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What is Shariah?
O you who believe! Stand out firmly for Allah, as witness to fair dealing, and let not the hatred of others to you make you swerve towards inequality and depart from justice. Quran 5:8 In the business context, Shariah is a means of conducting business through a distinct set of rules designed to facilitate fairness. High correlation between Shariah compliant investing and socially responsible investing
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Shariah terms
Halal that which is permitted or compliant Haram that which is not permitted Riba charging of interest or unjustified increase Gharar the taking of unreasonable risk; uncertainty Maisir reliance on chance or speculation, rather than effort
Industry prohibitions
Gambling Pork production or consumption Adult Entertainment Banking and finance Alcohol production or consumption Weapons production Tobacco production or use
Riba
The charging of sums for borrowed money (i.e. interest) is forbidden But the pledging of Halal assets, the guarantying of obligations and the leasing of property under what we might consider a finance lease (or ijara) is permissible Murabaha is the selling of a commodity at an agreed upon mark-up, and is used in Shariah as a fixed income investment substitute.
Riba
Things to Watch Out For: Default Interest Administrative fees for late payments Consideration in respect of third party guaranties (see AAOIFI Shariah Standard No. 5) Preferred Shares are generally not permitted (AAOIFI Shariah Standard No. 21); but dividends distributed from profits are permitted.
Gharar
The act of taking on unreasonable uncertainty Examples of Gharar:
Gambling Insurance FX Trading Options on stock (AAOIFI Shariah Standard No. 21, paragraph 16 of Appendix B)
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Mudaraba
Risk sharing; profit and loss sharing Limited partnership: one partner provides capital; other partner provides expertise/effort and makes business decisions Restricted or unrestricted Examples:
funded participation arrangement establishment of investment fund
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Mudaraba
MANAGER (Mudarib)
Provides expertise and manages funds
Invests funds
FUND
PROJECT/ENTERPRISE
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Musharaka
Risk sharing; profit and loss sharing in same proportions General partnership / joint venture arrangement between financier and investor Provides equity funding to a venture; greater riskreward factors and greater investor say in project management
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Musharaka
FINANCIER
CUSTOMER
Cash contribution
VENTURE
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Murabaha
Asset based Trade finance / Acquisition finance Unconditional contract of sale; goods, cost price, mark-up and payment date = defined and agreed Profit from marked-up sale price (not interest) paid in instalments Examples:
import-export finance infrastructure project financing leveraged acquisition
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Murabaha
Payment of Purchase price Payment of purchase price plus premium (deferred)
SUPPLIER
FINANCIER
CUSTOMER
Sale of asset
Sale of asset
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SUPPLIER
FINANCIER
CUSTOMER
THIRD PARTY
Sale of asset
Sale of asset
Sale of asset
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Ijara
Asset based Hybrid between conventional operational and finance leases; a business process Analogous to secured loan Examples:
aircraft finance ship finance project finance
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Ijara
Payment of purchase price Rent (= purchase price plus premium)
SUPPLIER / MANUFACTURER
FINANCIER
CUSTOMER
Sale of asset
Lease of asset
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Ijara wa-iktina
Asset based Lease with option for lessee to purchase leased asset Analogous to finance lease / hire purchase contract Examples:
medium term trade finance of equipment refinancing under sale and leaseback
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Bai salam
Asset based Forward purchase of specified asset paid in full for supply on pre-agreed fixed future date Working capital facility, especially for pre-export facilities
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Bai salam
Purchase price (discounted) Purchase price (plus premium)
SUPPLIER
FINANCIER
CUSTOMER
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Bai al inah
Asset based Sale and buy-back transaction Customer sells asset to financier and then buy it back at higher price Provides customer with cash sum Not approved by majority of Shariah scholars: profit differential constitutes riba Permissible practice in Malaysia
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Istisnaa
Asset based Funding agreement for production, manufacture or construction of asset to agreed specification: all specifications, delivery options, payment conditions and pricing must be agreed in contract No fixed delivery date and no payment in full at outset required Advance funding of:
major industrial, construction and real estate development project finance large equipment e.g. ships, aircraft
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Istisnaa
Purchase price Purchase price plus premium (deferred)
DEVELOPER/CONTRACTOR/ MANUFACTURER
FINANCIER
CUSTOMER
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Sukuk
Financial instruments / trust certificates representing undivided ownership share in underlying asset or interest held by issuer Right to share in profits and asset realisations Debt capital markets fundraising Bought and sold in secondary market Used in conjunction with other structures
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Sukuk al Ijara
CERTIFICATE HOLDERS
Issue proceeds
Return
Issues Sukuk
Sells assets
Leases assets
SELLER
Purchase price (issue proceeds)
SPV ISSUER
Rent
LESSEE
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Sukuk al Musharaka
CERTIFICATE HOLDERS
Issue proceeds
Return
Issues Sukuk
SPV ISSUER
Cash contribution Share in profits and losses Share in profit and losses
ORIGINATOR
Contribution in kind (at least 30%)
VENTURE
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Further resources
www.aaoifi.com Accounting and Auditing Organization for Islamic Financial Institutions www.islamic-finance.com www.securities.com/ifis Islamic Financial Information Services (subscription required) www.shariahcap.com Shariah Capital www.sii.org.uk/web5/infopool.nsf/html/qintifq Securities & Investment Institute: Islamic Finance Qualification
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Disclaimer
This webinar and these slides are for informational purposes only and do not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting with a lawyer.
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