Corporate restructurings were until recently relatively rare in the oil-rich Arab Gulf, but the experience is particularly novel for investment companies and banks that adhere to Islamic, or sharia, law. The Islamic finance industry grew exponentially in the years preceding the financial crisis – particularly in the Middle East – boosted by increasing religious awareness and an inflow of billions of dollars of oil revenue into the Gulf. The industry now holds total assets of about $950bn, according to Moody’s.
Yet it has been hit by the economic downturn, which caused several high-profile Islamic investment banks to default and restructure their operations and debt. Restructurings in the Gulf are already complicated by underdeveloped legal frameworks, a lack of transparency, inexperienced commercial courts and a “head in the sand” approach, bankers and lawyers say. Adherence to sharia adds another layer of complexity to the process. Bridging the gap between religious and secular commercial law – and Islamic financial theory and practice – is often complicated and gives rise to ambiguity and uncertainty, industry figures say. The difficulties have been highlighted by the $3.5bn restructuring of The Investment Dar, the Kuwaiti finance house, which is emerging as a key test case for the Islamic finance sector. TID defaulted on an Islamic bond last July and has since been struggling to get its creditors to agree to a restructuring plan. Other Islamic investment companies in Kuwait and Bahrain have also defaulted, but TID is the largest “Islamic restructuring” to emerge thus far. Islamic financial principles ban interest and promote equity-based risk sharing. While all transactions and instruments ostensibly follow sharia rules, almost all are drafted in accordance with English law. “One of the main problems is the way in which some Islamic financial contracts are drafted, which causes contentions when things go bad and a default takes place,” says Muddassir Siddiqui, a sharia scholar and head of Islamic finance at Denton Wilde Sapte, the law firm. “From a sharia perspective there is one interpretation, but from a conventional legal perspective, there is often a very different interpretation,” he says. This has been underscored by an ongoing legal case between TID and one of its creditors, Lebanon’s Blom Bank. The investment company has argued that a $10m “wakala” instrument the Lebanese lender placed with TID should be judged void since it breaks Islamic law and is therefore outside the company’s remit. An English judge said in December that Blom Bank would likely win the case if it went to a hearing, but controversially conceded that TID at least had “an arguable case”. Lawyers warn that this could potentially lead struggling Islamic companies to attempt to overturn contracts on the basis of whether they comply with Islamic law. No Islamic bank has failed during the crisis, but many have been hurt by the global downturn in real estate – the most popular asset class due to Islamic finance’s preference for real assets to back transactions. Islamic financial theory stipulates that sharia-compliant banks are agents who invest depositors’ money in profitable ventures. Therefore, according to many sharia scholars, if a bank loses money, depositors should in theory share in the loss. In reality this has never happened, as it could cause runs in the Islamic finance industry, bankers point out. Yet it is still uncertain what would happen if an Islamic bank were to default. Governments, particularly in the Middle East, are likely to step in to prevent banks collapsing – Islamic or conventional – but this could pose problems for some clerics due to sharia’s risk-sharing requirements. “Islamic bank depositors aren’t real depositors in the conventional sense, but investors that are supposed to share risks and rewards,” Mr Siddiqui says. “It’s complex. These areas have to be sorted out deal by deal, contract by contract and institution by institution.” Corporate restructurings were until recently relatively rare in the oil-rich Arab Gulf, but the experience is particularly novel for investment companies and banks that adhere to Islamic, or sharia, law. The Islamic finance industry grew exponentially in the years preceding the financial crisis – particularly in the Middle East – boosted by increasing religious awareness and an inflow of billions of dollars of oil revenue into the Gulf. The industry now holds total assets of about $950bn, according to Moody’s. Yet it has been hit by the economic downturn, which caused several high-profile Islamic investment banks to default and restructure their operations and debt. Restructurings in the Gulf are already complicated by underdeveloped legal frameworks, a lack of transparency, inexperienced commercial courts and a “head in the sand” approach, bankers and lawyers say. Adherence to sharia adds another layer of complexity to the process. Bridging the gap between religious and secular commercial law – and Islamic financial theory and practice – is often complicated and gives rise to ambiguity and uncertainty, industry figures say. The difficulties have been highlighted by the $3.5bn restructuring of The Investment Dar, the Kuwaiti finance house, which is emerging as a key test case for the Islamic finance sector. TID defaulted on an Islamic bond last July and has since been struggling to get its creditors to agree to a restructuring plan. Other Islamic investment companies in Kuwait and Bahrain have also defaulted, but TID is the largest “Islamic restructuring” to emerge thus far. Islamic financial principles ban interest and promote equity-based risk sharing. While all transactions and instruments ostensibly follow sharia rules, almost all are drafted in accordance with English law. “One of the main problems is the way in which some Islamic financial contracts are drafted, which causes contentions when things go bad and a default takes place,” says Muddassir Siddiqui, a sharia scholar and head of Islamic finance at Denton Wilde Sapte, the law firm. “From a sharia perspective there is one interpretation, but from a conventional legal perspective, there is often a very different interpretation,” he says. This has been underscored by an ongoing legal case between TID and one of its creditors, Lebanon’s Blom Bank. The investment company has argued that a $10m “wakala” instrument the Lebanese lender placed with TID should be judged void since it breaks Islamic law and is therefore outside the company’s remit. An English judge said in December that Blom Bank would likely win the case if it went to a hearing, but controversially conceded that TID at least had “an arguable case”. Lawyers warn that this could potentially lead struggling Islamic companies to attempt to overturn contracts on the basis of whether they comply with Islamic law. No Islamic bank has failed during the crisis, but many have been hurt by the global downturn in real estate – the most popular asset class due to Islamic finance’s preference for real assets to back transactions. Islamic financial theory stipulates that sharia-compliant banks are agents who invest depositors’ money in profitable ventures. Therefore, according to many sharia scholars, if a bank loses money, depositors should in theory share in the loss. In reality this has never happened, as it could cause runs in the Islamic finance industry, bankers point out. Yet it is still uncertain what would happen if an Islamic bank were to default. Governments, particularly in the Middle East, are likely to step in to prevent banks collapsing – Islamic or conventional – but this could pose problems for some clerics due to sharia’s risk-sharing requirements. source : FT
1 Comment
6/4/2014 02:40:31 pm
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