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The global Islamic finance industry is now worth more than $1 trillion in terms of assets, having quadrupled in the last three years. Moody's estimates that growth in the total size of Islamic financial assets will have been between 20% and 30% in 2008, following 27% growth in 2007. And the firm sees growth continuing in 2009, although at 'only' 15% or so.

A recent paper from the International Monetary Fund says that more and more countries are climbing aboard the sukuk issuance band-waggon in order to tap the massive pools of money in the hands of Muslim individuals and their companies. The UK, Japan and Thailand are among the countries which have recently begun to establish sukuk issuance programmes. This often requires significant changes to monetary and fiscal legislation, though, as does the opening up of domestic financial markets to Islamic finance. Dozens of countries have either already made these changes, or have indicated that they are about to do so, the latest being France - Finance Minister Christine Lagarde said in December that she will make regulatory changes to enable Paris to become a major market-place for Islamic finance.

The most prominent national issuers of Islamic debt instruments so far have been Malaysia, Qatar, Bahrain, and Pakistan, along with some of the multilateral institutions, including the Islamic Development Bank and the World Bank, although the market has been dominated by corporates, which have accounted for more than three-quarters of issuance to date.

Geographically, Asia, and especially Malaysia, have dominated the market, although issuance in the GCC (Gulf Cooperation Council) is rapidly catching up.

If 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, 2007 saw an explosion of demand for alternatives to western banking products structured along ethically-aware Islamic principles. In early 2007 Islamic finance received the financial equivalent of the accolade when UK Chancellor Gordon Brown 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 put the City of London at the forefront of the nascent but rapidly growing global industry.

Although the size of the Islamic sector 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.

One of the attractions of the Islamic financial sector and the institutions which populate it is that they have remained largely untainted by the global credit crisis."Islamic finance does demonstrate good banking behavior that has been perhaps lost over the last 10 years or so," said Neil Miller, head of Islamic finance at Norton Rose and an adviser to the British government, to Associated Press in December. "Islamic banking is saying we are close to our clients and we're only going to do genuine transactions where we can see the asset, we understand the asset, we can make an assessment of that asset: whether it's financing a ship or an aircraft they will go and have a look at the business. It's giving guidance as to what banking should be."

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 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.

Although starting late, Hong Kong may also become a major player. Chief Executive Donald Tsang noted in late 2007: "At present, assets worth more than US$300 billion are being held by some 300 Islamic financial institutions in 75 countries. A further US$400 billion is managed by the Islamic business units of international banks."

In August, 2008, the Hong Kong government said it hoped to be able to iron out tax issues that could complicate the issuing by local insititutions of Islamic bonds, or sukuk, by October. In the case of Hong Kong sukuks, it was feared that the intruments would be liable for stamp duty twice.

Stock exchanges around the world are queuing up to make markets in Islamic instruments, of course. In March 2008 the Luxembourg Stock Exchange announced that it had cemented its position as a key European listing centre for Islamic bonds, with the listing of its 14th Sukuk, issued by Salam Bounian Development Company Sukuk Limited. The face value of the issue, with a maturity of March 2018, was USD137.5mn. The Luxembourg Stock Exchange has been listing Sukuk instruments since 2002.

In July, 2008, the Johannesburg Stock Exchange, in partnership with FTSE Group launched the FTSE/JSE Shariah Top 40 Index, is a selection of Shariah compliant companies from the FTSE/JSE Shariah All-Share Index. The calculation of the index and the treatment of corporate actions are similar to the FTSE/JSE Top 40.

The FTSE/JSE Shariah Top 40 Index is suitable for the creation of financial products, such as index funds, warrants, certificates and Exchange Traded Funds.

“Internationally the market for Islamic investment products is growing exponentially, at an estimated 15-20% per annum,” explained Ana Forssman, Senior General Manager: Information Products Sales at the JSE, who went on to state:

“This index gives Muslim investors access to the top performing listed companies in South Africa without compromising religious beliefs."

