The City of London is an important player in the Global Islamic Finance arena, but a lack of representation on global Islamic Finance institutions is leading to UK Islamic Finance losing out against global peers.

London is a leading Islamic Finance Centre

When Prime Minister Cameron announced in October 2013 a push to make London the Western Hub of Islamic Finance, he would have known that London is already a leading centre for Islamic Finance. It leads globally in the provision of short-term liquidity for Islamic Institutions through commodity Murabahah trades at the London Metals Exchange, a massive market which eclipses all other areas in Islamic Finance. London also plays a major role in Wealth and Asset Management for international Muslim clients, as well as in Islamic Banking where the UK has five wholly Sharia compliant Banks.

Progress is also being made on the Sukuk front with the long anticipated sovereign UK Sukuk to be issued towards the end of this year, whilst the London Stock Exchange enjoys a leading position, (but now somewhat challenged) position as a Sukuk listing venue. Additionally the dominance of English Law in most Islamic Finance contracts, as well as the dominance of British Banks in HSBC and Standard Chartered as the leading players in the Islamic Debt Capital markets is often overlooked.

Lack of UK membership of Islamic Finance bodies

One area in which the UK does not perform so well is in representation within global Islamic Finance bodies, and this lack of representation is damaging UK Islamic Finance. A case in point is the short-term Sukuk issuance programs announced by the International Islamic Liquidity Management Corp (IILM) and the Islamic Development Bank (IDB). Both programmes are denominated in US Dollars with no issuance in British Pounds (GBP).

This lack of GBP short-term liquidity puts UK Islamic Finance institutions at a double disadvantage against conventional as well as peer Islamic Finance institutions.

The conventional disadvantage is illustrated through a lack of short-term liquidity (over-night funds placement) which forces institutions to hold large amounts of cash, or cash like instruments which earn nothing in contrast to conventional banks which can place overnight cash into yielding places. Blake Goud provides an excellent real world example in his blog using Al Baraka Banking Group. The good news is that as stated, the IILM and the IDB are working to fix these short-term liquidity challenges.

The disadvantage of UK Islamic Finance against Islamic Finance peers, say in the Middle East or Asia is that these peers currencies will be closely or loosely fixed against the US Dollar and therefore they will happily snap up the short-term IILM or IDB paper. Due to short-term currency risk, UK Islamic institutions will likely need to assess market risk before entering into over-night GBP to USD trades in order to hold the short-term paper overnight (this currency risk would still have been true if a short-term commodity Murabahah trade had occurred as commodities are also priced in USD).

UK Islamic Finance needs better global representation

Joining global Islamic Finance institutions will give UK Islamic Finance a voice and role to represent its interests. Only last month The Central Bank of Korea became the 59th regulatory body to join the Islamic Financial Services Board (IFSB). UK membership of IILM should be a formality given that Luxembourg was a founding member (Luxembourg Central Bank is also a member of IFSB), whilst membership of the IDB would be somewhat challenging, not only for political reasons in UK, but for the reason that IDB membership would require UK membership of the Organisation of Islamic Conference (OIC), though given that Russia and Thailand enjoy observer status of the OIC and that the UK already has in place agreements with the OIC, the challenge may not be that insurmountable.

U.S. Dollar investors are thinking twice about subscribing to the United Kingdom’s debut Sovereign Sukuk due to the U.K. Pound’s (Sterling) soaring value, one Gulf-based Islamic banker said, but the deal is still likely to be heavily oversubscribed with the likelihood of it being upsized.

With the Sukuk to be denominated in Sterling, the case of Sterling strength is illustrative of the challenges London faces as it seeks to be the Western hub of Islamic Finance; that of the excess liquidity London seeks to tap is strongest in the energy exporting U.S. Dollar linked markets of the Gulf Cooperation Council (GCC) and Malaysia. Negative movements in currency valuations for the U.S. Dollar against Sterling will make U.K. based investment decisions unattractive for such U.S. Dollar based investors.

Whilst in the short-term Sterling does seem to be overbought against the Dollar, it is widely expected Dollar strength will emerge towards the end of 2014 thereby making subscription to the Sukuk (likely to be issued around October 2014) more attractive to GCC and South East Asian subscribers, hence the delay in the Sukuk issuance may be a blessing.

UK debut Sovereign Sukuk announced on 29 October 2013

Since the announcement of the intended issuance of the debut UK Sovereign Sukuk by Prime Minister David Cameron at the end of October 2013, Sterling has surged in value trading last week at yearly highs of over 1.68 against the US Dollar, up from 1.59 at the time of the announcement and seen in a slightly wider context up from 1.55 just a month prior to the announcement.

Whilst this near 8% rise may be welcomed in some quarters from a macro UK economy perspective (lower fuel costs leading to lower inflation), it makes U.S. Dollar based investors think twice about subscribing to the UK Sovereign Sukuk, for whom subscription to the primary offering costs around 8% more than it would have done in September 2013. This 8% hit is made more stark when we assume a maturity of 5 years for the Sukuk, in which case it will likely yield a similar lowly amount to conventional Gilt’s at around 1.97%.

Whilst the UK Sovereign Sukuk is aimed at domestic consumption from a growing domestic Islamic Finance services industry, seen from a wider context the secondary aim of the issuance would have been to attract demand internationally and whilst some interest has been expressed publicly, the strong Pound will dampen interest from the key GCC and South East Asian markets, all of whom are tightly linked to the US Dollar, either in terms of a fixed exchange rate, or a managed float against the basket of currencies of which the US Dollar would be the core component.

Chart showing Sterling’s soaring value against the U.S. Dollar.

Despite this, strong domestic Sterling demand will ensure the UK Sukuk will be heavily oversubscribed, and indeed similar to Turkeys Sukuk debut, there is a likelihood the deal maybe upsized as demand will greatly outstrip supply.