When money meets religion: Sharia compliant pensions in the UK

Limitations on asset classes, stocks and profiteering present institutional investors with a unique set of barriers to their investment objectives.

Is sharia the next frontier for ethical investment? Pension schemes are increasingly attempting to understand their members' preferences when setting investment strategy, and adoption of exclusion policies over so-called sin stocks, such as alcohol and tobacco, is on the rise across the UK.

With credible providers, the demand could be substantial

Iqbal Asaria, adviser to the Muslim Council of Britain

Moreover, there is a considerable overlap in thinking between sharia and the rest of the UK institutional investment landscape on what constitutes socially responsible investment.

The need for sharia-accommodating pensions is likely to grow. The UK’s Muslim population reached 2.8m in 2011, according to its most recent census.

Not all Muslim savers expect sharia compliance from their pensions, but some do.

HSBC’s Life Amanah Pension Fund, the Al Rayan Bank-backed Islamic Pension Trust and Nest’s Sharia Fund demonstrate a British demand for sharia pensions. These bespoke strategies require accompanying administrative and governance structures.

If the pensions industry is to take 21st century Britain seriously, perhaps it is time to consider greater access to sharia-friendly pensions.

No interest in Islamic finance

The biggest challenge associated with sharia compliance relates to its policies on investments.

Islamic law prohibits investment in interest-bearing instruments. Speculative investments are also banned. A sharia-compliant fund cannot invest in companies involved in sectors including alcohol, tobacco, pornography and armaments.

Restrictions on investments that yield interest rule out corporate and government bonds, while conventional derivatives, including liability-driven investment strategies, fall foul of rules over speculation.

Sukuk, a form of fixed income similar to bonds, can take the place of conventional debt instruments in shariah-accepting portfolios. Mohamed Damak, senior director and global head of Islamic finance at S&P Global Ratings, describes sukuk as “the most important asset class” for funds seeking to adhere to sharia law.

In 2014, the UK government became the first country outside the Islamic world to issue sukuk, making a £200m sale. But the asset class has yet to mature here.

The Nest Sharia Fund and the HSBC Life Amanah Pension Fund both use investment strategies that mirror the Dow Jones Islamic Markets Titans 100 index, which is designed to measure the performance of the world’s 100 largest shariah-accepted equities.

Source: Nest

The Islamic Pension Trust has a portfolio largely composed of UK equities that either sit in the FTSE 350 index, or are soon expected for inclusion. It also holds cash.

A spokesperson from Nest says: “Effectively diversifying beyond global large cap equity is very difficult for a UK pension scheme to achieve in its sharia offering”.

This is partly due to a “very thin” market for sharia-compliant funds and the immaturity of asset classes such as sukuk, which have “a significant regional concentration in a few Gulf states and Malaysia”, according to the spokesperson.

Pricing is another issue. Christine Hallett, chief executive of Carey Pensions UK, which administers the Islamic Pension Trust, says sukuk is currently too expensive for the workplace DC default charge cap of 0.75 per cent.

The industry is faced with a circular problem. Lack of demand limits the range of mature markets sharia funds can invest in. If schemes are to adhere to sharia principles and achieve a suitable level of diversification, a solution to the narrow selection of investments will have to be found. This will likely depend on greater demand for sharia compliance.

Responsibility to members

Opponents of restrictive investment strategies may cite The Occupational Pension Schemes (Investment) Regulations 2005, section 4.2, which reminds trustees that “the assets must be invested in the best interests of members and beneficiaries”.

Rebecca McKay, partner at law firm Trowers & Hamlins, says case law generally dictates that these interests are financial. The Law Commission has stated that "the law is wide enough to allow trustees however to take into account non-financial interests, but it has to be that there is no material financial detriment associated with that", according to McKay.

There is arguably a difference, however, between excluding stocks on ethical grounds, and making it impossible to invest in several asset classes. Heavily concentrated asset allocations have the potential to undermine members’ financial interests.

Should the shortcomings of a sharia-compliant investment strategy ultimately result in a poor outcome for its members, the trustee is unlikely to face legal recrimination.

“If the member has actively chosen a sharia fund, provided the trustees have been clear about how it works and the risks involved, then the risk of a successful member claim against the trustees for failing to invest appropriately is low,” says McKay.

Schemes need to identify the needs of their employees

Administering a sharia-compliant fund carries additional governance burdens. Schemes are required to appoint experts in sharia. HSBC, which manages Nest’s Sharia Fund, relies upon Islamic scholars with a knowledge of both sharia law and finance.

The Islamic Pension Trust's activities are reviewed by Al Rayan Bank’s sharia committee. This scrutiny can reach a staggering level of detail. “If there’s been a requirement to not use the word ‘interest’ in any documentation, then we wouldn’t use the word ‘interest’,” says Hallett.

For employers considering offering sharia pension access to their Muslim employees, identifying the needs of their employees will need data security to be managed carefully. This will be a sensitive matter for employers and members.

Kim Gubler, deputy chair at the Pensions Administration Standards Association, says: “They need to be able to assess that need through interrogations of the information that they have in their HR systems, and they are going to need to take care as to where that’s held and the security of it.”

The issue will gain further significance following the imminent introduction of the General Data Protection Regulation, according to Gubler. This will come into force in May 2018.

GDPR will place specific legal obligations on employers with regard to the security of the personal information of their employees, and will raise legal liability if they are responsible for a data breach.

Is there the demand for sharia pensions?

Demand for sharia pensions is currently low. The Islamic Pension Trust has thus far enrolled 1,800 members spread across 60 employers. Nest has 1,100 members in its Sharia Fund.

The movement towards sharia-compliant pensions gathered pace approximately 15 years ago, when the Trades Union Congress sought a sharia solution for a number of its members, according to Iqbal Asaria, special adviser on business and economic affairs to the secretary general of the Muslim Council of Britain.

“[Demand] is growing. The Muslim population is very young, predominantly… now they are beginning to think about pensions,” he said.

Providers have made tentative steps towards expanding sharia pension provision in the UK. Mastertrust Now Pensions explored launching its own sharia fund, going as far as to establish the legal framework for it, before reversing its decision to enter the market.

“We analysed the demand, and it was non-existent at the time,” says Rob Booth, director of investment and product development at Now Pensions.

“The trustees discuss it regularly, so we analyse the member feedback… at the moment, there isn’t the demand, but should that be appropriate, then the trustees would look to consider launching that fund,” he adds.

The UK is ready to provide sharia pensions

The solution may lie in providing access to self-selection products for Muslim savers. Maria Nazarova-Doyle, head of DC investment at JLT Employee Benefits, echoes sentiments over a current absence of demand for sharia pensions, but adds that sharia considerations are becoming more prominent.

She says: “While it may not be necessary to have sharia-compliant defaults... the self-select range should include a sharia option for those members who would otherwise be precluded by their religious beliefs from investing into non-compliant funds.”

While UK sharia pension provision is probably adequate for now, some Muslim savers may not have access to the tailored advice capabilities they need.

Asaria believes that the standard of advice available to Muslims is currently below par. With more choice and greater knowledge, Muslim savers looking for sharia pensions will represent a larger share of UK pension assets.

“With credible providers, the demand could be substantial,” he says.