The UK has made considerable efforts to develop itself into a centre for Islamic banking, and it has paid off, with London now considered Europe’s main hub for sharia-compliant finance.

In London today there are 23 conventional banks offering consumers Islamic financial products, more than in the rest of Western Europe combined, as well as five fully sharia-compliant banks and one independent takaful (Islamic insurance) provider.

Although Islamic finance remains a nascent industry in the UK, it has grown at an exponential rate, largely helped by the strong government support it has received since 2003, as well as the investments made in London by Gulf-based Islamic banks looking to offer services to the UK’s 2 million Muslims.

“The Treasury [finance ministry], the Financial Services Authority [FSA] and the Bank of England have done a huge amount to establish a legal, fiscal and regulatory level playing field for Islamic finance,” says Ian Luder, Lord Mayor of the City of London. “The success of this is shown by the major growth in the market.”

Key initiatives have included the removal in 2003 of double taxation on Islamic mortgages and the extension of tax relief on Islamic mortgages to companies as well as individuals.

Meanwhile, the 2007 budget introduced new measures enabling sukuk (Islamic bonds) to be held and traded in the same way as conventional bonds.

Of the five standalone Islamic banks in the UK, the Islamic Bank of Britain (IBB) is the only one that offers retail banking services. On its establishment in 2004, it became the first sharia-compliant bank in the Western world and has since gained a sizeable presence, with more than 40,000 customers and $250m in customer savings.

The remaining four banks – the European Islamic Investment Bank (EIIB), The Bank of London & The Middle East (BLME), European Finance House and Gatehouse Bank – specialise in investment banking. All five are either partly or fully owned by Gulf investors. For example, Gatehouse Bank is wholly owned by The Securities House, a Kuwaiti Islamic investment company.

UK Islamic banking sector

  • 23 – Number of banks offering Islamic finance products in London
  • 2004 – Year the first sharia-compliant bank was set up in the UK
  • 13.32 per cent – Size of Qatari emir’s stake in Islamic Bank of Britain
  • $2bn – Estimated value of UK Islamic mortgage market by the end of 2009

Source: MEED

IBB was formed by a group of Qatari investors that includes Prime Minister Sheikh Hamad bin Jassim bin Jabr al-Thani, with a 29.99 per cent stake, Emir Sheikh Hamad bin Khalifa al-Thani, with 13.32 per cent, Qatar International Islamic Bank, with 11.22 per cent, and Qatar Islamic Insurance Company, with 3.78 per cent.

BLME’s primary shareholder is Kuwait’s Boubyan Bank, and EFH and EIIB also have retail Islamic banks as shareholders. In this way, Gulf Islamic banks have gained considerable access to the UK market.

Industry experts say approaching the London market through investing in new banks, rather than opening an overseas branch in the UK, is a deliberate strategy on the part of the Gulf banks. “Having a clearly identifiable ‘onshore’ brand and structure may well help marketing in the UK,” says Luder.

“They are not targeting existing customers from the Middle East who already know their brand,” says Junaid Bhatti, a fellow of the Institute of Islamic Banking & Insurance in London, who helped set up IBB’s operations.

“They are targeting British Muslims and the British public who are not familiar with the Gulf banks. The logo of Islamic Bank of Britain is red, white and blue to resemble the Union Flag.”

Setting up a branch in London has given banks like The Securities House far greater ability to address the investment needs of their clients in Europe.

In August this year, The Securities House announced it was merging its two London-based subsidiaries, Gatehouse Bank, which specialises in capital market services, and Global Securities House, which specialises in asset and fund management, into one entity under the Gatehouse Bank brand.

Growing opportunities

“The combined entity will create an even stronger business with which to approach the growing opportunities in sharia-compliant financial markets, both in London and worldwide,” said a statement issued by the Securities House at the time of the merger.

Gatehouse’s Bank’s decision to consolidate in this way is considered a sensible strategy by industry insiders, who claim the relatively small size of London’s Islamic banks has constrained them from taking part in financing deals in Europe.

“The major players in the Islamic finance market in Europe aren’t the Islamic banks,” says one London-based banker. “Over the past five years, we have worked on deals across the continent out of our London office that require more than $4.4bn in sharia-compliant debt. So Gulf institutions that are looking to make a sizeable investment in, for example, the London property market, are forced to work with a conventional bank with an Islamic finance window, as they know the UK’s Islamic banks can only provide a portion of the financing.”

For London’s Islamic banks to capitalise on opportunities across the European continent and increase operations on a large scale, these institutions either need to increase their capital base or undergo some consolidation.

