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Islamic finance

Farmida Bi
Partner
Norton Rose Fulbright LLP
28 October 2013
Islamic Finance – Overview
• Importance of Islamic Finance
• Features of Islamic Finance
• Traditional Islamic Contracts
• Governing law
Importance of Islamic Finance
• Demographics
• Emerging economies
• Political identity

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Incorporation of Shariah law into English law
• Tax changes
• Regulatory changes – CIS, deposit protection scheme, status of
SSB
• AFIBs
• London Stock Exchange
• English law and courts

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Islamic finance in UK
Name Date Licensed Retail Products Offered

Islamic Current Account


(qard);

Home Purchase Plan;


Islamic Bank of Britain
August 2004 Yes Savings Accounts; and
PLC
Personal Finance

Discretionary Portfolio
Service

European Islamic Treasury and Capital


March 2006 No
Investment Bank Plc Markets
Corporate Banking,
Bank of London and Wealth Management,
July 2007 No
the Middle East Islamic Capital Markets
Products
Treasury& Corporate
QIB (UK) PLC January 2008 No Finance/ Asset/Wealth
Management
Treasury & Corporate
Gatehouse Bank Plc April 2008 No
Finance

Lloyds TSB - Yes Islamic Current Account

(ceased trading in
HSBC Amarah Yes Islamic Current Account
September 2012)

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Islamic Products in UK
• Islamic Funds – leveraging
• UK Islamic mortgages
• UK Deposit Account
• UK Current Account
• UK Student financing
• Takaful - Cobalt
• SME financing

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Examples of Islamic financing in the UK
• Shard
• Battersea
• Chelsea Barracks
• IIT
• Aston Martin

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Features of Islamic Finance
• Riba (usury or unjust enrichment)
• Gharar (uncertainty)
• Maisir (speculation)
• Assured Profit
• Unethical Investment
Features of Islamic Finance (cont)
The Nature of Money
• Money is a means of exchange only
• Money is not a commodity
• Money can only be exchanged for the same par value
The basic difference
Conventional

money
Bank Client
money + money (interest)

Islamic

Goods &
Bank Services
Client

money
Use of funds by Islamic financial institutions

The main contracts


DEBT BASED used in Islamic EQUITY BASED
financing activities

Murabaha / Musharaka
Tawarruq
Mudaraba
Istisna’a
Wakala
Ijarah

Wa’ad
Traditional Islamic Contracts: Murabaha

3. Assets (spot)
Bank Counterparty
(Financier) (Borrower)
4. $110 Sale Price
(deferred payment)
1. $100 2. Assets 6. $100
5. Assets
Cost Price (spot) Cost Price
(spot)
(spot) (spot)

Market Market
Traditional Islamic Contracts: Murabaha (cont)
Cost-plus financing:
• terms are fixed from the outset of the agreement (in particular
quantum of payment)
• in the event of early termination, no discount applied for early
settlement
• rebate on the deferred sale price permitted, but at the discretion
of the financier
Traditional Islamic Contracts: Wa’ad

1. Undertaking to purchase Assets in the


future for a Sale Price calculated pursuant
to a formula
Bank 4. Assets (spot)
Counterparty
(Financier) (Borrower)
5. Sale Price calculated pursuant
to formula (deferred payment)
2. $100 3. Assets 6. Assets 7. $100
Cost Price (spot) (spot) Cost Price
(spot) (spot)

Market Market
Traditional Islamic Contracts: Wa’ad (cont)
Wa’ad (unilateral promise):
• allows for flexibility in future cashflows
• due to the unilateral nature of the promise, only the
issuer of the undertaking is bound to perform
• consideration from the recipient of the promise is
generally not permitted
Traditional Islamic Contracts: Ijara

1. Assets (spot)
Lessor Vendor
(Financier) 2. Purchase Price

3. Grant of 4. Rental 5. Grant of 6. Grant of Call


Lease Payments Put Option Option

Lessee
(Borrower)
Traditional Islamic Contracts: Ijara (cont)
Ijara (leasing):
• allows for flexibility in future cashflows through the mechanism to
calculate rent on a periodic basis
• Financier holds a proprietary interest in the asset during the term
of the financing. Financier takes on risk that may not exist in a
conventional transaction
Governing Law
• Shariah law
– non-national system of law
– applies to all aspects of life and behaviour
– Different schools of thought as to how principles
should be interpreted or applied
• English law
– has a well-known and developed jurisprudence
– not open to doubt on basis of religious or
philosophical principles
Governing law: Shamil Bank v Beximco
• Leading case in the United Kingdom
– High Court & Court of Appeal judgements
• Background
– Shamil operated in accordance with the principles of
Shariah law
– Shamil’s commercial activities supervised by its Religious
Supervisory Board and audited each year
Governing law: Shamil Bank v Beximco (cont)
• Court of Appeal, Lord Justice Potter’s leading judgement in
January 2004 concluded:
– when interpreting governing law clauses court should lean
against a construction that would defeat the commercial
purpose of the agreements
– there could not be two governing laws
– although possible to incorporate provisions of Shariah law
the general reference to Shariah law here did not identify
any specific aspects which the parties intended to
incorporate
Governing law: Best practice
• Non binding statement in recitals
• Representation from each party as to Shariah compliance
• Covenant / undertaking that it will raise no objection as to
matters of Shariah compliance
• Submission to single governing law
• Fatwa from Shariah Supervisory Board
The Scholars
• Limited number
• Different jurisdictions
• SSB
• Annual audit
• Fatwa

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The Fatawa process

Preliminary Structure
Prepared by financiers, lawyers and accountants
Memorandum

Informal discussions with Shariah Scholars

Provided by Shariah Supervisory Board based on the preliminary structure


Interim Fatwa
memorandum

Due Diligence Analysis of legal, commercial, tax and credit risk etc.

Draft Documentation Prepared by lawyers with input from financiers and, if necessary accountants

Informal discussions with Shariah Scholars

Final Fatwa Provided by Shariah Supervisory Board based on the documentation

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The future of Islamic finance
• 9th WIEF: 29-31/10/13
• UK government Sukuk
• Changes in global economy – move east/developing markets
• Legislation normally needed to accommodate Islamic finance
• Demographic and political factors
• Equity investment
• Infrastructure funding

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BD#19060212-3