Cash with conditions

More than 1,000 investors from over 100 countries gathered for the ninth World Islamic Economic Forum last November – and for the first time, they met in a non-Islamic country, the UK.

The choice of venue reflected the increasing influence of Islamic finance in the global investment market and notably the emergence of the UK as a major centre for Islamic finance. British Prime Minister David Cameron recently set out his ambitions for London ‘to stand alongside Dubai and Kuala Lumpur as one of the great capitals of Islamic finance’.

And there are plenty of high-profile projects to show the way: Islamic financing supported The Shard and the 2012 Olympic Games athletes’ village, and DP World’s London Gateway port and logistics park also has an Islamic financing package behind it.

According to UK Trade & Investment, the global market for Islamic finance was worth around $1.3tr at the end of 2012/13, with $19bn of reported assets in the UK. More than 20 international banks operating in the UK are working in Islamic finance, six of which are fully Sharia compliant and in a news item about opportunities for Islamic finance in the country, UKTI has drawn up a list of key projects which currently need investment and development partners. These include offshore wind project and the Atlantic Gateway project, a £75bn regeneration development in northwest England, covering an area which includes the Port of Liverpool and Manchester Ship Canal.

Global appeal

Islamic finance, which operates according to Sharia law, would seem an obvious investment solution in Islamic countries but figures show that it is growing fast, with Sharia-compliant assets globally expected to reach $2tr this year, a 150% increase compared with 2006.

Islamic finance is becoming increasingly widespread – not only in the UAE and Middle East, but in the West. There is probably more than one factor behind this, says Robert Newman, real estate partner and head of the Islamic property finance team at the global law firm Stephenson Harwood.

“I think this growth is broadly because of where funds are available – and at the moment various Middle East countries are particularly keen to invest in the UK and the West, and they are increasingly wanting to do that in accordance with their Islamic principles,” he says. “Countries like Malaysia and Indonesia are also quite active, and wanting to promote Islamic finance in their deals.

“Secondly, some of the Islamic finance institutions haven’t suffered as badly with problems in the finance industry and therefore are not quite as hampered as traditional lenders. It is probably true to say that if you look at areas where international banking suffered the biggest losses, these tend to be in the more speculative areas where the Islamic finance people have not gone into – so they have not suffered such big losses.”

Islamic finance establishments have tended to be more cautious and conservative, adds Mr Newman. “However, opinions differ on whether it is true to say it is a safer form of banking or not, because it partly depends on how liberal a view they take in the decision to fund – Saudi organisations tend to take a stricter view than Malaysian, for example. They still have to take credit decisions, like any banker. Certainly Islamic bankers would say they are more cautious, much lower risk. But a lot of traditional banks would not necessarily accept that is the case.”

Ethics eye

Another key factor held out as an advantage is that some people put Islamic finance into an ‘ethical banking’ category, says Mr Newman. Sharia law prohibits taking or receiving interest at exorbitant rates, requires general fairness and sharing of risk between parties, and does not (usually) allow investment in ventures that might feature gambling, alcohol, tobacco, weapons and other areas considered non-ethical.

Of course, that raises issues such as a hotel with one slot machine, or a port that handles imports of wine. Some Islamic finance institutions try to ring-fence and avoid these areas, while others choose to set them off against something else – much like carbon offsetting, they might make charitable donations to Islamic charities to offset the potentially ‘bad’ income they might receive.

Islamic finance has been used for various assets, including aircraft, ships and real estate. “It lends itself to real estate and fixed assets, particularly because the main principle is that there should be tangible assets involved,” says Mr Newman.

Whatever financial structure is used, this must be approved by a Sharia board of scholars. Some international banks with a strong involvement in this type of finance will have their own retained Sharia boards to sign off a deal, while others go to external boards for approval of a financial package.

That means a demand for scholars who are financially well versed as well as qualified in Islamic principles – and they can be difficult to find. “One of the problems the industry has it the lack of standardisation of opinion on what is Sharia-compliant and what is not,” says Mr Newman. “There are a couple of bodies trying to issue guidance but none is accepted by everybody as the last word on this, and that does lead to concerns about the degree of inconsistency. There are probably not enough good scholars who understand the ins and outs of international finance as well as the religious principles and it can be a problem getting a ruling on a complicated international deal.”

Increasing interest

Stephenson Harwood advised on the UK’s first ever Sharia-compliant secondary buyout, voted Islamic finance deal of the year by The Banker magazine in 2009, and the firm has designed, developed and documented Islamic structures for a variety of transactions.

Mr Newman says the use of Islamic finance will continue to increase. “Middle East investors are becoming an increasingly important part of global financing. With those numbers growing, they have more self confidence and increasingly they are saying – we will invest, but we want these principles to be respected.”

This will also be reflected in global investments in the ports sector. Towards the end of 2013, Ahmed Osman, governor of Djibouti’s Central Bank, said he would be promoting Islamic finance to increase government revenues and boost investment into internal infrastructure projects. After passing a banking law in 2011 allowing Islamic finance, the country is hoping to boost the economy through building ports, railways, roads and airports.

DP World’s Doraleh Container Terminal in Djibouti was built using Islamic finance from the Jeddah-based Islamic Investment Bank.