...As interest is not allowed under Islamic law, three broad financing structures have been developed by Islamic scholars, all involving bank purchases of the goods that the buyer wishes to procure. The bank will then either resell the goods to the buyer (Murabaha), lease them to the buyer (Ijarah), or go into partnership with the buyer with the bank putting up the money and getting a return only if the venture is profitable (Musharaka). While lenders have modified these structures to minimize their exposure to the underlying commercial transaction, Islamic loans must obtain the approval of Islamic scholars. It is often controversial as to what structures are truly Shariah compliant.Got that? Me neither. All I know is that what really needs to be watched is the free world's waiver of sovereignty--to sharia.
The sukuk or Islamic bond was further developed to facilitate Islamic financing. This instrument allows the debt to be securitized and syndicated, while the underlying financing must follow one of the acceptable Islamic structures. Sukuks are traded on the Nasdaq Dubai exchange. Elaborate sukuks have been developed to mitigate risk and provide returns similar to that of conventional interest-bearing loans.
Existing Nakheel assets were sold to a special purpose vehicle (SPV) and the assets were then leased back to Nakheel. The SPV raised the funds to buy the assets by issuing lease-based sukuks. The proceeds of the sukuk were used to fund construction of the Palm and the sukuk holders were to be paid out of Nakheel's lease payments to the SPV.
The major strength of sukuks was also their major weakness. There had been no history of sukuk defaults. While this was very reassuring to lenders it also meant that there was no experience as to how the Dubai courts would treat a sukuk in default.
The potential default of Nakheel's sukuk raises key issues for both sukuk holders and proponents of Islamic financing. While structured according to Shariah law, sukuks are typically governed by U.K. law and international arbitration. There is no experience as to how the courts of Dubai will view these bonds and whether U.K. or Shariah law will take precedence. The prospectus warned that the Dubai courts are not bound to enforce U.K. judgments without re-examining the merits of the case and may not consider U.K. law as the governing law. If Islamic lenders are supposed to risk share with the borrower, the courts may consider Islamic loans lower priority to Nakheel's or DW's conventional debt. Lenders would probably rather see these loans restructured than be pursued through the courts. Acceptance of DW's waiver of sovereign immunity also needs to be watched...
Tuesday, December 8, 2009
Is That a Sukuk in Your Pocket Or Are You Just Happy To See Me?
Remember when Wall Street took the tumble that landed us in our current recession? Remember how there were those--not mentioning names--who insisted that the shellacking showed that capitalism was on the way out while that sharia-compliant finance was the up-and-comer? Well, as Lorne Cutler 'splains in the Financial Post, Dubai's dire financial situation is set to show that sharia finance isn't any better able to weather the ups and downs of the marketplace than is the infidel system. In fact, because of its freaky set of rules, sharia finance may make things even worse: