GROWING UK ISLAMIC FINANCE IS GOOD POLITICS AND

C O N F I D E N T I A L SECTION 01 OF 03 LONDON 002596

SIPDIS

SIPDIS

E.O. 12958: DECL: 06/13/2017
TAGS: EFIN KISL UK
SUBJECT: GROWING UK ISLAMIC FINANCE IS GOOD POLITICS AND
GOOD BUSINESS

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Classified By: ECON Minister Sandra Clark; EO 12958 reasons 1.4(b) and
(d)


1. (C) SUMMARY The UK government has a high priority goal to
make London a center of Islamic finance to both assimilate
the indigenous Muslim UK community(ies) and capture a niche
market of high net worth Muslims internationally. The world
market for Islamic finance grew from about $150 billion in
the mid 1990's to $500 billion currently with forecasts of
growth to $1.0 - $1.2 trillion by 2012. Although five year
growth of $500 - $700 billion seems impressive, a global
market for Islamic financing valued at $1 trillion will only
be as large as today's market for domestic debt in the UK
alone and will total less than 1% of the value of global debt
and equity capitalizations. The UK government maintains a
favorable regulatory regime for financial services generally
and supports efforts to develop new shariah-compliant
products and standardize terms and market practices. Because
it is a niche market and because much Middle East liquidity
is already invested in London in traditional investment
instruments, the growth of Islamic finance has little
potential to affect UK government policy. END SUMMARY

THE ISLAMIC FINANCE MARKET


2. (U) Limited hard data and poor transparency make it
difficult to determine the size of the Islamic finance
market. Rapid growth in recent years is clearly visible, but
the structure of the market makes it difficult to pinpoint
exact figures according to a June 6 Research Paper from
Goldman Sachs (The Old Becomes New: Islamic Finance in Global
Capital Markets, Global Economics Weekly, Issue No: 07/21,
June 6, 2007) (Copy available on Embassy London Website at
http://www.state.sgov.gov/p/eur/london/ and select Background
on Britain / British Economy / Islamic Finance). The
consensus estimate among analysts regarding current market
size is $500 billion, up from $150 billion in the mid-1990's,
as per a widely-cited estimate from Standard and Poors.


3. (U) Market participation has expanded beyond Islamic banks
to include conventional banks, investment banks, and a range
of non-bank financial institutions, including venture
capital, private equity, microfinance, and housing
cooperatives, according to the Goldman Sachs study. The
range of Islamic finance products has likewise grown from its
roots in commercial finance to include bond-like products,
insurance, real-estate and infrastructure financing, and
retail banking. London has come only recently to the Islamic
finance market, following regulatory changes to allow
non-interest bearing accounts to enjoy tax treatment similar
to more traditional accounts.


4. (U) Global growth of 15% - 20% per annum in Islamic
finance is likely over the five years to 2012 according to
the Goldman Sachs report. Accordingly, the market will grow
from the current $500 billion to $1.0 - $1.2 trillion by

2012. After 2012, the growth of the market is expected to
slow as the current pool of excess liquidity will largely
have been directed into shariah-compliant investment
instruments.


5. (U) Although five year growth of $500 - $700 billion seems
impressive, a global market for Islamic financing valued at
$1 trillion will only be as large as today's market for
domestic debt in the UK alone and will total less than 1% of
the value of global debt and equity capitalizations,
according to the Goldman Sachs research report. Although
Islamic finance may never represent a significant portion of
global financial market activity, it may have a significant
impact on the recycling of petro dollars and diversification
of the Middle Eastern oil producing economies.

ISLAMIC FINANCE: LONDON VS. THE U.S.


6. (U) The Goldman Sachs study and other observers conclude
that the U.S. will participate only to a very small extent in
the global Islamic finance market, mostly in Islamic
mortgages. It is unlikely to become a major Islamic market
for three reasons. First, the regulatory regime is not
conducive to promoting Islamic finance. There's no unified
regulator for tax, reporting, or trading Islamic instruments.
States retain much autonomy over insurance products and
taxation, making it difficult to standardize the treatment of
Islamic finance products in these areas. The second reason
is that New York has only a limited pool of qualified
religious, financial, legal, and accounting talent to
develop, issue, and trade Islamic financial instruments.
Third is that New York is particularly remote in time and
space. There is an 8 hour time difference between New York

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and Dubai vs. 1 hour for London; and New York is 6800 miles
from Dubai vs. London's 3400 miles.


