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reframing conventional debt to Islamic finance reframing conventional debt to Islamic finance Presentation Transcript

  • A successful “Islamic finance”-road show - re-frame a conventional loan scheme to an Islamic finance structure - have the cutting edge - Paul Wouters - Lawyer Counsel Bener Law Office – Istanbul Turkey pwouters.law@gmail.com Singapore Dec 2009
  • A successful "Islamic finance"-road show Who should have a look at this presentation At present you have a concrete project that needs financing and you were planning to attract financiers / investors to support you with conventional, interest based finance. Together with your accountant or auditor, you probably drafted an executive summary (1) with the financial data / collateral .. that your prospected financier / investor expects to see, (2) with the projected IRR and (3) with any further merits of the deal. You probably are ready to start your road show or maybe even conducting it as we speak. Paul Wouters - Bener Law Office
  • A successful “Islamic finance”-road show Who should have a look at this presentation (ctd) And then someone did mention the possibility of “Islamic finance” to you. It is a buzzword, but you have no experience yet. You wonder : is Islamic finance something for me ? Maybe you even plan to present your existing financial exec-sum to some Middle East or Southeast Asia based Islamic bankers in order to obtain “Islamic finance”. Then this small presentation is meant for YOU. Paul Wouters - Bener Law Office
  • A successful "Islamic finance"-road show First orientation : I am not a Muslim – “Islamic finance” therefore is nothing for me ? WRONG : Islamic finance is accessible to everyone. I am a Muslim – when I lend money from another Muslim, we are making “Islamic finance” ? WRONG : when a Muslim lends money from another Muslim, that is not necessarily “Islamic finance”. In fact, any loan of money could involve Riba. It is not the religion of the people involved that decides if something is Islamic finance, it is the way that money is put to work that makes finance Islamic compliant or not. Paul Wouters - Bener Law Office
  • A successful "Islamic finance"-road show First orientation (ctd) : You did hear that Islamic finance actually is the same as conventional finance ? Islamic finance is “only hiding the interests” ? WRONG : YES: it is finance consisting out of a business transaction for a profit; BUT NO: Islamic finance is about the way money “is put to work”. That is in business situations that create permissible profit and NOT by a mere loan of cash that generates impermissible profits (interests) or RIBA. The Islamic finance project and its' documentation and structuring will therefore not be centered around a loan agreement, but around a business agreement. We will touch this aspect briefly later in the slide show. Paul Wouters - Bener Law Office
  • A successful "Islamic finance"-road show Option 1 – the object is to finance 1 single project only In a conventional environment one prepares the financial data and looks for the necessary collateral. Then a bank or financier is visited negotiate a loan and the terms and conditions thereof. Depending on the creditworthiness of the debtor, the value of the collateral and the solidity of the project one will get more / less money in the form of a cheaper / more expensive interest-based loan . Paul Wouters - Bener Law Office
  • A successful "Islamic finance"-road show Lesson 1 – the Islamic Bank / Investor does not extend pure financial loans Basically, in Islam a financial loan is extended for charitable reasons only (Qard Hasan) . This does not mean however that Islamic finance is “for free”. The same as in conventional finance, one will enter into a business transaction that will cost money. Only this time it will be structured in a “real economy”-deal with a more transparent and just profit margin. Paul Wouters - Bener Law Office
  • A successful "Islamic finance"-road show Solution – package the finance needs in a partnership or a business deal If the finance needs can be translated to the acquisition or production of assets, there could be several ways to solve your problem : 1. isolate the assets or activity into a partnership that meets Islamic standards (Mudarabah or Musharakah are widely used) OR maybe – if accepted - even use a Special Purpose Vehicle SPV-structure. One puts labor (and maybe some investment) into the partnership and the financier helps out with the rest of the needed financial means. The way of profit sharing is agreed upon with the financier and - if so desired - the conditions of his exit out of the project. Paul Wouters - Bener Law Office
