In response to growing demand for Sharia-compliant tools and investment services, Tadawul, the country’s stock exchange, launched its first ever Islamic index last month.

The TASI Islamic Index will track the performance of Sharia-compliant companies listed on the Saudi Exchange. The TASI Islamic Index is constructed from the Tadawul All Share Index “TASI” and will be screened for Sharia compliance, which are approved by the exchange’s Sharia Advisory Committee. The committee will be responsible for overseeing and approving the list of Sharia-compliant listed companies on a periodic basis.

The proliferation of Sharia indices makes sense, according to Redha Al Ansari, Head of Islamic Finance Research, Data & Analytics at the London Stock Exchange Group.

“In the past two or three years so many retail and institutional investors started to invest,” he said. “And with Saudi being one of the largest Islamic finance markets globally, you need to actually provide more investment opportunities for Islamic financial institutions beyond sukuk and real estate.”

Companies within the index are screened by an independent screening provider under the supervision of Tadawul’s recently formed Sharia Advisory Committee that include representatives from leading financial institutions.

Tadawul did not respond to a request by Salaam Gateway for further information about the methodology that will be adopted for the index.

The index will also act as a tool for investors and other stakeholders to guide and inform decisions when analysing investments. It will also help asset managers benchmark the performance of their Sharia-compliant portfolios.

One Riyadh-based portfolio manager said that the new Islamic index is a natural step given that a large proportion of companies on Tadawul are already inherently Sharia compliant.

“Most money managers were using the IdealRatings index for performance evaluation, now they can be measured vs a published index which most (retail) investors can track,” he said, requesting anonymity.

Monem Salam, executive vice president/portfolio manager at US-based Saturna Capital, said that any step that is taken towards Sharia compliance benefits the industry.

“It is still a bit unclear as to which methodology they will be using,” he said. “They mention a panel of scholars from various institutions. My experience from Saudi Arabia is that the institutions have varying guidelines, so it will be interesting to see what consensus they come up with. However, coming up with guidelines can be very beneficial for individual/retail investors and I applaud this move.”

But a Dubai-based multi-asset portfolio manager said that whilst the TASI Islamic index is positive it is not a game changer given the small number of global funds with a Sharia-only mandate as well as the small size of the Saudi stock exchange in comparison to other equity markets worldwide.

In addition to benchmarking, the new index can also serve as a base for financial instruments like derivatives and Exchange Traded Funds (ETFs).

Tariq Al Rifai, CEO of the Quorum Centre for Strategic Studies, a London-based think tank, said that the Saudis establishing their own benchmarks gives them a strategic advantage, since the country has the largest market cap in the Middle East and North Africa (MENA) region.

“This is because index providers may not know your objectives for a particular benchmark and more importantly, you own the data. That’s where the money is,” he said.

Adding to Islamic index universe

The TASI Islamic Index will join a growing number of Islamic indices that track regional and global equities as well as other asset classes. Providers like S&P, IdealRatings, MSCI and FTSE offer their own Sharia-compliant indices.

The most notable global Islamic indices include Dow Jones Islamic Market index and the MSCI World Islamic Index. In addition, providers also offer regional indices such as the Dow Jones Islamic Market GCC index. FTSE also offers Sharia indices in other jurisdictions like Malaysia and Taiwan.

“It is important to have Sharia-compliant indices as there is a big, growing market for Sharia-compliant investments and investors would need credible benchmarks to compare the returns,” explained Faisal Hasan, CIO and Head of Asset Management at Dubai-based Al Mal Capital.

“This is a positive move that help in measuring the performance for Sharia-compliant investments. I’m sure there will be more Sharia indices that will be coming in future as the market become more diverse and deeper,” he added.

Becoming an Islamic finance hub

The launch of the new TASI Islamic index is part of a wider drive by Riyadh to position the kingdom as the Islamic finance capital of the world by 2030.

Bashar Al Natoor, Global Head of Islamic finance at Fitch Ratings said that launch of the TASI Islamic index is not a surprise and was set out as one of the kingdom’s Financial Sector Development Programme (FSDP) initiatives relating to Islamic finance, part of its Vision 2030.

“This is part of the international positioning goals that aims to enhance Saudi Arabia’s international position as the leader in Islamic finance, along with other strategic goals and initiatives that aim to enhance and develop the Islamic finance industry’s governance, educational and research institutions to support growth of the sector,” he said.

The launch of the TASI index follows the formation of Tadawul’s Sharia Advisory Committee in April. The Committee consists of representatives from the country’s largest financial institutions to ensure independency and transparency.

Fitch’s Al Natoor reiterated that the progression and development of the kingdom’s Islamic finance industry is part of a wider objective of economic diversification.

“Beyond Islamic finance the FSDP aims to develop a diversified and effective financial sector to support the development of the national economy, diversify its sources of income, and stimulate savings, finances and investments,” he said.

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In the February 2021 issue of the International Sharia Research Academy (ISRA) International Journal of Islamic Finance, Abdulsalam Ahmed Sawmar and his co-authors say the key element of Muslim charity, zakat (obligatory charity), has historically “been an integral part of the Islamic economic system because of its sizable impact in achieving social harmony and preserving decent living standard for the needy segments of Muslim communities”.

