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Islamic Finance August 2011

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HOW TO RUN AN ISLAMIC BANK PUTTING CORPORATE STRATEGY IN PLACE

UK: ÂŁ6.00

Islamic Project Financing Setting the Agenda for Innovative Opportunities

State of Qatar End of Islamic Banking Windows

Islamic Finance gains momentum in Europe

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Contents;QWERTYUIIOPDFHJUIIOPDFHJJ News

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9 Islamic Finance News Islamic Banking 14 How to run an Islamic bank Part I: Putting corporate strategy in place, values, regulations

The term ‘Islamic banking’ means the carrying out of banking operations in compliance with Shariah principles. Islamic banking and finance have been growing rapidly over the years. Its successes not only include countries with large Muslim populations but also those countries where the Muslim population is a minority. Banking practices with the concept of receipt and payment of interest are not in accordance with Shariah principles. In the past Muslim communities could not avoid conventional ways of banking but Islamic banking practices have been flourishing over the past years so that Islamic finance is now recognised throughout the financial world...

Interview 25 Islamic Finance is one of the key functional areas for the Halal Industry

Interview with Mahmood Hasan, CEO of Rasul Group of Companies Mahmood Hasan is the CEO of Rasul Group of Companies, Pakistan. With a Masters in Business Administration he established this entrepreneurial venture in 1983. His transformational leadership and visionary approach led to the establishment of the brand Bake Parlor. The Halal industry and Islamic finance share an economic and ideological interdependence and also have a high growth potential when looking at the retail and commercial forefront...

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World Islamic Finance Review 28 State of Qatar: End of Islamic Banking Windows

At the beginning of February, 2011, Qatar Central Bank (QCB) notified all conventional banks in Qatar that they were required to stop operating Islamic windows (IWs) by the 31st of December 2011. On the 10th of February 2011, QCB issued a public press release detailing the requirements and explaining the reasons for its decision to stop the operation of the IWs...

32 Part 1: Islamic Finance gains momentum in Europe

Islam all too often resonates negatively in Europe, with much non-Muslim public opinion uncomfortable with Islamic culture and values. Secular and Christian opinion is at best suspicious of Shariah, Islamic law, and indeed often antagonistic. The notion of wanting to apply Shariah principles to banking and finance is treated with scepticism if not outright hostility, especially as there is no concept of Christian or Jewish banking, even if there are some parallels between Shariah financial principles and the teaching of the Old Testament...

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Islamic Finance 42 Part 1: Islamic Project Financing Setting the Agenda for Innovation Opportunities

The global demand for Islamic project financing is growing at an unprecedented rate where many investors around the world are looking into major financial hubs to aid in funding lucrative projects. As the Islamic financial market adheres to the principles set out by Shariah law all investments and projects have to be constructed in a Shariah compliant manner and authorised by an Islamic financial governing or regulatory body of the country. There are many lucrative sectors which provide scope for profitable projects across the spectrum of Islamic finance. Traditionally projects in the infrastructure sector proved more rewarding as there were many opportunities especially in the Islamic financial hub of the United Arab Emirates...

48 Do Conventional and Islamic Finance Share Common Epistemology?

An overall socio-political-economic system gives rise to an economic system out of which grows a system of financing to facilitate production, trade and exchange. The idea of the contemporary conventional economic system is usually traced to Adam Smith’s conception of an economy as envisioned in his book, the Wealth of Nations. What has been ignored until recently, however, the fact that, from an epistemological point of view, Smith’s vision of the economy is embedded in his vision of a moral-ethical system that gives rise to the economy envisioned in the Wealth of Nations...

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August 2011


Marketing and Branding

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55 Unleash the Power of Internal Marketing in your Islamic Financial Institution

There are various forms of marketing techniques and strategies that can help to spur the Islamic finance industry forward. However one such technique which cannot be understated is the effectiveness of using internal marketing strategies. So what exactly is the concept of internal marketing? Internal marketing is the application of processes and principles within the marketing framework of financial institutions. Internal marketing therefore involves a business or company using various different methods and dividing marketing roles within their departments transforming them into business units...

Sukuk 62 Analysis of Sale/Debt based Sukuk: The Malaysian Saga, part 2

The absence of bonds instruments in most al-murabaha project finance particularly in the ever liquid Middle-East countries may be explained by the controversy on the validity of using bai al-‘inah in the securitisation process and the application of bai al-dayn at a discount in bonds in secondary trading. The question now is; what are the underlying issues behind this controversy about the legitimacy of bai al-‘inah and bai al-dayn in Islamic law? What could explain its rejection in the Middle-East countries while gaining acceptance in Malaysia?...

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Market Review 54 Russia needs Changes to Law to Facilitate Sukuk

As the Islamic finance industry is growing at an unprecedented speed, Russia still remains to have changed laws in order to facilitate sukuk. Russian borrowers are pitching plans to sell the nation’s first Islamic bonds even as regulators lag behind in customising laws for the industry...

72 Oman to Add a Staggering $6 Billion Worth of Islamic Financial Assets

It has been reported that Oman is to add a staggering $6 Billion worth of assets for the development over the next few years, according to estimates by Ernst & Young’s Islamic Financial Services Group...

74 Islamic Countries Urged To Adopt Economic Financial Reforms

Saudi Arabia’s finance minister has reportedly urged Muslim countries to adopt suitable economic reform programs and adapt to the changing global financial economic changes to confront the challenges of facing them and building solutions...

75 Islamic Finance Trade Sector Expands in Asia and Middle East

Islamic trade finance has grown progressively towards Shariah-compliant banking and could serve as one of the key growth drivers to aid the $1 trillion Islamic finance industry in its growing global expansion...

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80 Gulf Banks Tackle Challenges to Boost Shariah Investments

Gulf Banks are making significant efforts to boost Arabian Gulf banks saying that they are more ready to accept Asian Islamic debt as Shariah-compliant, allowing them to invest in a market that has issued twice as much sukuk as the Middle East this year...

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International Editorial Board Prof Dr Khawaja Amjad Saeed, Principal of The University of the Punjab, Pakistan Prof Habib Ahmad, Sharjah Chair in Islamic Law and Finance in the School of Government and International Affairs at University of Durham, United Kingdom Prof Rodney Wilson, Professor in the School of Government and International Affairs at Durham University, United Kingdom Prof Humayon Dar, Chief Executive Officer at BMB Islamic UK, United Kingdom Prof Muhammed Shahid Ebrahim, Professor of Islamic Banking and Finance at the Bangor Business School, United Kingdom Prof Andrew White, Director of International Islamic Law & Finance Centre, Associate Professor of Law, Singapore Management University, Singapore Prof Simon Archer, ICMA Centre, Henley Business School, University of Reading, United Kingdom Hailey College of Banking & Finance, University of the Punjab Dr Majdi Ali Ghaith, King Saudi University Assistant Professor Business Administrator Department, Saudi Arabia Dr Abu Umar Faruq Ahmad, School of Law University of Western Sydney Australia, Australia Dr Julien Pelissier, Lecturer in Islamic economics’ law, France Dr Alberto Brunoni, Founder and Director of AASAIF, Italy Dr Aznan Hassan, Shariah scholar Bursa Malaysia, Malaysia

Dr Zukifli Hassan, PhD Research Scholar at University of Durham, United Kingdom Dr Mohammed Obaidullah, Economist at the Islamic Research and Training Institute (IRTI) of the Islamic Development Bank, Saudi Arabia Dr Amal El-Kharouf, Head of Research and Consultancy Department at University of Jordan, Jordan Dr M.Kabir Hassan, Associate Professor and Associate Chair of the Department, University of New Orleans, USA Dr Abdelhafid Benamraoui,Westminster Business School, United Kingdom Dr M. Ishaq Bhatti , Faculty of Law and Management, La Trobe University, Australia Mughees Shaukat, PHD researcher and Assistant Researcher in INCEIF & ISRA, Malaysia Warren Edwards, CEO of Delphi Risk Management, United Kingdom John Sandwick, Islamic Wealth & Asset Management Independent Consultant, Switzerland Brian Kettel, Director at Islamic Banking and Finance Training, United Kingdom Salina Hj. Kassim, Department of Economics atInternational Islamic University Malaysia, Malaysia Kasim Randeree, Saïd Business School, University of Oxford, United Kingdom Abbas J. Ali, School of International Management Eberly college of Business,Indiana University of Pennsylvania, USA

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Basil Armoush, Jordan Bouhssine Ben Jadda, Morocco Auwalu Ado, Nigeria Adeeb Zaki, Pakistan Asim Hameed, Pakistan Muhammad Farrukh Saleem, Pakistan

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Editorial Letter Islamic Banking is fast developing in the global financial world with many establishments being set up worldwide to cater for the demands of both Muslims and Non Muslims around the world. It is therefore imperative that the development of Islamic banks is well defined and the system of running a Shariah compliant bank is well understood by all industry professionals. The last decade has seen an increasing demand for Shariah compliant banking with well established conventional banks opening up Islamic windows to cater for the rising demand. The UK alone has an estimated US$300 million of combined assets and overall the Islamic finance industry is expected to rise to over US$1 trillion. This provides adequate scope for the development of Islamic banks and a real opportunity for companies and interested business professionals to learn more about running an Islamic banking institution.

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Islamic banking is at the peak of its success with many branches opening up worldwide. It is therefore crucial that both business professionals and entrepreneurs understand the best ways to establish an Islamic financial institution which adheres to the principles of the Shariah

If you are considering opening up an Islamic bank there are a number of issues which need to be addressed. It is first and foremost crucial that you have a good support team and reliable regulatory body who understand the concepts of Shariah finance to the core. With efficient Shariah supervisory backing your financial institution you can then implement the facilitation of Shariah compliant products and services which are currently in global demand around the world. Islamic banking institutions cannot divert from the ethics of Shariah as all transactions should remain Shariah compliant and this should be the primary ethos when establishing and running your bank. Malaysia, the Middle East and the GCC have played a significant role in supporting the facilitation of the running of Islamic banks around the world. The Islamic Development Bank (IDB) in particular has contributed significantly to the implementation of Islamic banks and funding throughout the world and is a forerunner in establishing Islamic banking institutions worldwide. It is important to remember that developing strategies is key in achieving profitable asset growth for any potential development of an Islamic bank. Improving the position of risks is a crucial aspect that contributes significantly to the Islamic banking strategy, although Islamic banks have managed well in overcoming negative asset of invest-

To write the letter to the editor, send an email to editor@globalislamicfinancemagazine.com.

8 Global Islamic Finance

August 2011

ment depositors. Islamic banks have more than 300 institutions spread over 51 countries, including the United States, as well as an additional 250 mutual funds that comply with Islamic principles. It is estimated that over US$822 billion worldwide Shariah-compliant assets are managed according to The Economist. Although the implementation of Islamic banks may face some challenges such as liquidity and the lack of Islamic liquid instruments it still has potential for any avid investor wishing to tap into the lucrative current market. Islamic banking is continuing to grow which is why many international banks such as HSBC, Deutsche Bank and many others have developed their own Islamic windows or services. The main challenge that the heads of Islamic banks face is the core problem of regulatory conformity to the Shariah. Therefore standardisation is key in Islamic finance to ensure that all transactions and services have set guidelines which can be applied to Islamic banking institutions worldwide. Islamic banking institutions need to address these challenges and work effectively alongside Islamic regulatory bodies to ensure Shariah compliancy at all times which will help to build up the prestige of Islamic banks around the world. Promoting transparency and product breadth can further help Islamic banks to be successful in promoting Shariah-compliant funds. With almost 2 billion Muslims worldwide and a vast number of Non Muslims who prefer to use the ethical methods of Shariah-compliant financing there is much scope for the development and success of Islamic banks worldwide.

Farhad Reyazat PhD in Risk Management Editor in Chief


News

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Islamic finance news Bank Rakyat Indonesia’s Shariah Branch Debuts Scheme to Tap Gold in Islamic Finance It has been reported that BRI Shariah, a subsidiary of state-owned Bank Rakyat Indonesia, has launched a new product that allows its customer to buy gold in instalments, in a bid to draw broader segments of the population to Islamic banking. The bank plans to provide Rp 400 billion ($46.4 million) in financing for customers to buy gold, president director Ventje Rahardjo said. The first scheme of its kind in Indonesia, Precious Metal Ownership (KLM) is intended to appeal to the young, middle-class population because of its long-term investment appeal, with customers able to pay in instalments from six months to 15 years, Ventje said.

At the end of May, BRI Syariah’s total financing was almost Rp 6 trillion, about a third of which came from consumer financing. Ventje said the bank wants to reach Rp 9 trillion in financing by the end of 2011. The high target will erode the lender’s capital adequacy ratio to 15 percent by the end of this year, he said. As of May, its capital adequacy ratio was at 20 percent. Although the bank has the full support from its parent company, it did not rule out selling sub-ordinate sukuk to bolster its capital. Tenaga to Sell $1.7 Billion 20-Year Islamic Bond, CEO Says Tenaga Nasional Bhd., Malaysia’s biggest power producer, plans to raise as much as 5 billion ringgit ($1.7 billion) from a 20year ringgit-denominated Islamic bond offering.

“Imagine that in 1998 gold was around Rp 78,000 per gram, and now it’s already over Rp 400,000 per gram,” he said. “How many have regretted not buying it at that time? With this facility, customers can buy gold at the current price and pay that in monthly instalments.”

Its chief executive officer said, “We plan to sell the bonds in August or September,” Che Khalib Mohamad Noh said. Proceeds from the offering, the company’s first debt sale since 2004, will be used to finance a coalfired Manjung power plant in the northern state of Perak, Che Khalib said.

The product utilises two Shariah contracts, qardh and ijara. Under qardh, the bank loans money to the customer to buy the gold, and the debtor is only required to repay the amount borrowed. The customer must keep the physical gold in the bank’s vault which, under ijara, is rented out by the bank.

The utility is raising power generation capacity to meet rising demand on the Malaysian peninsula after shelving plans to buy electricity generated by the Bakun hydroelectric dam on Borneo Island earlier this year. The 20-year paper will help alleviate a shortage of longer-dated securities that insurers need to match assets and liabilities.

Islamic finance must match the level of service and innovation of conventional banking, Ventje said, and that means taking unique approaches. “I think the ‘hardcore’ Shariah market is finished,” he said, “For Islamic banking to expand, it has to see itself as part of overall banking, not as an alternative.” Total Islamic lending in Indonesia reached Rp 75.7 trillion by the end of April, compared with Rp 1,843.5 trillion in conventional banking, according to Bank Indonesia data.

“There will be demand for Tenaga’s sukuk as long-dated corporate Islamic paper is scarce,” said Michael Chang, who oversees $1 billion as head of fixed-income at MCIS Zurich Insurance Bhd. in Kuala Lumpur. “Ultimately, demand will depend on the interest-rate outlook and pricing.” The Islamic insurance, or takaful, industry grew at an annual pace of 16 percent over the last five years, double that of non-Islamic insurers, RAM Rating Bhd., the bigger of Malaysia’s two rating companies said last

week. Sarawak Energy Bhd., a Malaysian state-owned electricity company based on Borneo Island, sold 3 billion ringgit of 5-, 10and 15 year Islamic bonds last month at the lower end of its yield guidance. “It’s the right time to sell bonds in the domestic market as there’s a lot of liquidity,” Che Khalib said, adding that three investment banks have been short-listed as underwriters. “The attractive price for the government’s sukuk sold last week is a good benchmark.” Sri Lanka Commercial Bank Launches Islamic Finance Unit Sri Lanka’s Commercial Bank said it is starting alternative banking services compliant with Islamic Shariah principles with a three member committee of scholars to ensure that all products and services under the Islamic unit are Shariah compliant. “As one of Sri Lanka’s largest private banks it is our obligation to ensure that the services the unit provides are fully compliant with the tenets of the Shariah,” managing director Amitha Gooneratne said in a statement. M M A Mubarak, Fazil Farook and M M Murshid, from Sri Lanka’s All Ceylon Jamiyyathul Ulama will be on the Shariah board. Commercial Bank will offer deposit products such as ‘Mudaraba’ savings accounts and ‘Mudaraba’ investment accounts’ and asset products such as ‘Murabaha,’ ‘Musharaka,’ ‘Diminishing Musharaka,’ and ‘Ijara’ leasing and import financing. The bank said the products operate on the Islamic principle of both the bank and the customer sharing returns as well as risks. Mudaraba, which is a form of profit sharing investment, is a partnership where one partner provides full capital while the other manages the business. Any profit made using the funds is divisible between the customer and the Bank at a predetermined ratio agreed to by both parties. Murabaha is the sale of goods by the Bank to customers at a cost plus profit where the selling price is decided at the time 2011 August Global Islamic Finance

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News

of the sale. Murabaha can be used for local purchases or import of trading commodities and the customer is given a fixed tenor to settle the sales proceeds, the bank said. Musharaka is a method of financing based on partnership, used for asset financing and export financing. Partners are entitled to a share in the profits that result from the project at a predetermined ratio which is mutually agreed upon at the time of entering into the contract. Diminishing Musharaka is a partnership in which one partner (the customer) will purchase the Bank’s share in a fixed asset over a predetermined period and become the owner of the asset. The ownership of it will be passed to the client upon successful completion of the agreed terms. This can be used for property purchase, housing purposes and project finance. Available for unregistered vehicles and equipment and machinery, Ijara is a contract where the lessor (Bank) who owns the asset transfers its usufruct to another person for an agreed period at an agreed rental. The asset will be gifted to the customer when all lease rentals are met on time. Import financing involves providing letters of credit with financing on Islamic terms, this includes import Murabahas. Bahrain’s Elaf Bank Licence Granted By Malaysia Bahrain-based Elaf Bank, licensed by the Central Bank of Bahrain to operate as a wholesale Islamic bank with a paid-up capital of $200 million, has been granted a license by the Ministry of Finance Malaysia to open a branch office under the Malaysia International Islamic Finance initiative in Malaysia. Elaf Bank was presented with the license during a formal ceremony held at Bank Negara Malaysia in the presence of key officials and representatives from both sides. Elaf Bank plans to start its branch office operations in Kuala Lumpur immediately now that it has fulfilled the formalities required for obtaining the license. Jamil El Jaroudi, CEO of Elaf Bank, highlighted the importance of opening a branch office in Malaysia, which falls in line with the bank’s long-term business strategy. He said “Elaf Bank is developing its business through two hubs covering the GCC and MENA region and the South East Asia region, as a two-way business corridor. Be10 Global Islamic Finance

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ing a wholesale Islamic bank headquartered in the capital of Islamic finance in the Middle East (Bahrain), the logical next step would be to open our first international branch office in the capital of Islamic finance in South East Asia (Malaysia). This will help us operate more efficiently and closely to meet the needs of our cross-regional clients, and be able to execute deals that will contribute to the sustainable growth of the Islamic finance industry in both strategic markets,” he added.

sukuk secondary market to act as a market maker. Elaf Bank currently provides a wide range of financial services to clients involving investment banking including fund-raising advisory, mergers and acquisitions and asset management and treasury and capital markets such as liquidity management, foreign exchange, investment, structured products and derivatives.

“We firmly believe the bank is poised to not only widen its scope and reach through the opening of the branch office in Malaysia, but also to consolidate its excellent client relations and business activities as a result of this step, which will no doubt generate benefits for both regions and create value for the Bank,” Jaroudi said.

The UAE Central Bank is doing unprecedently well and is about to launch a facility for repurchase for Islamic certificates of deposits in order to provide a new liquidity tool for the OPEC member’s banks.

Elaf Bank is a closed shareholding company incorporated in Bahrain. The bank encompasses the full spectrum of wholesale Islamic banking with an additional differentiating dimension geared toward developing the Keep updated with latest news online

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UAE Central Bank To Launch Islamic Certificates of Deposit For Repo Facility

It has been quite a challenge for the UAE with the lack of liquidity management tools in the Islamic finance industry, which has close to $1 trillion worth of assets globally. The Shariah compliant principle of the ban on interest rules out the possibility of most interbank tools therefore liquidity tools need to be further developed. “The Shariah-compliant facility, which accepts the Central Bank’s Islamic certificates of deposits as collateral, is introduced to provide a source of liquidity to banks,” the central bank said in its circular to banks, which was seen by Reuters. The new facility is based on a murabaha concept; the circular also showed Murabaha is a sales contract, usually employed in commodity transactions, that involves the purchase from an independent supplier which is then sold at an agreed price that includes the institution’s costs plus additional profit. In November, the UAE central bank launched auctions of Islamic certificates of deposit, which saw volumes increasing steadily. Banks held 12 billion dirhams ($3.3 billion) worth of the certificates in April, some 10 percent of the overall volume, central bank’s data show. “It is a repo with Islamic certificates of deposits as collateral against cash and allows them to free up liquidity when needed,” said an executive at an Abu Dhabi-based bank. “There is a shortage of liquidity instruments and it is more pronounced on the Islamic side,” he said, asking not to be named. Islamic finance accounts for around 17 percent of banking assets in the UAE. The UAE central bank’s monetary policy is limited by its dirham peg to the US dollar. It uses CDs auctions and repurchases facilities among other tools to regulate liquidity in the banking system. Late last month, the central bank said it planned to tighten regu-


News

Malaysian Islamic Banks See A Brighter Future Islamic banks in Malaysia enjoy a bright future as they are able to compete and have the resilience to survive in the country’s open and competitive economy said Dr Awan Adek. Malaysia is an unprecedented Islamic financial hub with a significant scope to provide a benchmark to other Islamic financial hubs around the world.

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Islamic finance is one of the fastest growing industries in the world. However, authentic education on the subject is not widely and easily available. We are delighted to work with Durham University and Hawkamah to fill this vacuum and create what will be the benchmark in Islamic finance teaching. For the first time in the UAE, practitioners as well as students can benefit from a curriculum designed to teach both the academic and practical skills needed to succeed in Islamic finance

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Dr. Hussain Hamed Hassan, Managing Director, Dar Al Sharia

ercise for banks, including for Islamic banks, except if the banks themselves conducted such an exercise. He alluded to the government’s merger of commercial banks under which 23 local banks were merged into nine. “Any merger exercise in future will hinge on the business decision by the banks’ board of directors and shareholders. “Given the increasingly competitive economic scenario today, banks will find ways and means that will favour them,” he said. Awang Adek said completed merger exercises thus far had yielded good impact for banks as they have emerged stronger with higher working capital, have opened more branches and enjoyed higher national profile in the banking sector. “The mergers have also enhanced banks’ financial standing; improved their internal

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lations on how banks in the second largest Arab economy manage liquidity so they can better cope with future crises. UAE lenders remain hesitant to lend following Dubai’s $25 billion debt restructuring last year and weakness in the property sector, although deposits stand at their highest level in more than two years as the country enjoys safehaven status amid unrest in the region.

Institutional and corporate banking will always be more volatile than the retail side. However, the retail side has the most untapped potential in terms of offering investment products, Takaful and other forms of financing. Financial institutions that focus on the retail side will win over those focused on the institutional side

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Tariq Al-Rifai,

Director, Dow Jones Islamic Market Index

Deputy Minister of Finance Datuk Dr Awang Adek Hussin said 21 Islamic banks are operating in Malaysia, with RM351 billion in combined total assets.

risk management; quality of their assets, efficient management; and are able to venture into regional and global markets,” he added.

“There are 11 domestic Islamic banks; six foreign Islamic banks; and four international Islamic banks, reflecting bright prospects to plans to transform Malaysia into a premier international Islamic financial centre,” he said.

Bahrain Takaful Industry Prospering in 2011

Siti Zailah sought explanation on the implications to Islamic banks in the country following impending restructuring of the banks. Awang Adek said the government had still no definite plans to carry out a restructuring ex12 Global Islamic Finance

August 2011

The takaful industry in Bahrain is said to be prospering in 2011 as people are favouring Shariah-compliant methods of Islamic insurance. Takaful total contributions grew by 16.5 percent to reach BD13.4 million ($35.6m) in the first quarter of the year compared with BD11.5m for the same period last year,

according to the Central Bank of Bahrain (CBB). But traditional insurance still took the largest share of the market, down slightly at BD43.3m in the first quarter compared to BD44.1m last time. The insurance market in Bahrain consists of 27 domestic insurance companies and 11 branches of foreign insurance companies covering both direct insurance and reinsurance. The recorded data for the insurance market during the first quarter of the year shows a slight increase of 1.8 percent in gross written premiums in the quarter up from BD55.7m last time to BD56.7m. This growth was mainly due to the surge in the premiums of life insurance and the remarkable growth of the takaful. The combined capital of both conventional and takaful insurance companies grew by 4 percent to reach BD163.6m in the first quarter

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To prosper and grow, the Islamic financial industry needs to be served by firms that can deliver well-researched and designed tools that are Shariah-compliant and commercially viable; [it must] also comprehensively consider taxation, audit and accounting perspectives

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Neil D Miller, Global head of Islamic finance, KPMG

compared to BD157.2m in the first quarter of 2010. The total assets of insurance companies increased by 6 percent to BD1.29 billion compared to BD1.22bn last time. Conventional insurance reported the highest contribution in total assets at the rate of 79 percent. Reinsurance companies that operate from Bahrain showed a rise in both reinsurance premiums and net profit during the first quarter, increasing reinsurance premiums by 5.6 percent to BD151m compared with BD143m. The net profit of reinsurance companies increased by 3.8 percent to reach BD8.1m compared to BD7m reached previously. “The key indicators show that


News there has been minimal negative effect on the growth of insurance companies due to recent events in Bahrain, where indicators clearly show a rise in total insurance premiums, capital and assets of the insurance market in Bahrain, in addition to the remarkable growth of the takaful insurance industry keeping up with the growth of both the direct insurance market or the reinsurance market in previous years,” the CBB said. Islamic Finance The ‘Greener’ Ethical Option

Seetharaman, however, noted that Islamic banking is currently in its infancy and faces several challenges. Young people should be encouraged to take up these challenges to ensure that this significant economic system carries through and plays a leading role in the current global financial stage. He added that Islamic banking is growing in popularity as Japan has just issued five Sukuk Ijara (Islamic leasing bonds) and many other countries including Italy, Canada and Spain are showing great interest in such products and services of Islamic banking.

The Chief Executive delivered the inaugural address at a seminar on Islamic economics,

In the UK, there is a full-fledged Islamic bank, called the Islamic Bank of Britain, and there are 22 counters at conventional banks that offer Islamic banking services and products. Seetharaman noted that infrastructure development projects in India can attract foreign investment if the country opens up its banking sector to Islamic banking. India’s

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Islamic Banking is the right platform to boost ‘green financing’ as it is based on the concept of promoting good practices and values,” said R Seetharaman, Chief Executive Officer of Doha Bank.

Islamic finance is becoming much more prominent throughout the financial institutions of the world, rapidly growing from a niche industry to a mainstay of finance

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John Willsdon,

CIMA, the Chartered Institute of Management Accountants

organised by the Indian Islamic Association – Qatar (IIAQ), under the title “Towards an Alternative Economy” at Omar Bin Al Khattab Preparatory School for Boys in Doha. Seetharaman said Islamic banking is not just a financial system but it is part of a total value-based social system that seeks to enhance the general welfare of society as a whole. “Sustainable environment development, developing water resources, facing global warming, ensuring women’s participation and promotion of small-scale enterprises are all part of green financing. This is clearly an area where Islamic Banking can play a pivotal role,” he said.

We want to make that capacity available to regional Takaful, both in the GCC and Asia, in order to assist them in their reliance upon conventional facultative reinsurance for those risks that either exceed their own underwriting capacity or are for exposures that are not core to their underwriting capabilities. We hope that in time, all Takaful operators will realise that there is abundant Retakaful capacity available, and that they will seek to utilise only Retakaful when looking to mitigate their risk exposures and volatility of profits

,,

Richard Bishop, CEO of GNL Insurance

11th Planning Commission has earmarked $542bn for this sector, but hardly any money comes from the Gulf-based financiers as they are reluctant to deposit in an interestbased system. P P Abdur Rasheed, former Head of Economics Dept at Government College, Malappuram, India, and K Abdullah Hassan, Head of Research at Islamic University, Santapuram, India, also delivered speeches on ‘Fundamentals of Islamic Economics’ and ‘Basic Principles of the Zakah System in Islam’. Nizar Kocheri, lawyer and noted humanitarian activist, delivered a felicitation speech and Abdul Wahid Nadvi, Acting President of Indian Islamic Association, Qatar,

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presided over the ceremony. V T Faisal, General Secretary of IIAQ, welcomed the guests and Taj Aluva proposed a vote of thanks. Albaraka Turkish Unit Secures $150m Funding Albaraka Banking Group said its Turkish subsidiary has mandated several major banks to arrange a $150 million dual-currency syndicated finance facility to expand its activities in the country. Albaraka Türk said the banks involved in the arrangement of Murabaha financing facility are ABC Islamic Bank, Emirates NBD Bank, Noor Islamic Bank and Standard Chartered Bank (together the initial mandated lead arrangers and the book runners). As a prominent participation bank in Turkey, Albaraka Türk enjoys a market share of 19.14 per cent in the participation banking segment by asset size in Q1’ March 2011. The financing facility has a tenor of one year and carries a profit rate of 150 bppa over the relevant Libor/Euribor. The facility was launched into general syndication last month with banks from across the globe invited to participate in the facility. Financing under this facility will be used by Albaraka Türk to expand its financing activities in Turkey. The facility has a tenor of one year and carries a profit rate of 150 bppa over the relevant LIBOR/EURIBOR. The facility was launched into general syndication on the 29th June 2011, with banks from across the globe invited to participate. Albaraka Türk is amongst the first financial institutions and one of the pioneers in the field of interest-free banking in Turkey. It completed its establishment in 1984 and commenced operations in the beginning of 1985. Albaraka Türk is currently rated “BB” with negative outlook by S&P. Albaraka Türk continues its operations in compliance with the Law of Banking numbered 5411. Albaraka Türk was founded by Albaraka Banking Group (ABG), one of the prominent groups of the Middle East, Islamic Development Bank (IDB) and Alharthy Family, which served the Turkish economy for more than half a century. As of the 31st May 2011, the foreign partners own 66.16 per cent, the domestic partners 11.33 per cent and 22.51 per cent are publicly held. Albaraka Türk has a market share of 19.14 per cent in the Turkish participation banking segment by asset size in Q1 2011. gif

2011 August Global Islamic Finance

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Islamic Banking

HOW TO RUN

AN ISLAMIC BANK

PUTTING CORPORATE STRATEGY IN PLACE, VALUES, REGULATIONS, PART I

Author: Imran Pasha, Head of Retail, Islamic Bank of Britain, United Kingdom Richard Williams, Finance Director, Bank of London and Middle East, United Kingdom Tajah Brown, Global Islamic Finance Magazine Editorial Team, United Kingdom Abstract: When considering the aspects involved in running an Islamic bank it is vital to channel resources such as knowledge and relationships in the right direction in order to strike a balance between innovation and control. Strategy is the art of creating value and providing frameworks, models and governing ideas. It could be compared to software, which needs to be updated as people expand their knowledge and gain experience. How to run an Islamic bank will explore the different strategies involved in the running of an Islamic bank such as risk positioning and financial fundamentals. Islamic banking is a rapidly growing industry with the establishment of many new institutions embracing Shariah compliant banking. The UK has combined assets of US$300 million and overall the Islamic finance industry is worth an estimated one trillion US dollars globally. This article explores the key factors in running an Islamic bank, covering topics such as regulations and risk management. Imran Pasha and Richard Williams will give their views and advice on subjects such as the tailoring and overseeing of Islamic products and the attraction of non-Muslims to Islamic finance. The article also looks at the comparison of Islamic and conventional banks and the steps required when establishing an Islamic institution. Keywords: Strategies, Shariah Principles, Basel III, Risk Management, Islamic Financial Products

14 Global Islamic Finance

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Islamic Banking

Exploring the structure of Islamic banking The term ‘Islamic banking’ means the carrying out of banking operations in compliance with Shariah principles. Islamic banking and finance have been growing rapidly over the years. Its successes not only include countries with large Muslim populations but also those countries where the Muslim population is a minority. Banking practices with the concept of receipt and payment of interest are not in accordance with Shariah principles.

Richard Williams, Finance Director, Bank of London and Middle East Having qualified as a Chartered Accountant with KPMG in 1980, Richard’s early career in Investment Banking was spent with Chase Manhattan, Credit Agricole and Bankers Trust. He then spent 10 years at Robert Fleming & Co setting up their Global Equities Derivatives business which took him to Tokyo and 3 years in Hong Kong with Jardine Fleming. Richard joined BLME in January 2007 as Finance Director.

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lenges when introduced to a world where interest plays an important role in most financial operations. The key principles of Islamic finance are the prohibition of riba, uncertainty and forbidden assets such as alcohol and the existence of underlying assets and finally, profit and risk sharing. The Shariah principles explain in detail the ethical aspects of money and capital within Islamic finance and the relations between risk and profit as well as the social duty of the financial institutions.

In the past Muslim communities could not The definition of ethics could be described avoid conventional ways of banking but Isas a set of moral values that distinguish lamic banking practices have been flourright from wrong. There are various negaishing over the past years so that Islamic tive effects of interest based finance such finance is now recognised throughout the as instability, under-financing the economy, financial world. One of the first tasks that which may lead to employshould be implemented when ment losses, and not enough establishing an Islamic bank Figure 1: Comparison of Islamic and conventional banking frameworks attention given to economic is the establishment of a relidevelopment. When considable body to provide Shariah ering the ethical and moral Paradigm Version of supervision. principles within Islamic fiCharacteristics Conventional Banking Islamic Banking nance and banking there is a Nominal value guarantee of: With the advice and approvresponsibility to ensure that Yes Yes Demand deposits al of a Shariah supervisory Shariah principles are met, No Yes Investment deposits body the bank can then start such as full transparency and Equity-based system where development of Shariah coma focus on the Shariah board Yes No capital is at risk pliant products. The Shariah membership ensuring that Uncertain, no guarCertain and guaransupervisory board enables the Shariah quality of finanRate of return on deposits anteed teed the Islamic bank to conduct cial products is met. financial transactions which Depending on Banks Irrespective of Banks Mechanism to regulate final performance/profits performance/profits follow Shariah principles. Islamic banks cannot separeturns on deposits from investment from investment The board should be a group rate themselves from moral of scholars who are expert in and ethical decisions. Their PLS principle is applied Yes No Islamic jurisprudence. surroundings and staff, inUse of Islamic modes of financYes N/A cluding experts, should ing: PLZ and non-PLS modes When focusing on the theoabide by the moral and ethiPossible for reducing retical aspect of Islamic fical standards of the Islamic moral hazard in PLS Use of discretion by banks with nance, the dominant issue religion, which therefore modes Yes always regard to collateral is that of interest, which is determines the values and Yes in non-PLS prohibited in Islam and is standards within Islamic fimodes not wanted or needed within nance. Conventional banking Banks pooling of depositors Islamic banking operations. uses the interest rate to confunds to provide depositors Yes No Islam teachings provide a duct financial actions. On the with professional investment strong foundation for organother hand Muslim scholars management ising banking operations. within Islamic banking have This attitude towards interest Source: IMF working paper: Islamic Banking Issues in Prudential regulations and developed a different model in Islamic finance faced chal- supervision of banking that does not use 2011 August Global Islamic Finance

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Islamic Banking

interest. Islamic banks in comparison with conventional banks both have similar types of deposits. Conventional banks offer current accounts, savings accounts and fixed deposit account and Islamic banks have current and savings account. The Islamic banks also have investment accounts. The big difference between conventional and Islamic banks is that the conventional banks pay a guaranteed interest rate on the savings and fixed accounts while Islamic banks pay the depositor a profit depending on the deposit amount. Figures 1 and 2 show the comparison of conventional and Islamic banks and their banking frameworks. The first standalone Shariah compliant retail bank in the UK authorised by the Financial Services Authority is the Islamic Bank of Britain (IBB) established in 2004. The IBB is also a member of the Financial Services Compensation Scheme. The bank aims to provide its customers with an individual and welcoming service.

