Singapore Should Sharpen Its Edge in Islamic Finance (as published in The Straits Times)

The Straits Times
Singapore Should Sharpen Its Edge in Islamic Finance
By: Dr Emir Hrnjic
July 22, 2014

AT the 2014 World Islamic Banking Conference in Singapore last month, Mr Ravi Menon, managing director of the Monetary Authority of Singapore (MAS), asserted that “the sun is shining on Islamic finance”.

Indeed, over the past decades, the global Islamic finance industry – which refers to financial activities compliant with Syariah law – has grown faster than other financial sectors, mostly thanks to petrodollars, changing demographics and the establishment of the Islamic Development Bank.

Global Islamic banking assets surpassed S$2.25 trillion in 2013, while Standard & Poor's and the Ernst and Young World Islamic Banking Competitiveness Report have projected that the industry would be worth between S$2.5 and S$3.75 trillion by 2015. Putting it in context, another finance industry that has experienced dramatic growth recently - hedge funds - managed S$2.5 trillion worth of assets in 2013.

To be sure, Singapore has not stayed on the sidelines. To encourage the sector’s growth, MAS has levelled the regulatory playing field for Islamic and conventional finance, and introduced tax incentives for Islamic finance in 2008.

The city-state also recorded several milestones such as Sabana's listing of the world's largest Islamic Reit, Khazanah Nasional's issuance of S$1.5 billion worth of Islamic bonds, and Parkway Holdings' S$750 million Islamic syndicated loan.

However, Singapore was a late entrant into this industry; MAS only joined the Islamic Financial Services Board in 2005.

Globally, the Islamic finance industry in Singapore, with assets of roughly S$11 billion, lags far behind that of Saudi Arabia (estimated S$258.7 billion of Islamic assets), Malaysia (S$132.5 billion), and UAE (S$93.75 billion). According to the Islamic Finance Country Index, Singapore is ranked 23rd in the world, behind countries such as Britain.

Singapore issuers have launched more than S$4 billion of Islamic bonds to date  –  a mere 4 per cent of the S$105 billion issued by neighbouring Malaysia last year alone.

Some benefits of Islamic finance

THERE is good reason to worry about Singapore missing out on this fast-growing area of finance, which brings benefits not just to the overall economy but to individual issuers and investors as well.

My colleague Professor David Reeb, the Government of Dubai's Mr Harun Kapetanovic and I recently analysed Emirates Airline's US$1 billion (S$1.25 billion) Islamic bond issue last year, during which the firm also issued US$750 million (S$937.5 million) via conventional bonds.

Even though the airline’s conventional bonds had similar maturity and appeared to have similar risk, the Islamic bonds provided capital at a significantly lower cost – a difference of roughly 50 basis points or S$6.25 million in interest cost savings per year.

This most likely arose from the huge mismatch between demand and supply for Islamic finance products. For every Islamic bond issued, there are, at least, two willing buyers.

Similar benefits have been seen by other companies that issued Islamic bonds, vis-à-vis those that issued conventional bonds. Firms that raise capital through Islamic bonds do so at a lower cost, while Islamic bonds provide an opportunity for Islamic institutions to invest in Syariah-compliant securities issued by reputable companies with strong credit credentials.

Competition heating up

AT the same time, other international financial centres – including those without a Muslim population as large as Singapore’s – have jumped on the bandwagon.

Britain successfully issued a 200 million pound (S$425.7 million) Islamic bond in June 2014, making it the first Western country to sell such bonds.

This amount may seem like a tiny fraction of the overall Islamic bonds market, but the issue was 10 times oversubscribed and underpins London's efforts to be a global hub for Islamic finance.

Luxembourg, another large European financial centre, is now preparing to sell €200 million (S$337.8 million) worth of sovereign Islamic bonds.

In the Middle East, the Islamic finance industry centred in Dubai includes commercial banking, asset management, Syariah consulting, insurance, endowments, and other financial services. Islamic assets in Dubai have grown 15 per cent yearly and represented about 16.7 per cent of overall finance in the emirate last year.

Closer to home, Hong Kong has shrewdly and aggressively started developing Islamic finance by intensifying its ties with Malaysia, another credible hub. The government is working on issuing its first sovereign Islamic bond, potentially worth U$500 million (S$625.15 million which would mark a milestone for the Asian market.

Cementing Singapore's role

AGAINST this backdrop, Singapore can, and should, foster further growth of Islamic finance domestically so that the country does not get left behind.

Singapore can find its own niche in Islamic finance by relying on its key strengths. While Malaysia has become the leading hub for Islamic bond issuance, with a market share of more than half of the global Islamic bonds outstanding, Singapore can focus on Islamic wealth management, for instance.
 
Islamic wealth management is based on long-term relationships and investor confidence; Singapore’s well-known reputation for safety, security and stability will provide a distinct advantage in the global market.
 
The city-state could promote itself as a preferred destination for high-net-worth individuals in search of world-class Syariah-compliant wealth management services and products.

Like Hong Kong, Singapore should also leverage on Malaysia's organic Islamic finance strengths, while Malaysia (and Indonesia, another Muslim-majority nation) at the same time could benefit from Singapore's strength as an international wealth and financial management centre. 

In addition, with the strong and growing international demand for Islamic financial products, Singapore could potentially become a global intermediary between institutional investors and firms in need of funds.

With the help of the Singapore Exchange, it could become a major trading arena for Islamic bonds, hence increasing liquidity in these bonds in the process.

To that end, Singapore should consider issuing government Islamic bonds regularly, preferably with differing maturities, to attract international Islamic capital, while providing a benchmark for potential corporate issuers.

Given that Islamic bonds are sometimes issued at the same yield  as conventional bonds’, the sovereign version could even appeal to non-Islamic investors, such as the Central Provident Fund.

Once there is enough critical mass here, it could be advantageous to provide a benchmark for Islamic equity investments, which can be achieved through either a Singapore Islamic Exchange Traded Fund, similar to iShares MSCI USA Islamic, or a Singapore Islamic index, similar to the Dow Jones Islamic Market Index.

The government would need to establish clear rules for the industry, possibly through the introduction of a central Syariah Board to provide clear guidelines, similar to MAS' banking codes.

In addition, Singapore needs to strengthen the connections between academia, business, and government to develop the necessary human capital and financial technology that supports a comprehensive and holistic Islamic finance ecosystem.

To that end, the government could consider building an institute for education and research in Islamic finance to develop the necessary human capital, educate future industry leaders, and advance knowledge in this area.

This new initiative should preferably be hosted by a Singapore university, while leveraging the academic strengths of all tertiary institutions in Singapore, including those headquartered overseas.

Similarly, MAS, in collaboration with the institute, could jointly help to attract top scholars in the field to share their knowledge as well as to showcase academic expertise based in Singapore. This could be achieved by organising more high quality international conferences.
 
Finally, MAS had introduced an initiative to provide tax incentives for Islamic finance in 2008, which had a fixed five-year tenure, but these incentives recently expired.

Potential future tax incentives should preferably include tax deductions on the cost of issuance, exemption from income tax for Special Purpose Vehicles (SPV), and tax deductions for the SPV originator company.

In conclusion, Islamic finance in Singapore has yet to reach its full potential. Success in this sector needs robust, long-term government support. The game is global, and only long-term players will prosper.

Dr Emir Hrnjić is director of education and outreach at the NUS Business School's Centre for Asset Management Research and Investments.