However, the potential of zakat is not being maximised and its management faces challenges including various regulatory frameworks in different Muslim countries, the paper warned.

One impact was “a significant gap” between the estimated potential of zakat proceeds and its collection through formal institutions.

UK-based international aid agency Islamic Relief is one group trying to create a common good practice in Islamic social finance. It offers a definition for Islamic social finance, saying the sector aims to improve social justice through wealth distribution and fair financial dealings.

It bans problematic practices such as gharar (uncertainty, deception and risk), while promoting philanthropy that includes zakat, sadaqah (voluntary charity) and waqf (endowment).

The UK’s National Zakat Foundation, another body laying down advice on Islamic social finance, stressed how zakat, one of the five pillars of Islam, requires Muslims to give 2.5% of their qualifying wealth (money and property) annually.

The Zakat Foundation of America has been offering guidance in the USA, outlining eight categories of people eligible to receive zakat-based assistance based on the Quran. The non-profit organisation includes the poor, debt-ridden and the displaced among its recipients.

It also promotes waqf or hubous, noting how it typically involves donating a building, plot of land or other asset for Muslim or charitable purposes to a religious, educational or charitable cause.

The Islamic Development Bank states the annual global zakat contributions amounts to $500 billion, but in 2019 only one third of the then-33-strong membership of global advocacy platform World Zakat and Waqf Forum (WZWF) (formerly World Zakat Forum) had laws on zakat, potentially hindering its development according to the WZWF.

National governments and international organisations are trying to establish the extent of the problem and offer solutions to increase zakat collections.

In Indonesia, the world’s largest national Muslim population, the zakat collected is just 0.03% of gross domestic product (GDP) against a potential 1.59%, according to the 2019 International Sharia Scholars Forum’s Regulatory Framework of Islamic Social Finance.

Taking into account the latest World Bank economic statistics on Indonesia, these sums are large – $3.57 billion collected against the $186 billion potential. However, the framework also states Indonesia’s zakat collective collection has increased more than 31 times in the past decade.

Greget Kalla Buana, Islamic finance specialist of the United Nations Development Programme (UNDP), told Salaam Gateway Indonesia offers “the most recent example of regulatory reforms in zakat management,” including the government’s creation of a Badan Amis Zakat Nasional, a public agency whose sole objective is zakat management.

In Malaysia, Singapore and Brunei, state-created majlis (entities) are solely responsible for the collection and distribution of zakat, while Pakistan operates a dual system whereby zakat is paid to the state for some wealth and income types and to the state and private zakat bodies for others, said Buana.

Meanwhile, despite being home to more than 200 million Muslims, India does not have a formal institutional or regulatory framework for zakat management. Buana says the government does not seek to intervene as zakat is entirely voluntary and collected by religious schools and institutions.

With such disparity of frameworks, Buana said the Zakat Core Principles, launched in 2016 by Bank Indonesia, Badan Amil Zakat Indonesia (Indonesia’s National Zakat Agency), the Islamic Research and Training Institute of Islamic Development Bank and countries participating in an international working group, was a positive step.

He said they “help in effective operation and supervision” of zakat, but added there was an additional need for “detailed technical guidance that aligns with each country’s local jurisdiction, rules and regulations”.

Globally, WZWF works “to address the lack of a standard international system for cross-border services and financial transactions in Islamic Social Finance,” said Buana, adding it carries out awareness-raising of instruments, such as zakat and waqf.

It also responds to the need for international consolidation in the practice of zakat and waqf, including the possibility of any cross-country collaboration, south-south cooperation and business-to-business partnerships.

A three-year memorandum of understanding signed by the WZWF and the UNDP, in November 2019, intends to help national and international partners “leverage and align” Muslim philanthropy, particularly the zakat, with the UN’s sustainable development goals (SDGs). Under the pact, both bodies promised to promote zakat’s potential to tackle goals one, two and 10, namely poverty, hunger and inequality.

A 2021 Global Islamic Finance Report by Cambridge Institute of Islamic Finance and Ajman University Centre for Excellence in Islamic Finance also noted a link between Islamic social finance and “the SDGs, climate remediation and circular economy,” pointing out zakat could help fund important environmental initiatives and progress.

Still, with such traditional Islamic social finance practices already established as a pillar of Islam, the 2019 International Sharia Scholars Forum suggested compliance incentives for zakat (such as tax incentives). A proper enforcement of penalties for non-compliance in jurisdictions where Zakat is compulsory could be another solution to improving regulatory systems.

Other operational improvements, including better zakat institution governance, have been advised.

“Greater public trust, transparent and effective governance and openness towards the formal zakat institution’s performance are critical for zakat to achieve its full potential,” said Buana in a 2020 Global Islamic Finance Report from Cambridge International Finance Advisory with its Cambridge Institute of Islamic Finance.

While significant work is required to develop a global Islamic social finance model, the fact serious experienced minds are debating the issue may yet yield fruit.

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One key issue is developing common principles for dispute resolution. The Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) has developed more than 100 standards on Sharia law, accounting, auditing, ethics and governance issues for international Islamic finance.

