How rule standardisation is boosting Islamic finance in Abu Dhabi

As one of the UAE’s two major financial centres, Abu Dhabi has played a prominent role in the development of the nation’s Islamic financial services (IFS) sector. In January 2020 Islamic banks accounted for about 18% of total banking sector assets in the country, according to the Central Bank of the UAE (CBUAE). In the local capital markets, sovereign and corporate sukuk (Islamic bonds) issuances comprise the bulk of the Islamic offerings, while in the insurance sector takaful (Islamic insurance) companies operate as either standalone entities or as part of larger, conventional banks.

Abu Dhabi’s local IFS market features an onshore component, populated by companies transacting directly with the domestic market, and an offshore component, operating within the jurisdiction of the Abu Dhabi Global Market (ADGM), the emirate’s financial free zone that opened for business in late October 2015. ADGM was home to more than 100 financial service companies as of early 2020.

Banking

Islamic banking in the UAE has experienced notable growth in recent years. In 2019 around 60% of UAE residents used at least one Islamic banking product, up from 55% in 2018, according to the Islamic Banking Index from Emirates Islamic Bank.

Abu Dhabi-based institutions are helping to drive this trend. Some the UAE’s most prominent wholly Islamic banks are headquartered in Abu Dhabi City: the largest of them, with total assets of approximately Dh126bn ($34.3bn) at the close of 2019, is Abu Dhabi Islamic Bank (ADIB). This is among the emirate’s largest banking institutions and the second-largest sharia-compliant institution in the wider UAE. ADIB became the first purely sharia-compliant bank in Abu Dhabi when it began operations in 1997, and is currently majority-owned by members of the ruling family of Abu Dhabi and the emirate’s sovereign wealth fund. The bank has progressed through a number of development phases since the turn of the century. In 2008 it put in place a new management team that deployed a three-tiered expansion strategy aimed at positioning the bank as a market leader in the UAE, while also pursuing expansion opportunities abroad. Efforts on the latter saw ADIB acquire a large wholesale and retail operation in Egypt, as well as establish a corporate foothold in Iraq, the UK, Saudi Arabia, Sudan and Qatar. ADIB emerged as a technical pioneer in IFS during this period, issuing the world’s first sharia-compliant, hybrid perpetual Tier-1 sukuk in November 2012 for $1bn.

Having appointed a new CEO in 2019, the bank plans to implement a four-pillar, five-year strategy in order to improve customer retention and attract new clients; boost revenue by diversifying its business mix; improve operating efficiency by rationalising internal structures and processes; and enhance its risk-management framework, while reinforcing governance.

Second Player

ADIB’s status as the emirate’s only Islamic bank ended in 2008 with the arrival of Al Hilal Bank. The new entrant was established with authorised capital of Dh4bn ($1.1bn) by the Abu Dhabi Investment Council, the emirate’s primary investment vehicle, and became profitable after its second year of operation. Its capital base received a boost in 2013 with the bank’s debut sukuk offering, and by the close of 2018 it held more than Dh43.6bn ($11.9bn) in assets.

Al Hilal Bank opened its sharia-compliant insurance unit, Al Hilal Takaful, that same year, and ventured into the vehicle financing market with Al Hilal Auto in 2009. The bank increased its geographic footprint in 2010, creating Al Hilal Islamic Bank Kazakhstan, the first Islamic bank in the predominantly Muslim country. In May 2019 Al Hilal Bank was part of one of the region’s most significant restructurings: the merger between Abu Dhabi Commercial Bank (ADCB) and Union National Bank, which saw the two lenders acquire Al Hilal Bank to form a new banking heavyweight with Dh405.1bn ($110.3bn) in assets as of December 2019. The new group carries the ADCB identity, but Al Hilal Bank remains a separate Islamic provider within the group.

Regulation

IFS institutions are governed much in the same way as their conventional counterparts: by the CBUAE for onshore banking; by the Emirates Securities and Commodities Authority for securities; and by the UAE Insurance Authority for takaful. Under UAE law, onshore banking institutions may secure licences as standalone sharia-compliant banks or offer sharia-compliant instruments through Islamic windows of conventional banks. Licensing for the takaful segment differs, in that conventional insurers are not permitted to offer sharia-compliant coverage through Islamic windows. However, takaful companies are permitted, where it can be proved necessary, to pass risk on to conventional insurance firms.

