13 Nov 2013
Market participants could have been forgiven for feeling a sense of déjà vu last month when UK Prime Minister David Cameron announced plans for a government sukuk. Such sharia-compliant bonds, which avoid interest payments forbidden in Islamic finance, have been discussed before.
Islamic finance set to make its mark in UK
In 2008, before the full scale of the financial crisis became known, the Labour government announced similar plans, but these were soon shelved when economic policy priorities changed.
But bankers active in the Islamic sector believe that this time it’s different. Samad Sirohey, chief executive of Citigroup’s Islamic bank, believes Cameron’s plans are more than just a way of raising more money for government coffers.
He said: “This announcement is strategic rather than a commercial move. There’s a desire to create an Islamic finance hub for instruments, for listing, and for indices.”
Crucially, a successful issue would address the tax and regulatory treatment of sharia transactions. This is important because, given the prohibition of interest, Islamic bonds usually involve the transfer of specific assets which are ordinarily subject to capital gains tax, stamp duty and other levies in developed economies. This, say industry participants, is why western markets have yet to play host to a sovereign sharia transaction. Nor has there been any corporate issuance in the western world, despite the growing sophistication of corporate sharia financing in Islamic centres.
Experts in the sector believe the UK debut will involve an infrastructure project, which could also give rise to further sharia issuance from non-government borrowers.
Atif Hanif, a banking partner at law firm Allen & Overy, said: “If the government sukuk is a success, infrastructure issuers might say the Treasury has raised money using this, we have these requirements in infra so maybe we can try and replicate the same sort of approach to obtain funding.”
Investors, as well as issuers, are also likely to be watching developments closely. An investor base for a UK government issue already exists in the form of London-listed Islamic financial institutions.
Bank of England regulations require banks licensed in the UK to hold a stock of liquid assets – securities that can easily be converted to cash. Typically, banks seek liquid assets denominated in the currencies in which they pursue their day-to-day lending and other businesses, but Islamic banks based in the UK do not have appropriate sterling assets to invest in for this purpose.
Citi’s Sirohey said: “Even if [London-listed Islamic financial institutions] were to go for the triple-A instruments issued by the Islamic Development Bank, they’re all dollar-denominated. Something in sterling will help their treasury currency position – matching the currency on their book.”
Abdulaziz Al Duweesh, chief investment officer at Gatehouse Bank, a London Islamic investment bank, said that his bank’s “whole model would collapse” if it failed to maintain its liquidity buffer.
“If the government issues sukuk, that would make our business easier. We wouldn’t have to get a fatwa from our sharia board giving us an exception because we operate in an environment that doesn’t have a sharia bond,” he said.
Bankers believe that solving this problem could lead to more liquidity in the UK.
Mohammed Dawood, global head of sukuk financing at HSBC, said: “Potentially this will encourage the flow of Islamic finance to support infrastructure finance.”
London is already a destination for Islamic money, which is underpinning landmark projects such as the London Gateway deep-sea container port, the Shard and the redevelopment of the Battersea power station site.
Sectors likely to be attractive to Islamic investors include healthcare and affordable housing – Hanif at Allen & Overy said that Islamic money from the Gulf and Malaysia was already funding the development of student accommodation in the UK.
Like all investors, those with sharia mandates want a predictable rate of return and a relatively safe investment. But they also have another box to tick, said Hanif: “On top of that they’re concerned about investments that add social value. These are areas where they will see themselves adding value to society.”
But while infrastructure is an obvious target market given the asset-backed nature of much Islamic finance, there is also opportunity for corporate issuers to prepare less complicated structures for general funding purposes.
Dawood believes this is crucial to the Islamic finance sector’s viability in the UK: “While we’d welcome the market if it moves ahead into infrastructure funding, the development of a broader market across more vanilla issuance would be more sustainable in the longer term,” he said
Jamie Durham, international capital markets partner at Allen & Overy, said there was no legal or regulatory reason why non-Islamic corporates could not issue in sharia format. “Whether they’re looking to borrow on an Islamic basis probably will depend more on how much they are looking to raise and what pricing advantage is there from having an Islamic tranche within the funding structure as opposed to it all being done on a conventional basis,” Durham said.
Corporate issuance need not relate to tangible assets such as property. As the Islamic market has developed, some deals have emerged backed by intangible assets that have a measurable value. Citi’s Sirohey said: “We’ve done that in other jurisdictions. We’ve set up programmes for telecoms built around the concept of minutes of airtime in the network and did an Emirates Airline transaction build around passenger capacity. We’ve got greater flexibility – the market is used to seeing more innovation in structures that have all the appropriate approvals.”
But not every corporate borrower is a good fit for the market as sharia investing is based on ethical principles and not simply the prohibition of interest. Tobacco companies, for example, are excluded as are property companies with bank tenants.
Issuers and structures alike are signed off by sharia boards, but investment committees then make their own decisions.
Spencer Maclean, head of syndicate, west at Standard Chartered Bank said: “Dedicated Islamic investors will have to consider not only the fatwa that is issued on the deal but also their own subjective view on the deal being genuinely Islamic.”
Once a UK benchmark is established, corporates will have a better basis on which to make that analysis.
• Leading the way
Islamic finance is not just done by banks set up with a sharia mandate; several mainstream investment banks enjoy market-leading positions in the global market.
The Islamic bond market was worth more than $44 billion in 2012, with HSBC enjoying a market share of just below 24% of issuance according to figures from Dealogic. Other prominent western financial institutions in the sector are Standard Chartered, which was fourth in the global league table, Deutsche Bank which was sixth and Citigroup eighth.
Mohammed Dawood, HSBC’s Dubai-based global head of sukuk financing, is key to the bank’s effort in the market, as are Rafe Haneef, chief executive of the subsidiary HSBC Amanah Malaysia, and Fahad Al-Saif, head of capital markets and corporate finance at HSBC Saudi Arabia.
The bank works across emerging markets, the Middle East, south-east Asia and relevant markets such as north Africa and Turkey. It has worked on transactions including the first Saudi Arabian government-backed Islamic finance bond, issued via its civil aviation authority last year. The bank was also on this year’s follow-up to that $4 billion transaction.
Other recent deals include Turkey’s debut sovereign sukuk in 2012 and the follow-up this year and, a few weeks ago, the first corporate hybrid sukuk, for Saudi Arabian dairy company Almarai. The team was also involved on the first sharia-compliant bank capital transaction, on behalf of HSBC, last year.
Dawood believes the UK government’s intention to issue will provide opportunities for investment banks active in the sector.
“This will certainly give the banks more options for them to consider when it comes to arranging funding in the capital markets. This transaction will lay the groundwork and provide a number of very useful data points,” he said.
Given that he has an established team based in Dubai, Dawood believes that the bank could service a developing British Islamic finance market from there, in co-operation with bankers based in London.
–This article first appeared in the print edition of Financial News dated November 11, 2013