Islamic Finance: Instruments and Markets

Why Islamic Finance has become popular? 2. Main Islamic Financial Instruments : Banking. 3. Main Islamic Financial Instruments:Capital Markets. 4. The future.
Table of contents

The primary structures used in home finance in the UK are ijarah and an ijarah with diminishing musharakah structure, which contain many of the features of a conventional repayment mortgage. Under the terms of an ijarah mortgage, the bank purchases the property with title in and to the property registered in the name of the bank and leases it to the homeowner for a specified period. The homeowner gives an undertaking that, at the end of the specified period, it will purchase the property from the bank using the final lease payment, following which legal title is transferred to the homeowner and title in and to the property is registered in the name of the homeowner.

Under the terms of an ijarah with diminishing musharakah structure, the bank and the homeowner together purchase the property in proportion to the capital put forward by each of them. However, title in and to the property is registered solely in the name of the bank. The homeowner pays the bank rent for the use of that part of the property that is owned by the bank under the terms of the musharakah. In this scenario, the homeowner pays the bank rent for that portion of the property owned by the Islamic bank through the musharakah term.

Much of the growth in the shariah-compliant home finance market was facilitated by an amendment to the tax laws in the UK in that removed what had previously been a double charge to stamp duty land tax: This change in tax law is discussed further below. Insurance companies in the UK offer takaful products to Muslim customers using structures typical to the takaful market. As with many other facets of Islamic finance, London is seeking to become a hub of takaful and the Islamic Insurance Association of London IIAL was launched in July with the aim of promoting that goal.

Friendly societies and other mutual insurance companies are potential vehicles that could be adapted to provide takaful. Friendly societies in particular have an affinity with shariah principles because all contributions to a friendly society are made voluntarily. Friendly societies have evolved in different ways over the years. Since most have taken advantage of the ability to incorporate, which allows them to undertake a defined range of activities. There would be significant challenges in establishing a new shariah-compliant friendly society since, to be authorised by the Financial Services Authority to carry on regulated activities in the UK, the friendly society would need significant amounts of regulatory capital.

As a mutual institution, a friendly society does not have shareholders that might provide that capital.

United Kingdom - The Islamic Finance and Markets Review - Edition 2 - The Law Reviews

On the contrary, Section 5 2 b i of the Friendly Societies Act provides, in effect, that only members or persons connected with members can receive benefits from the society and the converse of this is also generally held to be true, namely that a person cannot be a member of a friendly society unless he or she or a person connected receives insurance or similar benefits from the society. The leverage that private equity funds obtain in connection with investments normally presents an insurmountable barrier to entry for Islamic investors who, as a result, are unable to invest in conventional private equity funds.

Fully shariah-compliant funds require tight restrictions on debt and the appointment of a full-time shariah supervisory board to approve individual investments, DIFC and are expensive to establish. The demand does not appear to have been sufficiently high to make overcoming these obstacles economically viable and, as a result, the Islamic private equity space has not grown with any conviction. Opportunities exist in the synthetic feeder fund space in relation to specific identifiable investments, but this is yet to become a significant tool in the UK private equity market.

UK real estate is one of the most popular asset classes for both international and domestic Islamic investors. Local players Gatehouse Bank and 90 North Square have offered shariah-compliant real estate investment products to Islamic investors for a number of years. Real estate investments typically apply a wakalah, mudarabah or musharakah structure to invest in an underlying portfolio of real estate assets, as well as shariah-compliant real estate investment trusts.

However, care must be taken around certain shariah red flags, including any terms of any underlying leases that may include late payment interest charges. For new assets that are yet to be rented, late payment interest can generally be restructured as a late payment administrative charge — an approach that is common in shariah structures. However, with established assets especially those held by conventional landlords , late payment interest may be embedded in the contracts, and amending such contracts is both impractical and undesirable.

In this situation, the documents governing the Islamic investment typically provide that if any haram income exceeds a de minimis threshold typically 5 per cent of the total income from the real estate assets then those amounts should either be directed solely to a conventional co-investor if there is one or otherwise to charity. As noted above, the specific requirements of shariah-compliant investment funds such as the requirement for a shariah supervisory board , the restrictions on any leverage that may be applied to investments in assets and the need for an annual shariah audit have meant that the UK has not seen a high number of shariah-compliant investment funds established.

The sukuk was structured as a sukuk al-ijarah being the simplest and most widely accepted Islamic finance structure and pays out profits based on the rental income from three government-owned properties in lieu of interest. The interesting aspect of the structure is that it did not adopt the delegate model the Islamic equivalent of a conventional bond trustee but opted instead to replicate the structure used for UK government gilts.

