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| 31 July, 2016

Notes on a smaller island

A trader monitors his screen on a trading floor in London January 22, 2010. REUTERS/Stefan Wermuth

A trader monitors his screen on a trading floor in London January 22, 2010. REUTERS/Stefan Wermuth

Reuters/Stefan Wermuth

Islamic finance thrived in Great Britain, but, post-Brexit, could it survive in Little England?

Islamic finance thrived in Great Britain, but, post-Brexit, could it survive in Little England?
What a difference a day makes. When Britain leap-frogged New York to become the world's number one financial centre in 2015, it was the envy of the world and the obvious hub for Islamic finance in Europe.

London has always welcomed Gulf money; a large part of its skyline was forged with Islamic investment.
 
In return, London seemed the ideal spot for Islamic institutions looking to gain a foothold in the west, and soak up the City's centuries-strong regulations and infrastructure.

Then, on 24 June, Britain shocked the world by announcing that its public had voted to leave the EU. Overnight, the FTSE 100 tumbled, the sterling crumbled and Britain's credit rating lay in tatters after being downgraded by Moody's, Standard & Poor's and Fitch. Banks, still recovering from their near death experience in 2008, bore the brunt of panicked investors as stocks nosedived.

This is a very different crisis from that of 2008, when Islamic banks came out smelling of roses thanks to a ban on speculative investments. Now Britain's Islamic banks are in the same position as its conventional peers, and may suffer alongside them. It is not yet known under what terms Britain will exit the EU, leaving the financial services sector--which Islamic institutions are very much a part of--facing a long period of uncertainty.

BUSINESS AS USUAL

Perhaps understandably, the Islamic banks we contacted remained tight-lipped about the outlook for Islamic banks in Britain. In fairness, with no clarity likely to materialise before a new Prime Minister moves into Number 10 in September, there is little they can do but reassure their customers that business will continue as usual. "Our priority is to ensure that we serve BLME's customers and support the staff here at the bank," Jabra Ghandour, Chief Executive Officer of the Bank of London and the Middle East (BLME), told Islamic Business & Finance. "Our priority is to ensure that we serve BLME's customers and support the staff here at the bank. 

"Following the vote to leave the EU there will be much debate about what happens next. Our commitment remains to our customers and our shareholders. We are open for business as usual in London and Manchester and there are no plans for this to change. BLME will continue to work closely with the Government and the regulators to develop and support an environment in which Shari'ah finance and investment can thrive."

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Al Rayan Bank voiced a similar stance. "We are a stable and secure UK bank," said its Chief Executive Officer, Sultan Choudhury. "Our customers' money will continue to be protected by the Financial Services Compensation Scheme up to a limit of GBP 75,000. Our financial position is very healthy and we have a strong parent in Qatar-based bank, Masraf Al Rayan. We have limited exposure to the European market.

"There are no changes planned to the expected profit rates of our savings accounts. Until any impact of the referendum on the UK savings market is known and understood, we will continue to operate on a business as usual footing."

However, there is little escape from the volatility that the Brexit vote has wreaked. Banks and property developers, the two sectors most vulnerable to market sentiment, were among the hardest hit in the market fallout following the referendum result. Islamic banks partiality for UK real estate could be particularly painful if property prices fall, as they are predicted to, by as much as 10 per cent. Islamic banks' overreliance on the property sector is well documented, and Britain has long been a favourite destination for real estate investment.

"As yet, we do not know the long-term effect on the UK housing market of the UK's decision to leave the EU," Choudhury assured us, adding that business had to go on as usual until more clarity was offered.

DON'T FORGET YOUR PASSPORT

The biggest issue facing the UK financial services sector is whether institutions will retain their passporting rights. Currently, a British bank can provide services across the EU from its UK home. More importantly, a Swiss or an American bank can do the same from a subsidiary established in the UK. Unless a special deal is negotiated, this won't be possible in post-Brexit Britain. As such, London's gateway to Europe will be slammed shut.

