Islamic Funds & Investment Report (IFIR 2010), Ernst & Young

Islamic Funds & Investments Report 2010

Post Crisis: Waking up to an investor-driven world

Dear Investments Industry Leader,

On behalf of MEGA, it is with great pleasure that we introduce the 4th annual edition of the Ernst & Young Islamic Funds & Investments Report (IFIR 2010), which has rapidly established itself as an indispensable reference source for decision-makers in the industry seeking to successfully navigate the changing investment landscape.

The Report is exclusively launched at the 6th Annual World Islamic Funds & Capital Markets Conference (WIFCMC 2010), the world’s largest and most influential gathering of Islamic investment industry leaders, held in Bahrain on the 24th and 25th of May 2010. The findings of the Report are debated by the more than 400 industry leaders gathered at the conference as they seek new insights to strengthen their market position and adapt their strategies for success in the global Shari’ah-compliant investments market.

Last year’s Report provided an in-depth analysis of the impact of the global economic crisis on the Islamic funds landscape, with key recommendations for industry leaders on surviving and adapting in a downturn. The Report concluded with insights into key investor segments, asset classes, and products as well as competition and business model shifts. IFIR 2010 will revisit these findings as well as offer new insights that will kick-start new business strategies in the Shari’ah compliant investments industry as crisis begins to give way to recovery.

Our gratitude goes to leading audit and business advisory firm, Ernst & Young and their Islamic Financial Services Group who have invested their considerable international talent and resources in leading the research project and in developing the insights contained in this Report.

We hope that the content of this 4th annual edition of the Ernst & Young Islamic Funds & Investments Report will be useful in your own strategic planning activities and will assist your organisation in its quest for success in this dynamic industry. To find out how your organisation can play a part in this initiative in the future, please email [email protected]

Yours sincerely,

David McLeanManaging DirectorThe World Islamic Funds & Capital Markets ConferenceA MEGA Brand

A MEGA Brand: Shaping the Future of the Global Islamic Finance Industry Since 1993P.O. Box 72045, Dubai, UAE | t. +9714 343 1200 | f+971 4 343 6003 MEGA Brands. MEGA Clients. Market Leaders.www.megaevents.net

Islamic Funds and Investments Report 2010Post crisis: Waking up to an investor-driven world

Page 2 The World Islamic Funds and Investments Report 2010

The contents of the Islamic Funds and Investments Report 2010 are based on a combination of quantitative data and qualitativecomments and hence provide a subjective assessment of the current market. All quantitative comments are based on published information wherever possible. Where published reliable data was not available, qualitative comments were made which may or may not reflect the true state of affairs. Information has been assimilated from secondary sources, including published country, industry and institutional information, and primary sources, in the form of interviews with industry executives.

We are not expressing any assurance on the accuracy or completeness of the information obtained. Although this report has been documented based on our understanding of Islamic financing activities to include only such activities that are deemed Shari’acompliant, no Shari’a opinion whatsoever has been taken on this report. Hence, the contents of this report, in terms of the activities to be carried out, might not necessarily be consistent with Shari’a in all cases, and the opinion of a Shari’a scholar(s) should be taken before any further steps are made to implement suggestions made in the report.

Whilst every care has been taken in the preparation of this report, no responsibility is taken by Ernst & Young as to the accuracy or completeness of the data used or consequent conclusions based on that data, due to the respective uncertainties associated with any assumptions that have been made.

This report is documented for the World Islamic Funds and Capital Markets Conference. No part of this document may be republished, distributed, retransmitted, cited or quoted to anyone without prior written permission from MEGA Events and Ernst & Young.

Disclaimer

ISLAMIC FUNDS & INVESTMENTS REPORT 2010: POST CRISIS: WAkING UP TO AN INVESTOR-DRIVEN WORLD2


Contents

1. Setting the scene 52. Supply analysis – products and asset classes 11 3. Current state of the Islamic fund industry 194. Demand analysis – investor segments and asset allocation 275. Changes affecting the industry 376. The future risk environment 437. Jurisdiction overview 518. Appendix 1: Islamic fund characteristics 599. Team and references 61

3


Introduction to the Islamic Funds and Investment Report 2010

Dear Investment Executive

On behalf of Ernst & Young, I would like to take this opportunity to introduce you to the fourth edition of the Ernst & Young Islamic Funds and Investments Report 2010.

While the overall economic environment continues to remain tough, 2009 saw signs of recovery in global financial markets. Islamic equity, sukuk and commodity funds also posted gains during this period and in the first quarter of 2010. However, fund assets under management remained stagnant at US$52 billion from 2008 as the number of funds liquidated during 2009 almost equaled those incepted. It is a cause for concern for the Islamic funds industry as the participation of retail investor remains negligible.

In 2010 and beyond, Islamic asset managers must respond to an investor-driven world in order to sustain themselves in the long run. Our analysis identifies the following key points which we believe should top their priority list:

► Achieve scale to ensure long term sustainability – over 55% of Islamic fund managers currently manage less than US$ 50 million each, which is commercially unsustainable in the medium term and demands serious re-evaluation of business strategy.

► Diversify into new asset classes to improve performance and better match investors’ needs – equities remain the predominant asset class for Islamic investment funds with little focus on new product development.

► Adopt flexible business models – given the continuing difficult market conditions, strategic alliances, fee structures, distribution arrangements and costs should be re-assessed.

► Regain investor confidence through increased transparency, frequent investor communication and proactive risk management.

There is a real risk that executives may be tempted to shy away from making radical changes or tough decisions about businessmodels, people, processes or systems. Those who can do so are most likely to emerge as long-term winners.

Sameer AbdiPartnerErnst & Young



►Global asset management industry is on the road to recovery from lows in 2008

► Islamic fund management industry plateaued during 2009

► Funds launched have focused on institutional investors leaving the retail segment underserved

►Preference for the placement of wealth with banks rather than Islamic fund managers

Setting the scene

5


Source: National Mutual Funds Association, Ernst & Young analysis

Global Mutual Fund Industry

Note: The data is for 44 countries

11.7 11.3

14.1

16.2

17.8

21.8

26.1

19.0

22.0

0

10

20

30

40

50

60

70

80

0

5

10

15

20

25

30

2001 2002 2003 2004 2005 2006 2007 2008 Q3 2009

Worldwide Total Net Assets of Mutual Funds (LHS) Worldwide Number of Mutual Funds (RHS)

Dot-com Crisis

Financial Crisis

Estimated AuM (US$t)

Number of Funds(‘000)

Global mutual funds AuM reached US$ 22 trillion in 2009 and exhibited signs of recovery from the lows of 2008



Source: Eurekahedge, Zawya, Ernst & Young analysis

Global Islamic Fund Management Industry

Number of FundsEstimated AuM (US$b)

29.2

34.1

39.5

48.751.4 52.2 52.3

0

100

200

300

400

500

600

700

800

0

10

20

30

40

50

60

Assets Under Management (LHS) Number of Funds (RHS)

2004 2005 2006 2007 2008 2009 Q1 2010

In contrast, the global Islamic fund management industry growth remained flat, with AuM of US$ 52 billion

7


The number of new funds launched has been offset by the number of funds liquidated

Global Islamic Funds - Annual Launches and Liquidations

Source: Zawya, Eurekahedge, Ernst & Young analysis

Number of Funds

173

78

29

1119

27

0

20

40

60

80

100

120

140

160

180

200

2007 2008 2009

Number of Islamic funds launched Number of Islamic funds liquidated



The majority of funds being launched have targeted institutional investors

Source: Eureka Hedge, Zawya, Ernst & Young analysis

Note: Retail funds are defined as funds that have a minimum initial subscription of US$2,000 or less

Breakup of Retail and Institutional Islamic Funds Launched

55%

43%32% 33%

45%

57%68% 67%

0

10

20

30

40

50

60

70

80

90

100%

2006 2007 2008 2009

Institutional Funds

Retail Funds

9


Potential investors tend to place money with banks rather than investing in Islamic funds –these accounts constitute part of the Islamic asset management industry and form over 30% of the Islamic finance sector

