European Experiences and the Challenges of Integrating Ethical Finance Prof. Dr. Volker Nienhaus

1. 3rd COFISS Annual Conference, Paris, 6 February 2012 European Experiences and the Challenges of Integrating Ethical Finance Prof. Dr. Volker Nienhaus

2. 0 Outline • European Experiences (Selected Countries) • European Economic Area • Non-EEA Europe • Islamic and Ethical Finance Countries in red not covered: No Islamic finance activities or insufficient data Data: BBC (2005), for Russia: Hunter (2004)

3. 0 Outline • European Experiences (Selected Countries) • European Economic Area • Non-EEA Europe • Islamic and Ethical Finance France 6,000,000 Germany 3,000,000 United Kingdom 1,600,000 Spain 1,000,000 Netherlands 950,000 Italy 830,000 Belgium 400,000 Austria 340,000 Switzerland 310,000 Sweden 300,000 Denmark 270,000 Luxembourg Ireland Countries in red not covered: No Islamic finance activities or insufficient data Data: BBC (2005), for Russia: Hunter (2004)

4. 0 Outline • European Experiences (Selected Countries) • European Economic Area • Non-EEA Europe • Islamic and Ethical Finance France 6,000,000 Germany 3,000,000 United Kingdom 1,600,000 Spain 1,000,000 Netherlands 950,000 Italy 830,000 Belgium 400,000 Austria 340,000 Switzerland 310,000 Sweden 300,000 Denmark 270,000 Luxembourg Ireland Turkey 68,000,000 Russia 18,000,000 Albania 2,200,000 Serbia, Montenegro, Kosovo 2,200,000 Bosnia-Hercegovina 1,500,000 Macedonia 630,000 Countries in red not covered: No Islamic finance activities or insufficient data Data: BBC (2005), for Russia: Hunter (2004)

5. 1a France Start in Retail, Expansion with Reduced Speed • Tax and legislative changes in support of Islamic finance (in particular regarding ijarah, istisna’ and murabahah) • French government hopes to take 10% of the global Islamic market by 2020 • Graduate degree programs in Islamic Finance at the universities of Paris and Strasbourg • AAOIFI approved sukuk structures which are in accordance with French law (2010), framework fur sukuk issues ready by early 2011 – but no issue so far • AAOIFI standards translated into French • No Islamic windows of conventional banks • Moroccan Chaabi Bank (in France since 1972) first to offer licensed Islamic retail banking products; Al Baraka Bank announced market entry 2012 • IDB Group’s Islamic Corporation for the Development of the Private Sector (ICD) French partner Islamic financing tools for SMEs • Public opinion not in favor of Islamic peculiarities (see ban on burqa)

6. 1a Germany Continued Talks, Little Action • German banks, wealth managers and insurance companies active abroad (mostly out of London and Dubai) for Middle Eastern and Asian markets but not in Germany • First sovereign sukuk: Saxony-Anhalt (2004-2009), no successor • BaFin (= German regulator) conferences 2009 and 5/2012 to signal openness, but no comparable signal from tax authorities • Growing interest of insurance brokers in takaful products, but so far no active distribution • KuveytTürk’sapplication for full banking license pending • Two Shari’ah compliant investment funds terminated/liquidated: Commerzbank’s “Al Sukoor” (2000-2005), Meridio’s “Global Islamic Multi Asset Funds” (2010-2011) • 2012: WestLBlaunched Islamic Strategy-Index-Certificate (open ended index tracker certificate with a stop loss mechanism) sold through savings banks

7. 1a United Kingdom Re-Starts in Retail, Mixed Results in Investment, Spooky Sukuk • FSA for “level playing field”, government amended tax laws and regulations to remove obstacles (double taxation, treatment of profit-based costs of funds [equivalent to interest payments]) • Re-starts in retail banking (e.g. takeover of Islamic Bank of Britain by QIIB) and takaful; Islamic windows of approx. 20 banks (notably HSBS, Lloyds TSB) • Mixed performance of the four Islamic investment banks; at least one bank in serious restructuring; expertise in Shari’ah compliant project financing • Sovereign sukuk considered since 2007, postponed several times (candidate for “non-deal of the decade”); much attention for a small UK corporate sukuk; sukuk listings on the London Stock Exchange • Wide range of academic study programs and certificate courses on all aspects of Islamic finance • Highly qualified law firms and consultancies; top expertise for advanced Shari’ah compliant structured products (implementation mostly outside UK) • Growing expertise of British courts in Shari’ah contracts and disputes

