Riding The Waves Of Global Political And Economic Uncertainties In 2017
What is driving Islamic asset management industry? What is on the horizon for Islamic asset management in light of global political and economic uncertainties? Ramlie Kamsari of Nomura Islamic Asset Management takes a closer look at some of the key developments and provides insights into this niche sector.
The global asset management industry has undergone fundamental change in recent years. Increased regulations, geopolitical uncertainty and market volatility are some of the profound challenges reshaping the industry. Islamic asset management, dubbed as the “new frontier” for the global Islamic finance industry, is no exception. Despite being a growing industry, Islamic funds represent a mere 5% of the total global Islamic finance assets. According to the ISFB Stability Report 2016, 71% of Islamic funds have assets under management (AuM) of less than US$25 million, which primarily means that these funds have not reach critical mass that is necessary for efficiency and sustainability.
Similarly, Thomson Reuters’s Global Islamic Asset Management Outlook 2015 highlighted the substantial growth opportunities of Islamic funds. With AuM of about US$60 billion in 2016 and current latent demand of US$147 billion, the supply-demand gap for Islamic AuM is estimated at US$87 billion.1 This supply-demand gap is expected to widen as the global Islamic asset management industry is forecasted to grow to US$77 billion by 2019. In the recent ICD-Thomson Reuters Islamic Finance Development Report 2016, global Islamic funds are projected to reach US$77 billion in 2017 and US$105 billion by 2021.
LACKLUSTRE GROWTH
Overall, 2016 was another slow year for Islamic asset management after the global Islamic funds fell 1.6% in 2015. The performance of Islamic funds reflected the sluggish global market environment. The persistent low oil prices since 2014 further dampened Islamic funds growth, predominantly in oil-exporting countries. However, Asia performed better than the Middle East with Asia Pacific mandated Islamic funds up by 2.63% while that of the Middle East lost 8.87%. Global macroeconomic events including geopolitical events in the Gulf Cooperation Council (GCC) and Southeast Asian countries- the two main regions where Islamic funds are heavily concentrated; also weighed in on the overall performance of Islamic funds. With Standard & Poor forecasting that oil prices will remain low in the next two years – US$45 a barrel in 2017 and US$50 a barrel in 2018; the lacklustre growth is expected to continue into 2017.
By geographical area, the largest proportion of AuM in terms of Islamic funds outstanding are to be found in the GCC countries (37%) and in the Southeast Asia region (30%) (ICD-Thomson Reuters [2016]). By country, Saudi Arabia, Malaysia and Iran are the top three in terms of the percentage of Islamic funds outstanding, making up 81% of total global Islamic funds’ AuM. Meanwhile, the US and Luxembourg are major centres where Islamic funds are domiciled, representing 4% and 3%, respectively, of the Islamic fund market outside the Muslim countries. It should be noted here that Iran had displaced the US and Luxembourg to rank number 3 globally in 2015.
Equity Islamic funds, which made up 51% of total Islamic funds outstanding, had a rough year in 2016 primarily due to the heavy exposure to the GCC equity markets. Another key drags on performance was the fall in annual management fees. On the global front, global sukuk issuance increased marginally by 2.2% in 2016 to reach US$77.1 billion as compared to $75.4 billion during 2015. However, this increase was much smaller than the growth registered in 2015 at 5.5%.
This is a stark contrast to what was happening a few years ago where sukuk issuance totalled more than US$100 billion a year from 2012 to 2014. At its peak, sukuk issuance came close to US$150 billion in 2012, which is more than twice the Level expected for 2016. The subdued issuance volumes in 2016 were the result of external factors affecting global financial markets but mostly driven by the Bank Negara Malaysia’s resolution to cease issuance of its short-term sukuk. Malaysia is currently the largest sukuk issuer and is expected to continue playing a significant role together with Indonesia, after issuing US$28.4 billion and US$7.3 billion of sukuk, respectively last year. However, in 2017 the GCC may likely take a larger share as we can expect to see more issuance coming out of the GCC countries to finance their large budget deficits and infrastructure projects.
