ISSUE NO. 172 JULY–SEPTEMBER 2009 RAJAB–RAMADAN 1430

PUBLISHED SINCE 1991 GLOBAL PERSPECTIVE ON ISLAMIC BANKING & INSURANCE

SUKUK: WHERE NEXT?

ISLAMIC WORKING CAPITAL FINANCING

UNDERSTANDING GHARAR

SHARI’AH-COMPLIANT ASSET MANAGEMENT: MYTH OR REALITY?

TAKAFUL: KEEPING TRUE TO ITS SPIRIT

ACADEMIC ARTICLE: SHARE MURABAHA

NEWHORIZON Rajab–Ramadan 1430 CONTENTS

Features 20 Understanding gharar Although gharar prohibition is a fundamental pillar of Islamic finance (alongside the prohibition of riba), it has not been receiving due attention. NewHorizon attempts 10 At the crossroads to redress the situation. Should the Islamic finance 24 industry concentrate its efforts 24 Islamic working capital financing on Shari’ah-compliant, Shari’ah- based or Shari’ah-tolerated Working capital financing, the lifeline for many businesses across the world, products, asks Dr Humayon has dried up since the start of the financial crisis. Dr Salman Khan from Abu 10 Dar. Dhabi Islamic Bank looks at how Islamic working capital financing can and should be applied. 14 Sukuk: where next? 28 Islamic asset management: 42 NewHorizon asks how the sukuk industry will respond myth or reality? to the dip in 2008. To date, asset management has not been prominent on 19 Interest rate risk: a threat to the the Islamic finance scene. Is it time for it to become mainstream? Islamic banking system? 42 Book review In this recently introduced section, ‘Food for Thought’, NewHorizon continues the debate on the controversial ‘Shari’ah Law: An Introduction’ issue of interest rate risk. by Mohammad Hashim Kamali. Regulars

05 NEWS 34 IIBI WORKSHOP 38 ACADEMIC ARTICLE A round-up of the important stories Review of sukuk workshop Spirit and models of takaful: from the last quarter around the organised by the IIBI. meeting of minds or parting of ways? globe. 34 43 DIARY 16 ACADEMIC ARTICLE Upcoming Islamic finance events Share murabaha: its use and what endorsed by the IIBI. to watch out for. 44 APPOINTMENTS 32 IIBI NEWS Summary of appointments within Poznan University students from the Islamic finance industry. Poland visit IIBI. Representatives of King Fahd University of 45 RATINGS & INDICES Petroleum and Minerals, Saudi MSCI Barra GCC Countries Islamic Arabia, call on IIBI. More students 35 IIBI LECTURES Index. complete the IIBI’s Post Graduate May and June lectures reviewed; Diploma course. July lecture preview. 46 GLOSSARY

www.newhorizon-islamicbanking.com IIBI 3 EDITORIAL NEWHORIZON July–September 2009

Deal not unjustly, and ye shall not be Executive Editor’s Note dealt with unjustly.

Surat Al Baqara, Holy Quran This quarter has been full of mixed news for Shari’ah-compliant banking and insurance. The sad loss of Lord Eddie George, a former governor of the Bank of England and a prominent figure in the world of finance, has seen a flood of praise sent to NewHorizon from all parts of the industry EXECUTIVE EDITOR Mohammad Ali Qayyum, for Lord George’s valuable contribution to the development of Islamic Director General, IIBI finance.

EDITOR Tanya Andreasyan But life goes on and the progress of the industry continues. Banks in Iraq and Indonesia are pushing for regulatory reforms to facilitate the IIBI EDITOR Mohammad Shafique growth of Islamic finance. A number of prominent banks in Pakistan have teamed up to kick start the country’s interbank market for Islamic CONTRIBUTING EDITOR Don Brownlow financial institutions. Countless reports of heightened activity within the Islamic finance industry are coming from across all sectors and NEWS EDITOR geographies. Lawrence Freeborn

IIBI EDITORIAL ADVISORY PANEL Having experienced a substantial plunge in 2008, what is the sukuk in- Mohammed Amin Richard T de Belder dustry’s strategy today? NewHorizon puts the question under the spot- Ajmal Bhatty light. This issue of the magazine also discusses in depth the subject of Stella Cox Shari’ah-compliant working capital financing, with the assistance of Dr Dr Humayon Dar Iqbal Khan Salman Khan, head of Shari’ah at Abu Dhabi Islamic Bank in Dubai. Dr Imran Ashraf Usmani

DESIGN CONSULTANT When talking about Islamic finance products, the debate on Shari’ah Emily Brown compliance vs Shari’ah basis inevitably crops up. A well-known Islamic

PUBLISHED BY finance expert, Dr Humayon Dar, adds his voice to this discussion, with IBS Publishing Ltd the very interesting concept of a third category – Shari’ah tolerance. 8 Stade Street Hythe, Kent, CT21 6BE United Kingdom The IIBI continues to provide its input to the development of the industry Tel: +44 (0) 1303 262 636 worldwide. To date, professionals from around 80 countries have Fax: +44 (0) 1303 262 646 Email: [email protected] completed its Post Graduate Diploma (PGD) course in Islamic banking Web: www.ibspublishing.com and insurance. The Institute is also exploring the avenues of possible

CONTACT co-operation with Saudi Arabia’s King Fahd University of Petroleum Advertising and Minerals. IBS Publishing Ltd Paul Minister Advertising Manager Together with the industry’s leading experts the IIBI is organising and en- Tel: +44 (0) 1303 263 527 dorsing a series of practicum this year, including its 3rd annual three-day Fax: +44 (0) 1303 262 646 Email: [email protected] residential workshop on structuring innovative Islamic financial products and a workshop on managing Shari’ah risk through Shari’ah governance. SUBSCRIPTION IBS Publishing Limited 8 Stade Street, Hythe, Kent, CT21 6BE, United Kingdom Tel: +44 (0) 1303 262 636 Fax: +44 (0) 1303 262 646 Mohammad Ali Qayyum Email: [email protected] Web: newhorizon-islamicbanking.com Director General IIBI

©Institute of Islamic Banking and Insurance ISSN 0955-095X This magazine is published to provide information on developments in Islamic finance, and not to provide professional advice. The views expressed in the articles are those of the authors alone and should not be attributed to the organisations they are associated with or their management. Any errors and Cover photo: © Abawab, Dreamstime.com omissions are the sole responsibility of the authors. The Publishers, Editors and Contributors accept no responsibility to any person who acts, or refrains from acting, based upon any material published in the magazine. The Editorial Advisory Panel exists to provide general advice to the editors regarding matters that may be of interest to readers. All decisions regarding the published content of the magazine are the sole responsibility of the Editors, and the Editorial Advisory Panel accepts no responsibility for the content.

4 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Rajab–Ramadan 1430 NEWS

Sad loss of respected governor and renowned proponent of Islamic banking

Lord Eddie George, governor surrounding boroughs. From cluded tax and regulatory Lord Eddie George of the Bank of England for ten this, and following parallel changes and also official encour- years between 1993 and 2003, conversations with Dr Pasha, agement in examples such as has passed away after a pro- general secretary of the Union working towards a government- longed battle with cancer. of Muslim Organisations in the issued sukuk. Richard T de Known as ‘Steady Eddie’, he UK and Ireland, the working Belder, partner of international dealt with the aftermath of Black group dedicated to Islamic fi- law firm Denton Wilde Sapte, Wednesday, when Britain exited nance was created. believes that all the progress the the Exchange Rate Mechanism, UK has made in Shari’ah-com- in his first term, and led the bank Praise for Lord George’s efforts pliant finance can be traced into independence in 1997. Lord in the area of Islamic finance has back to Lord George’s early George will also be remembered flooded to NewHorizon from support. De Belder agrees with fondly by many in the Islamic all parts of the industry. Iqbal Wilson on Lord George’s global finance industry in the country, Asaria, managing director of influence, saying that the devel- for his determination over many Islamic advisory firm Afkar Con- opments in the UK, at Lord years in pushing Shari’ah-com- sulting, and a former member of George’s instigation, ‘can be pliant finance forward. the Bank of England working Meanwhile, Professor Rodney seen as providing a template committee, says: ‘On several oc- Wilson of the Faculty of Islamic for other countries, both in the Speaking to NewHorizon in casions he hosted the working Studies, of the Qatar Founda- West and in Muslim states, 2007 (NewHorizon, April–June group’s meetings in his own of- tion, suggests that Lord about what is required to en- 2007) , Lord George had relayed fices at the Bank of England and George’s appreciation of the im- courage Islamic banking’. his particular delight about facilitated dialogue with key de- portance of the Muslim commu- paving the way for Islamic mort- cision makers across government nity in the UK dates back over Mohammad Ali Qayyum, gages. He recounted how he had departments.’ Highlighting par- 20 years. Long ago, he ‘recog- director general of the IIBI, has been touched by the plight of ticularly Lord George’s joy at the nised that many Muslims were added his own praise. ‘Lord one Muslim couple in the UK passing of legislation to remove unhappy with the conventional George was admired for his ex- who had not been able to find double stamp duty on Islamic products offered by banks in the pertise, judgment and wisdom. a mortgage in accordance with home finance, Asaria adds that UK, and that Islamic finance He made immense contributions their religious beliefs, saying ‘I ‘it was his untiring efforts which would enhance community co- in giving Muslims, and others couldn’t think of any rational made the government commit to hesion and help eliminate finan- interested in alternative invest- reason for this’. Under his guid- creating a level playing field for cial exclusion’. Wilson adds that ment products, access to such ance, issues such as standardisa- Islamic banking and finance in Lord George’s influence spread offerings. As a result of Lord tion, and how Islamic economic the UK’. well beyond the British Isles, George’s efforts, the UK now principles could be fitted into the affecting developments in the has six authorised Islamic finan- UK’s existing legal framework, ‘Lord George was the first gover- Islamic finance industry as far cial institutions, with several started to be addressed. nor of the Bank of England who afield as Malaysia and the Gulf others providing Shari’ah-com- attempted to understand the states. Referring particularly to pliant finance.’ He was instrumental in setting need for financial inclusion of the warm relationship between up a working committee, the Is- Muslims,’ says Dr Humayon Lord George and the Muslim Governor from 1993 to 2003, lamic Finance Advisory Group, Dar, CEO of BMB Islamic and a Council of Britain, Wilson de- he originally joined the Bank of to examine the challenges sur- prominent specialist in Shari’ah- scribes Lord George as a ‘true England from Cambridge in rounding the introduction and compliant finance. ‘He, in my friend of Islamic finance’. 1962. He served as executive expansion of Shari’ah-compliant opinion, should be accredited for director and deputy governor, finance in the UK. This came out bringing Muslims into the British The UK authorities have in re- and was knighted in 2000 be- of the Bank of England’s ‘Heart mainstream. No politician has a cent years remained positive to- fore being made a life peer in of the City’ charity, which was greater impact on the British wards Islamic finance, straining 2004. He died aged 70, and is initiated in 2000 to encourage Muslim community than Eddie to create a global hub ahead of survived by his wife Vanessa City companies to reach out to George.’ potential rivals. This has in- and three children. www.newhorizon-islamicbanking.com IIBI 5 NEWS NEWHORIZON July–September 2009

Sri Lanka to launch first Islamic bank

The Amana Group has recently Sri Lanka. The Central Bank of compliant investment flows Amana Investments, the parent received provisional clearance Sri Lanka has given the group a from the Far East and Middle company, became a certified to open the first fully-fledged letter of provisional approval, East, and to utilise the Islamic member of the AAOIFI (Ac- Islamic commercial bank in which sets out certain condi- banking knowledge and tech- counting and Auditing Organi- tions the new nical expertise of Bank Islam sation for Islamic Financial bank would Malaysia, which holds a ten Institutions) in July 2005. The Mosque in Galle, Sri Lanka have to fulfil, per cent stake in Amana In- company dates from 1997. Its such as a mini- vestments. The partnership Shari’ah supervisory council in- mum capital re- will design a wide range of cludes Justice Taqi Usmani, quirement. What Shari’ah-compliant banking a prominent scholar. Across Amana Group is services, such as current ac- its 14 branches, it already offers referring to as counts, foreign exchange trans- a number of Islamic financial the ‘first truly’ actions, remittances, export services, such as ijara, murabaha Islamic commer- financing, guarantees, per- and musharakah. Bank of Cey- cial bank on the formance and bid bonds, cor- lon, the largest Sri Lankan bank, island will be porate treasury placements, was planning to launch Islamic called Amana private banking, long term banking services in early 2008 Bank Limited. housing finance, infrastructure (NewHorizon, October–Decem- It intends to at- and agricultural finance and ber 2007) , but this appears not © Shanin, Dreamstime.com tract Shari’ah- leasing. to have transpired to date. Iraq’s Islamic banks push Large new Shari’ah- for regulatory reform compliant bank planned

The Islamic banking industry The laws of the country cur- in Bahrain in Iraq looks set to receive a rently constrain investment in boost as the authorities look real estate, which has been a Istikhlaf Bank, a huge new investors. Its ten shareholders for ways to encourage its de- strong source of activity for bank with capital of $10 bil- include Islamic Development velopment. Islamic banks elsewhere. Al- lion, is soon to be launched in Bank, Saudi Investment Bank Bilad Islamic Bank is one insti- Bahrain, according to Adnan and Kuwait Real Estate Bank. Mudher Kasim, a senior advi- tution which has been pushing Ahmed Yousif, chairman of sor at the Central Bank, has for a change. Abdul-Hussein the Union of Arab Banks. In June it was reported that said in an interview to Reuters al-Rabaie of the bank said a feasibility study had been that the regulator is consider- that, since Shari’ah-compliant The investment bank will be completed, and that a private ing new laws to differentiate banks are less risky than their listed on the Bahrain Stock placement would soon follow between the country’s conven- conventional counterparts, Exchange and Nasdaq Dubai. in Bahrain and other Islamic tional and Shari’ah-compliant they should be given more lee- Yousif told Reuters at a con- countries. Yousif suggested to institutions. Seven of Iraq’s 42 way, for example in relation to ference in Dubai that the es- Reuters that a launch had initially banks are now Shari’ah-com- the Basel II capital adequacy tablishment of founding been scheduled for early 2009, pliant, and they have requested rules. Islamic banks also want shareholders was in its ‘final but the plans had changed due that the authorities loosen a cut in the reserve require- stages’ in April, and that an to the financial crisis. banking rules which currently ment from 25 per cent to 15 IPO would take place for define what size and types of per cent. He said that, while about $3 billion. The Union of Arab Banks, investments can be made, as Al-Bilad has grown since founded in 1974, is headquar- well as capital adequacy re- 2006, it remains hampered by The bank had already raised tered in Lebanon. Its objective is quirements. the restrictions. $3.5 billion in April, from pri- to consolidate relations and foster vate and semi-governmental co-operation between members.

