‫التمويل االجتماعي اإلسالمي‪:‬‬

‫الواقع وآفاق املستقبل‬

‫‪Product Development in Islamic‬‬

‫‪Syndicated Financing :‬‬
‫‪Current Practices and Challenges‬‬
‫‪of Innovation‬‬

‫‪Dr. Muhammad Imran Ashraf Usmani‬‬

‫الراعي الرسمي‬ ‫اجلهة املنظمة‬ ‫الشريك املصرفي الرسمي‬

‫الراعي الشريك‬ ‫الشريك اإلعالمي‬ ‫اجلهة الداعمة‬ ‫الشريك املعرفة‬

 Product Development in Islamic Syndicated financing :
Current Practices and challenges of innovation

Executive summary

The Islamic finance industry is a relatively new entrant to the world of finance
because its operating principles differ from the conventional finance modes of
operation. It operates in compliance with Islamic Sharia. This raises the need
for developing appropriate financial product and services for the industry. The
paper sought to analyze the challenges of product innovations in Islamic
Syndicated financing and deliberate recent cases of Islamic syndicated
financing. The study discusses grave shariah issues arise in product
development of Islamic syndicated financing and their solutions such as lack
of standardized documentation, NOC and charge on the assets, true
implication of sale and purchase of assets, tax issues on sale and purchase
and lack of related trained professionals. The study concludes that although
the various financial innovations were indeed significant and have positively
affected the Shariah compliant Syndicated financial service,. IFIs should focus
their efforts on financial innovations and should introduce Shirkah
(participation) based Islamic syndicated financing products because Shirkah
(participation) truly reflects the Islamic concept of fair distribution of wealth
among its stake holders. The study also figures out the risks associated with
shirkah based syndicated financing and suggests actions which can address
this issue and will ultimately help the growth of Islamic financing.

Introduction:

In this note we have put our efforts to find the innovative ideas for Islamic generally and
syndicated financing specifically. The Islamic financial institutions have a great potential
to increase their market share in syndicate financing and there are plenty of avenues

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available as the awareness of riba free system has caught the momentum in general
public, organizations and the stake holders of the society overall.

With the intensification of the IFIs, there have been vigorous developments in the
structures used to effect Shariah compliant financings as well as in the techniques used
to implement these structures, including balance sheet and off balance sheet financings.
Islamic syndicated financing is one of these techniques.

The objective of Islamic financial innovation is to develop financial structures that are not
only Shariah compliant but also offer a distinct social value. At this juncture, it is important
that the industry develops its own unique selling point as Shariah premium continues to
decline. One possible way to achieve this is through the development of alternative
Islamic financial institutions with a focus on the societal improvement. Innovative product
development teams have developed sophisticated Islamic alternative assets over the last
decade. These innovations have opened up a whole new array of asset classes to Islamic
investors enabling them to gain access to the risk and return profiles of previously
untapped areas. This trend is expected to continue as the industry develops. Without a
doubt product innovation will be an important factor in the continued growth of the
industry.
Unfortunately there is ignorance in understanding the dynamism of human scenarios, that
is mainly due to the fact that Muslim society took Islamic fiqh as ready-made source of
Islamic economic and financial system, though it is obvious that the rules of fiqh were
established centuries ago and considering the current dynamic situation to develop the
Islamic financial products may suffer the industry and cause a pause into the financial
innovation process and definitely post a great mismatch in the flow of ideas.

Definition & Concept of Islamic Syndicated Finance:

It is a form of financing or banking facility which refers to a form of financing where two or
more banks or financial institutions (FIs) decide to group together to participate in a deal
and each provides a portion of the principal financing sum to a borrower who is in need.
The borrower could be a corporation, a large project or sovereignty, such as a
government.

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As per AAOIFI standard No. 24 “It refers to the participation of a group of institutions in a
joint financing operation through one of the Shari’ah-compliant modes of financing. The
accounts of the syndicated financing operation are kept independent from the accounts
of the participating Institutions.”