KEY DEVELOPMENTS
While demand for Shari’a-compliant investments is rising, about US$9.5 trillion of Islamic wealth still remains outside of Islamic finance industry. But unlike the conventional funds industry, 80% of Islamic AuM is made up of retail investors whilst only 20% comprises of institutional investors. Hence, the key challenge remains penetrating the institutional investor segment, which includes pension funds and sovereign wealth funds. In this respect, the move by the Malaysian pension fund, the Employee Provident Fund (EPF), to offer a Shari’a-compliant investment option to its members has been seen as a positive development. According to statistics released by EPF, as at 31 October 2016, a total of 50.25%, amounting to RM50.25 billion from the initial allocation of RM100 billion for Simpanan Shariah 2017 have been taken up since registration for the Shari’a investment scheme was opened to its members on 8 August 2016.
Two major events in 2016 that will help boost the sukuk market (infrastructure sukuk in particular) in 2017 are the launch of Saudi Arabia’s Vision 2030 and the lifting of international sanctions on Iran. Unveiled in April, the plan aims to shift the Kingdom’s economy away from its dependence on oil revenue, increase non-oil government revenue and increase private sector’s contribution to GDP. It is anticipated that Vision 2030 could potentially contribute to the growth in sukuk market as the Kingdom turns to sukuk issuance to fund its large-scale infrastructure projects.
Iran’s return to the global market is expected to drive sukuk issuance as the country entire financial sector is Shari’a-compliant with the passing of the Law for Usury Free Banking Operations in 1983. Due to the sheer size of the country’s investment needs, the government will be looking at issuing sukuk as it shifts its funding needs to the capital market. Nevertheless, Iran needs to review its current legislation, which forbids sukuk trading in foreign currencies, if it wants to tap the international sukuk market (for recent developments in the Sukuk market, please refer to Chart 1).
A positive development in the Malaysia’s Islamic wealth management industry was the launched of the 5-year Islamic Fund and Wealth Management Blueprint by the Securities Commission Malaysia (SC) in January this year. The Blueprint aims to further strengthen Malaysia as a leading international centre for Islamic fund and wealth management. Malaysia currently has Islamic assets under management at US$29.66 billion (MYR132.4 billion), which is among the largest in the world. In order to broaden the global capacity of Malaysia’s Islamic fund industry, which is very much domestic-centric, several initiatives were highlighted including formalising a framework on Shari’a sustainable and responsible investments (SRI), the introduction of a digital investment services framework, the broadening of linkages and connectivity, capitalising on global opportunities and increasing the value add and talent base within the Islamic capital market to enhance its product and service offerings. The SC is also proposing to set up a fund which would invest in multi-currency Islamic investment products managed by Malaysia-based asset managers, and including equity products, to increase their size and make them more attractive to investors. The move is aimed at attracting significant institutional money and foreign investors.
A NEW GLOBAL ERA
However, two important developments in the Western hemisphere continue to shake up the world market as the bumpy ride of 2016 is expected to linger in 2017 with another momentous year in global economics and politics. Continuing uncertainty over Brexit, politics and economic policy developments in the US as Trump takes on the US presidency as well as the upcoming elections in Europe are likely to add to uncertainty in the global economy this year.
The Brexit vote in June 2016 sent shockwaves through the UK’s political landscape, shook the European Union and dragged global financial markets with it. In the immediate aftermath, the global markets lost US$2.1 trillion in value while the British pound fell to a record 30-year low. In a recent twist of events, the Supreme Court ruled that the British government cannot trigger Article 50 of the Lisbon Treaty to formally start the Brexit negotiation process without Parliament’s consent. Thus, adding to greater economic and political uncertainty in the country. The question of passporting still hangs in the air and remains front of mind for asset managers in the UK.
As the city of London is the leading international financial centre, ongoing uncertainties on the timing and nature of the Brexit process could pose additional risk to the already fragile global economic recovery. According to the World Bank’s semi-annual Global Economic Prospects 2017 report, Brexit uncertainty could drag down growth prospects across Europe. According to World Bank forecasts, the UK GDP growth is predicted to fall from 2% last year to 1.2% in 2017 (for other GDP growth forecasts, please refer to Chart 2).
