IslamicFinance2009.pdf

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I SLAMIC F INANCE 2009

F EBRUARY 2009

WWW.IFSL.ORG.UK

Islamic finance has been developed in its modern form over the past three

decades, although its key principles, as set out in the side panel on page 7,

remain unchanged. This report, the second that IFSL has published on

Islamic Finance , features the countries and sectors that are leading the way.

The report highlights the growing UK position in the market, and indicates

where Islamic finance has been impacted by the global economic downturn.

OVERVIEW

Chart 1 Global assets of Islamic finance

$bn, assets end-year

The global market for Islamic financial services, as measured by Sharia

compliant assets, is estimated to have reached $729bn at end-2007, 37% up

from $531bn in 2006 (Chart 1). Islamic commercial banks accounted for the

bulk of the assets with investment banks and Sukuk issues making up most

of the remainder. The developing funds and Takaful sectors also made a

contribution. Key centres are concentrated in Islamic countries including

Iran, Saudi Arabia, Malaysia, Kuwait, UAE and Bahrain (Chart 2).The UK,

in 8th place, is the leading Western country with $18bn of reported assets,

largely based on HSBCAmanah.

750

729

Takaful 1%

Funds 2%

Sukuk 11%

600

531

Investment

banks 12%

450

300

537

Commercial

banks 74%

397

150

The Islamic finance industry has felt the influence of the credit crunch and

downturn in the global economy in 2008, with a drop in Sukuk issuance and

a fall in the value of equity funds. Islamic banks, however, have been less

affected than many conventional banks because they are not exposed to

losses from investment in toxic assets nor have they been dependent on

wholesale funds, as they are prohibited from these activities.

2006

2007

Source: IFSL estimates based on The Banker, Ernst & Young,

World Islamic Funds & Capital Markets Conference

While London has been providing Islamic financial services for 30 years, it

is only in recent years that this service has begun to receive greater profile.

An important feature of the development of London and the UK as the key

Western centre for Islamic finance has been supportive government policies

intended to broaden the market for Islamic products. The outcome is

reflectedintheestablishmentofvariousaspectsofIslamicfinanceintheUK:

Chart 2 Geographic breakdown of Islamic finance

- 22banksincludingfivethatarefullyShariacompliant,morethaninany

otherWesterncountry.TwoIslamicbanksweregrantedlicencesin2008.

- 18 Sukuk issues raising $10bn listed on London Stock Exchange,

exceeded only by Dubai Nasdaq.

- SevenShariacompliantETFs,includingfourlaunchedin2008;twonew

equity funds also launched in 2008.

- First company to offer Takaful to UK residents authorised in 2008.

- 18 law firms supplying services in Islamic finance.

- Advisory services provided by Big Four professional service firms.

- A total of 55 institutions offering educational and training products in

Islamic finance, more than that provided in any other country

worldwide.

- Off-exchange trading in commodity-based agreements linked to LME

contracts.

Banking, Takaful & fund assets, $bn, end-2007

Tu rkey

Others

Qatar

Bahrain

Iran

235

UAE

Kuwait

Malaysia

S.Arabia

Banking, Takaful & fund assets end-2007: $639bn

Source: The Banker

IFSL

Islamic Finance 2009

GLOBAL MARKET FOR ISLAMIC FINANCE

Table 1 Islamic finance by country

The global market for Islamic financial services, as measured by Sharia

compliant assets, is estimated to have reached $729bn at end-2007, 37% up

from $531bn in 2006 (Chart 1). This growth is partly related to improved

coverage of the Banker’s second annual survey of Islamic financial

institutions, which make up the bulk of the figure. However there continues

to be underlying growth in assets including a number of new firms that have

startedbusinessduringtheyear.Assetshavegrownfromabout$150bninthe

mid-1990s. Islamic commercial banks accounted for 74% of the assets,

investmentbanks12%andSukukissues11%.Thebalanceismadeupbynet

assets of funds and assets of Takaful providers.

