Creating a global bond

Jane Dellar is managing director of Bahrain Financial Services Development Bureau.

Record oil prices mean the number of HNWIs in the Middle East has risen to unprecedented levels and wealth management is now big business. Jane Dellar looks at the services being offered and the impact on the financial services industry globally

The Middle East is home to many of the world's richest individuals and families – and the number is growing dramatically. There are 300,000 high-net-worth individuals (HNWIs) in the region – almost 10% more than last year – holding an estimated $1.2 trillion-worth of wealth between them.

With this prodigious rise in wealth management business in the Middle East, it is little wonder that the financial world in the region – and globally – is looking at new, innovative and diverse ways of servicing the needs of this expanding community. Investors in the region are knowledgeable and sophisticated about financial opportunities globally. They demand excellence, high performance and exceptional returns on their capital and, increasingly, are looking to achieve this through Sharia-compliant investments.

Under Sharia law, Muslims are not allowed to receive interest or go into debt. It prohibits trading in financial risk and investing in companies that do not conform to Islamic ethics (such as businesses that deal with pork, gambling or alcohol). Essentially, money is viewed as an enabler of further business activities, but not as a commodity in itself.

Investment trends
The nature of investor requirements in the region has changed markedly since the 1990s, when traditional investments – property, mutual funds, bonds, etc – were the ones of choice. These needs have shifted – in line with global investor demand – to a much more sophisticated and strategic portfolio, such as hedge funds and direct acquisition of majority stakes in foreign companies.

During the early 21st century, when oil prices started to rise dramatically leading to a sharp increase in wealth in the region, Middle Eastern investors started to direct much more of their money inwardly. This has certainly played its part in fuelling one of the biggest property development booms that the region – or even the world – has ever seen.

The situation changed again over the past two years, and Arabic investors are looking outward again for more diverse opportunities for their money.

The burgeoning Islamic finance sector
Financial services organisations around the world are competing fiercely to attract the Middle Eastern investor. Private-wealth management and Islamic finance are two of the fastest growing segments in the industry, with the latter estimated to be worth somewhere between $300 billion and $500 billion – compared with $200 billion just two years ago.

The main Islamic products available include:

- Murabaha – Sharia-compliant finance, sometimes called "mark-up" financing.
- Musharaka – partnership financing.
- Mudaraba – a contract between two parties where one brings capital and the other expertise.

The sukuk (Islamic bond) market, however, is particularly buoyant, and is worth around $41 billion globally, according to credit rating agency Moody's. Most of the bonds originate in the Gulf, but their popularity with Western banks and investors is growing.

According to John Sandwick, managing director of Swiss-based Encore Management, there is no doubt that the Swiss have cornered the market for private wealth management in the Middle East. "But if they are complacent the Swiss will lose to other financial centres, particularly if they miss the opportunity to attract and retain Arab wealth tied to Islamically compliant investments," he said. "For example, Bahrain is making substantial strides to cater to the newly emergent world of Islamic investments, and is doing so in a predictably professional and welcoming fashion. Over time Swiss wealth managers may find themselves moving some of their operations to Bahrain in order to take part in what we envisage could be a sea change in how Muslims want their wealth managed. In the long run that is fine, as a Bahraini–Swiss axis for Islamic wealth management could be mutually productive for both sides."

On the spot
Middle Eastern HNWIs are no longer willing to have all their investment dealings managed remotely. They need to talk to someone face to face who understands their needs. The providers of Islamic finance products have to understand Islam as well as global finance. And these days, it is essential that they have a local presence.

There are now hundreds of Islamic banks and investment funds across the world, all offering Sharia-compliant products to attract Middle Eastern investors. Even the most traditional of Western private banks are launching new Islamic investment products and opening up offices across the Middle East to boost their presence in the region. The Central Bank of Bahrain has just granted a licence for Coutts & Co to set up an office in the Kingdom, and this is the 49th licence it has granted in the past 18 months.
 
Dubai and Qatar are also building up their Islamic banking and private banking sectors. The Dubai International Financial Centre and the Qatar Financial Centre have both recently set up ring-fenced legal and regulatory frameworks to create more favourable environments for financial institutions. Saudi Arabia is also making strides to develop its financial services offering.

A developing industry
The Sharia-compliant wealth management industry is still in its infancy but developing quickly. Historical criticisms regarding transparency, liquidity levels and little standardised regulations are being addressed, and important steps have been taken to strengthen the industry.
 
The Islamic Financial Services Board (IFSB) has issued its first two standards, one on capital adequacy and another on risk management. The IFSB is supported by the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOFI), which seeks to standardise accounting, governance, auditing and Sharia procedures across the Islamic world. Bahrain is taking the lead in the region on ensuring that all its Islamic financial bodies fully comply with AAOFI guidelines.

The Central Bank of Bahrain has also developed a number of other legal and regulatory initiatives to strengthen the environment for financial services organisations. A key element has been the upgrading of the licensing regime, which now offers banks either retail or wholesale bank licence categories. In addition, a new trust law was issued in August 2006, providing a legal foundation for the creation of trusts. The Central Bank of Bahrain has also established the Wafd fund – the first of its kind in the region – to finance research, education and training in Islamic finance. And it has created a regulatory code specifically for Islamic Banks, known as the Prudential Information and Regulatory framework for Islamic banks (PIRI).

The rise and rise of the HNWI in the Middle East over the past few years is phenomenal. These investors are demanding new and innovative products to meet their specific requirements, and this is changing the face of the wealth management industry not just in the region but across the world.