LONDON — There are signs that fund managers from the MENA countries are considering voting with their feet by relocating the domicile of their funds from certain Western jurisdictions such as Luxembourg to other major international locations. The fund managers are concerned, frustrated and incensed at the arbitrary and gratuitous way some regulatory authorities have been acting perceivedly against Islamic investment funds, even those managed by blue-chip Western institutions, and conventional funds promoted by Arab banks, in the aftermath of the Sept. 11 attacks.
One senior asset management firm from Saudi Arabia confirmed to me that it was looking at Labuan, the Malaysian international offshore financial center, and Bahrain. It already has some funds domiciled in British Virgin Islands (BVI) and Cayman Islands, which together with Dublin and the Channel Islands (Jersey and Guernsey) are the preferred fund registration domiciles of most of the world’s top funds. Luxembourg is primarily popular with US financial institutions or with global institutions that already have a presence through an extensive family of funds already registered in the Duchy.
One can understand the sentiments and frustrations of these asset management firms. On the one hand, cynics might argue that they are being opportunistic now that they are facing allegedly discriminatory compliance scrutiny post Sept. 11 in jurisdictions such as Luxembourg. Where were these asset management companies when Labuan and Bahrain were seeking their support in their development, both from the conventional and Islamic financial institutions?
On the other hand, both offshore locations cannot afford to look a gift horse in the mouth. They should grab this opportunity for several reasons.
Bahrain will over the next few years be faced with competition in the region — Beirut has ambitions of rebuilding itself to its former glory as the regional banking center for the Middle East; Abu Dhabi is developing its Saadiyat Financial Center; Dubai is also fast establishing itself as a financial center; and even Cyprus may be tempted down this route.
In South East Asia, Labuan faces competition from Brunei, which is also trying to develop an offshore center, and from the much more established and sophisticated Hong Kong and Singapore. Further down the Indian Ocean, Port Louis in Mauritius is already preferred by many Indian financial institutions as their offshore center.
The apparent proliferation of offshore financial centers does not imply a free-for-all access to such centers. On the contrary, even before Sept. 11, the previous Clinton administration was threatening punitive sanctions against small islands offshore centers, should they refuse to cooperate with the US and institute greater transparency, monitoring and enforcement. This in an effort to primarily flush out money laundering by drug barons and corrupt politicians.
The ‘quality’ of offshore financial centers are very often defined by the perception of their country and political risk; of their communications infrastructure and access to transport and airlinks; of their legal, regulatory, and compliance infrastructure and measures; of their accommodation and leisure facilities; and of their human resources and visa policy.
How then do Bahrain and Labuan compare in the league of offshore centers? Market perception is that Labuan is currently better placed, although Bahrain has both got potential and also drawbacks.
Labuan’s country and political risk is lower; its communications infrastructure is excellent; its transport links adequate through Kuala Lumpur and Singapore, a major regional hub; it has excellent accommodation and leisure facilities; and its legal, regulatory, and compliance measures are second to none in the Asia-Pacific region. There may be a looming bottleneck in human resources should there be a spate of sudden applications to set up offshore entities, but then the Labuan Offshore Financial Authority (LOFSA), the regulator, is on record saying that only institutions which passes its rigorous compliance and capital requirements will be registered. In addition, LOFSA has ceilings in place for the number of applications it will grant in a particular development plan.
Labuan has a number of upsides — it has already more than 60 offshore financial institutions, with most of the global and regional banking majors present. It is also trying to develop its offshore Islamic financial and insurance business.
Last year Labuan got the thumbs up for passing an international inspection test carried out in March and April 2001 to determine the efficacy of its anti-money laundering measures. The inspection was conducted by a team from the Australia-based 21-member Asia-Pacific Group on Money Laundering. On May 10, 2001, the Malaysian parliament (Dewan Rakyat) also passed the Anti-Money Laundering Act 2001, which came into effect in August last year.
The Act includes the 40 recommendations made by the Financial Action Task Force (FATF), set up by the Group of Seven Industrialized Countries (G-7) in 1989 to combat money laundering. The Act applies to both Malaysian onshore and offshore banks and non-bank financial institutions and requires them to inform the authorities on certain exceptional or suspicious transactions that may involve proceeds from unlawful activities such as drug dealing, tax evasion, and funding terrorism.
In January this year, the first US dollar denominated international Islamic bond started trading on the Labuan International Financial Exchange (LFX), an important component of Labuan’s offshore financial system.
What is ground-breaking in the $150m Sukuk Al-Ijarah (or Islamic leasing bond) issued by Kumpulan Guthrie Bhd, is the participation for the very first time by a Gulf Islamic financial institution, namely Bahrain-based but largely Saudi-owned Shamil Bank of Bahrain, as a lead subscriber together with seven other financial institutions of a Malaysian Islamic debt security, which is in this case asset backed.
Labuan does have much going for itself. But its challenge is that of culture and marketing. For some inexplicable reasons, there seems to be a cultural divide between the Gulf and Malaysia, especially in the financial services sector. Perhaps the impact of Sept. 11 attacks will force through a new realism and force institutions cooperate in their best interests. Many Gulf bankers and businessmen privately admire the almost solitary stand which Malaysian Premier Mahathir Mohamed has taken against Washington, London and the IMF on crucial issues. The fact that his policy of taxing foreign fund managers and imposing capital and other controls in the immediate aftermath of the Asian financial crisis paid off, has increased his stature in the Muslim countries, with the fallout of his treatment of his former deputy Anwar Ibrahim, fast receding in the post Sept. 11 scenario.
Bahrain on the other hand carries more risk. There are funds registered in Bahrain, for which there are conditions that the depository has to be outside the emirate. In other words the investors insist that the documents of the fund must be held by an institution outside Bahrain.
In 2001, Sheikh Hamad ibn Isa Al-Khalifa introduced a national charter (Mithaq), overwhelmingly endorsed in a referendum by the population, which promised wide-ranging political and constitutional reforms, and this would go a long way in eventually mitigating many of the risk associated with it.
At best, the country’s legal, regulatory and compliance infrastructure is still developing, and human resources development remains a major challenge. Bahrain also is not an individual member of FATF (the GCC is in the unique position of being a member state). This means that although Bahrain has completed all self-assessment surveys and have undergone mutual evaluation, it has not yet acquired equivalence status with FATF members.
Bahrain is set to open up further especially in the Islamic banking sector later this year when the International Islamic Financial Market, which comprises an International Islamic Money Market; a Liquidity Management Center, which will act as a market maker for the issuing and trading of international Islamic securities; and an Islamic Rating Agency to rate these issues; will finally come on stream.
If both Bahrain and Labuan can demonstrate that they are determined to develop into world-class offshore centers with international best practice in regulation, supervision, compliance, enforcement, and offshore banking business, then financial institutions from the Muslim countries, other emerging countries, and from the West would ignore these locations to their disadvantage and cost.