It works with the central banks and regulatory authorities, financial institutions, accounting, auditing and legal firms from more than 45 countries. A recent development is a Sharia standard on gold trading that categorises the metal and explains Sharia parameters for its trading and Sharia rulings for using gold-based financial products in Islamic finance institutions.

Its accounting standards include those on recording sukuk (Islamic bonds) investments and financial reporting for zakat charitable donations.

One solution floated by Gordon Blanke, founding partner Blanke Arbitration LLC, an arbitration specialist operating from London, Paris, Dubai and further afield focused on international commercial and investment arbitration, is developing semi-secular arbitration systems.

These can potentially combine civil and Sharia law rather than “settling for one or the other option, devoutly Sharia or entirely secular” that can be the initial hurdle for arbitration. Writing in Arbitration: The International Journal of Arbitration, Mediation and Dispute Management, he said tribunals need banking and finance and, if a three-member panel, “it might be sufficient only for the chairperson to have Islamic finance experience or expertise”.

Solid examples for dispute resolutions emerging from the UAE

The UAE is leading the way in developing dispute resolution systems and jurisprudence. Here, Islamic finance disputes can be resolved through litigation, arbitration or other alternative processes. Mediation (wasata) and arbitration (tahkim) are deeply rooted in the Islamic culture that values reconciliation (sulh) and a discreet settlement of conflicts, noted Antonin Sobek, counsel at the Dubai International Arbitration Centre (DIAC) and dispute resolution lecturer at the Paris-based Sciences Po University.

Last year Dubai issued a decree to consolidate all local arbitration centres under a revamped DIAC with Sobek indicating the centre is exploring opportunities to become the parties’ choice for Islamic finance dispute resolution.

He says in consultation with major global Islamic finance industry players, the DIAC can design sector-specific services including dedicated dispute resolution rules. It can also establish a list of arbitrator experts in Islamic law, banking and finance.

This development could be important given the UAE does not operate Sharia courts for Islamic finance disputes. Sobek says commercial and finance disputes are currently resolved by the civil courts, but there is potential for establishing specialised Islamic finance courts.

“Such courts could ensure Sharia compliance and contribute to developing consistent approaches to Islamic finance, thereby bolstering the attractiveness of the Islamic finance sector,” he says.

Industry not fully behind arbitration

However, the Islamic finance industry has not fully embraced arbitration.

“Islamic financial institutions may be reluctant to have their disputes resolved by private arbitrators in accordance with Sharia law. They may also be unfamiliar with the advantages of arbitration and the services available to deliver a Sharia-compliant dispute resolution process,” Sobek told Salaam Gateway.

The rapid growth of the global Islamic finance market has been accompanied by an increasing sophistication and proliferation of Islamic finance offerings. These factors inevitably create potential for future domestic and cross-border disputes between financial institutions and between these institutions and their clients and third parties.

Such concerns may have inspired the launch in 2005 of the Dubai-headquartered International Islamic Centre for Reconciliation and Arbitration to assist in resolving, through reconciliation or arbitration, disputes arising from the Islamic finance industry.

Parties to IICRA-administered proceedings are mainly from the Gulf Cooperation Council (GCC) countries and Malaysia, although Sobek noted claims that the “IICRA is yet to achieve widespread acceptance in the Islamic finance community”.

“In the absence of casework statistics, IICRCA’s popularity and international outreach remain uncertain,” he said.

Another proposal anticipates disputes resolved via dedicated rules and experienced Sharia scholars

Another option on the table is establishing a Dubai World Islamic Finance Arbitration Centre (DWIFAC) specialised in settling Islamic finance disputes; equipped with a dedicated set of arbitration rules and staffed by experienced Sharia scholars.

First proposed in 2013 by Camille Paldi, CEO of the Franco-American Alliance for Islamic Finance, the institution would be assisted by a jurisprudence office entrusted with developing a unified Islamic banking law.

While the centre has yet to be established, Sobek believes this proposal may have “nourished the debate about the need to design Sharia-compliant dispute resolution processes and harmonise Islamic finance standards and practices”.

The discussions led to a tangible initiative in May 2020 to build a unified global legal framework for Islamic finance. Announced by the UAE ministry of finance in partnership with the Islamic Development Bank and the now-defunct Dubai Islamic Economy Development Centre (DIEDC), the project aims to adopt an international treaty or global Islamic finance code.

Ultimately, it will expand the global reach of Islamic finance by integrating local differences in Islamic finance standards, practices and product offerings. A steering committee held its first meeting in November 2020 with participation from multiple global Islamic finance bodies.

More talks on the cards

Sobek says while dissolving the DIEDC in 2021 and transferring its duties, assets, rights and obligations to Dubai’s department of economic development may have slowed down progress, more talks will be staged.

He added a global Islamic finance code is currently being drafted in consultation with international strategic partners and with due regard to the AAOIFI’s non-binding Sharia standards. He expects arbitration and mediation to progressively gain traction as a mechanism for resolving Islamic finance disputes, especially as they provide significant advantages compared to litigation.

For instance, the UAE announced in March it would join the Singapore Convention on Mediation that provides its signatories from 55 countries with a mechanism for enforcing settlement agreements in other jurisdictions.

