London, 5 February 2007 — The Treasury is in the process of drafting laws which will govern the tax treatment of Sukuk issuance and Takaful (Islamic insurance) products in the UK. In fact, Chancellor of Exchequer Gordon Brown, in perhaps his last budget in March 2007 before he is widely tipped to succeed Tony Blair as the Labour leader and prime minister, will include enabling legislation for Sukuk and Takaful products in his next finance bill.
Ed Balls, the Economic Secretary to the Treasury and a close colleague of the Chancellor, confirmed at a conference in London last week that the Treasury is currently looking at how the UK tax system interacts with the Sukuk market; what barriers there are to establishing a secondary Sukuk market in the UK; what barriers there are in the way of UK origination and issuance; and how UK Sukuk certificate holders are taxed.
“Our intention,” stressed Balls, “is to set out in the budget what a tax framework for Sukuk will look like and what the consequences would be for any London market. Detailed legislation will follow in the finance bill. Alongside this statement on Sukuk, HMRC (Her majesty’s Revenue and Customs) will be publishing guidance on how Diminishing Musharaka products will be treated for capital gains (tax) and capital allowances. This will provide certainty of interpretation. Similarly, HMRC plan to clarify uncertainty in the market over the tax treatment of Takaful products by publishing guidance on how these products will be taxed within the current rules.”
The aim of the Treasury is to enable the Islamic finance market to develop and flourish; to help the industry go “from strength to strength”; and of course to cement London as one of the global centres for Islamic finance and trade.
However, the UK government like others elsewhere, is also aware that the rapid growth of Islamic finance globally has given rise to many structural challenges facing the industry. The lack of standardization, for instance, warned Balls, is hindering liquidity, and this prevents investors from knowing what risk they are assuming when they invest and increases the costs associated with Sukuk issuance.
“Increasingly it is negotiation and regulatory decisions being taken at the global level that have a major bearing on the competitiveness and efficiency of our financial markets. Increasingly globalization calls for increased co-operation and, over time, where appropriate, convergence in global standards. There should be no competition between us on the objectives of regulation,” he added.
The City has been buzzing with anticipation in the last few months. London-based financial institutions, law and auditing firms already heavily involved in the Islamic finance market, have been aware of the impending UK Sukuk law and the clarification of Takaful tax rules.
“The passing of a Sukuk law will be a major boost for the Islamic capital markets (ICM). It will once again put the UK at the forefront of enabling legislation in Islamic finance. Following the Islamic mortgage legislation, we have had the regulations allowing Ijara, Mudaraba, Murabaha, Diminishing Musharaka and now the Sukuk and Takaful products. The potential impact on the role of the City in global Islamic finance is huge,” explains one British banker, who has worked in the Islamic finance sector for the last two decades.
The City today is one of the world’s two truly global financial centres. It is home to 70 percent of the global secondary bond market, over 40 percent of the derivatives market, over 30 percent of world foreign exchange business, over 40 percent of cross-border equities trading and 20 percent of cross-border bank lending.
In the ICM specifically, London-based banks such as Barclays Capital, HSBC, WestLB (London branch), Deutsche Bank (London branch), Citigroup (London branch), Standard Bank (London branch), and ABC International have spearheaded Sukuk structuring and leand managing mandates albeit for origination out of the GCC, Malaysia, Pakistan and the German state of Saxony Anhalt.
Only Malaysia’s CIMB Bank has trumped these institutions in terms of global mandates in terms of total volume Sukuk funds. Its latest mandate concluded was in September 2006 — the pioneering $750 million Khazanah Exchangeable Sukuk, the first equity-linked Sukuk to date. CIMB is in the process of converting its London branch of CIMB Bank into a dedicated Islamic finance branch, Arab News learned. This, according to a Malaysian banking source, underlines CIMB Group’s commitment to Islamic finance and its view of London as a major potential international centre for ICM.
CIMB has also recently got a license approval from the Central Bank of Bahrain to open an Islamic finance company in Manama. The company would be a joint venture between CIMB Islamic Bank and the Kanoo Group of Bahrain.
In the UK context once again, City law firm Norton Rose has played a major role in assisting the Treasury, FSA (Financial Services Authority) and HMRC in drafting the Sukuk law; a similar role which Norton Rose played in the drafting of the Alternative Housing Finance Schemes legislation (Islamic mortgages). Today, the total volume of Islamic mortgages extended in the UK thus far totaled 500 million pounds, according to the Treasury.
Other City law firms such as Denton Wilde Sapte, Trowers & Hamlins, Linklaters, Stephenson Harwood, Taylor Wessing and Clifford Chance have virtually dominated the legal advisory work for the global Sukuk issuance market. In this respect, London has an infrastructure headstart to many financial centres including those in the GCC countries.
The recent US$300m Dar Al-Arkan Sukuk jointly lead arranged by WestLB, Unicorn investment Bank, Standard Bank, ABC Islamic Bank and Arab National Bank, is also listed on the London Stock Exchange, a trend which is expected to increase following the introduction of the Sukuk Law.
In the international market, Japan and Indonesia, among others, are widely expected to issue their debut sovereign Sukuk issuances during 2007. Once again, these benchmark issuances are vital towards creating a critical mass of issuances upon which a secondary market could flourish. Some experts estimate this critical mass to be around $400 billion worth of issuances amounting to some 270 individual issuances worldwide. Only then would a potential secondary market attract the Western banking majors as market makers.
European Finance House, a subsidiary of Qatar Islamic Bank, has lodged an application to the FSA to set up an Islamic bank in the UK. Another group from the GCC has also lodged an application with the FSA to set up a further Islamic bank — to be called The Bank of London and the Middle East.
As for the future in terms of Islamic finance in the UK, Balls stressed that he is “aware that there are outstanding issues with regulation. We have successfully extended the FSA’s mandate to cover Islamic mortgages, but there is more to do. I look forward to taking this agenda forward in partnership with the FSA over the coming months. Our task is to build on our platform of stability, to foster economic growth and maintain competitive position of the financial services sector.”