We can summarize the investment industry today as: It is still recovering from market crash and ongoing liquidity problems as well as more current situations like Greek debt issues, migrants flooding into Europe, and what seems to be a slowing Chinese economy. Expert investors include among other tests that any person investing at least $100,000 or currency equivalent. In return, legal ownership is passed to the SPV. Sukuk (Islamic bonds). equity, such that all parties involved in a transaction can make informed decisions without being misled or cheated, pursuing personal economic gain but without entering into those transactions that are forbidden (for example, transactions involving alcohol, pork-related products, armaments, gambling and other socially detrimental activities). But this was only part of the solution. Time is another huge factor in delivering the objective of a fund with more risk likely to happen in achieving short-term returns. This is also the major hurdle for the full development of this family of products. Islamic finance is almost invariably part of a larger multi-sourced financing. Professional groups include the IASB and the International Federation of Accountants (IFAC). Fixed claim instruments include murabaha, ijarah, salam, and istisna. The financer is entitled to compensation from the user in case of damage determined by negligence, but bears the full risk of delayed payments for the use of the goods once the usufruct is transferred to the final user. A gambling casino can borrow money from a bank to develop its gambling business. The latter makes all the payments during construction and becomes the owner when this phase is complete. Governments may be less willing to interfere with projects which have debt obligations to international banks, multilaterals and so on. The SPV uses the funds raised and purchases the asset from the obligor (seller). This will include retail and alternative investment funds. The rules and guidelines that Islamic finance operates under is referred to as Sharia which is a framework of rules, principles, and guidance derived from Islamic teachings. considered by sharia null and void ab initio (originally and To summarize the first point, the terms loan, lending, and their equivalent are seen in entirely different paradigms: for Islam, charity; for non-Muslim banking, credit allocation and wealth creation. Figure 6.30. Islamic banks lend funds A number of the largest oil and gas infrastructure projects have also been financed using project finance techniques. Several significant and high-profile projects have raised very large amounts of project finance debt. 0000002277 00000 n the strict prohibition of interest (riba = excess). The lessee enters into a sales agreement with the SPV/buyer. However, it is obvious that, like in the case of Sukuk (see Section 6.12.3), establishing a deep and stable market for Islamic finance products will involve some additional difficulty in defining contractual structures compared to how this is done in advanced economies in Western countries.33. This contrasts with conventional bonds where the investor has a debt instrument earning the return predominately via the payment of interest (riba). This sukuk is based on the partnership musharakah contract. Financing on the basis of salam and istisna also creates real assets. The structure of a Salam contract. Financial leases and murabahah, are not originally modes of financing. Also, speculation is also prohibited (so options and futures are ruled out). The need to prove that the yield of the deal is determined by a specific asset is a complication that has led to the creation of very complex contractual structures that investors often do not understand. Significant at the 5% level, indicating that interim winners (losers) increase (reduce) second-period risk (i.e. In fact, the holder of a sukuk bears the risk of incurring losses, which is completely at odds with a traditional bond contract in Western economies. The payment of rentals provides the return and the final redemption of the sukuk is at a pre-agreed value. The SPV provides funds to the entrepreneur today in exchange for a forward delivery of goods39 The entrepreneur then uses the funds to carry out the activity in question and produce the goods to be delivered in the future. PassiveInvestment manager does not exist as there is a constant composition of the portfolio, for example, tracker funds. Emirates initial injection of equity finance at the time of its creation 24 years ago has been supplemented by a variety of financing options, including leasing, EU/US export credits, commercial asset-backed debt, Islamic financing, conventional bonds, as well as sukuk. This is especially important for sponsors whose access to capital is restricted or constrained. The teachings of Islam encompass all aspects of life, Islam is an Arabic term which means submission to Gods will, Islam is dynamically involved in public affairs unlike typical Western religions, Islamic faith has clear principles and guidelines for business and financial dealings. The profit earned through dealing in money (of the same currency) or the papers representing them is interest, hence prohibited. 