Dubai’s ambition to become the capital of the global Islamic economy, as announced last year by the emirate’s ruler, Sheikh Mohammed bin Rashid al-Maktoum, goes far beyond encouraging a few more Islamic banks to open.

It is about introducing elements of sharia-compliant thinking to many aspects of Dubai’s economy. Its goals range from improving the import-export processes for halal food as well as incorporating Islamic values and culture into tourism, arts, design and education.

Supporting sharia-compliant banking and finance is, however, central to the initiative. Dubai has been working on establishing the right physical and regulatory framework to encourage Islamic banks to set up and for companies to choose the emirate’s financial exchanges rather than other international markets to list their sukuk (Islamic bonds).

Growing demand

Demand for Islamic finance is growing as large sections of the world’s growing Muslim population call for sharia-compliant services. Interest has also increased as a backlash against conventional banking, which is blamed for causing the financial crisis in 2008-09.

In both Dubai and elsewhere, the banking world has been characterised by excessive lending and a lack of consideration of whom or what they are lending to. In contrast, sharia-compliant finance promotes itself as a more ethical form of banking. For instance, it prohibits the funding of certain products such as alcohol or tobacco.

Dubai wants to seize this opportunity to build an Islamic economy and in doing so find a new way of generating non oil-related sources of revenue that will support long-term growth.

Dubai achievements

Although Dubai is home to one of the first modern-day Islamic banks, Dubai Islamic Bank, which was set up in the mid-1970s, only recently has it become a leading player in the Islamic finance world.

Historically, Bahrain has been the regional centre for banking, both Islamic and conventional, boasting far more Islamic financial institutions than Dubai. It currently has 18 wholesale and six retail sharia-compliant banks. But the sector was hit hard by the financial crisis and real estate crash, and there are now growing efforts to consolidate the Islamic banking sector, building larger and stronger institutions through mergers and acquisitions.

In contrast, Dubai has just a handful of Islamic banks, but these have large asset bases and have been producing some healthy quarterly results. The Islamic banking sector’s growth in the emirate is outstripping expansion in the conventional sector.

Dubai Islamic Bank reported an 81 per cent jump in its first-half profits, reaching AED1.337bn ($36m). Net revenue increased by 26 per cent to reach AED2.66bn.

Noor Bank

Noor Bank, a relative newcomer, having only opened in 2008, reported an increase in net income in the first quarter of the year, to reach AED85m. The bank rebranded itself at the beginning of the year, after having decided to drop the word “Islamic” from its name.

Despite not wanting to draw attention to its Islamic status, the lender has been actively supporting the sharia finance industry. Total customer financing increased by 14 per cent year-on-year in the first quarter to reach AED16.3bn, while customer deposits grew by 11 per cent to AED20.7bn.

The emirate is also leading the way as a location to list sukuk, with Nasdaq Dubai the third-largest sukuk market in the world. A total of $22.2bn-worth of sukuk are currently listed in Dubai, with $417.5bn on Nasdaq Dubai as of June this year.

Natural contender

“Dubai is a natural contender to attract sukuk listings,” says Mohamed Damak, global head of Islamic finance at US ratings agency Standard & Poor’s.

So far this year, Nasdaq Dubai has already listed almost a third more sukuk  compared with the total volume in 2013, with $8.2bn listed to date in 2014 and $6.1bn listed in the whole of 2013.

The exchange is aiming to attract more issuers from outside the UAE. Saudi firm Dar al-Arkan Real Estate Company listed three sukuk totalling $1.2bn from its Islamic bond programme on the exchange at the end of May.

Bahrain-based Islamic investment bank Gulf Finance House is the latest company to announce a potential listing on the exchange, stating in August that it was expecting to issue a $200m sukuk in the coming months.

Nasdaq Dubai has also pioneered new sharia-compliant products this year, having launched a new platform for the trading of murabaha or asset-backed types of Islamic securities. The scheme was launched in conjunction with Emirates Islamic Bank, with Sharjah Islamic Bank joining a month later. Talks with other lenders potentially interested in joining the initiative continue.

Government support

The Dubai government itself is further supporting the Islamic economy by raising funding via sukuk structures.

In April, the government issued a $750m Islamic bond on the Dubai Financial Market and is looking to raise more before the end of the year.

