Islamic Finance at the London Stock Exchange

Gillian WalmsleyNovember 2010

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Islamic Finance in London

• London is established as the leading western centre for Islamic finance and has been at forefront of key developments in Europe

• to date FSA has authorised five wholly-Islamic banks, one Shariah-compliant hedge fund manager and one dedicated Takaful provider in the UK

• there are over 20 banks providing Islamic financial services, more than in any other European country

– depth and liquidity of London’s capital markets

– extensive pool of expertise offered by one of largest concentrations of legal, regulatory and tax specialists

– commitment of UK Government with series of regulatory changes to offer ‘level playing field’ between conventional and Shariah-compliant instruments

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UK Development of Tax & Regulatory Structure

• London offers most open, flexible and attractive tax & regulatory structure for facilitating Islamic finance

• 2003 – introduction of Stamp Duty Land Tax (SDLT) legislation to remove double SDLT in Islamic instruments structured with property transactions

• further changes made in 2005 and 2006 to introduce new types of borrowing concepts – murabaha and diminishing musharaka

• Finance Acts 2007 and 2008 contained measures to facilitate sukuk issuance by addressing differences in tax treatment between Alternative Finance Investment Bonds (AFIBs) and conventional bonds

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Recent Developments

• October 2009, FSA and HM Treasury summary of responses to joint consultation paper on AFIBs proposed changes aimed at regulating sukuk in equivalent way to conventional bonds– aim was to remove additional regulatory burden associated with sukuk

which had seemed to fall within definition of Collective Investment Scheme (CIS)

– expected to facilitate sukuk issuance by removing barriers structuring of property-backed sukuk in the UK

• legislation introduced in Finance Bill 2009– amended SDLT and Capital Gains Tax (CGT) rules to allow sukuk issuers

to retain capital allowance in relation to transactions linked to UK land

• ‘liquidity buffer’ arrangements 2009– FSA recognised specific needs of Islamic banks in relation to

requirements of regulator’s strengthened liquidity standards, amendments introduced to allow Islamic banks to hold IDB securities rather than conventional sovereign bonds

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Islamic Finance on London Stock Exchange

• four Islamic institutions are listed on AIM

– Alternative Investment Market offers growing companies all the benefits of being traded on world-class public market within regulatory environment that has been designed to meet their needs

• Islamic Bank of Britain

• authorised by FSA in August 2004, first alone Islamic retail bank in a non-Muslim majority country

• European Islamic Investment Bank

• authorised by FSA in March 2006, the first Shariah-compliant wholesale bank in any western country

• The Family Shariah Fund

• Shariah Capital

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Shariah-compliant Exchange Traded Funds

• two of Europe’s key ETF providers offer Shariah-compliant ETFs on the London Stock Exchange:

– iShares offers ETFs based on the MSCI World Islamic, MSCI USA Islamic and MSCI Emerging Markets Islamic indices

– db x-trackers, the ETF provider of Deutsche Bank, offers Islamic ETFs are based on the S&P Japan 500 Shariah, S&P 500 Shariah, S&P Europe 350 Shariah and DJ Islamic Market Titans indices

• total Assets under Management (AUM) in these Islamic ETFs is over $128 million

• London Stock Exchange Group awarded ‘Largest European Exchange for ETF volume’ at 2009 Global ETF Awards

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Sukuk

• London is one of the most important listing venues for Sukuk and is the leader in Europe

• London offers choice of markets, depending on issuers’ needs:

– Main Market

– Professional Securities Market

• to date there have been 30 issues on London Stock Exchange, with just under $19 billion raised

– closest competitor in Europe, Luxembourg has 16 sukuk issues, $7.3 billion raised

– Nasdaq Dubai, another key listing venue, has 16 sukuk listed, with money raised totalling around $17.8 billion

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Most Recent Sukuk Listings in London

• Islamic Development Bank - $500 million issued via IDB Trust Services sukuk, first sukuk issuance via programme – October 2010

• Qatar Islamic Bank - $750 million raised via QIB Sukuk Funding, first international issue by QIB – October 2010

• Kuveyt Türk – $100 million issued via KT Turkey Sukuk, first sukuk issued by a European bank – August 2010

• Dar Al-Arkan International - $450 million raised as certificates in February 2010

• GE Capital Sukuk - $500 million raised, the first sukuk to be issued by a major US corporate issuer – November 2009

