GE has had a presence in the Middle East for over 50 years, supporting countries and companies in critical and high growth industries, such as water reclamation, healthcare, power generation, aerospace, and oil and gas. With economic growth in the region at 5% or higher, demands for investment in infrastructure have increased accordingly, and GE has become an ideal partner for these projects.
“We are an infrastructure company,” said Liam McCollum, general counsel for GE, Middle East and Africa. “We sell power stations and medical equipment and there’s a direct correlation between the phenomenal GDP growth in the Middle East and the building of infrastructure.”
In 2009, GE expanded its commercial financing business in the Middle East by entering into a Joint Venture agreement with Mubadala Development Company of Abu Dhabi. The joint venture, Mubadala GE Capital PJSC (MGEC), received its financing license from the Central Bank of the UAE in January 2010. MGEC now offers commercial financing solutions to businesses in the region across region relevant industries. Ronald Herman, a 25-year GE veteran, was elected as the CEO of the newly formed company.
“Our business model is to provide structured financial products to companies in the Middle East, similar in many respects to those offered in the rest of the world,” said Herman. “Some of our financing is done in an Islamic finance basis and it is an important segment need that cannot be ignored. We closed our first Islamic financing transaction earlier this year to a locally based manufacturing company by partnering with a local Islamic Bank.”
FUNDAMENTALS OF ISLAMIC FINANCE
Islamic finance is a financial system based on Shariah, or Islamic law, which guides both religious and secular life for millions of Muslims around the world. Shariah law prohibits certain fundamental elements of conventional finance, such as interest and speculation. As a result, financial institutions that serve customers in regions with large Muslim populations have had to create customized and often complex alternatives to traditional financial products. These products must be certified as Shariah compliant by Shariah scholars who are experts in Islam.
While Islamic finance has been around for decades, the industry has entered a boom period, where Islamic financial assets have grown to an estimated $1 trillion globally. From 2004 to 2006 alone, the issuance of sukuk, non-interest bearing securities based on Shariah, quadrupled from $7.2 billion to approximately $27 billion. While the banking sector in much of the developed world came close to collapse in 2008, Islamic banking, which forbids derivatives and mortgage-backed securities, continued to grow at a healthy 20% per year, on average.
“Most Islamic banks were protected during the financial crisis. One of the key requirements for Shariah compliance is that you have to have a tangible asset to underwrite. So they never invested in those risky products…”
FARID FEZOUA, MANAGING DIRECTOR OF GE CAPITAL MARKETS FOR THE MIDDLE EAST AND AFRICA
The majority of Islamic financial institutions are located in Malaysia, the Middle East or one of six countries that are part of the Gulf Cooperation Council (GCC)—the United Arab Emirates, Bahrain, Saudi Arabia, Oman, Qatar and Kuwait.
Attracted by the region’s large pools of capital—from the ongoing oil boom and the need to reinvest to diversify economies—international financial institutions have begun entering the Islamic securities market. Today, local players, including Saudi Arabia’s Islamic Development Bank and National Commercial Bank, Bahrain’s First Islamic Investment Bank, and UAE’s Dubai Islamic Bank and Abu Dhabi Islamic Bank, which are joined by such western financial institutions as HSBC and Standard Chartered, have set up local Islamic Finance-only offices throughout the GCC. These offices will seize opportunities to further capture market share and the customer demand for Islamic financing in corporate and consumer financing markets.
In order for a financial product to be certified as Shariah compliant and ultimately traded within the Islamic financial system it must meet the following rules:
- Association with businesses that are considered haram, or forbidden, such as those selling pork products, pornography, or firearms is prohibited.
- Debt must be backed by an underlying asset.
- Gharar, or excessive risk and uncertainty due to lack of clarity in contracts or financial dealings, must be avoided.
- Riba, or usury, is forbidden and therefore the paying or earning of interest is not permitted.
- Businesses must share in both the risk and reward of each transaction with their clients.
