Following the announcement of a General Election in the UK and subsequent publication of party Manifestos, we provide an outline of what the Labour Party, the Conservative Party and the Liberal Democrats have to say about Islamic finance and we describe the implications for business. This is part of The Election Briefing, which covers: climate change and energy; competition and economic regulation; corporate governance, takeovers policy and company law; employment and equality; environment; financial services regulation; Islamic finance; media and electronic communications; pensions; PFI and PPP; planning and local government; rail; and tax.
Islamic finance is an increasingly important part of British business. UK Government policy has in recent years recognised this, and measures have been taken to promote and facilitate Britain as a centre of Islamic finance.
A key question is how the outcome of the General Election will affect this. Although issues relating to Islamic finance are not at the centre of the national political debate, it is clear from Government policy where Labour stands – and private and public statements from the Conservatives indicate that that they are broadly supportive. Whatever the outcome of the Election, there is likely to be considerable continuity with existing policy.
In this briefing we explain the context and development of Islamic finance in the UK, describe UK Government policy and legislation under Labour, and offer indications of the policies of the other main parties.
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Understanding Islamic finance
Islamic finance is the fastest growing market in ethical finance with an annual average growth rate of some 10 to 20 per cent. Current global Islamic finance assets stand at US $800 billion and are predicted by practitioners in the Islamic finance industry to rise to US $4 trillion by 2015.
Islamic finance distinguishes itself from conventional finance through its compliance with the principles of Islamic commercial jurisprudence. Islamic finance employs techniques that seek to promote ethical and socially responsible investment while providing an alternative to interest-based finance. The main tenets of Islamic commercial jurisprudence prohibit interest payments on monetary loans or securities, speculation, uncertainty in certain contractual terms and engaging in anti-social business activities. Some of the main Islamic financing techniques include Murabaha (cost-plus financing), Sukuk (Islamic bonds), Ijara (based on the leasing of an asset), Istisna’a (production/construction financing) and Musharakah (equity investment).
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The growth of Islamic finance in the UK and Europe
The growth of the Islamic finance industry in the UK can be attributed to a number of factors. Excess liquidity in the Middle East over the last few years resulted in an increased demand for both conventional and Islamic financial products. This demand spilled over into the international markets and because of the UK’s legal, accounting and financial capabilities, some of the funds were redirected into the UK.
The UK Government, along with the Financial Services Authority (FSA), took the view that there should be a regulatory framework based on the notion that no one should be denied access to competitively priced financial products on account of their faith. Shariah-compliant institutions and products were offered a level playing field by being regulated to the same standard and being conferred a similar degree of consumer protection to that afforded non-compliant institutions and products.
Under Labour, the Government has sought to establish London as Europe’s gateway to international Islamic finance. The Exchequer Secretary to the Treasury, Sarah McCarthy-Fry, has said that in these difficult times for international financial markets, “new opportunities for growth and development become increasingly important. The Islamic finance market presents huge long-term opportunities for London and for the UK.”1
The FSA has, to date, authorised six wholly Islamic banks and one Islamic hedge fund manager.2 According to a recent industry survey, the UK has over £18 billion worth of Shariah-compliant assets, the eighth largest amount in the world. To date, there have been 18 Sukuk listed in London and admitted to trading on the London Stock Exchange.
The UK Government has been at the forefront of facilitating Islamic finance in Europe by removing all tax barriers to a UK corporate issuing Ijara-based Sukuk. This approach will enable UK corporates to draw on alternative funds whilst underscoring the City’s role as the primary financial market for the issuance and trading of Sukuk and dealing with Islamic products.
The UK Government has also given serious consideration to issuing sterling sovereign Sukuk, although it concluded in the November 2008 Pre-Budget Report that an issuance at this time did not offer “value for money”. Practitioners in the Islamic finance industry have queried the “value for money” rationale and would like the UK Government to explain the criteria that need to be fulfilled in order for a sterling Sukuk issuance to be viable. There has been an increased interest in the possibility of the UK Government issuing 2012 Olympics Sukuk since the decision not to proceed with the UK Treasury Sukuk issuance was taken. Our discussions with market participants have shown that there is a huge amount of interest in the Islamic finance investor market for a UK Government Sukuk issue, for largely strategic reasons.
As European economies come to terms with the effects of the economic crisis, Islamic finance is attracting greater attention. The French Government has expressed its support for Islamic finance by introducing tax changes and introducing a concept of trust law into its existing civil law system, with the promise of a Sukuk issue in the near future. Issuers in Germany and Italy are also actively pursuing Islamic finance opportunities, while Hong Kong and Singapore are actively vying to become the Asian hub for Islamic finance.
The recent defaults in the Islamic finance industry have shown that the Gulf has been affected by the same liquidity issues as the West, with central banks actively intervening to encourage inter-bank lending. However, bankers based in countries in the Gulf with rich energy resources tend to be more optimistic with regard to the long-term prospects for the industry. The general view among bankers is that they are monitoring market performance in the first half of this year.
