Winds of change

CGS-CIMB Securities CEO Ruzi Rani Ajith tells The Edge Singapore that global investors are increasingly aware of the synergy between ESG investments and Islamic finance, which prohibits interest. Islamic loans are also structured using discounts, sale or lease, profit participation or repurchase agreements. This contributes to the growing demand for Shariah-compliant (or a service that complies with the principles of Islamic law) financing as investors seek greater portfolio diversification and an alternative to funding in traditional ESG.

Shariah-compliant and ESG investing are complementary investment approaches that have important points in common, like being a good steward of society and the environment, says Ruzi. “According to research by Refintiv, Shariah compliance screening can do much to improve ESG performance. There is a direct correlation between Shariah compliance and higher ESG scores, combining the two could improve overall risk-adjusted returns,” she adds.

The synergy has also led to collaborations, like the one between Bursa Malaysia and FTSE ST Singapore Shariah Index. In December 2014, the two entities partnered to launch the FTSE4Good Index (F4GBM), aiming to encourage best practice disclosures and support the transition to a more sustainable economy. This collaboration was further expanded into the FTSE4Good Bursa Malaysia Shariah Index in July 2021, to track constituents in the F4GBM Index that are Shariah-compliant. Encouraged by this, CGS-CIMB Research analysts expect other exchanges within the region — like the Indonesia Stock Exchange (IDX), The Stock Exchange of Thailand (SET) and the Singapore Exchange (SGX) — to promote similar projects in the future.

Although the definitions differ for both concepts due varying standards, Shariah takes an exclusion approach to prohibit investments in harmful activities such as interest generation, gambling and alcohol. Meanwhile, ESG investing is the consideration of environmental, social and governance factors, alongside financial factors, in the investment decision-making.

See also: Maybank becomes first bank in Singapore to offer end-to-end Islamic wealth solutions

CGS-CIMB Research found that ESG uptake has been rapid in Asia since 2019, led by regulators and exchanges requiring integration and disclosures. Asian asset owners and managers have taken up the mantle with over 100 ESG funds launched in Asia in 2021. While global ESG assets under management (AUM) is forecast to treble between 2020 and 2025 to US$6.5 trillion ($9 trillion), Asia is expected to be the major contributor with Asia’s ESG AUM forecast to increase five times from US$90 billion in 3Q2021 to more than US$500 billion by 2025.

Refinitiv and the Islamic Corporation for the Development of the Private Sector research found that global Islamic financial assets are expected to hit US$3.69 trillion in 2024. This is due to continued growth in Islamic banking assets as well as the elevated levels of sukuk (Islamic bond) issuance and growing popularity of green and ESG sukuk.

See also: CGS-CIMB Securities unveils first Shariah-compliant cash upfront trading account

CGS-CIMB Securities CEO Ruzi Rani Ajith. Photo: CGS-CIMB

There is no explicit breakdown how much of the total inflows into Shariah-compliant products was directly a result of investors looking for ESG solutions, but Aiiman Asset Management managing director Akmal Hassan says both investing approaches have grown in tandem over the years. The Islamic investment management company, headquartered in Kuala Lumpur, handles assets for pension funds, institutions, corporates and high net worth and mass affluent individuals.

“Inherently, both Shariah and ESG investing are similar in the sense that both are values-based with a common goal to avoid harm

and bring about positive impact to the welfare of society and the environment. This is in addition to instilling more climate-friendly and socially responsible practices, as well as sound corporate governance among investee companies,” he explains. “This intersection of values can help broaden the appeal of Shariah-compliant products to investors of all faiths and allow the industry to make similar strides alongside ESG investing.”

A 2019 study by Schroders Global Investors concludes that many investors in Asia and in the Muslim world are putting an increased emphasis on this in how they allocate their investments and are concerned about the impact that climate change will have on their portfolios.

Among others, the review found that 66% of Asian respondents said they would consider sustainability factors when selecting an investment product — higher than the 57% globally who agreed with this statement. An even higher percentage felt this way in Indonesia (76%), a predominantly Muslim country, whereas the figure for the United Arab Emirates (UAE) was also above average at 62%.

To stay ahead of Singapore and the region’s corporate and economic trends, click here for Latest Section

Regional development

Citing the Islamic Financial Services Industry Stability Report 2021, Maybank Singapore head of Islamic banking Norzulkarnien Nor Mohamad says global Islamic finance assets stood at US$2.7 trillion, of which 74% are in Asia, including countries in Southeast Asia and the Gulf Cooperation Council. The largest share of Islamic finance assets is Islamic banking (about 65%), followed by sukuk (about 25%), Islamic investments (with AUM of 5%) and takaful or Islamic insurance (under 1%).