The bank, based on its Shariah principles, is often viewed as an ethical and stable alternative to conventional banks. Certainly, its achievements are well recognised both in the UK and internationally. As a result it has earned a well deserved reputation as the UK leader in British Islamic banking. The strategies behind the success of Islamic banking. Imran Pasha, Head of Retail, Islamic Bank of Britain Having over 10 year’s experience within the financial services sector, Imran held management positions with Merrill Lynch and HSBC. At IBB Imran has held various positions progressing from Branch Manager to Area Manager. He currently holds the position of Head of Retail. In this role Imran holds responsibility for Bank’s the distribution network, the marketing function and deposits.

There are a range of strategies to consider when running an Islamic bank, such as risk positioning and the financial fundamentals. The purpose of having a strategy is to help the banks improve and establish a strong place in a selection of markets rather than a place in a range of competitive markets. Islamic banks have ways to manage commercial risk, such as profit equalisation, investment risk reserves, Mudarib fees and share holders. In addition, Islamic banks pay more attention to assets and liabilities compared to their conventional counterparts.

Islamic banks have problems in managing liquidity and risk because of the limited amount of financial instruments on offer. Head of Retail, Imran Pasha, shares his exIslamic products are not as commoditised pert knowledge of how to run an Islamic bank. and tend to need more altering and atHe is currently responsible tention, which can result in for the bank’s distribution operation risk. The latest inThe first steps to establishing an Islamic bank – Establishment of the IBB network, marketing funcstrument to complement the Imran Pasha, Head of Retail at the Islamic Bank of Britain talks us through the tion and deposits. With over operating systems of Islamic steps: 10 years of experience in transactions internationally the financial services sector is the wakalah structure. The Licensing. Establishing a bank is a long and painstaking task consisting of several and various positions in the exclusion of limitations within elements. The first is regulatory and financial. IBB therefore came into existence in IBB such as Area Manager the Islamic finance industry August 2004 when the UK government’s regulatory body, the Financial Services Authority (FSA), granted the bank its license. In September 2004 IBB became a UK and Branch Manager, Imran should encourage the develpublicly listed company on the Alternative Investment Market (AIM). Pasha talks us through the opment and growth of the establishment of the IBB industry. The rapidly growing Retail financial services. Once the capital was raised by investors in the UK and and the effect it had on the Islamic finance industry is althe Middle East, the bank set about implementing the vision of offering Shariah financial industry. ready worth an estimated one complaint retail financial services. This included designing and setting up the infrastructure, processes and products as well as bringing together the team. trillion US dollars globally. He says that the IBB has Branch network. This was followed by the setting up of a branch network. IBB now impacted the UK and EuLiquidity management struchas a national branch network in key locations including London, the Midlands and ropean financial industry, ture can be challenging for North West. “The bank has continued Islamic banks because of Smart banking facilities. To complement this, and to enable Shariah compliant to maintain this position the lack of liquid instruments banking to be accessible to consumers across the UK, IBB also developed its Smart and still remains the only within Islamic finance. After banking facilities. These allow customers to carry out their banking over the internet Islamic retail bank in the attaining extra revenue the or telephone by liaising with one of the bank’s customer services representatives. UK and Europe. It is conGCC Islamic banks kept a Marketing and awareness. Marketing and community relations have also played sidered a pioneer of retail large amount of core liquidan important role in the bank’s activities. In order to establish a presence IBB has Islamic banking and curity in the form of short-term played a strong role in the British Muslim community, providing services to local rently offers the largest Murabaha and deposits from mosques and charities. It has also undertaken extensive marketing, advertising range of Shariah-compliant central banks. The result of and PR activities to ensure its target audience are aware of the bank and its prodretail financial products to these actions proved that ucts and services. the UK consumer.” Almost it was the right choice for Product development. Finally, the bank has undertaken extensive product develseven years on and IBB has that particular area, which is opment so that its customers can genuinely manage their finance according to the grown at a steady rate and known for numerous cycles principles of their faith, i.e. without the use of interest. As a result of its ongoing carved itself a niche in the and recurring shocks. work, the bank now offers the largest range of Shariah compliant retail financial UK retail banking sector. products and services in the UK. 16 Global Islamic Finance

August 2011


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1st

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WILL YOUR INSTITUTION BE IN

2011

TOP ISLAMIC FINANCE INSTITUTION RANKING?

Global Islamic Finance Awards & Rankings Now Open For Submissions »» Global Islamic Finance Awards of the Decade »» Top 300 Islamic Finance Institutions across the Globe »» Top 50 Most Influential People in Islamic Finance »» 50 Best Companies to Work for in Islamic Finance Industry

These prestigious rankings provide a comprehensive outlook into the Global Islamic financial industry and are the first of their kind. GIF is working hard to ensure that both individuals and institutions are included in the list of high ranking categories. If you are interested in taking part please register your interest at the earliest opportunity. We are only able to include Institutions for which we have updated results in each category, so ensure that your Institution will provide us with updated data. No financial payment is made as the cost of the research is funded by Global Islamic Finance magazine, with no third party financial sponsorship or support.

www.globalislamicfinancerankings.com


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Islamic Banking

Warren Edwardes, CEO, Delphi Risk Management, United Kingdom Islamic products require more tailoring which could create operational risk. In what way can Islamic banks reduce the operational risk? Shariah risk and reputational risk are prime sources of operational risk for Islamic banks. The Holy Qur’an states: [3:130] ‘O you who have believed, do not consume usury, doubled and multiplied …’ [2:275] ‘Allah hath permitted trade and forbidden interest.’ Hadith I in al-Nawawi’s Forty Hadith, states that ‘actions are according to intent’ or ‘actions are what they are by virtue of intent’. Niyyah is intention: an inner act of the heart whereby one performs an outer act as the fulfilment of a particular duty, rather than merely a series of motions without religious value. The point of Shariah finance is to fulfil religious compliance and not just to appear to do so. An issue for Islamic banks is the tendency to replicate conventional products with an Islamic veneer rather than create Islamic products based on Islamic principles of profit and loss sharing and genuine, rather than fabricated, trade transactions. Cleverly engineered products, perhaps not fully explained to Shariah scholars, may initially be deemed Shariah compliant. However, when the undisclosed side trades affected by the SPVs become apparent, the products are uncovered as repackaged conventional products thus damaging the reputation of the Islamic bank. Niyya, the intention which underlies all transactions, is the responsibility of the end-user investor or finance-seeker. It is important to have full transparency and disclosure about all of the transactions making up the structured product, so that stakeholders can evaluate the true intention behind it and see if it is compliant with their own Niyya, which may be genuine Shariah compliance or just the appearance of Shariah compliance. It is for the Muslim end-user to enter into contracts, directly or via financial institutions, with which he is happy to be judged on the day of judgement and not just on earth. For that transparency is key. Products may be structured as a package of trades, which are individually Hallal, while the Niyya of the package as a whole is to replicate Riba, which is Haram. Each person involved must ask himself what his own Niyya is. If the transactions involve trades in certain markets, do the investors really understand these markets or are they entering into a synthetic Riba transaction that does not depend on the performance of these markets? Transparency will help to mitigate operational risk represented by Shariah and reputational risk.

The risks within banking strategies A selection of people in Islamic banking, such as regulators, shareholders, customers and company employees and management, determine its business strategy and performance All these people affect the financial strength of Islamic banks, but regulators in particular have an affect on the bank’s strategy and ratings through their influence on the regulatory environment and overall support. The main aims of the bank regulator are to ensure that the depositors are protected and to spread awareness of a strong banking system. Shariah compliant products and investments are very important within Islamic Banking and may determine the bank’s reputation. If an investment did not follow Shariah principles it would have negative consequences on the bank and create a risk of dissolution of the investment entity. It is vital that all investments are checked by the bank and by a Shariah authority or regulator. The product structure, contracts, asset securities and other aspects should be assessed before deciding whether the product or project is Shariah compliant. After the approval of the Shariah board the product or project can be released on to the financial market. If the legitimacy is uncertain then the issue should be taken on by a Shariah auditor or supervisor, who can quickly deal with and solve any problems. The purpose of most of Islamic banking strategies is to achieve profitable asset growth. Certain factors can affect the use of strategies, such as the progression of Islamic banking and finance, the position of the banks in their home markets, the resources available and medium and long term goals. Improving risk position is another aspect that is part of Islamic banking strategy, although Islamic banks are able to overcome negative shocks to the assets aspect of the investment depositors. Commercial risk is also something to be considered and, according to CPI Financial, Islamic banks have put in place buffers against loss in order to manage commercial risk. These are: • • • •

Profit equalisation (consistent earning across the cycle) Investment risk reserves (attract negative shocks on asset value) Mudarib fees (can decrease in order to avoid having a negative affect on the depositing Rab al Maal) Shareholders (always supplying Qardh Hasan to profit-sharing depositors)

The Finance Director at the Bank of London and the Middle East, Richard Williams gives his views on Islamic banks in the financial crisis. “When the credit crisis hit in 2008 many commentators and industry leaders appeared to believe that Islamic banks were ‘immune’ from the financial crisis. Now, however, we can see that some Islamic banks were exposed due to over-zealous expansion and excessive risk concentrations, particularly in the property sector.” He continues “One of BLME’s priorities has been to offer a diversified range of products and services, ranging from asset management to trade finance and leasing.” The legal and regulatory changes in Islamic finance and banking An important aspect of Islamic banking regulations is the ‘maintenance of a level playing field between banking institutions’, this re-

18 Global Islamic Finance

August 2011


Islamic Banking

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sults in the regulators within Islamic finance applying the same principles of handling risks to all banks. Regulators apply the national supervisory principles to all banks, no matter what services they offer, Islamic or conventional. However the generic principles may not apply to every Islamic banking framework and the regulatory requirements should be tailored to cater to any relevant characteristics when running an Islamic bank.

Shah Fahad Yousufzai, Vice President, Products Development Department, Islamic bank of Thailand

The Islamic financial industry is challenged by the development of consistent regulatory standards that apply to the specific features of Islamic banking. It is necessary for the regulatory standard to apply within the industry and to meet the requirements of the basic regulatory standards worldwide. Capital adequacy is a very important part of assessing whether a bank will succeed or fail. It is an important aspect when looking at a bank’s risk exposure and may reveal a bank’s risk relationships.

Any muamilat (financial transaction) without Akhlaq (ethics) is considered irregular and inappropriate.

The Basel III system is the most recent of global regulatory standards which has developed from the previous Basel I and Basel II agreements. The Basel committee agree on the Basel II standards for banks’ capital adequacy and liquidity. The goal of the Basel III system is to strengthen bank capital requirements and encourage new policies on bank leverage and liquidity. Imran Pasha explores the legal and regulatory changes to ensure the aims of Islamic banks are met. He says that within the UK the government and the Financial Services Authority (FSA) have worked with and encouraged those aiming to establish Islamic financial institutions. The overall goal is to make the UK the capital Islamic financial hub in Europe. Imran Pasha says “To illustrate, the UK was the first member of the EU to authorise Islamic banks. The government also introduced changes so that Islamic mortgages would not be subject to double taxation. There have been at least five Financial Acts since 2003, where legislative changes have been introduced to put Islamic finance on a level playing field with conventional finance.” He adds that there have also been numerous changes made by the HMRC and the FSA covering the aspects of profits, taxation and regulation of Home Purchase Plans. He refers to the CityUK Islamic Finance 2011 report and gives examples of the UK within Islamic finance. “There are 22 banks in the UK offering Islamic products. This figure exceeds that of any other western country. There were five Sukuk listings at the London Stock Exchange (LSE) in 2010 and one in early 2011. This brings the aggregate total at the LSE to 31 listings worth US$19 billion. Islamic funds in the UK have combined assets of US$300 million.” The Bank of London and the Middle East (BLME) is an independent wholesale Shariah compliant bank based in London and provides Islamic investment and products to businesses and individuals. The financial director, Richard Williams, discusses the changes in regulation and how it affects Islamic banks. Joining the BLME in 2007 the financial director spent his early career working in investment banking.

How are values and regulations tailored to apply to Islamic finance and banking?

Muamilat (financial transaction) and Akhlaq (ethics) work side by side within Islamic finance. Business transactions under the umbrella of Shariah must be according to the ethos of Islam. One can ask what the logic is behind not earning funds through interest. Islam prohibits it because it greatly restricts the physical activity and circulation of capital. As Islamic business transactions are based on real trade such as Murabaha sales, Musharakah venture capital and Istisna for construction purposes etc. Islam is against the concentration of wealth in the hands of one individual and also encourages the distribution of wealth from rich to poor, as in the Zakath and Ushar system. Islamic prohibits unlawful practices within Islamic finance and prohibits activities that could harm society, such as uncertainty and gambling. The role of the Shariah supervisory board and Shariah audit and compliance team is crucial. One sees many examples of the Murabaha role in developed Islamic banking market economies. All concerned authorities, for example Shariah compliance and audit teams and finance assigning executives, are responsible together with Shariah advisors for supervising financial practices. Each IFI needs a team of experts to eradicate non-Shariah compliant transactions and strictly monitor each and every transaction. The main objective of Islamic banks is to carry out precise and accurate transactions according to Shariah principles. The executives of IFIs all over the world always associate profitability with their success, but profit is a secondary aspect of Islamic finance; the primary aspect is Shariah compliancy while practicing any mode of Islamic finance. My suggestion to all central banks of countries practising Islamic banking is that a Shariah advisor should be an employee of the central bank and not of the commercial banks involved in practising Islamic banking. Islamic banks must add spiritual satisfaction to the job description, since it is an essential professional and social responsibility. It would be helpful for true Islamic banking to function according to the real Islamic spirit.

He spent the next ten years at Robert Fleming & Co setting up the global equities derivatives business and travelled to Tokyo and Hong Kong. Richard also has experience with start up companies and in the areas of private equity with legal and general ventures. He shares his views saying “Basel III was introduced over the coming years with full accord, scheduled to be fully implemented by 2019.” Richard Wil2011 August Global Islamic Finance

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Islamic Banking

Figure 2: Comparison of conventional and Islamic banks

Conventional Banks

Islamic Banks

The functions and operating modes of conventional banks are based The functions and operating modes of Islamic banks are based on the principles on fully manmade principles. of Islamic Shariah. The investor is assured of a predetermined rate of interest.

In contrast, it promotes risk sharing between the provider of capital (investor) and the user of funds (entrepreneur).

It aims at maximising profit without any restriction.

It also aims at maximising profit but subject to Shariah restrictions.

It does not deal with Zakat.

In the modern Islamic banking system, it has become one of the service-oriented functions of the Islamic banks to be a Zakat Collection Centre and they also pay out their Zakat.

Lending money and getting it back with compounding interest is the Participation in partnership business is the fundamental function of the Islamic fundamental function of the conventional banks. banks. So we have to have thorough understanding of our customer’s business. It can charge additional money (penalty and compounded interest) in case of defaulters.

The Islamic banks have no provision to charge any extra money from the defaulters. Only a small amount of compensation and these proceeds are given to charity. Rebates are given for early settlement at the Bank’s discretion.

Very often it results in the bank’s own interest becoming prominent. It makes no effort to ensure growth with equity.

It gives due importance to the public interest. Its ultimate aim is to ensure growth with equity.

For interest-based commercial banks, borrowing from the money market is relatively easier.

For Islamic banks, it must be based on a Shariah approved underlying transaction.

Since income from the advances is fixed, it gives little importance to Since they share profit and loss, Islamic banks pay greater attention to developing developing expertise in project appraisal and evaluations. project appraisal and evaluations. Conventional banks place greater emphasis on credit-worthiness of clients.

Islamic banks place greater emphasis on the viability of the projects.

The status of a conventional bank, in relation to its clients, is that of creditor and debtors.

The status of Islamic bank in relation to its clients is that of partners, investors and trader, buyer and seller.

A conventional bank has to guarantee all its deposits.

Islamic banks can only guarantee deposits for a deposit account, which is based on the principle of al-wadiah, thus the depositors are guaranteed repayment of their funds. However if the account is based on the mudarabah concept, clients have to share in a loss position.

Source: Mohdhafez.wordpress.com

Figure 3: The structure of an Islamic bank

Board of Directors

Shareholders

Shariah Supervisory Board

CEO & COO Executive Management

Shariah Advisory

Source: Gatehouse Bank Organisation Chart 2011

Products & Expertise

Capital

Treasury

Real Estate

Asset Finance Shariah Advisory

Distribution

Placement

InfrastructureBoard

Finance & Operations Dept Compliance Dept

Communications

Office Management and Support Board

Credit and Market Risk Legal Dept IT Dept Human Resources Dept

20 Global Islamic Finance

August 2011

Advisory Line of Reporting


Islamic Banking

liams continues by saying that the reason for the mixture of complexities and Shariah prohibitions when increasing alternative and lower quality forms of capital, is that most Islamic banks have capital structures that are led by Tier 1 capital in the common equity form. This results in a lack of debt in Shariah compliant form, as well as meaningful levels of significant preference shares and hybrid capital structures. He lists the factors that put Islamic financial institutions in a beneficial position compared to their conventional counterparts. The capital adequacy positions of Shariah compliant banks will benefit in a range of ways, which are: •

The limited role of Trading Book businesses, where Shariah principles prohibit short selling and impose strict limitations on the use of derivatives. Consequently, Shariah financial institutions will be negligibly affected by the higher capital charges for such operations. The modest and very limited use of derivatives and securitised structures by Shariah compliant banks will result in such institutions not being adversely impacted by the additional capital charges that are being applied to address the inherent risks in such products (e.g. wrong way risk). The lack of leverage and contingent risks within Islamic banks will result in the new leverage ratio only having a very modest impact.

He ends by saying “However, it is vital that Islamic financial institutions continue to develop liquidity instruments and for central banks to offer Shariah compliant facilities.” Risk management in Islamic banking According to the Financial Services Authority’s Financial Risk Outlook 2010, the financial crisis created asset losses, uncertainty about the amount of loss and the breakdown in funding liquidity. This resulted in the authorities creating a new capital regime that considers recapitalising the banking sector and of a large amount of liquidity support. However, with this regime came challenges such as capital adequacy and problems with funding as the new regime is introduced and low interest rates produced by margin challenges. A risk may develop when not all the developers of a project attend the presentation of a project or investment to the Shariah board. This can result in a disagreement when deciding if the project or investment is Shariah compliant or not. To resolve this risk the Shariah auditor needs to check the project or investment before and after its launch. If the product is launched without being checked for legitimacy by the Shariah board, then there may be a demand for the investor to return the profits or cancel the product. Islamic banks need to bring attention to risk management in Islamic banking and finance. The profit-and-loss-sharing modes of financing could change the credit risk of investment depositors for Islamic banks and increase the risk for the asset section of the banks’ balance sheets. Profit-and-loss-sharing can make Islamic banks vulnerable to risks produced by equity investors. Operation risk is an important aspect in Islamic banking and can develop from a number of sources, such as the internal activities conducted by Islamic banks, the non-standardised aspect of some Islamic prod-

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Dr Osama Alsulaiman, Legal Consultant in Islamic finance, Saudi Arabia How are values and regulations tailored to apply to Islamic finance and banking? It is of the utmost importance for the proper functioning of Islamic finance (IF) that there is an appropriate legal framework to accommodate its applications. Traditional finance has enabled legislation, contract enforcement measures and effective settlement dispute mechanisms. In addition to that IF requires a framework which takes into consideration its own distinctive characteristics. This necessitates the establishment of a competent legal framework to achieve the following: 1. 2. 3.

Enabling legislation for the creation and authorisation of financial instruments, establishing Shariah governance, and addressing conflicts between common or civil law and Shariah principles. Ensuring that contracts can be enforced by assuring that the legal documentation of any transactions or instruments complies with both Shariah and local law. Forming an appropriate mechanism for dispute settlement.

These legal considerations are crucial not only for proper implementation but also to maintain the growth of the industry. After examining the second and third points above, it can be seen that in practice contracts should comply simultaneously with two sets of laws: Islamic law and secular law. Compliance in this situation can be looked at in the same way as compliance between the laws of two or more jurisdictions when structuring any cross-border transactions. However IF, as part of the corpus of Islamic law, does not pertain to any particular country, territory or sovereign legal system. This raises concerns about the extent to which the norms and principles of IF are recognised by western countries. For example, in some cases the UK courts have ignored the reference to Shariah as a governing law; for instance in the case of Shamil Bank of Bahrain EC v Beximco Pharmaceuticals Ltd and others. In Islamic countries such as Malaysia, conflicts also arose in the civil courts over Islamic finance contracts since judges have not been able to reach an agreement when dealing with Islamic finance cases. This can be seen for example, in the cases of Bank Islam Malaysia Berhad v Adnan bin Omar and Dato’ Hj Nik Mahmud Daud v Bank Islam Malaysia Bhd. However, the Central Bank of Malaysia Act 1958 was replaced in 2009 by a new Act. Section 56 of the new Act makes it mandatory for the court or arbitrator to take into consideration any published ruling by the Shariah Advisory Council (SAC) relating to any Islamic financial business. Sec 57 from the same Act provides that the SAC’s ruling is binding on the court and the arbitrator. The financial regulator also put the SAC under the Securities Commission so that it must be consulted by judges and its rulings must be considered binding. Malaysia has sought to give authority to the SAC to rule on any cases involving Islamic finance issues, rather than them being challenged in the court. It is therefore apparent that a prerequisite to the sustainable development of any financial industry is a suitable regulatory framework, which includes an effective dispute resolution mechanism. In contrast, the lack of enforceability of contractual agreements ultimately increases the possibility of default and delinquency.

2011 August Global Islamic Finance

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ucts and the lack of a dependable system to implement financial contracts. There are a number of factors that make the operation of Islamic banks a higher risk and therefore could make them less profitable than conventional banks. The factors are fewer risk-hedging instruments and techniques, less developed or no interbank and money markets and government securities, and less availability of facilities operated by central banks such as lender-of-last-resort.

the short-term funding markets they will remain vulnerable and will appear less resilient than their conventional counterparts. Imran Pasha talks about the tailoring and overseeing of Islamic products. He says “Islamic products require more tailoring and as a result are subject to a dual set of rigorous controls and monitoring. This ensures that as much risk as possible is mitigated and oversights are avoided”.

Shariah scholars encourage that all transactions be linked to a tangible and underlying asset. This results in a gap between cash and long-term bonds. Asset-based financing and lending products, which may well be found on an Islamic bank balance sheet, operate to lengthen the liquidity gaps because exits from the transactions are not always decided beforehand. Until Islamic banks are able to use

He continues, saying that the first sets of controls are put in place when the product is conceptualised and launched. The controls are there to ensure the products are Shariah compliant and are managed by the bank’s Shariah Compliance Officer. The bank’s Shariah Supervisory Committee provides any additional support, monitoring and controls. The second sets of controls are to ensure the operational and business risk is mitigated.

Figure 4: The four key areas in Basel III

Capital adequacy

There must be more capital and more high quality capital in the banking system. Fundamentally, all Tier 1 capital must be fully effective at absorbing losses and Tier 2 capital must be far more loss absorbent in order to protect capital.

Liquidity

Strengthened liquidity disciplines that stress test the robustness of a bank’s funding profile and the adequacy of liquid asset reserves.

Leverage ratio

A back-stop measure to control banks unduly increasing their absolute leverage and level of model risk while retaining a high capital ratio. This is of particular importance when considering that some of the institutions that suffered the largest losses were among the best capitalised banks in the world.

Counterparty credit risk

Implementation of a capital charge based on a stress test volatility assessment of counterparty pre-settlement risks.

Figure 5: The sets of risks Product risks

This requires identifying and managing the risks involved in operating the investments for the product.

Payment risks

This risk has the same profile in a conventional bank. It can occur because of an error or mistake in processing payments. As with conventional banks, IBB has processes and controls in place to manage this risk.

Fraud risks

This again has the same profile in any conventional bank. Again, IBB has robust processes and controls to mitigate any such risk.

Operation risks

This would include any risk associated with processing queries related to products, services, counterparties and third parties. The risk is again mitigated through the controls IBB has in place.

22 Global Islamic Finance

August 2011

The IBB has distinct processes put in place to manage the operational and Shariah compliance risk. He ends by saying “in fact, Shariah compliance adds another layer of rigour to IBB’s overall risk management procedures. Shariah compliance control is therefore the safety net that conventional banks do not have.” What does the future hold for risk management in Islamic banking? As the Islamic financial industry grows rapidly there is a need for the risk management sector of Islamic investments to improve. Islamic assets are estimated to be worth US$126 billion in the next ten years. The risk management sector needs to focus on strong management, vigorous governance and the ability to address Islamic banking issues. The complicated Islamic banking products and relations, together with Shariah compliant substance and form, create issues such as displaced commercial risk. Islamic banks must have a consistent Shariah interpretation and standardisation to enable the banks to take advantage of opportunities quickly. Establishing Islamic banks around the world Today’s modern commercial banking system in the majority of countries is developed from the financial practices in Europe. The banking system revolves around the principles of capital certainty for depositors and the assurance of the rate of return on deposits. In order to ensure the successful running of the banking system the Central Banks have the power of regulation and influence. This means that all other banks have to abide by the rules of the Central Bank. However, Islamic banks face challenges when complying with the rules when operating in non-Muslim countries. The challenges that Islamic banks face when operating in nonMuslim countries are the tax procedures, the fact that the Islamic banking system cannot ensure any fixed rate of return on deposits and some Islamic banks cannot ensure the capital because if there is a loss it is taken from the capital. Another challenge that Islamic banks face is the Central Bank regulation and influence, which relates to liquidity and capital adequacy. These aspects depend on the assessment of the worth of assets from Islamic banks. Non-Muslims within Islamic finance Imran Pasha discusses the attraction of non-Muslims within Islamic finance. Shariah compliant products and investments are based


Islamic Banking

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Figure 6: Islamic modes of financing TYPE

DESCRIPTION

COMMENTS

PLS modes

Profit and loss sharing modes

At the core of Islamic banking

Mudaraba

Trustee finance contract The bank provides the entire capital needed for financing a project, while the entrepreneur offers his labour and expertise. The profits (or losses) from the project are shared between the bank and the entrepreneur at a certain fixed ratio. Financial losses are borne exclusively by the bank. The liability of the entrepreneur is limited only to his time and efforts. However, if negligence can be proved he may be held responsible for the financial losses incurred. It is usually employed in investment projects with short gestation periods and in trade and commerce. It affects both the assets and liabilities sides of banks’ balance sheets. On the liabilities side, the contract between the bank and depositors is known as unrestricted Mudaraba because depositors agree that their funds be used by the bank, at its discretion, to finance an open-ended list of profitable investment and expect to share with the bank the overall profits accruing to the bank’s business. On the asset side, the contract between the bank and the agent-entrepreneur is known as restricted Mudaraba because the bank agrees to finance a specific project carried out by a specific agent-entrepreneur and to share the relative profits according to a certain percentage

Three conditions need to be met: 1. The banks should not reduce credit risk by requesting collateral for this purpose. It bears the financial risk entirely and exclusively. However, collateral may be requested to help reduce moral hazard, e.g., to prevent the entrepreneur from running away. 2. The rate of profit has to be determined strictly as a percentage and not as a lump sum. 3. The entrepreneur has the absolute freedom to manage the business.

Musharaka

Equity participation contract The bank is not the sole provider of funds to finance a project. Two or more partners contribute to the joint capital of an investment. Profits (and losses) are shared strictly in relation to the respective capital contributions. It is usually employed to finance long-term investment projects.

Banks can exercise the voting rights corresponding to their share of the firm’s equity capital. Their representatives can sit on the firm’s board of directors. All parties invest in varying proportions, and have the right to participate in the management of the enterprise.

Muzar’ah

Traditional counterpart of the Mudaraba contract in farming. The harvest is shared between the bank and the entrepreneur. The bank may provide funds or land.

Musaqat

Traditional counterpart of Musharaka contract in orchard keeping. The harvest is shared among the partners based on their respective contributions.

Direct investment

The same concept as in conventional banking. The bank cannot invest in the production of goods and services which contradict the value pattern of Islam, such as gambling.

Banks can exercise the voting rights corresponding to their share of the firm’s equity capital. Their representatives can sit on the firm’s board of directors.

Non-PLS Modes

Non Profit and loss Sharing modes

They are used in places where PLS modes cannot be implemented. For example, in cases of small scale borrowers or for consumption loans

Qard AlHasanah

Beneficence loans, These are zero-return loans that the Quran exhorts Muslims to make to “those who need them.” Banks are allowed to charge the borrowers a service fee to cover the administrative expenses of handling the loan, provided that the fee is not related to the amount or maturity of the loan.

Bal’ Mua ‘ jja

Deferred payment sales, The seller can sell a product on the basis of a deferred payment in instalments or in a lump sum payment. The price of the product is agreed upon between the buyer and the seller at the time of the sale and cannot include any charge for deferring payments.

Bai’ Salam or Bai’ Salif

Purchase with deferred delivery, The buyer pays the seller the full negotiated price of a product that the seller promises to deliver at a future date. This mode only applies to products whose quality and quantity can be fully specified at the time the contract is made. Usually, it applies to agricultural or manufactured products.

Ijara Ijara wa iqtina’

Leasing Lease purchase, A party leases a particular product for a specific sum and a specific period of time. In the case of a leas-purchase, each payment includes a portion that goes toward the final purchase and transfer of ownership of the product.

Murabaha

Mark-up, The seller informs the buyer of his cost of acquiring or producing a specified product; then profit margin (or mark-up) is negotiated between the buyer and the seller. The total cost is usually paid in instalments.

Jo’ alah

Service charge, A party undertakes to pay another party a specified amount of money as a fee for rendering a specified service in accordance to the terms of the contract stipulated between the two parties. This mode usually applies to transactions such as consultations and professional services, fund placements, and trust services.

The bank is entitled to receive from the entrepreneur the principle of the loan at the end of the period stipulated in the contract if, and only if, a surplus exists. If the enterprise’s books show a loss, this will not constitute default on the part of the entrepreneur, except for negligence or mismanagement.

Contrary to contracts based on the PLS principle, modes such as markup, leasing and lease purchase have a predetermined and fixed rate of return and are associated with collateral. In fact, banks add a certain percentage to the purchase price and/or additional costs associated with these transactions as a profit margin, and the purchased assets serve as a guarantee. Additionally, banks may require the client to offer a collateral. These instruments can be considered to be more closely associated with risk aversion and they do not substantially differ from those used in a conventional banking system, other than in their terminology and in some legal technicalities. They are considered to conform to Islamic principles because the rate of return is meant to be tied to each transaction, rather than to the time dimension. However, some Muslim scholars advocate a stricter utilisation of such modes.

Source: Kazarian, 1993; Iqbal and Mirakhor, 1987 2011 August Global Islamic Finance

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Islamic Banking

on ethical and equitable principles, taken from Islamic law and are compared with the values of socially responsible investing. He says “Many of Islamic Bank of Britain’s products have a wide appeal to consumers of all faiths who are seeking an ethical, competitive alternative. IBB is certainly very welcoming of customers who practise faiths other than Islam”. He continues saying “When judged on its products, the bank strives to ensure its products are competitive as well as Shariah compliant. As a result, several of its products have been taken up by customers of different faiths because they have proved to be very competitive when compared with competitor products.” Imran also says that the recent financial turmoil proved that the Islamic finance system is more resilient, transparent, asset-based and asset-backed compared to the conventional system. The Islamic finance system is a good base for people of other faiths to discover more about Islamic banking. He ends by saying “With ethical banking and socially responsible investing on the increase, Islamic banking has the potential to appeal to an even wider customer base, irrespective of their religious belief.”

Richard Williams also shares his views on the attraction of non-Muslims to Islamic finance. He begins by saying “For Islamic banks to continue to expand their market share, raise awareness and diversify their investor base they must attract more Muslims but also appeal to conventional investors.” He continues by saying that the investors are now looking for alternative investment options or a change to their current holdings which is different from the ‘conventional high street banks.’ The reason for this is the last three years of economic turmoil, which some agreed is because of the high risk strategies of some conventional financial institutions. He says that “Shariah finance is one of the alternatives available to investors, both non-Muslim and Muslim.” He concludes by saying that there are a number of reasons why Islamic banking is attractive to non-Muslims. The reasons include a personal service, competitive offerings and the similarities with ethical financing. “From BLME’s perspective, being a relatively small, nimble, flexible bank with competitive products and rates resulted in many of our clients being non-Muslims.”