  • A successful "Islamic finance"-road show Case 1– “diminishing musharakah” house financing 2 1 20 / 100 Client House 3 Finance 1 Financier 1 80 / 100 1. Agreed upon part in capital gives pro rata in property units 2. Client pays periodic rent to occupy the units that are property of the financier 3. Client pays periodicy a part of capital and acquires steadily all the property of all units until full exit financier (simplified model) Paul Wouters - Bener Law Office
  • A successful "Islamic finance"-road show Solution – package the finance needs in a business deal or partnership (ctd) : 2. look for an Islamic based or at least Islamic compliant business contract with potential finance features. Islamic law recognizes different types of nominate contracts (Murabahah, Ijarah, Istisna, Salam etc) that may allow the construction or acquisition of assets or services against deferred payment and such with various delivery conditions. This will be subject however to specific rules and regulations that might differ from the conventional framework that you are familiar with. Example: your financier buys the asset cash from a producer. He then sells it down to you with deferred payments against an agreed upon mark up (using a Murabahah contract). Other structures that resemble conventional construction contracts, leasing etc are also available. Paul Wouters - Bener Law Office
  • A successful "Islamic finance"-road show Case 2 – “ijarah muntahia bi tamleek” or financial leasing-type contract 2b Financier Client 2a 1b 1a Manufacturer 1a.Financier buys goods cash for 1000 with promise to lease from client (client may act as agent bank to assure conformity goods) 1b.Delivery goods to financier (client may act as agent bank to assure conformity goods) 2a.Client leases goods from financier at 1000+ 2b.At lease end delivery property of the goods to the client as gift or for consideration (simplified model) Paul Wouters - Bener Law Office
  • A successful "Islamic finance"-road show It is important to know that the Islamic financier will exclude some industries (gambling …). Or that IF he might be able to allow certain “haram” activities (sale of alcohol …) and some exposure to conventional interest based products, such will be in minor proportion only and probably with time bars combined with the “cleansing” of any non-permissible profits. Such cleansing will result in less residual profit and will therefore diminish the appetite of your potential Islamic financier to go ahead. Other financial ratios and business reasons also might prevent the financier from easy dealing with structures that are for example too cash-liquid. The use of conventional trust.. structures mostly is allowed, but whilst the Islamic partnerships and nominate contracts resemble sometimes closely the conventional ones, small differences can have big consequences that may decide on the viability of the project. Paul Wouters - Bener Law Office
  • A successful "Islamic finance"-road show Option 2 – looking for stable business partner In a conventional environment one prepares the financial data, looks for a partner and convince him of the viability and profitability of the enterprise. The partner will analyze the projected return on investment, market evolutions etc. Subsequently he will negotiate the conditions of his entry. Conventional legal structuring is very flexible and inventive in terms and conditions. We assume that you are familiar with those aspects (waterfalls, convertible bonds etc). Paul Wouters - Bener Law Office
  • A successful "Islamic finance"-road show Lesson 2 – observe Islamic limitations As stated above, the use of conventional trust and company structures mostly is allowed. But even when the traditional Islamic partnerships are set aside in favor of those, certain of their ground rules will have to be respected. It is important that you are aware of the basic understandings. Some activities or industries are not suitable for Islamic investments and residual presence of conventional interest based financing can cause problems. Also liquidity management of the venture has to be looked at. As stated above, there also will be some financial ratios to be taken into consideration, next to industry screening. Paul Wouters - Bener Law Office
  • A successful "Islamic finance"-road show Case 3 – “mudarabah” partnership for point-of-sales 4 2 Client / POS- mudarib venture 3 1 Financier 1 4 1. Financier invests capital 2. Client invests labor only and manages the venture 3. Client may receive monthly advance on profits for his labor (refundable if no profits show at the end) 4. Profit share according to agreement – loss only for capital financier except by serious breach management client/mudarib (simplified model) Paul Wouters - Bener Law Office