This might boost Islamic arbitration worldwide including in Indonesia where Amran Suadi, chair of the religious chamber at Indonesia’s Supreme Court, notes disputes involving Islamic finance are usually settled in religious courts for litigious cases and Sharia arbitration bodies plus the country’s Financial Services Sector Alternative Dispute Settlement Agency for non-litigious disputes.

The Supreme Court oversees the country’s regular and religious courts.

Amran said Islamic finance disputes handled by the religious courts had steadily increased from 229 in 2017 to 562 in 2020. Cases were becoming increasingly varied from simple ones involving sales and profit-sharing contracts to more complex subrogation and novation issues.

The country has more than 1,300 judges certified to handle Sharia finance cases, some trained in Saudi Arabia and Bahrain. Under Supreme Court rules, a dispute involving money less than $34,300 must be settled in 25 days.

“Thank God many disputes involving Sharia banks and customers are now settled through mediation. They don’t have to be decided by courts and that’s better,” he said.

Indonesia boosting its judges’ capacity

Indonesia’s Supreme Court has continued improving the capacity of its judges to handle Sharia finance cases via training conducted in co-operation with Indonesia’s Financial Services Authority (OJK – Otoritas Jasa Keuangan) and other authorities including Saudi Arabia and Morocco.

The LAPS SJK began operating on 1 January 2021, replacing six such agencies and simultaneously expanding the settlement scope to include the fintech sector. It works alongside the National Sharia Arbitration Board (Basyarnas-MUI) established in 2003 by the Indonesian Council of Ulema (MUI - Majelis Ulama Indonesia), a semi-official authority on Islam, amid rapid growth in Indonesia’s Islamic finance sector.

The board is tasked with resolving disputes in trade, finance, law, industry and services based on Sharia principles and provides binding legal opinions at the parties’ request. Basyarnas-MUI now has representative offices in 20 of the country’s 32 provinces.

Mochammad Buchori Muslim, head of the MUI Sharia economic department, said the council regularly issued fatwas (edicts) on points of Islamic finance.

“The Supreme Court conducts annual deliberations where our recommendations are included in the court’s circulars. Universities with law faculties have also been engaged in discussions on dispute settlement via theses, dissertations and journals,” he says.

Progress in Malaysia

In November the Kuala Lumpur-based Asian International Arbitration Centre (AIAC) in November introduced the i-Arbitration Rules 2021, a neutral international framework for resolving disputes related to Islamic finance. Malaysia’s national news agency Bernama quoted the prime minister’s department (parliament and law) minister Seri Wan Junaidi Tuanku Jaafar saying the rules meant the AIAC had pioneered the development of global disput resolution.
“This method is believed to help consumers around the world bring an integrated approach in dispute resolution and provide continuity in conventional business practices as well as Sharia requirements for such transactions,” he said.

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According to research conducted by Maybank Islamic Berhad, the Islamic banking arm of Malaysia’s Maybank Group, and IslamicMarkets.com, a UK-based financial intelligence and investing platform, more than a third (36%) of Islamic finance professionals expect “dramatic growth” in combined ESG/Sharia compliance funds over the next two years.

The research, published in a report called Driving Sustainable Impact Through Islamic Finance in March this year also showed 73% of those surveyed believe the Islamic finance market has yet to meet the demand for ESG investment strategies.

They add there is ample room for new Sharia-compliant ESG products. The Maybank findings also indicated the majority of these new funds could be bought by non-Muslim investors whose appetite for ESG investments will potentially outstrip Islamic investors given the comparatively larger non-Muslim finance market.

These investors are also unconcerned about whether the key ESG component is Sharia compliant.

Research by Refinitiv, an American-British global provider of financial market data owned by the London Stock Exchange (LSE), also published in March, claims 2021 was a particularly busy year for the launch of Sharia-compliant funds with an ESG focus.

Refinitiv points to the establishment of new funds in Saudi Arabia (SEDCO Capital), Switzerland (Lombard Odier) and Malaysia (Pheim Global ESG Islamic Fund – PPGEIF) as examples of some of the most recent launches.

The group identifies Saudi Arabia as the global hotspot for Sharia-compliant capital aimed at ESG. The kingdom’s favoured approach to ethical investment has been to issue ESG-focused sukuk (Sharia-compliant bond-like instruments used in Islamic finance).

Refinitiv’s data shows in the first two months of 2022, the kingdom issued ESG sukuk totalling $1.5 billion, more than any other country. The Refinitiv league table names next largest sukuk issuers were Indonesia, Malaysia and the United Arab Emirates (UAE) as the next largest sukuk issuers.

Muhammed-Shahid Ebrahim, a professor of finance at Durham University’s Business School in the UK, said part of the reason the Islamic finance market was playing catch-up with ESG-focused investment opportunities was that “financial literacy” in the Muslim community had not been historically widespread to support growth in Sharia-compliant ESG investments.

Unlike the non-Muslim finance industry, partly driven towards ethical investments by retail investors, individual shareholders and pension fund members, the appeal of ESG-focused investments in the Islamic finance market has been mostly limited to institutional and sophisticated investors.

“ESG-focused assets use a general value system instead of a religious value system. An average Muslim consumer is keener on an investment approved by religious scholars than one based on general values,” Ebrahim explained, adding a lack of development of theory in Islamic finance had similarly restricted the expansion.