Source: Central Banks Reports, Securities Commission Malaysia, DataMonitor, Eureka Hedge, Zawya, IFSL, Ernst & Young analysis

Asset Under Management to Total Banking Deposits

%

AuM to Banking Deposits

28%14% 15% 9%

25% 20%

67%

83% 84%

43%

159%171%

180%

133%

0

20

40

60

80

100

120

140

160

180

200

2005 2006 2007 2008

Saudi Arabia Malaysia UK USA

Size of Fund Management Industry to Total Industry Size (2008)

Islamic Financial Services Industry

Text

► Other AuM includes off balance sheet direct investments managed by banks and investment companies and restricted profit sharing accounts

► Islamic funds represent only 5.5% of the total Islamic financial services industry

Total Industry US$ 939 b

Islamic Assets Managed

US$ 292 billion31.1%

IslamicFunds5.5%

Estimated Islamic FinanceAssets US$ 939 billion


►A shift was witnessed in 2009 with the number of new funds launched in alternative asset classes outnumbering traditional types

►Concentration remains with 35% of total AuM invested in equity funds

► Islamic funds across the majority of asset classes witnessed improved performance during 2009

Supply analysis – products and asset classes



►A shift was witnessed in 2009 with the number of new funds launched in alternative asset classes outnumbering traditional types

►Concentration remains with 35% of total AuM invested in equity funds

► Islamic funds across the majority of asset classes witnessed improved performance during 2009

Supply analysis – products and asset classes

11


Number of Islamic Funds Launched by Asset Class

During 2009 there was a shift away from traditional asset classes such as equities and real estate funds with a number of new asset classes being introduced including Shari’a compliant ETFs and hedge funds

Source: Zawya, Eurekahedge, Ernst & Young analysis*Note: Other includes alternative investments and feeder funds

79 37

3

14 5

3

2015

14

18

5 411

3213 3

318 10

2007 2008 2009

Real Estate

Commodities

Balanced

Money Market

Other*

Fixed Income

Equity

173 78 29


Assets Under Management of Islamic Funds by Categories (Q1 2010)

18.5 35%

16%

7.4 14%

7.2 14%

12%

8.3

6.1

3.5 7%

Equity Other* Fixed Income Money Market Commodities Real Estate Total

1.3

Balanced

Figures in US$b

2%

52.3

However, overall AuM remained concentrated in traditional asset classes such as equities and fixed income




Assets Under Management of Islamic Funds by Categories (Q1 2010)

18.5 35%

16%

7.4 14%

7.2 14%

12%

8.3

6.1

3.5 7%

Equity Other* Fixed Income Money Market Commodities Real Estate Total

1.3

Balanced

Figures in US$b

2%

52.3

However, overall AuM remained concentrated in traditional asset classes such as equities and fixed income


13


The concentration in equities proved successful during 2009 as equity markets rebounded from the lows of 2008, but 2010 may prove to be more volatile

Islamic and Conventional Indices

Index return

Islamic Equity Funds - Average Returns

41.7%

(10.4%)

48.6%

4.2%

17.4%

(41.8%)

20.9%

(3.8%)

(50)

(40)

(30)

(20)

(10)

0

10

20

30

40

50

60%

2007 2008 2009 Q1 2010

Top Quartile Return Average Return%

Source: Bloomberg, Zawya, Eurekahedge, Ernst & Young analysis

(70)

(60)

(50)

(40)

(30)

(20)

(10)

0

10

20

MSCI World Islamic Index MSCI World Index Standard Core

31 Ju

l 07

30 S

ep 0

7

30 N

ov 0

7

31 Ja

n 08

31 M

ar 0

8

31 M

ay 0

8

31 Ju

l 08

30 S

ep 0

8

30 N

ov 0

8

31 Ja

n 09

31 M

ar 0

9

31 M

ay 0

9

31 Ju

l 09

30 S

ep 0

9

30 N

ov 0

9

Note: Data includes returns of 290 funds



Sukuk issuance gained ground in 2009 and is forecast to remain at similar levels in 2010, with returns likely to remain at or below 2009 levels

Source: IFIS, Zawya Sukuk Monitor, Eurekahedge, Ernst & Young analysis

Global Sukuk Issuance Islamic Fixed Income Funds - Average Returns

*Deals rumored/announced. Malaysia constitutes a significant part of deals announced for the rest of world.

8.2%

5.5%

11.6%

1.1%2.4%

(0.1%)

4.4%

0.2%

(2)

0

2

4

6

8

10

12

14%

2007 2008 2009 Q1 2010

0

50

100

150

200

250

0

5

2001 2002 2003 2004 2005 2006 2007 2008 2009 Q1 2010 2010*

MENA Rest of World Number of Sukuk Issues (RHS)US$b Number

10

15

20

25

30

35

40

Top Quartile Return Average Return


15


Global commodity prices recovered during 2009 resulting in strong returns for commodity funds and with an expectation of further recovery in 2010

Source: Merrill Lynch, Bloomberg, Eurekahedge, Zawya, Ernst & Young analysis

Merrill Lynch Commodity Excess Return Index Islamic Commodity Funds - Average Returns

21.3%

2.5%

56.5%

3.1%8.0%

(15.1%)

29.0%

(0.9%)

(20)

(10)

0

10

20

30

40

50

60

70%

2007 2008 2009 Q1 2010

Index level


0

100

200

300

400

500

600

700

800

900

3 Ja

n 05

3 Ap

r 05

3 Ju

l 05

3 O

ct 0

5

3 Ja

n 06

3 Ap

r 06

3 Ju

l 06

3 O

ct 0

6

3 Ja

n 07

3 Ap

r 07

3 Ju

l 07

3 O

ct 0

7

3 Ja

n 08

3 Ap

r 08

3 Ju

l 08

3 O

ct 0

8

3 Ja

n 09

3 Ap

r 09

3 Ju

l 09

3 O

ct 0

9

3 Ja

n 10

3 Ap

r 10




Money market funds remained popular with investors seeking safety and liquidity, but a prolonged low interest rate environment may prevail in 2010

Source: Bloomberg, Eurekahedge, Zawya, Ernst & Young analysis

USD 3 Month LIBOR Islamic Money Market Funds - Average Returns

6.5%

5.6%

4.1%

1.1%

3.4%

2.5%

(1.9%)

0.2%

(3)

(2)

(1)

0

1

2

3

4

5

6

7%

2007 2008 2009 Q1 2010


0

1

2

3

4

5

6

7

Jan

02

Jun

02

Nov

02

Apr 0

3

Sep

03

Feb

04

Jul 0

4

Dec

04

May

05

Oct

05

Mar

06

Aug

06

Jan

07

Jun

07

Nov

07

Apr 0

8

Sep

08

Feb

09

Jul 0

9

Dec

09

%


17


Property valuations suffered a correction during 2008, however there appears to be signs of a recovery in 2009

Source: Bloomberg, Eurekahedge, Zawya, Ernst & Young analysis

Global REIT Index Islamic Real Estate Funds - Average Returns

16.4%

13.8%11.3%

1.1%3.5%

(12.4%)

(2.9%)

(0.64%)

(15)

(10)

(5)

0

5

10

15

20%

2007 2008 2009 Q1 2010

Index level


0

50

100

150

200

250

2 Ja

n 06

2 M

ar 0

6

2 M

ay 0

6

2 Ju

l 06

2 Se

p 06

2 N

ov 0

6

2 Ja

n 07

2 M

ar 0

7

2 M

ay 0

7

2 Ju

l 07

2 Se

p 07

2 N

ov 0

7

2 Ja

n 08

2 M

ar 0

8

2 M

ay 0

8

2 Ju

l 08

2 Se

p 08

2 N

ov 0

8

2 Ja

n 09

2 M

ar 0

9

2 M

ay 0

9

2 Ju

l 09

2 Se

p 09

2 N

ov 0

9

2 Ja

n 10

2 M

ar 1

0




►Over 70% of Islamic fund managers have under US$ 100 million in AuM

►Average management fee has fallen to 1.15% in Q1 2010

►US$ 80-100 million required in AuM to break even based on average management fee

►There remains potential for consolidation or shake-out as many Islamic fund managers have below the break even level AuM required

