Islamic Finance Growth in the West

Islamic Finance:

A Sustainable and Growth Alternative Financing Option

Suitable for Western Real Estate Investments

in the Wake of the Financial Crisis?

(2008 survey; revisited 2013)

James A. Sawyer March 2013

As the economic crisis deepened towards the end of 2008, I worked on a research
project to explore the impact of the economic downturn on attitudes to Islamic Finance
(IF). I was interested in discovering any correlation between this event and its increased
use as a financing instrument. Is IF a sustainable financing option in the long term and
how effective is its application as an alternative funding source in the area of real estate
investment in Western markets such as the UK? How well does IF stack up against
conventional finance in the wake of the current economic model being questioned?

Over a three month period, questionnaires were sent to
selected senior level influencers at leading institutions
specialising in IF to gain a variety of board and executive-level
perspectives on these and other questions, relating to the
practice of IF outside of predominantly Islamic centres and its
value in the context of real estate investment.

1

Outline

I. Recent industry developments: Growth in assets; UK attractiveness & UK property deals

II. Legal aspects: Sharia interpretations; scholar governance; standardisation & transparency

III. Macro factors: Ethics; financial crisis; globalisation; oil & political landscape

IV. Financial instruments: Preference; competitiveness; product innovation & real estate

V. Conclusion: Outlook of IF in the West & real estate markets; future concerns & issues to monitor

I – Recent industry development: Growth in assets; UK attractiveness & UK property deals

Chart 1 According to a recent report by Ernst & Young (EY, Dec 2012), Islamic
Global assets of Islamic finance
$bn, assets end-year
assets are valued at about $1.3 trillion in 2011, representing about 1%
2000 1800 of the global financial market. One scenario shows assets to have a
1750 1567
growth potential of a further 17% in 2012 to reach $1,800bn by 2013,
1500 1334
1250 1130 making a rise of about 250% from $509bn in seven years since 2006
861 933
1000
677 and with double digit growth expected to continue beyond (Chart 1).
750 509
500
250 The UK is the leading Western country and Europe’s premier centre
0
2006 2007 2008 2009 2010 2011 2012* 2013*
1 2 3 4 5 6 7 8 with $19bn of reported assets (Chart 2). Five fully Sharia compliant UK
Source: The Banker, UKIFS, *Ernst & Young estimates based banks and a further 17 Islamic banking windows (totalling more
than any other Western country) have formed to help accommodate a
Chart 2
Islamic Finance by Country growing appetite for cross border investments from IF geographies
Others
Banking, takaful &
UK
such as the Middle East & Malaysia into Western territories.
fund assets, 83
Turkey
$bn, end-2010 19
Qatar 28
52 Iran
There is much scope for growth in the IF industry. Underpinned by
Bahrain 388
58 high population growth in Muslim nations (expected to reach 30% of
global population by 2025), rising oil prices, economic and financial
Kuwait 80
stability in most countries (despite political unrest in a few arising
94 from the Arab Spring), the Banker estimates that only 12% of Muslims
UAE
151 worldwide use IF products. Also, the customer base is not restricted
133
Malaysia S. Arabia to Muslims; others may be attracted by the ethical basis of IF. 4
Source: The Banker, UKIFS

I – Recent industry development: Growth in assets; UK attractiveness & UK property deals

The UK macroeconomic environment and real estate market is an attractive destination for deployment of Islamic funds. Pull factors:
● political stability ● favourable legislative, regulatory, tax and legal environment ● geo positioning as a bridge for investment flows
into other major Western territories ● highly skilled and IF qualified labour market with specialist advisory business units ● supply
constraints due to strict planning controls and lack of land for development in Central London ● mature, deep and liquid property
investment market ● transparent land governing institutions ● large variety of stock and micro markets (no property/market is the
same) ● tangible quality of real estate is well suited to IF principles. Push factors: ● Arab Spring gave cause for investment flows to
seek out safe havens ● deepening eurozone crisis ● portfolio diversification away from commodity reliant economies ● oil revenue
surpluses ● growth within Muslim population throughout emerging markets in the MENA and Asia regions.

The maturation of Islamic money markets is evidenced by Thomson Reuters launching, in 2011, an Islamic Interbank Benchmark Rate
(IIBR), based on rates contributed by 16 Islamic banks and Islamic sections of conventional banks, which provides a sharia-compliant
alternative to traditional interest-based benchmarks; the industry has long used the London Interbank Offered Rate (LIBOR).

Emerging Islamic geographies include Oman as a future hotspot. In 2010, Oman introduced Islamic banking through a Royal Decree
and has awarded Islamic banking licences. EY estimates that Islamic banking could potentially gain up to 10% of the Oman market
share over the next five years (a $6- $10bn Islamic banking market), also facilitating sharia-compliant foreign investment.

