The most important player in Islamic finance in London is the UK Government

Date: 25 Feb 2016

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Dermot O’Reilly, consultant at Amanie Advisors says there will be increased activity in the debt capital market as continued low oil prices increase the fiscal strain on both GCC governments and corporates.

Who are the most important players in the field of Islamic finance in London?

The most important player in Islamic finance in London is the UK Government but they need to do more to promote the sector with their ‘The CityUK Islamic Finance Group’. The UK in general and London in particular has a large quantity of assets that investors in the GCC would like access to, for instance logistics operations, office blocks, student accommodation, and retail parks. These assets are sharia-compliant and there are a number of sharia-compliant funds that acquire them on behalf of investors.

What are the terms of using Islamic finance?

Islamic finance cannot exist without sharia scholars. For a product to be marketed as a sharia-compliant product it must have a resolution executed by a sharia scholar or a board comprising of sharia scholars, such as the Sharia Supervisory Board. This resolution, or fatwa, will give comfort to potential investors that someone who knows what they are doing has reviewed the transaction structure and the transaction documents and is satisfied that same are sharia-compliant. The sharia scholar or the Sharia Supervisory Board may, depending on the nature of the product on offer, be required to certify on an annual basis that the product continues to be operated in a sharia-compliant manner. Sharia compliance is a cradle-to-grave concept.

Lending money at interest is not a compliant activity so leasing a commercial building to a conventional bank will render the rent received from the conventional bank “tainted income” which will need to be channelled to charity. The entire transaction will be non-compliant. So Islamic fund managers will need to abide by the investment guidelines given to them by the Sharia Supervisory Board to avoid instances of non-compliance which may lead to losses for the Islamic investors.

Typically, in Islamic finance transactions, the returns to Islamic investors are linked to the performance of the underlying asset or activity. In Islamic finance you cannot obtain a reward without first risking your money in an economic activity. There are a number of risk mitigation measures that can be employed in structuring the transaction. The overarching goal of Islamic finance is to develop the real economy of a country.

If defaults occur in emerging economies, will we see Islamic financial institutions taking a hit as economic difficulties bite?

It is entirely possible. Like conventional banks, this is where the quality of the security, if any, taken by the Islamic Financial Institution (IFI) will assist. In many cases where there is an underlying asset, in the event that the bank’s customer defaults on its payments, the IFI may have immediate recourse to the asset, which may already be in its name due to the particular nature of the transaction. In these cases, the IFI can dispose of the asset if it wishes in the open market or find a new tenant or user of same. Risk management for an IFI is the same as that for a conventional bank, the only addition is sharia compliance risk, the risk that the product will not be operationally carried out in the proscribed sharia-compliant manner.

Will we see a rise in Islamic finance as oil revenues affect the Middle East?

Conversely, market data, indicates a rise in conventional bonds as opposed to sukuk, which is an Islamic bond. There will be increased activity in the debt capital market in the region as continued low oil prices increase the fiscal strain on both GCC governments and corporates. The longer lead time to bring a sukuk to market as opposed to a bond may be a factor in the increased bond issuance. Other avenues for Islamic finance to grow are via asset or equipment leasing by asset rich but cash poor entities.

What else should ultra-high net worth individuals know about Islamic finance?

It is a new form of financial intermediation and there are a number of reputable organisations engaged in it. The sharia scholars add another level of oversight onto the product. This is not necessarily a bad thing. One of the main differences between Islamic finance and conventional finance comes down to the concept of money. In Islamic finance money is a unit of exchange, it has no intrinsic value. To make money in Islamic finance you must do something with your money, buy an asset and sell it at a profit or invest in a joint venture and take the profits, if any, or bear the losses. Sharia scholars will ensure that your money is not put to any use that is not sharia-compliant, whereas a conventional bank will take your money and offer you an interest rate. They may make a profit utilising your funds or not, but they keep the profits and bear the losses and give you a return.