6 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Rajab–Ramadan 1430 NEWS

Pakistan’s Islamic Iranian Islamic bank banks look to kick-start burnishes green credentials interbank market Bank Keshavarzi, an Iranian and multi-purpose trees in the Islamic bank, has been awarded degraded national lands located Meezan Bank, the largest and others) and Interbank Wakala a special plaque of merit for in the north of Iran. oldest Shari’ah-compliant (a contract of agency in which the successful performance of bank in Pakistan, has con- one person appoints someone its Tooba plan for agricultural It involved local people and ducted a meeting of product else to perform a certain task and environmental develop- communities, and was aimed at development experts and Shar- on his behalf, usually against a ment. The special citation was creating employment and raising i’ah advisors from a number of certain fee) have been negoti- given at the Association of De- the productivity of land. Similar fully-fledged Islamic banks to ated and finalised. The banks, velopment Financing Institu- planting activity was under- settle on a single mechanism which include BankIslami, tions in Asia and the Pacific taken on land belonging to the for interbank placement be- Dubai Islamic Bank, Emirates (ADFIAP) Outstanding Devel- Ministry of Agriculture. tween Islamic banks in Pak- Global Islamic Bank and First opment Project awards 2009. istan. The aim is to mature Dawood Islamic Bank, have Banks and institutions from Other banks to win awards and improve the liquidity of undertaken that only these 40 countries participated. included Development Bank the Islamic interbank markets. standard contracts would be The formal awarding ceremony of Japan, Small Industries The meeting has been hailed as used. A more developed inter- marked the occasion of the Development Bank of India, a ‘major milestone’ by Meezan bank market is considered key 32nd annual meeting of Development Bank of Kaza- Bank. to improving the dynamism ADFIAP, in Oman. Bank khstan and Oman Development and liquidity of the Islamic Keshavarzi had also won an Bank. The ADFIAP awards Standardised agreements for banking sector. It also moves award the previous year in programme was inaugurated Interbank Musharakah (an the Islamic banks of Pakistan a the development finance-led in 1997 in the Philippines. The agreement under which the Is- step closer to a Shari’ah-com- poverty reduction category. purpose was to honour mem- lamic bank provides funds that pliant alternative to the bers of the association that are mingled with the funds of Karachi Interbank Offered The Tooba project was centred have contributed substantially the business enterprise and Rate (KIBOR) as a benchmark. on the activity of afforestation. to the development of their re- It involved planting fruit species spective countries. Dubai Bank launches women-only service

Dubai Bank, an Islamic bank ther eight to ten ‘ladies only’ rah, will help women customers based in the UAE, has launched branches and departments by experience our world-class prod- a female-only banking service the end of 2010. A dedicated ucts and services within a more called Amirah, which means team of female staff will cater discrete setting.’ Dubai Bank ‘princess’ in Arabic. The service for the Amirah customers, pro- now has 22 branches in the is intended to provide ‘en- viding advisory services as well UAE, having most recently hanced, targeted and more per- as operational assistance. opened one at the office of the sonalised’ banking for ladies. Dubai Department of Economic Women, initially in the Ras Al Mohammed Amiri, head of Development in Dubai Mall. Khaimah branch of Dubai retail banking at Dubai Bank, Dubai Islamic Bank opened Bank, will be afforded greater said: ‘Over the past few years, what was believed to be the first privacy with the service thanks the number of Dubai Bank’s women-only bank branch in to exclusive areas of branches. female customers has risen sig- the Gulf a few years ago, and nificantly. There is immense has expanded its female specific Dubai Bank plans to expand demand from our female cus- services to ten women-only Amirah to six further branches tomers for a more personalised branches and a women-only in the UAE this year, and a fur- service. Our new initiative, Ami- credit card. www.newhorizon-islamicbanking.com IIBI 7 NEWS NEWHORIZON July–September 2009

Ratings agency shows mixed picture of Islamic banking industry

The Islamic International Rat- some extent protected Shari’ah- Most Islamic banks still carry business,’ says the report. ing Agency (IIRA), a Bahraini compliant institutions from the adequate liquidity. Excluding Meanwhile, a gap analysis rating agency whose purpose fall in value of asset-backed se- start-up banks, liquid assets of the maturity profile of is to provide Shari’ah-compli- curities, but not entirely. constituted 32.5 per cent in assets and liabilities of the ant capital markets and banks 2007, but this figure fell to 26 Islamic banks in the study with a spectrum of creditwor- The research was based on a per cent of total assets at the suggested that some banks, thiness, has recently published sample of Islamic commercial start of 2008. However, looking such as Kuwait Finance a report into the state of liq- banks, including Meezan Bank at interbank funding, the report House and Bahrain Islamic uidity of Islamic banks. Its in Pakistan, Dubai Islamic found a reversal of the positions Bank, might face challenges conclusion, based on data Bank and Jordan Islamic Bank. of most Islamic banks from with liquidity. The report from between December 2007 Domestic Islamic financial insti- being net lenders in the inter- does state, however, that and December 2008, is that tutions, such as Al Salam Is- bank market to net borrowers. ‘Islamic banks are less likely Islamic banks’ liquidity lamic Bank, Bahrain Islamic ‘This shows that they have in- than conventional institu- positions deteriorated over Bank, Al Baraka Islamic Bank, creased reliance on professional tions to suffer negative out- the period studied. Islamic Kuwait Finance House and sources (interbank and brokered comes beyond their capacity finance’s stricture against the Khaleeji Commercial Bank also deposits) of funds to cover the to sustain core profitability earning of interest has to participated in the study. increased deployment in the and capital’.

Indonesia considers removing hurdles to Islamic banking

The parliament of Indonesia is A campaign to release the po- currently debating whether to tential of Islamic finance in In- Sumatra, Indonesia change double taxation laws donesia has existed for some that pose an obstacle for time, but has so far failed to Shari’ah-compliant finance in resolve the issue of double tax- competing with conventional ation. This crops up when a banking. transfer of assets, often neces- sary more than once in an A member of parliament, Islamic transaction, is taxed. Melchias Markus Mekeng, Mekeng, who is a member of said in an interview with the parliament’s commission Reuters that ‘we will attempt overseeing financial affairs, to finalise the rules by the end says it is too early to state of September this year’. The what the law will look like. double taxation of Islamic transactions has been criticised However, Indonesia’s central by those working in the bank has set a target for Is- industry as an impediment lamic finance to amount to ten to its growth in the world’s to 15 per cent of the country’s largest majority Muslim coun- banking assets by 2015. At try (with over 200 million present, the figure is just over followers). two per cent.

8 IIBI www.newhorizon-islamicbanking.com

POINT OF VIEW NEWHORIZON July–September 2009

At the crossroads

The current financial crisis is a time for taking stock of where Islamic banking and finance is heading, argues Dr Humayon Dar. Should we be focusing on Shari’ah-based, Shari’ah- compliant or Shari’ah-tolerated products, he asks.

Islamic banking and finance has emerged Some industry observers have for some time as a legalistic phenomenon, perceived to called for developing more Shari’ah-based be different from its conventional counter- rather than mere Shari’ah-compliant prod- part primarily in its legal form. It attempts ucts to add authenticity to Islamic banking to achieve the economic effects of almost practice. Apparently, the notion of Shari’ah all banking and financial products in ways basis is gaining ground amongst a new that comply with the requirements of generation of Islamic banking supporters. Islamic law. Critics view most Islamic financial products as Shari’ah-compliant Shari’ah compliance vs Shari’ah basis caricatures of conventional offerings. While these products may offer mental satisfac- It is well understood that a financial prod- tion to religiously motivated users of finan- uct is deemed Shari’ah-compliant if it fulfils cial services, they have yet to appeal to Islamic legal requirements in terms of the the Muslim masses. An estimated 75 per prohibition of interest (riba), contractual cent of Muslims reject Islamic banking uncertainty (gharar), gambling and other and finance on the grounds that it does activities like the production, distribution not offer any real economic value, different and marketing of alcohol, pork, tobacco from what conventional products other- and other unethical products and services. wise provide. In some countries (particu- larly Pakistan), some sort of organised Some industry analysts suggest that there movement by clerics (‘Ulama) against the Dr Humayon Dar, must be another category – that of Shari’ah current practices in Islamic banking has BMB Islamic tolerance – even before Shari’ah compliance. already started taking shape. According to them, most of the Islamic financial products offered at present in the Given the current downturn in financial market are merely tolerated in Shari’ah, markets, the Islamic finance industry due to the lack of development of an Islamic faces an even greater challenge than many financial infrastructure. A notable example Islamic banking practitioners and observers of Shari’ah tolerance is that of Islamic yet perceive. This is the time for those in- mutual funds based on the contemporary volved to take a pause and reflect on the Shari’ah screening methodologies. Accord- developments in the industry to assess both ing to these screenings, certain prohibited its progress and shortcomings. Although activities (like interest-based borrowing and many analysts argue that the Islamic fi- financing) are tolerated to some extent (e.g. nance sector is more resilient to financial a 33 percent debt to equity ratio), due to the crises, the real question to ask is, which lack of Shari’ah-compliant businesses. This Islamic banking? The one based on view holds that something tolerated in Shar- theory, or the one in practice? While one i’ah (in accordance with the principle of can unambiguously claim that Islamic necessity) should not qualify as Shari’ah- banking in theory works better than compliant. conventional banking, the answer is not necessarily straightforward when we refer The proponents of the Shari’ah-based ap- to practice. proach, nevertheless, maintain that Shari’ah

10 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Rajab–Ramadan 1430 POINT OF VIEW

tolerance of compliancy of a financial prod- products must offer a distinctly different policy does not exist, Islamic banks may uct is not sufficient; rather, such a product economic value proposition. This, in their delineate a voluntary code of conduct for should offer more than just compliancy view, can only be achieved by observing the themselves to adhere to a disclosed commit- with Islamic law. One such view suggests spirit of Islam rather than merely relying on ment to social responsibility and to the com- that Islamic financial products should be Shari’ah-compliant legal documentation. munities it aims to serve. Product offerings structured so as to fulfil the objectives of of Islamic banks must remain consistent Shari’ah (or maqasid al-Shari’ah). A closer look at criteria for Shari’ah basis with the disclosed social responsibility code.

The objectives of Shari’ah are commonly In light of the above discussion, at least Criteria B refers to the common sense based defined in terms of Imam Ghazali’s classifi- three criteria emerge, which may help deter- on simple prohibitions. For example, given cation of unrestricted public interest (known mine whether a product is merely Shari’ah- that there is no scope for money (cash) lend- as maslaha mursala), in terms of the protec- compliant or is indeed Shari’ah-based. ing in Shari’ah other than in the form of an tion and preservation of religion, life, intel- These can be summarised as follows: interest free loan (qard hasan), any product lect, property and progeny. Thus, Islamic that gives a customer direct access to cash financial products based on (the objectives A Criteria related with the public interest; against a return (either in the form of fixed of) Shari’ah must attempt to enhance unre- B Substance-over-form criteria with profit or rent) can at best be Shari’ah-com- stricted public interest. According to Imam respect to: pliant, if not merely Shari’ah-tolerated. Such Shatibi, public interest can be divided with J cash advancement; products are certainly not in the spirit of respect to essentials, necessities and what is J irrelevance of trading; Shari’ah. known as luxuries in economic literature. C Economic criteria. The preference order on these runs from Criteria C is probably least liked by most essentials, to necessities, to luxuries, with Criteria A (based on the objectives of of Shari’ah scholars advising Islamic banks the latter the least preferred. For example, Shari’ah) must be more relevant to public and financial institutions because it does not education for children is an essential, while policy in a country than to the practice of make obvious sense independent of Criteria shelter for family is a necessity. A financial Islamic banking, per se. It is, after all, the A. When analysed closely, the Criteria C product that facilitates provision of educa- government’s job to determine what type of are no different from the issue of pricing. In tion to children contains more public inter- consumption pattern it deems fit for its pop- effect, this implies offering Islamic financial est than a home financing product. ulous. In a modern Islamic society, this must services for a price lower than their conven- be done through a mechanism that should tional equivalents. For example, the propo- Thus the distinction between Shari’ah com- truly reveal public’s preference ordering. nents of the Criteria C seem unconvinced by pliance and Shari’ah basis with respect to Needless to say, the preference ordering the value proposition of an Islamic mort- the objectives of Shari’ah has a social di- should be only on Shari’ah-compliant con- gage that happens to be dearer than conven- mension, as evidenced by public interest. sumption choices. tional mortgages. They would prefer a home Any financial activity or banking product financing programme that must offer more that enhances public interest is deemed Public policy can easily be implemented affordable options to people than what con- Shari’ah-based. Shari’ah compliance re- in banking, by issuing guidelines on what ventional mortgages may otherwise provide. mains a necessary condition for Shari’ah type of activity may be financed by Islamic basis while public interest is a sufficient banks. For example, a ban on the financing Categorisation of the existing products condition. This means that while all Shar- of luxury items like cars and big houses can i’ah-based products must be Shari’ah-com- be restricted by the financial regulator. This Any product that fulfils Criteria A, B and C pliant in addition to offering unrestricted can easily be implemented and monitored should be considered as Shari’ah-based. public interest, merely Shari’ah-compliant by the relevant authorities by applying and Thus, personal finance products based on products do not contain significant public enforcing an upper limit on finance for cer- tawaruq, while deemed Shari’ah-compliant interest. A second possible explanation of tain goods and services. To ensure that Is- by many, cannot be considered as Shari’ah- Shari’ah basis may refer to a debate of ‘sub- lamic banking best serves unrestricted based because in substance they are not suf- stance over form’. Many critics object to public interest, an enabling tax and reward ficiently different from money lending. Islamic financial products on the grounds system may also be adopted to provide Commodity murabaha based deposits also that they are different only in terms of legal sufficient incentives to such institutions to fall short of Shari’ah basis. Similarly, while a documentation and execution processes that adhere to tenets of public policy. credit card, if structured properly, may be aim to achieve the economic effects of con- deemed Shari’ah-based, cash withdrawal is ventional offerings. In countries (especially where Muslims are a feature that does not have strong Shari’ah in a minority, or those with a very small basis. Having said that, most Islamic credit A third group believes that Islamic financial share of Islamic banking) where such a cards available in the market have features

www.newhorizon-islamicbanking.com IIBI 11 POINT OF VIEW NEWHORIZON July–September 2009

associated with Shari’ah-compliant prod- to replicate the economic effects of conven- that the first two are not acceptable while ucts. From a Shari’ah basis perspective, tional products, by using Shari’ah-compliant the last ones are. Accepting all these types charge cards or debit cards are deemed principles and structures. as Shari’ah-compliant, it is always desired more in line with the spirit of Shari’ah. (and must be intended) that Shari’ah com- The figure below locates different Islamic pliancy of Islamic financial products be The Islamic credit cards – whether based on financial products on a Shari’ah map. It is improved. tawaruq (as in the GCC countries), bai al- obvious from the figure that most of the ina (as in Malaysia) or ujra (as in the UAE) existing Islamic financial products are either Finally, Islamic banking and finance has – all offer access to credit (either by way of Shari’ah tolerated or compliant. made considerable progress in the last few financing a transaction or through cash decades, primarily with the help of relax- withdrawals) in ways that can at best be Conclusions ations based on the principle of necessity. deemed Shari’ah-compliant. While these exceptions have helped in devel- It appears from the above discussion that oping a range of Islamic financial products, As a rule of thumb, any product that is a distinction between Shari’ah-compliant it will be inadequate if these exceptions based on a mechanism or transaction that and Shari’ah-based products is at best an re-enter the books of fiqh to change the is indeed undertaken by the transacting emphasis on the degree of Shari’ah compli- principles of Islamic jurisprudence. There- parties for its intrinsic value and not just a ancy. Shari’ah-based products, if someone fore, it is imperative that a constant effort is facilitating tool, should be Shari’ah-based. really ought to use the term, are those which made to push the Islamic financial offerings For example, murabaha-based car financing comply with Shari’ah requirements more into the top left corner of the below figure. must be considered a Shari’ah-based prod- than some other products. In other words, That should happen without rejecting the uct, because it is the intention of the bank Shari’ah-tolerated, Shari’ah-compliant and current offerings, as only they will pave the to buy from the vendor and sell to the cus- Shari’ah-based products lie on the same way for the next (more authentic) genera- tomer who is actually interested in buying side of the fence. It is certainly not the case tion of Islamic financial products. the car to benefit from it by using it himself or selling it onwards for a profit. However, in order to pronounce a product Shari’ah- based, it must also be weighed against other criteria. For instance, Criteria A (enhance- ment of unrestricted public interest) may adjudge it only Shari’ah-compliant, if the bank finances excessively expensive or luxury cars. This is so because, while Shar- i’ah does not disallow buying expensive items, it strongly recommends that such things should be used only when a person has means in place to do so. Acquiring ex- pensive things (like yachts, for instance) on credit is certainly against the spirit of Shari’ah.

The above examples come from Islamic retail banking. Islamic investment banking and fund management is also full of similar products. While some proponents of Islamic hedge funds find no problems with short- selling (by using arboun or murabaha), they tend to have problems with Islamic struc- tured products based on what is known as Shari’ah conversion technology. Neverthe- less, a closer look at such products and ones like the ShARE (Shari’ah Alternative Return Emulation) Platform developed by the BMB Group suggests that these products attempt

12 IIBI www.newhorizon-islamicbanking.com

ANALYSIS NEWHORIZON July–September 2009

Sukuk: where next?

Trevor Norman (right) , Volaw's director of Islamic finance and funds group, asks how the sukuk industry will respond to the dip in 2008.

Turbulence in the financial sector during reflect on the basic principles in order to principal) of the cash flow would be charac- 2008 and the resulting collapse of the secu- appreciate how the market for sukuk may terised as riba. Similarly, collateralised debt ritisation markets has made it increasingly develop. obligations (CDOs) and other such instru- difficult for companies to access this indus- ments could not be allowed as an asset class try to raise additional finance. The Islamic In Shari’ah Standard No 17 on investment as these represent ‘debt’ rather than an al- securitisation market, often referred to as sukuk, the Accounting and Auditing Organ- lowable commodity or activity. However, the sukuk market, has not been immune to isation for Islamic Financial Institutions investment in tangible assets, used for pro- this economic downturn, indeed it has also (AAOIFI) gives the following definition of ductive purposes, and reaping the rewards suffered from controversy over the very na- sukuk: arising from those assets, is a core principle ture of some sukuk structures and sugges- of Islamic finance. It is this principle on tions that some sukuk in issue were not ‘Investment sukuk are certificates of equal which sukuk securitisation structures are Shari’ah-compliant. value representing undivided shares in founded. ownership of tangible assets, usufructs and However, even with a struggling global services or (in the ownership of) the assets Whilst AAOIFI standards are not compul- economy, organisations throughout the of particular projects or special investment sory from an international perspective, world still need to raise finance to fund their activity.’ they are generally binding in six Middle activities, and in some cases their expansion Eastern countries, together with the Dubai plans. With a continuing lack of bank credit The standard makes it clear that sukuk International Financial Centre (DIFC). Fur- and with no sign of a recovery for the IPO must be backed by assets that are subject thermore, it is difficult to imagine how an markets, corporate issuers seem to be re- to a Shari’ah-compliant contract, e.g. an issuer would be able to obtain a fatwa from turning to the financial and securitisation ijara contract, sets out 14 examples of a recognised Shari’ah supervisory board if markets and several of these prospective sukuk structures and distinguishes invest- the structure did not comply with Standard issuers have indicated that they are either ment sukuk from shares, notes and bonds. 17, thereby making adherence with the planning or actively considering raising Furthermore, the standard makes it standard obligatory from a business per- funds through the sukuk market. clear that the sukuk documentation must spective. demonstrate: This article will seek to show that sukuk AAOIFI resolution on sukuk structures continue to be a useful way to a) that any income arising must derive raise finance for both Islamic and non-Is- from the underlying activities for which In late 2007, Sheikh Muhammad Taqi lamic organisations. Furthermore, if, as is the funding has been used, and not Usmani, as chairman of AAOIFI Shari’ah expected, these sukuk-based securitisation simply comprise interest; Board, issued a statement (that was heavily markets (particularly for asset-backed trans- b) that the sukuk must be backed by real misquoted) in which it was claimed that actions), recover more quickly than their underlying assets and these assets must many of the sukuk structure in existence at conventional counterparts, will those in- be halal (allowable) in nature and be that time would fall foul of basic Shari’ah volved in structuring non-Islamic securitisa- being utilised as part of a halal activity; principles. In particular, many appeared to tion transactions learn any lessons regarding c) that there must be full transparency violate the principle of risk and profit-shar- the principles of sharing risk and reward as to rights and obligations of all ing by promising to pay back capital. Subse- and reflect this in conventional structures? parties. quently, in February 2008, AAOIFI issued a statement setting out six core principles for Sukuk Thus a large part of the conventional secu- structuring and implementing sukuk trans- ritisation market – for example, mortgage- actions, noting that it was these principles Many readers will be familiar with the gen- backed securities – would be prohibited that were often being disregarded in the eral concept of sukuk, but it is important to because the income element (though not the larger or volume-based sukuk structures.

