As the dust settles after last month’s Brexit vote, the smoke is only getting thicker with no clear visibility on the tough road ahead. However, is it really all doom and gloom? Or, seen through a wider context, is it a bitter short-term pill for a better long-term future? In this article, SIRAJ IBRAHIM discusses the implications of Brexit, how this may result in the fulfilment of real Islamic finance, and how Islamic finance will not be significantly affected in the UK.
The country may appear more akin to some sort of an unruly third world quagmire, rather than one of the leaders in the global corridors of power and the fifth-largest national economy in the world when considering the following facts:
- the pound plunging to a 31-year low, twice the amount seen during the UK’s 2008 recession
- the FTSE-250 down 7% (an index of mid-sized companies regarded as more closely tied to the UK economy as it contains more UK-centric businesses)
- the suspension of half of all UK retail property funds – and possibly more to follow
- two main political parties in a state of desperate disarray, and
- a huge surge in race-hate crime.
The UK’s slick and developed media machine (which actually on closer inspection, is mired in darkness – a staggering 69% of national newspaper readership is controlled by right-wing press owned by a handful of billionaires, one of which is Rupert Murdoch, whom the Chilcot report did not include in the role of such influencing media despite having beaten the drum for war in Iraq in 2003, thus allowing the press free to push the public into future disasters) failed the UK electorate once again. Both camps – Leave and Remain, scaremongered the nation with inaccuracies and distortion of facts; the newspapers facilitated such messages with their usual spin-doctored drivel. It was hard to come by an impartial piece discussing objectively, both sides of Leave and Remain.
Such covert manipulation came from top-down. The HM Treasury published economic projections of how dire a Brexit would be, under assumptions such as the Bank of England (BoE) or Treasury not stepping in. Thankfully, such assumptions were hot air. Last week, for the first time, the BoE released banks from a requirement to hold GBP5.7 billion (US$7.38 billion) of capital as a protection against downturns, resulting in an increase in banks’ capacity for lending to households and businesses by up to GBP150 billion (US$194.2 billion). This, coupled with other measures, such as an expected cut in BoE interest rate this week, from the current 0.5% which has been the same for nearly 90 months, to – according to Bank of America Merrill Lynch – as low as 0.1%, will get the cogs moving in the right direction for damage limitation.
And the support is not only coming from within. In recent days, four Tier 1 Wall Street banks and Standard Chartered put their names to a joint statement with Chancellor George Osborne, promising to work with the UK to “help London retain its position as the leading international financial center”, asserting that London boasts:
- one of the most stable legal systems in the world
- a brilliant workforce
- deep, liquid capital markets unmatched anywhere else in Europe, and
- world-class regulators.
The statement continued: “In recent years, it has established itself as a global hub for renminbi (yuan), rupee, Islamic finance and green finance, as well as leading in new markets such as FinTech.”
What does Brexit involve?
So why have the markets been shaken and nerves wrecked? Well put very simply, it’s a divorce of sorts. After a 41-year union, during which period and after a number of iterations, the evolution of the EU allowed all the member countries to operate as if it were a single country, with respect to the free movement of goods, services, money and people. Brexit now means the UK will exit from this ‘special club’, and start afresh with respect to its relationship with the EU and the countries therein.
This means a Pandora’s box of issues that need to be dealt with. Negotiating and balancing the situation of single-market access (if it was on the table in the first place, that is) against freedom of movement, fresh trade agreements with the EU and countless non-EU countries, managing the situation within the UK – Scotland and Ireland, UK citizens abroad in the EU, EU citizens in the UK, re-issuing of passports, and a whole other plethora of details need to be ironed out. This is going to be a long and interesting journey to say the least.
How did it come to this? Well the UK’s prime minister, David Cameron, took what he thought was a calculated risk, by caving in to right-wing pressure to call for a referendum. By some stretch of imagination, Cameron, who resigned immediately after the vote for Brexit (washing his hands off from when the party and the country yearned for a real leader), can be compared to a young Tunisian gentleman who set himself on fire in December 2010, which became the catalyst for the Arab Spring. How the action of a very few can have such a profound effect on the wider region is remarkable.
