After great excitement about Islamic finance in Europe, the early promise has given way to stagnation and there has not been the hoped-for development. However, many jurisdictions have enacted legislative changes to facilitate Islamic finance and the environment is broadly favorable for future development. With the appropriate catalyst, such as a UK government Sukuk, FARMIDA BI nevertheless believes that the market could still realize its potential.
The UK has led the way in Europe for over 10 years in promoting a level playing field for Islamic finance but now faces the prospect of an Islamic finance industry disappointed with it for failing to issue the sovereign Sukuk promised in 2008 and a government questioning why more of its infrastructure projects are not funded by Islamic money. Great hope is being placed by both sides in the World Islamic Economic Forum (the Islamic Davos!) which will be taking place in London at the end of October this year.
The purpose of Islamic finance in Europe is often a confusing one — should it be a form of religiously compliant finance for the Muslim populations of Europe (with Islamic retail banks offering mortgages, credit cards, etc., which has, thus far, not penetrated deeply) or does it refer to Muslim investors accessing European markets using structures which comply with their own internal requirements? It can of course also be a form of ethical finance that appeals to non-Muslims, both as customers and as investors, but this unfortunately receives less coverage.
Current position in the UK
Islamic finance has gained a significant degree of acceptance in the UK. Of note is the establishment of Shariah compliant banks, including the first wholly Shariah compliant retail bank in the West. There are currently five fully Shariah compliant banks in the UK (Bank of London and the Middle East, European Islamic Investment Bank, Gatehouse Bank, Islamic Bank of Britain and Qatar Islamic Bank (QIB) UK) as well as Islamic windows at conventional banks.
The government stated its objective to make London the European gateway to Islamic finance, and has enacted legislative changes designed to create a level playing field for Islamic finance. Finally, there has been significant Shariah compliant investment in the UK such as the P&O acquisition, Aston Martin, Chelsea Barracks and the Shard. All these factors have ensured London’s position as the Islamic finance hub in Europe, and the leading center for Islamic finance in the West.
The UK government has acted to promote Islamic finance in the UK in several ways. Since 2008, a series of orders have been issued clarifying the tax and regulatory treatment of alternative finance investment bonds (AFIBs), a category which includes Sukuk.
Despite these efforts to facilitate Islamic finance and numerous expressions of interest in issuing a sovereign Sukuk, the UK government has so far failed to do so on the grounds that a Sukuk would not offer value for money, a position most recently confirmed by Lord Sassoon, the commercial secretary to the Treasury, in January 2012. There has also been an inconsistency in legislation which acts to the detriment of Islamic finance; demonstrated most recently when new rules about stamp duty intended to apply to properties bought by companies unintentionally affected the structure of Shariah compliant mortgages.
However, the UK remains a vibrant market for Islamic finance and over 40 Sukuk have been listed on the London Stock Exchange with a total value of more than US$35 billion. Smaller corporates in the UK with no direct link to Islam have also taken advantage of Islamic finance as a form of financing in the credit crunch, most notably with the International Investment Technologies Sukuk in Gateshead worth US$10 million and the refinancing of a warehouse in Colchester worth GBP20 million (US$30.4 million). Shariah compliant investment in the UK also encompasses high profile deals such as Chelsea Barracks and the Shard by Qatari investors, and with significant new investment from the Gulf and the ASEAN countries there could be substantial growth in this area.
The UK profits from the fact that most international Islamic finance contracts are governed by English law under the jurisdiction of English courts/UK arbitration, and English courts have clarified the legal position of Islamic finance in the UK (e.g. the Beximco case). This reaffirms London’s position as a center for Islamic finance even if the number and size of transactions are smaller than in the GCC or Southeast Asia. The UK has also emerged as a center of innovation in Islamic finance, as demonstrated by the recent Gatehouse Bank Sukuk which used a real estate-backed Sukuk structure to create an Islamic equivalent of a covered bond.
With the expertise from its established Islamic banks and conventional banks with Islamic windows, a favorable legislative and regulatory framework and its reputation as an international financial center, London has the potential to become a much larger focus for Islamic finance. One way for this potential to be realized would be through a clearer sign of commitment by the government. This could best be expressed by the issuance of a sovereign Sukuk, a development which could galvanize the Islamic finance industry.
However while London remains the center of Islamic finance in Europe, other European jurisdictions have launched bids to attract Islamic finance, including funds launched in Luxembourg and legislation in Ireland.
Ireland has sought to position itself as a center for Islamic finance and although to date the level of activity has been comparatively small, the framework is in place for Ireland to become a much more significant force in the industry.
Ireland has taken a proactive stance regarding legislation and the Finance Act 2010 gave equal treatment to Islamic financial products. Ireland also has double tax treaties in place with 67 countries including key Islamic markets such as Bahrain, Kuwait, Malaysia, Turkey and the UAE.
The Irish Stock Exchange is a globally significant exchange, and key Islamic listings include the US$2 billion Goldman Sachs-backed Sukuk on the 19th October 2011 and the CIMB-Principal Islamic Asset Management Islamic UCITS fund platform and Islamic Asia Pacific ex-Japan fund, Islamic Global Emerging Markets fund and Islamic ASEAN Equity funds.
More generally, Ireland’s favorable tax regime and low corporate tax make it attractive for all investors, and with the government support demonstrated over recent years the country could become a much more significant player in the industry.