Fitch Ratings found that the AUM in Islamic mutual funds have increased substantially, having peaked at around US$130 billion at end-2Q2021 before slipping to around US$120 billion at the end of last year. The agency estimates that the growth rate of Islamic funds at 84% nominal and 12% annualised has exceeded that of the broader global mutual fund industry at 68% nominal and 11% annualised. This is based on the latest comparable Lipper and ICI Global data for the five years to end-3Q2021.

Saudi Arabia and Malaysia remain the pre-eminent Islamic fund domiciles worldwide, reflecting strongly established local markets. Offshore markets — like Jersey and Luxembourg — also have nascent Islamic fund markets. Jersey — the largest of the Channel Islands, located between England and France — is an Islamic exchange-traded fund (ETF) hub, where multiple commodity ETFs claim Shariah status, adds Fitch Ratings.

In Malaysia, the establishment of Islamic finance has its roots in 1963, when the Lembaga Tabung Haji — formerly Pilgrims Management Fund and Board of Malaysia — was set up to facilitate Muslims’ haj pilgrimage by pooling and investing their savings. In 1983, Bank Islam Malaysia was established, leading to a slew of various Shariah-compliant offerings in the country and is now regarded as the mainstream of finance similar to the conventional counterpart.

“Over the last several decades, Malaysia has built a strong and resilient ecosystem for the Islamic finance landscape. Through concerted efforts from various stakeholders, Malaysia has embarked on major steps in developing its infrastructure, strengthening Islamic finance institutions and putting in place robust regulatory and supervisory frameworks,” says Akmal.

“Today, we see the internationalisation of Islamic finance as linkages between different financial markets are formed, allowing the industry to transcend religious and national boundaries. And with a broader outreach, Islamic finance offers a significant opportunity for us to harness its strengths to serve the real economy as well as promote financial inclusion and overall wellbeing,” he adds.

After Malaysia, Saudi Arabia and UAE, Indonesia ranks as one of the largest Islamic finance industries, notes the State of the Global Islamic Economy Report 2020-2021 report by research firm Dinar Standard and insights platform Salaam Gateway. Early last year, Bank Rakyat Indonesia Syariah, Bank Syariah Mandiri and Bank Negara Indonesia Syariah merged to become Bank Syariah Indonesia (BSI), a single state-owned bank seeking to meet and facilitate the increasing demand among Indonesian citizens for Islamic banking products.

In an interview with McKinsey, BSI CEO Henry Gunadi says that despite having about 210 million Muslim population, the penetration of Islamic banking products in Indonesia is “surprisingly low” at about 7% — compared to the share of Islamic banking in Malaysia and Brunei at around 30% and more than 50% respectively.

In regional finance hub Singapore, Islamic finance has been around since 1998 with the establishment of Islamic banking under conventional banks. Norzulkarnien says the journey of Islamic finance in the city-state has seen advancements as a result of robust regulatory framework, the growing acceptance and demand for Islamic finance among the public as well as continuous support from media in reporting its news, among others.

The regulatory framework includes the Monetary Authority of Singapore’s (MAS) issuance of Guidelines for Islamic Banking, amendments of tax regulations to facilitate the growth of Islamic finance and removing the additional stamp duties for certain Islamic transactions involving real estate.

“The above coupled with the proximity and strong ties with Muslim majority countries, especially those pioneering in Islamic finance or are keen to develop the sector, have helped spur Islamic finance activities in conventional finance jurisdiction with non-Muslim majority population,” says Norzulkarnien.

Despite this, the Islamic finance industry in Singapore is relatively small in terms of penetration and exposure compared to conventional finance. Maybank’s rough estimation suggests that Singapore’s Islamic finance market size is about 1% of the total size of the city-state’s financial industry.

“We have witnessed the progress of Islamic finance in Singapore from low to mid-scale but not yet of landmark and large-scale deals in the corporate banking space. At the same time, Islamic retail banking penetration is marginal and is growing at a moderate pace. We are still playing at the periphery of mainstream banking,” observes Norzulkarnien.

Maybank Singapore head of Islamic banking Norzulkarnien Nor Mohamad. Photo: Maybank

Pioneering and growing the market

Even though the Singapore market is relatively small, players here are working to capture and grow the market. Maybank Singapore, for example, launched its first Islamic savings account in 2005, the first Islamic term financing for properties in 2010, the first Islamic auto-financing in 2013, and the first Shariah-compliant balanced fund in the republic, Maybank Asian Growth and Income — Islamic Fund, which was launched last year.