Furthermore the same standard states that the syndicated financing operations can take
place either between Islamic financial Institutions or between IFIs may also practice it it
with the other conventional banks. So the participants pool their share into the financing
facility and make substantial investments.

In general, Islamic syndication has the same theoretical foundation and takes into relation
the same marketable considerations as its conventional counterpart syndication, but there
are certain ground breaking material dissimilarities between the two dealings that must
be measured.

The Initiation of Syndicated loans:

The syndication is a form key of financing which has been largely used in the interest
based financial markets for decades and is being increasingly practiced nowadays in the
Islamic financial market. It is usually managed under the investment or corporate banking.
The dedicated teams of expert members perform such transaction after proper
evaluations and research.

From the review of existing literature under the nomenclature of “Syndicate Financing” or
“Loan Syndicate” this can be revealed that the evolution of syndicated lending can be
divided into various phases. Credit syndications first developed in the 1970s as a
sovereign business. On the eve of the sovereign default by Mexico in 1982 and it was the
time when certain restructuring events occurred.

Many large infrastructure projects are financed with a syndicated loan. For example the
Panama Canal expansion was financed with a syndicated finance. The syndicate was
comprised of Andean Development Corporation, the European investment bank, the

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Inter-American development bank, the Japan bank of international cooperation, the
International finance corporation and few others.

When it comes to the Islamic Finance syndication events, with the growth of the Islamic
finance industry, there have been significant developments in the structures used to affect
Shariah compliant financings as well as in the techniques used to implement these
structures. Similar to conventional syndicated finance, the participating FIs in an Islamic
syndicated finance will appoint a lead bank who is responsible for the syndication,
coordinating the process of preparing and finalizing the documentations and closing the
deal. The concept of syndicated finance from the Shariah perspective works in similar
ways to that of the conventional syndicated finance except that it uses structures
acceptable to the Shariah. A significant feature of an Islamic syndicated finance is the
absence of elements of interest. Instead, the transaction involves trades/ leases of
tangible assets and these assets are expected to generate profit for the transaction;
however profit cannot be guaranteed, that is a condition of Islamic Finace.

In the recent past, in 2009 a worth noting example is the Islamic syndicated Ijarah facility
of US$125 million was made. In this syndicate, Boubyan Bank acted as the lead
arrangers, while the major participants were Liquidity Management House, Kuwait
Finance House, BNP Paribas, Gatehouse Bank, Ahli United Bank and other financiers
and Burgan company for well drilling trading and maintenance (Burgan) for the acquisition
by Burgan of four new oil rigs. It was the first Shariah compliant corporate syndication out
of Kuwait and it was oversubscribed, that suggests a confidence level in Islamic
syndicated finance even in the adverse situation.

The European banks, which had their huge participation in Islamic syndicated financings,
drastically withdrew from the market to safeguard their own liquidity and to manage their
balance sheets in a better way. In 2011 Islamic syndicated financings volumes in the
Middle East and North Africa (MENA) region experienced a nose-dive to 40% decrease
and were reported at $1.97 billion, the lowest since 2004 as per sources.

Current Practices & Notable Transactions:

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Nowadays in practices of Islamic Finance industry is to increasingly approve the Wakalah
as a contrary to the Mudarabah structure. Although the latter was introduced much earlier
in the practices of the industry, at this point several elements and components which may
need to be taken into account on when it comes to the utilization of a Wakalah or
Mudarabah for an Islamic syndicated finance in the process. Being considered that a
Wakalah relationship which is actually an agency setup, may draw the specific purpose
of agency laws in the authority of the prevailing law. The tax treatment, indication and
implication under the respective and valid tax laws for each and every structure may be
contingent and dependant on how the laws read these relationships. With relation to this
there may also be dissimilar behavior and treatment of the funds received by the Wakeel/
Mudarib which may post the considerable issues in case of the insolvency or liquidation
of the Wakeel or the Mudarib.

