The panic caused by Dubai World at the end of last year asking for a 'standstill' on repaying its multi-billion debts sent global stock markets tumbling and has spooked some people causing them to question sukuks and other wholesale Islamic finance instruments. Vivienne Rosch cautions not to follow the herd though, pointing out that the market has grown massively over the last decade, offering technology vendors, banks, exchanges and many others much needed growth opportunities over the long term. Indeed London is still pushing strongly to grab a slice of the pie

In its latest report called Islamic Finance 2010, the non-profit body that promotes London, International Financial Services London (IFSL), estimates that the global Islamic finance market, measured by sharia-compliant assets, was worth $951bn at the end of 2008 (the latest figures available). That is up 25% from $758bn in 2007. The Islamic finance sector has experienced steep growth from about $150bn in the mid-1990s. The largest chunk of about 74% of global shariah-compliant assets is attributable to Islamic commercial banks; 10% to investment banks; 10% to sukuk (Islamic bond) issues; 5% to funds and 1% to takaful (Islamic insurance). It's a market that can't be ignored, despite the recent wobbles in Dubai, and long term growth predictions are keeping people interested.

While the Middle East and Malaysia remain its natural centres, at eighth place overall with $19bn of reported assets, the UK is clearly the western Islamic finance leader. The government's proposed exemption of Islamic sukuk bonds from capital gains tax in the Finance Act 2010 also shows how serious the UK is in targeting the market. Best established in London are Islamic banking and the issuance of sukuk bonds, with Islamic funds and shariah-compliant insurance (takaful) both on the increase too, says IFSL's economics director, Duncan McKenzie.

Dubai International Financial Centre (DIFC), which includes the Nasdaq Dubai exchange and numerous brokers, asset managers and others on the 110 acre site that wants to rival New York, London and other financial centres, is also predicting double-digit growth rates in Islamic finance for the next 15-20 years. This now depends, of course, on how the global markets react long-term to Dubai World almost defaulting on the $4bn Nakheel sukuk, which was due for repayment in December 2009. The plunge in stock markets and loss of confidence when it asked for a 'standstill' on debt repayments was only alleviated when neighbouring Abu Dhabi arranged a $10bn bail-out, but restructuring of its remaining debt is still ongoing.

Principles of Islamic finance
The principles of Islamic finance derive from Shariah, Islamic law, and include a ban on riba (interest), gharar (excessive risk) and maysir (gambling). There is an emphasis on sharing risks, profit and loss, and the idea that transactions must be asset-backed, and a prohibition on dealing in commodities such as alcohol and pork.

Financial transactions take the form of traditional 'contracts' such as murabaha, where goods are sold at a price, including a fixed profit agreed upfront, or ijara (Islamic lease). What is shariah-compliant is ultimately not standardized, since scholars interpret Islamic law differently. Every Islamic financial institution appoints its own shariah board of bankers and Islamic scholars to vet all its products and ongoing operations.

The Dubai crash
"Islamic investment banking suffered less from the banking crisis and recession initially than conventional investment banking," says Mohammed Amin, chairman of the business and economics committee of the Muslim Council of Britain (MCB) and a well-known expert in Islamic finance, who used to head up PwC's consultancy in this area. "This was partly because the rules of Islamic finance prohibit buying the assets that proved to be most toxic in 2008/9, collateralised debt obligations, part of which were based on US sub-prime mortgages. Similarly they weren't involved in credit derivatives."

"However, Islamic investment banks have recently suffered their own credit quality problems with the collapse of the real estate market in the Gulf. There have been big defaults in Kuwait, a very big insolvency in Saudi Arabia and, of course, Dubai. However, I think they will start to come out of that, in just the same way that the conventional industry has picked up."

The global recession combined with declining property values in the Gulf hit sukuk (Islamic bond) issuance in 2008. IFSL reports that global sukuk issuance fell from $34bn in 2007 to $15bn in 2008. "It virtually dried up," says Gillian Walmsley, debt and specialist securities product manager at the London Stock Exchange (LSE), "due to the crisis in the conventional markets, and also certain questions being raised about the shariah-compliance of existing sukuk."

The LSE lists 20 sukuks, which have raised a total of £6.8bn. "Our two listings in 2009," Walmsley reports, "were the Central Bank of Bahrain sukuk, one of the first sukuks to be listed in 2009 and after the credit crisis, and the GE Capital sukuk, a landmark deal, the first Islamic finance instrument issued by a major US corporate entity, specifically aimed also at conventional investors." Four Islamic companies, who together saw £7.8m worth of trading in 2009, are admitted to the LSE's AIM, and db x-trackers and iShares allow investors to buy single units in seven shariah-compliant exchange traded funds, which saw £13.4m worth of trading in 2009, so the UK is active in the wholesale arena.

Most commentators believe the sukuk market will eventually recover, reinstating the long-term growth trend, and expand beyond its current trading centres in London and Dubai. Just one new sukuk was listed on the Dubai Nasdaq in 2009 though, and the exchange itself is now controlled by Dubai Financial Market (DFM) after a change in ownership, but Dubai does still have a total of 21 sukuks listed, worth $18bn.

