Asset Management

Much like other Shari'ah-compliant investment structures in Egypt, Shari'ah-compliant asset management entities suffer from a legislative vacuum, which constitutes one of the principal impediments to the development of the Shari'ah-compliant investment industry in Egypt. Despite the potential of the Egyptian market to become one of the main international Islamic finance markets, misconceptions surrounding the industry prevent any legislative developments from occurring.

The experience of Egyptian society with Shari'ah-compliant asset management did not have a promising beginning. The failure of several capital investment companies that promoted their business as being Shari'ah-compliant in the 1980s and 1990s after gathering millions of pounds from the public undermined the credibility of the Shari'ah-compliant investment industry and was exploited by the former regime of Hosni Mubarak as justification for ignoring the development of Islamic finance for political reasons.

Despite the ousting of the Mubarak regime, there is still no legislation that governs the Shari'ah-compliant asset management industry. The most notable example is Shari'ah-compliant investment funds—there is no legislation that governs their licensing, management, and termination of Shari'ah-compliant investment funds. Shari'ah-compliant investment funds are licensed pursuant to Capital Market Law No. 95 of 1992 in accordance with the licensing and compliance requirements of conventional investment funds. Therefore, the characterization of an investment fund as Shari'ah-compliant is generally done at the fund's internal level, by confirming the fund's Shari'ah compliance in its issuance notice, accompanied by the appointment of a Shari'ah committee to ensure the compliance of the fund's transactions with the principles of Shari'ah.

There is also no national legislation regarding the Shari'ah compliance of wealth assets. Wealth management is governed by the same legislation that governs conventional investment banking activities—that is, the Central Bank Law No. 88 of 2003. Compliance with Shari'ah is generally done at the internal level through specialized Shari'ah committees appointed by the investment bank.

It is clear that the need for adopting legislation to regulate this investment sector is essential for the improvement of the status of the national Islamic finance industry, which would rejuvenate the deteriorated Egyptian economy. It is difficult, however, to verify the government's intention to carry out any efficient reforms in this regard, given the negative perception of Islamicization that dominates the Egyptian political scene at the moment.

Tax and Accounting

The main legal reference for tax regulation in Egypt is the Egyptian Income Tax Law (EITL) No. 91 of 2005, which governs the income tax imposed on both individual and corporate income. Accounting standards are contained in the ministerial decree number 243 of 2006. Neither law contains any specific provisions for the Islamic finance industry, which has been criticized by the Islamic finance experts who called for the adoption of legislation for Islamic finance taxation and accounting. The hostility of the former Mubarak regime toward the Islamic tendency has been a major factor in the delay of any effective reformation of Islamic-compliant tax and accounting systems.

The EITL imposes an income tax of 20 percent on net revenue. This rule applies without distinction to all financial institutions, whether Islamic-compliant or conventional. There is neither a specific tax neutrality policy nor taxation incentives for the Islamic finance industry, which remains subject to the tax rules governing the conventional finance sector. The Islamic finance sector's performance would be improved through the granting of exemptions to Islamic financial institutions, Islamic investment funds, and Islamic-compliant transactions.

The absence of an Islamic-compliant version of accounting standards has also been a major obstacle to the improvement of the performance of Islamic finance institutions in Egypt, which are legally bound by conventional national accounting standards (which are themselves a mere reflection of the international accounting standards). Islamic finance institutions have adopted the nonbinding Accounting and Auditing Standards for Islamic Financial Institutions, issued by the Accounting and Auditing Organization for Islamic Finance Institutions, as a reference in their transactions to ensure their compliance with Islamic law.

Islamic compliance is therefore absent from the tax and accounting national system. Reformation of the system is essential to improve Egypt's regional competitiveness in the Islamic finance sector. Since the adoption of a sukuk law, Islamic finance experts have speculated that reforms may take place, but the timing and potential efficiency are uncertain.

Retail and Microfinance

Egypt was among the first countries in the region to have a Shari'ah-compliant microfinance institution. In 1963, the Mit Ghamr Local Savings Bank (MGLSB) was established by Ahmad al-Najjar. The MGLSB was one of the most successful Shari'ah-compliant financial institutions at the time, and it managed to penetrate social classes in the town of Mit Ghamr that were not the focus of conventional banks. The experience, however, was discontinued after disputes with the Egyptian government, and the MGLSB was liquidated in 1967.

