Islamic Finance and Banking in Post-Brexit Britain

This post explores an area in which government and the private sector including providers of legal services can seek to maximise the opportunities posed by Brexit whilst avoiding some of its potential perils and pitfalls. Of particular interest to barristers and solicitors seeking fertile fields for transactional and contentious work (through dispute resolution and to a lesser degree in litigation and the courts) is financial services purporting compliance with Islamic law (shari’a) — that is, Islamic finance and banking (‘IFB’).

The government imprimatur

The first Islamic bank in the United Kingdom, licensed by the FSA in 2004 was the Islamic Bank of Britain (‘IBB’). It was purchased by a Qatari bank and renamed Al Rayan in 2014. About the same time a series of amended Finance Acts and statutory instruments provided for reliefs making Islamic mortgages viable. In competition with the largest European home of Islamic funds (Luxembourg), in a bid to attract listings to the London Stock Exchange (‘LSE’) and a reputation as western centre of Islamic finance, the government floated a sukuk worth £200 m in 2014. It was oversubscribed ten-fold.

A sukuk is, in shorthand, called an Islamic bond. It is a structured capital market instrument that combines features of an equity and a bond. Sixty-five sukuk have been listed on the LSE, with a combined value of USD$48 b (LSE data, April 2017). The Bank of England’s on-going consultation concerning establishment of a liquidity facility for Islamic financial institutions (‘IFI’s) is evidence of a continuing government policy of fostering IFB.

Passporting’s disparate significance for financial institutions

Brexit raises multiple questions for British banks and foreign owned banks operating in or from the United Kingdom. Principal among these is the loss of passporting rights. Passporting gives a considerable boost to the nationally important banking sector. More likely than not passporting will not survive Brexit; however it is possible that some equivalent might be agreed — even if at the level only of companies, not countries. With passporting a financial authorised in this jurisdiction is (without more) authorised to offer services throughout the EU, with the converse also being true. In addition to benefiting most British banks, passporting attracted to London banks from outside the EU, such as Goldman, Citibank, and JP Morgan.

With respect to loss of passporting (and the escalation of compliance and overhead costs attendant upon it) conventional banks suffer a detriment and IFIs secure a possible benefit. IFIs benefit to the extent that they stand to gain from the consolidation of conventional banks. Deposit taking IFIs largely offer services within this jurisdiction only, not cross-border. Where IFIs attract customers beyond national boundaries they do so without relying upon passporting; for example, investment in shari’a compliant equities, funds and sukuk occurs by means of recognised exchanges in Britain and therefore falls only to be regulated by UK rules.

IFIs will not be adversely affected by loss of passporting. To the extent (as will be suggested below) the government takes further measures to stimulate IFB and to attract inward investment with it, the most logical and cost effective way of doing so would be by means of lighter touch regulation, reducing compliance costs (and increasing the profitability and scope for growth) of IFIs.

Dublin, Paris, Frankfurt

Whether or to what extent conventional financial institutions will be compelled to relocate (with Dublin, Paris and Frankfurt being probable destinations) some or all of their front, middle, or back office operations, and to incorporate in the EU 27 cannot be known now. Should they do so they will be relocating to jurisdictions that are already well populated by financial service providers. Should IFBs do so (for other reasons) it will effectively be an expansion into new markets. The first Islamic bank in the Eurozone (KT bank, a subsidiary of a Turkish company) was formed only in July 2015, in Germany. As with IBB, KT Bank cleared a path through a regulatory thicket through which competitors could follow; IFIs could now more readily secure a German banking license and serve a still under-served Muslim demographic in Germany, possibly expanding in due course into other European countries.

According to Pew Research Centre figures (published July 2016) Germany has the second highest proportion of Muslims in the EU (5.8 pc), France the highest (7.5 pc), with Britain possessing the third largest (4.8 pc). These statistics demonstrate the efficacy of regulatory action. It is apparent that the government led growth of IFB in the UK comprises a decisive, successful policy intervention — not the relative size of the Muslim population. However a jointly necessary contribution has been made by other factors: this country’s legal and judicial system, human capital, location and time zone — among other factors, some of which will be elaborated in the next three sections.

IFB’s relationship with English contract law and courts

Due to the perceived weakness or relative novelty (or both) of the jurisdictions in which international IFB contracts are performed or the nationalities of the parties (legal or human), English law is frequently adopted for choice of law provisions, rather than any law with a connection to performance or parties. A sukuk for instance may have as its core assets interests in land in Dubai. Lex situs is inescapable with regard to those assets. However the transaction documents in relation to the capital market instrument, those setting out the rights and duties of obligor and the obligee, would often nevertheless be English law.

There is both a pull, exercised by features of this jurisdiction; and a push — away from civil legal systems (which recognise neither the trust nor beneficial title) and the weak insolvency laws of, for example, the UAE. Insolvency regimes are generally either non-existent or weak in the Gulf Cooperation Council countries, although there is recent evidence of efforts aiming at improvement.