Whether such a significant decision for the UK to exit the EU should have been given to the public in the first place, while demonstrating democracy albeit gung ho democracy, is another question in itself, especially considering the fog of misinformation from both Leave and Remain camps. Irrespectively, it is an eye-opener outcome that only 51.9% for Leave, against 48.1% for Remain, resulting in 1.27 million votes for Leave above that of Remain, has such weighty implication for many years to come. Or will it? There may even be an ‘Exit Brexit!’, the possibility of which is detailed in the following paragraphs.
Brexit and real Islamic finance
The UK is the largest center for Islamic finance in Europe, and the western hub for the sacrosanct form of financing. A handful of Islamic finance banks, a host of international banks offering Islamic finance products, a multitude number of law firms and accountants involved in Islamic finance, a number of associations/bodies in this space, and a relatively large number of educational academic and professional courses and qualifications in Shariah finance, can be found in the UK.
Just recently – April 2016 – the Economic Secretary to the Treasury, Harriett Baldwin, asserted that the government was determined to cement the UK’s status as the leading western hub for Islamic finance. This was one of the more recent such announcements from UK government officials, trailing back more than a decade ago, when the double stamp duty requirement was removed to make Islamic financing more accessible in the UK. Cameron himself, a few years ago, stated that he wanted London to “stand alongside Dubai as one of the great capitals of Islamic finance anywhere in the world”.
While that particular statement was slightly ambitious, from a transaction perspective, the UK government has made some headway. In 2014, the UK government issued a GBP200 million (US$258.94 million) ‘Islamic Sovvie’ (a Shariah compliant UK government bond). This debut capital market issuance, while small in amount, signaled that the UK meant business, especially considering it was the first such sovereign bond issued by a country outside the Islamic world.
A year later in 2015, the UK Export Finance had underwritten its first Sukuk. This guarantee was for the 10-year US$913 million Sukuk issued by Emirates Airlines to finance the acquisition of aircraft.
Is such commercial traction of Islamic finance in the UK going to be compromised as a result of Brexit? In one word – no. In fact, there is a line of thought to suggest, as broached earlier, that Brexit may result in the fulfilment of real Islamic finance. However, before we consider the more ‘higher’ reasons for such an argument, let us first discuss the following more basic reasons why Islamic finance may very well not directly be affected as a result of Leave.
1. Needs-based financing
We live in a needs-based world. Let’s be honest, the international banks, ranging from Citibank, HSBC, JPMorgan, Deutsche Bank, Standard Chartered, Credit Agricole and Natixis to many others, are not in it to fulfil philanthropic objectives. One of the key objectives for such players is to attract Middle East liquidity.
Along the same bandwidth of thought, the UK having lost its coveted ‘AAA’ credit rating from S&P, and Fitch lowering its rating from ‘AA+’ to ‘AA’, means the government would theoretically find it fractionally harder to sell their bonds. While I am not advocating the idea that this will result in the UK government approaching the Middle East with hat in hand, what I am saying is that Islamic finance could find itself that little more useful in supporting liquidity if and when the needs arise. Indeed, Theresa May, now the only candidate to take the poison chaliced leadership to succeed Cameron as prime minister, said last week that the government should borrow more in an attempt to avoid raising taxes.
One could argue that with the right-wing being emboldened in the UK by the Brexit vote and finding more airtime in the political landscape, they may have a less of an appetite for ‘Islamic’ finance. But let us not forget, politics is, basically, politics. Nigel Farage, one of the cartoon-type architects that twisted Cameron’s arm for an EU referendum, made ridiculous claims, like how the UK exiting will save GBP350 million (US$453.14 million) a week, only to detract from such claims fairly soon after Brexit. Politicians of his ilk – and there many of those in the Tories – will be open to Islamic financing, depending on the function of need. This is especially in the case where precedent and the legal structure for government issuance has already been laid.
Also, with the London Stock Exchange developed to support Islamic finance, with more than US$34 billion in Sukuk raised through 49 issues at the exchange, it is sufficient to say the international capital markets are comfortable with the London ‘setup’ and there will be no change in direction in this regard.
