Introduction to Islamic Finance - David Simpson - 3 Verulam Buildings

Introduction to Islamic FinanceDavid Simpson3VB

Nature of Shari’ah

Sources• Qur’an• Sunnah• Hadith• Ijma

Schools• Hanafi• Hanbali• Maliki• Shafi

Saudi ArabiaBasic Law of Governance

Article 1:The Kingdom of Saudi Arabia is a sovereign Arab Islamic State. Its religion is Islam. Its constitution is Almighty God's Book, The Holy Qur'an, and the Sunna (Traditions) of the Prophet (PBUH).

Saudi ArabiaBasic Law of Governance

Article 55:The King shall rule the nation according to the Sharia. He shall also supervise the implementation of the Sharia, the general policy of the State, and the defense and protection of the country.

Principles of Shari’ah

Unjust enrichment

• “receiving a monetary advantage without giving a countervalue”

• undue influence• duress• payments to charity

Surah Baqarah:

“O ye who believe! Give of the good things which we have (honourably) earned, and of the fruits of the earth which we have produced for you, and do not even aim at getting anything which is bad, in order that out of it ye me give away something, when ye yourselves would not receive it except with closed eyes.”

• “a monetary advantage without a countervalue which has been stipulated in favour of one of the two contracting parties in an exchange of two monetary values”

• excess in quantity• delay in performance

Abu Sa'id al-Khudri, citing the Prophet:

“Do not sell gold for gold, except if they are equivalent in amount, and do not sell a lesser amount for a greater one. Do not sell silver for silver except if they are equivalent in amount, and do not sell a less amount for a greater one…”

• “a monetary advantage without a countervalue which has been stipulated in favour of one of the two contracting parties in an exchange of two monetary values”

• excess in quantity• delay in performance

Abu Sa'id al-Khudri, citing the Prophet:

“Do not sell gold for gold, except if they are equivalent in amount, and do not sell a lesser amount for a greater one. Do not sell silver for silver except if they are equivalent in amount, and do not sell a less amount for a greater one…”

Gharar

• hazard

• there must be no doubt concerning the obligations undertaken by the parties to a contract

• undue or excessive risk or uncertainty in a trade

Ibn Mas'ud, citing the Prophet:

“Do not buy fish while it still exists in the water, as it is Gharar.”

Gharar

• hazard

• there must be no doubt concerning the obligations undertaken by the parties to a contract

• undue or excessive risk or uncertainty in a trade

Ibn Mas'ud, citing the Prophet:

“Do not buy fish while it still exists in the water, as it is Gharar.”

Darura• necessity

Profit and loss sharing• prohibition on hoarding

Segregation of activities• carrying on haram activities

Shari’ah supervisory boards• indoor management

Islamic financial products

Takaful• insuranceIjara• leaseMurabaha• sale with deferred paymentMusharaka• partnershipSukuk• bondsIstisna’a• manufacture and sale

Takaful

• gharar• mutual insurance• P&I club• contributions to central pool• distribution of surplus• possibility of future calls• darura: non-takaful reinsurance

Takaful

• gharar• mutual insurance• P&I club• contributions to central pool• distribution of surplus• possibility of future calls• darura: non-takaful reinsurance

Murabaha

FinancierSupplier Customer

First contract• sale of asset from supplier to financier• payment of purchase price• financier may act by agent• financier takes possession• supplier cannot be customer or his agent• asset must not be gold, silver or currency• asset must not be subject of earlier murabaha

Murabaha

Second contract• sale of asset from financier to customer• must post-date first contract• payment of purchase price + profit• profit must be certain and disclosed• payment may be by instalments• ownership must pass immediately• default fees not permitted• extending date of payment not permitted• financier responsible for defects

Murabaha

Murabaha Documentary Credits

Shares Murabaha Finance

Reserve commodity murabaha (tawarruq)

Commodities Exchange

First contract• sale of commodity• immediate delivery• immediate paymentSecond contract• sale of commodity• immediate delivery• deferred payment• price + mark-upThird contract• sale of commodity• immediate delivery• immediate payment

Commodity broker

IFI providing finance

Commodity broker

IFI requiring finance

Conditions• contracts separate• commodity must be

real and identifiable• not gold, silver or

currency• customer must take

delivery • must not be sold

back to the seller

Commodity broker

AAOIFI Shari’ah Standard 30, Monetization (Tawarruq):

“Monetization is not a mode of investment or financing. It has been permitted when there is a need for it, subject to specific terms and conditions. Therefore, the institutions should not use Monetization as a means of mobilizing liquidity for their operations, and exert no effort for fund mobilization through other modes such as Mudaraba, investment proxy, Sukuk, investments funds, and the like. The institution should resort to monetization only when it faces the danger of a liquidity shortage that could interrupt the flow of its operations and cause losses for its clients.”

