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Cover Story: Disrupting Islamic finance

For many years, the global Islamic financial services industry has been seen as a laggard in digital innovation compared with its conventional counterpart. There has been a lack of shariah-compliant alternatives to meet the growing demand for wealth management, investment, insurance and banking products that offer easier access and greater transparency.

But things are looking up for the industry as Islamic finance players play catch-up with their conventional peers. Innovations have already been seen in the financial technology (fintech) segment. They include shariah-compliant cryptocurrency, robo-advisory services, crowdfunding investments and peer-to-peer (P2P) lending platforms, targeting both Muslim and non-Muslim investors.

According to Zeeshan Uppal, co-founder of UK-based property crowdfunding investment company Yielders, some Islamic finance players have embraced technology — particularly fintech — to come up with shariah-compliant digital financial products.

“Generally, Islamic finance seems slow to pick up things and react while conventional finance has always spearheaded growth and influenced the whole finance industry. Today, the players have realised that fintech has opened up opportunities for Islamic finance to catch up because it allows scalability to provide economic diversity and financial fair play, which is in line with shariah law,” says Uppal.

“Shariah-compliance is not only about the lack of riba (interest). It is also about financial literacy and inclusion. The use of technology has really enabled that and allows Islamic finance to evolve, creating the possibility of new solutions being introduced to investors globally.”

Ibrahim Mohammed, the founder of OneGram, the company behind the world’s first shariah-compliant cryptocurrency, says so much more can be done in Islamic finance within the digital space. “We can leverage blockchain technology to create digital banks or P2P lending platforms that adhere to Islamic principles, and many other asset classes can be made shariah-compliant.

“At the same time, I think we need to move away from copying what is already there in the conventional space. We have to come out with our own solutions. And while we are not seeing it yet, I am sure the time will come soon when we have truly innovative Islamic products.

“People need to understand that Islamic finance is a good market. It is a tough one because you must pay attention to every detail and you must have a solid proof-of-concept. It does not help that in Islam, there are different schools of thought. But instead of looking at it as a threat, we should think of it as an opportunity.”

Datuk Seri Mohamed Hassan Kamil, group CEO of Takaful Malaysia, says the use of technology is no longer an option but a necessity for those in the Islamic finance space, especially the traditional players. “Ultimately, Islamic finance players must recognise that digital disruption is real. It has been observed that these businesses can effectively engage technology to sustain and reinvent their business models and have the ability to effectively adapt to the different dimensions of change.”

Islamic finance players must continue to innovate to continue grow their market share, he adds. “Meanwhile, most are struggling to maintain profitability as margins are under pressure and investments in new capabilities are required to capture growth opportunities.

“Players must compete with their conventional counterparts in critical areas of technology and innovation. In order to respond robustly and collectively, the players need a digital game plan that includes creating a digital strategy for customers and the operations of their organisations.”

Umar Munshi, founder of EthisCrowd, Kapital Boost and Ethis Kapital, finds the slow innovation in Islamic finance perplexing as there are clearly more gaps to be filled in this space and there is an urgent need for financial inclusivity in the Muslim world. “In fact, many of the new innovations in the conventional space are very much in line with fundamental Islamic finance models and structures. I believe this is due to a combination of lack of sincere support from industry stakeholders and lack of support for entrepreneurs. Thankfully, there have been observable improvements in both aspects over the past year,” he says.

Umar says the pent-up demand for more Islamic financial services will lead to the inevitable development of the sector. He expects to see more players in the takafultech, crowdfunding and P2P financing, payment and remittance, and smart contract space next year.

According to EY’s Banking in Emerging Markets GCC FinTech Play 2017 report, the risk of fintech disruption for both Islamic and traditional financial institutions across emerging markets is real, with the finance function of banks at the centre of the disruption. Fintech can propel Islamic banks into the mainstream space in 20 promising markets by 2021, up from five markets today, and effectively add

150 million new Islamic banking customers.



