Global shift fires growing influence of Islamic principles in finance

Markets fluctuate. Principles don't

Dow Jones Islamic Fund

After the events of September 11, Arab and Muslim investors have had to rethink their investments of US$1.3 trillion in the United States.

Many are now channeling at least a portion of their portfolios away from New York, even as soaring oil prices have pumped an additional US$240 billion into Arab hands this year.

Arab investors face unusual risk. What if an angry US administration were to radically expand the definition of 'terrorist' assets, for example?

Now that the US Patriot Act, passed after the September 11 attacks, requires full disclosure of any foreign investment exceeding US$10,000, there is no way to hide the origins of their capital.

There is also growing political pressure on Muslim investors to withdraw their money from a country perceived to maintain a hostile agenda to the Islamic world.

It is no surprise, therefore, that wealthy Muslims are looking for friendlier places to keep their money. Egypt's Cairo Stock Exchange is this year's best-performing equity market in the world, up 83 per cent. Equity valuations on the bourses of Bahrain, Qatar, Kuwait, the United Arab Emirates and Oman have tripled on average since 2002, despite regional unrest and the seemingly intractable war raging in nearby Iraq.

Even Saudi Arabia's tiny bourse, largely closed to foreign investment, is booming.

Another striking phenomenon since September 11 is the meteoric rise of Islamic finance and banking. Although the trend was in evidence long before 2001, global financial institutions - even in the west - are scrambling to develop instruments that are compliant with Islamic law and ethics, or sharia.

Islamic law prohibits transactions involving interest or speculation. This does not mean, however, that Muslims do not ascribe time values to capital. Islamic law allows for transactions in which assets are leased and the risks between lessee and lessor are shared.

Sharia also demands that financial activities promote economic and social development. The world's 1.5 billion Muslims are expected to evaluate the ethical character of a business before investing in it. Business activities are divided into those that are halal, or acceptable, and haram, or forbidden, because they generate profits in unethical ways.

Haram activities include the manufacture or marketing of alcohol, gambling, interest-based financial products, pork and pornography. Other businesses, such as those that harm the environment, exploit labour, or produce and market tobacco, weapons or defence products, may also be unacceptable to some Muslim investors.

Companies that harbour debt to equity ratios greater than 33 per cent are also haram. Bahrain's General Council for Islamic Banks and Financial Institutions estimates that sharia-compliant investment managers control at least US$300 billion in assets, a figure growing by 10 per cent to 15 per cent every year.

A recent survey conducted by the Bahrain Monetary Authority found that of the approximately 9,000 companies listed on the London Stock Exchange, the New York Stock Exchange and the Nasdaq, up to 66 per cent are acceptable to Islamic investors.

But some Islamic analysts say the criterion used - that less that 10 per cent of a company's investments be haram - is not strict enough. If a 5 per cent maximum were used, the universe of acceptable investments in the US and Britain dwindles to less than 25 per cent of listed companies.

Because there are many different interpretations of what is acceptable in Islamic finance, there are many efforts to standardise it, both among academic institutions such as the International Institute of Islamic Business and Finance, and the financial authorities of countries such as Malaysia and Bahrain.

Europe's first Islamic retail bank, the Islamic Bank of Britain, opened this month, hoping to tap business from the nation's 1.8 million Muslims by offering modern sharia-compliant retail banking services. Rather than issuing traditional mortgages, for example, the bank purchases the home and rents it to the borrower, whose payments apply towards eventual transfer of ownership plus an agreed profit for the bank.

Previously, such a system would have attracted double stamp duty under British law, as the property is transferred twice. The laws were amended last year to ensure that transfer of the same property was not taxed twice under a single Islamic mortgage.

The German state of Saxony-Anhalt has just sold Europe's debut Islamic bond.

In Asia, the flight from US dollar-denominated assets is accelerating the development of Islamic finance instruments. Even non-Muslim countries such as Thailand and Singapore are trying to make their sovereign debt instruments sharia-compliant.

Malaysia, which is 60 per cent Muslim, has more than 20 local and foreign banks offering sharia-compliant services.

Li Ka-shing, through his flagship company, Cheung Kong (Holdings), recently joined forces with Dubai Islamic Bank to set up a US$450 million Islamic Property Fund.

Even the US finance sector is increasingly sensitive to Islamic requirements. The Department of the Treasury has named an in-house scholar in Islamic finance. The US-based Shariah Equity Opportunity Fund is marketing itself as an Islamic hedge fund. Dow Jones has an Islamic Market Index that filters out haram listed companies.

The development of Islamic finance is more than a fad. Asian market professionals must pay attention to stay ahead of the game.

Michael Preiss is a Research Fellow with the Asian Bond Market Forum, and is qualifying as a certified Islamic financial analyst