14 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Rajab–Ramadan 1430 ANALYSIS

A key feature of the AAOIFI resolution is to port can be built into a structure while still able through the secondary market, which be found in the final paragraph. This calls giving an element of risk. Similarly, private makes it difficult for retail investors to ac- for Islamic financial institutions to: companies throughout the region have been quire sukuk. Several institutions have estab- starved of finance. While these companies lished sukuk funds to allow retail investors ‘decrease their exposure to debt-related op- will need to demonstrate that they either to participate in sukuk issued by a number erations and to increase their operations have a strong track record or a good busi- of different institutions, but to date these based on true partnerships and the sharing ness case together with a pool of appropri- too seem to be having difficulty in acquiring of risk and reward’. ate assets to securitise, the entrepreneurial appropriate assets due to the lack of supply. spirit of the region, coupled with pent-up Whilst there is still much debate as to demand for Shari’ah-compliant investment Summary whether sukuk can be used to raise debt products, is likely to make such corporate for an institution (i.e. where the underlying sukuk structures an attractive proposition The similarity between sukuk and tradi- structure is asset-based), it is clear that the for both regional and international in- tional asset-backed securitisation structures resolution endorses the use of sukuk to vestors. will be readily apparent. However, as finance the acquisition of actual assets on demonstrated in the points raised above, behalf of an Islamic entity and in particular International institutional demand for there is much more to establishing a Shar- where the financing is structured as a tradi- sukuk cannot be understated, with both i’ah-compliant securitisation transaction tional asset-backed security. Islamic and non-Islamic or Western institu- than a simple rewording of conventional tions participating in many of the large transaction documentation. The markets quasi-governmental sukuk issues of 2006 and 2007. Similarly, several countries in The call for a ‘back to basics’ approach The growth of the sukuk market in the 21st the West have made various announcements contained within the AAOIFI resolution on century, albeit from a very small base, as to their own plans to issue sukuk, most sukuk had a negative impact on the issuance seemed unstoppable, with an approximate notably the UK Treasury, whose plans for of sukuk in 2008. Whether this will affect cumulative doubling each year from 2002 a sukuk have been on and off for the past the ability of institutions to create innova- through to 2007 (see the chart below). three years. tive sukuk structures going forward is an unanswered question, but in the author’s The chart shows the dramatic decline in The retail market for sukuk is slowly open- experience, provided the basic tenets of new issues during 2008, but it is impossible ing up although demand seems to outstrip Shari’ah are adhered to, the scholars will to determine how much of this decline was supply because of the lack of sukuk avail- generally accept such innovation. attributable to global economics and how much to restraint arising from concerns over the validity of sukuk structures following Global sukuk issuance the AAOIFI announcement. Similarly, many of the sukuk issued previously would have had a three to five year tenure and therefore were repaid in 2008, with market condi- tions preventing these from being rolled over.

So what are the factors that will drive the resurgence of the sukuk market? First and foremost, there is a need to finance the large number of construction and infrastructure projects throughout the GCC. Historically, the financing for many such projects bene- fited from direct or indirect governmental guarantees, but this was one of the concerns that led to the original AAOIFI statement, as sukuk holders are supposed to bear the risks of ownership and not be immune to effects of changes in the profitability of the Source: Ernst & Young IFIR 2009 venture; it remains to be seen how such sup-

www.newhorizon-islamicbanking.com IIBI 15 ACADEMIC ARTICLE NEWHORIZON July–September 2009

Share murabaha: its use and what to watch out for

Richard T de Belder, head of Denton Wilde Sapte’s global Islamic finance practice, Shaikh Muddassir Siddiqui, head of the firm’s Islamic practice in the Middle East, and Robert Finney, head of the firm’s financial markets and regulation group, examine the structure and application of this prevalent Islamic finance tool.

The typical trade murabaha In practice, the customer has the relationship This structure is also used by Islamic finan- with the supplier. It is in a better position ciers for short-term placements as part of Murabaha transactions still account for a to negotiate the specifications, the price, etc. their liquidity management programmes. significant percentage of the annual global Therefore, the customer often acts as the Here the customer would be the Islamic Islamic finance business. Islamic financier’s agent in dealing with the financier. The Islamic financier as the cus- supplier. Shari’ah boards of Islamic finan- tomer will have the use of $100 and the A ‘trade’ murabaha is a contract of sale ciers allow the customer to act as an undis- other Islamic financier that sold the com- used to finance a customer’s acquisition of closed agent of the Islamic financier and take modities would have a debt on its books an asset for his personal or business use the title in its name for the Islamic financier. due on a deferred payment basis of $110. (such as a home or a piece of equipment). If a customer wants to pay the deferred The use of this structure has been the sub- The Islamic financier buys the asset in its payment price early, the murabaha contract ject of prolonged debate. Historically, all name from the supplier and sells it to the itself cannot include a provision obliging jurists allowed tawaruq. People often used customer with a mark-up on a deferred the Islamic financier to give a discount. to buy goods on a deferred payment basis payment basis. Shari’ah requires that title However, it is possible that the Islamic at a higher price, use it for some time and and possession of the asset passes from the financier can, in its discretion, give a rebate. then decide to sell it for cash when they no supplier to the Islamic financier before its In practice, most Islamic financiers provide longer needed it. onward sale to the customer. Possession of a rebate. the asset can be actual or constructive. Many scholars have criticised the use of or- Tawaruq ganised tawaruq by Islamic financiers. They The customer pays the deferred purchase have argued that tawaruq involves sham price in one amount or by instalments. Unlike a ‘trade’ murabaha, tawaruq (which purchases and sales of commodities which Title and possession pass to the customer is a form of murabaha) is used to provide a are a cover for money being made available when the murabaha is entered into. The cash or ‘working capital’ facility. Histori- now for more money later (interest). purchase price is calculated by reference cally, tawaruq used commodities such as to the price the Islamic financier paid to metals (other than gold or silver) that are The Accounting and Auditing Organisation the supplier, any costs associated with bought and sold on an exchange like the for Islamic Financial Institutions (AAOIFI), the purchase and a mark-up. The mark- London Metal Exchange. the international standard-setting body up is often calculated by reference to a based in Bahrain, has issued Shari’ah Stan- benchmark, such as the London Inter- By way of example, the Islamic financier dard No. 30 which allows tawaruq on the Bank Offered Rate (LIBOR). The Shari’ah buys commodities through a broker for spot ground of necessity, but only if strict limits board justifies using an interest rate (say $100) and then immediately sells them are followed. The Standard specifically benchmark on the grounds that, so long to the customer on a deferred payment basis prohibits the use of tawaruq for the benefit as the contract in itself is Shari’ah-compli- for, say, $110. The customer immediately of a conventional bank if the Islamic finan- ant, the fact that the profit is identical to sells the commodities to a second broker for cier knows the conventional bank would a conventional financing does not affect spot and so, less the brokers’ fees, ends up use the liquidity for onward interest-based its Shari’ah validity. with $100 cash. lending.

16 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Rajab–Ramadan 1430 ACADEMIC ARTICLE

On 30th April 2009 in Sharjah, UAE, the under local ‘doing business’ licensing laws the transaction, the rules of the Financial International Islamic Fiqh Academy of the (which may entail the annual payment of Services Authority (FSA). Organisation of Islamic Conference (OIC) fees, filing requirements, etc). closed its 19th session during which it also The FSMA can catch transactions without passed resolutions attacking the use of Often these issues are not considered in an obvious or significant UK connection, an tawaruq. It will be interesting to see the ex- enough detail. The laws of multiple jurisdic- issue which is all the more serious given the tent to which these resolutions affect its tions are potentially relevant. Where are express provision of criminal and civil con- overall use. the parties located? Where will negotiations sequences for breach. These include fines and/or solicitation take place? If there is (criminal and administrative), imprison- Within the Islamic finance industry one in- a special purpose vehicle, where is it incor- ment, voidability of transactions and liabil- teresting development has been that, when porated? Where is the asset that is being ity for damages/restitution. using tawaruq, some Islamic financial insti- financed? Where are the commodities lo- tutions are no longer using commodities cated, and if warrants are being delivered Licensing and solicitation such as metals, but shares. It seems that one then where are they? In the case of shares, reason for this is to avoid paying brokers’ where will they be traded and where else Regulated activities: Shares are one of the fees. However, the use of shares as the basis are they listed or traded? many categories of financial instrument of tawaruq does raise various legal, regula- covered by the FSMA regime, even when tory and Shari’ah issues which often are not However, as these questions suggest, the use issued by a non-UK company. Anyone who fully appreciated by Islamic financiers. of shares as the asset being traded does raise carries on any of a broad range of activities other additional issues. in relation to these instruments may need a Tax and licensing issues licence (‘authorisation’ by the FSA) under Regulatory issues if shares are the traded the FSMA. The activities include acquiring As tawaruq (as with trade murabaha) in- asset or disposing of such securities as principal, volves the purchase and sale of assets, it will as agent or just making arrangements for also be important to consider the possible Financial regulation and other laws often someone else to do so. The regime also impact of tax on the various transaction have an element of extra-territorial applica- covers advising an investor or potential legs. tion. Their application can be triggered by a investor. fairly tenuous connection with the jurisdic- Does the purchase and then onward sale of tion concerned – for example because par- Financial promotion: The financial promo- the assets by the Islamic financier result in ties to the transactions are incorporated or tion regime prohibits any communication any capital gains or other profit-based tax? operate in the jurisdiction concerned, assets of an invitation or inducement to engage Is VAT, which has been an increasing con- which are the subject of the transactions are in investment activity (which includes enter- cern with greater focus on delivery mechan- located or are listed or traded there, or even ing or offering to enter into any agreement ics in commodity murabaha/tawaruq because negotiations or other actions in re- under which a party would buy or sell secu- transactions, an issue? The Shari’ah requires lation to the deals have been initiated or rities or exercise rights conferred by shares), proper documentary evidence of the transfer performed in a jurisdiction. except where the promotion is made or ap- of title from the original supplier to the proved by a person authorised under FSMA. Islamic financier and then from the Islamic Where shares are the traded asset, the par- financier to the customer: are there any ties to the transaction should consider their There are safe harbours from both of these documentary or registration fees to be paid? position under licensing, solicitation and regimes, but the two sets of safe harbours This is a reason why UK shares are not market abuse regimes in particular. In the are not the same and all must be navigated generally used, since stamp duty reserve tax UK these are: carefully. Any person who is not an FSA (SDRT), or possibly stamp duty, would ‘authorised person’ should not conduct a generally be payable – it is not easy to rec- J the restriction on ‘regulated activities’ potentially licensable activity or issue a po- oncile the repo exemption criteria with under the Financial Services and tentially prohibited communication without Shari’ah principles. Markets Act 2000 (FSMA); first checking that appropriate safe harbours J prospectus requirements and the FSMA apply, such as the safe harbours: If the Islamic financier is involved in re- restriction on ‘financial promotion’; peated trades in a particular jurisdiction this J the FSMA regime penalising ‘market J for certain promotions targeted at can raise more general issues as to whether abuse’; institutional or professional investors it has created a permanent establishment for J UK criminal laws preventing insider or large corporates; tax purposes and there can also be other is- dealing; J which exclude from licensing require- sues such as whether it needs to register J for any UK-licensed firms involved in ments persons who do not hold

www.newhorizon-islamicbanking.com IIBI 17 ACADEMIC ARTICLE NEWHORIZON July–September 2009

themselves out as engaging in the pre-arranged between certain parties; J is based on information not generally business of buying securities (or any J the shares or interests in shares may be available to market users; other investments) with a view to selling transferred off-exchange, before the J could give a false or misleading impres- such investments, if their regular shares are resold; sion as to the supply of, or demand for, business is not the provision of any J various parties may know about the the price of shares, or shares related to services or the performance of any intended dealings of other parties; investment. activities in relation to securities, J even if dealings take place on exchanges derivatives or similar investments. in one country (the USA for example), Finally, there is another UK criminal of- some or all of the shares concerned may fence of misleading practices. This applies The UK connection: The regulated activity also be listed in or traded on markets in where a person does any act or engages in and financial promotion restrictions do not other countries (such as the UK). any conduct which creates a false or mis- apply to any activities that take place out- leading impression as to the market in side the UK and do not involve any person UK and European regulation: Insider shares if certain other conditions are also in the UK. If any person within the UK dealing is a criminal offence in the UK. satisfied: (even temporarily) is involved in a transac- tion, or receives promotional documents, There is a risk of the offence being commit- J a purpose to create a false or the restrictions may bite, even on a party ted in the context of share transactions, if the misleading impression; outside the UK. Temporary presence in the information about the transactions would be J an intention to induce any other person UK for the purposes of negotiation is not likely to have a significant effect on the price or persons to deal in or refrain from generally a problem, especially if the negoti- of any securities in the event that such infor- dealing in any investment. ating parties are institutions or other sub- mation were made public. However, this risk stantial entities. However, the involvement exists only if dealings involve a person within These risks are real if any of the shares of local unlicensed affiliates may be prob- the UK or take place on a UK market. which are the subject of a transaction are lematic, depending upon their precise role. also listed in Europe, or traded on any Of greater concern is market abuse. This exchange or multi-lateral trading facility Market abuse regime mostly stems from European rules. in Europe (or where a related investment It penalises various kinds of behaviour in is so listed or traded, such as depositary The concern: Because the regulation of relation to shares and other instruments receipts, convertible bonds, options, war- insider dealing, market manipulation and admitted to trading on a market in the rants, etc). other market abuse is so broad in many European Economic Area (EEA), and in jurisdictions, it is possible for what might particular: Despite this web of regulation, there are appear to be innocent or innocuous activi- ways to mitigate the risk of committing ties to constitute offences under one or more J transactions or trading orders which some kind of market abuse offence. Careful regimes. The extra-territorial application give or are likely to give a false or mis- selection of stocks and transaction timing of the US, UK and some other market abuse leading impression as to the supply of, may help, especially if combined with other laws and regulations are a particular con- or demand for, such investments; risk management actions. Even market cern, especially when many of the most J dealings on the basis of ‘inside abuse laws have definitions, delimitations liquid stocks to facilitate share murabaha information’ which, as with the UK of scope, defences and exemptions and it are listed or traded in multiple locations. criminal offence of insider dealing, is a is important to negotiate this terrain care- Share murabaha financing transactions can widely defined concept not limited to fully, for all relevant jurisdictions. exhibit a number of factors which may give information deriving from the issuer. rise to concerns in relation to anti-market For example, it includes information Insider dealing, market abuse and fraud abuse laws, such as: relating indirectly to a stock but which provisions in the UK are quite complex would, if such information were made and catch various types of action outside J the scale of aggregate purchases and generally available, be likely to have a the UK. But complexity and extra-territori- disposals of shares can be quite high, significant effect on the price of that ality in this area are not unique to the UK. especially in the current market stock or any related investment. That is why, especially given the current environment; volatility of and depressed volumes in cer- J the operation may involve a purchase In the UK, market abuse also covers behav- tain stocks, it is important to obtain advice and immediate (or almost immediate, iour in relation to shares traded on the in relevant jurisdictions and develop a clear and perhaps pre-arranged) resale of London Stock Exchange or any other UK dealing strategy to ensure that the risks of shares; recognised investment exchange where that market abuse allegations are minimised or J some legs of the transactions may be behaviour: eliminated.

18 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Rajab–Ramadan 1430 FOOD FOR THOUGHT

Interest rate risk: a threat to the Islamic banking system?

IIBI would like to thank everyone who responded to the controversial issue of interest rate risk and its impact on Islamic finance, featured in the previous edition of NewHorizon. A lot of responses were critical of the Islamic finance industry as it stands today, accusing it of being nothing more than an adapted version of its conventional counterpart.