Property crowdfunding

One of the key benefits of technology in Islamic finance is to enable financial inclusion. One channel that meets this objective is property crowdfunding platforms, which have become popular in the past five years.

While there are more options when it comes to shariah-compliant investments with low barriers to entry in Muslim-majority countries, the same cannot be said for other parts of the world. To meet this demand, Uppal and his team introduced the Yielders platform, which provides shariah-compliant digital investment opportunities for high-net-worth individuals (HNWI) and other retail investors.

Yielders was launched in April last year to allow investors to crowdfund investment properties that might otherwise not be available to individual investors. The team handpicks assets in the robust parts of the UK such as London and the South East that meet its strict criteria in terms of returns for investors, while minimising investment risks and making the transaction as hassle-free and transparent as possible.

Uppal says the problem with shariah-compliant products in the UK is that they generally do not provide competitive returns. “Being a young Muslim in the country, I noticed that while the limited products available may abide by the rules and regulations prescribed in the Quran and shariah law, they seem to forget the competitive side of things. The idea was really born out of frustration and the lack of opportunity for Muslim millennials to take on more risk to reap good returns.”

Yielders sets an upfront fixed-term rental agreement of two to five years on all assets. A unique feature is that the commercial and residential properties are fully funded and acquired by Yielders’ network of HNWIs. Therefore, retail investors do not have to wait or spend a lot of money to buy a property. Instead, they earn income from the monthly rents paid by tenants until the end of the term.

That means retail investors can start earning almost immediately an average monthly rental income yield of 5% over two to five years. “Our investment opportunity at the retail level is as close to risk-free as possible because the assets have already been acquired. Thus, the initial risk is taken by the HNWI who funded the acquisition,” says Uppal.

For example, the platform’s currently featured offering is a three-bedroom bungalow in Sydenham, Leamington Spa. With an investment term of three years, investors are expected to receive an annual rental yield of 6.49% and an annual return (derived from the total rent and estimated capital appreciation) of 27.39%.

Retail investors can invest between £100 and £20,000 a month while HNWIs can put in as much money as they want. The UK’s Financial Conduct Authority (FCA) defines HNWIs as those with annual incomes of more than £100,000 or net assets of more than £250,000.

By meeting Yielders’ preliminary requirements and providing the necessary Know Your Customer documents, HNWIs will have access to the daily vetted off-market property deal flows by the Yielders team, says Uppal.

Yielders uses a transparent structure of strictly no debt and no interest-fee model. The platform provides detailed information so that investors can make informed decisions. Besides having the right to vote in key decisions, each investor has the right to keep or sell their shares. An annual shariah audit is conducted to ensure that the company adheres to the shariah guidelines and principles.

Uppal says that before the introduction of Yielders’ platform, there were no Islamic real estate investment offerings in the UK with such a low barrier to entry. “Typically, you cannot get involved in real estate deals in this country without a massive deposit involving mortgages and interest rates. Some may offer a return of 2% per annum, but the initial investment required is £10,000. So, it is not exactly promoting financial inclusion.

“We have completely levelled the playing field with our offering, giving people the ability to test the market and understand how the platform works with a lower risk. Since the barrier to entry is so low, people who have tried out the platform ended up repeating their investments.

“Since we went live, we have been inundated with investments. Today, we have 400 users signed up and about 75 active investors.”

Yielders charge a monthly management fee of 10% on gross rent while the profit-sharing fee of 15% is payable upon the investor’s exit. Returns are paid out quarterly or monthly, depending on the investment chosen.

All payments are made directly to the investors’ e-wallet accounts provided by the platform. While the investments have a defined exit, investors are free to exit anytime by relisting the property to other buyers (with a £50 processing fee). The company only earns a fee if there is capital appreciation when the investors exit the investments.

Yielders recently received accreditation from the FCA, making it the first regulated shariah-certified fintech company in the country. “With the added credibility given to us via the regulation, we have set ourselves some pretty distinctive targets this year. For one, we aim to have £5 million worth of assets under management this year. We have already reached about £1.6 million,” says Uppal.