According to the latest European property investment statistics by Savills (Mar 2013), the volume invested in the UK grew 12.5% over
2012 up to €44bn, amounting to 38% of total commercial investment volume across 13 countries surveyed, of which London
accounted for 23% of total turnover on its own. Cross border investment played an increasingly important role characterised by
growing activity from the Middle East and Asia (SWF, institutions and family offices). 5

I – Recent industry development: growth in assets; UK attractiveness & UK property deals

Landmark London IF funded property deals include The Shard of Glass
and the redevelopment of Chelsea Barracks ($2.4bn ijara financing),
constituting the highest value UK land acquisition in history.

Sep 2012: CIT Group secured $406m from a Middle East consortium for the 30-
storey Kings Reach Tower scheme in London. Project funding came from a club
of Middle East banks led by ABC International Bank and Saudi-based
Mohammed Al Subeaei & Sons Investment Company (MASIC). As the largest
financier to the scheme, MASIC’s involvement marked its UK market entry.
Central London’s The Shard of Glass; Europe’s tallest
building; majority IF funded and 95% Qatari owned

Oct 2012: Gatehouse Bank completed £165m acquisition of the law firm SJ Berwin’s offices at 10 Queen Street Place, London, in
collaboration with a Malaysian Sovereign Wealth Fund (SWF). Gatehouse acted as Investment and Sharia advisor on the deal, which marked
the SWF’s first investment into the London real estate market and is a key part of its wider global investment strategy.

Dec 2012: a new entrant into the UK IF market – 90 North Real Estate Partners (an investment & fund manager co-founded by the serial
entrepreneur James Caan) – has secured funding for total assets under management of £90m over 1.5 years, including the acquisition of
L’Oreal’s UK logistics headquarters for its ‘LUXE’ luxury product division.

Feb 2013: Bank of London and Middle East (BLME), the largest Islamic Bank in Europe, was awarded ‘Best UK Islamic bank of the Year (2012)’
by Islamic Finance News. The accolade supplements its winning ‘Best Real Estate Deal of the Year (2011)’ for its financing of The Brewery
Square Development Company, a partnership between Resolution Property and Waterhouse to finance Phase 2 of Brewery Square,
Dorchester; the largest town centre regeneration project in the South West. 6

II – Legal aspects: Sharia interpretation; scholar governance; standardisation & transparency

Sharia law appears flexible enough to accommodate the advancement of investment flows in non-Islamic countries (Chart 3).
Similarly, although sharia scholars are central to influencing product compliance, the majority of respondents note they are not
exclusively responsible (Chart 4), which might go some way towards explaining the growth in IF and its wide application in
predominantly conventional finance driven markets. As one lawyer pointed out: “The development of new sharia-compliant
financial products in recent years evidences the fact that sharia law (at least in finance) is capable of creative solutions.
Furthermore, interaction with sharia scholars indicates that they are willing to engage in a constructive discourse into the ways in
which various products may be brought into compliance with sharia principles”. But it is not broadly accepted that a counterbalance
exists in order to keep a check on the authority of scholars (Chart 5). Furthermore, the unlevel interpretations of laws / fatwa
issuances backing IF due to the various Islamic schools of thought give way to unilateral advancement and an element of

Chart 3 Chart 4 Chart 5 Chart 6
Is sharia law flexible enough Are sharia scholars exclusively Is there a counterbalance Due to diversity of interpretation, is
for the advancement of IF in responsible for product for keeping check on the there a risk that a contract valid
non-Islamic countries? compliance? authority of scholars? today is void tomorrow?

Yes No Yes No Yes No No Comment Yes No No Comment

8% 8%
23% 23%
38%
46%
62%
31%
92% 69%
8


uncertainty that prompts a call for harmonisation, as pointed out by another lawyer: “At this point, the need to react to the
requirements of the market is driving scholars to ‘create’ legal interpretations in one jurisdiction which is prohibited in another. The
result is chaos.” Moreover, whilst it is widely accepted that Islamic contracts are iron-clad and free from retrospective change, they
appear to be not entirely risk-free from the diversity in interpretation (Chart 6). The majority of respondents conceded that the IF
industry is poorly standardised (Chart 7) and lacks transparency (Chart 8); by some margin in comparison to Western transparency
requirements (Chart 9). This may, in part, explain the complexity involved in structuring IF products versus conventional equivalents
(Chart 10). Though IF products can co-exist alongside conventional products without adversely affecting the enforceability of
national laws (Chart 11). A fund manager noted: “For most scholars national laws come first”. But what impact would the
standardisation of contracts, methods and, if possible, the opinions of scholars, have on IF industry growth in new geographies?