Despite this partial hesitancy of the Islamic finance market to embrace ESG investing, according to some experts, incorporating ESG principles into Islamic finance was a natural fit. A central pillar of Islamic finance is to screen Sharia-compliant products to avoid industries deemed unlawful (haram) under Islamic guidance and law. This includes tobacco, alcohol, weapons and gambling – areas theoretically also prohibited in ESG investing.

Amanjit Fagura, a Dubai-based partner at US-headquartered international law firm Morgan Lewis, says because ESG-focused and Islamic investments are guided by principles of morality, transparency, and fairness, it was possible for an investment to be simultaneously Sharia and ESG compliant.

However, the two concepts do not always overlay each other perfectly. Fagura cited investment into a highly leveraged solar energy project.

“(This) may be a sound ESG investment, but would not be Sharia-compliant due to the prohibition on riba (earning interest on loans),” she said.

Improving access

Fagura acknowledges there is currently a lack of access to investment opportunities that explicitly satisfy both sets of values, but this is changing as financial institutions respond to market demand.

“While green investments that tick the boxes of ESG and Sharia compliance may currently be limited, the rise in innovative structured solutions that allow for exposure to certain ESG investments not otherwise Sharia compliant are increasingly being used by family offices, regional banks and institutional investors,” Fagura said, noting this could further bridge the gap between Islamic finance and ESG investing.

A 2019 report published jointly by the World Bank and Securities Commission Malaysia suggests such innovative structures could include sukuk designed exclusively to manage green projects, mortgage-backed securities that could act as a new asset class to bridge sustainability and profit; waqf (a special philanthropic deed that involves donating a fixed asset to produce a financial return or provide a benefit) and zakat (an annual obligation to donate a proportion of wealth to charitable causes) funds structured into broader financing purposes that give impacts on social and environmental dimensions.

Another solution to the access issue could be developing Islamic fintech that promises to bring retail investing to Muslim consumers who have hitherto lacked the opportunity to participate in financial markets.

Bashir Yusuf Ahmed, founder and CEO of eTijar, a Nigerian Sharia-compliant fintech platform providing Islamic investment and saving services to Muslims and non-Muslims, expects young Islamic consumers to be attracted by the prospect of making direct ethical choices about their investments.

eTijar screens for Sharia-compliant investments and mutual funds to offer its users, allowing customers to build their portfolios using its platform and earn profit rather than interest.

“For the general ethical user, (our screening process means) they know we are playing by ESG rules and not dealing with anything that conflicts with (Islamic) principles and beliefs,” Yusuf explained.

However, he admits there is work to do to persuade potential investors to choose ethical investments.

“Some people think when you talk about halal or ethical (investing), this means there is no return on investment, but in fact there is the possibility of very good returns. Some of the industries or companies that qualify (as ESG investments) are dividend-paying entities,” said Yusuf.

Ebrahim thinks breaking down cultural barriers and better financial education would allow Muslims to make informed and participate more in financial markets while broadening the appeal of Islamic finance to the wider market.

“The integration of the Muslims with the rest of the society can lead to the development of ESG Sharia funds. There are issues in the Islamic scripture and traditions … not understood or applied by the religious scholars or political Islamists. If these issues are understood in their proper context, it will expand the scope of ESG Sharia funds and attract non-Muslims,” he added.

Standardisation

An issue repeatedly cited as a barrier to the growth of ESG investing in Islamic finance is the lack of agreed standards for what constitutes an ESG investment and how that maps across to Sharia principles.

According to the Maybank report, 72% of recipients felt introducing a global standard for ESG and Sharia would boost the demand for ESG investment opportunities among Islamic investors. However, immediate progress in this area was not anticipated.

“Respondents are concerned about the lack of a global standard for ESG and Sharia,” it said, with 55% of respondents believing the launch of a global standard was two years or more away.

While global ESG standards were under development by bodies including the newly established International Sustainability Standards Board (ISSB) that incorporate work developed by the older Sustainability Accounting Standards Board (SASB), there was no current move to link these standards to Sharia rules.

Meanwhile, standards were being set in individual markets, presenting the challenge of harmonisation. A joint 2019 report by the United Nations-supported Principles for Responsible Investment (PRI) and the CFA Institute, a US-based finance education organisation, stock exchanges are developing reporting guidance and listing standards for ESG that impact Islamic finance.

According to the report titled ESG and Islamic Finance: Complementary Investment Approaches, this standardisation method has been followed by the Dubai Financial Market (DFM), a Sharia-compliant exchange. In 2019 it updated its DFM Shari’a Standards to cater to investors’ growing interest in sustainability and a green economy and in 2020 launched its own ESG Index.

In principle, until more comprehensive regulation is approved, especially internationally, anything can be marketed as an ESG/Sharia investment and it was up to investors to decide if they agreed – a situation that makes some Muslim investors uncomfortable.

Fagura said, “Investors will likely conduct their due diligence on any Sharia-compliant opportunities claiming to be ESG investments to ensure such investments do comply with their investment aims and are not misled by greenwashing”.

Some national regulators are taking steps to tackle this issue by personally vetting ESG claims. Securities Commission Malaysia launched the FTSE4Good Bursa Malaysia Sharia index in July 2021 that measures the companies demonstrating strong ESG practices.