Although perhaps not as obviously involved in the Islamic finance market as the UK, Luxembourg’s unique characteristics give it a significant role. Luxembourg is the second-largest investment fund center in the world after the USA and the fifth-largest Islamic fund domicile worldwide after Saudi Arabia, Malaysia, Cayman Islands and Bahrain. In 2002, the Luxembourg Stock Exchange was the first to list a Sukuk and it now lists Sukuk from Malaysia, Pakistan, Saudi Arabia and the UAE.
Luxembourg has taken care to give equal tax treatment to Islamic transactions. The key legislation includes the Investment Funds Law of 2002, the Luxembourg Law of the 22nd March 2004 (securitization law) and the regulations of the Commission de Surveillance du Secteur Financier (CSSF), the financial supervisory authority. In 2010, the Luxembourg Tax Authority published a circular to clarify the tax treatment of Murabahah and Sukuk transactions and guarantee that they receive the same tax treatment as conventional products.
Luxembourg actively protects its reputation as a leading financial center and has launched several initiatives to identify obstacles to Islamic finance and act to remove them.
Germany issued the first Sukuk in Europe, the Saxony-Anhalt Sukuk, but despite continued interest in Islamic finance and recent events organized by the Federal Financial Supervisory Authority (BaFin) and the European Central Bank, it has not become a center comparable to the UK or Luxembourg. There is considerable potential however, not least because of Germany’s large Turkish population, and Kuveyt Türk is currently applying to become the first Islamic bank in Germany. The bank’s stated aim is to invest EUR45 million (US$58.96 million) in its German unit to support the activities of a variety of companies, particularly SMEs.
At the end of 2012 FWU, a Munich-based financial services company offering Takaful solutions, issued a US$55 million Sukuk based on intellectual property rights under an Ijarah structure. The Sukuk was issued using a Luxembourg SPV issuer incorporated by a Dutch stichting, as in the Saxony-Anhalt Sukuk. The deal shows the way forward for other German issuers, although the fact that a 12-year old Sukuk structure was used suggests that more focus is needed from the German authorities in addressing the needs of Islamic finance.
In recent years France has attempted to challenge London as the European capital of Islamic finance, and although in many ways this seemed like a logical strategy given France’s large Muslim population, a series of legislative setbacks has hampered the growth of Islamic finance in the country. Nevertheless, recent Sukuk issuances show that there is optimism in the French market.
However, France has caught up with the UK in significant ways. In June 2011 Chaabi Bank, a subsidiary of the Moroccan Banque Populaire Group (Banque Populaire du Maroc), opened an Islamic window offering Islamic deposit accounts for private customers, and now has 17 branches in France. Chaabi Bank also offers Murabahah funding for house purchases.
Most importantly, in 2012 two Sukuk were issued in France. The first, for BIBARS SAS, was issued to finance investment in Halal catering. The second, the Oraisi Sukuk, was the first French Sukuk open to private individuals and was for the financing of solar panels: a good example of the role Islamic finance can play in broader ethical investment.
Russia has the largest Muslim population in Europe, and with its strength in energy and mining, it is a natural market for Islamic finance. Although to date there has not been a great deal of activity, there are signs that the industry is growing. In 2009 VTB Capital, a unit of Russia’s
VTB Bank, and Liquidity Management House, a subsidiary of Kuwait Finance House, signed a memorandum aimed at promoting the development of Islamic finance in Russia and other former Soviet countries, and specifically to issue Sukuk. Although this has not yet happened, VTB has remained active in trying to issue a Sukuk.
The traditional idea of Turkey as a bridge between Europe and the East is true in Islamic finance — its recent sovereign Sukuk issuance makes Turkey the leading country for Islamic finance in Europe. Kuveyt Turk issued Sukuk in 2010 and 2011, and the US$1.5 billion Islamic bond issued by the government in September 2012 puts Turkey in the mainstream of Islamic finance.
Turkey’s government showed a commitment to Islamic finance, with its 2007-13 economic development plan referring to “asset-based” and “interest-free” financial instruments as part of efforts to develop the country as a regional financial center. Islamic finance could be key in this development since 34% of Turkish exports went to the MENA region in 2012, and engaging with Islamic finance could be an advantage in these markets.
Albania has an interest in Islamic finance because of its large Muslim population, attracting the attention of the Islamic Development Bank (IDB), which has financed road building in Albania. A recent conference organized by the Albanian Investment Development Agency (AIDA) and the IDB attracted business leaders from 30 member countries of the IDB.
In October 2000, Bosna Bank International (BBI) was established in Sarajevo and is the only bank in Bosnia and Herzegovina to operate in accordance to Islamic financial principles. The founders of the bank were the IDB (45.46%), Dubai Islamic Bank (27.27%) and Abu Dhabi Islamic Bank (27.27%). BBI mostly provides long-term financing to individuals.
As other jurisdictions recognize the benefits that Islamic finance can bring to the economy, further government support for the UK’s Islamic finance sector would be welcomed.
This survey shows that although there is great potential for Islamic finance in Europe, a stimulus is needed to show commitment to the market. The most significant form this could take would be a sovereign Sukuk, and the UK government is the best placed to undertake this. There is still an enormous amount of capital in the Muslim world which could be attracted to invest in European jurisdictions if Shariah compliant investment were made more welcome.
Farmida Bi is a partner and the European head of Islamic finance at Norton Rose Fulbright. She can be contacted at