Australia: Shariah funds: Opportunities and challenges in the Australian market

Last Updated: 30 December 2009
Article by Zein El Hassan and Amanda Riethmuller

Key Points: Australian fund managers wishing to test investor demand for Shariah-compliant products should consider Shariah windows when making investment decisions.

Australia is well placed to service the increasing regional and domestic demand for Shariah funds (also known as Islamic funds). However despite increasing demand, understanding of Shariah funds remains relatively low in the Australian financial services industry.

Shariah funds, products and finance are not confined to people of Islamic faith and provide an alternative to conventional investment and financing arrangements.

This article examines the key features of Shariah funds, and outlines the current opportunities and challenges for Australian financial institutions and fund managers looking to establish or provide services to these funds.

Key features of a Shariah fund

Shariah funds are investment funds that are established and managed according to the principles of Shariah (Islamic Law).

Shariah funds can be broadly compared to ethical or socially responsible funds in that they rely on certain guiding principles that dictate the form of their investment structure and that inform their investment objectives and strategies. In the case of Shariah funds, these guiding principles are the tenets of Shariah, which do not allow investment in entities or products that involve:

  • interest paying financial arrangements (eg. a prohibition on investment in non-Islamic banks and certain financial institutions);
  • speculation, betting and preventable uncertainty (eg. a prohibition on the use of certain derivatives and insurance contracts); or
  • banned activity (eg. a prohibition on investments associated with gaming, armaments, pork, alcohol, tobacco or pornography).


To ensure compliance with Shariah, a Shariah fund would most commonly engage a board of scholars known as a "Shariah Board" to advise the fund on the appropriate form of investment and governance structure as well as approve the fund's investment objectives and strategy.

Similar to the experience in the ethical investment funds industry, it is possible that different Shariah Boards may hold different opinions regarding the interpretation and practical application of Shariah. In addition, it is not uncommon for individual members of a Shariah Board to have different points of view on investment matters and this is an ongoing practical consideration for fund managers. As a result, there are both subtle and material differences in the structure and investment philosophy of different Shariah funds around the globe.

One particular aspect unique to Shariah funds and which is not seen in the ethical investment funds arena is the process of "purification". It will often be difficult for fund managers to ensure that a Shariah fund is entirely Shariah-compliant. Where a Shariah fund is unable to comply with a particular aspect of the Shariah Board's advice, or where income or profits of the fund are unavoidably obtained from sources that are not Shariah-compliant, Shariah funds can take advantage of "purification" whereby the tainted profits or income are given to an approved charity. It is usual practice for a Shariah fund's "purification ratio" (that is the ratio of untainted income to income requiring purification) to be assessed on a regular basis and for the fund to set "purification ratio" targets (usually around 20:1).

"Shariah windows": an intermediary step

In addition to establishing Shariah funds, Australian financial institutions are able to participate in Shariah finance through targeted investment in Shariah-compliant investments or projects known as "Shariah windows".

The ability of an institution to operate a Shariah window is conditional on the assets in the Shariah-compliant investment being segregated from an institution's non-compliant investments. An example of a "Shariah window" may be where a fund manager invests in Sukkuk, which are Shariah-compliant bonds backed by Shariah-compliant assets. Another example is where a fund makes a segmented investment in a major works project which uses Shariah-compliant financing. Importantly, the bonds confer a beneficial interest in the underlying assets and provide the holder with up and downside exposure to those assets.

Shariah windows also provide an opportunity for Australian institutions and fund managers, to become familiar with Shariah finance and to scope investor appetite for Shariah-compliant products.

Shariah investment options

As a way of better serving the investment needs of Australia's Muslim community, Australian institutions and fund managers may also wish to consider including Shariah funds, bonds and windows as investment options within their investment funds or on their investment platforms.

Opportunities

Opportunities in the global Shariah funds industry are increasing. Globally, there are now over 700 Shariah funds whose assets under management total around US$50 billion. Confidence and momentum in the industry is also increasing, particularly as Shariah funds have fared well during the global economic crisis.

In Australia, four factors in particular are fostering opportunities:

  • Australia's proximity to Malaysia, Indonesia, Singapore and other countries with significant Muslim populations;
  • Australia's increasing domestic Muslim population;
  • increasing global influence of Shariah finance and increasing global infrastructure and experience to service Shariah funds and products in both Muslim and non-Muslim countries[1] ; and
  • the commitment of the Australian Government and the financial services industry to positioning Australia as a leading financial services centre in the region, including a commitment to assist in the building of the local infrastructure and modifying the regulatory and tax regime to attract and service Shariah funds.