He points out that 35% of the investors on the platform are non-Muslims as it also attracts ethical investors. “To us, that is fantastic uptake by non-Muslim investors. This shows that we appeal to the ethical investment market, which is massively underserved in the UK.”

Yielders has received growing interest from Malaysian investors. But while an expansion to this part of the world is in the pipeline, Uppal says this may not happen in the near future.

Another player in Islamic real estate crowdfunding is Singapore-based EthisCrowd, which focuses on social impact projects that supply affordable housing in Indonesia. Instead of using the funds to trade, flip or buy properties, they are used to build homes in underdeveloped areas.

The platform pools investors’ money and channels it to property developers to build houses and sell them. This allows just about anyone to invest in real estate through a structure that combines crowdfunding with P2P financing, as it provides access to its associate Kapital Boost, an Islamic P2P funding platform.

Umar says the platforms have a total of 19,554 registered members and almost 400 investors. The investors are from 25 countries. Singapore, Dubai and Germany have the largest group of investors.

The platform’s main focus is social housing in Indonesia, which is backed by the government’s national subsidy programme. “In the middle of last year, 32 individuals from our crowd invested S$330,000 in a social housing project called Griya Cariu in Bogor to build 130 houses. In such projects, the developer already has the buyers and their Islamic mortgages confirmed beforehand,” says Umar.

EthisCrowd provides bridging finance for the construction of the projects while Islamic banks and lead investors finance other parts of the project. The company has just started its payouts to investors. On average, investors get an annual return of 15%.

The minimum investment on the platform ranges from S$500 to S$10,000 (Singapore-based projects) or RM3,000 to RM5,000 (Malaysia-based projects), with a projected return of 4% to 52%, depending on the type of project. As at June 19, there had been S$4.3 million worth of crowd investments made by the platform’s investors while more than S$1.3 million had been paid to investors. On average, investors received a return of 11% on top of getting their capital back.

Last year alone, EthisCrowd raised S$3.7 million and funded 15 projects while Kapital Boost raised S$1.4 million for 26 small and medium enterprise (SME) projects.

Ethis Kapital, meanwhile, is an up-and-coming licensed Islamic P2P lending platform in Malaysia. It aims to focus on projects that are both commercially viable and socially responsible for its crowd of ethical and Islamic investors. It expects to host loans of RM50,000 to RM500,000.

EthisCrowd complies with Islamic finance structures and principles — a risk-sharing model of no capital guarantee and no interest fee. All contracts are based on shariah-compliant structures, with documentation prepared by lawyers with expertise in structuring shariah-compliant contracts.



Islamic robo-advisory

Robo-advisory platforms, which replace the need for human decision-making in wealth management and advisory services, are anticipated to heavily impact the wealth management industry — especially since the Securities Commission Malaysia (SC) has introduced a digital investment management framework that sets out licensing and conduct requirements for the offering of automated discretionary portfolio management services to investors.

Although many types of robo-advisory services have entered the global market, there has only been one shariah-compliant platform to date. Launched last September, US-based Wahed Invest is the world’s first Islamic robo-advisory platform that offers investors portfolios of shariah-compliant assets that can give the greatest returns for the least amount of risk.

The company, which previously set its minimum investment amount at US$7,500, has lowered it to US$500 to appeal to Muslim millennials and retail investors in general. The annual management fee ranges from 0.29% to 0.99% of the total portfolio value, depending on the investor’s assets under management. To protect users against failed brokerage firms, all Wahed Invest accounts are Securities Investor Protection Corporation-insured up to US$500,000.

The robo-adviser only invests in shariah-compliant or ethical securities. That means the platform screens companies to ensure that they do not manufacture products or offer services that are not ethical such as liquor, tobacco, gambling and pornography. It is registered with the US Securities and Exchange Commission and is monitored by its ethical review board to ensure shariah compliance.