Retail banking activities in general do not get the same attention as corporate banking in the Egyptian market. However, banks have started to pay more attention to this field of banking services, and several banks began establishing retail units to diversify their banking activities and maximize their income. The Egyptian market, however, is still in need of a greater expansion in retail banking. Small and medium enterprises, which contribute a significant portion of the GDP, are generally under-banked because of the limited size of retail banking compared to other banking services.

The limited size of retail banking services offered by conventional banks leaves Shari'ah-compliant banks and other financial institutions with a good opportunity to invade this sector and expand their business there. However, as with all Shari'ah-compliant financial practices in Egypt, Shari'ah-compliant retail banking remains unregulated by national laws. The licensing of all retail banking services, whether conventional or not, follows the same process before the Egyptian Central Bank, pursuant to Egyptian Central Bank Law No. 88 of 2003. Ensuring the compliance of banking services is the job of a Shari'ah expert appointed by each bank.

The legislative vacuum has not prevented Shari'ah-compliant banks from providing retail banking services in addition to corporate banking; however, Shari'ah-compliant retail banking represents a small portion of the overall banking services carried out by Shari'ah-compliant banks as well as by conventional banks. We believe that Shari'ah-compliant banks should pay more attention to this growing banking sector in order to be able to compete with conventional banks in a more efficient manner. Imitation of the modus operandi of conventional financial institutions does not confer any competitive advantage on Shari'ah-compliant institutions.

Takaful and Re-Takaful

The takaful and re-takaful industry in Egypt is a growing business. The number of takaful and re-takaful companies has increased in the last decade, and the industry has started to gain a foothold in the Egyptian market, although their numbers remain largely limited compared to the number of conventional insurance and reinsurance companies. The potential for future growth of takaful and re-takaful in the Egyptian market is enormous. Such growth, however, faces several challenges, the most significant of which are (1) low public awareness of the nature and benefits of takaful and re-takaful, (2) pricing, product features, and service quality that are incapable of effectively competing with the conventional sector, (3) a lack of Shari'ah-compliant assets and national investment channels in the business, and (4) the absence of legislation to govern the industry.

The legal and regulatory framework of takaful and re-takaful business is the same as for conventional insurance and reinsurance. Law No. 10 of 1981 constitutes the main legislation governing the industry in Egypt. The licensing process is conducted before the Egyptian Financial Supervisory Authority, which also ensures the compliance of the industry with the applicable laws and regulations. There is no specific license for takaful and re-takaful.

There is no official authority that ensures or requires the compliance of takaful and re-takaful with Islamic law. Compliance with Islamic law is achieved only at the internal level, through Shari'ah experts appointed as either employees of the relevant entity or as independent consultants. The level of compliance with Islamic law is a measure of the credibility of an entity.

Legislation and government support are essential for the growth of the national takaful and re-takaful industry. However, it does not seem that the industry will be regulated any time soon, especially in light of the unstable political circumstances and the unfavorable public and official perception of the political role of Islamic parties and of Shari'ah-compliant investment.

Sovereign Sukuk

Sovereign sukuk has been the subject of constant controversy in the past because of major general misconceptions about its nature and role. Sovereign sukuk was absent from the Egyptian legal system under the Mubarak regime because of the general political hostility toward Islamicization of the financial system. Since the successful ousting of Mubarak in the January 25, 2011, revolution and the rise of political Islamist parties, however, the situation has changed in favor of sovereign sukuk. Awareness of the importance of sovereign sukuk as a financial instrument increased under the Morsi regime, and a legal framework was established with the issuance of the sukuk law passed in May 2013. The law never entered the practical application phase, however, because of the nonissuance of its implementing regulation, which was delayed as a result of the unstable political situation in Egypt.

The newly issued sukuk law allowed the issuance of asset-backed and asset-based sovereign sukuk, provided that the underlying asset is a private domain, governmental immovable property and that the subject of the sovereign sukuk is not the abuse of the said asset. The legislature excluded all public domain property from the scope of application of the law to evade the controversy and misconceptions about foreign ownership—the Egyptian public feared that foreign intervention might increase in Egypt. The sukuk law granted the right to sovereign sukuk issuance to all government and public authorities.

Furthermore, the law stated the necessity of evaluating the underlying assets by an official committee and established a specific public sovereign sukuk unit to control, oversee, and regulate sovereign sukuk issuance and management process. To this day, however, no sovereign sukuk has been issued.