Current state of the Islamic fund industry

19


The Islamic fund industry remains fragmented with over 70% of investment managers having under US$ 100 million in AuM, with less than 10% with AuM in excess of US$ 1 billion

Number of Islamic Fund Managers by Assets Under Management (Q1 2010)

Source: Eurekahedge, Zawya, Ernst & Young analysis

Total AuM (US$m)

79

32

18

10

20

9 11

22

< 25 25 - 50 50 - 75 75 - 100 100 - 200 200 - 300 300 - 500 > 500

55% of Fund Managers have less than US$ 50m AuM



Meanwhile their conventional counterparts have developed significant asset gathering capabilities

Top 25 Global Asset Managers (2008)

Bank of America

Nippon Life InsuranceGenerali Group

Prudential Financial

Northern Trust Global

Wells Fargo

NatixisLegg Mason

HSBC Holdings

Credit Agricole

ING GroupGoldman Sachs Group

BNP Paribas

UBS

Bank of New York Mellon

Capital Group

JPMorgan Chase

Vanguard GroupDeutsche Bank

BlackRockAXA Group

Fidelity investments

State Street Global

Allianz Group

Barclays Global Investors

0 200 400 600 800 1,000 1,200 1,400 1,600

AuM US$b

Source: Watson Wyatt

21


Source: Zawya, Eurekahedge, Ernst & Young analysis

Average Management Fee of Islamic Funds

An investor driven market has forced fund managers to reduce fees by a quarter (40 basis points) on average since 2006, and the highest fees charged are more in line with global standards

2006 2007 2008 2009 Q1 2010

1.53% 1.44%1.39%

1.20%1.15%

High

Low

6.00%

0.10%

10.00%

0.03%

Average

5.50%

0.30%

2.00%

0.35%

2.00%

0.05%

Note: Data includes stated management fees of 369 Islamic funds



Based on the average asset management fee of 1.15%, AuM of between US$80-US$100 million is required to break-even for an average fund manager according to industry players

Source: Industry interviews, Annual Reports, Ernst & Young analysis

Note: The methodology for the breakeven calculation is based on the average annual operational costs for listed equity mutual funds. It is important to note that costs/AuM will vary for more sophisticated asset classes

Break Even Management Fee for Selected AUM Levels

0

25

50

75

100

125

150

175

200

4.03.53.02.52.01.51.00.5

Assets Under Management (US$m)

Management fee (%)

Industry Average Management Fee

23


Source: Pew Research Center, Ernst & Young analysis

100m +

50 - 100m

10 – 50m

5 – 10m

1 – 5m

Estimated Muslim Populations in 2009

India~161m

Indonesia~202m

Pakistan~174m

Bangladesh~145m

Turkey~74m

Egypt~79m

Nigeria~78m

Algeria~34m

Morocco~32m

Iran~74m

Global Estimated Muslim Populations in 2009

Under 1m

Muslim populations are growing globally indicating future demand

Malaysia~17m

GCC~36m



Nominal GDP per Capita (US$)

In addition, income levels in key Muslim countries are growing and provide opportunities for Islamic fund managers

US$

Source: Global Insight

2006 2007 2008 2009 2010 2011 2012

Bahrain

Kuwait

Oman

Qatar

Saudi Arabia

United Arab Emirates

Iran

Algeria

Egypt

Morocco

Turkey

India

Indonesia

Malaysia

Pakistan0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

25


The Islamic fund industry has significant room to grow if assets are reallocated from investment accounts to funds

The fund management industry has

significant scope for expansion

Income levels are rising in

these key markets

Savings are invested with Banks rather than funds



► Investors are expected to seek higher returns and move up the risk return profile

►Asset allocation strategies for investor segments are changing to reflect renewed optimism

► Investment pool for Islamic fund managers is estimated to be between US$ 360–480 billion

Demand analysis – investor segments and asset allocation

27


Capital Appreciation► Significant risk ► Returns achieved through capital gains► Requires a long-term investment

horizon

Total Returns► Moderate level of risk► Returns obtained through capital gains

and reinvested dividends► Requires a long-term investment

horizon

Current Income► Moderate risk ► Returns achieved through income

generation

Capital Preservation► Little or no risk ► Nominal returns that are at least equal

to inflation ► Short investment horizon

Investors are expected to move up the risk-return profile as they seek higher returns in the next 12 to 18 months

Return

Source: Industry interviews, Ernst & Young analysis

Risk Profile - Key Islamic Investor Segments

Key:

Gradual Shift in investor preference

Risk

Individual Investors

Capital Preservation

Capital Appreciation

CurrentIncome

Total Returns

Other Institutional

Investors

Quasi Institutional

Investors

Individual Investors

Takaful Companies

Takaful Operators

Post-crisis Investor

Investor

Other Institutional

Investors

Quasi Institutional

Investors

Medium-term

11

2

3

4

2

3

4



Mass affluent investors are expected to lower allocations in cash/money market funds in favor of riskier investments

Mass Affluent

2009 Market Size: US$ 358 Billion*

Shari'a Sensitivity:

2010 Asset Allocation Expectation:

2009 saw a panicked shift by the mass affluent towards liquid, short-term and safe assets. In the wake of improved market performance and economic recovery, this segment is expected to seek higher exposure to equities and fixed income products in 2010. Nonetheless, the mass affluent being the most cautious segment, is expected to take a 12-24 month period to return to the pre-crisis risk-return profile. 40% 45%

5%

15%

55%35%

5%

2009 2010EEquity Fixed Income Cash / Money Market Real Estate Alternatives

Source: World Wealth Report 2009, Datamonitor Global Wealth Model, Industry interviews, Ernst & Young analysis

*Sizing includes mass affluent individuals with liquid wealth between US$ 50K and US$ 500K. Regions include GCC countries, Pakistan, Malaysia and Indonesia.

35% 40%

“The key feature of any investment I make is knowing that my money is safe.”

Individual investor

29


Similarly, HNWI/UHNWIs are expected to shift towards riskier assets in search of returns

HNWIs / UHNWIs




2009 saw a tactical allocation shift by UHNWIs / HNWIs towards more liquid investments in the face of market uncertainties. As the market stabilizes in 2010, the UHNWIs / HNWIs are expected to return to strategic asset allocations composed of higher allocations to equities and fixed income products in search of higher returns.

Source: World Wealth Report 2009, Datamonitor Global Wealth Model, Industry interviews, Ernst & Young analysis

*Sizing includes UHNW/HNW individuals with liquid wealth over US$ 1 m. Regions include GCC countries, Pakistan, Malaysia and Indonesia

20% 25%

20%28%

5%

30%50%

20%

5%

15%20%

7%


“I would like to place my funds with an Islamic institution but none of them give me the same level of

comfort and safety that the larger western banks offer.”

HNW investor



As markets recover, SWFs are expected to shift to long-term strategic asset allocations with reduced exposure to low yielding, liquid assets

SWFs

2009 Market Size: US$ 1.4 Trillion*



In the quest for higher returns in 2010 SWFs are expected to increase exposure to alternatives. For 2010, SWFs are exhibiting a particular interest for large market capitalization equities, commodities including gold and multi-strategy hedge-funds.

Source: Sovereign Wealth Fund Institute, Industry interviews, Ernst & Young analysis

*Sizing includes SWFs from the GCC, Malaysia and Indonesia

5% 10%

45% 50%

25%25%

20% 5%

10%20%


“Our mandate does not allow too much of a variation in our strategic asset allocation, we are currently

focusing on infrastructure investment in our home market.”

Sovereign wealth sub-fund manager

31


Pension Funds




With market recovery and an improvement in risk appetite during 2009, regional and global pension funds increased exposure to equities as well as alternatives. In 2010, allocation to higher return asset classes including equities and private equity, among other alternatives, is expected to increase.

Source: 2010 Global Pension Asset Study (Towers Watson), Industry interviews, Ernst & Young analysis

*Average historical growth of 12% has been applied to the 2007 Aggregate Public Pension Reserve. Fund assets for GCC, Pakistan, Malaysia and Indonesia.