Banking, Takaful & fund assets, $bn, end-2007

Total

2007

235.3

92.0

67.1

63.1

49.1

37.4

21.0

18.1

15.8

6.3

5.7

5.3

17.2

639.1

Banks

233.0

91.2

65.7

54.0

48.2

37.1

19.3

18.1

15.8

6.3

5.7

5.2

16.6

622.0

Takaful

2.3

0.8

1.3

0.2

0.9

0.3

0.4

---

0.1

0.4

6.6

Inv.

firms

---

0.1

8.9

0.0

---

1.3

---

0.2

10.5

Total

2006

154.6

69.4

65.1

37.7

35.4

26.3

9.5

10.4

10.1

15.9

14.3

3.9

4.5

14.4

471.5

Number

of firms*

280

Assets that can be allocated to individual countries from The Banker’s

survey of 500 organisations reveal that the leading countries for Sharia

compliant assets are Iran with $235bn, Saudi Arabia $92bn and Malaysia

$67bn (Table 1). Other Gulf states including Kuwait, UAE, Bahrain and

Qatar are also prominent. The UK, in 8th place, is the leading Western

country with $18bn of reported assets, largely based on HSBCAmanah.

*Includes only those firms submitting data to survey

Source: The Banker

Emerging centres of expertise Bahrain,Dubai/UAEandKualaLumpurhave

both strong historical positions and future ambitions as centres for Islamic

financial services. Saudi Arabia, Qatar, and Singapore also have aspirations

to become centres for Islamic finance. Following the lead set by the UK,

other countries, such as Japan and France, are looking to make the

appropriate regulatory and legal reforms that would facilitate provision of

Islamic financial products. London is seeking to consolidate its position as

the gateway to Islamic finance in Western Europe. Providers in London are

likely to focus on services that complement those available in other centres.

Government strategy for the development of Islamic finance in the UK is set

out on page 7.

Broadening geographical customer base for Islamic services The market is

currently most developed in Malaysia, Iran and the majority of countries that

form the Gulf Co-operation Council (GCC). However, Islamic finance is

moving beyond its historic boundaries in these countries into new territories

both within and outside theArab world. Key future markets include:

- OtherArab countries such as Egypt, Turkey, Lebanon and Syria.

- Other Asian countries such as Indonesia, which has the largest

indigenous Muslim population in the world, and China.

- Western countries in Europe and North America. Countries such as the

US, France, Germany and the UK each have indigenous Muslim

populations of between one and five million. Moreover, the customer

base in Western countries is not necessarily restricted to Moslems: other

customers may be attracted by the ethical and environmental basis of

Islamic finance.

Iran

S.Arabia

Malaysia

Kuwait

UAE

Bahrain

Qatar

Turkey

Pakistan

Bangladesh

Egypt

Sudan

Others

Total

IFSL

Islamic Finance 2009

Sharia compliant financial services

Table 2 Islamic banks in UK

Fully sharia compliant

Bank of London and Middle East

European Finance House

European Islamic Investment Bank

Gatehouse Bank

Islamic Bank of Britain

Banking and Sukuk - the issue of Islamic notes - represent the forms of

Islamic finance that are most well established, although Takaful (insurance)

and funds are also evolving. Products that may be the subject of innovation

include private equity and private wealth management.

Banking Islamic banks have been perceived more positively during 2008 in

viewofthemajorchallengesfacedbymanyconventionalbanksarisingfrom

the credit crunch. Islamic banks have not, like many conventional banks,

been exposed to losses from investment in toxic assets or become dependent

on wholesale funds, as they are prohibited from these activities. Islamic

banks,likeconventionalbanks,needtohaveappropriatecapitalandadequate

access to liquidity and manage risks appropriately. This includes managing

their exposure to bad debts arising from the general downturn in business.

Islamic windows

Ahli United Bank

Alburaq

Bank of Ireland

Barclays

BNP Paribas

Bristol & West

Citi Group

Deutsche Bank

Europe Arab Bank

HSBC Amanah

IBJ International London

J Aron & Co.

Lloyds Banking Group

Royal Bank of Scotland

Standard Chartered

UBS

United National Bank

Islamic banks have continued to build on their natural competitive

advantages including customer loyalty, sensitivity to religious practices and

stable base of deposits. They compete not only with each other but also

conventional banks that have moved to open Islamic ‘windows’ through

settingupbranchesorcreatingShariacompliantsubsidiaries.IntheBanker’s

survey, balance sheet assets of Sharia compliant bank assets totalled $622bn

in2007,ofwhich$537bnwereincommercialbanksand$85bnininvestment

banks. Countries with most of the 280 banks reporting to the Banker’s

survey, include Malaysia with 38, while Kuwait, Bahrain, Iran and Pakistan

each have between 20 and 29 banks supplying Islamic financial services

(Table 1).