Imogen Dillon Hatcher, Managing Director, EMEA - FTSE Group, added:

“With approximately 1.5 billion Muslims worldwide, there is huge growth potential for investment vehicles with a faith-based mandate.

The constituents of the FTSE/JSE Shariah Top 40 Index are screened by Yasaar Research Inc, a well-respected authority on Shariah law.

To qualify as a constituent of the index, companies undergo a detailed screening process, which filters out any organisations considered unacceptable or non-compliant according to Shariah-law, including businesses involved in conventional finance, alcohol, pork-related and non-halaal food, entertainment, tobacco and weapons.

The remaining companies are then further screened according to Shariah compliant financial criteria.

In order to remain in the index, the companies are reassessed by Yasaar quarterly.

London's Growing Role

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.

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.

Gordon Brown's 2007 budget introduced 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.”

UK City Minister, Kitty Ussher hosted two meetings of the Islamic Finance Experts Group in 2007, in August and December. The focus of the initial meeting was the Government's feasiblity study into issuing sovereign sukuk.

The second meeting focused on how to improve access to and awareness of retail Islamic finance products. Speaking after the meeting, Kitty Ussher announced that:

"The UK is at the forefront of developments in Islamic finance and London continues to seize new opportunities. We have made tremendous inroads in the wholesale markets, where it is estimated that the market is worth more than GBP250 billion worldwide and growing at 15 percent a year."

"But there is also an important domestic market which we want to be accessible and open. There are nearly two million Muslims living in the UK and, thanks in part to legislative changes introduced by this Government, the Islamic mortgage market is now worth over GBP500 million. Going forward, the Government and industry want to continue to do all we can to see the retail market flourish and ensure that everyone - regardless of faith - has equal access to competitive financial products."

The Government's aims for Islamic finance are to continue the growth of the global wholesale Islamic finance market in the UK, as part of the city competitiveness agenda being pursued by the Chancellor's High-Level Group on City Competitiveness; and to create a level playing field in alternative finance and investments, such as Islamic finance, in the retail market.

In December, 2008, a joint Treasury–Financial Services Authority (FSA) consultation on proposals for the legislative framework for the regulation of alternative finance investment bonds, which include sukuk, was launched by Ian Pearson, Economic Secretary to the Treasury. Commenting on the launch of the consultation, Pearson said: “This consultation is an important part of the work government is doing to support the growth of Islamic finance in the UK and to increase our position as a leading global centre in this market."

“The government wants to ensure no one in the UK is denied access to good financial services on account of their religious beliefs. We value the contribution Islamic finance makes to London’s position as an international financial centre and we want to see this sector continue to grow and prosper in this country.”

The consultation paper states:

"This document sets out the proposed legislative framework for the regulatory treatment of ‘Alternative Finance Investment Bonds’. AFIBs refer to a type of financial instrument commonly known as sukuk or Islamic bond, but can also refer to any financial instrument with similar characteristics. This consultation paper considers the regulatory policy options for these instruments."

"Sukuk are one of the most prominent instruments used in Islamic finance. Since 2003, there have been several initiatives by the authorities to create a ‘level playing field’ for Islamic finance. For example, the government has introduced, and has proposals to further introduce, various tax changes with respect to AFIBs."

"Classifying Islamic financial instruments, including sukuk, under existing regulatory frameworks has posed challenges in the UK and other jurisdictions. Although many instruments are designed to replicate the economic functions of certain conventional financial products, their legal structure and risk characteristics may be different. It may therefore be difficult to map these products into the existing legal framework. Some of these instruments currently appear to fall within the definition of a Collective Investment Scheme (CIS) as set out in the Financial Services and Markets Act (FSMA 2000). However, alternative interpretations exist, and assessment is currently conducted on a case-by-case basis."