According to a June 6 press release, Wahed Invest plans to expand to other markets this year to provide halal automated portfolio management services to Muslims and non-Muslim investors. The platform has a human review panel to screen stocks, commodities, real estate investment trusts and other investments for shariah compliance before using an automated algorithm-based system.

“While online investing may seem unorthodox to some Muslims across the globe, Muslim millennials in the US have been interested in digital investment services and computer-generated wealth management advice for some time. To date, they have been forced to use online investment platforms that do not mirror their beliefs. Wahed Invest offers them an opportunity to invest online in a way that is both sophisticated and true to their values,” says CEO Junaid Wahedna in the press release.

Farringdon Group, an investment and fund management firm headquartered in Labuan, has announced that it will launch a robo-advisory service on July 10. The platform, named Algebra, is based on shariah investment guidelines and uses a shariah investment strategy that has been approved by Amanie Advisors founder and group chairman Datuk Dr Mohd Daud Bakar.

According to the firm’s June 20 press release, Algebra relies on smart beta trading algorithms to derive its active equity portfolio and blends it with fixed interest exchange-traded funds or sukuk funds.



The potential of and outlook for takafultech

Malaysia is one of the key players and the largest market for takaful in Asean, followed by Indonesia.

Datuk Seri Mohamed Hassan Kamil, group CEO of Takaful Malaysia, says both countries have similar growth potential, with some differences in their regulatory frameworks. For example, Indonesia allows conventional insurance companies to operate with a takaful window, which restricts the growth of a full-fledged takaful operator in the country.

Despite having a smaller base than the conventional segment in Malaysia’s insurance industry, the takaful industry’s growth has surpassed that of its conventional counterpart in recent years, says Mohamed Hassan. “Family takaful contribution grew 8% per annum while general takaful contribution grew 8.5% per annum from 2011 to 2016. The takaful industry has been growing in tandem with the expansion of Islamic banking.

“The strong regulatory framework and directive from Bank Negara Malaysia has also helped fortify the governance on shariah-compliant insurance to drive the growth and competitiveness of the takaful industry. The demand for protection, medical and health products continues to enhance the growth of the family takaful sector, mainly due to high medical inflation and increased consumer awareness.”

Despite the increasing market size, most of the country’s takaful players have yet to leverage technology to enhance their product offerings and distribution. In fact, the innovations in insurance technology (insurtech), which has disrupted China and South Korea’s insurance industry, among others, have not penetrated any of the takaful industries around the world.

However, the players are moving towards takafultech products, albeit at a slow pace due to the challenges the industry faces, says Mohamed Hassan. “The implementation of an online distribution strategy, for example, requires a comprehensive and in-depth evaluation of substantial investment in technology and resources, alignment of distribution strategy with existing distribution channels, strong risk management measures for data security and customer expectations of products and services, and adequate disclosure to ensure good accessibility, efficiency, security and quality of financial services. Insurers and takaful operators will need to ensure the implementation is done right and prudently managed to avoid dissatisfied customers.”

There is also the high investment cost of technology and resources, on top of the marketing expenses required to create consumer awareness, to generate customer traffic that ultimately translates into online sales. Therefore, industry players will need to carefully evaluate the financial impact from the perspective of their short and long-term strategic plans to decide the implementation priority, says Mohamed Hassan.

In response to the digital disruption, Takaful Malaysia has prioritised the development of digital products and services by partnering financial technology (fintech) players and embracing social and digital marketing as part of its growth strategy. It recently launched an online distribution platform, Click for Cover, as its first step in offering digital solutions and is planning to expand its product offerings to consumers.

Mohamed Hassan says the belief that takaful is only for Muslims has been refuted, with a growing interest in takaful products among non-Muslims in recent years. “This, however, is not enough to cultivate a universal culture of awareness and acceptance of takaful products in Malaysia. Continuous awareness can be cultivated by offering a wider range of takaful products that is superior to those offered in the conventional market.