It seems likely Sharia-compliant and ESG investing are destined to remain separate approaches for the time being, but will increasingly converge as market factors and financial and technological innovations break common ground.

Ebrahim said the Islamic finance industry had a long way to go before seeing “a truly Islamic financial architecture” that could comfortably accommodate ESG investing.

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Jakarta: Despite its promising outlook and early results, Bank Syariah Indonesia (BSI), Indonesia’s largest Islamic bank, has its work cut out to achieve the economies of scale demanded to compete nationally and globally where the knowledge of Sharia-compliance banking systems remains poor.

BSI was formed in February 2021 following the merger between the Islamic banking units of Indonesian state-owned banks Bank Syariah Mandiri, BRI Syariah and BNI Syariah, producing the country’s seventh largest bank with a 2.5% share of industry assets. Medium-term plans are to be among the top 10 Islamic banks globally by 2025.

However, analysts and officials said this could be challenging as the share of Islamic services in the overall Indonesian banking market remains stagnant – less than 7% over the past few years. This is despite its status as the world’s largest Muslim-majority nation with nearly 90% of its 270 million people following the faith.

By contrast, the market share of Islamic banking in neighbouring Malaysia is around 30%.

“The merger has not resulted in an increased market share for Islamic banking in Indonesia. There are more steps that need to be taken by the government to that end, including increasing capitalisation of Islamic banks to improve the economies of scale and make them more competitive vis-à-vis conventional banks,” Aziz Setiawan, a researcher in Islamic finance at the SEBI School of Islamic Economics, West Java, told Salaam Gateway.

This includes unique business models; investment into digitisation and improved human resources as key elements to future growth. He said for Indonesia to be a global Sharia financial hub, it must increase the market share of its Islamic banks and make bold regulatory steps.

Among its innovations to achieve goals would be allowing Islamic banks to improve product and service quality by working in synergy with conventional banks in areas like information technology (IT), networking and other infrastructure.

Setiawan believes this would enable BSI to expand on the real growth that has occurred since its launch. The bank recorded a 33% increase in net profits in the first-half of 2022, boosting confidence in sustainable future growth, the bank said in a statement late April.

Hery Gunardi, SBI president director (CEO), added that cost efficiency and expansion of cheap funds had supported healthy and solid financing.

Earlier this year BSI opened a representative branch office in Dubai, United Arab Emirates, as part of its efforts to tap into the Middle Eastern Islamic banking market and expand its customer base.

“This proves people are increasingly interested in experiencing Islamic banking services in all segments. The growth is also an injection of enthusiasm for BSI to expand its market globally with Dubai being the first,” Hery said.

The bank’s assets grew 15.73% year-on-year in the first quarter of 2022 to Rp 271.29 trillion rupiah ($18.6 billion), while capital adequacy rose to 150.09% and the efficiency ratio to 75.35%.

BSI operates under the Islamic tenets that forbid charging and paying interest, as well as trading assets deemed haram. In Islam wealth can only be generated through legitimate trade and investment in assets meaning making money from money is forbidden.

Hery said this year BSI would focus on developing the Islamic ecosystem by expanding its reach to mosques, hajj and umrah pilgrimage travel industry, alms and donation payments, Islamic educational institutions, as well as the modest fashion and halal industries.

He added this was a potential segment on which BSI must continue to work; having the uniqueness and characteristic to develop a halal and Muslim ecosystem.

Meanwhile, the number of people using the bank’s BSI mobile app (available to any device with an Indonesian phone number) grew 124% year-on-year to 3.77 million in the first quarter of 2022. The bank said the increase was driven by people switching to BSI mobile e-channels from ATMs and internet banking with more than 96% of its customers now digital savvy.

Going digital, expanding global network

The bank had also taken steps to improve online user experience, allowing customers to not only use basic features such as opening accounts or making payments, but also access “spiritual” features including prayer times; the direction toward Mecca for prayer and technical assistance when contributing to charities.

It was also creating a network of financial institutions to raise its profile. In March the bank signed cooperation agreements with several Dubai-based banks including the Abu Dhabi Islamic Bank, UK-based Standard Chartered Bank’s Islamic section and Malaysia’s Maybank Islamic to expand its network.

These innovations will enable BSI to improve its position, but its small domestic market base may mean it takes time to realise the ambitious growth goals, said Lucky Ariesandi, analyst at Fitch Ratings, the global credit rating agency.

“Growth potential for BSI is big in line with the potential for the Islamic banking sector due to its small market share and a strong preference for Islamic banking. However, growth will be gradual because there are still many processes that need to be addressed before Islamic banking can reach its potential,” he said.

Notably, Indonesia is a long way off from becoming a global hub for Islamic finance, he said. BSI’s focus was on improving its local competitiveness to compete for less exploited banking sub-segments like corporate and retain banking. Given the bank’s current phase, the Indonesian Sharia ecosystem may still require time to improve.

Lucky said BSI might help small Muslim entrepreneurs, currently reluctant to bank because of their religious views, gain access to funding. However, this would only benefit BSI if the bank could reach and provide value-add to those communities.

This included providing loans with affordable yields without sacrificing pricing for the risks the bank took.