In the UK, five fully Sharia compliant banks have been established putting it

in the lead in Western Europe (Table 2). The Islamic Bank of Britain (IBB)

became the first stand-alone retail Islamic bank in the country in 2004 and

has over70,000customers.EuropeanIslamicInvestmentBank(EIIB),AIM-

listed in 2006, was created with the aim of recycling surplus institutional and

private liquidity from the Gulf into Sharia compliant asset classes inWestern

markets. Opening in 2007, The Bank of London and The Middle East

(BLME) offers Sharia compliant investment and corporate banking to

businessesandhighnetworthindividualsglobally.EuropeanFinanceHouse,

a unit of Qatar Islamic Bank, and Gatehouse Bank each received a banking

licence in 2008. European Finance House offers a balanced range of Sharia

compliantinvestmentproductsandservicestoclientsthatincludecompanies

and wealthy investors. Gatehouse Bank is a wholesale investment bank

operating in capital markets, institutional wealth management, Treasury

business and advisory services.

Table 4 Islamic banks in western countries

& offshore centres

Number located in each country, end-2007

UK*

France

S. Africa

Switzerland

Australia

Canada

Cayman Islands

Germany

Source: The Banker

*IFSL 2008 estimate for UK

InadditiontothefiveShariacompliantbanks,thereareanestimated17

conventional banks that have set up windows in the UK to provide

Islamic financial services (Table 2). These include Alburaq (ABC

International Bank), Barclays Bank, Deutsche Bank, HSBC Amanah,

Lloyds Banking Group, Standard Chartered and UBS. HSBC Amanah

is the only conventional bank with an Islamic window to report to the

Banker’s survey: its assets of $15.2bn account for 87% of the UK’s

identifiedassetsandwereupoverahalfonthepreviousyear(Table3).

Table 3 Assets of Islamic banks in UK

Shariah compliant assets, $m

Year-end

Jun-08

Dec-07

Sep-08

Dec-07

2006-07

9727

589

483

241

---

2007-08

15194

1196

648

337

% change

103

---

HSBC Amanah Finance

Bank of London and the Middle East

European Islamic Investment Bank

Islamic Bank of Britain

European Finance House

Gatehouse Bank

Source: The Banker

IFSL

Islamic Finance 2009

BLME, EIIB and IBB also reported a substantial rise in assets in the latest

year to be reported. The 22 Islamic banks in the UK substantially exceeds

that in any other western country or offshore centre (Table 4). The UK mar-

ket for Islamic mortgages has grown to about £500m, some 0.3% of the total

UK mortgage market.

Chart 3 Sukuk global issuance

$bn, annual issues

Sukuk are issues of Islamic notes that represent an alternative to

conventionalbonds.IssuanceofSukukincreasedrapidlyfrom$1bnayearin

2002to$42bnin2007(Chart3).Incommonwiththebroad-basedslowdown

in global capital market activity, Sukuk issuance fell away during 2008 to an

estimated $20bn. Key contributing factors were a decline in asset valuation,

a lack of liquidity and a lack of market confidence. There was also an earlier

pause in February 2008 due to a ruling from the Accounting and Auditing

Organisation for Islamic Financial Institutions (AAOFI) questioning Sharia

compliance of some Sukuk structures, but issues resumed in March. The

leading underwriters in 2008, based on value of issuance, were HSBC,

CIMB, Calyon and Standard Chartered, according to Bloomberg data

reported in The Banker.

2001

2002

2003

2004

2005

2006

2007

2008

Source: Zawya Sukuk Monitor, Islamic Financial Information Service, Moody's

A breakdown by country for 2007 show that Malaysia remains the main

issuer in the market with issuance of $26bn, over half the annual total. Much

of the rest was accounted for by the UAE $10bn and SaudiArabia $6bn with

Pakistan, Bahrain and Kuwait each accounting for issues of $1bn each. Over

a third of Sukuk are listed with the remainder being over the counter. Nasdaq

Dubai and London Stock Exchange are the main centres for listing. At end-

2008 there were 20 listings in Dubai totalling $18bn and 18 in London worth

$10bn.

Although market activity has fallen away, particularly in the second half of

2008, the long term prospects for Sukuk are positive once markets recover.

Three factors should have a role in fostering growth in demand when market

conditions improve:

- There is a commitment to a substantial programme of infrastructure

investment in the GCC totalling up to $1,000bn over the next ten years,

some of which will be financed through Sukuk.

- Recent years have shown that there is an appetite and demand for

investment in Sukuk that goes well beyond Islamic investors amongst

those investors that wish to gain exposure to diverse but high quality

assets.

- Governmentsandregulatorsinavarietyofcountrieshaverecognisedthe

important role that Sukuk can play in capital markets and have been

giving priority to developing their countries as Sukuk centres. In

addition to Dubai and the UK, these include Bahrain, Malaysia,

Pakistan, Singapore and Japan.

