At the ninth annual World Islamic Economic Forum in London on 29 October, David Cameron announced that he wants London to stand alongside Dubai and Malaysia as one of the great capitals of Islamic finance.
Islamic finance continues to grow at a much faster rate than conventional banking and has come out of the global financial crisis much stronger than its conventional counterparts. Global Islamic investments are expected to be worth around £1.3 trillion next year.
Britain has paved the way. The removal of double taxation and the extension of relief on Islamic lending were aimed at making this form of finance more attractive to investors. Real estate is a natural fit for Islamic investment, as Islamic law states that wealth should only be made from investment in tangible assets.
An Islamic, sharia-compliant transaction will involve a lender buying the property and leasing it to the borrower, who then pays the lender regular rental payments before buying it back.
A host of London landmarks, among them the Shard, the Olypmic Park’s East Village, Battersea Power Station, Chelsea Barracks and Harrods have been financed by Islamic finance investments. The Shard risked being abandoned amid global financial turmoil until it was financed by a consortium of Qatari investors, using sharia-compliant means.
The £1.25bn purchase and funding of Chelsea Barracks was underwritten by an Islamic financing arrangement in the form of a diminishing “musharaka” sale and “ijara” lease structure, whereby a lender and borrower enter into a “joint enterprise” and the lender then gradually transfers its share in the investment to the borrower, until ownership of the venture finally transfers to the other party.
Investment in real estate is neither restricted to London nor to premier buildings. This summer, the University of Bradford’s Green Student Village and the Argos national distribution centre in Stafford were bought using sharia-compliant investment structures. Last year, a care home was developed in Surrey with a sharia-compliant loan.
This demonstrates that a diverse range of investors are turning to sharia-compliant finance arrangements, and there is clear potential for this type of investment structure to grow in popularity.
As part of a package of measures designed to attract and retain investment from the expanding economies of the Middle East and south-east Asia, Cameron announced at the forum several Islamic finance initiatives, in particular the issuance of sukuk next year, valued at £200m.
Sukuk refers to bonds that are structured in such a way that they do not infringe Islamic law, which prohibits interest and a number of other harmful - or “haram” - activities. Sukuk holders share beneficial ownership in the underlying investment, asset or transaction on which they are based. Each sukuk holder can have an undivided ownership interest in the underlying asset. Consequently, sukuk holders are entitled to a share in the revenues generated by the sukuk assets, and will sometimes accept a share of any loss incurred.
The government’s Islamic bonds are likely to make use of real estate, probably government buildings or land, where a predetermined rental stream will substitute interest payments.
Despite the clear political will for the UK to become an Islamic finance hub, there will undoubtedly be challenges. Regulations could be streamlined to standardise practices and provide more confidence for borrowers and investors. Adopting recognised rulings, as opposed to making decisions on a case-by-case basis, would also assist in that process. Challenges are also likely to come from more competitive pricing of conventional products, so a strong value proposition and product differentiation need to be outlined to attract more customers to use sukuk over conventional bonds.
The size of the sukuk to be issued by the government may be small and largely symbolic, but it is likely to be heavily over-subscribed. No doubt the government will use this as an opportunity to assess the appetite for such products.
The UK is putting down a marker in aiming to be the first western country to issue a sukuk and this is welcome. The success of efforts to remove some of the hurdles faced by this niche sector will help shape the direction of the UK Islamic finance market for many years to come.
Qari Asim is a senior associate at DLA Piper and specialises in real estate and Islamic finance. He is a senior imam at Leeds Makkah Mosque, and holds executive positions in several national Muslim organisations.