Islamic Finance - The New Mainstream Alternative
by Jeremy Hetherington-Gore, April 2007

2006 was the year in which Islamic finance, a concept virtually unheard of outside banking circles a decade ago, finally crossed the border-line between slightly exotic alternative territory and the mainstream. Islamic banking and finance industry has undergone something of an explosion in recent years as demand for an alternative to western banking products structured along ethically-aware Islamic principles has grown, and in early 2007 it received the financial equivalent of the accolade when UK Chancellor Gordon Brown's announced that the Islamic finance industry would be given the same tax treatment in the UK as other investments. The move was applauded by tax and finance experts, who say it puts the City of London at the forefront of the nascent but rapidly growing global industry.

What Is Islamic Finance?

It's almost no longer necessary to ask that question, but for the record, under the guiding principle of Shariah law, the goal of trade and enterprise within an Islamic-based society is the sharing of wealth and prosperity within the community through morally acceptable business activities. Likewise, Shariah law dictates that risk in trade and business should also be shared. This means that the accumulation of wealth through the receipt of interest, or riba, is prohibited, as interest income is deemed effortless profit. It also means that investment in certain business activities is forbidden on ethical and moral grounds, such as those involving alcohol, tobacco, pornography, armaments and gambling.

Whilst trade along Islamic lines is as old as the religion itself, modern Shariah banking didn’t really take off until the 1960s with the launch of the Social Bank in Egypt, a project later replicated in other areas. In the intervening years, some countries, such as Pakistan and Sudan, have made attempts to completely ‘Islamicise’ their financial systems, although the Islamic banking and investment industry has been, until recently, confined largely to the Middle East.
The concept of a bank making a profit without charging interest can be a difficult one to grasp for those of us brought up in a western-style capitalistic environment. However, numerous financial products and contracts have been developed and are appearing on the market place all the time, based on a number of structures which seek to eliminate the need for interest, and share both profit and risk.

Possibly the most popular of these is the contract known as Murabaha. Described as a cost-plus-financing contract, a Murabaha contract can be used to finance a variety of purchases. For example, in order to buy a house using this contract, the prospective buyer agrees a sale price with the seller and approaches a bank, which will buy the property and sell it back to the customer at a higher price. The house will be registered in the buyer’s name and he will agree to pay back the amount in instalments. This technique is also applied to the financing of other purchases, such as cars or household appliances. Murabaha contracts are also used to issue letters of credit and to provide financing for trade.

A similar method, known as Ijara, works in much the same way, except that the bank will buy an asset and then effectively lease it to the customer for an agreed period. During the term of the lease, the buyer is required to pay a form of rent, which is deemed by the bank to be reflective of the risk that it is taking as part of the transaction. This rent can be either fixed or variable, depending on the specific contract terms offered by the institution.

Another popular method of financing under Islamic law is Musharaka, which can be loosely translated to mean a partnership. This is widely recognised as perhaps the purest form of Islamic contract available within the modern banking framework because it has more of a basis in the profit and risk sharing principle. Within a personal banking context, a Musharaka arrangement may see the bank providing the funds to enable the customer to buy an asset, with the bank and customer agreeing a profit or equity sharing ratio for that asset. Losses are shared on a similar basis.

There are also variations on the above themes, such as Ijara-wa-iktana. This is similar to Ijara, the difference being that included in the contract is a promise from the customer to buy the asset or goods at the end of the lease period at a pre-determined price. Rentals paid during the period of the lease constitute part of the purchase price and often under these arrangements the final sale will be for a token sum.

Ijara with diminishing Musharaka means that an institution’s equity in an asset may be reduced as the buyer makes capital payments over and above the agreed rental payments or lease payments. This means that the bank’s ownership decreases and the customer’s equity increases over time, until ownership is eventually transferred entirely to the buyer.

Another important tool within the Islamic finance framework is the Mudharabah contract, which is used in the financing of new business ventures. In short, under this arrangement, one party known as the rabal-maal provides the funding, while the other party - the entrepreneur or mudarib - provides the effort and labour. Profit is shared at an agreed ratio at the start of the contract; however, in the event that the venture fails, any losses are borne completely by the owner of the capital, whilst the entrepreneur derives nothing for their efforts.

