Could London be the global centre for Islamic finance?

Published: July 18, 2008

By Julian Evans

London, amid the gloom of the global credit crunch, one topic is sure to bring a smile to the faces of the City's down-trodden bankers: Islamic finance. While the sukuk market is as quiet as other bond markets this year, City players are still positioning themselves in expectation of a prolonged boom in Sharia-compliant financial products. The Islamic Development Bank in Jeddah predicts that global sharia financial assets will grow by 20% per annum from US$900bn to US$2trn by 2010. And a lot of that business is going through London.

Alderman David Lewis, the Lord Mayor of the City of London, says: "There are now 25 UK banks who provide Islamic products. There are five dedicated Islamic banks, nine Islamic funds, and one Islamic insurance company. There are 20 sukuk listed on the LSE. It's a huge potential area of growth for the City."

Jason Peers, CEO of Jasper Capital, a London-based investment bank that focuses on the Middle East, says: "Islamic bankers are beginning to accept London as the global centre for Islamic banking, which probably wasn't the case two years ago. Initially, Malaysia clearly stole a march on the Gulf in setting the market up. Then Dubai and Bahrain scrambled to catch up, but regional and parochial differences between them meant no clear financial centre has emerged in the Gulf. Meanwhile, London has quietly established itself as an alternative centre, and it's an alternative that bankers and issuers from Dubai, Bahrain and Malaysia are all equally happy to accept."

London really established itself as a centre in 2007, via several landmark deals. First of all, the sukuk market came of age, and London banks arranged global sukuk, such as DP World's LSE-listed US$1.5bn global sukuk, which was lead-managed by Deutsche Bank, Merrill Lynch, Millennium Finance Capital and Shuaa Capital, with Linklaters acting as lawyers. Jon Weguelin, CEO of European Islamic Investment Bank in London, says: "The interesting thing about the deal was it was 60% bought by non-Islamic investors. It really raised the profile of Islamic finance globally."

While Malaysia was, and is, the most active market for sukuk, the City established itself as the place to arrange big-volume deals. Ken Eglington, director for Islamic finance at Ernst & Young, says: "I don't think London will be able to displace traditional centres like Bahrain Dubai and Kuala Lumpar, but what London can do is to become the wholesale centre, with the big wholesale and secondary banks working here to provide structuring and innovation."

One only has to look at the league table for sukuk arrangers in 2007 to see the rising dominance of UK-based institutions. While CIMB led the pack, HSBC was second, Barclays Capital fourth, JP Morgan fifth, Deutsche Bank (London) was sixth, Citigroup seventh and Standard Chartered were 10th. And English law firms had undisputed dominance, thanks to the fact that many Islamic finance products are typically structured under English law, which has proved flexible enough to be relatively easily-combinable with Shariah law, while also secure enough to give confidence to international investors.

Roger Wedderburn-Day, partner for Islamic finance at Allen & Overy, says: "We've sometimes had long debates with Shariah advisory boards, where they've said to us, 'Under Shariah law you can't do this', and we've said 'Under English law, we have to do this'. It's been challenging at times, but so far we've always found a way of harmonizing the two approaches."

This year, while the sukuk market has been more active in the Gulf, and in local currencies, UK firms are still arranging the deals - for example, Standard Chartered arranged the US$2bn sukuk for RAK Capital in May, which was the first Ijara programme in the UAE, and Clifford Chance acted as lawyer. In other markets, London has a definite advantage, such as public-private partnerships (PPP) and private finance initiatives (PFI), two forms of financing typically used for infrastructure and municipal deals, which were pioneered in the UK in the 1990s and then exported around the world by UK firms like PWC and KPMG. Alderman David Lewis says: "There's around US$500bn in infrastructure investment planned in Saudi Arabia alone in the next few years. How will that all be financed. We think the City of London has a big role to play in that sort of financing. PPP and PFI was originated here, and UK firms have done 900 different projects around the world."

So this is one obvious advantage the City has in Islamic finance - its large pool of highly-trained financial professionals, in banking, in law, and also in PR, conferences and journalism, all of which help the London market establish itself as a global centre where Islamic bankers can come, network, gather information and do deals. Just in June, for example, London is home to the Middle East Association's annual meeting, the Reuters Islamic Finance conference, and the London Sukuk Summit, with IslamExpo and the World Islamic Banking Conference (WIBC) also happening in London in early July. One banker jokes: "Some people say the only people making money in Islamic banking right now are lawyers and conference organizers."