"HM Treasury is seeking to introduce legislative changes to align the regulatory treatment of AFIBs with conventional debt securities. Four policy options have been identified:

• Option 1: introduce legislative amendments to explicitly exempt these instruments from CIS regulations and create a new specified investment under the Regulated Activities Order (RAO). Introduce a unique regulatory definition for AFIBs for this purpose;
• Option 2: same as option 1 but AFIBs will be defined by the existing tax definition;
• Option 3: same as option 1 but include AFIBs under the existing specified investment of creating or acknowledging indebtedness; and
• Option 4: is to do nothing."

"The preferred option is option 1. As with options 2 and 3, its main benefit is that it treats AFIBs as conventional bonds. This provides clarity about the regulatory treatment and compliance costs for AFIBs and thus facilitates UK issuance of these instruments. It also creates a level playing field between AFIBs and the conventional bonds that they mirror in economic substance. Option 1 produces this benefit in a flexible and simple manner that creates legal certainty. It does not distinguish between private and public issuance of AFIBs."

"Option 1 may incur costs associated with upgrading the FSA’s technology platforms which record regulatory permissions and other associated systems. The scale of these costs is presently unclear and the FSA is currently conducting a detailed assessment to estimate the costs associated with these changes. If the costs are unavoidable and material, the Authorities will examine the feasibility of other legislative solutions that would avoid such costs (such as those set out in option 3 of this document)."

As well as this consultation, the government has also published a new paper, entitled: ‘The development of Islamic finance in the UK’. This paper’s purpose is to raise awareness of the growing role of Islamic finance in the UK by providing a stock take of achievements to date, as well examining the remaining barriers to growth.

Britain has already licensed 5 Islamic banks, with Gatehouse Bank being the most recent; while other key European financial centers continue to develop opportunities for Islamic finance, including exciting initiatives in Germany, France, Italy and Belgium.

The Role Of Offshore Jurisdictions

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

Malaysia and Labuan

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.

In September, 2008, Malaysia's Prime Minister, Abdullah Ahmad Badawi, unveiled plans to implement a series of economy-boosting measures in the country's 2008/2009 budget, which include hefty tax breaks for Islamic bonds, or Sukuk. The Prime Minister announced that in a bid to encourage fiscal growth, the government will award fees and profits gained from non-ringgit Islamic bond deals distributed outside of the country a three-year tax exemption.

Coming into effect from 2009, the exemption will apply to the fees and profits on arranging, underwriting, distributing and trading non-ringgit sukuks. Making sukuks tax-free will further enhance Malaysia's current position as the world's largest sukuk market. In June 2008, Malaysia accounted for 62.6% of global outstanding sukuk issuance.

In addition to this, the Prime Minister also announced the introduction of a double tax deduction for Islamic finance courses on offer at one of the Malaysian universities to compensate for the shortage of industry experts.

Dubai and the UAE

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 N ovember, 2007, the Dubai Financial Services Authority (DFSA) received the accolade of 'Best Regulator for Islamic Funds', which was awarded during the recent 5th Annual Islamic Funds World Conference.

The award was co-presented to the DFSA and the Malaysian Securities Commission (SC), at the Master of Islamic Funds Awards luncheon in Dubai, which took place on 13th November 2007. The award was co-sponsored by Dow Jones and Standard & Poor's, and recognises the DFSA’s efforts to facilitate cross-border marketing of Islamic investment funds.

In March 2007, the DFSA and the Malaysian SC entered into a mutual recognition agreement, allowing Islamic funds that have been approved by the SC to be marketed and distributed in the Dubai International Financial Centre (DIFC) with minimal regulatory intervention, following the entry of Malaysia onto the DFSA's list of Recognised Jurisdictions. Similarly, Islamic funds which have been registered or notified with the DFSA have access to Malaysian investors.

David Knott, Chief Executive of the DFSA commented: "We are delighted to be recognised again for innovations that facilitate the growth of Islamic Finance. This award further exemplifies the DFSA's strong commitment towards taking a leadership regulatory role and establishing the DIFC as a Centre promoting innovation and growth of Islamic capital markets in the Middle East."