Significantly there is one other issue where the Wakeel is not amongst the participating
FIs of the syndicate, the Wakeel would apparently have no motivation and incentive in
pursuing the benefit of the said syndicate, therefore wakeel will still earn the agency
fees/income, regardless of the performance of the deal and as a result may deliberate on
closing as many deals as possible irrespective to make sure the eminence of the deal. In
current practices of IFIs there are two tiers under Islamic syndicated finance. The 1 st one
is the liaison between the participating FIs & the lead bank while the 2 nd tier defines and
explains the structure of the financing and role of lead bank. It has been witnessed that
there are two ways that have been widely used while structuring the bond and relationship
of lead bank and participants of a syndicate. It could be either a Mudarabah (partnership)
or the Wakeel (Agency). When the relationship between the participating FIs and the lead
bank is based on Wakalah or agency principles the participating FIs act as the Muwakeel
or principals and the lead bank acts as the Wakeel or agent in this situation.

Recently demand for Islamic syndicated loans was on the rise in UAE and US$ 9 billion
in Islamic debt was issued in 2015-16, that is a 30% increase over the previous year.

UAE's Ajman Bank finalized $205 million Islamic syndicated loan. It also raised $155
million through another two-year murabaha loan and an additional $200 million three year
syndicated Islamic debt facility in 2015.

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Abu Dhabi Islamic Bank (ADIB), a top-tier Islamic financial services institution, closed a
Dh. 302 million syndicated Islamic financing deal for Emirates National Factory for Plastic
Industries in 2013.

In 2018, Abu Dhabi Islamic Bank (ADIB) also participated in a syndicated Dh. 1.14 billion
Islamic financing deal for UAE’s Majid Al Futtaim (MAF) Group where ADIB acted as the
Initial Mandated Lead Arranger, United Arab Bank acted as Lead Arrangers and Ajman
Bank as Arranger.

Meezan Bank Limited (MBL), the first Islamic bank based in Pakistan has reported 5 major
syndicate transactions in its 2017 annual report. MBL participated in these financing
under different capacities. Infrastructure development financing of Rs. 144 billion to
WAPDA for manufacturing of 2,160 MW Dasu Hydropower Project Stage-1
Wakalatul Istismar based construction for Power Holding Pvt Ltd for their funding
requirement of Rs. 20 billion. Syndicated financing of Rs. 13 billion for capacity expansion
project of a large cement producer, Cherat Cement Company Limited
Rs. 2.275 billion financing for development of a residential scheme in capital Islamabad
Shifa International to facilitate financing of Rs. 2 billion for their expansion project in health
care.

The Syndicate Mix:

Participant parties who are participating in syndicated financing/ loan pool are members
of the consortiums and these can be usually separated into the lead bank, correspondent
banks and other members based on their occupation and expertise in a syndicated
financing project.

Lead Bank: A lead bank acts as a pilot of the project and also termed as managing bank.
In a syndicate setup this refers to a bank that has been approved by the borrower and
takes the responsibility to create and organize the syndicate by distributing and managing
the shares to other participants. The percentage of the lead bank in the setup may help
to classify the business as an exclusive underwriting, partially financed underwriting and
the aggressive promotion for the sale of the financing of the project or syndicate.

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Correspondent Banks: A lead bank can also be a correspondent bank or any another
bank/ financial institution which is selected by the bank consortium. The main function of
a correspondent bank is to disburse or to payout the financing amount to the borrower
with respect to the terms of the agreement. Together with this it may also manage the
financing as entrusted and delegated by the syndicate based on its initial agreed duties
and responsibilities. This is generally include

Alliance and Liaison: Liaise and contact the borrowers by representing the whole team
of syndicate on daily basis to facilitate the business and to share the updated information.

Supervising and Managing: Acts as financing manager and supervise the amount of
payout of the syndicate funds as per the contractual preconditions, supervising the
utilization of the financing and to deal with the instances of breaches of the certain terms
which have been agreed.

Carrier of the Mails: During the term it may receive notices from the borrower on behalf
of the members of the syndicate.

Payment Agent: It falls under its duties to disburse and recover the financing dues. In
case the syndicate financing has a complex guarantee composition, a guarantee
representative can be selected and appointed who takes the responsibility to implement
guarantees for syndicated financing, for the registration of collaterals (pledges) and
management of relevant matters.

