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The current crisis provides Islamic finance with a rare opportunity to reinvent itself and to appeal not just to the 1.5 billion Muslims in the world but the rest of humanity too, which is suffering as a whole from the collapse of free market capitalism and for whom the pain is likely to intensify next year, as the effects of the financial crisis are fully felt in the real economy in the form of higher costs and fewer jobs.
Islamic finance needs to focus less on complying with each rule and more on reflecting the principles which underlie those rules so that transactions are no longer Sharia-compliant but are Sharia-based.
The AAOIFI statement on sukuk issued in February 2008 (which stated that purchase undertakings, where the exercise price was fixed at issuance, were not Sharia-compliant for sukuk based on musharaka, mudaraba and wakala structures) reflected the frustration of scholars at the manipulation of Sharia rules by clever bankers and lawyers wanting to create products that did not reflect the underlying principles of Islamic finance but that do fit into a model that is easily understood by conventional investors who thus far have tended to be the main investors in sukuk.
This may change as Islamic investors are attracted by the more predictable returns offered by sukuk in an attempt to diversify their asset pool from the more volatile property and equity markets.
In the current climate there seems to be a widespread revulsion against excessive speculation, the trading of risk and the payment of large bonuses for short term gains that are believed to have been amongst the causes of the current financial crisis.
If Islamic finance is seen in its true guise as a form of ethical financing, of interest to all rather than only as a faith-based activity of interest to the Muslim population, it is likely to find favour with a different type of conventional investor who would be potentially willing to consider different types of risk-reward stuctures.
The non-Islamic world's increasing interest in understanding Islamic finance is likely to continue as cash-strapped companies look to the Gulf as a possible source of funding and begin to explore Sharia-compliant structures for the first time.
Their governments are responding by following the UK model to create a level playing field through removing tax and regulatory obstacles.
Non-Muslim majority countries in Europe, such as the United Kingdom, France and Italy are ensuring that their legal systems create a level playing field for Sharia-compliant structures.
In Asia, Singapore and Hong Kong are vying to be the hub for Islamic finance, despite Malaysia's traditional dominance.
Even if the hoped for liquidity does not materialise for many of these companies and their advisers, their research into Islamic finance as a source of possible funding will be valuable in consolidating the position of Islamic finance as a form of finance available to all.
This process could help to realise the 'New Silk Road' of financial flows linking Asia and the Middle East that Dr Zeti Akhtar Aziz, Governor of Bank Negara Malaysia (the central bank), has discussed.
Tougher business conditions and a reduced deal flow next year will also give market participants an opportunity to respond to the demands of the market for increased harmonisation of Islamic principles, products, documentation and processes both markets and across markets.
This process has already started with the launch of the IIFM/ISDA Commodity Murabaha form and with the creation of working groups to consider how best to structure sukuk in order to address AAOIFI's concerns.
It is possible to argue that the market reaction to the AAOIFI statement on sukuk has demonstrated the importance of AAOIFI as an institution to the Islamic financial markets and so the need for a central decision making body is also being addressed in response to the current crisis.
The next year is likely to be a milestone in the development of Islamic finance since it will address its first global crisis and is likely to respond by consolidating its principles and procedures, developed in the very short time period that it has formed part of the global financial industry.
Islamic finance is a very young industry despite relying on principles established 1,400 years ago. It was only used in the West in the 1970s when Sharia-compliant trades were carried out on the London Metal Exchange.
The pace of innovation that Islamic finance has shown in the last four years demonstrates that it is a fast learner and that it is likely to respond to the challenges of 2009 by emerging as a stronger and larger part of the global finance industry.
l Farmida Bi, a partner at Norton Rose LLP, has specialised in capital markets transactions for over 15 years and has advised on English and New York law debt and equity capital markets transactions (including Islamic finance and securitisations), emerging markets, regulatory issues, structured finance and mergers and acquisitions.
She acts for a broad range of the leading financial institutions and for both sovereign and corporate issuers.
Farmida is an expert in Islamic capital markets and has advised the arrangers on a number of the leading transactions, including the Tamweel securitisation, recognised as the first Islamic true securitisation, and on the PCFC Sukuk issue to fund Dubai World's purchase of P&O. Farmida qualified as solicitor in 1992 and as a New York attorney in 1999.
Norton Rose LLP is an international legal practice with offices worldwide. Its Bahrain office was established in 1979 at the request of the Bahrain Monetary Agency - now called the Central Bank of Bahrain.
