Can The Malaysian and Dubai Sukuk Model Apply to the United Kingdom?

Malaysia and Dubai have been at the forefront of the sukuk market in the last few years. Malaysia, in particular has been very successful in taking their sukuk market to the rest of the world, playing a very important role in the global sukuk market. Now that the United Kingdom has issued sukuk, will it stop there? After all, the United Kingdom has not expressed intentions to build on their sukuk issuance to create a real curve or long term business model. Will the much touted UK sukuk be a one-of event? Perhaps by following Dubai’s model, London can create a truly successful domestic market. Local sukuk issuance can then lead to success on the world stage. The fact is that the main reason for the UK to continue issuing sukuk is to make sure that their domestic market will benefit, and there is little reason to believe this will happen unless steps are taken to create a successful domestic market for Islamic financial instruments in the UK.

Perhaps London has already missed the boat when it comes to becoming the worldwide or European center for sukuk. However, there is reason to believe that the potential for growth as an Islamic finance hub is there. Their first sovereign sukuk issuance was a great first step that was the result of years of work. However, it does not stop there, especially because the UK sukuk wasn’t particularly substantial. More frequent issuing of sovereign sukuk can create a market curve that can allow more accurate pricing and a more dynamic market. It is also important to note that the economic crisis in many Western countries has made many investors in GCC states wary of investing in Western economies, traditionally the destination for most of their oil revenue. Fixed income securities, which include sukuk, are a great way of fostering investor confidence. What better way to court investors in Muslim countries than by actually issuing more Islamic financial instruments? When faced with the choice between sukuk and conventional bonds with the same projected returns, the choice for a Muslim investor is clear.

The recent history of Islamic finance makes it clear that Malaysia and the GCC states will continue to be the global centers of Islamic finance. The bulk of the capital and investors is in the GCC states, with many important Islamic banks with substantial government backing concentrated in this region. Malaysia has the legal framework, demand, and disposition to create a dynamic, successful sukuk market. Since 2012 the securities market in the GCC states has been mostly about sukuk rather than about conventional bonds. This was brought about by favorable pricing conditions in 2012 and has continued as a long term trend.

Today, the UK stands at a favorable position to play an important role in the global sukuk market. Let’s examine some of the reasons for and against this possibility. First let us remember that English law already plays an important part in the sukuk market. Although most sukuk are issued in United States dollars, even when the assets and sukuk are completely unrelated to the United States, the legal platform of choice all around the world for these financial instruments is based on English law. However, there is no doubt that the critical mass of market activity lies in the relationship between the GCC states and the Malaysian market, which reached a new level after important Malaysian sukuk listings appeared in the Singapore market. In this critical mass is the difference between a market hub and a market center, and the principal driver of these events is the presence of constant, growing activity in the markets. Although London is well positioned to become a center for Islamic project financing and wealth management, it’s sukuk market does not seem to contain the needed activity for London to become a center for the global sukuk market. The UK’s sovereign sukuk was a great gesture of goodwill and disposition, but unless very large scale projects or corporate sukuk based in the UK are released, matching the enormous capitals that are managed by GCC issued sukuk, further market growth is unlikely to match that of the GCC states or Malaysia.

It is important to note that London has the deepest pool of capital, the deepest liquid market. However, for the UK to become an Islamic finance center, it will need to access the enormous liquidity in the GCC states and Southeast Asia. A true center of Islamic finance will demonstrate that it has the needed market and circumstances to provide a safe home for this liquidity. Wealth and asset management, currently the UK’s strongest Islamic finance areas are not likely to access this capital at the same level as sukuk, where the UK is lagging behind many other nations.

Islamic finance has already played an important part in transforming London with enormous infrastructure projects of recent years. The Shard, Harrod’s, Chelsea Barracks, and the Olympic Village were all financed in whole or in part through Islamic financial instruments. The key question is, are these projects examples of Islamic finance done well, or are they simply conventional infrastructure projects that were financed by Muslim sources using conventional financial instruments? Today, the UK needs all the money that it can get. Due to the National Infrastructure Plan, there are billions of USD that are required for investment around the country. There is no doubt that the wealth in sovereign sukuk from GCC states and Malaysia could very well help meet these investment requirements.

Corporate sukuk issuance would play an enormous role in helping the UK’s finances. However, corporate issuances require sovereign sukuk issuance as a way of setting precedents and benchmarks for these Islamic financial instruments. If the UK were to follow Malaysia’s model, then a substantial boost from the government, both in the form of regulation and sovereign sukuk issuance would be needed to nudge corporate issuers into following suit. This type of help from the government would not be unprecedented in the UK. It is an often overlooked fact that the world center for finance is not Wall Street, it is London. The combination of London opening its doors to banks around the world in the 1960s and 1970s and the enormous changes in regulation in the 1980s, all boosted by the British government led to positioning the UK as a center for world finance, even better suited for the task than New York thanks to its conveniently located time zone. If the UK is thinking in the long term, a similar movement for removal of restrictions (not unlike what Malaysia did in the last decade) could actually create the circumstances for a well developed sukuk market. However, this is unlikely to happen soon, and Malaysia already has an enormous head start.

There is a curious fact about the economies of Muslim nations when it comes to sukuk. These countries are either too rich to need to issue large sukuk to finance their projects, as is the case of the oil producers, of are not so well off that they can issue many sukuk (this is the case of many North African nations, which are unable to issue large sukuk while backing them in a way that would alleviate investor concerns.) This particular set of circumstances has often been an obstacle for Islamic banks and is one of the reasons why nations in Southeastern Asia have been so successful in creating an active sukuk market. Increased issuance of sovereign sukuk from London would provide an additional outlet for this inactive capital and give sukuk a much needed boost to becoming global financial instruments with a wider acceptance.

Today, there is no question that the Malaysian market is the largest, most active sukuk market in the world. However, Malaysia has not been entirely successful in helping the sukuk market grow outside of its borders – perhaps to their benefit, since sukuk have played such an important role in helping Malaysia’s domestic finances and economic development. On the other hand, London is nowhere near Malaysia when it comes to issuing sovereign sukuk. However, when it comes to trading and listing sukuk, the UK already plays a very important role in the global market. Most sukuk issuers choose to list and trade sukuk on the London Stock exchange. In fact, there are about $44 billion USD worth of sukuk listings on the London Stock Exchange, the highest in the world, surpassing the other three important stock exchanges: Bursa Malaysia, NASDAQ Dubai, and the Luxembourg Stock Exchange. Thanks to the LSE’s preeminence as the center of world finances and the high number of Islamic finance listings, London has become an important hub for Islamic finance investment and trade. However, this does not reflect that the vast majority of the sukuk listed have their assets and activity centered around the Malaysian market and the GCC states.