Infrastructure Financing Through Islamic Finance in the OIC Member Countries—Part 1

12th Meeting of the COMCEC Financial Cooperation Working GroupAnkara, Turkey

March 28th, 2018

Professor Habib AhmedSharjah Chair in Islamic Law & Finance

Durham University Business School United Kingdom

Presentation Plan

• Infrastructure and financing—Introduction

• Status of OIC Member Countries

• Islamic Finance and Infrastructure Investments

2

Infrastructure—Introduction

• Infrastructure: Social overhead capital producing public goods & services essential for functioning and growth of economies – Economic infrastructure—energy,

telecom, transportation, water & sanitation

– Social infrastructure—education, health, social housing

3

Key Features of Infrastructure Projects

• Large, lumpy, indivisible• Capital intensive with high sunk costs• Long gestation period• Long payback period• Natural monopoly characteristics• Public good characteristics • Non-tradability of output• Large externalities• Interconnected network systems

[Table 1.1] Sources: Pratap and Chakrabarti (2017) and OECD (2014)4

Infrastructure and Development• Infrastructure

– provides basic and essential services to household sector (transportation, power, water, etc.)

– is an input in production, lowers the cost and enhances productivity

• Empirical studies: Better infrastructure increases growth and reduces income inequality

• Achieving SDGs linked to infrastructure– Overall infrastructure: SDG 9– Economic infrastructure: SDG 6, SDG 7 & SDG 11 – Social infrastructure: SDG 3, SDG 4

5

Global Infrastructure Spending by Asset Class

1.089 785

236 430

1.250

28,7%

20,7%

6,2%11,3%

33,0%

0%

5%

10%

15%

20%

25%

30%

35%

-

200

400

600

800

1.000

1.200

1.400

Transport Power Water Telecom Socialinfrastructure

% o

f to

tal

USD

(b

illio

n)

Spending (US$ billion) % of total

[Chart 1.3]Source: McKinsey (2017: 1) 6

0,0

1,0

2,0

3,0

4,0

5,0

6,0 4,94,4

3,8

5,1

4,0

2,93,4 3,6

4,64,3

3,5

4,9

3,93,2

3,7 3,7

Ind

ex V

alu

e (

0-7

be

st)

Overall Infrastructure Quality of Overall Infrastructure

[Chart 1.2] Source: WEF Global Competitive Index Historical Dataset 2007-2017

Infrastructure Status of Regions and OICMember Countries

7

Global Cumulative Infrastructure Spending and Investment Needs 2016-2040

0

20

40

60

80

100

Current trends Investment needs Infrastructurespending gap

78,8

93,7

14,9USD

tri

llio

n

[Chart 1.6] Source: GIH and Oxford Economics (2018 8

Infrastructure Financing Sources

• Traditionally, governments have been responsible for infrastructure development

• Alternative sources to funds are sought due to – Increasing demands on public funds,

budget deficits, and increasing public debt

– Huge investments needs for infrastructure finance to meet the SDGs

9

Infrastructure Types and Financing

• Private sector involvement relates to risk-return features of infrastructure projects– Fully self-sustainable projects (power,

energy, telecommunications, highways)

– Partially self-sustainable projects (railways, urban light rails, water and sewerage)

– Financially unsustainable projects (schools, hospitals and public housing)

10

Public-Private Partnerships (PPP)• PPP:

– A long-term contract between a private party and government entity

– To provide a public asset or service– Private party bears significant risk and

management responsibility – Remuneration is linked to performance of

projects

• Parameters of PPPs– Type of assets: Brownfield or greenfield– Functions and responsibilities of private party:

design, build or rehabilitate, finance, maintain and operate

– How the private party is paid: fees/tariffs from service users or government or both

11

Contract Types Involving Private Sector for Infrastructure Projects

Contract Type Functions Asset TypeaDesign Build Rehabilitate Finance Maintain Operate

Design-Build-Finance-Operate-Maintain (DBFOM)

x x x x x GF

Design-Build-Finance-Operate(DBFO)

x x x x GF

Design-Construct-Manage-Finance (DCMF)

x x x x GF

Build-Operate-Transfer (BOT) x x x x x GFBuild-Own-Operate-Transfer(BOOT)

x x x x x GF

Rehabilitate-Operate-Transfer(ROT)

x x x x BF

Concession x x x x x x GF,BFPrivate Finance Initiative (PFI) x x x x x GF

Operations and Management(O&M)

x x BF

[Table 2.1] Source: Adapted from World Bank (2017c: 7) 12

Sources of Infrastructure Financing

[Table 2.3] Source: Adapted from Ahmed (2017) 13

Sources of Infrastructure Financing Estimates in Emerging Economies & Developing Countries

