GLOBAL PERSPECTIVE ON ISLAMIC BANKING & INSURANCE

ISSUE NO. 180JULY–SEPTEMBER 2011RAJAB-SHAWWAL 1432

MARKETING STRATEGIESFOR ISLAMIC BANKS

ANALYSIS: THE OUTLOOK FORISLAMIC REITS AS ANINVESTMENT VEHICLE

POINT OF VIEW:ISLAMIC FINANCE ANDSRI – THE EXPECTATIONSGAP

COUNTRY FOCUS:MAURITIUS – ANEMERGING CENTRE FORISLAMIC FINANCE

LEGAL MATTERS:FORM OVER SUBSTANCE– WILL SECULAR COURTSFORCE THE ISSUE?

TAKAFUL FOCUS:THE TAKAFUL JOURNEY –A FORK IN THE ROAD

PUBLISHED SINCE 1991NEWHORIZON

NewHorizon_Issue180_NewHorizon 05/07/2011 09:22 Page 1

NEWHORIZON Rajab-Shawwal 1432

CONTENTS

development in Islamic banks and the May lecture on thefundamentals and rationale ofIslamic banking.

38 AWARDSListing of IIBI awards of postgraduate diplomas.

39 TECHNOLOGY NEWS

40 BOOK REVIEW

05 NEWSA round-up of the important storiesfrom the last quarter around the globe.

32 IIBI NEWS ANDEVENTS ENDORSED BYTHE IIBI

35 IIBI LECTURESReports of the March 2011 lecture on Shari’ah governance; the April2011 lecture on product

10 The Outlook for IslamicREITs as an InvestmentVehicle

Momna Saeed analyses the future prospectsfor Islamic REITs. She comes to theconclusion that there is every reason to beoptimistic, given their natural fit withIslamic finance.

14 A New Market forIslamic InvestmentProducts: TheConventional Market

Tariq Al-Rifai argues that to succeed Islamicfinance must attract a wider audience; thatit needs to target all investors irrespective ofreligious belief or investment strategy.

16 Mauritius – AnEmerging Centre forIslamic Finance

Mauritius is one of the most stable andsuccessful democracies in East Africa.Najmul Rassool provides a background anddescribes the progress so far in makingMauritius an attractive centre forShari’ah-compliant financial services.

20 Marketing Strategiesfor Islamic Banks

We revisit the remarkably prescientpresentation, ‘Vision of the 21st Century’,given by the late Mr Muazzam Ali,founding Chairman of the IIBI, in 1994.His thoughts echo some of the themes inthis and other recent issues ofNewHorizon.

26 Islamic Finance andSRI – The ExpectationsGap

Usman Hayat suggests that honestcommunication is one way to begin to close the expectations gap between what people expect from ethical

finance and what in practice can bedelivered.

27 Form Over Substance– Will Secular Courts Forcethe Issue?

The decisions of the secular courts may beabout to trigger a close scrutiny of thedocuments and structures used to kick startthe Islamic finance industry argues Richardde Belder.

30 The Takaful Journey –A Fork in the Road

Muhammed Muqeem reviews the progressof the takaful industry to date.

NEWHORIZON July–September 2011

Many readers may remember those old school reports, which saidsomething like, ‘This pupil has made considerable progress duringthe year, but with a little more concentration and attention to detailhe/she could do better.’ The message contained in several of thearticles in this issue carry a similar message about the Islamicfinance sector.

Islamic finance is reaching that stage of its development where itneeds to decide whether it is going to remain a niche industry or carryits message of moral, just and socially-responsible financial services toMuslim populations and the wider world. To do so industry playersnot only need to make a serious financial commitment to researchingand developing effective sales and marketing strategies, they also needto address other issues. These include building a solid track record ofsuccess in its investment strategies and ensuring that Shari’ahgovernance is robust and transparent. The latter would requirehuman capital committed to revisiting transaction structures anddocumentation to make absolutely clear what the intentionsunderpinning these agreements are and also that they comply with theletter and spirit of the Shari’ah principles. IIBI is proud to be playingan important part in building the knowledge and skill base for thesustainable growth of the Islamic finance industry through itseducation and training programmes.

Certainly there is a growing recognition of the opportunitiespresented by Islamic finance. This quarter’s issue of NewHorizonhighlights the ambitions of states as diverse as Mauritius, Bermuda,Japan and Ireland to attract Islamic investment. These are just thetip of the iceberg; we confidently expect to see moreannouncements of states adjusting their legal and regulatoryregimes to make them more Islamic finance friendly.

William Shakespeare’s words perhaps sum up the point at which theIslamic finance industry stands today, ‘There is a tide in the affairsof men, which, taken at the flood, leads on to fortune.’ The messageis clear and it is now up to individuals and organisations to thinkoutside the box and to grasp the opportunities that are so evidentlybefore them. If they fail to do this, the Islamic finance industry willnot be the only loser; the world in general will have lost apotentially steadying and moral influence on the conduct of itsfinancial affairs.

EDITORIAL

Mohammad Ali Qayyum,Director General, IIBI

Andrea WhartonSue Dobson

Mohammad Shafique

Humphrey Tizard

Mohammed AminRichard T de BelderAjmal BhattyStella CoxIqbal KhanDr Imran Ashraf Usmani

Cambridge Corporate Management LtdIckenham ManorIckenham UxbridgeUB10 8QTTel: + 44 (0)1895 625555Email: newhorizon@cambcorp.co.ukWebsite: www.cambcorp.co.uk

Cambridge Corporate Management LtdIckenham ManorIckenham UxbridgeUB10 8QTTel: + 44 (0)1895 625555Email: newhorizon@cambcorp.co.ukWebsite: www.cambcorp.co.uk

Mohammad ShafiqueInstitute of Islamic Banking andInsurance7 Hampstead Gate1A Frognal London NW3 6ALUnited Kingdom Tel: + 44 (0) 207 2450 404Fax: + 44 (0) 207 2459 769Email: iibi@islamic-banking.com

©Institute of Islamic Banking andInsuranceISSN 0955-095X

Surat Al Baqara, Holy Quran

NEWHORIZON Rajab-Shawwal 1432

Advent Software, who specialisein portfolio managementsolutions, have published theresults of a recent surveyfocussing on the major concernsof investors, fund companiesand distributors in the GCC andthe Levant. The results areinteresting and applicable toboth conventional and Islamicfinancial organisations.

It will come as no surprise tohear that, although there iscautious optimism about thefuture, there is more than a littleconcern about the unrest

affecting many parts of theregion. In the short termrespondents to the survey fearedthe potential inflationaryconsequences of the turmoil andalso the effect on investorconfidence, thus reducing theinflow of funds. In the longterm, however, they felt thatmore democratic regimes wouldbe good for private investment.It also seems that, despite someof the unresolved issues stillsurrounding the propertyboom/bust in the United ArabEmirates, notably Dubai and thereal pain felt by some

respondents as a result of this,real estate investments remainattractive with Qatar, SaudiArabia and Abu Dhabi beingmentioned in this context.

Although it was not the topissue, there was a significantlevel of concern about theunderlying weakness andopacity of regulatory regimesaround the region. While therewas a general acceptance thatthe situation was improving,when compared to Westernmarkets the report card read‘could do better.’ This issue

Cautious Optimism in the GCC and the Levant

went hand-in-hand with theacceptance that there is ashortage of suitably-qualifiedfinance professionals in theregion ready and able to ensurecompliance with regulations.Perhaps the 19th centuryAmerican exhortation to ‘GoWest, young man,’ needs to berewritten to read ‘Go East,young man.’

Readers who would like todelve further into theconsiderable detail of this23-page White Paper can do soby going to www.advent.com.

Elaf Bank, licensed by theCentral Bank of Bahrain tooperate as a wholesale Islamicbank with a paid-up capital of$200 US million, has beengranted a license by theMinistry of Finance Malaysiato open a branch office underthe Malaysia InternationalIslamic Finance (MiFC)initiative. Elaf Bank waspresented with the licenseduring a formal ceremony heldat Bank Negara Malaysia on15 June 2011. Elaf Bank plansto start its branch officeoperations in Kuala Lumpur,Malaysia immediately nowthat it has fulfilled theformalities required forobtaining the license.

Dr. Jamil El Jaroudi, CEO ofElaf Bank, commented on theimportance of opening a branch office in Malaysia,which falls in line with theBank’s long-term businessstrategy. ‘Elaf Bank isdeveloping its business throughtwo hubs covering the GCC and MENA regions and theSouth East Asia region, as atwo-way business corridor. This will help us operate more efficiently and closely tomeet the needs of ourcross-regional clients and beable to execute deals that willcontribute to the sustainablegrowth of the Islamic financeindustry in both strategicmarkets.’

NEWS

Elaf Bank Granted Licence in Malaysia

Dr Jamil El JaroudiReceives Malaysia License

NEWHORIZON Rajab-Shawwal 1432

need to considerin complyingwith the existingregulatoryframework,such as requireddisclosures,notification ofmaterial changesand the role andresponsibilitiesof the Shari’ahSupervisoryBoard.

A copy of theGuidance Noteentitled ‘IslamicCollectiveInvestmentSchemesGuidanceNotes’ isavailable on theAuthority’swebsite,www.bma.bm.

UAE-headquartered TakafulEmarat has announced apartnership with Reliance AssetManagement (Malaysia) Sdn.Bhd. (RAMMY), the Islamic

Takaful Emarat Form Two New Partnerships

NEWS

asset management arm ofReliance Capital AssetManagement Limited,India (RCAM). As part ofthe alliance, TakafulEmarat will offer itscustomers three Shari’ah-compliant funds managedby RAMMY – the WSFReliance Global Shari’ahGrowth Fund, theReliance India Shari’ah

Growth Fund, and the proposed Shari’ah EquityGrowth fund investing intoChina and India.

This announcement is part ofRCAM’s Islamic AssetManagement strategy todevelop its Malaysian subsidiary as a global Islamicfinance hub for Shari’ah-compliant products. Thepartnership will allow RAMMY to offer acomprehensive range of diverseShari’ah-compliant, unit-linkedinsurance products to TakafulEmarat’s clients throughShari’ah-compliant fundsmanaged by RAMMY.

In a second announcement theyannounced a partnership withthe German Emirates Club, theexclusive club for all German-speaking expatriates residing inthe UAE. The initial partnershipallows Takaful Emarat to be thepreferred partner of the GermanEmirates Club for health andlife insurance products andservices. (The German EmiratesClub, founded in 2006, is a clubfor all German, Austrian andSwiss expatriates in the UAE.)

The Bermuda MonetaryAuthority has publishedGuidance Notes that facilitatethe establishment of Islamicinvestment funds in Bermuda.The Guidance Notes aredesigned to help prospectiveapplicants looking to establishsuch funds to comply withBermuda’s funds regulations,specifically the InvestmentFunds Act 2006. They alsocomplement Bermuda’s effortsto promote the jurisdiction as a domicile of choice for Islamic financial products.

Commenting on the newGuidance Notes, Jeremy Cox,CEO of the Authority said, ‘TheAuthority is pleased to confirmthat Bermuda’s regulatoryframework can accommodatethese types of products. Byissuing the Guidance Notes weare helping the market take

advantage of this potentialbusiness opportunity forBermuda, while ensuring thesector remains appropriatelyregulated. As Bermuda’sfinancial services regulator, theAuthority is keen to ensure thatthis jurisdiction upholds thehighest standards in regulation,while at the same timemaintaining a regulatoryenvironment that supportsbusiness growth anddevelopment.

The Authority drafted theGuidance Notes following areview it conducted ofBermuda’s regulatory regime forinvestment funds. The reviewfound that there was noimpediment to authorisingIslamic investment funds inBermuda under the currentframework, however, the Notesprovide guidance on a numberof issues that Islamic funds may

Bermuda Clarifies Islamic Investment Rules

Jeremy Cox

Signing of the agreementbetween Takaful Emarat andthe German Emirates Club

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TheCityUK has announced thatthe UK Islamic FinanceSecretariat (UKIFS), launched inMarch 2010, has beenintegrated into TheCityUK.UKIFS is the cross-sectoral bodyassisting with the promotionand development of Islamicfinance, both domestically andto represent the UK industryinternationally.

Under TheCityUK’s structure,efforts will focus onsafeguarding and furtherdeveloping the UK’s strengths inIslamic finance, ensuring it notonly remains the West’s hub forthis financial specialism, butcontinues to be a significantcontributor on a global stage.The UKIFS’ working groupstructures and member base willbe integrated into TheCityUK’s

operations with members of itsboard and executive appointedto the board of UKIFS. RichardThomas, CEO of Gatehouse

Bank has been appointed Chairof the Working Groups.

Chris Cummings, CEO ofTheCityUK, commented,‘TheCityUK is looking forwardto playing a key role inensuring the UK’s ongoingsuccess as the leading Westernprovider of Islamic finance. Theintegration of UKIFS intoTheCityUK is a landmarkdevelopment that will providefresh opportunities to promotethe Islamic finance capability,building on the workundertaken by UKIFS’ foundingdirectors and by the CharteredInstitute for Securities &Investment (CISI). This latestdevelopment will ensure theUK’s capability in Islamicfinance can continue to evolveand we encourage firms to

TheCityUK Absorbs the UK Islamic Finance Secretariat

support this importantinitiative.’

Endorsing the acquisition, LordGreen, UK Minister of State forTrade and Investment said: ‘Asthe undisputed leading Westernhub for Islamic finance services,the UK has recognised the roleof the sector in contributing tofuture economic growth. UKIFShas achieved a great deal inrepresenting the industry since itwas launched in 2010. I ampleased that it is becoming partof TheCityUK, in a move thatwill strengthen the promotion ofthe wider UK offer overseas. Iwish TheCityUK and UKIFSevery success for the future andUKTI looks forward tosupporting this exciting marketdevelopment both at home andabroad.’

Bank of London and TheMiddle East (BLME) hasannounced the launch of itsLight Industrial Building Fund(LIBF), a Shari’ah-compliantUK real estate fund whichinvests in sustainable propertyassets. Targeting institutionalinvestors, the LIBF invests inlight industrial buildings acrossthe UK. The target cash oncash yield is 8% to 10% perannum, with quarterly cashdividends paid to investors.The target IRR (Internal Rateof Return) is 15% for the five-year duration of this closed

ended fund. The target close forthe fund is between £50 millionand £100 million in equity,which will be leveraged to createa portfolio of up to £200million of assets.

‘As the UK economy recovers,we anticipate an increasingnumber of SMEs operating newbusinesses from industrialestates,’ commented DerekWeist, Director – AssetManagement at BLME. ‘Pricingin this sector is consideredattractive with high yieldsavailable on many types of

industrial property assets. Inaddition, the highly diversifiedmix of tenants, by industry andgeography and strengtheningoccupier demand supports theprospect for rental growth infuture, which can provide astrong positive cash flow forprivate clients and institutionalinvestors.’

The fund is available to both UKand non-UK resident investors.The fund is a compartment ofthe BLME Shari’ah UmbrellaFund SICAV-SIF, which isdomiciled in Luxembourg.

NEWS

Chris Cummings

BLME Launch Real Estate Fund

Derek Weist

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Pointon York has launched arange of Shari’ah-compliantSelf-Invested Personal Pensions(SIPPs) to meet the growingdemand from Muslims for asuitable retirement vehicle.The specialist SIPP provider is

the first to receiveShari’ah-compliantaccreditation by the IslamicBank of Britain (IBB) for its fullrange of SIPPs.

Pointon York will be offering

four Shari’ah-compliant SIPPproducts:

❑ e-SIPP – a low cost SIPP,which can be easily managedonline

❑ Single Investment SIPP – astraightforward SIPP for clientswishing to invest in a singleasset

❑ Individual SIPP – a fullyflexible SIPP allowing anextensive range of investments

❑ Corporate SIPP – suitable foremployers, it has three tiersproviding flexibility. It is madeup of the e-SIPP, the SingleInvestment SIPP and theIndividual SIPP.

