Islamic Finance Guide to Investing Your Money Ethically

In recent years Islamic Finance has firmly established itself as one of the most vibrant and yet often overlooked sectors within FinTech, as well as within the global financial services industry more broadly.

However, Islamic Finance is in fact a very broad term that encompasses a wide range of products, services and types of firms. What is true across this diverse segment of global financial services is that there is a lot of excitement for good reason. This is not at all surprising given the wave of innovation, growth and success of both the leading firms and the sector as a whole over recent years.Whether you are new to the world of Islamic Finance or a professional, our Insider’s Guide to Islamic Finance provides expert insights and latest data analysis on the sector - highlighting just how successful Islamic finance has become at a global level.


WHAT IS ISLAMIC FINANCE?

Islamic finance refers to financial services activities, most notably banking, insurance and financing (credit), that must adhere to Sharia law (Islamic Law). The term can also be used to refer to Sharia-compliant investments as well as broader capital and equity markets.

The common practices of Islamic finance and banking arose alongside the establishment of Islam. However, institutional Islamic finance did not emerge until the twentieth century. Currently, the Islamic finance sector is growing at a rate of 15% to 25% per year, with Islamic financial institutions managing assets worth over 2.7 trillion USD globally.

SIZE AND GROWTH OF ISLAMIC FINANCE

The global market for Islamic Finance continued positive momentum in 2020, recording a growth rate of 10.7% year-on-year, driven primarily by strong performance within Islamic Banking as well as the Equity and Capital markets:

• Islamic Banking: 4.3% year on year growth with a growth in total assets of 248 billion USD, particularly in the largest Islamic markets such as Saudi Arabia and Iran.
• Capital Markets: 26.9% year on year growth
• Islamic Insurance (Takaful): 10% annual growth rate and over 51 billion USD in total assets in 2019 prior to the global financial slowdown caused by COVID-19.

While the size and growth of the Islamic finance sector is heavily concentrated in those countries and regions where Islam is predominant, this is rapidly changing in recent years, due to an increase in global migration patterns as well as broader trends in society around ethical investments and sustainable development.

Currently the top 3 countries where Islamic Finance is most well established account for 66% of the global market size across a wide range of metrics:

• Saudi Arabia
• Iran
• Malaysia

However, the Islamic Finance sector is growing rapidly in terms of overall scale, diversity and reach around the globe and into new periphery markets. In 2020 there were over 1,526 islamic finance institutions in operation around the world, with over 46 countries now supporting the growth and development of Islamic Finance within their legal and regulatory frameworks.

This is particularly true within FinTech, where firms and growth has gravitated towards London, the global hub of innovation in financial services, despite the relatively small Islamic community in the United Kingdom.

THE FOUR MAIN AREAS OF ISLAMIC FINANCE

Our guide breaks the data and the sector down into four key areas that are currently driving innovation and global success:

• Islamic Banking
• Islamic Capital Markets (ICM)
• Islamic Insurance (Takaful)
• Islamic Fintech

This page provides an overview of each, including the latest data trends and key highlights, which are expanded on further in each of the individual sections to provide detailed analysis and insight on each area of Islamic Financial Services.

Section 1- Islamic Banking

In 2020 the total size of the Islamic Banking sector had a growth rate of 4.3% year on year and reached over 2.7 trillion USD in total assets. While Islamic banking is still largely regional in terms of market share and overall size, it now accounts for over 6% of the global banking market. Islamic Banking is also both the oldest and most important sub-sector within the global Islamic Financial Services industry, comprising 68.2% of the total market.
SIZE AND GROWTH

In the worldwide IFSI, the Islamic banking category maintained its dominance. Among the 36 jurisdictions included by the IFSI Stability Report 2021, the domestic market share of Islamic banking in relation to the total banking market segment has increased in at least 23 nations.

