Last Updated October 08, 2019

Law and Practice

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Winston & Strawn London LLP provides a wide range of legal services through its banking and finance practice, to public and private companies, leading financial institutions, multilateral and development finance institutions, private equity and investment funds, alternative funding sources, investors and emerging companies, on investment grade, leveraged and mezzanine financings. The firm advises on high-profile transactions and matters ranging from cross-border transactions, initial public offerings (IPOs) and project finance matters, to distressed acquisitions and creative “first-of-their-kind” financings. Clients include leading international funding sources which provide senior, subordinated, secured and unsecured debt, and hybrid (equity/debt) products, as well as institutional investors who regularly participate in senior debt markets, equity sponsors, and borrowers in both developed and emerging economies. Additional thanks to partners Ed Denny and Dan Meagher and associate Shaheer Momeni, among others, for their contributions to this chapter.

Islamic financial services have been provided in the UK since the 1980s and in June 2014 the UK became the first non-Muslim country to issue sukuk (Islamic bonds). 

Currently, five standalone Islamic banks and more than 15 conventional banks offer Shari’a-compliant Islamic financial products and services in the UK, with the number expected to grow. The value of sukuk listed on the London market to date is over GBP40 billion, with more than 72 sukuk listed on the London Stock Exchange as of January 2019.

In recent years, Islamic finance has been increasingly used for financing major infrastructure projects in the UK, such as The Shard, the Olympic Village and the redevelopment of the Chelsea Barracks and Battersea Power Station. This is likely to grow following Brexit, as the UK takes a greater interest in Islamic finance as part of its goal to broaden its economic ties with non-EU countries.

The development of Islamic finance in the UK is a priority of the British government as highlighted by former Chancellor George Osborne's remarks that the development of the Islamic finance industry is essential to make Britain the “undisputed centre of the global financial system”.

There are a broad range of Islamic financial products available in the UK and each must be analysed independently for tax and regulatory compliance. The UK government does not employ a separate framework for regulating Islamic financial products and transactions; the main legislation governing Islamic finance in the UK is the Finance Act 2005 as amended by the Finance Act 2007. The Finance Act 2005 characterises Islamic finance transactions as "alternative finance arrangements" which must comply with all the laws and regulations applicable to such arrangements. Similarly, from a regulatory perspective, Islamic banks providing Islamic financial products are subject to the same regulations as conventional banks and must be authorised by both the FCA and the PRA.

This approach reflects the UK government’s neutral position as a secular regulator, focused solely on adherence to and enforcement of applicable laws and regulations rather than having deference to faith-based considerations. As such, the UK government does not take responsibility for the Shari’a-compliance (or lack thereof) of Islamic financial products. Instead, the responsibility for ensuring the Shari’a-compliance of such products is borne by private financial institutions and other private sector participants in such financing arrangements.

There is no official supervisory body for Islamic finance in the UK. Islamic banks and takaful operators operate as conventional banks and insurers respectively, and are regulated by the FCA and the PRA. However, the vast majority of financial institutions in the UK elect to establish Shari’a supervisory boards (SSBs) to monitor and regulate Islamic financial products.

The Islamic Financial Services Board (IFSB), an international standard-setting organisation and supervisory agency, publishes prudential standards and guiding principles for institutions offering Islamic financial services; however, membership of the IFSB and compliance with such standards are voluntary. Furthermore, the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), a non-profit organisation, seeks to maintain and promote Shari’a standards for Islamic financial institutions, participants and the industry generally.

Islamic Financial Products

Tax legislation in the UK has developed to ensure that the tax treatment of Islamic financial products, as alternative finance arrangements, is neither more nor less advantageous than their conventional finance alternatives. This has been achieved in respect of some Shari’a-compliant products – such as murabaha (a financing structure based on asset/commodity purchase and resale), musharaka (a structure based on shared ownership), mudaraba (an arrangement in which one party provides the relevant funds and the other provides management expertise), wakala (an agency structure entailing profit sharing) and sukuk (Shari’a-compliant bond) – but not across the full range of available Shari’a-compliant products. Legislation to ensure a level playing field for Islamic finance in the UK was introduced by the government in 2003 and special exemptions were utilised to counter unintentional double-taxation charges caused by structures used by Islamic mortgages.

The tax treatment of some of the most commonly used Islamic financial products is currently set out for income tax purposes in Part 10A of the Income Tax Act 2007 and for corporate tax purposes in Chapter 6 of Part 6 of the Corporate Tax Act 2009 (CTA). For example, under English law, holders of sukuk will be treated like bondholders, provided that they meet the criteria set out in Section 507 of the CTA. If these conditions are satisfied, the returns paid on the sukuk will be treated as interest paid by the sukuk issuer to the sukuk holder and will be deductible or taxable accordingly, which may increase the popularity and development of sukuk in the financial market in the UK.