10% 20%

Pension Funds are expected to follow suit and focus on higher risk assets such as equities and alternatives

35%

54%

15%

28%30%

1%5%

15% 17%


“We naturally look for longer-term investments that will allow us to meet our future obligations.”

Pension fund investment manager



Takaful Companies

2009 Market Size: US$ 8 Billion



Due to a sharp decline in profitability in 2009, Takaful companies assumed a conservative stance with a distinct shift towards cash and money market instruments. In 2010, as the Takaful industry recovers, companies are expected to cautiously increase exposure to equity and fixed income while reducing exposure to cash & money markets.

Source: World Takaful Report 2010, Industry interviews, Ernst & Young analysis

Given the weak performance of 2009, Takaful companies are cautiously increasing exposure to fixed income and equities

30% 33%

20%

34%

40%

26%

6%10%


100%

“There is nothing available in the market that perfectly meets our investment needs.”

Takaful executive

33


Awqaf Institutions

2009 Market Size: US$ 105 Billion



Awqaf institutions have been sluggish in adjusting asset allocations due to illiquid real estate holdings (which cannot be sold off under the concept of Awqaf). The remaining allocation is expected to remain unchanged evenly split among equity, fixed income, cash and alternatives.


Awqaf institutions continue to remain concentrated in real estate

100%

5% 5%5% 5%5% 5%

80% 80%

5% 5%


“Market movements are not a big factor for us, as most of our investments have been gifted to us in the

form of property or cash that we hold for charitable purposes – we are not active investors.”

Awqaf administrator


Estimated Assets 2009

Approximately US$360-480 billion of individual and institutional savings are potentially available to the Islamic asset management industry

Estimated Shari'a Sensitivity Range (%)

Estimated Shari'a Sensitive Assets 2009

UHNWIs /HNWIs

Mass Affluent

SWFs

Pension Funds

Takaful Companies

Awqaf Institutions & Endowments

US$ 105 Billion 100% US$105 Billion

US$ 8 Billion 100% US$ 8 Billion

US$ 177 Billion 10-20% US$18-35 Billion

US$ 1.4 Trillion 5-10% US$ 70-140 Billion

US$ 358 Billion 35-40% US$ 125-143 Billion

US$ 184 Billion 20-25% US$37-46 Billion2

1

3

4

5

6

Estimated Shari’a Sensitive Assets (2009)

US$ 360-480 billion

*Note: Market size has been revised due to a change in Shari’a sensitive allocations as a result of industry interviews and research. The market now includes those investors which are likely to invest in Shari’a compliant funds and not those that are ambivalent.

(2008: US$ 350-400 billion) Revised 2008 market sizing was done based on 2009

sensitivities.



Estimated Assets 2009

Approximately US$360-480 billion of individual and institutional savings are potentially available to the Islamic asset management industry

Estimated Shari'a Sensitivity Range (%)

Estimated Shari'a Sensitive Assets 2009

UHNWIs /HNWIs

Mass Affluent

SWFs

Pension Funds

Takaful Companies

Awqaf Institutions & Endowments

US$ 105 Billion 100% US$105 Billion

US$ 8 Billion 100% US$ 8 Billion

US$ 177 Billion 10-20% US$18-35 Billion

US$ 1.4 Trillion 5-10% US$ 70-140 Billion

US$ 358 Billion 35-40% US$ 125-143 Billion

US$ 184 Billion 20-25% US$37-46 Billion2

1

3

4

5

6

Estimated Shari’a Sensitive Assets (2009)

US$ 360-480 billion

*Note: Market size has been revised due to a change in Shari’a sensitive allocations as a result of industry interviews and research. The market now includes those investors which are likely to invest in Shari’a compliant funds and not those that are ambivalent.

(2008: US$ 350-400 billion) Revised 2008 market sizing was done based on 2009

sensitivities.

35


Develop ‘Go-To’ market strategy and entry approach to win market share from incumbents

Launch new funds based on customer

needs analysis

Conduct market

analysis and customer

segmentation

Islamic asset managers need to focus on the evolving needs of their target customer segment rather than create ‘one size fits all’ products



► Investment managers have had to optimize their market reach through geographical expansion and by adopting flexible distribution channels

►Customers are no longer satisfied with the fixed fee model and managers are having to tailor fees according to customer requirements

► Investment managers have accelerated their cost reduction programmes through a number of short, medium and long term initiatives

Changes affecting the industry

37


Last year we highlighted that Islamic fund managers would have to adapt their business models to survive during the downturn…

TakafulIndustryTakaful

Industry

IslamicInvestment

FundIndustry

Support Functions

► Increase product base to retain market share?

► Keep distribution in-house?► Or move towards a wider

distribution strategy?

► Focus on value added services and generate alpha?

► Revise fee structure to encourage investor participation?

► Consider cost reduction by moving back and middle office functions to shared service centers or off-shore?



Embedding innovation and continually challenging existing business models to ensure they are aligned and focused on the new market.

A broader risk perspective at the time of decision making and a stronger control framework during execution is needed to reflect the complexity of the market and the new, more risk-aware environment.

Recognizing the continued importance of cash and constricted funding, it's critical to optimize capital availability and deployment to achieve greater balance sheet flexibility.

Improving the responsiveness of the organization and sharing risk-taking to drive down cost and adapt more quickly to changes in the market.

Increasing the speed of decision-making and the effectiveness of project execution to capitalize on shorter windows of opportunity and increased volatility.

A more complex market and operational environment requires focus on gaining, retaining and enhancing management capabilities.

Optimizing market reach and product/service mix to exploit new customer opportunities, achieve better returns and mitigate risk.

Regaining and retaining stakeholder confidence means increasing communication and transparency around both financial and non-financial performance.

Re-evaluate the

business model

Optimize market reach

Accelerate decision making

and execution

Optimize operational flexibility

Optimize capital

availability and

deployment

Strengthen stakeholder confidence

The Performance

Wheel

Strengthen management

talent

Revitalize risk management

… in 2009 the adoption of these changes were assessed as part of an extensive research exercise which resulted in over 400 unique insights as to what investment management companies are doing to respond and drive performance improvement

Source: Ernst & Young “Lessons from Change – Asset Management”

39


Reassessing corporate and enterprise locations for market growth, tax and regulatory reasons

Seeking alternative distribution channels and exploiting new technologies to accelerate growth

Diversifying geographically into markets with higher growth/profit potential

Leveraging local producer/agent/distributor alliances and their knowledge to accelerate market entry

Consider new horizontal integration strategies to buy up weaker competitors and expand market share in new geographies

Pioneering innovative market entry strategies (e.g., exploring opportunities outside of mega-cities into tier 2/3 locations)

Finding new market opportunities for existing assets (e.g., intellectual property, patents, products)

0% 20% 40% 60% 80% 100%

Adopted Considering Not Considering

IslamicInvestment

FundIndustry

Support Funct ions

Optimize market reach – asset managers have sought to diversify their revenue base through a number of strategic initiatives such as geographical expansion




Organizing around customers, breaking down functional silos to get closer to the customer

Refocusing on core competencies

Exploring partnering and collaboration to drive innovation and knowledge acquisition (e.g., with customers, suppliers, distributors and select competitors)

Capitalizing on tax credits/subsidies that support investments in new innovations

Adopting flexible pricing strategy to maximize value creation (e.g., value based pricing) and rewarding loyalty

Proactively challenging fit of strategy and traditional organizational structure to new business realities

Explicitly understanding and regularly reassessing customer and segment profitability

Consider new vertical integration strategies to enhance value creation and mitigate risk

Embracing environmental sustainability as an engine of future business growth

0% 20% 40% 60% 80% 100%

Reevaluate the business model – asset managers have had to proactively review their strategy and core competencies to reshape their business model in line with new business realities

IslamicInvestment

FundIndustry

Support Funct ions



41


0% 20% 40% 60% 80% 100%

Adopting enhanced forecasting processes and business analytics to identify and respond to market volatility

Optimizing business support functions to drive greater efficiency (e.g., consolidation, outsourcing, shared service centres)

Building flexibility into long-term contracts and obligations internally and externally

Aggressively reducing proportion of fixed cost (e.g., sell and lease back, outsourcing, hired staff)

Adopting holistic net present value or similar measure to assess cost reduction programs

Accelerating cost reduction programs

Developing new collaborative processes to drive improved performance (e.g., assessing and rewarding suppliers for innovation and cost reduction delivery)

Exploring new ways to improve staff productivity and workforce mobility as an alternatives to headcount reduction

IslamicInvestment

FundIndustry

Support Funct ions

Optimize operational flexibility – most asset managers have undertaken cost reduction initiatives spurred on by the financial crisis and fee pressures





►There has been a significant change in the key business risks that the Islamic fund industry is expected to face in 2010

►The key risks identified by respondents are rebuilding trust with investors and ensuring the enforcement of a comprehensive risk management framework

The future risk environment

43


As the asset management industry recovers from the economic crisis, rebuilding trust with investors is the most pressing concern for 2010


Financial Compliance

Strategic Operational

Decline in Investors’ trust

Operational flexibility

Business Risks - Islamic Funds and Investments Industry

Cost management

Risk management

* Note: To ease comparability, the names of the 2009 risks have been amended to reflect responses from this year.