In addition, the sukuk law stipulated the possibility of the issuance of sukuk by Shari'ah-compliant investment funds. It seems that the sukuk issued in this specific field is strictly asset-backed, since the law expressly states that the sukuk holder also holds a common ownership share in the underlying asset, which implies that the holder has recourse against the asset in the event of default. No sovereign sukuk wealth funds, however, been issued to this day, and there are indications that the government may adopt a rather pro–conventional finance tendency in the near future.

The Egyptian market is full of opportunities for sukuk investment. The Egyptian infrastructure in particular is in need of financing, and the Egyptian economy is in need of financial instrument diversification to speed up its recovery process. Egypt has the potential to acquire a large share of the international sukuk market, estimated at approximately US$61 billion. However, after the ousting of the Morsi regime and the increase in misconceptions about the role of sukuk, it is very probable that the Islamic finance industry in general and the national sukuk market in particular will suffer a setback for the foreseeable future.

Sukuk

After a long period of regulatory and legislative absence, Egypt succeeded in passing its first sukuk law in May 2013. The issuance of Sukuk Law No. 10 of 2013, which was delayed for several decades because of the Mubarak regime's political opposition to Islamic finance, is an important step in the national and regional development of the Islamic finance industry. The issuance of the Sukuk Law No. 10 has been welcomed by GCC investors, who are more involved in this field of investment than Egyptian investors are, and it has been an effective step in the globalization of the sukuk market.

Among the most important features of the newly issued sukuk law is that it allows the issuance of both corporate and sovereign sukuk and permits both asset-based and asset-backed sukuk structures, which allows a higher degree of flexibility and diversity for investors. However the inclusion of asset-based sukuk has been the subject of much criticism by Islamic finance scholars because of the absence of recourse against the underlying asset; this implicitly violates the rules of Islamic law, which requires the issuer to hold ownership shares in the underlying asset and allows him or her recourse against it in case of the originator's default.

Another important feature of the law is its establishment of a system of official control over the issuance, structuring, and compliance of private and sovereign sukuk through the setting up of two official bodies: (1) The Central Sovereign Sukuk Issuance Unit at the Ministry of Finance for the structuring, issuance, and risk management of sovereign sukuk, and (2) the Central Shari'ah Authority for Sukuk Issuance, which ensures the compliance of all aspects of sukuk transactions with Islamic law. The implementation of this dual system of control ensures maximum efficiency of sukuk issuance while ensuring respect for Islamic law.

One of the main drawbacks of Sukuk Law No. 10 is the necessity for the underlying assets to be located in Egypt, even if the issuer is an offshore special purpose vehicle, reflecting a tendency of the government to discourage capital outflow. This limitation could have a negative effect on the size and liquidity of Egyptian sukuk.

Despite this significant development of Islamic finance in Egypt, the industry may suffer a substantial setback because of the ousting of the Morsi regime. To date, the implementing regulation of the sukuk law, which is fundamental for its enforcement, has not been issued, nor has its issuance date even been declared. The national media reported statements from public officials confirming that sukuk will not play a role in the upcoming financial reformation recently proposed by the Ministry of Finance. Political factors may therefore interfere once again in the development of the Islamic finance industry in Egypt, making any progress in the near future doubtful.

Debt Capital Markets

The Egyptian Shari'ah-compliant debt capital market sector, like the entire Shari'ah-compliant financial sector in Egypt, is not regulated. Shari'ah-compliant financial institutions may be licensed by the central bank to issue debt-based financial instruments, and the internal Shari'ah committees or experts appointed by the bank ensure their compliance with the principles of Shari'ah. However, Shari'ah-compliant debt-based financial instruments are not yet fully developed, and their structure still largely resembles that of conventional debt-based instruments.

It has been argued that debt-based sukuk resembles a conventional bond. Unless the underlying asset is taken as collateral, the rating of the bond should be based on the credit rating of the obligor. However, the issuance of debt-based sukuk is not common in Egypt. Furthermore, the newly issued Sukuk Law No. 10 recognized only two types of sukuk: asset-based and asset-backed.

Regulatory intervention for the installation of a Shari'ah-compliant issuance system for debt-based financial instruments is essential to the development of the industry in Egypt. The compliance of the debt capital market with Shari'ah requires lateral thinking and serious efforts to achieve, since the Islamic finance industry is essentially based on equity participation, not debt-based financial agreements.

