Islamic Finance Expertise in the UK
Islamic finance has been developed in its modern form over the past three decades, although its key principles remain unchanged. A number of countries, including Malaysia, Iran, Saudi Arabia and the Gulf states, have led the way in the development of Islamic finance. More recently, London has been keen to establish itself as the key western centre of choice for Islamic finance. This has involved key roles for government and the private sector. The process of establishing London as the western centre in the growing market for Islamic finance is central to IFSL’s remit of promoting expertise of UK financial services around the world.
The global market for Islamic financial services, as measured by Shariah-compliant assets, is estimated to have reached US$729bn at end-2007, 37% up from US$531bn in 2006. Islamic commercial banks accounted for 74% of the assets, investment banks 12% and sukuk issues 11%. The balance is made up by net assets of funds and assets of takaful providers. Global assets have grown from about US$150bn in the mid-1990s.
The Islamic finance industry has felt the influence of the credit crunch and downturn in the global economy in 2008, with a drop in sukuk issuance and a fall in the value of equity funds. Islamic banks, however, have been less affected than many conventional banks.
Assets that can be allocated to individual countries from The Banker’s survey of 500 organisations reveal that the leading countries for Shariah-compliant assets are Iran with US$235bn, Saudi Arabia US$92bn and Malaysia US$67bn. Other Gulf states, including Kuwait, UAE, Bahrain and Qatar, are also prominent. The UK, in eighth place, is the leading western country with US$18bn of reported assets, largely based on HSBC Amanah.
Banking and sukuk – the issue of Islamic notes – represent the forms of Islamic finance that are most well established, although takaful (insurance) and funds are also evolving. Products that may be the subject of innovation include private equity and private wealth management.
Islamic banks have been perceived more positively during 2008 in view of the major challenges faced by many conventional banks arising from the credit crunch. Islamic banks have not, like many conventional banks, been exposed to losses from investment in toxic assets or become dependent on wholesale funds, as they are prohibited from these activities.
In The Banker’s survey, Shariah-compliant bank assets totalled US$622bn in 2007, of which US$537bn were in commercial banks and US$85bn in investment banks. Countries with most of the 280 banks reporting to the survey include Malaysia with 38, while Kuwait, Bahrain, Iran and Pakistan each have between 20 and 29 banks supplying Islamic financial services.
In the UK, five fully Shariah-compliant banks have been established putting it in the lead in western Europe. These are The Islamic Bank of Britain (IBB), the European Islamic Investment Bank (EIIB), The Bank of London and The Middle East (BLME), European Finance House, and Gatehouse Bank. The latter two each received a banking licence in 2008. In addition to these five Shariah-compliant banks, there are an estimated 17 conventional banks that have set up windows in the UK to provide Islamic financial services. The 22 Islamic banks in the UK substantially exceed that in any other western country or offshore centre.
Sukuk are issues of Islamic notes that represent an alternative to conventional bonds. Issuance of sukuk increased rapidly from US$1bn a year in 2002 to US$42bn in 2007. In common with the broad-based slowdown in global capital market activity, sukuk issuance fell away during 2008 to an estimated US$20bn. Key contributing factors were a decline in asset valuation, a lack of liquidity and a lack of market confidence. Over a third of sukuk are listed with the remainder being over the counter. Nasdaq Dubai and London Stock Exchange are the main centres for listing. At end-2008 there were 20 listings in Dubai totalling US$18bn and 18 in London worth US$10bn.
Although market activity has fallen away, particularly in the second half of 2008, the long-term prospects for sukuk are positive once markets recover. Three factors should have a role in fostering growth in demand when market conditions improve. First, there is a commitment to a substantial programme of infrastructure investment in the Gulf Co-operation Council (GCC) totalling up to US$1,000bn over the next 10 years, some of which could be financed through sukuk. Second, recent years have shown that there is an appetite for investment in sukuk beyond Islamic investors among those investors that wish to gain exposure to diverse but high quality assets. Third, governments and regulators in a variety of countries have recognised the important role that sukuk can play in capital markets and have been giving priority to developing their countries as sukuk centres.
The market for Islamic funds has expanded over the past decade. Eurekahedge estimates that the total number of Shariah-compliant funds reached 680 funds during 2008 having risen from around 150 in 2000. These funds include mutual, alternative, investment trusts, private equity, real estate and structured products. The total value of 420 Islamic equity funds fell from US$17.2bn at end-2007 to an estimated US$12.5bn end-2008. The bulk of Islamic funds are domiciled in the GCC and Malaysia, although several UK offerings were launched in 2008.
Takaful, similar to mutual insurance, is a risk sharing entity that allows for the transparent sharing of risk by pooling individual contributions for the benefit of all subscribers. The global market is at an early stage of development, with two thirds of global premiums, US$4.8bn out of an estimated US$7.2bn in 2007, based in Iran where takaful is the compulsory form of insurance. Other than Iran, the takaful market is mainly concentrated in Malaysia, Saudi Arabia, Kuwait and UAE. Penetration of takaful is nevertheless low in these and other countries with Islamic majorities and therefore represents a strong growth opportunity. The first Shariah-compliant independent takaful company, Principle Insurance, was launched in the UK in 2008.
The range of products generated by Islamic finance has broadened steadily. In 2008, Barclays Capital and Sharia Capital of the US launched the first Islamic fund of hedge funds. The UK has a successful record as a trading centre for Islamic products as commodity-based London Merchantile Exchange (LME) contracts are traded off exchange. This has been a key mechanism for Islamic financial institutions to manage their assets and liabilities. In 2008, ETF Securities launched a Shariah-compliant precious metal exchange trade commodity platform, based on platinum, palladium, silver, gold and a basket of other metals.
The UK is a major global provider of the specialist legal expertise required for Islamic finance: Chambers & Partners list 18 major law firms in the UK as providing legal services. The Big Four professional services firms – PricewaterhouseCoopers, KPMG, Ernst & Young and Deloitte – have each established an Islamic finance team in London.
There is a growing demand for skills as Islamic finance expands and UK institutions are at the forefront of providing qualifications for the global industry. Research Intelligence Unit has identified 55 such institutions in the UK, more than twice as many as Malaysia, the next largest provider with 24. The UK offering spans the full range of qualifications starting from 16 year-old school level through vocational and career-based qualifications, and undergraduate and postgraduate degrees. The courses offered by the Securities and Investment Institute (SII), Chartered Institute of Management Accountants, Association of International Accountants and Cass Business School have been key to the development of Islamic finance qualifications. In a separate initiative, the Islamic Finance Council UK has developed a pioneering ‘Scholar Professional Development Programme’ in conjunction with the SII, the objective of which is to teach conventional finance to Shariah scholars worldwide.
An important feature of the development of London and the UK as the key western centre for Islamic finance has been supportive government policies intended to broaden the market for Islamic products for both Shariah-compliant institutions and firms with ‘Islamic windows’.
Since 2003, a key focus of UK government policy has been the establishment of an enabling fiscal and regulatory framework in the UK for Islamic finance. Initiatives have included:
Following a review into the case for issuing Shariah-compliant government bonds, the UK government announced in November 2008 that this would not offer value for money at the present time but it would keep the situation under review. At the same time the UK government announced other initiatives designed to support the UK as a centre for global finance and to ensure conventional and alternative finance are treated on the same basis. The outcome of policy is seen in the establishment of various aspects of Islamic finance in the UK. In summary, the UK offering includes:
These services provide a firm platform on which London and the UK can build on its position as the key western centre for Islamic finance.