In December, the DIFC welcomed Tokio Marine Group to its growing portfolio of financial and management service providers.

A leading Takaful insurance services provider with operations in the UAE and Saudi Arabia, Tokio Marine Group will expand across the Middle East North Africa (MENA) region through its new company, Tokio Marine Middle East Limited (TMME). Registered with and located within the DIFC, Tokio Marine Middle East Limited is regulated by the Dubai Financial Services Authority as an insurance management services provider.

Takaful is a form of insurance that conforms to the principles of Islamic finance. Using the Shariah 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. At a basic level, it provides mutual protection of assets and property in the event of loss or damage, based upon joint risk sharing.

Nasser Al Shaali, CEO of the DIFC Authority, commented: "Takaful services are increasingly sought after in today's dynamic business environment and are of particular relevance to the region. DIFC is further consolidating its leading role in Islamic Finance with the addition of Tokio Marine Group, through its new company. The inception of a company dedicated to Takaful services also illustrates the DIFC's increasing focus on socially responsible financial services."

Tokio Marine entered the Takaful industry in 2001 through its conventional financial operations in Saudi Arabia, and subsequently became the first foreign company in the Kingdom to introduce property and casualty Takaful products. Recognising the potential in opening markets to new licenses, Tokio Marine Group established Tokio Marine Retakaful company, based in Singapore, in September 2004. In 2006, the Tokio Marine Group took a 35% stake in the new joint venture with Hong Leong of Malaysia for US$29m, to form Hong Leong Tokio Marine Takaful Berhad.

"We are pleased to establish this company with the objective of seeking new business opportunities and expanding the Group's existing business in the Middle East and North African markets," announced Hisato Hamada, President and CEO, Tokio Marine Group. He continued: "We are committed to providing products and services that are fully aligned with our customers' cultural and social values."

Hamada added: "Tokio Marine with its long history of a local presence believes that with its diverse portfolio, backed by conventional and Takaful expertise, is well placed to take advantage of opportunities that open up in the MENA region. The Group has set its goals to establish or acquire a number of operations in the MENA region to better serve the indigenous insurance needs. TMME will help the Group to achieve these goals."

TMME will be a technical and management services provider, instituting products, systems and procedures for the existing and new ventures fully or partially owned by the Group.

"Tokio Marine Group is committed to finding socially responsible ways of bringing insurance solutions to its customers. These solutions are in complete harmony with its environment and culture," continued Ajmal Bhatty, Chief Operating Officer and SEO of the Company. "Takaful may be a system that has its roots in the Islamic Shariah, but because of its ethical nature it has proven to be of benefit for everyone. Not only does a Takaful customer benefit from the surplus of the business when it does well, but he also gains the satisfaction of knowing that his contributions and premiums are only channeled towards ventures that are socially and environmentally responsible."

"The biggest challenge and potential for the region lies in the development of Family Takaful which is life insurance in compliance with Shariah principles. The cultural mind-set against conventional life insurance has been one of the main reasons why development of life insurance has been slow. With strong professional approach and innovative takaful solutions, the regional markets should be able to realize the excellent potential that exists in Family Takaful with its related savings and pensions products," he concluded.

In November, 2008, the Dubai International Financial Centre (DIFC) announced that it had enacted new regulations that enable companies within the financial district to quickly form Special Purpose Company (SPC) structures.

The new regulations allow companies to create SPCs for facilitating both Islamic and conventional transactions as well as vessel registrations. Transactions that can be facilitated by the new law include acquisitions and financings.

Under the law, Special Purpose Companies can be easily structured and incorporated, while enjoying exemptions from some filing and disclosure rules relating to conventional companies in DIFC. For example, they are not required to hold annual shareholder meetings, can be administered by a corporate service provider and are not required to file annual returns.