4.5.2). In this section we only consider contracts that are more suitable for financing large industrial or infrastructure projects. The depositor is rewarded by a share in that profit, after a management fee is deducted by the bank. The ability to structure risk sharing arrangements that allow project sponsors to transfer project risks to third parties and project lenders. 342 0 obj <> endobj Murabaha: A credit sale agreement pursuant to which an agreed profit between a financier and a client is specified in a sale and purchase contract. An organization of swaps and derivatives professionals, ISDA has developed the standard documentation underlying the global OTC derivatives market, including addressing netting and collateral. Figure 6-29 shows how a sukuk issue works. This definition encompasses both nonmonetary quantities (such as a barter trade of agricultural products), as well as monetary dealings. The key distinction between a murabaha and a loan is that, with a murabaha, the bank will take actual constructive or physical ownership of the asset. Sitemap | See Diagram1.3. In an interest bearing loan, the amount to be repaid by the borrower keeps on increasing with the passage of time. Figure 6.31. Sukuk is about the finance provider having ownership of real assets and earning a return sourced from those assets. It would be harder to win a seal of approval from Islamic finance scholars for a sukuk that was based on assets, which the airline did not yet own. It has worked most closely with the OECD, developing standards for pension regulation and supervision. For dedicated and specialist vessels the underlying commercial rationale, risk profit and economics of the underlying project strongly influence financing structures and project finance methods have been successfully applied to these types of transaction. The Islamic economic model has developed over time based on the rulings of Sharia on commercial and financial transactions. In Islamic finance, all financial services have to be in conformity with the prohibitions of usury (Riba), financial speculation (Gharar), and gambling (Maysir, Quimar). At this point, the financer transfers ownership to the purchaser, adding a markup to the price, which is paid upon delivery. Comments In turn, the SPV launches a sukuk issue that allows it to raise the funds used to pay for the assets. The SPV will then purchase a portfolio of assets, which are already generating an income stream. The financing of infrastructure in countries adhering to the Muslim religion is incompatible with the network of financial contracts discussed in the previous chapters of this book. Islamic Finance, World BankIMFFederal Reserve System, Seminar for Senior Bank Supervisors from Emerging Economies, Washington DC. The structure of a Sukuk al Istisnaa. The structure of a sukuk al Ijara. Profit is generated when something having intrinsic utility is sold for money or when different currencies are exchanged, one for another. As such, the terms are not limited to AIFs, which are structured as companies or unitized funds and may include other forms of collective investment undertakings, such as partnerships or nonunitized trusts. It is generally the case, however, that within any one jurisdiction there are now sufficient precedents to have confidence that commonly used structures are compliant with the relevant Sharia legal system by which the financing is regulated. Under Salam, the goods in question are sold in advance but with strict indications of their characteristics: quality and quantity are predefined between the counterparties and these parameters are binding. About | Republished with permission. In Islamic banking there are broadly two categories of financing techniques: (a) Murabaha 0000001395 00000 n This will include research services that the investment manager will combine with their own inhouse research before deciding on the asset allocation of the portfolio. The ability to match financing terms to project cashflows. The most important Islamic structural instruments for project finance are summarised as follows. A variety of unit trusts can be found in the market, which can be divided into public mutual funds and MAAKL mutual funds. However, the Nakheel story paints a different picture. Financing instruments in Islamic finance consist of equity-like and debt-like instruments. A wider sample size would definitely be more conclusively convincing. The structure of a Sukuk al Musharakah. Asset backed raising finance where the principal is covered by the capital value of the asset but the returns and repayments to sukuk holders are directly financed by these assets. Table 22.2. 