8. 1a Spain Looking for Muslim Investors • Islamic finance is seen as a vehicle to promote employment generating investments from Muslim countries (in particular GCC) • Conference of Madrid Stock Exchange to explore Islamic finance (2010) • Exploring in particular sukuk as an alternative vehicle for corporate and infrastructure finance • Establishment of the Center for Islamic Economics and Finance (CIEF) by Instituto de Empresabusinessschool and King Abdulaziz University, Saudi Arabia; re-named November 2011 as Saudi-Spanish Center for Islamic Economics and Finance (SCIEF) • Cooperation of Dubai International Financial Center (DIFC) with Madrid Financial Center (MCF) for investment promotion • No Islamic financial institution, no sukuk issuance • Problems with racism and Islamophobia

9. 1a Netherlands Suitable Legal and Tax System, but no Business • Legal and Tax system suitable for Islamic finance and attractive in particular for sukuk SPVs • No Islamic financial institutions

10. 1a Italy Studies and Consultancy • Government produced a series of detailed market studies to promote Italy as a viable market for Islamic finance. • Several conferences • Academic interest • Individual Shari’ah compliant real estate financings • No Islamic banks, no windows, no sukuk • Islamic finance consultancy ASSAIF: clients in other countries (including Russia/Tatarstan)

11. 1a Belgium Niche Targeted, Modest Beginnings • Moroccan Chaabi bank prepares launch of a Shari’ah compliant account later in 2012 • Academic interest in Islamic banking and ethical finance • Governments targets niche market: Islamic venture capital through Belgium (shelved?)

12. 1a Switzerland Specialists in (Conventional) Wealth Management and Private Banking • Domicile of Dar al-Maal al-Islami(Islamic finance holding) since 1981 • First (and for long only) Islamic private banking license in 2006 (Faisal Private Bank) • Wealth manager Bank Sarasin (controlled by RabobankGroup) offers Islamic services and publishes the “Islamic Wealth Management Report” since 2010 • Opening of second Islamic bank: Islamic Bank of Switzerland in Zurich (2011), shareholders from Qatar • Swiss index provider STOXX launched three Shari’ah indexes (2011) • Some (conventional) private banks observing Shari’ah rules in their business (windows, divisions), no integration of Islamic finance into the Swiss legal system

13. 1a Denmark Forgotten Pioneer • First European Islamic bank: International Islamic Bank of Denmark (1982) • No follow-up, reportedly Shari’ah compliant home financing schemes

14. 1a Luxembourg European Hub for Funds and Leader in Sukuk Listings • 1978 first Islamic finance institutions in the West: Islamic Banking System International Holding ( International Islamic Bank of Denmark) • 2008 Task force to identify obstacles to the development of Islamic finance and to suggest solutions and promotional measures • Central bank first European member of IFSB (since 2009) and founding member of International Islamic Liquidity Management Corporation (2010) • Sovereign sukuk expected for 2011 delayed • Tax circulars on murabahah and ijarahcontracts and sukuk (2010) • Training courses and academic programs in Luxembourg • Now European leader in sukuk listings (16) • Now first in Europe as domicile for UCITS (Undertakings for Collective Investment in Transferable Securities) and Shari’ah compliant funds (> 40), some in UCITS structure • Still unexploited potentials in takaful (including bancatakaful) linked to the investment (funds) industry [notably with regard to unit-linked policies]

15. 1a Ireland Low Corporate Tax, Chasing Funds • Inclusion of Islamic finance into the rebuilding of the financial services industry (2011) • Ambitions to become a center for Islamic finance, notably a hub for funds • Adapting tax laws and financial regulations (“level playing field” approach) (2011) • Several licenses granted for Islamic institutions to operate from the International Financial Services Center, Ireland (IFSC Ireland), but no reports of use of these licenses • Sukuk listings on the Irish Stock Exchange • Proponents claim for 2009 an Irish market share of 20% (equal to Luxembourg) for key Islamic funds domiciles outside of the Middle East • Strong competition from UK and Luxembourg (UCITS), response of the Islamic finance industry so far seemingly very limited

