Why Sharia complaint finance is the smart choice for ethical investors

Introduction
Equity financing refers to a particular method of funding a business to sustain and grow its operations. Equity involves raising funds by issuing shares for investors. Investors who buy shares of a company become shareholders and can earn investment gains if the stock price rises in value or if the company pays a dividend. Dividends are typically cash payments as a reward to shareholders for investing in the company. Equity finance allows a company to raise these funds without borrowing from conventional banks, which typically charge interest. In equity financing, there is no promise to repay the investment like in a loan arrangement, nor is there an interest component.

Impact
Equity finance has no impact on a firm's profitability, but it can dilute existing shareholders' holdings because the company's net income is divided among a larger number of shares. This means that the overall number of shares have increased but the percentage of shares owned by a shareholder decreases. For example, let's say a company has 100 shares outstanding, and an investor owns ten shares or 10% of the company's stock. If the company issues 100 additional new shares, the investor now has 5% ownership of the company's stock since the investor owns five shares out of 200. In other words, the investor's holdings have been diluted by the newly issued shares.

Generally, equity finance has the following characteristics:

• Shareholders get a level of ownership in the company
• Shareholders do no receive any interest payments, but may receive a dividend
• The investment is generally permanent without any maturity
• Upon liquidation, shareholders through equity financing are generally last to be paid

Sources of Equity Financing

• Funds are generally raised through the following methods when financing through equity issuance:
• Personal finances / bootstrapping - most small business begins this way
• Venture capital (VC) - businesses who specialise in making investments in companies in whom they see potential
• Private investors / angel investors - like VC, but they are usually individuals rather than firms
• Family & friends - taking cash from people you know in exchange for part ownership
• Crowdfunding or equity crowdfunding - a recent method of fundraising which gives the public early or exclusive access to a product or service in exchange for up-front funds. Equity crowdfunding involves offering shares for funds at an early stage
• Government - in certain circumstances a government grant may be available for small businesses
• IPO (or initial public offering) - to float your company on a stock exchange and sell shares to the public

Shariah structures for Equity Financing
There are two famous structures in Islamic Finance which are used to establish equity financing, they are Mudaraba and Musharaka.

Mudaraba
Mudaraba refers to a relationship between an investor (Rab al maal) and an investment manager (Mudarib) to establish a profit-sharing partnership to undertake a business or investment activity. Under this structure, the Rab al maal provides the financing or funds and the Mudarib provides the professional, managerial, and technical know-how to carry out the business or manage the investment. The Mudarib must invest the funds in a Shariah compliant way. The parties share in any profits according to a pre-agreed ratio. In a Mudaraba, the Mudarib:

• Puts only its time and effort at risk and does not contribute any capital.
• Is not responsible for any losses of the venture. Losses, however, are borne entirely by the Rab al maal.

Musharaka
A Musharaka is an investment partnership or joint venture compliant with Islamic principles. In a Musharaka, the financing party and its client contribute assets (cash or property) to a joint venture and share in the profits of the joint venture in agreed percentages. The joint venture is structured so that the financing party receives its initial investment plus a return that is usually calculated by a reference to a benchmark. Losses, however, are shared in accordance with the parties' initial investment. All Musharaka parties have the right to exercise control over the joint venture but it is typically managed by the client.
Musharaka is similar to Mudaraba except that in a Mudaraba only the financing party bears the losses associated with the joint venture or partnership.

Waqf is an ongoing, sustainable, charitable donation and has been used throughout Islamic history to benefit and support communities, and aid community development. Islamically, waqf is a mechanism through which the condition of society can be improved. Waqf refers to an endowment made to a charitable, educational or religious cause.

It is a voluntary action that the whole community can benefit from, for example, the building of a university, research centre or hospital.

WAQF - WHAT DOES IT MEAN?
The Arabic meaning of waqf means 'restriction'. This is based on the principle that all property essentially belongs to Allah. So, whilst a Muslim may donate to a charity for community development, the donation is not owned by the Muslim but by Allah.

For example, if you donate some land or an asset for the purpose of community development, then the community will reap the benefits. The donation releases an ongoing community benefit that supports future generations. A famous example of waqf is the Al Azhar Mosque and University in Cairo, Egypt. This University was founded as waqf in 1908, with funds donated by wealthy Egyptians.