Instruments have also been developed to serve part of the investment industry that were previously off limits to the Islamic investor, such as the international bond markets, in which sukuks are fast becoming a visible feature. These certificates bear a resemblance to conventional bonds, but unlike their western counterparts, they are backed by an asset, such as pools of ijara contracts. The asset will be leased to the client to yield the return on the sukuk and backing by real assets ensures that a sukuk is also tradable in a Shariah-compliant secondary market.

Location And Size Of The Islamic Finance Sector

Key locations for the rapidly developing Islamic finance sector are Dubai and Labuan, because they are sophisticated low-tax centres in Islamic regions with concentrations of wealthy investors, while London and the Cayman Islands, as existing banking and investment fund centres, are home to the highly skilled legal and financial professional communities needed to bring Islamic products to market.

The global Islamic finance industry is now worth more than $1 trillion in terms of assets, having quadrupled in the last three years. Although this figure remains just a fraction of global assets, given a world Muslim population of around 1.5 billion people, the industry has enormous potential, and this is a fact that is starting to be recognised in boardrooms of some of the world’s largest western-based banking, fund management and insurance groups, many of which have now launched banking facilities compliant with Shariah law.

2006: A Watershed Year

A round-up Of Islamic finance developments in 2006 and early 2007 shows the growing size and maturity of the industry:

European Islamic Investment Bank Plc (EIIB), the first independent, Sharia-compliant Islamic investment bank to be authorised and regulated by the UK Financial Services Authority, announced the launch of a Sharia-compliant real estate fund. The EIIB Pan-European Islamic Real Estate Fund is structured as a tax-efficient Sharia-compliant fund which will directly purchase commercial real estate assets in the office, retail and industrial sectors in and around major cities in the UK and Western, Central and Eastern Europe.The fund takes the form of a closed-end fund with a fixed term of five years plus up to two years wind-down. With a target size of between EUR200 million to EUR500 million at launch, the fund may consider a listing on a stock exchange after the initial capital is deployed.Jeremy Beswick, Head of Asset Management, EIIB, announced that: "The launch of this fund is a significant milestone in the development of EIIB, representing an example of EIIB's intention to offer sophisticated and differentiated products to the Islamic investments marketplace. We believe there will be significant investor interest in this fund, which will deliver to investors a diversifed commercial property portfolio including exposure to the rapidly-developing markets in Central and Eastern Europe."The launch is part of the roll-out of EIIB's own Sharia compliant investment fund range, covering the real estate, hedge fund and private equity asset classes, and including capital-protected structured products.EIIB is also developing a number of derivative and asset securitisation products, and expects further new issue mandates in the coming months. EIIB will also partner with other financial institutions, both Islamic and conventional, to create bespoke Sharia-compliant investment products according to demand.

Bursa Malaysia Berhad, the Malaysian Stock Exchange, in collaboration with FTSE Group, the global index provider, launched the FTSE Bursa Malaysia EMAS Shari'ah index, designed to provide investors with a broad benchmark for Shari'ah-compliant investment for the Malaysian market. The index takes the constituents of the FTSE Bursa Malaysia EMAS Index, which has been free float weighted and liquidity screened, and overlays the Securities Commission’s Shariah Advisory Council’s (SAC) screening methodology to derive a highly investable and transparent Shari'ah-compliant index.The new index will run parallel with the existing Shari'ah index (KLSI) for nine months. The KLSI will be deactivated on 1 November 2007, making the FTSE-Bursa Malaysia EMAS Shari'ah Index the singular benchmark index for Malaysian Shari'ah-compliant investments. Bursa Malaysia’s Chief Executive Officer, Dato’ Yusli Mohamed Yusoff said: “The new index provides investors with a clearer picture of quality Shari'ah investments in the Malaysian market. It uses globally-adjusted criteria that make it easier for institutional investors to track our Shari'ah-compliant investment offerings more effectively. This is critical to ensure our Shari'ah market continues maintaining its competitiveness with other international Shari'ah investment destinations.”He added that the new index also represents a first step towards the creation of more Islamic products. “With the new FTSE Bursa Malaysia EMAS Shari'ah Index, we can now work on creating a tradable Shari'ah index which in turn allows us to introduce Islamic structured products.”