The performance of the Islamic banking category increased by 4.3 percent in 2020, compared to 12.4 percent in 2019. The Islamic banking segment now accounts for 68.2 percent of the global Islamic Financial Services Industry, down from 72.4 percent in 2019. This decrease is primarily due to the rising significance and strong performance within the Islamic Capital Markets during recent years, rather than indicating a drop in the performance within Islamic Banking.

Islamic Banking is still largely concentrated within geographic regions and markets, where it is the market leader within financial services. Taken together the 15 systemically important Islamic banking jurisdictions accounted for 92.4 percent of global Islamic banking assets, representing only a small increase from 91.4 percent in the previous year. These combined markets also now account for 82.7 percent of the total global assets linked to Sukūk that are currently outstanding, which indicates the availability of high-quality liquid assets (see SECTION 2 for more on Islamic Capital Markets).

DIVERSITY WITHIN ISLAMIC BANKING

As of 2020 there are now 526 Islamic Banking Institutions operating across 72 countries, with a systemically important market share in 15 of these jurisdictions. Within the Islamic Banking sector there is both innovation and diversity in terms of their operations and structures.Breakdown of Islamic banking institutions:

• 428 commercial
• 57 investment
• 22 wholesale
• 19 specialized

Regionally, GCC (the Gulf Cooperation Council countries) retained its position as the largest domicile for Islamic finance assets in 2020. The region accounted for 48.9% of global Islamic finance market share, increasing from 45.9% in 2019. The Middle East and South Asia (MESA) region constituted the second-largest share, accounting for 24.9% of global IFSI assets, remaining consistent with the previous year.

The South-East Asia (SEA) region's share shrank slightly to 20.3% in 2020 from 23.8% in 2019, while that of the Africa region remained small, with a share of 1.7%. The “Others” region, comprising Turkey, the UK and countries from the Commonwealth of Independent States (CIS) region, accounted for 4.3% of total global IFSI assets.

Section 2 - Islamic Capital Markets (Icm)

SUKUK

Growth Rate: 26.9%
Share of IFSI: 30.9%

3,420 - Number of Sukuk issuances Outstanding (2019)
538 Billion USD - Total Value of Sukuk Outstanding (2019)

The sukuk market grew 30% in issuance value in 2019, increasing from 124.8 billion USD in 2018 to 162.1 billion USD. This is the 5th straight year where the sukuk sector has achieved double-digit growth in the sukuk industry, a leader within the overall strong performance in recent years across the Islamic Financial Services Industry.

Notably, although the volume of ṣukūk issuances dropped in 2020, ṣukūk issuances denominated in foreign currencies increased by 7% due to favourable liquidity and global market conditions created by a range of policy actions taken by central banks in Islamic majority markets in response to the COVID-19 pandemic and resulting economic slowdown.

The yield buckets for outstanding ṣukūk have shifted higher, with almost 80% yielding 3–10%

As with other sectors of Islamic Finance, Sukuk market share is both concentrated and significant within several key countries, where it is the debt instrument of choice for governments and has been relied upon to finance budget deficits during the COVID-19 pandemic.
Key Sukuk Markets:

• Malaysia
• Indonesia
• Saudi Arabia
• Iran is the Fastest Growing Market for Sukuk within Islamic Finance

ISLAMIC FUNDS

Number of Funds: 140
Share of ISFI: 30.9% of total assets
Annual Growth Rate: 30% (2019)

In 2020 the ICM sector made up 30.9% of the total assets within the global Islamic Finance Industry, with growth and positive performance in key markets driven by sovereign and multilateral Sukuk issuances.

Islamic funds also recorded a noteworthy growth of 31.9% in terms of the total value of assets under management, while the Islamic equity markets also rebounded in the later part of 2020 after the initial shock and volatility in 1Q20 due to the outbreak of COVID-19 pandemic.

The total assets under management (AuM) of Islamic funds grew by 31.9% in 2020 despite the pandemic . While total AuM grew significantly, the total number of funds increased at a slower rate, which is a positive indication of growth in the average size of funds. The increase in scale of funds may be an indication of the flow of funds into emerging markets' fixed-income funds as a result of the search for yield and increased global liquidity.

