Islamic sovereign wealth fund over mega bank?

At the recent National Bank of Abu Dhabi's Global Financial Markets Islamic Forum in Abu Dhabi, UAE, I was requested to make a presentation on an Islamic sovereign wealth fund (SWF). An appropriate topic at an appropriate jurisdiction for an appropriate audience and at the appropriate time.

But why isn't Malaysia Inc "talking up" an Islamic SWF?

An Islamic SWF, also seen as a fund-of-funds, may actually be the necessary spark to jump-start a global Islamic asset management or, in today's hub-centric parlance, an Islamic asset management hub!

The industry has been talking up an Islamic mega bank for a few years, from Sh Saleh Kamal to Malaysia, but will it have an Organisation of the Islamic Conference (OIC), or G-20 (The Group of Twenty Finance Ministers and Central Bank Governors) impact?

In the post-crisis period, G-20 regulators are examining "ways and means" to reduce the systemic risk associated with the mega-banks. Islamic finance industry, without a lender of last resort and sporadic Islamic deposit insurance, needs to examine the suggestions before wholesale adoption of a proposed mega bank.

The Islamic finance industry, as part of Islamic finance 2.0, needs to move away from product pushing to a more holistic approach, which includes big "ticket" offerings while becoming "conventionally efficient". An Islamic SWF would fill both roles for asset management.

SWF

To understand a SWF, we need to demystify it before looking into the merits of an Islamic SWF. Additionally, we also need to look into the ideal western 'model' of an SWF for asset class exposure and ask, "are there sufficient liquid Islamic asset classes for a diversified portfolio?"

One of the best definitions of a SWF is provided by Monitor Group/FEEM:

1. It is owned directly by a sovereign government

2. It is managed independently of other state financial institutions

3. It does not have predominant explicit pension obligations

4. It invests in a diverse set of financial asset classes in pursuit of commercial returns

5. It has made a significant proportion of its publicly-reported investments internationally

Here, three major points for an Islamic SWF include: (1) ownership by an OIC country; should it be a country, bilateral or multi-lateral fund? (2) Funding of the fund via commodities, trade surplus, etc, and (3) what is the mandate of the fund; is it future generations, rainy day, Islamic lender of last resort, etc?

Next, the "model" SWF for transparency has been Norway's oil fund, and examining 3rd quarter (2010) asset class exposure provides some hope for an Islamic SWF.

Table 1 shows the fund's largest equity holdings as of September 30 2010, with bias towards Group of Seven (G-7) countries and emphasis on telecommunications, energy and basic material sectors.

The same bias exists with global Islamic equity funds, below nine out of 10 companies (Table 1) are syariah-compliant, ex-HSBC Holdings plc.

Thus, SWFs have (unintended) exposure to syariah-compliant companies, as the global universe of compliant companies, according to S&P data, is nearly 3,000 companies with a market capitalisation of US$15 trillion (RM45.6 trillion) as at end-2010.

The challenge is on the fixed income exposure.

Table 2 shows the fund's largest bond holdings as of September 30 2010, hence, concern for an Islamic SWF is accessing benchmark sized sovereign/quasi sovereign sukuk. Outside of Malaysia sovereign sukuk and Islamic Development Bank (IDB), there are size and supply constraints in the US$130 billion (RM395.2 billion) sukuk market.

Beyond equity and bond exposure, alternative asset classes are commonly utilised by SWFs including hedge funds, private equity, commodities, REITs, real estate, FX, securities lending, and so on. But, how many of these asset classes may become syariah-compliant?

The National Shariah Council (Malaysia) may be best positioned to offer suggested pathways on screening and structuring parameters for the above asset classes, but needs to work closely with information vendors in real time data.

Sensitivities

A SWF, as advised by western consultants, acquire strategic and/or financial stakes in companies across countries, which may include board seat(s). Yet, some G-7 country politicians, both well meaning and publicity seeking, have inquired about SWF's intent, especially those from China and the Gulf Cooperation Council (GCC) countries. The issue becomes more pronounced during election year cycles.

To date, the record of SWFs objectives has been both commercially oriented and long-term passive investors. Furthermore, distressed western companies, like Barclays, have tapped SWFs as "white knights" because of their deep pockets and quick turn-around time.

However, an Islamic SWF will have to jump through more hoops to prove their "commercial intent" over alleged back-door creeping syariah for portfolio investments in G-20 countries.

This is more of a failure of the Islamic finance industry to professionally lobby and properly establish a public relations/marketing industry body, much like AAOIFI or IFSB.

Finally, according to the Monitor/FEEM Research, there are 35 SWFs, and 54 per cent is from Muslim countries. An Islamic SWF would not only spark Islamic asset management and Islamic equity capital market, but also have a global reach.

There are few Muslim countries with the will, vision and gravitas to start discussions for an Islamic SWF, who will lead? Khazanah Nasional Bhd?

* The writer is Global Head of Islamic Finance for Thomson Reuters based in New York