Two new courses are set to begin at the University of Bedfordshire.

| Saturday, August 14, 2010

The courses will recognise the increase in demand for Islamic financial products and services.

They will guide students through the principles of Islamic finance and the theory of Islamic commercial practice which is based on Shari'a Law According to these principles, Islamic financial products prohibit the charging of interest and investment in alcohol, pork, pornography or gambling.



The university says that students choosing these courses, The Master of Science (MSc) in Islamic Banking and Finance and the Master of Laws (LLM) in Islamic Commercial Law, will benefit from growing employment opportunities in the West representing Muslim interests and in Muslim countries.

Tariq Khan from the University of Bedfordshire told the BBC there is a demand for this type of course:

"We are based just outside London, the financial capital of the world, where there is a large demand for Islamic finance and banking products.

"Our international students, who are often from the Middle East, and who will return home to practise law, have also highlighted a need for a foundation in Islamic banking and finance laws."

Although the growth of formalised Islamic products and services is relatively new, a recent estimate puts the value of assets managed by the Islamic financial industry at US$1 trillion, a figure that is predicted to grow between 10 and 15 per cent per year.

Today, there are more than 500 financial institutions offering Islamic finance in more than 80 countries

bbc.co.uk

Islamic finance continues to thrive in Asia

|
The global Islamic bonds or sukuk issuance market for the first half of 2010 has doubled on-year to US$20 billion. 

Sukuk volume in 2007 was about US$24 billion in the first half, a record year. 

And industry watchers believe the sukuk volumes for the second half of this year will fare even better compared to the same period last year. 

Asia, they said, will be the main driver of growth. 

More investors in Asia, observers said, are turning to Islamic finance as an additional source of funding. This is reflected in a growing number of new transactions. 

One example is Khazanah Nasional's landmark S$1.5 billion sukuk issue in Singapore last week. This makes them the largest foreign issuer in Singapore dollars to date. 

Malaysia has been a big player in the Islamic finance industry because of its large domestic sukuk market. 

Experts said it makes up nearly two-thirds of the global sukuks issued this year. 

Using Islamic bonds to raise money in Indonesia is also gaining popularity because there is high demand for corporate borrowings. 

But observers believe that Indonesia has more room to grow the sector. 

Although a young player in the industry, many believe that Singapore is well positioned to benefit from more sukuk sales in Asia. 

Hooman Sabeti-Rahmati, partner of Allen & Overy LLP said: "The key for Singapore is intermediation of transactions. This is where deals get done. 

“And by making sure that the right human and institutional infrastructure exists here to do Islamic deals, Singapore can transition fairly naturally into a centre for doing these deals.” 

Singapore's central bank, the Monetary Authority of Singapore (MAS) said the sector has grown steadily in recent years with greater interest from high-quality borrowers and issuers such as IDB, Khazanah and Olam. 

MAS added that it will continue to review its regulatory framework and work with industry participants and international bodies to further promote the development of Islamic finance in Singapore and the region. 

But the sector in Singapore also faces challenges. 

Tan Jeh Wuan, MD of Corporate Banking & Capital Markets, The Islamic Bank of Asia said: "I think as a relatively newcomer to this space, it is natural that the talent pool for Islamic finance is smaller compared to countries which are more well established. We need to step up on the training of the people. 

"We noticed a couple of educational institutions in Singapore like the NTU and SMU which have put in place Islamic finance courses for people who want to further develop their knowledge in this field." 

The global Islamic finance sector is expected to cross the US$1 trillion mark in total assets this year.

channelnewsasia

Islamic Finance

| Monday, August 9, 2010

A surge in Islamic financial services in Sri Lanka has seen a host of companies offering Sharia (or Islamic Law) compliant services to the market.
Recent entrants include LOLC and LB Finance. They seem to have sprung up in response to burgeoning demand for Sharia compliant financial services expected to increase from the North and East.
Amaana, Sri Lanka’s biggest Islamic finance service provider to date offers nine different financial solutions under the segments of leasing, financing, leasing and investment. Other service providers also offer pawn broking services.
A 2005 IMF working paper indicated that the markets targeted by Islamic financial institutions are largely untapped by regular commercial banks; and with a potential market of almost two billion Muslims, this explains to a certain extent the growth in the sector worldwide and why many commercial banks are hurrying to develop Sharia compliant divisions of their own.
Islamic Banking and Finance have to adhere to certain fundamental principles as laid down by Islamic law (or fiqh). It prohibits the use of interest (riba) in monetary transactions and also prohibits dealing in any item considered to be haraam (forbidden) by the word of God and the example of the Prophet (pbuh). These principles formed the basis of a “robust” economy in the Islamic world, but it was not until the late 20th century that entities calling themselves banks were established commercially in Islamic Communities.
The sector since then has seen fast growth.  The IMF paper said that the sector was growing at 10-15% yearly with signs of consistent future growth. CIMB group, Malaysia’s second largest financial service provider recently estimated that Islamic finance was the fastest-growing segment of the global financial system and sales of Islamic bonds may rise by 24% to $25 billion in 2010.
In addition to prohibiting interest, Sharia law also stresses the importance of profit sharing and asset backed financing as cornerstones of Islamic finance. The original modes of financing since ancient times has been Mudarabah and Musharakah; cost plus financing and partnership financing. Other modern forms of financing such as ijarah (leasing) and murabahah (pawn broking) have been recommended by contemporary jurists to apply to areas where conventional methods may not have had been suitable. Whatever the mode, all Sharia based financing have to adhere to certain fundamental principles (Mohammad Taqi Usmani 2008); Profit Sharing-Financing does not take the form of cash advancement. In the case of Mudarabah and Musharakah. It means participating in the business and in the case of the latter, also sharing in the assets.
Profit and loss-Both financier and entrepreneur must share the loss incurred to the extent of his financing.
Ratio Determination-Partners have the right to determine the rations of sharing profits which can exceed the ratio of capital invested except in the case of a sleeping partner. Loss sharing-The loss suffered by each partner must be exactly the proportion of his or her investment.
Together with policies of not using interest and investing in things deemed forbidden by the religion, these basic tenets form the cornerstones of Islamic financing and its proponents have adapted its various forms to meet many modern finance requirements.

The foremost belief around which Islamic concepts revolve is the belief in one God and in his commandments. These commandments both set down by the Quran as well as the life and example of pbuh cover many areas of almost every aspect of a Muslim’s life. They are neither exhaustively restrictive nor are they ambiguous. Rather, it has a balanced approach to govern human life.


Capitalism and Islamic economy
The basic difference here is the exercise of divine injunction. Capitalism’s unrestricted faith in the market system where private ownership and the profit motive is given unbridled power is reigned in to a certain extent. It does not however deny the action of market forces; it only lays down some guidelines with which to regulate them. Interest, speculative transactions and the lack of ethics has undeniably caused a lot of problems and contributed to the increase in income gaps. A statement issued soon after the financial meltdown by the Vatican’s official newspaper Osservatore Romano said that, “The ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service.”

Regulation is good, but  still causes imbalance in society simply because humans are not capable of knowing all the consequences of their decisions. The fundamental tenet then, is a religious one. This is reflected in the market structures that have emerged after decades of operation of Islamic banks.

The IMF paper cited above also said that “small Islamic banks tend to be financially stronger than small commercial banks and large commercial banks tend to be financially stronger than large Islamic banks. Further, small Islamic banks tend to be financially stronger than large Islamic banks, which may reflect challenges of credit risk management in large Islamic banks. We also find that the market share of Islamic banks does not have a significant impact on the financial strength of other banks.”

thesundayleader.lk

Shariah Stock Fund Winners Led by Namal, MFC: Islamic Finance

| Sunday, August 8, 2010
Aug. 5 (Bloomberg) -- Islamic stock funds in Sri Lanka, Thailand and Pakistan provided the biggest returns among global counterparts investing in Shariah-compliant securities as accelerating economic growth pushed shares higher.
Namal Amana Equity Fund, based in Sri Lanka, rose 71 percent in the last 12 months, beating all the other 299 funds tracked by Bloomberg. MFC Islamic Long Term Equity in Thailand increased 55 percent and Al-Meezan Mutual Fund of Pakistan gained 51 percent in the period.
Investor confidence is improving as Sri Lanka emerged from a 26-year civil war, Thailand prepared to lift a state of emergency in Bangkok and Pakistan’s government predicted the fastest pace of economic growth in three years. Sri Lanka and Thailand have yet to sell bonds that comply with the religion’s ban on interest, limiting investment options for Muslims in those countries.
“Sri Lankan stocks did very well as the climate was right for investment,” S. Jeyavarman, chief executive officer of National Asset Management Ltd., of which Namal Amana is a unit, said in an Aug. 3 interview from Colombo. “Investor interest will pick up as they see these kinds of returns.”
Namal Amana holds shares of Nestle Lanka Plc, a local unit of Switzerland’s Nestle SA, which rose 103 percent in the last 12 months, and tea processing company Tea Smallholders Factories Plc, which gained 89 percent, said Jeyavarman, who manages the equivalent of $60 million at National Asset, of which less than $1 million are Islamic funds.
Average Returns
Shariah law forbids gambling, payment of interest, smoking and alcohol, so fund managers have to select investments deemed as halal, or permissible. Companies and products are screened by a board of scholars to ensure they don’t violate religious principles. Namal Amana, MFC Islamic and Al-Meezan Mutual beat the average return of 36 percent among the top 20 funds.
The Dow Jones Islamic Market World Index, which tracks shares that meet Shariah guidelines and has a market capitalization of $12 trillion, climbed 11 percent in the past 12 months, the same as the Dow Jones Global Index. The Colombo All-Share Index reached a record high of 5,225.60 on Aug. 3, after more than doubling in the past year.
MFC Asset Management Plc’s Islamic fund beat the 36 percent gain in Thailand’s SET Index by avoiding banking stocks that generally don’t comply with the religion’s ban on interest, Supakorn Soontornkit, chief investment officer at the Bangkok- based company, said in an interview on Aug. 3.
Banking shares carry a 20 percent weighting in the SET Index, the second-biggest after energy and utilities, Bloomberg data show.
Growth Accelerates
“Apart from Shariah-compliance, the main criteria for picking those stocks are strong earnings growth and high liquidity of the shares,” said Bangkok-based Supakorn, who oversees $7.5 billion at MFC Asset Management.
The fund holds Delta Electronics (Thailand) Pcl, Thai Union Frozen Products Pcl, PTT Chemical Pcl and Hemaraj Land & Development Pcl, according to the company’s website.
Thailand’s central bank expects the economy to expand 6.5 percent to 7.5 percent in 2010, the most in at least seven years, Assistant Governor Paiboon Kittisrikangwan said on July 23. That’s up from an earlier forecast of as much as 5.8 percent. Pakistan’s government estimates 4.5 percent growth for the fiscal year that started July 1, 2010, compared with 4.1 percent last year. Sri Lanka’s government is aiming for 7 percent, the fastest pace since 2006.
Sukuk Spreads
State-run Islamic Bank of Thailand plans to raise 5 billion baht ($155 million) in the nation’s first sale of sukuk, the Thai Securities & Exchange Commission said in a July 15 interview. Pakistan has 42 billion rupees ($491 million) of the notes outstanding, according to the central bank.
The HSBC/NASDAQ Dubai US Dollar Sukuk Index, made up of Islamic bonds from Indonesia to Saudi Arabia, rose 11 percent in the past year and dollar debt sold by developing nations gained 20 percent, JPMorgan Chase & Co.’s EMBI Global Diversified Index shows.
The spread between the average yield on emerging-market sukuk and the London interbank offered rate, has narrowed 55 basis points to 388 since the end of June, according to the HSBC/NASDAQ Dubai US Dollar Sukuk Index. The difference reached this year’s low of 369 on April 15.
‘Right Time’
The yield on Malaysia’s 3.928 percent note due June 2015 rose one basis point to 2.99 percent today, according to prices from Royal Bank of Scotland Group Plc. The rate has declined 85 basis points since the securities first traded on May 28, prices from HSBC Holdings Plc show.
The 51 percent return from Al-Meezan, a unit of Islamic Al- Meezan Investment Management Ltd., outpaced the Karachi Stock Exchange 100 Index’s 33 percent rally in the past year, according to data compiled by Bloomberg.
The fund holds shares of Oil & Gas Development Co., Pakistan’s fuel explorer, Muhammad Asad, Al-Meezan Asset’s chief investment officer, said in an Aug. 3 interview.
Shares of Oil & Gas rallied 67 percent.
“Our investment in energy and cement shares was just at the right time,” said Asad, who manages the equivalent of $210 million including $20 million at Al-Meezan Mutual.
--With assistance from Anuchit Nguyen in Bangkok and Anusha Ondaatjie in Sri Lanka. Editors: Simon Harvey, Claudia Maedler.
To contact the reporter on this story: Khalid Qayum in Singapore kqayum@bloomberg.net. David Yong in Singapore at dyong@bloomberg.net.

The Islamic financial system has potential to serve better than conventional banking system, a top official of the central bank said on Thursday.

| Saturday, August 7, 2010
Addressing the inaugural session of the Islamic financial news road-show on Islamic banking, State Bank of Pakistan Acting Governor Yaseen Anwar said that the Islamic financial system has the potential to provide better banking and financial services than the conventional system provided it capitalises on its own inherent strengths and avoids following the conventional system.

Anwar said that the current Islamic banking paradigm, both in Pakistan and elsewhere in the world, is based on replication of conventional banking products.

“While the replication of conventional products to make them Shariah compliant does pass the Shariah permissibility test, it is insufficient to achieve the larger objectives of the Islamic financial system, particularly the broad-based and equitable distribution of economic gains,” he said.

The acting governor said that reliance of Islamic banks on debt-based fixed income products and minimising the risks to almost close to those of the conventional system is not only blurring the distinction between Islamic and conventional finance, but also making Islamic banks relatively less efficient than their conventional counterparts.

“Thus, to sustain the growth momentum, the industry will have to diversify its products mix by focusing on the areas where it has comparative advantage rather than blindly following the conventional system,” he said.

He said that 67 percent of the Islamic banks’ financing in the country is concentrated in the corporate sector through Murabaha, Ijarah, and diminishing Musharaka. With most of the corporate entities having banking relationships with conventional banks, the Islamic banks have to offer significant price discounts to attract corporate clients, he said.

“This improves the quality of their financing portfolio, reduces their profit margins and inhibits their ability to offer better returns to the depositors,” the SBP acting governor said.

It also restricts the access to finance to the well-established businesses and corporates and leaves the small and medium enterprises (SMEs) and start-up businesses financially excluded, he said.

“This is contrary to the natural business model of Islamic finance, which promotes risks and reward sharing and encourages financing to promising start-ups that is critically important for promoting entrepreneurial culture,” said Anwar.

He said that the present scope of Islamic banks’ business model is confined to that of conventional banks, which generally caters to the short-term financing needs of the real economy through interest bearing instruments and facilities.

“While this scope is in line with the business model and deposit streams of conventional banks, it is not sufficient for the Islamic banks, which were originally conceived for catering to the genuine financing needs of the real economy through risks and reward sharing instruments,” he said.

“Islamic banks with this narrow scope will find it difficult to compete with the conventional banks, which are giants as compared with the Islamic banks and are highly efficient and flexible in catering to such financing needs of the real economy,” he said and reiterated that the Islamic banks will have to expand their scope to offer both commercial and investment banking services to be financed by different streams of deposits.

Anwar said that there are numerous areas and sectors, which could be explored to sustain and even accelerate the growth momentum of the Islamic banking industry.

Agriculture is strategically an important sector of Pakistan’s economy with 20 percent share in the GDP and a major source of livelihood for 65 percent of the country’s population living in rural areas, he said.

ìThe sector is also largely un-served or under-served by banks as less than 20 percent of about seven million farm households in the country have access to bank credit,” he said.

He suggested that the Islamic banks can capture a sizeable proportion of this market by reaching out to the growers either directly or through the non-governmental organisations (NGOs) or microfinance institutions.

“The Islamic banking institutions are likely to have better acceptance in the rural areas as the rural population is believed to be relatively more faith sensitive,” he said.

At present, Islamic banking institutions largely concentrate in large urban centres and they would need to expand their outreach to smaller towns and rural and semi-rural areas and optimally leverage the technology to serve the rural markets, he said.

Similarly, he said, there is also a great potential in the SME sector, while Islamic banks can also have partnership with the federal and provincial governments in developing and building low-cost housing projects, which are on the priority agenda of the federal and provincial governments.

Anwar said that the central bank fully recognises and appreciates the potential of Islamic banking in increasing the depth and breadth of the banking system and making it more diverse and stable.

“It is an important component of the SBP’s strategic goals and we are actively engaged with the industry as the regulator-cum-partner to catalyse and facilitate development of the industry on sound footings,” he said.

“We have plans to further improve our legal and regulatory framework to provide the necessary support and flexibility to this budding industry and enhance its commercial viability. There are additional plans to strengthen the Shariah compliance framework to improve the Shariah compliance levels in the industry and give comfort to the masses about the Shariah permissibility of Islamic banks’ operations,” he added.

www.thenews.com.pk 

Why are more firms issuing bonds?

|
The recent announcements by state investment arm Khazanah Nasional Bhd and several listed companies to raise debt might have stemmed from demand in the market for such issuance after the relatively quiet first half of the year.
Malaysian Rating Corp Bhd fixed income research head Wan Murezani Wan Mohamad said since primary market activity was relatively quiet in the first half, the number for the second half would likely be higher if a comparison was to be made.
He told StarBiz in an email reply that bond issuances would pick up in the second half “based on bond deals in the pipeline.”
“Companies seen tapping the bond market actively of late is a manifestation of improving economic activity which gives them more confidence for expansion,” Wan Murezani added.
Wan Murezani Wan Mohamad
He said as government bond yields were quite low at present, bonds or sukuk issued by private entities would be more appealing, especially given the return of economic growth.
Khazanah announced on Tuesday that it was raising S$1.5bil (RM3.6bil) of five- and 10-year sukuk while it was reported that Axiata Group Bhd had planned to sell the bulk of its RM4.2bil Islamic bonds to the Employees Provident Fund.
Bankers also said it was likely that T. Ananda Krishnan-associated companies Astro All-Asia Networks plc, Measat Global Bhd and Tanjong plc going private would be financed via debt.
Yesterday, CIMB Investment Bank Bhd announced on behalf of the board of Malaysia Airports Holdings Bhd (MAHB) that the company, through subsidiary Malaysia Airports Capital Bhd (MACB), was proposing to raise Islamic commercial papers and Islamic medium-term notes of up to RM3.1bil.
The investment bank said the proceeds would be used to part-finance the construction of a new airport terminal expected to be completed by the end of the first quarter of 2012.
CIMB said the proceeds could also be used to refinance MAHB’s existing borrowings/financings, which were utilised for syariah-compliant purposes and/or for MAHB’s syariah-compliant general corporate purposes.
Singapore-based Rothschild debt advisory division director Enoch Tan said the recent slew of debt raising “demonstrates that credit appetite for banks and other debt investors have returned somewhat after a relatively quiet past two years.”
He noted that there was sufficient liquidity in the domestic market currently to support a large raise-up whether by bonds, sukuk or loans at a reasonable rate.
AmResearch Sdn Bhd treasury analyst Karen Wan said “in general, the new issuance will help to satisfy some of the demand for corporate bonds that has built up in the relatively quiet market so far this year.”
However, she said, activity in the corporate bonds market would still depend on whether the bonds were offered to the market or whether they were privately placed out, as was likely in the case of Axiata.
Meanwhile, RAM Ratings has assigned a preliminary long- and short-term ratings of AAA and P1 respectively to MACB’s Islamic medium-term notes programme and Islamic commercial paper programme.
RAM Ratings said in a media release that the ratings were a reflection of MAHB’s credit risk given the strong credit link between MAHB and MACB.
The rating agency said MAHB’s airport-operating concessions in the country and monopoly position reflected a strong business profile with a strong margin on operating profit.
It added that the rating also reflected the Government’s financial support for the company due to its critical role as the operator of the country’s airports.
http://biz.thestar.com.my

Maldives issues first Islamic bank license

| Thursday, August 5, 2010
MALE, August 4, 2010 (HNS) - Maldives Monetary Authority (MMA) Tuesday issued license to Maldives Islamic Bank Private Limited (MIB) to set up the country’s first Islamic bank.

According to the authority’s website, “MMA issued a banking licence to the ‘Maldives Islamic Bank Pvt. Ltd.’ to conduct Islamic banking business in the Maldives, with effect from 2nd August 2010.”

An MMA official told Haveeru that an Islamic bank could be established under the current commercial banks regulations.

“These regulations are suitable for any kind of bank. But we are drafting specific regulations for Islamic banks before the first establishment,” he said.

MIB Managing Director Harish Haaroon said the company would set up the bank by the end of 2011. 

“We hope that the bank will be established within the next six months according to MMA regulations,” he said.

A press release issued by the company read that the bank was formulated on April 1 by the government in collaboration with Islamic Corporation for the Development of Private Sector (ICD). While the government and ICD signed the agreement on October 4, 2009 a Memorandum of Understanding (MoU) was reached on April 12, 2007.

The government also signed agreements with Dubai International Finance Centre’s Ridge Solutions International Holdings on October 15 and Dubai’s Noor Islamic Bank on July 7, 2008.

haveeru.com.mv

Two industry figures call for standardisation in Sukuk issuance

|
r. Ahmad Rufai Muhammad Head of Shari’ah, and Ijlal Ahmed Alvi, CEO of International Islamic Financial Market say that as Islamic finance has grown, differences in rulings on whether or not products are Shari’ah-compliant have surfaced.


Rufai and Alvi opined, “Although Shari’ah interpretations and applications are similar, this does not always translate into unified documentation and unified application.

Conformity amongst the Shari’ah supervisory boards of Islamic financial institutions is needed. We believe that standardisation of certain structures and contracts is necessary in order to avoid inconsistencies between different Fatwa rulings and their application by Islamic financial institutions regionally and globally.


“The existence of a unified Shari’ah board through a council representing different Islamic schools of thought worldwide is necessary as this would facilitate the conformity of certain existing wider market product structures such as Sukuk. Sukuk are a vital mechanism for raising money in the financial markets. Hence, continuous improvement of the functions of Shari’ah boards to achieve a global standard for Sukuk is essential because lack of standardisation in the Sukuk area is a contributory factor to low issuance levels. Moreover, the present financial crisis has raised a number of structural issues in Sukuk such as transfer of ownership and the Sukuk holder's ability to have direct control over the assets in case of default.


“The present market conditions have clearly identified the urgent need to revisit the issue of asset based versus asset backed Ijarah Sukuk. The issue has legal and documentation implications but must be studied by Shari’ah scholars in order to safeguard the rights that holders have perceived at the time of issuance of the Sukuk as well as issues such concerning fair risk and reward in the case of Musharaka and Mudaraba Sukuk (refer Sheikh Taqi Usmani's ruling), needs to be looked at from a convergence point of view. These issues have global significance and universal convergence is absolutely essential.

“In our view the establishment of a Shari’ah Board at a global level will be helpful and can play a major role in convergence as well as in facilitating the development of a robust and unified Islamic financial services Industry. This can be achieved if Shari’ah scholars from around the globe contribute towards a greater understanding at national and international level of convergence. Such convergence and harmonisation can only happen with greater engagement among regulators, practitioners, Shari’ah scholars and other stakeholders in the Islamic finance industry.


“We believe that collective efforts through cooperation and collaboration between major Islamic financial standard-setting and development bodies such as the International Islamic  Financial Market, the Accounting and Auditing Organisation for Islamic Financial Institutions, Islamic Financial Services Board and central banks is important in strengthening the fabric of Islamic finance.”

haveeru.com.mv

Trends in taxing Shariah Structures

| Wednesday, August 4, 2010
Introduction
The slightly altered words of Shakespeare "we know where we are, but we know not where we may be" may be self evident in many spheres of life.  However the words are certainly very apt when one looks at the changes that have been made to the tax laws in various jurisdictions to facilitate Shari'ah compliant financing.

In this article we have a bird's eye look at how Shari'ah compliant financing in the UK, US, Germany, Luxembourg and Ireland have been/will be facilitated in the future and are attractive for Shari'ah compliant investors in making their real estate or private equity investments, in or through such jurisdictions.

Why worry about Tax?
Tax can be an inhibition to Shari'ah compliant financing because various jurisdictions' tax codes have not been designed with Shari'ah compliant structures in mind.  However, the UK, French, Luxembourg and Irish Governments have amended or clarified their tax codes in order to facilitate Shari'ah compliant financing.


What are different jurisdictions doing?
As you would expect, different jurisdictions are adopting different approaches according to their existing tax codes.  Broadly the approaches can be divided into two categories:

substance over form; and

(ii) form over substance with amended/new legislation.


Substance over form
In adopting the substance over form approach, each of the US, German (guidance has been sought), Luxembourg (guidance issued) and French (guidance issued) authorities look at the objective economic goals of the transactions rather than just to the legal form of the commercial arrangements.


The basic requirement of the tax authorities in each of the US, Germany and Luxembourg in order to identify a debt for tax purposes is to look for an indebtedness in the form of an unconditional, legally enforceable obligation for the payment of money. In several Shari'ah compliant structures, there will be a clear obligation for the payment of money, with a separate price for the delayed repayment of that indebtedness.

US
From a practical perspective, it is important that the documentation should clearly show and identify the principal and the price for the deferral which should be clearly calculated by reference to the length of the deferral (the "profit amount").

For leasing transactions (including in the context of Sukuk transactions), it is already well established in the US that there can be a financing lease or an operating lease.  The lease payments can be broken into two distinct components, namely principal and interest.  The documentation should also clearly state that the parties intend that the lessee will be treated as owner of the property for tax purposes.

The Shari'ah advisers will require the lessor to be responsible for the maintenance of the assets.  Thus, such cost is passed back to the lessee through additional rent provided the Shari'ah adviser is satisfied with this.  Furthermore, it is important that the transaction documentation does not preclude the parties from utilising the substance over form approach and that it is clear that the parties intend that the arrangements be treated as finance arrangements for tax purposes.

Any transaction involving the US must also take into account state and local tax issues especially if the assets are located in the US.  Although most state and local rules generally follow the US federal rules in terms of determining the characterisation of transactions, this is not always the case and local and state taxes can vary widely from state to state.

Luxembourg
The Luxembourg authorities have accepted the use of Shari'ah compliant structures as financing transactions and have issued guidance to this effect.  The guidance issued by the Luxembourg tax administration in the form of a circular (the "Circular"), refers to Islamic finance as the "financial instruments used by investors who wish to manage their investments observing the values of Islam".  In particular, the Circular addresses the tax treatment of the murabaha and the sukuk.  With regards to the murabaha, the Circular allows the profit to be recognised over the life of the murabaha where certain requirements are met.


With regards to the sukuk, the Circular provides that it should be treated in the same way as a conventional bond is treated.

It is also possible to obtain formal interpretation confirmation from the Luxembourg authorities, which gives comfort for the investor and the investee provided proper disclosure is made.

Germany 
There is currently no specific guidance from the German tax authorities on the treatment of Shari'ah compliant finance arrangements but this is being actively sought.  With respect to existing Shari'ah compliant investment in Germany to date investors in real estate and private equity, the Shari'ah compliant structuring associated with such investments has been implemented outside of the country (for example, in Luxembourg).


Given the lack of guidance from the tax authorities, such Shari'ah compliant structures must be capable of fitting within the appropriate tax definitions. The general definition of (debt) interest under German income tax law is the temporal commitment of capital against compensation. The traditional murabaha would probably be considered as debt financing by the buyer for German tax purposes as - substance over form - the fair market value of the underlying commodity is below the amount the buyer finally has to pay under the murabaha. The deferred price in such murabaha is, from the German tax law perspective, compensation for financing the acquisition under the murabaha.

Once certain structural requirements are met and the criteria of the tax authority's circulars on leasing, the tax implications of the "ijara lease" mean that it should be considered as debt financing.  One would expect that the typical ijara lease would be treated as a financing lease, therefore subject to the same German tax rules on deductions for finance costs.   

In real estate finance transactions there are no specific exemptions from German Real Estate Transfer Taxes ("RETT") for Islamic compliant structures, thus it is necessary to adopt other structures which may enable the RETT to be avoided or reduced.

Form over substance and enabling legislation
In jurisdictions where tax is determined more on form over substance, the challenge for the authorities in introducing rules to facilitate Shari'ah compliant financing is to strike a balance between flexibility for the Shari'ah compliant investors and investees and loss of revenue for the Government if the tax rules are too widely drafted.


In the UK and Ireland, the form of a transaction is generally the basis on which that transaction is taxed, although not exclusively.  Thus the UK and Ireland have introduced rules which treat certain arrangements (which would be expected to be regarded as Shari'ah compliant) in the same way for tax purposes as conventional debt arrangements. 

UK
At a very basic level, the conditions set out by the UK legislation include the requirement for there normally be a "financial institution" involved and the return by or to the financial institution must equate to an amount which one would reasonably expect to be a return on capital lent.


In order for a murabaha, which is often used in private equity financings, to qualify as a financing the conditions are not onerous, provided the basic conditions are met and the assets used do not give rise to VAT, stamp duty, stamp duty reserve tax (SDRT) or SDLT.  It is relatively easy to achieve this by using the sale of certain metals or metal related instruments in practice.

However, the landscape is more complicated when dealing with real estate financing or a sukuk backed by real estate assets.  Normally, a special purpose vehicle ("SPV") is used to generate the ijara lease and create the cashflow.  Thus, in addition to the tax aspects associated with a conventional real estate financing, one has to look at the capital/chargeable gains, VAT and SDLT implications for the lender, borrower and the SPV.

However, unless such SPVs meet the qualifying criteria to be a financial institution, certain SDLT, corporation tax and capital gains tax reliefs will not be available.  While a "financial institution" is broadly defined, a SPV will only qualify in limited circumstances.  Furthermore, refinancing can raise additional tax issues which have yet to be resolved. 

In 2009, the UK introduced further rules to facilitate the issue of the sukuk backed by real estate assets.  However, these rules still need some tweaking before they can operate smoothly on a standalone basis unless one were to use existing rules to supplement the new rules.

In addition, it is worth noting that the UK authorities are still working with interested parties in refining its legislation to ensure that the political objectives can be reached without providing an avoidance mechanism for other taxpayers.

Ireland
Ireland has introduced legislation to facilitate the use of certain Shari'ah compliant financing techniques, described as "specified financial transactions".  Like the UK, the specified financial transactions will have to meet certain requirements and can be broadly categorised as credit transactions (like the murabaha), deposit transactions (akin to the mudaraba) and sukuk transactions, which are seen as akin to investment transactions.  The Explanatory Notes to Ireland's Finance Bill 2010 state that the legislation "is designed to extend the tax treatment applicable to conventional finance transactions to Shari'ah products which are the same in substance as the conventional products."  The scheme of the Irish legislation follows, to a limited extent, the UK legislation but provides a broader definition to "financial institution" as well as not having such a detailed list of requirements.


Conclusion 
New rules or the imaginative and proper use of existing rules provide opportunities for Shari'ah compliant investors who seek to expand the geography of their investment base, spread their risk or explore new, more or better opportunities in a cost efficient way.  In addition such rules provide investees with more options for raising investment for new or existing strong ventures.  The investors' and investees' due diligence of such opportunities should consider the tax implications and the means of reducing any unnecessary tax cost considering the new rules, guidance or opportunities.


By Kevin Conway, John Taylor and Markus Krismanek of King & Spalding
© Zawya Select 2010

Is there scope for Islamic Banking?

| Tuesday, August 3, 2010
The hyperinflationary conditions and shortage of foreign currency that prevailed in Zimbabwe before the adoption of the multi-currency regime gave a whole new meaning to speculation, spawning the “burning” phenomenon. As if it needed any explaining, “burning” is generic euphemism for the speculative activities under which people basically created money out of thin air not by sleight of hand but by merely standing at street corners and manipulating exchange rate differentials between the “official” and “black” markets for foreign currency. 

At one time, an SMS joke apparently meant to sanitise this “burning” sensation (pun intended) did the rounds claiming that “Zvekuburner izvi hazvina kutanga nhasi, zvakatanga munguva yaJesu. Iye mbune akaburner 5 loaves nehove mbiri vanhu vanokwana 5000 vakaluma!” (This burning thing is not new; it was there in the time of Jesus. He himself miraculously multiplied 5 loaves of bread and two fish and produced enough food for more than 5000 people!) Morally, this crude attempt could not have been wider off the mark but — bordering on blasphemy as it may seem — it appears to have a measure of factual plausibility, because even in the time of Jesus, the spectrum of human endeavour boasted of everything from simple trading to speculation. In Matthew 21:2 we are told that “Jesus went into the temple and drove out all those who were buying and selling there. He overturned the tables of the moneychangers…’ Apparently, money changing — as burning was known then — is as old as the gospel!