Government Budgets ($500-

550 bil)

Private Finance ($150-250bil)

NDBs ($70-100bil)

ODA/MDB Finance ($40-

60bil)

Other Developing

Country Finance (<$20bil)

[Chart 2.1] Source: Bhattacharya A., Romani M. (2013) 14

40,229 26,5

10,9 6,3 3,4 2,7 1

33,5%

24,2%22,1%

9,1%5,3%

2,8% 2,3% 0,8%

-5,0%

5,0%

15,0%

25,0%

35,0%

05

1015202530354045

USD

(tr

illio

n)

AUM ($ trillion) Percentageof total[Chart 2.2]: Source: McKinsey (2016: p. 16)

Assets under Management of Institutional Investors (Global Assets $ 200 Tr. 2016)

15

Investment Horizon & Risk Appetite of Different Financial Institutions

Institution Investment Horizon Risk Appetite

Commercial Banks Short term Low to medium

Nonlife insurance Short term MediumInvestment Company Short to medium term Depends on funds

mandatesLife insurance and privatepension

Long term Medium

Public pension Long term MediumSovereign wealth funds Long term Medium to highEndowments andfoundations

Long term High

[Table 2.4]: Source: ADB (2018), African Economic Outlook 2018, African Development Bank, p. 109. 16

Global Infrastructure Investment-Equity and PPP by Type of Owner

[Chart 2.3] Source: PWC & GIIA (2017)

52%

64%

32%

44%

76%

60%

46%50%

24%18%

45%38%

11%15%

39%32%

5%1%

14%

4% 2% 4%7% 5%6% 5% 3%

6%2%

9%

1%5%

13% 12%6% 8% 9% 12%

7% 8%

0%

10%

20%

30%

40%

50%

60%

70%

80%

Africa Asia Australasia Europe Latin America Middle East NorthAmerica

Global

% o

f to

tal

Corporate Infrastructure fund/investment firm

Pension fund Sovereign wealth fund/government agency

Other

17

Factors Affecting Financing of Infrastructure Projects

1. Infrastructure Policy Framework

2. Legal and Regulatory Framework

3. Institutional Arrangements for Procurement Processes & Procedures

4. Project Related Factors

5. Human Capital

18

Methodology Used in the Study—1

• The study identifies status and deficits in infrastructure investment needs, role of Islamic finance in filling these gaps, and suggests appropriate policy recommendations

• Research is descriptive and evaluative • Arranges, summarizes and present data/information to enable

meaningful interpretation• Some analyses are qualitative and conceptual in nature

• Analyses both quantitative and qualitative data • Quantitative data

• Size and status of the infrastructure financing needs• Islamic financial sector in different jurisdiction

19

Methodology Used in the Study—2

• Data and information collected using Content Analyses of various documents– Relevant literature, surveys of countries, policy documents

from international organizations and standard setting bodies, national level public policy and legal/regulatory documents, etc.

• Case studies carried out by principal investigator and country level specialists– National level public policy and legal/regulatory documents – Meetings and interviews with key stakeholders (policy

makers, industry players, regulators)20

Presentation Plan

• Infrastructure and financing—Introduction

• Status of OIC Member Countries

• Islamic Finance and Infrastructure Investments

21

Infrastructure Status of Regions & OICMember Countries

4,94,4

3,8

5,1

2,93,4

3,6

4,6

4,0

3,4

4,5

2,9

3,4 3,5

5,14,8

4,2

5,6

2,93,3

3,8

0,0

1,0

2,0

3,0

4,0

5,0

6,0

East Asia andPacific

Middle East &North Africa

Latin America& Caribbean

Europe &North America

Sub-SaharanAfrica

South Asia OIC Members

Ind

ex V

alu

e (

0-7

be

st)

Overall Infrastructure Transport Infrastructure Electricity & Telephony Infrastructure

22[Chart 2.6] Source: WEF (2018), The Global Competitive Index Historical Dataset 2007-2017