‘Islamic and conventional banks are under is selling lamb meat without any regard the majority of Islamic finance transactions the same roof of a federal reserve,’ says one for these conditions, even if both have the are based on debt-based contracts such as reader. ‘They both depend on the interest same sale price, one is halal and other is murabaha (cost plus mark-up) and ijara rate, so it doesn’t make any difference what- haram. Similarly, payments may appear the (leasing). There is little focus on equity- soever whether a product is labelled Islamic same in conventional and Islamic offerings, based contracts of musharakah and mu- or conventional. It is practically one and the but due to the difference in the process and darabah, and there are genuine commercial same thing.’ He goes on to state that the the contracts, one is halal and other one is reasons for this avoidance of equity-based problem lies not in a specific financial insti- not. contracts. tution, but in the way the entire financial system has been created. He calls for tack- The biggest problem IFIs are facing today is Is there a need to re-invent the wheel and ling the problem at the root: ‘once we that there is no alternative to LIBOR that create a new financial system? Probably not. change the financial system we can then they can apply. Due to their small size and Holy Prophet (PBUH) ratified those busi- change the banking system’. minimal bargaining power, they have to ness practices which were prevalent at his ‘follow the traffic’. time and were good for the society, and for- For this reader (as well as many others who bade those that were harmful. Gradualism have responded to the ‘Food for Thought’ Conventional financial system practices is the approach used by Islam whether it is section), the real Islamic bank is the one have evolved in the last two centuries and finance or other matters. All rulings men- without any interest at all. And the real Is- there will be a similar learning curve for tioned in the Quran or all prohibitions of lamic finance system is the one that does not Islamic finance. Broadly, every financial Shari’ah were not declared in one go, it was have the sentiment of time value of money product may be either equity or debt or hy- a gradual process. (TVM). ‘TVM has been created to make brid of two. With debt, normally there are this financial system work to meet its inter- fixed returns but a person providing finance Concept of ‘opportunity cost’, or TVM, est and has been proved by the pretentious has no upside participation and is usually has always been there and will remain so. formula.’ indifferent to commercial results of the busi- For example, sale price on deferred payment ness, provided there is no risk of business is normally higher than on spot and vice But Islamic financial institutions (IFIs) oper- becoming insolvent. With equity finance, versa. TVM concept is different in Islamic ate within legal and regulatory frameworks the financier is essentially buying a stake finance compared to conventional finance that were not developed for them. That is in the business with unlimited upside partic- as TVM can only be applied when capital why countries like Malaysia and the UK ipation. Conversely, if the business does is used in trading, leasing and business ven- have made amendments in their regulations badly the financier may make no returns ture. There is no fixed return (interest) on to facilitate Islamic finance transactions. and also be unable to recover the initial in- capital. Similarly, there is no concept of However, the use of interest-based bench- vestment. Hybrid contracts lie between compounding of interest in Islamic finance. marks such as London Interbank Offered these two extremes of debt and equity. Late payments charges, for instance, cannot Rate (LIBOR) for pricing does not make be part of Islamic banks’ income and must Islamic products haram. Debt financier is normally considered risk go to charity. If this concept of TVM is ap- averse compared to equity financier who plied with prudence and prohibition of For example, if a person is selling lamb is a risk taker. As different investors have gharar (excessive uncertainty) is observed, meat which was processed in compliance different attitudes to risk and reward in a it will have a tremendous impact on the with Shari’ah principles (i.e. the way the society, therefore, both forms are essential stability of the financial system and chan- animal was slaughtered) and another person to meet the needs of investors. At present, nelling capital for productive purposes.

What do you think? Please email us at: [email protected] or [email protected]

www.newhorizon-islamicbanking.com IIBI 19 ANALYSIS NEWHORIZON July–September 2009

Understanding gharar

Riba and gharar prohibitions are fundamental pillars of Islamic finance. Yet it seems that there has been much more focus on the former, even though both are equally essential for understanding the industry. Beata M Paxford, Poland-based lawyer and PhD candidate at Warsaw University, attempts to redress the balance.

When talking about Islamic banking and fi- legally binding contract. Thus, if one of nance, for those who are not very familiar the afore-mentioned resolutions contains with the subject, the only known notion is gharar, the whole contract is deemed in- the lack of interest. The idea of riba prohibi- valid. However, it is different when it comes tion derived directly from the Holy Quran to the minor matters of the contract. If they seems the most essential pillar of the trade. have an element of gharar, they can be sim- However, to fully grasp the whole concept ply removed from the contract without de- of Islamic finance, one must not forget, and stroying its core. One can of course argue therefore undermine, the second essential about the importance of such minor matters pillar of Islamic finance and banking, which and what exactly can be regarded as minor. is the prohibition of gharar. Still, if you look at a standard westernised contract, clauses based on interest can be Gharar, when translated literally from Ara- removed from the contract without danger bic, means cheat, or uncertainty. The term of infringing its main resolutions. refers to behaviour that can be regarded as dishonest, or to a situation that is unclear or To facilitate the matters of interpretation, ambiguous for those involved. Nevertheless, the scholars came up with a division of it is fair to say that there is no uniform defi- gharar into two categories: gharar-e-kathir nition of the term. It has to be emphasised and gharar qualil. Gharar-e-kathir means that gharar pertains to a whole area of situa- excessive uncertainty in respect to the key tions and types of behaviour that can be resolutions of the contract. Meanwhile, viewed as unclear, deceitful or risky. gharar qualil refers to a so-called nominal uncertainty, where the scope of gharar pres- From the legal point of view, gharar as a ent does not render the contract void. The concept refers to a contract or an agreement contract which contains gharar-e-kathir is that contains elements of gharar, or in other simply invalid and prohibited in Islam. words, an agreement which implies cheating, uncertainty or risk. Any legal relationship To inspect the matter closely, one has to of contractual origin between the parties, ponder the existence of gharar in the main which contains an element of gharar, is elements of the contract, i.e. subject matter deemed null and void by virtue of law and remuneration (or the price). A simple (ex lege). sale contract can be used to demonstrate this. The concept of gharar and the invalidity of the contract cover two key resolutions of Gharar can refer to: What is interesting is that the contract. That is subject matter and re- 1. uncertainty towards the existence of the gharar in a modern legal muneration (or the price in a sale contract). subject matter; system can be regarded as These two resolutions are the most important 2. uncertainty towards the possession/ elements of the contract and their presence ownership of the subject matter; unfair competition or unfair is obligatory. Otherwise, there would be no 3. uncertainty towards the price; business conduct.

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4. uncertainty towards the payment of the which a man cannot have any influence. fee, which is usually based on LIBOR (the price; Moreover, it is argued that time and future London Interbank Offered Rate, an interna- 5. ignorance (jihalat). are divine domains, and thus they should tionally recognised interest rate benchmark). not be governed in any way by a man. Hence, the borrower does not know how In the case of the first example, as all schol- However, the assumptions in takaful (co-op- much money he is obliged to pay back to ars agree, a contract where the subject eration and support in communities) prevail the bank. There is uncertainty in respect matter does not exist is prohibited and thus over the possible existence of gharar, thus of one of the most important elements of void from the outset (ab initio). It refers, for making these contracts Shari’ah-compliant. contract. instance, to a contract where a seller sells the foetus of an animal that has not been The second example presents a situation In a wider understanding of the term, gharar born or a crop that has not been sowed. where a seller disposes of a thing without also indicates cheating or deceit. It may, Generally, the rule has it that the subject any legal title to it. It renders the contract therefore, imply that one of the parties to matter must exist at the time of entering automatically invalid. For instance, a seller the transaction wishes to cheat on the other into the contract. Otherwise, a person dis- sells something that is not in his owner- or to simply mislead the other. This can be poses of madum (a non-existent item), ship/possession. The good example of this observed in the advertising of banks and and the sale of madum (bai al-madum) is kind of gharar is naked short selling. Naked financial institutions. They sometimes use deemed null and void. Nevertheless, there short selling takes place when a trader sells unfair advertising which might lead if not are still some doubts between the scholars if derivatives or other instruments like bonds to deception then confusion of a client. For the presence of madum in a transaction will or promissory notes that he does not pos- instance, a bank that wishes to collect the de- always lead to its invalidity due to the pres- sess, but hopes to possess in the future. The posits from the market organises an advertis- ence of gharar. It is argued that in the case transaction is worthwhile if the price of the ing campaign where it promises clients the of takaful, the existence of gharar cannot underlying instrument (currency, gold, stock highest annual percentage rate (e.g. ten per impair the validity of a contract. First of all, prices etc.) is going the way the trader ex- cent per deposit). The clients see the advert takaful, similar to standard insurance, does pects. If it goes the right way and the trader as a potential way of making money quickly not stipulate the exact amount the person buys the underlying instrument, he can and enter into a deposit agreement with this entitled to insurance gets. Furthermore, it make a profit. If not, he loses as well as bank. They are not aware that the advertised can be cited that insurance as such does not those who bought the subject matter that percentage is, in fact, ten per cent only if the exist at the time the contract is entered into. was not in the possession of the seller at the deposit is kept in the bank for two years, and In a conventional insurance contract, the in- time of the transaction. Such a transaction is they get it in the very last month of the de- surer promises to the insured that the latter obviously invalid from the Islamic point of posit term. The whole agreement with the will receive some amount (stipulated in the view. Firstly, the seller does not have a legal bank as well as the advertising campaign contract) if a certain event, for example, an title to the item he wishes to sell. Secondly, would be deemed null and void due to the accident or unemployment, takes place. This the success of the whole transaction is based very existence of gharar in respect of the happens only providing that the insured purely on speculation. Therefore, the whole main subjects of the transaction. pays a fixed premium. Such an arrangement contract contains gharar and is considered contains gharar due to two main reasons. haram. A similar situation took place in Poland Firstly, the insured never knows if he will not so long ago, where one of the leading receive the stipulated insurance coverage, Uncertainty in regard to the price appears financial institutions coaxed the potential even if the event occurs. Secondly, according when the parties decide to enter the transac- customers into opening a deposit account to some scholars, it is wrong to subject tion, in which the subject does not have an offering them hefty percentage. However, values like health and life to a contract. exact price stipulated in the contract. There- what was skilfully omitted by the bank was fore, neither the seller nor the buyer knows that the deposit account was to be created Conventional insurance is, as a rule, re- how much money will be earned or spent not for twelve months but 18, and the garded as haram. The answer to this is cre- for the item. One of the basic requirements promised percentage was accrued in the ation of takaful, Islamic insurance based on for a standard sale transaction is that the 18th month. The bank was fined for unfair co-operation and help. Takaful can be cre- price has to be precisely fixed. Otherwise, competition by the authorities. ated on the grounds of mudarabah, wakala the contract contains gharar and is deemed or a combination of both. Takaful in its invalid ab initio. Such a situation would What is interesting is that gharar in a modern essence is aimed at protecting communities take place if a borrower takes a consumer legal system can be regarded as unfair com- against some unexpected events like natural loan from a conventional bank to buy, for petition or unfair business conduct. Why? disasters. Both in the mudarabah and instance, a car. He gets from a bank, say, Gharar, contrary to riba, has not been ex- wakala models, some scholars see elements $10,000, but he has to pay back the princi- pressly defined, and as a term it covers of gharar, in respect to the future events on pal amount plus interest (riba) or the bank’s certain types of behaviour that involve risk,

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uncertainty, cheating, deceit or misleading. stance, the example of jihalat in contracts In respect of gharar qualil, the issue seems While some scholars remain unanimous to- is bai’tan fi bai’atin, which indicates a situa- to be more complicated. The analysed car wards the existence of gharar in certain tion when two contracts are combined in financing contract can be deemed haram if transactions, in other contracts the question one transaction. This can apply to the mis- gharar affects the main elements of it – the is still disputable. Unfair competition under- understanding of an ijara wa iqtina contract, subject matter and the price. But, if gharar mines honest trade and business; it jeopar- which, for those unfamiliar with Islamic affects other terms and conditions that are dises the credibility of a company and of the rules, is seen as combined contracts of lease also important for the client, can it then be whole industry that the company stands for. and sale. considered halal? It is doubtful; the idea of Hence, it may be regarded as an important any contract under Shari’ah is the absence issue from the gharar point of view. Gharar also refers to so-called informational of riba, gharar, maysir and qimar, and the asymmetry. It occurs when one of the parties presence of the informational symmetry as However, some argue that unclear advertis- of a contract is not fully aware of their well as profit and risk sharing. In a stan- ing might be considered as gharar qualil. It rights and obligations. It might occur when dard facility agreement, there is no risk is the author’s opinion that if a client enters a borrower enters a standard facility agree- sharing in a way understood by Islamic into a deposit account contract with a bank ment to obtain financing to buy a house. He banking and finance. The bank’s risk is due to misleading advertising, such an is then served with a contract which con- covered by the mortgage created over the occurrence can be regarded as gharar-e- tains many clauses that are usually difficult property, while the client’s risk is with the kathir, which renders the contract invalid to comprehend. Banking contracts often use property and the money he invested in it. In the author’s opinion, conventional loans and other facility agreements are affected Gharar cannot be perceived as a certain element, but as a whole by gharar-e-kathir and should be consid- set of elements depicting different behaviours. As it is not clearly ered haram ex lege. defined (unlike riba) it may sometimes lead to ambiguity and doubt. Gharar cannot be perceived as a certain element, but as a whole set of elements depicting different behaviours. As it is not ex lege. The influence of the advertising in- complicated legal and banking language and clearly defined (unlike riba) it may some- dustry cannot be discredited or undermined. the clients are confused as to the meaning of times lead to ambiguity and doubt. How- Regardless of the financial crisis, companies the terms and conditions stipulated therein. ever, if one intends to get to the bottom of do not decrease their expenses on advertising References to LIBOR, payment default or gharar, it is necessary to understand the aim as everyone is aware of its strength. Many of liquidated damages are clear for lawyers and of its prohibition. The idea in Islam is to us buy an item that might not be necessary bankers, but an average customer is rarely facilitate trade. The ban on gharar does for our existence at all, but we are encour- closely familiar with these terms. not simply serve to limit transactions for aged to purchase it by adverts. the sake of it, but its main aim is to protect Hence, a contract where one party is obvi- the main pillars of Islamic business con- In the case of uncertainty in the payment of ously misinformed about the risks and its duct. Thus, when one wishes to verify the price, it is advised that the price should duties and entitlements could be considered whether the existence of gharar and its be paid on the spot. This can refer as well haram. The question appears, though, if the scope will render a transaction haram, to the forward sale contract (e.g. salam). To gharar refers to the linguistic sphere of the one needs to see what elements of the avoid any doubts or ambiguities, a spot pay- contract or its terms and conditions which contract are affected by gharar and then ment ensures that the seller gets its due re- imply the asymmetry between the parties. take a decision. muneration and it proves that the buyer has If it is only the language that is affected by a serious intention to purchase the item. gharar, this can be omitted by changing the Although it is not problematic for the That is why, in general, derivatives are re- terminology or explaining it in a simple and Shari’ah scholars to ruminate over differ- garded as invalid due to the existence of unambiguous manner. However, even after ent types of gharar, it would be virtually gharar-e-kathir. the linguistic correction, there still may re- impossible for them to analyse every single main some doubts about the conditions, clause. It should be the role of each Islamic Jihalat is one of the ways in which gharar is rights and obligations of the parties. Can bank or Islamic banking professional to expressed. Jihalat indicates ignorance, which it render the contract null and void? It verify each contract from the gharar point can be understood as lack of knowledge depends on the scope of gharar. As previ- of view, concentrating on the scope of it, and awareness of its duties in the world. In ously mentioned, gharar-e-kathir usually that may contradict and undermine the finance and banking terms, it can be viewed invalidates the contract as it affects the key values that the prohibition of gharar as uncertainty in legal contracts. For in- resolutions thereof. protects.

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ANALYSIS NEWHORIZON July–September 2009

Islamic working capital financing

Dr Salman Khan, NIBAF-certified Islamic finance practitioner and head of Shari’ah of Abu Dhabi Islamic Bank in Dubai, examines the issue and looks into moving beyond murabaha, tawaruq, sale and lease back and covered drawing structures.

Overview In conventional finance, WCF is typically provided via interest-bearing loans to the Capital investment is an obvious prerequi- business, or alternatively by offering a site for the establishment of all new busi- ‘credit line’ of finance on which interest is nesses and productive enterprises. However, charged depending upon the amount and once in operation, businesses and firms also duration of usage of funds. need to maintain access to capital resources and liquidity on a regular basis in order to In comparison, a number of Shari’ah-com- be able to function smoothly and efficiently. pliant product options have successively This latter type of capital is defined as emerged seeking to address both WCF-1 working capital, ‘working’ in the sense that and WCF-2 needs of businesses. it allows enterprises to carry on working and functioning in accordance with their At the outset, it should be observed that business objectives and production goals. As WCF-1 products are generally regarded as a more formal definition, working capital is being more acceptable since they are largely defined as current assets of the business less based on real trade or financing genuine Dr Salman Khan, current liabilities, where the balance pro- productive activities. In contrast, since the Abu Dhabi Islamic Bank vides the figure available to the business to majority of WCF-2 solutions do not really develop, build, and expand its operations involve directly any real productive activity, further. they are often not viewed to be first-choice WCF options. Working capital financing (WCF) may be required for a number of purposes: Yet, since WCF-2 products provide ‘cash-in- hand’ to the client, in theory they could also 1. Raw material purchases; be used for WCF-1 purposes. Moreover, 2. Buying inventory; since many clients are used to dealing with 3. Purchasing equipment/land/resources conventional banks based on a ‘fixed cost of to expand productive capacity; funds’ arrangement, they often have the in- 4. Advertising; clination of seeking ‘cash-in-hand’ WCF-2 5. Paying staff salaries; from Islamic banks, even if the money is 6. Meeting other business-related costs needed for a specific WCF-1 requirement – (e.g. utility bills, other debts due on the and also because this gives them the per- firm, etc). ceived benefits of less accountability and added flexibility to use the money ‘wher- Hence, WCF needs may in general be seen ever, for whatever, however’, in exchange to target two categories of business needs: for a known liability. Therefore, to minimise the use of WCF-2 products, Islamic banks J Specific asset or good-based needs of the must initially scrutinise thoroughly the un- business (1–3 above), defined as WCF-1; derlying need for which the finance is being J Periodic liquidity needs and miscella- requested by the customer, and to the fur- neous costs (4–6 above), labelled as thest degree possible try to find a WCF-1 WCF-2. solution.

