In January 2013, Dubai’s ruler, Sheikh Mohammed bin Rashid Al Maktoum, announced an initiative to turn Dubai into the “global capital of the Islamic economy”. The six-pillar strategy calls for the development of the halal food and tourism industries, as well as the expansion of the Islamic financial services (IFS) sector, and small and medium-sized enterprises in related fields. Sheikh Mohammed also pledged to create a legal centre to resolve disputes over Islamic contracts and appoint an independent sharia council to help develop and promulgate national standards in Islamic finance. The chairman of the Union of Arab Banks, Adnan Yousuf, told local media in August 2013 that Islamic business and finance is expected to account for 40% of economic activity in the UAE within five years as a result of the initiative.
Expanding Islamic Finance
Though Dubai has already established itself as a leading trade and finance centre for the Middle East, Africa and South Asia region, to claim its title as the global capital of the Islamic economy, it will have to compete with neighbours in the GCC that are also developing their IFS sectors, as well as the world’s largest sukuk, or Islamic bond, markets in Malaysia and London. Dubai also faces a lack of diversity in its own bond market. Its competitors, meanwhile, have already begun to address many challenges facing the industry.
Standardisation
Foremost among these is the debate over standardisation, according to Adnan Chilwan, CEO of Dubai Islamic Bank. “The debate around standardisation should primarily be restricted to the regulatory framework. Further developments, especially for liquidity management, are a key area for the regulator, and the Islamic certificate of deposit is a major breakthrough,” he said.
“Such moves are critical in enabling banks to manage excess liquidity, but banks want to retain autonomy vis à vis product development. The key factors governing growth are the quality of products and services offered, with innovation the major driver.”
Malaysian regulators have taken a step towards unifying standards by revising the screening guidelines used to classify equities as sharia compliant so they are more compatible with those in the GCC. Jordan also passed a law in September 2012 governing sukuk issuance and was followed by Tunisia.
While the UAE’s legal system has proven more supportive of Islamic legal principles than some Western markets, the country currently lacks specialised legislation regulating sharia-compliant business transactions and structures.
Ijara Exemption
The emirate was the first to exempt ijara transactions (a structure whereby title to property needs to be transferred to the bank and back to the customer) from the double payment of registration fees on the transfer of an asset, according to UAE law firm Al Tamimi & Company, in a pioneering move that has since been copied by London. However, the concept of beneficial ownership, where an individual or group of individuals indirectly benefit from the title of the asset held in someone else’s name, is not clear under UAE law. “Many Islamic structures, such as sukuk and property musharaka, apply the concepts of trust and beneficial ownership, which are concepts that are not accepted under UAE law and make enforcement of Islamic structures in the UAE challenging and, to an extent, uncertain,” Al Tamimi wrote. “If the local legislator could consider recognising this legal concept or introduce alternatives, this would add certainty to the application of these structures under UAE law and any related security granted over assets located in the UAE. As an example, options available in other jurisdictions include the ability to record beneficial interests in land and to legally register trust interests.”
Addressing Challenges
Dubai has also not made as much progress as Malaysia in addressing inconsistencies and conflicts of interests arising from sharia supervisory boards. The majority of supervisory boards in the UAE have reasonably unified stances on common instruments and concepts, according to Al Tamimi & Company, but there is no overarching accreditation process for sharia scholars participating on advisory boards, nor has a clear role for these boards been established. To reduce potential conflicts of interests arising from sharia scholars participating on multiple boards, Malaysia has limited them to serving on one board per market segment.
The Central Bank of the UAE is reportedly working on comprehensive Islamic finance legislation that aims to further bridge regional gaps that have emerged between South Asia and the GCC.
Making Experts
The dearth of qualified IFS specialists is another challenge facing the industry. Ernst & Young’s (EY) “World Islamic Banking Competitiveness Report 2012-13” found that human capital is the single largest operating expense for Islamic banks.