Cumulative Regional Infrastructure Spending Requirements 2016-2040

-

5,0

10,0

15,0

20,0

25,0

30,0

Africa (9) Americas,excluding

US (10)

Asia,excludingChina (18)

Europe (9) Oceania(2)

US China OICmembers

(13)

4,3 5,2

19,7

12,8

1,7

8,5

26,5

5,6 6,0 7,8

22,4

14,8

1,9

12,4

28,4

7,2

1,7 2,6 2,7 2,0 0,2

3,9 1,9 1,6

USD

tri

llio

n

Cummulative at current trends 2016-2040 Cummulative at investment needs 2016-2040

Infrastructure spending gap 2016-2040

Total Investment Needs per member country per year USD 22.1 billionInvestment Gap per member country per year USD 4.9 billion

[Chart 2.12] Source: GIH and Oxford Economics (2018) 23

Infrastructure Gap in Selected OICCountries 2016-2040

8 191 230 70 18 84 77 36 221 125 406 19 114

15,1%

86,0%72,3%

8,1%

47,4% 47,5%

25,9%36,0%

44,6% 46,6%62,8%

135,7%

13,3%

0,0%20,0%40,0%60,0%80,0%100,0%120,0%140,0%160,0%

050

100150200250300350400450

US$

Bill

ion

Gap (USD billion) Relative Gap (% of GDP 2015)

[Chart 2.14] Source: GIH and Oxford Economics (2018) 24

Total Infrastructure Investments & Private Sector Contribution (2011-2015)

20,7%

14,8%

14,7%

26,4%

21,0%

46,0%

17,8%23,8%

19,3%

37,1%

9,8%

13,9%

0,37%

3,01%

0,30%0,46%

1,04%

8,26%

3,13%

1,33%

1,09%

1,91%

14,04%

3,21%

6,71%2,79%

0,0% 5,0% 10,0% 15,0% 20,0% 25,0% 30,0% 35,0% 40,0% 45,0% 50,0%

Benin

Cote d'Ivore

Egypt

Guinea

Indonesia

Morocco

MalaysiaNigeria

Qatar

Saudi Arabia

Senegal

Tunisia

Turkey

UAE

Total value of private finance infrastructure (% of GDP) Total infrastructure investment (% GDP)25[Chart 2.10] Source: https://infracompass.gihub.org/compare_countries

Presentation Plan

• Infrastructure and financing—Introduction

• Status of OIC Member Countries

• Islamic Finance and Infrastructure Investments

26

Principles of Islamic Finance • Basic principle of Islamic commercial law is

permissibility (ibahah)—all transactions are permitted except what is prohibited by Shariah

• Two broad categories of prohibitions are ribaand gharar

• Riba (literally meaning ‘excess’) is usually translated into interest, it has wider connotations such as the prohibition on the sale of debt

• Gharar (legal ambiguity or excessive risk) can include deception, excessive uncertainty and contractual ambiguity in transactions

27

Major Islamic Contracts used in Islamic Finance

• Key contracts– Debt based—Murabahah, Istisna, Salam– Asset based—Leasing (Ijarah)– Equity based– Mudarabah, Musharakah– Agency based—Wakala– Interest free loans (qard hassan) or loans

at service charges

• Supporting contracts/relations– Gift (hiba), guarantee (kafala), mortgage

(rahn), etc. – Promise (W’ad)

Islamic Perspectives on Infrastructure Financing

• AAOIFI Standard Number 22: Permits use of concessions as long as the contracts do not contradict the rules and principles of Shariahsuch as riba and gharar.

• The principle applies to the utilization, construction and management concessions

• Specific structure of Islamic financing depends on nature of PPP contracts – For example, a combination of istisna and ijarah

can be used when the project is greenfield, in case of brownfield projects a sale and leaseback (ijarah) structure can be used

29

Conventional and Islamic Finance Contracts for Infrastructure Financing

ContractCategories

Conventional Finance Islamic Finance

Equity Equity provided by sponsors Infrastructure Equity funds

Equity provided by sponsors—can take the form of musharakah or mudarabah

Infrastructure equity funds—the fund manager works as an agent (wakil) to manage the funds

Debt Loans with interest Interest-based bonds

Sale-based instruments (murabahah and istisna) Debt based Sukuk

Hybrid Various structures such as convertible bonds, preferred shares, mezzanine financing, etc.

