Given the wide geographical scope, the continued integration of services in the mainstream markets and the increased understanding and appreciation of the challenges and prospects, Asian asset managers show keen interest inleveraging the opportunities of Islamic financing. Francis Braeckevelt of BNY Mellon Asset Servicing discusses the implications.
As tempting as it may be, one must avoid treating Asia Pacific as a homogenous region along the lines of Europe or the US. Each country has its own economic and political climate and regulators often have a different take on what is, and is not, permissible. The same is true of Islamic finance in Asia, with different countries looking to embed Islamic activities in existing regulatory and supervisory frameworks.
Although Asia Pacific is home to more than 60% of the world’s Muslim population, Islamic financial assets, in the Asia region, are largely confined to a single country: Malaysia. It has a smaller Muslim population than Indonesia but accounts for more than 60% of global sukuk issuance, an instrument akin to the more commonly known asset-backed securities, albeit different with regards to the underlying structures and provisions.
Bahrain, Dubai, Kuala Lumpur and Labuan are the more established Islamic financial centres but other cities, like London, New York and countries like Singapore, Hong Kong, Australia and Korea, aspire to play an increasing role in this fast evolving area, modifying local laws and tax regulations to deal with sharia compliant activity.
These countries and the wider market participants continue to monitor and address general challenges around complying with multiple sharia board rulings and the resulting questions around the lack of homogeneity or cross-border applicability. This includes the absence of significant depth and breadth in liquidity in the short-term money and sukuk market or the challenges around the need for harmonised standards.
As Islamic contracts are asset based (subject to sharia law), Islamic fund administration stands most apart from the administration of conventional funds in the areas of investment restriction monitoring, cash management, purification support and Islamic instrument support.
Any fund administrator wishing to enter the Islamic funds servicing arena in Asia Pacific needs to not only understand the regulatory and political landscape of each country, the disparity in rulings by varying scholar boards, but also invest in a bespoke suite of fund administration solutions that are designed to meet the specific needs of sharia compliant portfolios.
Full compliance with sharia prohibitions is often difficult – which in turn presents challenges for fund administrators. Sharia scholars acknowledge that funds may earn non-permissible, or haram, income.
This acknowledgement is relatively recent – only 20 years – and represents one of the most significant changes in sharia principles. Non-permissible income can take several forms and can be purified through the payment of a part of the income to a charity. Some simply pay a flat purification amount without determining the non-permissible income.
For others, the administrator has to calculate the non-permissible income and the purification amount in great detail. Some index providers calculate non-permissible income factors, which can be applied in the purification calculation process.
The fund administrator should in principle always publish the fund’s net asset value net of purification adjustments. Where a fixed percentage is applied to calculate the impure amounts, which typically are accrued on a monthly or quarterly basis and paid to the selected charity at the end of the agreed period – usually every quarter.
All charitable payments must be screened against blacklists applicable to the domicile of the fund to ensure that anti-money laundering and know your customer obligations are thus maintained. To reduce risk in this area, many sharia fund managers have mentioned the beneficial charities in the fund's prospectus.
In addition to equities, which are subject to the purification rules, there is a broad range of specific Islamic instruments. While the main types of Islamic financial instruments are conceptually relatively straightforward, they may become complicated in practice as issuers combine aspects of two or more types of instruments.
This impacts how the securities are set up in the fund administrator’s accounting system, how the instruments are valued and accounted for. The Islamic instruments must be set up as distinct assets. As the profit accruals are different from other asset types, new classifications also have to be created.
UNDERSTANDING
Also the general ledger reports have to be adapted to reflect the profits and losses instruments such as sukuk, murabaha [mark-up] and wakala [agency agreement]. While the fund domicile’s financial reporting, and other regulatory standards have to be fulfilled, the manager and sharia board may require additional reporting according to standards by the Accounting and Auditing Organizaton for Islamic Finance.
The trade capture process may or may not be fully automated, depending on the instrument type. Asian fund administrators servicing their clients who may be launching Islamic funds next year will have to invest in dedicated specialised staff to the servicing of funds entrusted to it.
People need to have a thorough knowledge of not only conventional fund administration, but also of the processes which are specific to Islamic fund administration, but the nuances of the legal and prudential foundations governing Islamic finance alongside the conventional financial systems across Asia Pacific.
People who understand sharia principles need to be able to apply that understanding in the day-to-day servicing of the fund, its manager and sharia board.
It is not easy, and will require a great deal of investment.
Francis is chief operating officer for BNY Mellon’s Asset Servicing business in Asia Pacific in Singapore
©2012 funds global asia