Islamic Banking: Balancing Faith & Finance?

The state of the financial sector in Zimbabwe up to 2008 would no doubt have brought into sharp focus ssues of morality/ethics/faith in finance. Was it moral or ethical for such a large number of people to wish wealth into existence without any underlying productive activity happening, some may ask? In an attempt to answer this and other questions, this week we focus on a form of finance that seeks to strike a balance between faith and finance: Islamic Finance/Banking. Islamic Finance is based on the principle that money must never spontaneously generate money. Instead capital must be made fruitful or “fecundated” by labour, material or intellectual activity or be invested in a wealth creating activity. Islamic Finance therefore frowns upon speculation and applauds risk sharing.

Common Terms
Some common terms used in Islamic finance include sukuk issue (bond issue), Mudarabah (profit and loss sharing), Musharakah (joint venture) and Ijarah (leasing). Interest is called riba and an instrument that complies with the dictates of Fiqh al-Muamalat (Islamic rules on transactions) is described as sharia-compliant. Investing in businesses that provide goods or services considered contrary to the principles of Islam is haraam (forbidden) while those that are permitted are halaal.
Joint ventures under which the funder and the borrower share profits and risks are common in Islamic Finance because of the strict prohibition of the giving and taking of interest. Shariah- compliant mortgages, for instance, are typically structured so that the lender buys the property and leases it out to the borrower at a price that combines a rental income and a capital payment. At the end of the mortgage term, when the price of the property has been fully repaid, the house is transferred to the borrower.
Challenges

Apart from skepticism about its financing techniques, Islamic finance faces a number of challenges including transactions costs which tend to be higher in complex Islamic transactions than in more straightforward ones. Shortage of skills is another since scholars, who are the central industry figures, are in short supply to fulfill roles for international players – demanding knowledge of Islamic law and Western finance, as well as fluency in Arabic and English. Banking institutions that offer Islamic Banking products and services are required to establish a Shariah Supervisory Board to advise them and to ensure that their operations and activities comply with Shariah principles. Since Islamic instruments typically finance long-term assets, in the context of Zimbabwe, liquidity would be a formidable challenge given the mismatch between the duration of banks’ liabilities and their assets in an environment in which banks struggle to raise long-term debt.

Why Islamic Finance? 
Apart from the moral/ethical issues of finance, why would the issue of Islamic Banking be topical in Zimbabwe at this point? Firstly, even though Zimbabwe is predominantly a Christian nation, we can’t ignore the fact that there is a sizeable Muslim/Islamic community in Zimbabwe and the fact that some of whom may control significant amounts of wealth. It is reasonable to assume that this group has unmet investment needs that seek to benefit their savings as well as their souls. 

Secondly, the President of the Bankers of Zimbabwe, Mr John Mushayavanhu recently said that growth in the banking sector would hinge on the players’ ability to come up with innovative ideas to convince the public to channel their savings into the financial system. Could Islamic Banking be one of the innovations Zimbabwe needed to mobilize finance from Muslims? Institutions like NMB Bank Limited have flirted with the idea of Islamic Banking since the early 2000s but it is territory that remains largely uncharted for the majority of banking sector players, so it can be considered to be a growth area. 

Experts note that Muslims account for 20% of the world’s population, but Islamic finance accounts for less than 1% of its financial instruments hence this gap represents a big opportunity. Thirdly, due to the ban on speculation, Islamic transactions must be based on tangible assets such as commodities, buildings or land. Islamic Banking therefore lends itself to financing infrastructural development. The Zimbabwean economy has such a huge need for infrastructure financing right now that the case for Islamic banking instruments is a compelling one. The argument is that Islamic banking can, in the short to medium term, be used to mobilise internal resources for purposes of infrastructural development and in the long term, when our sovereign risk rating improves; it could be a vehicle through which foreign direct investment can be attracted from those wells-healed Middle-Eastern sovereign funds. After all, don’t we already have a Saudi Prince as an investor in Joina Centre?

International Perspective
Recently, GTR Magazine announced that Japanese investment bank Nomura won an oversubscribed $70million (from an initial request of $50 million) syndicated shariah-compliant commodity murabaha facility, signifying the first time a Japanese firm has tapped the Islamic market using a murabaha structure. A murabaha structure is basically a credit sale of goods at a price which includes a profit margin agreed to by both parties. The deal, which has ABC Islamic Bank as its mandated lead arranger, comes at a time when the bank has issued a US$100 million sukuk in Malaysia. Commenting on the transaction, Naveed Khan, managing director of ABC Islamic Bank said, “We believe strongly that this will act as a trailblazer for other Japanese issuers looking towards the fast-growing market of Islamic banking.”

African Perspective
According to Alhaji Mohammed Bintube, the Managing Director of Jaiz International Plc, Nigeria’s Islamic Banking marketwas worth around N4,35 trillion (US$27,7 billion) as at July 2009. Speaking at a forum titled Increasing Access to Finance through Islamic Banking, Modupe Ladipo, an industry executive said Islamic finance is a potential innovative approach to give the unbanked access to finance. He added that Islamic banking is globally being discussed as innovative, profitable and ethical, especially in the light of the global financial crisis and volatile interest rates. The Central Bank of Nigeria recently developed a draft framework for non-interest banking in response to a growing desire by banks and investors to establish Islamic Banking products. West Africa has a significant Muslim population, so Islamic Banking appears to be catching on quite fast in that region. 

Recently, Exporta, the publishers of GTR Magazine announced that they will be convening a conference on Structured Commodity Finance in West Africa and one of the topics up for discussion is “The growth of Islamic Finance and adoption of Shariah-compliant financing models.” 

