The risks and rewards from the explosive growth in Sharia finance

BOOMING Middle Eastern economies and increasing affluence across the Islamic world are fuelling rapid growth in the $1 trillion (£502bn, E677bn) market in Sharia finance.

Sukuk have certainly been snapped up in recent months: a 10-year $1.5bn sukuk issued by Dubai Ports in June paying a fixed coupon of 6.25% drew 70% of its investors from outside the Middle East, hoping to make expected robust returns in the oil-rich region.

There is also a developing British market for Islamic mortgages: banks (such as HSBC) will buy a property and lease it back to a customer under an agreed timescale. The client makes monthly payments composed of rent for the use of the property (rather than interest, as with conventional mortgages) and an amount towards the purchase price of the house, which will be owned by the lender until customers make their final payment and take full ownership.

The banks make money from the rents – seen as legitimate under Sharia because they are a charge for a service. Banks also charge a fee to cover the set-up costs of the mortgage; rents, which fall as the occupiers increase their ownership, will vary depending on the cost of the property.

This market, which won official regulatory approval from the Financial Services Authority last year, is expected to rise from just £40m in 2002 to £1.4bn by 2009, according to Datamonitor, the information service.

Islamic house “loans” are tougher on borrowers than traditional mortgages, however: borrowers must typically put down at least 30% of the purchase price as a deposit.

Traditional long-only funds and hedge funds are also breaking into Sharia finance; they make sure they do not invest in credit or Western banks. Barclays Capital has launched a business unit, the Al Safi Trust, to serve clients of Islamic-compliant hedge funds. These include the Old Mutual Al Saqr Fund, an equity hedge fund managed by Old Mutual Asset Managers (UK).

For hedge funds, though, a problem has been the Islamic ban on the classic hedge fund technique of short-selling – borrowing an asset in the hope it drops and repurchasing it at a cheaper price.