“The real potential of takaful products lies in their solid ethical structure, which can be marketed to both Muslims and non-Muslims. This structure serves as an offshoot to the principles of fairness and sharing the burdens among members of a given community, and thus extends protection to its less fortunate members. On this basis, takaful products stand a chance of being accepted by both Muslims and non-Muslims.”



Embedding shariah compliance in cryptocurrency

One area that has attracted much attention in Islamic finance is the development of cryptocurrencies. Bitcoin exchanges such as are already available in Kuwait, Bahrain, Saudi Arabia and the UAE.

Dubai-based OneGram has found a way to capitalise on the growing use of cryptocurrencies and the introduction of the Shariah Gold Standard last December by the Accounting and Auditing Organisation for Islamic Financial Institutions, World Gold Council and Amanie Advisors. Last month, it introduced the OneGram Coin (OGC) — currently, the world’s only shariah-compliant gold-backed cryptocurrency.

Ibrahim, the company’s founder, says the digital coin was introduced for two reasons. First, fiat money is debt-driven and has no intrinsic value. Therefore, it does not fulfil the properties of “money” under the Islamic definition.

“Also, unlike paper money, gold has an intrinsic value that has withstood the test of time compared with other precious metals. Gold does not tarnish or decay, making it an evident choice to store wealth that can be preserved through time,” he says.

“While other cryptocurrencies such as bitcoin are much closer to the Islamic definition of money than modern fiat money, they are not backed by any tangible, real-world assets. [To address this] each OGC is backed by a minimum of one gramme of gold.”

As OGC complies with the Shariah Gold Standard, it allows Muslim investors to own and use a shariah-compliant cryptocurrency, says Ibrahim, adding that OGC has all the hallmarks of a universal Islamic currency. This is something many parties have tried to initiate to achieve monetary union among Islamic countries, but it has not become a reality for various reasons.

According to OneGram, there is a fee of 1% for every OGC transaction. Of this amount, 25% is used for operations and development, 2.5% is donated to charities, 2.5% is used to reward the cryptocurrency miners and 70% is reinvested to buy more gold and increase the amount of gold that backs each token.

As transaction volumes increase, more gold is added to the vault and all OGC owners share in the profit. This ensures perpetuity, where the value of the coin rises over time.

“By following the three basic criteria of Islamic finance — no interest mechanism in OGC issuance, profit-sharing model and minimal speculation, as the cryptocurrency is backed by physical gold — OGC is a comprehensive shariah-compliant product,” says Ibrahim.

Referring to the performance of other cryptocurrencies such as bitcoin, Ibrahim says OGC is likely to offer good returns in the near future. “Although I may not be able to say that your initial investment will double your money, the cryptocurrency market went from US$20 billion to US$40 billion last year, and has gone up to US$70 billion in the past four months. It is absolutely impossible to predict what the returns will be, but I am confident that it will be strong with gold pegged to the cryptocurrency.

“In fact, some economists say we may be able to rival bitcoin in the future. No one has ever said that about another cryptocurrency before.”

The development of OGC took nine months. The most challenging part was ensuring that physical gold not only works in the digital space but is also shariah-compliant.

Ibrahim says innovation in Islamic finance is limited to non-existent as there is an assumption that creating a shariah-compliant product requires the innovator to be a scholar or expert in Islamic teachings, although this may not necessarily be the case.

“We do not need to be Islamic scholars to come out with innovation in the industry. What we need is confidence in the solution, observe the ethical practices and understand the basic Islamic guidelines,” he says.

“Afterwards, you can consult a scholar to understand how workable the solution is. Scholars are available everywhere and are very accommodating in offering their assistance.”

The gold-backed model is made possible with a partnership with GoldGuard, a gold trading platform licensed by the Dubai Airport Free Zone Authority. GoldGuard provides a secure platform for the cryptocurrency while OneGram manages the digital token.