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WCF-1 – specific finance needs acquire joint ownership of the required provide liquid resources to the client, un- asset. Beyond this, it involves two independ- fortunately, it is used rather sparingly, and We begin with WCF-1 needs, such as fi- ent contracts of lease, and (periodic) sale. mainly in Sudan and Pakistan, largely be- nance for specific goods, e.g. raw material, Over time, the client periodically buys the cause banks feel the risk of exposure of machinery, electronics, etc. One option is bank’s share in the asset and eventually holding ownership of the good until deliv- goods murabaha, in which the bank pur- owns it fully. In the interim, the client must ery is unacceptably large. however, it is chases the requisite specified goods and pay the bank rent for the portion of the possible to mitigate this risk if the bank sells them to the client, earning an added asset owned by the bank. The bank makes enters into a parallel salam sale, timed to profit (mark-up) over the cost of the goods, its return via the sale of its asset shares plus sell the same goods to a different party just with price typically deferred in instalments. the rental charged to the client on the bank’s after the seller from the first salam delivers share of the asset leased to the client. these goods to the bank, thereby locking its Another potential WCF-1 solution may be profit. Alternatively, the bank could delib- available via the manufacturing sale con- It is observed that banks increasingly tend erately select products from markets that tract of istisna which covers most raw mate- to prefer IMBT to DM since the former af- display less volatility in general, as a fur- rial, inventory, and durable goods needs. fords the bank ownership of the asset until ther hedge. Moreover, as a general point, Typically, the bank will conduct two parallel the very end of the lease term, a situation as and when salam products become used istisna transactions; firstly, via a purchase which particularly helps to avoid mess and more frequently, it may realistically be ex- istisna the bank will sell the client the re- legal wrangle in a default situation. pected that successively better arrange- quired goods, and next, it would organise ments for managing this price-risk by the a sale istisna with the actual producer of WCF-2 – ‘cash-in-hand’ finance bank would emerge over time. the goods who would supply it the required items, enabling the bank to deliver the In addition to WCF-1, the need for WCF-2, An ijara-based product which is commonly goods to the client on the due date. As an i.e. ‘cash-in-hand’, is a very frequent and used to satisfy WCF-2 needs is sale and added benefit, istisna payment schedules ubiquitous requirement for most businesses. lease back (SLB). In effect, SLB is an exten- can usually be made as flexible as the client While none of murabaha, ijara, DM or is- sion of IMBT discussed above, with the needs. tisna can be used for intangible WCF-2 pur- crucial difference that the transaction be- poses (such as cash requirements to pay gins with the sale of an existing durable Carrying on with WCF-1 needs, ijara via salaries or utility bills) other options are asset owned by the client in the first place the application ‘ijara muntahiya bit tamleek’ available. to the bank, followed by the client acquir- (IMBT), which translates as ‘lease of asset ing the same asset on an IMBT or lease-to- culminating in ownership of the asset by A prominent solution lies in the use of own basis from the bank. Thus, SLB is the lessee’, may also be used for all durable salam, a sale contract in which the price is actually a staggered buy-back where the goods requirements. Here, the bank pur- paid in full upfront while the commodity underlying asset simply provides the basis chases the asset needed by the business, and is delivered later on at a specified time and for bank offering the client finance, and then leases out the same to the business for date. This way, the client gains access to the purchase or sale of the asset are not a certain duration. The total lease payments finance in an indirect way. The bank con- the real purpose of the transaction. More- include the asset price plus the bank’s ex- tracts to buy a salam-eligible commodity over, the lease term must be at least one pected profits. At the end of lease period, from the client as seller, and the salam sale year, a Shari’ah restriction which has been the bank sells the asset to the business at a price of the goods being sold is usually inserted with the aim of breaking the link nominal price. equal to the amount of finance sought by between bai al-ina and SLB. the client for his liquidity needs. Typically, As opposed to murabaha where the bank’s in salam, to incentivise the buyer to pay Bai al-ina is an ‘immediate buy-back’ fea- return is fixed at the outset, ijara has the upfront, the buyer is offered a below-market turing a spot sale of an asset by the client extra advantage of allowing the use of float- price with the prospect of selling the com- to the bank, followed by the immediate ing rates of rental which protect the bank’s modity later upon delivery at a profit. resale of the same by the bank to the client, position better, which is particularly useful Moreover, to help the client avoid potential at a higher price on instalments; it is, there- for longer-term payment durations. liquidity challenges associated with the fore, strictly outlawed in most Islamic need to make a bulk purchase at the due financial jurisdictions since it is widely Musharakah provides a potential WCF-1 date, delivery may be staggered over a suit- believed to be a thinly-disguised interest- solution for financing durables, based on able duration. bearing loan. the idea of diminishing musharakah (DM), or declining partnership. DM begins with Even though salam is the only truly Shar- Another similar product in the market is client and bank pooling together funds to i’ah-based product specifically designed to based on tawaruq in which the client buys

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an asset (usually metal or shares) on de- account, the net effect is zero and the client overview on existing Shari’ah-compliant ferred payment from one party, and immedi- doesn’t pay anything. However, if there is a solutions for WCF needs. It is noted that ately sells the same onwards to a different withdrawal (i.e. the ‘credit line’ is used), a number of developments have emerged party on spot to generate the requisite he then needs to pay the bank the shortfall, over the last few years in the Islamic finance finance. The bank usually participates in and that is where the bank makes its profit. industry and Shari’ah-compliant solutions one sale and typically organises both. The ijara and mudarabah work on a similar for WCF-1 or specific asset needs based on Both tawaruq and SLB are viewed with cau- basis whereby in each period: murabaha, ijara, DM, and istisna are now tion in certain quarters, largely due to the commonly available. In contrast, ‘cash-in- perceived artificiality of these transactions. Profit – instalment = client liability hand’ finance or WCF-2 is also offered at present based on SLB and tawaruq as well In tawaruq, the vital issues of meaningful A key criticism of all these SCD products is as the covered drawing structure, while ownership of the traded commodity and its that they are based on an amalgamated salam is also used for WCF-2, although less transfer of ownership at the right time are structure which uses various individually so. In addition, a new musharakah-based typically poorly executed; this is especially Shari’ah-compliant arrangements to copy product seeking to provide a holistic substi- true in case of the high volume repeat day- virtually exactly conventional interest-based tute to conventional running finance (WCF- to-day transactions which in many cases ‘credit-line’ products in terms of customer 1 and 2 needs) has been trialled recently, represent the bulk of tawaruq deals entered liability, payment structures and flows, and albeit with limited Shari’ah acceptability into by Islamic banks. fundamental purpose. Hence, questions thus far. with regard to ‘form’ vs ‘substance’ arise In SLB, the client sells the asset to the bank for these products. Obtaining genuine Shari’ah-compliant prod- based only on a private sale document and ucts to meet WCF-2 needs remains the most the actual transfer of ownership to the bank As an interesting development, a ‘prototype’ challenging task. Perhaps the most natural rarely happens; the asset formally remains musharakah product has been trialled in solution is provided by salam, the only in the client’s name (to avoid extra proce- Pakistan with the aim of potentially provid- transaction that was specifically sanctioned dures/registry costs). Instead, the Islamic ing a solution to all WCF needs, and is by Shari’ah for the purpose of providing bank simply takes a claim to ownership structured as a Shari’ah-compliant alterna- liquidity for economic activity; nevertheless, based on a private document, supplemented tive to a conventional running finance SLB, tawaruq, and covered drawing are the by a mortgage on the asset (similar to con- facility. The bank effectively enters into a most widely used, most probably since the ventional banks’ practice). Moreover, SLB musharakah partnership with the client and bank views its risk as being better covered does not involve any real production or sets up a running musharakah account for when using these products. economic activity of any kind, and in most its client’s business. The client can draw cases, neither does tawaruq. upon this account up to the agreed finance Moving forward, two points will be particu- limit, and can also pay money into this ac- larly relevant to the health and future of Shari’ah-compliant covered drawing (SCD) count. Depending on the net ‘daily balance’ the industry vis-à-vis achieving real Shar- products have emerged recently, and may be position of the account, the client will pay i’ah-based solutions for WCF-2 needs. based on variations of murabaha, ijara, or the bank a corresponding profit share, First, to keep the use of WCF-2 products mudarabah. Typically, they operate via a based on the realised actual profit for the to an absolute minimum, Islamic banks system of parallel transactions of profit- business over the duration. Also, profit may must reliably ascertain at the outset from earning and liability settlement. For in- be shared on a ‘gross’ basis, which should the client the purpose for which the finance stance, in SCD murabaha, the client buys in theory make cost evaluations and profit is needed, and the preference should always metal on credit and sells it immediately calculations easier. be to offer a WCF-1 solution. Only when it (both transactions are arranged by the is genuinely not possible to do so should a bank); the lump sum from the sale is put in Nevertheless, this product very much re- WCF-2 option be considered. an investment account and it earns profit. mains a prototype for the moment since it is seen to be a rather radical innovation, given Second, where customer needs are undoubt- In contrast, the client has the liability to that certain scholars are not comfortable edly for WCF-2, banks should make a pay instalments for the murabaha metal with using the concept of the daily balance determined effort to move away from purchase on credit. Normally, the return method and gross profit sharing for tawaruq, SLB and SCD products in a mean- accruing to the client on the lump sum in musharakah. ingful manner, and instead use salam, the the investment account and the murabaha most natural and purposely designed solu- price instalment that the client needs to pay Conclusion tion for WCF-2, with the necessary arrange- are set so as to be equal to each other, so if ments for managing price-risk as best as nothing is withdrawn from the investment This article aims to provide a useful possible.

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POINT OF VIEW NEWHORIZON July–September 2009

Islamic asset management: myth or reality?

A back-water of Shari’ah finance for a long while, can asset management finally become mainstream? John A Sandwick, an Islamic asset management specialist based in Switzerland, explores this issue.

History of Islamic asset management Conventional vs Islamic asset management

In the early days of the Islamic banking Conventional asset management combines sector back in the 1980s, there was one big the tremendous progress made since the debate about whether zero-coupon corpo- 1950s in statistical evaluation of historic rate and government bonds were Shari’ah- security pricing and the quantification of compliant or not. The practitioners were expected risk and reward. Many Nobel understandably naïve then, as no one at that prizes were awarded to those who advanced time had addressed some of the core issues our thinking on how to invest our savings, surrounding the precise definition of Islamic ensuring that we had a high probability of banking. achieving both income and capital gain objectives in a rational, coherent fashion. Since then the industry has skyrocketed, in particular since 2002 and the modernisation Modern Portfolio Theory, or MPT, first of much of the banking sector in the Middle advanced by a distinguished American econ- East. Just as conventional banks in the Arab omist, Harry Markowitz, in his ground- world were upgrading and updating systems breaking work in 1955, relies on our and procedures, so did the Islamic banks. intuitive sense that we need moderation Moreover, some key figures emerged to help John A Sandwick and diversification among our investments. standardise the process of at least thinking In 1970s, James Tobin advanced this work about basic rules and principles of Islamic by introducing the risk-free rate of return banking. Among them were Mohamed El the professionals than high-volume retail (wrongly criticised by some Islamic banking Gari, Humayon Dar and Mohamed Daud banking or highly compensated investment neophytes), and later William Sharpe gave Bakar, to name only a few of the most no- banking. us tools for more careful evaluation of as- table pioneers. These Islamic scholars and sets through the Capital Asset Pricing specialists placed the first level surface on Now, however, there are the tools and Model (CAPM). which banking professionals could begin knowledge to make Islamic asset manage- developing products and services that met ment a reality. Whether institutional MPT is the bedrock of conventional asset both Shari’ah and international banking investing for pension funds, takaful (Islamic management. It calls for diversification standards. insurance) companies or corporate treasur- among asset classes – cash, fixed income, ies, or retail investing for households, the stocks and alternative investments – and However, very little of this innovative and technology exists to professionally create, diversification inside these asset classes. By ground-breaking work entered the Islamic manage and distribute Islamic mutual funds fine-tuning the allocation over time one can asset management space. Rather, it was the and other assets on a wide scale. reasonably expect MPT to help achieve retail, corporate and investment banking one’s investment goals. sectors that benefited from the professional- All that’s missing is banking institutions isation of Islamic finance industry. Asset willing to follow the path. Strangely There are very good critics, of course, such management seemed to have been the poor enough, the market has witnessed as a French mathematician, Benoît Mandel- stepchild, less exciting and less rewarding to enormous demand, yet almost no supply. brot, who is considered to be the father of

28 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Rajab–Ramadan 1430 POINT OF VIEW

fractal geometry, and a US scholar, Nassim in such a fashion as to achieve the objectives venture capital to be introduced into the de- Nicholas Taleb, the author of the Black of MPT. veloping economies of the GCC. But what Swan theory, but no matter how valid these should have been the normal evolution of a critics may sound they still have not given Islamic asset management: what to buy new, high-risk investment industry became us any practical substitute for MPT. Profes- instead a stampede. From only two private sional asset managers, in other words, must In fact, over the last six years there has been equity houses in the Middle East at the be- still allocate their clients’ money according a pell-mell rush into the sale of derivative- ginning of the decade, we saw over 100 es- to the same rules and principles that have based structured products with a fatwa tablished by 2008. been with us now for almost 60 years. wrap. These products are by and large toxic waste, and the recent meltdown in global The abundance of so many private equity Importantly, just as there is no specialised markets only magnified the underlying houses in the region, plus a big push from field of professional practice called ‘Islamic mistrust about their application in nearly foreign banks to sell their own private eq- dentistry’, so too there is no real separate all institutional and private client portfolios. uity deals, was too much for less sophisti- body of work called Islamic asset manage- Don’t blame the Shari’ah scholars for these cated investors. They consumed them in ment. In other words, both conventional time bombs. They are hired only to say vast amounts, in the process tilting the bal- and Islamic asset management start and whether the investment violates the rules ance of MPT allocations far too deeply into continue in nearly identical processes and and norms of Islamic ethics. The responsi- risky, illiquid assets. share nearly all of the same methodologies. bility for such wasteful investment schemes lays entirely on the shoulders of bankers. Now the chicken has come home to roost. When clients ask a major global asset After all, structured products are not a sub- Investors everywhere – and not just in the management bank to manage their wealth stitute for MPT allocations. They never Arab states – indulged themselves in the using conventional asset management, they have been and never will be. Like Warren fantasy that somehow private equity pro- generally get very good service and perform- Buffet famously said, derivatives are vided less risk and more reward than MPT. ance. No asset manager at Deutsche Bank weapons of financial mass destruction. The cost is high. It hurt the biggest investors or Morgan Stanley would ever consider the most, where private equity cash calls deviating from the universally accepted Yet, that didn’t stop many western banks dried up liquidity. Now we have seen that professional rules of asset management, or and equally Islamic banks operating in the an overly amorous approach to this danger- MPT. They would be fired if they placed Middle East from pushing hundreds of mil- ous zone of the investment universe is best client money into new or untested theories lions, if not billions, of dollars worth of taken in extreme moderation. It may be of investing. these products onto unsuspecting clients. another generation before we see the kind Islamic investors were coaxed into thinking of over-investment in private equity that The performance of conventional asset they were getting a responsive product with occurred during the last five or six years. managers has been extensively studied for fatwa, yet in fact were being peddled irre- The great shame of today’s so-called Islamic almost a generation in what is called attri- bution analysis, and the results are surpris- ingly homogenous among all the world’s asset managers. Why? Because they all use Many investors are seeking the golden egg, the one style of the same methodologies to invest client funds, founded on MPT. investing that is foolproof during all economic conditions. Unfortunately, no one has come up with that bird yet! But when a client walks into a bank and asks for Shari’ah-compliant asset manage- ment there is either one of two responses. The first is an honest ‘no, we don’t offer that service here’. Truthfully, no institution sponsible trash that no professional would asset management industry is that there re- anywhere outside of Malaysia can offer ever buy himself. ally is no such industry. Many claims being Islamic asset management today. made about the applicability of most Islamic During the same period we saw an over- products are generally false. No single The second response is dishonest. Some of whelming consumption of regional and in- major bank or investment company has de- the most prestigious banks in the world ternational private equity, including for real livered a credible line-up of professionally claim they have Islamic asset management, estate, by investors in Saudi Arabia and the developed products that also meet the stan- but in reality, they use derivative-based Gulf region. Why did this occur? Firstly dards of Shari’ah. Perhaps greed, perhaps structured products (with fatwa) combined there was in fact a real need for professional inertia, and perhaps ignorance are reasons

www.newhorizon-islamicbanking.com IIBI 29 POINT OF VIEW NEWHORIZON July–September 2009