The announcement of the launch of the Dubai Centre for Excellence in Islamic Banking and Finance, which will offer certification courses in Islamic banking and finance through the Hamdan bin Mohammed e-University, was a welcome step towards addressing this gap. There are 31 institutes and nine universities offering IFS courses in the UAE. However, both London and Malaysia have more universities that teach the subject, according to a study published by the Jeddah-based Islamic Corporation for the Development of the Private Sector (ICD). In terms of intellectual capital, Dubai has an excellent advantage for its long-term aspirations to become a global capital for the growing international Islamic economy. However, this will need to be leveraged to use it as a foundation to build up other aspects of the Islamic economy.
Pension Funds
One potential avenue by which Dubai could achieve its goal would be by making a concerted regulatory push towards the development of sharia-compliant pension funds, which are currently in high demand, yet underrepresented in major potential growth markets with the largest Muslim consumer bases, according to EY. Although most existing pension schemes in the GCC are run by the state, shifting their holdings to the private sector could bring $160bn-190bn to the global Islamic asset management industry, EY noted.
“With the maturity of the sukuk market and sharia-compliant equity indices, as well as technology available to screen conventional indices to carve-out subindices, there appears to be sufficient assets available for many of the pension funds to build out sharia-compliant propositions,” Nida Raza, a director with EY’s Islamic Banking Centre specialising in fixed-income advisory, wrote in a July 2013 newsletter. “Greenfield operations could take too long to satiate market demand. An alternative is the partial transformation of existing pension funds to be sharia compliant.”
If Dubai takes this route, a key decision will be whether to allow members to transfer their existing account balance to the sharia-compliant fund or only allow them to segregate future contributions as sharia compliant and conventional, Raza wrote. Once a business model is determined, the carving out process may involve further valuation of a pension funds’ assets on the date of transformation, which may have “level, financial, or tax implications”.
In Dubai’s case, the transformation of the existing end-of-service gratuity programme into an investable savings scheme would not only lend itself to realising Dubai’s goal of becoming the global capital of the Islamic economy, but it would also bolster the emirate’s capital markets by creating a much-needed pool of investable funds to grow the UAE’s asset management industry, according to Michael P Grifferty, the president of the Gulf Bond and Sukuk Association, which is headquartered in the DIFC. “We are very supportive of efforts to provide an alternative to the endof-service gratuity in Dubai, which would help our members grow the institutional investor base for sukuk and sell more,” Grifferty told OBG.
Streamilining
Thanks to recent efforts to streamline trading for international investors, such as the introduction of a new platform to allow both conventional and Islamic bonds to be traded in May 2013, sukuks issued in Dubai are appealing to an increasingly diverse pool of investors. GCC investors typically account for 40% of the base for sukuks issued in Dubai, while the remaining buyers are split between East Asia and Europe, Grifferty said.
Nonetheless, national banks are both the most active buyers and issuers of sharia-compliant bonds in Dubai, which is a reflection of the relatively small institutional investor base in the region.
Boosting Trade Volume
Another objective for the Gulf Bond and Sukuk Association in 2014 that would address this challenge, boost trading volumes on Dubai’s financial markets and, by extension, bolster the emirate’s burgeoning sukuk market, is to encourage more local-currency issuances.
“If you are issuing a sukuk on Dubai’s international exchange, sometimes your investors will be local banks or other entities, but most of your buyers will be outside the region, so that is not really developing local capital markets. In developed capital markets you usually see more individual project-financing bonds and local-currency issues,” Grifferty told OBG.
“The way to do that would be for the government to issue and create a bond market benchmark,” he told OBG. Although the Federal National Council has approved a law authorising the issuance of a federal UAE debt instrument, it has yet to be ratified.
A more fundamental way that Dubai could grow its share of the global sukuk market would be to encourage more national issuers to list on NASDAQ Dubai, the emirate’s international exchange on which eight of the nine sukuks issued are listed, as opposed to the London Stock Exchange (LSE). In a recent address Abdullah Al Turifi, the CEO of the Emirates Securities and Commodities Authority, pointed out that half of the 49 sharia-compliant bonds listed on the LSE were issued by UAE-based entities. The results of Dubai’s campaign to become the global capital of the Islamic economy will not be clear for years to come, but it looks to be well on track, with ample room for growth.
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