London has the potential to be the prime hub, however it depends on their willingness to nurture this niche market within the UK. As you know Islamic finance is heavily dependent on reputation and perception, in addition to the metal market London outweighs Dubai in its validity of the Sukuk they issue, as people perceive London to be a more regulated and transparent market. However, Dubai has the upper hand when it gets to institutions and banks that are founded on the principals of Islamic finance and also the geographic proximity to the biggest markets (Saudi, Iran, Malaysia). Which is the reason why Middle Eastern Banks were chosen as the lead sellers of the UK Sukuk, as they ensure their investors on the validity of such instruments. This sector is still under developed and needs to be structured more efficiently as there is a lot of issues and controversy around it. For example, on the retail level it is transparency, it is almost impossible for the borrower to see if the bank has really traded the precious metal or not. Thus requiring a high level of trust between the bank and the customer. If London is willing to step up and create an educational hub for Islamic Finance and create new instruments and structures that cater the needs of the market, they will get the upper hand. If they decide not to do so, NASDAQ Dubai or Malaysia might emerge,as they are growing in rapid speed and gaining international credibility. At the time being, small institutions will have the lead as they have the clientele and the understanding of their target market, it is a very niche market with high barriers.

The Conservative government’s decision to implement the sukuk-issue program that, as the FT article notes, has its roots in a government-funded research started under a Labor cabinet on the feasibility of such program’s application in 2007, shows an important bipartisan consensus on exploring the prospects of Islamic finance in the UK. With a Muslim population of over 2.7 million and presence of noted Sharia scholars, the United Kingdom possesses a great potential for becoming the bastion of Islamic finance in the Western world. Moreover, London's fundamental position as one of the world's most vital financial centers eager for constant diversification and expansion provides the necessary arena for mobilization of Sharia-based finance. However, in order to ensure London's global competitiveness in the domain of Islamic banking with such powerhouses as Kuala Lumpur, Dubai, and Riyadh, the UK government needs to adopt a parallel institutional approach that would properly complement its current introductory sukuk-issue program. As such, a full-fledged industry of Islamic finance would necessitate a corresponding amount of experts among the academia and student body in the field. Thus, there needs to be additional funding – whether from the private sector in the form of investors (preferably from the Middle East, where there are plenty) interested in westward expansion of the industry, or the government – on specific programs oriented towards Islamic banking and finance in UK’s institutions of higher learning. Fortunately, the UK has a strategic advantage in this field also given the rising amount of degree programs related to Islamic finance being offered at various universities across the country. In the meantime, prioritization of this approach initiates a wider discussion on the framework of effective broadening of the current sukuk-based program into other areas of finance, drawing the attention of catalyzers of research and expertise – the college academia and students.

The view from the UK is somewhat jaded. On the one hand, the relevance of Islamic finance as an asset class has been recognised for years, and a sizeable industry has sprung up to serve those needs, with enthusiastic government backing. This is a sensible strategy in order to solidify London's position as the world's premier financial centre. On the other hand, it is widely accepted that the investment constraints created by shariah are both arbitrary and irrational. The Economist put it succintly: "Non-Muslims may find the distinctions between conventional finance and Islamic finance a trifle contrived. An options contract to buy a security at a set price at a date three months hence is frowned upon as speculation. A contract to buy the same security at the same price, with 5% of the payment taken upfront and the balance taken in three months upon delivery, is sharia-compliant. Then again, winning over non-Muslims is not really the point." In effect, Islamic finance is a niche for a sub-group of investors who wish to abide by a fictitious behavioural code. That is why many in the City regard Islamic finance as overhyped: its appeal is inherently limited to those who abide by these religious precepts. They key investment rules of Islamic finance are: the prohibition of interest payments and a ban on speculation. The implication of the first is that payments to lenders are classified as 'fees' rather than interest, adding administrative overhead to an otherwise analogous process of lending with interest. The implication of the second is that transactions must be based on tangible assets, which creates biases in the portfolio of funds that can be offered. In other words, Islamic finance is somewhat akin to 'ethical investing': rules-based finance that appeals to a specific group of investors. Which, in economic terms, translates into product differentiation to fulfil a market need (eg. just as there are ethical investment funds to satisfy investors like the Church of England). That is an interesting business phenomenon, but a revolution it is not. That said, the UK government's issuance of the first Western sukuk bond this week (ie sharia compliant) may be indicative of new, creative ways of reaching lenders who had hitherto not tapped the G7's sovereign bond market.

Good background reading on the subject:
http://www.economist.com/node/12052679
http://www.economist.com/node/12052687

Whether or not London can become a prime hub for Islamic Finance depends, to a large extent, on local financial institutions’ capacity to build and grow their Islamic Finance portfolio. This is why the UK Government’s decision to not include any UK Islamic Bank among the five issuers of its first sukuk issue is surprising. To me, this seems like a disconnect with Osborne’s plan to make London “unrivaled Western center for Islamic finance”. After all, why not use the opportunity to build further local expertise in this niche concept?
If we take South Asia as an example where financial institutions have recently started embracing new concepts such as sustainable energy finance and gender finance, it is very necessary to build local “demonstration cases” in order to promote the adoption of the concept among the entire industry. Speaking from experience, homegrown financial institutions tend to have very low appetite for concepts that do not have “tried-and-tested business models”. For this very reason, multilateral development banks tend to provide technical assistance to one or two local financial institutions to develop their expertise in particular fields so that these FIs can later serve as local demonstration cases for the entire industry.
It is important to realize that supporting the growth of the UK Islamic banks must be a strategic imperative for London’s ascent in the arena of Islamic finance. With the sukuk issuance, the UK Government has certainly taken a big leap in the arena of Islamic Finance, but it still has a long way to go to materialize its vision of becoming a prime hub.

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