In November, 2006, Walkers, an offshore law firm, reported that their Dubai office had seen an increase in the use of sukuk, Shari'ah-compliant bonds, with the Cayman Islands emerging as one of the world's most favoured domiciles for the vehicles. "While the sukuk market is still very small compared to the conventional debt market, there is enormous potential for growth from both local investors and international markets," stated Robert Varley, a partner in Walkers' Dubai office. "As local institutions in the Middle East partner with conventional Western banks to issue these types of bonds with increasing frequency, it is certain that banks outside the region are watching the sukuk market with great interest," he added. "Recently Dubai Civil Aviation announced that it would raise roughly US$1.6 billion through sukuk to fund the first phase of the new Jebel Ali International Airport. Almost every day we see a new deal being developed," he added. "Offerings are hugely oversubscribed. The recent listing of Cayman Islands-issued sukuk on both the London Stock Exchange and the Dubai International Financial Exchange will only strengthen that demand," he concluded.Sukuk that are developed and marketed in the Middle East predominantly use Cayman-domiciled issuers over other jurisdictions because of its established trusts law regime, lower costs, relatively fast turnaround, and flexibility in structuring. The Cayman Islands' strong reputation in the world of global finance can also make listing and rating Cayman-issued bonds much easier compared to bonds issued from other jurisdictions.Meanwhile, new regulations introduced by the Dubai Capital Markets Authority and the launching of the Dow Jones Citigroup Sukuk Index earlier this year are helping to fill a number of gaps in the Islamic market, says Walkers. General business and acquisition finance, project finance, and securitizations have all been funded with sukuk.

In February, 2007, Deutsche Bank published a White Paper outlining an investment structure that facilitates the issuance of Sharia compliant securities that offer investors access to alternative asset classes.Deutsche Bank said it had made public its procedures both in the interests of transparency and in an attempt to help alleviate some of the 'supply side' constraints that exist in Islamic financial markets. These constraints are mainly related to capacity - in respect of the number of qualified bankers involved and their Islamic structuring capabilities. In addressing these issues, the market will be more able to develop in line with customer demand.Geert Bossuyt, Managing Director, Regional Head of ME Structuring, Deutsche Bank, commented: "We are confident that the structure will eventually be viewed as a significant milestone in the development of the Islamic finance industry as it provides Islamic investors with exposure, in a liquid and cost-efficient way, to new asset classes and pay-outs, removing one of the main structuring barriers. The structure itself is the result of close co-operation between academics, bankers and, of course, scholars."Too often, 'innovation' is achieved by pushing the barriers and/or misusing fatawa by taking them out of their context. Innovation ideally should be the result of a well documented and fundamental discussion on Sharia. Deutsche Bank wishes to encourage the use of academic resources to assist the industry in developing new products as this has not been a feature of the industry to date.Bossuyt concluded: "We believe that those institutions with the vision, creativity, innovation, courage and commitment to develop the Islamic financial markets will be recognised for their hard work and ideas. Sharia itself has inherent flexibility and fewer constraints than is often assumed by the financial services industry. Fundamental research is the key to unlocking this inherent flexibility, thereby allowing this market to grow to its full potential."

London's Growing Dominance

Already in 2005, the UK's RICS (the Royal Institution of Chartered Surveyors) was able to publish a report saying that London had become a major centre for Islamic banking and investment.

Based on research commissioned by international property consultants, King Sturge, the report said that London was securing its position as a major centre for Islamic banking and investment due to the availability of relevant expertise and a flexible, well developed regulatory environment.

The report detailed how Middle Eastern investment in European real estate reached £827m in 2001, an increase of 225% on the previous year. 90% of investors cited the UK as their favoured location for Shari'ah funds because of its political environment, legal and institutional frameworks, human capital and expertise. London’s wide range of skills in particular puts its commercial property industry in the strongest position to take advantage of the growth in Shari'ah compliant real estate investment.