Participating Banks:
The participating banks of a syndicate accept the invitations and requests from the lead
bank to syndicate the financing and make payouts and disbursements to the borrower as
per their own credit lines which they have agreed upon.

The Legal Documentation Requirements in Syndicate Financing

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Selection of Lead Bank & Financing Agreement Drafting:
In this step borrower must position an appropriate lead bank and present a Mandate Letter
and a summary of the syndicate financing. As the process goes on, and bank finds after
carefully assessing the feasibility and review it, thus the conditional commitment letter
should be issued to borrower. It will make discussion on the fundamental structure, the
way forward and methodology of the financing facility, and conclude the preliminary steps.
When the commitment letter has been received the borrower should take its board of
directors on the same page by securing the approval and issue the authorization letter.
At this critical point lead bank will reckon the legal liability of the determined financing and
thus organize the syndication or consortium.

Preparing Syndicated Loan Documents:

After getting the Mandate Letter, the lead bank entrusts lawyers to prepare the legal
documentation, which generally includes, An Information Memorandum, Term Sheet,
Letters of Guarantee and Collateral Agreements.

Loan Marketing, Risk Allocations and Invitations:

The lead bank invites the potential members of the syndicate while assessing the demand
for the project, participants sign the confidentiality, so information memorandum is shared
and terms are agreed. Potential participants analyze and accept the invitation and sign
the letter of commitment to their respective % share of the facility and also put certain
conditions. Lead bank has to determine participants share, allocate them with the
associated risks and approved the preconditions.

Execution and Negotiation:

On behalf of the syndicate lead bank negotiates with the borrower for the master financing
agreement and relevant clauses. As per market practices financing agreements are
confirmed in advance and prevailing the sensitive market terms such as KIBOR/ LIBOR
+ markup and the spreads.

Follow up, Enforceability and Supervision:

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It is utmost important process to ensure that after validation of syndicate, the
correspondent bank should perform daily follow-ups, disbursements, manage
withdrawals and confirm the prevailing rates of the facility as per the agreement,
representing the loan consortium in collecting principal, reviewing service fee incomes,
guarantee clauses, supervising the borrower’s performance while simultaneously
generate the updated periodic reports to the members of the syndicate and arrange the
meetings when needed to safeguard the interests and financing of the participants.

Challenges of Innovation:
Innovation and modernism in Islamic finance has principally been driven by the need to
emulate and imitate the monetary effects of conventional financial products. As a matter
of fact it has fairly been achieved as can be the testimony and evidence by the occurrence
of Islamic planned products and hedge funds in current scenario. Nevertheless, it is
indispensable that Islamic financial modernization incorporates a constituent and element
of societal responsibility in order to make sure it is accepted widely and globally. Shari’a
observance and conformity may no longer be the one and only factor to be considered in
the Islamic financial products and contracts innovation. It is important at this moment of
time that the industry develops and designs its own exceptional and unique selling point
to earn the shari’a based pure premium and increase the economic activity by utilizing
the deposits in certain types of financing opportunities available in the market or to be
researched.

The promising way to attain this is through the expansion and development of alternative
Islamic financial avenues with a focus on community improvement at large in the society.
The alternative institutions with innovative products jointly with the traditional Islamic
banks should collaborate each other in order to accomplish these objectives of economic
growth.

Over the past two decades innovation in Islamic Finance has considerably amplified as
the industry continues to grow at a length. It has been witnessed that the product
development teams of Islamic financial institutions have developed sophisticated

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innovative Islamic substitute and alternative assets and found the great outcomes in
terms of customer response and won their trust. Undoubtedly the innovations in IFIs have
opened up a complete array of products to Islamic investors which enabled them to pool
their investments with respect to the risk and return profiles. It is expected that the trend
will continue to grow in the industry and product innovation will bring a revolution and
financial inclusion, greatly inspired from the Islamic financial innovations.