Although all banks will suffer as a result of this, passporting rights are arguably less of an issue for Britain's Islamic banks who, in reality, do very little trade with the rest of the EU. "A considerable portion of Islamic finance activity in London has been focused on non-EU markets like the Gulf and Malaysia, and Brexit should not affect London's ability to continue dealing with those jurisdictions as before," Habib Motani, Partner at Clifford Chance in London, told Islamic Business & Finance. "Of course, there will be the question of accessing investors in the EU from London. This is the same single passport issue as banks and others will be facing in relation to the conventional market.

"We will have to wait and see what agreement there will be regarding this between the UK and the EU, but whatever solution the banks implement in relation to the conventional market will affect Islamic banks too. There will be questions around which market or exchange to list a new issue on--London or another; but to be honest, I am sure this will prove manageable in the context of instruments like Sukuk. Accordingly, much of Islamic finance should continue as before."

LIVING WITHOUT EU

Losing access to the EU's single market may not hurt Islamic banks as much as conventional ones, however there is a real danger that London will lose its competitive edge. If the City's reputation as the best place to bank wanes, will Islamic institutions be as keen to do business there? If the UK loses its status as the Islamic finance capital of Europe, there are plenty of financial centres lining up to take its place.

"I have seen reports that Luxembourg is viewing Brexit as an opportunity to surpass London as a hub for Islamic finance," said Motani. "Of course Luxembourg has, for many years, been very active in Islamic finance; especially in the context of Islamic funds, Luxembourg already has an excellent standing, complementing its high stature in the investment fund world more generally."

Luxembourg isn't the only contender. France has previously made bids to woo Islamic finance, as has Germany. Whether they will rekindle their interest if the number one spot opens up remains to be seen. Neighbouring Scotland, which voted overwhelming to remain a part of the EU, has also courted Islamic finance and would make a convenient second home for Islamic institutions should it choose to divorce itself from the UK.

However, London would be a hard act to follow. No country outside the Muslim world has embraced Islamic finance as wholeheartedly as Britain. The number of institutions in the UK that offer Islamic financial services is nearly double that of the US, and dwarfs other western countries. The UK was the first non-Muslim nation to host the World Islamic Economic Forum, and to issue a sovereign Sukuk.

BEST OF BRITISH

Over 20 banks offering Islamic services, of which five are fully Shari'ah-compliant, are licensed in the UK. The London Stock Exchange is a key global venue for the issuance of Sukuk. The UK offers by far the most complete service for Islamic finance outside its home markets, with financial intermediaries, asset managers, insurance providers and over 30 international law, accountancy and consultancy firms all catering to an Islamic crowd.

If Britain's global clout is softened in the wake of Brexit, Islamic finance will have lost its champion in the western corner. The UK is also by far the largest provider of Islamic finance courses, with offerings at around 70 educational institutions. The UK Government is also working on Shari'ah-compliant student loans. In the midst of a severe talent shortage, this isn't an asset Islamic finance could afford to lose.

There is much at stake for Britain too. Islamic finance plays a significant role in infrastructure development in the UK, from The Shard to the Olympic Village. Over 6,500 homes are currently being financed by a GBP 700 million investment by Gatehouse Bank. The UK cannot afford to lose this funding, especially when investment from Europe dries up.

In the short-term, this is unlikely to happen, as the crumbling pound has only made Britain more attractive to foreign investors. "The fall in sterling makes UK assets and, just as importantly, services cheaper to non UK investors, meaning they will represent good value," said Motani. "I expect vigorous marketing efforts to promote these. Let's be optimistic and look forward to UK-based houses making the most of the opportunity, even though there will be some downside to have to cope with."

Long-term, the impact Brexit will have on Islamic finance remains unclear, because no one yet knows what shape Britain will take when it finally exits the EU. Because of how intricately Britain is woven into the world's financial markets, the consequences of Brexit will touch every segment of the financial services industry,
including Islamic finance.

It would be a great pity if this led to either party distancing itself from the other, as there is much to be gained, and lost, on Britain's future relationship with Islamic finance.

© Islamic Business and Finance 2016