Yet, there is little doubt Islamic banking was growing in Indonesia. Overall assets grew 12.3% in 2021 to Rp 646.2 trillion ($44.4 billion), according to the Financial Services Authority of Indonesia (OJK – Otoritas Jasa Keuangan).

“There are growing opportunities for Islamic banking development, supported by a vast growing in the halal industry and rapid technological advancement,” said the OJK in its Indonesia Islamic Banking Development Roadmap 2020-2025 report.

However, the OJK warned it may struggle to maintain such growth, given “the strategic issues currently facing Islamic banks, such as …low competitiveness”. Islamic banking in Indonesia was impeded by a lack of business model differentiation, sub-par manpower quality and low financial inclusion and literacy, said the regulator.

Islamic banking services also lacked digitalisation compared with conventional banks, stemming from lower supporting IT infrastructure capacity. However, as with any challenge in an immature market, should solutions be discovered, success would follow.

The OJK said following its 2019 regulation on banking synergy that allows Islamic banks and their affiliated conventional banks to optimise resources, Islamic banks are expected to leverage the available infrastructure from any corresponding parent bank.

This meant they performed a gap analysis of existing digital banking services and compiled an action plan for services to be developed. While BSI does not have a parent, should it follow such a sensible strategy, growth will surely follow.

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London: Sharia-compliant fintech is poised for explosive growth across both Islamic and western jurisdictions with Refinitiv expecting the market to reach $4.9 trillion within three years.

The American-British global provider of financial market data owned by the London Stock Exchange (LSE) forecast the growth figures in its Refinitiv Islamic Finance Development Report 2021. The report states Islamic fintech providers were among the standout performers in the sector during 2020 “as regulators have moved fast to facilitate Islamic fintech players and digital banking after years of ‘sandboxing’ and building foundations”.

The Islamic Global Connect Forum Report 2022, published in March 2022 by Malaysian bank Maybank, stated 89% of respondents believe fintech has already accelerated digitalisation of Islamic finance products. They also believe fintech has made them more accessible globally, while improving client experiences.

A month earlier the bank conducted research among 143 Islamic finance professionals across banking, insurance, asset management, asset ownership, private equity, regulation and fintechs.

Zaakira Allana, a Birmingham, UK-based dispute resolution director at international law firm Fieldfisher, said this was important given consumer demand was accelerating Islamic finance fintech from mobile banking to digital lending, trading and cryptocurrency.

She said fintech expansion varied by sub-sector, “but the direction of travel is towards a broader, more inclusive market for Islamic consumers, of which there is a huge global untapped reserve”.

Perhaps unsurprisingly, Middle East and south-east Asian countries with mature international financial systems sport the most Islamic fintech.

According to the 2021 Global Islamic Fintech Report produced by DinarStandard (the parent company of Salaam Gateway) and London-headquartered digital structured finance firm Elipses, Saudi Arabia, Iran, United Arab Emirates (UAE), Malaysia and Indonesia are the leading countries in terms of Islamic fintech transaction volumes within Organisation of Islamic Cooperation (OIC) countries.

The report estimates 241 Islamic fintechs operated globally across OIC and non-OIC countries and that the market for fintech in OIC countries was worth $49 billion. Outside the Islamic finance hotspots, countries with less developed financial systems could be significant drivers for the Islamic finance market if fintechs successfully mobilised their customer bases.

Central Asian fintech

Central Asian countries with large Muslim populations, such as Kazakhstan where around 70% of the population practices Islam, are among those with the greatest potential for Sharia-compliant fintech products to take off, said Marina Kahiani, an Almaty, Kazakhstan-based partner at GRATA International, a law firm with a special focus in central Asia and eastern Europe.

“Kazakh companies are trying to develop Sharia-compliant fintech products. However, they are just at the beginning of the process,” she explained.

In 2019 Kazakhstan unveiled its Islamic Finance Master Plan 2020-2025 complete with developing a fintech hub to support industry innovation. It was coordinated by the Astana International Financial Centre (AIFC), based in the country’s capital Nur-Sultan (formerly Astana).

The AIFC was established in 2018 as a special zone to foster growth in Kazakh financial services companies. Its legal system is based on English law principles rather than Kazakh law – a significant move as the former is less restrictive and has wider international application for transactional rules.

In its fintech section, the Master Plan acknowledges that Kazakhstan financial inclusion is “relatively low” with one key reason being the country’s financial service providers focusing on business and wholesale work rather than consumer products.

According to the plan and data reported by the World Bank in 2017, only 59% of adults (aged 15 years and older) in Kazakhstan hold an account at a formal financial institution. Some of the reasons included a “lack of awareness and understanding on fintech and Islamic finance; lack of funds and disposable income; trust deficit towards the financial system and currency accessibility”.

However, Kahiani notes the stagnation was lifting with fintech products aimed directly at Islamic consumers now being launched in the country. She said successful early movers were those with international partners who had more fintech experience.

“The first digital Islamic card was recently launched in Kazakhstan by Islamic fintech company Tayyab in cooperation with Kazakhstan’s RBK Bank and Visa with Dubai Fintech Ventures as an investor”, said Kahiani.

