Bridging the Gulf in Islamic Finance

Islamic finance has its roots in the Islamic jurisdictions of the Middle East and parts of south-east Asia with large Muslim populations. It may, however, take many by surprise to note that the UK has its own credible offering in Islamic finance. A nascent industry that is fundamentally in its infancy compared to its counterparts and supporting only a small Muslim population, it begs the question: how does a UK-based bank offer products of relevance and importance to its Gulf Co-operation Council (GCC) neighbours?

This is a key issue for Western banks who are practitioners in the art of Shariah-compliant finance. The Gulf represents a huge market with wealth, appetite and investment expertise. It is home to the second largest sukuk market, the ‘hub’ between east and west and is serviced by an array of Islamic institutions that reside on its doorstep.

Rather than compete, I would prefer to look at the involvement and evolution of the UK Islamic market as complementary to our Gulf neighbours for a number of reasons. First, there is the universally accepted belief that the UK regulatory environment excellent. All UK banks operate under the regime of the Financial Services Authority (FSA), which is a market leader in risk management, liquidity management and compliance standards. An FSA-regulated bank carries much weight and credibility.

Second, London is arguably the financial capital of the world, with its solid infrastructure, deep liquidity pockets, and concentration of resource and technological expertise – with global representation of the largest, wealthiest and most successful financial institutions. For Islamic banking, London provides a platform for opportunity and real business growth. Third, for Islamic finance to really be considered as a global alternative it needs to actively belong to the mainstream, international trade activity of major financial centres around the world. The concentration of Shariah-compliant institutions in the Gulf and south-east Asia is overwhelming and the development of a 24-hour service spanning into Europe and the Americas gives investors access to diversity on a scale that transcends the Muslim world per se. Why would GCC investors turn to a UK Islamic bank? Let’s take a closer look at what is on offer.

New Opportunities

One opportunity that will be of interest for our GCC audiences is Shariah-compliant asset financing that is being considered in the quasi-sovereign/ government/large utilities corporate space. Gulf investors are attracted by the quality of the household name, the standing of the issuer and the desire to attract investment from the Middle East. One attractive trait of this kind of asset transaction is its ability to promote sukuk structures, in particular the asset-backed form. sukuk issuance has been weighing heavily in recent months after the worrying events in Dubai in late 2009. The issue of ‘asset-based versus asset-backed’ is a subject currently under constant discussion, and the general view was that more transparency in the sukuk market and a better education of the product was required.

The viability of sukuk structures has, in my opinion, been unfairly discredited in the press. It has been directly associated with default and bail-out issues when the inherent cause of all problems resulted from uncertainty behind the credit status of the companies involved, not the structure of the components. While there were some relevant questions in the debate behind the ‘asset-backed or -based’ issues discussed, sukuk remains a very favourable mode of debt and credit financing, and the UK keeps an open mind to consider its viability as demonstrated through a number of supportive government initiatives that has maintained its leadership in the West as the key provider of Islamic financial services.

Three years ago, when three UK Islamic banks were formed, it was believed that the capital markets would be a cornerstone to the new businesses. The fall-out from the global financial crisis rocked this particular class, and the markets completely dried up with without even a shred of hope to cling on to. While UK Islamic banks achieved some transaction success, the liquidity squeeze, credit crunch and overall loss of confidence meant that new issuance was sparse and refinancing was a luxury only a few could afford. Some held the belief that the perceived lack of manageable instruments weakened and diminished the capacity of the market.

The perception was erroneous. Financial institutions in the main kept resilient, went back to basics, sat tight, and on the whole rode out the storm. These institutions are now embracing capital markets technology as a way to restructure existing debt, refinance balance sheets and raise capital in a more diligent and regulator-friendly fashion.

Many institutions in the UK are finding that clients, many of whom are from the Gulf, are looking to the UK banks for their corporate advisory needs. Moreover UK Islamic banks, which had experienced little exposure to the toxicity of the market, have been able to focus their time and efforts on providing a quality of service rather than dealing with the debt-related issues and problems of their conventional counterparts.

Supply and Demand

A compelling reason for the UK’s increasing capability in Shariah-compliant financing comes down to a desire for enhanced return – one of the pillars of supply and demand. With demand comes the necessity to be able to supply that hunger. With that comes innovation and that is another area where I believe banks in the UK can add value to what our neighbours from the East are doing. The UK remains one of the most adaptable and sophisticated nations globally and represents a growth potential far higher than most. As a UK bank, we are already halfway there, just by being domiciled in a country that promotes proactive and innovative investment. The support for Shariah financing is swiftly gathering pace. Not so long ago, structured products were commonly talked about. Almost any underlying asset could be accommodated and any structure given credibility. The drivers of these products were the larger banks with ample resources for financial engineering teams but they also found themselves with other focuses and, as a result, the short-note market went into prolonged hibernation.

Now it is time for a wake-up call in the Islamic finance industry. Liquidity needs to be managed in a much more dynamic way, realising better returns and shareholder value. There are already some attractive structures coming through the Shariah-approved pipeline that address the issues of overnight and short-dated liquidity management, and it seems likely that in a matter of months we will see a raft of structured product-type offerings giving greater value to those banks fortunate to have excess funds at their disposal.

Why shouldn’t these opportunities be realised in the UK market? It is perfectly feasible to offer a product with enhanced yield for less risk to capital within the comfort of the UK regulatory system. Although new, the UK Islamic finance market has a great deal to offer the global market.

8 views

Related reading