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London is looking to its burgeoning market in Islamic finance - already the largest in the Western world - to boost its reputation as a financial center, banking on growth in an industry with the bonus of being partly shielded from the global credit crisis.
An eagerly awaited decision next week by the British government on whether it will borrow money by issuing a sovereign Islamic bond, or sukuk, could open up new avenues in a market that Standard & Poor's estimates could reach US$4 trillion overall.
"We are very excited," said Humphrey Percy, the chief executive of the Bank of London and the Middle East, one of four Islamic banks in the British capital.
"It will further underline London as an international Islamic financial center because it will be the first hard currency, highly rated, government sukuk to be issued. These are all milestones," Percy said at BLME's headquarters in the capital's financial district, where the bank opened for business just six months ago.
Islamic financing is increasingly seen as a key support for the city in its competition with other centers such as New York, after London's reputation as a financial center took a beating thanks to the failure of Northern Rock PLC and criticism of proposals to raise taxes on wealthy expatriates living here.
"Islamic finance is a tool that the government realizes it has in its hand, which it can utilize to re-establish some clear blue water between themselves and Wall Street," said David Testa, the Chief Executive Officer of Gatehouse Capital PLC, which is expecting to receive its license to become the fifth standalone Islamic bank in London within weeks.
As the fallout from the US subprime mortgage market collapse continues to take its toll on the conventional banking sector, there is increasing interest in Islamic banking, which conforms to Shariah, or Islamic law, forbidding forbids interest and requiring deals to be based on tangible assets have provided some insulation from credit turbulence.
While more than two-thirds of Islamic finance business is currently originated in the Middle East, the oil rich region is increasingly looking to international capital markets to finance their grander development projects - a US$1.5 billion sukuk issue from Dubai Ports World and arranged by
London-based Barclays Capital last year allocated 60 percent of its paper to Western buyers.
A British government sukuk - which could be announced in next week's annual budget - would increase liquidity in the market and expand the secondary commercial market in the takaful, or Islamic insurance, sector.
"Sukuk and other bonds would absolutely explode," David Lewis, the Lord Mayor for the City of London, the capital's financial district, told leading Islamic bankers at a meeting this week. "If we in London could promote such a market, there would be huge international interest."
Unlike conventional bonds, a sukuk confers to investors a proportional ownership of an underlying physical asset, such as leased land, as well as the income that it generates.
Takaful, where resources must be pooled, benefits because a sukuk offers a tradable fixed income component that was previously lacking.
The global sukuk market grew by 75 percent to reach US$85 billion in the first half of 2007.
The US$24.5 billion raised in the first half alone nearly surpassed 2006 new issuance of US$26.8 billion, according to the Islamic Finance Information Service.
The potential of the commercial sukuk market was revealed recently by the launch of a US$300 million convertible bond for Tamweel, the second largest mortgage lender in the United Arab Emirates.
Tamweel said its December bond issue, again managed by Barclays Capital, was oversubscribed within hours.
Rodney Wilson, chairman of the London-based Institute of Islamic Banking and Insurance, noted that some other deals had been put on hold - UAE-based Dana Gas postponed placing its US$1 billion sukuk until September due to credit market weakness, while First Gulf Bank of the UAE and Bahrain's Ithmar Bank announced deferment of their issues.
"On the other hand, there is no Islamic financial institution which is in trouble," said Wilson.
Wilson added that the British government is likely to go ahead with the sukuk even after a furor earlier this year over comments from Rowan William, the archbishop of Canterbury and the head of Britain's Anglican Church, that a limited application of Shariah in Britain was inevitable.
"The sukuk would look very good in the interest of the Islamic finance altogether and UK Muslim community in particular," said Wilson.
Britain has worked to position London to take advantage of the rapid growth in wholesale Islamic banking. It is the only Western country among the top 15 for Shariah-compliant assets, ranking ninth, according to industry group International Financial Services London.
Both retail and wholesale services have grown rapidly since the Islamic Bank of Britain became the first stand-alone domestic bank in the sector to cater to the country's 2 million Muslims just four years ago. There are now also some 23 conventional banks, including Lloyds and HSBC, offering Islamic products.
In contrast, France, with a Muslim population of more than 5 million, has just four conventional banks offering Islamic products.
The United States is the only other country that comes close to Britain, with around 20 Islamic banks, but those are so far predominantly focused on domestic retail operations instead of high finance.
Many credit 2003 legislation enabling the retail Islamic market - that the government then widened to wholesale banking and capital markets.
London is also far ahead in training for the industry. The Islamic Finance Qualification offered by its Securities and Investment Institute is recognized around the world and the Chartered Institute of Management Accountants' Certificate in Islamic finance is the first offered by a professional chartered accountancy body.
The burgeoning market is not without its problems, however.
A key issue is potential disagreement among Shariah scholars at different institutions and in different parts of the world about what constitutes compliance with Islamic law. Shariah compliant products attempt to replicate the concept of interest through cost-plus transactions, leasing arrangements or by linking payments to returns on underlying assets. The process is normally blessed by a board of religious scholars affiliated with a bank.
One of the world's leading scholars, Sheik Mohammed Taqi Usmani, recently rattled the market by saying 85 percent of sukuk are not Shariah compliant because they were too much like conventional interest-bearing bonds.
Wilson said that a consensus would likely evolve with time.
"I don't really see any huge problems ahead," he added. "I expect it will expand into other areas and more conventional institutions will join which is what we are seeing now."