Conclusion The Islamic financial industry will continue to develop and become more established in Muslim and non-Muslim countries. The participatory financing is an exclusive feature of Islamic banking and can provide funding for social and economic development projects. This is an example of an alternative service that Islamic banks offer compared to the traditional services of conventional banks. This alternative way of banking gives the customer much more choice. With increasing information about Islamic finance becoming available to Muslims and non-Muslims there is no reason why Islamic banking and finance will not continue to expand. Richard Williams says “With each new product or service launch IBB engages in an education programme to help the consumer understand how it will benefit them. Explaining how products are Shariah compliant is also critical”. BLME’s financial director gives his thoughts on the future of Islamic banks. He says “Growth and consolidation, with Reuters predicting an increase in Sukuk issuance, the IMF forecasting growth of 10-15% in the Islamic market and Moody’s anticipating the worth of the Islamic finance industry reaching US$5 trillion by 2015.” gif

References and Further Reading • • • • • • • • • • •

• • • • •

Islamic Banking from: http://www.islamicbanking.nl/chap4.html#_Toc3149130 Prudential Regulation of Islamic banks: An analysis of Capital Adequacy Standards from: PDF 8-1-M.A.Noibi_3 Islamic Banking: Issues in Prudential Regulations and Supervision from: http://www.nzibo.com/IB2/IMFprs.pdf Islamic Finance Explained (briefly) from: http://www.blakewatersolicitors.com/content.php?id=islamicfinance Commercial risk from: http://cbb.complinet.com/cbb/display/display.html?rbid=1821&record_id=8374&element_id=7257&highlight=commercia l+risk#r8374 Islamic banking: state of the art from: http://www.irti.org/irj/go/km/docs/documents/IDBDevelopments/Internet/English/IRTI/CM/downloads/ IES_Articles/Vol%202-1..Ziauddin..ISLAMIC%20BANKING.pdf CAMEL rating system from: http://pdf.usaid.gov/pdf_docs/PNADQ079.pdf Islamic Banks – Their strategies and ratings from: http://www.cpifinancial.net/v2/FA.aspx?v=0&aid=247&sec=Islamic%20Finance Growing pains: Managing Islamic banking risks – PricewaterhouseCoopers from: http://www.pwc.com/en_GX/gx/financial-services/pdf/growing_ pains.pdf Financial Services Authority – Financial Risk Outlook 2010 from: http://www.fsa.gov.uk/pubs/plan/financial_risk_outlook_2010.pdf Islamic Financial Institutions and Products in the Global Financial System: Key Issues in Risk Management and Challenges Ahead by V. Sundararajan and Luca Errico from: http://books.google.co.uk/books?hl=en&lr=&id=9FtK7n6r_dwC&oi=fnd&pg=PA3&dq=islamic+banking+risk+management& ots=Dte1LB7gy3&sig=eTTUlU-zheeu-fJkXJHM-OazvUQ#v=onepage&q&f=false The Basic Principles of Islamic Financial Institutions: Compared to Conventional Ones from: http://www.nzibo.com/IB2/basic.pdf Differences between Islamic bank and conventional from: http://mohdhafez.wordpress.com/2007/03/03/differences-between-islamic-bank-andconventional/ Regulation and Supervision of Islamic Banks from: http://www.sbp.org.pk/departments/ibd/Regulation_Supervision.pdf Regaining the ethical standards of Islamic finance from: http://eng.assaif.org/Temi-generali/Finanza-islamica-e-finanza-etica Gatehouse Bank organisation chart from: http://www.gatehousebank.com/about-us/corporate-governance/organisation-chart/

24 Global Islamic Finance

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Interview

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ISLAMIC FINANCE IS ONE OF THE KEY FUNCTIONAL AREAS FOR THE HALAL INDUSTRY Interview with Mahmood Hasan, CEO of Rasul Group of Companies Mahmood Hasan is the CEO of Rasul Group of Companies, Pakistan. With a Masters in Business Administration he established this entrepreneurial venture in 1983. His transformational leadership and visionary approach led to the establishment of the brand Bake Parlor. The Halal industry and Islamic finance share an economic and ideological interdependence and also have a high growth potential when looking at the retail and commercial forefront. Both sectors have common grounds such as sharing the aim to attain sustainable growth and innovation under the Shariah principles. Only 5 to 10 percent of Halal businesses opt for Islamic finance the problem could be the Islamic banks limited understanding of the Halal industry. Islamic banks are focussing on Shariah-compliant index and Halal industry focus on Halal index. To bridge the gap both sectors need to identify the upcoming challenges and proactively implementing a solution. Mahmood Hasan shares with GIF the connection between the Halal industry and Islamic banking.

Islamic Finance is also in the process of strengthening its footing in the industry. It is faced with several regulatory and product development issues. Islamic financial expertise is limited in Halal food industry so employees need to be trained and be made aware of the potential benefits of Islamic Finance Please tell us a little bit about yourself and how you became involved in the Halal food industry? As an entrepreneur and industry representative in a Muslim country like Pakistan I have observed that food manufacturers primarily deal in or rather choose to believe that they deal in Halal food products by default. Over the years ‘Halal’ has turned out to be more than just a religious concept. Total global halal food market size is estimated to be about USD 635 billion. The domestic and international markets are gradually becoming more aware of the concept of ‘Halal’ and market demand for halal products is on the rise. How would you best define the term ‘Halal’ and what type of food products is it applicable for? Awareness of the real meaning and implication of the term Halal is limited and subjective. Infact, there exists an inherent issue in

Muslim majority regions that Muslim manufacturers at times believe that whatever they produce is by default Halal. Halal food manufacturing implies integrity in supply chain by adherence to Shariah Law, maintaining high quality products, assuring consumer safety, fair trade and animal welfare. Halal food should be manufactured under hygienic Shariah compliant guidelines. The primary prohibitions include items containing alcohol or intoxicants, animals where the name of Allah has not been invoked during slaughter and animals which have not been slaughtered or dead before slaughtering. There are several prominent halal-certification agencies. How is your organisation abiding by these certifications? Do you see the possibility of a natural collaborative effort amongst them in any areas? Prominent Halal certifications include South African Halal Certification and Malaysian Halal Certification bodies. There are certification agencies in Canada, Europe and United States as well. Infact, I would like to share that the importance of these certifications has been recently realised in Pakistan.

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Interview

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Food companies are now realising that to enter international markets and to attain credibility in the local market halal certifications are a must. Rasul Group has recently attained Halal certification from Bureau Veritas which is Halal certification agency registered in France. Bureau Veritas together with the approval of Pakistan standard quality control authority (PSQCA) has lead to attainment of Halal certification by Rasul Group. The certification attaining process is highly rigorous and involves amendment measures to be incorporated in supply chain and specialised training of key employees. Surely, the issue of having a range of different certification agencies leads to be a major pitfall. The Halal food industry is in the process of establishing a strong footing and to attain long-term sustainable growth these certification bodies will have to find a collaborative mid way. What is the potential demand of Halal food products? Well, I would say that more important than the current demand figure is the potential increase in demand for Halal food products. Currently the demand is about USD 635 billion out of which about 63% demand lies in Asian markets. However, to cater to this demand, food manufacturers and Halal certification bodies need to find a plausible solution to cater to this fragmented market. As it is a highly fragmented market in terms of awareness level and understanding of the term halal. What are the major challenges faced by the Halal food industry? There are several regional challenges faced by the Halal food industry. Three major challenges that the industry is facing are: •

Need for Certification: Halal food manufactures need to realise and understand that they need to attain certifications. A huge majority of market players especially in Pakistan do not realise the importance of these certifications. They need to realise that halal certification label on the packaging has a value in domestic and international market and has a high acceptance level in not only religious terms but also in terms of hygiene.

Promoting Halal Brand: Halal is a brand in itself. Although Halal food associations and bodies exist yet the brand equity is yet to be strengthened. For starters there exists a need for collaborative effort amongst industry players and halal food associations.

Halal food markets are highly diverse and fragmented. They are basically fragmented markets by ethnicity, location, income level, awareness level, religious factors and a few other determinants. Hence, a onesize-fits-all strategy simply cannot work. It is a challenge for Halal food manufacturers to deal with product adaptability and to cater to target market needs.

Should it be compulsory for Halal food manufactures to adopt Islamic Finance? In the extremely rigid sense one may argue that Halal food manufacturers should adopt and abide by Islamic means of financing. At Rasul Group we use a mix of conventional and Islamic finance. However the ratio of use of Islamic finance is increasing day by day. 26 Global Islamic Finance

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Why don’t Halal food manufactures strictly adopt Islamic Finance? What are the hurdles? How can they be removed? As for any other business, finance is one of the key functional areas for Halal food industry. Halal food industry is in the process of strengthening its brand equity and improving its supply chain. In the process it is faced by range of challenges with respect to market demand, product acceptability and certification issues. Islamic Finance is also in the process of strengthening its footing in the industry. It is faced with several regulatory and product development issues. Islamic financial expertise is limited in Halal food industry so employees need to be trained and be made aware of the potential benefits of Islamic Finance. These issues can best be resolved through mutual effort of Islamic Finance and Halal food industry. Islamic finance industrial players need to recognise the Halal food industry as a key niche market and provide tailored solutions to suit their needs. What is the future potential for Halal food exports to international markets? The major players in Halal food export market include Halal food manufacturers in Malaysia and Indonesia. These markets are better regulated and understand the importance of Halal certifications. Infact, majority of Halal products exported to European and American markets are from these regions. As for Pakistan the demographic trend is such that we are a thickly populated country with a large proportion of young generation. The domestic demand is immense and production capacity of local Halal food manufacturers is usually targeted to fulfilling this ever-increasing demand. As in our case we do export Halal products to Middle East, Europe, America Canada and Australia but most of the production is catered to fulfil the local demand. What is the future potential for Halal food investment in Asian markets? There exists an immense potential for Halal food investment in Asian market. Since 63% of the global halal food market demand is currently derived from Asian markets the market can be tapped by European and American investors. However, international investors need to understand the concept of Halal and the need for Halal certification. What advice would you like to give to potential Halal food investors in Asian markets? Asian markets have high demand potential and capacity for further investment. However, international investors need to identify the market dynamics of selected Asian market, awareness level of consumers and requirements of Halal food industry supply chain methodology. Infact total integrity in the Halal supply chain needs to be well preserved. If consumers lose credibility in the status of Halal, as in the case of Ajinomoto MSG product in Indonesia, it is extremely hard to earn back the required trust and credibility. Therefore, it is important for investors to get the Halal certificate from the most reputable certification body. gif


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World Islamic Finance Review

At the beginning of February, 2011, Qatar Central Bank (QCB) notified all conventional banks in Qatar that they were required to stop operating Islamic Windows (IWs) by the 31st of December 2011. On the 10th of February 2011, QCB issued a public press release detailing the requirements and explaining the reasons for its decision to stop the operation of the IWs. What are conventional banks required to do? New Operations The press release indicated that conventional banks are required to stop the following actions: • • •

Opening Islamic branches; Accepting Islamic deposits; and Entering into Islamic financial operations.

Existing Operations For existing assets and liabilities, including deposits and finance operations, conventional banks are obligated to do the following up to and including 31 December 2011: •

• •

STATE OF QATAR: END OF ISLAMIC BANKING WINDOWS Author: Siraj Al Islam, Associate, Dewey & LeBoeuf LLP

28 Global Islamic Finance

August 2011

• • •

Collect the relevant assets and liabilities and dispose of their obligations within any earlier agreed upon dates; and Pay back all Islamic deposits upon any earlier agreed maturity date. Following 31 December 2011, to the extent that neither of the above options could be exercised, banks may do the following: Manage the remaining Islamic assets in a special portfolio; Transfer some of the remaining Islamic assets to the existing Islamic banks; and Convert the existing Islamic window branches to conventional branches.

Although it is not stated, there appears to be no reason why such conventional banks could not open independent Islamic banks and then transfer the existing assets to the newly established Islamic banks. This option, however, appears not to have been clearly provided for and has created a situ-


World Islamic Finance Review

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In addition to specialising in Islamic banking and finance, Siraj has a long history of advising sponsors, banking institutions and quasi-governmental entities with the structuring, implementation and delivery of major projects, including PPP and PFI. At the age of 28, Siraj was appointed and served as the United Kingdom General Counsel for ISS, a global organisation listed by Forbes as the world’s 5th largest private employer and as the 6th best outsourcing company in the world by American Fortune Magazine. Prior to joining Dewey & LeBoeuf, Siraj worked at international law firms including Clifford Chance LLP

ation where customers of such IWs have been left without a clear understanding of their rights and obligations. It is argued that QCB should now categorically provide a mechanism whereby IWs should be allowed to convert to full Islamic banks and that the process should be simplified and made clear to ensure that this is affected in a smooth and transparent manner. In the publicly available information from QCB, it is not clear whether it would be possible for existing Islamic banks to acquire the IWs portfolios and thus allow the conventional banks to dispose of their IWs portfolios. To the extent that the QCB agrees with and allows such disposal, it may be that the customers of such IWs may not wish to deal with the existing Islamic banks and this may have been a reason as to why such customers did not choose the existing Islamic banks in the first place. Another possible, voluntary scenario on the part of all the IWs, their customers and existing Islamic banks may provide for a program whereby the IWs agree with their customers to bring to maturity their existing relationship. At the same time the IWs agree with existing Islamic banks to provide the same facilities so that the customers of the IWs are not commercially affected. Subject to Qatari law, this may even be achieved by the parties entering into a novation agreement. It is argued, however, that this may not be a workable solution from a commercial perspective as the existing Islamic banks may not be willing to provide the same terms to the IWs customers as they currently have, on the basis that existing customers of the Islamic banks may be under different terms which may not be on par with the IWs’ terms. Why is QCB stopping the operations of Islamic windows by conventional banks? QCB has provided two categories of reasons for its decision: • •

Supervisory issues and monetary policy issues, both of which are dealt with in full detail below.

Supervisory Issues QCB believes that, under Article (1) of the Qatar Central Bank Law No.33, enacted in 2006, a bank may either conduct its affairs following conventional banking practices or it may conduct its affairs according to Islamic banking and financing principles. There is no option for the same entity to provide both conventional and Islamic banking, and, as such, Islamic windows are incompatible with the law. QCB further believes that there is no need to provide Islamic window operations, on the basis that there exist well-established Islamic banks which are capable of meeting the needs of investors and depositors who wish to conduct their affairs according to Islamic banking and finance principles. QCB contends that conventional banks are effectively commingling the non-Islamic banking practices and Islamic banking practices, and, as a result, are having difficulty in managing the following specific risks. 1. Bank Risks The principle of Islamic banking is based on trade and a return on a specific trade, which always has an element of ownership, as opposed to conventional banking, which does not look at trade or base its return on trade or a value of a product of a trade, but rather on a direct increment of an amount borrowed or lent. Thus, the general risk profiles of Islamic and conventional banking are completely different. As more large and complex transactions are entered into, both Islamic and conventional deposits are being utilised for the same transactions. Clearly, the rates of return for conventional interest-bearing deposits are wholly different from deposits based on Islamic banking practices. QCB appears to contend that both Islamic and conventional risks are getting recorded in the same manner, and therefore that reliability, application of oversight, calculating ratios and indexes, and preserving the rights of conventional and Islamic depositors are becoming increasingly complex. The risk related to commingling has been widely debated by leading scholars in the past. The end result of the debate

appears to be that insofar as strict controls are adhered to, then effectively there are no particular issues that cannot be overcome. The controls discussed by the leading contemporary scholars such as Taqi Usmani are as follows: 2. Segregation of Funds The conventional funds and the Islamic funds should be completely segregated. This means that Islamic funds should be held in separate accounts and that books and records should be maintained which evidence the segregation so as to ensure that there is no commingling of conventional and Islamic funds. 3. Shariah Supervision The bank should have a group of Shariah scholars who are fully independent of the bank, whose decisions should be fully binding on the bank, and who provide effective supervision of how the bank conducts itself. The Shariah scholars would effectively control each and every aspect of the operation of the bank so as to ensure that each and every product that is stated as being Islamic does indeed comply with the Shariah. 4. Managerial Commitment It is argued that the management of the bank should be fully committed to Islamic banking and should not be there simply for the purpose of “exploiting practicing Muslim investors and in so doing unfairly compete with Islamic financial institutions”. 5. Providing Security for Investors Funds To the extent that Muslims only deposit their funds with the bank, this amount should be fully guaranteed, and even where the bank is only acting as an investment manager, there should be proper screening and security in place to protect Muslim investors from such matters as fraud and deception. 6. Adhering to Islamic Standards It is paramount for a bank to adopt either the AAOIFI Standards or the Islamic Financial Services Board (“IFSB”) standards and clearly demonstrate this. It is argued by many whether a conventional bank operates a window or incorporates a wholly owned subsidiary the net effect is the same and 2011 August Global Islamic Finance

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World Islamic Finance Review

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At the beginning of February, 2011, Qatar Central Bank (QCB) notified all conventional banks in Qatar that they were required to stop operating Islamic windows (IWs) by the 31st of December 2011. On the 10th of February 2011, QCB issued a public press release detailing the requirements and explaining the reasons for its decision to stop the operation of the IWs. What are conventional banks required to do? New Operations The press release indicated that conventional banks are required to stop the following actions: • • •

Opening Islamic branches; Accepting Islamic deposits; and Entering into Islamic financial operations.

Existing Operations For existing assets and liabilities, including deposits and finance operations, conventional banks are obligated to do the following up to and including 31st December 2011: •

Collect the relevant assets and liabilities and dispose of their obligations within any earlier agreed upon dates; and Pay back all Islamic deposits upon any earlier agreed maturity date.

Following 31st December 2011, to the extent that neither of the above options could be exercised, banks may do the following: • • •

Manage the remaining Islamic assets in a special portfolio; Transfer some of the remaining Islamic assets to the existing Islamic banks; and Convert the existing Islamic window branches to conventional branches.

Although it is not stated, there appears to be no reason why such conventional banks could not open independent Islamic banks and then transfer the existing assets to the newly established Islamic banks. This option, however, appears not to have been clearly provided for and has created a situation where customers of such IWs have been left without a clear understanding of their rights and obligations. It is argued that QCB should now categorically provide a mechanism whereby IWs should be allowed to convert to full Islamic banks and that the process should be simplified and made clear to ensure that this is affected in a smooth and transparent manner. In the publicly available information from QCB, it is not clear whether it would 30 Global Islamic Finance

August 2011

be possible for existing Islamic banks to acquire the IWs portfolios and thus allow the conventional banks to dispose of their IWs portfolios. To the extent that the QCB agrees with and allows such disposal, it may be that the customers of such IWs may not wish to deal with the existing Islamic banks and this may have been a reason as to why such customers did not choose the existing Islamic banks in the first place. Another possible, voluntary scenario on the part of all the IWs, their customers and existing Islamic banks may provide for a program whereby the IWs agree with their customers to bring to maturity their existing relationship. At the same time the IWs agree with existing Islamic banks to provide the same facilities so that the customers of the IWs are not commercially affected. Subject to Qatari law, this may even be achieved by the parties entering into a novation agreement. It is argued, however, that this may not be a workable solution from a commercial perspective as the existing Islamic banks may not be willing to provide the same terms to the IWs customers as they currently have, on the basis that existing customers of the Islamic banks may be under different terms which may not be on par with the IWs’ terms. Why is QCB stopping the operations of Islamic windows by conventional banks? QCB has provided two categories of reasons for its decision: • •

Supervisory issues and monetary policy issues, both of which are dealt with in full detail below.

Supervisory Issues QCB believes that, under Article (1) of the Qatar Central Bank Law No.33, enacted in 2006, a bank may either conduct its affairs following conventional banking practices or it may conduct its affairs according to Islamic banking and financing principles. There is no option for the same entity to provide both conventional and Islamic banking, and, as such, Islamic windows are incompatible with the law. QCB further believes that there is no need to provide Islamic window operations, on the basis that there exist well-established Islamic banks which are capable of meeting the needs of investors and depositors who wish to conduct their affairs according to Islamic banking and finance principles. QCB contends that conventional banks are effectively commingling the non-Islamic banking practices and Islamic banking practices, and, as a result, are having difficulty in managing the following specific risks. gif

Islamic Finance Lawyers Clifford Chance Launches Offices in Qatar Source: GlobalIslamicFinanceMagazine. com Clifford Chance has further expanded its business in the Middle East with the opening of a QFC regulated office in Tornado Tower. The new QFC office is headed by Richard Parris, a projects specialist, together with Greg Englefield, who previously spent two years on secondment to a local Qatar law firm. They have also been joined by Islamic finance lawyer and Arabic speaker Hussain Shalchi. They anticipate that the headcount will increase over the coming months. Parris comments, “Clients have responded very positively to our presence in Qatar. While we have long-standing and wellentrenched relationships in Qatar, there is an understandable desire to have advisors near at hand when working on strategically critical mandates.” Clifford Chance has been active in Qatar since the 1980s and already regularly works with leading Qatari entities, international banks, financial institutions and corporate entities based in Qatar. The team in Doha are working closely with Clifford Chance lawyers across the Firm’s Middle East and international network to provide clients with access to the full range of the Firm’s expertise. Graham Lovett, Middle East Managing Partner, comments, “We are delighted with the headway the Qatar team is making, both with existing and new Qatari clients.” David Childs, Clifford Chance Managing Partner adds, “We are very pleased to be joining our clients in Qatar and offering them access to the entire Clifford Chance network through our dedicated presence in Doha.”


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ISLAMIC FINANCE GAINS MOMENTUM IN EUROPE, PART I Author: Professor Rodney Wilson, Durham University, UK

Abstract: Part 1 of Islamic Finance gains momentum in Europe will take you through the years of Islamic finance with in Europe covering the various financial sectors such as Sukuk issuance, liquidity management, investment banking and wealth management. Professor Rodney Wilson will also discuss the development of Sukuk issuance in Europe covering factors such as the political desire to ensure that British Muslims feel welcomed rather than outsiders. Keywords: Sukuk Issuance, Muslims, Investment Products, Shariah-compliant Finance

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slam all too often resonates negatively in Europe, with much nonMuslim public opinion uncomfortable with Islamic culture and values. Secular and Christian opinion is at best suspicious of Shariah, Islamic law, and indeed often antagonistic. The notion of wanting to apply Shariah principles to banking and finance is treated with scepticism if not outright hostility, especially as there is no concept of Christian or Jewish banking, even if there are some parallels between Shariah financial principles and the teaching of the Old Testament. Yet Islamic finance is thriving in Europe, and many major European banks perceive it as a profitable opportunity to generate new business rather than as a threat to existing business. Although Islam is sometimes viewed as prescriptive and concerned with restricting choice, Islamic finance is about widen-

ing choice, and in particular about providing alternatives to interest based finance. The aim is to develop financial products that are seen as ethical and within the realm of socially responsible investment. The approach in this paper is largely thematic and institutional rather than geographical, with the subject viewed from a European rather than an Islamic world perspective. It is perhaps appropriate to start by examining the role of Islamic finance in Euro-Arab banking relations. Much of the focus is on Shariah compliant asset management, with a section on liquidity management without the use of conventional instruments such as treasury bills, and an extensive discussion of the structuring of Islamic sukuk securities. In the banking field the development of Islamic retail banking in Europe is reviewed, with a further section devoted to Shariah compliant wealth management and private


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The Islamic financial activities of major European banks will become apparent from the discussion, as will the Islamic finance operations of some of the Arab banks with subsidiaries and branches in Europe. The achievements of the European based exclusively Islamic banks will also be reviewed, notably those of Islamic Bank of Britain and the European Islamic Investment Bank. The role of Islamic finance in Euro-Arab banking relations Islamic finance has become a key dimension of the relationship between Arab banks and their European counterparties. While the Arab banks imported most of their conventional financial products from Europe in the past, now European banks are importing Shariah compliant products from the Arab World, not only for their overseas Arab clients, but more significantly for the growing Muslim population of Europe. Thanks to the emergence of Islamic banking, knowledge transfers in finance have become a two way process rather than simply a one sided affair. European banks have as much to learn from the Arab World as the latter have from Europe as interdependence replaces dependence. The increasing spread of Shariah compliant finance, and the dynamism of the economies where it is important, is making the Euro-Arab financial relationship more a partnership of equals in the twenty first century. In contrast for much of the nineteenth and twentieth centuries the Arab economies underperformed those of Europe, and one explanation for this underperformance was the development of a financial system in the region based on riba that was never fully accepted given its inherent conflict with Islamic values. Fortunately now pious Muslims have a real choice, as Shariah compliant products have been developed over the last three decades to serve most of their financial needs, and these products are at least as efficient as their conventional counterparts. The United Kingdom has been the gateway for Islamic finance to enter Europe, partly reflecting the role of London as the leading international financial centre, but also as a consequence

of the exposure of leading British banks to the Arab and wider Islamic World and their knowledge of these markets. It was the Arab joint venture banks that first brought Islamic finance to London in the early 1980s as Islamic banks in the Gulf found that re-depositing on a murabahah basis could be an effective tool for liquidity management, with the marks-ups generated from trading activity on the London Metal Exchange. The United Kingdom has also hosted the first Islamic retail bank in Europe, the Islamic Bank of Britain which started operations in September 2004, and the European Islamic Investment Bank, which opened for business in 2006. The leading conventional banks have also become involved in serving the local retail market for Islamic financial services, notably HSBC and Lloyds TSB, both of which provide Islamic deposit facilities and housing finance using Shariah compliant structures. It is of course internationally that European banks have made the greatest contribution to Islamic finance with Barclay Capital partnering Dubai Islamic Bank for the world’s largest sukuk issuances, Standard

banking. Prospects for Islamic investment banking are also considered as well as the European experience of Shariah compliant fund management. Finally future prospects for Islamic banking and finance in Europe are assessed, notably the provision of Shariah compliant services for continental European Muslims, and the possible implications of Turkey’s accession to the European Union will be examined, although there the fortunes of Islamic finance have been rather mixed.

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dah to provide money changing services for pilgrims from Dutch Indonesia, the condition being that it avoided all interest based transac- tions. For the next fifty years most of the European banks involved in the Muslim world carried out their business using interest, as indeed did their local counterparts, within financial systems where governments believed religion had no role to play. By the late 1970s however the perceptions of European bankers was starting to change, largely as a result of the emergence of Islamic banks in the Gulf, with the Dubai Islamic Bank the first to be established in 1974, followed by the Kuwait Finance House in 1977 and the Bahrain Islamic Banks in 1978.

In the banking field the development of Islamic retail banking in Europe is reviewed, with a further section devoted to Shariah compliant wealth management and private banking. Prospects for Islamic investment banking are also considered as well as the European experience of Shariah compliant fund management

Chartered making a notable contribution to Islamic finance through its networks in the Gulf, Pakistan and Malaysia, Deutsche Bank in pioneering capital protected funds in the Gulf and UBS in developing Shariah compliant wealth management services to name just some examples. It is the operations of these major European banks that will be also reviewed here.

All these banks were extensively involved in Shariah compliant trade finance, especially of imports from Europe, using a structure known as murabaha, whereby an Islamic bank would purchase an imported good on behalf of a client, and then resell the good to the importer for deferred payments covering the costs of the purchase plus a mark-up representing the bank’s profit. As the bank was involved in a real trading transaction which involved ownership risks this justified its profit, unlike interest on a conventional loan where there was only the credit risk of default.

Early Islamic trade finance operations of major European banks It was the involvement of European banks in the Gulf that first resulted in them encountering demands for Islamic finance. These date back over eighty years, as it was in the 1920s that the Eastern Bank, the predecessor of Standard Chartered, was asked by the ruler of Bahrain that the bank’s proposed branch on the island would only be allowed if it avoided all interest based transactions. At the same time the National Handelsbank of the Netherlands, the predecessor of ABNAmro, was allowed to establish itself in Jed-

As the payments by the Islamic banks would be made to the European exporter’s bank those bankers involved started to learn about Islamic finance. In a conventional trading transaction usually the exporter’s bank would demand a letter of credit from an importer’s bank that would guarantee the payment. With murabaha however, as it is an Islamic bank, and not the import distributor or agent who is making the payment, letters of credit are arguably unnecessary, as well regulated banks are less likely to default than individual corporate clients. This potentially lowered the costs of trade financing, 2011 August Global Islamic Finance

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but European banks acting on behalf of their exporting clients were only prepared to wave the requirement for their Shariah compliant counterparties to provide letters of credit if they were satisfied that these Islamic banks could meet their payments obligations. To be confident in the timely payment of receivables European banks needed to find out more about Islamic banking and understand how Islamic financing techniques worked. Shariah compliant liquidity management in Europe All banks need to maintain liquid assets to meet depositor withdrawals and financial obligations to other institutions including banks. Rather than merely holding cash, which yields no return, usually liquid assets are held as treasury bills or repos, repurchase obligations on which a financial institution which holds these monetary instruments earns interest. Islamic banks cannot hold such instruments, as interest is regarded as riba, which is explicitly prohibited in the Holy Koran. This presented a challenge for Islamic banks, as they were required by regulators to hold liquid assets as part of prudential risk management requirements, but there were no Shariah compliant liquid instruments available which they could hold. From 1980 onward a number of banks in London offered Shariah compliant liquidity management services to Islamic banks from the Gulf and the Jeddah based Islamic Development Bank. This involved inter-bank wholesale operations, with banks in London providing overnight deposit facilities for the newly established Islamic banks in the Gulf. The major institutions involved were the joint venture Arab banks in London, such as Saudi International Bank and the United Bank of Kuwait. They accepted deposits on a murabaha mark-up basis, with the associated short term trading transaction being conducted on the London Metal Exchange. The margins were very small on these buying and selling transactions, but they were sufficient for the banks in London to offer the Islamic financial institutions in the Gulf and Jeddah a return which was comparable to that on conventional treasury bills. The attraction of London was the financial expertise available and the low risk transactions facilitated by the London Metal Ex34 Global Islamic Finance

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Professor Rodney Wilson is Director of the Islamic Finance Programme in Durham University. He has researched on Islamic finance since the 1970s and has written numerous books on the subject for leading international publishers including Edinburgh and Columbia University Presses and Brill. He has extensive consultancy experience, including with the Islamic Financial Services Board with respect to its Shariah Governance Guidelines. He is currently working on a project on Islamic finance in North Africa for the African Development Bank. From January until June 2009 Rodney Wilson was a Visiting Professor at the Qatar Foundation’s Faculty of Islamic Studies in Doha, and he returned there in 2010 for a four month period. Professor Wilson’s teaches masters level courses on Islamic economics and finance and supervises PhD students working on Islamic finance. He has acted as Course Director for Euromoney Legal Training in various regions such as London, Bahrain, Kuwait, Riyadh and Abu Dhabi.

change because of the depth of the market. The joint venture counterparties were not directly involved in the trading, but rather engaged specialist brokers, notably Dawnay Day, which soon acquired the knowledge of the Shariah issues that concerned their Gulf clients. Although the provision of murabaha facilities as an instrument for liquidity management remains significant, the real transactions involved result in it being a relatively costly means of ensuring Shariah compliance. A

preferable and less costly solution is for Islamic banks to hold modified treasury bills that satisfy Shariah requirements. Progress has been slow in developing such instruments, and the trading of securities based on bai’ dayn debt contracts, which is allowed by Shafii scholars in Malaysia, is not permitted by more conservative schools of Islamic jurisprudence, including those whose opinions prevail in the Gulf. European Shariah scholars tend to follow the more conservative interpretations in the Gulf and South Asia associated with the Hanafi and Malaki schools of Islamic jurisprudence rather than the Shafii School which prevails in Malaysia and Indonesia. How to manage liquid assets remains a major matter of controversy in Islamic finance, not least because many Islamic banks continue to have liquidity well in excess of regulatory requirements. Although the Islamic Financial Services Board has provided guidelines for regulators on liquidity management, it does not specify what instruments should be used. In Bahrain salam sukuk securities have been developed which serve the same function as treasury bills, but as these are asset backed, the issuance and redemption involves buying or selling a claim to the underlying real asset rather than simply acquiring or disposing of debt. This has been approved by the more conservative Shariah scholars in the Gulf as a preferable alternative to bai’ dayn debt contracts and the bai’ bithaman ajil sukuk traded in Malaysia which are backed by financial rather than real assets. A salam contract involves a payment for a real asset to be delivered in the future, with the timing of delivery and the precise details of the asset specified in the contract. In the case of Bahrain the issuer is the government, the assets are commodities such as aluminum used by the country’s smelter and the time to maturity is ninety days. Islamic financial institutions purchase the salam sukuk and on maturity are reimbursed after ninety days with a mark-up representing their return on the asset. On receipt of these funds they relinquish their rights to the underlying asset which reverts to the government as the issuer. At present salam sukuk are not traded on a secondary market, even though Bahrain has a Liquidity Management Centre established for sukuk trading, as the Shariah scholars view them as financial instruments and are concerned about the link with the underlying asset. This is a major limitation for salam sukuk, as treasury bills and repos are usually widely traded in secondary markets, resulting in greater liquidity.


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Sukuk issuance and trading in Europe At present there are no salam sukuk available in Europe although most countries have active treasury bill and repo money markets. This presents a problem for Islamic banks in Europe that have to continue to rely on murabaha inter-bank deposits for their treasury management. There is an opportu- nity to develop markets in Islamic securities in Europe which would attract institutional Shariah compliant investment from the Middle East as well as serving Islamic banks in Europe. London is an obvious location given the depth and breadth of its financial markets, especially as the Islamic Bank of Britain and the European Islamic Investment Bank are listed on the Alternative Investments Market (AIM). Developing a market in salam sukuk is problematic however unless tradability is allowed by the Shariah scholars, as merely having issuance is not a substitute for an Islamic money market. The pioneering sukuk in Europe was by the German Federal State of Saxony-Anhalt which raised €100 million through an issuance on 31st July 2004. The sukuk is for five years using an ijara leasing structure with a floating return based on the six month Euribor rate plus one percent. In other words in financial terms it is identical to a floating rate note but because of the ijara structure the payments to the investors represent rent rather than interest or riba which is prohibited under Shariah. This is not merely the renaming of the return, but rather having a structure that is recognized as distinctive under national law, and in the case of the Saxony-Anhalt sukuk, German law. Like other German state debt instruments the sukuk was listed in Luxembourg, with an additional listing in Bahrain to attract Gulf investors. Citigroup Global Markets was the arranger for the sukuk, and the Shariah advisory board of Citi Islamic Investment Bank in Bahrain vetted the legal documentation for Shariah compliance. The sukuk was rated –AA by S&P and –AAA by Fitch with the state of Saxony-Anhalt acting as guarantor. The Kuwait Finance House, the second largest Islamic bank in the Gulf, acted as lead manager for the issue, with its visibility and reputation helping ensure that other Islamic financial institutions would invest in the sukuk. As sukuk have to be asset backed, the solution under German law was to establish a “Dutch” foundation, which corresponded to the classical Islamic concept of a waqf. 36 Global Islamic Finance

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The Ministry of Finance then transferred usufruct rights to its building to the foundation, which served as the underlying asset. When the sukuk is traded investors are buying and selling rights to the real underlying asset which is permissible under Shariah, rather than simply paper debt instruments which cannot be traded in the view of Gulf Shariah scholars as already indicated. Effectively the structure is a sale and lease back arrangement, with the foundation serving as a special purpose vehicle, (SPV), which is wound up on termination of the sukuk, when the usufruct rights revert back to the Ministry of Finance which no longer pays rent to service the investors. In this respect it is different from a waqf religious endowment trust which exists in perpetuity rather than for a definitive period. The idea for the sukuk followed an earlier road show during 2001 when German states tried to ascertain if there was a market for near sovereign issuers in the Gulf countries, with institutions there suggesting that any offering would attract more attention if it was Shariah compliant rather than being structured as a conventional bond or floating rate note. Most of the sukuk issued in the Gulf and South East Asia are for corporate clients rather than sovereign sukuk, but corporate issuances have been slow to start in Europe. The Swiss company, EnergyMixx AG announced on 15th August 2007 that it had appointed Faisal Private Bank and the law firm Vinson Elkins to advise it on a suitable sukuk structure to fund a power plant project in the Gulf, but the structure and the terms have still to be decided. A relatively small corporate sukuk worth $26 million was arranged in April 2005 by ABC Islamic Asset Management in London and the Abu Dhabi Commercial Bank on behalf of Al Safeena Ltd of London. The English Law firm Norton Rose advised on the structure together with Voisin and Co. of Jersey, as the trust structure governing the sukuk was registered under Jersey’s offshore laws. This was the first Islamic security to be used to finance shipping, as the asset used was a Very Large Crude Carrier (VLCC), Venus Glory, which was chartered to a Saudi Arabian shipping company. An ijara structure was used for the sukuk, with the tenor being five years and the return a fixed six percent payable quarterly with the return of the principle on maturity. A fixed return is unusual on an ijara sukuk, which in this case means in financial terms it is equivalent to a bond rather than a floating rate note. Normally a murabaha structure with a mark-up would be used for a fixed return sukuk, but as murabaha is a short term instrument, arguably an ijara structure is

preferable for a period of five years. A larger corporate sukuk worth $261 million was used to finance the purchase of the Sanctuary Building in London in 2005. Taylor Wessing, the international law firm, advised on the structuring, the clients being Bahrain based Taib Bank and Hong Kong based Dominion Asset Management, represented in the United Kingdom by Pelham Associates. This sukuk was also based on an ijara structure, but with a variable return linked to LIBOR, the London Inter-Bank Offer Rate, rather than a fixed return. Turkey, an aspiring European Union member, has more Islamic bank branches than any other European country, although the role of Shariah compliant finance in its banking system remains marginal. It is an active member of the Jeddah based Organisation of the Islamic Conference (OIC) and subscribes to and has received Shariah compliant funding from the Islamic Development Bank, the aid agency of the OIC. At present all of Turkey’s government debt is funded through conventional bill, bond and note issuance involving interest based payments, but since September 2005 consideration has been given as to whether some debt should be funded through sukuk securities. As always in Turkey the issue has been complicated by political considerations, given the tensions between the AK, the moderate Islamist governing party, which supports Islamic finance, and the former president, and upholder of Turkey’s secularist constitution, who was at best skeptical towards the notion of finance being Shariah compliant. The tensions between Islamists and secularists in Turkey are long standing, and Islamic banking and finance is viewed from the perspective of political symbolism, rather than being simply about financial choices. The change in Turkish law necessary for the issuance of sukuk has been made more likely since the decisive election win by AK in 2007 under the Prime Minister, Recep Tayyip Erdogan, and the appointment of his political ally, Abdullah Gül, as President. It is inevitably London that has the most potential as a centre for sukuk issuance in Europe given its established reputation in Islamic banking, the depth and breadth of its financial markets and a regulatory framework that encourages rather than inhibits financial innovation. There has been over three decades of official support, initially by the Bank of England, and from 1997 onwards by the Financial Services Authority as it took over regulatory responsibility for banking, including Islamic banking. However the Treasury has only been marginally involved,


World Islamic Finance Review

The first is to ensure that British Muslims see that their government is open and responsive to the opportunities that Islamic finance offers. There is a political desire to ensure that British Muslims feel included rather than excluded, not least because Muslims who are United Kingdom nationals may vote, and their support is crucial to ensure that the Labour Party maintains control of key marginal constituencies. A second factor is to ensure that the City of London continues to play a major international role in Islamic finance and attracts business for investment banks and law firms, which results in well paid jobs. The government has established a Working Group on City Competitiveness to ensure that London’s leading role in international finance is consolidated and enhanced, and the encouragement of Islamic finance is viewed as part of this strategy. Third although government debt is relatively modest in relation to gross domestic product (GDP) in the United Kingdom and funding can be secured easily, there is a desire to diversify funding sources to keep costs low and attract attention to Sterling as a stable and attractive currency for international investors, including Muslim institutions and individuals concerned with Shariah compliance.On 23rd April 2007 the Treasury announced that it would be undertaking a feasibility study of the po-

tential for sovereign sukuk issuance by the British government, the aim being to include a statement of progress in the pre-budget report for 2007. On 16th August 2007 the first meeting of the Islamic Finance Experts Group was convened in London, an official body established to advise the Treasury and the Financial Services Authority on issues relating to Islamic finance, including sukuk issuance. Issues being considered include who and how Shariah compliance will be ensured, the structure and size of the issuance, the period to maturity and the pricing.

would be made in 2008, and that a report identifying key issues in the sukuk issuance would be announced, including the tax treatment of assets transferred into and from the SPV. It was also proposed that National Savings and Investment (NS&I), the British government savings scheme, would offer Shariah compliant products to retail investors through the national post office branch network.

