November 23, 2005
Sharia Products: Market grows for Muslim investors
Laying in bed mildly delusional from anti-haemorrhagatic drugs and other items, I thought I might indulge myself in a reflexion on an interesting arty from The Financial Times on Islamic Finance and products.
The arty in question Market grows for Muslim investors covers some interesting territory even if it is a bit general.
As I can not think of a better time to indulge in commentary on sharia products than when slightly delusional from from anti-haemorrhagatic drugs, what follows are some comments on the text itself:
The fast-growing demand for Islamic finance products, most recently fuelled by investors from Gulf states flush with returns from high oil prices, is presenting a growing but rewarding challenge to some of the leading banking lawyers at top US and UK firms.
Immediately coming to mind in these contexts is the question: "When will the fancy lawyers go a bit too far and shoot the golden goose?"
It's almost inevitable, but from another perspective, it is interesting the manner in which Islamic products are being as much driven by Western banking innovation as by in-region innovations.
However, I would caution against over-reading this. Two thoughts come to mind here. One, much of the demand is in the Gulf and in the Gulf they have a habit of going to London for advanced work, rather than developing or drawing on in-region talent.
That has some goods and bads involved, which I will restrain myself from commenting on, other than to note that I would not draw strong conclusions as to the capacity to innovate in region based on the Gulf's rather odd habits.
Often hailed as a levelling of the playing field for Muslim investors, and even a force for world harmony, what is certain is that the growth of sharia-compliant investment and financing schemes is good news for western lawyers.
On the first, that's true in part, and well I don't necessarily see world harmony, to the extent that sharia-compliant (a funny term - and which sharia.... well, the buyer's sharia obviously - caveat emptor) financial products can draw into a modern financial system participants that have stayed aloof, that is a good thing.
I tend to view Islamic products as being in part, esp. as pimped by the big boys like HSBC, voudou and smoke and mirrors to make the religiously correct more comfortable. That, however, is perfectly valid on some level.
As the Islamic finance market begins to mature, banks and investors are demanding new products and new structures that do not infringe the principles of sharia, the parameters by which devout Muslims conduct their lives. But while products must often be sanctioned by sharia scholars, it is finance lawyers versed in the workings of English and US law who are finding ways to make the Islamic products work.
An interesting question glossed over here is the lack of "one sharia" and a unamity of views on what is "halal" in these contexts.
I also note that the article remains very Gulf focused. Of course the vast oodles of money flowing into the Khalijis' pockets justifies this in large part, but it's not the only game around. Regardless, likely to be the reference point.
“From the lawyer’s perspective, Islamic finance is just about a different set of contracts,” says Neil D. Miller, head of the Islamic finance practice at UK law firm Norton Rose. Strict Muslims recognise sharia law but international fin-ance needs more certainty, and that is provided by the English and US laws underpinning the contracts, he says.
Well, this is a bit of a silly statement.
Contract law in region is largely civil code based (as indeed most law is, rendering rather silly the idiocies about Muslims not being able to adopt anything but Sharia - in the end most activists only really care about some headline issues), not in any way "sharia" in a strict sense, but a lot of Gulf finance and Machreqi is done with common law.
In simple terms – though little is simple in the Islamic structures required for international commerce – the Islamic finance industry finds ways for Muslims to arrange their business affairs in accordance with their religious beliefs. Often, that can mean using a range of transactions to mimic the outcome of a standard loan or investment vehicle.
For lawyers that tends to mean a “ritualistic dance” of buying, selling and leasing transactions all occurring within split seconds of each other, says Mr Miller.
The last paragraph and the last portion of the preceding paragraph capture this faily well.
The basic principles of sharia include the prohibition of paying or receiving interest, or riba, as well as a ban on undefined risk, or gharar.
The sharia view is that money is not a commodity to be traded and so it is unacceptable that it should increase in value merely by being lent to another person. Instead, money should be deployed in a way that involves fair commercial risk in a venture of benefit to the community. Risk-free investments or those that do little to benefit society are also unacceptable, such as gambling and, by extension, playing the money markets.
It is worth noting that large numbers of Muslims, including observant ones see through the kabuki dance of contracts and understand the Quranic injunctions in this area in a modern sense (or shall we say, getting to the spirit rather than an archaic literalist reading) of prohibiting abusive use of money.
That being said, many have the literalist view as well.
Conventional loan agreements allow banks to increase costs, which is prohibited as an undefined risk. However, a capital owner can give use of an asset for a fair return, which makes leasing structures very popular, for example.
Although the leases are not really different from a loan under many such structures.
Of course, the difficulties are in the details. Not only do Islamic scholars differ in their interpretations of sharia, but different countries’ laws can also invalidate the techniques used. Mr Miller says some of the leasing techniques used in the Middle East, which are familiar to investors, cannot be used in the west because of problems caused by income tax, corporate tax or sales tax. There can also be problems getting local regulatory approval for Islamic products.
Indeed. Indeed. I would note that Islamic finance as such is almost non-existent in North Africa. The demand seems strongest in the Gulf, but also strong in conservative Jordan and Egypt.
“Some people say it’s all smoke and mirrors,” Mr Miller adds. “But it’s not. It is constructing things in a way so that the outcome is not dissimilar to conventional arrangements while managing the risk profile at the same time.”
I have to say that .... that's an admirable piece of PR speak.
