Globally, there is a strong impetus to expand Islamic financial services to access funds from the Middle East and to meet the demand of a growing Muslim middle class by providing retail and takaful (insurance) as alternatives to conventional riba (interest-based) products and services. Although the move has been driven by key Organisation of the Islamic Conference (OIC) players, different jurisdictions, from Singapore to the Gulf States and from Malaysia to the United Kingdom, are competing for a dominant position. Hong Kong is a late entrant to the burgeoning markets in Asia, far behind Malaysia and even Singapore, but ahead of Indonesia, which, with its vast Muslim population, probably has the greatest potential.
Hong Kong has no specific legislation on Islamic finance, and it must decide whether to enact a legalistic or economic form of legislation to accommodate the special features of Islamic finance and to ensure tax neutrality with conventional financial products.
The territoryÆs legacy as a former British colony and hence its adoption of the ôspiritö of UK law means that it might be more likely to adopt the legal form for transactions, whereby the specific features of a product rather than any religious or philosophical parameters are accommodated. But, although the intention would be to avoid favouring one form over another, the danger is that this might create loopholes for sellers of conventional products to exploit. For instance, common Islamic structures such as istisna (purchase order) often used for sukuks (bonds), or murabahah(cost-plus sale) used for short-term financing, involve a sale and purchase agreement with a price mark-up to circumvent interest payments.
If legislation was drafted to allow a tax deduction of those price differences to create parity with the tax treatment of interest, then without an explicit requirement of shariah compliance, conventional sale-purchase or sale-leaseback arrangements could also claim tax deductions û obviously leading to lower government revenues. Similarly, many Islamic products are underpinned by layers of transactions which would all currently attract stamp duty, making them commercially unviable in Hong Kong. However, isolating one transaction among them to apply the duty would again open the system to abuse.
An alternative route would be to follow the Malaysian model of enacting legislation that would specifically give Islamic financial transactions equal treatment to conventional financing arrangements. In Malaysia, this requires approval both from the countryÆs Securities Commission and shariah authorities made up of a board of Islamic scholars. Malaysia has additionally provided tax incentives, including extra deductions and exemptions for Islamic products, which are not enjoyed by riba-based products, as it is especially keen to attract Middle Eastern banks to use Kuala Lumpur as a spring board into the large Asian markets.
Whatever form the future legal framework takes, Hong Kong has a lot of catching up to do, but it can be reassured by the fact that Islamic finance is still in its infancy compared with conventional finance. Nevertheless, itÆs growing fast. According to PWC, it is now present in 75 countries and the Islamic private capital pool in the Middle East is greater than $1.5 trillion. Assets in Islamic banks or ôwindowsÆ [within conventional banks] exceed $560 billion, Islamic mutual funds are worth more than $300 billion and sukuks more than $50 billion, while the equity capitalisation of companies included in the Dow Jones Islamic Index exceeds $1.5 trillion.
The May issue of FinanceAsia magazine, which will be out around the middle of the month, features an article taking a closer look at Islamic finance in Malaysia and an interview with Badlisyah Abdul Ghani, chief executive officer of CIMB Islamic Bank Berhad.
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