Contrasting with the previous year, about 47% of funds now hold AuM of 1 billion USD or more each, while only 1% of funds hold AuM of less than 10 million USD (2019: only 2% held AuM of more than 1 billion USD each).

Section 3 - Islamic Insurance (Takaful)

Growth Rate: -14.8 %
Share of ISFI: 0.9% (2019)
The share of global takaful industry in the global IFSI declined marginally to 0.9% with a -14.8% growth y-to the exchange rate used for some member jurisdictions.

Section 4 - Islamic Fintech

Islamic FinTechs: 241 active in 2020
Transaction Volumes: 49 billion USD
Market share: 0.7% of total FinTech Transaction Volumes
SIZE AND GROWTH

Islamic Fintech is relatively small and recent but has shown strong initial signs of high growth and levels of innovation on a par, or superior to the wider FinTech sector even in the most competitive markets, such as London.

In 2020 the total transaction volume for Islamic Fintechs reached 49 billion USD, which is around 0.7% of the total global FinTech transaction volume.

While this represents an initial period of rapid growth, overall Islamic FinTech remains a relatively small part of the global Islamic Financial Services Industry. However, it is misleading to quantify the results as ‘poor performance’ in comparison to the strong growth within the mature sectors of Islamic Banking and Islamic Capital Markets. Instead, the demonstrated levels of innovation and competitiveness of Islamic FinTech also represents a huge opportunity for future growth.

At present the sector has yet to be fully developed across many regions and also many areas within the diverse FinTech landscape of innovation. Collectively, firms in the top 5 markets for Islamic FinTech account for 75% of the total market size, indicating a high concentration of market activity and room for future growth.
Top 5 Markets for Islamic FinTech:

• Saudi Arabia
• UAE
• Malaysia
• Turkey
• Kuwait

PERFORMANCE AND INVESTMENTS

The performance of Islamic Fintechs is particularly impressive, with projected transaction volumes set to reach over 128 billion USD in total by 2025. This represents a 21% CAGR, compared to the projected CAGR of 15% for the non-Islamic FinTech sector over the same period.

Investors have recognized this strong performance during recent years, with 56% of Islamic Fintechs expecting to complete an equity funding round in 2021. The expected average deal size for these investments was 5 million USD, providing a further indication that investors have high expectations for the performance of Islamic FinTech in the coming years.

Sources Used In This Report

• IFSB - the Islamic Financial Services Industry (IFSI) Stability Report 2021 [https://www.ifsb.org/download.php?id=6106&lang=English&pg=/index.php]
• DinarStandard & Ellipses - The Global Islamic Fintech Report 2021 [https://www.salaamgateway.com/specialcoverage/islamic-fintech-2021]
• ICD-REFINITIV - Islamic Finance Development Report 2020 [https://icd-ps.org/uploads/files/ICD-Refinitiv%20IFDI%20Report%2020201607502893_2100.pdf]

A sukuk is a form of financial certificate that is issued in compliance with Islamic finance principles and Sharia law. Sukuk is an Arabic word meaning 'deed, cheque, or legal instrument'.

The main purpose of a sukuk is to create returns for investors that are similar to the returns available on traditional fixed income bonds.

As the Islamic finance market has grown over the last few decades, so has the interest in and demand for sukuk bonds. Essentially, sukuk bonds are similar to traditional bonds in that they have parties who are involved in seeking a return on investment, and sukuk bonds are subject to the same credit rating as conventional bonds.

Sukuks are commonly used by corporations and even governments to finance their business operations.

Islamic Finance Principles And Sukuk

Sharia law does not permit investors to partake in investment activities that involve riba. The payment or receipt of riba (interest) is strictly forbidden in Islam.

