London has taken a decisive step towards becoming a global centre for Islamic finance, establishing the world’s first secondary market for trading bonds that comply with the Koran’s strict laws on earning interest.
These so-called shariah-compliant bonds, or sukuk, are structured to pay profits from an underlying business, rather than interest, which is banned under Islamic law as the creation of money from money itself is considered sinful.
The development marks a significant new step for London in its fight with New York as the world’s premier financial centre. Although Islamic banking products are available in the US, officials there have not been as aggressive in promoting the concept as their counterparts in London.
An academic who has advised the US government said: “Americans tend to assume that Islamic finance means terrorist finance. That is an obstacle.”
In contrast, business leaders and politicians in the UK hope that Islamic finance will provide a bridge to the Muslim world, both at home and abroad.
Ed Balls, City minister, says the government wants to do everything possible to make London a global centre for Islamic finance, but also help practising Muslims living in the UK to use retail Islamic products, such as Islamic mortgages.
“We want London to be a global financial centre for Islamic finance,” he said. “This is a fast growing market. We want centres such as Dubai and Bahrain to look to London as their first-choice financial partner for Islamic financial business.”
Last week, he announced plans to introduce legislation this year making it more attractive for issuers of Islamic bonds in the UK by allowing them to offset the coupon payments they pay to investors against company profits for tax.
At present, an issuer of a non-Muslim bond can offset the coupon interest payment against profits, but an Islamic bond does not qualify for this relief as the coupon payment is based on profit rather than interest and profit cannot be offset against profit.
Ken Livingstone, mayor of London, and John Stuttard, the lord mayor of the City of London, who represents the financial community in the square mile, have thrown their weight behind the drive to attract Islamic finance to the City.
Mr Livingstone said: “It is highly important for London that it becomes a world centre for Islamic finance. It is a principle that all persons should be able to carry out business in accordance with their religious convictions and it is practically important for London with the increasing wealth of the Gulf and other Islamic states.”
The signs of life in a secondary trading market in London, where bonds are bought and sold once they have been listed, are also a key development for the fledgling Islamic financial market, which until now has seen almost no trading in shariah-compliant products.
Traders estimate the number of trades in London’s sukuk market rose from a trickle in December to about $2bn (EUI 1.5bn, £1bn) in January, spurred on by the world’s largest sukuk bond issue: a $3.52bn issue in November from the Nakheel Group, the Dubai property developer.
A large chunk of the issue was bought up by hedge funds and other non-Muslim investors. Most of the previous bond issues were bought up by Muslim investors, who tend to hold on to the paper rather than trade it.
London faces competition from places such as Bahrain, Dubai, Riyadh, Singapore and Kuala Lumpur as a centre of Islamic finance. There are more sukuk listed in Dubai than anywhere else, although it is yet to establish a secondary market.
Most bankers forecast these centres will grow. But London has far more international reach and expertise.
Bankers say this financial sector is relatively underdeveloped, even in the Islamic world, where products that comply with Islam’s ban on interest represent only a small part of the financial industry.
John Weguelin, head of the European Islamic Investment Bank, said: “Secondary trading in sukuk is still in its infancy, but you have to remember that the corporate bond market in the UK and Europe also started off as a small market when you go back to the early days in the 1970s. Now the volumes in those markets are huge. Who’s not to say that the sukuk market could follow a similar trend?