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Part One – Islamic Finance: How Big?
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Part One – Islamic Finance: How Big?

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With an estimated 1.8 billion Muslims worldwide, significant increases in the UHNW population and wealth being generated in the Middle East and Asia, the demand for Islamic Finance and Shari’ah acceptable investment products is on the rise. Following the financial crisis, time and time again, the topic of whether the principles embedded in Islamic Finance could be used as the backdrop to a more stable financial system is being debated.

In a 3 part series of articles, we will introduce our audience to Islamic Finance and attempt to answer the question How Big, is the potential for the Islamic Finance industry? Although, Islamic Finance is a relative newcomer to the Finance industry, just the last 40 years, the investment principles and practices were established centuries long ago.

In the UK alone, 25 Banks offer Islamic Finance products and given that the UK’s prime minister, David Cameron, is keen to promote London as the “Western Hub” for the $2+ trillion Islamic Finance industry, we expect to see a further flurry of events.

Luxembourg is another strong European player in the Islamic Finance industry especially, given the Grand Duchy’s reputation for developing innovative structures in Islamic Finance. Last year, HM’s Treasury issued its first 5-year, non-Muslim sovereign Sukuk, the Islamic equivalent to a bond. The £200 million issue was oversubscribed by more than 1000%, with a demand of £2.3 billion. Needless to say, the orders were carefully allocated with a good spread across client segments and countries.
The current Mayor of London, Fiona Woolf, is another advocate of Islamic Finance, with her wish to promote Islamic Financing as an investment alternative for the current 30+ infrastructure projects planned UK-wide. Infrastructure projects, including transport and energy, usually involve big sums and can easily be funded using a contractual setup acceptable by Shari’ah law.

What is Islamic Finance?

Islamic finance is a financial system that operates according to Islamic/Shari’ah law. Key is the belief that “absolute ownership belongs to God” and man is entrusted in administering the wealth in a just and equitable manner. Therefore Islamic Finance encourages trade and the acquisition of wealth through “lawful” means that promote mutual consent and goodwill to society as a whole. Thereby, balancing material pursuits with spiritual needs and balancing individual needs with social needs. Paying interest is prohibited, as is trading in pork, intoxicants and gambling. In addition, parties to an Islamic Financing contract should share both the risks and the rewards, thereby minimising the appeal for excessive profits and losses by either party.

How does it differ from Conventional Finance?

Conventional Finance, is primarily motivated by interest rates, typically takes risk in favour of lenders and is generally not concerned with the actual use or application of funds. These inherent features of Conventional Finance fall short in meeting the requirements of Shari’ah principles and rules. It is because of this shortfall, the strong need for an autonomous Islamic Finance industry has arisen. Financial Institutions around the world have taken up the call for new products and almost all business areas of the Conventional Finance industry are being adapted in a way that is acceptable to Shari’ah principles and rules.

Governance of Islamic Finance

Adequate systems and controls in any form of financing are paramount. Islamic Finance is no different. A vital part of Islamic Financial activities is to achieve a Shari’ah compliant status. Adequate compliance and controls are assessed by an Internal Shari’ah Control system (ISCS) review, whereby the ISCS has the objective of ensuring that all financial activities are conducted in accordance with Shari’ah standards and best practices.

The Shari’ah Advisory Boards and the Accounting and Auditing Organisation of Islamic Financial Institutions (AAOIFI) have additional duties in providing independent advice and opinions in Islamic Financial products. The Advisory Boards, which include scholars and jurists in Islamic Commercial Law, generally formulate policies and form opinions to guide best practices in Islamic Finance. Whilst the AAOIFI, established in 1990, is the standard setting body and has the responsibility of establishing Financial Accounting Standards (FAS) which address the specific needs of investors and stakeholders engaged in Islamic Finance.

In part two we will take a look at the Islamic Capital Market with specific emphasis on the Equity, Fixed-Income and the Structured Products Markets. Until then!

For more information about our Investment Management Advisory service, please contact at contact@ibrahim-schneidawind.com.

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