Chart 7 Chart 8 Chart 9 Chart 10
How standardised is the Transparency of legal framework Does IF compare well with Is the sharia compliance process
IF industry? for structuring IF products. Western transparency more or less complex compared to
1 = poorly standardised 1 = very opaque requirements? conventional financial compliance?
5 = well standardised 5 = very transparent 1 = less complex 5 = more complex
Yes No

1 2 3 4 5 1 2 3 4 5 1 2 3 4 5

18% 45% 18% 18% 8% 31% 38% 15% 8% 7%7% 14% 50% 21%
33%

67%

9


Chart 11 The level of response indicates that standardisation would strongly benefit the IF
Does sharia interfere with the industry (Chart 12). However, standardisation does appear to come with a health
enforceability of national laws in
Islamic and non-Islamic countries? warning. One senior bank advisor comments: “While standardisation has its
Yes No No Comment benefits in creating a structured and organised approach to IF products, it can be
a threat as well. This is because a lot of what attracts people to IF is the
8% 17%
innovation of its products, which is only possible through the flexibility. This
flexibility allows IF to adapt to different countries, laws, and cultures”. One
lawyer argues that: “Standardisation would lead to greater certainty in the IF
market. It would also increase the ease with which transactions could be carried
75%
out, decrease the costs involved in carrying out the transaction and, as such,
increase the volume of deals being done”.
Chart 12
Would standardisation benefit or
threaten the IF industry? Effects of IF standardisation...
Benefit Threaten
Both No Comment “It will reduce costs” (Accountant)
“IF products will be
8% universally marketable”
(Academic)
“Increase the volume of
deals being done” (Lawyer)
50%
42%
“Create a structured and organised approach
for IF products” (Investment Banker)
10

III – Macro factors: Ethics; Financial crisis; globalisation; oil & political landscape

Chart 13 Results clearly demonstrate IF will succeed in conventional financial markets
Is IF likely to succeed in (Chart 13). Respondents commented on supporting fundamentals: ● “There is a
conventional markets compared
to Islamic financial markets? certain segment of the market that requires this service; they are not going

Yes No anywhere and their needs are growing” ● “Markets are global; not restricted to
specific countries” ● “Added layer of complexity, though clearly aspects of IF are
being implicitly adopted” ● “IF is an alternative source of finance and as long as
25%
it is competitive it can succeed” ● “Conventional financial markets are becoming
more willing to place IF structures on equal footing with conventional

75% structures” ● “IF is a fast growing product; there is no reason to believe that it
will not become more widely available over time”.

Chart 14
Given Muslim population and oil revenue
But how has the credit crisis affected IF’s ascendancy and future path towards
growth, does IF’s success lie in its inherent growth? The underlying principles in IF appear to be a winning formula for its
principles or extrinsic circumstance?
wide application, with 67% of respondents in agreement. Yet they are not the
Inherent External
only factors at play and external factors, such as exponential Muslim population
No Comment Both
growth as well as the oil boom, might also be viewed as success contributors

8% (Chart 14). When asked about the merits of using IF compared to conventional
17% finance, and aside from any ethical considerations, respondents acknowledged a
variety of market drivers. An advisory services partner stated: “Lack of
8%
67%
speculative transactions and short sales”. A lawyer mentioned: “The use
12

III – Macro factors: Ethics; financial crisis; globalisation; oil & political landscape

Chart 15 of IF allows a new investor base (significantly the Gulf region and Malaysia) to be
Has the recent financial tapped into, bringing with it new streams of capital”. One banker noted: “Less
crisis increased the
audience for IF funding? risky (shared risk) – everything loaned is backed by collateral, interest free, not

Yes No centred on credit worthiness and ability to pay loan and interest, but the actual
merit and profitability of the project”, whilst an accountant expressed: “Are not
ethics enough? Some of the features of transactions can make it more flexible,
33% or commercially efficient”. The above points might infer that the excessive risk
taking and short-termism characterised by conventional financial markets in the
67%
lead up to the credit crisis has helped bring IF to the fore. Indeed, IF appears to
have been on a different track and a 67% majority confirms that the financial
crisis has helped bolster the audience for IF funding, but its appeal will continue
Chart 16
Assuming funding levels return to normal, regardless with a 91% vote of confidence (Charts 15 & 16 respectively).
would Sharia-compliant financing
decrease in popularity?
Since this survey, the degree of fallout from the banking crisis would surely have

Yes No No Comment maintained such a majority view. The UK Islamic Finance Secretariat (UKIFS, Mar
2012), noted: ‘at a time when global recovery has slowed and conventional