The Tayyab card, issued to users’ mobile phones when they download the Tayyab mobile app, is fully Sharia-compliant, a status confirmed by the Shariyah Review Bureau of Saudi Arabia. It does not charge interest on customer card balances (haram under Sharia law) and allows users to make contactless payments and instant transfers via Apple Pay and Samsung Pay. Plastic Visa cards can be issued to users on request.

The Tayyab card also allows customers to store funds in four currencies (Kazakh tenge, US dollars, Russian roubles and euros) and withdraw cash from any ATM worldwide. It was also set up to prevent it being used for haram activities such as in casinos and other gambling outlets, alcohol and tobacco stores, bars and nightclubs, through restrictions built into the technology that recognise such transactions.

African fintech

African countries with large populations of young Muslims are also embracing Sharia-compliant fintech. The 2021 Global Islamic Fintech Report noted sub-Saharan Africa and Middle East and north African (MENA) countries (excluding Gulf states) “have gaps” across the nine key fintech services of social finance, insurance, wealth management, deposits and lending, raising funds, payments, capital markets, digital assets and alternative finance.

This indicates “ample opportunities for growth”, said the report.

In July 2021 Nigeria launched eTijar, a Sharia-compliant fintech platform delivering Islamic investment and saving services to Muslims and non-Muslims. According to Bashir Yusuf, founder and CEO of eTijar, when his team began working on the platform in 2018, they identified a major vacuum in the country’s consumer finance market.

“Many young Muslims who are on a good income are not even saving or investing. We had to build the technology infrastructure to allow the younger demographic accessible ways to save and invest their money,” he said, adding the problem was more acute in rural areas, where most people were excluded from financial systems through a lack of knowledge and physical access.

The platform allows users to build investment portfolios from funds screened by eTijar and approved as Sharia-compliant. The platform takes a management fee rather than charging interest on users’ funds.

Yusuf said by cooperating rather than competing with Sharia-compliant fund managers and Islamic banks, eTijar was expanding the market for all Islamic financial service providers.

However, despite generally positive growth, Islamic finance fintech still faces challenges including regulatory barriers especially in Muslim-minority countries. Lingxi Wang, managing associate at UK law firm Foot Anstey, said during an Islamic finance roundtable the firm hosted in 2021, the general consensus was that a significant amount of time and resources were being spent trying to explain to the UK’s Financial Conduct Authority (FCA) how their products fitted into the current regulatory regime.

“This pushes back the initial launch dates. They also found even when being referred to an FCA specialist function, those experts did not have the requisite knowledge and understanding of Islamic finance to provide our panellists with immediate effective solutions,” said Wang.

He said while the FCA accommodated Islamic finance through its current regulatory regimes, creating a bespoke product in the UK required a lengthy statutory consultation process. He contrasted the UK’s approach to Malaysia, a country proactively promoting a strong Islamic fintech ecosystem.

Islamic fintech in Malaysia and the Middle East

In August 2020 the Securities Commission Malaysia announced a collaboration agreement with the Financial Services Authority of Indonesia (Otoritas Jasa Keuangan – OJK) on sharing knowledge about on fintech trends and regulatory developments.

“The UK could learn lessons ... from Malaysia in their proactive approach in creating a regulatory background for Islamic fintech. Also, some aspects of new Islamic fintech may run into problems, especially in non-Islamic jurisdictions,” Wang said.

For example new Sharia-compliant challenger banks and services may not have full banking licences and may need services and funds from conventional banks, thus creating a grey area when it comes to their regulatory and Sharia-compliance obligations.

Another area of confusion is the Sharia-compliant status of cryptocurrency, the lifeblood of some fintechs. In May 2022 Qatar Central Bank released a statement warning the country’s financial services from dealing with unlicensed financial institution or service providers, stressing Qatar currently has not licensed any virtual asset service providers (VASPS) including cryptocurrency operators.

The Maybank report said innovation may provide answers to these problems with regulatory technology being created to deliver robust digital tools certifying compliance with both Sharia and national government requirements through smart contracts on blockchain.

In a 2019 lecture, Fahad Yateem, director, Islamic financial institutions supervision for the Central Bank of Bahrain, explained essentially, regulatory technology and supervisory technology in Islamic finance aimed to enhance the transparency, consistency and standardisation of regulatory processes to promote a proper interpretation of regulatory standards at a lower cost and ensure risk-based supervision for Islamic banks’ regulators.

Examples of Sharia-compliant regulatory technology developers include UK and Jordan-based ICS Financial Systems (ICSFS), an Islamic banking and finance software provider. ICSFS' Islamic software suite is designed to cover all Islamic banking requirements including Sharia law compliance.

In February 2022 Hassan Baan, a member of the International Committee at the Iranian Association of Islamic Finance wrote a blog stating Islamic regulatory technology was “not about regulatory reporting, risk management, identity management and control or transaction monitoring”, but rather about finding “a solution for Sharia-compliance that includes real-time monitoring and tracking of the current state of Sharia-compliance and upcoming regulations in Islamic banks and fintech platforms”.

According to the Maybank report, 34% of respondents believed the impact of regulatory technology on growth would increase dramatically over the next three years, while 47% predicted it would increase slightly.

Should Islamic fintech and regulatory technology combine forces, this important Islamic finance segment may grow even more robustly than projected.

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