Until recently, the UAE deployed a decentralised approach with regards to questions of sharia-compliance, with each financial institution operating a proprietary sharia board to which it deferred on important matters such as product development. However, in May 2016 the UAE Cabinet approved the establishment of a centralised sharia authority to monitor and set the standards of the Islamic finance industry, as well as issue fatwas (Islamic rulings) on the sharia compliance of products and services. The announcement was broadly welcomed as a step towards regulatory harmonisation in an increasingly complex IFS sector. While the agency, called the Higher Sharia Authority (HSA), is still in an early stage of development, it made its first significant move in 2018, when it adopted the sharia standards of the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions.

The authority met a number of times during 2019, discussing drafts of new standards for murabaha ( costplus financing) and ijara (leasing). According to the UAE Banks Federation, which cooperates with the HSA in many areas, the authority is considering appointing a fatwa committee that will have the final say in disputes related to sharia law, while allowing institutions to retain their proprietary sharia boards.

Offshore Framework

ADGM, meanwhile, has its own legal system, which is based on UK common law, its own court system and an independent regulator, the Financial Services Regulatory Authority (FSRA). The FSRA aims to establish a robust and well-regulated financial market that is aligned with global standards and best practices, so the body’s Islamic finance rules cover a wide range of activities, including general obligations, accounting and auditing, managing profit, Islamic collective investment accounts, offers of Islamic securities and takaful operations. The financial free zone is an active member of the Islamic Financial Services Board under the CBUAE, and boosting its sharia-compliant segment is a key component of its development strategy. In August 2017 ADGM partnered with the Responsible Finance & Investment Foundation, a London-based think tank, to boost Islamic ethics in financial technology (fintech) platforms and identify opportunities for sharia-compliant fintech services. The following year ADGM signed a memorandum of understanding with Al Hilal Bank to promote Islamic finance across the UAE. Under the agreement, ADGM is cooperating with the bank to create sharia-compliant solutions in areas such as e-banking, digital value-added services, blockchain, application programming interfaces and automation.

Takaful

Most insurance activity in Abu Dhabi and the wider UAE is conducted along conventional lines, but a vibrant sharia-compliant segment is emerging. The founding of Islamic Arab Insurance Company (Salama) in 1979 made the UAE the second GCC country to adopt the takaful concept, and today Salama is the world’s largest takaful and re-takaful (Islamic reinsurance) provider, with paid-up capital of Dh1.2bn ($329.4m).

As Saudi Arabia’s cooperative insurance model is not categorised as takaful by many industry reports due to a number of technical differences with the sharia-compliant model, the UAE is considered to have the largest takaful market in the region. The most recent annual report from the UAE Insurance Authority shows that the domestic market was home to 12 takaful operators in 2018, all of which are national companies. In 2018 sharia-compliant insurance accounted for approximately 10% of the nation’s total gross written premium (GWP), up from 9.5% in 2017. Like in the conventional segment, health insurance accounts for the largest share of aggregate GWP, at Dh1.7bn ($462.7m) out of Dh4.4bn ($1.2bn) in 2018. Motor coverage is the second-most important business line for takaful operators, contributing Dh1.2bn ($326.6m) to total GWP.

Segment Providers

Islamic insurance’s share of the market continues to grow, and Abu Dhabi’s takaful operators are an important driver of this trend. Abu Dhabi National Takaful Company (ADNTC) was the first firm to enter the local market, beginning operations in 2003 and listing on the Abu Dhabi Securities Exchange (ADX) two years later. The company’s footprint covers the entire UAE, with offices in Abu Dhabi, Dubai and Al Ain. Holding Dh1.2bn ($326.6m) in assets as of September 2019, ADNTC is the largest of the locally based takaful firms. In 2009 a second Abu Dhabi-based player commenced operations: Methaq Takaful Insurance Company, which had Dh684.5m ($186.3m) in assets as of September 2019. The company has since established branches in Dubai, Ras Al Khaimah and Al Ain.

Abu Dhabi’s third-largest standalone takaful provider, Watania, began its underwriting operations in 2011, listing on the ADX that same year with paid-up capital of Dh150m ($40.8m). Founding the company was an initiative of several shareholders: Abu Dhabi National Insurance Company, Abu Dhabi National Islamic Finance, Abu Dhabi National Energy Company and Aldar Properties. In August 2014 a 51% stake was secured by MB UAE Investments and a 9.5% stake was sold to Oman’s Al Madina Insurance Company. Watania operates a head office in Abu Dhabi and a branch in Dubai. Credit ratings agency AM Best revised its outlook for Watania from stable to positive in May 2019, and the company’s total assets stood at Dh119.4m ($32.5m) in September 2019. In addition to Abu Dhabi’s standalone takaful providers, the local market is served by the emirate’s Islamic banks. ADIB holds a 40% stake in ADNTC, and Al Hilal Takaful has operated as a subsidiary of Al Hilal Bank since the company’s establishment in June 2008.