Most conventional Western market bonds are based on an interest paying structure, and this is not permissible for investors who do not want to receive or pay interest on their financial investments.

Sukuks were first issued over a decade ago in Malaysia who were forward-thinking when it came to creating and supporting financial investment products that Muslims could be involved in. Bahrain was quick to follow Malaysia in issuing sukuks, and these days sukuks can be found in economies across the globe.

Sukuks take up a respectable share in the fixed income market globally. Sukuks have emerged as a great Sharia compliant alternative to traditional interest based bonds.

Sukuks offer Muslim investors the opportunity to invest in bonds and subscribe to certificates that represent the right to actually receive a share of profits that are generated by an asset base. The profits are generated by the asset base being traded on the market.

What do we mean when we refer to fixed income bonds? Sukuks are fixed income bonds. This means that they are fixed income investments and they can provide what is considered to be a more steady stream of income.

Islamic Bonds

Sukuks are considered to be Islamic bonds. They involve asset ownership which is direct, rather than indirect interest based bonds that Western markets tend to offer.

Any income, return, or profits generated from a sukuk cannot be derived from any speculative activity. This would render the return haram under Sharia laws.

So, how do sukuks work? What normally happens is that the issuer of the sukuk certificate will sell an investor a certificate. The proceeds of the sale are then used towards the purchase of an actual asset. The investor then has a partial interest in the asset based on their respective investment.

Another element of sukuk that is important to note is that the issuer of the certificate must promise that they will buy back the sukuk at a future date.

When it comes to sukuks, compliance with Sharia law means that any profits that are derived from the investment must be totally free of speculative activity and interest.

Sukuk Versus Traditional Bonds

As Islamic finance rules do not permit interest, this means that the traditional Western debt and loan instruments are not accessible to Muslim investors who want to comply with Sharia rules.

Sukuks have therefore become a great alternative for investors (Muslim and non-Muslims) to use sukuks as a viable alternative method of raising funds.

Sukuks are considered to be an interest in an asset, and not a debt obligation or debt instrument.

Conventional bonds and sukuks do have some similarities:

• Both traditional bonds and sukuks offer investors a stream of income payments. The payments on traditional bonds include interest payments, and the payments from sukuks are based on profits from the assets.
• Both bonds and sukuks are sold initially by issuers of the certificates.
• Sukuks and bonds are viewed as less risky than equity based investments

When it comes to ownership, sukuks allow for partial ownership of the asset, whilst conventional bonds are more of a debt obligation. Sukuks are not debt obligations.

It is also important to note that often, conventional bonds finance businesses or industries that are deemed to be haram under Sharia law principles. These haram industries include the gambling industry, alcohol industry, and porn industry. Sukuk bonds cannot be linked to any form of haram activity or industry.

HOW ARE SUKUK CERTIFICATES ISSUED AND HOW DO THEY WORK?

Sukuks are usually found in the form of certificates, also known as trust certificates. In the United Kingdom, sukuk certificates are regulated by the Financial Services Authority. In other countries and economic landscapes across the world where sukuk certificates are issued, there is similar regulation of them.

There is a very specific process for issuing any form of financial certificate including sukuk certificates/ bonds.

The steps below outline the most common steps that are involved in issuing a sukuk certificate:

1. Normally a company that requires some form of capital will establish a special purpose vehicle that is known as an SPV for short.
2. The company is known as the originator.
3. The special purpose vehicle aims to protect the underlying asset from potential creditors in the event that the originator gets into financial difficulties.
4. The special purpose vehicle issues the sukuk certificates.
5. These sukuk certificates are then sold on to investors for a price.
6. The originator uses the funds raised from the sale of the sukuks to purchase the asset they want.
7. The special purchase vehicle will then purchase the asset from the originator.
8. The special purpose vehicle will then establish a form of lease to lease back the asset to the originator.
9. The originator will make the necessary lease payments to the special purpose vehicle.
10. The special purpose vehicle will then distribute the lease payments to the investors.
11. Once the lease is terminated, the originator will buy back the asset from the special purpose vehicle at nominal value.
12. The proceeds of the sale are then distributed by the special purpose vehicle to the holders of the certificate.