Since Islamic banks operate under firm rules of Shariah and stringent internal policies
thus it is always challenging to deal with syndicate members especially when there are
other conventional banks are the participants of the same facility. The challenges that
IFIs face are as follows:

Syndicate Financing could cause supplementary risks for the banking system if the
originating or lead banks withhold information and update about the borrower from
participating banks or misinform them into allocation of financing that is riskier irrespective
of their perceptions on that. The most important expenses and cost associated with
syndicate financing result from the agency tribulations, causing differences in the attempt
banks put forth when arranging financing, especially when the differences in skill and
competencies level vary among the members are significant. This could be the case for
instance if a member competent enough in technical knowledge, expertise and
experience, the latter may has a free ride with the former.

In general Islamic banks perform the Diminishing Musharakah, Sale & lease back
(DMSLB) contracts while involving in the syndicate finance. This practices arises certain
issues within the consortium like charge on the assets and collaterals of the deal.

It is witnessed that great efforts have been made, but yet Islamic syndications lag pretty
much behind the conventional counterpart syndications due to the lack of standardized
international Sharia principles that can guarantee borrowers and investors that their
transactions and structures are in accordance to the Sharia, will be upheld and can give

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them the same self-assurance, feelings and protections they experience in the
conventional syndicated financings.

This practice also triggers the Non Objection Certificates (NOC) issuance from the
members of the syndicate and to decide and determine the type of charge on the assets
when it comes to conclude whether the floating or fixed rates of the market practices and
understanding of the syndicate members. The covenants of the members normally
highlight few issues in this setup.

Unfortunately the Islamic finance industry missing a universally agreed form of

documentation and credentials to match its conventional counterparts, which is a great
challenge. The documents used in a Sharia-compliant structure must be vetted by the
lenders to make sure they better comprehend their rights and obligations. Notably it is a
time consuming and cumbersome process.

Certain Sharia scholars have permitted the use of the forward lease arrangement (known
as ijara mawsufah fi al thima or ijara fil thimma). This may arise an issue in case if any of
the members do not agree on this based upon their belief and understanding.

Professional legal advices are required as Taxes liabilities that may occur on sale and
purchase contain sales, revenue or value added tax types or income taxation as a result
of purchasing and disposing off an asset.

Islamic syndicate dealings are adhered and governed by Sharia law. This creates some
legal issues because the English law is generally favors due to its clarity in most of the
situations and considers creditor/customer friendly. For instance if we see Shamil Bank
of Bahrain v Beximco Pharmaceuticals case, The Court held that Sharia doctrine did not
apply and that the financing was enforceable under English law, a case of 2004.

Since the loan and syndication credentials must also be permitted and agreed by the
Sharia scholars or boards of the lenders so this may inhibit the syndication process

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because the manager may not be able to sell its underwriting commitment to a new bank
or financial institution, except if the financing or the structure is deemed companionable
with Sharia, as explained by the Sharia scholars or boards of that new bank, it could me
time consuming and result in delays of the operating process. Certain transaction
structures have been condemned or denounced as disguised loan transactions and few
IFIs may not participate in them like Tawarruq etc. With addition to this there could be
insufficient Islamic scholars who are accessible to assess the Sharia fulfillment of Islamic
finance contracts or if there is over-representation of certain scholars on the boards of
few companies.

Shirkah based Islamic Syndicated Financing

In the syndicated financing, the mode of Musharkah is best option for financing which
truly reflects Islamic concept of fair distribution of wealth. The concept of Musharkah
presumes that this contract is meant for initiating a joint venture whereby all the partners
participate in the business right from its inception. In Shirkah based financing, It is argued
that the arrangement of musharkah is more likely to pass on losses of the business to the
banks whereas banks are always shy to accept the risk of losses. This challenge can be
addressed through proper study of the feasibility of proposed business for which fund is
needed. After taking proper measures and due care, what can happen at the most is that
some of them may make loss. But on the other hand, the profitable Musharkahs are
expected to give more return than the interest based loans because the actual profit is
supposed to be distributed between them.