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Further Information

Tel: +44 (0)20 7797 3921Web: www.londonstockexchange.com/islamic-financeEmail: islamicfinance@londonstockexchange.com

Overview of the new electronic Order book for Retail Bonds (ORB)

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New Retail Market

• London Stock Exchange recently launched its Order book for Retail Bonds (ORB), which aims to develop a liquid, transparent, on-screen market in fixed income for private investors

• this new market may present interesting opportunities for sukuk issuers who wish to access the growing retail appetite for alternative asset classes

• ORB offers an entirely new market model for fixed income in the UK and is in early stages of development, but our aim is to expand this market to offer a wider range of securities in the coming weeks and months

• for admission to ORB, securities must be issued in ‘retail-size’, for example, in trading denominations of £1,000 and must be supported by a market maker committed to quoting two-way tradeable prices throughout continuous trading session

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Investor Demand

• increasing private investor focus on fixed income

– seeking alternative asset classes given current low interest rates and recent equity market volatility

• private investors using bond funds are keen to take more active role in managing their portfolio by selecting and trading individual bonds

• strong demand from UK private client brokers for electronic retail bond offering

– customers seeking cost-effective, transparent mechanism for retail price discovery in secondary markets for UK sovereign and corporate bonds

– strong appetite for wider range of retail-size corporate bonds to be made available

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Existing Fixed Income market

• over 10,000 debt securities currently admitted to LSE’s markets, but these bonds are available on-exchange for trade reporting only – no segments available for electronic trading

• limited number of sterling corporate bonds currently offered on SEAQ but quotes only, effectively trade reporting mechanism

• very few bonds available in retail-size trading denominations

• no centralised, on-exchange venue to concentrate liquidity

• fragmentation of price discovery, multiple opaque sources for quotes

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Electronic order book for retail bonds

• offers an open and transparent market model for trading in retail-size

– dedicated market makers are committed to quoting two-way prices in a range of retail bonds throughout the trading day

– all other registered member participants will also be able to enter orders into the book

– new market model means private investors will be able to see prices on-screen and trade in bonds in a similar way as they currently do for shares

• greater efficiency of electronic on-book execution and option to use straight-through-processing to settlement system

• cost-effectiveness and simplicity of transaction charging• standardisation of market structure

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Order book

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Accessing the UK electronic order book

• new UK electronic Order book for Retail bonds (ORB) comprises two new segments on TradElect platform:

– UKGT – ‘UK Gilts’– UKCP – ‘UK Corporate and Other bonds’

• electronic order-driven model similar to SETS

• trading day starts with an initial opening auction phase running from 8.00 to 8.10 followed by continuous trading until market close at 16.30

• London Stock Exchange Members must submit a Static Data Form to register for access to the trading service

• list of market participants with access to ORB published on the LSE web site

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Bonds available on electronic ORB

• offers range of 50 gilts

– covers range of maturities, standard gilts (excludes strips, undated, rump issues)

– includes inflation-linked gilts

• offering continues to grow and now includes 88 corporate and 3 supranational bonds

– aim is to develop liquidity in smaller number of securities before expanding the electronic order book to wider pool of retail bonds

– further ORB-specific bonds expected to be issued due to introduction of electronic order book

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Stimulating retail bond issuance

• trend on Italian electronic bond market is for UK institutions to issue dedicated retail bonds for distribution on the electronic order book

• expected that benefits of extending transparency and liquidity in retail-size fixed income will increase distribution for bonds by opening up these markets to private investors who may have previously felt excluded from this market

– facilitating new flow for private client brokers

– opening up new pools of capital for issuers seeking access to large pools of retail liquidity

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New retail issues on ORB

• UK market still in early stages of development, but issuer appetite to access retail market is growing

• ORB has already seen three new issues, specifically introduced to the order book

– new RBS bond, tradeable in £100 denominations, issued on the launch day of new market

– Provident Financial Group also introduced a £1 denomination bond in early April 2010

– Lloyds TSB raised £75m through dedicated retail issue in June 2010

– two new RBS bonds, inflation-linked and floating-rate, listed in November 2010, first bonds on ORB to quoted as ‘dirty’ prices

• still very much a new market model, issuers are in early stages of working to establish distribution mechanisms

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Publications

Issuers Private Investors Brokers

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Factsheets

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