Although Sharia-compliant finance has existed in some form for hundreds of years the world's first Islamic bank was founded in 1975 and it is only in the last five years that this area of finance has surged.
Regarded for many years as outside the mainstream, Islamic finance has been boosted by a number of factors. Firstly, at a very basic level, there are more Muslims in the world seeking mortgages, investments, bonds and specialist finance products.
What used to be a sector for high net worth individuals is now open to the fast growing Muslim middle classes.
Secondly, economic growth in the Middle East, fuelled by high oil prices, has created an increased demand which local financial markets have been unable to keep up with. As a result Middle Eastern investors are looking for suitable alternatives.
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Global banking giants such as HSBC, Barclays Capital, Royal Bank of Scotland, BNP Parabas and Deutsche Bank, are putting their weight behind Islamic finance as they realise many products have a wider appeal than the immediate Muslim community.
But it is London that has taken a lead for various reasons. It has been a major financial centre for centuries and is regarded as open to innovation and ideas. The UK was the first member of the EU to authorise Islamic banks.
English law is highly regarded throughout the world. It is the preferred jurisdiction for many Islamic transactions.
Also the UK government is actively encouraging the growth of Islamic finance. It has introduced a number of changes to support the growth of Islamic finance. Most notably it acted quickly to introduce changes so that Islamic mortgages would not be subject to double taxation.
The latest figures from the International Financial Services London show there are 23 banks, nine fund managers and a number of law firms in the city now offering Islamic compliant services.
'When you look at London what you have is a global financial centre that makes it easier to trade with other markets. Taxation issues have been dealt with, the regulatory authorities are sending out encouraging messages and there is good co-operation with other banks, particularly in the Middle and Far East,' said Mohammad Shafique of the Institute of Islamic Banking and Insurance in London.
The UK government has also created an Islamic Finance Expert Group with representatives from the industry, the City and Muslim organisations to advise on future opportunities.
Further evidence of London's growing role in Islamic finance is shown by the UK being the only western country to feature, at number 10, in the IFSL global ranking of Sharia-compliant assets by country.
The UK's first stand along Islamic Bank, Islamic Bank of Britain, opened in 2004 and there are now five totally Sharia-compliant banks registered by the Financial Services Authority, the UK's banking regulator.
Indeed the FSA is taking a leading role and actively encouraging expansion. 'Islamic finance is a fast growing force in the world economy. The FSA has an open and principle-based approach to regulation that offers the right environment for it to flourish in the UK. There is huge potential for expansion,' said FSA chairman Sir Callum McCarthy.
In April this year the London Stock Exchange listed its maiden Sukuk, a Sharia-compliant bond. There are now at least eight and the government is expected to sell its own Sukuks soon. 'The UK has taken some commendable steps to allow Sukuk financing,' said Arul Kansasamy, head of Islamic Banking at Barclays Capital.
The FSA describes London as 'a centre of choice for listing Sukuk by establishing the world's first secondary market for Sukuk.' Sukuk trade volumes in London now exceed $2 billion.
Islamic finance is based on the principles of Sharia law and operates without the use of interest. So the products offered are structured in a different way to those provided by conventional banks and financial institutions.
There are also laws regarding the type of business financial institutions can deal with. Investment in business involved with arms, pork, tobacco, drugs, alcohol and pornography are not permitted.
Although they cannot charge interest, they can profit from customers buying a property using different schemes whereby the customer is charged rent, for example. They are structured so that they retain a clearly differentiated status between shareholders' capital and clients' deposits to make sure profits are shared.
A key issue, according to James McDonald of international legal firm Lovells, is the interpretation of Sharia law. Each bank has a Sharia Supervisory Committee or Board who advise on Sharia law.
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But according to McDonald, and this is backed up by the FSA, there is a shortage of scholars. Also the interpretation of Sharia law varies with some scholars more strict than others. 'We need Sharia scholars that are flexible and open to the needs of investors,' he said.
Lovells, a major player in the sector that advises on the structuring, regulation and tax implications of Islamic finance, has seen a huge surge in demand for its services and has an office in Dubai. McDonald, a partner in the funds team based in London, believes Sharia-compliant investment funds are a major growth area and large funds cannot ignore this. 'If your investment fund is not Sharia-compliant then you have no chance of tapping in to the huge amount of wealth in the Middle East,' he said.
A sign that Islamic finance is edging towards becoming more mainstream is the range of products now on offer. IBB launched the UK's first completely 100% Sharia compliant home purchase plan earlier this year. It is not just aimed at Muslim customers.
'As lenders withdraw many of their products, customers uncertain of what their options are as a result of the credit crunch will find this offers a new way of financing a home purchase. A growing number of non Muslims are turning to more ethical products,' said Sultan Choudhury, commercial director of IBB.
Indeed IBB has always marketed its services and products beyond the Muslim community.
Although banks like HSBC are involved in Islamic retail banking, they have not yet moved into investment banking or commercial financing. But it is only a matter of time. 'The opportunities are growing. The UK government is really committed to making this market flourish in order to make London a hub for Sharia banking in Europe,' said Nade Kamel, of HSBC.
Islamic insurance, or Takaful, is another growth area. London now has its first Islamic insurance provider. The Salaam Halal company is backed by finance from the United Arab Emirates, Saudi Arabia, Bahrain, Kuwait and Malaysia.
Not only is London becoming the key centre outside the Middle East, it is also acting as a global gateway for Middle East banks into Europe. By having offices in London they can, under EU agreements, offer products in other EU countries without the need for separate authorisation, or even a presence, in each country.
This also offers opportunities for investment companies. Global Securities House, a Sharia-compliant international property firm based in Kuwait, has opened an office in London to establish a UK investment arm.
'We were attracted by the UK government's policy to attract more Islamic financing to London. The city is increasingly popular with Muslim investors because of the favourable regulatory regime. The UK is well known for its innovative financial products and also for the deep pool of professional talent,' said managing director Richard Thomas.
Gatehouse Bank, a subsidiary of the Securities House of Kuwait, was approved by the FSA in April this year. Samer Merhi, executive director, believes the potential for growth is massive. 'The UK has the potential to become the international heart of the Islamic finance business because of the high demand,' he said.
Other European nations are envious and indeed anxious to catch up. France, in particular, is trying to attract more Islamic finance. Recently Rudolf Bohmlet, executive board member at Deutsche Bundesbank, praised London.
Next year sees the world's first conference fully focused on exploring the financial relationship between Europe and the Middle East. Islamic Investment World 2009 next May in Geneva is taking place as a result of demand.
'Investors globally are seeking a safe haven from sub-prime debt, excessive volatility, out of control inflation and central bank meddling. Private equity, structured products, hedge funds and other alternative opportunities are rapidly emerging and catching the eye of the biggest investors in the Middle East,' said a spokesman for the event.
