By some estimates, more than US$1 trillion in assets are now managed worldwide under Shariah principles. Shariah compliant investors are seeking and obtaining investment opportunities around the world. When the global economy and capital markets normalize, the demand for Shariah compliant investment opportunities will accelerate.
As Shariah compliant investors, including private equity funds, sovereign wealth funds and real estate investors, continue to acquire assets in the US, the market for syndicated Islamic financing in the US is expected to grow substantially.
Syndicated Islamic financing refers to “the participation of a group of institutions in a joint financing operation through one of the permitted modes of financing” according to the Accounting and Auditing Organization for Islamic Financial Institutions. In the US, as in other financial markets, the syndication of financial investment is a time-tested method used to increase liquidity and disperse risk among a group of lenders who, through collaboration, are able to make more capital available for a transaction than any individual lender.
A syndicate of lenders is organized and led by a lead arranger, who typically acts in one or more agent capacities on behalf of the syndicate of lenders. In return for performing these functions and syndicating the loan, the lead arranger receives various fees.
These concepts generally translate well in the Islamic finance context, with a number of structural nuances necessitated to achieve compliance with Shariah principles. An Islamic finance syndicate is organized by the lead arranger (Wakeel) entering into an investment agency agreement (Wakalah) with all syndicate members (Muwakkil), which defines the relationship of the parties. The Muwakkil provide the financing and the Wakeel is responsible for managing the funds on behalf of the Muwakkil.
Traditionally, in this structure only the Wakeel has direct contact with the obligor. In a syndicated Islamic financing, when a Wakeel syndicates its interest therein it must do so at par without any mark-up, because functionally the spread would constitute “interest” (riba), which is prohibited by Shariah principles. The Wakeel instead receives a fee for its services as lead arranger, administrative fees for managing the syndication process, collateral management fees, and/or documentation fees.
If the Islamic financing is to be syndicated among Western or other conventional financial institutions, the Wakalah, to the extent consistent with Shariah principles, should be designed in a manner economically and structurally equivalent to the relationship afforded similarly situated conventional lenders.
In light of the relatively recent institutional and cultural efforts to educate finance professionals and attorneys in the US regarding Islamic finance, there is less familiarity in the US with Shariah compliant financial products than there is in other non-Muslim jurisdictions that are financial centers, such as the UK. There is a shortage of trained practitioners and scholars who are conversant with both Shariah principles and conventional finance, and the attendant complexities of each.
US financial institutions have been cautious in their origination of and participation in Shariah compliant financings due to a variety of real or perceived institutional, regulatory and tax risks. As a result, in the US, the vast majority of Shariah compliant financings have assumed a complex bifurcated structure that allows the financial institution, on the one hand, to be issued a conventional debt instrument and the Shariah compliant entity, on the other hand, to receive Shariah compliant financing.
On the Shariah compliant side of the transaction, when the objective is to replace conventional term or revolving debt, an Ijarah (financing facilitated by a sale-leaseback transaction) or a Murabahah (financing facilitated by a cost-plus commodities back-to-back sale transaction) are suitable alternatives, among others. Concurrently, on the conventional side of the transaction, the financial institution enters into the desired loan with a special purpose vehicle (SPV) formed for the sole purpose of facilitating the transaction.
The SPV will then enter into the relevant Shariah compliant mode of financing with the Shariah compliant entity. If the debt provided by the syndicate of financiers is underwritten as a secured financing, the SPV will be granted a lien on the assets of the Shariah compliant entity and will in turn assign its lien and rights of enforcement to the collateral agent acting on behalf of the syndicate of financiers.
To some extent, this is a compromise that allows each party (the conventional lenders and Shariah compliant financing recipient) to work within their respective paradigms. Although US financial markets have become relatively comfortable with this structure, and financing of this type have been widely syndicated in this US, it has its shortcomings.
Foremost, philosophically, some Shariah scholars view this as a non-Shariah compliant structure, in that it is, in essence, form over substance. Practically, this bifurcated structure is burdensome from a documentation standpoint and, ultimately, less efficient in terms of transaction costs. Also, given the scarcity of precedent in the US courts regarding these structures, in bankruptcy or otherwise, a degree of uncertainty survives regarding the ability of the collateral agent or the syndicate to exercise all of its customary remedies against the Shariah compliant finance recipient through the SPV.
Although the Shariah compliant syndicated financing market has shown significant growth and maturation in Europe, Asia and the Middle East in its direct form (such as, where the financial institution is a direct counterparty to Shariah compliant financing) it remains a nascent market in the US. Going forward, if US based financial institutions wish to participate significantly in Shariah compliant financing of the acquisition of assets and businesses in the US (and abroad), whether through the purchase of syndicated investments or otherwise, they must expand their institutional knowledge of, and their comfort level with, Islamic finance structures. If they do not, opportunities to originate and participate in these financings will go elsewhere in the global financial marketplace.
Despite a lag in the US, the syndicated Islamic market has grown beyond its Islamic roots. European banks, such as Credit Agricole Corporate and Investment Bank (Credit Agricole CIB) and Intesa Sanpoalo, and Asian banks, such as Mizuho Corporate Bank and Industrial & Commercial Bank of China, have already seized upon these opportunities. As a consequence, outside the US, syndicated Islamic finance transactions have become an increasingly common means to finance large scale projects.
By the same token, further maturation of the Islamic finance market in the US will open additional sources of capital to US companies from Shariah compliant financing sources that have traditionally avoided the US market because of a lack of Islamic financial instruments. This could allow Islamic finance to emerge as a significant supplemental source of liquidity, particularly at a time when US conventional debt markets remain at bay in the aftermath of the global credit crunch.
Within the US, there have been only a handful of notable examples of syndicated Islamic financings. In 2006, the East Cameron Partners Sukuk offering was heralded as a major advance in the US Islamic finance market. The US$165 million Sukuk offering was backed by natural gas royalty interests originating off the coast of Louisiana. Sadly, in 2008, East Cameron filed for Chapter 11 bankruptcy protection under the US Bankruptcy Code, due to a precipitous decline in natural gas prices, tainting this offering.
The most notable US recipient of Shariah compliant financing has been General Electric, which in 2009 became the first major US company to issue a Sukuk as a means to attract international investors wishing to invest in accordance with Shariah principles. Although the syndicated Islamic finance market in the US remains largely undeveloped, it is likely that major US financial institutions will begin to evolve in order to compete for, and satisfy, the financing demands of Shariah compliant investors seeking to leverage and expand their investments in the US.
Joel Bannister
Associate
Patton Boggs
Email:
[email protected]
Bannister advises financial institutions and investors in connection with acquisition financings, asset-based financings, mezzanine financings, project financings, securitizations, equity investments and restructurings. His experience includes regularly representing finance providers in Shariah compliant financings and restructurings.
James Baker
Partner
Patton Boggs
Email:
[email protected]
Baker has significant experience representing traditional lenders in connection with investments structured to be Shariah compliant, including Ijarah, Murabahah and Sukuk based facilities.
John Vogel
Partner
Patton Boggs
Email:
[email protected]
Vogel has assisted clients in negotiations with the US and foreign private and public financial institutions to structure conventional and/or Islamic financings for private and public sector investment, real estate and infrastructure projects located in the US and globally.