All GoldGuard accounts are asset-backed, audited by PwC and are insured against theft and damage. Once an OGC is issued, it can be redeemed for physical gold or spot gold value on the GoldGuard platform. The digital coin is then permanently removed from circulation via a publicly verifiable burn address — a process to effectively eliminate the coin from existence. Ibrahim is also managing director of GoldGuard.

The target buyers of OGC include conventional cryptocurrency buyers, commodity traders, shariah-compliant investors and alternative lending platforms. Ibrahim says the shariah-compliant cryptocurrency is a good addition to the evolving Islamic finance industry as there is a shortage of products despite the growing need, as non-Muslims also want access to more Islamic finance offerings.

“Although we applied the ethical laws of shariah to govern the OGC, the product’s offerings — such as potential good returns and limited risk exposure — make it an ideal investment for any smart investor, not just Muslims. So, we are not only looking at Muslim-majority markets such as Malaysia, Indonesia and Pakistan but also Hong Kong, China and India,” he says.

“We are skewed towards Asian investors as they tend to value gold more than their Western counterparts. We are in talks with potential partners in these countries to reach out to local investors and reach the widest audience possible.”

The OGC is currently undergoing its initial coin offering (ICO). According to the OGC

Roadmap, the company will proceed to the “testnet” (process of proof-of-concept and experimenting with new features without interfering with the main cryptocurrency network) launch on June 30. The digital coin will then be distributed to ICO buyers and listed on cryptocurrency exchanges on Aug 15.

ICOs are considered high-risk investments. It can be hard to tell the genuine from the scams. OneGram has taken steps to assure investors and provide clarity.

“First of all, GoldGuard is a regulated gold trading company licensed in Dubai. We accept bitcoin through our processing partner Bitpay, which ensures that the bitcoin we receive is clear of any money laundering,” says Ibrahim.

“We work with shariah advisers Al Maali Group to ensure that we comply with the model we have proposed to our investors and that our operations remain within the principles of Islamic law. We have PwC certify that the financial information we publish is independently verified and we partner compliance company CDDS to ensure that our coin holders are genuine.

“Finally, we purchase our gold through Australia’s Allocated Bullion Exchange to provide us physical delivery in Dubai, which is then vaulted with international security and logistics company Loomis. When you take all this into consideration, no other cryptocurrency has made this much effort to gain consumer confidence.”

OneGram is currently in talks with regulators to see if there is a possibility of OGC being regulated so as to increase its credibility. “We consider regulations very important in the development of cryptocurrencies as an asset class. As we are asset-backed, we are speaking to the authorities to request to be regulated. I believe they can regulate the asset-backed part of the operation and allow the blockchain to remain decentralised,” says Ibrahim.

He adds that in addition to introducing an OGC wallet, the company will launch a payment gateway called YalaPay on Sept 15. The gateway will provide fiat money conversion, loyalty programmes, special offers and discounts for users. In the future, OneGram plans to introduce a GoldGuard MasterCard debit card that can be used at automated teller machines and point-of-sales systems as well as for online transactions.

“We are not just focusing on the cryptocurrency. We are always innovating, looking for ways to enhance what we have in place. In the future, we plan to create a merchant clearing service for cryptocurrencies. There are also discussions to create a cryptocurrency bank and a cryptocurrency money transfer solution. So, there is a lot of exciting stuff in the pipeline,” says Ibrahim.

According to Charles W Evans, associate professor of finance and economics at Barry University in the US, autonomous blockchain management systems such as bitcoin can conform with the prohibition of riba — as bitcoin does — and incorporate the principles of maslahah (social benefit of positive externalities) and mutual risk-sharing (as opposed to risk-shifting).

“With regards to maslahah, the world’s unbanked number in the billions and represent the majority of the world’s adults. Those among them with internet access — especially those who own smartphones — can use bitcoin to transact as equals in the increasingly integrated global marketplace, bypassing inefficient banks, rapacious money transmitters and multiple layers of wholesalers, cooperatives and other intermediaries that extract mark-ups that could accrue to the original producers,” he says in a paper published in June 2015.


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