ISLAMIC BANKING LAW.
- TOPIC AND IMPORTANCE.
Islamic finances are unique in that they have to be compliant with the provisions of the Sharia law. Banks thus have to comply with the laws of Islam which are available in different documents per se. Apart from the holy book of Islam called the Qur’an, there are several other documents and precedents from which the Islamic banking laws. According to the third edition of the Islamic Finance and Markets Law Review published in 2018, there are different sources of the Islamic finance law which regulate the business operations of commercial and financial importance according to the Islamic law, otherwise called the Sharia law (Ahmed, 2010).
Quran having been mentioned earlier is the chief source of these laws and guidelines. However, there are other supporting documents. The Sunnah, which refers to the words and practices of the Prophet Muhammad, which are instituted and approved by him. The Sunnah includes the Hadith which simply means the oral traditions about the Prophet Muhammad which are based on the deeds of the Prophet. Hadith is constituted and compiled by the Sahabah, the closest companion to the Prophet Muhammad. Islamic finance laws can also be derived from a consensus of jurists who exude extreme independence called the ijma. They are qualified to exercise the action of ijtihad (Ahmed, 2010). They are expert interpreters of the law. Qiyas refers to the application of analogical reasoning where in principle situations are compared against each other by the mujtahids following the Qur’an, Sunnah, and ijma.
It’s important to understand Islamic finance and the laws governing it because it’s unique from conventional practice. Carrying out of business transactions has to be done in strict conformity to these laws. In his research paper, Inutu Lukonga states that financial illiteracy with regards to Islamic banking is a reality therefore the Islamic law on banking and finances ought to be clear, which is not the case as of now. He, therefore, recognizes the need for consumer protection. The importance of these laws is based on faith in Islam and a bid to practice ethically (Ahmed, 2010). This is cognizant of the fact that some entrepreneurs may not always put these principles into action and are entirely guided by profit.
- SUKUK; INTRODUCTION AND DEFINITION.
According to the Islamic Finance and Markets Law Review, Sakuk is a term that’s used to refer to “Islamic bonds”. It is the trust certificates in Islam where a beneficial underlying asset under undivided ownership brings return based on the asset in question. Sukuk is the plural of Sakuk which means certificates (Ali, 2011).
An issuer of Sukuk pays a certain amount of revenue that’s earlier agreed upon that is produced by the Sukuk assets to the Sukuk holders. There is a thin distinction between two forms of Sukuk based on the assets; an asset-backed Sukuk which provides the holders of the Sukuk a claim to the assets which are overseen by the issuer of Sukuk and an asset-based Sukuk where cash can be drawn from the assets, however, Sukuk holders do not have a direct claim to the assets. Just like conventional bonds, Sukuk is available in certified forms, is freely transferable upon listing on the secondary market, and regularly pays a common return. Moreover, redemption is ripe upon the maturity of the Sukuk (Ali, 2011). The major difference however is that conventional bonds can be used as tradable debts and this is haram according to Sharia law which therefore makes it unlawful according to the provisions of Islam.
C (i) ISLAMIC LAWS THAT SUPPORT SAKUK AND HOW THE LAWS DO NOT SUPPORT SUKUK
The principles of the law of Islamic financing seem to support the issuance of Sukuk. These principles are deeply embedded in Islamic law and govern the issuance of Sukuk by banks and other entrepreneurs who are engaging in different business ventures. Riba is one such principle that can be translated directly to mean excess. In requisite financial terms, it is referring to the interest that is also seen with the issuance of conventional bonds. The exact definition of Riba attracts widespread debates among various scholars of Islamic law. However, the implication and understanding of Riba in Islamic financing can be clearly stated. Sharia law views interest as solely based on the mere passage of time upon issuance of a bond (Ibrahim, 2015). Thus, it does prohibit the factor of interest in connection with the use of money. Sharia law prohibits the application of interest in monetary terms and therefore contracts that have the element of riba are void according to Sharia law. This is because of how money is viewed by the law of the Islamic religion. That unlike gold, silver, wheat, dates, and other commodities, money is not accorded any intrinsic value. It is the determination of this law that money is merely used as a medium of buying goods and services and as such no profit can be derived from the exchange of money of the same denomination, or as a result of the passage of time as is the case with the principle of charging interest.