Jo French, Managing Directorof Pointon York, said, ‘Thelaunch of ourShari’ah-compliant SIPPs issignificant for Muslims, their

IFAs (Independent FinancialAdvisors) and employers; itwill encourage all parties toconsider pensions as animportant tool when planningfor their retirement. It willalso provide IFAs with theright products to deliverbespoke tax andwealth-management strategiesto the Muslim community.Employers will also benefit bybeing able to offer staff apension scheme in advance ofthe 2012 auto-enrolmentdeadline. This is the first timethat Muslim employees, IFAsand employers will haveaccess to SIPPs accredited byIslamic Bank of Britain.’

Pointon York’s SIPPs havebeen accredited by IBB toensure they meet all Shari’ahrequirements. The Bankoversees the entire lifecycle ofthe product from setup toongoing monitoring.

Alliance Islamic Bank Berhad(Alliance Islamic Bank), asubsidiary of Alliance BankMalaysia Berhad, recentlylaunched the Alliance FamilyTakaful Investment-Linked Plan,a Shari’ah-compliant familytakaful investment-linkedproduct. This product launch isa tripartite collaborationbetween Alliance Islamic BankBerhad with Takaful Ikhlas SdnBhd (Takaful IKHLAS), ageneral and life takaful providerand FWU Malaysia Sdn Bhd(FWU Malaysia), a subsidiary of

Alliance Family Takaful Investment-Linked Plan Launched

NEWS

German-based financial servicesprovider, FWU Group.

The Alliance Family TakafulInvestment-Linked Plan is asavings and investment planthat comes with family takafulcoverage and is suitable forcustomers who wish to plan for their future financial needssuch as retirement or children’seducation. Customers may optfor either the Lump SumContribution or RegularContribution Plan. Theminimum contribution for

the Lump Sum Plan is RM5,000 while the minimumfor the Regular ContributionPlan is from as little as RM200 per month. From theinvestment perspective,customers may select either the Cash Strategy or EquityStrategy depending on their riskappetite.

The strategic collaborationbetween Alliance Islamic Bank,FWU Group and TakafulIKHLAS leverages foreignexpertise in terms of systems

and product development,whilst riding on Alliance Bank’sdedicated sales force, extensivecurrent branch network of morethan 90 branches and significantcustomer database. Theaddition of this new productcomplements Alliance FinancialGroup’s objective in becoming aleading player in wealthmanagement and bancatakafulbusiness. Alliance Islamic Bankaims to distribute 5,000contracts with an average first year premium of RM67million.

Pointon York Launch Shari’ah-Compliant Pensions in the UK

Jo French

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At the beginning of May theSultanate of Oman issued aroyal decree paving the way forthe establishment of Islamicbanks. Existing banks will notbe allowed to convert to fullIslamic status, but may openIslamic windows. The Sultanatehad previously insisted thatbanking should be universal andhad set its face against theestablishment of Islamic banksmaking it unique among theGCC states. The move is said tobe a response to the outflow ofinvestments seeking Shari’ah-complaint havens in otherjurisdictions.

Watania, the takaful companyfounded by Abu Dhabi NationalIslamic Finance, Abu DhabiNational Insurance Company,Abu Dhabi National EnergyCompany and Aldar Properties,was seven times oversubscribedwhen its IPO closed at thebeginning of May. The foundingshareholders retained a 45%stake in the company, with afurther 13.3% open only toUAE investors. The remainingstocks were made available toUAE, GCC, and other retail andinstitutional investors.

Following the central bankdirective issued in February,HSBC Amanah (see NewHorizonApril 2011 for the full story) willclose their operations in Qatar bythe end of 2011. The staff of theShari’ah-compliant operationwill apparently be absorbed intoHSBC’s conventional bankingorganisation.

Dubai’s Noor Bank has deniedrumours that it will merge with

Dubai Bank. The Dubaigovernment had to provideDubai Bank with a significantcash injection in early May,effectively taking over itsoperations. The government isapparently considering its futureoptions, which include thepossibilities of merging DubaiBank with another bank andallowing the bank to continueas a standalone operation.

In mid May 2011 the IslamicDevelopment Bank dual listed a$750 million benchmark sukukon the London Stock Exchangeand Bursa Malaysia. Theissuance was arranged by BNPParibas, Deutsche Bank, HSBCand Standard Chartered Bank.Despite the volatile globaleconomic environment, IDBachieved both a larger deal sizeas well as tighter pricing thanprevious issues, with the dealpricing 3bps inside thesecondary market levels. Theissue saw strong participationfrom the Asia and the MENAregion with good interest fromEuropean and US offshoreinvestors based on allocations of26%, 53%, 16% and 5%respectively. The deal alsorevealed encouragingparticipation from real moneyaccounts and official institutionsalong with strong first timeparticipation fromsupranational institutions.

In mid May 2011 Japan’sNational Diet passed a bill toease the way for sukuk issuance.In addition tax legislation willbe amended, so that sukuk andconventional bonds can competeon an equal footing. The

amendment to the AssetSecuritisation Act is due to comeinto force in the late autumn.

In an address to the Irish FundsIndustry Association at thebeginning of June Taoiseach,Enda Kenny, gave notice thatIreland intends to make itselfmore attractive to the Islamicfinance sector as part ofIreland’s strategy to rebuild itsfinance sector. He said, ‘We aredetermined to ensure that theIFSC (International FinancialServices Centre) is a centre ofexcellence for Islamic financeand the changes in recentFinance Acts will support itsdevelopment. In addition,Ireland has been active inconcluding double taxationagreements with importantMuslim majority states,including recently Saudi Arabia,Bahrain, Kuwait and the UAE.The Central Bank of Ireland hasalso said that it is open to theestablishment of Islamic financeinstitutions in Ireland and it hasalready authorised a number ofShari’ah-compliant funds.Islamic Finance is one of themajor growth areas ininternational finance and theGovernment is playing its roleto support the development ofthis sector in Ireland.

The Rafidain and Rashid banks,Iraq’s two main state-ownedbanks, are to offer Islamicbanking services. Funding of$42 million is to be sharedequally between the two banksto finance this project. The planis to have Islamic operations upand running by midsummer. Inthe short term, the Islamic

In Brief

operations will be regulated bytemporary arrangements draftedby the central bank, but in duecourse a bill will be presented toparliament, so that regulationswill be enshrined in law.

AAOIFI has announced thatDr. Mohamad Nedal Alchaar,Secretary General, Accountingand Auditing Organisation forIslamic Financial Institutions(AAOIFI) has been appointedas the Minister of Economyand Trade of Syria. Dr Alchaarhas served as Secretary Generalof AAOIFI since 2003.

H. E. Shaikh Ebrahim BinKhalifa Al Khalifa announcedthat AAOIFI is carrying out thedue process for selection andappointment of a new SecretaryGeneral. In the meantime,Dr Alchaar will continue tooversee its operations includingthe standards developmentprogrammes and relatedactivities during the transitionperiod.

AAOIFI subsequently issued aninvitation for applications tobecome the next SecretaryGeneral. They are looking foran individual with a Ph D inaccountancy, economics orfinance, with at least 20 years’professional or academicexperience in one of these fieldsand fluent Arabic and English.

In the UK’s summer RoyalHonours List Richard Thomas,Chief Executive Officer ofGatehouse Bank was awardedan Order of the British Empire(OBE) for civic excellence andcontributions to the UK Islamicfinancial services industry.

NEWS

NEWHORIZON Rajab-Shawwal 1432ANALYSIS

Islamic REITs (iREITs) are gainingmomentum as a viable alternative channelfor Shari’ah-compliant investments, but theextent to which this investment vehicle willtap the trillion dollar Islamic financeindustry remains to be seen. Beforeexamining the many attributes of iREITsand their potential for becoming thepreferred choice for Islamic investors, it isperhaps useful to highlight the attributesand relevance of conventional Real EstateInvestment Trusts (cREITs).

Conventional Real Estate Investment Trusts

Investment trusts acquire shares in othercompanies to provide a collectiveinvestment. In the case of REITs, thatinvestment is in real estate only. Theinvestment may take the form of buying,managing, selling and leasing real estate;purchasing shares in publicly listed propertycompanies or investing in the debt securitiesof property companies. By combining thebest features of real estate and stocks, REITs provide a practical and effective way of including professionally-managedreal estate within a diversified investmentportfolio. There are three types of REITs:

❑ Equity REITs own and operateincome-producing assets. Many are fullyintegrated organisations that engage in theacquisition, development and managementof commercial real estate

❑ Mortgage REITs extend credit to ownersof real estate

❑ Hybrid REITs combine aspects of theother two.

Each type can be structured either as apublic or private REIT.

Major Benefits of REITs

Major reasons why REITs are a popularinvestment vehicle include:

1. Diversification: participants broadentheir investment portfolio and diversify risk

2. Liquidity: shares in REITs can be readilypurchased and sold

3. Tax transparency: with no tax levied onits profits, full dividends accrue toshareholders, who pay tax according totheir personal rate

4. High dividend yields: REITs are typicallyrequired to distribute at least 90% of theirincome to shareholders

In the case of Shari’ah-compliantinvestment, the additional attractions ofiREITs to investors are: low correlation with common stocks and as a potentialhedge against inflation; high dividend yields and the higher certainty of income.

Islamic Real Estate Investment Trusts

The unique characteristic of an iREIT is thatit invests primarily in income-producing,Shari’ah-compliant real estate and/or singlepurpose companies whose principal assetscomprise Shari’ah compliant real estate.

The structure of an Islamic RIET is shownbelow.

The Outlook for Islamic REITs as an Investment Vehicle

By: Momna Saeed, PhD Student at Gulf One Lancaster Centre for EconomicResearch (GOLCER)

Source: Islamic Banking and Finance Institute Malaysia (IBFIM) and Securities CommissionMalaysia

Figure 1

NEWHORIZON Rajab-Shawwal 1432 ANALYSIS

A portion of iREIT funds can be invested inother Shari’ah compliant asset classes; e.g.cash or Shari’ah acceptable deposits.

Malaysian Securities CommissionGuidelines for iREITs

In Malaysia the growth of iREITs has beenfacilitated by guidelines issued by theSecurities Commission, which include thefollowing:

❑ Rental incomes from non-permissibleactivities must not exceed 20%

❑ An iREIT cannot own properties whereall the tenants operate non-permissibleactivities

❑ An iREIT shall not accept new tenantswhose activities are fully non-permissible

❑ Tenants engaged in non-permissibleactivities may occupy no more than 20% ofthe total area

❑ For non-space using activities, decisionsmust be based in ijtihad (the process ofreasoning by Islamic jurists)

❑ All investment, deposit and financinginstruments must comply with Shari’ahprinciples

❑ Property insurance must be based ontakaful schemes. Conventional insuranceschemes are permitted if no takaful schemesare available.

Rental activities that are classified asnon-permissible are:

❑ Financial services based on riba

❑ Gambling/gaming

❑ Manufacture or sale of non-Halalproducts or related products

❑ Conventional insurance

❑ Shari’ah non-compliant entertainmentactivities

❑ Manufacture or sale of tobacco-based orrelated products

❑ Trading in Shari’ah non compliantsecurities

iREITs and cREITs differ primarily in howincomes are earned and how the fund ismanaged. Each of these aspects must be incompliance with Shari’ah principles.

Investing in iREITs – Issues and Risks

Although their business model is a stableone, iREITs are not without risk. Dividendpayments are not guaranteed and the realestate market is prone to cyclicaldownturns. In addition high distributions ofannual profit and lower reinvestment leadto a slower growth rate. Although iREITsare exposed to the same risks as cREITs,Shari’ah non-compliance risk’ requirementsrestrict investment options. Two majorissues which could hinder the growth ofiREITs are the lack of a developedsecondary market for Islamic instruments;and the absence of a guidance andregulatory framework.

The Scope for Development in AsianMarkets

Malaysia took the initiative of issuing theIslamic REIT guidelines and since that timethe promotion and development of Islamicfinance by the Malaysian authorities hasbeen exemplary. The Al-Aqar KPJ REIT,with seven hospitals within the KPJHealthcare group as its main asset, was thefirst iREIT to be established in the world.

Malaysia currently has fourteen REITs, ofwhich three are Shari’ah-compliant. Eachspecialises in a different asset subclass. Forexample, Al-Hadharah specialises in palmoil plantations. Another, specialising inoffice buildings and industrial properties,was formed by the conversion of a cREIT.

Malaysian iREITs have performed steadilyin terms of the income generated fromrental income and capital gains and havemaintained a healthy dividend payout rate.(see Table 1) The key arrangement of ‘selland lease back’, between owners of realestate and the iREIT, is that the owner sellsan asset to the iREIT and simultaneouslyenters into a back-to-back asset lease

Two major issues which couldhinder the growth of iREITsare the lack of a developedsecondary market for Islamicinstruments; and the absenceof a guidance and regulatoryframework.

NEWHORIZON Rajab-Shawwal 1432ANALYSIS

arrangement. This is an effective riskmitigation tool allowing the iREIT to secureits income while avoiding the issue offinding a long-term tenant and buyer for theproperty at the end of the tenancy.

All the iREITs were fully subscribed whenthey were launched and all involvedhigh-quality assets expected to generate astable cash flow. In the case of Al-’Aqar KPJREITs, for example, a portfolio of hospitalbuildings had a 100% guaranteedoccupancy rate. According to the RatingAgency of Malaysia (RAM), good qualityassets are more likely to commandsustainable resale values through economiccycles, thereby ensuring timely repayment offinancial obligations through refinancingand/or disposal of assets.

Malaysia is also drawing investors from theMiddle East as two UAE based real estatedevelopers are currently looking to listiREITs in Malaysia worth a total ofRM2 billion .

Several iREITs are in the pipeline in Asia.Bahrain, Saudi Arabia, Singapore and theUAE are also working towards establishingtheir real estate sectors. In 2009, theBahraini asset management companyInovest initiated fundraising for$79.5 million of property within an iREIT.The principle objective of the BHD 30million ($79.8 million) iREIT is theacquisition of income-generating propertiesin the Gulf Cooperation Countries (GCC).The purpose is to ensure an acceptable,risk-adjusted return on investment in theform of quarterly profit distribution, in

addition to ‘reasonable capitalappreciation’. The iREIT is estimated toearn an annual 8.5% return from a ‘buyand leaseback’ approach. Inovest alsointends to list the iREIT in Kuwait andSaudi Arabia.

In the UAE, Dubai Islamic Bank and EiffelManagement launched the country’s firstShari’ah compliant REIT. Established inNovember 2010, Emirates REIT is Dubai’sfirst iREIT. It will initially list on the DubaiNasdaq stock exchange before undertakinga second listing within the next 18 months,most probably in London.

Despite a slow start for iREITs in the GCCand Middle East, the prospects for iREITs inthe region are still positive due to themarked-down valuations of asset pricesafter the recent financial crises. Thedistressed sales of assets open attractiveinvestment opportunities for managers ofiREITs.

Another notable development, indicatingthe growth of iREITs in the region, was thelaunch of the Sabana iREIT, the world’sbiggest publicly-traded iREIT. Sabana madeits debut in the Singapore market and raisedSG$664.4 million (US$539 million) in aninitial public offering that wasoversubscribed by 2.5 times. Sabana investsin properties such as warehouses and high-technology office space.

iREITs in European Markets

European financial markets have been in theforefront in attracting and promoting

Malaysian iREITs haveperformed steadily in terms ofthe income generated fromrental income and capitalgains and have maintained ahealthy dividend payout rate.

Source: Faizah C. Din, Malaysia Report, Islamic Finance, July 2009

NEWHORIZON Rajab-Shawwal 1432 ANALYSIS

Islamic financial services by amending theregulatory framework and devisingstrategies to encourage and support thegrowth of Islamic finance. For instance, theLuxembourg Central Bank is the firstEuropean central bank to be a member ofthe Islamic Financial Services Board and isworking actively to gain experience ofsupervisory practice in this area, identifyinginstruments, practices and solutions formanaging liquidity in a Shari’ah compliantmanner.