Key Business Risks 2010

1 Decline in investors’ trust

2Risk management enforcement

3 Operational flexibility

4Increased regulatory focus

5 Cost management

6Global economic downturn

Key Business Risks 2009

1Global economic downturn

2Prolonged reduction in investors' risk appetite

3 Valuations

4Risk management enforcement

5 Decline in investors’ trust

6Business model redundancy

Increased regulatoryfocus

Global economicdownturn

Key to Symbols

Up from 2009

Down from 2009

New entry



Due to the losses suffered, investors have lost trust in their investment managers who promised returns they could not deliver

One of the most important challenges is to rebuild trust and confidence by strong customer relationship management and greater transparency

► Interviewees agree that the most successful asset management companies have been those which focus clearly on their customers and that this is going to be even more important in the future. There has been a notable increase in investor requirements for transparency which has led to greater recognition of the importance of data management and reporting.

Asset managers without a track record will find it difficult to attract investors

► During the credit crunch, there was a real flight to quality. In such an environment, consistently performing funds with a track record had a competitive edge. In the current market, interviewees have noted a ‘flight to reliability’, with many investors looking for a reliable, well established global organization to invest with.

The reputation of the investment management industry has been hit hard by the crisis

► For good reasons and bad, interviewees agree that the industry’s reputation has been adversely affected during 2009. Asset managers agree that they will need to work hard to avoid even the appearance of failure to deliver on promises. In the current market environment, the asset management industry cannot afford a “credibility crisis”.

Decline in Investor Trust

Key Considerations

The fundamentals of asset management must be handled with unflagging professionalism► Rebuilding trust is going to take some time and will not be accomplished without a sustained and serious effort by all stakeholders including managers,

regulators and governments.

“Banks are bursting at the seams with cash, but people are preferring to keep the cash in the bank than invest in a fund.”Saudi executive


“Investors that have been burnt in the past are looking for liquidity in the funds they choose to invest in to ensure it doesn’t happen again.”Bahraini executive

45


The financial crisis has highlighted that asset management firms have to manage a far wider set of risks than simply investment portfolio risk

Asset management is, first and last, an exercise in risk management► Interviewees stated that the asset management industry was built around risk management and the fact that the

industry failed at managing its own risks and those of its customers is particularly ironic, and particularly bitter.

Interrelationships not recognized and hence not managed

► Interviewees expressed surprise at how far the economic and business reality diverged from the long held business models of investment managers. The complexity of interrelationships between asset classes, and the growing correlation of assets as the panic increased — particularly as large investors found themselves forced to liquidate even profitable positions to cover losses elsewhere — led to a general sense that the old diversification model needs to be re-examined. This posed a significant challenge to asset managers in terms of how to respond and retool in an evolving risk environment.

Embedding risk management

► Today, asset management companies are increasingly moving towards integrating risk management across the business. Many interviewees have stated that risk cannot simply take a back seat in the business anymore and risk management is regularly raised at front, middle and back office levels with a fully integrated risk management approach being implemented across the industry.

Risk Management

Key Considerations

Understand and plan for risk management► Asset management firms must clearly understand the various types of risks they are likely to face under different scenarios. Mitigants and controls should be

planned and implemented for each of these risks.

“Risk is now the buzzword of the industry and we cannot afford to not keep a grip of our risks.”UAE executive

“We have moved away from a passive investment management approach and are actively monitoring our portfolio on a daily basis.”Malaysian executive

“Risk management now plays a much more integral role in our business.”Saudi executive




Investment managers must increase the responsiveness of their organization by emphasizing flexibility

Last year’s events have caused a profound change in attitudes toward the industry► Interviewees confirmed that clients at every level of the market, from the largest institutional investor to the

smallest retail client, are now demanding a lot more value for their money. ► In addition to negotiating on fees, clients are asking for the provision of a lot more detailed information on the

investments within the fund and justification for purchase as well as supporting evidence for any expected returns.

Changing fee structures► Interviewees have suggested that the fixed management fee and incentive fee (fee charged over a defined

hurdle rate) structure that funds have typically levied will no longer be applicable in the current economic environment.

► In addition, the growth of lower-cost alternatives such as ETFs and the pressure by institutional investors to cut costs is forcing changes in the fee structure.

Moving away from the proprietary model towards an open architecture approach► Interviewees acknowledge that institutions with the broadest product set tended to outperform during the crisis,

as they could offer clients more alternatives. Many asset managers are now seeking to add a broader array of products through joint ventures or white labeling to be able to meet their clients’ investment needs.

Operational Flexibility

Key Considerations

More products at the right price► Clients are demanding greater choice of financial products that best meet their wealth management needs. Additionally, they are not prepared to pay high

fees. Managers therefore have to be creative about their offering as well as cost/price structures.

“Clients are now asking for proof of returns, looking at business plans, annual accounts and management reports prior to investing.”Bahraini executive

“We have had to be flexible and be prepared to negotiate on our fees with potential investors – this is something we would never have done in the past.”Saudi executive

“Products which have failed to generate enough interest have been immediately axed from our portfolio.”UAE executive


47


Following the crisis regulatory authorities are adopting a more stringent stance in monitoring the asset management industry

Initiatives by regulators► In line with regulations impacting the conventional asset management space, interviewees expressed concern about

the impact of potential new regulations, especially in the areas of leverage, disclosure to clients and external assurance.

► Interviewees cited examples of global regulations impacting the asset management industry including: ► The proposed Alternative Investment Fund Managers (AIFM) Directive which will restructure the supervisory

and regulatory framework for AIFM in European Union.► International Organization of Securities Commissions (IOSCO) Standing Committee on Investment

Management is focusing on the introduction of best practice standards for fund governance and for dealing with the challenge of market timing activities.

► The Undertakings For The Collective Investment Of Transferable Securities (UCITS) IV Directive will come into force in July 2010, which will expedite the fund launch process and make cross-border targeting easier in the European Union.

Fear of clamp down by regional regulators

► Interviewees expressed concern that a clamp down by regulators may increase costs for investment managers and in many cases hamper growth. The interviewees expressed comparisons to the hedge fund industry which developed exponentially with a light touch regulatory approach.

Increased Regulatory Focus

Key Considerations

Keep a close eye on regulatory initiatives and lobby from the platform of industry association► Asset managers need to be diligent and preemptive in identifying global and regional regulatory initiatives to ensure that any structural change introduced

by the authorities does not come as a surprise.

“A fear exists in all regional asset managers that the regulatory authorities will increase regulation”Bahraini executive

“Regulatory developments taking place in Europe and USA in the asset management space are a good predictor of changes set to take place in the Middle East”UAE executive

“Going forward UCITS IV will play an important role for Islamic funds looking to increase capital and widen their investor base” Malaysian executive




Controlling costs is a significant concern for Islamic asset managers in the foreseeable future

Increased focus on cost efficiency► Interviewees commented, and research reveals, that there is a clear declining trend in fee structures which are

being closely scrutinized and aggressively negotiated by investors. The impact on the bottom line is causing managers to closely monitor and control operational costs and relook at staffing requirements.

► Interviewees have noted a shift in focus of asset managers from revenue growth towards making operations leaner and cost-effective.