Under English law, the tax treatment of murabaha is equivalent to the payment or receipt of interest on a loan, provided that the arrangement meets the criteria set out in Section 511 of the CTA. If an asset is bought and sold under an alternative finance arrangement, Section 514 of the CTA excludes the return made on the arrangement for the purposes of capital gain tax under the Taxation of Chargeable Gains Act 1992.

The development of Islamic finance in the UK has entailed a rise in the Shari’a-compliant home finance market, which was facilitated by an amendment to the tax laws in 2003 that removed what had previously been a double charge to stamp duty land tax.

Islamic Insurance

The takaful industry, a Shari’a-compliant form of insurance based on the principle of mutual protection and shared responsibility, is still at an early stage in the UK but is expected to benefit from the general promotion of Islamic finance by the government. The FCA and the PRA will determine on a case-by-case basis whether an arrangement amounts to insurance and some takaful providers have received FCA and PRA authorisation. Under English law, a takaful arrangement will generally be treated as an insurance contract.

Islamic banks and takaful providers are established in the UK as conventional banks and insurance companies respectively and have to be licensed by both the FCA and the PRA under the Financial Services and Markets Act 2000. There is no specific regulatory regime for Islamic banks or for takaful providers. As recommended by AAOIFI, each Islamic bank and takaful provider has its own SSB, which is generally comprised of three Shari’a scholars who oversee takaful operations, supervise the development and operation of takaful, and determine the Shari’a-compliance of Islamic financial products. In addition, SSBs carry out their own independent audit to determine whether any element of the institution’s operations is considered haram, ie, prohibited under Shari’a.

Most Shari’a-compliant products are available in the UK, the main among these being sukuk, murabaha, mudaraba, musharaka and ijara – see 9.2 Regulatory and Tax Framework for more details.

Recent developments in the Islamic finance sector in the UK include an increasing focus on:

  • offering Shari’a-complaint student financing;
  • the adoption of fintech in the Islamic finance sector;
  • the growth of the sukuk market, including the recent GBP250 million mortgage-backed sukuk issuance by Al Rayan Bank; and
  • the development of products to provide short-term Shari’a-compliant funding to SMEs.

In addition, the Bank of England plans to launch a Shari’a-compliant facility through a new subsidiary that will offer a non-interest-based source of liquidity to support the Islamic finance industry in the UK. 

There is significant scope in the UK for the growth of Islamic project finance (IPF), as currently witnessed in the Middle East where istisna’a-ijara and, in some cases in Saudi Arabia, wakala-ijara structures have been increasingly adopted for financing projects, particularly power, petrochemical and industrial projects.

Furthermore, although traditional IPF structures require the transfer of an ownership interest in tangible assets, recent market developments have demonstrated the suitability of IPF to financing PPP projects (where the Project Company does not have an ownership interest in the underlying project assets).

Al Rayan Bank Sukuk

In February 2018, Al Rayan Bank (UK) issued the largest ever sterling sukuk for GBP250 million. Al Rayan Bank became the first bank in the world to issue a public sukuk in a non-Muslim country.

Fintech

Although still in the early stages of development, there has also been increased focus globally on fintech in Islamic finance, driven by growth in demand and greater awareness among Islamic finance market participants – and prospects for developments in this area (particularly in the Islamic peer-to-peer financing and crowd-funding space) appear positive in the UK.

Outlook

Consistent with the long-standing perception of it as a Western hub for Islamic finance, the UK is encouraging the growth of Islamic finance through the implementation of amendments to legislation and government policy, and the potential for the further development of its Islamic finance industry remains positive. The UK’s commitment towards the development of the Islamic finance market is expected to continue post-Brexit, particularly because even a no-deal Brexit could incentivise investment from the Gulf if real-estate assets decrease in value.

Winston & Strawn London LLP

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JeRobertson@winston.com www.winston.com
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Authors



Winston & Strawn London LLP provides a wide range of legal services through its banking and finance practice, to public and private companies, leading financial institutions, multilateral and development finance institutions, private equity and investment funds, alternative funding sources, investors and emerging companies, on investment grade, leveraged and mezzanine financings. The firm advises on high-profile transactions and matters ranging from cross-border transactions, initial public offerings (IPOs) and project finance matters, to distressed acquisitions and creative “first-of-their-kind” financings. Clients include leading international funding sources which provide senior, subordinated, secured and unsecured debt, and hybrid (equity/debt) products, as well as institutional investors who regularly participate in senior debt markets, equity sponsors, and borrowers in both developed and emerging economies. Additional thanks to partners Ed Denny and Dan Meagher and associate Shaheer Momeni, among others, for their contributions to this chapter.

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