Nuruddeen Sani Gwarzo, Executive Director, South, Access Pensions in this interview takes a deep dive into the principles of non-interest finance as it applies to pension funds and operators manage the risk associated with investments in a non-interest-based pension fund. Except:
Can you explain the principles and concepts of non-interest-based finance, particularly as they apply to pension funds?
Non-interest finance, often referred to as Islamic finance or Sharia-compliant finance, refers to a financial system that operates in accordance with Islamic jurisprudence (Sharia). In general, a key distinguishing feature between traditional finance and non-interest finance is with regard to the prohibition of interest (Riba) and the promotion of ethical and socially responsible financial practices. In general, there are four broad pillars upon which non-interest finance revolves around which are set out as follows:
Prohibition of Riba (Interest): Non-interest finance strictly adheres to the prohibition of interest. In the context of pension funds, this means that pension funds managed by a PFA under Fund VI would not invest in interest-bearing financial instruments, such as conventional bonds, fixed-income securities, or traditional savings accounts. Instead, investments should be structured to generate returns without interest.
Risk-Sharing: Non-interest finance emphasizes the concept of risk-sharing. In the context of pension funds, this could be achieved by structuring investments as partnerships (Mudarabah) or joint ventures (Musharakah), where the PFA and fund contributors share both profits and losses.
Asset-Backed Financing: Non-interest finance promotes investments in tangible assets, such as real estate, equities, and commodities, rather than purely financial instruments. Pension funds should focus on investments backed by physical assets to ensure a more transparent and ethical investment approach.
Ethical and Social Responsibility: Non-interest finance principles require investments to be consistent with Sharia-compliant ethical and social values. This means that the PFA should avoid investments in businesses involved in activities deemed incompatible with Islamic ethics, such as gambling, alcohol, pork, and usurious financial institutions.
In the pension industry, the National Pension Commission of Nigeria (PenCom) introduced a fund designed for RSA account holders who prefer to have their pensions invested in a manner consistent with non-interest principles called Fund VI in July 2021. The Fund shall be separated into two funds for Active RSA holders and Retirees, respectively. The fund complies with the provisions of Islamic Commercial Jurisprudence and other non-interest principles, as approved by the Financial Regulation Advisory Council of Experts (FRACE) or any other body constituted by the Central Bank of Nigeria (CBN) and the Securities and Exchange Commission (SEC), from time to time. The basic principles behind the fund are that all its assets will be invested only in ethical and non-interest-bearing instruments. Thus, these assets will not be invested, for instance, in the production and trading of alcohol, weaponry, gambling, speculation, interest-bearing instruments, and other similar endeavors. FRACE is entrusted with reviewing investible instruments from time to time.
How have Nigerians embraced the non-interest pension since its inception?
Since its creation in July 2021, the non-interest pension funds (designated RSA Fund VI) have grown to N45.6 billion at the end of July 2023 relative to N17 trillion of total pension assets. This would imply that non-interest offtake remains minuscule.
However, when compared with total non-pension assets managed under non-interest principles, which stood at N27.3bn at the end of July 2023, one can say that there has been relatively rapid uptake within the pension space in such a short time. That said, relative to the wider pool, this might seem small. Nonetheless, we think there is sufficient room for growth within the segment given Nigeria’s large Muslim population. Furthermore, with greater awareness about the existence of the fund, improved clarity on investment performance as well as growth in the supply of non-interest investment securities, we believe the segment can grow rapidly in a short time.
How do you assess and manage the risk associated with investments in a non-interest-based pension fund?
In assessing assets for consideration in our non-interest pension fund, we go through a rigorous process that entails the following:
Firstly, we screen a potential investment to check for exposure to prohibited activities, such as alcohol, gambling, and interest-based financial institutions. For equity investments, we ensure that these are companies listed on the Lotus-Halal equity index while for fixed income, our focus is on sukuk issued by Federal and State Governments as well as by Nigerian corporates.
Our checklist includes a requirement that potential investments have a certificate of compliance from FRACE. The approval ensures that the proposed investment complies with the provisions of Islamic Commercial Jurisprudence and other non-interest principles, as approved by the Financial Regulation Advisory Council of Experts (FRACE).