Like “ethical funds”, Islamic investment funds require careful portfolio and stock selection to ensure compliance with Shariah law. Shariah property investment funds also prohibit renting properties to organisations engaging in business relating to pornography, gambling, arms, pork, tobacco, cinema and alcohol consumption.

The commercial and industrial property sectors are reported as the most popular investment by Shariah funds, with three quarters of respondents already investing in industrial property. A growing trend is the market’s move into property investments in leisure and care for the elderly which are compatible with Shariah principles and somewhat reflective of developments in other ethical funds.

According to Angus McIntosh, Partner & Head of Research at King Sturge international property consultants: ‘UK business is now familiar with ethical funds but there is a real need to find out more about the growing opportunities for Shari'ah compliant real estate investment and the nature of the market as this area represents a crucial opportunity for many UK businesses.’
The most important factor considered by Shari'ah compliant funds when buying and selling property was tax status (cited by 65% of respondents), followed by the availability of specialist expertise (61%), the regulation of investment and risk assessment regulation (both 47%) and the transparency of transactions (41%).

According to Ali Parsa, author of the report, and director of research at London South Bank University’s Property Surveying and Construction department: ‘The research indicates the likelihood of a substantial increase in the funds available for Shari'ah investment as a result of growing wealth in Muslim countries and communities, and that most of the new investments will be through some form of Shari'ah compliant funds.’

UK-based HSBC has launched a number of Shariah-compliant products through its Amanah Finance division. The bank is also seeking to establish a firm foothold in the US market, offering Islamic banking services through 300 branches in the New York area. Other institutions, such as the UK’s Lloyds TSB and the US-based bank Citigroup, have also stepped into the market.
However, new ground was broken in 2004 with the launch of the Islamic Bank of Britain, the first in the UK to concentrate solely on offering Shariah-compliant banking services to the country’s 1.7 million Muslims (although it must be pointed out that one doesn’t necessarily have to be of the Muslim faith to take up Islamic banking services). Its product offerings include mortgages, current accounts, savings accounts and personal finance. The bank is also planning to launch its own credit card.

Brown's 2007 budget introduces two key measures to encourage growth in Islamic finance, namely a new regime for sukuk (Islamic securitisations) giving comparable tax treatment to conventional securitisations, and guidance clarifying the treatment of diminishing musharaka (partnership share) and takaful (insurance) products.

Commenting on the move, Darshan Bijur, Director, KPMG Islamic Finance Advisory, said this new legislation has created the framework for London to emerge as undisputed global leader in the Islamic finance industry.

“Sukuk will be the equivalent of Eurobonds, and the likely exponential growth in UK Sukuk issuance will ensure that Islamic finance moves from niche to the mainstream," he observed. “It will cost the UK next to nothing, and opens up the way for UK companies to access Islamic finance, and the Middle East wealth that has been generated by oil."

Peter Muir, tax partner at Deloitte, says that the Chancellor should be applauded for his reforms, which will benefit both the Muslim and non-Muslim investment communities.
"The UK is the only country which is changing legislation to create a level playing field for both individuals and companies investing in Islamic finance products," he noted. "Reform of sukuk (Islamic bonds) is the latest addition to the suite of specific legislation that gives certainty to the taxation of Islamic financial products. Before this reform was introduced, there was ambiguity around how capital gains tax, income tax and capital allowances would apply to these products."
Muir added: “Gordon Brown seems to have taken a personal interest in ensuring Islamic products are brought into a level playing field. This is intended to meet the financial needs of the Muslim community as well as, increasingly, non-Muslim investors in these products."
"From a capital markets perspective, the reforms are a boost to the City of London, improving its global competitiveness in the Islamic finance market. Notably, the measures reach out to a potentially much wider group of international exchanges who can be given tax recognition in the UK in relation to ‘sukuk’ bonds.”

Mohammed Amin, tax partner, PricewaterhouseCoopers, said that Sukuk have become increasingly important in the Muslim world, as companies prefer to obtain finance directly from international investors.