9% banking in Western countries has remained under pressure... infrastructure
projects require funding’ and ‘the customer base in Western countries is not
necessarily restricted to Muslims: other customers may be attracted to the
ethical basis of IF’.
91%
13


Chart 17 IF’s relatively recent integration into mature global financial markets may have
Is IF largely unaffected by crises because offered some form of protection from crises with one third of respondents in
its market is not yet fully interconnected
with other world financial markets? agreement (Chart 17) but, whilst the effects of globalisation has impacted
mature markets, it was not the sole reason for its resilience (59%), which further
Yes No No Comment
supports IF’s inbuilt strengths as well as other circumstantial factors. There is a
8% consensus that gradual ascent and petrodollars have helped (Chart 18).
33% However, it does appear that IF is not entirely immune to systemic shocks. One
lawyer stated: “IF is still finance and all the finance markets have been severely

59% impacted by the credit crisis. The Middle East finance market (both IF and
conventional) has been equally affected”.
Chart 18
Has IF’s gradual ascent into mainstream Nor is IF free from oil market pressures, as 41% of respondents have concerns
financing and the amount of petrodollars
behind it helped to avert global financial crisis? that reduced oil revenues would adversely affect IF progress (Chart 19). Indeed,
1 = not helped 5 = helped
1 2 3 4 5
a key driver of Gulf investment in the West is surplus liquidity from high oil
revenues. Though less commodity dependent markets exist to pick up any slack
9% 18% 36% 27% 9%
in the event of such scenarios, as pointed out by one lawyer: “Significantly
Chart 19
Would low oil prices, or even oil shortages reduced oil prices will adversely affect the Middle East economies and therefore
adversely affect the progress of IF?
adversely affect the need for and availability of finance. IF is also prevalent in
1 = minor effect 5 = major effect
1 2 3 4 5 parts of Asia which will be less oil dependent and therefore less affected”.

8% 17% 33% 33% 8%
14


How do the politics of both mature economies and emerging nations, such as those in the Gulf and SE-Asia, affect IF? At the
time of this survey, modest political risk (non-country specific) threatened the advancement of IF (Chart 20). Following the Arab
Spring in 2010, a broad flight to safety in more stable Western environments such as the UK out of the MENA region has been
witnessed. Interestingly, opinion was split on political differences impacting IF’s reception in the West (Chart 21), which leaves
this question open to further debate. Increased government stakes in the banking sector is viewed as highly beneficial, however
results show some concern exists (Chart 22). In the main, respondents cited assistance in standardisation, boost in investor
confidence, improved capitalisation and better regulation as being positive by-products of government involvement. One banker
noted: “Islamic banks (like conventional banks) will need to consolidate to grow; government shareholdings could accelerate this
process” and a fund manager pointed out: “The current Islamic investor market is a private banking one; SWF investments will
make it a more institutional one”. Cautionary remarks included: “Political involvement in IF in the form of negative interferences
would adversely affect the development of IF” and “Strengthen locally and regionally, weaken internationally”.

Chart 20 Chart 21 Chart 22
What level of political risk is posed on Do differences in political rule Could larger government stakes in
the advancement of IF? between Western and Islamic states Islamic banking strengthen or weaken IF?
1 = high risk 5 = low risk affect IF’s reception in the West?
Strengthen Weaken
1 2 3 4 5 Both No Comment
Yes No No Comment
8% 8% 25% 33% 25%

8% 8%

42%
50%
42%
50%
15

Outline

I. Recent industry developments: Growth in assets; UK attractiveness & UK property deals

II. Legal aspects: Sharia interpretations; scholar governance; standardisation & transparency

III. Macro factors: Ethics; financial crisis; globalisation; oil & political landscape

IV. Financial instruments: Preference; competitiveness; product innovation & real estate investment

V. Conclusion: Outlook of IF in the West & real estate markets; future concerns & issues to monitor

IV – Financial instruments: Preference; competitiveness; product innovation & real estate investment

Across asset classes, murabaha followed by ijara are the two most prevalent IF instruments (Chart 25). When prompted for
reasons as to why, murabaha was most favoured due to its simplicity, cost and short-term nature (Chart 26). As one accountant
put it: “Because it gets closest to the economics of conventional debt”. Moreover, a lawyer noted: “murabaha is the most
standardised IF instrument. As such, it is the most cost/resource effective to structure and the most widely used. The popularity
of the instrument is further attributable to the fact that murabaha transactions offer a predictable rate of return to lenders as
the marked-up re-sale price is set at the outset”. Chart 27 illustrates a commodity murabaha property investment transaction
structure. However, there is some resistance amongst Shariah scholars as to its appropriateness for broad application, as noted
by one lawyer: “Commodity murabaha are the most prevalent for straight-forward deposit/loan arrangements but not for asset
finance as the scholars tend not to approve for that purpose.” Ijara also ranks high due to the volume of transactions that
require such a structure, as remarked by one lawyer: “Leasing of cars, aircraft, etc. is more common than projects”.

