Islamic securitisation in the UK – what next?

Islamic securitisation in the UK has to date been the financing format of the future. The big question is whether that previous sentence should be finished with the words “…and always will be”? Only one public transaction has ever been successfully completed. Even private transactions have been relatively few in number. As of 2024, there were only 3,000 Islamic mortgages in the UK and recent changes to the ATED and CGT rules in relation to Home Purchase Plans (particularly buy-to-let Home Purchase Plans) has revealed that legislative changes designed to facilitate Islamic finance have not always succeeded in doing so. Was HM government correct to identify Islamic finance as a growth area for the UK back in 2003?

Despite the relatively small numbers of transactions to date, there are reasons to be optimistic about the growth of the Islamic finance market. It is a little counterintuitive, but the discovery of problems with the UK’s existing Islamic finance regimes is a growth indicator. Were Islamic finance dormant within the UK, these issues would not have come to light. The very fact that these issues are being brought to light and solutions are being sought (and implemented) demonstrates the vigorousness of the UK Islamic finance market. Similarly, there was a very targeted response by the Islamic finance industry to certain elements of the Renters Rights Bill which threatened to undermine the operation of Home Purchase Plans. The response of the government to that response was encouraging and if enacted in its current form, the Renters Rights Bill should not be disruptive to the Home Purchase Plan market.

We are also seeing increasing growth in the number of Islamic finance businesses. Increasingly, these businesses are non-bank financial institutions (or NBFIs). This is an evolution in the development of the UK Islamic finance market, which to date has been dominated by banks. It also echoes the development of the non-Islamic UK finance market, where specialist NBFI lenders developed significant businesses and market shares in residential mortgage lending (particularly non-conforming mortgages), credit cards and SME finance. These developments are encouraging for the Islamic securitisation market, as warehouse finance, forward flow finance and securitisation tend to be major tools for funding the portfolios of NBFI lenders.

Nevertheless, the Islamic securitisation market continues to face some challenges. The forward flow and warehouse finance products for Islamic funders are subject to a requirement to list on recognised investment exchanges, which requirement does not apply to equivalent non-Islamic financings. It should be noted that the list of recognised investment exchanges is considerably shorter than the list of recognised stock exchanges and excludes many of the “private listing” exchanges (such as TISE and Vienna). This requirement imposes costs on Islamic NBFIs looking to finance themselves in the warehouse finance and forward flow markets that non-Islamic NBFIs are not subject to. These costs are not merely the obvious ones of needing to pay listing fees. They also extend to a need to prepare extensive prospectuses or listing particulars (itself a five or six figure cost), to liaise with and obtain approval from a listing authority or stock exchange (with attendant effects on timing of a transaction) and the ongoing compliance with the requirements of a listed security. In addition, it can mean having to disclose to the outside world information about the business and cost of funding of such Islamic NBFIs that their non-Islamic equivalents would regard as proprietorial and confidential information.

The Building Safety Act 2022 is another area where otherwise commendable legislation has inadvertently  disadvantaged Islamic home finance products. The Building Safety Act was introduced in the wake of the Grenfell Tower fire in London. Part of that Act seeks to apportion the costs of remedying safety issues in high rise residential buildings (such as removing and replacing non-fire-retardant claddings). Individual apartment “owners” in such buildings typically have a leasehold interest in the particular apartment that they “own” and occupy. The Building Safety Act 2022 exempts such residential owners from having to bear the costs of remedying safety defects and instead impose those costs on the landlords and/or developers of such buildings. However, where an occupant of such an apartment has financed the purchase of such apartment via a Home Purchase Plan, they do not benefit from this exemption (whereas an “owner” of such apartment who had financed its acquisition via a non-Islamic mortgage would). This is because under a Home Purchase Plan, the actual “owner” of the leasehold interest in the apartment would be the financial institution providing the finance. This potentially makes both the occupant of the relevant apartment and anyone they sell the apartment to, liable for meeting the costs of safety refits to the building. On the face of it there is no reason for distinguishing between occupants who financed their apartment through a Home Purchase Plan and those who did so through a non-Islamic mortgage. This issue is being debated by the UK Islamic finance industry and a remedy is being sought. But in the interim Home Purchase Plan providers are unlikely to be willing to finance apartments in buildings that fall within the scope of the Building Safety Act 2022.

