Fast growth emerging markets like Malaysia, Saudi Arabia and UAE seeing strong demand for retirement plans that are Shari’ah-compliant, says Ernst & Young
Billions of dollars are on the backburner in sovereign pension funds while the Islamic world awaits Shari’a compliant schemes, claims new research. Up to $190 billion could be deposited in Islamic pensions if the right products were available to the market, says the report from the Global Islamic Banking Centre at Ernst & Young. Demand is increasing from emerging and rapidly growing markets like Malaysia, Saudi Arabia and the United Arab Emirates (UAE).
According to estimates by EY’s Global Islamic Banking Center, the pent up global demand for Islamic pension funds is currently between $160 billion and $190 billion. At present, most of these funds are parked under conventional sovereign pension funds due to lack of investing options.
Retirement savers want Shari’a compliant products so they can move their money away from more conventional investments, explained Ashar Nazim, of Ernst & Young. “There’s certainly enough money out there for pension companies to consider opening Shari’a compliant investment funds,” he said
Ashar Nazim, Partner, Global Islamic Banking at EY said, “Several fast-growth emerging markets including Malaysia, Saudi Arabia and UAE are seeing strong demand for retirement plans that are Shari’ah-compliant. With the maturity of the Sukuk market and Shari’ah-compliant equity indices, as well as technology available to screen conventional indices to carve-out Islamic sub-indices, there appears to be sufficient assets available for many of the pension funds to take the first step towards Shari’ah-compliant propositions.”
According to the EY Global Islamic Banking Center, greenfield operations would take too long to satiate market demand.
Nazim added, “Speaking to several of our clients, it appears that a more practical approach is the partial transformation of existing pension funds to carve out Shari’ah-compliant tranches. However, this carving out further involves the valuation of pension funds’ assets as of the date of transformation, which in turn may have legal, financial and tax implications.”
“With the maturity of the sukuk market and Shari’a compliant equity indices, as well as technology available to screen conventional indices to carve-out Islamic sub-indices, there are sufficient assets to take the first steps.”
The study suggests that rather than starting from the ground up, existing pension funds could be adapted to shelter Sharia’a compliant holdings.
“This may not be easy, but it’s better than starting from nothing,” he said. “Fund asset valuations will have to take place which could complicate financial and legal factors involved in opening the market for Islamic pensions,” he said.
However, the research had identified a clear clarion call from Islamic savers for the tools to manage their own finances in a way that was completely Sharia’a compliant.
The report also revealed that this is a comparative recent call for action in the Islamic world as the concept of wealth management and retirement saving that is well established in other regions is only just catching on.
The transformation will need to be carefully planned to choose the right business model and operational framework. The choice of business model will determine the governance structure, the complexity of financial reporting, tax implications, and go-to-market time frames.
“There is a clear preference by individuals in these markets to manage their financial affairs in a Shari’ah-compliant manner. This segment represents anywhere between 10 and 70 per cent of the overall market, which is sizeable. Traditionally, the focus had been on switching their banking relationship from conventional to Islamic. Only now we are beginning to see a greater awareness regarding wealth management and retirement planning, which in turn is encouraging public pension funds to consider offering Shari’ah-compliant alternatives,” said Nazim.
A key decision is whether to allow members of the fund to transfer their existing account balance to the Shari’ah-compliant fund, or if only the future contributions should be segregated as conventional or Islamic. Additionally, timing for the desired transfer is important. The fund would model the expected outcomes based on scenarios built around the number of members, their selection, and product restrictions.
“We believe that the emerging demand for Shari’ah-compliant retirement plans offers significant opportunities for financial institutions to diversify their products and strengthen fee income. This in turn will help improve profitability which is clearly under stress for many Islamic banks,” said Nazim.
Indonesia and Turkey are two other rapid growth markets with strong prospects for Shari’ah-compliant pension programmes. The development, however, is likely to be a gradual evolution due to the relatively smaller size of the Shari’ah-compliant asset management industry.
“Regulatory impetus will be critical for successful roll-out. Countries that are able to move swiftly are likely to strengthen their global leadership in Islamic finance,” concluded Nazim.
Nevertheless, the market had enough pent-up demand to make the shift to Islamic pensions and wealth management feasible.
“Financial institutions need to look for new products and markets to maintain growth, and this is one they have not considered before,” he said. “We believe enough people with enough money want Shari’a compliant retirement schemes to make a case for banks and funds to diversify.
“This opens a whole new market for many Islamic banks which need a new way to make profits.”
The report also points out that as Islamic pensions are a new market, those who take the first steps are likely to become the big winners as they have little or no competition.
“Strong regulation is crucial and the nations that move first will take global leadership in Islamic finance,” he said.