Talk to many a City of London financier, and you will find a surprisingly intimate knowledge of the terminology of Islamic jurisprudence. For an increasing number of bankers and lawyers in the Square Mile, the terms murabaha (credit), ijara (leasing), and sukuk (bonds) now trip off the tongue as readily as the more familiar buzzphrases of Libor, CDS and seeking alpha.
This is not for effect. Rather, it reflects the growing realisation that London-based institutions need to stay abreast of one of the world’s fastest-growing financial sectors.
Over the past 10 years, the UK government has made a significant effort to court the sharia-compliant market, as part of a broader mission to maintain the City’s status as a leading global financial centre.
Attracting capital from the Middle East
Sharia-compliant financial assets globally constitute less than 1 per cent of total financial assets today, although Muslims account for almost one-quarter of the world’s population. With a growing number of Muslims seeking to structure their financial activities according to sharia principles, City strategists are aiming for a significant slice of these flows to be channelled through London.
The bottom line is that to continue to attract capital from the Middle East, the UK needs to have the capability to offer both conventional and Islamic financing mechanisms to clients.
It has done much to lay the groundwork for building a sustainable Islamic finance industry, gilding the regulatory architecture to make it as easy for investors to conduct sharia transactions in London as it would be in Kuala Lumpur or Manama.
“The UK has made key strides in creating a level playing field for Islamic finance,” says Asim Siddiqui, executive vice-president of UK-based sharia-compliant lender Gatehouse Bank. “We witness this in personal financial services with sharia-compliant home financing and savings products, and international cross-border products, such as sukuk, where the alternative finance investment bonds [AFIB] legislation has levelled the playing field for domestic corporate sukuk issuance, as well as international issues that have been listed on the LSE [London Stock Exchange].”
The first adaptation of the UK tax system for Islamic finance came in 2003, when the stamp duty rules applicable to residential mortgages were amended to eliminate the double stamp duty charge for Islamic home loans.
An accommodating tax and regulatory system has handed the UK a clear advantage. “Most sharia-compliant transactions that are not governed by their local laws tend to be governed by English law when there is a choice of international laws to be made,” says Farmida Bi, European head of Islamic finance at international law firm Norton Rose.
“Commercially, the legal system and the certainty of longer-term UK property lease contracts combine with the legislative work done in parliament to create a level playing field for tax for sharia-compliant investors that is way ahead of any other jurisdiction in the West,” says Siddiqui.
London legal influence
“English law is internationally recognised and most investors are comfortable with the associated legislative framework,” says Nigel Denison, head of Markets and Asset Management at Bank of London and the Middle East, Western Europe’s largest Islamic lender. “Many of our GCC-based clients are looking for investments within the UK, and in particular London, so it is natural that these transactions are in English law.”
Most sharia-compliant transactions … not governed by local laws tend to be governed by English law
As important as the legal framework is, it is London’s sheer influence as Europe’s largest international financial centre that draws transactions in, whether conventional or Islamic. “Whether you are a Gulf or Southeast Asian investor, this is a market and a place that you tend to know well and feel comfortable in,” says Bi.
The UK now has significantly more sharia-compliant assets than any other European country, with most of these assets being held in London. The UK Financial Services Authority authorised the first Islamic bank in Europe more than 10 years ago. Since then, four additional banks have been given the green light to establish operations. The 22 banks offering Islamic finance products far exceed the number seen in any other Western country.
Sukuk listings and Islamic fund management are buttressed by the City’s robust infrastructure of professional support, encompassing law firms and accounting practices.
“Not only are there a significant number of Islamic financial organisations operating out of London either as a branch or a head office, but there is also the full suite of supporting professional services, such as accountants and lawyers,” says Denison.
In line with this experience has come a strong pipeline of sharia deal-flows. The LSE now has 38 sukuks listed, cementing its credentials as the non-Muslim world’s premier listing venue for sharia-compliant debt products. Several issuers of these instruments have leveraged the LSE’s Professional Securities Market and the Main Market to access the City’s diverse pool of capital.
Now UK fund managers are realising the potential of tapping a new market by offering Islamic-compliant products. A recent report by property consultancy Savills found that the Middle East and North Africa region accounted for 9 per cent of buyers in the prime London property market in the first half of 2011. Given such a demographic, it came as little surprise when a local fund manager, London Central Portfolio, last year launched an Islamic fund designed to invest in prime London property.