Another potential challenge lies in HM government proposals to reform commonhold law. Lease structures constitute an important part of many Islamic real estate finance products. If such products are caught, inadvertently, or otherwise, within the scope of commonhold (or indeed other leasehold) reform legislation that imposes additional costs on such landlords or makes it more difficult or expensive for them to exercise their rights, then this may have a chilling effect on the Islamic finance market. Any new legislative proposals in this area will be scrutinised by the UK Islamic finance industry. Should any potential impacts on Islamic finance be identified in it, then Islamic finance industry bodies are likely to make submissions seeking to ameliorate those impacts. That being said, to date HM government has, where these have been brought to its attention, been receptive to submissions that seek to prevent Islamic finance products being disadvantaged relative to non-Islamic finance products.

All of the above demonstrates the difficulties in seeking to “rewire” a shared understanding of “how finance is done” to reflect a different financing paradigm. While Islamic finance seeks to achieve similar outcomes to non-Islamic finance, the techniques it uses are, in the UK legal and commercial context, associated with non-finance transactions. While the UK the regulatory and taxation regimes are seeking to manage and tax such transactions by reference to their economic effects, the rules have developed to such an extent and over such a long period of time, that the economic effects of such transactions (such as, for example, sales or leases) are assumed rather than (in any given transaction) examined. As a result, Islamic finance transactions would, in many cases, be regulated and taxed as non-finance transactions but for the special regimes developed by HM government.

It is reassuring that the response of HM government to date has demonstrated its understanding of the importance of a vibrant finance market to the UK economy. It has, so far, seen Islamic finance as being an important part of that finance market.

But as noted above, there were only 3,000 Islamic mortgages outstanding as recently as 2024. Is it realistic to be optimistic about the potential of this market?

Islamic mortgages have to date been more expensive than non-Islamic alternatives. Many people who would like to finance their home purchases through Islamic mortgages have instead taken non-Islamic mortgages on pure cost grounds. Pure consumer residential financing has also tended not to be a target market for the Islamic banks in the UK, who have instead tended to focus products attractive to high-net-worth customers, such as buy-to-let mortgages. The newer breed of Islamic mortgage NBFI originators are working towards being able to offer products that are cost comparable to non-Islamic mortgages. It would be safe to assume that, were such products available, the demand for them would be significantly higher than the demand for Islamic mortgages has been to date.

The 3,000 Islamic mortgages figure is also probably misleading. Not all Islamic finance products are readily identifiable as such. For instance, a murabaha financed property acquisition will be secured by a mortgage in exactly the same way as a non-Islamic mortgage financing and may not be picked up in surveys as being an Islamic financing. A number of the current Islamic home purchase finance products on the market use murabaha financing structures and these may not have been included in the statistics as Islamic mortgages.

The number of Islamic NBFIs is increasing and these institutions will need to tap securitisation techniques and investors as part of their growth strategies. Within the last year alone we have seen two examples of notable private Islamic securitisations in the UK buy-to-let Home Purchase Plan market. As noted above, there are still some challenges in this market. While we do expect to see more such transactions regardless of any changes to this legislation, if the challenges that UK private Islamic securitisations face can be addressed by HM government, then we would expect to see even faster growth in this area.

We also see the market for Gulf Cooperation Council consumer assets starting to grow. There have been a number of private financings of such assets using European SPVs and structures. Growth of, and growing familiarity with, this market is likely to lead to increasing interest in UK domestic Islamic securitisation. We see this dynamic as a result of both structurers and originators becoming more familiar with Islamic securitisation products and in Islamic investors seeking to increase the range of Islamic investment opportunities that they can participate in. For all of the reasons set out above, we do think that optimism about the growth prospects of the UK Islamic finance market is warranted.

New markets can take time to develop and grow. Benz produced his horse-less carriage in 1885. However, Ford’s production line was introduced in 1913 and it was only after this that the motor car became a high-volume product. While Islamic securitisation has developed relatively slowly in the UK, to date, it is now showing significant signs of a coming grow spurt. If HM government continues to nourish these shoots of growth, it is likely to be rewarded with a flourishing and vibrant market.