Meeting the Potential

Mohammed Dawood Head of Islamic Finance, HSBC, MENAT reflects a positive overall outlook for Islamic Finance in the region and beyond, encouraged by the application of technology, the growth of ESG considerations and an expected increase in Sukuk activity

Mohammed Dawood, Head of Islamic Finance, HSBC Middle East, North Africa & Turkey

Will digital transformation help to grow the market share of Islamic Finance in the region and the wider world?

Digital transformation is revolutionizing the way that the banking sector conducts operations, making transactions and payments easier, faster and even more secure. But the Islamic finance sector still has much to do to fulfil the potential of its own digital transformation journey.

Currently, the execution of daily Islamic finance transactions conducted by Islamic banks is reliant upon manual processes and is characterized by its use of a large amount of documentation. Applying new technologies, such as blockchain, to Islamic finance would speed up processing, reduce human error and provide a strong foundation for further growth of in market share.

Over the past few years, we have seen the emergence of Islamic fintechs and roboadvisors in the MENA region and beyond. These innovations are crucial to Islamic finance maintaining and building market share, particularly in the GCC region and South-East Asia. In markets where Islamic finance is underrepresented, such as Western Europe or the United States, new technology will provide access to consumers who previously had no access to Islamic finance products and services.

Are Shariah-compliant social principles appealing to investors whose decisions are following ESG principles?

There is significant alignment between ESG and Shariah-compliance principles,

in particular the overarching principle of “do no harm” to the environment and its inhabitants. For example, in most financing syndications, a covenant is usually inserted into documentation to ensure that the obligor does not take any action which could harm the environment and lead to adverse legal repercussions for the borrower.

As of today, most Shariah-compliant investors in the Middle East do not have a set of ESG criteria to adhere to beyond the “do no harm” principle.

Instead, ESG-focused investors in Europe, Asia and the Americas have requirements which go beyond the “do no harm” principle. Such ESG-focused investors want the impact reporting of their investments to be done by the issuer of green or social Sukuk on a periodic basis. For example, the impact analysis needs to quantify the number of people who have benefited from a Sukuk, where the proceeds have been allocated to a public healthcare project, or the amount of carbon emissions reduced by the installation of a solar power plant in a city.

How do you predict the rate of Sukuk issuance in the region will change in the coming five years?

The volume of the international Sukuk market, comprising hard-currency Sukuk which can be bought by cross-border investors, hit an all-time record of USD 34 billion last year. The compounded annual growth rate in the past decade has been 12.6% per annum, representing a strong growth in volume.

At the same time, the number of issuances has grown from nineteen issuances in 2011 to 48 issuances in 2021, representing a 153 per cent increase over a decade.

We expect the volume of issuances to continue to grow as issuers become more familiar with Sukuk structures and seek to diversify their sources of funding from the traditional bond market. At the same time, further standardization of Sukuk documentation is expected to lead to quicker access to markets for issuers. High energy prices are also expected to contribute to increased liquidity within the GCC countries, which means that investors will be on the hunt for good investment opportunities including Sukuk issuances.

We see the potential for the market to grow to around USD 40 billion worth of Sukuk issuances per year in the coming five years, as long as the drivers of growth mentioned above remain conducive.

In the current economic environment, will we see increased M&A activity between Islamic Banks in the region?

Whilst there has only been a handful of M&A transactions involving Islamic banks, this has been a very positive development in the growth of the Islamic finance sector. In the UAE, the acquisition

of Noor Bank by Dubai Islamic Bank has cemented its position as the largest Islamic financier in the Emirates and the second largest Islamic bank globally. In Qatar, M&A activity has resulted in the two of the top three banks in the country being Islamic, as a result of Islamic banks acquiring conventional counterparts.

As Islamic banks seek growth opportunities within their domestic markets and beyond, this emerging trend of Islamic banks acquiring conventional banks may continue.

Do you feel that the universal standardisation of Islamic Finance is a realistic prospect?

Islamic financial structures and contracts are not the same as their conventional equivalent. Even different shariah standards between Islamic financial institutions has led to many iterations of the same or similar product, as we see in the market today.

In recent years there have been positive advances made in this space, primarily led by the International Islamic Finance Market (IIFM) – a global standard body for the Islamic financial services industry, focusing on standardising Islamic financial agreements, with the introduction of market standard contracts across Islamic hedging, money market, trade finance and collateralized financing structures. However, until such time that shariah standards and standardisation initiatives are consistently applied by all

WE SEE THE POTENTIAL FOR THE MARKET TO GROW TO AROUND USD 40 BILLION WORTH OF SUKUK ISSUANCES PER YEAR IN THE COMING FIVE YEARS

relevant regulators of Islamic financial institutions, there will likely remain a tendency for bespoke contractual arrangements based on the preference of specific institutions and clients.

Standardisation of Islamic finance contracts will ultimately enhance the market for Islamic financial products and services by introducing efficiencies into execution. This will lead to improved customer experiences, and it is something the Islamic finance market continues to strive towards.