Some unlikely players are getting into Islamic finance

Global markets are vying to get a piece of the action in Islamic finance. With an emphasis on ethical investing and prohibitions against interest and excess risk, the relatively nascent industry has struck a chord with investors burned by conventional finance in recent years. According to Ernst & Young’s World Islamic Banking Competitiveness Report 2013, Islamic banking assets held by commercial banks globally are expected to exceed $1.8 trillion this year, a 38% increase since 2011. The vast oil wealth present in the Middle East and an aggressive push by Malaysia to serve as an Islamic finance hub in Asia have helped drive the growth. But the industry is also getting a boost from markets outside the Muslim world. Here are four markets to watch: 

UNITED KINGDOM

With 2.7 million Muslims, the UK is ramping up ambitions to be the Western capital of Islamic finance. The country launched an Islamic finance task force in March, aimed at bolstering business compliant with sharia, or Islamic law.  London is hosting the World Islamic Economic Forum this month, a conference of Islamic financiers that attracted more than $8.6 billion in financial deals last year. London’s involvement marks the first time the event has been held outside of a Muslim country. Currently, 22 British financial institutions offer Islamic products and there are three standalone Islamic banks, including the Bank of London and the Middle East, which plans to list its shares on Nasdaq Dubai this month in a clear bid to participate in the growing Islamic economy in the Gulf.  The country revised its tax legislation to accommodate Islamic bond, or sukuk, issuance but plans to offer its first sovereign sukuk were abandoned in 2009 as the global economic crisis sapped enthusiasm. Even so, London remains a major player in the sukuk market with the London Stock Exchange reporting that over £22.3 billion has been raised through 49 issues of sukuk on the LSE.

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INDIA

By all measures, India should be a natural player within the Islamic finance industry. The world’s largest democracy boasts one of the largest populations of Muslims in the world at 177 million; only Indonesia has more. But a long history of religious strife and political power struggles between the dominant Hindu population and Muslims has made India reluctant to embrace Islamic finance. Under the country’s current laws, the financial sector requires banking to be pegged on the concept of interest, forbidden in Islam. But a recent decision by the country’s central bank, the Reserve Bank of India (RBI), to allow a firm in the Kerala to operate as a non-banking financial company that follows Islamic principles is raising hopes that India will soon allow sharia-compliant business to develop further.

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It is an uphill battle, to be sure, based on precedent. Last year, the RBI pulled Kerala-based financial firm Alternative Investments and Credits Ltd.’s (AICL) license after 10 years, saying it violated India’s laws on charging interest, through its Islamic model. But experts say there is a change in the air, with India seeing Islamic finance as one method of helping to attract more investment from cash-rich Gulf states to help finance proposed infrastructure projects. If the political and economic will is present, there may be enough momentum to overcome pressure from right-wing critics, such as the Bharatiya Janata Party (BJP).

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LUXEMBOURG

This tiny country is playing a big role in the development of Islamic finance. It has grown into the leading non-Muslim domicile for sharia-compliant investment. Luxembourg already is a hub for internationally distributed investment funds but its emphasis on developing Islamic finance helped it attract Middle Eastern capital. It became the first country in Europe to host an Islamic finance institution in 1978, and with its reputation as one of the best tax regimes in Europe, Luxembourg has been a magnet for Islamic finance deals. As of 2012, the country has 41 sharia-compliant funds with €4 billion in assets under management. It is the main destination for listing sukuk in Europe, according to a report by Ernst & Young.

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While Islamic finance is certainty gaining in popularity, the industry has struggled to expand due to a shortage of highly liquid, investment-grade financial instruments that Islamic institutions can trade to manage their short-term funding needs. To help with that, Luxembourg’s central bank co-founded the International Islamic Liquidity Management Corp (IILM) in 2010 with other central banks from Asia, the Middle East and Africa. The IILM issued its first dollar-denominated $490 million Islamic bond August, a move that is being seen as a first step toward create a cross-border market for Islamic financial instruments.

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TURKEY

At first glance, Turkey seems to be a no-brainer when it comes to embracing Islamic finance. As the eighth most populous Muslim country in the world and Europe’s only Muslim country, there’s a natural market for sharia-compliant business. But Turkey long prided itself on a secular stance toward finance and politics, even referring to its four Islamic banks as so-called participation banks to imply the profit-and-loss-sharing model of Islamic finance. As the global financial crisis weakened Western markets, however, Turkey made the strategic decision to put aside its reluctance and strengthen ties with its oil-rich Middle Eastern brethren.

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That decision is expected to make Turkey a major player in Islamic finance going forward. Ernst & Young estimates that the Islamic banking sector will triple in 10 years reaching $100 billion by 2023. Sukuk will play a major part in this growth. Turkey revamped its tax laws to allow for the issuance of one type of sukuk without double taxation and the country’s Capital Markets Board said in April that it is looking to expand its offerings to encompass other forms of Islamic bonds. Turkey issued its first sovereign sukuk in 2012 and said it will issue lira-denominated sukuk twice a year. Given Turkey’s secular legal environment, the success of its offerings has been hailed as a benchmark for Western markets seeking to enter the Islamic finance market.

(Quartz / 03 Oct 2013)

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Alfalah Consulting - Kuala Lumpur: www.alfalahconsulting.com
Islamic Investment Malaysia: www.islamic-invest-malaysia.com