Sukuk is also based on this premise of riba. The contribution of Sukuk holders is used to purchase an asset that has intrinsic value, unlike money that will generate revenue to be shared between the holders according to an agreement made before even the revenue is met. Gharar is another law that can be taken to support the issuance of Sukuk by banks to Islamic faithful. Gharar prohibits the presence of a huge amount of uncertainty in conducting business. However, it does not rule out the taking of risks as is the case with any investment or business endeavor (Ibrahim, 2015). This is in tandem with Sukuk that encourages investment in physical assets that can be seen by Sukuk holders and has been agreed upon unanimously as a viable business option. Just like Gharar, Sukuk rules out the presence of undue uncertainty. Maysir is another law that seems to support the Sukuk as an investment option in Islamic financing. This law prohibits the conducting of businesses that depend chiefly on the chance to succeed. Qamar refers to the prohibition of gambling activities by Islam as a way of getting money. Sukuk is also done in the acquisition of assets that are not related to gambling or any activities that generate profit that is not due to effort.
Due to the ambiguous nature of the Sharia law, they often lead to litigations regarding issuance of Sukuk by financial institutions or even joint investment ventures by the Sukuk holders. The laws are subject to interpretation by experts who sit in the Sharia Supervisory Boards in financial institutions and more often than not, opinions sometimes are the opposite of one another. As the application of the sharia law is unclear, it may affect the Sukuk in a detrimental manner (Khan, & Bhatti, 2008). Thus, the law does not support Sukuk in this manner.
- ii) DANA GAS CASE STUDY.
Dana Gas is an independent company in the United Arab Emirates. In 2013, Dana gas through its CEO and advisors thought that the existing mudarabah Sukuk was not shariah compliant in what has attracted attention to the Islamic finance world and the viability of Sukuk as a business initiative (Hekmatyar, & Parkar, 2018). Dana gas argued that since they thought the existing deal was not sharia-compliant, a restructuring was inevitable. This resulted in the creation of an ad hoc committee by the company to discuss the terms of restructuring with the Sukuk holders. However, the terms were unacceptable to the Sukuk holders as over $700 million was up for restructuring in what could down the profits rate by up to 50% without a conversion rate. This dispute culminated in a serious litigation fight both in the UK and UAE (Khan, & Bhatti, 2008). Although the UK court ruled in favor of the Sukuk holders, the major decision rested on the courts in the UAE. In a report by the financial times, Dana gas on the 13th May 2018 reached a deal with the ad hoc committee of the Sukuk holders to restructure over a new three-year period of US $530 million with a four percent profit rate while those who wanted to exit the Sukuk could do so at 90.5 cents on the dollar. The Dana gas case study is potential a detrimental factor in the Islamic finance industry as it could scare off investors thus hampering growth.
Dana gas is the largest regional and first private sector natural gas company in the Middle East which has initially enjoyed a good business model. However, the company faced some non-financial and financial problems later on which ended up putting it into a situation of financial distress (Hekmatyar, & Parkar, 2018). There has been intense speculation that the organization may default on its Sukuk due to lack of government support, the weak liquidity position of the company, and lack of guidance from the company’s management. Additionally, these negative sentiments have been attributed to the limited availability of commercial bank credit to companies in distressed financial situations in the region. In short, both external and internal factors have pushed Sukuk to the brick of default. In the end, Dana Gas company went to default in October 2012 (Hekmatyar, & Parkar, 2018). An announcement from Dana Gas stated that the company had reached an agreement with Sukuk holders on the restructuring terms of the Sukuk in November 2012. Both Sukuk holders and shareholders approved the restructuring proposal because the terms were convenient and favorable. Instead of entering into a complex process of liquidation, the restructuring proposal aimed to monetize its assets.
A recent announcement by Dana Gas stated that the company’s bonds have run afoul of Muslim law. This statement has sent ripples all over the whole Islamic financial business and has also fueled concerns that lack of global and clear standards may scare off investors (Siddiqi, 2006). This controversy erupted on June 13 when Dana Gas announced restructuring plans to restructure about $ 700 million in Islamic bonds which is expected to reach maturity in October (Hekmatyar, & Parkar, 2018). However, the company recently received legal advice on the restructuring plan involving the Sukuk was not Sharia-compliant due to the continual development and evolution of Islamic financial instruments.
Sukuk holders for Dana Gas instead receive a share of the profits because interest payments are prohibited under the Quran. The company now believes that there would be an interest in having a pre-fixed level of profit distribution. Due to this concern, the company seeks to replace the existing Sukuk with a new version with a new maturity date and half the rates of profit (Hekmatyar, & Parkar, 2018). Many creditors including Deutsche Bank have protested vehemently, accusing the company of trying to avoid default. But many analysts believe that the company has little cash on hand. A variety of instruments have been developed in the Islamic finance sector to look into the ban on interest. Certain types of Sukuk operate in such a way that investors are considered business partners. Also, in exchange for marked-up payment, investors sell assets to the company. In April, $9 billion was raised in Saudi Arabia in a record-setting Sukuk issuance (Siddiqi, 2006). It was believed that an increase in sovereign Sukuk will turn out to become a huge step towards achieving a stable Islamic financial market.
