Legal, Accounting, and Auditing Standards in Islamic Finance           Date: 2008-10-01

Article prepared by Claire Spencer containing summary of an interview with Ziad El-Khoury, published in Financier Worldwise October 2008 Issue


The Islamic corporate finance market has grown considerably over the past few years, and experts suggest there is plenty more to come. Currently $700bn worth of Islamic assets are under management, but the ratings agency Standard & Poor’s believes the industry could eventually control as much as $4 trillion.


There are numerous reasons for this generous estimate. Both the number of Muslim investors and the number of opportunities based in Muslim countries are growing, and they require Islamic financing solutions to satisfy Shari’ah law. Furthermore, the Gulf region is awash with liquidity due to the sharp rise in oil prices. It makes sense for Islamic investors to put that liquidity to work in a global market that desperately needs it. But Shari’ah law is open to interpretation, and market players have identified the need for a globally standardised legal, accounting and auditing system.

The evolution of the Islamic corporate finance market

In spite of the pronounced troubles in the wider market, Islamic corporate finance has gone from strength to strength in the last few years, and now bears little resemblance to the simple market it was 30 years ago.

“The Islamic corporate finance market has steadily evolved in terms of product sophistication and market reach,” notes Dr Mohamad Nedal Alchaar, the secretary general of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). “Credit must be given to the financial institutions that have been proactively developing Shari’ah-compliant corporate finance solutions. Needless to say, the evolution has also been driven by the increasing demand for Islamic finance from the corporate sector.” Now there are over 250 Islamic financial institutions worldwide, and 50 of those are considered to be ‘major players’.

This growth has also been fuelled by a variety of other factors, including the exploding, oil-driven wealth of the Gulf region, the maturing Middle Eastern business centre and the rising middle class. So far, Islamic finance has been most evident in the retail banking sector, with the introduction of instalment sales for consumer products on a murabaha basis, outright personal loans on a tawaruq basis, and Shari’ah compliant credit cards. But corporate and infrastructure finance is a growing area, according to Dr Adli Hammad, a partner at the Alliance of Abbas F. Ghazzawi & Co. and Hammad & Al-Mehdar. “Project financing of various projects including petrochemical, power, port and telecom projects have started to have significant Islamic finance tranches,” he says. “This trend culminated in the financing of Al Waha Petrochemical Company, which was entirely financed on an Islamic basis. The issuance of sukuks by the likes of SABIC, SEC and Saad Trading has added another dimension to Islamic finance.” He adds that now, the amount and terms of Islamic financings have increased to become a viable alternative to conventional financing.

Although Islamic finance only represents a small percentage of the world’s financial products, things are starting to get interesting. Dubai International Financial Centre (DIFC) estimates the current market for Islamic financial products at $260bn, forecasting that this will grow at the rate of 12-15 percent per annum for the next decade. More institutions are seeing the value in Shari’ah-compliant products, observes Ziad El Khoury, a Beirut based lawyer at Squire Sanders & Dempsey LLP. “Significantly, a number of banks in the region have become wholly Shari’ah compliant and report significant growth in profitability. Another factor facilitating the evolution of Islamic finance is the growth in the number of Shari’ah scholars who have developed expertise in complex financial transactions such as project finance. However, differences in interpretation mean that, at present, unified precedents for more complex financing instruments have not emerged.” He adds that a number of major Islamic products are now well-established, including murabaha, mudaraba, musharaka and istisnaa. Murabaha and istisnaa products in particular can be used to facilitate leveraged buyouts and global loans, and leasing and asset financing respectively. Furthermore, techniques such as ijara (leases) are available to facilitate the purchase of assets.


But there are hurdles. The prohibition of riba (interest) and excess leverage limit the replication of huge, Western-style leverage buyouts. It may also be challenging to conduct cross-border deals involving Western countries. “Prohibitions on borrowing as well as certain business activities make cross-border acquisitions of target companies outside the Muslim world in a Shari’ah compliant way difficult, as these companies themselves may engage in practices that are inconsistent with Shari’ah. Acquisition financing is in an early state of development and is likely to develop first in connection with acquisitions in the region before spreading to non-Muslim countries,” predicts Mr El Khoury. However, cross-border deals can work well as long as the Shari’ah financiers are careful. There is no prohibition against joint enterprises with non-Shari’ah-compliant financial products as long as the Shari’ah instruments are compliant in their own right and are ‘ring-fenced’ to avoid participation in interest receipts. In addition, the project cannot involve a forbidden business such as arms, alcohol or gambling.

This shows real complexity, and advisers and arrangers are slowly becoming more creative and innovative when structuring Islamic finance deals. As the market matures, their techniques have become increasingly intricate. Dr Hammad points to the example of the Al Waha Petrochemical project, in which the lawyers for the sponsors introduced the concept of lenders and borrowers jointly procuring the plant and equipment during the construction phase of the project. “This new structure was used instead of an istisnia, which would have imposed greater liability and construction risk on the lenders. The lawyers for the lenders then revised this new structure to ensure that the SAMA Committee – the judicial committee responsible for adjudicating banking disputes – rather than Shari’ah courts, would take jurisdiction in case of any disputes,” he explains.

Complex cases of this sort would not be possible without Shari’ah scholars, who work to ensure that financing structures adhere to Shari’ah law.


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