Furthermore. we focus on diversification within the investment portfolio to spread risk by investing in a mix of asset classes, such as Shariah-compliant equities, real estate, commodities, and Sukuk (Islamic bonds), to reduce exposure to the risks associated with a single asset class.
Do we also have non-Muslim subscribers subscribing to Fund VI?
Yes, we do. The appeal of ethical and socially responsible investment of savings is something that generates universal appeal, and we have several instances of non-Muslims who subscribe to Fund VI.
In the context of non-interest-based pension funds, how do you balance the need for competitive returns with the ethical considerations of Islamic finance?
At Access Pensions, we follow a disciplined process around non-interest pension investing with a focus on strong compliance which helps manage the trade-off between returns and ethical considerations.
Sharia-Compliant Investments: In assessing all investments for consideration, we check for compliance with Sharia principles. This means avoiding interest-based investments, as well as businesses involved in activities such as alcohol, gambling, and pork production, which are considered haram (forbidden).
Ethical Screening: We apply a rigorous screening process to select investments that align with Islamic finance principles. This includes assessing the business activities and financial structures of potential investments to ensure compliance with Sharia.
Sukuk Investments: Given the present dearth of instruments, a big focus of our present investment program revolves around the annual Sukuk sale by the DMO. Sukuk provides a way to generate returns without involving interest, as they represent ownership in an underlying asset or project.
There have been talks about the lack of debt instruments for non-interest investment. Where are we as a country in this regard?
Presently, much of the global and domestic financial architecture is constructed around traditional finance which entails the use of interest. In recognition of the need to catalyze the development of non-interest finance, the Debt Management Office (DMO) introduced sukuk instruments in its borrowing mix. These instruments have formed the mainstay of the non-interest fund at Access Pensions. Unlike bond issuances, sukuk sales are done once a year, recently the DMO sold N350bn worth in October at a rental rate of 15.75% amid robust subscription (435%). Also, this year, Lagos State sold N20bn worth of sukuk instruments and we think there is scope for corporates to also tap the segment which would help deepen the depth of Nigeria’s financial markets.
What do you believe are the key challenges and opportunities in managing a non-interest-based pension fund in today’s financial landscape?
The paucity of investment securities are consistent with non-interest principles: In Nigeria, the total supply of FGN sukuk securities is around N767bn which compares to NGN17.9trillion in FGN bond instruments. On the equity side, there are not many securities that are non-interest compliant. Beyond this, there are limited vehicles or funds which offer other Islamic finance products which creates challenges for portfolio diversification.
Insufficient Awareness and lack of track record: As with most new developments, most people are reluctant to jump in at the onset due to the lack of a long enough track record to view investment performance. There is not enough awareness about the existence and investment track record to educate the potential customers.
Ethical Screening: Conducting thorough ethical screening to ensure investments are Sharia-compliant can be time-consuming. Identifying suitable, profitable investments that align with Islamic principles requires extensive due diligence.
Competitive Returns: Achieving competitive returns while adhering to Sharia principles can be challenging. Islamic finance often demands ethical investments, which may have varying profitability levels compared to conventional investments.
However, the Key opportunities include Growing Market Demand: Given Nigeria’s large Muslim population, we believe there is a strong latent demand for ethical and Sharia-compliant financial products which presents a significant growth opportunity for pension funds that demonstrate a high level of compliance with the underlying principles.
Diversified Investment Opportunities: Non-interest finance encourages diversification into tangible, ethical assets like real estate, infrastructure, and commodities. This allows investors to have a more diversified and potentially resilient portfolio.
Financial inclusion: Non-interest pensions can play a crucial role in financial inclusion by reaching underserved and unbanked populations who might have reservations about conventional interest-based finance due to religious or ethical reasons.
Despite the challenges, Access Pensions has been at the forefront of pushing non-interest pensions with a combined AUM at N19bn relative to total RSA Fund VI assets for the industry of N45.6bn at the end of July 2023.
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