SUHAIMI ZAINUL-Abidin believes that there is tremendous potential for Islamic syndicated finance to grow, given its importance as a financing tool to spread risks and pool resources.
It has been almost two decades since Islamic financial institutions began providing large-scale financing through syndicated means. While there has generally been significant growth in the Islamic syndicated financing space during that time, there have also been periods of stagnation and slowdown. For instance, as reported by Islamic Finance news previously, the current Eurozone financial crisis has dampened Islamic syndicated financing this year due to the withdrawal or easing of participation by some European banks, resulting in a sizable drop in syndicated financing activity in North Africa and, to a certain extent, the Middle East.
Nonetheless, the fact that the Eurozone financial crisis has had such a significant impact on Islamic syndicated financing is itself a testament of how much the sector has grown, and how actively Islamic and conventional financial institutions alike have participated in such financing.
Importance of Islamic syndicated financing
Regardless of the current challenges, Islamic syndicated financing remains a critically important financial tool for banks and financial institutions, and an important funding avenue for corporations looking for large-scale funding. Given the exponential growth in the conventional syndicated loan market in the past 20 years, it would not be unrealistic to expect a similar period of growth for Islamic syndicated financing in the years to come.
Syndicated financing generally refers to a form of financing where two or more financiers form a syndicate to make available a principal sum to a borrowing entity. Conventional syndicated financing has of course long been utilized as a risk-spreading means of providing sizable financing. Islamic syndicated financing is similar to conventional syndicated financing in many aspects. Islamic syndicated financing works in very much the same way as conventional syndicated financing, except that the syndication structure is premised upon concepts and contracts permissible under Shariah. It goes without saying that one of the hallmarks of an Islamic syndicated financing is the absence of the charging of interest. Instead, an Islamic financing transaction is based on gainful activities, such as trading or leasing, which generate profit for the participant financiers. However, the commercial and legal considerations are intended to be similar.
Relationships in syndicated financing
There are two main relationships in an Islamic syndicated financing structure. The first is the relationship between the agent bank and the borrowing entity. The second is the relationship between the participating financiers and the agent bank.
The relationship between the agent bank and the borrowing entity can be described as the investment tier, as it essentially results in the financing being provided to the borrowing entity and, more importantly, determines how and on what terms profits are derived for the benefit of the participating financiers. In principle, almost all Islamic financing structures (such as Murabahah, Istisnah, Ijarah, Musharakah, Mudarabah, Wakalah, etc.) can be used for this investment tier. However, the funding structure adopted would be designed to suit the purpose of the financing, the commercial expectations in terms of returns and risks, and the assets available for the structure.
In general and in conformity with conventional bank lending norms, Islamic syndicated financing structures have been used to give effect to fixed-return financing rather than partnership or profit-and-loss sharing structures, meaning that Musharakah and Mudarabah structures are rarely used.
Murabahah/Tawarruq structure
The most common structure adopted in Islamic syndicated financing remains the commodity Murabahah or Tawarruq structure. Notwithstanding the resolution by the International Council of Fiqh Academy (ICFA) that organized Tawarruq conflicts with the real objectives of Shariah because it is designed to get around the prohibition on interest and merely disguises the elements of interest-based lending, many prominent Islamic finance scholars continue to endorse organized Tawarruq structures on the basis that it is in the social interests of Muslims as a means of financing. Having said that, the resolution of ICFA has prompted certain corporations and Islamic financial institutions to explore and adopt alternative structures such as Ijarah.
The relationship between the participants and the agent bank in Islamic syndicated financing is today commonly documented based on the concept of Wakalah (agency), where typically, one of the participating financiers would be appointed to play the role of the agent bank, acting as agent (Wakeel) for the participant banks (Muwakkil). This role encompasses essentially receiving funds from the participating financiers, investing such funds in the manner agreed between the parties, executing contracts to effect such investment and collecting the profit and other sums from the borrowing entity (including making demands for early repayment based on the terms of the financing documentation).
The appointment of the agent bank and its roles would usually be documented in an investment agency agreement entered into between the agent bank and the participating financiers. The investment agency agreement also details the terms of each participating financier’s participation, such as its commitment, the funding mechanics, sharing and distribution of payments, and transfers and assignments by the participating financiers.
In addition, it sets out the scope of powers and authorities of the agent bank, including its discretion and its responsibility to take instructions from the participating financiers or a group of them (such as the majority participating financiers), limitations of liability for the agent bank and resignation and appointment of a new agent bank. This documented agency relationship would be supplemented by applicable laws of agency, meaning that there may be additional responsibilities imposed and protections afforded to the agent bank by virtue of it being an agent in particular jurisdictions or under certain governing laws.
There are benefits to ensuring that the Wakalah concept and the agency relationship in an Islamic syndicated financing are economically and structurally equivalent to the agency relationship in conventional syndicated loans, so long as it does not compromise the Shariah compliance of the relationship and the relevant contracts. This is because the agency provisions in conventional syndicated financing transactions have been refined over many years to deal with various circumstances and events, and continue to be refined over time, for example, by the Loan Market Association (LMA) in the UK. For instance, following the collapse of Lehman Brothers in 2008, the LMA proposed changes to its recommended form of syndicated loan agreement to deal with defaulting lenders and defaulting agents. It would be wise for Islamic financing players to draw on the experience and norms of conventional syndicated financing.
It is also important for the agent bank and the participating financiers to consider whether there are any particular or specific issues relevant to the agent bank which would not have arisen in a conventional setting. Among other things, participating financiers and agent banks should consider:
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The ability and experience of the agent bank to play the role of the agent in an Islamic syndicated financing. Where a commodity Murabahah structure is adopted, it would be important for the agent bank to be able to coordinate the commodity transactions with or through one or more commodity brokers. It may therefore also be important to ensure that any replacement agent bank that may be appointed by the borrowing entity or the participating financiers will have the requisite ability and experience as well, to ensure that the financing mechanics can be carried out.
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The consequences of one of the participating financiers failing to provide the funds in a timely manner. Even where the funds in question are not ultimately meant for an acquisition of assets by the borrowing entity, the structure may dictate that certain assets (such as commodities or real estate) would be purchased using such funds. The insufficiency of funding from the syndicate could result in a gridlock of the whole funding structure, unless proper alternative mechanisms are provided.
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How the agent bank will collect and distribute monies (such as compensation monies) where different participating financiers have different standards or requirements in terms of the application of such monies or the ability to retain such monies.
Conclusion
There is tremendous potential for Islamic syndicated finance to grow, given its importance as a financing tool to spread risks and pool resources. However, the realization of any such growth aspirations would require greater effort to be made to formulate a common position to deal with the agency related issues which are peculiar to Islamic syndicated financing, and ultimately standardize the agency structures and provisions in the same way as conventional syndicated financing.
Suhaimi Zainul-Abidin is a partner at Allen & Gledhill Singapore. He can be contacted at
[email protected]
.