While a comparatively small issuance by the standards of the UK government, the sukuk was intended to act more as a marketing tool for the UK government in its push to promote the UK and London as a centre for Islamic finance. The proceeds of the sukuk issuance were to be used to purchase four new Airbus A aircraft, which would become the ijarah assets. This was an example of the UK government seeking to promote Islamic finance in tandem with the interests of British industry the wings for the Airbus A are manufactured in Filton, near Bristol, and Broughton, in North Wales.

It is also another example of alternative assets — the rights to travel — being used to underpin sukuk and builds on the success of issuances by Axiata Telecom which utilised airtime vouchers and FWU Group which utilised the intellectual property in computer program source code of sukuk backed by alternative assets. Reforms to tax law and regulation have led the way in terms of the accommodation of Islamic finance within the laws of the UK. In Parliament passed the Finance Act , which introduced the concept of alternative property finance to cure the double charge to stamp duty land tax that had affected the Islamic mortgage market up to that point.

Under ijarah and diminishing musharakah structures there are effectively two sales of the property being financed: Each of these purchase transactions previously gave rise to a charge to stamp duty land tax, which made the Islamic mortgage market prohibitively expensive. The Finance Act introduced specific exemptions for Islamic mortgages to ensure that they incurred only one charge to stamp duty in the same manner as a conventional mortgage.

The Stamp Duty Land Tax Alternative Finance Investment Bonds Regulations fixed a point of confusion by clarifying that the exemption from stamp duty land tax that applies to a transfer of leases as part of an alternative finance income bond structure will not be denied on the basis of other provisions of those regulations that would otherwise deem such a transfer to be a grant for stamp duty land tax purposes i. These regulations are further supplemented by the Alternative Finance Investment Bonds Stamp Duty Land Tax Prescribed Evidence Regulations , which prescribe the evidence that needs to be provided to HMRC in relation to claims for relief from stamp duty land tax in these circumstances.

The common purpose of this legislation has been to allow Islamic instruments the same treatment as conventional ones by making a distinction between the transfer of ownership of land for the purposes of occupancy or other use and the transfer of a form of ownership of land that is intended purely to facilitate a shariah-compliant transaction.

There are various structures that can be adopted for a sukuk that may affect how it is classified for insolvency, tax and regulatory purposes. Sukuk, are, however, typically structured to have the same economic effect as a conventional bond and are treated as such for IFRS International Financial Reporting Standards purposes.

To date, the treatment of Islamic finance instruments in insolvency remains untested in the UK. Further, no Islamic institution has filed for insolvency or any insolvency-related procedure in the UK, meaning that it is not clear how the English courts would treat any such situation. Whether a sukuk is treated as an equity or a debt instrument depends on the structure and the risks and rewards of the sukuk. In particular, whether the sukuk is asset based or asset backed could affect this analysis. Legislation now provides that where certain conditions are satisfied, the return paid to sukuk holders is tax-deductible by the issuer, consistent with the treatment afforded to conventional bondholders.

However, it is worth noting that the Financial Services and Markets Act Regulated Activities Order made certain consequential amendments to legislation necessitated by the inclusion of a new definition of alternative finance investment bonds. This appears to indicate clearly that the intention of lawmakers in the UK is for sukuk to be treated in the same manner as conventional bonds and from that we may extrapolate that in the event of insolvency under English law, shariah-compliant instruments would be treated in the same manner as their conventional counterparts.

United Kingdom

Much of this is based on the economic effect of those instruments as well as their legal form, but it is clear that there is no current intention for a separate insolvency regime to be introduced for shariah-compliant instruments. As a general comment, shariah is not applied in the UK and English law does not recognise shariah as a system of law capable of governing a contract, on the basis that English law does not provide for the choice or application of a system of law other than a system of national law.

This is based on the Convention on the Law Applicable to Contractual Obligations the Rome Convention , which requires that a governing law of an agreement must belong to a country see below on the Shamil Bank case. The English courts have, however, taken the uncontroversial view that they have jurisdiction to decide cases involving shariah-compliant products and structures that are documented under contracts governed by English law. The main question that arises is how English courts — being courts in a non-Muslim jurisdiction — will address matters that concern shariah compliance.

In particular, will English courts consider matters of shariah law in reaching a judgment? The Shamil Bank case 2 looked at the question of conflict of laws between English law and shariah law. The full facts of the case are not relevant to the discussion on this topic; what is important is the wording of the governing law clause in the agreements that were in dispute. That clause read as follows: The defendants advanced a defence that, for the agreements in dispute to be enforceable, the above governing law clause required that they be valid and enforceable both in accordance with the principles of shariah and in accordance with English law.