for this unhealthy situation. Certainly it is i’ah, in particular when it comes to Shari’ah worst of the swings we’ve seen in the world not a lack of resources. If major interna- compliance of investment products. today. tional and regional banks dedicated them- selves to MPT with fatwa, the situation The community of generally accepted A Muslim investor who wants to achieve could change dramatically in short order. Shari’ah scholars makes it easier for the the same objectives can do so, as long as novice investment manager to achieve a he seeks the aid of a dedicated professional How to invest today according to Shari’ah balanced, professional portfolio allocation. who understands both Shari’ah compliance By choosing assets that have been granted and MPT. Proper security selection can A very few asset management professionals a fatwa by that group of Shari’ah specialists now be made at every level of the alloca- have taken a serious look at what consti- who closely follow financial markets, tion spectrum, from cash to fixed income tutes Islamic asset management and Islamic any investor or asset manager can start to stocks to alternative investments, all wealth management. We have developed the process to assemble a portfolio alloca- with respectable fatwa from notable quantitative models that start with a deep tion that meets both Shari’ah and MPT Shari’ah scholars. While presently there scan of the available universe of Islamic standards. is a dearth of professional managers in products, and then combine them in a for- Islamic asset management sector, with mat that achieves the desired results re- All that said, we are living in dangerous the high demand this trend is likely to quired by MPT. times. One major investment company change. chairman declared earlier this year that Many investors are seeking the golden egg, nearly 40 per cent of worldwide wealth had At the end, we start at the beginning the one style of investing that is foolproof been destroyed by the global credit crisis. during all economic conditions. Unfortu- Clearly we have to be careful. Islamic banking has like other areas of pro- nately, no one has come up with that bird fessional practice witnessed some very cre- yet! There still remains more than abundant Being careful means diversifying your assets. ative, innovative expressions of human risk in the world, and avoiding risk occupies It means not overloading on any single ingenuity. From nothing we have seen the as much time of a professional asset man- asset class, but instead insuring that your development of world-class Islamic retail, ager as actually seeking profits. portfolio is carefully constructed with cer- corporate and investment banking in little tain amounts of cash, fixed income, stocks more than a generation. But, this didn’t yet However, it can be stated unequivocally and alternative investments. A typical allo- extend to Islamic asset management. here that Islamic asset management is no cation today for a non-Muslim investor different than conventional asset manage- might be five per cent in money market in- Hopefully, over the next few months and ment when it comes to constructing a port- vestments (cash), 45 per cent in a diversified years, new Islamic investment products folio that will have a high probability of mix of bond funds (fixed income), 35 per will be introduced to the market. MPT achieving an investor’s goals. To do that an cent in a globally diversified allocation of has given asset managers a path to respon- investor seeking professional investments stock funds, and 15 per cent in a mix of sibly invest their clients’ savings, and if with competent fatwa does not need to real estate funds, hedge funds, commodity they want those investments to also carry sacrifice anything: not performance, not funds and other alternative investments (but fatwa then we owe it to them to deliver. transparency, and not pricing. no structured products, please!). This pro- Now that we’ve seen Islamic asset manage- vides no guarantee of outstanding perform- ment can become a reality, it’s time to The process starts by choosing an asset ance in the short run, but it does guarantee deliver the products and services people manager who understands Shari’ah. For that your savings are protected from the want. many bankers, the entire concept of socially conscious investing is perfectly acceptable, but the idea of Shari’ah-compliant investing Islamic asset management & Islamic wealth management is strange and exotic. It isn’t. Shari’ah is not rocket science, understood only by a rare Some readers may be confused by the often interchangeable use of Islamic wealth and qualified few. It is the guiding principles of Islamic asset management. Conventionally, there is a difference. Wealth management a faith with over a billion adherents. Surely often refers to professionally managing the wealth of an individual or a family. Asset such a popular and common religion doesn’t management means investing for an institutional client, such as a pension fund or exist based on mysteries and secrets. The waqf, or a bank’s treasury department. However, whatever the name there is no es- moral precepts of Shari’ah are abundantly sential difference between the two. Professional asset management involves the same clear to anyone who wishes to pick up a rules, processes and results whether for individual or institutional savers. This equally copy of the Holy Quran. Bankers unfamiliar applies to Islamic wealth and asset management. with Islam will find nothing alien in Shar-

30 IIBI www.newhorizon-islamicbanking.com

IIBI NEWS NEWHORIZON July–September 2009

Poznan University students visit IIBI

A group of ten students led by B briefed the group on Islamic value of money in Islamic and relevant to modern day financial W Kulas from Poznan Univer- economic concepts, their appli- conventional finance. He transactions and whether Islamic sity of Economics in Poland cations, and how the modern pointed out that the requirement banking is for Muslims only. called on the IIBI, as part of the Islamic finance industry has for all activities to comply with Shafique explained that business London Study Excursion, the evolved in the last three Shari’ah provided an extra layer principles of profit-and-loss university’s prestigious business decades. He also explained the of regulation, with independent sharing were not invented by meeting programme with pro- popular contracts used in Is- Shari’ah scholars supervising Islam. These were there before fessionals from London’s finan- lamic finance transactions and this function. It was the screen- the advent of this religion, but cial institutions. The group how Islamic financial activity ing criteria used in Islamic in- have been properly endorsed and was received by Mohammad needs to be institutionalised in Shafique, the IIBI’s programme linked to real Poznan University students and Mohammad Shafique (far right) Islamic commercial development co-ordinator. It in- activity. He law. These principles cluded members of the Students’ emphasised that are universal in na- Scientific Association of Capital while the Shar- ture and very close Investments, ‘Profit’, which is a i’ah-compliant to the concept of part of the department of invest- industry may venture capital in ments and capital markets at the play the same modern context. university. The overall purpose role as a finan- However, due to of the visit to London was to cial intermediary legal, regulatory broaden the students’ knowl- in its conven- and tax reasons edge in local and international tional counter- these cannot be capital markets. The excursion part, its activities are subject to vestment that could be said to applied fully by Islamic banks. was promoted by the Leslaw A. Shari’ah compliance, which re- have saved Islamic investors Islamic finance is an inclusive Paga Foundation. stricts debt creation out of thin from massive losses and shielded phenomenon where persons air, and its trading. This princi- Islamic financial institutions from all faiths or even no faith Shafique provided the group ple, along with others, such as from the effects of the global may work as long as they sub- with an overview of IIBI’s edu- avoidance of interest (riba), financial crisis. scribe to the ethical and moral cation, training and publication excessive uncertainty (gharar) principles emphasised by activities for raising awareness and gambling (maysir) provides After the presentation, there was Shari’ah that promotes socio- of Islamic economic principles stability to the financial system. a lively Q&A session. Students economic justice, such as not and building a skill base for the Shafique also explained the dif- raised various questions, such as undertaking an activity which Islamic finance sector. He ference in the concept of time how 1400 year old concepts are is harmful to society.

King Fahd University of Petroleum and Minerals calls on IIBI

Dr Nabil Ghalleb, assistant pro- centre of excellence on Islamic of other institutions like the lenges the industry faces in terms fessor of Islamic finance, and Dr finance and banking. The cen- IIBI that will help KFUPM to of shortage of qualified personnel. Salah Al-Shalhoob, assistant tre’s main objective is to spread achieve its vision to become a professor of finance and eco- knowledge in the field of Shar- leading centre for the research, KFUPM, established in 1963, nomics at the King Fahd Univer- i’ah-compliant finance through training and teaching of Islamic adopted advanced training in the sity of Petroleum and Minerals academic and training activities. finance in the Middle East. fields of science, engineering and (KFUPM), visited the IIBI. They It is expected to encourage and management as one of its goals in met with Mohammad Qayyum, enhance education and scientific Qayyum briefed Dr Ghalleb and order to promote leadership and director general of the institute, research as well as professional Dr Al-Shalhoob on the continu- service in Saudi Arabia’s petro- and Shafique. KFUPM is consid- development in the field. ing role that the IIBI is playing leum and mineral industries. The ering enhancing its research ca- in the professional development university also furthers knowl- pabilities in Islamic finance, and The purpose of the KFUPM visit of human capital for Islamic fi- edge through research in these is in the process of establishing a was to learn from the experience nance industry, and the chal- fields.

32 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Rajab–Ramadan 1430 IIBI NEWS

IIBI awards post graduate diplomas

The IIBI’s Post Graduate Diploma (PGD) course in Islamic banking and insurance, Excellent course! For someone who had only studied and inter- offered since 1994, is highly regarded acted with the discipline from a distance, I found the course worldwide. UK-based Durham University extremely helpful to bridge the theoretical side with how its has accorded this course recognition as an principles can be applied to daily business life. entry qualification for its postgraduate de- grees in Islamic finance, including the MA Thomas Polson, Cascade Risk Placement and MS in Islamic finance and the Research MA. Applicants will also have to fulfil the specific entry qualifications for each specialist degree programme. This course gets to the core of why Islamic finance is truly an To date, students from nearly 80 countries alternative. It does not hinge on one unacceptable practice but have enrolled in the PGD course. In the rather the full spectrum of what is permissible or not. The period of April 2009 to June 2009, the course addresses the challenges faced when operating within following students successfully completed the conventional system and how to deal with them. I believe it their studies: caters for both novice and professional individuals. I wish that the Institute continues going from strength to strength. J Abdellatif Dafir, project manager, Sungard, Zaid Bhana, Swiss Re Africa France; J Muhammad Salman Chaudry, J Tarig Osman Abbas Bakheit, assistant J Adnnan, senior vice president, associate (audit and assurance vice president, Union National Bank, Allied Bank, group), PricewaterhouseCoopers, UAE; Pakistan; Pakistan; J Thomas Polson, director of marketing J Auwalu Ado, regional J Oguz Aktuna, Turkey; and research; Cascade Risk Placement, training manager, US; Intercontinental Bank, J Rayya Al-Azzawi, Jordan; Nigeria; J Wilson Valerian Monteiro, process J Sajid Saleem, managing executive, Deutsche Bank, India; J Hiba Ali Elarabi, Saudi Arabia; director, Globex 2000, UK; J Zaid Bhana, vice president, Swiss Re J Mamoun Shaikh Mahmoud J Shafiel Karim, US; Africa, South Africa; Yousef Naser, ITS consultant, GBM (Oman), Oman; J Shruti Jaipuria, consultant, Oracle J Zamri Bin Mohd, Singapore. Financial Services Consulting, India; J Maryam Uwais, Wali-Uwais & Co, Nigeria;

J Mohammed Furqan Habib, manager, underwriting, ABN Amro Central Enterprise Services, India;

J Muhammad Haneef, vice president, Security Investment Bank, Mohammed Furqan Shruti Jaipuria Wilson Valerian Shafiel Karim Pakistan; Habib Monteiro www.newhorizon-islamicbanking.com IIBI 33 WORKSHOP REVIEW NEWHORIZON July–September 2009

Sukuk, their applications and challenges

In April, delegates from as far away as Tanzania and Malaysia gathered in London to attend the IIBI sukuk workshop, looking at the factors facing these instruments and examining the detail of some actual structures used by recent issues.

The spectacular growth of the sukuk market The workshop heard that the size and cov- Sukuk workshop from 2004 through to 2007 may have erage of the issues to date means that there slowed recently. The announcement by is potential for growth outside of the tradi- AAOIFI in 2008 regarding the perceived tional Muslim markets, with interest being compliance of some sukuk arrangements shown by the monetary authorities of Singa- coincided with the credit crunch. While the pore and Hong Kong, as well as the govern- slowdown may initially have been a reaction ments of UK and France. Although most to the global financial turmoil, internal pres- sukuk issues have been done by govern- sures within the industry itself have not ments or government-backed entities, there helped to ease investors’ minds. The work- is more potential for large corporates of in- shop examined the underlying structure of ternational standing to enter the market and these instruments, their strengths and the benefit from raising long term funding sources of their future appeal. through sukuk issues, rather than the owner of income-producing assets, for ex- conventional debt markets. An increase Sukuk are sometimes compared to conven- ample residential or business properties that in the size and depth of the sukuk market tional bonds – which they are not, although produce rental income, can package and could benefit the Islamic finance community they do share some similar financial charac- sell them to a special company set-up purely in general by providing a ready secondary teristics. Bonds are debt instruments, so for this purpose (called a Special Purpose market that will provide Shari’ah-compliant could never comply with Shari’ah. The Vehicle, or SPV) which, in turn, re-sells liquidity. This is not a significant source workshop looked at those aspects that make packets of those assets to investors. The at the moment because most sukuk are sukuk different from bonds and the essential certificates representing this ownership are held by investors until maturity, partly factors that make sukuk Shari’ah-compliant called sukuk. Periodically, income from the because of a lack of viable alternative – the actual ownership of the underlying assets is distributed to the investors – the Shari’ah-compliant investment types. asset(s) by the sukuk holders; the underlying sukuk holders. At the end of the term, the Shari’ah-compliant contract types, whether assets are re-sold and the investors re-coup The degree of Shari’ah compliance and the ijara, musharakah, mudarabah, murabaha or an amount of their original investment. It nature of the AAOIFI announcement may indeed any of the fourteen types recognised was this ‘buy back’ arrangement used in have been misreported in some quarters. by AAOIFI; the returns to the sukuk holders some types of sukuk (mostly mudarabah Mufti Muhammad Nurullah Shikder, EVP being linked not to an interest rate but to the and musharakah-based contracts) that was and head of Shari’ah advisory and compli- actual profit of a project (which includes the questioned in 2008. ance at Gatehouse Bank, felt that the risk of loss) – all coming together to make comments related to purchase undertakings sukuk closer to conventional bank securitisa- Despite the current downturn, sukuk have at the end of the sukuk term, and particu- tion than to conventional bonds. several factors that may favour them when larly those regarding sukuk issues whose the expected upturn in the markets occurs. underlying contract-type was a mudarabah Muhammad Ismail, financial controller of The sukuk issues to date have proven to be or musharakah. The trend of issues at that Sony Europe, explained that securitisation stable and prudent investments and have time was moving towards these types of is a financial process where cash flow-pro- created a knowledge and experience base contract because of what was seen as the ducing assets are pooled and repackaged in the market for issuers and support serv- guaranteed buyback, and the announcement into securities that are sold to investors. In ices alike. The maturity of the market, even reversed that trend. The comments did not Islamic finance, this process is achieved at this early stage, is setting the scene for relate to ijara-based contracts which make through ‘taskeek’ – the process of issuing more standardisation which may reduce up the majority (around 80 per cent) of the sukuk, which are certificates that represent legal costs and improve confidence by market. The basic problem was whether or ownership of the asset pool. In this way, the sukuk participants. not the purchase undertaking actually

34 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Rajab–Ramadan 1430 IIBI WORKSHOP/LECTURES

amounted to a guarantee to buy back the experienced market participants examined pliance issues existed, relating to how the assets at their face value (not market value), some of the actual structures used in recent three different investor classes could be ac- thereby guaranteeing the capital, and elimi- issues and some of the practical problems commodated, how the mudarabah ap- nating the possibility of profit or loss – an that needed to be overcome. For example, proach could be used and, particularly, essential element of Islamic investment the workshop heard that one of the com- how the purchase undertaking was struc- products. mon problems with ijara-based contracts – tured in light of the AAOIFI statement. avoiding gharar while still enabling variable The workshop looked at other issues relat- rental amounts – can be accommodated by Phil Heath, director, Pricewaterhouse- ing to sukuk that are of interest to Shari’ah splitting the lease term into individual lease Coopers, tackled the topic of taxation scholars and authorities, some of which re- periods and giving appropriate notice for on sukuk, particularly from a UK perspec- late to profit distribution. It is not disputed each individual term at a known rental. For tive in light of the changes made by the that incentives can be in place to reward the other structures, profit distribution can raise government. These changes have been manager for good performance. However, the problem of having different classes of progressively incorporated into UK tax sometimes the nature and size of these in- investors – each with different risk/return legislation since 2003 with particular centives may be in question. In a mu- profiles. changes relating to sukuk in the 2007 darabah-based structure, for example, the Finance Act but still more changes being manager (mudarib) is often rewarded for De Belder and Sapte demonstrated the expected in 2009 tax legislation. These good performance, which generally means structures used, and the specific issues changes will bring sukuk legislation in that the performance has exceeded an involved, in the convertible mudarabah line with conventional corporate bonds agreed benchmark. When this occurs, the sukuk used for the Aldar Properties issue, and securitisations and address capital mudarib is paid from the investors’ (rab-al- an Abu Dhabi property developer; the gains and capital allowances issues. maal) share of the profit according to a pre- Tamweel $210 million sukuk, which is At some point in the future, investor agreed ratio. Depending on the ownership sometimes referred to as a ‘true’ sukuk in- confidence will return to the market, and of the mudarib, this could raise the potential volving Islamic securitisation of properties sukuk offer a proven and ethical alterna- for a conflict of interest. and leases, but which involved special oper- tive to the conventional debt markets. ational issues relating to the dual SPV struc- With international interest rates at historic Of particular relevance to the workshop’s ture and issues relating to UAE law. They lows, financial intermediaries may look participants were the case studies and obser- also discussed an Abu Dhabi-based issue, to sukuk, whose returns are dependent vations presented by Richard T de Belder the Sun Finance (Sorouh) sukuk, where the on actual profits from the project and not and Matthew Sapte, partners at an interna- property sale formed the basis of the mu- interest rates, to begin the financial re- tional law firm, Denton Wilde Sapte. These darabah assets but legal and Shari’ah-com- building process. Promoting Islamic finance