2. Scotland and Northern Ireland
Brexit has created fault lines across the land and breadth of the UK. While it seems unlikely that Scotland and Ireland will become independent from the UK (so did a Brexit not so long ago), there does not appear to be much choice if they want to remain as part of the EU. Taking Scotland as an example, 62% voted to Remain against 38% to Leave, putting it at odds with the UK as a whole. The charismatic Nicola Sturgeon, Scotland’s first minister, insisted that a Scottish independence referendum, a second one in as many years, was now highly likely. Northern Ireland too stated that they want to remain in the EU and a border poll may be on the cards.
The other alternative is for Scotland and/or Northern Ireland to retain EU membership (some even tout that London in itself as a city could be part of that ‘in’ club!) while still being part of the UK. Such possibility can be understood in the context that the EU has a history of flexible and variegated participation. For instance, West Berlin was a member of the EEC for 33 years, although not part of West Germany.
In any case, if Scotland and /or Northern Ireland were to break away from the UK, the take-up of Islamic finance could potentially increase. In Scotland, the Islamic Finance Council UK has advised the Scottish government on a number of issues, as Scotland may emerge as a new hub for Islamic finance. In Ireland, according to PwC, there is approximately EUR2.5 billion (US$2.76 billion)-worth of Shariah compliant funds in Ireland, making up to 20% of Islamic funds based outside of the Middle East. Independence for both countries could very well mean more dependence on outside sources..
With all the uncertainty, it is obvious that London, which has been seen usually been seen as a safe haven for international investors to park their excess cash, including billions from the Middle East, has dropped a peg or two. Thus in this regard, some may feel there may be less ‘Islamic funds’ finding itself from the GCC to London.
However, the word on the ground is this – there isn’t much choice when it comes to investing in large-ticket real estate transactions which have a tried and tested robust and transparent legal structure. If anything, the devaluation of the pound sterling coupled with the uncertainty may very well result in great bargains for Middle Eastern investors, buying up more of the city’s skyline. In actual fact, it has been reported that investors as far afield as Hong Kong have been looking to purchase sought-after London property in light of the devalued pound. Thus, Islamic finance from a real-estate investment perspective may be part-shielded.
As a side point, some within the Islamic finance space opine that Islamic finance will take a hit as a result of the UK financial institutions potentially losing ‘passporting’ privileges. In basic terms, what this means is that such financial institutions use the UK as a gateway to Europe’s vast markets, taking advantage of an EU financial ‘passport’ that allows them to sell products in all 28 countries. This can very much affect financial institutions which actually do European-wide business.
However, domestic Islamic banks usually do business within the UK, thus even if the UK was to lose such passporting rights, it will not greatly affect the small Islamic finance space. In any case, London will very much push the government to ensure Brexit negotiations preserve the passporting rights of financial institutions.
One of the key tenets of Islamic finance is the fair distribution of wealth. For all the fanciful Shariah compliant structures within the capital markets used by international banks to woo Islamic banks and large corporates, to earn fees and revenues (and fair enough if the international banks obtain the requisite green light from the respective Shariah boards), this one fundamental and significant key tenet is not fulfilled.
This crucial principle is emphasized in the Quran, with respect to the idea that wealth produced in a society must be distributed in a just and fair manner, so that it may not be concentrated in the hands of a few people. The Quran says: “So that it may not circulate only between the rich among you (chapter 59, verse 7).”
Keeping this in consideration, let us see how Brexit may affect the distribution of wealth.
The Transatlantic Trade and Investment Partnership (TTIP) is a proposed US-EU bilateral trade agreement with the alleged claim of promoting trade and multilateral economic growth. It would do this by reducing the regulatory barriers to trade for big business, and would affect things like workers’ rights, public services, food safety law, environmental legislation, banking regulations and the sovereign powers of individual nations. Masses of people within the EU do not want this, and the petition against it may very well be the world’s largest petition ever – signed by approximately 3.5 million people. Some of the critics of TTIP argue that multinational corporations would be able to sue over government policies that harm their profits or contravene trade rules, for example taking reasonable policy decisions such as putting cigarettes in plain packages. It has been seen by many as a way of ‘corporate power grabbing’.
The UK was one of the strongest supporters of the TTIP in the EU. As a result of Brexit, the eventual departure one of the US’s closest allies has, at the least, delayed the TTIP drive.
