Download Islamic Finance Review 2009/10

Another year of growth and development for the
London Stock Exchange markets for Islamic finance
by Gillian Walmsley, London Stock Exchange
In the Islamic Finance Review 2009/10, we explored the key factors contributing
to London’s position as the gateway for Islamic finance in Europe, namely the
depth and breadth of its capital markets, the extensive pool of expertise
offered by one of the largest concentrations of specialist legal and advisory
expertise in the world and the sustained commitment from the UK
Government to developing Islamic finance with a series of tax and regulatory
changes specifically aimed at facilitating the growth of Shariah-compliant
financial products.We also highlighted the diverse range of products and
services offered across the London Stock Exchange’s markets – from the
trading of equity shares on the Alternative Investment Market (AIM), which
offers growing companies all the benefits of being quoted on a world-class
public market within a regulatory environment that has been designed to
meet their specific needs, to the listing of sukuk on the Main Market, an EU
Regulated Market under MiFID, or the Professional Securities Market, which
is Exchange-regulated and offers the benefits of more flexible regulatory
requirements. In addition to this, a vibrant and growing ETF market means
that the London Stock Exchange is able to provide Islamic institutions and
investors with a broad choice of Shariah-compliant financial instruments
within a range of market structures.
UK regulatory update
London continues to offer the most open, flexible
and attractive tax and regulatory structure for
facilitating Islamic finance transactions over any
other European or US centre and this has been
achieved by tailoring the tax and regulatory regime
to reduce barriers to Islamic financing structures
with the aim of affording them the same
opportunities as conventional financial products.The
UK has been keen to promote a ‘level playing field’
between conventional and Shariah-compliant finance
by seeking to remove the barriers inhibiting the
competitiveness of Islamic financial instruments in
relation to conventional structures.
Building on changes introduced in the Finance
Acts of 2007 and 2008, the FSA and HM Treasury, in
their October 2009 summary of responses to the
joint consultation on alternative finance investment
bonds, proposed changes to UK regulation with an
aim to regulating sukuk in an equivalent manner to
conventional debt securities.To date, the structure
of many sukuk instruments has meant that, in
regulatory terms, they appeared to fall within the
definition of a Collective Investment Scheme (CIS)
which led to an additional regulatory burden when
compared to convention debt securities. Under the
amendments, first introduced into Parliament in
January 2009, the treatment of sukuk with a similar
economic and risk profile to conventional debt
securities would be more akin to the regulatory
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treatment of conventional bonds.The consensus
from market participants has been that these moves
will greatly facilitate the issuance of sukuk securities
in the UK.
Perhaps the most significant steps taken to
further enhance the UK tax and regulatory
framework for Islamic financial products were
contained in the UK Finance Bill 2009.This
legislation introduced measures for Stamp Duty
Land Tax (SDLT), Capital Gains Tax (CGT) and
capital allowance rules for land transactions involved
in the structuring of sukuk instruments and are
intended to remove the previous tax barriers to the
issuance of property-backed sukuk in the UK. Under
these Finance Bill arrangements, the SDLT due on
the transfers of UK retail estate between the
operating company and the sukuk issuer will be
removed, as will any liability for CGT in respect of
these transfers. In addition, changes to the Capital
Allowance Regime will allow sukuk operators to
retain their entitlement to capital allowances in
relation to the UK property involved in the sukuk
transaction.
The reception to these changes has been very
positive. Norton Rose, a key advisor for many
significant Islamic transactions commented, “for the
last few years, HMRC have been very receptive to
representations made for the tax treatment of
Islamic finance to be no more onerous than
conventional finance.These changes should ensure
that there are now no UK tax obstacles to issuing
sukuk backed by UK land” and highlighted that
“these tax changes will give a considerable boost to
the UK Islamic Finance initiative and ensure that in
these difficult times alternative sources of finance
1
will be available in the UK”.
Furthermore, an October 2009 policy statement
by the FSA also highlights the UK regulator’s
recognition of the specific needs of Islamic banks
and offers promise for interesting new developments
in the UK sukuk market in the future. Policy
Statement 09/16 relates to strengthening liquidity
standards and outlines requirements for banks to
maintain a buffer of high-quality liquid assets in the
form of high-quality government bonds, central bank
reserves and supranational debt – the “liquidity
buffer”.
In response to extensive consultation, the FSA
recognised a number of practical difficulties raised by
Islamic banks, particularly in relation to holding
conventional debt securities, and amended the
proposed liquidity buffer requirements for Islamic
banks as a result. In addition to now being eligible
for the simplified liquidity approach, Islamic banks
will be allowed to count bonds issued by the Islamic
Development Bank (IDB) towards their liquidity
buffers.The IDB is currently the only multilateral
development bank to issue Shariah-compliant
securities and it has announced its intention to issue
a sterling-denominated security to support the
development of a liquid Islamic banking system in the
UK.This is a highly significant step in the further
development of London’s sukuk market and will
respond to strong demand for a sterling sukuk issue.
Sukuk issuance
Despite a general slowdown in sukuk issuance
following the credit crisis and some uncertainty
regarding the Shariah-compliance of some existing
structures, the London Stock Exchange saw six
issues during the 2010 financial year, with a total of
£2.8bn raised. Since the first London-listed sukuk
was launched in July 2006 over £9bn has been raised
by issuance of 26 issues on the London Stock
Exchange’s markets.