May: The evolving takaful Governor’s working party set up to facilitate members. This is either reserved for the introduction of Shari’ah-compliant financial future claims or redistributed to the model and the spirit products in the UK market. He is an associate members. Many co-operatives or mutu- of takaful – a meeting of the IIBI. als also have ethical investment policies for the deployment of the contribution of minds or a parting pool. of ways? The lecturer explained that the underlying principles and rationale of takaful share a These commonalities have led many lot of features with co-operative mutual commentators to liken takaful to mutual Iqbal Asaria from Afkar Consulting discussed insurance models. Essentially, members or co-operative insurance. However, whether the fast growing takaful industry come together to enable risk sharing for many of the mutuals and co-operatives was keeping true to its underlying rationale. particular events by contributing to a com- have grown organically over long peri- mon pool. This pool is managed by or on ods of time and so have overcome issues behalf of the members. There are usually of adequate reserves to meet adverse Asaria has worked as an investment analyst no shareholders involved. The operator is claims experiences and the like. Even in the City of London for several years. He remunerated for the services provided and so, over the last three decades, with the was also a member of the Bank of England’s any underwriting surplus accrues to the frenetic activity in financial markets,

www.newhorizon-islamicbanking.com IIBI 35 IIBI LECTURES NEWHORIZON July–September 2009

many succumbed to the lure of shareholder- June: ‘Substance’ over ventional financial system and there are cer- driven models and de-mutualised. tain restrictions on debt creation and its ‘form’ in Islamic finance: trading which facilitates the stability of the Takaful companies, starting over the last Islamic financial system. four decades, were faced with a dilemma: analysis of murabaha and waiting for organic growth could take a ijara contracts He pointed out that in order to substantiate long time. Some way needed to be found these claims of the Islamic financial system’s to create viable companies in a short space stability, it is time to examine the Islamic Muhammad Ismail, financial controller at Sony of time. They have thus evolved into finance products and their underlying con- hybrids, incorporating many features Europe and the company’s trainer for its UK tracts. As mentioned above, around 80 per of the mutuals, but also providing for accounting team, examined the issue of cent of the underlying contracts today are shareholder involvement in a variety of ‘substance’ and ‘form’ of murabaha and ijara murabaha or ijara. Murabaha is a contract ways. contracts, which at present constitute around in which an Islamic bank buys an asset 80 per cent of Islamic finance transactions. from a vendor and then sells it on to its Asaria explained that this has resulted in He compared them with secured loans and client with a mark-up. Ijara is similar to a number of models being developed. The leasing, respectively, in the conventional conventional leasing except that the ijara most popular one is the wakala model, financial system. He then commented on the asset must be used for Shari’ah-compliant whereby the operator acts as an agent for areas that may bring credibility to Islamic activities. the members. The others are mudarabah finance and ensure its mainstream relevance, and waqf models. All incorporate a hybrid Then, Ismail went on to discuss ‘substance’ and that would facilitate in establishing Islamic of shareholder and mutual features. over ‘form’; this concept has been much Finally, he drew some conclusions from finance identity as an alternative to current debated in professional circles. Tax laws the hybrid nature of takaful operations. financial problems. normally rely on the substance of a transac- In particular, he pointed out that a signifi- tion instead of its legal form. He described cant number of potential conflicts between Ismail is an Associate Fellow of the IIBI. He the text below of the International Account- shareholders and members were likely to has over 20 years of experience in various ing Standards Framework, which empha- emerge. Thus, takaful operations needed finance and accounting roles, and developed sises the importance of substance over legal to recognise these explicitly and deal with the finance function and team for the Pepsi form: them. In particular, involvement of members plant in Baku, Azerbaijan. in the decisions on surplus distribution and ‘If information is to represent faithfully other management issues needed to be the transactions and other events that it pur- institutionalised. The recent financial crisis has sparked de- ports to represent, it is necessary that they bates among the regulators, governments are accounted for and presented in accor- and bankers to review current banking prac- dance with their substance and economic May lecture tices. There are calls for tough actions by reality and not merely their legal form.’ the regulators for supervision of financial He explained that ijara and murabaha are institutions and evaluations of their ac- Islamic debt-based contracts resulting in counting practices. In some markets, short similar financial impacts for a customer as selling was suspended temporarily due to its those of leasing and asset-based financing harmful effects in further destabilising the in the conventional financial system. In financial markets in crisis times. The finan- these contracts, debt creation is based on cial sector bailout of trillions of dollars was real economic activity. He then explained justified on the premise that the costs of fi- the following key differences of ijara and nancial system collapse are far greater than murabaha respectively with conventional bailout costs to the public purse. leasing and secured loans:

Asaria argued that if these issues were not Ismail mentioned that the crisis has pro- J Murabaha transactions are always successfully addressed, the whole takaful vided supporters of Islamic finance an op- asset-based, while this is generally movement could be compromised and portunity to present the industry as a viable not the case in secured loans. would lose its appeal for Muslim alternative. They argue that Islamic finance Conventional banks extend finance customers. is inherently stable and ethical and links fi- based on the creditworthiness of the nancial activity with real sector activity. client with an asset as collateral, without A more detailed article on this subject can Islamic finance does not have a money mul- any reference to utilisation of funds be found on p38. tiplier mechanism as in the case of the con- extended to client.

36 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Rajab–Ramadan 1430 IIBI LECTURES

J Ownership of asset: Islamic banks bear of the asset. However, the ownership is that practitioners have not yet developed the ownership risk in case of murabaha risk is covered by insurance. Therefore, flagship products and solutions not avail- and ijara transactions which justifies it does not constitute a major difference able in conventional finance. The creativ- their returns. However, this is not the with the charge on assets in case of ity of Islamic finance practitioners should case in conventional banks’ financing. conventional loan which extends bank’s be invested in development of products right to asset used as collateral. and structures which are based on profit- J Insurance of leased assets: the lessee is and-loss sharing, and risk-sharing prod- normally responsible for insuring assets At the close, Ismail emphasised that intellec- ucts in ‘substance’ as well as ‘form’. obtained through conventional lease. tual discussion of Islamic finance as a viable According to him, these products will However, the lessor is required to pay solution, to get rid of the weaknesses of unveil the real potential of Islamic finance insurance costs of the assets which conventional finance, is mainly limited to to minimise the severity and frequency of are provided on an ijara basis as per theoretical debate. The main reason for this financial crises. AAOIFI Shari’ah standard No.9. However, the insurance cost may reflect in ijara rentals, and therefore July lecture preview: Would Islamic finance have the financial impact of an ijara transaction may appear similar to that prevented the global financial crisis? of a conventional one.

J Prohibition of late-payment penalties: 2008 saw the greatest crisis conventional and Islamic in Islamic banking, such penalties act in global finance for over finance. He is a chartered as a deterrent, to discipline the clients, 70 years. Stock markets accountant and a member of and are not considered a source of plunged, bank lending dried the Association of Corporate income. Islamic banks have to give up, major banks failed and Treasurers, serving on that away late payment charges to charity; governments around the body’s policy and technical however, this is not the case for world had to intervene to committee. He is also UK conventional banks. prop up their financial sys- head of Islamic finance at tems. At the bleakest point, PricewaterhouseCoopers, J Prohibition of securitisation of debt: governments were con- and is a member of the in the majority of jurisdictions where cerned that the entire bank- Editorial Advisory Panel Islamic finance is practiced, this ing system might cease to for NewHorizon. prohibition stops Islamic banks from function. selling financial assets to pass on the There is no charge to attend this lecture default risk created by irresponsible How well do you understand both but you must register. To register, please investment. This forces Islamic banks what caused the crisis and its major visit www.islamic-banking.com to evaluate risks carefully by carrying effects? Would it have happened if the out proper due diligence processes financial system had been Islamic instead The lecture will take place instead of relying on securitisation and of conventional? on 13th July at 6pm at: credit default swaps. The speaker for IIBI’s July 2009 lecture British Bankers’ Association J Prohibition of dealing with assets and will be Mohammed Amin (above) , who Pinners Hall activities which are not allowed under is particularly well qualified to give 105-108 Old Broad Street Shari’ah principles, such as gambling, this lecture, with his knowledge of both London EC2N 1EX sale of pork and alcohol. Murabaha and ijara contracts cannot be used for financing any prohibited activities. The mission of the IIBI is to be a centre of excellence for professional education, training, J Asset ownership in murabaha vs a research and related activities, to build a wider knowledge base and deeper understanding charge on assets in the case of a secured of the world of finance promoting the Islamic principles of equity, socio-economic justice loan: an Islamic bank takes ownership and inclusiveness. The Institute holds regular lectures on topical issues, delivered of an asset, even for a very short period, by industry experts. For information on upcoming lectures and other events, before selling it to the customer. This please visit the IIBI’s website: ownership period (by the bank) is an www.islamic-banking.com insignificant part of the total useful life www.newhorizon-islamicbanking.com IIBI 37 ACADEMIC ARTICLE NEWHORIZON July–September 2009

The spirit and models of takaful: meeting of minds or parting of ways?

Iqbal Asaria, from Afkar Consulting, looks at the continuous development of Islamic insurance and assesses whether the industry is keeping true to its underlying principles.

Based on Asaria’s presentation at the IIBI’s alised. The present credit crunch has seen a monthly lecture, London, May 2009. revival in interest in pure mutuals, but it is too early to say if this change in sentiment It is time to look at the evolving models of will result in any concrete move towards takaful in various jurisdictions and make a co-operative models. reality check with the spirit of takaful. This will allow us to look at this growing indus- Takaful companies, starting over the last try and detect any tensions in keeping the four decades, were faced with a dilemma. takaful movement true to its underlying Waiting for organic growth could take a rationale. long time. There was an expectation that the Islamic Development Bank in conjunc- The underlying principles and rationale of tion with national central banks could come takaful share a lot of features with co-oper- up with some modalities to provide a cush- ative mutual insurance models. Essentially, ion in the early years. This expectation was members come together to enable risk shar- not met in a sufficiently timely manner. ing for particular events by contributing to a Thus some way needed to be found to cre- common pool. This pool is managed by or ate viable companies in a short space of on behalf of the members. There are usually time without waiting for communities to no shareholders involved. The operator is organically develop the equivalents of mu- remunerated for the services provided and tuals. As a result, over the last thirty years Iqbal Asaria, any underwriting surplus accrues to the takaful companies have evolved into hy- Afkar Consulting members. This is either reserved for future brids, incorporating many features of mutu- claims or re-distributed to the members. ality, but also providing for shareholders’ Many co-operatives or mutuals also have involvement in a variety of ways. ethical investment policies for the deploy- ment of the contribution pool. Thus, in the In practice this has resulted in a number best cases, investment returns will also be of models being developed. Initially, in ethically derived. Malaysia the mudarabah model was favoured and pioneered by Bank Islam via These commonalities have led many com- its Syarikat Takaful Malaysia subsidiary. mentators to liken takaful to mutual or co- The Malaysians used what is now termed a operative insurance. However, many of the modified mudarabah model. The pure mu- mutuals and co-operatives have grown or- darabah model, allowing for sharing of ganically over long periods of time and so only the investment return, was found to be have overcome issues of adequate reserves commercially challenging. to meet adverse claims experiences and the like. Even so, over the last three decades, The modified mudarabah model allowed with the frenetic activity in financial mar- the operator to share in the investment re- kets, many have succumbed to the lure of turn on the contribution pool and also in shareholder-driven models and de-mutu- any underwriting surplus.

38 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Rajab–Ramadan 1430 ACADEMIC ARTICLE

Over the years, this has also been found to be challenging and most operators are Basic mudarabah model moving towards the wakala or a modified wakala model. Variants of the wakala model, pioneered in the GCC countries, have become the most popular operating mode for takaful operators. In the wakala model, the operator acts as an agent for the members. The operator, in return for an agency fee, manages the member claims fund. In the pure wakala model the operator has no further claim on the investment re- turn or the underwriting surplus.

In practice, the operator has one further obligation. This is to indemnify the mem- bers fund in the event of a deficit in the con- tribution pool. This is to be done via a qard hasan (virtuous) loan to be recouped from future contributions and reserves. Modified mudarabah model

This obligation, and the need for incentivis- ing the operator to perform optimally, has led to two modifications of the pure wakala model. In some cases the operator is en- gaged to manage the contribution pool on a mudarabah basis and allowed a perform- ance incentive on the investment return. In many other cases, in addition to sharing of the investment return on a mudarabah basis, operators have also been successful in persuading Shari’ah scholars to allow them to share in the underlying surplus.

In both the mudarabah and wakala models and its variants, members’ contributions are treated as tabarru, or gifts, to the claims pool. This, it is argued, absolves the possi- bility of gharar (uncertainty of outcome) Basic wakala model and maysir (gambling). Most of the Shari’ah scholars have accepted this formulation although there is an element of implied con- ditionality in the tabarru. Some scholars, especially in Pakistan, have argued that this can be mitigated by devising a third model based on the institution of waqf (perpetual trust). This well established mechanism in Islamic jurisprudence allows for settlers and contributors to the members pool and also for defined beneficiaries from the pool. Since defined beneficiaries for specified out- comes are explicitly allowed, this avoids the idea of compromising the ‘gift’ attributes of

www.newhorizon-islamicbanking.com IIBI 39 ACADEMIC ARTICLE NEWHORIZON July–September 2009

tabarru perceived in other models. Apart from this feature, the operational modalities Modified wakala model are quite similar to those found in mu- darabah and wakala models.

It can be seen that all the prevailing models are essentially hybrids between mutuality and shareholder-driven insurance compa- nies. This hybrid nature of takaful opera- tions can lead to a significant number of potential conflicts of interest between share- holders and members. These could prove to be minefields in setting pricing policy, establishing an adequate level of reserves in the contributions pool and definition and sharing of the underwriting surplus. At a minimum level this demands a high de- gree of transparency and institutional in- volvement of members’ representatives in decision making for the whole operation. Presently, transparency levels leave much to be desired and members’ interests are Wakala-mudarabah model assumed to be guarded by the Shari’ah scholars.

Experienced commentators on takaful operations, consulting actuaries, rating agencies and academics have started to raise these issues in a number of fora. They all point to the fact that these are not satisfac- torily addressed and urge takaful operators to recognise these explicitly and deal with them. In particular, there is a growing call for involvement of members in decisions on surplus distribution, and other manage- ment issues, to be institutionalised.

As the number of takaful providers and their take-up increases, users of these prod- ucts will want to see the benefits of this kind of insurance provision vis-à-vis other alter- natives. As discussed, the unique selling This may mean renewed support suance market this should be possible. point (USP) of takaful is its Shari’ah-compli- from the Islamic Development Bank and Such a development, in turn, can allow ant mutuality. To achieve greater penetra- other Islamic financial institutions to pio- members to moderate the demands of the tion, takaful operators will need ways to neer ways of funding periodic deficits in operators and their shareholders. In time enhance this USP. If these underlying issues the claims funds without relying on the mature takaful operations can move emanating from the hybrid nature of domi- operator to fund these via qard hasan more towards mutuality and the spirit of nant takaful models are not satisfactorily loans. With the growth in the sukuk is- takaful. addressed, the whole takaful movement could be compromised and would loose its appeal for Muslim customers. There was an expectation that the Islamic Development Bank in Present penetration rates, even in Malaysia, conjunction with national central banks could come up with some are low and need to be boosted. Takaful op- erators will need to find ways of enhancing modalities to provide a cushion in the early years. This the mutuality aspects of their operations. expectation was not met in a sufficiently timely manner.