Shariah assurance could imply the Treasury either appointing its own Shariah board or Islamic retail banking in Europe outsourcing compliance, both options having As the main source of support for Islamic advantages and disadvantages. The struc- banking has always come from ordinary ture is most likely to be based on an ijara Muslims, and the development of Islamic leasing contract, with the payments The United Kingdom has been the gateway to the sukuk holdfor Islamic finance to enter Europe, partly ers being rents. As with other ijara reflecting the role of London as the leadbased sukuk the ing international financial centre, but also as a consegovernment would quence of the exposure of leading British banks to the establish an SPV which would hold Arab and wider Islamic World and their knowledge of the asset, a piece these markets of state owned land, for the duration of the sukuk that is anticipated to be five years. The gov- finance can be regarded as a populist moveernment rental payments for the use of the ment rather than an initiative from governasset would be paid through the SPV to the ments, it is not surprising that retail Islamic investors with the tax treatment the same banking has been the dominant activity. The as for conventional securities. Rents would world’s largest Islamic financial institutions, be benchmarked to either the London Inter- the Al Rajhi Bank of Saudi Arabia and the KuBank Offer Rate (LIBOR) or Bank of England wait Finance House, primarily provide retail, Minimum Lending Rates (MLR), the expecta- personal and private banking products, as tion being that the actual rents paid would do the Dubai Islamic Bank and Bank Islam be at a discount to LIBOR or MLR reflecting Malaysia. In Europe Islamic finance has also the high quality of the government paper is- been a bottom up rather than a top down sued and its implicit AAA rating as the United movement, although it is only in the United Kingdom government always meets its finan- Kingdom that the regulator, the Financial cial obligations. Services Authority, has actively facilitated the development of the industry. The pricing would be in line with conventional government debt instruments, and it Yet France and Germany have much larger is anticipated that the same financial institu- Muslim populations than the United Kingtions will take up the offer as hold the con- dom, where the total was only 1.8 million ventional equivalent. The prime aim is not when Islamic retail banking started in the to attract Gulf capital inflows, but rather 1990s and still remains below two million to establish a benchmark for high quality today. Islamic debt that can be used as a base for the higher pricing of future more risky As Muslims are no different to non-Muslims corporate sukuk issuance in London. in their needs and demands for financial services, not surprisingly Islamic banks and There was some disappointment that conventional banks offer Shariah compliant no sukuk announcement was made retail products that mirror those provided to in the Chancellor of the Exchequer’s ordinary clients. Current account or transacpre-budget statement of October 2007, tions deposits are always offered, as these but given the complexity of the legal and facilitate payments through cheques, standtechnical issues to be resolved, the ing orders, direct debits and most imporomission at this early stage was not sur- tantly debit cards for use at point of sale prising. The Chancellor Alistair Darling or through automated teller machines. Of indicated that further announcements course as conventional current accounts

largely through granting tax concessions to ensure a level playing field for Shariah compliant housing finance, rather than viewing Islamic finance as a vehicle for raising revenue. During 2006 the idea of London serving as a centre for sukuk issuance was first raised at an Islamic finance conference in June, which was attended by the then Chancellor of the Exchequer, Gordon Brown, and his deputy Ed Balls. As they became involved this gave the cause of sukuk issuance political momentum which has propelled subsequent developments. Three factors appear to be positively influencing developments.

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pay little or no interest, some observers may question the need for special Shariah compliant current accounts. Such accounts however are provided using wakala trust structures, where the financial institutions guarantees that the amounts deposited will not be used for interest based financing, or under the qard hassan principle, where the depositor provides the bank with in interest free loan on the understanding that no riba will be charged when the finance is utilised. In the United Kingdom both Lloyds TSB and HSBC Amanah offer Shariah compliant current accounts. Banks providing Shariah compliant retail financial services in Europe all offer a range of savings and investment products. The Islamic Bank of Britain offers a treasury account, where those who have £100,000 or more to invest can place their funds for fixed periods ranging from 1-24 months, with higher returns offered for longer time deposits. The deposits are structured on a murabaha basis, with the funds used to buy and sell commodities on the London Metal Exchange, with the client being paid a markup reflecting the trading profit. The profit rate is pre-determined, eliminating risk for the client, and the bank covers its position in the commodity exchange by agreeing the sale price at the time of purchase. Such transactions are permissible under Shariah, as the hedging does not involve the use of derivatives such as futures and options, but rather real trading transactions involving physical commodities. Savings accounts are also offered where no minimum balance is required but returns are significantly lower than with the treasury placements. The Islamic Bank of Britain offers three instant access accounts, an internet direct access account paying 3 percent in September 2007, a young persons account paying 2.5 percent and a undetermined savings account using a passbook with branch deposits and withdrawals paying 2.0 percent. It also offers term savings deposits with minimum notice periods for withdrawals, the 30 day account

paying 3.25 percent, the 90 day account 3.50 percent and the 180 day account 3.75 percent. These accounts are based on a mudaraba structure, with the depositor sharing in the profits of the bank rather than earning interest. It should be noted that the percentage returns indicated are target rates, which are not guaranteed, as under a mudaraba structure returns cannot be predetermined. With mudaraba the profit rate declared on which returns on deposits are based should be related to the profitability of the financial institution. However most Islamic banks, including the Islamic Bank of Britain, maintain a profit equalisation reserve into which a proportion of bank revenue is paid rather than being distributed to depositors. The aim is to maintain a reserve fund, from which a profit share can be paid, even in years when the bank generates less profit. The cost to depositors is that they receive less in the more profitable years. This profit smoothing, which is encouraged by regulators, including the Financial Services Authority, enables Islamic banks to stay competitive with conventional banks, with the option of increasing profit rates when interest is rising and other financial institutions pay more to depositors. Islamic banks are often criticized by strict Muslims for benchmarking profit rates to interest indices, but legally the returns they pay are profits, not interest, and as Islamic banks only account for a minute share of bank deposits in most markets, they are price takers, not price makers. There is a potential conflict between mudaraba depositors and shareholders in an Islamic bank, as higher dividend payments to the latter may be at the expense of profit share payments to the former. However if the mudaraba depositors are not sufficiently rewarded, not many will be attracted to the bank, which will adversely affect the bank’s growth and its long run profitability. In other words the market can provide a solution, without the need for regulatory intervention. Mudaraba is regarded as an equity type arrangement, but it is not the same as equity investment, as it is the shareholders who own the bank and enjoy voting rights, not the mudaraba depositors. However while the shareholders may receive very variable dividends, and suffer capital losses as well as gains, returns to the mudaraba depositors fluctuate less, but they do not benefit from capital gains. Under Shariah the nominal capital value of mudaraba deposits cannot be guaranteed,

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but in practice it is never written down as it is the shareholders dividend that is cut or eliminated when losses occur, with mudaraba depositors also higher in the pecking order with regard to claims in the case of insolvency. In part 2 of Islamic Finance in Europe Professor Rodney Wilson will give his insight of the future of Europe’s Islamic finance industry looking at Turkey and the Financial Services Authority, their roles in the success of Islamic finance. The article will focus on sectors such as Islamic wealth, retail banking and Islamic investment banking. gif

References and Further Reading •

• •

Chapra, M. Umer, The Future of Economics: An Islamic Perspective, Islamic Foundation, 2000. El-Ashker, Ahmed and Wilson, Rodney, Islamic Economics: A Short History, Brill Academic Publishers, 2006. El-Gamal, Mahmoud A, Islamic Finance: Law, Economics and Practice, Cambridge University Press, 2006. Iqbal, Zamir and Mirakhor, Abbas, An Introduction to Islamic Finance: Theory and Practice, Wiley, 2007. Hassan, M. Kabir and Lewis, Mervyn K., Handbook of Islamic Banking, Edward Elgar, Cheltenham, England and Northampton, Massachusetts, 2007. Henry, Clement and Wilson, Rodney, The Politics of Islamic Finance, Edinburgh University Press and Columbia University Press, New York, 2004. (reprinted by Oxford University Press, Karachi, 2005) Adam, Nathif J. and Thomas, Abdulkader, (eds.) Islamic Bonds: Your Guide to Issuing, Structuring and Investing in Sukuk, Euromoney Books, London, 2004. Archer, Simon and Karim, Rifaat Abdel (eds.) Islamic Finance: Innovation and Growth, Euromoney Books, London, 2002. Islamic Finance Information Service: http://sitesecurities.com/ifis Institute of Islamic Banking and Insurance, London: www.islamic-banking.com


Event Review

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JAMES CAAN OF BBC’S DRAGOS DEN IS SUPPORTING THE GLOBAL INVESTOR WINDOW

Investors from this region [Middle East] generally expect entrepreneurs to have more direct contact, demonstrate their understanding of the local/ regional market, and structure deals in accordance with cultural norms

Global Islamic Finance magazine was proud to support UCI’s annual conference at the London Stock Exchange for investors from the Middle East region. Conference organizer, Mr. Tahar Benourrad, and his team from UCI put together an exciting Dragons’ Den type format, with James Caan of BBC Dragons’ Den fame as the keynote speaker. The format gave the panellists an opportunity to see presentations from entrepreneurs requiring investments of between £5m and £150m in sectors ranging from real estate to renewable energy. The UCI event was heavily over subscribed and attracted some leading figures from both the UK and the Middle East, including sovereign wealth funds, private investors, and government representatives. The conference panellists, who included Mr. Michael Clark, CEO of Qatar Islamic Bank, Mr. Hadi Damirji, Managing Director of Trinity Group, Dr. Hatem Abou Said of Al Baraka Banking Group, and Mr. James Caan, shared their views on the cultural and commercial nuances of raising finance from the Middle East and investing into the region. Mr. Caan kicked off the event with en exhilarating keynote speech highlighting his signature approach on private equity and real estate investing. Mr. Caan introduced his real estate investment firm Hamilton Bradshaw Real Estate (HBRE), which was represented at the conference by himself and his colleague and fellow investor Mr. Faisal Butt. One of Britain’s most successful and high profile entrepreneurs and in-

vestors, James Caan was in familiar territory, having seen over 1,000 presentations during his time at the BBC’s hit series Dragons’ Den. In Mr Caan’s opening remarks he shared his ideas with the audience, advising them on how to raise investment from the Middle East. He focused on the importance of understanding the Middle Eastern investor, who values relationships and trust above other factors. Mr. Caan stressed that investors from this region are highly sophisticated and professional, and their investment analysis is led by top talent recruited from leading global investment houses. “Investors from this region generally expect entrepreneurs to have more direct contact, demonstrate their understanding of the local/regional market, and structure deals in accordance with cultural norms”, said Caan to an audience of private investors and entrepreneurs. Mr Caan went on to explain that the Middle East attracts literally thousands of entrepreneurs/investors looking to raise capital; investors from this region see presentations almost on a daily basis. “They understand risk, they understand returns and they can discern the difference between an attractive, well thought out opportunity and hype”. He highlighted the importance of co-investment, i.e. “skin in the game”, from those seeking investment as an essential ingredient to establishing any investment relationship in the Middle East. gif


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Islamic Finance

ISLAMIC PROJECT FINANCING SETTING the Agenda for Innovative Opportunities Author: Tasnim Nazeer, Global Islamic Finance Magazine Editorial Team, United Kingdom

Abstract: Global Islamic Finance Magazine will present part 1 of the Islamic Project Finance Series which will be discussing the key components of project financing in adherence to the Shariah. This article aims to raise awareness of the functions and Islamic financial instruments used in Islamic Project financing along with an overview of the various opportunities presented in the sector primarily focusing on the UAE in Part 1 and then looking at various other countries around the world throughout the series. Islamic Project Financing is a growing sector and provides the avid investor with an excellent alternative to indulge in profitable projects through Islamic financial transactions which have the advantage of dealing with a prohibition of interest and many other benefits. Part 1 of the Global Islamic Finance Project Finance series outlines the various different types of Islamic financial instruments such as Mudaraba, Musharaka, Ijarah, Salam and most popularly Istisna and the implementation of the instruments in Islamic financial transactions. We will also look at the Insurance aspects of financing projects such as Takaful Islamic Insurance. All these components are vital to know when making that lucrative financial deal. Keywords: Islamic Project Financing, Islamic financial Instruments, Mudaraba, UAE, Musharaka, Istisna, Salam, Takaful, Quard Hasan, Tranches, Saudi Arabia, Infrastructure, Energy

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Global Islamic Project Financing taking the Nation by Storm The global demand for Islamic project financing is growing at an unprecedented rate where many investors around the world are looking into major financial hubs to aid in funding lucrative projects. As the Islamic financial market adheres to the principles set out by Shariah law all investments and projects have to be constructed in a Shariah compliant manner and authorised by an Islamic financial governing or regulatory body of the country. There are many lucrative sectors which provide scope for profitable projects across the spectrum of Islamic finance. Traditionally projects in the infrastructure sector proved more rewarding as there were many opportunities especially in the Islamic financial hub of the United Arab Emirates. Presently there are other sectors for Islamic project financing deals which are currently spearheading the market such as the energy, education, health and the Takaful market amongst many others which will be further discussed in this article. In this Islamic Project Finance Series Global Islamic Finance Magazine will take you through a comprehensive look at the role of Islamic Project Finance and its use in many countries around the world such as the Middle East, Asia, Europe and America. In the first part of Islamic Project Financing we will be focusing on opportunities and the role of Islamic financing in particularly in the United Arab Emirates. GIF will also be giving you the vital information you need so that you acquire the knowledge of utilising Shariah compliant transactions when making project financing deals. Ian Cogswell, director of natural reserves, corporate finance division, Mizuho Corporate Bank, said: “Increased liquidity in the region means that financial institutions will have to diversify their income streams on projects and be more innovative in their product offering.” Current projects in the oil and gas sector in Qatar alone amount to more than $60b, including Ras Laffan’s RasGas Onshore Expansion Project Trains, expected to produce 15.6m tonnes of LNG” (Khaleej). Knowing the Vital Financing Principles of Islamic Project Financing Islamic project financing should be undertaken with adherence to Shariah principles which include the following: Figure 1: Prohibition of Interest (Riba) Profit and loss Sharing (PLS) Specific Islamic Finance Instruments By Tasnim Nazeer

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Islamic Finance

It is important for any prospective investor or business professional to know the three main Shariah compliant rulings in Islamic finance as outlined in Figure 1 and discussed in more detail.

Four Conditions of Validity in Islamic Financial Projects/Investments 1) A price should be agreed mutually and not under duress

• Prohibition of Interest (Riba) 2) The project should be between parties that are sane and have the legal capacity to underThe prohibition of Interest in Islamic finanstand the implications of their actions; cial transactions cannot be understated as it plays a significant role in distinguishing 3) At the time of contracting, the subject matbetween a conventional transaction and an ter of the contract should be in existence and Islamic Shariah compliant one. In Islam it is able to be delivered without uncertainty or deprohibited when lending money in an unjusception; tified manner. In the context of Shariah it re4) The contract should not be based upon a fers to the premium that must be paid by the consideration (for the purposes of this broborrower to the lender along with the princhure, this is translated as counter-value) that cipal amount, as a condition for the loan or is itself prohibited under the Shariah (e.g. alcofor an extension in its maturity, which today hol, pork products, etc.) is commonly referred to as interest. The UAE Federal Law No. 5 of 1985 Concerning Civil Table by Tasnim Nazeer Information from Transactions (the ‘Civil Code’), which was Tamimi.com issued with the aim of achieving maximum compliance with the Figure 2: Shariah, outlines this principle, and states in Article 714: • Istisna ( To Manufacture) “If the contract of loan provides for a benefit in excess of the essence of the contract otherwise than a guarantee of the rights of the lender, such provision shall be void but the contract shall be valid.” (Tamimi.com) • Profit and Loss Sharing (PLS) One vital concept in Islamic financing which you should be accustomed to is the role of profit and loss sharing. This means that two partners in an investment must share their profits and losses on the basis of their capital share and the effort that they put into the project. PLS comprises of equity based financing as the justification for the PLS financiers profits rely upon his effort and the risk which he holds. If the investment or project makes a loss than the PLS financier would also incur loss. • Specific Islamic Financial Instruments There are specific Islamic financial instruments when financing Shariah compliant projects which will be discussed further in this article. The variety of Shariah compliant instruments help to aid with investments and comply with the rulings laid out by the Shariah. It is always important to ensure you are utilising specific Islamic financial instruments when carrying out an Islamic financing project. 44 Global Islamic Finance

• Prohibition of Uncertainty or Suspicion ‘Gharar’ in Projects Any transaction or investment project that a person wishes to indulge in that involves Gharar which is suspicion or uncertainty about the project should be avoided and is prohibited under Shariah Islamic law. For example it would be prohibited to sell goods for a project if those goods had been lost and you are not able to supply it. The Role of Islamic Financial Instruments in Project Financing It is vitally important to have thorough knowledge of the Islamic financial instruments which you may wish to utilise when carrying out project investments. Figure 2 outlines all the major financial instruments that you should refer to before carrying out an Islamic financial project.

Istisna means commissioned manufacture which is to ask someone to manufacture. It is a relatively modern form of Islamic finance used globally by Islamic financial institutions and banks. Istisna involves one party purchasing goods and the other undertakes the manufacturing of the goods as agreed by both parties. Many Islamic financial institutions use Istisna to finance construction projects. • Musharaka (Partnership Financing) Musharaka is a traditional form of Islamic financing which is more widely used in small scale projects and investments. Profits are shared out between two parties and both parties provide capital to the investment project. In a typical Musharaka contract between a bank and a customer the customer or partner will pay the bank its share in the profits and also a pre-determined portion of his own profits, which then reduces the bank’s shareholding in the investment. Eventually, the customer becomes the complete and sole owner of the investment. • Mudaraba (Cost Plus Financing) In Mudaraba contracts it involves the financial institution such as bank who will agree to fund the purchase of assets from a third party as requested by their client. The bank will then go on to resell the goods to its client with a market profit. The client can then choose to purchase the goods immediately or as a deferred payment which is particularly popular Islamic financial instrument to use. • Ijarah (Leasing) In the Ijarah contract it contains similarities to that of its conventional counterparts as it is defined as a sale of leasing. The financial institution or bank purchases an asset which is required by its client for a rental fee. The ownership of the asset remains in the hands of the lesser who is responsible for its maintenance so that it continues to give the service for which it was rented. The lesser assumes the risk of ownership and in practice seeks to mitigate such risk by insuring the asset in its own name. Under an Ijarah contract, the lesser has the right to re-negotiate the quantum of the lease payment at every agreed interval. This is to ensure that the rental remains in line with prevailing market leasing rates and the residual value of the leased asset. • Salam (Advanced Purchase) If you did want to purchase a property or building for the means of project financing then there is the Islamic financial instrument of Salam which means advanced purchase. The Salam contract is defined as forward purchase of specified goods for full forward payment. This contract is regularly used for financing agricultural production and projects. By Tasnim Nazeer with information from Tamimi.com

August 2011

In addition to the main forms of Islamic project financing there are various Islamic loans which can be utilised such as the following: • Quard Hassan (Interest Free Loan) The Quard-Hasan instrument is equivalent to an interest-free loan either to corporate customers in financial distress, (which later might be converted into an equity stake in the enterprise), or to individual clients for welfare purposes. In making the loan available, the bank may take security for the loan (e.g. mortgage over the customer’s premises) and some may charge a nominal fee. The service charges are not for profit; they are the actual costs recovered less than one important condition, (to prevent the charges from becoming equivalent to interest), that the charge cannot be made proportional to the amount or to the term of the loan. • Takaful (Insurance) When financing any Islamic project or investment it is worth noting the Islamic financial concepts of insurance which is primarily Takaful Insurance. There are many Takaful companies around the world and particularly successful ones in the United Arab Emirates such as Takaful Re. Takaful Islamic insurance differs from conventional counterparts as the concept of Takaful relies upon providing security to its customers in a way that is seen to be socially responsible


Islamic Finance and fair. It refers to the pool of payments by a group of participants of an agreed sum into a common fund that will be managed in accordance with the Shariah, particularly the Mudaraba contract. In the case of the insured event, the participant benefits through Takaful by claiming compensation from the fund. In the absence of the claim, the participants share the surplus of the invested funds. Conventional insurance companies manage the funds of its clients on their behalf. Similarly in takaful, the Islamic Bank is a trustee (not to be confused with the legal concept of trustee under English law) managing the funds of the participants for a fee. Thus, each participant retains title over its share of the funds, and under certain conditions may withdraw its share. However, in practice, it is seen that the pure Islamic Shariah compliant nature is detracted from the actual concept of takaful. The reason behind this is because the takaful funds are currently reinsured on a conventional basis due to the lack of a developed Islamic reinsurance market and the need to build up the reinsurance Takaful market. To shed more light on the implementation of specific Shariah compliant instruments when dealing with Islamic financial projects GIF has displayed figure 3 which shows the process of Istisna from the construction stage up until the operations stage whereby Ijarah leasing can also be implemented. 1. Construction phases (Istisna) — the borrower procures construction of project assets and then transfer’s title to assets to Islamic financiers. As consideration, Islamic financiers make phased payments to the borrower (equivalent to loan advances). 2. Operations phase (Ijarah) — Islamic financiers lease project assets to the borrower. Borrower makes lease payments (equivalent to debt service). Source: Chadbourne.com

A Wealth of Islamic Project Finance Opportunities in the UAE The United Arab Emirates hold a world of Islamic project financial opportunities for investors from all over the globe. Some of the main sectors for Islamic financial investments are:

• • • • • •

Infrastructure Projects Agricultural Construction and Energy Educational Charity Projects Real Estate

What do experts say about UAE Islamic Project Finance? There is much scope in the UAE primarily for infrastructure but the latest of deals from top Islamic financial Abu Dhabi Islamic Bank (ADIB) had undertaken the largest UAE project financing deal for Emirates Steel Industries. It had been reported on ADIB that, “Emirates Steel Industries sought the facility to expand its steel production capacity and diversify its product offering as part of its strategic plan to become one of the largest integrated steel manufacturers in the region, in line with Abu Dhabi’s vision 2030” (ADIB). Tirad Mahmoud, CEO of ADIB had reportedly said, “There are various reasons this is a very important deal for the UAE, the key one being that it is for the expansion of a strategic project of national importance. It will create additional employment opportunities and revenue sources for the UAE. In addition, this deal signals that the financing environment in Abu Dhabi is improving and could grow this year. This also shows ADIB’s unique capabilities to structure and arrange large and complex financing for major projects such as Emirates Steel Industries’ expansion, with co-participation of Islamic and conventional financiers to achieve an optimal outcome for the client”(ADIB). Stephen Pope, CFO of Emirates Steel Industries, said, “ADIB impressed us with their innovation and flexibility in structuring this large financing agreement. They were initially chosen due to their robust financial strength, commitment and experience in customising financing for many UAE companies. We are pleased to note that their efforts and capabilities, that involved structuring this complex agreement with eight other banks in a dual-tranche Islamic and Conventional Facility, have justified our confidence in them.” (ADIB). Saudi Arabia had also made unprecedented achievements in contributing to the Islamic project finance sector such as the project with Saudi Aramco in 2006 which was named the Ragibh Project. The Rabigh complex was one of the world’s largest integrated export-oriented refinery and petrochemical complexes to be built in the United Arab Emirates. The Rabigh complex has produced 18.4 million tons per annum of high value petroleum products which gives it much scope for the industrial sector to further advance and create more opportunities for Shariah compliant project financing. In Saudi Arabia they have successfully utilised the concept of tranches which primarily uses the Istisna instrument for the sale to be constructed and the Ijarah instrument which has worked as a successful partnership promoting profitable successes in Islamic financial projects.

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The Rabigh Project had established a credible framework within the Saudi legal system for the inclusion of Islamic tranches in multi-sourced transactions. Islamic financing products are most attractive to project finance sponsorship organisations especially in large capital projects when they can deliver additional capital participation. Another benefit is the inclusion of multiple financing sources from export credit agencies, bond or Sukuk which adds structural complexity (and with complexity comes a time cost and execution risk). The Islamic financing therefore needs to bring that “additional benefit” to overcome the perceived process and structural burden associated with the inclusion of an Islamic financing tranche. However in Islamic tranches there poses challenges of tenor and price. Pricing which runs over a long period of time in Islamic projects can often be unattractive for domestic and Islamic banks. However despite challenges that Islamic Project finance faces there has been unprecedented growth especially in the United Arab Emirates. “The growth in Islamic project financing has been phenomenal. It exemplifies the success of both the burgeoning Islamic finance sector and the booming construction industry in the region,” said MEED, organiser of the upcoming Islamic Project Finance conference (Khaleej Times). “Ensuring that tranches of Islamic funding work effectively with conventional finance, that clients understand where the liability lies in Islamic arrangements, and the implications this has for relationships between conventional and Islamic investors is at the heart of our current work in the sector. It is an approach that is appreciated both by our clients and by their stakeholders.” said Oliver Agha, Global Head of Islamic Finance at DLA Piper (Khaleej Times). Not only do non conventional project sectors such as steel incur lucrative deals in the UAE but there is also scope for infrastructural opportunities in the UAE. The energy sector saw a vast opportunity in the UAE from Dolphin Energy whereby the government of Abu Dhabi secured a project financing deal for the construction of the Taweelah Fujairah pipeline, as well as the expansion of storage facilities at Ras Laffan, is progressing well, with the final stage of the pipeline due to be completed in the first quarter of 2011, and storage substantially complete. Tony Boon, director of project finance for Dolphin Energy, said that despite the increased liquidity available in the market, project finance will continue to play a major part in financing options. “It is prudent to spread the risk across the types of finance available; 2011 August Global Islamic Finance

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Islamic Finance Figure 3: Islamic finance providers

Intercreditor agreement

Conventional lenders

Investment agency agreement Purchase undertaking

Islamic facility agent Service agency agreement

Sale undertaking Investment agency agreement

Ijara

Istisna’a

Project company

Construction contract

Construction contractor

Source: Chadbourne.com

in addition, banks providing finance can also validate the investment decision.” Dolphin Energy has one of the largest financing deals in the UAE, with the $3.5 billion deal to fund the construction of its Bridge 1 (Khaleej). The UAE Steel industry has seen unprecedented demand following the largest project financing deal as discussed above and therefore any potential investor or business professional may want to investigate the options in the steel industry further in the United Arab Emirates. There had also been opportunities in the UAE to get involved in Islamic law project such as the UAE Federal Supreme Court Justice Project. “A plan has been chalked out to implement the e-justice project in Ajman, Umm Al Qaiwain and Fujairah, the minister said during a tour of the progress of the project in Sharjah courts. The e-management and archiving project, he added, aims at raising the

efficiency and competence of the federal justice system under the ministry’s strategy which primarily seeks to deliver best judicial services” (Global Arab Network). As you can see there are many opportunities across the various sectors and some opportunities in the UAE expand out into many sectors of expertise. If you do have an expertise or knowledge in the field of infrastructure, energy or feel you can bring your knowledge and expertise to the project than the UAE may be the perfect place for you to start your Islamic project financing deal. In the next part of the Islamic Project Finance Series Part 2 will be looking at the Middle East and Africa and the various opportunities it holds for the potential investor. The Future of Islamic Project Financing in the UAE There is much scope for an unprecedented growth in Islamic Project financing in the UAE especially since Islamic finance as

an industry is attracting investors from all over the world. Islamic Finance as an institution has become a globally renowned sector which caters for the demand of both Muslims and Non Muslims. In a predominant Muslim population of the UAE it holds the advantage for many numerous Islamic projects to be undertaken through the various Islamic financial instruments discussed in this article. If you are considering participating in an Islamic Project in the UAE then this article will give you the comprehensive information you need to know the vital components of instruments you can use including the type of insurance that you may want for your project such as Takaful insurance. The future of Islamic Project financing looks bright for the UAE seeing lucrative deals especially from the largest project finance deal in the Emirates Steel sector which is expected to see profitable returns for years to come. gif

References and Further Reading: • • •

• •

Islamic Finance a UAE Legal Perspective (2010) Al Tamimi & Company, Article Retrieved from: http://www.tamimi.com/files/Legal%20Brochures/ IslamicFinance.pdf ADIB leads the Islamic Tranche of the AED 4 Billion (2010) Abu Dhabi Islamic Bank, Article Retrieved from: http://www.adib.ae/adib-leads-islamictranche-aed-40-billion-project-finance-facility-prestigious-emirates-steel-indust Islamic Project Finance Structure and Challenges (2010) Chadbourne, Article Retrieved from: http://www.chadbourne.com/files/Publication/ c4ae820b-24ba-4e5b-9f7d-186814289e7e/Presentation/PublicationAttachment/20d7847a-8644-4b0f-b3e7-19a496eebf22/pfn_Intl_0210. pdf UAE Federal Supreme Court Justice Project (2010) Global Arab Network, Retrieved from: http://www.english.globalarabnetwork. com/201009047135/Related-news-from-UAE/uae-federal-supreme-court-completes-first-phase-of-e-justice-project.html Islamic Finance Project in Saudi Arabia (2006) White & Case, Article Retrieved from: http://www.whitecase.com/files/Publication/5f53893ac38a-4d3b-873d-c7da9f181b27/Presentation/PublicationAttachment/536c71d1-05f5-4c04-a230-c8e647ca455e/article_Islamic_Project_Finance.pdf $1 trillion project financing market spurs Islamic lending sector growth (2007) Khaleej Times, Article Retrieved from: http://www.khaleejtimes. com/DisplayArticle.asp?xfile=/data/business/2007/June/business_June447.xml&section=business

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Islamic Finance

DO CONVENTIONAL AND ISLAMIC FINANCE

SHARE COMMON EPISTEMOLOGY? Author: Abbas Mirakhor, PhD in Economics, Iran Edib Smolo, Researcher and Coordinator of Islamic Capital Market Unit, ISRA, Malaysia

Abstract: Simply stated, epistemology deals with the question of what we know about a phenomenon and how do we know it. The practitioners use the term Islamic finance industry (IFI) to refer to their activities in designing and trading “Shari’ah-compliant” ways and means of financing. Taxonomically, industries in an economy belong to a sector and sectors belong to subsystems which in turn belong to a larger system. For example, a bank belongs to a banking industry which belongs to the financial sector which belongs to the financial subsystem which belongs to the larger economic system which, finally, belongs to an overall socio-political-economic system. Before the current inception of IFI, there was what could be called a “market failure” in the conventional financial system. There was substantial unmet demand for Shari’ah-compliant financial products. IFI grew out of the conventional finance to meet this demand. Muslim scholars writing mostly since the 1970s about Islamic finance focused on development of an Islamic finance system; they not only emphasised elimination of riba contracts but urged their replacement with risk-sharing contracts. The practitioners, most of whom had been operating in the conventional finance, were however interested in developing ways and means of finance that, while Shari’ah-compatible, would be familiar to and accepted by market players in the conventional finance. The former emphasised Profit-Loss Sharing (PLS), the latter focused on traditional methods of conventional finance centred on risk transfer and risk shifting. This article argues that there are two ideal financial systems based on risk sharing, conventional and Islamic, and one actual conventional system focused on risk transfer. There are two industries within the actual system; conventional and Islamic finance industry. The paper then proceeds to discuss the epistemology and the main characteristics of each of the two ideal systems. Keywords: Conventional Economy, Arrow-Debreu, Financial Instruments, Islamic Finance Industry, Risk 48 Global Islamic Finance

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Islamic Finance

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The work of Arrow-Debreu (1954) is fundamentally about optimal risk sharing in a decentralised market economy. It addresses the question of how best to allocate risk in an economy. The answer is that risk should be allocated to those who can best bear it.

sioned in the Wealth of Nations. That moralethical system was well-described in Smith’s book: The Theory of Moral Sentiments which preceded his Wealth of Nation by a decade and half (Mirakhor & Askari, 2010; Mirakhor & Hamid, 2009). Whereas conventional economics considered Smith’s notion of “invisible hand” as a coordinator of independent decisions of market participants, in both The Theory of Moral Sentiments and in the Wealth of Nations the metaphor refers to the design of the Supreme Creator “who arranged the connecting principles such that the actions of all those seeking their own advantage could produce the most efficient allocation of resources, and thus the greatest possible wealth for the nation. This is indeed a benevolent designer” (Evensky, 1993, p. 9).

