options subsidiary which has partnered with the London-based clearing provider LCH.Clearnet; Eurex, Deutsche Börse’s derivatives exchange; and ICE US Trust, a start-up founded by Intercontinental Exchange (ICE), the US futures and commodities exchange, in conjunction with The Clearing Corporation, a dealer-owned consortium in which ICE recently bought a major stake.
Both CME Clearing and NYSE-Euronext have gained regulatory approval and are operational while Eurex plans to go live by March. As a start-up venture, ICE US Trust, which declined to comment, lags behind although its strong dealer governance marks it out from its rivals as the most promising contender. CME Clearing and Eurex are in the process of courting dealer and buy-side stake holdings, although some parties believe that the predominance of Citadel in the governance of CME Clearing might deter other participants. CME believes it has an advantage, however, by consolidating its new service on its existing platform. “We’re not creating a start-up, or a separate clearing house, or one focused only on CDSs, that would therefore have concentrated risk profiles related to CDSs,” says Kim Taylor, managing director and president at CME Clearing. “We’ve tried to provide efficiencies to users of the clearing service,” she adds.
Eurex has taken the reverse approach, defining a new licence for credit clearing in order to avoid the “co-mingling of highly concentrated and different CDS risks within the existing business to ensure the market’s integrity”, says Uwe Schweickert, senior project manager in the strategy department of Eurex Clearing. Ms Taylor argues, however, that the CME model creates a more “capitally efficient” default fund by spreading the risk across a broader set of products. ICE US Trust, by contrast, will have to raise a hefty $2bn or more, which would be more costly for its members than raising an incremental $400m. In this regard, says Brian Yelvington, an analyst at CreditSights, the CME proposal is favoured by a larger number of parties. “But the same people will tell you that it is not going to happen because they’re going to have to trade where the liquidity is, which comes from dealers.”
The collapse of insurance behemoth American International Group (AIG) on September 16 2008 was the biggest financial catastrophe never to happen, or so it was billed at the time. When the financial superpower experienced a paralysing liquidity shortage, leaving it unable to meet its obligations to its trading partners – with whom it had racked up a net notional credit default swap (CDS) exposure of $372.3bn – the US regulators galloped in to prevent what they feared would be a financial and economic apocalypse.
The near fatality of AIG, combined with the demise of Lehman Brothers, shone a light on a sizeable yet opaque over-the-counter (OTC) CDS market that had hitherto escaped regulatory oversight, convincing many that both regulatory and infrastructural change is urgently needed. Discussions on the matter have turned to the well-established central clearing counterparty (CCP) model, found to be successful in the stock, futures, commodities and a number of derivative markets. By enthroning a central clearing and, in time, exchange infrastructure, the obscure CDS market will become transparent, with information on pricing and risk exposures visible to all. In the event of a default, the CCP would absorb any collateral losses and fund the resetting of positions, thereby buffering the wider market and its participants from the systemic chaos of recent months.
Persuaded by this paradigm, the US authorities, led by the New York Federal Reserve, have vigorously campaigned for the creation of a CDS CCP facility, while Senator Tom Harkin, chairman of the Senate Agricultural Committee, has introduced a bill requiring OTC derivatives to be traded only on exchanges. In Europe too, plans are now afoot to set up a CCP infrastructure, in what has been presented as an open-and-shut case in favour of the long-lived model. But as market participants descend into the detail of the proposition, its suitability for the OTC CDS market is growing ever doubtful.
A tempting opportunity
For the clearing agents and global exchanges, of course, the clarion call for a central clearing infrastructure is good news. Recent market developments offer a tempting opportunity for such parties to take a large slice of the high volume that has so far remained all but beyond their purview. For the exchanges in particular, using their clearing businesses to secure a grip on the CDS marketplace is one strategy by which they hope eventually to promote the full on-exchange trading of such instruments.
Four major contenders are vying for this foothold, including CME Clearing, a joint-venture between the Chicago Mercantile Exchange and hedge fund monolith Citadel; Liffe, NYSE-Euronext’s futures and options subsidiary which has partnered with the London-based clearing provider LCH.Clearnet; Eurex, Deutsche Börse’s derivatives exchange; and ICE US Trust, a start-up founded by Intercontinental Exchange (ICE), the US futures and commodities exchange, in conjunction with The Clearing Corporation, a dealer-owned consortium in which ICE recently bought a major stake.
Both CME Clearing and NYSE-Euronext have gained regulatory approval and are operational while Eurex plans to go live by March. As a start-up venture, ICE US Trust, which declined to comment, lags behind although its strong dealer governance marks it out from its rivals as the most promising contender. CME Clearing and Eurex are in the process of courting dealer and buy-side stake holdings, although some parties believe that the predominance of Citadel in the governance of CME Clearing might deter other participants. CME believes it has an advantage, however, by consolidating its new service on its existing platform. “We’re not creating a start-up, or a separate clearing house, or one focused only on CDSs, that would therefore have concentrated risk profiles related to CDSs,” says Kim Taylor, managing director and president at CME Clearing. “We’ve tried to provide efficiencies to users of the clearing service,” she adds.