"While London-based lawyers and bankers regularly structure and market sukuk for companies from Muslim countries, until today tax uncertainties have precluded them being issued from the UK," he stated. “The changes announced should enable the City of London to become the global centre for international sukuk issuance and trading, in the same way as it dominates the eurobond market. There should also be scope for mainstream UK companies to issue sukuk to both Islamic and conventional investors.”

Under Shariah law certain investment practices commonplace in the world of conventional finance are prohibited, the charging of interest a notable example. This is because Shariah law dictates that risk in trade and business should be shared and the accumulation of wealth through "effortless" profit is frowned upon. Islamic finance doctrine also states that investment in certain business activities deemed unethical are forbidden, such as those involving the selling of alcohol, tobacco, pornography, armaments and gambling services.

The Role Of Offshore Jurisdictions

Offshore jurisdictions have played a major role in the development of Islamic finance markets, particularly Labuan and Dubai.

Kuwait Finance House, a leading Islamic banking group, announced in December, 2005, its intention to break into the South East Asian market through a new base in Labuan, which it hopes will come on stream in 2006.

Jamelah Jamaluddin, deputy chief executive of Kuwait Finance House in Malaysia, said that the group sees potentially lucrative investment opportunities in real estate, infrastructure assets and power plants within the region.

"We want to position Malaysia as a regional hub for KFH in this part of the world which includes Thailand, Singapore, the Philippines, to a certain extent China and India, and maybe Australia and New Zealand," Jamelah stated, adding that KFH is also attempting to make inroads into the Indonesian market.

KFH's Malaysian operation will initially focus on investment banking, and will later branch out into commercial and retail banking, providing consumer credit products such as mortgages, car financing, credit cards and insurance.

Kuwait Finance House was incorporated in the State of Kuwait in 1977, and is listed on the Kuwait Stock Exchange with a market capitalization of US$1.95 billion as of 31 December 2001. The Government of Kuwait owns 49% of the equity, and the general public holds the remaining shares.

AMBB Capital (L) Ltd, a wholly owned subsidiary of AmBank (M) Berhad, Malaysia's sixth largest bank with total assets of $13.7 billion, said in July, 2005, that it would list $200 million in Hybrid Securities on the Labaun International Financial Exchange (LFX).

The bank announced that it had completed the book building process in relation to the issue of the 'Fixed-to-floating Rate Step-up Non-cumulative Non-voting Guaranteed Preference Shares,' or Hybrid Shares, with AmMerchant Bank Berhad, BNP Paribas and Credit Suisse having been appointed by AmBank as the joint lead managers and joint bookrunners.
The Hybrid Securities are guaranteed on a subordinated basis by AmBank and will be listed on the LFX and the Singapore Exchange. They are open to international institutional investors.
The initial book size was set at $150.0 million, but was twice oversubscribed, leading to its increase to $200 million.

"The Hybrid Securities issued by AMBB Capital has garnered strong demand from international investors and the attractive pricing for the Hybrid Securities demonstrates international investors' confidence in AmBank's Business model," commented Mr Cheah Tek Kuang, Chief Executive Officer of AmBank.

The LFX is an offshore exchange wholly owned by the Kuala Lumpur Stock Exchange (KLSE). It was officially launched in November 2000 and it is seen as one of the key components in promoting Labuan as an offshore financial centre.

In August 2005, the total market capitalisation of Labuan International Financial Exchange (LFX) had reached $12.09 billion, and the exchange accepted its 34th listing with the debut of Eucalyptus Investment Holdings Limited's $30 million variable rate guaranteed secured bonds.
AmBank, with total assets of RM51.6 billion ($13.7 billion) as at 30 September 2005, is the sixth-largest Malaysian bank by assets with over 170 branches nationwide.

Emirates Islamic Bank said in July, 2005, that it had launched a new real estate investment fund which will investment in property along the principles of Shariah law.

The new fund, which is registered in Jersey and managed by Belgravia Asset Management, will investment mainly in property based in the United Arab Emirates.

The fund is open to both institutional and individual investors with a minimum investment of US$100,000. Minimum top-up investments are set at US$25,000. In addition to capital growth, the fund will target an income distribution of 7% per year, which will be paid on a bi-annual basis.

