Islamic finance Farmida Bi Partner Norton Rose Fulbright LLP 28 October 2013

Islamic Finance – Overview Importance of Islamic Finance Features of Islamic Finance Traditional Islamic Contracts Governing law

Importance of Islamic Finance Demographics Emerging economies Political identity 3

Incorporation of Shariah law into English law Tax changes Regulatory changes – CIS, deposit protection scheme, status of SSB AFIBs London Stock Exchange English law and courts 4

Islamic finance in UK NameDate LicensedRetailProducts Offered Islamic Bank of Britain PLC August 2004Yes Islamic Current Account (qard); Home Purchase Plan; Savings Accounts; and Personal Finance Discretionary Portfolio Service European Islamic Investment Bank Plc March 2006No Treasury and Capital Markets Bank of London and the Middle East July 2007No Corporate Banking, Wealth Management, Islamic Capital Markets Products QIB (UK) PLCJanuary 2008No Treasury& Corporate Finance/ Asset/Wealth Management Gatehouse Bank PlcApril 2008No Treasury & Corporate Finance Lloyds TSB-YesIslamic Current Account HSBC Amarah (ceased trading in September 2012) YesIslamic Current Account 5

Islamic Products in UK Islamic Funds – leveraging UK Islamic mortgages UK Deposit Account UK Current Account UK Student financing Takaful - Cobalt SME financing 6

Examples of Islamic financing in the UK Shard Battersea Chelsea Barracks IIT Aston Martin 7

Features of Islamic Finance Riba (usury or unjust enrichment) Gharar (uncertainty) Maisir (speculation) Assured Profit Unethical Investment

Features of Islamic Finance (cont) The Nature of Money Money is a means of exchange only Money is not a commodity Money can only be exchanged for the same par value

The basic difference Bank Client Conventional Islamic BankClient money money + money (interest) Goods & Services

Use of funds by Islamic financial institutions DEBT BASEDEQUITY BASED The main contracts used in Islamic financing activities Murabaha / Tawarruq Istisna’a Mudaraba Musharaka Ijarah Wa’ad Wakala

Traditional Islamic Contracts: Murabaha Market Bank (Financier) Counterparty (Borrower) Market 1. $100 Cost Price (spot) 2. Assets (spot) 3. Assets (spot) 4. $110 Sale Price (deferred payment) 5. Assets (spot) 6. $100 Cost Price (spot)

Traditional Islamic Contracts: Murabaha (cont) Cost-plus financing: terms are fixed from the outset of the agreement (in particular quantum of payment) in the event of early termination, no discount applied for early settlement rebate on the deferred sale price permitted, but at the discretion of the financier

Traditional Islamic Contracts: Wa’ad Market Bank (Financier) Counterparty (Borrower) Market 2. $100 Cost Price (spot) 3. Assets (spot) 4. Assets (spot) 5. Sale Price calculated pursuant to formula (deferred payment) 6. Assets (spot) 7. $100 Cost Price (spot) 1. Undertaking to purchase Assets in the future for a Sale Price calculated pursuant to a formula

Traditional Islamic Contracts: Wa’ad (cont) Wa’ad (unilateral promise): allows for flexibility in future cashflows due to the unilateral nature of the promise, only the issuer of the undertaking is bound to perform consideration from the recipient of the promise is generally not permitted

Traditional Islamic Contracts: Ijara Lessee (Borrower) Lessor (Financier) Vendor 3. Grant of Lease 4. Rental Payments 1. Assets (spot) 2. Purchase Price 5. Grant of Put Option 6. Grant of Call Option

Traditional Islamic Contracts: Ijara (cont) Ijara (leasing): allows for flexibility in future cashflows through the mechanism to calculate rent on a periodic basis Financier holds a proprietary interest in the asset during the term of the financing. Financier takes on risk that may not exist in a conventional transaction

Governing Law Shariah law –non-national system of law –applies to all aspects of life and behaviour –Different schools of thought as to how principles should be interpreted or applied English law –has a well-known and developed jurisprudence –not open to doubt on basis of religious or philosophical principles

Governing law: Shamil Bank v Beximco Leading case in the United Kingdom –High Court & Court of Appeal judgements Background –Shamil operated in accordance with the principles of Shariah law –Shamil’s commercial activities supervised by its Religious Supervisory Board and audited each year

Governing law: Shamil Bank v Beximco (cont) Court of Appeal, Lord Justice Potter’s leading judgement in January 2004 concluded: –when interpreting governing law clauses court should lean against a construction that would defeat the commercial purpose of the agreements –there could not be two governing laws –although possible to incorporate provisions of Shariah law the general reference to Shariah law here did not identify any specific aspects which the parties intended to incorporate

Governing law: Best practice Non binding statement in recitals Representation from each party as to Shariah compliance Covenant / undertaking that it will raise no objection as to matters of Shariah compliance Submission to single governing law Fatwa from Shariah Supervisory Board

The Scholars Limited number Different jurisdictions SSB Annual audit Fatwa 22

Preliminary Structure Memorandum Interim Fatwa Due Diligence Draft Documentation Final Fatwa Prepared by financiers, lawyers and accountants Provided by Shariah Supervisory Board based on the preliminary structure memorandum Analysis of legal, commercial, tax and credit risk etc. Prepared by lawyers with input from financiers and, if necessary accountants Provided by Shariah Supervisory Board based on the documentation Informal discussions with Shariah Scholars The Fatawa process 23

The future of Islamic finance 24 9 th WIEF: 29-31/10/13 UK government Sukuk Changes in global economy – move east/developing markets Legislation normally needed to accommodate Islamic finance Demographic and political factors Equity investment Infrastructure funding

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