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Tuesday, 15 July 2008

Locust: Islamic finance – London banks on sharia law

Locust looks at how London is positioning itself as the west’s centre for Islamic finance.

The cutting edge of finance is usually associated with the likes of ever-more complex derivatives instruments or ultra-fast trading systems. Yet with the rise of modern Islamic finance, bankers the world over may soon find that knowledge of thousand-year-old religious principles is as much an asset as the ability to write clever algorithms.

Islamic finance consists of financial products or services that adhere to Islamic, or sharia, law. Islamic financial services include banking, the issuing of Islamic bonds (sukuk), insurance and fund management.

For a financial service to be certified as sharia-compliant, it needs to meet a number of criteria. These include that no interest be paid on any financial product, that all financial products be backed by a tangible asset, and that the service or product not be linked with anything incompatible with sharia law, such as alcohol, tobacco or gambling.

While these principles have guided commerce in the Islamic world for a millennium, the last decade in particular has seen a surge in both the demand for and supply of Islamic financial instruments.

Surprisingly, alongside the likes of Bahrain, Saudi Arabia and the United Arab Emirates in the Middle East and Kuala Lumpur and Singapore in south-east Asia, London is also looking to take advantage of the modern wave of sharia-compliant banking by positioning itself as a centre of Islamic finance.

The UK now has three fully-sharia-compliant banks, founded in 2004, 2006 and 2007. In addition there are over 20 major western banks – four times more than in any other European country – that can offer customers in the UK an “Islamic window” through which to buy Islamic financial products and services. Many UK-based law firms also offer services relating to Islamic finance.

Regulatory support

The UK’s large Muslim population along with London’s status as a global centre of finance and its relatively much closer financial ties with the Middle East than, for example, New York, are driving the organic growth of Islamic finance.

But Islamic finance has another great advantage in the UK, namely the support of the government. The UK has adapted its financial regulations to accommodate the requirements of sharia-compliant banking.

This support has a number of objectives. For example, it contributes to the government’s effort to combat the social exclusion of minorities (especially young Muslim men), which is further backed up by the relatively large number of courses and qualifications in Islamic finance offered by UK institutions.

The support also has a clear financial rationale in that, if the City of London is able to establish itself as the west’s main port of call for financial banking, then the UK will be in a better position to benefit from international flows of sharia-compliant investment.

These flows are increasing at a staggering rate. International Financial Services London estimates, in a report released in January, that the market for sharia-compliant financial services grew from $150 billion in the mid-1990s to $531 billion by the end of 2006. And a report released in May by Damac Capital International says that the global market for sukuk more than doubled between 2006 and 2007, hitting $62 billion from $27 billion a year earlier, and that it will reach $200 billion by the end of the decade. The Damac report suggests also that the entire Islamic banking and finance market is itself growing at 15 to 20 per cent annually.

The UK has, since 2007, been expressing a determination to be the first western government to issue an Islamic bond. So far, the only western issuers of sukuk have been the Texas-based oil company East Cameron Partners, the German state of Saxony-Anhalt and the World Bank.

The SRI factor

There is another, less obvious way in which London is suitable as a home for Islamic finance: its experience and leadership in the field of socially responsible investing (SRI). For with its injunctions against investing in financial products linked with alcohol or tobacco, and, more generally, with its use of criteria and rules at odds with standard western practices, Islamic finance bears a striking resemblance to SRI.

The fact that SRI managed to make a home for itself in the City of London augurs well for this new wave of investors who once again call for some outside-the-box thinking by the mainstream of UK investment professionals. What is more, the growth in Islamic finance in the west may in turn serve to break down more barriers for SRI advocates pushing for the greater use of non-financial investment criteria by western investors.

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