Epistemology of Conventional and Islamic Finance

Major contribution of Smith in his Theory of Moral Sentiments is to envision a coherent moral-ethical social system consistent with the Supreme Creator’s design and how each member of society would enforce ethical positions. Recognition of human frailties led Smith to recognition of a need for an organic co-evolution of individual and society in a stage-wise process of accumulation of ethical system of values from one generation to next. Compliance with and commitment to a set of values – virtues of prudence, concern for other people, justice and benevolence – would insure social order and cohesion (Mirakhor & Askari, 2010; Mirakhor & Hamid, 2009; Smith, 2006). Smith and Arrow.

An Ideal Conventional Financial System An overall socio-political-economic system gives rise to an economic system out of which grows a system of financing to facilitate production, trade and exchange. The idea of the contemporary conventional economic system is usually traced to Adam Smith’s conception of an economy as envisioned in his book, the Wealth of Nations. What has been ignored until recently, however, the fact that, from an epistemological point of view, Smith’s vision of the economy is embedded in his vision of a moral-ethical system that gives rise to the economy envi-

It was not until the second half of the last century when attempts were made to present a particular conception of Smith’s vision of the economy. This conception saw the economy as a market system guided by the “invisible hand” toward smooth functioning, coordinating “autonomous individual choices in an interdependent world” (Evensky, 1993). Two such attempts were the works of Arrow and Debrau (1954) and Arrow and Hahn (1971) that sought to show “that a decentralised economy motivated by self-interest” would allocate resources, such that it “could be regarded, in a well-defined sense, as superior

to a large class of possible alternative dispositions …” (Arrow & Hahn, 1971, pp. vi-vii). These attempts focused primarily on Smith’s idea of a decentralised market economy but in the process it abstracted from much of the well-spring of his thoughts represented by the societal framework emphasising moral-ethical values envisioned in The Theory of Moral Sentiments. The work of Arrow-Debreu (1954) is fundamentally about optimal risk sharing in a decentralised market economy. It addresses the question of how best to allocate risk in an economy. The answer is that risk should be allocated to those who can best bear it. It appears that Arrow-Debreu took for granted the existence of such institutions as property rights, contracts, trust, rule of law, and moral-ethical values. Two key assumptions of this work were complete contracts and complete markets. By the former it was meant that it was possible to design contracts such that all contingencies were covered. The latter assumption meant that there was a market for every conceivable risk. Crucially, all future payoffs were contingent on specific outcomes. Arrow-Debreu model did not include fixed, predetermined rates of interest as payoffs to debt contracts. Subsequently, Arrow made it clear that “the process of exchange requires or at least is greatly facilitated by the presence of several ... virtues (not only truth, but also trust, loyalty and justice in future dealings) ...” (Arrow, 1971, pp. 345-346). For example, if the institution of trust is strong in an economy, the universe of complete contracts can be replicated by simple contracts entered into by parties stipulating that terms and conditions of the contracts would be revised as contingencies arise. Arrow himself was to place emphasis on trust as the lubricant of the economy (Arrow, 1974). Despite Arrow’s attention to some important elements of the institutional structure that were integral to Smith’s vision of an economy, such as its value system, the economics profession developed its own vision of that economy focusing primarily on 2011 August Global Islamic Finance

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Islamic Finance

Dr. Abbas Mirakhor, born in Tehran, Islamic Republic of Iran, attended Kansas State University, where he received his Ph.D. in economics in 1969. From 1969 to 1984, he taught in various universities in the US and Iran. From 1984 until 1990, he served on the staff of the IMF, and from 1990 to 2008, he served as the Executive Director at the IMF. Currently, he is The First Holder of International Centre For Education in Islamic Finance (INCEIF) Chair of Islamic Finance. He has received several awards including “Order of Companion of Volta” for service to Ghana, conferred by the President of Ghana in 2005; Islamic Development Bank Annual Price for Research in Islamic Economics, shared with Mohsin Khan in 2003; and “Quaid-e-Azam” star for service to Pakistan conferred by the President of Pakistan in 1997. Dr. Mirakhor is the co-author of essays on Iqtisad: Islamic Approach to Economic Problems (1989), Theoretical Studies in Islamic Banking and Finance (1987), Introduction to Islamic Finance: Theory and Practice (2007), New Issues in Islamic Finance and Economics: Progress and Challenges (2009) and Globalization and Islamic Finance: Convergence, Prospects, and Challenges.

two concepts of “invisible hand” and “self interest.” The first was mentioned only once in The Wealth of Nations (see Smith, 1976, p. 456) and the manner in which the second was used by economists has been referred to by Vivian Walsh (2000) as “vulgar … misunderstanding” of what Smith meant by “self interest”. This “narrowing” of Smith’s view has been subjected to rather sharp criticism by Amartya Sen (Sen, 1977, 1987) who suggests that: “Indeed, it is precisely the narrowing of the broad Smithian view of human beings in modern economics that can be seen as one of the major deficiencies of contemporary economic theory. This impoverishment is closely related to the distancing of economics from ethics.” Consideration of the above quotation as well as the rest of The Moral Sentiments, leads to, at least, three observations. First, this is the Smith that has been ignored by the economics profession. The Smith of economics is the author of the self-interest motive that is the basis of utility and profit maximisation at any cost to the society, including the impoverishment and exploitation of fellow human beings. Second, Smith makes clear in his Theory of Moral Sentiments that compliance with the rules prescribed by the Creator and with the rules of the market was essential to his vision. Third, it is also clear that Smith considers the internalisation of rules – being consciously aware of ever-presence of the Creator and acting accordingly - as crucial to all human conduct, including economics. Smith succinctly and clearly shares some of the fundamental institutional scaffolding of Islam: belief in One and Only Creator; belief in accountability of the Day of Judgement; belief in the necessity of compliance with the rules prescribed by the Creator; and belief that justice is achieved with full compliance with rules. To paraphrase Sen, no space need be made artificially for justice and fairness; it already exists in the rules prescribed by the Law-Giver. Arrow-Debreu economy An economy in which there are contingent markets for all commodities – meaning that there are buyers and sellers who promise to 50 Global Islamic Finance

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buy or sell given commodities “if and only if” a specified state of the world occurs – is called an Arrow-Debreu economy. In such an economy, it is the budget constraint of the participants that determines how much of each of the contingent commodities at prices prevailing in the market they can buy. Since these commodities are contingent on future states, they are risky. Therefore, the budget constraint of individuals determines the risk-bearing ability of each market participant. Arrow himself recognised that requiring such a market is unrealistic. “Clearly, the contingent commodities called for do not exist to extent required, but the variety of securities available on the modern markets serve as a partial substitute” (Arrow, 1971). Such securities, referred to as Arrow Securities whose payoffs could be used to purchase commodities, would reduce the number of markets required while replicating the efficiency of risk allocation of complete contingent markets. Associated with complete markets are complete contracts. These are agreements contingent on all states of nature. In the real world, not all contracts can cover all future contingencies. Therefore, they are said to be incomplete contracts and may indicate inefficiencies in exchange. However, as suggested above, optimal contracts can be devised provided there is mutual trust between the parties to the contract. That would be a simple contract with provisions for modification of terms and conditions and should contingencies necessitate change. From ideal to actual: conventional finance But, as Evensky suggests, “the Smithian story told by Arrow and Hahn – and they are representative of modern economists – is an abridged edition. The spring that motivates action in Smith’s story has been carried forward, but much of the rest of his tale has been forgotten” (Evensky, 1987, 1993). It can be argued, as Arrow himself seems to imply (1971), that the “rest of” Smith’s “tale” would have been his vision of the institutional infrastructure (rules of behaviour) that is envisioned in The Theory of Moral Sentiments, and, as such, abstracting from them would be unlikely to change the outcome of the mathematical analysis of Arrow-Debreu

and/or Arrow-Hahn. Furthermore, had actual finance developed along the trajectory discernible from these works, i.e., steps taken toward completion of markets and of contracts, keeping in mind the overall institutional framework for the economy as envisioned by Adam Smith, the result might have been emergence of conventional finance different from the contemporary system. That system would instead be dominated by contingent, equity, risk-sharing financial instruments. Perhaps the most influential factor in derailing that trajectory is the existence and the staying power of a fixed, predetermined rate of interest for which there has never been a rigorous theoretical explanation. All, so called, theories of interest from the classical economists to contemporary finance theories explain interest rate as the price that brings demand for and supply of finance into equilibrium. This clearly implies that interest rates emerge only after demand and supply forces have interacted in the market and not ex ante prices. In fact, in some theoretical models there is no room for a fixed, ex ante predetermined rate of interest. For example, introducing such a price into the Walras or Arrow-Debreu-Hahn models of general equilibrium (GE) leads to the collapse of the models as they become over-determined. Even though no satisfactory theory of a positive, ex ante fixed rate of interest exists, all financial theory development post ArrowDebreu-Hahn assumed its existence in the form of a risk-free asset, usually Treasury Bills, as a benchmark against which the rates of return of all other assets, importantly equity returns, were measured. These include theories such as the Capital Asset Pricing Model (CAPM), Modern Portfolio Theory (MPT); and the Black-Scholes option pricing formula for valuing options contracts and assessing risk. For all practical purposes, the assumption of a risk-free rate introduced an artificial floor into the pricing structure of the real sector of the economy, and into all financial decisions. It can be argued that it is the existence of this exogenously imposed rate on the economy that transformed Arrow-Debreu vision of a risksharing economy and finance. The resulting


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system became one focused on transferring or shifting of risk rather than sharing it. Such a system needed strong regulation to limit the extent of both. However, further developments in finance theory provided analytic rationale for an ideologically aggressive deregulation. One was the Modigliani-Miller Theorem of neutrality of capital structure of firms. In essence this theorem asserted that the value of a firm is independent of its capital structure. This implied that since firms want to maximise their value and since Modigliani-Miller showed that the value of the firm is indifferent whether the firm debt finances or equity finances its capital structure, firms would prefer to incur higher debt levels for the firm rather than issue additional equity. Hence, the risk of additional debt would be shifted to other stakeholders (Jensen & Meckling, 1976). Another was the development of the Efficient Market Hypothesis (EMH) that claimed that in an economy similar to that of Arrow-

The work of Arrow-Debreu (1954) is fundamentally about optimal risk sharing in a decentralised market economy. It addresses the question of how best to allocate risk in an economy. The answer is that risk should be allocated to those who can best bear it.

Debreu, prices prevailing in the market contained all relevant information such that there would be no opportunity for arbitrage. Hence, the Arrow-Debreu vision of an economy in which risk was shared was first transformed into an economy in which the focus became risk transfer but which quickly transformed into one in which risks were shifted, ultimately, to tax payers (Mirakhor & Krichene, 2009). An Ideal Islamic Finance System The ideal Islamic finance points to a fullspectrum menu of instruments serving a financial sector imbedded in an Islamic economy in which the institutional “scaffolding” (rules of behaviour as prescribed by Allah swt and operationalised by the Noble Messenger, including rules of market behaviour prescribed by Islam) is fully operational (Chapra, 2000; Iqbal & Mirakhor, 2007). The essential function of that spectrum would be spreading and allocating risk among market participants rather than allowing it to concentrate among the borrowing class. Islam proposes three sets of risksharing instruments:

1. mu’amalat risk-sharing instruments in the financial sector; 2. redistributive risk-sharing instruments through which the economically more able segment of the society utilise in order to share the risks facing the less able segment of the population; and 3. the inheritance rules specified in the Qur’an through which the wealth of a person at the time of passing is distributed among present and future generations of inheritors. The spectrum of ideal Islamic finance instruments would run the gamut between shortterm liquid, low-risk financing of trade contracts to long-term financing of real sector investment. The essence of the spectrum is risk sharing. It is worth noting that transaction contracts permissible in Islam and the financial instruments intended to facilitate them are not the same thing. Islamic real sector transactions contracts (‘uqud) that have reached us are all permissible. However, it is possible that a financial instrument designed to facilitate a given permissible contract may itself be judged non-permissible.

As the proliferation of derivative instruments in the period of run up to the global financial crisis demonstrated, the number of financial instruments that have some relation, even if only nominal, to a real sector transaction is limited only by the imagination of financial engineers. This is the essence of the theory of spanning developed in finance in the late 1960s and early 1970s which led to the design and development of derivatives. It is possible that a financial instrument may have weaker risk-sharing characteristic than the Islamic transaction contract it intends to serve. Since Islamic finance is all about risk sharing, then the risk characteristics of a given instrument needs to become paramount in decisions. One reason, inter alia, for nonpermissibility of the contract of riba is surely due to the fact that this contract transfers all, or at least a major portion, of risk to the borrower. It is possible to imagine instruments that on their face are compatible with the no-riba requirement, but are instruments of risk transfer and, ultimately, of shifting risk to tax payers. An example would be a sovereign ijarah sukuk based on the assets subject of ijarah but credit-enhanced by other means, say collateral. All costs taken into account, such a sukuk may well be more expensive and involve stronger risk transfer characteristic than a direct sovereign bond (see Mirakhor & Zaidi, 2007). It appears that at the present, the energies of financiers and financial engineers are focused on the design and development of instruments to accommodate the low-end of time and risk-return, liquid transactions. 2011 August Global Islamic Finance

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Islamic Finance

Gulf Islamic Finance Industry Set on Single Shariah Board The Gulf has made significant contribution the facilitation of Islamic finance and banking and it now wants to see through the launch of a single Shariah board. The United Shariah Board, which began drawing scholars from local Islamic institutions two years ago, now has two members from Saudi Arabia and one scholar each from Kuwait and Qatar, Scholar Hussein Hamid Hassan said at the launch of a policy briefing on corporate governance in Islamic finance. It was also reported that the Islamic finance industry is moving towards a centralised Shariah board as scholars from leading countries join a common UAE entity, a leading Islamic scholar said. “We have almost one united Shariah board for the Gulf,” he said. “I think within five to 10 years we will have one Shariah board for everyone.” Shariah scholars serving the United Shariah Board also represent individual bank Shariah boards, thereby transferring the Islamic rulings, or fatwas, issued by the centralised board to their individual institutions across borders. While progress has been made, there are still differences in interpretations of Islamic law that is preventing a quicker adoption of a centralised Gulf board. A unified Gulf-wide entity would boost corporate governance within the growing industry, said Nassar Saidi, executive director of Hawkamah, which issued 55 recommendations to Islamic financial institutions in its policy paper. Saidi added that creating a centralised board is a first step but would need support from regulators to give enforce its fatwas. The policy report, which was based on a survey of 22 Islamic institutions across the Middle East and North Africa, also determined that more should be done to limit the number of the same Shariah scholars serving on multiple boards. “You shouldn’t have multiplicity which can create a conflict of interest,” he told reporters. “If you have well recognised scholars on one central board, that would help.”

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Edib Smolo is a researcher and Coordinator of the Islamic Capital Market Unit, International Shari’ah Research Academy (ISRA) for Islamic Finance. He is also a Ph.D. candidate at the International Centre for Education in Islamic Finance (INCEIF), the Global University of Islamic Finance, Malaysia. Mr. Smolo received his double degree, Bachelor of Economics (Honours) and Bachelor of Islamic Revealed Knowledge and Heritage (Honours), as well as Master of Economics from International Islamic University Malaysia (IIUM), Malaysia. He also holds a Certificate for Professional Specialization in Political Management from Bulgarian School of Politics, jointly organized by the New Bulgarian University and the Council of Europe.

Without effort at developing long-term investment instruments with appropriate riskreturn characteristics, there is a danger of emergence of path-dependency where the market will continue to see more – albeit in greater variety – of the same. That is more short-term, liquid and safe instruments.

risk of default. But it is not risk taking per say that makes a transaction permissible. A gambler takes risk as well but gambling is non-permissible (haram). Instead what seems to matter is opportunity for risk sharing. Riba is a contract of risk transfer or risk shifting.

This is what led to the explosion of derivatives which played an influential role in the recent global financial disaster. Similar development could be awaiting Islamic finance if the ingenuity of financial engineers and the creative imagination of Shari’ah scholars continue to serve the demand-driven appetite for liquid, low risk, and short-term instruments. In that case, the configuration of Islamic finance would have failed to achieve the hopes and aspirations evoked by the potential of the ideal Islamic financial system. Epistemology of an Ideal Islamic Finance System

Achieving the Ideal: Uncertainty, Risk and Equity Markets Uncertainty is a fact of human existence. Humans live on the brink of an uncertain future. Uncertainty stems from the fact that the future is unknown and therefore unpredictable. If severe enough, uncertainty can lead to anxiety, decision paralysis and inaction.

The fountainhead of all Islamic thought is the Qur’an. Whatever the theory of Islamic knowledge may be, any epistemology, including that of finance, must find its roots in the Qur’an. The starting point of this discussion is therefore Verse 275 of Chapter 2 of the Qur’an, particularly the part of the Verse that declares contract of bay’ permissible and that of riba non-permissible. Arguably, these few words can be considered as constituting the organising principle – the fundamental theorem as it were – of the Islamic economy. It is worth noting also that all Islamic contractual forms, except spot exchange, involve time. From an economic point of view, time transactions involve a commitment to do something today in exchange for a promise of a commitment to do something in the future. All transactions involving time are subject to uncertainty. And, uncertainty involves risk. Risk exists whenever more than one outcome is possible. Therefore, it can be inferred that by mandating bay’, Allah swt ordained risk-sharing in all exchange activities. Furthermore, it appears that the reason for the prohibition of the contract of riba is the fact that opportunities for risk sharing are non-existence in this contract. It may be argued that the creditor does take risk – the

Lack of certainty for an individual about the future is exacerbated by ignorance of how others behave in response to uncertainty. Yet, individuals have to make decisions and take actions that affect their own as well as others’ lives. In other words, uncertainty is converted into risk. Risk, therefore, is a consequence of choice under uncertainty. Risk exists when more than one outcome is possible. It is uncertainty about the future that makes human lives full of risks. Risk can arise because the decision maker has little or no information regarding which state of affairs will prevail in the future, the person, nevertheless, makes a decision and takes action based on expectations. It seems difficult, then, to imagine the idea of testing without uncertainty and risk. Statistician David Bartholemu (2008) asserts that: “It could be plausibly argued that risk is a necessary ingredient for full human development. It provides the richness and diversity of experience necessary to develop our skills and personalities” (p. 230). Islam, in particular, has provided the ways and means by which uncertainties of life can be mitigated. First, it has provided rules of behaviour and taxonomy of decisions – actions and their commensurate payoffs in the Qur’an. Complying with these rules reduces uncertainty. Rules also promote cooperation and coordination (Mirakhor, 2009). Second, Islam has provided ways and means


Islamic Finance by which, those who are able to, mitigate uncertainty by sharing the risks they face by engaging in economic activities with fellow human beings through exchange. Sharing allows risk to be spread and thus lowered for individual participants. However, if a person is unable to use any of the market means of risk sharing because of poverty, Allah swt has ordered a solution here as well: the rich are commanded to share the risks of the life of the poor by redeeming their rights derived from the Islamic principles of property rights. Islam’s laws of inheritance provide further mechanism of risk sharing. It is important to note a nuanced difference between risk taking and risk sharing. The former is an antecedent of the latter. The decision to take risk to produce a product precedes the decision on what to do with the risk in financing the project. The decision to share the risk in financing does not increase the risks of the project but reduces the risks for individuals involved in financing it as it is spread over larger number of participants. It is also to be noted that the Islamic contract modes that have reached us are all bilateral real sector contracts. What the contemporary IFI has accomplished is to: 1. Multilateral the bilateral contracts as the latter move from the real sector to the finance sector, and 2. Employ instruments of risk transfer available in the conventional finance but made them Shari’ah-compatible.

Summary and Conclusion This article has sought to trace the epistemological roots of conventional and Islamic finance. The reason for interest in the two fields, the articles contends, is that the present IFI evolved over the past three decades from conventional finance to address a market failure to meet the demand for Shari’ah-compliant finance products. Most practitioners of Islamic finance were bankers and market players well familiar and often well established in conventional finance sector. Their focus was, and is, to develop financial instruments familiar to conventional finance market albeit with Shari’ah compatibility as an objective. Their ingenuity combined with active and creative imagination of leading Shari’ah scholars has managed to develop a rich array of synthetic and structured products all of which, in one form or another, are replicated, retrofitted or reverse engineered from the conventional finance. This article contents, however, that this is only meeting the second half of the part of verse 275 of chapter 2 of the Qur’an. It is crucial to note that in this Verse Allah swt first ordains exchange contracts and, second, He swt prohibits riba contracts. The present approach of focussing on the second part of the Verse (prohibition of interest rate based debt contracts) while ignoring the first part, i.e., risk sharing has

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further entrenched the present IFI within the conventional financial system rendering IFI a new asset class within the conventional system. The IFI could have taken a different course as a number of pioneer scholars had defined a trajectory for its development based on risk sharing (PLS). In the event, it was the conventional finance that gave IFI its take-off platform, thus making the study of the epistemology of conventional finance relevant. A related concern is that by focusing solely on short-termism, there is the possibility of emergence of path dependency. There is a concern that such path dependency may well emerge that conveys a message that short-termism, safety and liquidity, as well as no riba, are all there is to Islamic finance. The thrust of this paper is that this is not so. Islamic finance is more about risk spreading and risk sharing. That said, the current lack of equity and other risk sharing instruments within the menu of Islamic finance is akin to a market failure. For a number of decades now, economic theory has made a compelling case for government intervention when and where there is a market failure. In this case too, a strong case can be made for government intervention to remedy the current failure of the market to develop long-term, more risky, higher return risk-sharing instruments. gif

References and Further Reading • • • • • • • • • • • • • • • • • • • •

Arrow, K. J. (1971). Essays in the Theory of Risk-Bearing. Chicago: Markham Publishing Company. Arrow, K. J. (1974). The Limits of Organizations. New York: Norton. Arrow, K. J., & Debreu, G. (1954). The Existence of an Equilibrium for a Competitive Economy. Econometrica 22(3), 265-290. Arrow, K. J., & Hahn, F. (1971). General Competitive Analysis. San Francisco: Holder Day. Bartholomeu, D. J. (2008). God, Chance and Purpose: Can God Have It Both Ways? Cambridge: Cambridge University Press. Chapra, M. U. (2000). The Future of Economics: An Islamic Perspective. Leicester: The Islamic Foundation. Evensky, J. (1987). The Two Voices of Adam Smith. History of Political Economy, 19(3), 447-468. Evensky, J. (1993). Ethics and the invisible hand. Journal of Economic Perspectives, 7(2), 197-205. Iqbal, Z., & Mirakhor, A. (2007). An Introduction to Islamic Finance: Theory and Practice. Singapore: John Willey & Sons (Asia). Jensen, M. C., & Meckling, W. H. (1976). Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure. Journal of Financial Economics, 3(4), 305-360. Mirakhor, A. (2009). Islamic Economics and Finance: An Institutional Perspective. [Keynote Address II]. IIUM Journal of Economics and Management, 17(1), 31-72. Mirakhor, A., & Askari, H. (2010). Islam and the Path to Human and Economic Development. New York: Palgrave Macmillan. Mirakhor, A., & Hamid, I. S. (2009). Islam and Development: The Institutional Framework. New York: Global Scholarly Publications. Mirakhor, A., & Krichene, N. (2009). The Recent Crisis: Lessons for Islamic Finance. IFSB 2nd Public Lecture on Financial Policy and Stability, Kuala Lumpur: Islamic Financial Services Board (IFSB). Mirakhor, A., & Zaidi, I. (2007). Profit-and-Loss Sharing Contracts in Islamic Finance. In M. K. Hassan & M. K. Lewis (Eds.), Handbook of Islamic Banking (pp. 49-63). Cheltenham, UK: Edward Elgar Publishing Ltd. Sen, A. K. (1977). Rational Fools: A Critique of the Behavioral Foundations of Economic. Philosophy and Public Affairs, 6(4), 317-344. Sen, A. K. (1987). On Ethics and Economics. Oxford: Blackwell. Smith, A. (1976). An Inquiry into the Nature and Causes of the Wealth of Nations (1776/1976). Edited in two volumes by W.B. Todd. See vol. 2 of the Glasgow Edition of the Works and Correspondence of Adam Smith. Oxford: Clarendon Press. Smith, A. (2006). The Theory of Moral Sentiments (Dover Philosophical Classics). Mineola, New York: Dover Publications. Walsh, V. (2000). Smith after Sen. Review of Political Economy, 12(1), 5-25.

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Market Review

RUSSIA NEEDS CHANGES TO LAW TO FACILITATE SUKUK Source: GlobalIslamicFinanceMagazine.com

We are not supported by the government or by the legislators. The regulators and the government today for different reasons are almost ignoring this phenomenon.

As the Islamic finance industry is growing at an unprecedented speed, Russia still remains to have changed laws in order to facilitate sukuk. Russian borrowers are pitching plans to sell the nation’s first Islamic bonds even as regulators lag behind in customising laws for the industry. Executives from Gazprom bank, the lending arm of gas export monopoly Gazprom, are in Southeast Asia to seek support for issuance by as many as five companies, Alexander Kazakov, director of structured and syndicated finance at the bank, said in Jakarta. Tatarstan, a Muslim-majority Russian republic, will announce a dollar denominated sale soon, according to Kuala Lumpur-based adviser Amanah Raya Investment Bank, which is working on the proposal. Russia would join Thailand and Senegal in planning debut sukuk this year, helping accelerate glo54 Global Islamic Finance

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bal sales that increased 24 percent to $7.8 billion in 2011. Russia needs to change its legal framework to ensure Shariah compliant transactions get the same tax treatment as non-Islamic finance, said Aznan Hasan, associate professor at the International Islamic University Malaysia.

“The Russian tax code and legislation in general create obstacles for Islamic finance,” Djabiev said. “We are not supported by the government or by the legislators. The regulators and the government today for different reasons are almost ignoring this phenomenon.”

“It’s still very early days for Russia,” Aznan said. “A lot needs to be done before the first sale can happen. They need to level the playing field mainly for taxes.”

Amanah Raya Investment Bank, part of Kuala Lumpur-based Amanah Raya Capital Group, together with Kazan based financial advisory firm Linova and Kuwait Finance House (Malaysia) are “finalising the official mandate for the sukuk issuance” after conducting preliminary studies, Abas A. Jalil, chief operating officer at Amanah Raya Capital Group, said .

Islamic bonds pay a return on assets and may attract double charges on stamp duties due to the sale and purchase of goods to back the debt, Aznan, who was in Russia to speak at a conference last month, said on the 8th of June. Profits or capital gains incur taxes whereas interest is tax deductible, he said. VTB bank aims to raise about $200 million this year selling debt that complies with Islam’s ban on interest, Herbert Moos, the lender’s deputy chairman, said in April. The debut sale from Tatarstan will happen even as tax regulation issues linger, Adalet Djabiev, chief executive of Al Shams Capital Group, a Moscow-based Shariah-compliant advisory firm, said on the 8th of June from Astana, Kazakhstan.

“The sukuk will be offered to investors in Southeast Asia, Europe and the Middle East,” Abas said. “We expect the sukuk would be fully subscribed by Shariah-compliant funds across the targeted market.” Amanah Raya expects regulatory changes to be made to enable the offering, Abas said. Shariah-compliant notes have gained 5.5 percent in 2011, according to the HSBC/ NASDAQ Dubai U.S. Dollar Sukuk Index, while debt in developing markets has climbed 4.5 percent, JPMorgan Chase’s EMBI Global Diversified Index shows. gif


Marketing and Branding

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UNLEASH THE POWER OF INTERNAL MARKETING IN YOUR

ISLAMIC FINANCIAL INSTITUTION Author: Tasnim Nazeer, Global Islamic Finance Magazine Editorial Team, United Kingdom

Abstract: In this edition of the marketing and branding series, Global Islamic Finance Magazine is going to show you the key ways to unleash the power of internal marketing in your Islamic financial institution. Effective internal marketing can help to spur growth in your business and also aid in further promoting the growing Islamic financial and banking industry. Global Islamic Finance Magazine will discuss the various different ways that internal marketing can be implemented in your Islamic financial institution. This article will give you a thorough insight into the internal marketing industry and would be beneficial to professionals, students and anyone wishing to know the key to unleashing the power of marketing. We will be discussing marketing in the consensus of Shariah compliancy adhering to the principles of Islam in order to ensure that all promotion of the institution is done in a Halal way. This is an important part of marketing in the Islamic finance and banking industry. Many Islamic financial hubs across the world have been successful due to effective and strategically planned internal marketing processes which have helped to aid their development in the Islamic finance and banking sector. This article aims to explain the various ways development of internal marketing can be facilitated in your company or institution to ensure success and further spur the Islamic finance and banking industry which is expected to reach to over $2 trillion dollars by the year 2012. So if you want to know the key to success in internal marketing then this article is for you. Keywords: Internal Marketing, Islamic Branding, Islamic Financial Institutions, Islamic Banks, Promoting Islamic Finance, Process, Strategies, Media, Imagery 2011 August Global Islamic Finance

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Marketing and Branding

Firstly it is important to establish the rules and regulations of Shariah compliancy within Islamic financial institutions in order to effectively market your product or services to any given company. Global Islamic Finance Magazine will go through the rules of Shariah compliancy which all companies, individuals and businesses should adhere to in order to ensure successful internal marketing. A marketing professional or sponsor of Islamic finance marketing has to be aware of avoiding non Shariah compliant markets as figure 1 outlines the principles underlying Islamic finance and which markets should be avoided in order to remain Shariah compliant. There are various forms and ways for internal marketing strategies and both can be applied to Islamic banking institutions in addition to conventional Islamic financial institutions. It is important for any business, professional or corporate of a company to familiarise themselves and their employees with the key concepts of internal marketing. Once familiarised with the key concepts your company can be equipped with the understanding of the processes and many benefits that it will have in spurring your mar56 Global Islamic Finance

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It also gives room for existing employees to be involved in the process of hiring new employees to further prosper the company. Internal marketing ensures equitable recognition and reward whereby businesses must exercise employee recognition with reward to what the employee has achieved which will further motivate your employees Figure 1: Shariah compliancy rules and regulations

KEY PRINCIPLES UNDERLYING ISLAMIC FINANCE Prohibition of riba Prohibition of uncertainty Prohibition of forbidden assets (e.g. alcohol, gambling)

Islamic Finance

Profit sharing and risk sharing Existence of an underlying asset

Source: Melbourne APEC Finance Centre

Figure 2: Develop internal marketing strategies within your department

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When a company is considering imploring internal marketing strategies it needs to closely look at the ways in which performance of their company can be improved in order to ensure sustainable growth of their products and services. It is imperative that companies, businesses and Islamic financial institutions place importance in assessing their effectiveness of their marketing strategies.

Internal marketing helps to retain a positive customer focused outlook in achieving the main business objectives. Some of the key features of internal marketing that you and your company should be acquainted with is that it gives room for creativity and innovation. All employees are individuals responsible for his or her decisions in marketing processes and will have to retain accountability and responsibility for the decisions which they decide to make.

Divide your departments into business units focusing on different aspects of marketing strategies from promotion to events

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These business units control factors such as expenditure of marketing material. Businesses that effectively use internal marketing ensure that their employees gain significantly by treating them as customers to internal marketing with the goal of increasing their motivation to meet targets and focus on customer needs.

keting strategies for your company forward. So what are the key concepts and features of internal marketing? One of the main concepts of the internal marketing is that it arouses an ethos of employees promoting the core values of the organisation. It motivates employees reframing them and empowering them with responsibility to change their attitudes positively.

Ensure Shariah compliancy rules and regulations are discussed and clarified with employees

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An Introduction to Internal Marketing in Islamic Financial Institutions There are various forms of marketing techniques and strategies that can help to spur the Islamic finance industry forward. However one such technique which cannot be understated is the effectiveness of using internal marketing strategies. So what exactly is the concept of internal marketing? Internal marketing is the application of processes and principles within the marketing framework of financial institutions. Internal marketing therefore involves a business or company using various different methods and dividing marketing roles within their departments transforming them into business units.

Increase employee’s motivation to meet targets and focus on customer needs

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Diagram by Tasnim Nazeer

to get the best results from your campaign. Another key feature of internal marketing is that it demonstrates fairness during hard times including fair treatment of employees when faced with difficulty. It further creates an excellent organisational structure which promotes quality management, learning, educating and significant results. How can you use internal marketing to spur your company forward? This is a question asked by many corporate investors and students wishing to know more about the benefits of internal marketing in promoting Islamic financial institutional products and services. Figure 2 outlines the ways in which internal marketing can be used in your company to spur further growth of your business’s products, services and events. Internal marketing strategies can further help to educate and increase awareness amongst their employees by employing internal marketing strategies. Especially in Islamic banking institutions many Islamic banks find that internal marketing is imperative in order to help build up the relationship between business clients and the individual. This will provide the following advantages to your company as outlined in Figure 3: As outlined in Figure 3 there are countless advantages to develop internal marketing strategies in your business. These advantages outweigh the option of not developing internal market plans as any form of effective ways to promote your company should be developed at the earliest. If you take a laid back approach to creating an internal market then all other processes in the marketing strategy could hinder the profits of your company. It is especially important in Islamic financial institutions and Islamic banks that such measures are seriously considered in order to increase rewards and engage in excellent customer service which will not only benefit the company but also increase the reputation. An Islamic financial institution which has built up a good rapport with its customers and has used effective techniques with employees working hard to focus on customer needs undoubtedly will prosper in success. So there is nothing stopping you as an individual business, company or corporate considering implanting changes in the approach to marketing in order to dedicate time to this important field. In addition to complying with Shariah principles it is also equally important to market your product effectively and it can be guaranteed that the effectiveness of internal marketing is unprecedented.


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Marketing and Branding

Figure 3: Advantages of Internal Marketing for your Company Increased competitive advantages between other financial institutions in establishing excellent customer relations A chance to gain insights through customer collaborations and essential feedback Will help to create solutions in fulfilling customer needs and wants Will educate employees which will create motivation to generate higher demands for Islamic financial products Will establish significant business units focusing on various aspects of marketing such as expenditure Dedicated business units will create more quality promotional marketing material and ensure smooth reviews of profits and expenditure

Figure 4: Companies Strategic Planning in Marketing Islamic Financial Products Increase understanding of Islamic financial products so that the customer knows and understands what they are getting Dedicated to the Shariah compliant consumers needs Leaves scope for re designing products and services Can spur innovative to fulfil the expectations of the target customer Can put strategies and targets into focus so that marketing material can be facilitated effectively Avoids replication or the absence of certain marketing tools which can be followed in a plan of action Resistance to change.

