The development of Sharia-compliant financial products has been welcomed by the government and by leading figures in business and the City. But obstacles to the continued growth of Islamic finance remain
Hot on the heels of the furore sparked by the Archbishop of Canterbury's comments that Sharia law would inevitably become part of the fabric of British society, came news that the government was planning to announce Sharia-compliant bonds, or Sukuk, in the 2008 Budget. In the event—as with much else—Alistair Darling opted for more consultation, but debate in the media has been heated, and has confirmed (if confirmation were needed) that despite a large Muslim population in the UK, Islam is still a sensitive topic.
The government's argument is pragmatic. As an economic downturn looms, the country needs wealthy investors from the Middle East. Many of these investors need investment vehicles that comply with their Islamic beliefs. "It is a huge marketplace. We believe it is worth £250bn a year globally, and it is growing 10 to 15 per cent every year. We want a larger share of that," says Andrew Cahn, chief executive of UK Trade and Investment (UKTI), who also sits on the government's Islamic Finance Expert Panel.
The need to provide lending and investment structures for 1.8 million Muslims means the UK is now more ready for Islamic foreign investors. According to Davide Barzilai, partner in law firm Norton Rose, over the past eight years the Islamic finance market has grown at a tremendous rate. "As the scholars have developed new structures and improved their understanding of the economics and banking market, combined with their expertise in Sharia issues, new products have come to market, and that has attracted the money and the huge liquidity that has been around in the Middle East," he says.
So what exactly is Islamic finance and how does it differ from what's traditionally practised in the West? One of the central ideas is that Riba (in simple terms, charging and earning interest) is wrong. "What Islam says is that making money on money is prohibited. Money is just a medium of exchange, but making money on the use or the exchange of an asset is permissible," says Amjid Ali, head of HSBC Amanah, the Islamic division of HSBC, which launched its first UK Sharia-compliant mortgage in 2003.
Sharia-compliant home finance has been offered by several banks for some time. The basic, and most common, interest-free model for Islamic mortgages is the leasing structure, Ijara. Under Ijara the lender buys the property and charges the borrower rent rather than interest. The customer gradually acquires more of the property with monthly payments on top of a rental fee, which is usually discussed and agreed individually. Similarly, the planned Sharia-compliant bonds will be asset-based. "When there is Sukuk issuance there is some form of asset that is sitting in the structure beneath the actual note, and that is not the case in conventional bonds that the government issues in its securities," explains Barzilai.
As well as prohibiting interest, Sharia principles prevent investment in anything perceived to be unethical, such as gambling, pornography and armaments. All transactions must be transparent and involve a sharing of risk and profit between the lender and the borrower—in other words, a partnership.
Shabir Randeree is managing director of investment company DCD Group. He has completed several deals on Islamic principles and compares the purer models of Islamic finance, Mudarabah and Musharaka, to venture capitalism. "In these models, the lender and the borrower put up the money as a partnership and share everything, risks as well as profits," he says. Randeree believes this is where Sharia finance will get to if it continues to evolve. "This is the truest form of venture capitalism without some of the bells and whistles," he says.
Ijara, the leasing structure, is also used in large business transactions, while the third major model, Murabaha, is a more straightforward, and popular, cost-plus-profit arrangement, similar to a conventional trade-finance agreement.
The final major principle in Islamic finance relates to speculation that involves effortless gain—such as a gambling activity or scheme. According to Mohammad Qayyum, director general of the Institute of Islamic Finance and Insurance, this is a particularly pertinent issue in these days of the credit crunch and sub-prime mortgage crisis. "When someone lends money without any physical activity, you are creating money out of thin air," he says. "We have this crisis going on globally and it is caused by derivatives."
Serial entrepreneur and panel member on the BBC's Dragons' Den James Caan is in no doubt that enterprise can learn a lesson from Islamic finance. "If you look at the current credit crisis, institutions have lost $500bn. When was the last time you saw a financial crisis where the risk and exposure was of that magnitude?" he asks. "Without question, there is a lesson to be learned."
Randeree is less certain. "The scholarly view would be that under strict Sharia regime, the sub-prime crisis would not have happened. The practical view is that it could happen everywhere because you have to look at the underlying reason. I think that this could have happened under Sharia on the basis of greed, and under Sharia banking you cannot account for greed," he says. But he adds that the recent demise of Northern Rock is a different situation. "Under a Sharia system, Northern Rock would not have been able to borrow that money at such high risk; it would have had to have partners with it to give the customer money in the first place."
Randeree is keen to address what he says are misconceptions about Sharia law. "Firstly, Sharia law doesn't mess with common law—Sharia sits just below it, and when we can't fit Sharia law we follow conventional law," he says. "Secondly, it is between consenting parties, and both parties have to consent to an additional index or rule on top of common law."