Chart 25 Chart 26 Reasons for first choice...
Which instrument is most prevalent in IF ? Which instrument is increasingly popular? (Murabaha)
1 = most prevalent 4 = least prevalent
Short-term
8% 8%
Long-term “Simplicity” (Banker)
33% No Comment
33% “Ease and cost” (Lawyer)
67% 4
67% 25% “Relatively straight-forward, fair
3
method for short-term financing”
58% 2 (Advisory Services)
58% 1 58%
25% 17% “Used for short-term liquidity
25% management” (Lawyer)
8% 8%
Murabaha Ijara Mudaraba Musharaka 17


Chart 27
Example commodity murabaha property
investment financing structure

1. Investment Advisor screens & secures

Islamic target acquisition, conventional + IF
Investor funding e.g. 70% LTV. Fatwa issued.

Metal Metal 2. Conventional finance is raised in parallel
Supplier Buyer 5
offshore SPV with equity buy-in from

SPV Investment Agent & Islamic Investor(s).
4 4
Spot Holdco 3. Interest bearing (riba) debt is purified via
payment Metal
the commodity trade (murabaha) of an
2 underlying asset (e.g. metal or palm oil) on
Commodity trade Investment
SPV a deferred cost + mark-up payment basis.
Leverage Advisor
Propco
Provider
Murabaha (leverage) 4. Trade is instantaneous between
3
Deferred Payment 1 commodity supplier & buyer in a market
LIBOR / IBBR
such as LME and payment at a fixed price
benchmarking Property
pre-agreed at outset.

5. Offshore SPVs are set up reducing
corporate income tax from 28% to 20%
and zero capital gains tax on sale.

18


In examining the competitiveness of Islamic versus traditional finance products,
Chart 28
Is IF cost competitive against Western two thirds agreed it is less competitive on cost (Chart 28) for several reasons:
conventional financing?
“Additional structuring costs, sharia audit costs and asset related costs (e.g.
brokerage fees on commodity trades)”; “Market is not as liquid”; and “Less
Yes No
standardised which can lead to higher transaction costs and funding”. Though
costs are sometimes marginal: “Requires more transactions. However, while it is
33%
not cost competitive the excess cost can be very small”. The term competitive
caused quite a reaction in the light of IF’s religious underpinnings, as one lawyer
67%
stated: “You are missing the point. IF is a product that competes for a narrow
sliver of the market – it essentially ‘locks up’ that market. There is an extra cost
to launch IF products, but the sliver of market is willing to pay those added costs.
Chart 29
Management fees of Islamic funds When IF and conventional go head to head, non-economic factors are driving
Average management fee, % of fund value costing. As a result, the conventional product is the benchmark for cost, yet
1.6
because it is naturally unfit for the purposes in question, it is not ‘competitive’
1.4
1.2 with IF”. But varying degrees of devotion were considered alongside cost
1.0 implications, as another noted in the view of ‘yes’: “It has to be. If two products
0.8
are available, one IF and one traditional, and both are the same cost (and no
0.6
0.4 adverse tax consequences), the relevant market will opt for the IF. Yet if one is
0.2 more costly or less tax-efficient, my impression is that all but the most devout
0.0
2007 2008 2009 2010 Q1 2011 will opt for the non-IF alternative”. One accountant points out: “IF is based upon

Source: EY analysis based on Zawya and Eurekahedge data 19
(369 Islamic funds)


using a subset of the universe of possible financial contracts. This subset is
Chart 30
IF industry ability to develop sophisticated chosen for religious reasons. Logic therefore suggests that the financial
products such as derivatives and CDOs.
outcomes from using this subset of possible contracts should be inferior to the

Yes No
results achievable from using the full universe of possible contracts”. Whilst
overall costs may be high, a 30% compression in management fees posted by
Islamic funds, points to positive investor benefits from growing competition in
this space (Chart 29). In terms of product development, opinion is divided on the
50% 50%
IF industry’s ability to develop sophisticated products (Chart 30), yet research
and consultation is ongoing and demand plays an important role, as one fund
manager noted: “Tough question. Whilst the scholars are divided the market
demands such products. Historically demand normally wins”. One lawyer noted:
Chart 31
Product development rate. “All the major investment banks and law firms are involved in IF and focussing on
1 = slow 5 = rapid
these issues in conjunction with the leading scholars”. Responsible innovation
will be essential, as one lawyer observed: “Due to the fact that IF structures had
not invested in products akin to CDO2, its exposure to the effects of the financial
1 2 3 4 5
crisis has been more contained. However investor confidence (even Islamic) is
15% 54% 15% 15% subject to the global concerns in the conventional markets as all economies are
interconnected”. Strives towards innovation have been made, but not without
pockets of resistance as noted by another lawyer: “There are already examples
of sharia-compliant derivatives, and rated asset-backed securitisations in the