Different Types Of Sukuk

As mentioned above, most sukuk certificates have been presented in the various global markets as trust certificates. It is very common for English common law to govern the law relating to sukuk trust certificates in different countries.

However, the management of sukuks varies from country to country so it is always advisable to do your research about the jurisdiction that regulates your sukuk. Information and transparency are key when it comes to any form of investment, especially sukuks. Where possible, always carry out an analysis of the sukuk product or service before you proceed.

The main types of sukuk are as follows:

1. Trust certificates - in this form of structure the originator of the sukuk will create the special purpose vehicle and issue trust certificates to the investors. The proceeds are then used to build a portfolio of assets which will eventually yield a return.
2. Civil law structures - these types of structures have emerged to enable sukuk transactions to be undertaken in accordance with the local laws of the country where the originator is based. One example of a country that used civil law structures when it comes to sukuks is Turkey. Turkey have passed their own legislation relating to sukuks which has to be complied with.

Sukuk For Investors

As Muslim investors have historically not had the opportunity to invest in bonds without an interest element, sukuk bonds have been welcomed across many global economies.

Sukuks are a great way of enabling investors to link returns with the cash flow of financing assets without the riba of traditional form of debt financing.

However, it is important to point out that sukuks as a form of financing should only be used for identifiable assets. Identifiable assets are those assets whose commercial value can be ascertained at any given point of time. Identifiable assets include things like real estate, equipment, cash, and stock.

In this way, the holder of the sukuk bond /certificate does not own a debt, but as the owner of the sukuk certificate, they own a share of the asset that is purchased using the sukuk funds.

Even though the special purpose vehicles that issue the sukuk certificates are usually brand new, this does not mean that investors will bear exposure to the credit risk of that special purpose vehicle.

Advantages Of Sukuk

Here are some of the main advantages of investing in sukuks:

• For those looking for investment from Islamic economies and markets there is a great marketing benefit to sukuks who will appeal to investors looking for Sharia compliant ways of investing their money
• Sukuks are known to yield similar profit on par with conventional bonds
• More bank and financial institutions are offering sukuk products (always check the website of any organisation offering Sharia compliant products to ensure that you have all the information you need)
• The investor base of Sharia compliant investors is vast and continues to grow
• In addition to the Islamic finance investment market, there is also potential to tap into the ethical investment market which has developed over the last few decades and is always in the news
• Issuers of sukuk certificates are entitled to the same tax arrangements as the equivalent traditional financing arrangements
• Assets that are acquired by the sukuk bonds are jointly owned
• Instead of receiving interest, the holder of the sukuk certificate receives actual profits
• Sukuks offer banks the opportunity and tools to invest their excess liquid assets
• Sukuks can operate for contractual terms that are agreed upon between the parties
• Sukuks continue to grow with success attracting all kinds of high-quality investors including Muslim and non- Muslim investors
• Sukuks have been used across various locations and industries including transport, water, power, education, infrastructure and industrial

An Islamic crowdfunding platform has launched in the UK, providing Shariah-compliant finance to small- and medium-sized enterprises (SMEs).

Salaam Gateway reported that Qardus, which is an appointed representative of Financial Conduct Authority-regulated ShareIn, provides unsecured loans of up to £100,000 in the form of a commodity murabahah, an Islamic financing structure in which the seller and buyer agree to the cost and mark-up of an asset.

The platform, which is open to both Muslim and non-Muslim investors in the UK and Europe, has a minimum investment of £100 and offers target returns of 10 per cent per annum.

Capital at Risk. Returns are not guaranteed

July 13 2020, read the full article at P2P Finance News: https://www.p2pfinancenews.co.uk/2020/07/13/islamic-p2p-lending-platform-launches-in-the-uk/