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UK Government Launches Consultation On Islamic Finance

by Robin Pilgrim,, London

12 December 2008

A joint Treasury–Financial Services Authority (FSA) consultation on proposals for the legislative framework for the regulation of alternative finance investment bonds, which include sukuk, was launched on Thursday by Ian Pearson, Economic Secretary to the Treasury.

Commenting on the launch of the consultation, Pearson said:

“This consultation is an important part of the work government is doing to support the growth of Islamic finance in the UK and to increase our position as a leading global centre in this market."

“The government wants to ensure no one in the UK is denied access to good financial services on account of their religious beliefs. We value the contribution Islamic finance makes to London’s position as an international financial centre and we want to see this sector continue to grow and prosper in this country.”

The consultation paper states:

"This document sets out the proposed legislative framework for the regulatory treatment of ‘Alternative Finance Investment Bonds’. AFIBs refer to a type of financial instrument commonly known as sukuk or Islamic bond, but can also refer to any financial instrument with similar characteristics. This consultation paper considers the regulatory policy options for these instruments."

"Sukuk are one of the most prominent instruments used in Islamic finance. Since 2003, there have been several initiatives by the authorities to create a ‘level playing field’ for Islamic finance. For example, the government has introduced, and has proposals to further introduce, various tax changes with respect to AFIBs."

"Classifying Islamic financial instruments, including sukuk, under existing regulatory frameworks has posed challenges in the UK and other jurisdictions. Although many instruments are designed to replicate the economic functions of certain conventional financial products, their legal structure and risk characteristics may be different. It may therefore be difficult to map these products into the existing legal framework. Some of these instruments currently appear to fall within the definition of a Collective Investment Scheme (CIS) as set out in the Financial Services and Markets Act (FSMA 2000). However, alternative interpretations exist, and assessment is currently conducted on a case-by-case basis."

"HM Treasury is seeking to introduce legislative changes to align the regulatory treatment of AFIBs with conventional debt securities. Four policy options have been identified:

  • Option 1: introduce legislative amendments to explicitly exempt these instruments from CIS regulations and create a new specified investment under the Regulated Activities Order (RAO). Introduce a unique regulatory definition for AFIBs for this purpose;
  • Option 2: same as option 1 but AFIBs will be defined by the existing tax definition;
  • Option 3: same as option 1 but include AFIBs under the existing specified investment of creating or acknowledging indebtedness; and
  • Option 4: is to do nothing."

"The preferred option is option 1. As with options 2 and 3, its main benefit is that it treats AFIBs as conventional bonds. This provides clarity about the regulatory treatment and compliance costs for AFIBs and thus facilitates UK issuance of these instruments. It also creates a level playing field between AFIBs and the conventional bonds that they mirror in economic substance. Option 1 produces this benefit in a flexible and simple manner that creates legal certainty. It does not distinguish between private and public issuance of AFIBs."

"Option 1 may incur costs associated with upgrading the FSA’s technology platforms which record regulatory permissions and other associated systems. The scale of these costs is presently unclear and the FSA is currently conducting a detailed assessment to estimate the costs associated with these changes. If the costs are unavoidable and material, the Authorities will examine the feasibility of other legislative solutions that would avoid such costs (such as those set out in option 3 of this document)."

As well as this consultation, the government has also published a new paper, entitled: ‘The development of Islamic finance in the UK’. This paper’s purpose is to raise awareness of the growing role of Islamic finance in the UK by providing a stock take of achievements to date, as well examining the remaining barriers to growth.

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