•Omen N Muza is a banker and managing director of TFC Capital (Zimbabwe) (Pvt) Ltd. He writes in his personal capacity. Feedback: omen.muza@gmail.com

Understanding Islamic Finance

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TAP talks with Frank Vogel about Sharia-compliant finance, the financial crisis, and why banking is a chance to engage with the Islamic world.


During Elena Kagan's confirmation hearings, conservatives accused Kagan of being sympathetic to imposition of strict, Taliban-style Islamic law in the United States because an Islamic-finance study program was established at Harvard University during her time as dean.


The American Prospect caught up with Frank Vogel, an Islamic legal scholar who helped establish that program, at a recent forum on Islamic finance being held at George Washington University Law School by the Qatar Business Council and Arab Bankers Association of North America. When it comes to Islamic Finance, Vogel says, Americans have nothing to worry about.

What is Islamic/Sharia-compliant finance?
Islamic finance is conducting finance in compliance with the rulings of the traditional Islamic law as to commerce and investment and property.

Where does Islamic finance come from?
Well, in the '50s, people were thinking as Muslims about how they should engage with modern finance. So a number of theories came out about what Islamic law's requirements are as to finance. These were inspired mainly by the prohibition on collecting and charging interest in the Qu'ran.

How is it different from secular finance?
The difference is, for example, that they don't charge interest. They can't indulge in some particularly risky or speculative transactions. There's actually a whole long list of requirements, such as not selling debt, that are derived from these basic prohibitions against interest taking and against excessive risk. So because of those specific rulings, they have to design the transactions in slightly different ways.

For example, rather than borrowing money to buy some goods, they'll have the bank buy the goods and then resell the goods to the customer, so the bank becomes involved as an owner at one stage of the transaction. That makes it lawful, from the Islamic perspective. Whereas if the bank lent the money to the customer, that's an interest-bearing loan, and that's not allowed. So they use slightly different routes, typically involving ownership of goods at some point, to achieve finance.

Why is it important for Western institutions, for example GWU, to teach Islamic finance? 
Islamic finance is becoming extremely important in various parts of the world. It's shaping economies. Islamic finance is the most rapidly growing part of the finance industry throughout Southeast Asia, throughout the Arabian Gulf region, throughout the Arab world. Islamic banks are cropping up everywhere, in the UK, France, Germany. In fact, Europe is far ahead of the United States in this respect. There's been very little action in the United States. It's a lucrative field in finance, and it's rapidly growing. And many, many people want to get involved in it.

Why would, say, a non-Muslim American or student want to learn about Islamic finance?
Well, he would one day, perhaps, be advising an American company interested in developing business or investing abroad, and the foreign party wants to finance it by Sharia-compliant, Islamic-compliant banks, so he needs to have some idea of what Islamic-compliant investment is. Particularly if you're going to work in the Arabian Gulf, you have to know something about Islamic finance.

Is Islamic finance compatible with secular finance?
Totally. In fact, one of the criticisms of it these days is that it's too similar. Most financial transactions can be Sharia compliant with just a few changes and slight difference in the structuring. They're becoming closer and closer and closer to conventional finance.

Does America have to change its finance laws in order to deal with Islamic-finance companies?
No. There are many Sharia-compliant companies operating now within the United States. Most spheres of finance are quite possible according to Islamic principles already. There are a few areas where it poses a bit of a difficulty. For example, deposit insurance as a requirement for banking in the U.S. Islamically, it's difficult to arrange insurance deposits.

You mentioned that a lot of non-Muslims are starting to invest in Sharia-complaint finance products. What is it that interests people? 
People were interested, first, in the good returns that some of these funds have had, and second, I think that they're interested in the social-investing part. Islamic funds cannot invest in alcohol, gambling, arms, a list of objections. And because of that, they really are classified as social-investment vehicles.

You mentioned earlier that Islamic-finance companies suffered less during the financial crisis. 
Yeah, if Islamic law was applied pretty strictly, it would have been impossible for Islamic banks to be involved in any kind of derivatives, any seriously speculative transactions, in debt securitization, in the pyramiding of debt, in the credit-default swaps; all these things would have not been possible at all for Islamic banks. Although practices were beginning to head in that direction, they hadn't gone very far. So Islamic banks, basically, were still banking quite conservatively and came through relatively unscathed.

Can an Islamic-compliant bank function in the U.S.?
Yes. Well, as a bank, not yet. We were discussing this earlier, and apparently there are no Islamic banks as such yet in the United States. And I suspect the problem is as much as anything the deposit insurance requirement -- the Federal Deposit Insurance Company insurance requirement. But there are a lot of banking activities going on, on both the deposit and investment sides in the United States, and there are a lot of non-bank or investment-company activities going on. So there's a lot of Islamic finance happening.

In establishing a study program for Islamic, Sharia-compliant finance, are you trying to facilitate an Islamic takeover of the United States?
[Laughs] No. Islamic finance is one of the most opportune ways to engage with the Islamic world right now if you are concerned about terrorism. It strengthens economic links, it is being put forward by sort of the most Western-leaning individuals throughout the Muslim world, it draws them closer to the Western financial system. There are many, many aspects of it that are extremely favorable to a Western point of view. It's worlds apart from anything related to terrorism.

Why should we believe you? I have no particular stake in the matter! [Laughs] I'm not a practitioner of Islamic finance; I have no interest in it financially or personally. I just happen to be a student of Islamic law, and I see the virtues of Islamic law to a great degree. And this is a particularly opportune development of Islamic law. It leads to successful application of Islamic law in today's world. As it develops and becomes better adapted to the modern world, we could hope for similar developments in areas like family, family law, international law, human rights, and things like that.

prospect.org