Daniel Feetham provides an overview of Sharia’h law and outlines the proposals for Gibraltar to become a centre for Islamic Finance.
Islamic finance is finance in accordance with Sharia’h principles derived from three sources: the Quaran, the Hadith and the Sunnah (or sayings and traditions of the Prophet respectively).
One of the essential pillars of Islamic finance is the prohibition on the payment of interest. Thus, conventional deposit accounts and loans are prohibited. Lending or dealing in money in the same way as you would trade commodities is prohibited. Returns on lent funds must be based on actual profi ts generated and not on a pre-determined interest rate. However, Sharia’h law does not prohibit the making of a return on capital if the provider of the capital is willing to share in the risks of the enterprise through profit and loss sharing arrangements.
Islamic finance also prohibits investment in activities which are deemed unlawful. It is, therefore, prohibited to invest in businesses involved in the alcohol, gambling, drugs or tobacco industries.
Other fundament al Sharia’ h prohibitions include speculation and uncertainty in contracts (eg, derivatives).
Many believe that not only is interest the corner stone of the western banking system but that speculation, derivatives (etc) are fundamental to the modern capital markets. Striking the balance between compliance with Sharia’h principles and innovation is challenging, particularly in a market where investment products are subject to interpretation by conventional Islamic scholars. However, Islamic financial transactions are structured in ways that are broadly familiar to us.
Mudaraba financing: A partnership structure consisting of one or more partners that contribute capital and a managing partner who contributes knowledge and expertise and receives a fee for his services.
Musharaka financing: A partnership agreement where partners may acquire an asset jointly and the fi nancier’s share of the asset decreases through periodic payments containing elements of capital repayment and rent from the other partner, who eventually becomes the sole owner.
Murabaha financing: A mark up or cost plus financing where the financial institution purchases goods for the customer, and re-sells them to the customer on a deferred basis and agreed profit margin. A substantial amount of financial operations of some Islamic banks are based on mark up or cost plus financing and Credit Suisse Zurich in Gibraltar uses it to offer short term investment opportunities on an ongoing basis.
Ijarar or Islamic equivalent of a conventional lease: There are several variations on this structure one of which is similar to the hire purchase agreement. The bank buys the goods, rents them to the customer and transfers the goods to the customer in exchange for a defined terminal payment. Emirates Airways, Thai Airways, Royal Brunei Airlines all lease aircraft under Islamic style leases. You may say there is very little difference with a conventional lease and there are. Rental payments cannot be based on interest and, default interest on late payments is prohibited. But for instance, these contracts can be subject to English or Gibraltar Law (in international transactions Sharia’h compliance is a moral rather than legal issue).
Liquidity and markets
There is huge liquidity in the Middle East. In Saudi Arabia alone it is estimated that there was US$200 billion of liquidity last year.
It is perhaps of note that Sharia’h compliant investments first appeared in the 1970s when significant increases in crude oil prices brought excess liquidity to the Middle East with a lot of cash trying to find a home. The same is true now – while prices have dropped in recent months, they are still very high.
It is not only excess liquidity but also the dynamics of international politics that has had an effect in this area with more Muslims resolving to plough their money in Sharia’h compliant products over recent years. And the market is huge.
There are 1.4 billion people in 57 nations comprising OIC (Organisation of Islamic Conference). There are nearly two million Muslims in the UK and 700,000 temporary Muslim visitors. There are over 14 million Muslims in Western Europe, particularly in France and Germany.
It is not surprising that with these kinds of opportunities and the size of the market, the big players like Citicorp, HSBC, Deutsche Bank, Standard Chartered are rushing to offer Sharia’h compliant finance products that are economically equivalent to conventional banking products.
According to Moody’s the total issuance of sukuks or Islamic bonds has reached US$41 billion from almost nothing five years ago. In January 2006 an Islamic bond for the Dubai’s Ports, Customs and Free Zone Corporation was three times oversubscribed with bids of US$11.4 bn.
Moody’s also suggest that there are currently 250 Islamic mutual funds operating with US$300 billion and US$200 billion of assets are estimated to be held in Islamic “windows” – or subsets – of conventional banks, such as Western investment banks.
In the EU the United Kingdom has undoubtedly led the way in trying to tap into this market.
Middle East investors and regulatory cooperation has seen the setting up of Islamic Bank of Britain – the first of its kind in Europe. It is headed by an ex Barclays man called Michael Hanlon. The fact that he is middle class, white and non-Muslim shows that what is important to investors is that these structures are run on a proper commercial basis by people with experience. The expectations of those investing in Sharia’h products are not driven purely by moral considerations but by commercial considerations that allow non-Muslims with appropriate experience to flourish.