The City is not resting on its laurels. It knows it has to remain competitive to attract Muslim investors. Both Luxembourg and Dublin have attracted sukuk listings, though these markets lack the depth and breadth of the UK capital.
“London needs to continue to work hard on two fronts,” says Siddiqui. “First, to further harvest its talent pool through training and education – London is well-positioned as it has some of the best Islamic finance training providers; and second, by developing a regulatory regime that takes account of the Islamic finance framework in upcoming global capital and liquidity regulations being proposed. With so much excess liquidity in places such as the Gulf – and such need for it in places like UK infrastructure – a win-win solution is required.”
Those of us active in the market would very much like to see a benchmark sukuk in London
Asim Siddiqui, Gatehouse Bank
Siddiqui adds that there is no transaction London is not capable of accommodating in a sharia-compliant manner. “Whether it’s a sukuk, a sharia-compliant insurance product or real estate-based financing, you can do pretty much anything in London and there will be people here who can help you to achieve what you are looking for in a manner in line with Islamic principles,” he says.
Local capability is one part of the equation. It is important to ensure that London competes with international centres for Islamic funds, but it is also crucial the UK has high-quality credits that are attractive to Middle East investors who would like to structure their investments in a sharia-compliant manner.
For London to retain its edge, it may need to launch a benchmark sukuk issuance. Plans to issue the first Islamic debt security by a Western government were put on hold in 2008, with the onset of the global economic crisis.
Nonetheless, says Siddiqui, all the factors are in place for a sukuk offering from London. “Cross-border capital flows, a strong regulatory framework, political support and a pressing need for funding for UK infrastructure projects through public-private partnerships [PPPs],” he adds.
Bi would welcome such an offering. “Those of us active in the market would very much like to see a benchmark sukuk in London, as it would be an important step in proclaiming London’s serious desire to attract more of this kind of work. It would be a very welcome addition to the things London has to offer. It’s more about sending out a very strong signal that London wants to attract Islamic finance.”
Although economic factors will weigh on any decision to launch a benchmark UK sukuk, there remains a feeling among seasoned practitioners that it is more a matter of political will than anything else.
London popular with Middle Eastern investors
Both Houses of Parliament look at the sukuk issue regularly and are increasingly aware that the asset-based characteristics in a properly tradeable sukuk may well favour infrastructure and PPP initiatives.
“A UK issue will be soundly structured and, as such, will be a major boost to global Islamic financial markets when it does happen,” says Siddiqui. “It is also very important to educate the corporate market in the UK to the advantages of corporate sukuk issuance under AFIB, as this provides a viable alternative to conventional funding in constrained conventional markets.”
More work is being done to firm up London’s status as the preferred Islamic finance centre outside the Muslim world. As the junior treasury minister, Lord Sassoon, told a House of Lords briefing on Islamic financing in January 2012, there is ongoing consultation on variable rate murabahas and Islamic derivatives. Plans are also afoot for a takaful market for Islamic insurance.
Such new skills, married to the formidable pool of experience in the world’s oldest financial centre, should help the Square Mile remain a compelling proposition for Middle Eastern investors and borrowers alike.
Key Islamic finance products
Commodity murabaha Islamic banks use this product to replace conventional inter-bank deposits. It involves the sale and subsequent re-purchase of a commodity. It is structured in such a way that it is essentially similar to a loan granted by the seller to the buyer. The difference in the sale and repurchase price earns the seller a return that is broadly equivalent to interest.
Ijara A leasing agreement in which the bank buys, then leases, an asset (for example, consumer durables or a property) to its customer for a specified rental over a specified period of time. The bank may have the right to adjust the rental charge in line with changes in the cost of finance. This method can be used for home-buying purposes (Islamic mortgages). This usually entails the customer making capital payments in addition to the rental charge. The customer’s ownership share of the property increases and the bank’s decreases by a similar amount with each such payment. Once all payments have been made, ownership of the property passes to the customer.
Murabaha A form of credit that enables customers to make purchases without taking an interest-bearing loan. The bank buys the goods for the customer and re-sells them to the customer on a deferred basis, adding an agreed profit margin. The customer then pays the sale price for the goods over installments, effectively obtaining credit without paying interest.