Steps are being taken to reduce variable costs► Interviewees have highlighted that several asset managers are taking actions to diminish the company’s variable

costs such as eliminating failing products, reviewing brokerage fees, third-party agreements and variable compensation (bonus).

Scale as a means to control costs► Industry analysts have identified the success of ‘asset gathering machines’ that drive down costs and believe that

in part, cost savings can be achieved through scale and a well designed product mix.

Cost Management

Key Considerations

Implement cost reduction strategies► Operational cost reduction strategies include exploring outsourcing and shared services options for peripheral functions, developing scale to achieve

competitive advantage, forming technical alliances to drive down costs, rationalizing product offerings and reviewing the compensation structure and staffing requirement.

“Several asset managers managing less than US$ 50 million in AuM will have to consider closure due to cost inefficiency”Saudi executive

“Reduced investment management fee is forcing us to keep a close eye on costs to protect the bottom line”UAE executive


49


As markets recover, asset managers need to deliver returns to investors to regain their confidence

The economic downturn bottomed out early to mid 2009

► Interviewees generally expressed the opinion that the regional asset management industry has seen the worst and is showing signs of recovery in terms of performance and growth.

Investors who were conserving cash during the crisis are returning back to the market for returns

► Investors were keeping historic high levels of cash during the crisis as uncertainty prevailed in the market. These cash balances have diminished as investors are making a come back to the market in search of returns. Similarly, newly established asset management companies decided to maintain highly liquid positions through the downturn. Subsequently, with signs of recovery these investment managers are looking at different asset classes and markets for higher return.

Redemption requests in early 2009 were at a record level

► Managers have commented that in early 2009 they witnessed a surge of redemption requests as a result of revisions to the returns promised to investors. However, in the latter half of 2009, the redemptions gradually slowed down following the recovery in the market.

Global Economic Downturn

Key Considerations

Focus on delivering performance► During the gradual recovery phase, investment managers should seek to improve their performance and deliver returns to investors. This may require a

review of their operating model, restructuring of costs and an increased focus on core competencies.

“The pre-crisis period was one of fund-raising and investment whereas in the post-crisis period we see the start of the investment monitoring phase of the cycle”Bahraini executive

“The crisis and the ensuing losses have made a number of small fund managers consider the possibility of consolidating or closing as their AuMs fall to inefficient levels”Saudi executive




►The key players in the Islamic fund management industry are concentrated within the GCC and Malaysia

►A number of global investment fund centres are competing to become the domicile of choice for Islamic funds

Jurisdiction overview

51


Islamic funds industry is concentrated in the GCC and Malaysia but choices of fund domicile vary...

Source: Eurekahedge, Zawya Funds Monitor, Ernst & Young analysis

10+

1 – 10

0.5 – 1

0.1 - 0.5

0.01 – 0.1

Islamic AuM by Country (US$b)

Global Islamic Funds by Home Country of Asset Manager (Q1 2010)

177

34

181

KSA

~22.8

Malaysia

~5.1

Bahrain

~1.2

Kuwait

~4.0

UAE

~6.1

82

10024 21

1

1

4 5

8

26

13

14

9

1

2

2

3

Note: Funds per country include those managed by players headquartered in that respective jurisdiction. Boxes show total AuM of Islamic funds in US$ billion and circles show the number of funds.

USA

~2.7

2

1

7

6

1

8

4

8

1

3

5

1



Financial centers across the globe are vying to become ‘domiciles of choice’ for Islamic funds…

Malaysia

US$ 5.1b

184

Luxembourg

US$ 0.58b

35

Saudi Arabia

US$ 22.7b

174

Bahrain

US$ 2.15b

47

Cayman Islands

US$ 4.63b

63

Ireland

US$ 0.23b

24

Singapore

US$ 0.76b

13

Mauritius

US$ 0.12b

3

Malta*

-

-

Dubai (UAE)

US$ 0.58b

12

*Currently applications for Islamic funds are under reviewSource: Eurekahedge, Zawya, Ernst & Young analysis

Estimated Number of Islamic Funds

Estimated Islamic AUM (US$b)

53


Jurisdiction Overview

Bahrain Cayman Islands

Regulations & Licensing Process

Tax and Cost Incentives

Approximate Timeline to Launch




The government is keen to promote Bahrain as the centre of excellence for Islamic funds and has been very flexible and open to increasing the range and number of Collective Investment Schemes domiciled and operating in Bahrain. The country also has a strong Islamic finance infrastructure in place; it is home to Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and International Islamic Financial Market (IIFM). Currently, Bahrain has a total of US$ 2.15 billion in Islamic assets under management.

The Central Bank of Bahrain (CBB) is the primary regulator of Bahrain’s asset management industry. The Collective Investment Undertakings (CIU) Module in the CBB Rulebook (Volume 6) lays out the regulatory framework for both Islamic and conventional funds. CIUs are classified as retail CIUs and expert CIUs. Expert CIUs are designed to cater to individuals, companies, partnerships and trusts with financial assets more than US$ 100,000.

CBB licensees eligible to market funds in Bahrain are conventional banks, Islamic banks and investment business firms. Wholesale banking institutions are not allowed to deal with retail investors.

Income from all forms of CIUs registered in Bahrain is tax-exempt.

Each Bahrain domiciled retail CIU authorized by CBB is subject to an annual fee of BD 2,000. In case of umbrella funds, each sub-fund is also charged BD 2,000 per annum.

The Cayman Islands, the most recognized offshore financial center for fund establishment, has also become popular for Islamic funds. It offers a reliable legal system, availability of world-class professional services, an anti-money laundering and well-regulated culture, mechanisms to ensure speed of establishment and flexibility in fund structures and products. In addition, funds are allowed to submit financial statements and notifications in Arabic. Cayman Islands has a total of US$ 4.6 billion Islamic assets under management.

The process of incorporating and registering a fund (including the time that it will take to settle the fund's offering document and draft the fund's constitutional documents), generally takes 3-5 weeks from start to finish.

The Cayman Islands Monetary Authority (CIMA) is the regulatory body for the financial services sector. All registered funds in the Cayman Islands are governed by the Mutual Funds Law. The Mutual Funds Law covers companies, unit trusts and partnerships that issue equity interests.

The licensing process and regulatory guidelines are the same for Islamic funds as they are for conventional funds.

A Cayman Islands domiciled fund can obtain an undertaking from the Government that for a period of twenty years (in case of a company) or fifty years (in case of a trust or a partnership) from the date of the undertaking, no law which is enacted in the Cayman Islands imposing any tax on such profit, income, capital gains or appreciations will apply to such a fund.

The license application processing may take 60 calendar days depending on the completion of information. On average, the whole process is estimated to take between 3 to 6 months.

The annual licensing fee for a fund is US$ 3,000.




Bahrain Cayman Islands







The government is keen to promote Bahrain as the centre of excellence for Islamic funds and has been very flexible and open to increasing the range and number of Collective Investment Schemes domiciled and operating in Bahrain. The country also has a strong Islamic finance infrastructure in place; it is home to Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and International Islamic Financial Market (IIFM). Currently, Bahrain has a total of US$ 2.15 billion in Islamic assets under management.

The Central Bank of Bahrain (CBB) is the primary regulator of Bahrain’s asset management industry. The Collective Investment Undertakings (CIU) Module in the CBB Rulebook (Volume 6) lays out the regulatory framework for both Islamic and conventional funds. CIUs are classified as retail CIUs and expert CIUs. Expert CIUs are designed to cater to individuals, companies, partnerships and trusts with financial assets more than US$ 100,000.

CBB licensees eligible to market funds in Bahrain are conventional banks, Islamic banks and investment business firms. Wholesale banking institutions are not allowed to deal with retail investors.

Income from all forms of CIUs registered in Bahrain is tax-exempt.

Each Bahrain domiciled retail CIU authorized by CBB is subject to an annual fee of BD 2,000. In case of umbrella funds, each sub-fund is also charged BD 2,000 per annum.