20


market. However, certain barriers such as truly tangible assets (i.e. no receivables) would prevent CDOs”. A banker further
highlighted fundamental obstacles in view of ‘no’: “Because of the speculative nature involved as well as ‘selling what one does
not own’”. Another reasoned: “Essentially prohibited under sharia”. A lawyer and accountant added respectively: “Many
derivative products and forward contracts are argued to not be sharia-compliant (heavily debated)” “Some of these should be
precluded by sharia-compliance”. But collaboration and pulling of wider resources would help: “The IF industry is connected to
the conventional banking system and can learn and benefit from the skill sets available in the wider market”. Whilst this survey
showed that products were developing at a brisk and innovative pace (Chart 31), EY recently noted that responsible innovation
requires urgent attention (2013), following their previous report and more specifically: ‘product innovation e.g. credible and
compliant alternatives to commodity murabaha’ (2011-2012). The appeal of Western real estate for IF funding is clearly
significant with 54% agreeing that it is either important or very important (Chart 32) supported by various comments: “There is a

Chart 32 Chart 33
Level of importance of Western real estate Real estate exposure, Islamic versus conventional banks
to IF funding?
Islamic Banks Conventional Banks
1 = very unimportant 5 = very important

2010 15% 24% 25% 36% 11% 16% 33% 40%
1 2 3 4 5

9% 18% 18% 36% 18% 2009 18% 25% 25% 32% 11% 16% 32% 41%

2008 11% 20% 33% 35% 16% 12% 33% 39%

Source: Company Reports, Zawya, EY analysis (sample based on selective Islamic and conventional banks) (rounded numbers)
21


high propensity to invest in real estate”; “There is a big desire to invest in Western real estate”; “Just look at the Chelsea
Barracks financing. There is much Middle East interest in European property and if it can be financed with IF that will usually be
the preferred option”. And levels of importance works both ways, for Western real estate markets as well as for IF, as observed
by one lawyer: “It is more accurate to say that IF is important for Western real estate (as evidenced by the Chelsea Barracks
transaction) rather than vice versa”, whereas another stated: “Not important, but a perfect fit for this area”. The preference for
real estate assets is reinforced when Islamic and conventional bank holdings are juxtaposed (Chart 33), but a higher exposure
compared to conventional banks might also give cause for concern. Returns are underpinned by property values (driving capital
and rental yields) which are vulnerable to asset price corrections caused by systemic shocks, albeit such risks can be mitigated,
on a deal by deal basis, by altering location, covenant, lease term, leveraging, and purchase/exit date parameters. The most
common structures for IF real estate investments are ijara followed by musharaka in the first instance (Chart 34), as the majority

Chart 34 Chart 35 Chart 36
Which structure is the most common for IF real Does real estate investment conflict Can conventional finance be raised
estate investments? with the sharia principle of gharar? alongside IF in real estate investments?

Ijara Musharaka Mudaraba Murabaha
Yes No No Comment Yes No No Comment
First most common
60% 20% 10% 10%
9%
25%
Second most common
20% 20% 20% 40%
58%
17%
91%
22


of the sample have dealt in land transactions, exemplified by one lawyer: “Diminishing musharaka (coupled with ijara) is the
most sharia-compliant and tax-efficient form of IF”. When prompted for the second most common finance structure, murabaha
re-emerges. The aforementioned “perfect fit” when considering real estate as the underlying asset is helped by 91% agreeing
that it is void of speculative qualities – the sharia forbidden principle of gharar (Chart 35). Challenges do exist for real estate IF
practitioners in conventional markets whose investment spectrum can be considerably narrowed, not only due to a smaller pool
of investable products after screening for appropriate, halal, assets, but also the deal size can affect the IF decision to invest and
ability to generate desired returns. When asked, one lawyer replied: “Yes and no –depends on the economics of the deal” and a
fund manager responded: “Small projects are problematical as sharia costs tend to be fixed”. Amidst practical challenges, real
estate enjoys many sustainable drivers and one more than others in the form of diversification taking poll position.