International financial institutions providing Islamic financial products typically have dedicated Shariah departments that help with the product-development process. Each product is reviewed internally before it must be approved by a Shariah Board. Once a product is designed and approved, it must also be executed in a Shariah-compliant manner. For example, if an asset is sold, the financial institution must have had title to that asset the previous day. Experts within a financial institution’s Shariah department review each transaction daily to make sure it meets these requirements.
GE’S GROWING ROLE IN ISLAMIC FINANCE
Through Mubadala GE Capital, financing solutions offered to businesses can be structured conventionally or through an Islamic structure, depending on the customer need. In situations requiring an Islamic structure, Mubadala GE Capital will work with a local bank to structure a Shariah-compliant financing facility.
Most of GE’s industrial equipment sales in the region, in long-term industrial projects, may be ideal for Islamic financing. Since the projects involve tangible, high-grade assets, such as turbines and power generation equipment, they can meet the requirements of investors seeking to invest their capital in Shariah-compliant ways. In addition, GE often enters into leasing arrangements with these assets, which meet the requirements of Shariah law because GE remains the owner of the asset and charges customers a rental fee.
In 2009 GE became the first U.S. corporation to issue an Islamic bond. The five-year, $500 million denominated sukuk was sold across the Middle East, Asia and Europe and was met with strong demand. Unlike regular unsecured bonds, sukuks must be backed by assets. Instead of earning interest, bond holders get a share of the profit earned by that asset. For GE, which currently owns $5 billion in aircraft assets in the Middle East alone, finding an asset to back the sukuk was fairly obvious.
“The cash flow from leasing aircrafts is very reliable given GECA’s global customer base of 200 airlines,” explained Kathy Cassidy, senior vice president and treasurer for GE and GE Capital. “In this issue we dedicated a pool of these aircraft assets to the sukuk, so that bond holders would receive a percentage of the lease payments, which became their return.”
In order to structure the sukuk offering, GE worked with a number of international banks with experience in Shariah-compliant structures, as well as such regional financial institutions as the Liquidity House, National Bank of Abu Dhabi and Bank Islam Brunei Darussalam.
The sukuk was a relatively small offering for GE and slightly more expensive to offer than conventional products. But the company wanted to demonstrate its commitment to capital-market growth in the Middle East, and plans to issue additional sukuks.
Cassidy described GE’s decision to issue the sukuk as both a business decision and a corporate responsibility:
“We raise debt in about 20 different currencies and we’re always looking to diversify. The Middle East is an attractive market to expand into because there’s a large pool of cash to be invested and we’re looking for ways to put this excess capital to use. Investors have faith in our high grade credit, and they could also see that we were willing to go the extra mile to comply with and respect the social and cultural standards of the regions in which we do business.”
Islamic Finance’s Broadening Appeal
While Islamic finance is largely targeted towards Muslims, it is now showing a broader appeal, beyond those looking for religious compliance. In Malaysia, a hub for Islamic finance in Asia, a considerable number of Chinese Malay participate in Islamic finance because it’s risk averse and consumer friendly. The UK government is considering issuing a sovereignsukuk, as is Germany. The Islamic Development Bank of Saudi Arabia plans to offer a sukuk in South Korea.
Afaq Khan, CEO of Standard Chartered Saadiq, the Islamic Banking and Finance division of Standard Chartered, says the idea that Islamic finance is purely for Muslims is misleading.
“Islamic banking is for everyone,” said Khan. “It is not exclusive in any shape or form. If a customer comes to us for a financial product, I do not ask about his or her religion. Often what is appealing to the customer is the service that’s provided, how well-priced the deal is, or the disclosures required by Islamic finance that make the documents easier to understand. ”
Challenges in the Islamic Finance Industry
While the rapid growth of the industry is pulling many international financial institutions into Islamic finance, there remain significant challenges that are keeping the industry on the cusp of entering the mainstream.