The issue set new benchmarks for the Islamic finance markets, with the bond being the first 15-year sukuk to be issued globally to date.  Regional governments have typically only raised five-year bonds, but Dubai’s sukuk and the more recent news that the emirate of Sharjah is raising a debut 10-year bond suggests long-term Islamic funding will become increasingly common.

To further support the development of the Islamic finance sector in Dubai, new legislation was published last year to improve the regulatory framework. The emirate is also trying to establish the world’s first fully sharia-compliant export-import bank.

Regional competition

Yet as Dubai strengthens its capabilities, so do other global finance hubs, all vying to carve out greater market share of the Islamic finance sector.

“Dubai has a head-start with its existing infrastructure,” says Bashar al-Natoor, Dubai-based director, corporates, Islamic finance specialist at Fitch Ratings. “It can accommodate growth, but it still needs to prove itself against other international players. You have Qatar nearby, even the UK is trying to be a hub.”

Saudi Arabia also presents some strong competition; it is the second-largest market globally for sukuk.

Companies in the kingdom issued a record $10.5bn in local currency sukuk in 2013, according to the US’ Moody’s Investors Service. In the first half of 2014, another $10.3bn-worth was issued. The strong demand is driven by local preferences for sharia-compliant finance and the need to raise money for large-scale infrastructure plans, among other factors.

Doha meanwhile is working to enhance its physical and regulatory banking infrastructure required to support the growth of Islamic finance.

Oman has also joined the fray, with the government introducing legislation that permitted Islamic finance in 2012. Since then, several conventional banks have opened Islamic windows and two pure Islamic banks have been set up. The government is considering issuing a sovereign sukuk early next year as well.

Malaysia dominance

Yet the biggest market for Islamic finance lies outside the Gulf in Malaysia.

“Dubai and Malaysia are the two main engines of growth for the sukuk industry. In Malaysia, the central bank is issuing a significant amount of short-term sukuk,” says Damak, noting the key difference between the two markets.

Malaysia’s sukuk market is an essential part of the government’s fund-raising plans, with 35 per cent of its outstanding debt in sukuk, according to Moody’s.

The next most sukuk-reliant government is Bahrain, with 17 per cent of its debt in Islamic bonds.

The government of Malaysia is the largest issuer globally, with almost 59 per cent of the total sovereign sukuk outstanding, as of July. Most of this is issued in the domestic market and denominated in ringgit.

Given the importance of the sukuk market to the government, Malaysia is likely to remain the dominant power in the near term.

“Malaysia continues to play in a different league in my mind, although the recent tendency towards Dubai is becoming more evident,” says Al-Natoor.

Interest in Islamic finance spreads far beyond the Muslim world, with the UK and Hong Kong both big players in the market and presenting strong competition for Dubai.

UK strategy

The UK has 25 Islamic banks in London and wants to attract more. The financial services sector is a key cog in the country’s economy and expanding its capabilities further in the Islamic finance market is expected to open up new streams of revenue.

As a demonstration of its commitment to sharia-compliant finance, the government issued its debut £200bn ($339.7m) sukuk in June, which attracted several Islamic banks.

“It is a significant symbolic gesture,” says Al-Natoor. “It is tiny in the grand scheme of things, but it shows interest.”

Hong Kong is following the UK’s lead and issued a $1bn sukuk with a tenor of five years on 11 September, marking the world’s first US dollar-denominated sukuk issued by an AAA-rated government.

The offering attracted orders exceeding $4.7bn and was oversubscribed 4.7 times, with 36 per cent of the sukuk distributed to Middle East investors.

“[It] signifies an important milestone in the development of the Islamic capital market in Hong Kong,” said John Tsang, financial secretary of Hong Kong, in an official statement.

The sukuk is expected to be settled on 18 September and will not only be listed on the Hong Kong Stock Exchange but also the Malaysia Bursa and Nasdaq Dubai.

Conventional interest

Not only are non-Islamic governments raising sukuk, but conventional, international banks are also considering them as an alternative financing method.  

US bank Goldman Sachs is looking to issue about $500m in Islamic bonds and has been meeting with investors in the Gulf. 

The lender is the second non-Islamic bank to raise a sukuk, following the example of HSBC Middle East which issued a $500m bond in 2011.

 “This is something that will continue in the future as appetite increases,” says Damak. “Islamic finance has gained credibility over the past three decades.”

With its Islamic economy initiatives, Dubai will be hoping it becomes the focus of this appetite in the next decade.