Dubai is a key financial center in the Gulf, but is it also relevant as a regional hub for Islamic finance? CAMILLE KLASS looks at this hotly contested title to see where Dubai stands against rising competition from its neighbours.

Home to most of the world`s top banks, with a strong, cost-competitive and international business environment, excellent infrastructure and air links, not to mention its strategic commercial position, Dubai is regarded as the leading financial center in the Middle East. It is also viewed as a regional hub for Islamic finance.

But what does it mean to be a hub for Islamic finance?
"There has to be underlying demand and a critical mass of institutions, good business activity in capital markets, investment banking business, and of course, an underlying retail market, so that a secondary market can develop together with product innovation and a proper yield curve," says Humphrey Percy, chief executive officer of the Bank of London and Middle East (BLME), a London-based wholesale Shariah compliant bank.

Dubai ticks many of those boxes, thanks to a strong commitment to attracting Islamic financial institutions. The world`s first fully fledged Islamic bank, Dubai Islamic Bank, is based here, and the state has focused on developing effective legal and regulatory infrastructure, allowing it to create and export innovative Shariah compliant products to such countries as Australia and those in Europe.

The establishment in 2004 of the Dubai International Finance Center, a legal and financial free-zone, with a specific business objective of developing Dubai as a global center for Islamic finance, has played a major role in its claim to that title.

The DIFC hosts 17 of the world`s top 20 banks, eight of the world`s largest asset managers, four of the world`s largest insurers, as well as Nasdaq Dubai which, as the largest exchange for Sukuk trading, facilitates the primary listing and secondary trading of sophisticated Islamic financial instruments.
"Dubai`s key strength is the fact that it has managed to attract most of the major banks into the DIFC and these banks have all found different models to issue Sukuk and other Shariah compliant financial products," says Dubai-based Russell Matcham, chief executive officer of private business association Capital Club. "It`s because many banks in the Middle East have their headquarters in Dubai that it can be seen as a place where there`s leadership".

But with other Gulf countries stepping up their efforts to develop Islamic finance, can Dubai retain its leading position? After all, the title of Islamic finance hub is hotly contested, and one that Bahrain held until recently (and some industry participants argue still does).

"There is a shift taking place," observes a Bahrain-based Islamic banker. "In less than ten years, where Bahrain has been challenged is that most international banks, for whom Islamic finance isn`t a core component of the business, have re-domiciled to the UAE".

"Bahrain has from the 1960s been the banking hub and until recently everyone saw it as the financial hub," says Capital Club`s Matcham. "But, overtly, Dubai took that mantle quite quickly after opening the DIFC".

BLME`s Percy is among those who believe the title still belongs to Bahrain. "It should be remembered that Bahrain has a robust regulatory system and a strong central bank," he explains. "Although Dubai is the largest financial center [in the region], Bahrain is better suited for Bank of London and the Middle East and we consider it to be the Islamic finance hub of the region". BLME recently chose Bahrain as the location for the bank`s first overseas office, opening this year.

"Traditional banking people like the history and track record of, and are comfortable with, Bahrain," says Matcham. "It`s a more tested jurisdiction than Dubai because of its track record".

The constant flow of international conferences that come to Bahrain, plus a supportive central bank, transparent regulatory system, thriving funds industry, legal contracts governed by its own laws and an ideal position in the middle of the Gulf form the package of attributes that contribute to its position as a pre-eminent financial center, says the Islamic banker.

In terms of the quantity of transactions, the number of institutions that issue standards, and the number of banks, Bahrain is by far the leader in the region, he adds. Bahrain has over 400 licensed financial institutions.

In terms of influence-wielding organizations, Bahrain is the gold standard, with bodies including the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), the Liquidity Management Center, the Islamic International Rating Agency, and the International Islamic Financial Market all based there.

Dubai will have its own Islamic finance institute when the newly establis hed World Institute of Islamic Finance(WIFI) opens its office in Dubai this year. WIFI is supported by Agha and Company and includes several large banking groups such as Al Baraka Banking Group and Deutsche Gulf Finance.

Given Bahrain`s long financial sector track record and its strong legal and regulatory environment, and with countries such as Qatar and Saudi Arabia raising their game in the Islamic finance stakes as well, Dubai will need to be more proactive or it may risk losing the title of Islamic finance hub. "Qatar has fantastic resources - and it appears to be developing and implementing a vision for Islamic finance", said Agha & Co founding partner Oliver Ali Agha. "They seemingly want to be an Islamic finance hub".

Qatar`s central bank recently asked conventional banks operating in the country to cease their Islamic finance activities by the end of the year, because of the difficulty in managing the risks arising from the overlapping of their Islamic and non-Islamic banking activities. The bold move to keep conventional banking operations separate from Islamic banking operations could set a precedent for other countries in the region.

Saudi Arabia, the Gulf`s largest economy, is also a strong contender for the title and has an edge because "Shariah has been the law of the land since time immemorial," according to KFH Research in Kuala Lumpur. Couple that with their financial clout and the development of the King Abdullah Financial Center, and Saudi Arabia has a good shot at taking the mantle of Islamic finance hub for the region, foresees Matcham. "The only impediment is that it`s not the easiest place for non-Islamic banks to open and to attract top talent," he adds.

In view of the competition, Dubai - whose legal framework is relatively young and untested compared to Bahrain`s - will need to raise its game, even though the building blocks which contribute to its potential as an Islamic financial hub are based on far wider foundations than economic performance alone" says KFH Research. Dubai has a sound regulatory framework, transparency, human capital, and benefits from the presence of large institutional investors and global financial institutions.
"Having a Shariah supervisory board that helps guide the Shariah process, and legal representation that helps Islamic financial institutions understand how legal issues [and] concerns will be addressed, will give credence to entities operating in the grey area, knowing what will happen," Agha says. "Action needs to be taken on a high level".

What`s at stake for Dubai?
Dubai would stand to lose a lot if its bid for pre-eminence in Islamic finance fails and it is overtaken as regional hub by a competitive neighbor.

"In this part of the world, Islamic finance is an increasingly important avenue of financing," says Agha. "Therefore, those hubs that have a developed infrastructure and a legal and regulatory system that can house such financings will be in an advantageous position to draw projects vis-a-vis those that do not".
"With the trillions of dollars underway in projects and the amount of work that needs to be done in this region, the hub that boasts the leading expertise will stand to draw a lot of institutions and business," he adds.

KFH Research believes that given the importance of the financial sector to the Dubai economy, as well as the emirate`s strategy of diversification away from reliance on the oil industry, hub status is crucial for Dubai. While competition for the title is currently between Dubai and Bahrain, there is no clear indication of who will win the race, especially as more countries join the race.

In fact, industry participants believe the region may well end up with more than one Islamic financial center, instead of a single hub. "There can be more than one financial center in the Middle East because they fulfill different roles in the various individual countries," explains BLME`s Percy. "There isn`t a move towards a single financial center in the Middle East... that could have happened when the single currency was mooted in the Middle East, but plans for that are on hold".

What does this mean for Bahrain and Dubai going forward?
"You`ll continue to see two main trends. International banks setting up in the Middle East will want to maintain a larger head office presence in the UAE, while Bahrain will continue as the [center] for new Islamic banks being established, and will be recognized as the jurisdiction where you can set up Shariah compliant funds and have the right support," said the Islamic banker.

And, in the larger scheme of things, more Islamic finance centers - regionally and globally can only be a good thing if it means widening the market and increasing the number of offerings and level of participation.