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It’s not just pro-Muslim sentiment that is fuelling the emerging Islamic finance market, Government legislation is lending a helping hand too. By Farmida Bi
As law firms and investment banks stampede into the Gulf, the UK Government continues to legislate to support the City’s claim to be the international centre for Islamic finance. But against the competing claims of Dubai and Malaysia, it is worth asking whether Islamic finance is here to stay or if it is a short-term phenomenon, driven by the high price of oil and pro-Islamic sentiment that has followed 9/11.

Until recently Islamic finance was a niche practice area and financing structures focused mainly on commodity-trading murabaha transactions. It has been primarily the issue of international sukuk (Islamic bonds) that has given it its high profile, although Islamic financing techniques are now used in many sectors, including residential and commercial property, insurance and retail products.

The first international sukuk was issued by the Government of Malaysia in 2002 and in January 2006 part of the acquisition of P&O by Dubai Ports World was funded by a $3.5bn (£1.76bn) sukuk by Dubai’s Ports Customs and Freezone Corporation (PCFC), suggesting that the sukuk had become simply another product in the armoury of bankers.

Sukuk structures have evolved rapidly in response to the demands of issuers and investors, from simple sale and leaseback (ijara) structures, such as the $1bn (£502.54m) Dubai Department of Civil Aviation sukuk issued in November 2004, to the $2.53bn (£1.27bn) trust finance sukuk structure issued by Aldar Properties in March 2007, demonstrating the flexibility of Islamic finance principles.

The rise of the sukuk
It is expected that the number of sukuk coming to the market will continue to increase, both from the traditional Islamic finance regions of the Gulf and Malaysia and from new regions, including the West. Thus far, the only non-Islamic issuer has been the German state of Saxony-Anhalt, which tapped the sukuk market with its e100m (£67.78m) issue in August 2004.

The UK Treasury has repeatedly passed legislation to ensure that Islamic finance is on an equal footing with conventional finance to encourage, for example, the development of an Islamic mortgage market, and the Financial Services Authority (FSA) has authorised the Islamic Bank of Britain and the European Islamic Investment Bank to operate in the UK.

Most recently, the UK Finance Bill 2007 seeks to remove the tax penalties for a UK sukuk issuers, so it will be intriguing to see which UK issuer will come to the market first. It could even be the UK Government, since Ed Balls, the Economic Secretary to the Treasury, has said that the Treasury is examining whether the Government should issue a sukuk in order to support the City’s position as a leading centre for Islamic finance.

There has certainly been pressure on the UK Government to issue a sukuk, perhaps linked to the 2012 Olympic Games. The US has already seen a $165.67m (£83.26m) domestic sukuk issuance by East Cameron Partners, linked to offshore gas property assets near Louisiana.

Widening the net
In addition to a wider group of issuers, the potential pool of investors in Islamic finance products is now much bigger than the initial group of devout Muslims based in the Gulf and South East Asia. Investors in Europe, Asia and even the US, who are keen to participate in the exuberant markets of the Gulf but are limited by rules restricting foreign ownership, see sukuks as no more than asset-based securities that give them exposure to markets in the Gulf that they would otherwise be unable to access.

Recent large sukuk issues have been placed mostly outside the Gulf region and it is expected that this trend will continue and may well expand to include the large institutional investor base in the US. Many of the issuers to date have been sovereign issuers or corporates created by sovereigns, with a ’sovereign halo’, which have accessed the market in order to raise their profile.

It is likely that in the future, increasing numbers of corporates with no links to government and with a real funding need will access the market. The popularity of convertible and exchangeable issues, with guaranteed allocations of shares, including in some cases in future IPOs, are also likely to continue in the Gulf and are becoming increasingly popular in Malaysia.

This entry was posted on Monday, February 25th, 2008 at 5:04 am and is filed under Banking & Finance Law, Bankruptcy Attorney. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.