Toronto / Dubai: The UK remains a western hub for the Islamic finance industry, Fitch Ratings says. However, the domestic Islamic finance industry remains niche and is unlikely to gain mainstream relevance at least till the medium term.

The London Stock Exchange is the third-largest listing venue for US dollar sukuk globally, with 35% global share and around USD80 billion outstanding at end-1H24. English Law is the governing law for most dollar sukuk and Islamic syndications globally. UK banks are among the key sukuk arrangers, and Islamic interbank and derivatives counterparts for Islamic banks. Additionally, London Metals Exchange is accessed by Islamic banks in many countries to facilitate cash financing through tawarruq contracts.

The UK continues to attract foreign direct investments from the GCC and other OIC countries, including from Islamic investors. The UK is home to four Islamic banks, all with GCC ownership, and is on course to have its fifth Islamic bank, which is likely to increase competition and add depth to the sector. The conversion of Ahli United Bank (UK) PLC (A/ Stable) to an Islamic bank, following the acquisition of its Bahraini parent by Kuwait Finance House (A/ Stable) in 2023, is expected to be completed in 2024.

Despite their longstanding presence in UK and supportive regulations, Islamic banks held only 0.1% of the UK banking system assets at end-2023. Demand drivers are low as Muslims are only around 6.5% of UK’s population, with generally limited awareness of Islamic finance, as well as varying levels of sharia-sensitivity and confidence in the product offering. Supply drivers are also limited as Islamic banks have a narrower product range, limited branches, and may lack competitiveness versus conventional banks.

While the UK government issued sukuk in 2021, it has no such plans in 2024-2025. Sukuk issuance is not part of the government’s regular debt management policy but is instead intended to deliver wider benefits such as reinforcing the UK as the western hub for Islamic finance. Sukuk out of the UK by corporates and banks are also rare.

Islamic banks’ total assets grew 26% year on year (YoY) to USD8.2 billion at end-2023. Most Islamic banks primarily offer wealth management and real estate financing solutions to GCC clients. Two Islamic banks are seeking to expand outside the UK. Bank of London and the Middle East plc (A/Stable) commenced its operations in Saudi Arabia in 1H23 through its subsidiary BLME Capital. The new strategy of Al Rayan Bank PLC also seeks expansion in Saudi Arabia and the UAE, and increasing business origination in Qatar.

UK-domiciled public Islamic funds expanded 115% yoy to USD1.8 billion in assets under management (AUM) at end-2023, outpacing conventional public funds AUM, which grew 17.5% YoY to USD3.4 trillion at end-2023. About 95% of Islamic fund AUMs were under equity funds. UK-Islamic funds face stiff competition from leading western jurisdictions such as Luxembourg, Ireland, USA, and Jersey.

Despite being a niche, we expect the UK’s Islamic finance industry size to reach USD15 billion in the medium term, up from USD10 billion at end-2023, on the back of the conversion of a conventional bank to an Islamic bank, continued asset growth of Islamic banks and funds, and supportive regulations. The UK government intends to launch a sharia-complaint alternative student finance product as soon as possible after 2025, which could increase financial inclusion.

In January, HM Treasury published a consultation document “Tax Simplification for Alternative Finance”, acknowledging differences in tax treatment when a commercial or residential property is refinanced using alternative (Islamic), rather than conventional, financing. This may lead to capital gains liabilities and capital allowances could be lost for those using alternative financing. The document suggests a proposal for legislative change. Fitch will monitor its impact.

Matt Pearson
Senior Associate, Corporate Communications
Fitch Group, 30 North Colonnade, London, E14 5GN
E: matthew.pearson@thefitchgroup.com