On the 23rd of June 2016, the United Kingdom voted to leave the European Union. The purpose of this article will be to give an overview of the potential impact of that vote on Islamic finance in the UK while Britain’s new place in Europe is still in flux.
Islamic finance makes up a critical part – perhaps up to £14 billion – of a financial services sector worth around £126.9 billion to the UK economy. The success of financial services as a whole has been attributed in part to the framework provided by EU law, including in particular its rules on liberalisation of capital movements and harmonisation of financial services regulation. These rules allow investment to flow freely between member states and allow market participants to offer Islamic finance products on a Europe-wide basis. The ability to move capital within the single market also drives inward investment, including in Shariah compliant products.
The Islamic finance sector’s interests in the EU are thus both commercial and legal. The remainder of this article weighs the implications of Brexit in both senses. It assumes that the model to be adopted by the UK is ‘hard Brexit’ and thus there will be no automatic access to the single market and trade with the EU will require an individually negotiated agreement.
Markets and Islamic Investment
A remarkable loss of confidence followed the result of the July referendum. The FTSE 100 index fell more than 5% in two days, while sterling dropped to a 31-year low. A silver lining for Islamic finance, however, was an increase in foreign investment led by a weak pound. While the UK economy continues to suffer from a lack of confidence, the influx of investment has helped the FTSE to rise to a yearly high. As Jonathan Lawrence of K&L Gates notes, this effect has been especially beneficial to investors from countries who peg their exchange rate to the dollar. This class includes those from significant Islamic finance centres such as Bahrain, Qatar and Saudi Arabia.
Although it is likely that these favourable commercial conditions will exist only so long as the uncertainty over Brexit, there is at least a short term opportunity for inwards investment and sector growth.
As financial institutions, Islamic finance providers are subject to a range of regulatory requirements at EU level. Although the status of this regulation will depend on the precise settlement reached after Brexit, the government’s intentions in this regard are becoming increasingly clear.
In legal terms, EU law including financial services regulation is given effect to in domestic law by the European Communities Act 1972. The government intends to repeal that Act with a “Great Repeal Bill” which will simultaneously transpose all applicable EU law into UK law. It will then be for the government to unpick historical legislation and shape the regulatory framework as it sees fit.
A government wishing to encourage financial services could pursue a policy of deregulation and alter, for example, the capital requirements currently imposed by Basel III. Similarly, the objective of ensuring recognition of UK based financial services providers in European states and beyond – currently dealt with under ‘passporting’ rules – will be an important consideration in the scope of regulation and trade negotiations.
In this sense, then, the level of regulation applied to Islamic finance will be a matter of government policy. Given UK government commitments to ‘excellence in Islamic finance’ and the establishment of an Islamic Finance Task Force, it is hoped that the increased control made possible by Brexit will result in a positive regulatory environment.
Trade and Capital Movement
As noted, the ability of investors to take advantage of UK expertise in Islamic finance has been underpinned by minimal controls on capital movements – currently secured by EU law. Assuming that the negotiations which follow the government’s triggering of Art.50 will result in the UK outside of the single market, a liberal capital movements regime will be a matter for bilateral trade agreements.
There are challenges and opportunities here. Loss of single market access restricts UK access to an extensive pool of investment, but does allow it to negotiate with any state on an individual basis. Many new agreements contain provisions for the promotion of investment by relaxing national rules on capital flows: an example is the Transatlantic Trade and Investment Partnership into which the UK intends to enter in the near future. Replicating these provisions in future agreements with countries where demand for Shariah compliant products is high would encourage investment and boost the Islamic finance sector as a whole.
Islamic finance in the United Kingdom stands in a unique position. It is partially shielded from the exposure to European investors suffered from by financial services more generally and is enjoying an increase in international interest. But the continued growth of Islamic finance after Brexit will rely on a strong commercial and legal basis. It is hoped that the UK government bears this consideration firmly in mind as it takes the critical policy decisions that will precede formal separation with the EU.
Including, but not limited to, the Money Laundering Directive (2001/97), the Capital Requirements Directive (2006/48/EC and 2006/49/EC) (Basel III), the Solvency II regime (2009/138/EC), the Markets in Financial Instruments Directive (2004/39) and the Market Abuse Regulation (596/2014) (MAR)
Subject to negotiation. See http://trade.ec.europa.eu/doclib/docs/2015/september/tradoc_153807.pdf