Performance

Abu Dhabi’s banking sector has faced significant challenges in recent years; however, a gradual recovery in oil prices – until the latest drop amid the Covid-19 outbreak, with Brent crude trading at around $40 per barrel as of mid-June 2020 – and a stronger national economy helped to improve business conditions. The aggregate net profit of the 18 national banks listed on the UAE’s capital markets climbed to Dh24.5bn ($6.7bn) in the first half of 2019, up 16.7% year-on-year from Dh21bn ($5.7bn). With the purchase of Al Hilal Bank by the newly combined ADCB and Union National Bank, the only independently reporting, fully sharia-compliant bank in Abu Dhabi is ADIB. In 2019 the bank grew its assets by 0.6% and its net profit by 4%. The rise in net profit was supported by stable operating expenses over the year, which the bank attributed to “cost discipline initiatives that led to a decrease of 1% in the cost-to-income ratio”.

Takaful providers had to navigate the same economic headwinds in recent years. The regulatory response to these events – although important for sector stability – has further challenged insurers. One of the most significant restrictions came in 2015, when the UAE Insurance Authority issued rules that limited insurers’ exposure to real estate to a maximum of 30% of invested funds, while requiring them to maintain a minimum 5% exposure to cash and deposits. Nevertheless, the segment has continued to expand its aggregate premium: according to the UAE Insurance Authority, the combined GWP of the nation’s takaful companies grew by 4% to Dh4.4bn ($1.2bn) in 2018.

In 2019 Abu Dhabi-based players recorded a mixed performance. ADNTC and Watania posted profit growth of 11% and 129%, respectively, year-on-year in the first three quarters of 2019, while Methaq recorded a 62% contraction that same period.

Broad Islamic Asset Base

The development of the Islamic banking and takaful segments is helping to create a broader Islamic asset base. The UAE has emerged as a significant originator of sukuk, which are becoming increasingly popular with global investors and serve as an essential liquidity-management tool for Islamic financial institutions.

Dubai’s offshore financial free zone, Dubai International Financial Centre (DIFC), has traditionally been the centre of the nation’s Islamic fixed-income activity. At the outset of 2019 its 14 listed sukuk, with a combined value of $12bn, made the DIFC the largest centre in the world for sukuk by listed value. Corporate issuances out of Abu Dhabi in recent years have also boosted the nation’s sukuk profile. Aldar Properties listed the first corporate sukuk on the ADX in 2018, while First Abu Dhabi Bank, the UAE’s largest bank, was the first GCC issuer on the international sukuk market in 2019, with an offering of $850m. Emirates Strategic Investments Company also debuted a sukuk in 2019 (see analysis).

Abu Dhabi’s widening IFS sector also includes a thriving sharia-compliant asset-management segment. Some 82% of GCC assets under management (AUM) are domiciled in Saudi Arabia, amounting to $26.9bn, according to financial markets data provider Refinitiv. The UAE is the third-largest fund market in the region, with AUM of approximately $1.7bn in 2019. Both conventional and Islamic institutions market funds from Abu Dhabi, including First Abu Dhabi Bank, which offers the sharia-compliant MENA Dividend Leader Fund, Islamic MENA Growth Fund and Sukuk Income Fund, among other non-Islamic funds. ADIB, meanwhile, provides a range of products for investors, but has opted to take an advisory role with regards to mass market fund offerings, providing its customers access to nearly 30 third-party mutual funds from managers such as Mashreq Capital, Franklin Templeton and NCB Capital, as well as access to sukuk trading platforms for the secondary trading. Al Hilal Bank, for its part, retains its brand and proprietary investment products despite being owned by ADCB, offering the GCC Equity Fund, Global Sukuk Fund and Global Balanced Fund.

Outlook

Regulatory moves in the field of IFS made by both the CBUAE and ADGM – as well as the adoption of international sharia standards issued by the Accounting and Auditing Organisation for Islamic Financial Institutions – have laid the groundwork for the domestic IFS industry’s growth. Greater regulation and standardisation is expected to develop in the short term given that discussion on a variety of key topics for the segment is under way at the HSA.

Equipped with clearer regulatory and compliance guidelines, IFS providers in Abu Dhabi and the broader UAE have an opportunity to increase business across a wide variety of product lines. In the takaful segment premium growth will continue to be underpinned by the accelerating spread across the region of compulsory motor and medical coverage, as well as demand arising from preparations for hosting major events such as Dubai Expo 2020, which will now take place from October 2021 to March 2022.

Meanwhile, the ADX has worked to outline environmental, social and governance reporting standards for listed companies to allow players to service growing investor demand for sustainable sukuk (see analysis).