Regulatory Issues

The Egyptian Islamic finance market has frequently suffered from a lack of government support and the absence of a regulatory framework, despite the fact that Egypt was one of the first countries to experiment and develop Islamic finance, such as the Mit Ghamr experiment in 1963. Egypt was also one of the first Arab states to establish a Shari'ah-compliant bank, doing so in 1974. The Islamic finance industry, however, remained stagnated for decades because of political considerations and the confusion between Islamic finance as a field of investment and political Islam. Furthermore, the Egyptian public was not eager to experiment with Islamic finance, because of common misconceptions about Islamic finance as well as the unpleasant history of several investment funds, which failed in the 1980s after marketing themselves as being Shari'ah-compliant.

In the absence of a specific regulatory framework, compliance with Islamic law by financial institutions and companies that claim to be Shari'ah-compliant is not officially verified; verification of compliance is generally carried out internally by the private Shari'ah departments of the entities themselves. Despite the renewed interest in Islamic finance during the Morsi presidency, no steps were taken toward setting up an effective control mechanism.

Islamic finance experts have made several suggestions for reforming the current legal regime by examining the experiments of the leading countries in Islamic finance. One of the main propositions made by the experts is the creation of a central public authority that controls and ensures the Shari'ah compliance of the financial transactions operated by Islamic financial institutions. Such an authority could be established as a special department within the central bank, as is the case in Malaysia, or as an independent authority, as is the case in the United Arab Emirates.

Other suggestions have been proposed to render mandatory the incorporation of an internal mechanism of Shari'ah compliance to ensure effective control through a double layer of compliance verification. Sukuk Law No. 10 calls for the creation of public bodies to control Shari'ah compliance and the issuance of sukuk; however, the law has not yet been enforced because of the absence of an implementing regulation, the issuance date of which is still unknown.

In addition to the absence of a verification mechanism for Shari'ah compliance, the national standardization of Islamic financial products and accounting is nonexistent. Islamic financial institutions generally refer to the Accounting and Auditing Standards for Islamic Financial Institutions, but this remains optional as a result of the absence of mandatory legal provisions. Standardization of Islamic finance has occupied a low priority on the successive Egyptian governments' agendas because of a general lack of interest in the field, and it is unlikely that the situation will change any time soon.

Cross-Border Financing

Because of the limited size of Shari'ah-compliant financial banks in Egypt (Egypt has only 11 Islamic banking windows), Shari'ah-compliant cross-border financing became a frequently adopted way for Egyptian Shari'ah-compliant banks to finance major operations in the country. Egyptian Shari'ah-compliant financial institutions finance costly operations through the establishment of Shari'ah-compliant syndicated finance with foreign Shari'ah-compliant banks, especially those located in the GCC area because of their significant financial capabilities and sophisticated Shari'ah-compliant financial instruments structure.

Although Shari'ah-compliant cross-border financing serves as a temporary solution to satisfy the needs of major investors interested in Shari'ah-compliant finance structures, it does not constitute an alternative to the promotion of a Shari'ah-compliant finance market. The intervention of the government to promote the growth of the national Islamic finance industry is necessary to transform Egypt into an Islamic finance regional hub.

Conclusion

Despite the significant potential of the Egyptian market to become an Islamic finance giant at the regional level and potentially the international level, the challenges the industry faces are significant. An absence of legal and regulatory intervention, a lack of awareness of the importance of Islamic finance, a lack of government support, and a lack of innovation in developing the existing Shari'ah-compliant instruments delay the growth of the Islamic finance market in Egypt. However, these challenges are not insurmountable. The Egyptian government should adopt a full Islamic finance development strategy to promote the growth of the Islamic finance market before it becomes too late to join the leading countries in this highly lucrative industry.

About the Authors

Walid S. Hegazy holds a doctor of juridical science from Harvard University and currently occupies the position of managing partner of Hegazy & Associates in association with Crowell & Moring in Cairo. He has more than 15 years of experience in practicing law, in Egypt, the United States, France, and Saudi Arabia. Hegazy's main areas of expertise are Islamic banking and finance, project finance, corporate restructuring, and corporate governance. Before joining Crowell, he headed the Islamic Finance Practice Group at another leading international law firm.

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Hussein M. Azmy is an associate at Hegazy & Associates in association with Crowell & Moring in Cairo. He advises national, foreign, and multinational clients involved in various fields of business on corporate compliance, foreign investment, international business transactions, public procurement, and commercial law matters in Egypt and other MENA region countries, including Libya, Algeria, Saudi Arabia, the UAE, and Bahrain. He is fluent in English, French, and Arabic and has law degrees from Paris I Pantheon-Sorbonne University (with an emphasis on business law) and from Indiana University (in international and comparative law).