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The importance of Strategic Planning in Internal Marketing Processes of strategic planning in Islamic financial institutions cannot be understated as being the key to developing your company forward. Strategic planning involves reviewing and setting targets which need to be analysed in order to further spur successful customer relations. It also helps to identify and target customer needs focusing on a step by step route to successful marketing of products. The Halal branding of Islamic financial institutions has come a long way and many Islamic financial institutions are tapping into the sector of promoting its worth as a fully fledged Shariah compliant institution. Creating strategic plans will help companies and businesses to do the following as outlined in Figure 4: The emergence of Islamic Finance into mainstream finance and the growing interest in the industry globally coupled with the rising demand for Shariah compliant product seems to present the Islamic finance Industry a unique opportunity to develop a sound customer centric sustainable competitive advantage. In order to further develop this advantage, a re-look at just the product build up or marketing communications in addition to the company’s operational standards would not be enough to sustain success in marketing. To create and deliver a sustainable competitive advantage the entire process of business planning and operations would need to be reviewed. This review is imperative in ensuring identification of key operational efficiency areas coupled with strategic development which will identify the brand value benefit that the Islamic financial global market wants to see developed and would like to further utilise. Internal Marketing Focusing on Customers Needs Internal marketing is totally customer focused to ensure excellent standards are met and provisions are made which will hope to spur success within the company threshold and beyond. Especially in the Islamic retail banking sector, banks are increasingly aware that customers are the inspiration of the industry. Islamic banks therefore try

their utmost best to actively engage consumers in order to attract a wider customer base and generate a broad and stable revenue stream. Islamic banking institutions are increasingly adopting a consumer-centric strategy, with an aim of tapping into the increased potential of the market. The Islamic finance industry is at its peak indulging in lucrative investments which are all tailored to attract the consumer. Educating customers about Islamic finance is imperative to ensure that the Islamic financial institution understands their needs and delivers products and solutions that are innovative and adhere to Shariah principles. It has also been the aim of many Shariah compliant financial institutions to offer costeffective, solutions in order to develop the sector more fully and enlarge their share especially in the Islamic retail banking sector.


Marketing and Branding

Internal marketing is totally customer focused to ensure excellent standards are met and provisions are made which will hope to spur success within the company threshold and beyond. Especially in the Islamic retail banking sector, banks are increasingly aware that customers are the inspiration of the industry. Islamic banks therefore try their utmost best to actively engage consumers in order to attract a wider customer base and generate a broad and stable revenue stream “Players across the conventional sphere are moving away from product selling to solutions based on customer needs, and Islamic banks are doing this too,” says Wasim Saifi, the global head of Islamic banking for the consumer banking division of Standard Chartered Bank. “We take the same approach as on the conventional banking side. We encourage staff to engage customers in need-based conversation rather than engage in product pushing - that’s the need of the day.” (Islamic Finance Asia)

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The question remains as to how Islamic financial institutions and banks can further adopt methods to target the customer/ consumer base. The answer lies in the fact that internal marketing strategies focused on customer needs can solve the question. There are various methods of focusing on customers needs as described by Amman Mohammed the managing director of Absa Islamic Bank in South Africa. Mr Mohammed says in regards to achieving customer satisfaction from marketing that, “To educate via a customer focus group where we invite people from a certain area to congregate, and invite international Shariah scholars and members of our Shariah board to interact with them and answer questions. He further went on to say that “One of the challenges we face is creating enough awareness amongst Muslim and non-Muslim customers, potential customers and bank staff” (Islamic Finance Asia). 2011 August Global Islamic Finance

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Marketing and Branding

Figure 5: Identifying Potential Constraints in Marketing your Islamic Financial Product Language barriers – It is important to ensure that the language barriers are broken down and all internal marketing material is catered for the customer base and given with language options for them to understand.

Standardisation of Shariah compliancy - This has been one key challenge of the Islamic financial industry as a whole as what is deemed Shariah compliant in one country may not be compliant in another. Therefore it is best to stick to the overall consensus when making Shariah compliant decisions. Assess to data - It has often been a problem for Islamic financial institutions to have readily available data on their lists due to problems with technological software. Thankfully Islamic software providers such as Path solutions have provided innovative Shariah compliant software.

Table by Tasnim Nazeer

Figure 6: Constraints of Implementing Internal Marketing Managerial incompetence in interpersonal, technical and conceptual skills is some of the stumbling blocks against successful internal marketing. Poor understanding of internal marketing concept. Individual conflict and conflict between departments makes the implementation of internal marketing difficult. Rigid organisational structure coupled by bureaucratic leadership hinders success of internal marketing. Ignoring and not listening to subordinate staff. The tendency of ignoring employees’ importance and treating them like any other tools of the business. Unnecessary protection of information against employees. Resistance to change.

Source: Wickepedia 60 Global Islamic Finance

August 2011

Many conventional banking institutions have been rushing to facilitate and open up Islamic windows within their branches to cater for the growing demand of customers wishing to use Shariah compliant financing. Islamic financial institutions have an edge over conventional banks for catering for fully fledged, dedicated Islamic financial services. This advantage could be highlighted in all marketing aspects as the employees which are involved in helping customers to get the best Shariah compliant service are expected to know and educate customers in order for them to understand the principles of Islamic banking efficiently. Of course if employees in a conventional Islamic window were trained to be specialists in the Islamic finance or have adequate knowledge to sell the products sufficiently then customers would consider it as a viable option. However Islamic banking and financial institutions are a reliable source for fully fledged Islamic products and services and many customers will be attracted by this aspect. Highlighting and promoting customer centric advantages of products and services can further spur success. Enabling and educating staff and employees by sending them on courses, conferences and events can also aid in the successful facilitation of internal marketing. Overcoming Constraints and Challenges with Internal Marketing All Islamic financial institutions including their conventional peers will undergo challenges and constraints when dealing with marketing their services. However as a simple rule of thumb it can be reassuring to know that a strategy of action can be used to deal with the level of constraints that may be causing a delay in facilitation or marketing of an Islamic product and service. Firstly it is important to identify the potential constraints and challenges that may occur when looking to the global Islamic financial market in promoting your company or services. These constraints are outlined in Figure 5. As outlined in Figure 5 there are some potential constraints of the Islamic financial industry that can often hinder success, however internal marketing can help to overcome the challenges and constraints of marketing

your Islamic financial products or services. Figure 6 outlines further problems which may affect successful implementation of internal marketing. It is important to identify these problems at the earliest to ensure that constraints are overcome and necessary measures are taken to improve the overall service and delivery from your company. As internal marketing involves all employees of managerial level taking up employer branding in addition to employer brand management it is particularly important that they know what they may need to overcome and deal with it. As outlined in Figure 6 you may experience one or more of the potential constraints of implementing internal marketing. However addressing these problems at the earliest by working to overcome your objectives can help your employees to have a good understanding and work towards an ideal goal. A resistance to change by employees shows a lack of understanding of the benefits of internal marketing. It is always best if you are in a managerial position to discuss the possible changes and benefits that internal marketing strategies can bring. Explaining the various rewards of internal marketing to your employees can help them to understand the reasons behind following an internal marketing procedure and they may come round to enjoying the perks from its profitable success. Islamic financial institutions in particular will have benefits of using this form of marketing which the whole company can get involved in considering that Shariah compliant financing is a unique and ethical alternative to conventional financing methods. An understanding of internal strengths within the company can further help to spur success within your business which will benefit it both internally and externally in every stage of marketing. If you are a manager considering implementing internal marketing strategies for your company in order to facilitate Islamic financial services then it is important to have a thorough review of your employees and the cooperation between departments. If you are confident that your departments and employees can work together in collaborating with internal marketing strategies then the most confident move would be to discuss and implement internal marketing within your company. You should also


Marketing and Branding

ensure that if you are in a managerial position the ethos of internal marketing which to promote equality and designate tasks of responsibility in your work force is done in a way which does not treat your employees like tools. You have to give your employees the freedom to express their creativity, making the decisions and advising accordingly on matters that would benefit the company overall. How can internal marketing help me to overcome constraints and challenges? There are many ways in which internal marketing can help your company or business to overcome constraints and challenges of the growing Islamic financial market and attract key consumers into your league. Firstly internal marketing provides your business with the framework to review expenditure and data effectively. This tackles the problem of assess to readily available data. If you dedicate a business unit to deal with expenditure of marketing Islamic financial services then your team will be responsible for all entries of profits, losses, investments, marketing expenses and so forth. The managing director or CEO will therefore have a little flexibility in having the reassurance of assess to data when needed and reviewing their expenses accordingly to plan marketing campaigns for the present and future. If you know exactly how much a campaign will cost, how much tools you will need and the overall costs then you are more likely not to go over budget and you can even save money. Therefore internal marketing can make this a realistic proposition for dealing with expenses of the marketing essence. The training and education of staff in the Islamic Finance and banking arena can further help to give them a clear understanding of the concepts and principles of Shariah compliant financing. This will provide the employee and the customer with a basis of an easy relationship to communicate and foresee their customer’s needs effectively. Understanding Shariah compliant financing is key in achieving success in your marketing strategies as if you do market your product in a Non Shariah compliant manner you are more likely to lose consumers at the first instance or potentially put them off. You cannot risk this happening and therefore it is important to invest a little time and

money in training and educating employees in your chosen business of Islamic finance or banking. Once trained a diverse network of players or translators can cater to overcome language barriers. If you identify the potential for Islamic finance which has reached a global scale an employee with the skills of knowing more than one language can clearly help your cause. In addition any marketing material that is brought out into a country could have translations for the native languages of the population of that particular town, village or city. Making language accessible can break down the barriers and inform more people about your services who may not have English as their first mother tongue language.

component of any company and attracting them means your half way to success and profitability. Internal marketing may just be the answer you have been searching for in successful implementation of a broad marketing strategy which will affect your whole company at large. It holds many benefits for the Islamic financial institution of today and GIF hopes that you would have fully acquainted yourself with the necessary knowlgif edge and study to implement internal marketing strategies in your company today.

References and Further Reading •

Harnessing internal marketing practices can further help to create innovative new design structures which will attract the existing market in addition to further attracting other clients from around the world.

Unlocking the Keys to Internal Marketing for Your Islamic Financial Institution Global Islamic Finance Magazine has discussed in this first for the marketing and branding series the ways in which you can unleash the power of internal marketing to ensure effective progression of your company in the highly competitive financial world. As discussed there are numerous benefits of making the change of implementing internal marketing into the core essence of your company.

These positive changes range from motivating employees to one marketing target, giving and sharing responsibilities of tasks and creating an overview of expenditure for your successful marketing campaign.

Of course like with any strategy there will be limitations and as discussed there is inevitably going to be constraints that need to be overcome before facilitating the internal marketing strategies. Once discussed with your employees and everyone understands the key concepts and benefits of internal marketing than you can really unlock the key to promoting a successful Islamic financial institution. Internal marketing provides the new age experience for all Islamic financial institutions and widens the scope for attracting quality employees and motivating your company to do well in every possible customer focused driven task. After all customers are the vital

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Internal Marketing (2009) Marketing, Q Finance the Ultimate Financial Resource, Retrieved from: http://www.qfinance. com/dictionary/internal-marketing Professor S. Haron (2005) Marketing Strategies of Islamic Banks, A Lesson from Malaysia, Retrieved from: http:// docs.google.com/viewer?a=v&q=cac he:sHykm6dUUdkJ:klbs.com.my/Pdf/ Marketing%2520Strategy.pdf+Marketing +in+Islamic+Finance&hl=en&gl=uk&pid =bl& M Kabir Hassan & M. K Lewis (2007) Handbook of Islamic Banking, Edward Elgar Publishing, Pg 125- 126 The International Role of Islamic Finance (2009) Q Finance the Ultimate Financial Resource: Retrieved from: http://www. qfinance.com/capital-markets-bestpractice/the-international-role-of-islamicfinance?full Strategic Planning in Islamic Finance (2009) Daily Bakara EU, Retrieved from: http://dailybaraka.eu/2011/03/isstrategic-planning-necessary-in-islamicfinance/ C. Klass (2009) All about the customer, Islamic Finance Asia, Retrieved from: http://www.islamicfinanceasia.com/article.asp?nm_id=18904 U.S Marshall (2010) International Marketing, Country Decisions and Strategies, Retrieved from: http://www.consumerpsychologist.com/international_marketing. html Internal Marketing (2011) Definition by Wickpedia, Retrieved from: http:// en.wikipedia.org/wiki/Internal_marketing

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Sukuk

ANALYSIS

OF SALE/DEBT BASED SUKUK:

THE MALAYSIAN SAGA, PART II Author: Mughees Shaukat, PhD researcher and assistant researcher in INCEIF & ISRA, Malaysia

Abstract: The success of the sukuk market’s growth rate in the past few years has brought along itself many scrutinising questions over its authenticity with Islamic law, all over the Middle eastern countries. In Part one of The Analysis of Sale/Debt based Sukuk: The Malaysian Saga, we expalined the meaning of sale/debt based sukuk by detaching it from its stigmas and understanding it in its true light. Also GIF discussed, in detail, the acceptance of Sukuk in Malaysia and their version of sukuk with its legal codes and conducts, to keep sukuk controversy free. In the second part of the article, Global Islamic Finance Magazine will be looking closely into the depth of the issues surrounding Sale/Debt based sukuk, to be able to understand the contention better and therefore have an analytical point of view over its legitimacy. Keywords: Sukuk, Sale/Debt based sukuk, Malaysian Islamic Finance, Malaysian sukuk Practice.

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Author: Mughees Shaukat, PhD researcher and assistant researcher in INCEIF & ISRA, Malaysia

Underlying Issues: Sale/Debt Based Sukuk Legitimacy The absence of bonds instruments in most al-murabaha project finance particularly in the ever liquid Middle-East countries may be explained by the controversy on the validity of using bai al-‘inah in the securitisation process and the application of bai al-dayn at a discount in bonds in secondary trading. The question now is; what are the underlying issues behind this controversy about the legitimacy of bai al-‘inah and bai al-dayn in Islamic law? What could explain its rejection in the Middle-East countries while gaining acceptance in Malaysia? Analysis conducted on more than 300 sale/debt based sukuk issuance identifying a number of Shariah issues. Those issues had been classified into two categories, firstly termed as Primary or Common issues in term of the main principles which govern the issuance of most structures. Two most controversial principles namely, Bai al-Dayn and Bai al-Inah fall within this category. The BIMB Securities Sdn Bhd, outlines that the Malaysian Islamic bonds are structured on the basis of Bai al-inah (refinancing of assets) and subsequently traded on the basis of Bai al-dayn (debt-trading) which are commonly found in almost all structure. The second category of the possible Shariah issues termed as Secondary Issues or those involving secondary features of the sukuk issuance. The Shariah viability of issues like the position of SPV in sukuk issuance, hibah clause by a third party and re-hibah, proceed payment, collateral and guarantee, usage of proceed, and event of default clause will be put under the Shariah microscope. Foremost Issues The Issue of Bai Al-Dayn THE SAC RESOLUTION At its 2nd meeting on 21 August 1996, the Shariah Advisory Council (SAC) unanimously agreed to accept the principle of bai` al-dayn i.e. debt trading as one of the concepts for developing Islamic capital market instruments. This was based on the views of some of the Islamic jurists who allowed this concept subject to certain conditions. In the context of the capital market, these conditions are met when there is a transparent regulatory system which can safeguard the maslahah (interest) of the market participants. From the Islamic jurisprudence point of view, dayn encompasses a wide scope, including payment for product, qardh (loan) payment, mahr (dowry) payment before or after cohabitation, that is mahr which has not been given after the marriage `aqd (contract), rental, compensation for crime committed (arsy), compensation for damages, money to be paid for divorce (khulu`) and for purchase orders which have not yet arrived (muslam fih). In the context of the Islamic capital market, bai al-dayn is the sale principle i.e. the dayn which results from mu`awadhat maliyyah contracts (exchange contracts). The sale of debt or bai’ al-dayn is one of the key elements in the development of Malaysian Islamic Capital Market (ICM), as the trading of bonds in the capital market is mainly based on bai’ al-dayn. This is the consequence of the opinion of the Malaysian jurists as to the permissibility of the sale of debt. On the other hand, the majority of the scholars around the world and particularly the jurists from the Middle East opposed to the permissibility of bai’ al-dayn or trading of debt. The main ground for its impermissibility as argued by opponent is due to the elements of gharar and riba. Whereas the proponents claimed that in the context of modern practice of bai’ al-dayn in the capital market, these two major prohibitions in Islamic financial laws could be eliminated. ‘Bai’ is the Arabic term for sale. Thus, the literal meaning of bai’ al-dayn can be translated as the sale of debt. Scholars have technically defined bai al-dayn in different ways. 2011 August Global Islamic Finance

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Sukuk Case Study

SWEETWATER SPV SDN BHD (BBA SUKUK ISSUANCE) Issuer: Sweetwater Sdn Bhd [SPV] Lead Arrangers: Securities Sdn Bhd (ASSB) Trustee: Bank Trustees Berhad ‘SSPV’ used here as an SPV (Special Purpose Vehicle) is a wholly owned subsidiary of The Sweet Water Alliance (TSWA) incorporated in 0805 with the sole purpose of issuing purposed BaIDs. It also obtained approval from SC the security commission of Malaysia to raise funds of as much as RM195,000,000 through issuing BaIDS in October 2005 based on Bai Bithaman Ajil-BBA. This Sukuk deal is interesting because it contains not only all the common practices of other such issuances like the application of ‘Bai al-Inah’, ‘Hibah’ and ‘re-Hibah’ the practice of ‘Bai al-Dayn’ but it has even gone one step further by violating the basic requirement of an SPV that it should be a completely independent entity, but in this case the SPV in the form of SSPV is in fact a wholly owned subsidiary of TSWA i.e. the holding company. No wonder the underlying assets used in this deal are actually the very shares of the company in another company named ‘SPLASH’. Prior to the issuance date the asset owner (TSWA) who is the holding company of SSPV which is also the SPV, will ‘Hibah the underlying assets to the issuer SSPV. For this purpose TSWA and the issuer will enter into a deed of ‘Hibah’ (deed of gift) whereby TSWA will give and convey to the issuer the beneficial interest in the identified assets thus entitling the issuer to deal with the beneficial interest in the identified assets. Once this process is over, the issuer (SSPV) will then sell these ‘hibah’ assets to the primary subscribers through asset purchase agreements (APAs). Then Primary Subscribers will straight away then sell these assets back to the issuer through asset sale agreements at a price higher than what they were purchased the first time. This unconditional obligation of the issuer to pay the selling price will be evidenced by the issuance of BaIDs. These BaIDS as normal with such other Malaysian deals is also tradable in the secondary market on the basis of ‘Bai al-dayn’. Figure 6.10 depicts the structure of the deal. 1. 3rd party (TSWA) will first ‘hibah’ the underlying assets to be used for this deal to SSPV. 2. The Issuer (SSPV) will sell these assets to the investors at a purchase price through Asset Purchase Agreements (APAs). The payment will be made to the issuer on spot. 3. The Investors will then sell back the same assets straight away to the issuer but at a higher price including a profit margin through asset sale agreements based on ‘Bai al-Inah’. 4. The issuer (SSPV) will issue sukuk (BaIDS) to evidence his obligation to pay the sale price. 5. Once the Sukuk has grown to Maturity The Very underlying assets will then be given back to the 3rd party (which by the way is not the real owner but the beneficial owner of the assets) through the process of ‘re-hibah’. Third party • TSWA hibah asset to issuer

The Shariah Advisory Council of Security Commission in Malaysia provided a specific definition of bai’ al-dayn which is being practiced in Malaysia. They stated: Bai`al- dayn is the principle of selling the dayn which results from mu`awadhat maliyyah contracts (exchange contracts), such as murabahah, bai` bithaman ajil (BBA), ijarah, ijarah munthiyah bi tamlik, istisna` and others. It means that the debt in Malaysia’s capital market is traded which originated from different types of exchange contracts like murabahah, bai` bithaman ajil, ijarah, istisna and others. There are three opinions on the permissibility of sale of debt to a third party: 1. Some scholars from Shafie and Hanbali schools like Ibn Taimiyah and Ibn Qayyim opined that this type of sale is permissible. According to some scholars like Ibn al-Qayyim, the creditor has the right to sell only confirmed debt to the debtor or to a third party. This is based on the grounds that if he is allowed to sell it to the debtor, he can also sell the same to a third party too. This opinion is based on the following arguments: •

• •

2. This type of sale is permissible with condition by some Shafie and Maliki scholars. The Maliki School imposed eight conditions to permit this type of sale which are as follows: • • • •

• Issuer hibah back to TSWA

Issuer (SSPV)

• 2. Primary Subscribers Purchase asset at Purchase Price (APAs)

3. Payment of proceed

4. Sell asset at Sale Price, deferred (ASAs)

4a. Issue BalDS to evidence obligation to pay sale price

Primary Subscribers Figure.6.10: Sweetwater Spv Sdn Bhd (BBA Sukuk Issuance) 64 Global Islamic Finance

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There is no authentic source that prohibits such kinds of selling or giving. Thus, it should be allowed and permitted; Creditor has full right on possession and full right to sell it to a third party; and Based on a legal maxim which states that all transactions are permissible until they are proven non-permissible by an authentic source. Since there is no authentic source prohibiting this transaction, then, it should be allowed.

Expediting the payment of the purchase; The debtor is present at the point of sale; The debtor confirms the debt; The debtor belongs to the group that is bound by law so that he is able to redeem his debt; Payment is not of the same type as dayn, and if it is so, the rate should be the same to avoid Riba; The debt cannot be created from the sale of currency (gold and silver) to be delivered in the future; The dayn should be goods that are saleable, even before they are received. This is to ensure that the dayn is not of the food type which cannot be traded before the occurrence of qabadh; and there should be no enmity between


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buyer and seller, which can create difficulties to the madin (debtor). There should be no enmity between buyer and seller, which can create difficulties to the madin (debtor).

On the other hand, the conditions imposed by Shafie jurists are the followings: • •

The dayn must be a spot debt in nature otherwise it will not be allowed; The debtor must be a rich person and he has to accept the sale or there must be strong evidence to prove the existence of the debt in case of any denials from the debtor. Otherwise the sale should not take place; and The buyer must pay the price of the debt on spot basis otherwise, the sale will be considered as invalid and illegal.

The summary of the evidences that they provided is that the sale of debt contains some kind of gharar or uncertainty which may create conflict between the contractors, therefore, these types of conditions should be fulfilled to avoid gharar and other prohibited elements like riba and others.

The majority of the scholars around the world and particularly the jurists from the Middle East opposed to the permissibility of bai’ al-dayn or trading of debt. The main ground for its impermissibility as argued by opponent is due to the elements of gharar and riba. Whereas the proponents claimed that in the context of modern practice of bai’ al-dayn in the capital market, these two major prohibitions in Islamic financial laws could be eliminated 3. The majority of scholars at the Hanafi School of jurisprudence and some Hanbali and Shafie scholars and Ibn Hazm did not permit selling debt to the third party with cash price at all. The arguments supporting their opinions are the followings: •

The creditor is not able to submit the sold item to the purchaser as the debt is under the liability of the debtor and to possess what is under others’ responsibility cannot be imagined, therefore, it is not permitted as it is not capable of submission, subsequently contains risk to the sale. The risk might also arise from the fact that the debtor may deny his debt or delay in payment or he may become poor. In those cases, it is not possible to get the debt from him.

In the same line of argument, Koutoub Mustafa had listed more evidences supporting the view of this group which are summarised in the following:

• •

There is a Hadith of the Prophet (peace be upon him) which clearly states: (Don’t sell what you do not possess). It also based on another Hadith of the Prophet (peace be upon him) which prohibits selling or giving an item that the seller or giver is unable to deliver to the buyer or given: (Don’t sell the fish while they are in the water) On the same ground, there is a Hadith, which states: (The Prophet prohibited the sale of a missing slave or the offspring of the offspring).

It is clear that the scholars held different opinion to the issue of bai al-dayn especially in the case of selling it to a third party. With these many opinions and arguments of the scholars, the task is now to find out the most accurate opinion. In fact, the contemporary scholars have looked into these arguments and disagreed on deciding the preferred opinion. Some scholars mostly from Malaysia preferred that selling debt with cash price to the third party is permissible. The Maqasidi approach was adopted in coming into this conclusion by looking into the reason

for the prohibition itself, and to avoid these reasons in the current scenario of bai al-dayn. They pointed out that the main reason for prohibiting bai al-dayn by the Hanafies and also conditions imposed by the Malikies and Shafies is mainly because of the element of risk and uncertainty for the buyer as the debtor may not pay the debt. It follows that if this uncertainty could be avoided by having strong regulatory, supervision and control by the government then it should be permitted. Resolutions of the Securities Commission Shariah Advisory Council stated that: “The argument of the Islamic jurists that prohibited bai al-dayn to a third party for fear that the buyer will have to bear great risks (Hanafi Mazhab) has some truth in it. This is especially true if there is an absence of supervision and control. In this context, the buyer’s maslahah should be safeguarded because he is the party that has to bear the risks of acquiring the debt sale while making the sale contract. In the Malaysian context, the debt securities instruments based on the principle of bai al-dayn are regulated by Bank Negara Malaysia and the Commission to safeguard the rights of the parties involved in the contract. Therefore, the conditions set by the Maliki Mazhab and the fears of risks by the Hanafi Mazhab can be overcome by regulation and surveillance.” Another important issue is riba when the debt securities are traded in the secondary market at discounted price. Riba 2011 August Global Islamic Finance

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might arise due to the rule of parity in the exchange of money with money in the same denomination. However, in Malaysian context, it is claimed that there is no riba element involved and the rule of parity does not apply in this context: “In the context of the sale of securitised debt, the characteristics of securities differentiate it from currency, and hence, it is not bound by the conditions for exchanging goods.”

that riba al- fadl and riba al-nasiah. He stated that: “In fact, the prohibition of bai’al-dayn is a logical consequence of the prohibition of riba or interest. A “debt” receivable in monetary terms corresponds to money, and every transaction where money is exchanged from the same denomination of money, the price must be at par value. Any increase or decrease from one side is tantamount to riba and can never be allowed in Shariah.”

Adawiah forwarded 3 arguments to discard the element of riba and allowing debt discounting:

According to the Organization of the Islamic Conference (“OIC”) Islamic Fiqh Academy’s ruling, sale of debt is permissible so long as it is free from any element of riba and gharar. Following such ruling, it is pertinent to determine the nature and status of the debt. If the receivables of the debt are in the monetary form, the debt is considered as similar to money and the rules in the exchange of money will apply.

1) Securitisation of the debt has changed its nature into an independent financial right (haq maliyy) that is in itself an independent asset (mal). It means that after the Securitisation process, it becomes an asset which is capable of being bought and sold, at whatever price agreed by the parties. Hence, the 2) Securitised debt is no longer bearing the nature of money but analogous to financial rights such as shares, copyrights and patent rights. It follows that the sale of Securitised debt is no longer governed by the rule of sarf or currency exchange, therefore discount is allowed. 3) The debt discounting also allowed on the basis of the principle of ‘da’ wa taajjal’. Originally, this principle refers to an arrangement between debtor and creditor whereby the later gives discount to the former on his debt due to the acceleration of the date of payment. The principle had been approved by some scholars like Ibn Qayyim and Ibn Taimiyyah. Though the original application of the principle is between debtor and creditor, it can also be extended to other than debtor or the third party. Thus, the case of debt discounting for trading of securitised debt could be allowed under the extended principle of ‘da’ wa tajjal.’ 4) The third argument to allow debt discounting in the sale of debt to the third party is based on logical reasoning. It was argued that a debt which originated from deferred payment sales is different from straight loans. In the straight loans, the creditor is only allowed to take his principal amount. Thus, discounting the amount will cause a loss to the lender. On the other hand, in deferred payment sales, normally as in the banking practice there is a difference in terms of amount between the cost price and the selling price, such as in Murabaha sales. Therefore, if the creditor sells his debt to a party with discount, he is actually sharing his profit portion with the buyer of the debt. However, these arguments were rejected by the majority of the contemporary scholars. For example, one of the famous scholars Mufti Taqi Usmani has obviously pointed out that bai’ al-dayn is in fact, selling the ribawi item with discount price which is not other 66 Global Islamic Finance

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This means the transaction will have to adhere to the rule of parity and it must be carried out on the spot. If the receivables are in the forms of non-ribawi goods, it is considered as a non-monetary financial right and the rules in the exchange of money or ribawi items will not apply currency exchange and THE SAC RESOLUTION The SAC, at its 5th meeting on 29 January 1997, passed a resolution that bai` inah is a principle that is permissible in the Islamic capital market in Malaysia.

the practice of discounting in the sale of debt is allowed. Although it has to be noted that the SAC’s ruling merely represents the minority view in the market. Although the sale of debt with a discount is allowed in Malaysia, such practice may not pass the more stringent requirements of such sale as imposed by the classical and majority of the contemporary jurists. The Issue of Bai Al-Inah The Meaning of Bai al-Inah Bai al-inah is generally known as sale based on the transaction of Nasiah (delay). The majority of Islamic jurists state that there are three forms of trading categorised as bai` `inah, whereby it can be concluded that all the assets sold come from the financier. The financier will sell a product to the buyer at an agreed price to be paid later. The financier then immediately buys back the asset at a cash price lower than the deferred selling price. The difference between the two prices represents the interest. Such contract was evolved in the early period of Islam and it exists for the fundamental rea-

son that a loan for interest is forbidden because it is equivalent to usury (riba). In this contract, there is an economic interest for both the borrower and the lender, which at the same time circumvents the prohibition of usury. The issue which concerns us here is how Islamic law views such contract: The majority was of the opinion that bai`al inah was not permissible because it was the zari’ah (way) or hilah (legal excuse) to legitimise riba (usury). The majority of the jurists rejected the validity of Bai’ al Inah and considered it as a back door riba or using sales which at the end resulted in riba. Abdullah Ibn Umar reported that the prophet said: “When men become frugal with money (gold and silver) and trade on the basis of Inah and (when they) follow the tails of the cows and leave jihad in the path of Allah, Allah will send down a trial that he would not remove until they revert to their religion.” On the other hand, the Shafies and Zahiris approved the legality of Inah sales on the basis of the completion of all requirements of sales, irrespective of the intention of the parties. Imam Shafie said in his book al Umm: “When one purchases a commodity from another and takes its delivery and the price happens to be on deferred terms, it is not objectionable for him to sell it to the person from whom he had purchased it or to someone else, for a cash price or on credit or against another commodity.” The hadith relied by the majority was considered as weak hadith for this group of jurists. Another important hadith on bai’ al-inah is a famous narration from Aishah whereby 2 women came to her and asked: “O mother of believers, I sold a slave to Zayd ibn Arqam for eight hundred silver coins deferred until receipt of the grant, and I purchased him again for six hundred cash.” Aishah replied: It was an evil purchase that you did and an evil sale, convey to Zayd that his jihad in the company of the Messanger of Allah is annulled, unless if he repents.” Imam al Shafei was of the opinion that the issue is one in which 2 companions (Aishah and Zayd Ibn Arqam) have different opinions pertaining to the validity of the contract. When the companions have conflicting opinions, according to Shafei the matter must be resorted to qiyas, which is in favor of the position taken by Zayd. This is because a person is free to sell his asset to anybody he wishes. By applying qiyas, he may also sell it to the person from whom he bought the same asset. Another qiyas applicable here is if the person who bought a property may sell


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Sukuk

it back at any time, whether after a passage of time or immediately after the purchase. The Maliki and Hanbali Mazhab, on the other hand, rejected bai` inah and considered it invalid, because according to them the motive of the parties to the contract determines the legality or illegality of the contracts, and in the sale under consideration the motive of the parties is illegal and, therefore, the sales are not valid because they constitutes a legal device (Hilah) to get a loan with interest which should be averted at all costs according to the Shariah.

the relevant Shariah experts may have differently applied Shariah laws, which implies now that the legitimacy of Islamic bonds issued using bai’ al-’inah is suspect”. The Other Issues in Sale/Debt Based Sukuk Alongside the very foundational and prominent issues of Bai al-Inah and Bai al-dayn as detailed previously, a number of other issues which we have termed as secondary issues have also been pointed out which could be as controversial as the ones explained, if not more.

Ibn Qayyim, a Hanbali scholar states that intention influences legal acts: the formality of legal act can be the same but end results depend on the intention. The Maliki and Hanbali opinion was based on the principle of sadd zari’ah that aims to prevent practices that can lead to forbidden acts such as, in this case, riba.