Drivers for investment in Western asset classes, in particular real estate...
Diversification is in poll position

“A strong revenue stream and a “Currency diversification, low
“Real estate lends itself to IF, investing good return on capital” (Lawyer) political risk, strong economies”
in the West provides a degree of (Academic)
diversity by geography” (Banker)
“Stability and status” (Lawyer) “Diversification, returns, safety
(low risk)” (Advisory Services)
“Currency diversification, low
political risk, strong economies” “Simply the quality and
“Diversification and investment
(Accountant) diversity of assets” (Lawyer)
opportunity” (Banker)
“Consistent government policies and
creates a diversified portfolio” (Academic) “It’s a global asset class for Islamic investors”
(Fund Manager)
23


So long as products remain accessible, 33% believed this to be very much the
Chart 37
How accessible is IF compared to case (Chart 37), enough positive drivers exist for IF to endure over the long-term
conventional finance?
1 = highly inaccessible and compete with conventional finance as supported by 92% (Chart 37). It is
5 = highly accessible
clearly possible for a non-Islamic country such as the UK to be a forward-facing
global centres for IF with 83% of respondents in agreement (Chart 38), despite

1 2 3 4 5 some resistance.

8% 15% 46% 23% 8%
IF long-term drivers...

“Consumer demand driven” (Accountant)

Chart 38 Chart 39
Will IF compete with conventional As a non-Islamic country, can “IF is an alternative source of finance and as long as it
finance over the long-term, or will the UK become leading
it be a short-lived phenomenon? player in IF? remains competitive it will succeed” (Investment Banker)

Long-term Short-term Yes No “There is a market segment that is deeply-rooted
(Muslim) with growing needs that require IF service
8% in Western markets, such as the UK” (Lawyer)
17%

“Despite an added layer of
complexity, certain aspects of IF are
92% 83% being implicitly adopted” (Fund Manager)
24

Conclusion

Conclusion: Outlook of IF in the West & in Real Estate Markets

Significant recent industry developments (a steady stream of IF backed UK real estate deals (‘big ticket’ and other), opening up of
new hotspots like Oman to IF and launch of the IIBR), coupled with strong annual industry, current and forecast growth rates (17%
CAGR) underscore both the capability and capacity for IF to fund investments in Western territories.

Cross-border investment is facilitated by equally strong push and pull factors and the UK’s ideal geographical positioning, as a bridge
for Islamic investment into global territories, puts it at a considerable advantage.

Mature, stable, liquid, low political risk economies such as the UK are in a position to benefit from capital flows driven by a key
component of the IF investment decision – diversification – fuelled by the Arab Spring and the investment mandates of Gulf
commodity reliant and emerging Asian economies.

Whilst the credit crisis (67% agreed) and oil revenues (36%) have aided the growth in IF, respondents are unanimously agreed that IF
can hold its own after a return to normal funding levels (p.12). And it is not so much IF’s gradual ascent (36%) or low-level pre-crisis
interconnectedness with world financial markets (33%), but due to its ethical underpinnings (67%). Faith based financing
requirements, compounded by the unchanging fundamental factor of a growing Muslim world population, will be the driving force
behind its sustainable use and availability over the long-term as a competitive alternative (92%). Put simply by one respondent:
“There is a market segment that is deeply-rooted (Muslim) with growing needs that require IF service in Western markets, such as
the UK”.

26

Conclusion (Cont’d)_

Western real estate is as much an important asset to IF (54%) as IF is to Western real estate. This interdependent relationship is
marked by non-speculative, tangible qualities and continued conventional banking constraints. Indeed, IF can help unlock funding for
sizeable infrastructure projects in western markets. Case in point is the myriad of Qatar UK investments.

Sharia flexibility (92%); scholar willingness; development of intelligent, proven structures and financial instruments that enable riba-
free, short-term and liquid products which can get closest to conventional economics and ability to raise conventional finance
alongside IF (58%) all serve to establish a viable, alternative source of financing capable of funding acquisitions and growth.

Concerns for the future & issues to monitor

Since this survey, and when brought up to date with recent findings, several important themes remain unresolved:

Industry standardisation. Poor levels of standardisation (81% = medium- very poor) need careful review to provide increased
transparency (77% = medium- opaque), reduced complexity (85% = medium- very complex) and improved cost competitiveness (67%
= costlier) without threatening the creativity and flexibility that has helped its growth and wide application to date (42% =
standardisation can both strengthen & threaten IF).

Product innovation. A need to innovate beyond murabaha (92% agreed = most prevalent). The simplicity and ease of murabaha saw
it re-emerge as a second-choice finance instrument for real estate (40%). Whilst financiers, lawyers and scholars collaborate, the
50:50 stand-off for sophisticated product development requires responsible innovation, so as not to undermine IF’s governing
principles that aid its unique product differentiation and potential to attract non-Islamic investors in the wake of the financial crisis.