Apart from this, an Islamic economy must create a mentality which believes that any profit
earned on money is the reward of bearing risk of the business. This risk may be minimized
through expertise but this risk cannot be eliminated totally. The one who wants to earn
profit must accept the minimal risk.

Many a time, it is mentioned that the clients of Islamic syndicated financing are not willing
to share with the banks the actual profit of their business. Such clients need to be

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convinced and persuaded that by making a legitimate arrangement for obtaining fund
through Islamic syndicated financing based on Musharkah, not only do they earn Allah’s
pleasure but also a legitimate return for themselves.

Conclusion:

Wrapping it up, there is much room and potential for Islamic syndicated finance to rise,
grow and expand by far and wide, being a constructive and significant financing
instrument particularly it is even beneficial in the times of financial crisis. The reason
behind this is due to the spread of risks and pooling of resources. Although there are
certain controversies surrounding in few Islamic financing contracts and structures, the
cushion and flexibilities accorded by Islamic laws present the market participants with
ample of opportunities to drive for more ground-breaking and striking Islamic syndicated
finance products to facilitate in the process of financial inclusion and economic resources
mobilization.

Diversification and structural changes in monetary sector has been accompanied by

mounting amalgamation among different segments of the financial world. The customary
borders between banks and non-bank financial institutions are eroding and we can see
the growth of widespread banking and the mergers among different segments of the
financial sectors. It necessitate the need of integration of IFIs with similar institutions or
conventional FIs to perform cross border transactions, and Islamic syndicate financing.

The approaches and scholarly firmness which the Islamic finance industry has put into
the Islamic capital market and Islamic contracts platforms must be simulated in rising the
structure and scope of products offerings in the Islamic syndicated financings facilities.
This should not be a rocket science and trick game because compared to other Islamic
finance products syndicated financing is fairly easy to apply. In spite of the necessities
that must be met to satisfy Sharia, the concept of Islamic syndicated financing are
normally well-known to the conventional lenders and the usage of standard documents
that are well tested and implicit in the market.

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This is predominantly significant because syndication remains an imperative tool that
banks and other financial institutions exercise to administer their own balance sheets and
financial circumstance, which has turned even more important considering the current
economic scenario and regulatory frameworks and stringent policies.

It is recommended that the mode of Musharkah is best option for financing which truly
reflects Islamic concept of fair distribution of wealth. The concept of Musharkah presumes
that this contract is meant for initiating a joint venture whereby all the partners participate
in the business right from its inception. The challenge of risk in Shirkah based Islamic
syndicated financing can be addressed through proper study of the feasibility of proposed
business for which fund is needed. However, it should be realized that the risk cannot be
eliminated totally. The one who wants to earn profit must accept the minimal risk.

References:

Taqi Usmani, Introduction to Islamic Finance, Daul Ishat

https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1028.pdf?2ea2476aec952dbf33b6a0
70fe38683c

https://www.tamimi.com/law-update-articles/islamic-syndicated-finance/

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https://www.velaw.com/uploadedFiles/VEsite/Resources/IslamicSyndicatedFinancingUn
derdevelopedMethodShariaCompliantFinancing.pdf

https://www.lexology.com/library/detail.aspx?g=d3cfd2c1-7887-4184-9945-
b1e50966407d

https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1028.pdf?2ea2476aec952dbf33b6a0
70fe38683c

https://www.bis.org/publ/qtrpdf/r_qt0412g.pdf

https://www.thenational.ae/business/uae-demand-for-islamic-syndicated-loans-on-the-
rise-1.146130

https://www.reuters.com/article/ajman-bank-loans/uaes-ajman-bank-finalising-205-mln-
islamic-syndicated-loan-bankers-idUSL8N1CO1T1

https://gulfnews.com/business/sectors/banking/adib-closes-dh302-million-syndicated-
islamic-financing-deal-1.1168595

http://www.uaetoday.com/news_details_ad.asp?newsid=6236

http://www.sbp.org.pk/about/speech/governors/dr.shamshad/2007/Islamic-Banking-
Supervision-15-May-07.pdf

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