  • A successful "Islamic finance"-road show Option 3 – what about the so-called SUKUK ? The Islamic Fiqh Academy decided already more then 30 years ago that the issuance of and trading in shares (on the stock exchange) is permissible. Conventional bonds however represent a pure debt obligation (IOU from loan debt) and moreover contain the impermissible “riba” (usually translated to “usury” or “interest”). They cannot be used in Islamic finance. However, debt arising from (deferred) payment liabilities stemming from an Islamic contract can be securitized into Islamic bonds. Since such is also a pure financial obligation (IOU from contract debt), trading should be cash and at par value. Paul Wouters - Bener Law Office
  • A successful "Islamic finance"-road show Option 3 – what about so-called SUKUK ? (ctd) Islamic finance developed another financial instrument : Sukuk. Very summarized, Sukuk give title to a part of an underlying asset and the income thereof: it is not a pure financial debt instrument, but an equity-title. That underlying asset preferably generates more or less fixed income streams (for instance: rental income), that on their turn result in regular pay outs to the Sukuk holders. Another similarity with conventional bonds is that Sukuk usually have a 3 up to 10 year maturity. These are aspects that the market of the conventional bond holders specifically is looking for. One could say that Sukuk represents equity that however usually behaves like a conventional bond (medium term maturity and fixed income streams). Paul Wouters - Bener Law Office
  • A successful "Islamic finance"-road show Option 3 – what about the so-called SUKUK ? (ctd) Some jurisdictions already have specific Sukuk-regulations in place and others – mostly global financial centers - are planning them. Most types of Sukuk structures are acknowledged by the different Islamic jurisdictions. But not ALL structures will be allowed everywhere, nor be freely tradable everywhere. Not all Sukuk are aimed to the global market and/or are not expected to be tradable then at face value. But for others certain structuring might prevent international Islamic investors to participate in the issuance or on the contrary specifically interest them. The same would apply to conventional products that are tailored too much towards a specific market or jurisdiction. Paul Wouters - Bener Law Office
  • A successful "Islamic finance"-road show Option 3 – what about the so-called SUKUK ? (ctd) Approaching Islamic financiers to place Islamic Sukuk therefore needs sufficient consideration. One should comply with the local standards of the place of issuance, but if one also want to target an international investor audience, one might need some more consideration and eventually use different structures or even different jurisdictions. This entails that whilst most projects can be the subject of Sukuk issuance, not all those Sukuk might attract investors from all over the world. A project or the way it is structured may be suitable for Islamic financing, but might or might not fill the (tradable) Sukuk-bill of your targeted partners. It is worthwhile to stress that large scale project finance, turnkey and infrastructure projects are daily routine for regular Islamic (non- Sukuk) finance. Paul Wouters - Bener Law Office
  • A successful "Islamic finance"-road show Case 4 – “mudarabah” partnership Sukuk financing 2 4 Manager / Mudarib 5 Mudarabah 3 Compliant Venture Project SPV 5 2 5 1 1 Investors 1. Investment 100 by investors in SPV in return for Sukuk 2. Mudarabah: Cash contribution SPV/ labor contribution manager 3. Investment 100 in project 4. Advance mudarib remuneration (refundable if ultimate loss) 5. Profit / loss (loss absorbed by SPV only up to 100) (simplified model) Paul Wouters - Bener Law Office
  • A successful "Islamic finance"-road show Case 5 – “ijarah” Sukuk financing 2 6 SPV Investors 1 3 4 5 1. Originator sells asset for 100 to SPV Originator 2. SPV issues Sukuk and receives 100 asset from investors 3. Originator leases asset back at 100 + 4. Originator pays rent that is paid down to investors (income stream) 5. At end of lease the asset is bought back by the originator at 100 6. Proceeds are distributed to investors (simplified model) Paul Wouters - Bener Law Office
