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Will U.K.’s Entry Into Islamic Finance Help Boost Growth?

The U.K.’s economy appears to be on the mend at last. To ensure that its financial sector, at least, continues to improve, the country intends to enter the world of Islamic finance with the issuance of an Islamic bond and the creation of an Islamic index.

The first estimate of the third quarter’s GDP indicated that it grew at its fastest pace in three years, with progress in all three sectors: manufacturing, services and construction. Economic output was up by 0.8% for the quarter; coming on the heels of a second quarter increase of 0.7%, that’s the best the economy has done since 2010. Construction in particular, which was helped along by a government Help to Buy program, had its second positive quarter in a row and in the third quarter enjoyed a boost of 2.5%.

The Office for National Statistics also announced improvement of 0.5% for production—that includes a rise of 0.9% for manufacturing—and an increase of 0.7% for services, which has actually improved beyond its highest level in 2008 before the crisis. Services account for 75% of the country’s economic output.

Among those services is the financial sector, which is about to get a boost from a planned Islamic bond, or sukuk, as well as an Islamic index to be added to the London Stock Exchange.

Prime Minister David Cameron announced plans for the entry into Islamic finance at the World Islamic Economic Forum in London at the end of October. Citing statistics indicating that Islamic investments have risen 150% over the last 7 years and are expected to be worth 1.3 trillion pounds ($2.072 trillion) in 2014, he said that not only does Islamic finance present a good opportunity for the country’s financial sector but he intends for London “to stand alongside Dubai as one of the great capitals of Islamic finance anywhere in the world.”

Further, according to Ashar Nazim, partner, global Islamic banking at Ernst & Young, there is far more demand than supply for sukuk, as well as for other sharia-compliant investments. “Currently, the demand for sukuks is in excess of $500 billion, whereas the global supply is less than half,” he said.

Britain’s entry into the market, and it will be the first non-Islamic country to issue a sukuk, is planned as early as 2014, and is expected to be for 200 million pounds. To be compliant with sharia law, no interest can be charged, transactions have to be based on an actual trade or actual business activities, and those businesses cannot involve such things as pork, alcohol, or gambling.

The new Islamic index is also intended to draw Islamic investors by indicating which companies fulfill the conditions required by sharia law.

There is more to the story than sukuks, and growth is spurring ventures into other areas of finance in Islamic countries. Islamic pension funds are on the rise, as are other sharia-compliant products such as takaful (insurance) and banking that does not rely on interest. In an earlier look at the growth of Islamic pension funds, Nazim said that a number of countries could eventually create sharia-compliant tranches from state-owned pension funds.

 “Islamic pension and retirement plans are an important component of the Islamic finance ecosystem. As Islamic finance goes mainstream in several rapid-growth, emerging markets—such as Qatar, Indonesia, Saudi Arabia, Malaysia, UAE and Turkey—we are seeing increased demand-led pressure on state-owned and private pension funds to diversify to offer sharia-compliant programs,” Nazim said.

Other non-Islamic countries have already ventured into offering sharia-compliant investments including Germany, Britain, and Australia, and Dow Jones already has the Islamic Market Titans Index, which tracks the 100 biggest sharia-compliant businesses in Asia, Europe, and the U.S. But the move into sukuk, and the creation of a new index specifically for Islamic investments, could be a big move.

 “Currently, a dominant part of the pension assets in high growth and other emerging Islamic finance markets are parked under conventional schemes,” Nazim said. “A key constraint is the nascent state of the Islamic asset management industry that provides only limited avenues for compliant investing. Notwithstanding the above, we expect at least one key market to transition to [a] compliant pension program within the next 12 months. Success of this pilot project could see more funds following suit. The other game-changing initiative would be sufficient supply of quality fixed income instruments.”

Britain’s entry into the fray with its planned sukuk could certainly be part of that picture, and it may not be the only one. “We are aware of several private and sovereign initiatives currently on [the] drawing board; 2014 could see a major pilot project materialize,” Nazim said. While he expects that the six “high-growth” Islamic countries mentioned above “will lead the emergence of this industry,” they are by no means the only ones.

International investors stand to benefit the most. “The emergence of Islamic pension industry would offer international investors access to some of the high growth emerging markets, and will help further diversify their portfolio,” Nazim said. “Given that Islamic asset management is still in its infancy, there are less than 100 international Islamic fund managers and [approximately] 700-800 Islamic funds globally. Hence there is a good opportunity for conventional pension fund managers to tap into this fast-growing sector leveraging their conventional know-how of the asset management industry. We are already seeing some of the world's best managers entering this market and setting up compliant operations in Malaysia and UAE,” he said.

 

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