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Published On:18 July 2012
Posted by Indian Muslim Observer

Islamic Finance and Investment in U.S. expected to grow

By Michael J.T. McMillen

The United States has been, and is now, one of the largest markets in the world for Islamic finance and investment transactions, which are transactions conducted in accordance with those principles of the Shariáh that are applicable to commerce and finance.1 A wide range of U.S. and international practitioners have participated in Islamic finance and investment transactions, and it is likely that even more will participate as the global financial markets rebound and investment activity in the United States increases again. This article anticipates those increases in transactional volume in the U.S. and presents summaries of some of the main financing structures that U.S. and international practitioners will encounter in the Islamic finance and investment transactions.

Most U.S. Islamic finance and investment transactions involve investments by foreign investors in U.S. real estate, equipment and private equity assets and businesses throughout the country. Many of these transactions involve prominent U.S. real estate projects (such as sale and leaseback arrangements involving corporate headquarters buildings) and prominent U.S. corporate entities (including warehouse chains, nursing home chains, coffee companies, and clothing companies). It is estimated that more than 150 U.S. banks have provided financing for these transactions, usually by way of a conventional interest-based loan that is integrated into a Shariáh-compliant transaction.

It is anticipated that there will be a further increase in Shariáh-compliant transactions driven by strong accumulations of investable cash in the Middle East, decreased interest in European investments as a result of the current European woes, decreased enthusiasm for short-to-medium term prospects in BRIC (Brazil, Russia, India and China) countries, and the large number of bullet financings of outstanding Shariáh-compliant debt that will come to refinancing in 2012-2014.

The unfamiliarity factor is falling away as thousands of transactions have been completed in non-Muslim jurisdictions, including North America and Europe, many involving conventional interest-based banks. There is recognition that (i) Islamic finance and investment is not a mysterious process, (ii) it is an ethically oriented structured finance, (iii) customary risks are addressed in ways that are familiar and do not disrupt existing underwriting, credit, legal, regulatory and tax assumptions and practices, and (iv) there are no significant unanticipated risks as a result of using these financing and investment techniques.

Factors Affecting Growth

Islamic finance and investment transactions are conducted in accordance with those principles of the Shariáh that are applicable to commerce and finance. The Shariáh is a body of ethical, religious, moral, legal and ritualistic principles and practices; it is the 'path' by which a Muslim leads his or her life, in all aspects of life. Islamic finance and investment involve primarily the legal principles, which are comprehensive in respect of commerce and finance. The best known principle is that a compliant participant cannot pay or receive interest. However, the Shariáh has evolved as a body of law for more than 1,400 years, and lawyers, with time, tend to increase the complexity of the system in which they operate (if only to achieve greater precision, definition and certainty): 1,400 years is a long time. Thus, there are principles applicable to sales, leasing, agency, financing, guarantees, mortgages, pledges, and virtually every concept addressed by any other legal system. Mastery, even familiarity, takes a bit of effort, particularly in light of the absence of written compilations of the principles (knowledge transmission has been oral) and the absence of rigorous contemporary books and articles on the topic.

Before considering some illustrative modern contractual arrangements, consider five factors that have had the greatest impact on the development of the industry.

First, there has been a move toward consensus (ijma) in respect of transactional structures. Divergences as between the four orthodox schools of Sunni Islamic jurisprudence continue to exist, but there has been a focused effort to develop structures that work under all four schools. The consequent reduction in transaction costs is apparent.

Second, until recently transactions could make use of only one "nominate contract," which are long-approved, but quite rigidly defined, contractual forms. In the mid-1990s Shariáh scholars determined that a transaction could use more than one such contract. This allowed for significant advances in the sophistication of transactional structuring.

Third, the fatwa (opinion of Shariáh scholars) issued in 1998 to Dow Jones Islamic Indexes in respect of equity indices and equity investing (i) institutionalized a degree of permissible impurity or permissible variance from absolute adherence to principles, (ii) institutionalized purification or cleansing concepts, and (iii) institutionalized principles for determining permissible business activities in situations where a business has multiple lines of business.

Prior to 1998 a devout Muslim could acquire virtually no stock because essentially all companies either pay or receive interest (for financings or from investments). The fatwa set forth tests that allow investment if the amount of interest is not too great, and then required that the investment be purified or cleansed by donation of the impermissible interest income to charity. Impermissible business activities are relatively well known (pork or alcohol for human consumption, interest-based banking, non-compliant insurance, pornography, prostitution and others). But questions remained as to the permissibility of investment in companies that have multiple businesses, some of which are not permissible. Until 1998, an investment in an automobile, aircraft or turbine manufacturing company might well be precluded because the corporate group included an interest-based credit company. The fatwa established the principle that (with some exceptions) the determinative analysis is the core business of the group.

Fourth, the development of sukuk opened the financing side of the capital markets. And that area is now the fastest growing area of the industry.

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Posted by Indian Muslim Observer on July 18, 2012. Filed under , , , . You can follow any responses to this entry through the RSS 2.0. Feel free to leave a response

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