Challenges

Key challenges to establishing a viable Shariah funds industry in Australia include:

  • There is a shortage in Australia of potential Shariah Board members and of specialised skills to set up, manage and provide services to Shariah funds. These challenges are common to many jurisdictions wishing to develop a Shariah funds industry, and persist even in jurisdictions where the Shariah funds market is more developed. In Australia, these challenges are in part being remedied in the medium term through new courses in Islamic Finance [2] and through skilled migration. In the meantime, relying on institutions and Shariah Board members in overseas jurisdictions is one way of overcoming these challenges in the short term.
  • Australia's tax system may produce some unintended results or inefficiencies for Shariah funds [3]. There is also some uncertainty as to the characterisation for Australian tax purposes of certain types of income, margin or return derived by a Shariah fund from Shariah-compliant investments, which could lead to higher taxation for certain non-resident investors in a Shariah fund, as compared with those same investors investing in a non-Shariah fund [4].
  • Given that Shariah funds are a relatively new concept in the overall Australian investment landscape, the level of investor appetite domestically remains untested. Launching and promoting Shariah funds in the region is also relatively untested.


Recent developments

The Australian Government and the Australian financial services industry have indicated a willingness to ensure Australian institutions are increasingly well positioned to take advantage of emerging opportunities in Shariah finance, particularly in respect of Shariah funds.

For example, IFSA, the Australian financial services industry body, has recently set up a Shariah Finance working group with the aim of promoting awareness of Shariah finance and assisting industry in developing and marketing Shariah funds within and outside Australia.

Industry has also been working with Treasury to identify potential reforms to Australia's legal and tax framework. The Australian Financial Centre Forum (a joint industry-government initiative aimed at positioning Australia as a leading financial services centre in the region) conducted a roundtable on Shariah finance and tax issues in March 2009, and this is expected to be an ongoing focus of discussion in the Forum.

Another significant development has been the launch of Australia's first Shariah fund which occurred in mid 2009. The fund has engaged overseas institutions, including an overseas bank and Shariah Board, and is offering investment in a range of major international currencies. The fund is targeting mostly Muslim investors in the Middle East and Southeast Asia.

Conclusion

The Australian Government and the Australian financial services industry are increasingly focusing on the opportunities that Shariah finance, funds and products, can provide to investors and the industry. This focus is part of the ongoing partnership between industry and the Australian Government to position Australia to become a leading financial services centre in the region.

In this context, it is likely that the legal and tax framework in Australia will need to further facilitate the setting up and servicing of Shariah funds in Australia and to encourage foreign investors to invest in those funds or in Australian Shariah windows.

This process will be guided by investor demand for Shariah funds and by experiences in overseas jurisdictions, particularly of those in the region and in existing financial services centres such as Ireland. In the meantime, Australian fund managers wishing to test investor demand for Shariah-compliant products should consider Shariah windows when making investment decisions.

Related articles


[1] For example, the Irish Financial Services Regulatory Authority has now established a dedicated regulatory team for the authorisation of Shariah funds in Ireland.

[2] For example, La Trobe University has recently begun offering a Master of Islamic Banking and Finance.

[3] This issue has been recently addressed in countries such as France and the United Kingdom who have recently introduced tax neutrality laws specifically for Shariah financial products. The Australian Taxation Office released a Consultation Paper in August 2009, "Islamic Financing - Australian income tax implications for AFMA members and their clients", prepared for the purpose of initiating dialogue with the Australian Financial Markets Association to identify corporate tax issues relating to Islamic financing that require tax resolutions critical to the development of Islamic finance in Australia.

[4] For instance, if a return or profit from a Shariah-compliant investment is not characterised as "interest" for Australian tax purposes, the relevant amount could be taxed as Australian sourced income. This means the amount could potentially be taxed at a higher effective tax rate compared to the taxation of a return on an analogous conventional investment product that is characterised as "interest" and taxed at the Australian interest withholding tax rate of (generally) 10 percent. Alternatively, if a return or profit from a Shariah-compliant investment is characterised as "interest" for Australian tax purposes, the relevant amount could be subject to Australian interest withholding tax, without the benefit of any exemption that might otherwise be available if the investment was a conventional investment product.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Zein El Hassan
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert
Email Address
Company Name
Password
Confirm Password
Mondaq Topics -- Select your Interests
Accounting and Audit
Anti-trust/Competition Law
Consumer Protection
Corporate/Commercial Law
Criminal Law
Employment and HR
Energy and Natural Resources
Environment
Family and Matrimonial
Finance and Banking
Food, Drugs, Healthcare, Life Sciences
Government, Public Sector
Immigration
Insolvency/Bankruptcy, Re-structuring
Insurance
Intellectual Property
International Law
Litigation, Mediation & Arbitration
Media, Telecoms, IT, Entertainment
Privacy
Real Estate and Construction
Strategy
Tax
Transport
Wealth Management
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.