Innovation and Islamic syndicated financing facilities
The depth of Islamic financing modes is one of the driving factors for innovative and novel structures for project and business financing transactions in a Shariah compliant manner. This trend is going to continue as the Islamic financial industry gets itself more involved in the trade and business process of their client not only as a financier but also as a supplier, customer or business partner.
Recently in Pakistan, an innovative structure based on Shirkat ul Aqd (profit and loss sharing mode) was used to provide short-term syndicated Islamic financing facilities to power generation companies. In this transaction, the Islamic financing partners shared the operating gross profit of the company at a pre-agreed profit sharing ratio. The transaction was very successful and is now being replicated in other industries as well.
Another novel structure used recently by Meezan Bank in Pakistan was based on the simple trading and manufacturing concept. The transaction was executed with a large fertilizer industry customer where Islamic banks purchased the existing fertilizer stock of the company (acting as its customer) and took delivery of the identified stock in the selected warehouses of the client. Furthermore, the bank also gave an advance order for manufacturing of the new stock. Once the stock is delivered, it will be sold on behalf of the Islamic bank in the market and the funds received from the sale will go to the Islamic bank to complete the transaction.
The above two cases are just a glimpse of new structures coming up in the Islamic finance arena and it will further grow if the Islamic banks strengthen their product development thinking along the lines of a trading and investment house — not just as financiers but as active trade partners of their clients. Islamic banks also need to hire industry specialists and develop their own warehousing capabilities to meet the growing challenges of the business as part of their medium-term strategy.
AHMED ALI SIDDIQUI
Head of product development & Shariah compliance, Meezan Bank
Yes, there is definitely room for innovation in Islamic finance syndication. Focus is especially required for cross-border syndication where Shariah country boards/councils can be more streamlined in their interpretation of acceptable and non-acceptable products to enable active participation by multi-jurisdictional syndication houses.
HANIM HAMZAH
Partner, Roosdiono & Partners, a member of ZICOlaw (Zaid Ibrahim & Co)
The current trend in syndicated facilities is generally to structure them on the basis of a commodity Murabahah. After all, it’s fairly straightforward, provides a fixed return, and is easy to understand and easy to explain. These advantages should not be underestimated when considering whether or not the structure should be changed. The main areas for innovation would be in the structure itself. With the vast majority based on commodity Murabahah there is certainly scope for the application of different structures by designing them as close as possible to the underlying transaction.
DR NATALIE SCHOON
Principal consultant, Formabb
Islamic syndicated finance should be straightforward if the participating banks are Islamic and the project to be financed is Shariah compliant. Innovation is needed when not all the participating banks are Islamic and the corporation wishing to receive funding is not entirely Islamic. At this point, in the development of Islamic finance, Islamic banks must make a deliberate choice whether they would like to continue financing mainstream businesses or they would rather finance only Shariah compliant companies. This is the right time for Islamic banks to stop participating in deals that are not fully Shariah compliant. Financing airlines and hotels, which are involved in Shariah repugnant activities (like sale of alcohol) should not be considered by Islamic banks at all, even if the share of such impermissible activities is minimum in the total businesses of the projects seeking finance.
This might mean funding some of the Shariah compliant projects that are riskier than the conventional projects seeking finance. Islamic banks will thus have to come up with innovative structures that may allow them to limit their risk exposure in a Shariah compliant way. Halal industry should be a major focus of Islamic banks that must join hands by structuring syndicates to finance this industry. Given the under-developed Halal industry, Islamic banks may face challenges to finance projects in this niche area. Innovation will certainly be needed to meet these challenges.
PROFESSOR HUMAYON DAR
Chairman, president & CEO, Edbiz Consulting
Islamic syndicated finance has played a significant role in funding industrial and infrastructure projects for over two decades. Many Islamic banks are too small to fund such projects by themselves and do not have the staff to undertake complex project appraisal. Therefore syndications enable them to get involved in such finance, which often proves to be a learning experience.
Given the number of projects in the Muslim world requiring finance, Islamic syndicated finance has clearly a bright future. However from a client’s perspective, high arrangement fees can eat into project returns. More competition can help limit fees, but for the present this is an issue which should concern those seeking funding, especially governments who should be wary of taking on excessive expensive debt. Innovation and the provision of complex products add to fees. There is much to be said for plain vanilla products.
RODNEY WILSON
Emeritus Professor, Durham University UK
The sharp run down in growth expectations across the US and Europe has forced banks to abandon the small-to-medium size sector of the syndicated loan business, potentially opening opportunities for Islamic banks to develop local associations. Many credit-worthy borrowers are being left behind amid the retrenchment in banking activities, especially those looking for facilities in the US$25-75 million dollar range.
Our research highlights that loan value to US small businesses by US depository institutions has fallen some US$200 billion on an annual basis since its recent peak in 2008. While not all sectors of the US economy may be appropriate for Shariah compliant consideration, there are many sectors, such auto loans and equipment finance, offering asset-backed features. Currency concerns in Europe, at least at this time, suggest that the US may prove to be a better risk-adjusted target for syndication participants.
DOUGLAS CLARK JOHNSON
CEO, Codexa Capital
There is still a huge room available for innovation in Islamic finance syndicated facilities, particularly when there are a lot of opportunities to explore ways to use investors’ funds in a Shariah compliant manner. The syndicated facilities can be easily used by the syndicate arrangers in many areas. Two of these are summarized below.
a) Exploration of oil, gas and coal-based on the Jua’ala mode of Islamic finance
Under this method, investors’ funds can be used by the oil, gas and coal exploration companies in such a manner that the explored oil, gas and coal will either be used locally or exported, based on the local market conditions. Based on a syndicated legal documentation, the exploration companies will be entitled to negotiate with the local market players (including government bodies) and/or international market players to execute bilateral sale agreements immediately after obtaining licenses for this purpose. The sales proceeds after the deduction of all the costs will be shared among the investors, the exploration companies and the Islamic financial Institutions.On one hand, this will provide a unique opportunity for the development of the oil, gas and coal sector globally, by pooling investors’ funds, collected throughout the world. The Islamic financial institutions can become the ‘Mudarib’ of the investors to channel their funds through the exploration companies. Technical firms with expertise in the preparation of financial feasibility studies and able to analyze probabilities of successful exploration will have to be hired to predict on a best efforts basis the probability of success. Based on these analyses, the tentative profit can be ascertained. Since oil, gas and coal products have a higher demand, their sale proceeds will compensate the investors’ against the potential loss of unsuccessful exploration.
b) Production of agriculture products based on Muzara’a
The risk of a world food crisis can be mitigated by channeling investors’ funds to produce agricultural products in agriculture-based economies where financial resources are scared to finance agriculture products. The investors’ funds can be used to provide water, agriculture machines, seeds and fertilizer in the areas where they are most needed. The Islamic financial institutions should first rank the financing needs for the neediest areas. The Islamic financial institutions can then become the ‘Mudarib’ of the investors to channel their funds to produce agriculture products by the growers/cultivators. The agriculture products can be sold locally and/or internationally depending on market conditions. The sales proceeds of agriculture products after deducting costs will be shared among the investors, the growers/cultivators and the Islamic financial institutions.
MOHAMMAD MUJEEB BEIG
Senior vice-president, product development, MCB Bank