But most notably, Brexit has far-reaching implications on the geopolitical landscape in Europe as it has the potential to trigger similar referendum in other European Union countries. Many observers believe that the UK vote out of the European Union is part of a wider and more global backlash against the government, rising inequality and globalisation. If other EU countries follow UK’s lead, this will have wider ramifications on the global economic order and financial environment. However, the weaker pound and the declining property prices post-Brexit have generated considerable opportunities for international investors including Middle Eastern investors who are looking to buy real estates in London.
The election of Donald Trump as the US president also raised big questions about global policy uncertainty. Political analysts believe that Trump administration is going to reverse the cornerstone of seven decades of American foreign policy and scale back the US involvement in global affairs. Living true to his promises during his presidential campaign to take a more aggressive stance against foreign competitors as part of his “America First” approach, Trump’s recent executive order for the US to withdraw from the Trans-Pacific Partnership (TPP) carried broad geopolitical implications in a fast-growing region.
With the US looking inwards, China is ready to step in to fill the economic vacuum in an attempt to establish itself as an economic anchor among Asian nations. China is already moving swiftly to establish and strengthen bilateral trade ties with Pacific and Middle Eastern countries, thus strengthening its position as an economic power in the region. At the recent, World Economic Forum in Davos, China’s President Xi Jinping likened protectionism to “locking oneself in a dark room”, thus signalling that China would look to negotiate regional trade deals. And top of this list is the Regional Comprehensive Economic Partnership (RCEP), being led by China, countries, as well as Japan, South Korea, Australia, New Zealand includes southeast asian and India. What does all these means to Asian economies and global trade? The RCEP could be the new trading bloc on the block. Where the TPP tried to set regulations on environmental standards, labour rights and intellectual property, RCEP is focused on traditional matters like lowering barriers to trade, such as tariffs.
All eyes are on Europe this year with several key elections in France, Germany, the Netherlands and along with possibly Italy. All four nations are founding members of European Union. Against the backdrop of rising support for the populist parties across the globe, many political analysts expect the Brump (Brexit and Trump) factor to likely fuel the rising tide of nationalism, putting both the European Union and Euro at risk. The stress of such geopolitical uncertainties with political risk-taking centre stage are likely to continue to constraint global economic growth. It may also have a deeper impact on oil prices as the total EU bloc accounts for 15% of the global oil demand.
With expectations of market volatility and heightened global economic uncertainty in 2017, the European Central Bank (ECB) continued to keep its interest rate unchanged at zero and extended its bond-purchase plan until the end of 2017. However, it has announced to cut the monthly purchase amount from the present EUR80 billion to EUR60 billion in April 2017. The low-interest rate environment and strong demand for bond investors is expected to drive the sukuk market in 2017. Hence, negative yields in Europe could also be good news for the sukuk market as funds start flowing in as investors look beyond traditional fixed income products for better yields and portfolio diversification.
A GAME CHANGER
Moving forward, to further promote the growth of Islamic asset management, Shari’a-compliant socially responsible investments (SRI) could be the much-needed game changer. Both Islamic finance and SRI have weathered the economic downturn. In a number of developed markets, SRI is a fast-growing subsector of the conventional funds industry with the potential for alignment to Islamic funds. There are advantages to positioning Islamic funds as SRI funds. First, this would enable asset managers to reach broader range of investors’ increasingly diverse investment needs. Islamic funds could be attractive to some of those investing in socially responsible portfolios. Secondly, the combination of Shari’a-compliant screening and SRI principles would certainly reduce the risk profile of the funds.
As far as SRI sukuk is concerned, the market can expect to see more ‘green’ sukuk issuance to originate from the GCC countries in the coming years. For example, Abu Dhabi announced a target of generating 7% of its energy capacity from renewable sources by 2020. Similarly, the Dubai government has also stated its goal of financing clean energy and efficiency goals through sukuk. In 2015, Dubai launched the Dubai Clean Energy Strategy 2050, which aims to make Dubai a global centre of clean energy and green economy. In Saudi Arabia, the ACWA Power company has announced their intentions to finance renewable energy projects through sukuk. Hence, a convergence of SRI and Islamic funds could boost appeal in Western markets and tap into a market that complements Shari’a principles.
