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November 15, 2014

British observers have criticised and praised The Shard, London’s tallest building, in equal measure.
Points of disagreement range from its controversial design to the sheer scale of the project. One thing they can agree on is that the 308-metre tall tower symbolises something important about London, for good or ill.

In 2008, as the credit crunch hit the United Kingdom, a consortium of Qatari banks bought an 80 per cent stake in The Shard. The purchase contract was Sharia-compliant. Typically, a musharaka is an agreement through which the participants jointly undertake a business venture, from which they earn profits or take losses in line with their capital contributions.

For advocates of Islamic finance, this is an example of how London is well-suited to become a home to the world’s fast-growing financial sector and how it can compete with Dubai’s aim to become the capital of the Islamic economy by 2016.

“I want London to stand alongside Dubai as one of the great capitals of Islamic finance anywhere in the world,” the British prime minister David Cameron said at the World Islamic Economic Forum in London last year. The UK was the first country outside the Islamic world to host the event.

In June this year, the UK issued a landmark £200 million sukuk. Investors earn revenue generated from the transfer of ownership of three government properties, forming an ijara. The National Bank of Abu Dhabi helped to structure the product, which was 10 times oversubscribed.

“London’s reputation as Europe’s leading centre for Islamic finance, products and professional services goes from strength to strength,” said the London mayor Boris Johnson.

Harris Irfan, the managing director of the European Islamic Investment Bank and the author of Heaven’s Bankers: Inside the Hidden World of Islamic Bankers, says it is easier to conduct Islamic finance activities in the UK than in most Muslim-majority countries.
“The UK is a massively enabling environment for Islamic finance. There is an excellent, level playing field, from both a tax and legislative point of view,” he says.

There are also the skills and infrastructure to launch small, specialist banks with more creative and thoughtful approaches to Islamic finance, Mr Irfan believes.

“London is a large global capital of finance, and has access to a lot of talent,” he says.

The UK’s legal system is a great strength for the development of Islamic finance, says Professor Habib Ahmed, the Sharjah chair of Islamic Economics and Finance at the University of Durham in England, potentially giving it the edge over Dubai.

“English law has a long history and is more predictable than UAE law, so most international Islamic contracts are governed by English law,” he says.

While UK judges are formally barred from applying Sharia principles in their decision making, that does not prevent contracting parties from using Sharia-consistent principles in their contracts, Prof Ahmed says.

This means judges’ decisions will be in line with Sharia, so long as the relevant clauses do not clash with UK legislation.

“There’s not really any kind of problem with taking Islamic disputes to an English court,” Prof Ahmed says.

The UK government has been proactive in adjusting the law to ensure that Islamic banks face a level playing field. One example is how the UK government treated Islamic home financing products for tax purposes.

In ijara contracts used to fund consumer house purchases, UK law originally stipulated both parties would be taxed each time the house changed hands, while purchasers of conventional mortgages would be taxed only once.

This was changed in 2003.

With Dubai aiming to become the capital of the Islamic finance world by 2016, competition to claim the biggest share of the estimated US$1.7 trillion industry is heating up.

“In the last decade, Dubai has been the driver of Islamic finance,” Mr Irfan says, and has benefited from “an exodus of bright minds from London to Dubai, the repatriation of [Arabian] Gulf money after 9/11, the establishment of free zones including the Dubai International Financial Centre, and a boom in the stock market and real estate [prior to 2008]”. “A lot of leading banks sent talent to Dubai to create some very interesting [Sharia-compliant] products,” he says.

UAE companies, including Aldar and DP World, have listed sukuk on the London Stock Exchange. But in recent years the UAE Government has pushed for more firms to issue bonds on the country’s own bourses.

This has led to domestic sukuk listings increasing to $21 billion in 2013, with the Nasdaq Dubai adding around $6bn the same year.

Issuing Islamic finance products in Dubai is not without its problems, however.
Azlin Ahmad and Karim Shayib, lawyers from the Middle East legal firm Al Tamimi, point out UAE law does not have the concepts of trusts, special purpose vehicles, or beneficial ownership – each crucial to the structure of many Islamic assets. Many sukuk involve the transfer of assets from the issuer to a trust, which grants beneficial ownership and usufruct – or real rights – usually in the form of rent, to the sukuk holder.

Although Sharia transactions must be backed by an underlying asset, investors do not necessarily have legal rights over an asset that can be successfully and quickly pursued in the UAE’s courts.

When Nakheel defaulted on its $4bn sukuk in 2009, investors assumed its undertakings were implicitly backed by the Dubai Government, and that they could get their money back by selling underlying assets.

But these investors had not read the prospectus properly. The Dubai Government repeatedly said it would not guarantee Nakheel’s debts – despite the fact that Nakheel was owned by Dubai World, itself a state-owned company. Under the terms of the sukuk, investors had leasehold rights to assets underpinning the sukuk but did not own them.

This came with the catch that leasehold rights “are not viewed as real rights, or property rights, under the relevant [Dubai laws]”, according to the legal scholar Omar Salah.

All of which meant that, when Nakheel and its then parent company Dubai World ran into trouble, investors could not get their money back through the legal system.

The problem was not that investors had placed their trust in an Islamic bond. The problem was investors did not understand the UAE’s legal system.

Ensuring Dubai’s legal system can cope with the challenges of complex financial issuance is the key issue, Prof Ahmed says.
Recent regulations aim to address this.

In April, the Securities and Commodities Authority changed its rules to encourage increased sukuk issuance, reducing the minimum required size of sukuk to Dh10 million from Dh50m.

The changes also aimed to solve the two main issues affecting the Nakheel sukuk.

New regulations were introduced to cover default procedures, and introduced new rules stipulating that assets underpinning a sukuk must be legally transferred to the investor.

Mr Irfan believes the Islamic finance market is big enough for both Dubai and London to claim large chunks of the business. Global sukuk issuance is expanding rapidly, with issuance expected to grow to $420bn in 2016, up from $240bn in 2012, according to estimates from PwC. The industry as a whole is expected to hit $1.7tn in assets by the end of this year.

“Dubai and UK cater to different market segments,” Mr Irfan says. “Dubai is closer to the investor base and scholars and caters to the Middle East market, while London serves the West and its institutional investors.”

“London is a better place to do business,” Mr Irfan says, who now lives in the city.

“But if you want to sell Sharia-compliant products to the Middle East, Dubai is a better place to be.”