France, which has the largest Muslimpopulation in Europe, has taken notice ofthe importance of this sector by appointingan Islamic Finance Specialist, ThierryDissaux to help create legal routes forfinancial instruments based in accordancewith Shari’ah. Last year, new rules relatingto Islamic finance were published in theofficial French tax bulletin, aimed atfacilitating the development of sukuk bonds,murabaha, ijara and istisna. The changesaddress company tax, value-added tax andregistration fees. In addition the issue ofdouble taxation is under review and if this isresolved satisfactorily it should encourageinvestment in real estate.

Although London has provided Islamicfinancial services for nearly 30 years, it isonly recently that Islamic financial offeringshave achieved a significant profile. A keyaspect of supportive government policy wasthe establishment in 2003 of an enablingfiscal and regulatory framework for Islamicfinance. The removal of double taxation onIslamic mortgages, and the extension of taxrelief on Islamic mortgages to companiesand individuals, makes investing in realestate more attractive. Moreover, in the UK,a REIT is considered to be a residentcompany that benefits from tax advantages.UK REITs are exempt from tax deductionboth on rental income and on capital gains.In short, it replicates the tax treatment ondirect property investment. With more than20 banks offering Islamic services in the UK,iREITs expect to find a positive response totheir high return/low risk attributes.

The growing interest shown by Europeangovernments in accommodating andencouraging the development of Islamic

finance in the region is a positive step andshould create an environment in whichiREITs should thrive.

Going Forward

There is a considerable opportunity foriREITs to expand, not least because of theirnatural fit with Islamic finance, which looksfor stability by investing in the real economy.As a tangible asset, real estate is the preferredasset class amongst Muslim investors andinstitutions. iREITs fit the bill perfectly foraffluent Arab investors who are seekingviable investment avenues to channel theirfunds. IREITs can provide such investorswith selected projects that yield good returnsand a stable income. The interest shown inthe Asian Pacific region and the launch ofmultimillion dollar industrial Islamic REITsin Singapore suggests that iREITs willcontinue to prosper.

Momna Saeed, currently working for aPhD at Lancaster University, completedher MSc in Finance and Investment atthe University of Edinburgh, UK andcompleted her Bachelors in BusinessAdministration from the Institute ofBusiness Administration (IBA), Pakistan.Prior to the MSc, she worked in an assetmanagement company in Pakistan as anequity research analyst. The focus of hercurrent research is risks in Islamicfinancial Institutions.

The interest shown in theAsian Pacific region and thelaunch of multimillion dollarindustrial Islamic REITs inSingapore suggests thatiREITs will continue toprosper.

NEWHORIZON Rajab-Shawwal 1432POINT OF VIEW

Background

There is a huge market traditionallyoverlooked by Islamic fund managers thatneeds more attention in today’s competitivemarketplace. From its inception, Islamicfinance has focused on targeting the Muslimmarket. This was the main reason why thefirst Islamic equity funds and indexes (DowJones Islamic Market Index) were created.

Even though Islamic finance has enjoyedtwo decades of strong demand, it is still ayoung and small industry. Many fundmanagers rushed into the market hoping togain access to Muslim wealth, only to findthat raising assets can be problem whenthey do not have their own effectivedistribution channels.

Some Islamic funds have a significant assetsize but the majority of funds remain below

$20 million in assets under management.The largest funds, with very few exceptions,are those managed by retail banks in SaudiArabia and, to a lesser extent, Kuwait andMalaysia. Funds managed by European andUS fund managers without retaildistribution channels have not been able toraise assets above $100 million, again witha few exceptions.

One of the bottlenecks facing Islamic fundgrowth is the low percentage of householdsin the Middle East owning funds. The Gulfin particular, where the wealth isconcentrated, remains well below otheremerging markets in terms of fundownership. This is the result of severalfactors such as the lack of a savings culturewithin the region. Culturally, Arabs in theGulf have depended on trade and this stillplays a key role in the perceptions andexpectations of investors. Trading in real

estate is more appealing than putting moneyin funds and watching them grow steadilyover time.

Grounds for Optimism

So why are so many fund managers stilloptimistic? Even though Arab governmentsoffer generous retirement packages, there isa good chance that the monthly salarybenefit will not be able to support lifestylesafter retirement. Individuals and familiesneed to have a plan to supplement theirincome during retirement while planning forchildren’s education along with otherexpenses. For this reason, there is a greatneed for financial education, especially inthe Gulf. Fund managers who work withlocal financial institutions that understandthe importance of financial education willmost probably be the ones to achieve futuresuccess.

Marketing is Key

The launch of additional Islamic financialproducts needs solid marketing; it is notenough to launch funds in the hope thatinvestors will come across them one day.Fund managers should also avoid relying onone sales channel to help grow assets. Theyshould instead focus on multiple routes tomarkets and investors.

This brings us to the main question – whyare Islamic funds only targeting Musliminvestors? The Islamic fund market weighsin at the billions of dollars level, whereas theglobal fund market is worth trillions ofdollars. Islamic funds should change theirmarketing strategy to target all potentialinvestors, especially those interested incompanies with lower debt. Islamic investingis simply a form of faith-based investing — alow-debt, ethical investment style.

A New Market for Islamic InvestmentProducts: The Conventional Market

By Tariq Al-Rifai, Director – Islamic Market Indexes, Dow Jones Indexes

Source: Ernst & Young, Islamic Funds and Investment Report 2010

NEWHORIZON Rajab-Shawwal 1432 POINT OF VIEW

Saturna Capital

We mentioned earlier that there were someexceptions to the general rule that thelargest Islamic funds are domiciled in Saudi Arabia, Kuwait and Malaysia. One of those exceptions is Saturna Capital.Based in the U.S., Saturna manages twoIslamic equity funds – Amana Growth andthe Amana Income funds. The AmanaIncome fund, the first Islamic equity fund in the world, was launched in 1986.From 1986 to 2004, assets only grew to$30 million. The fund manager however,was consistently able to show goodinvestment results and earned the highest ratings in the U.S. among fundmanagers.

Saturna was then able to put its two Islamicfunds on fund distribution platforms, suchas Charles Schwab and TD Ameritrade andsaw their assets under management explode.Today, Saturna’s two funds combinedmanage over $3.6 billion. A majority ofinvestors in these funds are non-Muslimsseeking good returns from a disciplinedfund manager.

From the chart, ‘Growth in Assets UnderManagement’, it is clear how fast the Amanafunds grew to become the largest Islamicfunds. There is no other fund on the marketthat has been able to match this growth rate.Comparing the Amana funds asset growthwith the UBS Islamic Fund, benchmarked tothe Dow Jones Islamic Market Titans 100Index, it can be seen that the UBS fund hashad almost no growth in assets since itsinception. The reason may be that the fundwas mainly sold to Muslim investors whostepped forward and specifically asked for it.Amana appears to have made a strongersales effort in the long-term.

The Message is Clear

The message is clear, for Islamic funds tosucceed; they must attract a wider audience.Investors worldwide, regardless of theirreligious beliefs or investment strategieslook for a solid track record. If Islamicfunds can deliver this, then they should casta wider net and go for the mass-market. Inthe long-run, this can only lead to a win-winsituation for the Islamic fund industry andthe investors.

Source: Morningstar, 2011

Tariq Al-Rifai joined Dow Jones in 2009after a 13-year career in the Islamicfinance industry. He founded FailakaAdvisors in 1996 to promote and developIslamic financial instruments and sinceMay 2004 had served as vice president,UIB Capital, Inc., Chicago. Previously hewas vice president Islamic Banking atHSBC Bank in New York and was apartner at The International Investor, aKuwaiti shareholding company.

NEWHORIZON Rajab-Shawwal 1432COUNTRY FOCUS

Mauritius with its mixed population ofEuropeans, Africans and Asian has areputation for peaceful co-existence andracial harmony, as well as economic andpolitical stability. The island covers an areaof 1,865 square kilometres and is situated ina convenient time zone (GMT +4) in theIndian Ocean that makes same-daytransactions possible from the US, throughEurope, the Middle-East, Australia andAsia. It is now emerging as a majorinternational business platform in thisregion of the world aided by the fact that itspopulation of 1.3 million inhabitants hasthe highest adult literacy rate for the wholeof Africa as a result of free education atprimary and secondary school level. Thishighly-disciplined and educated workforceis also equally fluent in English and French,while many also speak a third internationallanguage - Hindi, Urdu, Arabic, Mandarinand a host of European languages. Most ofits professional workforce qualified frominternationally recognised institutionsand/or world class professional bodies. Inaddition, the government of Mauritiusrecently enacted legislation encouragingforeign professionals to set up in thecountry.

The success of Mauritius in achievingeconomic growth, despite the current

financial turmoil, can be attributed to itspolitical stability, the pursuit of stablemacroeconomic policies and theestablishment of a regulatory frameworkthat is favourable to private sectordevelopment. These policies have beenfundamental to the development of manysectors in the economy, including that offinancial services. In just three decades, thecountry has moved from a mono-crop,sugar-dominated economy to being servicesoriented. With traditional growth sectorslike tourism and manufacturing remainingstrong and new emerging economic activity,the island has become a mature economy,one of just two in Africa to have graduatedto middle-income status. This transition hasbeen facilitated by preferential accessagreements to markets worldwide, notablyto the EU, through the Cotonou agreement;with the US through the Africa Growth andOpportunity Act and with Eastern andSouthern Africa, through the CommonMarket for Eastern and Southern Africa(COMESA) and the Southern AfricanDevelopment Community (SADC).

Mauritius has a well-developed network ofinternal and external communications. Anextensive and well maintained roadinfrastructure; a modern, efficient and freeport; a web of sea links and direct air

connections with cities around the world;high bandwidth fibre cable connectivity; areliable fixed and mobile telephonenetwork; express courier service providersand freight forwarders and fully servicedbusiness and industrial parks.

Critically Mauritius complies with bestpractices in terms of transparency, goodgovernance and ethics. In particular it hasenacted legislation to prevent moneylaundering and terrorist financing, while thebusiness framework itself has been madesimpler. It has a hybrid legal systemconsisting of English common law practiceand the French Napoleonic Code, althoughcompany/commercial legislation isessentially based on English common law.

An International Financial Services Centre

In his keynote address to launch the 5thAsia/Africa International Fiscal AssociationConference in May 2011, the Vice-PrimeMinister and Minister of Finance andEconomic Development, Hon. PravindKumar Jugnauth, said, ‘Mauritius isrevisiting its legislative and institutionalframework to reinforce financial supervisionand strengthen the regime to fight moneylaundering and other financial crime. TheOECD, IMF and World Bank recognise that

Mauritius – An Emerging Centre for Islamic Finance

By: Najmul Hussein Rassool, Product Development Specialist in Islamic Finance, CimGlobal Business Mauritius

It seems that Kenya (see NewHorizon January 2011) is not the only East Africancountry with ambitions in the Islamic finance space. Mauritius, one of the mostsuccessful and stable democracies in the region, feels that it too is well placed tooffer Shari’ah-compliant financial products and services in both the onshore andoffshore markets. In this article Najmul Hussein Rassool, product developmentspecialist in Islamic finance at Cim Global Business Mauritius provides a backgroundon Mauritius and its investor-friendly tax and regulatory regime and reports on theprogress the country has made so far in accommodating Shari’ah-compliant financialservices.

NEWHORIZON Rajab-Shawwal 1432 COUNTRY FOCUS

Mauritius is an international financialservices centre of substance and integrity.’

Mauritius is recognised as a leading regionalcentre for offshore fund structuring andadministration and for investmentparticularly in Indian, Asian, Middle Eastand African countries. The Companies andSecurities Act and Rules permitestablishment of open and closed endedschemes, retail, professional, hedge andventure capital funds. Unit trust andpartnership schemes and foreign recognisedschemes may also be registered inMauritius. The jurisdiction imposes nocapital gains tax, no withholding tax, nocapital duty on issued capital,confidentiality of company information,exchange liberalisation and free repatriationof profits and capital, no estate duty,inheritance, wealth or gift taxes, as well asno stamp duties, registration duties orlevies. Mauritius also has the distinctadvantages of being a treaty-basedjurisdiction, with 36 double taxationavoidance agreements (DTA’s) signed so far and is a signatory to a number ofInvestment Promotion and ProtectionAgreements (IPPA).

Historically development financialinstitutions (DFIs) have been the maininvestors in African funds. While DFIs willremain the core investors in Africa funds,more and more foreign direct investmentsinto Africa is expected to be sourced fromthe East, mainly from China and India andMauritius would seem to be an idealjurisdiction to domicile African funds andgenerally to establish holding structures forAfrican foreign direct investments.

Why Mauritius?

Mauritius has all the advantages of atraditional international financial servicescentre, but in addition it has:

❑ Cost efficient professional services – fundadministration, accounting, legal services,etc.

❑ A network of 36 tax treaties that providestax efficiency, which most traditionaloffshore centres generally cannot offer.

❑ A system of foreign tax credit providedunder Mauritius domestic tax law thatreduces Mauritius tax liability on foreignsource income to an effective rate ofbetween 0% and 3%.

There are also some specific advantages asfar as African funds are concerned.

Capital gains tax, where imposed in Africa, are generally levied at a rate in therange of 30%–35%. All Mauritius taxtreaties, however, restrict taxing rights oncapital gains to the country of residence of the seller of the assets. With Mauritiusnot taxing capital gains, there is asignificant potential tax savings by using aMauritius domiciled fund. Mauritiuscurrently has tax treaties with 13 Africanstates (Botswana, Lesotho, Madagascar,Mozambique, Namibia, Rwanda, Senegal,Seychelles, South Africa, Swaziland, Tunisia,Uganda and Zimbabwe); has signed treatieswith two other states (Republic of Congoand Zambia), which are awaitingratification and is currently awaitingsignature with Egypt, Malawi, Kenya,Nigeria and Ghana. Mauritius is alsonegotiating tax treaties with Algeria andBurkina Faso.

Almost all African nations impose somewithholding tax on dividend paid tonon-residents – generally between 10% and20%. All Mauritius tax treaties limit thewithholding tax on dividends. The treatyrates are generally 0%, 5% or 10%, therebycreating potential tax savings of between5% and 20% depending on the country.The treaties guarantee the maximumeffective withholding tax rate in the face ofpotential changes in fiscal policy in theinvestee countries.

Being an African nation, Mauritius hassigned agreements with 17 African memberstates, with three more agreements in thepipeline, which typically provide thefollowing guarantees to investors from thecontracting states:

❑ Free repatriation of investment capitaland returns.

❑ Guarantees against expropriation

State Bank of Mauritius

A number ofShari’ah-compliant globalfunds have already been setup in Mauritius and there is anincreasing interest in Mauritiusas a place to structure sukukusing Shari’ah-compliant trustsas vehicles.

NEWHORIZON Rajab-Shawwal 1432COUNTRY FOCUS

❑ Most favoured nation rule with respect totreatment of investment, compensation forlosses in case of war, armed conflict or riot.

❑ Arrangements for settlement of disputesbetween investors and the contractingstates.

An Emerging Islamic Finance Hub

Mauritius is an active player in the globalIslamic finance industry. Indeed, acombination of fiscal and non-fiscal factorshas made Mauritius particularly attractiveas a jurisdiction in which to structureIslamic financial products. A number ofShari’ah-compliant global funds havealready been set up in Mauritius and there isan increasing interest in Mauritius as a placeto structure sukuk using Shari’ah-complianttrusts as vehicles.

A number of Shari’ah-compliant funds havebeen set up in Mauritius because of itsattractive taxation regime. Mauritiusgenerally imposes a flat rate of income taxof 15%. However, funds holding a Category1 Global Business Licence are effectively

taxed at a maximum rate of 3% and canend up paying no income tax depending onthe foreign tax credit.