16. 1b Turkey Dormant Participation Banking Comes on Steam • No ‘pure’ Islamic banks, participation banks as close proxies • Strong growth of participation banks (2009 to 2010 above 20%) • Protected market, no banking licenses for foreign Islamic banks [can only offer restricted range of Islamic financial products and non-bank corporate finance]; growing interest of Islamic Gulf banks; no Islamic windows • Tax neutrality for sukuk ijarah[only] by Finance Bill 2011 • Sukukissues of participation banks expected in 2011 – some delays; oversub-scribed dual-currency syndicated murabahah financing facility for one bank • Plans of participation banks for expansions on the Balkans and in the MENA region; KuveytTürk subsidiary in Germany; • Expected entry of one participation bank into investment banking and securities business by acquisition of brokerage house • Introduction of takaful in 2011, first Shari’ah compliant investment fund 2012 • Index of 30 listed Shari’ah compliant companies by Istanbul Stock Exchange

17. 1b Russia Latecomer with Potentials • Annual Moscow International Forum “Islamic Finance and Investments” since 2009 • Sukuk issuance is considered possible without adverse effects in the existing tax and legal framework; however, general complaint about absence of enabling legislation and regulatory framework • No Islamic bank • VTB Bank and Gazprombankannounced issuance of sukuk (in 2012) to attract Middle Eastern investments • First sovereign sukuk of Tatarstan (2011) to attract Russian and Arab capital • Ak Bars Bank’s syndicated murabaha Islamic financing facility has been awarded the Europe Deal of the Year by Islamic Finance News (Jan. 2012) • In preparation: syndication by a Russian, Western and Gulf bank of Shari’ah compliant financing for Russian SMEs through murabahah and ijarah

18. 2 Why is Islamic finance considered to be ethical finance? Islamic finance Religion Economics Ethical system incorporated • Models of a superior economic system • Allocation • Distribution • Stability • Justice • Public good (maslahah) • Core of models: • participatory finance (PLS, risk sharing) • for the real economy (= asset-backed finance)

19. 2 Why is Islamic finance considered to be ethical finance? Islamic finance Religion Economics Ethical system incorporated • Models of a superior economic system • Allocation • Distribution • Stability • Justice • Public good (maslahah) Islamic finance practitioners (industry, regulators, media, service providers, lobby, …) • Core of models: • participatory finance (PLS, risk sharing) • for the real economy (= asset-backed finance)

20. 2 Why is Islamic finance considered to be ethical finance? Islamic finance Religion Economics Ethical system incorporated • Models of a superior economic system • Allocation • Distribution • Stability • Justice • Public good (maslahah) • Problems: • Only very few clear economic instructions in Qur’an and Sunna • Concretization / application in ‘classical’ Islamic commercial law (10th-13th century) for an economy of very different structure  need of modernization Islamic finance practitioners (industry, regulators, media, service providers, lobby, …) • Core of models: • participatory finance (PLS, risk sharing) • for the real economy (= asset-backed finance)

21. 2 Why is Islamic finance considered to be ethical finance? Islamic finance Religion Economics Ethical system incorporated • Models of a superior economic system • Allocation • Distribution • Stability • Justice • Public good (maslahah) • Problems: • Only very few clear economic instructions in Qur’an and Sunna • Concretization / application in ‘classical’ Islamic commercial law (10th-13th century) for an economy of very different structure  need of modernization Islamic finance practitioners (industry, regulators, media, service providers, lobby, …) • Core of models: • participatory finance (PLS, risk sharing) • for the real economy (= asset-backed finance) • Problems: • Finance only part of comprehensive Islamic (economic) order • Assumed behaviour of Muslims in conflict with observed

22. 2 Why is Islamic finance not ethical finance per se? Islamic finance Religion Economics Ethical system incorporated • Models of a superior economic system • Allocation • Distribution • Stability • Justice • Public good (maslahah) Modify classical trade contracts for modern financial transactions Islamic bankers

23. 2 Why is Islamic finance not ethical finance per se? Islamic finance Religion Economics Ethical system incorporated • Models of a superior economic system • Allocation • Distribution • Stability • Justice • Public good (maslahah) • Role of Shari’ah scholars: • not religious leaders • but Islamic lawyers Modify classical trade contracts for modern financial transactions Islamic bankers • Extensive use of mark-up techniques • minimized risk • Weak links to real economy • Assets only vehicles •  Form over substance

24. 2 Why is Islamic finance not ethical finance per se? Islamic finance Religion Economics Ethical system incorporated • Models of a superior economic system • Allocation • Distribution • Stability • Justice • Public good (maslahah) • Role of Shari’ah scholars: • not religious leaders • but Islamic lawyers Modify classical trade contracts for modern financial transactions Islamic bankers • Extensive use of mark-up techniques • minimized risk • Weak links to real economy • Assets only vehicles •  Form over substance Micro-legalistic approach + pragmatism Examples Tawarruq Stock screening