“The UEA has been one of the market leaders for property development and innovation in the region," commented Mr Ebrahim Fayez Al Shamasi, CEO of Emirites Islamic Bank.
"The success of residential and commercial developments over the last three years has proved the increasing popularity of this asset class amongst investors in the Middle East," he added.
A substantial market is developing in both sovereign and corporate sukuks and some US$30 billion worth of certificates have been issued to date. Although the market is still in its infancy, on the sovereign front, sukuks are beginning to attract the attention of non-Muslim issuers and investors.

International law firm, Walkers announced in January, 2006, that it had opened the first fully transactional office for an offshore law firm in the Dubai International Finance Centre (DIFC). The office is staffed jointly with a combination of regional lawyers and leading attorneys from London who specialize in Islamic finance and Middle Eastern issues.

"As the formation of investment funds, private equity funds, and Sukuks – a type of Islamic bond – continues to soar, the need to provide global counsel has grown too," the firm explained in a statement.

"Walkers recognizes that having counsel in Dubai doing the transactional work in the same time zone and same culture is vitally important to getting the job done. Walkers’ expertise in investment funds, structured finance, and international insolvency matters coupled with a presence in the Cayman Islands, London, the British Virgin Islands, Hong Kong and now Dubai, means that the firm can offer worldwide clients an even broader range of products and services," Walkers added.

According to a survey by McKinsey & Company, more than 75 percent of the top 30 global asset managers are now active in Dubai. The MAN Group plc, a leading hedge fund group that has operated in the Gulf Cooperation Council region (GCC) for more than 20 years and was part of the McKinsey survey, reported an upswing of institutional investments in hedge funds.

"Also driving the need for greater offshore legal expertise in Dubai are the international entities who invest in the GCC region through British Virgin Islands companies and regional investment in United Kingdom commercial real estate,” observed Mr Palmer.

“With Walkers’ strong presence and experience in those jurisdictions, we can now provide a complete suite of offshore legal service to our clients in Dubai," he added.

The Dubai International Finance Centre (DIFC), a financial free zone that promotes economic development in the United Arab Emirates (UAE), has a strong regulatory framework based on best practices of the world’s leading financial centres.

Companies in Dubai recognize multiple benefits from the jurisdiction, including zero tax on income and profits, 100 percent foreign ownership, no restrictions on foreign exchange or capital/profit repatriation, operational support, and business continuity facilities.

In March, 2007, Dubai Islamic Bank listed a $750 million Sukuk on the Dubai International Financial Exchange (DIFX) after selling the Islamic securities to investors in the Europe, Asia and Middle East, cementing the DIFX's position as the leading exchange for the listing of these Islamic instruments.

The Sukuk was the first ever issued by the bank, which specialises exclusively in Islamic financial services.

Saad Abdul Razak, group Chief Executive Officer of Dubai Islamic Bank announced that: “The DIFX is a perfect venue to list our first Sukuk. It is established as the largest exchange in the world for Sukuk and its international stature gives our listing high visibility in the marketplace, both in the region and globally.”

Per E. Larsson, Chief Executive of the DIFX, added: “This listing by a prominent Islamic financial institution reinforces the central role played by the DIFX in the growth of Sukuk as an attractive asset class. It raises the value of Sukuk on the DIFX to $8.38 billion, which is more than the value on any other exchange.”

Forty-five per cent of the Sukuk issue was placed with investors in the Middle East, 30% in Europe and the balance was placed in Asia.

The Sukuk was issued by DIB Sukuk Company Limited, a company incorporated in accordance with the laws of, and formed and registered in, the Cayman Islands. The Sukuk issue is rated A1 by Moody's and A by Standard and Poor's. The lead managers and bookrunners for the issue were Barclays Capital, Citigroup and Standard Chartered Bank.

Hamed Ali, Executive Officer of the DIFX, noted: “The DIFX intends to strengthen its focus on Sukuk. The total value of Sukuk issued globally in 2006 was $27.1 billion, more than twice as much as in 2005, as issuers turn increasingly to this Islamic asset class as an effective way to raise capital.”