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Labour policy – the government’s contribution to Islamic finance
There have been significant symbolic and legislative changes under the “financial inclusion” policy of the Blair and Brown Labour Governments, designed to ensure that “everyone has access to appropriate financial services”. The UK Government has sought to ensure that the legislation that has been changed to accommodate Islamic finance is neutrally drafted; the legislation does not specifically refer to Islamic finance instruments but defines certain types of transactions or instruments and caters for them under the relevant changes by specifying a tax treatment for them.
This approach is being replicated in other jurisdictions such as France.
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The Government, along with the FSA and the Bank of England, has actively contributed to the development of Islamic finance in the UK. We set out below a summary of Government-led initiatives and legislative changes in the UK which have sought to facilitate the development of Islamic finance.
- In 2001, the Bank of England, together with HM Treasury, recognised the potential of wholesale and retail Islamic finance. A working group that was established to investigate the obstacles facing the industry led to legislative initiatives which facilitated its development.
- Since 2003, the Treasury, HM Revenue and Customs and the FSA have introduced tax and regulatory changes to enable UK companies to offer a range of Islamic finance products.
- Since 2004, the FSA has tried to create a level regulatory playing field by applying similar authorisation criteria to both Islamic and conventional financial institutions. It has authorised Islamic financial firms – which are currently the only standalone Islamic financial institutions in the EU.
- In 2007, UKTI (UKTI), the Government’s international business development body, set up a separate sub-group to produce strategy for the promotion of the UK as a centre of excellence and global partner for the provision of Islamic financial services.
- In 2007, the Treasury hosted an Islamic Financial summit at 11 Downing Street which led to the establishment of the Islamic Finance Experts’ Group (IFEG).
- In December 2008, the UK Government set out its strategy to spread awareness about the growth of Islamic finance in the UK and highlighted barriers to future development.
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Since 2003, the Labour Government has introduced tax legislation to cater for Islamic finance. The aim of each change has been to produce convergence between the tax treatment of a specific type of Shariah-compliant finance and that of its conventional counterpart. For example:
- In 2003, changes were made to stamp duty land tax (SDLT) so that mortgages of UK land which were structured as Murabaha sales (cost-plus financing) or Ijara leases would not be subject to a double charge to SDLT, once on the acquisition of the property by the financial institution, and subsequently on the sale or lease of the property to an individual (or even three times on a remortgage). This provision was extended to cover mortgages with a corporate borrower in 2006.
- In 2005, legislation was introduced to tax Murabaha (cost-plus financing) and Mudaraba (equivalent to savings or term deposit accounts) in the same way as their traditional banking counterparts. For the purpose of corporation and income tax, the “effective return” on Murabaha transactions, and the “profit share return” on Mudaraba transactions, are treated as if they were payments of interest (even though they are not). In addition, the purchase price payable under Murabaha, and the deposited amount under Mudaraba, are to be treated as the principal amount under a loan. This ensures that, both for banks and for their UK customers, the tax treatment should be the same as it would have been had the transaction been structured as an interest-bearing loan or deposit.
- The Finance Act 2006 contained legislation to extend equivalent tax treatment to two more financing techniques – Wakala (a form of agency agreement, which is equivalent to a savings account) and Musharakah (a partnership-style financing of real property or other assets).
- In 2007, legislation was introduced to enable Sukuk arrangements (bond issues) which allowed financial institutions which had granted Shariah-compliant mortgages to securitise those mortgages in a tax-efficient manner.
- Changes were introduced in 2008 to ensure that the sale of certificates issued under Sukuk where the underlying assets are UK land and buildings are exempt from SDLT. This replicates the SDLT treatment of bonds issued under a conventional securitisation.
- Further legislation was introduced in 2009 providing relief from SDLT in respect of transactions undertaken as part of the issue of alternative finance property investment bonds; giving relief from tax on capital gains in respect of transfers of land to and from Sukuk issuance vehicles and ensuring that the person obtaining the financing will continue to be entitled to claim capital allowances while the land is held by the Sukuk issuance vehicle. These changes have led to the further converging of the tax treatment of Islamic securitisations with traditional securitisations.
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Conservative policy towards Islamic finance
The Conservative Party has not published a formal policy on Islamic finance. Nevertheless, an informal understanding of the Conservatives’ position is that they will further the development of Islamic finance on the same basis as the Labour Government.
At a seminar on Islamic finance hosted by Norton Rose Group, Mark Hoban, the Shadow Financial Secretary to the Treasury, gave the keynote address. Mr Hoban's speech marked the first public statement made on behalf of the Conservative Party regarding Islamic finance. During his address, he confirmed that the Conservative Party supports the steps taken by the Government to promote Islamic finance and that it would continue the same approach. He recognised the concerns raised by the audience in respect of a need for clearer criteria to enable the industry to address any Government concerns in relation to the issuance of UK Government Sukuk.
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Liberal Democrat policy towards Islamic finance
As far as we are aware, the Liberal Democrat Party does not have a different approach from the other parties with regard to Islamic finance. There is generally cross-party support for the UK Government’s Islamic finance initiative.
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Business implications: the future
Islamic finance is an area with clear potential for development. The UK Government and the City are both promoting its growth, in both the retail and wholesale markets. London’s emerging role as a centre of excellence for Islamic finance seems likely to continue to develop irrespective of which party wins the Election.
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