Thursday, September 13, 2007

The Essential Legal Regulation Reform For Islamic Finance's Accommodation and Growth in UK & US:

The Essential Legal Regulation Reform
For Islamic Finance's Accommodation and Growth in UK & US:
By: El Waleed M. Ahmed, Legal Consultant, Head of Foreign Affair Department, Kuwaiti Lawyer Firm (Yaqoub Al-Munayae & Aisha Al-Shaiji Law Firm), Al-Jabriya –Kuwait. LL.M Degree "Master of Laws" From Temple University School of Law Philadelphia-PA USA. E-mail:

Islamic Finance in US:

Islamic banking products are available in the US, but the officials there have not been as aggressive in promoting the concept as their counterparts in UK. Even Although the US remains for many Islamic investors an important market because of its depth and diversity. Furthermore, Middle Eastern investors flush with oil profits are looking for new places to invest, and American Muslims are looking to invest in a way that does not conflict with their faith. Therefore, the US remains an attractive market to invest in. As most of the investors in the, Middle East, particularly in the GCC, are US dollar based, by investing in the US, GCC investors can avoid currency risk.Difficulties facing Islamic Finance in the US;
But the US still remains relatively closed to Islamic financial institutions and some of the challenges to conduct Islamic financial transactions in the USA relate to familiarity and understanding of Islamic finance itself, and the US regulatory framework such as offering a profit-and-loss sharing deposit is a particularly difficult proposition under US legal framework, which takes the certainty of deposit principal as a given. But in Islamic banking Profit-and-loss sharing deposits are typically structured so that the bank has something akin to a joint investment with the depositor, with returns based on a portion of the profits earned and not on a set rate, so if the bank loses money, so does the account holder. Anther difficulty facing Islamic banking in US the set of restrictions placed on the range of permissible investments that commercial banks may hold. To ensure that banks do not assume unnecessary risk, their investments are generally limited to fixed-income, interest-bearing securities, which are prohibited by the sharia. In addition, commercial banks in US generally must meet numerous disclosure requirements in order to comply with regulatory policy such as the "Truth in Lending Act". These requirements typically mandate advance disclosure of APR 'Interest rate" and other terms that do not fit the principles on which Islamic finance is structured.

Moreover, In the US, there is a complex system of financial services regulation, which divides responsibility for supervision among a number of federal and state agencies. In addition, one of the main challenges facing U.S. and Western regulators is to accommodate the free exercise of religion and still carry the secular mandate of fostering safe and sound practices in the banks that they supervise.
Furthermore, there is difficulty for Muslim consumers in obtaining sharia-compliant insurance presents another hurdle to the accessibility of Islamic finance in Western markets. Because the financial institution require property insurance and private mortgage insurance to be held on the securitized mortgages they purchase. This requirement forces customers of Islamic financial institutions to purchase traditional insurance for these mortgages which is against sharia principle. Also, many Americans remain hostile to Islamic finance in the wake of September 11 2001, thus many Americans tend to assume that Islamic finance means terrorist finance.

Islamic finance accommodations in US;

The U.S. law is "broad enough to encompass Sharia compliant structures." practitioners can produce products that simultaneously satisfy the demands of secular and religious law. This is so because the U.S. law is silent on matters of religion and because the common law tradition of the Anglo-Saxon legal system is flexible and adaptive. Moreover, the US legal system itself, which is among the most settled legal systems in the world and its dynamism, openness and substantive rather than formalistic approach make reviewing, structuring and documenting Islamic transactions simpler. Thus, the US regulator usually looks beyond the form of the transaction to determine that these structures were the economic equivalent of products already being offered by conventional institutions, and thus were permissible under existing banking law. For example, in a residential net lease-to-own home finance product; it considers this arrangement as a lease-buyback arrangement, rather than an interest-bearing loan. Because the purchase and sale transactions occurred simultaneously, the bank would be acting as a “reckless principal” in such transactions, and they were therefore permitted.