25. 2 Why is Islamic finance not ethical finance per se? Islamic finance Religion Economics Ethical system incorporated • Models of a superior economic system • Allocation • Distribution • Stability • Justice • Public good (maslahah) • Role of Shari’ah scholars: • not religious leaders • but Islamic lawyers Macro-systemic approach Modify classical trade contracts for modern financial transactions Islamic bankers • Extensive use of mark-up techniques • minimized risk • Weak links to real economy • Assets only vehicles •  Form over substance • Core of models: • participatory finance (PLS, risk sharing) • for the real economy (= asset-backed finance) Micro-legalistic approach + pragmatism Examples Tawarruq discrepancy between claims and realities Stock screening

26. 2 Islamic and Ethical Finance: Congruence and Divergence Ethical Finance and SRI Islamic Finance Screening process

27. 2 Islamic and Ethical Finance: Congruence and Divergence Ethical Finance and SRI Islamic Finance Screening process Negative list:‘per se’ prohibitions Negative list: ‘per se’ prohibitions Level 1: Pornography, weapons, tobacco, pork, gambling, riba Pornography, weapons, tobacco, human rights violations, … Examples: Type of filter: (form and) substance substance Investment universe

28. 2 Islamic and Ethical Finance: Congruence and Divergence Ethical Finance and SRI Islamic Finance Screening process Negative list:‘per se’ prohibitions Negative list: ‘per se’ prohibitions Level 1: Pornography, weapons, tobacco, pork, gambling, riba Pornography, weapons, tobacco, human rights violations, … Examples: Type of filter: (form and) substance substance Exclusion list: Businesses contradicting goals Exclusion list: Businesses violating financial ratios Inclusion list: Businesses supporting goals Level 2: (community deve-lopment, renewable energy, environmen-tal protection, … (child labour, country / company boycotts, …) Examples: liquidity, interest and debt ratio < 33% of market capitalisation substance Type of filter: form substance Investment universe

29. 2 Islamic and Ethical Finance: Congruence and Divergence Ethical Finance and SRI Islamic Finance Screening process Negative list:‘per se’ prohibitions Negative list: ‘per se’ prohibitions Level 1: Pornography, weapons, tobacco, pork, gambling, riba Pornography, weapons, tobacco, human rights violations, … Examples: Type of filter: (form and) substance substance Exclusion list: Businesses contradicting goals Exclusion list: Businesses violating financial ratios Inclusion list: Businesses supporting goals Level 2: (community deve-lopment, renewable energy, environmen-tal protection, … (child labour, country / company boycotts, …) Examples: liquidity, interest and debt ratio < 33% of market capitalisation substance Type of filter: form substance Investment universe

30. F Market Share and Growth of SRI Assets in the U.S. • The 2010 Trends Report has identified $3.07 trillion in total assets under professional management in the United States that use at least one of three socially responsible investing strategies: • the incorporation of environmental, social and governance (ESG) factors into investment analysis and portfolio construction, • the filing or co-filing of shareholder resolutions on ESG issues, and • deposits or investments in banks, credit unions, venture capital funds and loan funds that have a specific mission of community investing. Source: SIFF Report 2010

31. F Screening of Socially Responsible Mutual Funds Source: http://www.socialinvest.org/resources/mfpc/screening.cfm?&pdf

32. 2 For More Ethics in Islamic Finance • Regarding (the neglect of) ethical considerations (SRI) in banking operations and for financing decisions, the actual practice of Islamic finance does not differ fundamentally from conventional finance – Islamic banks do finance the same (non-haram) projects with the same partners at commercially the same terms as conventional banks. • Islamic finance can be ethical finance and SRI, but only with determination and serious efforts of CEOs or shareholders.

33. 2 For More Ethics in Islamic Finance • Regarding (the neglect of) ethical considerations (SRI) in banking operations and for financing decisions, the actual practice of Islamic finance does not differ fundamentally from conventional finance – Islamic banks do finance the same (non-haram) projects with the same partners at commercially the same terms as conventional banks. • Islamic finance can be ethical finance and SRI, but only with determination and serious efforts of CEOs or shareholders. estimated total financial assets 2010 in trillion US-Dollar Socially Responsible Investments in the United States 180 1 3 Global Islamic Finance Global Financial Assets

34. Contact Details Prof. Dr. Volker NienhausDachsfeld 38a45357 Essen – Germany Tel: +49 (0) 201 8695750Fax: +49 (0) 201 8695752Mobile Germany: +49 (0) 176 63755466 Mobile UK: +44 (0) 7787 049649 volker.nienhaus@gmx.net