0000002768 00000 n That means Islamic financing is backed by real goods or assets. Figure 6.33. The user bears the costs of the use of the goods, while maintenance costs are covered by the financer. The monied person is not supposed to extract any excess (rib) from the disadvantaged person. A third possible risk is that the sale, albeit possible, is executed at prices well below initial expectations. This allows the counterparties to avoid riba (formally no interest rate is applied to the transaction) and gharar (there is certainty regarding the sums exchanged between the counterparties). This is because there are two types of sukuk: There are fundamental differences between these. helps ensure stability in the value of money and also helps prevent In relation to global finance, UNIDROIT (http://www.unidroit.org) has focused on intermediated securities, factoring, financial leasing, as well as aircraft, railroad, and other mobile equipment financing. In order to ensure conformity with the obligation referred to in Article 5(1) of Directive 2003/71/EC, the competent authority of the home Member State, when approving a prospectus in accordance with Article 13 of that Directive, may, on a case by case basis, require the information provided by the issuer, the offeror, or the person asking for admission to trading on a regulated market to be completed, for each of the information items. The period of the repayments could be extended, but no penalties or additional mark-up may be added by the bank. This includes situations which constitute a contractual offer that can be accepted by a potential investor in order to make the investment and form a binding contract, and situations which constitute an invitation to the investor to make an offer to subscribe for the investment. For this reason, Salam requires that the object of the contract is frequently traded in the market. based on trade (i.e., real economic activities) rather than pure For example, the UK Financial conduct Authority (FCA) has in its conduct of business source book the following in respect of offering documents under the AIFMD. Retail funds are more low risk, that is, have no liabilities and have higher diversification. Figure 6.32. BakuTbilisiCeyan11: This is a 1768 km pipeline which transports oil from the Sangachal terminal in Azerbaijan through Georgia to the Ceyhan export terminal in Turkey. bid-dhaman and al-ghunm Becoming an ACCA Approved Learning Partner, Virtual classroom support for learning partners, How to approach Advanced Financial Management. Every financial transaction must involve a tangible asset, leaving aside certain exceptions, such as intellectual property. Despite the hurdles, however, project finance techniques have been used to finance many upstream projects, especially in the gas and LNG sectors which tend to have longer-term and predictable contractual arrangements. That inference, however, is misleading. To achieve these goals various modifications are made to conventional project finance structures. Support | The conventional / capitalist concept of financing is that the banks and financial institutions deal in money and monetary papers only. Islamic finance is structured in such a way so as to comply with the principles of Islamic, or Sharia, law. The Committee on the Global Financial System (CGFS; http://www.bis.org/cgfs/index.htm) has focused mainly on government bond market development. Contact | The SPV, in turn, leases the asset to the same entrepreneur; simultaneously, the latter commits to repurchase the asset at a predefined price at the end of the leasing period (Fig.6.32). This could include research on the importance of nudges and Islamic principles in uncertainty. Rib (commonly described as interest) is impermissible under the Shara; it is both a reward without commensurate risk and a preferential reward to one party (whether a debt provider or an equity provider). The offer document for an expert fund must comply with certain content requirements. We use cookies to help provide and enhance our service and tailor content and ads. This is especially attractive in joint ventures arrangements, particularly if certain partners are cash constrained. Equity instruments include mudarabah and musharakah. As history tells us, Nakheel did not default on its Islamic bond. It is important, however, to understand the nature of the projects which have been funded using project finance techniques. Yescombe, in Principles of Project Finance (Second Edition), 2014. This criticism is justified to some extent, and that is why the Shariah supervisory Boards are unanimous on the point that they are not ideal modes of financing and they should be used only in cases of need with full observation of the conditions prescribed by Shariah. Of most relevance to global finance, UNCITRAL (http://www.uncitral.org) has focused primarily on security interests, insolvency, and international payments. The interest-based, debtorcreditor paradigm is rejected, although debtorcreditor constructs are acceptable (if arising as a result of Shara-compliant arrangements). The global debt crisis sent shockwaves through the financial markets and, at the time of writing this article, the western banks remain reluctant to loan cash to the business community. Why does this impact on investment fund products? Thus, conventional financing is not bound by any divine or religious restrictions. Therefore the unit trust industry in Malaysia has a history of more than four decades. Sukuk can also be listed on secondary bond markets. 