A succinct explanation for the pull, the favour with which global IFB treats this jurisdiction, is: confidence in the impartiality of English legal system, augmented with the settled position that an English judge will not adjudicate Islamic law except insofar as Islamic law is incorporated into a contract (Shamil Bank of Bahrain E.C. vs Beximco Pharmaceuticals Limited and others [2004] EWCA Civ 19), therefore falling to be constructed under the established principles of English contract law. Further reasons for the choice of English law and courts are past (based in colonialism) and present: commercial ties with Muslim majority societies — members of the Commonwealth, and the Gulf Arab states.

Capitalising upon existing strengths in alternative dispute resolution (‘ADR’)

Regardless of the extent to which litigation and court dispositions of IFB disputes increase, with the local and global growth of the industry, the scope for dispute resolution out of court certainly will. In this respect as well the United Kingdom and IFB hold out the promise of a symbiotic relationship. Between the Arbitration Act 1996 (‘the 1996 Act’), the Civil Procedure Rules, and the existing magnitude of ADR cases and providers, this is manifestly a jurisdiction that sees value in promoting ADR.

Because of the religious element of IFB, and the importance accorded expertise in Islamic commercial law, arbitration agreements incorporated into IFB contracts may stipulate the religious or sectarian identity of the arbitrator or members of the arbitral tribunal. S 19 of the 1996 Act places a duty on the court to have regard to arbitrator(s)’ qualifications as agreed by the parties; these may include expertise in Islamic law. Jivraj v Hashwani [2010] EWCA Civ 712 establishes that selecting an arbitrator on the basis of religious or sectarian identity does not violate employment law, rendering the UK a more attractive juridical seat for arbitration agreements between IFB counterparties, and clearing the way for more IFB disputes to be arbitrated here. It is also true that since IFB has developed inside the modern system of banking, finance and markets, the knowledge of conventional variants of these possessed by professionals in London and regional centres such as Birmingham is highly facilitative to increasing the sophistication of innovative and credible IFB products and practices. In this regard the work of the Bank of England and its dialogue with IFB participants in creating a shari’a compliant credit facility is an example of the flexibility and entrepreneurial spirit of the central banking authority and its predisposition to support IFB, among other forms of alternative finance.

The secular approach of the material authorities (FCA, PRA, HMT, HMRC etc), like that of the English court, represents an incentive rather than a deterrent to the use of this jurisdiction for the formation, performance and enforcement of IFB contracts and for IFI growth. Admittedly this approach created difficulties in the licensing of the IBB. Principal among these challenges were the requirements under EU/UK rules of deposit insurance, and lender of last resort provisions. Due to the ingenuity and determination of both IFB professionals and the licensing authorities these challengers were overcome. This was an auspicious precedent for the development of innovative new products which may — as IBB did — attract inward investment from the Gulf, or from the other major regional centre of IFB, Southeast Asia. The same point may be made still more forcefully regarding the debut sovereign sukuk.

Existing human capital and its reproduction

British business and law schools with MBA and LLM offerings in IFB help to attract and shape the next generation of industry personnel who — whether staying on or returning to their countries of origin — may be predisposed towards this jurisdiction and the regulatory framework with which they will have become familiar. Magic and silver circle as well as some of the largest US firms operating in London have deemed IFB of sufficient importance and profitability to develop IFB units and to name some London based partners (in addition to those based in offices in Africa, Asia and the Middle East) specialist in IFB.

Concluding considerations

Shari’a compliant financing facilities such as that making possible the construction of London’s Shard, or the purchase of Chelsea Barracks by the Qatari sovereign wealth fund (Project Blue Limited v Commissioners for Her Majesty’s Revenue and Customs [2016] EWCA Civ 485) are not an exclusive means of attracting inward investment from GCC energy producers. However such facilities and the knowledge and legal infrastructure necessary to their effective formation and use comprise a card that the government has been wise to play; it has done so strategically for over a decade. The legal community would be well advised to follow suit, by means of developing familiarity with and actively seeking business development for and mediated by IFB.

The British Muslim demographic and policy of social inclusion initially motivated retail financial services compliant with Islamic law. The high end of the London property market, rendered still more attractive to foreign buyers (especially those holding currencies pegged to the US dollar, such as those of several GCC states) with the weakening of the pound sterling, is an element accorded special importance by IFB. This is a result of IFB’s orientation towards asset based means of financing, as exemplified by the now most popular form of sukuk: one based on a sale and leaseback arrangement of interests in land or other tangible assets — as with the sovereign sukuk issue (three government buildings) and a second issue in 2015 (based in aircraft) made possible by means of a sovereign guarantee.

Ex EU-27 trade agreements, and flows of goods, services, capital and labour will undoubtedly extend across the Atlantic. However the GCC and Commonwealth countries are already evidently targets of the government’s and businesses’ promotional efforts and expenditures. Some opportunities for inward and outward investment can only be captured and fully maxmised by means of IFB. As argued above this jurisdiction and the legal services sector in particular has an early mover advantage and a great deal both to gain and to offer by means of IFB, as a complement to the conventional banking and finance sector so crucial to the British economy.

 

 

 

 

 

 

 

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