  • A successful "Islamic finance"-road show Option 4 – Investment funds The Islamic finance universe knows Reit, Private Equity Funds, Unit Trusts, Funds of Funds etc. Often conventional trusts, companies … can be used, subject to not violating the basic features of the Islamic partnerships. The financial instruments representing parts in the funds might possibly be floated on the stock exchange and/or might be freely tradable. Islamic investment strategies are however imposed. Those investment targets that violate industry screenings (haram-halal) or financial screenings (targets that are too cash liquid or too loaded with conventional interest debt / income) are excluded or only allowed within certain conditions (cleansing interests or haram income or sale). Conventional debt “leverage” is problematic. Mostly Shari’ah Boards are appointed that will set those investment criteria and certify ongoing compliance therewith. Paul Wouters - Bener Law Office
  • A successful "Islamic finance"-road show Unit holders Investments Case 6 – Islamic REIT Trustee 3 2 Manager I-REIT 1 4 Shari’ah 5 Board 1. I-Reit makes investments and distributes returns to unit holders 2. Unit holders hold I-Reit units in return for capital input and receive returns 3. Manager gives management services in return for management fees 4. Trustee represents unit holders in return for trustee fees 5. Shariah Board advices Manager and I-Reit on Shariah issues (simplified model) Paul Wouters - Bener Law Office
  • A successful "Islamic finance"-road show Shari'ah differences and perceived Shari'ah risk Because of different cultural and jurisprudential interpretations. the same “Code Napoleon”-based civil law might allow 'blue' in Spain but prescribe 'yellow' in the Netherlands. Such issues also exist between the various Islamic jurisdictions and interpretations. The Shari'ah indeed knows several mazhab (schools of thought) that geographically can be located on the global map. Just be aware of this and relax. Do not get influenced by a spectacular fatwa of a Shari'ah scholar representing a minority position from a school different from the one that dominates the jurisdiction where your deal will be executed or eventually tried in court or later on enforced. The basic wisdom is always the same: Respect the ground rules. Do what you are allowed to do. Stay away from what you are not allowed to do. And be careful and slightly conservative when you enter a gray zone. Paul Wouters - Bener Law Office
  • A successful "Islamic finance"-road show Conclusion Conventional loan documentation cannot simply the “translated” to an Islamic finance-environment by changing dots and commas. A first analysis will help to understand the available ways of Islamic finance that might suit the specific finance needs. It will give insight into the mechanisms of the specific deal and make one understand if they are what one is looking for and whether or not one stands a chance in obtaining a positive result. These are the vital questions : Is the underlying project suitable for Islamic finance ? What structure might be advisable ? And if needed: can tradable Sukuk be issued ? Paul Wouters - Bener Law Office
  • A successful "Islamic finance"-road show Know that your competitors are asking the Islamic bank / investor for “a loan” and be aware of the fact that such is exactly what he does not want to hear. You may talk “loans and interests” with your conventional banker. But also your prospective Islamic partner deserves to hear the arguments and handed the tools that he is used to work with. His interest or disinterest in a project depends on the way it is presented. A good or bad first impression often decides on success or failure. Paul Wouters - Bener Law Office
  • A successful "Islamic finance"-road show Do not blindly assume that a conventional executive summary and road show will convince (or even interest) the potential “Islamic finance” partner. First understand the own needs within the framework of Islamic finance. Then translate them to the language of the prospected financier/ investor. Have the cutting edge. From project analysis to deal closing. Paul WOUTERS Lawyer Paul Wouters - Bener Law Office
  • A successful "Islamic finance"-road show For more information: Paul Wouters Lawyer Antwerp (Belgium) Bar Association Counsel Bener Law Office – Istanbul Turkey pwouters.law@gmail.com Bener Law Office Yapi Kredi Plaza C Blok Kat 4 34330 Istanbul - Turkey www.bener.av.tr info@bener.av.tr This document is provided for information purposes only and contains generalizations and simplifications for the needs of the presentation. It is intended to highlight issues only and no to be comprehensive. Professional legal advice or relevant Shari’ah opinion should be obtained before taking or refraining from any action as a result of the contents of this document. .