As at May, the Islamic Fund’s asset mix consists of sukuk (64.3%), equities (24.6%), cash (8.8%) and gold ETFs at 2%. The top five equity holdings are Taiwan Semiconductor Manufacturing Co at 1.6%, Singapore Telecommunications (Singtel) (1.4%), Samsung Electronics (1.4%), Petronas Chemicals Group (1.4%) and Australian multinational mining, metals and petroleum firm BHP Group (1.2%).

The portfolio has provided returns of –4.01%, –9.12% and –9.43% over the one-month, three-months, and ytd respectively. In the fund commentary, the fund manager said Maybank’s models indicate that the global economic conditions have proceeded deeper into the “slowdown” phase.

“The silver lining is that when markets fully price in a recession, it often turns out to be a good time to buy equities. Economic data in May continues to confirm our observation last month that China markets are showing the first signs of bottoming out into recovery. We have increased our equities allocation from 18% at its minimum to 25% currently while maintaining our sukuk allocation.”

Since Maybank began offering Islamic finance product offerings in 2005, it has seen steady take-up from both Muslim and non-Muslim individuals as well as from small businesses to corporates and institutions over the years. “Efforts are ongoing to assess, develop and launch new or enhanced Shariah-compliant solutions to tailor and personalise needs of different customers across segments,” says Norzulkarnien.

He adds that Maybank Singapore actively engages all segments in the city-state to promote and share Islamic finance propositions. As the operating landscape is different compared to Malaysia, the firm executes a niche strategy in the city-state. “Firstly, we target Muslim individuals and Shariah-compliant market players, as well as religious-neutral individuals and companies with a strong ethical and sustainability focus.”

Other banks that offer Islamic banking solutions in Singapore include CIMB Islamic and OCBC Al-Amin. The number of banks that provide the solutions have dwindled over the years — DBS Bank, for example, winded down their Islamic banking unit in 2015 as it failed to achieve economies of scale.

Norzulkarnien believes that after rationalising their operations, these parties may have chosen to focus on what they are good at, which is conventional banking. Maybank Singapore, however, is banking on the long-term benefits of Islamic finance as a unique proposition.

Recently, CGS-CIMB launched iCash, a first-of-its-kind cash upfront trading account. The account offers retail investors in Singapore access to Shariah-compliant stocks across five global exchanges, integrated with its iTrade platform. “Shariah-compliant equity investing continues to record improved developments and provides protection against the downward risk as it does not have excessive leverage elements,” says Ruzi.

Returns wise, Ruzi points out that between 2015 and 2020, the conventional S&P Global 1200 grew at a CAGR of 9.5% compared to a growth of 13.6% CAGR by S&P Global 1200 Shariah during the same period. During the Covid-19 pandemic, the conventional S&P Global 1200 dropped by 31.9% ytd by end March 2020 (year low), while the S&P Global 1200 Shariah was down by 28%, outperformance of 3.9% during the same period.

Up to December last year, the Global Islamic Equity Index had also outperformed the Global Equity Index by 60% and 43% over 10 and five-year periods respectively, Bloomberg data shows. There are two factors that contributed to the outperformance of Shariah-compliant indices — sector allocation with overweight on technology and healthcare sector and exclusion of highly leveraged companies. Ruzi explains: “In short, Shariah investing has a lower risk factor in a volatile market.”

Aiiman Asset Management managing director Akmal Hassan. Photo: AIIMAN

Challenges and limitations

Although Islamic finance only constitutes a small fraction of the overall financial sector in Singapore, it has a huge potential in the innovative, competitive and dynamic regional hub, says Maybank’s Norzulkarnien. “To value-add and spur vibrancy, Singapore’s Islamic finance industry needs to be seen, heard and become more prevalent. The sector requires structural transformation and coordinated efforts by market participants.”

On the demand side, the key challenge is to increase awareness and understanding of Islamic finance across segments. Additionally, Norzulkarnien says customers should stay open-minded to explore the option of Islamic finance. Providers and experts should also share the benefits and values of the alternative solutions and to journey together with clients.

“To boost supply of Islamic finance products and services, we recommend closer collaborations between regulators, Islamic finance institutions, business associations and community associations to jointly promote it,” he adds. “For demand-led and in-depth Shariah-compliant solutions, the industry providers have to focus on innovating its products and services and adopting technology to offer competitive advantages. Regular industry engagements will also provide platforms to discuss ideas, opportunities, challenges and strategies for Islamic finance in Singapore.”

To move the needle, he thinks it is essential to have regulatory focus on the Shariah-compliant financial industry by formulating and integrating Islamic finance into Singapore’s Financial Services Transformation Map to outline and track the industry’s roadmap, strategies, programmes and enablers. This includes regulatory tax incentives or schemes for Islamic finance instruments, especially those with sustainability elements.