Qayyum agrees: "There are rules and regulations that we follow that are laid down by the state, but we have this additional layer for those who want to practise the dealings in Islam," he says. "Islam is not defined to be a religion as such; it is really intended to be a way of life."
Islamic finance has undergone a revival over the past 40 years, but has only really taken off in the UK in the past 10 years. Randeree was involved in initial discussions to accommodate Sharia-compliant finance. "Lord Edward George, the former head of the Bank of England, and the former chairman of the Financial Services Authority, Howard Davies, were the two who really pushed this—both non-Muslims with a phenomenal track record in the City," he says.
The change that made Islamic mortgages more feasible happened in 2003. Before that, Muslim home-buyers paid stamp duty twice (first when the property was bought on their behalf and again when they made their final payment to the bank and it became theirs). By changing the law, the Treasury ensured that Sharia-compliant mortgages became cheaper and more available.
Barzilai points to the terrorist attacks of 9/11 to explain the increase in Middle Eastern investors in the UK. "The security and the lack of trust from the US side made many Middle Eastern investors turn to Europe and the UK," he says. Qayyum adds that the media persecution of Muslims after the attacks helped to solidify the Islamic identity and spark a demand in Sharia-compliant home finance.
Today, London is the world's fastest growing Islamic finance centre. According to figures from UKTI, it ranks among the top 15 countries involved with Islamic finance—the only western country to do so. "London and Bahrain remain as two major centres of Islamic structuring and finance," says Randeree. "We had Frankfurt, New York and other places in competition, but they have all fallen by the wayside."
Barzilai says Sukuk issuance is a natural development to broaden the options available to Muslims both here and from abroad. "The UK is a well established base for them, so this is ensuring they continue to choose the UK as a base for their investments in Europe," he says. But, he adds, it is also about encouraging Islamic overseas investors by ensuring they are not penalised by any legislation or tax disadvantages.
A large part of Sharia deals with bridging the gap between rich and poor, and on the face of it, capitalism is not right. Is it possible to be a Sharia-compliant capitalist? Randeree thinks so. "I feel that the Sharia system, in an unfair world, tries to redress the balance," he says. Alongside other Sharia issues, sits the concept of Zakat, which involves Muslims donating 2.5 per cent of their annual earnings to charity. Outside an Islamic society, capitalists might choose to take a huge chunk of their earnings and give to charity. "Bill Gates, for example," says Randeree. "For me, he is very much a proponent of Sharia, even if his banking isn't," he says. He adds that he would donate any interest he earns to charity. "On a personal level, Sharia is about trying to balance out the haves and the have nots in economic terms and that is a very nice ideal for any society to have."
The problem of public antipathy towards Sharia-compliant finance could, suggest some experts, be solved by re-branding. "The issue is that the word Islamic carries such negative connotations today. There has even been some discussion as to how you describe the methodology without including the word Islamic," says Qayyum. "Ethical comes close, but only up to a certain point."
The negative press has inevitably included claims of funding terrorism, which Cahn, at UKTI, dismisses as irrational. "These claims are just foolish. The vast majority of our Islamic population are good members of society. We have a very large Islamic population and it is in our interest to bind them into our broader society," he says. "This underpins the government's political efforts to reduce tension in all areas, and developments in Islamic finance will help those political objectives. And doing business together is one of the best ways of promoting understanding, peace and interdependence."
The single biggest obstacle to the continued growth of Sharia finance in the UK is probably lack of standardisation. Being a religious text, the Quran is open to interpretation, and Sharia law is not governed by a single set of guidelines. There is only a limited number of qualified scholars who are in a position to approve new Islamic structures and decide whether they comply with Sharia requirements; many of them sit on Sharia advisory boards in several financial institutions. Most are experts on the theological perspective of Islam and hold a degree in business and economics.
Cahn says standardisation is an issue that needs to be addressed, but admits that the UK can't lead here, simply because there is a lack of expertise. "We need one place, one set of rules, one set of interpretations. It is a real problem where we have conflicting interpretations," he says. He points to Malaysia, which has set an example with very strict regulation of Sharia finance. "It has to be standardised to some degree to gain any kind of credibility," agrees HSBC's Ali.
"There are issues that are controversial, but that is part of the evolution; one has to give it time," says Qayyum. "What any orthodox Muslim has to understand is that we live in a modern world and what the Islamic scholars are trying to do is devise a methodology where transactions in the conventional world can exist without using interest and without exposure to excessive risk and absolute uncertainty," he says.
Randeree, too, calls for patience. "I think it is fair to say that Sharia law was dead and buried for a long time and my view is that you cannot resurrect something like this in 20 or 30 years—you have to give it time," he says.