Dr. Omar Bin Sulaiman, Governor of the DIFC said: "The SPC Regulations form part of DIFC's constantly evolving legal framework that aims to provide a supportive environment for financial services companies. DIFC is committed to providing a world-class regulatory framework that offers companies the flexibility necessary to structure a range of financing transactions. At the same time, our regulations ensure that we retain our strong focus on integrity, transparency and efficiency. The enactment of the SPC Regulations will provide a great boost for conventional and Islamic acquisitions and financings in the region."

In another late-2008 move, the DIFC, in association with the International Islamic Finance Market, organised a project briefing session to re-affirm support for the Master Agreements for Treasury Placement (MATP), a major initiative that facilitates the unification and growth of the Islamic financial services industry.

Key representatives of the Islamic Finance industry hailed the MATP as a landmark initiative for standardising the Commodity Murabaha, a tool customarily used by Islamic institutions for Shari’ah compliant liquidity management. Officials who spoke at the briefing session included Mr. Nasser Al Shaali, Chief Executive Officer of the DIFC Authority and Mr. Ijlal Ahmed Alvi, Chief Executive Officer of the International Islamic Finance Market (IIFM).

The MATP is a benchmark document and a global first for the Islamic finance industry. Its adoption will enhance cost, time and operational efficiencies of Shari'ah compliant deposit arrangements. The initiative caters to the Shari’ah compliant commodities market, which represents, in some cases, 90% of commodity Murabaha transactions. The agreements cover principal to principal as well as agency arrangements. The global Commodity Murabaha market is currently worth over USD100bn.

Nasser Al Shaali said: "The MATP represents a significant milestone in the development of the global Islamic Finance industry. As part of DIFC's mission to catalyse the growth of the regional capital market, we will be seeking to raise awareness and understanding of the MATP not just within the financial district but across the region. The agreement will facilitate more harmonious practices, lower costs and greater clarity for institutions involved in commodity Murabaha transactions. It will give a significant boost to the growth of the Islamic financial services industry and the development of Islamic capital markets across the world."

The agreement is the culmination of a consultation with over 40 regional and international market participants. The project was driven by IIFM's Shari'ah panel consisting of several leading scholars while the DIFC and the Central Bank of Bahrain played key roles in facilitating the complex agreement. DIFC hosted the final review of the MATP by the scholars of the IIFM Shari'ah Panel on August 14, 2008.

The agreement was finalised when a pronouncement approving the MATP, was signed by the IIFM Shari'ah Panel at a meeting in Jeddah on September 7, 2008.

In June, 2008, Barclays Capital, the investment banking division of Barclays Bank plc, and the Dubai Multi Commodities Centre Authority (DMCC), an agency of the Dubai government, announced the first Shariah compliant hedge funds to be launched on the Al Safi Trust alternative investment platform.

DMCC has committed to seed five commodity hedge fund managers on Al Safi with USD50 million each, a total of USD250 million, for a Shariah compliant fund of funds product to be offered under the Dubai Shariah Asset Management (DSAM) brand.

The commodity strategies and hedge fund managers approved by DMCC are Tocqueville Asset Management Gold, Lucas Capital Management LLC Energy/Oil & Gas, Zweig-DiMenna Intl. Managers Natural Resources, Ospraie Management Agriculture and BlackRock, Inc. Global Resources and Mining.

Al Safi is a comprehensive Shariah compliant platform comprised initially of single strategy alternative investment managers with Shariah Capital as the Shariah advisor and Barclays Capital as the prime broker and structured product distributor.

Al Safi is described as a “plug and play” solution offering an established process of due diligence which accepts only those hedge fund strategies and managers that meet the exacting criteria of its Shariah Supervisory Board. It claims to offer Islamic investors the same high-quality managers and strategies available to conventional investors including comparable returns, competitive fee levels, diversification across asset classes and access to customised structured products which can provide full capital protection, all within a pre-established Cayman trust framework.

Al Safi has been created in response to market demand for Shariah compliant alternative investments and the considerable impediments fund managers have faced meeting that demand.