Eurex has taken the reverse approach, defining a new licence for credit clearing in order to avoid the “co-mingling of highly concentrated and different CDS risks within the existing business to ensure the market’s integrity”, says Uwe Schweickert, senior project manager in the strategy department of Eurex Clearing. Ms Taylor argues, however, that the CME model creates a more “capitally efficient” default fund by spreading the risk across a broader set of products. ICE US Trust, by contrast, will have to raise a hefty $2bn or more, which would be more costly for its members than raising an incremental $400m. In this regard, says Brian Yelvington, an analyst at CreditSights, the CME proposal is favoured by a larger number of parties. “But the same people will tell you that it is not going to happen because they’re going to have to trade where the liquidity is, which comes from dealers.”
Mexico and Poland turn to IMF
Poland credit: IMF chief Dominique Strauss-Khan says the country has a sound economic history
Both Poland and Mexico sought loans from the IMF last month, using the fund's flexible credit line (FCL), a new instrument designed to bolster strong performing economies against fallout from the current global economic crisis.
The IMF approved a $47bn credit line to Mexico in mid-April while Poland is still seeking a $20.5bn credit line. Under the IMF's conditions, the countries must meet certain criteria that demonstrate sound economic management prior to the loan being dispersed. In contrast to traditional IMF-supported programmes, disbursements are not phased nor conditioned on compliance with policy targets.
"Poland has a sustained record of sound economic policies," Dominique Strauss-Kahn, the IMF's managing director, said in a statement. "Its economic fundamentals and policy framework are strong, and the Polish authorities have demonstrated a commitment to maintaining this solid record." Jacek Rostowski, the Polish finance minister, said the credit line will help make "the Polish economy immune to the virus of the crisis and speculative attacks".
The Mexican government says it is treating the one-year arrangement as a precaution and does not intend to draw on the line.
The FCL forms part of a major overhaul of the IMF's lending framework as it seeks to expand its global role in the wake of the crisis.
Both Poland and Mexico sought loans from the IMF last month, using the fund's flexible credit line (FCL), a new instrument designed to bolster strong performing economies against fallout from the current global economic crisis.
The IMF approved a $47bn credit line to Mexico in mid-April while Poland is still seeking a $20.5bn credit line. Under the IMF's conditions, the countries must meet certain criteria that demonstrate sound economic management prior to the loan being dispersed. In contrast to traditional IMF-supported programmes, disbursements are not phased nor conditioned on compliance with policy targets.
"Poland has a sustained record of sound economic policies," Dominique Strauss-Kahn, the IMF's managing director, said in a statement. "Its economic fundamentals and policy framework are strong, and the Polish authorities have demonstrated a commitment to maintaining this solid record." Jacek Rostowski, the Polish finance minister, said the credit line will help make "the Polish economy immune to the virus of the crisis and speculative attacks".
The Mexican government says it is treating the one-year arrangement as a precaution and does not intend to draw on the line.
The FCL forms part of a major overhaul of the IMF's lending framework as it seeks to expand its global role in the wake of the crisis.
The Banker Top 1000 World Banks
The 39th edition of The Banker Top 1000 World Banks ranking, published in the July issue of The Banker, charts the world's banks according to Tier 1 capital. Tier 1 capital is the most relevant measurement of bank strength.
The ranking comes with an interactive CD and can be viewed in its entirety or sorted by assets, country or region. It also charts the new arrivals and fastest movers so you can see who is performing well in these troubled economic times and who isn't.
Top 1000 World Banks 2009
Despite huge losses, Western banks have retained their dominance of the rankings due to massive capital raising. But what will the future hold? Geraldine Lambe reports.
Hybrid capital under scrutiny
A wave of equity issuance and market distaste for complexity suggest that hybrids might be falling out of fashion as a source of bank capital in Europe.
Nout Wellink Interview
The Basel Committee has been at the forefront of efforts to re-stabilise the global financial system. Nout Wellink, the committee’s chairman, explains how.
FIG chiefs survey new financial landscape
As the financial crisis enters its second year, The Banker invited the heads of financial institutions groups at major banks to discuss what needs to be done.
Top 1000 World Banks 2008
Banks may be suffering as the credit crunch bites, but the past year shows the industry has the resilience to stop a setback turning into a disaster.
The ranking comes with an interactive CD and can be viewed in its entirety or sorted by assets, country or region. It also charts the new arrivals and fastest movers so you can see who is performing well in these troubled economic times and who isn't.
Top 1000 World Banks 2009
Despite huge losses, Western banks have retained their dominance of the rankings due to massive capital raising. But what will the future hold? Geraldine Lambe reports.
Hybrid capital under scrutiny
A wave of equity issuance and market distaste for complexity suggest that hybrids might be falling out of fashion as a source of bank capital in Europe.
Nout Wellink Interview
The Basel Committee has been at the forefront of efforts to re-stabilise the global financial system. Nout Wellink, the committee’s chairman, explains how.
FIG chiefs survey new financial landscape
As the financial crisis enters its second year, The Banker invited the heads of financial institutions groups at major banks to discuss what needs to be done.
Top 1000 World Banks 2008
Banks may be suffering as the credit crunch bites, but the past year shows the industry has the resilience to stop a setback turning into a disaster.
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