Should East Africa see Islamic Finance as the next frontier of finance? Mohammed Ameen Hassen

Islam and East Africa A 1450 year old relationship The history of Islam and East Africa and the deep relationship that it shares is a 1450 year old one. Oftentimes, when we speak of the Hijra our minds rush to the migration of Muslims from Makkah to Madinah, but we leave behind the very important event when the first band of Muslims reached Africa and were given refuge by an East African King. Thus, as African Muslims, we pay immense homage to East Africa as it is here that the roots of Islam on the continent lay. In light of the topic Should East Africa see Islamic finance as the next frontier of finance I feel it important to create this linkage to the deep history and relationship between Islam and East Africa.

Themes What is the market outlook for Sukuk and how can Sukuk / Islamic finance contribute to the vibrancy of the East African Capital Markets in terms of risk management, cost of funds, transparency and an increase in investor base? What needs to be done to develop the necessary infrastructure to facilitate the issuing of Sukuk? To what extent do (further) benchmarks need to be set by the sovereign issuer? Understanding what Sukuk investors are looking for when deciding where to invest?

Extract(s): Thomson Reuters, Sukuk perceptions and forecast study Market Outlook Extract(s): Thomson Reuters, Sukuk perceptions and forecast study

Issuances – January to October 2017 Supply / Demand (Subscription) (USD mn) 7.27x 5.03x 3.37x 2.25x 4.26x 3.73x 4.20x 2.96x 2.96x 2.27x

Preferences Appetite for International growing; easing on ratings Issuances in USD eliminates currency risk Quantitative easing program from ECB triggering European investors seeking higher returns in emerging markets Investors seem to be relaxing their demand for high grade Sukuk, given lower supply levels Investors with a Shari’ah mandate (window or full) have a stronger preference for lower rating Rating by credit agencies simplifies process of portfolio selection for investors. Inflow of funds would be a smoother process with a credit rating Asset-based Sukuk are preferred

Main reason for investing in Sukuk Shari’ah Mandate (Window or Full) The main reason for investing in Sukuk is diversification Second thereto is scarcity of alternative Islamic instruments ¼ feel reasonable credit risk is important Negative debt yields in many countries and low supply of investment opportunities in the international market resulting in demand for reasonably rated (credit) Sukuk from emerging markets

Portfolio allocation into Sukuk What value would be allocated to Sukuk? 20% are willing to allocate >50% of their portfolio to Sukuk The largest cohort (36%) are willing to allocate between 5% and 24.9% of their portfolio to Sukuk 14% of investors are willing to allocate >$250m into Sukuk from their portfolio 40% of investors are willing to allocate <$25m into Sukuk from their portfolio 16% of investors are willing to allocate between $75m and $150m into Sukuk from their portfolio

Global Supply and Demand Gap expected to widen as short supply (issuances) persist $bn 2018 F 2019 F 2020 F 2021 F Total global Sukuk issued 59.0 64.9 71.4 78.5 Total Global Sukuk matured 44.1 56.0 50.1 46.0 Total Global Sukuk outstanding 358.2 367.1 388.3 420.9 Total Sukuk Demand 536.6 588.2 645.2 692.2 Sukuk Supply & Demand Gap 178.4 221.1 256.9 271.3

Emerging (Islamic) Markets Which are the most attractive markets for Sukuk Investment 1/3 of the countries are in Africa From East Africa, Kenya features Higher preference for “larger” economies

What can be done? What should a sovereign issuer bear in mind? Liquidity Most investors would like to see a more liquid secondary market (currency choice; listings etc.) Lead arranger preference Most issuers prefer an international multinational lead arranger primarily engaged in conventional financial services More innovative structures With majority of all Sukuk issuances utilising similar “vanilla” Shari’ah structures, ¼ of investors and issuers would like to see the use of more innovative structures that can cater for intangible assets Tenor The largest cohort prefer 3 – 5 year tenor Legal and Tax We have heard very often the need for the legislative environment to be changed and indeed the efforts of sovereigns must be lauded. However, oftentimes the legal environment is amended but the Tax regime is silent on the treatment i.e. it is deemed legal but ambiguity on local tax treatment

Summary While there is certainly a noticeable mismatch between supply and demand – with demand exceeding supply by a few multiples – this does not detract from the fundamental investment principles that are applied generally There seems to be a cohort of investors that are willing to accept lower rated instruments simply because of the lack of Shari’ah compliant alternatives Decision to issue Sukuk by a Sovereign or company is no different to the normal decision flow (e.g. amending taxes to increase revenue vs take on debt) – macroeconomic fundamentals still need to stack up

Tel +27 (0)11 721 5922 Mail shariah@standardbank.co.za Web www.standardbank.com 30 Baker Street, Rosebank, Johannesburg, 2196