To maintain its phenomenal growth rates, Islamic finance is increasingly looking beyond sukuk and property investment to growth areas such as renewable energy and healthcare. 

The ongoing global economic crisis is still being felt by much of the world and, in particular, many conventional banks. They are focused on implementing the new regulatory requirements that demand that they strengthen their balance sheets. This has led some banks to reassess and ultimately withdraw lending facilities rather than raise more capital. Some are also trying to manage the damage to their reputation caused by the scandals associated with their roles in the economic crisis. Although not immune to these challenges, Islamic banks are starting to enter new markets and sectors that were previously dominated by conventional finance.

Now more than ever, Islamic banks are in a position to take advantage of these opportunities. The global Islamic finance industry has increased in volume by 33% since 2010, reaching $1100bn in 2012 according to Standard Chartered, and there are no signs of this slowing.

Not only is the growth significant in many key regions, but the market share in some countries is close to reaching critical mass. For the Islamic finance industry to sustain these growth levels, it must look to new markets, regions and services.

Sukuk still key

Despite this clamour for new avenues of growth, the sukuk market is still playing an important role in increasing Islamic finance’s international profile and attracting both sharia and conventional issuers and investors alike. This year has been a bumper year for sukuk, with issuance to the end of September matching the whole of 2011, placing the market back at pre-2007 levels.

This momentum is likely to continue with an expected threefold increase in sukuk issuance from $300bn in 2010 to $900bn by 2017, according to a report published in 2012 by Ernst & Young entitled Global Islamic Banking Centre of Excellence. 

Currently the majority of issuance is from Malaysia and the countries that make up the Gulf Co-operation Council (GCC), with the latter dominating the US dollar sukuk market with 70% of the market share, totalling about $8.5bn, as reported by Standard Chartered’s Middle East Compendium in 2012. 

However, investor demand for sukuk from outside Malaysia and the GCC is growing rapidly and bringing new investors to sukuk issuers. Some sukuk issued in 2012 have been 20 times oversubscribed. This demand is opening up Islamic finance on a global scale, with the number of countries issuing sukuk doubling since 2006. In the same period, the number of currencies sukuk has been issued in has also doubled.

Sovereign issue

A milestone for the industry has been the entrance of conventional sovereign issuers onto the scene. In July 2012, South Africa announced that it was planning to launch sub-Saharan Africa’s first Islamic bond, with the country’s treasury stating that it was leaning towards a dollar-denominated, five-year sukuk using an ijara structure. Kenya, Nigeria and Tanzania have also been planning sukuk issues.

September 2012 saw the first sovereign sukuk issued by Turkey. The $1.5bn transaction was significantly oversubscribed, with the book size closing at more than $8bn. Further progress is being made as countries such as Egypt and South Africa make their tax and regulatory environments compatible with sukuk.

Already there has been work done by conventional names such as Goldman Sachs, HSBC Middle East and the United Arab Emirates conglomerate Majid Al Futtaim to help pave the way for other non-Islamic corporates and financial institutions, and we expect to see a far more active primary and secondary market in the future.

The pent-up investor demand is providing the catalyst for conventional players to start issuing sukuk and, as longer-dated US dollar swap rates fall, the sukuk market will continue to outperform many conventional bonds, thereby attracting a new group of investors.

It is not only sukuk that appeals to countries looking to enter the Islamic finance space. Countries such as Australia are looking not only to tap domestic investors, but also to position themselves as the financial services hub for the Asia-Pacific region, which has a large Muslim population. Other countries such as France and Nigeria continue to review their regulatory framework to include the Islamic finance industry.

New markets

However, in many ways the sukuk market is only a small part of the Islamic finance industry. Current estimates put it at 7% of the total asset base. Therefore, if Islamic finance is to maintain its growth rates it will not only need to widen its geographical spread, but also to move outside its traditional markets of sukuk and property into areas such as renewable energy.

Renewable energy is a significant growth market, with global investment of $195bn in 2010, which is forecast to rise to $395bn in 2020 and $460bn by 2030. To sustain this level of growth, nearly $7000bn of new capital is required. Islamic banks, with their strong balance sheets and ethical principles, are well positioned to become leaders in this space.

Geographically, Europe is the largest regional market for renewables, with 25% of world investment. However, the eurozone crisis may impact negatively on the level of investment in future. The US has the highest investment amount of a single country in the world, followed by China and Germany.

A key region for this segment of Islamic finance will be the GCC, which has significant liquidity generated by its oil industry that can be used to finance future renewable energy projects.

The governments of the GCC countries are looking to the future, and high on their agenda are plans to diversify into a sustainable post-oil economy. The Middle East and north Africa (MENA) region is expected to at least double its renewable energy capacity over the next 10 years.

The GCC is already taking significant steps in building a solid foundation for renewable energy and encouraging development of the market. The region has the potential to become a key hub for the sector, and the International Renewable Energy Agency has decided to open an office in the 'zero-carbon' Masdar City in Abu Dhabi.

Green sukuk

In March 2012, the Climate Bonds Initiative, the Clean Energy Business Council of MENA and the Gulf Bond & Sukuk Association joined forces to launch a Green Sukuk Working Group. The group aims to channel market expertise to develop best practices and promote the issuance of sukuk for the financing of climate change investments and projects, including those in renewable energy.

Using its petrodollars (US dollars earned by selling oil to another country), there has been significant financial investment within the GCC to support the burgeoning green energy supply. In January 2012, the Dubai government announced a $3.2bn plan to develop the region’s largest solar power plant.

In May this year, Qatar Solar Technologies secured $1bn in financing for its flagship polysilicon manufacturing plant located outside Doha. The Saudi-headquartered Islamic Development Bank is also looking to resource-rich Kazakhstan and and the rest of central Asia with the launch of a $50m renewable energy fund.

Healthcare importance

The Islamic finance sector continues to grow in the GCC, with its market share of all banking assets having reached 25%. This growth and liquidity bodes well for future investment in emerging sectors, such as renewable energy and healthcare.

The provision of healthcare, particularly for the elderly, is becoming a more pressing issue for many countries. The deficiencies and weaknesses in the healthcare systems will become more apparent as Western populations age and as regions such as the GCC prioritise caring for their populations.

Healthcare expenditure against gross domestic product in the GCC lags behind many developed countries, such as the US (20%) and western Europe (10%), with levels varying from 2.4% in the UAE to 5% in Saudi Arabia, according to a report published by PricewaterhouseCoopers in 2011 entitled MENA Private Equity: the Next Five Years.

Many GCC governments are actively promoting private investment in this sector to reduce reliance on public finance, which is thought to sit at about 70%. With government backing, policy reform and a large funding requirement, this sector offers a range of attractive financing prospects for Islamic banks.

Part of the appeal of healthcare investment to Islamic banks is that it is often based on a property investment. However, there is also potential for the leasing of medical assets. Healthcare is also appealing as it provides regular cash flow, is linked to inflation and contributes to the well-being of society. As such, it is aligned to the ethical principles of Islamic finance. The Bank of London and the Middle East is already taking advantage of the opportunities in this sector in funding UK healthcare businesses, including care homes for companies such as Signature Homes, lease finance for healthcare assets and homes for the elderly with UK firm Retirement Security.

These opportunities and new markets not only offer Islamic banks diversified investment opportunities, but will stimulate product and service innovation while bringing Islamic finance to a global audience.

Humphrey Percy is chief executive of Bank of London and the Middle East

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