For one, there is a shortage of qualified Shariah scholars. Shariah scholars not only need expertise in Islam, but also in international finance, so they can understand what is commercially being offered. They need to know English, in order to read international law documents, and Arabic, in order to read the Quran. This combination of skills and expertise could create a bottleneck in the industry as financial institutions compete for the same resources. It is not unheard of for the same Shariah scholar to sit on the Board of many banks.
There is also a lack of consistency in the interpretation of Shariah law which poses risks to financial institutions interested in offering Shariah-compliant products. To address this risk, the industry needs a governance structure that reassures financial institutions that their products meet a standard requirement for Shariah compliance across the world.
“What if there is a swing back to conservatism in a country like Saudi Arabia? There is a risk that some financial products would no longer be considered Shariah compliant,” said McCollum.
The Islamic Financial Services Board in Malaysia has created governance guidelines to mitigate the risk of decertification, but they have not yet been embraced in the Arab region.
In addition, while the region is quite diverse, it is also rife with political risk, which is not uncommon. In recent months civil unrest has spread throughout the Arab world and toppled autocratic regimes in Tunisia and Egypt. Many of these countries have a burgeoning youth population combined with slow job growth, leading to some of the highest rates of youth unemployment in the world. However, such unrest underscores the need for global companies, like GE, to be in the region.
“Mubadala GE Capital is focused on financing private-sector companies in the region because we all recognize that these countries need to have a vibrant private sector in which businesses can thrive and create jobs,” said Herman.
LOOKING TO THE FUTURE
The Islamic finance industry is likely to overcome many of its challenges.
Hawkamah, a Dubai-based ‘think and do’ tank focused on corporate sector reform and financial market development in the region, has launched a task force on corporate governance in Islamic financial institutions. The task force brings together multilateral bodies, lawyers, Islamic bankers, and Islamic finance experts to create awareness about the importance of corporate governance in Islamic finance and to push for reforms. Hawkamah will soon be publishing a policy brief on the corporate governance of Islamic financial Institutions, which contains the survey results of corporate governance frameworks of 22 banks in 11 MENA countries. The policy brief identifies the corporate governance gaps in Islamic finance in the region and lays down specific policy recommendations on how to address these gaps. The brief is addressed to central banks and Islamic finance policy makers of the MENA region. Hawkamah is also addressing the issue of Shariah scholars serving on multiple boards by introducing capacity building programs for Shariah advisers and developing fresh talent.
And while the recent civil unrest is likely to have a short-term impact on investments in the region, the Islamic finance industry is expected to continue to grow in the long-term. Khan reiterated that the current crisis is causing a shock to the economies of the region, but they will recover, just as the developed economies recovered after the financial crisis.
“Macro events and global shocks are the same for Islamic finance as they are for conventional finance. Societies and economies go through changes,” said Khan.
The next step for the industry will be to innovate. Currently, the majority of Islamic financial products are variations of traditional financial instruments, rather than unique, innovative products based on the elements of Shariah law that make them consumer friendly. Nick Nadal, Director of Hawkamah, attributed the lack of innovation to the way the industry approaches Islamic finance.
“Within the industry you have a lot of people from conventional banking that try to make products Shariah compliant. Our push is for the industry to train Shariah scholars on international finance, so they can design innovative products instead of simply converting existing products. It’s about approaching the opportunity from the other side.”
GE is well positioned to ride the wave of growth in Islamic finance and to meet the challenges and opportunities the industry presents. The company’s long commitment to the Middle East has made it a trusted partner for businesses and governments in the region. Now that the company has successfully issued its first Islamic financial instrument in the form of a sukuk, GE can focus on additional commercial and consumer financial products and services to offer end-to-end Shariah-compliant solutions. Doing so will require the company to continue investing in human capital to build capacity internally on the complexities of Islamic law, and to leverage the same innovation GE brings to all of its products and services for the Islamic finance industry.