HOW DOES WAQF WORK?
Waqf involves donating a fixed asset which in turn provides a financial return.

Waqf is based on the principle that you can donate an asset that can then continue to provide a charitable service for the foreseeable future. The waqf project goes on to support others in the community through various activities and services.

This is how waqf works:

• Individual donates an asset to a waqf project.
• The donations are collated and invested in a Sharia compliant way.
• Any profits and returns on the investments are used to support charitable organizations such as education, relief of poverty, providing healthcare services and emergency solutions.
• Some profits are reinvested in a Sharia compliant manner.

The outcome is that your donation should keep going for a number of years, benefiting humans for generations. The incentive for Muslims wanting to donate to a waqf is that the donation is considered to be an ongoing charitable endowment that benefits others for many years.

History Of Waqf

Although waqf is not explicitly prescribed in the Quran like charity is, it is considered to be comparable to sadaqah. Waqf investments are deemed to be a crucial part of Islam as the Prophet (SAW) stated that:

"When a person dies, all their deeds end except three: a continuing charity, beneficial knowledge, and a child who prays for them"

Waqf investments have an important continuing charity element.

Waqf As A Social Finance Institution

Many Muslim majority countries in the world are still developing and income-poor. There is a lack of availability of private sector investment businesses and options. Waqf can be considered a social finance institution that can fill the gaps in development spending. Waqf provides an avenue for the effective utilisation of perpetual social savings.

With transnational waqf investments and support programmes, there is potential for philanthropic Muslims to support the development of communities across the world.

When viewed through an Islamic redistribution framework, it is clear that waqf harnesses selfless charitable giving in a way that is effective and impactful. Targeting social segments within society and aiming for long term improvement brings benefits to donors and society as a whole.

Donating assets for permanent societal benefit facilitates flexibility and stabilisation for deprived and needy communities. Waqf essentially transforms social capital into social infrastructure, complementing zakat and sadaqah donations.

Sourcing Sharia compliant waqf investments and donations online can be difficult, so you must ensure that you undertake the due diligence required.

In recent years Islamic Finance has firmly established itself as one of the most vibrant and yet often overlooked sectors within FinTech, as well as within the global financial services industry more broadly.

However, Islamic Finance is in fact a very broad term that encompasses a wide range of products, services and types of firms. What is true across this diverse segment of global financial services is that there is a lot of excitement for good reason. This is not at all surprising given the wave of innovation, growth and success of both the leading firms and the sector as a whole over recent years.Whether you are new to the world of Islamic Finance or a professional, our Insider’s Guide to Islamic Finance provides expert insights and latest data analysis on the sector - highlighting just how successful Islamic finance has become at a global level.


WHAT IS ISLAMIC FINANCE?

Islamic finance refers to financial services activities, most notably banking, insurance and financing (credit), that must adhere to Sharia law (Islamic Law). The term can also be used to refer to Sharia-compliant investments as well as broader capital and equity markets.

The common practices of Islamic finance and banking arose alongside the establishment of Islam. However, institutional Islamic finance did not emerge until the twentieth century. Currently, the Islamic finance sector is growing at a rate of 15% to 25% per year, with Islamic financial institutions managing assets worth over 2.7 trillion USD globally.

SIZE AND GROWTH OF ISLAMIC FINANCE

The global market for Islamic Finance continued positive momentum in 2020, recording a growth rate of 10.7% year-on-year, driven primarily by strong performance within Islamic Banking as well as the Equity and Capital markets:

• Islamic Banking: 4.3% year on year growth with a growth in total assets of 248 billion USD, particularly in the largest Islamic markets such as Saudi Arabia and Iran.
• Capital Markets: 26.9% year on year growth
• Islamic Insurance (Takaful): 10% annual growth rate and over 51 billion USD in total assets in 2019 prior to the global financial slowdown caused by COVID-19.

While the size and growth of the Islamic finance sector is heavily concentrated in those countries and regions where Islam is predominant, this is rapidly changing in recent years, due to an increase in global migration patterns as well as broader trends in society around ethical investments and sustainable development.