In addition to the above commodity fund managers, other long/short equity hedge fund managers available on the Al Safi platform will be announced shortly. The Al Safi platform expects to include a range of alternative investment strategies as well as specialised investment funds.

Richard Ho, Head of Fund-linked Derivatives at Barclays Capital commented: “The DMCC’s provision of seed capital for five fund managers on Al Safi is a strong affirmation of the robustness of the platform’s Shariah framework and an exciting development in the alternative investments available to Islamic investors."

Ahmed Bin Sulayem, Executive Chairman, DMCC stated: “DMCC is pleased to work with globally renowned organisations Barclays Capital and Shariah Capital to offer the first Shariah compliant hedge funds on the Al Safi Trust alternative investment platform. We have worked closely with our international partners to engage world-class fund managers with excellent track records in order to offer investors premium Shariah-compliant investment solutions."

Eric Meyer, Chairman and CEO of Shariah Capital added: “With the capital support of a sovereign government and the prime broker and structuring expertise of Barclays Capital, the Al Safi Trust platform is a historic development that unites modern investment strategies with Shariah. The initial commodity hedge fund managers who will be available through Dubai Shariah Asset Management are truly world-class. They represent the best and most successful commodity strategists in the world, and they have agreed to accommodate Shariah within the strict guidelines established by our Shariah Supervisory Board."

Russell Lucas, Co-Founder and Co-Portfolio Manager of Lucas Capital Management said: “Al Safi is built from the ground up upon compliant assets and is controlled within a credible Shariah framework. Barclays Capital Prime Brokerage is the first to provide the needed Shariah equivalent solutions for hedge funds. We are very pleased to be one of the first to be working with the DMCC in providing hedge fund access to Islamic investors."

Dan J. Rice III, CPA, Managing Director and Portfolio Manager for BlackRock noted: “The Middle East is a fast growing market, with estimated investment assets of more than USD3 trillion. BlackRock has already made strong progress in the region building extensive relationships, and we are excited to further deepen our presence in this area. We look forward to partnering with the DMCC, creating an attractive platform of investment opportunities for the Islamic investor."

John Hathaway, Portfolio Manager and Senior Managing Director of Tocqueville Asset Management L.P. observed: “This is an exciting opportunity for Tocqueville and we look forward to a partnership with the DMCC with the greatest enthusiasm."

Dr. David Rutledge, Chief Executive of DMCC commented: “The Al Safi platform is ideal for the Shariah compliant asset management capability we are developing in commodities. It enables us to access exceptional managers with strong track records in order to achieve our goal of delivering diversified exposure across a range of commodity sectors to both institutional and individual investors interested in Shariah compliant investment products and solutions. We are privileged to seed these initial managers and support Barclays Capital with our commitment to the platform’s success."

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 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.

In December, 2007, Deloitte appointed Mufti Hassan Kaleem as Shariah scholar in its Islamic Finance practice. The appointment makes Deloitte the first Big Four firm to appoint a Shariah scholar, who will ensure that products and transactions are fully compliant with the principles of Islamic finance.

There is a great shortage of qualified experienced Sharia’a scholars, but enormous demand. Deloitte revealed that Mr Kaleem possesses significant knowledge and experience, gained through a combined 16 years of education and practical experience. He holds a variety of consultancy posts in Pakistan with organisations ranging from Islamic bank and insurance companies to advisory committees for the State Bank and the Securities and Exchange Commission.

Deloitte believes that London is well positioned as a gateway for Islamic Finance, especially if the current Treasury consultation on the UK Sovereign Sukuk (Islamic bond) leads to an actual issuance.

“London represents a key location for Islamic Finance, as the principal based governance and regulation is more adaptable to accommodate innovation such as Sharia’a compliant products,” commented Maghsoud Einollahi, global head of Islamic Finance at Deloitte.

“I was drawn to working with Deloitte as I will be working on an array of different financial products from tax, to maybe government and institutional issues,” concluded Mr Kaleem.