The Governor of the Bank of Mauritius, MrRundheersing Bheenick, in his speech at thelaunching ceremony of Century BankingCorporation Ltd, the first Islamic Bank inMauritius, on 30 March 2011 commented,‘For a country which is second to none in itspluralism, we just could not stay away fromIslamic banking. We need to develop ourown niche market and strive to become aregional hub for Islamic finance.’

Milestones in the Development of IslamicFinance in Mauritius

In October 2005 the Government set up aSteering Committee to explore the possibilityof establishing Islamic financial services inMauritius and this committee proposed tohave the legislative framework reviewed andamended to facilitate the introduction ofIslamic banking in Mauritius. A Malaysianexpert on Islamic finance – Dato AhmadTajuddin, former CEO of Bank IslamMalaysia, seconded by the Islamic

Development Bank, was then called in tostreamline the Islamic finance regulatoryframework. The proposals were finalisedand the Finance Act 2007 brought thenecessary amendments into the legislation inJune 2007. It made provision for banks tooperate either as a fully-fledged Islamic bankor alternatively, to offer Islamic bankingservices through a window operation.

A working group on Islamic banking wasthen set up to work on guidelines forconducting Islamic banking business inMauritius. The objective was to design asimple and standard regulatory framework,within which Islamic banking could developand integrate in a seamless manner with theconventional financial system. The workinggroup was broadly based and includedrepresentatives from the banking industry.Those guidelines were finalised and issuedto the industry in June 2008.

The Bank of Mauritius, the country’s centralbank, also sought affiliation with theIslamic Financial Services Board (IFSB). InNovember 2007, the Bank was dulyadmitted as an Associate Member of theIFSB. In May 2009, the Bank of Mauritiuswith the IFSB hosted a seminar on Islamiccapital markets in Mauritius in jointcollaboration with the Financial ServicesCommission (FSC). This event aimed tobring Mauritius to the attention of theglobal Islamic finance community, as well asthe Mauritian community in general. In thesame month, the Bank of Mauritius wasadmitted as a full member of the IFSB whilethe FSC became an associate member -another major step towards theimplementation of a comprehensive Islamicfinancial services industry in Mauritius.

On 5 May 2009 HSBC Mauritius incollaboration with HSBC Amanah launchedits Islamic banking window to cater for thegrowing demand for Islamic bankingservices from global business clients. InApril 2010 a Statement of Standard PracticeSP5/10 was issued by the MauritiusRevenue Authority on VAT on murabahahtransactions.

In October 2010 the IFSB coordinated theestablishment of an International Islamic

Construction at Ebene, Mauritius Cyber City

NEWHORIZON Rajab-Shawwal 1432 COUNTRY FOCUS

Liquidity Management Corporation (IILM)and the Bank of Mauritius became afounder member, along with 10 othercentral banks and two multilateralorganisations (the Islamic DevelopmentBank and the Islamic Corporation for theDevelopment of the Private Sector). Thenew corporation, the IILM, will issueinvestment-grade instruments to facilitateliquidity management for institutionsoffering Islamic financial services and cross-border investment flows. The government ofMauritius contributed $5 million (US) to thecapital of this supranational body, a cleardemonstration of its commitment tocreating an environment conducive to thedevelopment of this new Shari’ah-compliantplatform in the banking landscape.

In October 2010, the Bank of Mauritiusalso entered into a Memorandum ofUnderstanding (MOU) with Bank NegaraMalaysia, a lead regulator in Islamicfinance. The MOU establishes acollaborative framework for mutualcooperation in capacity building and humancapital development in the financial servicesindustry with the expectation of creating apool of high-calibre professionals in thefield.

On 31st March 2011 the Century BankingCorporation, the first Islamic Bank licensedby the Bank of Mauritius, was launched.Born from a strategic partnership betweenQatari investors through Domasol Limitedand British American Investment Group,Century Banking Corporation will focus onwholesale banking, treasury and wealthmanagement targeting Africa, Asia,Mauritius and the Middle East. Bait ulMashura Finance Consultations, aconsultancy firm licensed by the CentralBank of Qatar provides Shari’ah advisoryservices to the bank.

The Use of Mauritius Trusts for WealthPlanning and Sukuk Structuring

The Mauritius Trust Act 2001 is based onthe English common law trust model andprovides for the setting up of private trusts(whether discretionary or fixed interest),charitable trusts, non-charitable purposetrust and commercial trusts (e.g. pension

and employee benefit trusts). All trusts mustbe created by written instrument and arelimited to a maximum lifespan of 99 years,except for charitable trusts, which may beof perpetual duration and non-charitablepurpose trusts, which are limited to 25years.

A trust can be set up as a resident ornon-resident trust. A resident trust, licensedas a Category 1 Global Business, is taxablein Mauritius on its chargeable income at therate of 15% per annum. According to theMauritius Income Tax (Foreign Tax Credit)regulations 1996, however, the resident trust is allowed a maximum credit of 80%of the Mauritius tax chargeable with respect to that income, which is not derivedfrom Mauritius. The effective rate of income tax is, therefore, 3.0%. On the otherhand, a non-resident trust pays no incometax on income derived outside Mauritius,but does not benefit from Mauritius’network of DTAs. Non-residentbeneficiaries of an offshore trust are exemptfrom income tax on the income derivedfrom the trust.

How Does It Work?

In the case of an ijara sukuk, the owner ofan asset will typically sell the asset to abankruptcy remote Special Purpose Vehicle(SPV), set up solely for the issuance of thesukuk. The SPV can be set up in Mauritiusas a trust. There will be no withholding taxin Mauritius on the periodic payments or onthe reimbursement of capital to the sukukholders that are not resident in Mauritius.

If the underlying assets are located in acountry with which Mauritius has a doubletaxation agreement then, depending on theterms of the DTA, there may be no capitalgains tax payable when the Mauritius SPVsells the assets back to the original owner. Ifthe underlying assets are not immovableassets and the Mauritius SPV does not havea permanent establishment in the sourcecountry, then the Mauritius SPV may end uppaying no tax in the source country on therental income derived from the lease of theassets. If the underlying assets are notlocated in a country with which Mauritiushas a DTA, then the SPV can be set up as a

non-resident trust and would be exemptfrom all income tax.

The SPV can be structured to be bankruptcyremote and such bankruptcy remotenesswill be enforceable in Mauritius. In the caseof a dispute, the courts in Mauritius willgive effect to any arbitration clause chosenby the parties and the parties can haverecourse to the Privy Council in England,which is the ultimate court of appeal.

The availability of Shari’ah-compliant trustsin Mauritius facilitates the creation ofShari’ah-compliant SPV’s, but also providesnumerous benefits to sukuk holders, theultimate beneficiaries.

Najmul Rassool was educated atuniversities in the UK and South Africaand is a Chartered Islamic FinanceProfessional (Malaysia). He isresponsible for developingShari’ah-compliant products at CIMGlobal Business Mauritius and forliaising with Shari’ah scholars.

NEWHORIZON Rajab-Shawwal 1432RETROSPECTIVE

Introduction

In order to give a better perspective ofIslamic banking I will begin by brieflyoutlining its salient features and how itdiffers from the conventional banking. My

purpose in doing so is to highlight the manyattractive features of Islamic banking, whichlend it a strong universal appeal. I suggestthat these features along with the generalprinciples and approaches to theformulation of marketing strategies can be

used to develop a sound marketing strategyfor Islamic banks. I do not propose to gointo the procedural matters, as these shouldbe covered by concerned specialists keepingin view the latest developments andadvances in the field of technology.

Marketing Strategies for Islamic Banks

By: the Late Mr Muazzam Ali, Founding Chairman of IIBI

This issue of NewHorizon carries ashort article by Tariq Al-Rifai,Director – Islamic Market Indexesat Dow Jones Indexes. In it hesuggests that Islamic banks needto strengthen their sales andmarketing, perhaps even going asfar as targeting non-Musliminvestors. This is an idea that wasbeing promoted by the late Mr Muazzam Ali more than 15years ago. Some of Mr Ali’sthoughts are also remarkablyprescient given the currentproblems faced by individuals andsmall businesses in particular whenthey seek to obtain bank finance,whether that is to buy a home or tofund the growth of a smallbusiness. It seemed appropriate,therefore, to revisit a paperpresented by late Mr Muazzam Aliat the 1st Global Convention onRetail Financial Services ‘Visions ofthe 21st Century’ in London inNovember 1994.

NEWHORIZON Rajab-Shawwal 1432 RETROSPECTIVE

The Two Systems of Banking

The two systems of banking, that is Islamicand conventional, are based on differentconcepts. While Islamic banking is valueoriented, conventional banking is valueneutral. It is also important to note thatIslamic banking is part and parcel of theoverall Islamic economic order, which aimsto establish a society based on equity andjustice.

As is well known, Islam rejects theinstitution of riba or interest and considersit as unjust and exploitative. It considers thecharging and paying of interest asunacceptable. Leaving aside the religion’sbelief, a critical examination of the issue ofinterest will show that it is indeed unjustand gives rise to several undesirable andharmful effects.

In the interest-based banking system, theowner of the capital is assured of apre-determined fixed return regardless ofwhether or not the borrower has made aprofit on the borrowed money. Failure to doso can have very unpleasant and tragicconsequences for the unfortunate borrower.

Another harmful effect of the interest-basedbanking system is that it widens the gapbetween the rich and the poor. Thisinevitably leads to social tensions, instabilityand economic problems. Take the case of alarge, interest-based international bank.Here, the number of depositors may runinto millions, but the numbers of borrowersconstitute a small percentage of it. The hugesums collected from the depositors at lowrates of interest are lent to a few rich andinfluential people who make huge profitsfrom the borrowed funds, but the depositorsdo not get a share in those profits. Similarlythe fat profits made by the banks aredistributed among their shareholders and,once again, not shared with the depositors.Yet again, the wealthiest and most powerfulcapitalists operate through banks, which aremajor stockholders in and creditors of largenon-financial corporations.

The conventional banking system based onthe creditor/debtor relationship is unfair asin such a relationship the creditor also

enjoys leverage over the debtor. Comparedto this, the participative system promotedby Islamic principles is fair and just asparties to a transaction share in the profitand loss in mutually agreed proportions

Lest I be misunderstood, I wish to make itclear that in discussing the differencesbetween Islamic banking and conventionalbanking it was never my intention to malignthe latter. The conventional banking systemhas played a major role in the economicdevelopment of the West and is stillperforming many useful functions, but beinginterest based and value neutral, it is notable to fulfil the material and moral needs ofsociety. Islamic banking has features which,properly projected and practiced, are boundto appeal to people of all religious faiths aswell as to people without any religious faith.

The lack of constraint in conventionalbanks investing in activities that may bedeemed to be unethical and morallyquestionable has in recent years troubled theconscience of increasing numbers of peoplein the West and the investment principles inIslamic banking should appeal to thisgrowing body of people in the West,including Muslims. (The 2008 financialcrisis is perhaps living proof of where someof these unethical and morally questionableinvestment activities led. Regrettably, it issome the poorest members of society whoare being hit hardest by the fallout asgovernments, which had to bail out thefinancial world, cut benefits and imposemore stringent taxes to recoup their outlay –Ed.) As such, a marketing strategy forIslamic banks must target all the people,regardless of their religious beliefs.

Most experts in the field of Islamic bankingalso believe that Islamic banking has thepotential to produce greater returns oninvestments than conventional banks. Thispotential of Islamic banks to outperform theconventional banks should play animportant part in a marketing strategy forIslamic banks.

The Benefits of Islamic Banking

Interest-free Islamic banking is essentially an equity-based system where the depositor

Islamic banking has featureswhich, properly projected andpracticed, are bound to appealto people of all religious faithsas well as to people withoutany religious faith.

NEWHORIZON Rajab-Shawwal 1432RETROSPECTIVE

in an Islamic bank is considered to be ashareholder. The enjoyment of the rightsand privileges of this position is anattractive feature of Islamic banking andshould be projected in developing themarketing strategy of Islamic banks. Thejust and humane treatment of borrowersin genuine difficulty should also beemphasised in the marketing strategy ofIslamic banks.

A number of eminent economists havesuggested that an equity-based system ismore stable than the traditional system. In1930, Henry Simons argued that thetraditional banking system was inherentlyunstable. He said that as a crisis developsand earnings fall, banks seek to contractloans to increase reserves, however eachbank does so at the expense of other banksand in the process some banks becomeinsolvent and are forced to close. Thebanking failures in the U.S. during the1980s have revived interest in the proposalsfor equity-based banking. This attractivefeature of Islamic banks must not beoverlooked in any marketing strategy forIslamic banks.

While the adherence of Islamic banks to justand socially-responsible principles holds apowerful attraction for the people, it isnatural for them to also expect a healthyprofit on their investments. Similarly, thelarge and growing body of people in theWest who, regardless of their religiousbeliefs, prefer to invest in financialinstitutions who do not deal with companiesengaged in unethical and morallyquestionable activities, also expect a goodreturn on their investments.

While a marketing strategy for Islamicbanks must exploit their moral and ethicalbasis, those same banks must also makeevery effort to make them at least asprofitable, if not better, than theconventional banks, so that they can offergood returns to their clients. This requireswell-designed and equipped organisations,highly competent and motivated staff, theuse of modern tools and techniques ofmanagement and advanced technologies.Islamic banks must also establish strongresearch and development departments to

bring new products and services to themarket to meet the needs of existing andpotential clients. Dissemination ofknowledge about these features of Islamicbanks would inspire confidence and attractclients.

Allaying Apprehensions

Any marketing strategy for Islamic banksmust also allay apprehensions, which somepeople have about Islamic banking.

Islamic banking has not made the progresswhich was certainly expected of it at thebeginning and which the Muslim peoplesaspired to and are still aspiring to. As longas rich Muslims do not place their funds inIslamic banks, Islamic banking will not beable to fulfil its true potential; it is crucialthat the relevant facts be brought to theattention of those Muslims in control offinancial resources.

Certainly, a reason why rich Muslims arenot supporting Islamic banks may be thatconventional banking, having been wellestablished for centuries, seems to themsafer and certainly guarantee apredetermined return with little or no riskto capital. They should, however, note thatmost of today’s powerful conventionalbanks started off in a small way withmeagre funds. They only grew strong andpowerful with the support of people; thepeople who backed these smallorganisations did so because they had greatfaith in them. They had the spirit ofenterprise and were willing to take risks forpotential gains.

This pertinent, historical fact must beemphasised if Islamic banking is to gain theattention of rich Muslims and so revive the early enthusiasm, whichfilled so many Muslims in the 1970s. Therich in the Muslim countries must,therefore, be persuaded that they have amoral obligation to support the system byinvesting their funds through Islamicfinancial institutions.

The Importance of the Human Factor

It goes without saying that in anorganisation, financial or otherwise, the

While a marketing strategy forIslamic banks must exploit theirmoral and ethical basis, thosesame banks must also make everyeffort to make them at least asprofitable, if not better, than theconventional banks, so that theycan offer good returns to theirclients.

NEWHORIZON Rajab-Shawwal 1432 RETROSPECTIVE

human factor is the most important by far.A corollary of this is that without qualitymanpower even an inherently good andsound idea or system will not yield theresults of which it is capable. Any marketingstrategy for Islamic banking must give thisrequirement the highest priority.

The personnel charged with the running ofIslamic banks must not only have athorough knowledge and understanding ofthe concept of Islamic banking, but also afirm belief in it and a strong commitment todevelop it to the best of their abilities. Toclaim that a bank is functioning on Islamicprinciples just because it uses Islamicterminology is not enough. Its clients must believe in the authenticity of the claim.

Many of the people working in Islamicbanks have been educated and trained in theconventional banking system; naturally theirmindset has been shaped by thevalue-neutral, interest-based conventionalsystem and they might find it difficult, if notimpossible, to presenting a proposition forIslamic banking to potential clients, bothMuslims and non-Muslims; nor are they ina position to explain Islamic bankingobjectives or to stand up to those whochallenge the concept of Islamic banking.All that some were able to do was to use theconventional financial products to whichthey were accustomed, alter them slightly,change the name and slap the word Islamiconto them. They did little to study the new

concepts with a view to designing newfinancial products.