Beyond Singapore’s shores, there are several other challenges in the development of Islamic finance which include the lack of standardisation of Shariah rulings. Although there are already certain organisations looking at standardising certain agreements for certain products, there is still a lot that can be done to achieve an environment where all Islamic finance institutions offer products based on standardised Shariah rulings, notes Ruzi.

But there have been criticisms that the Shariah-compliant stock universe is relatively small and provides limited options for investors. CGS-CIMB analysts say that this is a misconception, as securities deemed Shariah-compliant have been increasing every year — exchanges like Bursa Malaysia, IDX, SET and SGX have 80%, 60%, 39% and 20% respectively of their listed companies as Shariah-compliant.

The FTSE ST Singapore Shariah Index, for example, has 44 constituents with a net market capitalisation of $92 billion as at June 30. The top 10 constituents are Singtel (20.63%), Keppel Corp (9.96%), Hongkong Land Holdings (8.51%), Singapore Airlines (7.06%), Mapletree Logistics Trust (5.84%), Mapletree Industrial Trust (5.26%), Venture Corp (4.72%), Frasers Logistics & Commercial Trust (4.09%), ComfortDelGro (3.11%) and Netlink NBN Trust (3.08%). The Index, launched in 2018, tracks Shariah-compliant companies listed on the SGX.

Even so, the number of constituents have decreased from the 48 at launch back in 2018. One of the counters that have removed the Shariah compliance requirements for its business is Sabana REIT, effective Oct 21 last year. In a filing, the manager said the change is a result of taking into account unitholders’ feedback and further feasibility studies on its Shariah compliance requirement.

After careful deliberation, the manager concluded that the change will be beneficial to Sabana REIT and unitholders in enchanting its balance sheet resilience, diversification of its investor base, greater flexibility in capturing growth opportunities and the delivery of its “refreshed strategy”, as well as potential cost savings in the long run.

To comply with Shariah principles, the manager had to ensure that the total rental income from lessees, tenants and subtenants engaging in activities prohibited under Shariah guidelines would not exceed 5% per annum of the REIT’s gross revenue. With the change, the manager can attract more tenants in the F&B industry and in the banking, finance and insurance industries which it may not otherwise be permitted to lease. These tenants could potentially pay better rents and thus improve Sabana REIT’s performance.

Encouraging growth

Acknowledging the issue of the smaller Shariah-compliant stock universe, Aiiman Asset Management’s Akmal says one way to encourage growth of the Shariah-compliant stock universe would be to lower the Shariah financial metrics threshold, making it easier for companies to comply. These include financial ratios like cash over total assets, or debt over total assets that can affect the stock’s Shariah status. Nonetheless, this would require the cooperation of various stakeholders including the Shariah investment advisors.

Retail investors may continue to face issues with a small investable universe but as Ruzi notes that on the institutional investors’ side, there is an exponential growth in green sukuk issuances, where the demand supersedes the supply.

Green sukuk are Shariah-compliant investments in renewable energy and other environmental assets. Islamic investment bank GFH Financial Group says US$1.57 billion green sukuk were issued last year, growing by more than 17% y-o-y in 2021 globally to reach US$15 billion. As Ruzi concludes: “It could be at an infancy stage right now, but we think it has a huge growth potential, and we want to be there to capture it.”

How Islamic banking differs from its conventional counterpart

Islamic banking is not only for Muslims: It is open to everyone regardless of race and religion, should they find the Islamic ethics and values appealing or aligned with their own beliefs.

However, Islamic banking refers to a system that complies with the Shariah law and its practical application through the development of Islamic economics. This is not to say that the financial institutions do not adhere to the local financial regulations — the Monetary Authority of Singapore’s regulatory framework for banks applies to both conventional and Islamic banking.

There are a number of differences in Islamic banking compared to its conventional counterpart. For instance, interest or riba is considered unethical and hence prohibited. Instead, Islamic banking focuses on profit and risk sharing. This means that those with Islamic banking savings accounts would be provided with hiba (gift) as a form of dividends instead of conventional interests.

Unlike conventional banking, compounding of late payment charges is prohibited for Islamic finance products. When an Islamic financing product goes into arrears, the late payment charges will only be applied on the customers’ outstanding balance that is due and payable.

In Islamic financing, loans similar to higher purchase agreements are called murabaha (mark up). Murabaha is a sale contract in which the bank sells a commodity for profit where the original cost and the profit are disclosed to the buyer, avoiding interest. As the maximum amount to be paid by the customer is determined upfront, customers can be assured that the amount they pay will never exceed a stipulated maximum amount.

Islamic banks are also not allowed to invest in prohibited industries. This includes gambling and gaming, manufacturing or sale of non-halal products such as alcohol and pork, conventional insurance and financial services and non-Shariah-compliant entertainment, among others.