Also in March, the Dubai Financial Services Authority (DFSA) entered into a mutual recognition agreement to facilitate cross border distribution of Islamic investment products with the Securities Commission of Malaysia (SC).

The agreement was signed by Dato’ Zarinah Anwar, Chairman of the SC, and David Knott, Chief Executive of the DFSA at a ceremony in Kuala Lumpur, witnessed by the Second Finance Minister of Malaysia, Yang Berhormat Tan Sri Nor Mohamed Yakcop.

David Knott announced that: "The DFSA is delighted that, as a result of this joint initiative, DIFC domestic Funds will be the first foreign funds permitted to be sold into Malaysia. This arrangement is a positive step for both jurisdictions, and is intended to facilitate the cross border flow of Islamic capital market products, as envisaged when this initiative was first announced in August 2006.”

“The DFSA is committed to assisting both the Dubai International Financial Centre (DIFC) and the Dubai International Financial Exchange (DIFX) in their objective to promote innovation and growth of Islamic capital markets in the Middle East,” he added.

This is the first mutual recognition agreement entered into by both regulators, and is a significant milestone for both the SC and the DFSA in the area of cross-border regulation of Islamic investment funds, and the development of deeper and broader investment markets. Under the mutual recognition framework, Islamic funds that have been approved by the SC may be marketed and distributed in the DIFC with minimal regulatory intervention, following the inclusion of Malaysia on the DFSA’s list of Recognised Jurisdictions. Similarly, Islamic funds which have been registered or notified with the DFSA will be able to access Malaysian investors. Supported by a bilateral memorandum of understanding, both regulators will work closely in the areas of supervision and enforcement of securities laws to ensure adequate protection for investors.

This follows an earlier announcement, on 15 August 2006, of a joint initiative on regulatory alignment to facilitate Islamic finance transactions between the DIFC and Malaysia, which is now complete. The agreement today marks a significant liberalisation effort on the part of the SC and DFSA to encourage the bilateral flow of Islamic funds between the two jurisdictions.
Dato’ Zarinah said: “By entering into a mutual recognition arrangement with the DFSA, it demonstrates our mutual intention to accelerate the growth of our respective investment management industries through the trading in each other’s markets of mutually recognised investment products that are acceptable to both authorities. The mutual recognition framework will provide many benefits to market participants including lower regulatory cost as well as an enlarged investor base. It will also provide investors in each jurisdiction with greater choice of Islamic investment products. This arrangement with the DFSA is also in line with the Malaysia’s aspiration to evolve its role as an international Islamic financial centre."

In parallel with Dubai's distribution role, the Cayman Islands have emerged as the jurisdiction of choice for the listing of Islamic financial products.

The introduction of a new Arabic language facility by the General Registry in Cayman in March 2007 will trigger more valuable business from the Islamic region, according to international law firm, Ogier.

Ogier partner Gray Smith, who practices Cayman law from London, observed this week that the move demonstrated Cayman’s recognition of the Middle East as an important area for new business.

“We can now use both Arabic and English names on all documents when setting up a company and can also open bank accounts in both names. Previously we had to use only an English translation. The same ethos was applied to Chinese characters a few years ago and that was of huge benefit in Hong Kong, where both English and Chinese are used widely,” he explained .
Mr Smith went on to add that Cayman law particularly lent itself to Islamic finance structures because of its flexibility. It has become a centre for “sukuks” – bond issues that are Shari’ah compliant, prohibit interest payments and require tangible assets or equity as collateral.
“It’s straightforward, the processes are relatively easy and it’s very flexible, allowing for the drafting of articles and agreements that comply with the restrictions of Islamic law. Cayman is also a lighter regulation jurisdiction and a widely recognised international finance centre which suits Middle East companies looking for investments,” he revealed.

The Ogier partner also predicted further inflows of money into the Middle East as clients are increasingly marketing their funds outside the region.

“The inflow to Middle East funds is a new growth area. Furthermore, the establishment of the Dubai Finance Centre will enable the listing of Cayman funds on the Dubai Stock Exchange and dual listing, in Cayman and the Middle East or the Middle East and the UK,” he stated.