However, the Dana Gas controversy has raised questions as to who decides whether or not an instrument id Sharia compliant which is a question that has been avoided by most of the market players. Malaysia is at the forefront to campaign for the creation of monitoring mechanisms and universal standards for Islamic financial markets. In the future, investors could demand higher returns to offset risks if Sukuk holders in Dana Gas lose their investment (Laldin, 2008). Consequently, this scenario could make it more difficult for any organization that considers issuing these Sharia-compliant bonds. This case shows us that it is a small problem that usually leads to bigger problems.
The rapid growth of Islamic banking products globally in recent years have been very significant. The concept of Islamic banking is rooted in particular elements that are considered prohibited because they are innately haram in Islamic law. Any contract between contracting parties must, therefore, exclude such elements and if a contract incorporates such elements, then it is considered nonsharia compliant. These elements include speculation, uncertainty, gambling, and interest (Laldin, 2008).
Lending with interest payment is considered as an exploitative act in Islam that is focused on favoring the lender as the borrower’s expense. Sharia law indicates that interest is usury and is strictly prohibited. Secondly, it is wrong in Islam to invest in businesses that are involved in prohibited activities such as producing and selling pork or alcohol. Such activities are rendered forbidden or haram and therefore participating or investing in such activities are prohibited as well. Sharia law also forbids any form of gambling or speculation. Therefore, financial institutions under Islamic culture cannot take part in contracts where goods ownership depends on uncertain events in the future (Iqbal, & Molyneux, 2016). Also, Islamic finance rues have banned involving or participating in contracts with uncertainty and/or excessive risk. The legitimacy of uncertainty or risk is measured by the term gharar. Apart from the above prohibition in Islamic banking law, it is based on the following vital principles; profit/loss sharing and material finality of the transaction. Profit/loss sharing refers to the situation where parties who enter into a contract in Islamic finance must be able to share loss/profit as well as the risk associated with the transaction. It is fair that no one party should benefit more than the other party in the transaction. Also, every transaction must be associated with a real underlying economic transaction.
According to the financial view, for a contract to be rendered sharia-compliant, then the above elements must never form part in any transaction. There was a dramatic increase in Islamic banking and finance sector in the last decade. This increase is credited to the adoption of the profit and loss sharing principles in the Islamic culture. However, Islamic banks reply to debt-like financing methods like leasing finance and mark-up. As a result, the investors are exposed to risks of default (Iqbal, & Molyneux, 2016).
- CONCLUSION
The Islamic finance industry is growing fast throughout the world especially in countries where the Islamic religion has many followers. Islamic banking laws are subject to interpretation and therefore before reaching any deal in the form of a Sukuk, terms have to be clearly stated to avoid future litigations as in the case of the Dana gas company. There needs to be a common and standardized way of conflict resolution in the Islamic finance industry. This is in a view to ensure that arising conflicts between the issuers of Sukuk and the Sukuk holders are solved amicably and swiftly.
This report is prepared by the two students who shared reading materials in the form of journals, reputable websites, and papers on Islamic banking and finance industry. Further, the students made the draft and the final copy together occasionally debating some issues and trying to come up with solutions to the Sukuk industry.
References
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Ahmed, A. (2010). Global financial crisis: an Islamic finance perspective. International Journal of Islamic and Middle Eastern Finance and Management.
Ali, S. S. (2011). Islamic banking in the MENA region. The World Bank and Islamic Development Bank, February.
Ibrahim, M. H. (2015). Issues in Islamic banking and finance: Islamic banks, Shari’ah-compliant investment, and Sukuk. Pacific-Basin Finance Journal, 34, 185-191.
Khan, M. M., & Bhatti, M. I. (2008). Islamic banking and finance: on its way to globalization. Managerial finance.
Iqbal, M., & Molyneux, P. (2016). Thirty years of Islamic banking: History, performance, and prospects. Springer.
Laldin, M. A. (2008). Islamic financial system: the Malaysian experience and the way forward. Humanomics.
Siddiqi, M. N. (2006). Islamic banking and finance in theory and practice: A survey of state of the art. Islamic economic studies, 13(2).
Hekmatyar, M. S., & Parkar, E. (2018). An evaluation of Dana Gas’s Mudarabah Sukuk from shariah and legal perspectives. European Journal of Islamic Finance, (9).