As the Islamic finance industry has progressed, the involvement of US institutions has likewise increased. Information regarding Islamic finance has become and will likely continue to be more accessible and more widespread. US parties have become more and more comfortable and are not only willing, but actively seeking, to meaningfully participate. Moreover, Interest in Islamic finance has recently boomed as investors seek ways of tapping the wealth being generated by high oil prices and rising religious fervor across the Muslim world. Furthermore, the US investor, who are keen to participate in the flourishing markets of the Gulf but are limited by rules restricting foreign ownership, see Islamic bond "Sukuk" as no more than asset-based securities that give them exposure to markets in the Gulf that they would otherwise be unable to access. Thus, U.S. regulators have already started to make efforts to more fully understand and better foster Islamic finance. Thus, Educational dialogue between regulators and Islamic financial practitioners would be very useful in terms of expanding Islamic finance in the United States

Islamic Finance in UK;

U.K financial regulators have long recognized the growing demand for Sharia-compliant financial services, and recently recognized the importance of sukuk to the Islamic capital markets by introducing legislation to clarify the treatment of sukuk for UK tax purposes.

UK efforts to accommodate Sukuk & the New Tax Regulations:

Thus, the UK new tax law plans to extend its capital gains tax principles to accommodate Islamic bonds by allowing issuers of Islamic bonds in the UK to offset the coupon payments they pay to investors against company profits for tax. But before this reform an issuer of a non-Islamic bond can offset the coupon interest payment against profits, but an Islamic bond "Sukuk" does not qualify for this relief as the coupon payment in Islamic bond "Sukuk" is based on profit rather than interest and profit cannot be offset against profit. But now Sukuk would receive the same tax relief as conventional bonds. Thus, a level playing field is being created, this will allow sukuk to be issued, held and traded in the same way as corporate bonds.

Accordingly, the new rules provide that amounts paid by the issuer in respect of alternative finance investment bonds are deductible for corporation tax purposes under the loan relationships rules. They are taxable as interest, where the holder is subject to income tax; and as a profit under the loan relationships rules.

Furthermore, in order to avoidance tax schemes a number of conditions will have to be met for such arrangements to fall within the scheme. These include: the payments made to the Sukuk holders must not exceed a reasonable commercial return on the amounts subscribed; the arrangements must legitimately be treated as a financial liability of the issuer under International Accounting Standards; and the Sukuk must be listed on a recognized Stock Exchange
Although, In the UK regulatory regime for Islamic finance institutions the existence of Sharia Advisory board and the disclosure of its members are both required. But since Sharia board did not have a sufficiently managerial role in Islamic financial institutions therefore, the FSA regulator will not have to approve its personnel.

Furthermore, one of the most important issues faced by the FSA in its regulation of financial services suitable for the Muslim population in the UK was the treatment of deposits. The UK legal definition of a deposit is: "a sum of money paid on terms under which it will be repaid either on demand or in circumstances agreed by the parties." In other words, money placed on deposit must be capital certain. However with a savings account there is a potential conflict between UK law, which requires capital certainty, and Sharia law, which requires the customer to accept the risk of a loss in order to have the possibility of a return.

Thus, Islamic banks in UK resolved this problem by offering full repayment of the investment but informing the customer how much should be repayable in order to comply with the sharia principle" the risk-sharing formulation". This allows customers to choose not to accept full repayment if they wants to comply with sharia principle. Thus, the depositors are legally entitled to ask for their money back but if they wish to follow Sharia principles they can just ask for a share of the profit/loss.
In addition, Sharia-compliant home finance in Britain provides a good illustration of how regulation has been adapted to level the playing field between conventional and Islamic products. In Islamic mortgage the property must change hands twice — from seller to the bank and from the bank to the customer which means two sets of stamp duty to be paid to the U.K. government. But this disadvantage had been removed by government legislation in 2003.

London as global center for Islamic finance;

Britain is making a bid to become a leading market for Islamic finance in the world by Make London the global center and "the gateway to Islamic finance and trade.

Thus, London is far ahead of rival western financial centers, in terms of its success in attracting Islamic financial business, this is partly because of its geographical location and time zone, which give it an advantage over New York. Moreover, London's advantages include the critical mass of financial markets; its innovative, skilled and large labour force; efficient technological infrastructure; a level playing field for foreign firms; competitive personal and corporate taxation; world class regulation; the language; stability; flexibility and openness to the world have given London its historic advantage. That makes London a hospitable environment for Islamic finance. Therefore, London is seen as an ideal location by companies wanting to issue sukuk because it offers publicity, prestige and an established regulatory regime that attracts investors, potentially enabling companies to raise more money than in other locations.

After the recent tax changes in the UK these will make Sukuk issuance a valid financing option for UK business and most western governments are likely to follow with similar enabling legislation. Thus, these laws will create a level playing field for investing in conventional and Islamic securities. That development will create a huge global market for Sukuk and help the growth of the market and lead Islamic finance into the mainstream of global finance.