Retail securities
In February 2010, the London Stock Exchange
introduced a new retail bond market for private
investors.The new Order book for Retail Bonds
(ORB) offers electronic trading in a number of UK
gilts and retail-size corporate and supranational
bonds and aims to respond to private investor
demand by offering a cost-effective, transparent and
efficient mechanism for concentrating on-screen
liquidity and facilitating price discovery in a range of
fixed income securities.
The key benefit of this new retail market is that
it offers an open and transparent market structure
for trading in retail-size. Because dedicated market
makers are committed to quoting two-way prices in
a range of retail bonds throughout the trading day
and all other registered member participants are
also able to enter orders into the book, the market
model means that private investors will be able to
see prices on-screen and trade in bonds in a similar
way as they currently do for shares.
The new market also aims to provide corporate
issuers with an efficient way for distributing bonds
to retail investors and aims to encourage further
new issues of bonds tradable in smaller size
denominations. Under the Prospectus Directive, the
regulatory regime distinguishes between “wholesale”
bonds, which are tradable in units of £50,000 or
greater, and ‘retail’ bonds tradable in smaller size,
often in denominations of £1,000 for example.The
vast majority of bonds issued in the UK are
‘wholesale’ bonds and are therefore not accessible
to most private investors because of the large size
of the denominations in which they must be traded.
There is strong appetite from UK private investors
for a wider universe of bonds tradeable in retail-size
denominations to be made available. As a liquid,
transparent secondary market for retail bonds
develops it is expected that it will bring into focus
the benefits of retail issuance programmes as an
Recent sukuk issues on London Stock Exchange
• CBB International Sukuk Company (No. 2) US$750m trust certificates – June 2009.
• TDIC Sukuk US$1bn certificates – October 2009.
• Dubai DOF Sukuk – over £1bn raised via fixed and floating trust certificates denominated in
US dollars and Emirian dirham – November 2009.
• GE Capital Sukuk – US$500m raised, the first sukuk to be issued by a major US corporate issuer –
November 2009.
• Dar Al-Arkan International – US$450m raised as certificates.
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ETFs on Islamic indices
Two of Europe’s key ETF providers offer Shariah-compliant ETFs on the London Stock Exchange:
• iShares offers ETFs based on the MSCI World Islamic, MSCI USA Islamic and MSCI Emerging Markets
Islamic indices.
• db x-trackers, the ETF provider of Deutsche Bank, offers Islamic ETFs are based on the S&P Japan 500
Shariah, S&P 500 Shariah, S&P Europe 350 Shariah and DJ Islamic Market Titans indices.
additional source of funding for companies wishing
to raise capital from a wider pool of investors and
the indications are that this could stimulate
increased retail-size issuance of corporate bonds.
Currently only conventional debt securities are
available on the new ORB platform, but this new
market could offer exciting opportunities for issuers
of Shariah-compliant securities wishing to access the
retail market. Provided that a retail sukuk issue
meets all the listing and admission requirements of
the EU Regulated Main Market and a market maker
was committed to providing two-way prices it would
be possible for such a sukuk be made available for
electronic trading on the new ORB market.
investing in each of the constituent stocks making
ETFs a highly efficient and cost effective investment
tool. ETFs are supported by dedicated market
makers who quote tradeable prices throughout the
trading day and because they are backed by the
central counterparty, ETFs offer the security of an
exchange-traded product at a time when default risk
is of key concern to investors. In volatile and
uncertain market conditions, the benefits of
transparency, on-exchange security and simplicity
which ETFs provide were further highlighted as
more investors sought to access the markets using
these flexible and innovative instruments.
Looking to the future
Shariah-compliant Exchange Traded
Funds
In 2010 the London Stock Exchange celebrated the
10th anniversary of Exchange Traded Funds (ETFs) in
London. Since the first listing of the iShares FTSE
100 ETF in April 2000, the total number of ETFs and
other Exchange Traded Products (such as Exchange
Traded Notes and Exchange Traded Commodities)
now available on our market has grown to almost
500. Average daily valued traded in 2009 was over
£305m with an average number of over 4,200 trades
daily. In April 2010, the London Stock Exchange
Group was also winner of the award for ‘Largest
Exchange for ETFs by volume in Europe’ at the 6th
Annual Global ETF Awards in New York.
There are seven Shariah-compliant ETFs currently
listed on our market with assets under management
of over US$128m.The indices underlying these ETFs
are constructed by screening constituents for
compliance with Shariah-compliant investment
principles. Screening criteria include restrictions on
financial leverage and prohibited business activities.
ETFs are open-ended index tracking funds listed
and traded on exchanges like shares.They allow
investors to gain exposure to a diverse range of
assets and offer simple and efficient access to
developed and emerging markets, broad and sector
indices. By trading a single share, users can effectively
gain access to an entire index without the burden of
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Through ongoing review and development of the tax
and regulatory regime, London continues to build on
its pre-eminence as the Western centre for Islamic
finance. London remains at the forefront of Islamic
financial development in Europe and internationally.
The London Stock Exchange’s product offering,
spanning the traditional equity and debt securities
markets, as well as the exciting opportunities offered
by a new and expanding segment for retail bonds,
and also extending to a host of new and innovative
exchange traded products, offers a truly global
market where the world of Islamic finance can come
to do business.
Note:
1
Norton Rose, “The UK Budget 2009 and Islamic
Finance”, April 22, 2009.
Author:
Gillian Walmsley, Head of Fixed Income Products
London Stock Exchange
10 Paternoster Square
London EC4M 7LS
UK
Tel: +44 (0)20 7797 3679
Email: [email protected]
Website: www.londonstockexchange.com