Currently the top 3 countries where Islamic Finance is most well established account for 66% of the global market size across a wide range of metrics:

• Saudi Arabia
• Iran
• Malaysia

However, the Islamic Finance sector is growing rapidly in terms of overall scale, diversity and reach around the globe and into new periphery markets. In 2020 there were over 1,526 islamic finance institutions in operation around the world, with over 46 countries now supporting the growth and development of Islamic Finance within their legal and regulatory frameworks.

This is particularly true within FinTech, where firms and growth has gravitated towards London, the global hub of innovation in financial services, despite the relatively small Islamic community in the United Kingdom.

THE FOUR MAIN AREAS OF ISLAMIC FINANCE

Our guide breaks the data and the sector down into four key areas that are currently driving innovation and global success:

• Islamic Banking
• Islamic Capital Markets (ICM)
• Islamic Insurance (Takaful)
• Islamic Fintech

This page provides an overview of each, including the latest data trends and key highlights, which are expanded on further in each of the individual sections to provide detailed analysis and insight on each area of Islamic Financial Services.

Section 1- Islamic Banking

In 2020 the total size of the Islamic Banking sector had a growth rate of 4.3% year on year and reached over 2.7 trillion USD in total assets. While Islamic banking is still largely regional in terms of market share and overall size, it now accounts for over 6% of the global banking market. Islamic Banking is also both the oldest and most important sub-sector within the global Islamic Financial Services industry, comprising 68.2% of the total market.
SIZE AND GROWTH

In the worldwide IFSI, the Islamic banking category maintained its dominance. Among the 36 jurisdictions included by the IFSI Stability Report 2021, the domestic market share of Islamic banking in relation to the total banking market segment has increased in at least 23 nations.

The performance of the Islamic banking category increased by 4.3 percent in 2020, compared to 12.4 percent in 2019. The Islamic banking segment now accounts for 68.2 percent of the global Islamic Financial Services Industry, down from 72.4 percent in 2019. This decrease is primarily due to the rising significance and strong performance within the Islamic Capital Markets during recent years, rather than indicating a drop in the performance within Islamic Banking.

Islamic Banking is still largely concentrated within geographic regions and markets, where it is the market leader within financial services. Taken together the 15 systemically important Islamic banking jurisdictions accounted for 92.4 percent of global Islamic banking assets, representing only a small increase from 91.4 percent in the previous year. These combined markets also now account for 82.7 percent of the total global assets linked to Sukūk that are currently outstanding, which indicates the availability of high-quality liquid assets (see SECTION 2 for more on Islamic Capital Markets).

DIVERSITY WITHIN ISLAMIC BANKING

As of 2020 there are now 526 Islamic Banking Institutions operating across 72 countries, with a systemically important market share in 15 of these jurisdictions. Within the Islamic Banking sector there is both innovation and diversity in terms of their operations and structures.Breakdown of Islamic banking institutions:

• 428 commercial
• 57 investment
• 22 wholesale
• 19 specialized

Regionally, GCC (the Gulf Cooperation Council countries) retained its position as the largest domicile for Islamic finance assets in 2020. The region accounted for 48.9% of global Islamic finance market share, increasing from 45.9% in 2019. The Middle East and South Asia (MESA) region constituted the second-largest share, accounting for 24.9% of global IFSI assets, remaining consistent with the previous year.

The South-East Asia (SEA) region's share shrank slightly to 20.3% in 2020 from 23.8% in 2019, while that of the Africa region remained small, with a share of 1.7%. The “Others” region, comprising Turkey, the UK and countries from the Commonwealth of Independent States (CIS) region, accounted for 4.3% of total global IFSI assets.

Section 2 - Islamic Capital Markets (Icm)

SUKUK

Growth Rate: 26.9%
Share of IFSI: 30.9%

3,420 - Number of Sukuk issuances Outstanding (2019)
538 Billion USD - Total Value of Sukuk Outstanding (2019)

The sukuk market grew 30% in issuance value in 2019, increasing from 124.8 billion USD in 2018 to 162.1 billion USD. This is the 5th straight year where the sukuk sector has achieved double-digit growth in the sukuk industry, a leader within the overall strong performance in recent years across the Islamic Financial Services Industry.

Notably, although the volume of ṣukūk issuances dropped in 2020, ṣukūk issuances denominated in foreign currencies increased by 7% due to favourable liquidity and global market conditions created by a range of policy actions taken by central banks in Islamic majority markets in response to the COVID-19 pandemic and resulting economic slowdown.