40 IIBI www.newhorizon-islamicbanking.com

BOOK REVIEW NEWHORIZON July–September 2009

Shari’ah Law: An Introduction

of faith, life, intellect, lineage and property, creative and comprehensive intellectual ef- Author: Mohammad Hashim Kamali which he identified as essential values. Later, fort by qualified individuals and groups to Publisher: Oneworld Publications the protection of honour was added. How- derive the judicial ruling on a given issue (2008) ever, it was Tamiyyah (d.1328) who was from the sources of Shari’ah in the context ISBN-13: 978-1-85168-5653 among the first to open the door to making of the prevailing circumstances of society’. further additions that included such things Kamali’s proposition gives rise to the con- The book, comprising 13 chapters and 342 as ‘fulfilment of contracts, preservation of troversy in defining the meaning of ‘quali- pages (including bibliography and index), ties of kinship, honouring the rights of one’s fied individuals’, which is commonly is part of the ‘Foundations of Islam’ series neighbour in as far as the affairs of this denoted and has been understood to refer published by Oneworld Publications. It goes world are concerned, and the love of God, to a qualified jurist in Shari’ah. far beyond an introduction, providing a sincerity, trustworthiness and moral purity, comprehensive and accessible examination in relationship to the hereafter’. Contempo- Chapter nine, ‘Shari’ah and the Principles of Shari’ah. The author looks into the ori- rary scholars have extended the list of Legality’, explores the basic requirement gin, historical development and contempo- to include ‘social welfare support, freedom, of the modern principle of legality and rary debates about the nature of Islamic human dignity and human fraternity, among the extent of its application in Shari’ah. law. It is a system that is all too often mis- the higher objectives of Shari’ah’. These are ‘Democracy, Fundamental Rights and the understood and misinterpreted in the West. all upheld and supported by The Quran and Shari’ah’ is the title of ensuing chapter The first three chapters introduce the Sunnah. which provides a perspective on the extent nature, sources and objectives of Shari’ah of harmony (or otherwise) between the (maqasid al-Shari’ah) as well as its charac- basic postulates of democracy and those of teristic features. Literally, Shari’ah means Shari’ah. The author sheds light on Shari’ah ‘a way/path to a watering place’. Techni- positions on basic rights and liberties and cally, it refers to laws contained in, or de- Islamic and civil society. The chapter also rived from, The Quran and Sunnah of Holy provides a discussion on moderation as an Prophet (PBUH). The fourth chapter pro- important dimension of Islamic teachings. vides an overview of the leading schools of Islamic thought, with their different inter- The next chapter on ‘Beyond the Shari’ah: pretations that defined Islamic jurisprudence an Analysis of Shari’ah-Oriented Policy’ in the early days. The fifth, sixth and sev- explores the place of judicial policy and enth chapters discuss juristic disagreements discretion, political acumen and non-textual (ikhtilaf), the goals and objectives of Shar- procedures in an Islamic system of gover- i’ah and legal maxims of fiqh. Though the nance, and discusses contemporary words ‘fiqh’ and ‘Shari’ah’ are used inter- Malaysia as a case study in terms of imple- changeably, fiqh is the legal science and has menting a Shari’ah-oriented policy. been developed by jurists. It consists of rules based mainly on reasoning. The last two chapters deal with adaptation The discussion in chapter eight on ijtihad and reform, providing a concise update Importantly, chapter six, on maqasid and juristic opinion (fatwa) is equally im- of the 20th century developments and al-Shari’ah, discusses the history and portant. Ijtihad is a ‘method of finding solu- problematic issues of ijtihad and fatwa, methodology, and the arguments for why tions to new issues in the light of the goals and reflections of some challenging issues. it provides a more versatile toolkit and a and principles of Islam’. Kamali sees some matrix for legislation and independent rea- difficulties with the conventional theory of This book is a recommended reading to soning (ijtihad). The leading companions of ijtihad; he believes that ijtihad, as under- students of Islamic law and Islamic finance Prophet Muhammad (PBUH) saw Shari’ah stood, is conducted by a qualified jurist in practitioners working on product develop- ‘both as a set of rules and a value system in Shari’ah and that it is basically envisaged as ment, as well as to all those who are inter- which the specific rules reflected over-riding an individual effort. Kamali proposes a new ested in Islamic law. Kamali is Professor of rules’. According to Ghazali (d. 1111) who definition, with a view mainly to overcome Law at the International Islamic University wrote at length on public interest, the five the difficulties in the conventional theory of Malaysia, where he has been teaching Is- objectives of Shari’ah were the protection ijtihad. His proposition is that ‘ijtihad is a lamic law and jurisprudence since 1985.

42 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Rajab–Ramadan 1430 CALENDAR

Diary of events endorsed by the IIBI

July October Dubai

13: Access to Islamic Finance: Improving 12–14: World Islamic Retail Banking Islamic Finance Investment in UK 2009, Dubai Businesses, London Conference to seek what lessons can be Workshop to discuss the concepts and princi- learnt from the economic ‘meltdown’, ples of Islamic finance as well as requirements and how resilient Islamic banks have been for Shari’ah-compliant eligible business. Lead- during the current crisis, as well as to ing experts will also discuss the opportunities focus on Islamic banking and finance as and challenges for UK businesses, especially an alternative model to the conventional SMEs, for accessing Islamic finance. industry.

Contact: Daniel Maalo Contact: Anthony Permal Tel: +44 (0) 20 7785 6338 Tel: +971 4 609 1581 Email: [email protected] Email: [email protected] www.a2if.org www.fleminggulf.com Doha

August November

7–9: Structuring Innovative Islamic 3: 4th World Islamic Infrastructure Financial Products, Cambridge, UK Finance Conference (WIIFC), Doha

Three-day residential workshop to focus on Conference to strengthen the role Islamic different types of innovative structures, their project finance can play in meeting massive underlying techniques and legal issues, as infrastructure investment needs – which is well as new developments in this field. seen as key to revitalising growth.

Contact: Mohammad Shafique Contact: Naomi Njoroge Tel: +44 (0) 20 7245 0404 Tel: +971 4 343 1200 © Vatikaki, Dreamstime.com Email: [email protected] Email: [email protected] www.islamic-banking.com www.megaevents.net Bahrain 10: Managing Shari’ah Risk through Shari'ah Governance, London December

As Shari’ah compliance is the raison d’être 6–8: 16th World Islamic Banking of Islamic financial institutions, non-compli- Conference, Bahrain ance presents significant risk for the indus- try players. The workshop will discuss how Conference to discuss the key issues, to mitigate this risk in product development, developments and challenges of Islamic based on practical examples. banking and finance worldwide.

Contact: Mohammad Shafique Contact: Naomi Njoroge Tel: +44 (0) 20 7245 0404 Tel: +971 4 343 1200

Email: [email protected] Email: [email protected] © Matt Kunz, iStockphoto.com www.islamic-banking.com www.megaevents.net

www.newhorizon-islamicbanking.com IIBI 43 APPOINTMENTS NEWHORIZON July–September 2009

On the move

kets of Pakistan, and as joint director Dr Salah Al-Majdhoub (left) is the new chief operat- of Pakistan’s Securities and Exchange ing officer of Tharawat Investment House , an Islamic Commission. investment company in Bahrain. Dr Al-Majdhoub holds a PhD from Virginia Tech University, having previously studied at the King Fahd University of Pe- Dubai International Financial Centre troleum and Minerals in Saudi Arabia. He also holds (DIFC) has announced the appointment an MBA in finance from the University of Bahrain. of Abdulla Mohammed Al Awar as chief Dr Al-Majdhoub has represented Kuwait Finance executive officer of DIFC Authority. He House as a member of the board of directors for was previously managing director, and Mena Telecom since its inception and up to 2008. succeeds the preceding CEO, Nasser Al Shaali, who will return to the private sec- tor after a three year tenure. As managing Azhar A Jaffri has been appointed as direc- showaikh joins ABC from Ajman Bank in director of DIFC Authority, Al Awar is tor on the board of Takaful Pakistan . Jaffri the UAE, where he was deputy CEO and charged with developing overall strategy is also chairman and CEO of House Build- head of business. Prior to that, he estab- for the centre. ing Finance Corporation (HBFC), which lished Asian Finance Bank in Malaysia, is one of the main sponsors of Takaful and expanded it into Indonesia. Also, Pakistan. Takaful Pakistan was incorpo- he started the first Islamic shipping fund Raja Teh Maimunah Raja Abdul Aziz rated three years ago, is sponsored by both in Malaysia and South East Asia. Al- has been chosen as the new global head Pakistani and foreign financial institutions, showaikh also held senior posts at Gulf of Islamic Capital Market (ICM) at Bursa and can underwrite risks in all avenues of International Bank, Bahrain Islamic Bank Malaysia , the Malaysian exchange. Her general insurance. Jaffri became chairman and Standard Chartered Bank. role will be to spearhead the expansion and CEO of HBFC in February 2009, and and development of ICM infrastructure, has 30 years of experience in banking and products and services as well as the financial services. HSBC Amanah Takaful Malaysia has marketing of ICM products and services appointed Zainudin Ishak as executive internationally. She will also develop cross director and CEO. He has worked in the border ICM capabilities to help the initia- Arab Banking Corporation (ABC) has insurance industry for over 20 years. He tives of the Malaysia International Islamic made a couple of significant appointments moves from another local joint venture Financial Centre. She moves from Kuwait recently. Roy Gardner has been named takaful provider, where he was also CEO. Finance House (Malaysia), where she group chief financial officer. He moves He started his career in the broking divi- served as chief corporate officer and from Citibank, where he was chief finan- sion of a local insurance operator. Ishak executive director of international cial officer for treasury and trade solutions, has been a full associate of the Malaysia business. covering the cash and trade business Insurance Institute since 1994. worldwide. Gardner has 32 years of expe- rience in all, of which 20 were gained in Salman Younis is no longer managing the Middle East. Most of his time in Saudi CFA Institute , a global educational insti- director and CEO of Kuwait Finance Arabia was as chief financial strategist at tute for investment professionals, has House (KFH) (Malaysia), but will con- Saudi American Bank (SAMBA). moved its Islamic finance and environmen- tinue to work as senior advisor to the tal, social and governance investing chairman and CEO of KFH in Kuwait. Meanwhile, ABC has also named Faisal operations to London, and has appointed Ab Jabar Ab Rahman , hitherto the deputy Alshowaikh as head of Islamic financial Usman Hayat , FRM, CFA, as director. CEO of KFH in Malaysia, is now acting services. His job will be to expand and ad- Hayat moves to London from CFA Insti- CEO. He has over 30 years of experience vance the Islamic finance business, which tute’s Asia Pacific office, and his main in Islamic finance. Younis, who was once was first established in London in 1999. remit will be to assist in developing educa- an employee of Citi Islamic Investment The business presently covers real estate, tional content for investment profession- Bank in Bahrain, will remain a member leasing and Islamic home finance through als. Prior to joining CFA Institute, Hayat of the board of directors of KFH its Alburaq retail finance business. Al- worked as a consultant in the capital mar- Malaysia.

44 IIBI www.newhorizon-islamicbanking.com NEWHORIZON Rajab–Ramadan 1430 RATINGS & INDICES

MSCI GCC Countries Islamic Index Below is the performance of the MSCI GCC Countries Islamic Index vs its standard counterpart over the last year, together with sector weights and top 20 largest constituents, provided by MSCI Barra, an indices and risk/return portfolio analytics provider. Detailed information on the MSCI Global Islamic Indices can be found on MSCI Barra’s website www.mscibarra.com

MSCI GCC Countries Islamic Index – Top 20 Constituents Performance of the MSCI GCC Countries vs MSCI GCC Countries Islamic Index Security Name GICS Sector Weight 2nd June 2008 to 29th May 2009 AL-RAJHI BKG & INVST CRP Financials 19.7%

SAUDI TELECOM CO Telecommunication services 7.1%

KUWAIT FINANCE HOUSE Financials 6.4%

ALINMA BANK Financials 5.1%

EMAAR PROPERTIES Financials 3.9%

PUBLIC WAREHOUSING (THE) Industrials 3.1%

SAUDI ELECTRICITY CO Utilities 2.8%

SAVOLA Consumer staples 2.4%

YAMAMAH SAUDI CEMENT CO Materials 1.7%

SOUTHERN PROVINCE CEMENT Materials 1.7%

QATAR ISLAMIC BANK Financials 1.7%

MSCI GCC Countries Index AL RAYAN BANK Financials 1.6%

MSCI GCC Countries Islamic Index SAUDI CEMENT Materials 1.5%

MAKKAH CONS Industrials 1.4%

MSCI GCC MSCI GCC JABAL OMAR DEVELOPMENT Financials 1.3% Sector Countries Countries Difference Index Islamic Index YANBU CEMENT Materials 1.3% Energy 3.33% 1.35% 1.98% ARABIAN CEMENT Materials 1.3%

Materials 26.25% 13.14% 13.11% BANK AL-JAZIRA Financials 1.2%

Industrials 6.82% 7.12% -0.30% BANK ALBILAD Financials 1.2%

Consumer discretionary 0.26% 0% 0.26% THE QASSIM CEMENT CO Materials 1.1% Consumer staples 2.14% 2.86% -0.72%

Healthcare 0% 0% 0.00% 12-MTHS YTD Performance Financials 45.16% 60.81% -15.65% Performance Information technology 0% 0% 0.00% MSCI GCC Countries 11.86% -48.45% Telecommunication services 14.41% 11.30% 3.11% Index Utilities 1.63% 3.41% -1.78% MSCI GCC Countries 15.54% -51.84% Islamic Index

Data as of 1st June 2009 www.newhorizon-islamicbanking.com IIBI 45 GLOSSARY NEWHORIZON July–September 2009

arboun mudarib Shari’ah A non-refundable down payment for attaining the right In a mudarabah contract, the person or party who Refers to laws contained in or derived from the Quran to buy goods at a certain time and certain price in future; acts as the entrepreneur. and the Sunnah (practice and traditions of the Prophet if the right is exercised, it becomes part of the purchase Muhammad). price. murabaha A contract of sale between the bank and its client Shari’ah board bai for the sale of goods at a price plus an agreed profit An authority appointed by an Islamic financial Sale. margin for the bank. The contract involves the institution, which supervises and ensures the Shari’ah purchase of goods by the bank which then sells them compliance of new product development as well as bai al-ina to the client at an agreed mark-up. Repayment is existing operations. This refers to the selling of an asset by the bank to the usually in instalments. customer on a deferred payments basis, then buying back Sunnah the asset at a lower price, and paying the customer in musharakah It refers to the sayings and actions attributed to Prophet cash terms. An agreement under which the Islamic bank provides Muhammad (PBUH). funds which are mingled with the funds of the fatwa business enterprise and others. All providers of capital sukuk A ruling made by a competent Shari’ah scholar on a are entitled to participate in the management but not Similar characteristics to that of a conventional bond particular issue, where fiqh (Islamic jurisprudence) is necessarily required to do so. The profit is distributed with the key difference being that they are asset backed; unclear. It is an opinion, and is not legally binding. among the partners in predetermined ratios, while the a sukuk represents proportionate beneficial ownership loss is borne by each partner in proportion to his in the underlying asset. The asset will be leased to the fiqh contribution. client to yield the return on the sukuk. Islamic jurisprudence. The science of the Shari’ah. It is an important source of Islamic economics. musharakah, diminishing tabarru An agreement which allows equity participation and A donation covenant in which the participants agree to gharar sharing of profit on a pro rata basis, but also provides mutually help each other by contributing financially. Lit: uncertainty, hazard, chance or risk. Technically, sale a method through which the bank keeps on reducing of a thing which is not present at hand; or the sale of a its equity in the project and ultimately transfers the takaful thing whose consequence or outcome is not known; or a ownership of the asset to the participants. A form of Islamic insurance based on the Quranic sale involving risk or hazard in which one does not know principle of mutual assistance (ta’awuni). It provides whether it will come to be or not. qard hasan mutual protection of assets and property and offers An interest-free loan given for either welfare purposes joint risk sharing in the event of a loss by one of its halal or for fulfilling short-term funding requirements. The members. Activities which are permissible according to Shari’ah. borrower is only obligated to pay back the principal amount of the loan. tawaruq haram A sale of a commodity to the customer by a bank on Activities which are prohibited according to Shari’ah. qimar deferred payment at cost plus profit. The customer then Lit: gambling. Technically, an agreement in which sells the commodities to a third party on a spot basis ijara possession of a property is contingent upon the and gets instant cash. A leasing contract under which a bank purchases and occurrence of an uncertain event. By implication it leases out a building or equipment or any other facility applies to those agreements in which there is a definite ujra required by its client for a rental fee. The duration of the loss for one party and definite gain for the other Charge (fee or commission) for use of services. lease and rental fees are agreed in advance. Ownership without specifying which party will gain and which of the equipment remains in the hands of the bank. party will lose. wa’ad A promise to buy or sell certain goods in a certain ijara wa iqtina rab-al-maal quantity at a certain time in future at a certain price. It The same as ijara except the business owner is committed In a mudarabah contract, the person who invests the is not a legally binding agreement. to buying the building or equipment or facility at the end capital. of the lease period. Fees previously paid constitute part of wakala the purchase price. It is commonly used for home and retakaful A contract or agency in which one person appoints commercial equipment financing. Reinsurance based on Islamic principles. It is a someone else to perform a certain task on his behalf, mechanism used by direct insurance companies to usually against a certain fee. The agent (wakil) is ijtihad protect their retained business by achieving allowed to generate an income for himself in excess Lit: effort, exertion, industry, diligence. Technically, geographic spread and obtaining protection, above of the minimum agreed upon returns as agreed with endeavour of a jurist to derive or formulate a rule of certain threshold values, from larger, specialist rab-al-maal (investor of the capital). law on the basis of evidence found in various sources reinsurance companies and pools. of Shari’ah. waqf riba An appropriation or tying-up of a property in perpetuity maysir Lit: increase or addition. Technically it denotes so that no propriety rights can be exercised over the Gambling – a prohibited activity, as it is a zero-sum game any increase or addition to capital obtained by the usufruct. The waqf property can neither be sold nor just transferring the wealth not creating new wealth. lender as a condition of the loan. Any risk-free or inherited nor donated to anyone. ‘guaranteed’ rate of return on a loan or investment mudarabah is riba. Riba, in all forms, is prohibited in Islam. zakat A form of business contract in which one party brings Usually, riba and interest are used interchangeably. A religious obligation on Muslims to pay a prescribed capital and the other personal effort. The proportionate percentage of their wealth to specified categories in their share in profit is determined by mutual agreement at the salam society, when their wealth exceeds a certain limit. Zakat start. But the loss, if any, is borne only by the owner of Salam means a contract in which advance payment is purifies wealth. The objective is to take away a part of the capital, in which case the entrepreneur gets nothing made for goods delivered later on. the wealth of the well-to-do and to distribute it among for his labour. the poor and the needy.

46 IIBI www.newhorizon-islamicbanking.com