There is no denying that, with someexceptions, the majority of people who havebeen at the helm of affairs in Islamic banksdid not fully believe in establishing theIslamic financial system; nor did they havefaith in its viability. For this reason theyneither made much effort to seriously traintheir staff in the principles and operations ofIslamic banking, nor did they initiate much inthe way of serious research and developmentto evolve new Islamic financial products andservices. Trained personnel who do not havethe tunnel vision of conventional bankersalong with dedicated research anddevelopment are an essential support for anymarketing function to achieve betterunderstanding of customers and newproducts that will expand the customer base.

There is no shortage of talented andeducated Muslims in the world, particularlyin the field of banking and finance andWestern financial organisations have beenable to lure Muslim talents into their service.To promote and market Islamic bankingproducts and services, the new managers ofIslamic banks must be dynamic andforward-looking men of vision who canbuild their organisations on the distinctiveIslamic heritage. They should also be able topresent Islamic banking as a solid anddurable institution capable of representingthe Islamic identity and principles that canbe applied universally.

While conventional bankingpersonnel can succeed byrelying on precedent androutines built up overcenturies, Islamic banking stillpresents a continual stream ofnew problems needing theattention of alert and originalminds.

NEWHORIZON Rajab-Shawwal 1432

In 2004, in a research paper titled ‘SociallyResponsible Investing,’ Paul Hawken foundthat ‘the cumulative investment portfolio ofthe combined SRI mutual funds is virtuallyno different to the combined portfolio ofconventional mutual funds.’ In other words,the expected ethical difference was blurred.

In its 2007 ‘Guide to Climate ChangeInvestment,’ Holden & Partners provided asimilar finding: ‘SRI and ethical fundsperform just as well (if not slightly better)than their mainstream counterparts becausein most cases they are in fact mainstream.’

Perhaps the titles of these two biting articlespublished in 2010 summarise their content:‘100 Best Corporate Citizens? What aCROck!’ (Marc Gunther) and ‘When PigsFly: Halliburton Makes the Dow JonesSustainability Index’ (R.P. Siegel). PaulHawken also noted in 2004 that ‘Musliminvestors may be puzzled to find Halliburtonon the Dow Jones Islamic Index fund.’

How to deal with this gap betweenexpectations and practice? Do financialinstitutions mislead customers with labelslike ‘Islamic,’ ‘responsible’ and ‘sustainable’or do customers have unrealisticexpectations? Is it possible to bring thepractice and expectations closer?

There is no easy answer to these questions.Having said that, one thing that could helpin narrowing the gap between expectationsand practice is honest communication ofwhat exactly is the ethical proposition sothat when someone takes ‘a small step’toward ethical ideals, it is not criticised fornot being ‘a giant leap’ but appreciated forwhat it is.

Usman Hayat, CFA, is director of Islamicfinance & ESG at CFA Institute. Any viewsexpressed here are solely those of the writer.

When labels like ‘Islamic,’ ‘responsible’ and‘sustainable’ are placed on finance, theytrigger expectations of ethical differencesfrom the mainstream. Meeting customerexpectations is a tough task for anybusiness, but when it comes to Islamicfinance and socially responsible investing(SRI), the gap between expectations andpractice presents a significant challenge.

Anecdotal evidence suggests that, rightly orwrongly, some of the expectations triggeredby ‘Islamic’ finance are no lending moneyon interest, no financing of ‘sin’ industries,profit and loss sharing, asset and enterprise,microfinance, small and medium sizedenterprise (SME) finance, povertyalleviation and environmental sustainability.Perhaps the underlying theme is profitsharing, doing good and avoiding harm tosociety and the environment.

In practice, other than refusing to finance‘sin’ industries, these expectations are hardto meet. Despite the expectation of profitsharing, most of the financing in the Islamicfinancial sector is debt based, where theform of financing is changed to that of asale or a lease without necessarily changingits economic substance.

Customers are usually told that thedifference between Islamic finance andconventional finance lies in fulfilling certaintechnical conditions of classic Islamiccommercial jurisprudence, which givefinancing the contractual form of a trade ora lease. Some customers scale down theirexpectations and take what is available;others turn away in disappointment.

This gap between expectations and practiceproduces sarcastic media coverage—forexample, ‘Don’t Call It Interest’ (Richard C.Morais, Forbes, 2007) and ‘How Sharia-Compliant Is Islamic Banking?’ (John

Islamic Finance and SRI: The Expectations Gap

By: Usman Hayat, CFA

FOOD FOR THOUGHT

Foster, BBC News, 2009). Academicresearch papers such as ‘Incoherence ofContract-Based Islamic FinancialJurisprudence in the Age of FinancialEngineering’ (Mahmoud A. El-Gamal,2007) also raise similar issues. Regardingdoing good and avoiding harm to societyand the environment, some argue that thejob of financial institutions is to maximiseprofit for their shareholders and thatprofitable business leads to a prosperoussociety. If shareholders want to dosomething charitable, they can do so in theirprivate lives.

A counterargument is that to use the‘Islamic’ label, financial institutions need togo beyond changing the form of financingand earn their profits while actively doingsomething positive. The catch here is thatfor such positive pursuits to work,customers also have to do their part. Toavoid interest-bearing debt in financing,customers have to be ready to share profitswith the financier and to make investmentsrather than extend interest-bearing loans,customers should probably seek equityfunds and not bank accounts.

Similarly, if customers want institutions thatoffer Islamic financial services to pursuesocio-economic goals, they should be willingto share any additional risks and costs. Ifcustomers are unwilling to put their moneywhere their heart is, finance, pragmatic as itis, may also be unwilling to go very far innonfinancial pursuits.

This gap between expectations and practiceis not unique to Islamic finance. Othershades of ethical finance, such as SRI, face ittoo. One would think that because lendingmoney on interest is not an issue in SRI,meeting expectations would be easy – notexactly.

NEWHORIZON Rajab-Shawwal 1432 LEGAL MATTERS

Introduction

There is general agreement that thefundamental principles underpinningIslamic finance offer the potential for adifferent and perhaps sounder way forundertaking financial transactions. Itsposition towards risk sharing, the facts thatassets underpin its financing and its lack ofexposure to certain types of assetsassociated with the recent credit crisis haveattracted the attention of variousinternational institutions. For example, theUNCTAD (United Nations Conference onTrade and Development) secretariat issued anote entitled ‘Services, development andtrade: the regulatory and institutionaldimension – Expanding trade opportunitiesfor developing countries’ which favourablymentions the ‘asset-based and risk-sharingnature’ of Islamic finance. When, however,some of the more common Islamic financeproducts are analysed in detail, theconclusion is that Islamic finance will notalways be less risky when compared withconventional finance products.

The report issued by the Taskforce onIslamic Finance and Global FinancialStability adopts the useful approach ofsplitting Islamic banking into variousactivities on the asset side of the balancesheet – inventory, fee based services,asset-backed transactions and profit-sharingtransactions. This is a useful starting pointto consider some of the Islamic financeproducts and the way in which they areoften structured in practice.

Mudaraba and Musharaka Transactions

Mudaraba and musharaka fall within theprofit-sharing transaction matrix and canarguably be said to be the best form ofIslamic finance. In their purest form they

embody a different approach to conventionalfinancing in that here the Islamic financierinvests in an asset or business activity withits return solely depending on theprofitability of that investment.

There are risks though in this strategy. TheIslamic financier should take on a moreactive role in the investment. It will need tohave the skills and expertise to oversee themusharaka in which it is a partner or co-owner or to oversee the performance of themudarib. The risk of incurring losses islikely to increase if they do not have theseskills. In many jurisdictions there will alsobe risks (both for it and its representatives)in having its nominees as directors (or beingseen to be shadow directors) on the boardof directors or other managing body of theventure in which they invest. An Islamicfinancial institution that adopts thisbusiness model will look different to aconventional financial institution and,therefore, will have a different risk profilewhen it comes to considering whatregulations should apply to it.

Many mudaraba and musharakatransactions, however, have been structuredso that the risk-sharing element haseffectively been reduced. It was commonpractice for purchase undertakings to beused with musharaka and mudarabatransactions. These enabled the Islamicfinancier to exit the arrangements bycompelling the customer, through thepurchase undertaking, to buy back themusharaka or mudaraba interest at apre-determined price. This price wouldresult in the Islamic financier receiving anamount equal to its initial investment (lessany repaid ‘capital’ amounts).

The statement on sukuk issued by theAccounting and Auditing Organisation for

Form Over Substance – Will the Secular Courts Force the Issue?

By Richard de Belder, Partner, SNR Denton

When, however, some of themore common Islamic financeproducts are analysed indetail, the conclusion is thatIslamic finance will not alwaysbe less risky when comparedwith conventional financeproducts.

NEWHORIZON Rajab-Shawwal 1432LEGAL MATTERS

Islamic Financial Institutions (AAOIFI) inFebruary 2008 has meant that this type ofpurchase undertaking is now problematicwith these types of financings, unless theprice is fixed when the purchaseundertaking is exercised by reference to thenet value, market value, fair value or otheragreed price, which is fixed or agreed whenthe purchase undertaking is exercised. Thishas caused some concerns because oftenIslamic financiers (or their customers) wantmore certainty upfront about how much isto be repaid.

In structuring a transaction an incentive feeis often paid to the mudarib (under amudaraba) or to the managing partner(under a musharaka). There is nothinginherently wrong with such a payment;however, the fee is often structured so that itstrips out all profits above a trigger amount(usually calculated by reference to aconventional interest rate benchmark suchas LIBOR). This means the return payableto the Islamic financier will be similar to areturn that a conventional financier wouldreceive.

There are technical arguments to supportthe fact that the rate of return may be thesame as or similar to that achieved under aconventional financing. There are, however,those who question whether an incentive fee based on such an approach cuts acrossthe fundamental aim of musharaka ormudaraba financings, when the Islamicfinancier’s profit is supposed to be based on a fundamentally different risk-sharingmodel and, in return, for sharing in higherrisks, it is to receive a higher profit return.So, here the argument is that while on the face of it the documents are described as musharaka or mudaraba financings, the substance of the transactions produces an economic result which is often similar to that of a conventionalfinancing.

Asset-Backed Islamic Financing

While the Islamic Finance and GlobalFinancial Stability report uses the term‘asset-backed’ transactions, it is debateablewhether this is correct for all transactions.In reality a better term for some

transactions will be ‘asset-based’.

The economic outcome for commoditymurabaha and trade murabaha transactionsis arguably similar to conventional loansbecause, once the asset is sold, there is noasset other than a debt (the deferredpayment price). In this sense it is an‘asset-based’ transaction.

While it is true that, with both commoditymurabaha and trade murabaha transactions,the Islamic financier will own thecommodity or asset, that ownership will bebrief. That ownership, however, brings withit added legal risks, although these are oftennot reflected in the profit mark up. Forexample, as the owner of the asset (eventhough briefly) it may not be able to excludeby contract various statutory warranties andstrict liability obligations.

With a commodity murabaha, there areinsolvency-related risks with the variousbrokers and other counterparties involved inthe flow of funds on the transaction date. Inthe author’s experience, attempts to mitigatethese risks with revolving facilities throughlegal assignments of claims and othersecurity-related strategies have, on thewhole, not been approved by the Shari’ahscholars because their position has been thatno mention should be made of thecommodity brokers in the arrangementsinvolving the Islamic financier and thecustomer. If any document is required thatrefers to the brokers, it may be possible tohave a side letter.

There must, however, be concerns about this approach. If a banking officer were togo into the witness stand he would have tosay that everyone knew the involvement of the brokers was crucial to the flow offunds from the Islamic financier through the brokers and then down to the customer.It is also likely that a court would look at documents in the round and drawconclusions about what was going on.While splitting and dicing the documentsmay tick the boxes in the context of theform of the transaction this, in the author’s view, is not guaranteed to work if acourt looks at the substance of thetransaction.

If a banking officer were to gointo the witness stand hewould have to say thateveryone knew theinvolvement of the brokerswas crucial to the flow offunds from the Islamicfinancier through the brokersand then down to thecustomer.

NEWHORIZON Rajab-Shawwal 1432 LEGAL MATTERS

Will the Courts Force the Issue on the Formover Substance Debate?

The recent credit crisis has subjected Islamicfinance transactions (and conventionalfinancings) to more scrutiny. This has beenespecially true in parts of the Middle Eastwhere the property market has crashed. Oneexample has been a court decision in Dubaion ijaras.

Arguably an ijara transaction can be said tobe asset backed but whether it is ultimatelydepends on whether it is truly an operatinglease. An Islamic ijara financing is supposedto be an operating lease with the Islamicfinancier lessor remaining responsible forvarious owner-related matters such asproperty insurance, major maintenance andtaxes associated with ownership.

The normal approach, however, has been toput these obligations (including the initialcash flow obligations) on thecustomer/lessee through a service agencyagreement. The agency arrangement,however, results in the Islamic financier, asprincipal, being obliged to re-imburse thecustomer/lessee for the costs it has incurred.The economic aim is for the customer toremain responsible for these costs. Usually,therefore, more rent is charged that equalsthe re-imbursement obligation; the twoamounts are set off so the customer bearsthe cost.

In terms of form, it can be said, on adocument-by-document basis, that theIslamic financier is the owner and remainsliable for these owner liabilities. The effectof taking the documents together, however,means that it is more difficult to sustain thisargument, which is why internationalaccounting standards adopt the view that,taken in the round, these are financingleases.

These ijara financings also have purchaseundertakings in which the Islamic financiercan call for the leased asset to be bought bythe customer for a price that is usuallybased on the fixed rent (i.e., the initialpurchase price that remains outstanding)and other amounts due under the lease.There can also be a sale undertaking from

the Islamic financier allowing thecustomer/lessee to buy the leased asset early.

The AAOIFI Standard on ijaras (appendix Bto Shari’ah Standard No. (9) – Ijara andIjara Muntahia Bittamleek) says that anijara financing is different from a hirepurchase arrangement because, with hirepurchase, the ownership of the asset passesonce the last instalment has been madewithout the need for any further documents.With an ijara financing the use of theseseparate undertakings which, if exercised,require a separate sale and purchaseagreement, is seen as distinguishing the twotypes of transaction.

It is perhaps open to debate, however,whether this is a sustainable position. Inmany countries the courts will look at theintent of the parties to see what they weretrying to achieve. The reality is the customerwants finance to get an asset. A recentjudgment of the Dubai Court of FirstInstance took the position that, whendocuments were looked at together, ratherthan in isolation, the transaction was a saleby instalments.

There are arguments that Shari’ah scholarsraise to counter this view, but the analysis

used by the Dubai court is perhaps a wakeup call that the approach of cutting anddicing the documents to uphold anargument that each document is Shari’ahcompliant, may not result in the desiredoutcome if a dispute is heard by a secularcourt.

Conclusion

The early years of the last decade involved a sustained effort to developIslamic finance in an international context.Many of the transaction structures andagreements were approved on the basis thatthey were not to be treated as ‘set in stone’precedents. They were approved to kickstart the industry, but would need to beimproved over time. It may be that,sometimes, improvements have not beenmade to the level expected. In addition,there are arguments that there has been toomuch focus on the form of the documentsrather than analysing the real intentunderpinning the Islamic finance transactionand the intention of the parties. Thescrutiny of these documents and structuresby the secular courts may add impetus tothe need to revisit these issues with moreurgency.

Richard de Belder is apartner at SNR Dentonand returned to the UKin 2007 after being theManaging Partner in thefirm’s Abu Dhabi office.He has been involvedwith the Middle Eastsince 1979 and hasspent 20 years living andworking in the UAE andOman. Richard heads upthe firm’s Islamic financepractice. Richard hasmany years’ experiencein dealing with Shari’ahscholars and has beenactively involved in thestructuring anddocumentation of manyleadingShari’ah-complianttransactions.