An inherent problem in that, however, is the sheer cost of the complicated web of transactions. Isam Salah, head of the Islamic finance practice at US law firm King & Spalding, says: “While some of the structures that were being used worked, they were very, very complicated. So you got fees for lawyers and high transaction costs that were not really justified.” Finding more manageable, less document-intensive structures is a constant pressure.
But it takes time to go from "bespoke" products to packaged ones.
The figures are relatively impressive although this is PR speak so I would not fully trust:
For all the difficulties, there seems no let-up in demand. Estimates of the extent of sharia-compliant investments varies, although some bankers say up to $250bn has been invested along Islamic principles worldwide so far. The issuance of Islamic bonds, or sukuks, also accelerated to $6.2bn in the second quarter of this year.
...But English lawyers point to a landmark ruling in London’s Court of Appeal, the only significant ruling of its kind on an Islamic finance deal on either side of the Atlantic, to suggest that there is more legal certainty in the UK than in the US.
In that case, Shamil Bank provided two murabaha financing facilities to Beximco Pharmaceuticals of Bangladesh, which later defaulted. The defendants argued that the contracts were invalid because, although governed by English law and stating that the financings were “subject to the principles of the glorious sharia”, they did not in fact comply with sharia principles.
But the court dismissed their appeal, ruling that English courts would not second-guess an Islamic financial institution’s religious supervisory board and that the sharia principles did not trump the application of English law.
Now on this last there is an interesting question.
First, of course, the added expense of off-shoring the legal instruments is not something that will encourage extension of the lines. Obviously in country is cheaper, but often less reliable. Trade offs.
Even so, western lawyers are generally reluctant to include any provisos in contracts that might suggest the provisions are subject to sharia law.
Well, they'd be of the character of including some vague reference to "God's Laws" in a standard common law document. Probably not in any way helpful beyond making a particularly dim client happy, and might be trip up.
The bullishness aside, the generic law and contract enforcement issues in developing nations are clearly major hurdles.
On the future, as my lucidity slips away, I note the following
James Robertson, corporate partner at Taylor Wessing, the UK law firm, points out that retail banks have recently started to offer Islamic mortgages, but he believes many are now waiting to review their success before progressing with other retail products.
More pressing, though, is the desire of investment banks to offer services to Middle East financial institutions that currently have plenty of money to invest. There is an increasing number of Islamic real estate funds, he says, both for investment in Europe and Middle Eastern countries, such as Dubai.
Islamic real estate funds.
For me this is merely packaging to make some empty headed double zero more happy.
Now this is the amusing part:
In particular, lawyers are keen to grapple with the difficulties of Islamic derivatives products, which by nature involve no real assets and a degree of speculation – both factors that run counter to sharia principles.
Remember, “Some people say it’s all smoke and mirrors,” Mr Miller adds. “But it’s not. It is constructing things in a way so that the outcome is not dissimilar to conventional arrangements while managing the risk profile at the same time.”
So, Islamic derivatives......
The insurance angle is more interesting if less amusing for sheer gall:
...Islamic insurance is also likely to expand. It is currently restricted because there are not enough Islamic assets available in which to invest the cash generated by premiums. Mr Miller believes the demand from insurers could be a driver to increase Islamic investment products, expanding the insurance sector as a result.
However the concept mooted in the last part of marketing Islamic products as 'ethnical' investing products as well, presumably in the West, sounds moderately far fetched to say the least, if only due to the Islamophobia factor.
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"Sharia-compliant" finance instruments will never catch on in a very big way because they are, by definition, inefficient. Home loans are one thing, international project finance is another. Sharia is an additional, artificial constraint. If these products were more efficient, they'd already exist. To the extent that firms from, say, the Gulf, insist on them, they're basically an opportunity to pick their pockets. I smell arbitrage opportunities!
Posted by: Anonymous at November 24, 2005 12:12 AM
You are putting this in the wrong frame of reference. Such products, while inefficient, are not competing directly against classic finance. Rather they're moving into areas where the consumers (in the wide sense of the idea, or let us say the market), for religious reasons avoided such products. Virgin territory.
Now, with respect to increased efficiency, and already existing, perhaps, perhaps not.
Posted by: The Lounsbury at November 24, 2005 05:26 AM
"including observant ones see through the kabuki dance of contracts and understand the Quranic injunctions in this area in a modern sense (or shall we say, getting to the spirit rather than an archaic literalist reading) of prohibiting abusive use of money."
So, while they think Islamic finance isn't really Islamic, do the Muslims you speak of who look at the spirit rather than the law think that some cases of interest charging are kosher? I'm not clear on this because looking at the spirit and thinking of it in terms of "abusive"* could lead to a broader or a narrower proscription, depending on what one considers abusive.
It's possible that some Muslims are doing a concealed** aboutface concerning interest charging, much like the Catholic Church did.
*This reminds me of the word "exploitation" which goes anywhere from the reasonable reference to slavery to the idiotic Marxist use.
**"What, we never said interest shouldn't be charged, we said *excessive* interest should not be charged. Yes sir, that's always been our official policy. We swear to God."
Posted by: Baal Shem Ra at November 26, 2005 06:17 PM
The about face was actually executed a good 50-80 years ago, which is why most banks in the region operate on perfectly Western bases.
However, some portion of the client bases in the Islamic world would like "halal" products.
I say, serve it up, and if it turns out to be more profitable, well why not? While there are efficiency loses, the proper benchmark is not against Western products that this class of clients often outright refuse to use, but gains relative to more primative or less formalised financing means.
Posted by: The Lounsbury at November 29, 2005 08:12 AM