Chart 4 Islamic equity funds worldwide

$bn

Islamic funds The market for Islamic funds has expanded over the past

decade. Eurekahedge estimates that the total number of Sharia compliant

funds reached 680 funds during 2008 having risen from around 150 in 2000.

Thesefundsincludemutual,alternative,investmenttrusts,privateequity,real

estate and structured products. The value of many funds has been

1996

1998

2000

2002

2004

2006

2008*

*IFSL estimate

Source: World Islamic Funds & Capital Markets Conference, Failaka

IFSL

Islamic Finance 2009

substantially reduced by the sharp decline in equity markets in the third

quarter of 2008. The total value of equity funds, numbering around 420 in

2008, fell from $17.2bn at end-2007 to an estimated $12.5bn end-2008.

Funds’ value had previously risen from a low point of $3bn in 2002

(Chart 4).

Chart 5 Rate of return on assets

Annual % rate of return on assets worldwide

Eurekahedge estimates that returns on Islamic funds were down an average

28% in 2008. Overall Islamic funds have returned an average of 0.1% a year

since 2000, better than the -4% generated by global equities, but well short

of the 6% achieved by bonds (Chart 5). The bulk of Islamic funds are

domiciled in the GCC and Malaysia. Several UK offerings have been

launched in 2008:

Bonds

-10

Islamic

funds

-20

- Four exchange traded funds (ETFs) listing on the London Stock

Exchange;

- Afund of equity funds, the first of its type globally to be offered by SEI;

- Arab Banking Corporation, under its Alburaq brand, launching the first

Sharia compliant retail capital-protected equity product in the UK.

- FTSE Group, the global index provider, launching the FTSE Bursa

Malaysia Hijrah Sharia Index, in association with Bursa Malaysia.

-30

Equities

-40

2000

2001

2002

2003

2004

2005

2006

2007

2008

Source: Eurekahedge, S&P, Greenwich Alternative Investments

Chart 6 Takaful global premiums

$bn

These offerings supplement ScottishWidows’global equity fund launched in

2006 and the three ETFs already listed on the LSE.

7.5

Iran

Rest of world

Takaful, similar to mutual insurance, is a risk sharing entity that allows for

the transparent sharing of risk by pooling individual contributions for the

benefit of all subscribers. The global market is at an early stage of

development, with two thirds of global premiums, $4.8bn out of an

estimated$7.2bnin2007basedinIranwhereTakafulisthecompulsoryform

of insurance (Chart 6). Global Takaful premiums have doubled from $3.6bn

over the three years since 2004. Other than Iran, the Takaful market is

mainly concentrated in Malaysia, SaudiArabia, Kuwait and UAE (Table 4).

Penetration of Takaful is nevertheless low in these and other countries with

Islamic majorities. Takaful represents a strong growth opportunity,

particularly with regard to life insurance, as Sharia compliant products are

developed. Takaful assets of $6bn were identified in the Banker’s survey.

This probably understates global assets which IFSL has estimated at $10bn

in Chart 1.

6.0

4.5

3.0

1.5

0.0

2004

2005

2006

2007

Source: Ernst & Young World Takaful Report

Table 5 Law firms in UK offering

Islamic finance legal services

The Takaful market in the UK is at an early stage of development. Principle

Insurance, authorised by the FSA in 2008, is the first Sharia compliant

independent Takaful company in the UK. Its services to UK residents, sold

undertheSalaamHalalInsurancebrand,includeShariacompliantmotorand

home insurance. It is the second Takaful available in the UK, following

HSBCAmanah’s home insurance offering. Prudential was given approval in

2006 to launch a Takaful business in Malaysia in partnership with Bank

Negara Malaysia.

Allen & Overy LLP

Baker & McKenzie LLP

Berwin & Leighton Paisner LLP

Clifford Chance LLP

Dechert LLP

Denton Wilde Sapte

Eversheds LLP

Herbert Smith LLP

King & Spalding International LLP

Linklaters

Lovells LLP

Milbank, Tweed, Hadley, & McCloy LLP

Norton Rose LLP

Simmons & Simmons

Stephenson Harwood

Taylor Wessing LLP

Trowers & Hamlins

White & Case LLP

Other financial products TherangeofproductsgeneratedbyIslamicfinance

has broadened steadily. In the UK in 2007 Merrill Lynch structured the first

Sharia compliant credit default swap for a UK power company involving

GCC investors. In 2008, Barclays Capital and Sharia Capital Inc. of the US

Source: Chambers & Partners

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