The Cayman Islands, the most recognized offshore financial center for fund establishment, has also become popular for Islamic funds. It offers a reliable legal system, availability of world-class professional services, an anti-money laundering and well-regulated culture, mechanisms to ensure speed of establishment and flexibility in fund structures and products. In addition, funds are allowed to submit financial statements and notifications in Arabic. Cayman Islands has a total of US$ 4.6 billion Islamic assets under management.

The process of incorporating and registering a fund (including the time that it will take to settle the fund's offering document and draft the fund's constitutional documents), generally takes 3-5 weeks from start to finish.

The Cayman Islands Monetary Authority (CIMA) is the regulatory body for the financial services sector. All registered funds in the Cayman Islands are governed by the Mutual Funds Law. The Mutual Funds Law covers companies, unit trusts and partnerships that issue equity interests.

The licensing process and regulatory guidelines are the same for Islamic funds as they are for conventional funds.

A Cayman Islands domiciled fund can obtain an undertaking from the Government that for a period of twenty years (in case of a company) or fifty years (in case of a trust or a partnership) from the date of the undertaking, no law which is enacted in the Cayman Islands imposing any tax on such profit, income, capital gains or appreciations will apply to such a fund.

The license application processing may take 60 calendar days depending on the completion of information. On average, the whole process is estimated to take between 3 to 6 months.

The annual licensing fee for a fund is US$ 3,000.









Dubai (UAE) IrelandThe Irish government in its endeavor to project Dublin as a global centre for Islamic funds has been organizing seminars to educate prospective managers on the benefits of domiciling their fund in Ireland. Ireland’s reputation as a domicile of choice has been driven by the enormous wealth of expertise across the entire service provider community including firms providing back and middle office support, investment managers, lawyers, auditors, the Irish Stock Exchange and other industry specialists. Currently, 24 Islamic funds are domiciled in Ireland with an estimated AUM of US$ 0.23 billion.

The Irish Financial Services Regulatory Authority (IFSRA) is the single regulator for all financial institutions. The IFSRA is seen as a constituent part of the Central Bank and Financial Services Authority of Ireland.

Funds are classified into UCITS and non-UCITS. UCITS funds are governed under the EU legislation for such funds structured to provide passport to EU to target retail investors. Non-UCITS funds are governed under local Irish fund regulations and allow targeting retail as well as institutional investors.

A fund that is authorized/domiciled in Ireland is not subject to Irish tax. Non Irish resident investors that have completed a non Irish residency declaration on acquiring units in the fund will receive dividend payments or redemptions/sales without deduction of any withholding tax.

Annual license fee is around US$ 1,900 per fund for up to 5 sub-funds.

Timeline for a qualified investment fund is highly expedited at 24 hours. Other funds take an average of 4-6 weeks.

Dubai International Financial Centre (DIFC) has been established with the objective to position Dubai as a recognized hub for institutional finance. The positive regulatory features for fund registration offered by DIFC include permission of 100 per cent foreign ownership, no restrictions on capital/profit repatriation, high regulatory standards, strict supervision and enforcement of money laundering laws. Further cutting down of costs for fund management is under consideration to increase its attractiveness. Currently, DIFC has a total of US$ 0.58 billion in Islamic assets under management.

Dubai Financial Services Authority (DFSA) is the primary regulator for conventional and Islamic funds. The Collective Investments Law as part of the DIFC regulations provides the operational framework for the asset management industry.

Within the Collective Investments Law special provisions have been added for Islamic funds. These are broadly similar to those for Islamic financial institutions which include the appointment of a Shari’a Supervisory Board as well as additional disclosures in the fund prospectus.

Funds registered in the DIFC are tax-exempt. Moreover, a wide network of double taxation treaties is available to UAE incorporated entities.

Annual license renewal fee applicable to funds registered in DIFC is US$ 12,000.

The authorization process is estimated to take around 2 months from the application date. Timeline is sensitive to timely submission of information by applicants and any responses to requests for further clarification.

55









Luxembourg Malaysia

Luxembourg is being promoted aggressively by the government as a European hub for Islamic funds. The regulator is recognized for having a highly proactive and flexible attitude towards the launching of funds. Currently, Luxembourg has a total of US$ 0.58 billion Islamic assets under management.

The CSSF, Commission de Surveillance du Sector Financier, is the regulator for the asset management industry. Funds may be set up under Part I or II of the 2002 Investment Funds Law, as well as under the 2007 Law related to the Specialized Investment Funds (SIF) or as unregulated structures.

No specific laws or amendments are needed for Shari'a compliant funds in Luxembourg. Similar to conventional funds, Shari'a-compliant funds are required to satisfy the basic requirements of the Investment Funds Law of 2002 and the CSSF regulations to secure authorization and approval to launch a Shari’a-compliant fund.

Luxembourg is a tax-efficient jurisdiction which offers various financing and cash repatriation instruments. Specifically, fund vehicles are exempt from taxation in Luxembourg.

Annual license fee is € 2,650 for a single fund under the 2002 Investment Funds Law. It is € 1,500 for a single fund under the SIF law of 2007.

Typically, it should take no more than 6-8 weeks in setting up a UCITS Fund and 4-6 weeks in setting up a SIF Fund. However, the timing is dependent on pre-launch preparation and the completion of required documentation.

Malaysia established the Malaysia International Islamic Financial Centre (MIFC) in 2006, which was an initiative undertaken by the government, regulatory authorities and the private sector to jointly project Malaysia as a global hub for sukuk origination, Islamic fund management, Islamic banking, Takaful and human capital development. Currently, Islamic funds registered in Malaysia have total assets under management of US$ 5.1 billion.

Investors have the option of either setting up an Islamic fund under the Malaysian Securities Commission ('SC'), or an offshore Islamic fund under the Labuan Financial Services Authority ('LFSA'). Both SC and LFSA fall under the auspices of the MIFC. Islamic funds also have to comply with additional guidelines and rulings imposed by the SC or LFSA.

The license application is a two-stage process, which consists of an establishment stage and a licensing stage. Upon obtaining an approval in principle for the establishment of an Islamic Fund Management Company (IFMC), applicant must then submit an application for a fund manager license.

Under MIFC, there is an income tax exemption on all income derived from a business of providing fund management services to local and foreign investors up to 2016.

Annual license fee for a fund operating outside Labuan is RM 10,000 and operating in Labuan is RM 5,000.

Approval in principle for the establishment of an IFMC (Stage 1) would normally take up to 6 months while the licensing approval (Stage 2) may take another 6 months.




Malta

Regulations & Licensing

Taxation and Cost


Regulations & Licensing

Taxation and Cost


MauritiusThe Maltese government has expressed a specific interest in promoting the launch of Islamic funds. Recently through the issuance of a Guidance Note for Shari 'a-compliant funds the regulator, Maltese Financial Services Authority (MFSA), has laid out the details of the support to parties looking for a suitable domicile to launch an Islamic fund. A number of registration applications for Islamic funds have been received so far.

The Maltese Financial Services Authority (MFSA) is the regulatory body overseeing the asset management space in Malta. Given the relatively small size of the country the regulator is readily accessible, active in issue resolution and highly responsive to investor queries. This makes the licensing process fast and smooth.

The act governing the launch of Islamic and conventional funds is the Investment Services Act. Funds are divided into retail investment schemes known as professional investor funds. UCITS platform is available for Shari 'a-compliant funds as a passport to European retail investors.

Collective Investment Schemes (CIS), under which category Islamic funds fall, are tax-exempt. Annual fee for professional investor funds and retail investor funds is €1,500 and €1,630 respectively. Varying incremental rates apply for additional sub-funds.

Retail fund launch is expected to take between 2-4 months. Professional investor funds are expected to take 3-7 days. Variation in timing is dependant on the quality of information provided to the regulator.

The Mauritian government in collaboration with the private sector has been involved in projecting Mauritius as an ideal location for the development of Islamic finance and Islamic fund management. In 2007, the Finance Act 2007 amended the Banking Act 2004 to facilitate Islamic banking and finance by Mauritian commercial banks. Currently, Mauritius has total assets under management of US$ 0.12 billion.

The Financial Services Commission is the primary regulator for the asset management industry.

