Islamic, or more accurately sharia-compliant, finance is one of those topics that, in non-Islamic countries, seems to slide in and out of fashion. But a well-prepared treasurer needs to be aware of, and understand, as many alternate financing solutions as possible to ensure that they can access funds whenever they are needed, whatever the market conditions. This means they should have a grasp of sharia-compliant finance.
Under Islamic principles, sharia law defines the framework within which Muslims should conduct their lives. This includes all areas of commercial activity. The basic principle of Islamic banking is based on risk sharing rather than risk transfer as is the case with conventional banking.
To be sharia-compliant, finance arrangements have to be approved by appropriately qualified Islamic scholars and the following principles must be adhered to in order for a transaction to be compliant with Islamic requirements:
The lender and the borrower of capital should share the risk of any investment on agreed terms, and divide any profits or losses between them. In banking terms, this means that the depositor, the bank and the borrower should all share the risks and the rewards of financing business ventures.
Therefore, in order to be sharia-compliant, investing in the financing of a hotel would be subject to debate if a nightclub was planned as part of the scheme or if alcohol was available in the rooms as part of the mini-bar stock. It has been known for Islamic finance to be approved despite such mini-bar sales on the basis that the proportion of overall revenue would be tiny – but that approval is not guaranteed. The nightclub would be unlikely to gain approval.
There is not enough space here to cover the wide variety of Islamic finance instruments that exists in detail, but further information is widely available. Some of the more commonly used products include:
In response to the increased use of Islamic finance, the International Swaps and Derivatives Association (ISDA) and the International Islamic Financial Market (IIFM) have published an ISDA/ IIFM Tahawwut Master Agreement alongside the ISDA Master Agreement to accommodate sharia-compliant swap structures.
One of the reasons for the growth in Islamic finance is the strong demand from a large number of Muslim investors (who were largely unaffected by the financial crisis of 2008) for sharia-compliant financial transactions as a use for their money. These potential investors are not only based in the Middle East, but also in Malaysia (which has the largest sukuk market) and other parts of the Far East, Pakistan and parts of Africa.
As every treasurer knows, the best time to look for new sources of finance is when you don’t need them and (although this remains a relatively small market on a global scale) now is a good time to get to grips with the Islamic finance markets in case you want to access them in the future.
Sarah Boyce is associate director of education at the ACT