Islamic Insurance

The world of insurance, which by its very nature runs counter to Shari'ah principles because its profits are derived through effectively gambling on uncertain outcomes, was an area that until recently Islamic investors either had to tolerate or abstain from altogether. However, this problem has been overcome with the development of the takaful insurance industry. Using the Islamic principle of Ta'awun, or mutual responsibility, the takaful industry rests on the same foundations of profit and risk sharing as other areas of Islamic finance. On a basic level, it provides mutual protection of assets and property in the event of loss or damage based upon joint risk sharing.

Takaful Re Limited, an Islamic insurance company, was licensed by Dubai Financial Services Authority (DFSA) in January, 2006, to operate from the Dubai International Financial Centre (DIFC).

Takaful Re is dedicated to offer Shari’ah compliant reinsurance and related services to the growing Takaful & Islamic insurance markets. Takaful Re will offer reinsurance capacity in all major lines of property, marine and family Retakaful business.

Because profits in the conventional insurance industry are effectively derived through gambling on uncertain outcomes the world of insurance has been largely off limits to those wishing to invest along Shari'ah principles. However, this problem has been overcome with the development of the takaful insurance industry.

Using the Islamic principle of Ta'awun, or mutual responsibility, the takaful industry rests on the same ideal of profit and risk sharing as other areas of Islamic finance. On a basic level, it provides mutual protection of assets and property in the event of loss or damage based upon joint risk sharing.

With an authorised capital of US$500 million and paid-up capital of US$125 million, Takaful Re has plans to focus on retakaful business in the Middle East, North Africa and other Islamic countries.

“This is a significant announcement for DIFC, especially when we already have some major international insurance companies located here," commented Dr. Omar Bin Sulaiman, Director General of the DIFC Authority.

”The DIFC is committed to actively promoting the growth and development of the Islamic insurance industry in accordance with Shari'ah principles. The Takaful market is one of the fastest growing in the world. It is expected to grow at nearly 20 per cent per annum to reach US$7.4 billion in global annual premiums in 15 years. Firms domiciled in the DIFC will complement the regional market and help it grow. By providing the ideal environment, both in terms of regulations and infrastructure, the DIFC aims to maximise this potential," Dr. Omar Bin Sulaiman added.

Meanwhile, Mr. Khalid Ali Al Bustani, Takaful Re Chairman, commented that: “We are pleased to associate ourselves with the DIFC which is renowned internationally. For Takaful Re, to be in the DIFC is a commitment for integrity, transparency and efficiency."

Regulation Of Islamic Finance

Regulation and interpretation of Shari'ah law are two key issues in the Islamic finance industry. Before an institution can offer such products to the public, they must first be scrutinised and approved by a panel of Islamic scholars. However, this is by no means a clear cut issue, and the opinions of individual scholars can vary. Indeed, there are many academics in the Muslim world who have been quite critical of contemporary Islamic finance culture, and who have taken issue with certain forms of financing, notably Murabha and Ijara contracts which, it has been argued, are too similar to conventional forms of financing, and which do nothing to share risk and profit, the central tenet of Islamic capitalism.

To ensure a degree of quality control over the Islamic finance industry, regulating institutions, such as the Malaysian-based Islamic Financial Services Board (IFSB), have been set up to police the emerging industry. The IFSB serves as an international standard setting body of regulatory and supervisory agencies and its core mission is to guard the integrity and stability of the Islamic financial services industry across the spectrum of banking, capital markets and insurance. The board also provides guidance for institutions offering Islamic investment products and liaises with other rule-making bodies in the industry.

Whilst modern Islamic finance may not be as pure as some scholars and academics would like, the development of financial products to cover the whole gamut of the finance and investment industry, and the creation of the regulating institutions to oversee them, is evidence that the industry in its current form is likely to be here to stay. And the fact that the new industry has really only scratched the surface of potential demand for Shariah compliant and more ethically aware capitalism means that the Islamic banking and finance is likely to continue growing apace for some years to come.