Commodity broker

Sukuk al-Ijara

Originator

• SPV incorporated• SPV issues sukuk• investors subscribe for sukuk and pay proceeds to SPV• originator sells certain assets to SPV• SPV leases assets back to originator• originator makes rental payments to SPV• SPV issues Periodic Distribution Amount to Investors

Sukuk al-Ijara

SPVOriginator

• SPV incorporated• SPV issues sukuk• investors subscribe for sukuk and pay proceeds to SPV• originator sells certain assets to SPV• SPV leases assets back to originator• originator makes rental payments to SPV• SPV issues Periodic Distribution Amount to Investors

Sukuk al-Ijara

SPVOriginator Investor

• SPV incorporated• SPV issues sukuk• investors subscribe for sukuk, pay proceeds to SPV• originator sells certain assets to SPV• SPV leases assets back to originator• originator makes rental payments to SPV• SPV issues Periodic Distribution Amount to Investors

Sukuk al-Ijara

On default• SPV exercises option to sell assets back to Originator

at “Exercise Price”• SPV pays Dissolution Amount to Investors

Sukuk al-Ijara

On default• SPV exercises option to sell assets back to Originator

at “Exercise Price”• SPV pays Dissolution Amount to Investors

Sukuk al-Ijara

Sukuk al-Mudaraba

Originator

• SPV incorporated• SPV issues sukuk• investors subscribe for sukuk, pay proceeds to SPV• SPV and Originator enter into Mudaraba Agreement:

Mudaraba enterprise• SPV contributes principal amount• Originator contributes expertise and skills• agreed profit-sharing ratio

• SPV uses profits to pay periodic returns to investors

Sukuk al-Mudaraba

SPVOriginator

Sukuk al-Mudaraba

On maturity• Mudaraba enterprise dissolved• SPV calls on Originator to buy back Mudaraba interest

at (market) value• SPV uses profits to pay periodic returns to investors

Sukuk al-Mudaraba

On maturity• Mudaraba enterprise dissolved• SPV calls on Originator to buy back Mudaraba interest

at (market) value• SPV uses profits to pay periodic returns to investors

Sukuk al-Mudaraba

AAOIFI Statement, February 2008

• It is not permissible for the Mudarib to re-purchase the assets from Sukuk holders or from one who holds them, for its nominal value, when the Sukuk are extinguished, at the end of its maturity.

• It is not permissible for the Manager of Sukuk to undertake to offer loans to Sukuk holders, when actual earnings fall short of expected earnings.

• Shari'ah Supervisory Boards should not limit their role to the issuance of fatwa on the permissibility of the structure of Sukuk.

Caselaw

Albaraka International Bank Limited v Meliti1992 CoA (unreported)

• Woolf, Leggatt LJJ• possession action • murabaha financing a property portfolio• ultra vires• collateral contract• mistake

Caselaw

Islamic Investment Company of the Gulf (Bahamas) Ltd v Symphony Gems NV and others 2002 QB (Comm) (unreported)

• Tomlinson J• murabaha financing jewel purchase• consequence of mere non-compliance• illegality• ultra vires• misrepresentation

Caselaw

Shamil Bank of Bahrain v Beximco Pharmaceuticals Ltd and others

[2003] EWHC 2118 (Comm)• Morison J• $30m (reverse?) murabaha• choice of law

[2004] EWCA Civ 19• Potter LJ• choice of law• incorporation

Caselaw

Riyad Bank and others v Ahli United Bank (UK) plc [2005] EWHC 279 (Comm)

• duty of care owed by adviser to ijara fund

Caselaw

Musawi v RE International (UK) Ltd and others [2007] EWHC 2981 (Ch)

• David Richards J• dispute of agreements relating to land• choice of law• s46 Arbitration Act 1986

Caselaw

The Investment Dar Company KSCC v Blom Developments Bank SAL [2009] EWHC 3545 (Ch)

• HHJ Purle QC• Blom investment in TID wakala fund• TID fail to repay• ultra vires TID• restitution

Conclusion

• lack of consensus on shari’ah compliance• legal effects of non-compliance• choice of law• incorporation• ultra vires• collateral contract• mistake• illegality• misrepresentation• estoppel• regulatory claims

Thank you

Introduction to Islamic Finance - David Simpson - 3 Verulam Buildings

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