On the fiscal side, the UK has altered its rules on stamp duty to allow for Islamic mortgages and has made a policy decision to encourage and support the development of Islamic finance. The Chancellor of the Exchequer, Gordon Brown, recently gave a keynote speech on Islamic finance outlining what he was proposing to do to allow the development of the area in the future.
He said: “The foundation for making Britain the global centre for Islamic finance [is] our unique qualities – our language and geography, our stability and openness to the world, our inventiveness and flexibility – have given the City of London its advantage” (Gordon Brown, 13 June 2006).
All these factors apply with greater force to Gibraltar. Gibraltar has a rich and diverse cultural history, inextricably interwoven with Islamic history.
Our geography and proximity to North Africa (we have the only regulator in Europe who can see Africa from his office!) coupled with our position within Europe and our ability to take advantage of EU passporting rights makes us ideally placed to attract some of that excess liquidity into Gibraltar – either to banks here who may set up Sharia’h compliant windows or as start up businesses to passport to Muslims within Europe. The Channel Islands, for instance, do not have the ability to set up companies in their jurisdiction and then passport their services into the EU – Gibraltar does.
As for inventiveness and flexibility Gibraltar has built an extremely successful finance centre (despite considerable difficulties) on the back of the inventiveness of professionals within the industry and the flexibility of its government. In terms of flexibility there is no comparison between a small jurisdiction in Gibraltar (where we can introduce legislation changes as soon as we can draft them) and London for instance.
There are already enterprises within Gibraltar establishing links with Muslim jurisdictions. Gibraltar banks are setting up offices in Dubai; one of our fund administrators is also setting up an operation in Dubai. There are many businesses in Gibraltar with very close links to Morocco and recently the EU Commissioner for External Affairs, Benita Ferrero-Waldner, said that the EU was considering giving Morocco a more advanced status in its relations with the EU.
What are we doing?
Early in 2006 Hassans and Roy Clinton, the president of the Gibraltar Bankers Association, made detailed proposals to the Gibraltar government, which we believe can underpin our growth in this area.
We suggested the creation of a Sharia’h Ordinance compliance of which will be monitored by the Financial Services Commission. The Ordinance will not replace our existing financial services legislation but is intended as an overlay on those structures. The Ordinance will form a regulatory framework for Sharia’h compliant products. Compliance will be supervised by the FSC.
The UK has recently announced it is introducing legislation to make it the first western country to have a regulatory/ legislative framework for Islamic bond. We want to go further.
We believe that the introduction of such an Ordinance and its regulation will show a commitment by this jurisdiction to this business, which will assist us in attracting that business here.
There are certainly difficulties with Sharia’h products. You cannot simply replicate traditional structures in the conventional market and the additional requirements that need to be satisfied add to the cost. But it is such a lucrative business that the cost of conventional products and Sharia’h products are starting to slowly equalise as people compete to attract the business.
One distinct feature of the modern Islamic finance movement is the role of the Sharia’h board. Some scholars are very conventional and new products are sometimes difficult to approve but again, this is a fast developing market and many of them have developed a level of sophistication commensurate with a multi billion pound industry.
I am heavily involved in GIBEX, the Gibraltar Stock Exchange. This year Hassans and Bank Medici were joined by Van der Moolen NV (VDM) as partners in the project. VDM are specialists and market makers on the New York Stock Exchange accounting for about 11 per cent of all stocks traded on that exchange. On a counterparty basis they account for about 20 per cent of stocks traded in Euronext. We believe their involvement will provide GIBEX with the liquidity it needs to be a success. We are hoping to launch in March 2007 and are exploring the possibilities of dual listing of Sharia’h products listed on Middle Eastern exchanges.
Gibraltar is a recognised international insurance centre. Insurance licences have increased from 13 in 2001 to nearly 50 in 2006. These are not branches of UK operations but start up operations/ companies. There is only one Lloyds underwriter that offers Sharia’h compliant insurance in the UK despite there being nearly two million Muslims in the UK. With our passporting rights, the potential for Gibraltar is immense.
Islamic funds are growing at a tremendous rate. Early in 2006 the government introduced comprehensive legislative reform in this area to help turn Gibraltar into the locale of choice for funds. Fund administration licences have increased from one a couple of years ago to six since the legislation was introduced, with further applications in the pipeline.
Gibraltar is a leading jurisdiction in the provision of trust services and, as such, it is used by clients from all over the world. A trust is a legal device recognised throughout common law countries and is one of the most effective instruments available for tax, estate and succession planning. It is a concept that is also very similar to the Islamic structures eg, a waqf. Some historians actually believe that the concept of a trust was brought back from the Middle East by the Crusaders in the middle ages.
It is one thing to see the potential or to talk in generalities, but it is another to produce a detailed plan that works. But the Government has received our views positively and we hope to be in position to progress our proposals shortly.
Daniel Feetham, Hassans, Gibraltar