As we have seen before, super large corporates do not necessarily distribute money in society – in many cases, they are driven by pure and unadulterated capitalism; in fact many mega-sized corporates find innovative ways just to avoid paying tax! The TTIP would promote monopolies, economic and political globalization, and may very well compromise the fair distribution of wealth. In this regards, a Brexit, if indeed it does stop the TTIP in its tracks, can be seen as a means of fulfilling the higher objectives of Islamic finance.
Strictly from a trade perspective, the EU’s joint free trade agreement with multiple African countries through the Economic Partnership Agreement (EPA), compromises fairness. The EPA encourages African countries to open up the lion’s share of their markets to European imports. In exchange, African states receive customs-free access to the European market. But in actual fact, it is the African countries that get the bad end of the bargain, not just because many African countries risk losing their competitive trade advantage opposite European companies, but importantly because the negotiating power of the EU as a trade-bloc is very strong and can work exploitatively.
As a result of Brexit, the UK exiting would mean that as well as the UK requiring to negotiate its own free trade agreement with EU (and this is no easy job, considering the EU is the largest trading partner of the UK, accounting for 44% of the UK’s goods and services exports in 2015, and delivering 53% of the UK’s imports), it will also have to negotiate free trade agreements with other countries – like the African countries. Consequently, the result of the weaker negotiating power of the UK could potentially mean a slightly fairer deal for African nations. While it is accepted that renegotiation of the trade deals may very well result in a dip in trade volume between the UK and African nations, adversely affecting the latter, the long-term effect may very well outweigh such impact. However, Brexit means that Africa would lose one of its biggest supporter – the UK – to influence aid and support from within the EU.
Just literally a few days ago, more than 1,000 lawyers signed a letter addressed to Cameron saying the EU referendum result is merely ‘advisory’ and not legally binding. Brexit, under UK law, is not binding on parliament – a large majority of whose members are opposed to leaving the EU. As Geffrey Robertson QC points out: “It’s the representatives of the people, not the people themselves who vote for them.” Who is to know whether a U-turn, or a second referendum may be carried out?
As unlikely as the case may be, there has been precedents for similar U-turns. In 2008, the Irish voted against the Lisbon Treaty but supported it the second time around. In Denmark, voters originally rejected the Maastricht Treaty, and then reversed their decision. Such is the level of uncertainty that along with all the uncertainty that comes with Brexit, whether or not a Brexit itself will happen is not absolutely yet set in stone.
So what now?
Now that we are on the cusp of May taking the baton from Cameron, the much talked-about serving of Article 50 will be at the forefront. Article 50, written into the Lisbon Treaty (the constitutional basis of the EU) provides a formal mechanism for a country to withdraw from the EU. Amidst all the uncertainty, what exacerbates it further is that Article 50 has never been triggered before and there is no legal precedent for a country to leave the EU and renegotiate a trade agreement with the bloc.
To invoke Article 50, the UK government must inform the EU in writing or in an official statement at a meeting of the European Council.
The article states that the negotiations would take up to two years, but they can be extended if all the EU countries agree unanimously that they need more time.
The UK would very likely be without a trade deal after the end of the two-year negotiation period, as under EU law, the bloc cannot negotiate a separate trade deal with one of its own members, as rules have to apply to all member states equally. Similarly, individual member states cannot make trade deals with third countries on their own. Consequently, as the UK will remain a full member of the EU throughout the negotiating period set out in Article 50, it could only formally sign trade deals with other countries once it has left.
In other words, trade talks cannot be concluded until the UK officially exited the EU, implying that the UK may face a period in which it is outside the EU but does not have a new trade deal with the single market, nor with other non-EU countries. In this case, it would have to rely on World Trade Organization rules until the final deal is concluded.
The road ahead is littered with several directions, five to be precise according to an analysis conducted by the UK government in March 2016. As it stands at present, it appears the least smoggy is the Norway style, ie membership in the European Economic Area, but not in the EU. However, whatever happens, Islamic finance will not be significantly adversely impacted, and if it does, it would be more of a function of the overall finance system being affected, rather than Islamic finance on its own.
Siraj Ibrahim is the senior relationship manager at Qatar Development Bank. He can be contacted at email@example.com.