fundamentals shariah finance law

7/31/2019 Fundamentals Shariah Finance Law

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Fundamentals of Shariah Finance Law

IntroductionInternational perspective

Basic Shariah rules


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What is Shariah?O you who believe! Stand out firmly for Allah, aswitness to fair dealing, and let not the hatred ofothers to you make you swerve towards inequalityand depart from justice. Quran 5:8 In the business context, Shariah is a means ofconducting business through a distinct set of rulesdesigned to facilitate fairness.High correlation between Shariah compliantinvesting and socially responsible investing


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Where are Shariah rules codified?Interpretations of the Quran from various Islamicschools of thought

Accounting and Auditing Organization for IslamicFinancial Institutions (AAOIFI)The fact remains: Shariah mandates are not alwaysconsistently applied from Scholar to Scholar.Information is asymmetric, and Shariah Advisersand lawyers skilled in the area become useful towork through the counter-intuitive results


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Shariah termsHalal that which is permitted or compliantHaram that which is not permitted

Riba charging of interest or unjustified increaseGharar the taking of unreasonable risk; uncertaintyMaisir reliance on chance or speculation, ratherthan effort


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Industry prohibitionsGamblingPork production or consumption

Adult EntertainmentBanking and financeAlcohol production or consumptionWeapons productionTobacco production or use


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RibaThe charging of sums for borrowed money ( i.e.interest ) is forbidden

But the pledging of Halal assets, the guarantying ofobligations and the leasing of property under whatwe might consider a finance lease (or ijara ) ispermissible

Murabaha is the selling of a commodity at anagreed upon mark-up, and is used in Shariah as afixed income investment substitute.


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RibaThings to Watch Out For:

Default Interest

Administrative fees for late paymentsConsideration in respect of third party guaranties(see AAOIFI Shariah Standard No. 5)Preferred Shares are generally not permitted

(AAOIFI Shariah Standard No. 21); but dividendsdistributed from profits are permitted.


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GhararThe act of taking on unreasonable uncertaintyExamples of Gharar:

GamblingInsuranceFX TradingOptions on stock (AAOIFI Shariah Standard No. 21,paragraph 16 of Appendix B)


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Shariah Finance ThemesConnection to underlying assetsCommercial risk taking by all parties (including

financier)EntrepreneurshipReturns linked to actual investment outcomesSharing profit and loss


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Shariah Finance StructuresMudarabaMusharakaMurabahaTawarruq (Reverse Murabaha)IjaraIjara wa-iktinaBai salam

Bai al inahIstisnaa Sukuk


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MudarabaRisk sharing; profit and loss sharingLimited partnership: one partner provides capital;

other partner provides expertise/effort and makesbusiness decisionsRestricted or unrestrictedExamples:

funded participation arrangementestablishment of investment fund


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Mudaraba

INVESTOR(S)(Rab al Maal )

MANAGER(Mudarib )

FUND

PROJECT/ENTERPRISE

Fee(basedonshare ofprofits)

Providesexpertiseandmanagesfunds

Investsfunds

Share inprofitsandlosses


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MusharakaRisk sharing; profit and loss sharing in sameproportions

General partnership / joint venture arrangementbetween financier and investorProvides equity funding to a venture; greater risk-reward factors and greater investor say in project

management


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Musharaka

FINANCIER CUSTOMER

VENTURE

Share inprofits andlosses

Contribution inkind (at least30%)

Cashcontribution



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MurabahaAsset basedTrade finance / Acquisition finance

Unconditional contract of sale; goods, cost price, mark-upand payment date = defined and agreedProfit from marked-up sale price (not interest) paid ininstalmentsExamples:

import-export financeinfrastructure project financingleveraged acquisition


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Murabaha

CUSTOMERFINANCIERSUPPLIER

Payment ofPurchase price

Payment of purchaseprice plus premium

(deferred)

Sale of assetSale of asset


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Tawarruq (Reverse Murabaha)Asset basedFreely tradable commodities e.g. platinum, copper

(silver and gold are considered currency and cannotbe used)Provides customer with a cash sumCustomer then has deferred payment obligation tofinancier


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Tawarruq (Reverse Murabaha)


Payment of purchase priceplus premium (deferred)

Sale of assetSale of asset

THIRD PARTY

Payment ofpurchase price

Sale of asset


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IjaraAsset basedHybrid between conventional operational and

finance leases; a business processAnalogous to secured loanExamples:

aircraft financeship financeproject finance


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Ijara

CUSTOMERFINANCIERSUPPLIER / MANUFACTURER

Rent (= purchase priceplus premium)

Lease of assetSale of asset

Payment ofpurchase price


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Ijara wa-iktinaAsset basedLease with option for lessee to purchase leased

assetAnalogous to finance lease / hire purchase contractExamples:

medium term trade finance of equipmentrefinancing under sale and leaseback


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Bai salamAsset basedForward purchase of specified asset paid in full for

supply on pre-agreed fixed future dateWorking capital facility, especially for pre-exportfacilities


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Purchase price(discounted)

Bai salam


Purchase price(plus premium)

Sale of asset (deliverydeferred)

Sale of asset(delivery deferred)


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Istisnaa Asset basedFunding agreement for production, manufacture orconstruction of asset to agreed specification: all

specifications, delivery options, payment conditions andpricing must be agreed in contractNo fixed delivery date and no payment in full at outsetrequired Advance funding of:

major industrial, construction and real estate developmentproject financelarge equipment e.g. ships, aircraft


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SukukFinancial instruments / trust certificates representingundivided ownership share in underlying asset or

interest held by issuerRight to share in profits and asset realisationsDebt capital markets fundraisingBought and sold in secondary marketUsed in conjunction with other structures


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Sukuk al Ijara

CERTIFICATE HOLDERS

SELLER SPV ISSUER LESSEE

Purchase price(issueproceeds)

Issueproceeds

Sells assets

Return IssuesSukuk

Leases assets

Rent


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Sukuk al Musharaka

CERTIFICATE HOLDERS

SPV ISSUER

VENTURE

ORIGINATOR

Return IssuesSukuk

Issueproceeds

Cashcontribution Contribution in kind (atleast 30%)

Share inprofitandlosses



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Shariah finance challengesScholars and schools of thoughtLack of standardisation

Transaction costsAsset ownership by financier involves potentialliability e.g. environmental, warranty claimsInsurance / takaful Tax treatment


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Fundamentals of Shariah Finance Law

ConclusionAny questions?


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DisclaimerThis webinar and these slides are for informationalpurposes only and do not contain or convey legal

advice. The information herein should not be usedor relied upon in regard to any particular facts orcircumstances without first consulting with a lawyer.

fundamentals shariah finance law

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