NEWHORIZON Rajab-Shawwal 1432TAKAFUL FOCUS

A Brief History of Takaful

From its foundations in the middle of 1980stakaful has seen rapid, if not dramaticgrowth. By the end of 2010 the takafulindustry could boast 190 operators globally.The combined contributions of theseoperations are estimated to be USD$9.1billion in 2010 and projected to be aboutUSD$12 billion in 2011. The figures are stillrelatively small compared to conventionalinsurance premium incomes, but they aresignificant considering the size, age andgeographical spread of most of the takafuloperators.

The rapid progress of the takaful industrywas driven primarily by the growthpotential of insurance products and servicesthat would be acceptable to Muslimpopulations, which had hitherto shunnedconventional insurance as haram. This huge opportunity impelled a large numberof entrepreneurs and a few of theconventional insurance companies to set uptakaful companies to marketShari’ah-compliant products. During thisperiod a number of products have beenhurriedly put together, mainly by selectingconventional insurance products, modifyingtheir terms and conditions so that theyconform to Shari’ah requirements and thusqualify for approval by Shari’ah boards.There is very little evidence to indicate thatany concerted effort has been made toinnovate in terms of new product lines orprovide any unique added value to existingones that would delight the Muslimcustomer base.

Where Are We?

One of the main objectives of most of thetakaful operators was to start marketingtheir products as quickly as possible inorder to achieve profitability within two orthree years. Unfortunately, most of these

takaful operators are either still strugglingto become profitable or operating on verythin margins. The reasons why mostcompanies are still struggling to becomesuccessful are:

1. Product planning and development hasbeen poor. In their eagerness to becomeprofitable in the short term companieshave selected lines of business that maynot be suitable for long-term growth.For example, motor, travel andshort-term investment insuranceproducts, while providing a goodcontribution to volumes, have also led tohigher outgoings by the way of claims,resulting in weak balance sheets.

2. Insufficient attention has been paid to the development of properdistribution channels, which areproductive, cost effective and sustainablein favour of ineffective brokerrelationships.

3. Excessive eagerness for short-termprofitability has resulted in operatorsadopting strategies which may haveyielded some gains, but may not beconducive to long-term, stable growth.

4. There has been a lack of a clearunderstanding of the cost base and theeffective management of operating costsacross the functions of the organisationresulting in a failure to deliverefficiencies. This has been a verysignificant factor in most new companiesstruggling to either reduce losses orshow robust profits.

5. Unimaginative investment strategieshave resulted in poor investmentincomes.

6. There has been insufficient attention toand investment in the training of

administration and sales staff and thedevelopment of human resources,particularly in the area of understandingtakaful.

A Fork in the Road

The journey so far has been rapid, but theindustry has reached a stage when it needsto choose the road that would make it moreattractive and rewarding for all thestakeholders. Companies need to focusmore on the participants (policyholders inconventional terms) in terms of satisfyingtheir needs and expectations than has beenthe case so far; participants deserve thisattention. Takaful operators need toundertake a major review of what moreneeds to be done, not only to have a moresatisfied customer base, but also to develop more efficient organisations thatwould be better equipped to weathercompetition and are financially viable. Ernst& Young’s World Takaful Report 2010documents a number of issues to whichoperators need to pay attention in order tolive up to expectations. Some of theimportant things on which they need tofocus on are:

1. Design products that meet the needs ofdifferent market segments and clients.Each market has distinctive needs andhence the products offered shouldrespond to those needs. Theone-size-fits-all view should go andcompanies should develop unique sellingpropositions that would better satisfyneeds and have a higher degree ofacceptability to the market.

2. The demographic trends have seldombeen factored into developing productsand marketing strategies. This isparticularly true for geographies wherethe Muslim population is dominant orsignificantly large. A study of the

The Takaful Journey – A Fork in the Road

By: Muhammed Muqeem, Consultant, Takaful Consultancy Services

NEWHORIZON Rajab-Shawwal 1432 TAKAFUL FOCUS

population profile of the GCC andLevant countries indicates that theaverage age is about 22 years. Similarly,the average of age of the populations ofIndonesia and Malaysia is around 31years. This, compared to the populationprofile of European countries, isrelatively young. This profile will changesignificantly over the next 30 to 40years. The baby boomers of today willhave extensive liabilities in terms ofchildren’s education and taking care oftheir own retirement needs. Increasinglife expectancy is another factor that needs to be taken into consideration. Itis, therefore, necessary to designlong-term savings and pension plans that would satisfy the medium andlong-term needs of the population,where most of the takaful companies areoperating.

3. Takaful companies must never forgetthat their special role is to offer productsand services that not only ensurefinancial security, but also strictly adhereto the requirements of Shari’ah. Nocompromise whatsoever must be madein this regard as any laxity couldseriously damage the image of thecompany and may also irrevocablyaffect trust in the takaful system. Somecompanies for reasons of expediency orin the interests of short-term gains havenot been fully sensitive to this and thiscould seriously damage long growth.Customers need the comfort of knowingthat the products they are buying arefully compliant with Shari’ah.

4. The sharing of profits at the end of eachfinancial year constitutes an integral partof any takaful proposition. It isimperative that takaful companies havein place a transparent system todetermine the profits at the end of each

financial year and distribute thoseamongst the participants as quickly aspossible. Any profits that cannot beallocated to participants, for whateverreason, must be distributed to charitiesin consultation with and on the adviceof their Shari’ah boards.

5. The takaful business is a co-operativeeffort between the participants, thetakaful operator and the shareholders.Ideally, the participants are central to the takaful concept, as they are thecontributors to and the owners of thetakaful fund. In practice they simplycontribute to the funds and receivebenefits as laid down in the terms andconditions of the takaful contract. Thispractice is contrary to the takaful spiritand has been raised as a concern bysome Shari’ah scholars. It is, therefore,necessary to involve the participants, so that they have a say in the operations of the takaful company. Onepossible approach is to create aparticipants council, which could beconstituted by selecting fixed numbers ofparticipants on a limited-term, rotationbasis. Such councils could meetperiodically to review the progress of thecompany and make suggestions toimprove products and services, satisfythemselves that their fund is beingmanaged judiciously and ensure that theoperations reflect their aspirations. Thiswould be an important step towardsconforming to the takaful concept andincreasing the co-operative spirit byinvolving all stakeholders.

To continue the journey it is vital thattakaful operators choose the right road tomove forward and achieve the objectives ofIslamic finance and satisfy those people whohave made a conscious choice, which isbased on faith.

Takaful operators need to undertake a major review of whatmore needs to be done, not only to have a more satisfiedcustomer base, but also to develop more efficient organisationsthat would be better equipped to weather competition and arefinancially viable.

NEWHORIZON Rajab-Shawwal 1432IIBI NEWS

German University Students Visit IIBI

A group of 15 studentscompleting Bachelor’s degreein business and finance at theUniversity of Applied Sciences in Stralsund, Germany visitedthe IIBI in May 2011. Theywere led by Professor PatrickMoore, finance lecturer at theUniversity and Ms NadjaDoberstein. The objective of the visit was part of aprogramme to gain practical

insights into actual business lifein the UK.

The group was received byMohammad Shafique,programme development co-ordinator at the Institute. Healso delivered a presentation onthe concept and principles ofIslamic finance, its evolutionsince the early 1960s, keycontracts used in Islamic

financial transactions and recentdevelopments in the Islamicfinancial sector. He alsoemphasised the moral andethical principles of Islamicbanking.

There was an interactive Q&Asession after the presentationwhich included the impact offinancial crisis on the Islamicfinancial services sector, the

pricing of Islamic financialproducts and services, theregulatory framework forIslamic financial institutions andhow profit and loss sharingworks in Islamic bankingoperations. The group describedtheir visit as ‘a great andinteresting experience’, whichprovided them ‘an insight’ intothe Islamic financial servicessector.

Although the Islamic financeindustry was relativelyunaffected by the financial crisisin the initial stages, nonethelessit started to feel the pain asimpact from the fallouttranslated into the real economywith tumbling real estate values.There have been many defaultsin Islamic finance instrumentssuch as sukuk during the lasttwo years exposing the industryto many challenges. In order tomaintain the pace of growth andto make further progress, agood understanding of thechallenges faced by this industryis required.

Against this backdrop, IIBI incollaboration with the LondonUMNO Club organised a2nd international programmeon 26 March, 2011 titled

‘Challenges to Islamic Financein the Post Financial CrisisWorld’. This programme washeld at the London School ofEconomics and Political Science.The objective was to create anawareness among professionalsand the wider public of thedevelopment of the modernIslamic financial sector with thekey focus on the challengesfaced by this sector in the postfinancial crisis world.

Dato’ Sri Nazir Razak, GroupManaging Director/ChiefExecutive Officer of the CIMBGroup was the keynote speaker.He highlighted the contributionof Malaysia and the consistentefforts made by its governmentin the development of themodern Islamic finance industry.He drew attention to the

impressive growth made by theMalaysian Islamic financialsector over the last two decades.He also touched upon some ofthe main reasons for the recentfinancial crisis and the keystrengths of the Islamic financialsector. After the key noteaddress, there was a two-hourinteractive panel sessionmoderated by Dr Humayon Dar.

This very lively and interactiveQ & A session covered anumber of issues including legal,regulatory, Shari’ah complianceas well as the standardisation ofproducts and practices in theIslamic finance industry; anoverreliance on the debt-basedcontracts of murabaha andtawarruq in the Islamic financialsector was also scrutinised.

Challenges to Islamic Finance in the Post Financial Crisis World

The panel included DrMohammad Akram Laldin,Executive Director of theInternational Shari’ah ResearchAcademy for Islamic Finance(ISRA), Malaysia; WarrenEdwardes, CEO of Delphi Risk Management and amember of IIBI’s BankingAdvisory panel; Mike Rainey,partner in the Middle East &Islamic Finance Practice Group of King & Spalding; AliVania, Senior Manager, IslamicBank of Britain; MuftiMuhammed Zubair Butt, aUK-based scholar and MuftiAbdul Qadir Barkatulla who isa member of the Shari’ahsupervisory committees ofseveral Islamic financialinstitutions.

NEWHORIZON Rajab-Shawwal 1432 IIBI NEWS

April Workshop – Sukuk, Their Practical Applications andChallenges

The first corporate sukuk wasissued in mid-1990s in Malaysia,but the sukuk market did notgain international recognitionuntil the first Malaysiansovereign sukuk was issued in theearly 2000s. Sukuk marketgrowth was phenomenal between2001 and 2007, however, itnosedived in 2008 with the onsetof the financial crisis and thedrying up of liquidity in theinternational financial markets;this was coupled with theAccounting and AuditingOrganisation for IslamicFinancial Institutions (AAOIFI)statement in February 2008 thatquestioned the Shari’ahcompliance of certain sukukinstruments in the market, whichwere based upon the underlyingstructures of musharakah,mudarabah and wakala.

The market improved slightly in2009 and started to pick upagain in 2010. The number ofsukuk deals announced in thefirst quarter of 2011 is veryencouraging and provides abullish view of the futuredirection of the sukuk market.There have been many sukukdefaults in the last two yearsand the resolution of thesedefaults will be a good test forthe Shari’ah and legalframework for future sukukstructuring and restructuring.

Against this backdrop, IIBI’s 4th Annual Sukuk workshopwas held on ‘Sukuk, TheirPractical Applications and

Challenges’ in April, 2011,which was hosted by theNational Skills Academy forFinancial Services, London.

Understanding Sukuk

The workshop began with ascene-setting session, anoverview of sukuk. MohammedIsmail, IIBI’s Associate Fellowand Senior Manager at SonyEurope discussed the concept ofsukuk, its basic structure, itscomparison with conventionalbonds, key parties involved in atypical sukuk transaction aswell as the applications ofsukuk. Sukuk, plural of sakk, isan Arabic word, which means‘documents representing acontract or conveyance ofrights, obligations and/ormonies’. According to AAOIFI,sukuk are certificates of equalvalue representing undividedshares in the ownership oftangible assets, usufructs andservices or (in the ownership of)the assets of particular projectsor special investment activity.AAOIFI has listed 14 authorisedtypes of sukuk so far and itsclassification is based on theunderlying contracts in thesukuk transactions.

Ismail pointed out that the keyword in the AAOIFI definitionis ‘ownership’ by the investorsin the underlying assets financedby sukuk proceeds and it hasprofound implications for thenature of sukuk instrumentswhen compared with

interest-based bonds. With theright size and underlyingstructure, however, sukuk canbe viable products, competitiveproduct with bonds in terms ofpricing and issuance costs. In addition, sukuk provideaccess to an incrementalinvestor base.

An Evolving Instrument

In the next session, Richard T. deBelder and Matthew Sapte,Partners at SNR Denton UK LLP,an international law firm, used arange of case studies to illustratehow sukuk structures, riskallocations and documentationhave evolved. Most of the sukukdeals so far have been asset basedimplying that the undertakingand creditworthiness of theobligor was the crucial elementin the deal. There have also beensome asset-backed deals, wherethe returns to sukuk holders weredependent upon income from theunderlying assets and/or projectsfinanced by the sukuk proceeds.They also touched upon therating criteria for sukuk, whichhave been broadly based uponthe creditworthiness of theoriginator in most of the sukuktransactions. They pointed outthat there is still a lack ofdiversity in ratings, which meansthey only meet the risk appetiteof certain investors.

Finally they explained sukukrestructuring, which is importantbecause there have been manySukuk defaults in the last two

years. The restructuring of sukukdoes have some benefits, amongthem are that it minimises thebad publicity attaching to theobligor; it may be quicker thanformal proceedings and therestructuring company cancontinue to operate as a goingconcern.

Sukuk Taxation

In the financial session,Mohammed Amin, Islamicfinance consultant and amember of IIBI’s magazine,NewHorizon’s EditorialAdvisory Panel looked at thetaxation issues for sukuk from a UK market perspective. Using ijarah and mudarabahstructures as examples heanalysed the practical issues that a UK-based issuer wouldhave faced in the absence of any changes in the tax law interms of corporate tax,withholding tax, value addedtax (VAT), capital gains tax and stamp duty land tax (SDLT)for issuance of such instruments.He also explained the treatmentof income and capital gains in the hands of UK-basedinvestors. He then elaborated on the changes made in UK taxto accommodate the issuanceand trading of Sukuk. Heconcluded the session by statingthat even though rules arecomplex, UK tax law nowmakes it feasible for UKcompanies to issue sukuk usingUK land without adverse taxcosts.

NEWHORIZON Rajab-Shawwal 1432IIBI NEWS

July

11–13: The International Takaful Summit2011 – Bridging the Gap Between theTakaful and Insurance Industries,London

Although the takaful industry hasexperienced healthy growth in recent years, the untapped potential is enormous.The conference will address some of the issues that should help the industryachieve its full potential including betterconsumer education and acceptance, thelack of an experienced human resource and the need for more diversified productlines.

Email: attend@takfulsummit.comwww.takafulsummit.com

22–24: Structuring Innovative IslamicFinancial Products, Cambridge

The Institute of Islamic Banking andInsurance’s ever popular residential summerworkshop is in its fifth year and as usualtakes place at Clare College, Cambridge.Attracting delegates from all over the world,this is a unique opportunity to benefit fromthe formal sessions and the offlinediscussion and exchange of ideas.

Contact: Mohammad ShafiqueTel: +44 (0)20 7245 0404Email: m.shafique@islamic-banking.comwww.islamic-banking.com

September

26–27:7th Annual World Islamic Fundsand Financial Markets Conference,Bahrain

This year’s conference will include topicssuch as strategies for re-igniting growth andincreasing the diversification of Islamicfinancial instruments, as well as assessingnew initiatives to increase liquiditymanagement. The organisers promise theformat this year will be more interactive toencourage debate and audienceparticipation.