Regulators welcoming

London's role in Islamic finance has been strengthened by the support it has received from UK regulators. As early as 1995, then then-governor of the Bank of England, Eddie George, spoke of the "growing importance of Islamic banking in the Muslim world and its emergence on the international stage". The anecdote goes that Lord George met a young Muslim family who wanted to buy a house, but couldn't get a Shariah-compliant mortgage. Their faith effectively rendered them outside the UK financial community. Lord George thought this was unfair, and in 2001, he set up and chaired a consultative body, with representatives from the Bank of England, FSA, government, City and Muslim community, to look at the barriers to providing Shariah-compliant mortgages and other products to the UK's 3 million Muslims.

The Labour government also showed itself keen to set up the UK as the leading Islamic finance player in Europe. Ed Balls, the former City minister (and now education minister), undertook a consultation with several leading City players, to find out what the government could do to help the young market develop. The government agreed, in principle, to issue Treasury sukuk in order to help the secondary trading market develop and to give Islamic banks some AAA-rated assets with which to manage liquidity.

Ken Eglington of Ernst & Young, who was part of the Treasury consultation committee, says: "The industry is very keen on the government's proposals. A Treasury sukuk would raise the profile of the market enormously. It could develop a yield curve, which other issues would use as a benchmark, so deals would be priced over UK Treasuries."

The UK is also home to the first Islamic retail bank, the Islamic Bank of Britain, which received its FSA license in 2004. A source at the FSA, who did not wish to be quoted, says: "The government is very keen to reinforce London as a financial centre, including through Islamic banking. We want to maintain a level playing field for Islamic and non-Islamic banks. There were some initial issues, for example the issue of Shariah boards. We didn't know much about them. Would they play a role in managing banks? So far, we've discovered that the role is essentially advisory, which is fine by us."

ICMA, the International Capital Markets Authority based in London, is also playing a role in helping the Islamic finance market to improve standardization. Ruari Ewing, the advisor covering Islamic finance at ICMA, says: "We've been working with the International Islamic Financial Market (IIFM), a Bahrain-based organisation working to develop the Islamic capital markets. We're working with the IIFM to develop the repo markets, best practices in the primary markets and education of primary market participants."

London has been partly helped by the huge respect in which its regulatory system is held worldwide, though as Sir Thomas Harris, vice-chairman of Standard Chartered, admits: "This respect has been somewhat diminished by the credit crunch and by the bankruptcy of Northern Rock". Nonetheless, the UK is still exporting its regulatory expertise to the Gulf and the global Islamic finance market. Kitty Usher, economic secretary at the Treasury and the minister now in charge of developing the UK Islamic finance market, says: "We're helping to set up the International Centre for Financial Regulation in London, which should be set up by the end of the year. We hope it will be a world leader in regulatory training, including for regulators in the Islamic finance market."

The UK already exports such expertise - for example, the CEO of the Qatar Financial Authority is Philip Thorpe, formerly of the FSA, who used the UK tripartite agreement between the Bank of England, the FSA an the Treasury, as the basis for Qatar's own financial regulatory model. And UK universities are proving quick to establish themselves as centres of training and learning. Oxford University has a respect centre of Islamic finance, called the Oxford Centre for Islamic Finance, as does the University of Reading. Of course, the best known scholars for Islamic finance are in the Middle East. However, new scholars are being trained in the UK.

Re-packaging UK plc

And the UK has proved itself famously open to foreign money - you only need to look at the number of foreign owners and foreign players in the Premiership. And UK governments and companies have shown themselves to be very welcoming to Middle Eastern investment into UK assets. For example, last year Ford sold Aston Martin for £479mn to a consortium that included Adeem and Investment Dar, two Kuwaiti investment houses. The acquisition, which was arranged by WestLB, was a rare example of an Islamic LBO. David Richards, chairman of Aston Martin, says: "All the investment had to be Shariah-compliant, and we're now a Shariah-compliant company, which means we don't undertake activities that involve alcohol, or raise conventional debt financing."

Richards says he expects other UK firms to be bought up using Islamic finance. He says: "To the outside world it looks more complex. We've had a number of inquiries from people looking at receiving funds from Sharia-compliant investors, who are concerned about constraints on their business. But the reality is it's not at all complex."