Separate categories of licenses are available for off-shore and on-shore funds.Off-shore funds have to apply for a Category 1 Global Business License (GBL 1) while an on-shore fund falls under Category 2 Global Business License (GBL 2).

In case of listing, the fund needs to additionally comply with the Securities Act 2005.

GBL1 funds are subject to a minimum of 3% tax and can apply for a foreign tax credit. GBL 2 funds are subject to a tax rate of 15%.

Annual license fee is US$ 10,000.

The registration and launch process for a fund in Mauritius is expected to take around 4-6 weeks.

57



Saudi Arabia



Approximate Timeline for Launch



Approximate Timeline for Launch

Singapore

Singapore, as an established financial services centre in the Far East region, has a well-defined framework for fund management. Over the years, Singapore has revised its regulatory framework and tax structure to facilitate various Shari' a-compliant financial products. Islamic funds domiciled in Singapore have total assets under management of US$ 0.76 billion.

The Monetary Authority of Singapore (MAS) is the primary regulatory body for the fund management industry. There is no segregation between Islamic and conventional funds from a regulatory perspective.

Regulations relating to Collective Investment Schemes (CIS) are addressed in Part XIII Offers of Investments of the Securities and Futures Act (“SFA”). Under SFA two forms of schemes are allowed: retail schemes, targeting retail investors, and restricted schemes, targeting sophisticated / institutional investors.

Onshore funds are subject to taxation of 20%. Offshore funds, under a tax-exemption scheme, are exempt from taxation if 80% of the value of the fund is contributed by foreign investors.

Annual license fee for the fund is S$ 4,000.

Typical time period for registration is within 14-21 days of application submission.

In 2005, the regulatory authority passed a regulation calling for the separation of asset management and investment banking operations into distinct business entities. Saudi Arabia has Islamic funds with AUM of US$ 22.7 billion.

Capital Market Authority (CMA) is the regulatory body overseeing the asset management industry. The Investment Funds Regulations issued by the Board of CMA are applicable to both conventional and Islamic funds.

Under the Investment Funds Regulations the permitted fund categories include funds created to invest in foreign funds, Specialized Investment Funds, fund of funds and money market funds.

Local fund managers are subject to 2.5% Zakat. In case of foreign ownership the fund is subject to tax at a rate of approximately 20%.

Typical time period for registration is from 2-4 months. Delays in registration are primarily due to incomplete paperwork as per the requirements of the CMA.


Appendix 1: Islamic fund characteristics



Appendix 1: Islamic fund characteristics

59


► Conducting regular Shari'a audits for the fund is crucial to ensure compliance with Shari'a

► The Shari'a audit can be performed by the Shari'a board or an external third party

►The custodian does not have to be an Islamic institution but must adhere to Shari'a principles►The administrator must prepare fund accounts in accordance with AAOIFI standards

► Non-Shari'a compliant income must be ‘purified’

► Shari'a board input is essential in determining the type of income to be purified

► Purification is through donation to charitable institutions

► Screening must be performed to ensure compliance with Shari'a

► The first level of screening removes any companies involved in non-Shari'a compliant industries and businesses

► The second level of screening involves removing companies with financial ratios exceeding the acceptable levels

The Purification of

Income

Shari'a Compliant Investment

Shari'aAudit Failed

Trade

Key Differences

Appointment of a Shari'a

Board

► Shari'a compliant funds must appoint at least three Shari'a scholars to the Shari’a Board according to AAOIFI standards

► The scholars are responsible for issuing Fatwas related to the permissibility of the fund structure and investments

Custody of Assets

► In case of a failed trade, interest cannot be charged

► An alternative approach such as the imposition of a fee may be allowed

Key Differences Between a Conventional Fund and a Shari'a Compliant Fund


Team and references



Team and references

61


Ernst & Young’s Islamic Financial Services Group

EMEIA* Sameer Abdi +973 1751 2801 [email protected]

Bahrain Ashar Nazim +973 1751 2808 [email protected]

Saudi Arabia AbdulAziz Al Sowailim +966 1215 9411 [email protected]

Qatar Robert Abboud +974 4573 444 [email protected]

Kuwait Salmaan Jaffery +973 1751 2802 [email protected]

UAE Najeeb Rana +971 4312 9343 [email protected]

United Kingdom Ken Eglinton +44 207 951 2061 [email protected]

Luxembourg Pierre Weimerskirch +352 42 124 8312 [email protected]

Malaysia Abdul Rauf Rashid +603 7495 8728 [email protected]

* Note: Europe, Middle East, India and Africa



The report’s methodology and our interviews

Survey Methodology► Our survey sought to identify key trends and business risks for the global

Islamic asset management industry through in-depth interviews with executives and industry observers.

► These discussions were used to gauge business sentiment and identify key areas for inquiry.

► Interviews were conducted in March and April of 2010. A total of 18 interviews were conducted in six different countries by Ernst & Young staff.

► Interviews centered on four main topics of discussion, namely:► State of the industry► Demand side factors► Supply side dynamics► Business risks

Business Risk Ratings► Ernst & Young subject matter experts developed a list of Islamic asset

management business risks and contributing factors. ► All interviewees were provided with this list of business risks and

requested to rate each to reflect its severity to their respective business over the coming 12 months. Interviewees were also asked to add any additional risks they felt were important.

► The results of this rating process were tallied and a relative ranking assigned to each. This rank formed the basis for our comparative study with 2009 results.

Business Risks Radar► The Ernst & Young risk radar is a simple device that allows us to present

the top 6 business risks in the Islamic asset management industry.► The risks at the center of the radar are those that the individuals we

interviewed thought would pose the greatest challenge to the industry in 2010.

Business Risk Categories► The radar is divided into four sections that correspond to the Ernst &

Young Risk Universe™ model. ► Compliance threats originate in politics, law, regulation or corporate

governance;► Financial threats stem from volatility in markets and the real economy;► Strategic threats are related to customers, competitors and investors;

and ► Operational threats impact the processes, systems, people and overall

value chain of a business.

Acknowledgement, Anonymity and Quotes► We would like to thank all those interviewees that agreed to contribute

to our report.► All interviewees were assured of anonymity and minutes documented

during our discussions were approved by respective interviewees.► Quotations have been used to support argument made in the report.

63


References and the Project Team

Sources► Bloomberg► Central Bank Websites► Company Annual Reports ► Datamonitor Global Wealth Model► EFAMA► Ernst and Young: “Lessons from Change – Asset Management”► Eurekahedge► Global Insight► Investing in the GCC Markets: New Opportunities in a Changing

Landscape► Investment Company Institute► IFIS► Islamic Finance News► IFSL► Merrill Lynch► National Mutual Fund Association► OECD-Private Pensions Outlook 2008► Pew Research Center► SWF Institute ► Watson Wyatt► World Wealth Report 2009► Zawya► 2010 Global Pension Asset Study

Ernst & Young’s Project Team

Sameer Abdi Ashar NazimSohaib Umar Kamran AkhtarAli Shaikh Faisal HasanGhayas Saeed Zahra Al Sairafi

For questions or comments, please contact Kamran Akhtar on:+973 1751 [email protected]


65

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2 Decades of Supporting the Market LeadersMEGA is the leading international information firm focused on achieving business results for the Islamic banking & finance industry since 1993. Our exclusive focus on Islamic finance has enabled us to create significant value for the leading players in the Islamic banking, finance and investment markets. The portfolio of MEGA brands represents the landmark industry conferences and our clients are the leading players in the international financial markets.

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Our Portfolio of Brands:

SAUDISUMMIT

MEGA BRANDS. MEGA CLIENTS. MARKET LEADERS.MEGA is the market leading business information firm focused on achieving business results for the global Islamic banking & finance industry since 1993. The portfolio of MEGA brands represents the landmark industry conferences and our clients are the leading players in the international financial markets.

WIFCMC is a MEGA Brand

SAUDISUMMIT

MEGA Brands: Shaping the Future of the Global Islamic Finance Industry Since 1993P.O. Box 72045, Dubai, UAE | t. +9714 343 1200 | f+971 4 343 6003 MEGA Brands. MEGA Clients. Market Leaders.www.megaevents.net

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Islamic Funds & Investment Report (IFIR 2010), Ernst & Young

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