Contact: Sophie ShahTel: +9714 343 1200Email: sophie@megaevents.netwww.megaevents.net

October

18–20: 3rd World Islamic Retail BankingConference, Dubai

The theme of WIRBC this year is: ‘EvolvingEconomy: Spotlight on Islamic RetailBanking’. Conference topics will include‘Islamic Retail Banking: What is the nextstep?’, the ‘Annual Open Fatwa Session’ and‘Fuelling Regional Competition.’

Contact: Lucia KasanickaTel: +9181 0580 5411 800Email: lucia.kasanicka@fleminggulf.comwww.fleminggulf.com

25–26: 3rd Annual Moscow InternationalForum – Islamic Finance andInvestments

Leading economists and financiers willdiscuss the current situation and thespecifics of Islamic finance in the world andRussia in particular. Dialogue withregulators, included in the agenda for thefirst time, will give an opportunity to learnabout the regulators’ vision and possibleapproaches to the regulation of Islamicfinance in Russia. Business representatives,lawyers, experts and consultants will discussthe future development of the industry andnew opportunities for attracting Islamicinvestment into the Russian economy.

All enquiries via the website of BankConference Moscow atwww.bankconference.ru/en

November

21–23: 18th Annual World IslamicBanking Conference, Bahrain

This conference claims to be the world’slargest gathering of Islamic finance industryleaders. In 2010 it attracted 1,200 delegatesfrom 50 countries. One of the highlights ofthe event is the release of the annual ‘WIBCCompetitiveness Report’ produced incollaboration with McKinsey & Company.

Contact: Andrew ChopraTel: +9714 343 1200Email: andrew@megaevents.netwww.megaevents.net

Diary of Events endorsed by the IIBI

Shari’ah compliance is the backbone ofthe Islamic finance industry; it giveslegitimacy to the practices of Islamicbanking and finance and boosts theconfidence of the shareholders and otherstakeholders. Mufti Barkatulla discussedthe roles of Shari’ah scholars, highlightedcontemporary Shari’ah governancepractices and also looked at the keyissues, which need to be addressed forimproving and strengthening the Shari’ahgovernance framework.

Mufti Barkatulla started the lecture bystating that Shari’ah, which refers to theprinciples and rulings contained in andderived from the Quran and the Sunnah, iswidely adhered to by the vast majority ofMuslims across the globe. Shari’ah not onlygoverns faith and worship, but alsoeconomics, social and other aspects ofhuman life. Shari’ah transcends nationaljurisdictions and can be understood as anextra layer of jurisdiction in a multi-layeredworld of regulations and authorities.

Shari’ah Boards

AAOIFI standards define the Shari’ahSupervisory Board (SSB) as an independentbody of specialised jurists in Fiqh almuamalat (jurisprudence of commercialtransactions). He mentioned that accordingto the AAOIFI standards, the SSB isentrusted with the duty of directing,reviewing and supervising the activities ofthe Islamic financial institution in order toensure that they are comply with Shari’ahrules and principles. The main roles of theSSB, therefore, include ex-ante and ex-postShari’ah rulings; reviewing and certifying all

contracts, documentation and products andperiodic audits of products and practices.Every Islamic financial institution has anSSB to be appointed by the shareholders intheir annual general meeting upon therecommendation of the board of directors,taking into consideration local legislationand regulations. The hiring of SSB memberstakes place with the approval of theshareholders, so is the firing. SSB membersshould not, however, include directors orsignificant shareholders of the Islamicfinancial institution.

According to Mufti Barkatulla, a deepknowledge and insight about Islamicjurisprudence in the context of commercialtransactions, as well as a goodunderstanding of the conventional financialsystem, are primary requirements to becomea Shari’ah scholar; a person should alsohave at least three years’ experience ofgiving Shari’ah rulings. He or she shouldhave an impeccable track record in social,economic and financial dealings, as well as agood character and reputation.

Shari’ah-Compliance Risk

Mufti Barkatulla emphasised that Shari’ahnon-compliance risk is a significant risk foran Islamic financial institution (IFI). It willimpact on its revenues, because in the caseof an identified Shari’ah non-complianttransaction, the income arising from such atransaction would have to be given tocharity. This risk may also have verynegative impact on the reputation of an IFIand may result in a loss of confidenceamong the depositors, investors, customersand other stakeholders.

The Supply of Scholars

He pointed out that at present somescholars are in high demand due to theirknowledge and experience and there is aneed to train new Shari’ah scholars. There isalso a need to address the issue of conflict of

interest in the various roles of a Shari’ahscholar and there is a need for moretransparency in the various roles of Shari’ahscholars, especially those who are workingon the international level. He added that inthe last few years many Shari’ah advisoryfirms have appeared in the key internationalhubs of Islamic finance to support Shari’ah-compliance and advisory work.

The Future

Going forward, Mufti Barkatulla mentioned that there is a need to develophuman capital in the Shari’ah governancespace and that it will be one of the greatestassets for further development and growthin the Islamic finance industry. He believesthe Islamic finance industry should commitmore resources for the training of newShari’ah scholars as well as enhancing the skills of existing ones. There is also aneed for proactive engagement amongpractitioners and Shari’ah scholars to solvepressing issues and for Ijtihad to settledivergent points.

In Conclusion

He concluded the session by stating thatregulators, industry players,standards-setting bodies such as AAOIFIand IFSB and Shari’ah scholars should joinhands to strengthen the Shari’ah governanceframework. There is also need to harmonise Shari’ah governance practices as it will facilitate the further developmentof the Islamic finance industry andstrengthen its position on the internationalscene.

Promoting Islamic Finance

Mufti Barkatulla is a leading UK-basedShari’ah scholar with a strongbackground in economics and finance.He is a member of the Shari’ahSupervisory Boards of several Islamicfinancial institutions including the IslamicBank of Britain and the Arab BankingCorporation London.

NEWHORIZON Rajab-Shawwal 1432

The product development process entailsinput from various functional departmentsof a bank. Dr Ahmed discussed theproduct development process andShari’ah objectives and broadly looked atthe key ingredients, which are required tomeet the Shari’ah objectives in Islamicfinance product offerings.

The Product Development Process

The lecture began with a definition of theproduct development (PD) process, whichrefers to the structured flow of activities andinformation required to create newproducts. The process identifies thesequence of activities undertaken and thedistribution of responsibilities amongrelevant personnel to develop new products.An important aspect of this process is tohave a well-planned scheme that details thevarious phases and steps in each part of theprocess. This scheme acts as a roadmap todevelop new products. Elements of the PDprocess also facilitate the determination ofexecution time and the performance of theproduct after launch. Financial institutionswith rigorous PD process are more likely toproduce successful products.

Meeting the Objectives of Shari’ah

Dr Ahmed pointed out that Islamic financeis considered to be a part of an Islamiceconomic system, which has an inherentsocial orientation. The overall goal of thissystem is to realise the maqasid al-Shari’ah(objectives of Shari’ah), which shouldmanifest itself in the economy as enablinggrowth and justice. This implies that otherthan fulfilling the legal requirements, anIslamic financial system should also cater tothe social needs of a society. Accordingly,there is a general agreement that maqasidshould be inherent in the operations andproducts of Islamic financial institutions.

He highlighted the fact that the ability ofIslamic banks to develop products that canfulfil the legal and social Shari’ahrequirements depends on various factors atdifferent levels. At the macro level, theinstitutional environment in the form oflegal and regulatory regimes determines thetypes of products that can be developed.Given the external institutional settings, theorganisational structure and capabilities ofdifferent financial institutions determinesthe types of products that can be offered.Within the context of the international,national and institutional settings, DrAhmed went on to discuss the two mainproduct types – Shari’ah compliant andShari’ah based.

Shari’ah-compliant Products

Shari’ah-compliant products satisfy theform and substance of Islamic law, but failto pay attention to the social goals.Specifically, a Shari’ah-compliant productwill not adequately meet the financial needsof the poor and small/micro enterprises. Forexample, providing mutual funds only tothe affluent by setting very high minimuminvestment requirements would be Shari’ahcomplaint, but it would not meet socialgoals, because it does not serve themiddle-class and poorer sections of thepopulation.

Shari’ah-based Products

A Shari’ah-based product is aShari’ah-compliant product fulfilling thelegitimate needs of all market segments.Specifically, a Shari’ah-based product willnot only satisfy the form and substance ofIslamic law, it will also satisfy the financialneeds of all sections of the populationincluding the poor and small/microentrepreneurs. Thus, a Shari’ah-basedproduct is a Shari’ah-compliant onerealising the social goals. For example, ahome financing product that targets allsegments of the population, including thepoor would be Shari’ah-based.

As producing Shari’ah-based products canbe more costly and more risky, economicconsiderations may incline banks to movetowards Shari’ah-compliant or

pseudo-Islamic products. The board ofdirectors along with the top managementdetermine the overall strategy of a bank andthat will take market/product dimensionsinto account. Once the board determines thesocial orientation of the organisation byidentifying the market/product targets in theoverall strategic goals, the seniormanagement devises the productdevelopment strategy and plans forimplementation.

Dr Ahmed noted that a related decision thatthe board has to make is to identify thepreferences in the Shari’ah goals andprofitability domain. If profitability is theonly concern, the banks may sacrificecertain social Shari’ah requirements. Forexample, providing finance to the poor issocially desirable but may not makeeconomic sense in terms of profitability.While a bank may opt out of financing thismarket segment by considering theeconomics of financing, the Shari’ah-basedapproach would be to develop appropriateproducts that minimise the associated risksand provide the bank with a satisfactoryrate of return. He emphasised that theboard has to clearly demonstrate preferencefor Shari’ah-based products by acceptingthis approach and providing the resourcesto develop them.

The Role of the Shari’ah Board

As the product development process entailsinput from various functional departments ofa bank at different stages of the developmentcycle, the Shari’ah department and Shari’ahSupervisory Board (SSB) play a vital role inensuring the fulfilment of Shari’ahrequirements in the product developmentprocess. The SSB, among others, has directresponsibility for ensuring that productscomply with the principles and values of

NEWHORIZON Rajab-Shawwal 1432

Professor Dr Habib Ahmed is the SharjahChair in Islamic Law and Finance atDurham University. Prior to joiningDurham University in September 2008,Professor Ahmed worked at NationalCommercial Bank and Islamic Researchand Training Institute (IRTI) of the IslamicDevelopment Bank Group in Saudi Arabia.

IIBI 37

Shari’ah and provides a seal of approvalbefore they are launched in the market.

He concluded by stating that there is a beliefthat the SSB should be responsible for

implementing social aspects or maqasid inIslamic banks. The role of the SSBs is toensure that the maqasid is achieved at thecontract level by fulfilling the form andsubstance of Islamic law. The control of

the broader social character of bankingoperations in terms of product and market features, however, lies in the handsof the board and senior management, notthe SSB.

NEWHORIZON Rajab-Shawwal 1432

There is more to Islamic banking than themere abolition of interest (riba). Ali Vaniadiscussed the key principles of Islamicbanking as well as the underlyingstructures for Islamic banking products.He also looked at the current Islamic retailbanking scene in the UK.

Islamic retail banking has seen many upsand down since 1982 when the Al BarakaInvestment Company bought HargraveSecurities, a licensed deposit taker andconverted it into an Islamic bank. Al Barakaoffered investment deposits and housefinance products. In the wake of tighteningof regulations in 1993, however, Al Barakasurrendered its banking licence and closedits branches, but continued operating as aninvestment company. In the late 1990s TheUnited Bank of Kuwait, which was laterrenamed as the Ahli United Bank, started

offering Islamic mortgages. Thedevelopment that has attracted the greatestattention, however, was the establishmentof the Islamic Bank of Britain (IBB) in 2004.

Ali Vania began by discussing the mainprohibitions in Islamic banking, whichinclude riba (interest), mayser (gambling)and gharar (excessive uncertainty). Apartfrom these prohibitions, Islamic bankingavoids investments in those businesses thatare harmful to the environment or societyand aims at generating wealth by makinginvestment only in halal (permissible)businesses or sectors of the economy. Hewent on to explain the main structures ofmurabaha (cost plus mark up financing),ijarah (leasing), mudarabah (trust/participation financing), musharakah (jointventure or co-ownership financing) andwakala (agency). He emphasised theunderpinning of honesty, fairness andtransparency in financial dealing as the coreprinciples of Islamic banking.

He went on to look at the range of personaland business products available in the UKmarket with main focus on IBB offerings

and touched on the much debated issue ofthe link to the London Interbank OfferedRate (LIBOR) in the pricing of Islamicfinancial products. Vania shared hispractical experience at IBB and highlightedthe regulatory and consumer educationchallenges in offering true profit and losssharing products.

The interactive Q & A session includeddiscussion of several topical issues includingthe over reliance of Islamic retail bankingproducts on the debt-based contracts ofmurabaha, the performance and future ofIslamic retail banking in the UK andwhether it offers a real choice for customersseeking banking products and services thathave ethical and moral dimensions.

Mr Ali Vania is a senior manager at theIslamic Bank of Britain. He has extensiveretail banking and project managementexperience and has held senior positionsin conventional and Islamic financialinstitutions.

To date students from nearly 80 countries have enrolled in the PGDcourse. In the period April to June 2011, the following studentssuccessfully completed their studies:

IIBI Awards Post Graduate Diplomas

Diouf, Financial MarketsAnalyst, African GrowthAdvisors, South Africa

❑ Faycal Haddad, QuantitativeAnalyst, AXA IM, France

❑ Gbadamosi ShafiuKolawole, Supervisor, Nigeria

Import Export Bank, Nigeria

❑ Laila Adam, France

❑ Mohammad Siddick AsganyBundhun, Senior Manager – HRand Administration, GlobalBoard of Trade, Mauritius

❑ Laila Adam, France

❑ Mohammad Siddick AsganyBundhun, Senior Manager – HRand Administration, GlobalBoard of Trade, Mauritius

❑ Ibrahim Mohamed HajiBulushi, Malaysia

❑ Abdullahi Baba – Isah,Senior Audit Officer, CentralBank of Nigeria

❑ Abdurahman Jemal Yesuf,Lecturer, Hamamaya University,Ethiopia

❑ Birahim Abdallay Amrane

NEWHORIZON Rajab-Shawwal 1432

Ismail Fatima Umar, Economist, Central Bank of Nigeria,Nigeria

I liked all the aspects of the course. The content wascomprehensive. I wish to express my profound gratitude to theentire staff of IIBI for their immense support and understandingtoward the successful completion of the course. The programmehas extensively broadened my knowledge of Islamic bankingand insurance and the financial system in general. Theknowledge gained will be very useful in contributing to thedevelopment of an Islamic financial culture in my country.

Mukhtar Adam, Senior Manager, Financial Control &Strategic Planning, Zenith Bank Plc, Nigeria

This course provided me with adetailed and comprehensiveknowledge and insight into Islamicbanking and insurance. Through thiscourse, I acquired a good knowledgeabout Islam’s position on variousfinancial transactions. The course hasawakened me to the realisation thatcore Islamic principles can be

followed in modern day financial transactions and businessundertakings. In fact, as a result of taking this course, I havestarted reorganising all my personal businesses in line withthe Shari’ah principles studied. I sincerely believe that, asmore Muslim professionals undertake this course, Islamicfinance will continue to grow from strength to strength. Mohamed Rousdeen Ahamed Thashreef,

Hatton National Bank, Sri Lanka

This course enhanced my knowledge ofIslamic finance and in my opinion anyoneinvolved in Islamic banks should studythis course to ensure the Islamic financeindustry is operated according to theShari’ah.

M.B. Mohamed Yazar, Assistant Manager,Ceylon Exports UK (Pvt) Ltd, Sri Lanka

The course material has been prepared in anexcellent manner.

Naji Hawayek, Lawyer, Clyde &Co LLP,UAE

The course was informative and well-presented. I particularly enjoyed dealingwith the questions, which seemed totouch on the important aspects andconcepts of Islamic banking andinsurance. Overall, this was a veryenjoyable and useful experience.