While certain features such as convertibility of debt to equity are allowed, other structures such as preferred shares are not permissible.

Structures combining various contracts such as istisna-ijarah, wakala-ijarah, etc.

[Table 3.2] Source: Author’s own 30

Case Study of Islamic Infrastructure Finance

• Alternative Energy Development Board (AEDB) provided 1,408 acres land in Sindh to MWEL on a 20 year concession period to establish a wind farm – Project consisted of 33 wind turbines to generate 50 MW of

electricity

• Total cost of USD 132 million– USD 32 million was sourced internally– USD 100 raised from external sources: Split between the

US-based Overseas Private Investment Corporation (OPIC) and a syndicate of Islamic banks (Meezan Bank Limited, Habib Metropolitan Bank Ltd. and Bank of Punjab)

• Islamic financiers and MWEL entered into a musharakahpartnership

• After completion of the project, MWEL leased the assets of financiers under an ijarah contract and paid rentals on a quarterly basis 31

Master Wind Energy Limited Financing Structure

Islamic Financiers

AEDB

Investment PoolProject Company

(MWEL)

Musharakah

Project Assets

USD 100 million

GoP

GuaranteeConcession

OPIC

USD 32 million

[Chart 3.11] Source: Adapted from Ahmed (2017) 32

Relative Size of the Financial Sectors

0,020,040,060,080,0

100,0120,0140,0

OIC Average Low income Lower middleincome

Middle income High income

45,1 51,3 58,4

120,8

38,321,0

42,2

96,383,6

17,76,0

24,6

44,8

124,5

% o

f G

DP

Market capitalization of listed domestic companies (% of GDP)

Domestic credit to private sector by banks (% of GDP)

Domestic credit to private sector by non-bank financial institutions (% of GDP)

[Chart 3.7] Source: IMF Financial Sector Development Database 33

Islamic Financial Sectors Size (USD 2.2 bn.)

1598,9

42,5 124,4 344,8 91,2

72,6%

1,9%5,7%

15,7%

4,1%

0,0%

10,0%

20,0%

30,0%

40,0%

50,0%

60,0%

70,0%

80,0%

0,0

200,0

400,0

600,0

800,0

1000,0

1200,0

1400,0

1600,0

1800,0

Islamicbanking

Takaful Other IFIs Sukuk Islamic funds

Pe

rce

nta

ge o

f to

tal

USD

(B

illio

n)

US$ (Billion) Percentage

[Chart 3.9] Source: ICD & TR (2017) 34

Sukuk Issuances by Sector (%)

56,8618,07

6,32

5,21

4,29

4,25 1,9 1,13

1,97

Government Financial servicesReal estate Oil and gasPower and utilities Infrastructure

Sukuk issuance by the infrastructure sectors was 11.57% of the total

[Chart 3.14] Source: IFSB (2018) 35

Distribution of Investments by Takaful Operators in GCC (%)

17%3%

22%

7%16%

35%

Cash Equities

Government and other sukuk Properties

Funds/Unit Trust Others

[Chart 3.19] Source: Global Advisors World Takaful Report 2016 36

IDB Infrastructure Financing 1976-2018 (Q-2)

43.956

938 12.222 7.121 4.209 3.858

33,5%

0,7%

9,3%

5,4%3,2% 2,9%

0,0%

5,0%

10,0%

15,0%

20,0%

25,0%

30,0%

35,0%

0

10.000

20.000

30.000

40.000

50.000

Energy Information &Communication

Transporation Water,Sanitation &

Urban Services

Education Health

% o

f to

tal

USD

Mill

ion

IDB total financing (USD million) IDB financing (% of infrastructure total)

Total financing 1976-June 2018 of USD 131.28 billion to 57 member countries.Financing of USD 54.84 million per member country per year

[Chart 3.20] Source: IDB (2018) 37

Total Islamic Finance Investments in Infrastructure Sector (2017-2018)

Sectors (2017-2018)Total assets (USD

billions)Percentage going to

InfrastructureInfrastructure

Investments by Islamic Finance

(USD Billion)

Islamic Banking 1,598.9 4.74% 75.8

Takaful 42.5 2.0% 0.9

Sukuk 344.8 11.57% 39.9

IDB Project Financing 3.12

Total 119.7

Average per member country 2.1

[Table 3.4] Source: Author’s estimates 38

QUESTIONS??

39