These issues have certainly added more to the gloom over these sukuk and have made the debate even more furious on their Shariah compatibility which makes them worthy to be voiced and discussed. A number of such issues have been brought up from our research based on the study of more than 300 term sheets of these sukuk including the case studies integrated with the article. These secondary issues are:

The basis for the opinion of the majority of the Islamic jurists was the hadith dialogue between Aishah and the slave Zaid bin al-Arqam which showed the prohibition of bai` `inah. They also held to the hadith of the Prophet (p.b.u.h) in which he warned that those who practiced bai` inah would suffer scorn. From the above discussion on this issue, the following conclusion can be drawn. 1. It is obvious that Bai al-inah is a legal device in order to overcome the prohibition of riba, (no person would affect such sale if he cannot realize profit), and is not deemed to be an act of sale, as there is clear evidence that such act amounts, in effect, to a contract of loan. Thus, it is forbidden as it is based on unjustified enrichment or “receiving a monetary advantage without giving a counter value” (Saiful & Sanusi 1999). 2. Al-Shafii’s recognition of the validity (sahih) of Bai al-inah not based on interpretation of any authentic Islamic authority and is one’s own view. However, according to other schools the prohibition of such sale was based on the consensus of the jurists (Ijma al-ulama’) on the authority of Islamic law sources. As Ibn Qayyim prohibited Bai alinah quoting the following Hadith that Allah’s messenger says: “A time is certainty coming to mankind when they legalise the Riba under the name of Bai” (trade concerning that intending usury by words of a sale). 3. There is hardly any satisfactory evidence which enables one to say that al Shafii has expressly declared that al-Inah to be (Ha 68 Global Islamic Finance

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lal). It should be pointed out that al Shafii’s method of determining the validity of any contract by its formal evidence that they are legally concluded, cannot be cancelled on account of the intention of the parties, the Shafii may, thus permits contracts because its legal preconditions are fulfilled, but forbids the transacting act of the parties when it conflicts with Shariah principle (Saiful & Sanusi 1999). Al-Qaradawi states; Bai alinah is a clear case of usury and the device: why should one practice transaction which contains elements of devices while one is in position to have a clear and apparent alternative transaction? To echo further Saiful & Sanusi (1999): “The use of legal device is therefore evidence that the niyyah factor is undermined or made secondary in the securitisation process of Islamic bonds in Malaysia. It is apparently clear that most underlying assets used in the Malaysian Islamic bond securitisation have no direct relation with the actual project itself. These assets were simply collaterals that serve as guarantees to the debt issued. To retain the basic structure of traditional bonds in Islamic finance, that is providing fixed return to investors, practitioners and

1. The issues of SPV which directly links to the general and legal status of it i.e. on its degree of independence from the sukuk issuing company and on its basic requirement of being bankruptcy remote. Both of these basic requirements has been frivolously violated, where the SPV is in many issuance have actually been a subsidiary of the issuer which has been given a status of SPV only meant for the purpose of the sukuk issuance which eventually makes it nonbankruptcy remote. 2. The frequent use of ‘Hibah’ and ‘re-Hibah’ in these forms of sukuk where a third party agrees in some way to hibah the relevant assets, which are to be used as underlying for the issuance of the required sukuk, in order to make the issuer who has no ownership of the asset the beneficial owner so that he can use the assets just for the purpose of the issuance to raise funds. Eventually at the end of all when the sukuk is matured, those very assets after fulfilling the required purposes are then ‘Hibah’ back to the real owner. This whole process raises some serious issues which directly link to the concept of ownership of the relevant assets for the purpose of sale in the view of Shariah. Shariah requires the seller to own the assets before he can sell them to the other party. This is the basic requirement before entering into any sale contract. The asset should


Sukuk be owned in such a way that the owner should have a full and real procession of them. In other words he should be the real owner and not a beneficial one meaning he should have full control over it so that he can run the risk of any loss or gain or even damage to it. The owner should be able to practice his/her free will over the assets meaning he can do whatever he wants and use it the way he likes but within the ambit of Shariah. Beneficial ownership as is the case in a number of these sukuk contradicts all of these basic Shariah requirements and hence it violates and invalidates the whole Islamic concept of Sale. The whole transaction will be invalid and hence contradictory to Shariah which is the most severe consequence to a so called Islamic transaction. It means in such transaction the real ownership of the assets has never been transferred at any point be it to the issuer from the real owner or to the investors when it is further sold to the investors in an extensive approach and then re-sold back to the issuer using ‘AlInah’ as mentioned previously. Thus it is very clear that although it is a sale transaction and the assets are sold, they are just used rather fictitiously to raise fund under the Islamic banner but in an un-Islamic way through financial artifice or Hilah (legal stratagem). The question is that how can you call this practice Islamic, how can one term it an Islamic Sukuk or even Islamic finance for that matter? 3. The issue here relates to the presence of collateral and often guarantee by a third which has not even been found independent of the sukuk issuing party particularly when the issuance is not a sovereign one as has been the case in most of the sale based sukuk issuance in Malaysia. This issue can be seen in all the credit enhancement clauses given in the term sheets of majority of these sukuk. Before we explore any further, very briefly we understand what credit enhancement is in sukuk? This sort of Sukuk receives an irrevocable third-party guarantee, usually by a parent or original owner of the underlying collateral. The guarantor provides Shariah compliant shortfall amounts in case the issuing vehicle (usually a special purpose vehicle or SPV) cannot make payment. The ratings on this type of Sukuk largely depend on the creditworthiness of the guarantor or entity providing the credit enhancement mechanisms and other financial obligations of the guarantor. When it comes to the act of ‘Guarantee’, Shariah has some basic rulings. It says very clearly that guaranteeing is a voluntary act and should not be a conditional one; it can be performed in form of a gift or donation also, hence the guarantor should not ask for any fee or compensation in any way for such guarantee as it will violate the very concept of a voluntary act. Therefore it must and cannot be stated in contract either implicitly or explicitly as a pre-condition or even after the contract has been concluded. In other words the conclusion of a sale contract as in here should not be based or concluded on a decision of offering such a guarantee. The contract should be abrogated as a result of the absence of such voluntary offer of guarantee has been made conditional of the contract. The practitioners as is the case in these sukuk should abstain from making such conditional guaranteeing recur, for its recurrence would mean that it has become an established custom, which would have the force of a condition according to the general Shariah rule. Nevertheless there is no harm in such guarantees being offered as a pure gift or donation meaning that they are voluntarily done. Shariah also further ordains that such guarantees alongside being done volun-

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Case Study

OXBRIDGE HEIGHT SDN BERHAD MURABAHA MUNIF/IMTN SUKUK FACILITY. Issuer: Oxbridge Height Sdn Bhd-OHSB Lead Arrangers: Amanah Short Deposits Berhad (“ASD”) Trustee: AmTrustee Berhad Incorporated in September 2003 with principal activities of property development, based in Malaysia Oxbridge was permitted by the SC to raise funds up to RM154million through MUNIF issuance based on ‘Murabaha’ in April 2005 with tenure of 7 years. This deal is even more interesting because it not only involves the application of ‘Bai al-Inah’ it also includes the process of ‘Hibah’ and ‘re-Hibah’ of the underlying assets involved in the issuance which on the first occasion are owned beneficially before being used in hibah and re-hibah of it. First Trade wind Sdn Bhd will make Oxbridge either the beneficial owner of the assets or will hibah-gift the underlying assets which in this case are pieces of lands to the issuer Oxbridge Sdn Bhd to be used for the whole facility. In this case the assets are gifted to the issuer. The investor(s) shall then purchase the Assets from the Issuer (APAs). The investor(s) shall thereafter sell back the Assets to the Issuer (OHSB) at a Selling Price (ASAs) comprising the original Purchase Price and an agreed profit margin on a deferred payment basis. The obligation of the Issuer (OHSB) to pay the Selling Price shall be evidenced through the issuance of the negotiable and non-profit bearing promissory notes (“MUNIF Notes” or IMTNs”). The Issuer (OHSB) shall give back the Assets to the said Beneficial Land Owner base on the concept of “Hibah” once the sale and purchase transactions are executed-i.e. the process of re-hibah. See figure 6.9. 1. 3rd party (Trade Wind) will first ‘hibah’ the underlying assets to be used for this deal to Oxbridge. 2. The Issuer (Oxbridge) will sell these assets to the investors at a purchase price through Asset Purchase Agreements (APAs). The payment will be made to the issuer on spot. 3. The Investors will then sell back the same assets straight away to the issuer but at a higher price including a profit margin through asset sale agreements based on ‘Bai al-Inah’. 4. The issuer (Oxbridge) will issue sukuk (MUNIF/IMTNs) to evidence his obligation to pay the sale price. 5. Once the Sukuk has grown to Maturity The Very underlying assets will then be given back to the 3rd party (which by the way is not the real owner but the beneficial owner of the assets) through the process of ‘re-hibah’ • TW (Beneficial owner) hibah asset to issuer

Third party

1. Issuer hibah bank to TW (Beneficial owner)

Issuer (OXBRIDGE)

2. Investors Purchase asset at Purchase Price (APAs)

3. Payment of proceed

4. Issue MUNIF/ 4. Sell asset at IMTNs to evidence Sale Price, deferred (ASAs) obligation to pay sale price.

INVESTORS Figure.6.9: Oxbridge Height Sdn Berhad Murabaha MUNIF/IMTN 2011 August Global Islamic Finance

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tarily should be done by third party, a party who is completely independent to the other concerned parties, meaning this third party should not be a party having an interest or stake in the deal in anyway. However in the sukuk that we have studied the third party i.e. the guaranteeing party envisaged have most likely been an interested party somehow or the other. Such party is no longer considered a third party any longer and thus would not serve as a legally acceptable donor of the guarantee in the eyes of Shariah. Not only this, they also seek certain amount of fee (Ujrah) for their guarantee. Ujrah refers to rental or fees for usage of labour and benefits. In the current economic context, it may be applied to salaries, wages, fees, commission and the like. The majority of past Islamic jurists were of the view that the charging of fees on kafalah is not permissible. This view is based on the argument that a kafalah contract falls under `uqud tabarru`at which is voluntary and benevolent in nature. Hence, no fee is to be charged. Wahbah AlZuhaili was of the view that to charge ujrah on kafalah is permissible based on maslahah and society’s needs. Syeikh Ahmad Ali Abdullah was of the view that when there is a condition that the kafalah bears a fee, the said condition is considered valid. He also emphasised that kafalah contract is not qardh. He supported his views with qiyas, referring to fees that are permissible to be collected on utilising someone’s reputation and also on performing incantation using Quranic verses. Some of the past Islamic jurists allowed both situations and can be used as fees on the guarantee since it is similar from the aspect of work done. The OIC Fiqh Academy and

the Shariah Council AAOIFI resolved that ujrah on kafalah/dhaman is not permissible. However, the guarantor may claim for actual expenses incurred on the guarantee. 4. The issue of whether the proceeds, which has been raised from the sukuk issuance, have been used in a Shariah complaint or a Shariah contradictory way. In the case study of TESCO MALAYSIA MURABAHA NOTES (as published in Part one of the Article), it is evident from its term sheets that a significant portion of the proceeds raised from the issuance has been used to refinance existing external debt (up to RM410 million). Another example of such a case is in the murabaha sukuk deal of Bumiputra-Commerce Holdings Berhad (BCHB) where again a part of the proceeds raised were used to settle the already existing borrowings of the issuer. The question is how valid is it to raise another debt to settle the previously existing one? Were the investors aware of such usage of proceeds beforehand? Is it not a financial artifice to raise fund to settle pervious debt by not letting the investors know? It seems a clear case of legal stratagem to raise money in a so called Shariah complaint manner which it seems not to be. The sukuk issued by the International Finance Center and the World Bank based on BBA deal also rings the bell with such issue, where the proceeds raised from BaIDS were just used for general operations of International Finance Corporation (IFC). The challenge to Shariah is that IFC and neither the World Bank has an Islamic portfolio, so for which general operations were the proceeds applied? The point to stress here is that not only raising the proceeds should

be Shariah compliant but also the end use of them in the same manner is what completes the circle for a true Shariah complaint product. The above examples miss not one but both the points substantiating a clear effort of “Them molding Shariah accordingly rather than the other way round”. 5. One of the more contentious topics in the market today is the rights of sukuk holders in the event of non-payment or default. Do they have a claim on the underlying assets in the sukuk formation? Where do they stand in the line-up of creditors, given the general belief that sukuk are the more secured investments compared to their conventional counterparts. Given the Shariah emphasis that financing should be raised with respect to an economic activity, all sukuk shares a common feature in that they often take shape with an asset (or assets) at their core. Where there has been a real (true) transfer of asset ownership to a special-purpose vehicle (SPV) that has been formed to issue the sukuk, then the investors would have a legitimate claim on that particular asset that has been sold to them, but not so without a true sale (i.e. assets have not been transferred to the sukuk holders), and if the asset is present simply for the purpose of Shariah compliance, we believe that the legal recourse and cure for the sukuk holders are likely to be no more than those of unsecured creditors. Even from the rating perspective, an analysis of the asset will be inconsequential; instead, we will focus on the creditworthiness of the corporate obligor, with the final assigned rating depending on the ranking of the sukuk vis-a-vis the obligor’s existing senior unsecured obligations.

Primary/Common Shariah Issues

Secondary/Specific Shariah Issues

Issues

Description

Issues

Bai al-Dayn

This issue arises from trading of SPV the sukuk at discount. Secondly, This may also include the issue of Hibah and re-hibah clauses type of asset used for securitisation whereby the assets securitized are financial receivables (debt). Proceed payment

Analysis on the legal position of the SPV from Shariah perspective, independence of SPV from the originator.

Sale and buy back arrangement Collateral and guarantee between the same parties on the same asset, one with cash price Usage of the proceed which is lower and another with deferred higher price. Investors made profit on the difference between Event of Default Clauses the two prices

Credit enhancement for the sukuk whether in Shariah compliant manner, guarantee of third party with fees.

Bai al-Inah

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Description

Hibah clause from a third party as a legal device to enable the sale and subsequently re-hibah to return to the original position Flow of the fund and the stages of the Shariah contracts. The issue of which contract performed first. The APAs or ASAs the whole transaction is simultaneous.

Usage of the proceed whether for Shariah compliant purposes? What constitute the event of default clause, whether the conditions imposed contrary to the sale contract and compliant with the Shariah requirement, effect of the event of default on the sale contract.


Sukuk Asset ownership, in this instance, would strengthen the investors’ rights on the underlying asset(s) in the event of default or liquidation. However, in the Malaysian Sale/Debt based sukuk the issuer customarily declares a trust over the assets in favor of the sukuk holders, with the latter having beneficial ownership of the underlying asset(s). Legal ownership, however, remains with the original asset owner as has been made clear earlier. The intent of the issuer in this instance is to have an unsecured funding source. However, the event of default clauses in nearly all the sukuk deals studied add further to the gravity of the controversy when/where it clearly also states that if the issuer even defaults on any other of his obligation which may have no direct or indirect link to the concerned deal will also render the issuer as similar to defaulting in the sukuk deal. The exact wordings of the clauses in a condensed form are as follows: •

• •

Any indebtedness of the Issuer becomes (after the expiration of any applicable grace period) due or is declared due before its stated maturity as a result of default or is not paid on its due date; Any guarantee or similar obligation of the Issuer is not discharged at maturity or when called; Any security for such indebtedness becomes enforceable.

The legal documentation governing the transaction firmly renders the sukuk a financial obligation, listing the sukuk holders as creditors (as opposed to owners or equity holders) and ranking them pari passu with conventional creditors (within the same class of creditors). No wonder the investors are provided with even a “Recourse Clause” in the deal where the investors are provided a full recourse and in some deals partial if the issuer defaults as per the above ‘Events of Default’ clauses. The Table 6.2 depicts in a summarised form all the Primary and Secondary Issues that our study has raised after researching through more than 300 of such sukuk deals. By understanding the origins of the practices that give birth to Shariah issues involving sukuk, the nature of Islamic bonds issued in Malaysia can be very transparently understood and its heavy structuring also becomes understandable. All of the great criticism that Malaysia bore due to its strict structure involving sale/debt based sukuk has been vain and it has been able to prove the criticism wrong by becoming a leader in the global islamic finance sector, which in its effect shows that sukuk in itself is not questionable, it is how it is structured and practiced is what makes it abiding by the Islamic law. gif

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References and Further Reading • • • •

• • •

• •

• • • • • • • •

• • • • • • • • • • •

• • • • • •

Wahbah Al-Zuhaili, Al-Fiqh al-Islami wa Adillatuhu, Dar al-Fikr, Damascus, 1989, vol. 4, p. 432. Usmani, Taqi. What Shariah Experts Say about Bai al-Dayn, Dealings in Shares. International journal of Islamic financial Services, Vol. 1, No2. Securities Commission Malaysia, Resolutions of the Securities Commission Shari’ah Advisory Council, (Kuala Lumpur, 2nd edition, 2007) p. 16. Al-Nawawi, Yahya Ibn Sharaf, Rawdat al-Talibin wa ‘Amdat al-Muftin, (Beirut: al-Makhtab al-Islami, 1985) vol. 3, p. 514; Ibn Taymiyyah, Majmuwatu Fatwa, vol. 29, p. 506; Ibn al-Qayyam, Mohammad Bin Abi Bakr, I’lamu al-Muqiw’in an Rabb al-’Alamin, (Cairo: Daru al-Hadith, 1st edition, 1993) vol. 4, p. 5. Amin, Hanudin, “An Analysis Of The Classical And Contemporary Juristic Opinions On Bay Al- Dayn”, Labuan e-Journal of Muamalat and Society, Vol. 1, 2007, pp. 29-40. Al-Nawawi, Rawdat al-Talibin wa ‘Amdat al-Muftin, vol. 3, p. 516; Al-Hattab, Mohammad Bin Abdu al-Rahman, Mawahib al-Jalil Sharh Mukhtasar al-Khalil, (Beirut: Daru al-Fikr, 1978) vol. 4, p. 368. See: Al-Hattab, Mohammad Bin Abdu al-Rahman, Mawahib al-Jalil Sharh Mukhtasar alKhalil, (Beirut: Daru al-Fikr, 1978) vol. 4, p. 368; Translated version of these conditions are adopted from: Securities Commission Malaysia, Resolutions of the Securities Commission Shari’ah Advisory Council, (Kuala Lumpur, 2nd edition, 2007) p. 17-18. These conditions are adopted from: Amin, Hanudin, “An Analysis of The Classical and Contemporary Juristic Opinions on Bay Al- Dayn”, Labuan e-Journal of Muamalat and Society, Vol. 1, 2007, pp. 29-40. Al-Sharkhasi, Samsuddin, al-Mabsut, (Beirut: Dar al-Marifah, 1986) vol. 5, p. 141; alKasani, Badawe’ wa al-Sanawe’ fi Tartib al-Sarawe’, vol. 5, p. 148; al-Suyuti, Zalalu al-Din Abdu al-Rahman, al-Ashbah wa al-Nazair, (Beirut: Dar al-Kutub al-I’lmiyyah, 1983) p. 331; Al-Sharbini, Mohammad al-Khatib, Mughni al-Mahtaj, (Beirut: Daru al-Fikr, without date) vol. 2, p. 466-467; Ibn Hajm, al-Muhalla, vol. 9, p. 6. Al-Sharkhasi, al-Mabsut, vol. 12, p. 71. Koutoub Mustafa, The sale of Debt as Implemented by the Islamic Financial Institutions in Malaysia, p. 49. Sunan al-Tirmidi, Hadith no. 1153. Sunan Ibn Majah, Hadith no. 2178. Sunan al-Tirmidi, Hadith no. 115 Securities Commission Malaysia, Resolutions of the Securities Commission Shari’ah Advisory Council, (Kuala Lumpur, 2nd edition, 2007) p. 19.Ibid. Engku Rabiah Adawiah Engku Ali, Issues in Islamic Debt Securitisation, in Mohd Daud Bakar and Engku Rabiah, Essential Readings in Islamic Finance, Kuala Lumpur: Cert Publication Sdn Bhd, 2008, pp 482-484 Ibnu `Abidin, Hasyiah Rad al-Mukhtar, Dar al-Fikr, Beirut, 1992, vol. 5, pp. 273, 325. Al-Syaukani, Nail al-Authar, Dar al-Fikr, Beirut, 1994, vol. 5, p. 294. Al-San’ani, Subul alSalam, Dar al-Kitab al-Arabi, Beirut, 1987, vol. 3, pp. 76–77. Yusuf al-Qaradhawi, Bai` alMurabahah li al-Amir bi al-Syira’, Maktabah Wahbah, Cairo, 1987, p. 64. Al-Zuhaili, Al-Fiqh al-Islami, vol. 4, pp. 466–467. Ibnu `Abidin, Hasyiah Rad al-Mukhtar, vol. 5, pp. 273 & 325. Al-Syaukani, Nail al-Authar, vol. 5, p. 294. Al-San’ani, Subul al-Salam, vol. 3, pp. 76–77. Yusuf al-Qaradhawi, Bai` al-Murabahah, p. 64. Al-Zuhaili,Al-Fiqh al-Islami, vol. 4, pp. 466–467. The Hanafi, Maliki and Hanbali Mazhab. Narrated by Darulqutni and Baihaqy Ibn Qayyim al-Jawziyya-Iclam al-muwaqqicin, vol. 3, pp 98-99; and see for example the saying of the Prophet (saw) “deeds are judged according to intentions and every human being will have to take responsibility for what he intended” Sahih al-Bukhari. Ibnu `Abidin, Hasyiah Rad al-Mukhtar, vol. 5, pp. 273 & 325. Al-Shaukani, Nailul Authar, vol. 5, p. 294. Al-San’ani, Subul al-Salam, vol. 3, pp. 76–77. Yusuf al-Qaradhawi, Bai` al-Murabahah, p. 64. Al-Zuhaili, Al-San`ani, Subul al-Salam, vol. 3, pp. 76–77, see also Al-Fiqh al-Islami, vol. 4, pp. 466– 467. Ighatha al-Lahfan, vol. 1, p.352. Al-Qaradawi, Islam and Current Issues pp. 40-42 OIC, Majallah Majma` al-Fiqh al-Islami, no. 4, vol. 3, p. 1980). However, the OIC Fiqh Academy, disagrees with the basis of third-party guarantees that are based on debt and resolved that third-party guarantees have to be in the form of tabarru`. Otherwise, the contract is deemed to be an interest-bearing debt which is not permissible. Securities Commission, Guidelines on the Offering of Islamic Securities. Al-Hattab, Mawahib al-Jalil, Beirut, Dar al-Fikr, 1992, vol. 5, pp. 111, 113. Al-Zuhaili, Al-Fiqh al-Islami, vol. 5, p. 161. OIC, Majallah Majma` al-Fiqh al-Islami, Jeddah, 1986, no. 2, vol. 2, pp. 1146–1147. OIC, Majallah Majma` al-Fiqh al-Islami, no. 2, vol. 2, pp. 1134–1135. OIC, Majallah Majma` al-Fiqh al-Islami, no. 2, vol. 2, pp. 1209–1210. AAOIFI, Al-Ma’ayir al-Syar’iyyah,

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Market Review

OMAN TO ADD A STAGGERING $6 BILLION WORTH OF ISLAMIC FINANCIAL ASSETS Source: GlobalIslamicFinanceMagazine.com

The Islamic banking window operation is accepted as a successful model and in many markets such as Saudi Arabia, where Islamic windows account for nearly half of the Shariah assets, and UAE where they have an 11 per cent share. Given the similarities in the demographic landscape and appetite for these services, we see great potential in the Omani market for Islamic offerings

It has been reported that Oman is to add a staggering $6 Billion worth of assets for the development over the next few years, according to estimates by Ernst & Young’s Islamic Financial Services Group (IFSG). Total banking assets in Oman in 2010 were estimated to be $42 billion. Shari’ah-compliant financial institutions, which are expected to commence operation in the country within a short period, are expected to capture a substantial share of this market and of total banking assets within a few years. Speaking at Ernst & Young’s Islamic Banking session at the Muscat Holiday Hotel, Ashar Nazim, Executive Director and Head of Islamic Financial Services, Ernst & Young Mena said “The Islamic banking opportunity could be substantial as we expect the industry to reflect its performance in other GCC markets. 72 Global Islamic Finance

August 2011

As an indication of how Islamic banking would evolve in Oman, we can look at the neighbouring UAE market, where it has captured a significant share in a short period of time. New Islamic banks and Islamic banking windows in banks are set to capture a significant share of the market over the coming months.” Global Shari’ah-compliant assets are estimated to have crossed $1 trillion in 2010, growing at a sustainable 15-30 per cent per annum. He added “Given the size of the local market, early movers are set to create a strong advantage in both Islamic banking and takaful. The next 18 months could materially change the competitive landscape in favour of Islamic windows and banks.” The Central Bank of Oman has permitted conventional banks to operate their Islamic banking business through a ‘window’ operation. As a result, the market could see a number of conventional banks entering the Islamic finance space in the next couple of years. Ahmed el Esry, Senior Director, Tax, Ernst & Young Oman, said “The Islamic banking window operation is accepted as a successful model and in many markets such as Saudi Arabia, where Islamic windows account for nearly half of the Shariah assets, and UAE where they have an 11 per cent share. Given the similarities in

the demographic landscape and appetite for these services, we see great potential in the Omani market for Islamic offerings. Successful Islamic windows understand the various Shari’ah implications on the banking business and are able to apply its requirements in their strategy, operations, product, and governance and risk management functions.” The concept of Islamic banking window requires the conventional financial institution to have a distinct operational infrastructure for its Islamic business. Compliance is monitored by the regulator as well as the Shari’ah authorities and further strengthened through independent Shari’ah audits conducted by professional firms. Oman is expected to benefit from the most notable development in the Islamic finance market in 2010 — the growth of the Sukuk market. Sukuks are the Shari’ah-compliant form of conventional bonds and have a growing acceptability in international markets. Omani Sukuk instruments could be used for financing infrastructure projects and stimulating corporate activity, which would add to the growth of Oman’s buoyant economy. gif


Business News

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Market Review

ISLAMIC COUNTRIES URGED TO ADOPT ECONOMIC FINANCIAL REFORMS Source: GlobalIslamicFinanceMagazine.com

Al-Assaf called for greater efforts for manpower development and achieving sustainable economic progress in the member countries. The minister’s call is significant in the backdrop of anti-government protests in some Arab countries as a result of unemployment, poverty and political corruption. Saudi Arabia is the largest contributor to the IDB, holding 25 percent of its capital. “We have also contributed immensely to the capital of other regional and international development organisations. Moreover, we have been at the forefront of donors providing emergency assistance to countries hit by natural calamities,” the minister said. Referring to IDB’s annual report, Al-Assaf highlighted the assistance offered by the bank to member countries to help them overcome the global economic crisis. The minister welcomed a joint IDB-World Bank initiative to finance infrastructure projects. He supported the program proposed by IDB President Ahmed Mohamed Ali to transform the bank into a source of knowledge and efficiency to mobilise resources. The opening session at Jeddah Hilton was attended by more than 1,000 delegates including ministers, businessmen, bankers and economists. Abdul Karim Al-Arhabi, 74 Global Islamic Finance

August 2011

Saudi Arabia’s finance minister has reportedly urged Muslim countries to adopt suitable economic reform programs and adapt to the changing global financial economic changes to confront the challenges of facing them and building solutions. “We should also strengthen our joint efforts to overcome development obstacles,” Finance Minister Ibrahim Al Assaf told the annual conference of the Jeddah-based Islamic Development Bank.

O u r confused world is in dire need for financial, economic and social systems that are more balanced and more responsive to man’s material, moral and spiritual requirements

Yemeni deputy prime minister for economic affairs and minister of planning and international cooperation, presided over the meeting. IDB Chief Ali said Muslim countries were incurring heavy losses due to lack of cooperation among them. “If we take Maghreb Union as an example, the figures are really frightening. Some studies indicate that the stagnating level of economic cooperation among these countries cost them 2 percent of their annual growth and lowered their GDP by 5 percent. It is indeed surprising that trade among the countries of this group constitutes less than 2 percent,” he explained. The president also spelled out IDB’s plans and initiatives for the next four years. “We would like to improve the economic development facilities offered by the bank and stimulate the Islamic Solidarity Fund,” he said and urged more cooperation among

member countries in the fields of knowledge economy and trade. “Who will lead the world in the 21st century is the question raised by Arab youth,” Ali said, and urged Muslim countries to play a leading role on the world stage. He said the global financial crisis proved the relevance of Islamic banking and finance. “Our confused world is in dire need for financial, economic and social systems that are more balanced and more responsive to man’s material, moral and spiritual requirements.” Ali said the renaissance of the Ummah sought by the youth was not different from the IDB’s Vision 2020. “Ours is a vision for human dignity and is inspired by the resolutions of the emergency Islamic summit in Makkah in 2005. The IDB has taken strategic initiatives aimed at combating poverty and unemployment,” he said referring to the Solidarity Fund. The IDB chief pinpointed some of the major shortcomings, calling for urgent remedial action. The development models in member countries are based on outdated systems; the role of the Zakat and Awkaf has become ineffective in containing economic upheavals; there is a lack of strategic orientation toward knowledge economy; and debt-based products outweigh financing tools and investments in the real economy, he said. Ali said the IDB had signed an agreement with the UNDP to establish an effective mechanism for monitoring and taking preventive action in times of crises and disasters in favour of the citizens of member countries. The IDB has signed a memorandum of understanding with Jeffrey Sachs, head of the Earth Institute at Columbia University, with the objective of benefiting from its millennium village experience. gif


Market Review

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ISLAMIC FINANCE TRADE SECTOR EXPANDS IN ASIA AND MIDDLE EAST Source: GlobalIslamicFinanceMagazine.com

Total trade finance among the 57 members of the Organisation of the Islamic Conference, which includes Saudi Arabia, Malaysia and Turkey, is expected to reach $4 trillion by 2012, said Mohamad Nedal Alchaar, secretary general of the Accounting & Auditing Organization for Islamic Financial Institutions (AAOIFI). “(Islamic finance) could tap 20 per cent of the total trading financing, that’s very reasonable,” Alchaar said, adding that while the current Islamic trade finance market remains fragmented and non-competitive, there has been a shift towards pushing trade finance among Islamic practitioners. Part of the increased interest in Islamic trade finance is that the Islamic finance industry, which prohibits interest, has matured and can provide complicated instruments, such as Shariah-compliant hedging products to protect trade transactions, said Yakub Bobat, global head of HSBC Amanah commercial banking. “If you don’t have access to Islamic hedging, there will be a currency conversion impact. In the absence of

ment Bank. “There is a very compelling reason to promote this product given that the returns of trade financing can be very attractive, much more than real estate financing, for example,” he said. “Providers of this product have not been as aggressive in promoting it.” But with increasing cross-border trade among Asian and Middle Eastern countries, deBut with mand for more Shariah compliant financing from Muslims is still exincreasing pected to increase. Asia to Middle cross-border trade among East trade flows more than douAsian and Middle Eastern counbled between 2005 and 2008, according to the World Trade tries, demand for more Shariah Organization. “If I compare three compliant financing from Muslims years back, volumes have gone is still expected to increase. Asia up overall in the Islamic trade finance market,” said Ghazanfar to Middle East trade flows more Naqvi, managing director, Islamic than doubled between 2005 origination and client coverage at and 2008, according to the Standard Chartered Saadiq. “It’s a function of more awareness and World Trade Organimore offerings. Today we are seezation ing customer preference changing and trade finance is a key component of growth in Islamic finance.” Naqvi said it was difficult to pin those solutions, people go for conventional,” down tangible global figures for Islamic trade Bobat said. “But the proposition is now com- finance as the majority of deals are not pubplete and you can now use Islamic hedges lic transactions. for trade transactions.” Bobat said such innovations in the industry will help persuade The International Islamic Trade Finance people inclined toward Shariah-compliant Corp. (ITFC), an independent entity within business to opt for Islamic trade finance the Islamic Development Bank, said in its over conventional forms. In Islamic trade fi- annual report that it approved $2.17 billion nance, a bank will provide a letter of credit, in Islamic trade finance transactions at the guaranteeing import payments using its own end of 2009. That grew to around $2.55 bilfunds, for a client based on sharing the profit lion in 2010, with a majority of transactions from the sale of the item. But some banks taking place in OIC member nations. HSBC are still wary of providing Islamic trade fi- Amanah’s Bobat said Islamic trade finance nance services, citing it as more costly and will be a significant contributor to growth in time consuming. In addition, some see lit- Islamic finance but the industry will have to tle difference between conventional and look beyond asset finance. “The industry toIslamic trade finance as both are fee-based day is pretty much focused on asset finance products, resulting in lower demand for the and it needs to have the ability to capitalise Islamic product. Changing that view will be on trade,” he said. “(Islamic trade finance) key for the industry, said Shabir Randeree, should be as much bread and butter busichairman of the European Islamic Invest- ness as it is for conventional trade flows.” gif

Islamic trade finance has grown progressively towards Shariahcompliant banking and could serve as one of the key growth drivers to aid the $1 trillion Islamic finance industry in its growing global expansion. The global Islamic finance industry, which has been growing between 15 to 20 per cent a year is widely expected to reach $2 trillion in the next three to five years. While Islamic banking and Islamic bonds, or sukuk, are expected to lead growth, bankers say Islamic trade finance could serve as the dark horse emerging to propel the industry further. Trade finance, the lifeblood of global commerce, underpins 60-80 per cent of the $12-13 trillion trade in global merchandise and practitioners say it is safer than other forms of lending.

2011 August Global Islamic Finance

75


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Event Review

IFN Europe Forum opens its doors to investors and issuers

Author: Tajah Brown, Global Islamic Finance Magazine Editorial Team, United Kingdom

The growing Muslim population, financial regulations and infrastructure within Europe contributes to boost the growth of Islamic finance in the region. The IFN Europe forum hosted by Islamic Finance News (IFN) located at One Bishop Square, London took place on the 7th and 8th of July 2011. The purpose of the event was to generate fresh ideas, views and solid plans to take advantage of Islamic finance opportunities within the region.

The Investors day took place on the 8th of July and covered a range of topics such as takaful and re-takaful in the developing Islamic finance industry and crucial issues for investors in the UK and European Islamic financial markets. The day also included a presentation from Rafael Dalmau, global head of Shariah compliant management from BNP Paribas covering the topic of ‘Sukuk as part of a global portfolio allocation strategy’

The event endorsed by the London There are already major financial centStock Exchange, UKIFS/TheCityUK Global takaful contributions rose to USD 3.4 ers in regions such as Luxembourg also included a range of sponsors billion in 2007, compared with USD 2.5 billion and London which have a collection of such as Allen & Overy, BLME, Busi51 Shariah-compliant funds adding to in 2006. This shows the success in the Takaful ness Bermuda, CIMA, CIMB Islamic, US$500 million in assets and 16 listed industry, the contributions have currently surpassed the Gatehouse Bank, IFAAS, Trasset and Sukuk issuances totalling to US$5.5 bil$10 billion mark and have been predicted to go beyond Vinson & Elkins. It is only a matter lion. There is also proof that there has $12 billion by the end of the year of time before Europe becomes a been an increase in the market interest significant player within the Islamic and participation in these sectors and financial industry, with the growing countries such as France and Ireland Muslim population and boost in cross-boardhave been seeking changes in their regulatoIslamic, Neil D Miller global head of Islamic er trade and investments with the Middle ry system in order to integrate Islamic finance finance from KPMG and other major players East. European countries can offer a variinto the economy. The Chartered Institute of within the industry. The Issuers day ended ety of strengths such as regulation, expertise Management Accountants (CIMA) the world’s with the Shariah Scholar’s roundtable includand knowledge. The IFN Europe Forum covlargest professional body of management acing Dr Humayon Dar, Chief Executive Officer ered a wide range of topics for issuers and countants used the IFN Europe Forum as a from BMB Islamic, Mufti Abdul Kadir Barkatinvestors. The Issuers day commenced on the platform to launch its certificate, diploma and ulla, Shariah Advisor from Islamic Bank of 7th of July and gave influential people in the advanced diploma in Islamic Finance. The Britain, Sheikh Bilal Khan, Executive Director industry a chance to express their views. The purpose of their launch was to expand the Isand Shariah Scholar from Islamic Finance first panel of speakers spoke about Islamic lamic Finance qualifications market in order Education Council and Sheikh Muddassir Sidfinance and capital market developments in to increase human capital and improve the diqui, Partner and Shariah scholar from SNR Europe, the panel included Badlisyah Abdul talent pool. Denton & Co. Ghani, Chief Executive Officer from CIMB


Event Review

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takaful providers to utilise retakaful capacity as a first option, takaful provision for long term care needs and Shariah issues in the Mudharabah, Wakalah and Waqf modes in Takaful. Datuk Noripah Kamso, CEO from CIMB-Principal Islamic Asset Management gave her views on an asset manager’s take on optimising investment returns from contribution pools she says “today, Islamic investment product has shown evidence that it is resilient”. Global takaful contributions rose to USD 3.4 billion in 2007, compared with USD 2.5 billion in 2006. This shows the success in the Takaful industry, the contributions have currently surpassed the $10 billion mark and have been predicted to go beyond $12 billion by the end of the year.

