FT BeyondBrics: London and sukuk, the lessons of Malaysia

FT BeyondBrics, October 29 2013

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The UK’s decision to launch an Islamic bond has been a long time coming. For a decade the prospect has been raised at the many Islamic finance conferences that have been held in London; Ed Balls, when he was City of London minister, announced the first Shariah-compliant government bonds from the UK Treasury back in April 2007.

The rationale then, as now, was to bolster London’s standing as an international financial centre. The logic then, as now, was that London ought to offer everything it can to financial markets, and that if launching a sovereign sukuk bond helps to create a benchmark for others to issue against, then that’s what it should do so as not to miss out.

As David Cameron said on Tuesday: “When Islamic finance is growing 50 per cent faster than traditional banking and when global Islamic investments are set to grow to £1.3tn ($2.1tn) by 2014, we want to make sure a big proportion of that new investment is made here in Britain.”

There was also a sense that it would be a gesture to the Muslim community in the UK in order to demonstrate engagement in sometimes troubled times. Then, as now, that’s a good argument too.

Britain didn’t go ahead with its 2007 plan because the global financial crisis pulled the rug from under the market for new issuance, and the plan was eventually abandoned in 2011. However, it can be argued that the crisis underscored the usefulness of the Islamic capital markets. Since any Islamic finance transaction must be underpinned by real assets, Islamic institutions weathered the financial crisis rather better than many in the developed world that suffered from exposure to more opaque and synthetic securities.

Stability of funding is not really a driver for the UK Treasury, which has one of the most reliable and deep sources of funding in its own Gilt market, and the volume of funds available – the issue is likely to raise £200m – scarcely makes a difference to the national coffers either. But the government does understand that a sovereign bond could act as a magnet to other Islamic issuance in London.

In this respect, it is perhaps a little late. While it has waited for the right time to launch, several other British institutions have already issued, albeit usually through subsidiaries in Asia or the Middle East: HSBC is considered a pioneer in sukuk issuance, and Tesco has also issued in the Islamic format. And the London Stock Exchange has been the venue for $34bn of sukuk issuance from 49 issues, as well as hosting the company shares of four Shariah-compliant institutions on AIM: Islamic Bank of Britain, European Islamic Investment Bank, The Family Shariah Fund and Shariah Capital. The LSE also hosts seven Shariah-compliant ETFs based on Islamic indices.

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It’s not clear how much further a sovereign sukuk will take the UK in its plans to be Europe’s Islamic finance centre. It looks good: according to Dealogic, the UK will be the first western nation to launch a sovereign sukuk, if we don’t count Turkey. But then again Luxembourg has managed to establish itself as a European Islamic finance centre without a sukuk; it was the first European nation to list a sukuk in 2002, and has since attracted them from Malaysia, Pakistan, Saudi Arabia and the UAE, among other places.

So what’s to be gained from being a centre of this market? To answer that, it is instructive to look at Malaysia. No country worldwide has made a more concerted effort to make itself a centre for Islamic finance, with a rare alignment of government, central bank, securities regulator and institutional investor base working together to make it happen.

First Malaysia made Islamic finance work domestically, with Islamic banking assets topping 20 per cent of the total national banking system, and with 63 per cent of securities listed on Bursa Malaysia Shariah-compliant as of June 2013, according to the Securities Commission. It built one of the largest national Islamic fund management industries in the world, with 82.23bn ringgit ($26.1bn) in assets under management as of June 2013, 14.8 per cent of the national total.

And then it made itself an international centre for Islamic finance, inviting foreign banks in to set up in considerable size, and granting seed capital to foreign fund managers to build Islamic enterprises in Kuala Lumpur, among them Aberdeen, BNP Paribas, Principal, Franklin Templeton and Kuwait’s KFH. On the debt side, the market capitalisation of corporate sukuk in Malaysia stood at 303.9bn ringgit ($96.6bn) in June. Today, Malaysian sukuk in ringgit account for about two thirds of the global sukuk volume.

That’s the prize. One could argue, of course, that it’s natural for Malaysia to build this expertise since it is a majority Muslim country, but then again Indonesia has considerably more Muslims and has made nothing like the same progress. So London can look to Kuala Lumpur for a sense of how scale can be built beyond domestic participation, and indeed, Cameron’s remarks today suggest it is a role model. “I don’t just want London to be a great capital of Islamic finance in the Western world,” he said.”I want London to stand alongside Dubai and Kuala Lumpur as one of the great capital of Islamic finance anywhere in the world.”