The judge considered whether this gave rise to a conflict of laws point, noting that it is not possible for a contract to be governed by two systems of law.

Islamic Finance: Instruments and Markets

These interpretations are often not consistent and sometimes openly contradictory. Potter LJ went on to consider whether, instead, the principles of shariah had been included in the disputed agreements as a matter of contract. In considering this point, the judge noted that:.


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Potter LJ again cited the differences of opinion that are such a particular feature of Islamic finance and noted the lack of any specificity as to which aspects of shariah were intended to apply to the agreements in dispute. The Shamil Bank case has therefore set the standard under English law that the English courts will consider disputes under English law-governed shariah-compliant contracts as matters of English law to the exclusion of questions of shariah.

This case involved some dispute as to whether an agreement that had been labelled a murabahah contract was, in fact, a murabahah contract and therefore whether or not the agreement was shariah-compliant. That question had wider implications for the case but as to the question of how an English court will review an English law agreement whether or not it is expressed to comply with shariah , the judge continued: While by no means a weighty corpus of precedent, the fact that there is case law available from the English courts provides comfort to international market participants as to the treatment of Islamic finance contracts that are, for the most part, governed by English law.

As well as the governing law issues considered above, another issue that has been considered by the English courts is whether a claim for ultra vires can be made on the basis that a contracting party who is only permitted to enter into contracts that comply with shariah entered into a contract that purported to be a shariah-compliant contract but that may, on its facts, be non-compliant with shariah. The best-known case on this is Blom Bank.

Under the terms of the wakalah agreement, Blom Bank was to be paid a return on its wakalah investment that purported to be linked to the profits of the underlying investment i. TID is a shariah-compliant investment company that is required by its articles to contract only in a manner that is shariah-compliant, with those articles stating: TID argued that the wakalah arrangement was not a true wakalah arrangement but rather disguised lending at what amounted to an interest rate.

What is important to note about this case is that no ruling was made on the question of ultra vires. Instead, the issue was declared to be unsuitable for summary judgment and referred as a matter for trial. What is equally interesting is that the judgment declared that if the contractual claim that Blom Bank had made against TID for payments due to it under the wakalah contract failed as a result of the ultra vires defence, a claim in restitution which Blom Bank added to its appeal in response to the ultra vires argument was likely to succeed. Blom Bank was awarded summary judgment for the principal amount it invested with the question of ultra vires and whether or not Blom Bank had a claim for its profit left as questions for trial.

This was because the question of ultra vires was one for expert determination at trial involving consideration of Kuwaiti law, being the jurisdiction of incorporation of TID. At the time of this case, TID was in considerable financial distress and, having been placed under the protection of the Kuwaiti Financial Stability Law, the case went no further. What distinguishes the Blom Bank case from both the Shamil Bank case and the Symphony Gems case is the willingness of the court to consider issues of shariah compliance in front of an English court, albeit on the limited basis of the consideration of an ultra vires defence.


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As the Blom Bank case went no further, it does not provide a conclusive or even compelling guide as to how the English courts will consider issues of ultra vires and shariah compliance. However, one should also bear in mind that the judge was clear that, in his view, were an ultra vires defence to succeed, a claim for restitution would be successful. This may be read to confirm the view that English courts will consider English law-governed Islamic finance contracts as questions of English law only.

Dana Gas an issuer based in the UAE was attempting to render its mudarabah sukuk unenforceable on a number of grounds, one of which was that the sukuk were not shariah-compliant. Although Dana Gas has sought to bring proceedings to adjudicate on this matter in the Sharjah Federal Court of First Instance, a number of the sukuk documents are governed by English law, and so Dana Gas has also sought and obtained an interim injunction in the English courts preventing the sukuk holders from declaring an event of default or dissolution event in relation to the sukuk.

In its injunction claim, Dana Gas has referred to the Ralli Bros principle, which provides that an English law contract that requires performance of an act that is unlawful in the place of its performance will not be enforced by an English court.

Wider benefits

At the time of publication, it was not clear whether there will be a full hearing of this matter before the English courts. The UK has been the most prominent non-Muslim jurisdiction that has sought to promote Islamic finance and has taken concrete steps both through legislation and government-led transactions to promote Islamic finance. Further, several shariah-compliant institutions are listed on AIM alternative investment market , enabling the purchase of shariah-compliant shares and there are numerous shariah-compliant exchange traded funds based on Islamic indices.

While no new Islamic finance-specific legislation is expected in the near-term, the UK government has a track record in reacting to the demands of the market as they arise.

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