The International Takaful Summit fills the gap between takaful and insurance industries Author: Tajah Brown, Global Islamic Finance Magazine Editorial Team, United Kingdom

The International Takaful Summit 2011 commenced on the 12th and 13th of July located at Jumeirah Carlton Tower, London. The theme ‘mainstreaming and globalising takaful’ gave the panel speakers the opportunity to voice a range of topics such as challenges in making takaful the default option in Muslim countries and capital analysis of takaful companies. Economies around the world are showing signs of stability and growing enthusiasm for the niche and specialist insurance markets. Takaful is predicted to become one of the fastest growing sectors within the insurance industry. The Takaful Summit aimed to discuss issues such as the education and acceptance of the consumer and the lack of experienced human resources. The Summit’s goal was to solve the problems between the takaful and insurance industries. The Summit’s first day included major players within the industry such as Ajmal Bhatty, president and CEO from Tokio Marine Middle East, Dawood Taylor, senior regional executive from Takaful, Middle East, prudential corporation Asia and

Chakib Abouzaid, CEO from Takaful Re Limited. The first speaker at the Summit’s second day Dr Ludwig Stiftl, Head of Center of Competence Retakaful from Munich Reinsurance Company gives his views about the Summit. “There is a message to convey, London is a very focal point and the summit consisted of all the scholars gathering and having dense discussions, sharing fresh ideas and food for thought.” Dr Stiftl gave his presentation about the reflections on long term Qard al Hassan in Takaful/ Retakaful. He says “it doesn’t depend what you put in the fund it depends on the size of the fund”. The companies that sponsored the Summit are Norton Rose, AON Benfield, Dar Al Takaful and Hannover Re. Organiser Mohaned Abdullah is very pleased with the outcome of the Summit saying, “the feedback is fantastic with a collection of international discussions about a sector that is more relevant in Non-Muslim and Muslim countries” He added “Takaful is Shariah compliant but it’s for everyone”. The Summit’s second day covered a range of topics such as getting

Maulana Faizal Manjoo gives his views on the need for longevity Sukuk for takaful-based pension provision. He shares his knowledge saying “an average of 3 months is added to life expectancy each year, there would be a million centenarians worldwide by 2030” he added “people are living longer than data shows”. Media partners also attended the event and took part in the networking opportunities and maintaining business relationships. The companies included Islamic Finance News, Global Islamic Finance Magazine, Islamic Business and Finance and Mena Insurance Review. gif

Islamic Finance Ltd. Islamic Finance Ltd offers a comprehensive range of Islamic finance solutions to help expedite your international business, trade and risk mitigation. Islamic Finance Ltd is committed to providing its business customers with a range of innovative Islamic banking solutions. We do our best to arrange a wide range of financing that you can be certain your finance is structured in full accordance with Shariah requirements.

Visit our website for more information: www. ukislamicfinance.co.uk


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Business News

Book Review Attracting the World of Small and Medium Enterprises for Islamic Banking Part of Article Collection, individual article £4.99/

Attracting the world of enterprises for Islamic banking services discusses the various options available for Small and Medium sized enterprises (SMEs). It also ensures that all business professionals and those SMEs wishing to tap into the market are familiarised with the Shariah compliant principles and various methods of Islamic financing contracts. These contracts range from the successful and popular Ijarah contract through to Istisna, Mudaraba, Musharaka, Salam and many others which will be discussed comprehensively in this article. Global Islamic Finance Magazine aims to establish the various ways SMEs can successfully attract the numerous benefits of Islamic financial options and contracts which provide an ethical alternative to conventional methods of financing.

Order Number: 2011g069

Global Islamic Finance on Increasing Customer Loyalty Part of Article Collection, individual article £4.99 / $7.99

Financial industry might be viewed as one of the most global sectors yet the reality is otherwise. Irrespective of the globally accepted financial product base the industry is highly dependent on a key success factor: Customer relationship management. This intangible success factor is a key differentiating factor for both mainstream and Islamic financial institutions and is highly subject to regional dynamics. The article sheds light on the Islamic Financial Institutions’ (IFI) service offerings and IFI customer expectations.

Islamic Capital Markets

Products and Strategies by Kabir Hassan & Michael Mahlknecht Islamic finance has experienced rapid growth in recent years, showing significant innovation and sophistication, and producing a broad range of investment products which are not limited to the complete replication of conventional fixed-income instruments, derivatives and fund structures. Islamic finance represents an elemental departure from traditional interest-based and speculative practices, relying instead on real economic transactions, such as trade, investment based on profit sharing, and other solidary ways of doing business, and aims to incorporate Islamic principles, such as social justice, ecology and kindness, to create investment products and financial markets which are both ethical and sustainable. Products created according to Islamic principles have shown a low correlation to other market segments and are relatively independent even from market turbulences like the subprime crisis. Therefore, they have become increasingly popular with secular Muslims and non-Muslim investors, as highly useful alternative investments for the diversification of portfolios. In Islamic Capital Markets: Products and Strategies, international experts on Islamic Finance and Sharia’a Law focus on the most imminent issues surrounding the evolution of Islamic capital markets and the development of Sharia’acompliant products. The book is separated into four parts, covering: •

Order Number: 2010g068 •

Islamic Finance 3 Volume Set by Brian Kettell John Wiley & Sons Ltd. /£90.00 Islamic finance is the fastest growing sector within the financial market place, a growth rate which has not been matched by the vast need for educational and training publications. This set is an all in-one learning package for anyone interested in Islamic banking and finance, bringing together the core textbook Introduction to Islamic Banking and Finance, The Islamic Banking and Finance Workbook and Case Studies in Islamic Banking and Finance. The set combines coverage of a wide range of products and issues in Islamic finance with a series of real life case studies which follow the themes in the introductory text, illustrating Islamic concepts and transactions in the real world. The workbook contains questions and answers, chapter summaries and key learning outcomes, enabling readers to test their understanding of the main principles of Islamic banking and finance.

78 Global Islamic Finance

August 2011

General concepts and legal issues, including Rahn concepts in Saudi Arabia, the Sharia’a process in product development and the integration of social responsibility in financial communities; Global Islamic capital market trends, such as the evolution of Takaful products and the past, present and future of Islamic derivatives; National and regional experiences, from the world’s largest Islamic financial market, Malaysia, to Islamic finance in other countries, including Germany, France and the US; Learning from Islamic finance after the global financial crisis; analysis of the risks and strengths of Islamic capital markets compared to the conventional system, financial engineering from an Islamic perspective, Sharia’a-compliant equity investments and Islamic microfinance.

Islamic Capital Markets: Products and Strategies is the complete investors’ guide to Islamic finance. 978-0-470-68957-8 • Hardback • March 2011 • £45.00 / €54.00


Event

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Event Calendar September

October

2nd Fraud & Compliance Forum

2nd Annual Retail Banking Asia Pacific

8th Annual CEE Retail Banking

SME Conference

3rd Annual World Islamic Retail Banking

Petrochem Arabia

Islamic Investment and finance forum

19th-20th September 2011 Doha Qatar Organised by Fleming Gulf

2nd – 5th October 2011 Kuala-Lampur, Malaysia Organised by Fleming Gulf

2nd Abu Dhabi Investments Forum 26th - 27th September 2011 Abu Dhabi Organised by Fleming Gulf

3rd – 4th October 2011-07-18 Abu Dhabi Organised by Fleming Gulf

2nd Annual Investment Opportunities in Abu Dhabi 26th - 27th September 2011 Abu Dhabi United Arab Emirates Organised by Fleming Gulf

9th & 11th October 2011 Dammam, Saudi Arabia

3rd Operational Risk Forum

Quant Invest Middle East 2011 26th - 28th September 2011, Dubai, UAE Organised by Terrainn

10th – 11th October 2011 Dubai Organised by Fleming Gulf

Strengthening the Arab-African Cooperation

11th & 12th October 2011 Budapest Organised by Fleming Europe

18th – 20th October 2011 Dubai Organised by Fleming Europe

24th – 27th October 2011 Istanbul Organised by IIR

Solar Investment Summit – Middle East 2011 26th – 27th October 2011 Abu Dhabi Organised by Datamatrix

10th – 12th October 2011 Abu Dhabi Organised by Fleming Gulf

November

December

7th Operational Excellence in Banking OPEX 2011 November 2011, Dubai Organised by Fleming Gulf

Risk Management in Oil & Gas November 2011, Qatar Organised by Fleming Gulf

Islamic Finance Conference 11th November 2011 Frankfurt, Germany Organised by Maleki Group

Kurdistan – Iraq Oil & Gas 11th – 15th November 2011 Kurdistan Organise by CWC GROUP

18th Annual World Islamic Banking Conference (WIBC 2011) 20th & 22nd November 2011 Republic of Bahrain Organised by MegaEvents

Advanced Well Integrity Management 21st – 23rd November 2011, Qatar Organised by Fleming Gulf

Private Equity World MENA 2011

21th -24th November 2011, Dubai, UAE Organised by Terrainn

Russian Power: Finance and Investment 22nd- 24th November 2011 Moscow Russia Organised by Adam Smith Conference

Russian Banking Forum

22nd November- 1st Dec 2011 Moscow Russia Organised by Adam Smith Conference

8th GCC Financial Markets Listed Companies conference 29th – 30th November 2011 Dubai Organised by Datamatrix

Saudi Water & Power Forum 4th - 6th December 2011-07-18 Jeddah, Saudi Arabia Organised by CWC group

Saudi Infrastructure

11th – 14th December 2011 Jeddah, Saudi Arabia Organised by CWC group

Commodities Week Middle East 5th-7th December 2011 Dubai, UAE Organised by Terrainn

1st Annual Islamic Project Finance & Trade Finance Conference

10th & 11th December 2011 United Arab Emirates Organised by Global Islamic Finance Magazine

For more information and full events details, please visit www.globalislamicfinancemagazine.com/events


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Market Review

Gulf Banks Tackle Challenges to Boost Shariah Investments Source: GlobalIslamicFinanceMagazine.com

Gulf Banks are makThe lack of standardisation has hindered growth executive officer at Asian ing significant efforts to Bank, said in an in the Islamic finance industry, which has around Finance boost Arabian Gulf banks interview. “We’ve been $1tn of assets and is expanding by about 15% a year, ac- discussing with Malaysaying that they are more ready to accept Asian cording to the Kuala Lumpur-based Islamic Financial Serv- sian companies how to Islamic debt as Shariahadvantage of the ices Board. Scholars at the Auditing and Accounting Organ- take compliant, allowing them infrastructure projects isation of Islamic Financial Institutions, a standard-setting in Qatar,” he said on the to invest in a market that has issued twice as much body based in Manama, are making efforts to develop glo- 4th of June. “There’s sukuk as the Middle East abundant liquidity in the bal rules for the industry this year. Institutions from Middle East for these the two regions are workcompanies to tap. Malaying to overcome differsian firms would need to ences over whether Southeast Asian notes structure the sukuk and loans to meet the comply with Islam’s ban on interest, accordShariah standards required by the scholars ing to Albaraka Banking Group, Bahrain’s in that region.” The lack of standardisation biggest publicly traded lender, and Asian Fihas hindered growth in the Islamic finance innance Bank, the Malaysian arm of Qatar Isdustry, which has around $1tn of assets and lamic Bank. Last year, Saudi Arabia’s Al Rais expanding by about 15% a year, according jhi Group helped Cagamas Bhd, Malaysia’s to the Kuala Lumpur-based Islamic Financial largest mortgage holder, structure a sukuk Services Board. Scholars at the Auditing and after Gulf investors balked at debt sold by Accounting Organisation of Islamic Financial the same issuer in 2009. Institutions, a standard-setting body based in Manama, are making efforts to develop The co-operative approach is a change for global rules for the industry. investors from the Gulf who are seeking to diversify their investments amid political upGlobal sales of sukuk reached $7.7bn so heaval in the Middle East. It may also help far this year, from $6.2bn in the same peMalaysia to raise more funds from oil-rich riod in 2010, according to data compiled nations to support a 10-year $444bn de- growth. Both Albaraka and QIB, the Gulf na- by Bloomberg. Offerings reached a record velopment plan announced last year. “Gulf tion’s largest Shariah-compliant lender, said $31bn in 2007. Shariah-compliant bonds investors aren’t allergic to Asian sukuk any- this year they plan to acquire Islamic banks gained 5.4% this year, according to the more,” Malek Khodr Temsah, assistant vice in Indonesia. The “Shariah gap” between HSBC/Nasdaq Dubai US Dollar Sukuk Index. president of treasury and investments at Al- Malaysia and the Middle East has started Debt in developing markets rose 4.4%, JPbaraka, said in an interview from Manama to narrow but there are still significant dif- Morgan Chase & Co’s EMBI Global Diversion the 2nd of June. ferences, Rohit Chawdhry, who helps man- fied Index shows. age $350mn of assets at Bahrain Islamic “Middle East and Asian financial institutions Bank, the country’s second-largest Islamic Dubai Department of Finance’s 6.396% have a better understanding of each other’s lender, said “I’m sure that within the next 6 note due November 2014 widened three baregulatory framework so we are more com- to 12 months the issues will be sorted out,” sis points to 238, data compiled by Bloombfortable with exposure to Asian credits.” he said. “It’s a general recognition from the erg show. “The fundamental Shariah issues Sales of sukuk from Asia have amounted Malaysians that they need to make some aren’t going to change,” Jawad Ali, the Duto $5bn so far this year, more than double compromises if they want to attract Gulf in- bai-based global deputy head of the Islamic the $2.2bn from the Gulf, according to data vestors, but there is also an understanding finance practice at King & Spalding, said on compiled by Bloomberg. that regional investors are starting to warm the 6th of June. Islamic finance fatwas, judgments of scholars based on their interpretaup to the norms in Malaysia.” Malaysia accounts for about 60% of the glotion of Shariah, from Malaysia aren’t generbal Islamic debt market. Issuance of ringgit- Qatar plans to spend $88bn on building ally accepted in the Middle East, he said. denominated Islamic bonds increased 70% roads, hotels and other infrastructure beto 13.9bn ringgit ($4.6bn) this year, the data fore it hosts the soccer world cup in 2022, “Gulf-based Islamic finance institutions show. Malaysia and Indonesia plan to issue QNB assistant general manager Enrico penetrating the Malaysian market will no sovereign global Islamic bonds in 2011. Al- Grino, who oversees project finance, said doubt help bridge the gap between the two baraka’s Temsah said he bought Malaysian on the 16th of May. Malaysian companies Islamic finance centers,” he said. “Whether government sukuk in the fourth quarter of seeking to win contracts in Qatar may need this understanding is going to lead to more last year to diversify his holdings and take to raise funds in the Middle East, Mohamed harmonisation will depend on the particular advantage of Southeast Asia’s economic Azahari Kamil, Kuala Lumpur-based chief product in question.” 80 Global Islamic Finance

August 2011


Glossary Business Directory

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Business Directory Banks European Islamic Investment Bank

Arab Banking Corporation

Bank of London and Middle East

Contact person/ department: Keith McLeod Address: European Office 131 Finsbury Pavement London EC2A 1NT England Telephone: +44 20 78479900 Fax: +44 20 78479901 E-mail: reception@eiib.co.uk Website: www.eiib.co.uk

Contact person/ department: Nadia Mehdid Address: Station House, Station Court, Rawtenstall Rossendale BB4 6AJ, UK Telephone: +44 1706237900 Fax: +44 1706237909 E-mail: nadia.mehdid@arabbanking.com Website: www.arabbanking.co

Contact person/ department: Michelle Arnold Address: Sherborne House 119 Cannon Street London, EC4N 5AT United Kingdom Telephone: +44 20 7618 0000 Fax: +44 20 7618 0001 E-mail: Michelle.Arnold@blme.com Website: www.blme.com

Description: EIIB seeks to service a market for Sharia’a compliant investment banking services in Europe, the Middle East and Asia that it believes has been under-exploited by conventional and Islamic banks, and by non-banking institutions. EIIB intends to become a major participant in the market for Islamic securities, treasury and investment products, which is currently experiencing rapid growth.

Description: Arab Banking Corporation, popularly known as ABC, is an international Universal bank headquartered in Manama, Kingdom of Bahrain. Our network spreads over 21 countries in the MENA and GCC, Europe, the Americas and Asia. ABC is a leading regional bank in Trade Finance & Forfaiting, Treasury, Project & Structured Finance, Syndications, Corporate & Institutional Banking as well as Islamic Banking. We also provide Retail Banking services in the MENA region

Description: Bank of London and The Middle East plc (BLME) is a fully Sharia’a compliant wholesale bank in the heart of the City of London. BLME is managed by a quality team bringing together a combination of highly experienced international financiers and leading experts in Islamic finance. The majority of our Corporate Banking client base is located mainly in the UK, US and Europe.

ABN AMRO Bank N.V.

Dubai Islamic Bank PSJ

Al Baraka Islamic Investment Bank

(ABN AMRO Bank N.V. is an authorised agent of The Royal Bank of Scotland plc.) Contact person: Abbas Yousafzai - Head of Islamic Banking Address: Khalid Bin Waleed Road, PO Box 2567, Dubai, UAE Telephone: +971 4 506 2260 Fax: +971 4 506 2028 E-mail: Abbas.Yousafzai@rbs.com Website: www.rbsbank.ae

Address: P.O.Box 1080 Dubai United Arab Emirates Telephone: + 9714 2953000 Fax: +971 4 295 411 E-mail: contactus@alislami.co.ae Website: www.alislami.ae/en/

Al Baraka Tower , P.O. Box 1882 Manama , Bahrain Telephone: + 973 250 363 Fax: + 973 274 364 E-mail: baraka@batelco.com.bh Website: www.albaraka.com

Description: RBS within its Retail Banking Unit offers its clients competitive Islamic Banking Solutions. They have one of the largest options for Islamic Wealth Management Products and are also a distributor of the Takaful Product developed by Aman (Dubai Islamic Insurance & Re-Insurance Company). They are presently engaged in launching a full Retail Banking proposition with a Shariah Based Credit Card and Liability Accounts in 2010.

Description: Dubai Islamic Bank has the unique distinction of being the world’s first fully-fledged Islamic bank, a pioneering institution that has combined the best of traditional Islamic values with the technology and innovation that characterise the best of modern banking. Since its formation in 1975, Dubai Islamic Bank has established itself as the undisputed leader in its field, setting the standards for others to follow as the trend towards Islamic banking gathers momentum in the Arab world and internationally.

Description: Al Baraka Banking Group offers retail, corporate and investment banking and treasury services strictly in accordance with the principles of the Shari’a. The authorized capital of ABG is US$1.5 billion, while the total equity amounts to about US$1.52 billion. The Group has a wide geographical presence in the form of banking Units and representative offices in twelve countries, which in turn provide their services through 300 branches.

Accountancy firms Abbas Accounting

Baker Tilly MKM

HLB HAMT Chartered Accountants

Address: ABBAS ACCOUNTING P.O.Box : 78142 Dubai, U.A.E Telephone: +971 4 2820300 Fax: +971 4 2820322 E-mail: info@abbasaccounting.com Website: www.abbasaccounting.com

Address: Epico “Safar” Building Liwa Street Abu Dhabi United Arab Emirates Telephone: +97 1506226719 Fax: +971 26226088 E-mail: sumchart@eim.ae Website: www.bakertillymkm.com

Address: 106, Al Nayali Building Abuhail Road, P.O. Box: 32665 Dubai - United Arab Emirates Telephone: +97142627147 Fax: +971 4 2627148 E-mail: dubai@hlbhamt.com Website: www.hlbhamt.com/

Description: sad Abbas & Co is an audit and accounting consultancy firm in Dubai, United Arab Emirates. Services rendered by the firm include statutory, external and internal audit, accounting and financial management consultancy, accounting and finance outsourcing, project evaluation, feasibility studies and allied services. The firm is led by a team of qualified and widely experienced professionals dedicated to practice of the profession in the highest standards and committed to providing the best services to the clients.

Morison Menon

BDO International

Address: 204 Tower- A, Gulf Towers, Oud Metha, P. O. Box 55535, Dubai, UAE Telephone: +971 4 33 66 990 Fax: +971 4 33 66 992 E-mail: dubai@morisonmenon.com Website: www.morisonmenon.com/

Address: BDO - London 55 Baker Street London W1U 7EU Telephone: +44 207 486 5888 Fax: +44 0207 487 3686 E-mail: j.polin@bdo.co.uk Website: www.bdo.uk.com/

Description: Morison Menon Group is a group of firms offering professional advisory services in Financial Audit, Compliance and Accounting, Consulting (Business Plan, Company setup and business incorporation, Financial Consulting, Property Consulting, HR Solutions, BPO, IT and Web Solutions) since the year 1994. Headquartered in Dubai,UAE armed with a license to operate in DIFC, Dubai. The group has offices in Abu Dhabi, Jebel Ali, Sharjah and Ras Al Khaimah apart from overseas operations in Oman, Qatar, Bahrain, Iran and India. Morison Menon currently is a team of over 150 Professionals.

82 Global Islamic Finance

Description: We offer a wide range of service including auditing, accounting, consultancy, financial-management, profit-enhancement, feasibility studies, company-secretarial, offshore-company registration, and trademark-registration. You will receive a prompt response to every question or request. We serve our clients as a partner in order to help them make the best possible decisions for their business.

August 2011

Description: BDO is an award-winning, UK Member Firm of BDO International, the world’s fifth largest accountancy network with more than 1,000 offices in over 100 countries, including affiliates. We specialise in helping businesses, whether start-ups or multinationals, to achieve their goals. Through our own professional expertise and by working directly with organisations, we’ve developed a robust understanding of the factors that govern business growth. Our objective is to use this to help our clients maximise their potential.

Description: We have a full range of accounts and audit services to meet your business needs. A professional firm with regional focus and having global representation, HLB Hamt, Chartered Public Accountants spectrum of services cover all aspects of doing business in the UAE and the GCC countries. While based in the UAE, we offer comprehensive services for doing business in the Middle East including all the Free Trade Zones, right from company formation.

Barber Harrison and Platt Address: 2 Rutland Park Sheffield S10 2PD Telephone: +44 114 266 7171 Fax: +44 114 2669846 E-mail: info@bhp.co.uk Website: www.bhp.co.uk Description: Barber Harrison & Platt is committed to building professional relationships founded on the personal responsibility of a partner for a client’s affairs. As a Top 60 firm and the largest independent firm of chartered accountants in South Yorkshire and Derbyshire our continued success owes much to our dynamic approach and ability to fulfil client demands. This requires the highest level of commitment and performance. Barber Harrison & Platt provide advice to plc’s, private companies, partnerships, sole traders, individuals and trusts. The close working relationship we enjoy with clients provides a deep insight into a far wider range of business situations and problems than are traditionally associated with accountancy.

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Law firms Norton Rose (Middle East) LLP Contact person/department: Neil D. Miller, Partner Address: 4th Floor, Gate Precinct Building 3, Dubai International Financial Centre, Dubai, UAE PO Box 103747 Telephone: +971 (0)4 369 6300 Fax: +971 (0)4 369 6350 Email: neil.d.miller@nortonrose.com Website: www.nortonrose.com Description: We offer a full business law service and work in teams that cut across national and jurisdictional boundaries. In everything we work on, we provide expert advice, innovation and a commercial outlook. Our practice areas cover banking and Islamic finance, construction, corporate finance, dispute resolution, PPP, project finance, real estate

Allen & Overy Contact person/ department: Michael Duncan Address: Bishops Square Allen & Overy LLP One Bishops Square London E1 6AD United Kingdom Telephone: +44 20 3088 4197 E-mail: michael.duncan@allenovery.com Website: www.allenovery.com Description: Allen & Overy is one of a small group of truly international and integrated law firms with approximately 5,000 staff, including over 450 partners, working in 31 major centres worldwide. Allen & Overy also operates in regions where we do not have an office via our network of International Desks.

Lawrence Graham LLP (LG) Contact person/ department: James Foster, head of LG’s Dubai office Address: PO Box 33090 8th Floor Convention Tower Zabeel Road Dubai, UAE Telephone: +971 4 329 2420 Fax: +971 4 329 2430 E-mail: dubaioffice@lg-legal.com Website: www.lg-legal.com Description: LG is a firm of business lawyers, advising clients around the world. The opening of the firm’s Dubai office at the end of 2007 and the Moscow office earlier this year cemented its global growth and focus on clients internationally.

King and Spalding

Clifford Chance Contact person/ department: Anna Ward Address: 10 Upper Bank Street Canary Wharf London E14 5JJ Telephone: +44 20 7006 1000 E-mail: info@cliffordchance.com Website: www.cliffordchance.com Description: Clifford Chance is one of the world’s leading law firms, helping clients achieve their goals by combining the highest global standards with local expertise. The firm has unrivalled scale and depth of legal resources across the three key markets of the Americas, Asia and Europe and focuses on the core areas of commercial activity. Clifford Chance lawyers advise internationally and domestically.

Trowers & Hamlins

Contact person/ department: Jawad l Ali Address: 125 Old Broad Street London EN EC2N 1AR Telephone: +44 2075517500 Fax: +44 2075517575 E-mail: jali@kslaw.com Website: www.kslaw.com

Contact person/ department: Nicholas Edmondes Address: Sceptre Court 40 Tower Hill London EC3N 4DX Telephone: +44 20 7423 8000 Fax: +44 20 7423 8000 E-mail: nedmondes@trowers.com Website: www.trowers.com

Description: King & Spalding has provided the highest quality legal services to its clients for over a century. Today, with more than 800 lawyers and offices in Abu Dhabi, Atlanta, Austin, Charlotte, Dubai, Frankfurt, Houston, London, New York, Paris, Riyadh (affiliated office), San Francisco, Silicon Valley and Washington, D.C.

Description: We believe lawyers exist to serve their clients - not vice versa. We also believe that every task we undertake on your behalf is unique.We expect to be judged on results, on the added value we provide, the quality of our service, and our cost-effectiveness. These attributes have led to us being voted Law Firm of the Year 2007 by the Lawyer.

Advisory and Consultancy firms AR Business Consultants Chartered Certified Accountants Tel: + 44 (0) 208 776 9500 Fax: + 44(0) 208 778 8966 Regent House Business Centre Suite No: 209 291 Kirkdale London SE26 4QD U.K. Web: www.arconsultants.co.uk Description: Saving tax & building business. We providing a personalised service to business owners and individuals. For help with any of your accountancy and tax needs, please give us a call. All initial consultations are free of charge.

Dubai International Financial Centre (DIFC) Address: The Gate, Level 14 P.O. Box 74777, Dubai, UAE Telephone: +971 4 362 2222 Fax: +971 4 362 2333 E-mail: info@difc.ae Website: www.difc.ae Description: DIFC Authority establishes and develops a suitable Quality Management System that is the foundation of the ‚Service Excellence’ strategic theme, focusing on DIFC’s journey towards achieving its vision ‚To shape tomorrow’s financial map as a global gateway for capital and investment.DIFC Authority is committed to meeting and exceeding customer’s expectations in providing consistent and competitive high quality services, through continuously improving the effectiveness of the Quality Managements System as per ISO 9001. This is carried out in compliance with DIFC Law and applicable statutory and regulatory requirements.

Chahine Capital Group Contact person/ department: Andrew Pell Address: 43, Avenue Monterey Luxembourg, L-2163 Telephone: +44 20 7 1270001 +352 260 955 Fax: +44 20 7127 4611 E-mail: Andrew.pell@chahinecapital.com Website: www.chahinecapital.com Description: Specialists in quantitative equity investment strategies. Digital Stars Europe (Bloomberg: BILDSCELX) available as Chahine Islamic Stars Europe, with Fatwa from Sharia board headed by Dr Elgari. Bespoke investment strategies under mandate and client branded funds also available.

Qatar Financial Centre Address: P.O. Box : 23245, Doha Telephone: +974 496 7777 Fax: +974 496 7676 E-mail: info@qfc.com.qa Website: www.qfc.com.qa Description: Qatar is one of the world’s fastest growing economies, and the wealthiest country in the world measured by GDP per capita. The Qatar Financial Centre (QFC) lies at the heart of this small but dynamic country’s ambitious investment and development strategy.By attracting many of the world’s leading financial institutions to establish operations in Qatar, the QFC is supporting both the development of Qatar’s economy. The QFC Authority is committed to maintaining the highest international standards in its operations and activities. We welcome firms who will contribute to the development and success of Qatar’s financial sector and we will support them in achieving success.

Overseas Trade Finance Ltd Address: Bilton Tower London W1h 7LE Telephone: + 207 859 8201 Fax: +44 845 862 1220 E-mail: info@otfonline.co.uk Website: www.otfonline.co.uk Description: Specialises in sourcing trade finance, and arrange funding for export transactions on behalf of exporters, and international trade finance professionals world wide. Company arrange the finance for Trade related business and forfeiting. Specialise also in arranging non-recourse discounting of domestic and export receivables, based on the purchase of Bills of Exchange, Promissory Notes and invoices. Overseas Trade Finance is dealing with Trade Finance related business and Forfeiting

Malaysia International Islamic Financial Centre (MIFC) Address: MIFC Secretariat Bank Negara Malaysia Jalan Dato’ Onn 50480 Kuala Lumpur Malaysia Telephone: +603 2692 3481 Fax: +603 2692 6024 E-mail: mifc@bnm.gov.my Website: www.mifc.com/ Description: In August 2006, the Malaysia International Islamic Financial Centre (MIFC) initiative was launched to promote Malaysia as a major hub for international Islamic finance. The MIFC initiative comprises a community network of financial and market regulatory bodies, Government ministries and agencies, financial institutions, human capital development institutions and professional services companies that are participating in the field of Islamic finance. Malaysia has also the distinction of being the world’s first country to have a full-fledged Islamic financial system operating in parallel to the conventional banking system.

If you would like to list your company in Financial Directory, please send your order to marketing@gifmagazine.co.uk. Claim your 25% discount by giving the following discount code: X10G01. Please note that only limited space is available in the directory. 2011 August Global Islamic Finance

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Prosperitus Capital Partners Contact person/department: Kamran H. Khan Co-Managing Partner Address: Berkeley Square House London W1J 6BD Telephone: +44 207 193 5755 Mobile: +44 7943 866 552 E-mail: kamran.khan@prosperituspartners.com They are the first of their kind to launch a private equity fund. Their ideal drive and focus is centred on Sharia complaint funding and connecting the markets in the west to the markets in the Middle East. They are doing this by translating the message of Islamic Finance. Prospertious business approach is connected to both innovation and management of the individual asset classes. They intend to foster operations in the Middle East, North Africa. Porsperitus, also have a parallel conventional platform.

Commander Fund Asset Management Ltd Contact person/department: Mark Randall Address: 4 Creed Court 5 Ludgate Hill London EC4M 7AA Telephone: +44 (0) 20 7246 9940 Fax: +44 (0) 20 7246 9944 E-mail: mark.randall@commanderfund.co.uk Website: www.commanderfund.co.uk Commander fund is primarily a conventional based asset management and operations corporation. Yet, in recent years they have been working on pioneering the closes thing to a Sharia compliant Hedge fund. They are also promoting the Middle East and developing a strong client base and market presence there.

Capitala Contact Person. Department : Patricia Assaad Address: Al Moroor Street PO Box 30398 Email: patricia.assaad@capitala.ae Telephone: +971 2 412 1111 Fax: +971 2 412 1222 Description: Capitala are the masterminds behind some of the most beautiful and nubile real estate development in the Middle East. They are focused on striking the balance between community cohesion and good business decision making. There main project Arzanah, is a US$6 billion development on Abu Dhabi island. Located in the Zayed Grand Mosque District

Islamic Finance Glossary A Aaqilah

Mutual Help, which was an arrangement of mutual help or indemnification customary in some tribes at the time of the Prophet Muhammad (pbuh). This is a foundation doctrine based on which Islamic insurance practices, known as Takaful, have been developed.

Adl

A general term which conveys the meaning of justice, equity and fairness.

Ajr

A payment or compensation such as commission, fees or wages charged for services.

Ajr-un-kareem

A generous reward.

Al-Ghurm bil Ghunm

The principle that one is entitled to a gain only if one agrees to bear the responsibility for the loss. Earning profit is legitimised only by risk-sharing and engaging in an economic venture. This provides the rationale and the principle of profit-sharing in Shirkah(partnership) arrangements.

Al-kharaj bil daman

Link of exposure to risk, one can claim profit only if one is ready to bear the business risk, if any. The principle in Islamic jurisprudence that entitlement to return or yield ( al-kharaj) is for the one who bears the liability ( daman) for something, say an asset, and one who does not bear the liability has no claim to the yield.

Amanah

Trust. Lit.: reliability, trustworthiness, loyalty, honesty. Technically, an important value of Islamic society in mutual dealings; it also refers to deposits in trust. A person may hold property in trust for another, it entails the absence of any liability for loss, except for breach of duty. By extension, the term can also be used to describe different financial or commercial activities such as deposit taking, custody or goods on consignment. Deposits in current accounts (usually non-interest bearing) with Islamic banks are regarded as Amanah. If the bank obtains authority to use the funds in the current accounts to invest in its business,Amanah transforms into a loan from the depositor to the bank and the bank is liable to repay the full amount in the current account, irrespective of profit or loss made by the bank.

Amil

Literally it means worker. One who performs a task, an agent. One who deserves compensation for performing a task, such as the mudarib (manager) in a mudarabah contract or a zakat collector. However, inFiqh it also refers to the working partner inmudarabah contract. Under this contract, one partner provides the capital and the other provides the labour who is called amilor mudarib.

Amin

One who holds honestly the trusts of other people; trustworthy.

Amwal

Plural of Mal which means worldly possessions including both property and money (wealth).

Aqd

Contract, Agreement, Bond. Synonymous with the word ÂŤcontractÂť in modern law.

Aqd-al-Muawadah

A contract of exchange in which compensation is given against the goods or services received.

Aqd Ghair Lazim

A contract in which any one of the parties has a unilateral right to revoke it with the consent of the other(s).

Aqd Lazim

A contract in which none of the parties has a unilateral right to revoke it without the consent of the other(s).

Ariya

Loan, which means to give any non-fungible commodity to another for use, without taking any return for its use.

Arbun

A non-refundable down payment or deposit paid by a buyer for the right to purchase goods at a certain time and certain price in future; if the right is exercised, it becomes part of the purchase price. If the buyer does not complete the purchase or backs out for any reason, the seller has the option to forfeit the deposit. Also known as Urboun and Bai al-Arbun. Also see Hamish Jiddiyah.

Ayn

Monetary wealth. A tangible (physical) asset. Also, refers to currency or ready money. Ayn is often contrasted with Dayn.

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August 2011


Global Islamic Finance

Awards

of the Decade Now Open For Submissions

Our primary aim is to reward institutions and individuals for demonstrable achievement in promoting and developing Islamic finance market regionally and internationally. The Awards are open to everyone involved in Islamic finance and banking industry. Winning a Global Islamic Finance Awards demonstrates that your company is leading the world in its innovative thinking, ethical approach, and that your team is delivering effective, impactful solutions to Islamic finance market.

Important dates:

September 2011 – Entry Deadline October 2011 – Shortlist Announced December 2011 – Awards Ceremony

For more information, please visit

www.globalislamicfinanceawards.com


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TAKAFUL: CONCEPT, CHALLENGES, AND OPPORTUNITIES

Through desktop research, one can get a plethora of materials and papers on Takaful, but most tend to focus either on the fundamentals of Takaful or on Takaful models. In contrast, the objective of this report is to highlight the key issues and challenges facing the world of Takaful and suggested areas where work is required to find solutions. Therefore this report is intended to provide useful reference material for practioners by summarising the following key items: • • •

An overview of Takaful and the intricacies of the models Insights into the issues and challenges facing the Takaful industry Finding sustainable solutions to some of these challenges...

The Best Global Franchising Opportunities in Islamic Finance In this edition of Global Islamic Finance Magazine we will be looking at the best global franchising opportunities in Islamic finance and banking which will be a must read for any investor, professional or entrepreneur. There are many Islamic financial franchising opportunities which are exhibited globally around the world. In this article GIF will give you a comprehensive insight into the various franchising opportunities that the Islamic finance sector has across the globe. We will also look closely at the principles of the Shariah in dealing with franchises in addition to presenting the best 10 franchising opportunities in the Islamic Finance sector...

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How to run an Islamic Bank