As the world’s most influential economies struggle to make sense of their current fiscal states, Islamic finance has been suggested as a viable alternative to encourage Asian and Middle Eastern liquidity into the system. NAZNEEN HALIM addresses the current state of play in Europe and the US.
In recent weeks, the UK government has announced the setting up of an ‘Islamic Finance Task Force’, a special group assigned to study the viability of introducing Islamic finance into the UK financial landscape and to work on mobilizing the country’s much-anticipated sovereign Sukuk issuance. The task force, which on some levels is not dissimilar to the Malaysia International Islamic Financial Centre, has also been created to attract more Islamic investments into the country, via the myriad of Middle Eastern investors who have become increasingly interested in investing in the UK.
The Qatar Investment Authority has already gained a solid foothold in the country, pumping in big bucks for the development of western Europe’s tallest building, The Shard, as well as the acquisition of the Chelsea Barracks, Harrods and the London Olympic Village. Prime minister David Cameron is also actively pursuing Middle East investments into the country’s energy sector. In March, the Department of Energy and Climate Change, a branch of the UK government, initiated a collaboration with The Green Deal Finance Company to come up with Islamic financing options to allow British Muslims to take advantage of the government’s Green Deal initiative.
Catch-22
However, the recent set up of the UK Islamic Finance Task Force — co-chaired by financial secretary to the Treasury, Greg Clark; and senior minister of state at the Foreign & Commonwealth Office, Baroness Warsi, who is also the minister for faith and communities at the Department for Communities and Local Government — could remain futile if liquidity issues are not addressed promptly. According to UK-based Islamic finance practitioners, Shariah compliant banks are at a “disadvantage” with regards to current liquidity rules and a lack of availability of liquid assets. However, the country’s lenders are facing a catch-22 situation as it is currently more cost effective for the government and Treasury to issue conventional bonds over Sukuk; further fueling their liquidity woes.
“The cost of funding via conventional sovereign bonds is still more advantageous than the cost of funding via Sukuk,” said Haissam Saleh, head of MENA treasury structuring and sales at Qatar Islamic Bank (UK) to Bloomberg. Speaking to the newswire, Liam Parker, a representative from the Bank of England said: “An allowance is made for Shariah compliant firms with regard to the instruments they are required to hold to meet their liquidity requirements, but not to the quantity of liquidity.”
Although it has been suggested that a highly-rated international organization such as the IDB issue a Sukuk in sterling pounds in order to create movement in the UK Islamic capital markets, there have been no official comments from the multilateral lender. At present, there are five UK-based Islamic banks: Gatehouse Bank, the Bank of London and the Middle East, European Islamic Investment Bank, Qatar Islamic Bank (UK) and the Islamic Bank of Britain (IBB). IBB recently reported a loss of GBP6.99 million (US$10.82 million) at the end of 2012; a GBP2.01 million (US$3.11 million) improvement on 2011 loss, while its total customer financing grew by 86% to GBP129 million, with home financing and retail deposits seeing a 92% and 22% surge respectively.
Property prospects
Despite the current Eurozone crisis, the UK is also touted to be a strong market for real estate and property investments. There are several factors currently working in favor of the Shariah compliant real estate market in the UK including the search by investors for safe havens to park their money, a growing demand from the affluent Middle East market looking to explore opportunities outside the Middle East and an underdeveloped real estate and mortgage market with a myriad of untapped opportunities.
Naomi Heaton, the CEO of London Commercial Property, which launched the UK’s first Shariah compliant residential fund, elucidated: “As a whole, the UK property market has experienced little growth of late. Over the last year, property prices have slightly fallen in England and Wales by 0.68%. The UK property market is affected by domestic concerns: the level of employment, earnings and mortgage availability which are all under pressure in the current economic environment. However, our company, London Central Portfolio (LCP), and our residential property funds focus solely on the prime London central property market which is not correlated to the UK housing market or even Greater London as a whole. It benefits from international buyers who have little or no reliance on credit, making the market far more robust than the UK in general. London Central’s property prices were up 10% over the last year.”
Testament to growing interest in the UK property market; particularly in central London, was Takaful Malaysia’s recent foray into the London property market – the group’s first overseas investment. According to its group managing director, Mohamed Hassan Kamil: the depreciation of the sterling pound and a devalued market is what piqued the firm’s interest in the London property market.
Despite the ongoing Eurozone crisis, Heaton maintains that it has done little to deter international investments in London Central. She said: “From a short term perspective, it has probably done the opposite. In times of political and economic crisis and stock market volatility, investors retrench to blue-chip tangible assets – with London Central residential property being a favorite. Hence Eurozone investors have been turning to London to take advantage of its position as a safe haven asset class. This trend has been seen many times before, in recent times during the Arab Spring and the Russia Diaspora. It is interesting to see the very close correlation between the performance of prime London Central and gold in times of market volatility.”
According to Heaton, there have been fears that the UK Shariah compliant real estate has been over-weighted in the areas of student housing and the commercial property sectors; which has spurred the desire to explore the residential market primarily as a means of diversifying their investment portfolios. “It provides a way of re-balancing portfolios and providing investors access to one of the best performing asset classes in the UK. Our current investment profile, by value, shows that almost ¼ of our investment is from Muslims at 23.4%, with over (34.6%) coming from outside the UK,” she said.