"None of the recent problems is an indication that Islamic finance is in
some way defective," maintains the MCB's Amin. "It's just that Islamic finance is as capable of having financial crises as conventional finance. If you get property developers that overbuild and then find themselves short of tenants, they are going to have problems paying their financiers, regardless of whether they took out Islamic or conventional finance."

James Bagshawe, chief financial officer of Gatehouse Bank, owned by the Securities House of Kuwait, the latest of the five Islamic banks to be set up in the UK, agrees: "For the medium term, we're very optimistic about Islamic banking and we believe it's a story worth sharing worldwide. We believe there's a large cake of which only a small piece is being eaten at the moment by anyone." It's not just Muslims to whom Islamic finance may appeal. Bagshawe sees Islamic banking as "old-style ethical banking, good for everyone. It is structured differently, and the due diligence applied to the development of a shariah-compliant product offering is attractive to investors [if they understand it]."

Technology
Technology to support Islamic finance operations is available from conventional and purely Islamic suppliers. There is a choice between having a bespoke Islamic system and buying one that runs on top of your existing system. Which is best may depend on who you are and what you wish to achieve. "There are the purely Islamic banks," says Bagshawe, "and there are the Islamic windows of conventional banks, such as HSBC's Amanah. We've purchased a bespoke system, because we are a purely Islamic bank."

The big conventional players, like Oracle, Infosys, Misys and SunGard have been in the market for a number of years. "They've taken conventional systems, parameterized them, made them Islamic and changed some of
the terminology," says Fiaz Mansha, Gatehouse's head of IT. "Then you have other local players, such as International Turnkey systems, Sidat Hyder and also Path Solutions, from whom we've bought a system, that have managed to enter the European market."

Mansha recently completed an MBA at Cass business school in conjunction with DIFC, carrying out research exploring the issue of technological challenges facing Islamic financial institutions. He says he encountered a lot of frustration and customer complaints about the quality and functionality of the solutions offered. He puts much of this down to the relative youth of the industry. "Given the size and growth of the market, there is rich potential for any technology service and system providers that can deliver a high quality service and system to the Islamic finance industry."

3i-Infotech's senior banking consultant, Guru Raghavendran, explains his company's philosophy when supporting Islamic finance operations: "There are two kinds of vendors in the Islamic market, those who have 'tweaked' a conventional product to meet Islamic requirements, and those who did what we did: invest a lot of money, appoint an Islamic scholar who trained us on the fundamentals, and build an entire Islamic banking suite from scratch. We think this is preferable."

Wissam Khoury, managing director of SunGard Middle East, who supply a large number of the Gulf's banks, takes the alternative approach: "We have been equally successful with purely 100% Islamic banks and conventional banks stepping into the Islamic world. From the bank's point of view, it does not require drastic change. It can be achieved by the right flexibility in the solution, and probably introducing new 'golden adaptors' that can run on top of a conventional bank's system."

Nicholas Brewer, SunGard's vice president of global banking solutions, stresses that process flexibility is paramount, particularly because there is in Islamic banking a much greater desire to flex the terms of an agreement between the bank and other parties to ensure mutual profit-and-risk sharing: "To Islamicise a conventional banking solution, you have to adapt the process in it, rather than the underlying calculations, and one of the key things you need is very flexible technology, which can change not just from conventional to Islamic, but lets you rapidly reconfigure different kinds of arrangement under Islamic banking."

All agree that thorough knowledge of shariah principles and of how these translate into business processes, as well as experience of what is likely to be deemed shariah-compliant are of primary importance both when designing and choosing suitable technology support. Good advice is valuable, whether from an experienced vendor, a consultancy, or possibly another bank - Gatehouse Bank provides a service through its own shariah department with three scholars who can give an opinion relatively quickly on whether something is going to be shariah-compliant or not. Looking at the long view if you're in wholesale banking then you should look east - and I don't mean China.


Boxout: SWIFT offers Islamic services
SWIFT recently ran a pilot scheme testing out messages for Islamic trades. As Arun Aggarwal, managing director of SWIFT UK, Ireland & Nordics, explains: "We already have 240 Islamic finance institutions as members, who use SWIFT for a number of their standard messaging and back-office needs." SWIFT asked its Islamic members for which Islamic transactions they would most like to use SWIFT messages. Top of their list was murabaha. "It seemed to represent a good 60% of specific Islamic transaction processing, and it was being done in a very manual way", says SWIFT's Islamic finance initiative manager, Peter Ware. "We were able to re-use existing messages and put a rule-book in place to explain how to use them in the context of murabaha. The pilot began October 2009 with fifteen banks, in five different countries, testing these messages. The feedback is that they are very easy to use and meet our members' needs."

SWIFT sees Islamic finance as a fast growing market, with nearly 29% growth in 2009. "It's also one that is characterised by a lot of inefficiencies because it is new and clearly in need of standardisation and automation," says Aggarwal.

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