Sukuk Success: Islamic Finance Is Spreading Globally and Product Structures Are Evolving Rapidly. Can the Industry Keep Its Unique Identity amid All This Change?

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The global Islamic finance industry has grown from about $10bn worth of invested assets in 1975 to $2.2trn today, according to the 1st Ethical Charitable Trust, an adviser on sharia compliance in the UK.

The tenets of Islamic finance generally forbid the payment of interest and investing in activities deemed speculative, uncertain or unjust (such as gambling, alcohol and the sale of certain foods). This has appeal beyond the Muslim world. Indeed, about 80 per cent of sharia-compliant investment products in Malaysia are held by non-Muslim investors. So will the rise of Islamic finance continue, particularly given the lack of trust in Western banking? And what changes can be expected in the global sharia investment mix?

By the end of 2010 5.5 per cent of the $2.2trn invested in Islamic instruments was held in dedicated Islamic funds, with 31.1 per cent in broader-based assets (mainly in sharia-compliant bank accounts and money-market vehicles). The rest was held in other Islamic instruments, particularly sharia-compliant bonds (sukuk), insurance packages (takaful) and equities products.

Where are the world's Islamic finance hot spots? "The main centres have stayed largely the same for the past three years: Malaysia continues to lead the way in sukuk and equities products, while Saudi Arabia does the same for bank deposits," says Sohaib Umar, a partner in Ernst & Young's Islamic financial services group in Bahrain. Dedicated multi-product Islamic funds are split largely among Malaysia, Saudi Arabia, Kuwait, Luxembourg, Bahrain, the Cayman Islands and Ireland.

Yet the focus of the Islamic finance industry - especially for bond and equity products - is set to change, says Sam Barden, chief executive of SBI Fund Management in Dubai. "Saudi Arabia, most notably, is likely to lose further market share to Bahrain, Dubai and non-Muslim investment hubs, particularly Luxembourg," he says, explaining that Saudi Arabia's lack of amenities for non-Islamic financiers will hold it back.

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In a bid to boost its growing dedicated Islamic bond and equity funds business, the Central Bank of Bahrain has introduced a new regulatory framework for collective investments. This allows for a wider range of activities, including hedge funds, derivatives and alternative investment vehicles.

Another Bahraini innovation, in March 2010, was the first globally standardised documentation for privately negotiated tahawut (hedging) products. This followed the publication of a "tahawut master agreement" by Bahrain's International Islamic Financial Market and the New York-based International Swaps and Derivatives Association (ISDA). "This should bring the similar benefits of efficiency, certainty and liquidity to the Islamic finance markets - as did the development of the original ISDA Master Agreements in the 1980s," says Yousef Battiwala, an associate at London-based commercial law firm Allen & Overy.

Dubai has also been making itself more attractive to foreign users of sharia-compliant instruments. In 2006 the Dubai Financial Services Authority (DFSA) signed up to stringent standards for information-sharing and assistance between regulators set out by the International Organisation of Securities Commissions. The DFSA made 46 bilateral agreements with regulators of strategic importance to the Dubai International Financial Centre. Financial centres outside the Middle East are also targeting Islamic finance investors.

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Luxembourg is the best placed to win business, according to Barden. "No laws or amendments are needed for sharia-compliant funds to set up there; they are not charged any taxes; and the whole process can take as little as six weeks for both collective investment schemes and specialised investment funds," he says. "This timeframe contrasts with an average of two months in Bahrain and Dubai - and three months in Saudi Arabia. …