In terms of Islamic real estate investment trusts (REITs), the UK market is said to still be underdeveloped compared to the rest of the world, but industry players believe that the future is bright for this sector. Heaton said: “With 450,000 Muslim millionaires in the Middle East alone, Islamic investment options are becoming increasingly important on the world stage. It is also a sector in its infancy with only 765 Islamic mutual funds available globally, compared with some 60,000 in the conventional finance sector. We have definitely seen a growing demand for Shariah compliant funds amongst Muslim consumers both in the UK and abroad. We expect to see a growing demand for these forms of investment due to the benefits they can provide.”
America: The land of promise?
There is a growing affinity amongst Middle East and Asia-based issuers to issue RegS/144A paper in the market and it seems that this is currently the single greatest export from the US to the Islamic finance industry at present. Issuing 144A paper means that a Sukuk is on par with a bond in terms of disclosure and transparency. However, don’t hold your breath in terms of waiting for a US government Sukuk, industry players say.
Circa 2005-06, the US treasury department had hired an Islamic finance expert, Professor Mahmoud Amin El Gamal from Rice University in Texas to provide the department with an overview on Islamic finance and also to familiarize themselves with Sukuk. However, all went quiet on the Islamic finance front and no other efforts have been made from a government standpoint, except in some pockets throughout the vast state.With US municipal finances under strain and local government budgets tightening, there was a call in 2011 made to introduce legislations that will facilitate Islamic product introduction. Kevin Parker, a senator whose Brooklyn constituency includes a large Pakistani community, hoped that by structuring US municipal bonds to be Shariah compliant, it would encourage Muslim investors into local government projects such as schools, hospitals and community centers.
However, industry-wide standards has yet to exist across US regulatory bodies and while the regulatory environment continues to remain relatively hostile, US federal banking regulators have little incentive to issue formal guidelines pertaining to Islamic products and services. The complex layering of federal and state laws further exacerbates the introduction of Shariah production into the conventional system. This uneven regulatory environment and limited knowledge of Islamic financial principles continue to hinder the further implementation, development and growth of the industry.
William Rutledge, the executive vice-president in charge of the Bank Supervision Group at the Federal Reserve Bank of New York, stated: “US regulators are open to Islamic financial products. Our mindset is to try and accommodate a variety of approaches to finance.”
Formal guidance pertaining to Islamic products and services has been issued by US federal banking regulators in the past, in particular the Office of the Comptroller of the Currency, with regards to basic Ijarah and Murabahah products. However, several conditions were placed on the loans in relation to risk and legal entitlement, whereby they must conform to conventional banking standards in order to obtain approval.
Current US laws and regulations are not considered flexible enough to accommodate most aspects of commercially viable Islamic financial products without significant legislative changes. As a result, American domestic banking windows and mortgage brokers offering Shariah compliant products and services remain localized institutions catering to small concentrated Muslim communities.
Beyond funds
The Islamic finance sector in the US remains concentrated primarily in the mutual fund industry. With an estimated US$4 billion of assets under management, it represents the fastest-growing and most prominent Islamic financial product. Part of this success is its marketability to non-Muslim investors, attracted to the solid fund performance during the recent downturn and with increasing interest in socially responsible investments.
However, Tariq Al Rifai (caricature), executive director at Failaka Advisors, believes that there is a gap that exists on the financing side to encourage consumers to enter into the Islamic retail market. “Simply put, it is easier to give people money than to take their money — it is an easier sell. And there is huge demand for the financing of businesses, such as SMEs.”
“The investment products that exist now, provided by Saturna Capital, Azzad, etc, are all equity funds and there is demand for that because people understand the product, but there is also demand for fixed-income and income-generating funds. In Malaysia for instance, you have Balanced Funds, Sukuk Funds, Islamic REITs; and REITs are very popular in America, and the market could do with an experienced REIT fund manager to come up with an Islamic REIT,” he added.
When asked if Islamic REITs would be a wise choice in today’s US property market, Tariq believes that the property market has stabilized: “The US is not having the same kind of trouble Europe is having. The US real estate bubble has popped; unlike China, Canada and Europe.”
Tariq, who helped to set up the Amanah outfit for HSBC in New York in 2004, says there is much potential for the Takaful market to flourish in the US: “America is one of the largest markets for insurance in the world. There will be demand for investment products such as Auto Takaful and Life Takaful. If this sector were to grow in tandem with the US insurance market, there is no doubt that Takaful in America will be bigger than in the GCC.”
Long way to go
Although the UK has made significant traction in its bid to become Europe’s center for Islamic finance outdoing its other European counterparts such as Ireland, France and Luxembourg; there are still gaping holes in the country’s financial and regulatory systems that need to be addressed — such as the issue of liquidity and the creation of an Islamic interbank money market.
Despite several discussions and attempts at creating an Islamic financial system; the US is still far from fulfilling its potential. Mortgage lenders such as LaRiba and Devon Bank, which have demonstrated impressive staying power in the market are still few and far between.
Perhaps it is time for a little less conversation and a little more action; please.