What makes Islamic finance
different from conventional finance?
A common misconception is that Islamic
finance is just banking without charging interest. Islamic
finance however is concerned with the very nature of money and
how it is used. Since US President Nixon’s
decision to cut the link between gold and currency in 1972, it
has become commonplace for money to be made out of money. Since
the 1945 Bretton Woods agreement was reversed under Nixon,
countries’ budget deficits have ballooned to
unthinkable levels. Under Islamic finance, in a similar way to
convention previous to 1972, Islamic transactions have to be
underpinned by an asset. In the Islamic model, money is merely
a medium of exchange and a measure of value of real goods and
One of the biggest differences is that
Islamic finance has ethics very much at its forefront. It aims
to prioritise transparency, certainty of outcome and protection
of investor’s liabilities. It also does not allow
investment in gambling, pornography or alcohol, among other
There are a multitude of different
structures used in Islamic finance. Among the most common is
murabaha, which is generally considered to be the
Islamic framework for a conventional loan and is regarded as
the most straightforward to structure. An ijara
structure is the equivalent of a lease while mudarabah
is like a shared investment venture. The wakala
structure can be compared to an agency agreement, where the
principal appoints an agent to carry out a task.
Gateway partner Harris Irfan said English
law perfectly complements these structures. "It often appears
superficially that there is a conflict between English and
Sharia law but this is not true," he said. "Most Islamic
finance contracts are governed by English law precisely because
it is so compatible with sharia."
Al Rayan Bank treasurer Amir Firdaus said
the first step is about identifying a structure that works with
English law. "For example, debt structuring already exists in
English law so you need to look at the Islamic structure that
complements it best," he said. "Thankfully, a lot of English
law complements Islamic finance well. It is more about the
processes you tend to go for."
What is a
Sukuk are widely thought to be Islamic
bonds. But unlike a conventional bond, which is effectively a
debt instrument, a sukuk is a trust certificate where
there is no element of debt financing. It can be structured on
an asset base or be asset backed. Sukuk are growing in
popularity across Europe, the US and many jurisdictions in Asia
and the Middle East. The UK government issued its first
sukuk in 2014, becoming the first country outside of
Muslim nations to do so and to underline the demand for these
assets, the £200 million ($276.5 million) issuance
receiving orders totalling £2.3 billion. The UK plans to
reissue a sukuk in 2019, a move believed to be a
signal that investment in this area will be accelerated after
While countries across Europe are behind
the UK, a report from Malaysia’s RHB Bank
suggested that Germany is planning a $1 billion sukuk
issuance in the near future. Al Rayan Bank, the first UK-based
Islamic bank to receive a credit rating from
Moody’s, estimates a third of its customers are
not from the Muslim faith. The entire industry is expected to
grow to $3.5 trillion by 2021 and western countries will have a
big role to play if the industry grows to this level.
Irfan says that the structure of
sukuk is particularly attractive to conventional
investors. "Fixed income investors generally prefer
unsecured debt obligations like a conventional bond, and most
sukuk are structured this way," he said. "As a result,
they remain compatible with sharia but
perhaps might not be in keeping with the true spirit
of the Islamic economic model."
Firdaus says that sukuk are
particularly attractive because they tend to offer higher
yields than conventional bonds and are secured. The challenges
come with explaining the structure to an investor and
processing the large amount of documentation involved.
"The understanding of it takes time and it
is often about explaining the similarities to the conventional
bond," he said. "A conventional transaction normally has one
contract that encapsulates everything. In Islamic finance there
is often several contracts, because there are more than one
transaction happening at the same time".
The state of Islamic
Total sukuk issuances are
falling, however. According to an S&P Global report, total
issuances fell from just below $140 billion in 2012 to just
over $60 billion in 2015. Firdaus attributes this fall to the
decrease in oil prices and complacency on the part of Islamic
banks which are not offering enough products to the market. It
may also be due to the lack of global standards used to certify
sukuk are sharia-compliant – several
jurisdictions such as Malaysia, Indonesia and the Middle East
dominate in terms of issuance though they don’t
necessarily share the same approach when it comes to
structuring and issuing sukuk.
Irfan agrees with these views, but does
not believe this is an issue that cannot be corrected. "I think
Islamic finance has stagnated, growth rates are not increasing
as they should," he said. "Its future lies with disruptive
technologies and if we can combine Islamic finance with these,
then I believe we will see a return to the exponential growth
rates of the early 2000s."
The problems mainly lie in a
misunderstanding of the purpose of Islamic finance and as a
result, opportunities are not being exploited. "Much of the
Islamic finance industry is dominated by conventional
bankers, who do not typically hold any ideological
affinity to the Islamic economic model," he said.
Because of this approach he says some
people are sceptical about Islamic finance, merely seeing it as
interest with another name and not truly
sharia-compliant. Irfan says: "The banking industry
has not done enough to convince them otherwise."
The legal state of Islamic
Much of this is yet to be legally tested
in the UK, but as time goes on, legal precedents are expected
to become commonplace. Dana Gas, an Abu Dhabi energy firm,
recently declared $700 million worth of sukuk
non-sharia compliant and therefore concluded it was
not obliged to repay its debt. A court case was adjourned on
December 25, but everyone is the industry is keen to see
whether the mudarabah contracts associated with the
sukuk will be determined valid. IFLR understands that
a resolution is close in favour of the debtholders.
In 2010 the Investment Dar Company (TID)
refused to pay Blom Developments Bank because it did not
believe the wakala agreement was
sharia-compliant in the first place. The decision to
allow TID’s appeal created quite a problem in the
industry because people became worried that they would not
follow through with their agreement.
In the previous year, Dubai real estate
developer Nakheel delayed many of its projects and was unable
to repay its sukuk obligations after its holding
company Dubai World restructured $26 billion of debt.
Bondholders were concerned that the company may have to
default, but declared itself debt free in 2016 and fully repaid
the sukuk when it matured.
Other than these high-profile deals,
Islamic finance has largely avoided legal uncertainty though
the shadow of the Dana Gas case does loom at present. It is
beyond doubt that Islamic finance is becoming more common in
the west, but improvements need to be made if it is to truly
flourish as a mainstream financial tool outside the Middle
A lease contract that binds both parties.
Investment management partnership. One party contributes
financially, the other provides expertise and all profits and
losses are shared.
Referred to as a 'cost plus’ contract. A financial
institution purchases an asset and sells it to a customer on a
An investment partnership where all profits or losses are
A loan equivalent which is required to be repaid at a
Islamic teachings based on the Quran and other approved sources
of the Sharia.
Certificates that represent a beneficial ownership interest in
an underlying asset.
Members contribute funds into a pool to secure against
Agency contract. A customer appoints an agent to carry out
business for them.
sukuk (IFLR magazine,
first Malaysian sukuk to monetise real estate project
sukuk: why the market is
three principles of Islamic finance