7. (U) London benefits from a more favorable time zone, but
it is the favorable regulatory regime in London that provides
lasting competitive advantage over New York as a center for
Islamic finance. The following illustrate the UK
government's support of Islamic finance and the favorable
regulatory climate in London.

--The Financial Services Authority (FSA) is the single
regulator of Islamic finance, able to develop and maintain a
comprehensive regulatory regime for Islamic finance that is
equivalent to that for traditional financial instruments.

--The Treasury department (HMT) has eliminated the adverse UK
tax consequences of Islamic finance instruments vis a vis
traditional debt instruments benefiting from deductible
interest.

--In January, 2007, Ed Balls, the then-UK Economic Secretary,
announced measures leading to the first-ever issuance by a
Western government of sukuk and making Islamic finance a key
priority of the Chancellor's High-Level Group (HLG).
Citigroup and HMT contacts confirm that HMT may be ready for
its first sukuk issue as early as July, 2007. (Note: the HLG
is a group of senior executives from across the financial
sector charged with developing and supporting a strategy to
promote London as the leading international financial center.
End note).

--Secretary Balls's public support in January, 2007 of
industry developments. First, a January, 2007 memorandum of
understanding between the London-based International Capital
Market Association (ICMA) and the International Islamic
Financial Market (IIFM) to develop standardized contracts and
documentation and market practices for sukuk. Second, the
launch of the Islamic Finance Qualification in October, 2006.
This is a joint initiative to develop qualifications in
Islamic finance between the Securities and Investment
Institute, and the Ecole Superior des Affaires, one of the
leading business schools in the Middle East.

--HMG hosted an April 16, 2007 summit of Islamic financial
services experts and leading members of the Muslim community
at No. 11 Downing Street.

--UK Trade and Investment (UKTI) was tasked with developing a
strategy to make the UK a gateway for Islamic finance as part
of their wider strategy of making London a leading
international financial center.

OBSERVERS AGREE ISLAMIC FINANCE IS A SMALL MARKET BUT GOOD
POLITICS


8. (U) Interlocutors from Citigroup, Morgan Stanley, Goldman
Sachs, HM Treasury, and the office of UK Trade and Investment
generally agreed on several points. First, Islamic finance
will never make up more than a small portion of the total
London market. Second, the principal UK government
objective was to identify and remove structural obstacles to
Islamic finance in the UK and then let the market determine
what products to offer. Third, although the UK government
support of Islamic finance was justified on purely economic
grounds, the government recognizes that it is also good
politics. Supporting Islamic finance at the wholesale level
is expected to expand the UK availability of retail
shariah-compliant products like home mortgages, insurance,
term loans, demand deposits, and savings vehicles. These
will benefit the sometimes marginalized 1.8 million Muslims
in the UK, most of whom are neither rich nor Arab, but rather
poor and South Asian. Fourth, the growth of Islamic finance
has no potential to influence UK government policy. It is
too small. London's reputation for high standards precludes
undue influence. Additionally, since much of the liquidity
going into Islamic products is already in London in
non-Islamic products, Islamic finance offers increased choice
for investors, but not increased influence.


9. (C) COMMENT: The UK has moved smartly to capitalize on its
advantages in a niche market that complements its already
broad array of financial products. So far, the banks have
sought out high net worth Muslims, but the government expects
product offerings will trickle down to the UK's large middle
and lower class Muslim communities, giving them a greater
economic stake in social integration. We agree with those
who think that London is well positioned to benefit
economically and politically from its support of Islamic
finance but that there is little potential for investors in

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Islamic finance to influence UK policy. The UK commitment to
combat terrorist finance, for example, is not likely to be
influenced by this market. If anything, the growth of a well
regulated and transparent Islamic finance market might dry up
legitimate business in the informal networks favored by
terrorists and other criminals. END COMMENT



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