The London Stock Exchange (LSE) has played a pivotal role in London’s development as the European hub for the Islamic finance industry. Today, there are four sharia-compliant institutions quoted on the Alternative Investment Market (Aim), London’s junior stock exchange: IBB, EIIB, The Family Shariah Fund and Shariah Capital.

BLME is currently preparing for an LSE listing in 2010, after shelving plans to list on the exchange this year.

The LSE has also established itself as a popular platform for the issuance of sukuk. To date, more than $10.6bn has been raised through 18 issues of alternative finance investment bonds, the term used by the Treasury to refer to sukuk. This level is exceeded only by the Nasdaq Dubai stock exchange.

“Through the London markets, Islamic investors are able to take full advantage of product innovations in other areas of the industry – for example, exchange-traded funds [ETFs],” says Gillian Walmsley, the LSE’s product manager for debt and specialist securities.

“There are now seven sharia-compliant ETFs based on Islamic indices and, despite the prevailing market conditions, ETFs were one of the few areas of the market to show sustained growth in 2008.”

Two of Europe’s key ETF providers, Ishares and DB X-Trackers, offer sharia-compliant ETFs on the LSE. Ishares offers ETFs based on the MSCI World Islamic, MSCI USA Islamic and MSCI Emerging Markets Islamic indices. In 2008, these ETFs had a combined turnover of £75.5m ($123m) by value.

Budget boost

DB X-Trackers’ Islamic ETFs are based on the S&P Japan 500 Shariah, S&P 500 Shariah, S&P Europe 350 Shariah and DJ Islamic Market Titans indices, and recorded a combined turnover of £5.9m in 2008.

The sukuk market received a potentially major boost in the UK’s 2009 budget when finance minister Alistair Darling announced three new measures aimed at those wishing to obtain finance by issuing alternative investment bonds.

These include relief from stamp duty land tax in respect of transactions undertaken as part of the issue of property sukuk, and relief from tax on capital gains in respect of transfers of land to and from sukuk issuance vehicles. The third measure ensures that the person obtaining financing will continue to be entitled to claim capital allowances while the land is held by the sukuk issuance vehicle.

This amended legislation has made London a more attractive location for issuing and trading sukuk. “Corporate sukuk are imminent and a possibility before the close of 2009,” says Richard Thomas, chairman and chief executive officer of Gatehouse Bank.

In July 2007, the UK government carried out an impact assessment of sukuk legislation, with the aim of issuing the first UK sovereign sukuk in 2009. The issuance has since been delayed because of prevailing market conditions but is still eagerly awaited. Industry insiders say a UK sovereign sukuk issuance is needed to set a benchmark yield for other potential originators in the EU and kick-start a Euro-sukuk market.

In this regard, France looks set to be London’s main competitor, after the French National Assembly passed an amendment to its Civil Code in early September to assist in the structuring of sharia-compliant products in France.

“The market is also eagerly anticipating a French sukuk issue to create a benchmark for the European market as a whole,” says Farmida Bi, a partner at UK law firm Norton Rose who has specialised in capital markets transactions, including Islamic finance and securitisation, for more than 15 years. “This latest move shows a willingness by the French government to develop this market.”

London’s Islamic finance market is now looking ahead to new growth areas. “I expect to see active developments in the areas of savings and wealth management, and in takaful and retakaful,” says Luder.

Property market

In January this year, BLME, the largest of the UK Islamic banks, announced the launch of its private banking division, and will continue to focus on expanding this part of the business as it works towards its LSE listing.

The ailing property market is also seen as a potentially lucrative area of the market. “Right now there are certainly opportunities for the Islamic banks in UK real estate in light of the property crash,” says Bhatti.

Islamic home financing is becoming an internationally acceptable product and is an area where London is taking the lead.

According to the UK Treasury, the UK’s Islamic mortgage market grew by about 50 per cent between 2007 and 2008 to more than $1bn, and is set to reach $2bn by the end of 2009, with the FSA now regulating Islamic mortgages under the murabaha (cost-plus financing), Ijara (leasing) and diminishing musharaka (co-ownership) structures.

In addition to benefiting from London’s position as a well-established financial centre with deep capital markets and specialist expertise, the UK’s Islamic financial institutions are subject to higher standards of corporate governance imposed by the FSA, which has ensured that the industry remains of a high standard.

“London has been at the forefront of all the key developments in Islamic finance in Europe, and has led the way with a number of significant milestones,” says Walmsley.

With Paris now responding to London’s policy-making in the Islamic finance sector, the Gulf’s Islamic banks will have a key role to play in ensuring the UK remains at the forefront of the industry as competition for business in Europe grows.