Moataz Mohamed Zawam Abd Alhay,Credit Risk Officer, Al Rajhi Bank,Saudi Arabia

The course was useful in explaining thebasis of the Islamic economy, which isjustice and fairness. In addition, thecourse gave me a better understandingof the main concept of Islamic financewhich is Profit & Loss Sharing (PLS).

NEWHORIZON Rajab-Shawwal 1432

Reem Finance PJSC completedthe final deployment of itsstrategic Islamic bankingsolution, ETHIX financialsolution in April 2011. Theweb-service-based solutionoffers Islamic financialinstitutions a range ofpre-defined business modelsincluding Islamic finance,Islamic investment as well astrading and delivery channels.Reem Finance signed apartnership agreement withInternational Turnkey SystemsGroup (ITS), the owner of theETHIX financial solution,which paved the way for therapid deployment of theETHIX solution at ReemFinance’s headquarters in AbuDhabi.

‘This partnership with ITS is inline with our expansionstrategy across the UAE.Presently, we are operating outof one branch in Abu Dhabi,but plan to expand our branchnetwork to multiple locationsacross the country by the endof 2011,’ said Fatma Al-Mansour, CEO of ReemFinance. ‘We chose to partnerwith ITS because of theirextensive experience in Islamicbanking technology and theunmatched power of theETHIX financial solution.’

After an extensive evaluationprocess Reem Finance selectedITS to implement the ETHIXfinancial solution as the mostsuitable vendor to achieve thecompany’s strategic technologyand business goals. ITS rapidlycustomised, developed and

SAGE Announce Upgrades toProspero at MEFTEC

deployed the ETHIX financialsolution in record time to enableReem Finance to proceed withits 2011 expansion plan.

‘The ETHIX financial solution,the next generation solution forIslamic banking has allowedReem Finance to reduce its totalcost of ownership, operationalcosts and risks to meet growingcustomer demand for Islamicbanking products and services,’said Khalid Al-Saeid, ManagingDirector and General Managerof ITS. ‘The fully integratedsolution is Shari’ah compliantand has strong productdefinition features. We lookforward to building a strongrelationship with Reem Financeand assist in contributing to thecompany’s goal of being one ofthe most technologically-advanced Islamic financialinstitutions in the region.’

Reem Finance plans to useETHIX to offer products thataimed at retail andSME/Corporate Bankingbusinesses including goodsmurabaha finance, vehiclemurabaha finance, ijara, tradefinance, share finance andtawarruq. Future plans includeliability products such asmudaraba and wakala. ReemFinance selected ITS from ashort list of the top threevendors in Islamic bankingsolutions. ITS solutions areAAOIFI Certified, provide fullyintegrated systems and offerShari’ah-compliant products. Todate ITS have a client base ofmore than 70 banks across theworld.

Path Solutions has announcedthat it has entered into apartnership agreement withUniversal Payment Services(“UPS”) Kuwait, one of theleading firms in transactionprocessing and electronicpayments. The move will allowPath Solutions to offer a widerange of card managementapplications that will enhanceits services offering to theIslamic banking marketplace.

Universal Payment Services isthe first Shari’ah outsourcingcompany that offers inter-national electronic transactionprocessing services through ahigh-speed, robust electronicinformation network.

Under the terms of the

agreement, UPS will becomplementing Path’s iMALsystem with transactionprocessing solutions for debitand credit cards, POS (Point ofSale) applications with marketspecific features, ATM sharingand driving services and creditcard management solutions.

Path Solutions’ Group Chairman& CEO, Mohammed Kateebadded: ‘Our goal is to strengthenour product portfolio andcomplement our expertise bypartnering with UPS to deliverstate-of-the-art, end-to- endsolutions to Islamic financialinstitutions. We are pleased toteam up with UPS and areconfident that this agreementwill bring great value to ourcustomers.

Path Solutions ExtendCapabilities

Reem Finance CompleteDeployment of ETHIX

SAGE, founded in Switzerlandin 1986 and with a regionaloffice in Dubai announced thelatest upgrades to its Prosperomodular, integrated financialsoftware at MEFTEC in AbuDhabi. They have created sixdistinct solutions aimed atWealth Management, AssetManagement, FundAdministration, IndependentAsset Managers/Family Office,Trading, and PortfolioOptimisation. SAGE claims thatProspero is both robust andscalable. It is also compliant

with the requirements of Islamicbanks.

More importantly for small andmedium-sized organisation,clients have the option of using ahosted service, which means thatthey do not have to install thesolution on site with the attendantrequirement for a significant,in-house IT capability capable ofmanaging the solution. Clientscan simply plug into the Swiss-based host site and they are thenbilled according to the number ofusers and features used.

NEWHORIZON Rajab-Shawwal 1432

The first section entitled ‘Overview ofIslamic Capital Markets’ has two chapters.The first chapter by Rahail Ali provides anoverview of the sukuk market, its evolution,sukuk structures as well as legal andShari’ah compliance documentation. In thesecond chapter, Mark Morris of Latham &Watkins looks at the Islamic money marketand its relevance to Islamic capital markets;highlights the shortage of suitable moneymarket instruments to manage the liquidityof Islamic financial institutions anddiscusses the recent initiatives to developthe Islamic money market.

The second, four-chapter section is on thelegal and structural anatomy and parties.The first chapter by Yavar Moini ofMorgan Stanley considers the similaritiesand differences between sukuk andconventional bonds putting forward theargument that sukuk present a viable andcompetitive product to bonds in terms ofstructure, pricing and issuance costs. In thesecond chapter, Rahail Ali and Imran Muftiof Hogan Lovells (Middle East) discuss thelegal and structural anatomy of sukuk. Theauthors point out that in order to createcritical mass for liquidity in the sukukmarket, there is a need to educate the

investors about sukuk and that a legalunderstanding of sukuk compared withconventional bonds is the easiest way tocomprehend the similarities and differences.The third chapter by Tahir Jawed andManuela Belmontes from Maples andCalder deals with the role of the SPV(Special-Purpose Vehicle) issuer, anddiscusses in detail the nature of SPV and itsuses in capital market transactions.Offshore financial centres play an important part in the structuring of SPVissuers and several such centres have madelegislative changes to accommodate thestructuring of SPVs. In the last chapter,Sema Kandemir and Daniel Rankin ofHogan Lovells analyse the role of thedelegate and paying agent in sukuktransactions. This chapter also touches uponthe legal rights and responsibilities of thedelegate trustee and various agents whoplay crucial roles in facilitating sukuktransactions.

In the third two-chapter third section,regulation and standardisation of sukukcomes under discussion. The first chapter isjointly contributed by Rahail Ali andMustafa Kamal of Al Yaqoub Attorneys &Legal Advisors. It provides a concise

Sukuk and Islamic Capital MarketsConsulting editor: Rahail Ali. Publisher: Globe Business Publishing Limited (2011)(ISBN 978-1-905783-42-7)The book is presented in five sections with contributions by a number ofpractitioners. Rahail Ali, the consulting editor, is global head of Islamic finance atHogan Lovells and one of the most eminent lawyers in this area with many accoladesfor working on a number of innovative and high-value Islamic finance deals. The publication of this book is timely given the reviving interest in sukuk. The sukukmarket had seen healthy growth between 2001 and 2007, but the worldwide financialcrisis caused the market to nosedive in 2008. There were a few green shoots in2009, but the market did not really start to bounce back until 2010. In the first quarterof 2011, however, market activity was brisk and would seem to portend substantialgrowth for the full year.

NEWHORIZON Rajab-Shawwal 1432

discussion of Islamic law and its sources andpoints out that standardisation has not beena norm in Islamic legal history. It also delvesinto the historical efforts to codify andstandardise Islamic law and goes on to lookat the issue of standardisation of Shari’ahprinciples in the modern Islamic financeindustry, highlighting the efforts of theAccounting and Auditing Organisation forIslamic Financial Institutions (AAOIFI) instandardising Shari’ah rulings throughissuing Shari’ah standards, even thoughmany issues in the application of thesestandards are still unsettled. This chapteralso touches upon the role of the IslamicFinancial Services Board (IFSB) and theInternational Islamic Financial Market(IIFM) in standardising market practices.It also looks at the issue of the

standardisation of legal documentation as well as the regulation of sukuk andprovides a brief description of regulatorydevelopments in Malaysia and the UnitedKingdom to facilitate sukuk issuance. The second chapter on by RogerFankhauser of Hogan Lovells (Middle East)explains the process of sukuk listing, andprovides an overview of listing procedureand disclosure requirements. The authornotes that the main benefit of listing is thediversification of the investor pool, butcautions that this benefit needs to beweighed against the extra cost and effortinvolved in the listing process, as well as the

efficiency and reliability of the listingauthority.

The fourth section on ‘New Directions’ hasfive chapters. The first chapter byRafe Haneef of HSBC Amanah Malaysiaexamines the use and the reasons for the useof tawarruq for Islamic treasury products aswell as recent tawarruq controversies. Thenext chapter on ‘Equity-linked Sukuk’ byImran Mufti looks at different sukukstructures with equity-linked features.Though a number of Sukuk deals with suchfeatures took place prior to AAOIFI’sstatement in 2008 especially in 2006 and2007, such deals are rare in thepost-AAOIFI-statement environment. Thefollowing chapter by Shibeer Ahmed ofWhite & Case discusses the use of sukuk inproject finance. It highlights the increasedemphasis by project sponsors on the use ofIslamic finance for the development ofmajor power, petrochemical andinfrastructure projects in the Middle Eastand Southeast Asia and the sukuk market’spotential to provide project sponsors withan alternative source of long-term funding.Shibeer Ahmed also examines the use ofsukuk for refinancing existing projects. Thepenultimate chapter by Debashis Dey andStuart Ure of Clifford Chance looks atIslamic securitisation. This chapterhighlights the fact that true securitisationuse is not common in sukuk transactions as

a majority of sukuk deals have no directrecourse to the underlying assets. The lastchapter by Daniel Rankin deals with variousaspects of the process of restructuring andbuy-back of sukuk.

The road ahead is the focus in the lastsection of the book. Moinuddin Malim ofMashreq Al-Islami discusses the future ofthe sukuk market and looks at some of theimportant issues highlighted by the 2008AAOIFI ruling. It is highlights the fact thatsukuk market is young and facing manychallenges including greater clarity intransaction structures; an enabling legal andregulatory framework; harmonisation andstandardisation of sukuk issuanceregulations and a deep secondary market.

There appears to be some repetition ofcontents in various chapters, which ispossibly due to the fact that manypractitioners contributed to various sections,although the book’s clarity is unquestionable.The overwhelming focus on legal issues maybe due to the profile of the contributors asmost of them are eminent lawyers andexperts in this subject area. This book is,however, a good addition to the library ofIslamic finance practitioners. This will alsobe is a good read for anyone interested ingaining insight into sukuk and Islamic capitalmarkets, though students may find the£122.00 price of the book prohibitive.

NEWHORIZON Rajab-Shawwal 1432

GLOSSARY

An Islamic version of option, a deposit for the delivery ofa specified quantity of a commodity on a predetermineddate.

This refers to the selling of an asset by the bank to thecustomer on a deferred payments basis, then buying backthe asset at a lower price, and paying the customer incash terms.

A murabaha contract using certain specifiedcommodities, through a metal exchange.

A ruling made by a competent Shari’ah scholar on aparticular issue, where fiqh (Islamic jurisprudence) isunclear. It is an opinion, and is not legally binding.

Lit: uncertainty, hazard, chance or risk. Technically, saleof a thing which is not present at hand; or the sale of athing whose consequence or outcome is not known; or a sale involving risk or hazard in which one does notknow whether it will come to be or not.

A record of the sayings, deeds or tacit approval of theProphet Muhammad (PBUH).

Activities which are permissible according to Shari’ah.

Activities which are prohibited according to Shari’ah.

A leasing contract under which a bank purchases andleases out a building or equipment or any other facilityrequired by its client for a rental fee. The duration of thelease and rental fees are agreed in advance. Ownership of the equipment remains in the hands of the bank.

A sukuk having ijara as an underlying structure.

The same as ijara except the business owner iscommitted to buying the building or equipment orfacility at the end of the lease period. Fees previouslypaid constitute part of the purchase price. It is commonly used for home and commercial equipmentfinancing.

A contract of acquisition of goods by specification ororder, where the price is fixed in advance, but the goodsare manufactured and delivered at a later date.Normally, the price is paid progressively in accordancewith the progress of the job.

Gambling – a prohibited activity, as it is a zero-sumgame just transferring the wealth not creating newwealth.

A form of business contract in which one party bringscapital and the other personal effort. The proportionateshare in profit is determined by mutual agreement at thestart. But the loss, if any, is borne only by the owner ofthe capital, in which case the entrepreneur gets nothingfor his labour.

In a mudarabah contract, the person or party who actsas entrepreneur.

A contract of sale between the bank and its client for thesale of goods at a price plus an agreed profit margin forthe bank. The contract involves the purchase of goods bythe bank which then sells them to the client at an agreedmark-up. Repayment is usually in instalments.

musharakahAn agreement under which the Islamic bank providesfunds which are mingled with the funds of the businessenterprise and others. All providers of capital are entitledto participate in the management but not necessarilyrequired to do so. The profit is distributed among thepartners in predetermined ratios, while the loss is borneby each partner in proportion to his contribution.

An agreement which allows equity participation andsharing of profit on a pro rata basis, but also provides a method through which the bank keeps on reducing its equity in the project and ultimately transfers theownership of the asset to the participants.

An interest-free loan given for either welfare purposes or for fulfilling short-term funding requirements. Theborrower is only obligated to pay back the principalamount of the loan.

In a mudarabah contract the person who invests thecapital.

Reinsurance based on Islamic principles. It is amechanism used by direct insurance companies toprotect their retained business by achieving geographicspread and obtaining protection, above certain thresholdvalues, from larger, specialist reinsurance companies andpools.

Lit: increase or addition. Technically it denotes anyincrease or addition to capital obtained by the lender as a condition of the loan. Any risk-free or ‘guaranteed’rate of return on a loan or investment is riba. Riba, in allforms, is prohibited in Islam. Usually, riba and interestare used interchangeably.

Salam means a contract in which advance payment ismade for goods to be delivered later on.

Refers to the laws contained in or derived from theQuran and the Sunnah (practice and traditions of theProphet Muhammad (PBUH).

An authority appointed by an Islamic financialinstitution, which supervises and ensures the Shari’ahcompliance of new product development as well asexisting operations.

A contract between two or more persons who launch a business or financial enterprise to make profit.

Similar characteristics to that of a conventional bondwith the key difference being that they are asset backed;a sukuk represents proportionate beneficial ownership inthe underlying asset. The asset will be leased to the clientto yield the return on the sukuk.

A principle of mutual assistance.

A donation covenant in which the participants agree to mutually help each other by contributingfinancially.

A form of Islamic insurance based on the Quranicprinciple of mutual assistance (ta’awuni). It providesmutual protection of assets and property and offers joint risk sharing in the event of a loss by one of itsmembers.

A sale of a commodity to the customer by a bank ondeferred payment at cost plus profit. The customer thensells the commodities to a third party on a spot basis and gets instant cash.

The diaspora or ‘Community of the Believers’ (ummatal-mu’minin), the world-wide community of Muslims.

A promise to buy or sell certain goods in a certainquantity at a certain time in future at a certain price. It is not a legally binding agreement.

A contract of agency in which one person appointssomeone else to perform a certain task on his behalf,usually against a certain fee.

An appropriation or tying-up of a property in perpetuityso that no propriety rights can be exercised over theusufruct. The waqf property can neither be sold norinherited nor donated to anyone.

An obligation on Muslims to pay a prescribed percentageof their wealth to specified categories in their society,when their wealth exceeds a certain limit. Zakat purifieswealth. The objective is to take away a part of thewealth of the well-to-do and to distribute it among the poor and the needy.

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