0000004153 00000 n Project finance debt of over US$ 15 billion has been successfully raised from a variety of sources for these projects. through sale (bai such as In a recent study by Thomson Reuters and their subsidiary Lipper, it was found that Islamic mutual funds globally now hold $53.2 billion of assets under management, recovering from a low of $25.7 billion in 2008, and that the total numbers of Islamic mutual funds established reached 943 in 2014, up from 828 a year earlier, and double the number in 2008 (May 2015full article can be found at http://www.reuters.com/article/2015/05/19/islam-financing-funds-idUSL5N0YA04I20150519). The metaphor of the swelling of earth after rainfall connects the literal and legal meaning of rib. The link is addition, or synonymously, excess, as an Explanatory Note to the chapter containing the adiths on rib compiled in Sa Muslim states: The word Rib is partially covered by the English word usury which, in modern parlance, signifies only an extortionate interest. At the same time, although traditionally a private organization, it is now taking on quasi-regulatory roles, especially in the context of defining credit event occurences for credit default swap trigger purposes and valuation in the event of default. In return, the SPV obtains the title deeds to the leasing portfolio. The maintenance costs and possible risks related to the possession of the asset are borne by the SPV, but the vehicle can stipulate an insurance contract against said risks. It is estimated that by the end of 2012 Islamic financial assets will have exceeded $1,600bn, which is around 12% of global financial assets worldwide. (2012) to assess whether managers in Islamic funds and conventional funds engage in risk-shifting behavior. In fact, Islamic finance is an economic order which seeks to obey the religious rules of Islam and the Islamic laws (Sharia), known as Fiqh al-Muamalat (Islamic rules on transactions). Islamic economy, unlocking commercial opportunities. It is a manifestation of love and empathy by a wealthy person toward a poor or needy person. Islamic banking effectively Refinery and petrochemicals projects in Eastern Europe, Russia, Vietnam, China, India, Latin America and, most recently, the United States have raised project finance. Both participants inject capital and have the possibility to manage the joint venture. If the Abu Dhabi bailout failed to materialize, then the story may have been significantly different. A taxonomy of Islamic finance contracts. allowing use of equipment for a period of time against fixed rental paymentscf. Figure 6.27. The adaptability of project finance explains why this form of funding has been used to finance projects throughout the industry value chain. 0000014734 00000 n Figure 6.29. Rather, the moral lapse lies in obtaining an increase free of charge, without giving value in exchange, or exerting effort in brief, without doing a shred of work. The approval process for seeking a permit for the fund is streamlined and allows for the establishment of a fund within as little as three days of the formal filing of the application. Contrary to Riba, Gharar is not absolute and thus Islamic law tolerates a certain degree of uncertainty because there is always some risk involved when doing business. Takaful is commonly referred to as Islamic insurance. The Ijara structure is usually used for the operational phase of a project financing in conjunction with an Istisnas structure during the construction phase. (see Part5). This is the main difference with Salam (Fig.6.24). As in other sukuk structures, the ownership of the asset is divided among the investors and transferred to them. The repayment of our first ever sukuk bond is part of Emirates varied financing strategy and reflects our robust financial position, said Sheikh Ahmed bin Saeed Al Maktoum, chairman of the Emirates Group and chief executive of Emirates airline. An offering includes situations where the units or shares of an AIF are made available to the general public and a placement includes situations where the units or shares of an AIF are only made available to a more limited group of potential investors. Sukuk holders subscribe by paying an issue price to a special purpose vehicle (SPV) company. That is why they are forbidden, in most countries, from trading in goods and making inventories. For new aircraft, it is not impossible but it is much more complicated as the cash would have to go from investors through a special purpose vehicle to the manufacturer before a lease-back arrangement is put in place. The definition embodies the principle that any unreasonable increase is considered rib. The asset is then sold to the borrower or buyer for a profit but they are allowed to pay the bank over a set number of instalments. In a prospectus attached to the new sukuk, Nakheel revealed that it wrote down the value of its property and project portfolio by almost Dh74bn (US$20.14bn) in 2009 as its fortunes flagged. 0000004759 00000 n Sukuk is the equivalent of bonds in Western economies. Examples include mortgage loans (which also include rib elements), debts (including receivables, which frequently include rib elements) that have been divorced from underlying assets, and derivatives.11.