UK: A western hub for Islamic finance

Key Highlights

• A leading western hub for the Islamic funds industry
• The LSE raised over US$50 billion through 68 Sukuk issuances
• Islamic funds in the UK manage over US$11 billion in AuM

Overview

The UK is among the leading western hubs for the Islamic finance industry, behind Ireland – which has the third largest Islamic funds market globally as Fitch Rating figures show Ireland with a 17.9% share at the end of H1 2024 after Malaysia (26%) and Saudi Arabia (18.5%).

Islamic finance has had a presence in the UK for over 30 years – it became the first country outside the Islamic world to issue sovereign Sukuk in mid-2014. That GBP200 million (US$253.57 million) five-year Sukuk was oversubscribed by 10 times.

The UK attracts significant foreign direct investment, particularly from GCC and OIC countries. With substantial ownership from the GCC, the UK is home to four Islamic banks and is on track to welcome a fifth. This new addition is expected to enhance competition and further deepen the Islamic finance sector in the country.

Following Brexit, the UK also faces significant competition from Luxembourg – which hosts a large number of Islamic funds that straddle investment opportunities between the GCC region and the EU bloc of nations.

Looking at historical data over a span of 12 years, the average number of funds launched in the UK have been around two to three funds yearly. The IFN Investor Funds Database noted that 2022 and 2023 experienced the highest number of launches in the UK, at 16 and 29 funds respectively.

Regulatory framework

AAOIFI sets standards for Islamic finance institutions, which are prescribed for use around the globe. These standards are not legally binding in the UK as domestic regulation is overseen by the Financial Service Authority – which was divided into the Financial Conduct Authority (FCA) and the Prudential Regulations Authority (PRA) in 2013.  

The FCA role includes protecting consumers, keeping a sound financial industry and promoting a healthy competition between financial service providers. The PRA on the other hand is a part of the Bank of England (the central bank) and is responsible for creating policies and conducting supervision.

The UK’s regulations are clear, any financial institutions seeking to conduct a regulated activity needs the approval of the FCA and they are subjected to the same standards, regardless of their country of origin and which sector they specialise. It is stated that Islamic institutions must follow the same process as conventional counterparts in the UK when applying with the FCA.

Although the UK authorities does not regulate Shariah compliance, the Bank of England recognises the importance and has become an associate member of the Islamic Financial Services Board (IFSB) in 2015. The UK also practices the appointment of a Shariah scholar or Supervisory Board (SSB) to certify that activities and products are compliant with Shariah principles.

A key recent development in the UK’s Islamic finance sector was the Bank of England’s creation of a Shariah compliant liquidity facility for Islamic banks. This facility addresses the challenge Islamic banks face in meeting international banking rules requiring them to hold liquid, high-quality assets, which must also comply with Shariah principles.

Announced in 2014 and launched in 2021, the facility operates under a Wakalah model, where participant deposits are backed by a fund of assets, and returns are distributed to depositors without interest. The facility has been well received, offering UK Islamic banks more flexibility in meeting liquidity requirements while adhering to Shariah law.

Capital market

The UK has one of the largest and most-developed capital markets in the world, offering a wide range of capital raising and trading options for issuers and investors. Regulators and authorities for the UK’s equity and debt capital markets are the FCA, the PRA and the Bank of England.

As the primary regulator for the UK’s capital markets, the FCA is responsible for the approval of prospectuses, market listing and maintaining the official list of securities listed on the London Stock Exchange (LSE) – which is the third largest listing venue for US dollar Sukuk globally, with 35% global shares and with US$80 billion outstanding as of the first half of 2024.

Benefiting from favourable regulatory and tax frameworks that support Islamic finance, over US$50 billion was raised through 68 Sukuk issuances on the LSE. Additionally, the LSE hosts a dynamic market for exchange-traded funds (ETFs), with three Islamic ETFs listed, available in six different currencies.

The LSE also offers two index series. The FTSE Shariah Global Equity Index Series is designed to serve as the foundation for Shariah compliant investment products. This index encompasses both developed and emerging markets, providing a comprehensive indexing solution.

The second, the Russell-IdealRatings Islamic Index, offers investors a precise and thorough global equity market index that adheres to Shariah investment principles. Based on the Russell Global Index, which includes over 10,000 listed securities, this index incorporates Shariah screening by its partner, IdealRatings.

Asset management

The IFN Investor Funds Database reports a total of 73 Islamic funds registered in the UK totalling US$11.04 billion in assets under management (AuM). Among these, growth funds make up 53% of the whole Islamic asset management landscape in the UK and the second most common fund type at 17 funds.

ETF, a popular fund type and the highest fund count amongst other fund types, are all domiciled in Ireland, with HSBC hosting 20 of the 25 funds, Blackrock manages four funds and HANetf Management offering one. Blackrock’s funds make up 84% of the total ETF AuM with its four funds – the iShares MSCI World Islamic UCITS ETF is the largest among the four.

HSBC’s funds dominate the index fund category, hosting 90% of total AuM.

*The number of funds includes multiple sub-classes of umbrella funds.

Chart 1: Islamic fund breakdown by asset class in the UK

Source: IFN Investor Funds Database

As of the 18^th November 2024, the leading fund in the UK – based on annual return – is the Baillie Gifford Worldwide Islamic Global Equities Fund managed by Baillie Gifford & Co, followed closely by the Aegon HSBC Life Islamic Global Equity Index (ARC) and Aegon HSBC Life Islamic Global Equity Index (BLK) funds, managed by Aegon Asset Management, these top three funds combined manage US$353 million.

Table 1: Top performing Islamic funds in the UK by one-year returns

Source: IFN Investor Funds Database

Outlook

The UK remains a leading hub for Islamic finance outside of Muslim-majority countries, with steady growth in its domestic market. According to Fitch Ratings, the UK Islamic finance sector benefits from strong government support and an established regulatory framework.

Islamic asset management continues to expand at a far greater pace than conventional funds, Fitch continues to see the conversion of conventional banks to Islamic and the expansion of UK banks in foreign soil offering Islamic banking services.

Islamic banking market is a niche segment in the UK, partly due to the low Muslim population of 6.5% and limited awareness of Islamic finance. Sukuk issuance was initiated by the UK government in 2021, but this financing model is not the go-to method for government’s financing. Plans for another sukuk issuance is nowhere to be seen for the near term, but the government did announce a Shariah student finance product to be implemented from 2026.

Whether the nation can leverage on this favourable position as a major global capital market to grow the Islamic funds landscape and continue attracting investors is another interesting case study moving forward.