David Testa, the banker who worked on the Aston Martin deal at WestLB, has since left and set up Gatehouse Bank, a new Islamic investment bank that launched in May, which aims to become the market leader in Sharia investment bank advisory work. It joins the European Islamic Investment Bank (EIIB), the European Finance House and the Bank of London and the Middle East (BLME), all of which have been set up in the last 18 months to provide Islamic advisory and commercial banking, as well as private equity, within western markets.

These banks are bringing the story of Islamic finance to western markets. Humphrey Percy is CEO of BLME, which was set up in July 2007 with capital mainly from Kuwaiti investors, including Boubyan Bank. It has £250mn in equity capital, which Percy says "makes us the largest UK Islamic bank by some distance", and gives it the ability to establish itself as a leading commercial bank.

Percy says: "Our business was not set up to deal with the Middle East. Out function is to develop Islamic finance internationally. We're doing business in the US, in the EU, in the UK and Turkey. For example, we're working with a mining company in Colorado that needs mining equipment. So we've provided that company with an Ijara [an Islamic leasing structure] for the equipment."  BLME is also setting up funds to help channel Middle East money into western assets - it is launching a medical office building fund which will allow investors to access the medical office building sector in the US.

The EIIB is a similar model, with £185mn in equity capital. Its CEO, Jon Weguelin, says: "Ours is more of an investment banking approach, it's more diversified". The bank works on treasury and capital markets transactions, particularly term financing, and it also recently set up a private equity business, to take direct stakes in European businesses like Aston Martin, for which it was in the finance syndicate. Weguelin says: "A lot of UK companies are Sharia-compliant already. We're completely Shariah-compliant. We don't even have alcohol at the Christmas party."

He says: "I do think we'll see many more UK assets bought up using Shariah-financing. But there are some tax issues to be cleared up first. The idea with the Aston Martin deal was that the financing would be taken up quickly by a sukuk. But that hasn't happened yet. The government needs to clear up some tax and VAT issues before the Islamic acquisition market can really take off."

Ken Eglington at Ernst & Young says: "Some in the government have been talking about exempting transactions from tax. I've tried to say 'that would be nice but it would be better to ensure that such deals are treated exactly the same as conventional deals, as that would help British corporations. There are too many tax disadvantages at the moment to make sukuk attractive for UK companies. If that issue is cleared up, I absolutely believe UK companies will be issuing plenty of sukuk. London has a massive opportunity to re-package OECD assets in a Shariah way."

Cultural sensitivities

Of course, for all of the City's flexibility and adaptability, Islamic finance in London is still a meeting of two different cultures. In the UK, selling British companies and making them Shariah compliant could be portrayed negatively in the press. Some papers, for example, raised eyebrows at Aston Martin, once the car of the hard-drinking and gambling imperialist James Bond, now following the Koran. And there was tabloid apoplexy when the Archbishop of Canterbury suggested allowing British muslims to have civil law cases heard in Shariah courts.

Percy of BLME says he thinks this media storm, in February, dissuaded the Treasury from going forward with its plans to issue a sukuk this year. Others agree. "They bottled it", says one banker. Ken Eglington says: "We were deeply disappointed by the government's response to the consultation. They basically delayed it. If we delay much further, we're heading towards an election, when the last thing they want is ill-informed tabloids making headlines."

Kitty Usher, the minister at the Treasury responsible for Islamic finance, says: "Our decision absolutely was not affected by the media. It's just the timetable wasn't right. We want to make sure we get this right, and we'll make our decisions based on the interests of British companies and citizens, not based on what the right-wing press says about us."

But the government had better get a move on. While it has stolen a march on other western capitals such as New York and Amsterdam, other cities are moving faster. Hong Kong has big ambitions to establish itself as Asia's centre of Islamic finance, and the Hong Kong airport authority has already announced plans to issue a sukuk this year.

On the other side, non-Muslim British bankers have a job in convincing Middle Eastern companies and investors that they are the best intermediaries for the Islamic market. After all, Islamic finance is a culture-specific market, that reflects the cultural pride of Islam. So why not give the business to local businesses run by Muslims, rather than outsourcing it to non-Muslims in London?

Percy of BLME says: "It's not a disadvantage, not being Muslim, as long as you know what you're talking about. And if you're experienced in conventional finance, it's much easier to understand Islamic finance, because there's a lot of similarities. And we do employ a completely international team." And of course, western businesses might be more likely to use Islamic products or to sell to Islamic investors if they are faced with a banker with a thoroughly English name like Humphrey Percy, rather than a foreign gentleman in a thoub.