The yield buckets for outstanding ṣukūk have shifted higher, with almost 80% yielding 3–10%

As with other sectors of Islamic Finance, Sukuk market share is both concentrated and significant within several key countries, where it is the debt instrument of choice for governments and has been relied upon to finance budget deficits during the COVID-19 pandemic.
Key Sukuk Markets:

• Malaysia
• Indonesia
• Saudi Arabia
• Iran is the Fastest Growing Market for Sukuk within Islamic Finance

ISLAMIC FUNDS

Number of Funds: 140
Share of ISFI: 30.9% of total assets
Annual Growth Rate: 30% (2019)

In 2020 the ICM sector made up 30.9% of the total assets within the global Islamic Finance Industry, with growth and positive performance in key markets driven by sovereign and multilateral Sukuk issuances.

Islamic funds also recorded a noteworthy growth of 31.9% in terms of the total value of assets under management, while the Islamic equity markets also rebounded in the later part of 2020 after the initial shock and volatility in 1Q20 due to the outbreak of COVID-19 pandemic.

The total assets under management (AuM) of Islamic funds grew by 31.9% in 2020 despite the pandemic . While total AuM grew significantly, the total number of funds increased at a slower rate, which is a positive indication of growth in the average size of funds. The increase in scale of funds may be an indication of the flow of funds into emerging markets' fixed-income funds as a result of the search for yield and increased global liquidity.

Contrasting with the previous year, about 47% of funds now hold AuM of 1 billion USD or more each, while only 1% of funds hold AuM of less than 10 million USD (2019: only 2% held AuM of more than 1 billion USD each).

Section 3 - Islamic Insurance (Takaful)

Growth Rate: -14.8 %
Share of ISFI: 0.9% (2019)
The share of global takaful industry in the global IFSI declined marginally to 0.9% with a -14.8% growth y-to the exchange rate used for some member jurisdictions.

Section 4 - Islamic Fintech

Islamic FinTechs: 241 active in 2020
Transaction Volumes: 49 billion USD
Market share: 0.7% of total FinTech Transaction Volumes
SIZE AND GROWTH

Islamic Fintech is relatively small and recent but has shown strong initial signs of high growth and levels of innovation on a par, or superior to the wider FinTech sector even in the most competitive markets, such as London.

In 2020 the total transaction volume for Islamic Fintechs reached 49 billion USD, which is around 0.7% of the total global FinTech transaction volume.

While this represents an initial period of rapid growth, overall Islamic FinTech remains a relatively small part of the global Islamic Financial Services Industry. However, it is misleading to quantify the results as ‘poor performance’ in comparison to the strong growth within the mature sectors of Islamic Banking and Islamic Capital Markets. Instead, the demonstrated levels of innovation and competitiveness of Islamic FinTech also represents a huge opportunity for future growth.

At present the sector has yet to be fully developed across many regions and also many areas within the diverse FinTech landscape of innovation. Collectively, firms in the top 5 markets for Islamic FinTech account for 75% of the total market size, indicating a high concentration of market activity and room for future growth.
Top 5 Markets for Islamic FinTech:

• Saudi Arabia
• UAE
• Malaysia
• Turkey
• Kuwait

PERFORMANCE AND INVESTMENTS

The performance of Islamic Fintechs is particularly impressive, with projected transaction volumes set to reach over 128 billion USD in total by 2025. This represents a 21% CAGR, compared to the projected CAGR of 15% for the non-Islamic FinTech sector over the same period.

Investors have recognized this strong performance during recent years, with 56% of Islamic Fintechs expecting to complete an equity funding round in 2021. The expected average deal size for these investments was 5 million USD, providing a further indication that investors have high expectations for the performance of Islamic FinTech in the coming years.

Sources Used In This Report

• IFSB - the Islamic Financial Services Industry (IFSI) Stability Report 2021 [https://www.ifsb.org/download.php?id=6106&lang=English&pg=/index.php]
• DinarStandard & Ellipses - The Global Islamic Fintech Report 2021 [https://www.salaamgateway.com/specialcoverage/islamic-fintech-2021]
• ICD-REFINITIV - Islamic Finance Development Report 2020 [https://icd-ps.org/uploads/files/ICD-Refinitiv%20IFDI%20Report%2020201607502893_2100.pdf]