27

Conclusion (Cont’d)

Sharia governance. In the view of no counterbalance to keep an adequate check on scholars authority (69%) and a risk that contracts
can become null and void due to the diversity of interpretation (46%), improved governance is needed to avoid repetition of the
sukuk debacle.

Competitiveness. IF financial centres of excellence, including the pre-eminence of London as an IF hub and long-term position (83%)
will need to focus efforts to maintain marketshare, as emerging IF markets mature. Market players need to continue working in
tandem with government agents and further government investment in the IF banking industry would help (50%) to avoid risk of
losing a competitive advantage, but care must be taken (40%). Also, the industry could do more to educate consumers and promote
IF’s ethical risk-sharing qualities on a broader level to encourage non-Muslim investor take-up. Competitive costs through
standardisation would help to stimulate both Muslim and non-Muslim demand.

Systemic shocks & real estate investment. Islamic and non-Islamic investors have been equally affected following global asset price
corrections in the financial crisis. Whilst a higher exposure to real estate by Islamic banks versus conventional ones might pose an
element of concern, it demonstrates that real estate is a traditionally popular asset class. Also, low prices in Western markets present
attractive opportunities to new entrants and will assist in rebuilding the confidence of those who have sustained losses. Geo-political
turbulence across the MENA region has aided capital flows into the Western markets, but differences in political rule do affect IF’s
reception in the West (42%). Oil revenues have contributed to IF investment, but caution must be noted that oil price/supply shocks
might adversely affect the progress of IF (41%). Though institutions have the option to develop new investment channels and
diversify into growing Muslim wealth segments in fast emerging Asian economies that would be less affected.

28

Sources of information
Ernst & Young UK Islamic Finance Secretariat (UKIFS) Savills
The Islamic Funds & Investments Financial Markets Series ‘Islamic Market Report ‘European Commercial
Report 2011 Finance’ March 2012 Investment’ March 2013
The World Islamic Banking www.thecityuk.com www.savills.com
Competitiveness Report 2011-2012
The World Islamic Banking
Competitiveness Report 2013
The World Takaful Report 2011
www.ey.com

CBRE Islamic Finance News
MarketView ‘European Capital Markets’ www.islamicfinancenews.com
Q4 2012
www.cbre.com

Approach & participants profile
Who? The target population was a mixture of senior level professionals from the fields of banking, advisory, accountancy, law and
academia. The most influential and leading practitioners, as nominated by their peer group according to Islamic Finance News (IFN)
Awards 2008 polling methodology, comprising of ‘Magic Circle’ and ‘Big Four’ advisory firms. And access to a critical group of
practitioners at a Centre for Study of Financial Innovation (CSFI) ‘Sharia-compliant financial instruments’ roundtable. All are experienced
in conventional banking & finance with a high proportion working exclusively in, and with specialist knowledge of, IF. 93% have
experience of IF real estate investment transactions.
Area of operation

14 senior level
respondents; 220+ London, UK (7)

cumulative years Manama, Bahrain (1)
Kuwait City, Kuwait (1)
experience in IF Dubai, UAE (4)

Kuala Lumpur, Malaysia (1)
Where? Focused on UK, Middle East and
South-East Asia.

How? Email survey questionnaire – 35
items comprised of 6 question types:
demographic, open-ended, dichotomous,
multi-dichotomous, rank order and
semantic differential scales.
Profession Position
When? Data collected between 29 Sep 2008
Lawyer 6 Heads of IF Departments 8
and 1 Dec 2008. Updated with industry
developments over 2012-2013 period. Advisors 3 Senior Partners 8
Banker 2 Senior Consultant 4

93% experienced in IF real Accountant 1 Directors 2
Fund Manager 1 CEO 1
estate transactions Academic 1 Academic 1

About the author

Email: james@sawyerAAA.com
Skype: callto://sawyerAAA
Linkedin: uk.linkedin.com/in/jamessawyeruk
Website: www.sawyerAAA.com

James Sawyer MSc BA
James worked as an analyst for Gatehouse Bank plc – an institution at the forefront of UK Islamic banking. His primary function
was to support the real estate team in the origination, structuring & funding of sharia-compliant investment products. He
graduated with a BA in History of Art from the University of East Anglia (UK) and an MSc in International Real Estate from the
Royal Agricultural College (UK), which included a summer exchange programme at the National University of Singapore. Prior to
working at Gatehouse, he gained a mix of property, sales & marketing experience at Savills, Colliers International, Jaguar, LVMH
and more recently worked on an innovative venture capital backed transport project for the 2012 London Olympic Games.

James Sawyer is grateful to all those who participated in this survey and for their
many insights on the topic of Islamic Finance.

Islamic Finance Growth in the West

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