As Middle Eastern money continues to flood into the UK, the Chancellor has reacted with regulatory reforms to establish the necessary framework to support Shariah-compliant products
In June 2006, Chancellor Gordon Brown announced London will become an Islamic finance centre and regulatory reforms will be established to support the creation of Shariah-compliant products.
There can be no doubt as to the motivation - the flow of funds from Muslim countries is estimated to be somewhere in the region of $300bn-$400bn, growing at a rate of 15% annually. With the oil price near its historic all-time high, this global flow of funds seems set to continue for the medium term at least.
One area, which has been a focus in Shariah investing, is real estate investments. These have proved to be a popular home for Shariah-compliant funds with Middle Eastern money accounting for approximately 11% of the total foreign investment in UK commercial property, having grown from about 4% in 2004.
A recent survey carried out by King Sturge International Property Consultants and London South Bank University showed that Europe was the focus for Shariah property investing.
Within Europe, the focus over the last three years has been on the more established real estate markets in Northern and Western Europe, with the focus on the UK. Outside the UK, Germany and France were the next most desirable investment locations and were expected to absorb the bulk of Shariah-compliant investment over the next three years.
However, there is a push to explore more emerging markets, with greater interest in countries on the peripheries and in Central and Eastern Europe. Recently, Poland and Hungary proved the only Eastern European countries to garner any interest, with investors now looking more seriously at countries such as the Czech Republic, Slovenia and Slovakia.
Outside Europe, the US remains the prime investment focus, both now and in the future.
In regards to Shariah-compliant real estate investment funds, their performance has been comparable to the market. For example, Shariah real estate investments in Europe have been in the range of 10% to 18%, very much in line with the marketplace as a whole.
It is likely the amount of money being invested through Shariah-compliant funds is going to increase. At the moment, the organisations interviewed in the survey have about E650m available, and almost all interviewees were of the view that their Shariah-related investment activity will increase over the next 12 months.
What are the financial structures used?
The most popular Shariah financial structure used is the Ijarah. Of those surveyed, some 90% said that this was their preferred financial structure, up from 74% in the 2005 survey. The other structures that have experienced an increase in popularity are the Sukuk, Musharakah and Murabahah. However, the Mudarabah version appears to be falling out of favour.
Additionally, the survey reported a new form of financial structure emerging called Istisna'a, which was favoured by about half of those surveyed. The survey also revealed that Shariah funds structured as Real Estate Investment Trust (Reits) could prove popular.
More specifically, investments, which comply with Shariah law, can be thought of as ethical investments organised in compliance with Islamic law. As such, they are prohibited from investing in:
lConventional financial services
lArms and munitions
The key financing methods used are as follows:
Ijarah is an Islamic lease agreement. Instead of lending money and earning interest, Ijarah allows the bank to earn profits by charging rentals on the asset leased to the customer.
Murabahah is a purchase and resale agreement. Instead of lending out money, the capital provider purchases the desired commodity (for which the loan would have been taken out) from a third-party and resells it at a predetermined higher price to the capital user, paying this higher price over instalments.
Sukuk is similar to a conventional bond with the difference being that they are asset backed. A sukuk represents proportionate beneficial ownership in the underlying asset. The asset will be leased to the client to yield the return on the investment.
Musharakah is profit and loss sharing. It is a partnership where profits are shared according to an agreed ratio and the losses are shared in proportion to the capital/investment of each partner. In a Musharakah, all partners to a business contribute funds and have the right, but not the obligation, to exercise executive powers in that project, which is similar to a conventional partnership structure and the holding of voting stock in a limited company. This is widely regarded as the purest form of Islamic financing.
Mudarabah is an investment partnership, whereby the investor (the Rab-ul-Mal) provides capital to another party/entrepreneur (the Mudarib) in order to undertake a business activity. While profits are shared on a pre-agreed ratio, loss of investment is born by the investor only. The Mudarib loses its share of the expected income.
Istisna'a is a contract whereby a party undertakes to produce specific goods and services, and is made according to certain agreed-upon specifications at a determined price and for a fixed date of delivery. The production of goods includes any process of manufacturing, construction, assembling or packaging.
Qard Hassan is an interest-free loan, which is given for either welfare purposes or fulfilling short-term funding requirements. The borrower is only obliged to repay back the principal amount of the loan.
All financing methods have to be certified by a panel of experts, the Shariah board. Members are drawn from respected Shariah scholars with the expertise to interpret Islamic law. Similarly, every single transaction will have to be scrutinised by the Shariah board to ensure full compliance with Islamic principles.
How do they differ from conventional and ethical funds?
In some areas, there is little difference. The management of Shariah-compliant portfolios is considered similar to ethical funds and not much different to conventional funds.
However, monitoring of compliance is one area that stands out, with just over one-third of those surveyed commenting that Shariah funds were similar to conventional funds. Almost 90% of respondents thought that ethical and Shariah funds were similar in this respect.
In a Shariah fund, up to 5% of an investment can be non-compliant, and can be offset by donations to charity, a process known as portfolio purification. For example, some real estate investments will include a small proportion that does not comply with Shariah Law - a tobacconist in a shopping centre, for instance. Shariah funds are set to grow with many investors being attracted to property investments. With the UK the most popular area to invest, the Government has indicated it plans to create a regulatory framework so growth can continue. key points
London aims to become a centre for Islamic finance
Regulatory reforms will be put in place to support Shariah-compliant products
Shariah investments are similar to ethical funds
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