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CELESQ Webinar Attracting and Using Middle Eastern Money - Investing in Real Estate in a Shariah Compliant Way
Steven J. Adelkoff, Jonathan Lawrence, Remsen M. Kinne IVJune 23 2009
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Attracting and Using Middle Eastern Money - Investing in Real Estate in a Shariah Compliant Way Introduction Basic Shariah Rules
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What is Shariah?
“O you who believe! Stand out firmly for Allah, as witness to fair dealing, and let not the hatred of others to you make you swerve towards inequality and depart from justice.”Qur’an 5:8
In the business context, Shariah is a means of conducting business through a distinct set of rules designed to facilitate fairness.
High correlation between Shariah compliant investing and socially responsible investing
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Where are Shariah rules codified?
Interpretations of the Qur’an from various Islamic schools of thought
Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)
The fact remains: Shariah mandates are not always consistently applied from Scholar to Scholar. Information is asymmetric, and Shariah Advisers and lawyers skilled in the area become useful to work through the counter-intuitive results
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Shariah terms
Halal – that which is permitted or compliant Haram – that which is not permitted Riba – charging of interest Gharar – the taking of unreasonable risk; gambling
Sukuk – Shariah compliant debt Ijara – Shariah compliant lease Takaful – Shariah compliant form of insurance Maduraba/Musharaka – forms of partnership Murabaha – a form of Shariah compliant forward sale for commodities that is used as a fixed income substitute
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Industry prohibitions
Gambling Pork production or consumption Adult Entertainment Banking and finance Alcohol production or consumption Weapons production Tobacco production or use
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Shariah-compliant investment screens
Screens haram industries Screens use various ratios to determine if a company is too leveraged
AAOIFI Shariah Standard No. 21 forms the basis of the theoretical underpinnings for screens and ratios.
Debt to assets of 30% or less (3/4/2 of Standard 21)
Impermissible income of 5% or less (3/4/3 of Standard 21)
Many companies are now failing the total debt to market capitalization ratio test
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Riba
The charging of sums for borrowed money (i.e. interest) is forbidden
But the pledging of Halal assets, the guarantying of obligations and the leasing of property under what we might consider a finance lease (or ijara) is permissible
Murabaha is the selling of a commodity at an agreed upon mark-up, and is used in Shariah as a fixed income investment substitute.
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Riba
Things to Watch Out For: Default Interest Administrative fees for late payments Consideration in respect of third party guaranties (see AAOIFI Shariah Standard No. 5)
Preferred Shares are generally not permitted (AAOIFI Shariah Standard No. 21); but dividends distributed from profits are permitted.
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Gharar
The act of taking on unreasonable uncertainty
Examples of Gharar: Gambling Insurance FX Trading Options on stock (AAOIFI Shariah Standard No. 21, paragraph 16 of Appendix B)
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Attracting and Using Middle Eastern Money - Investing in Real Estate in a Shariah Compliant Way Conventional Leasing v Shariah Compliant Leasing (Ijara)
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Ijara
Literal translation: providing goods or services for temporary use against a wage
Qur’an legitimacy: “said one of them, ‘O my father engage him on wages’” (Qur’an Surah al-Qasas verse 26) and “if you had wished, surely you could have exacted some recompense for it” (Qur’an Surah al-Kahf verse 77)
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Ijara (cont’d.)
Sunnah legitimacy: “whoever hired a worker must inform him of his wages” and “ give a worker his wages before his sweat is dried”
Scholar reasoning: Ijara is a convenient means for people to acquire the right to use assets that they do not own since not all people may be able to own tangible assets
AAOIFI Standard No. 9
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Lease terms
Amendments to terms Duration Commencement date Deposit monies to secure the lease Two contracts for same asset for same period
Sub-leases Sale and leaseback
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Use of the real estate
Prohibitions: Gambling Alcohol Pork Western style insurance and banking Defence industry Adult entertainment
Controlling sub-leases and assignments
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Treatment of rent
Fixed for life of lease or adjusted periodically
Rent variation via reference to benchmark based on clear formula
Payment by lump sum or instalments Late payment Lease repricing Rent acceleration
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Obligations of lessors and lessees
Maintenance Major repairs Insurance cost Property defects Lessee misconduct Insurance
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Guarantees and rental income
Security to secure rental payments and against misuse of the property
Instalments may be accelerated on failure to pay one instalment
No increase in rental due to delay Charitable donation in lieu of penalty payment
Future rental payments may not deducted from security enforcement
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Selling of or damage to the leased asset Termination of Ijara lease on sale of property to lessee
Lessee’s consent not necessary for sale to third party
Total destruction: Ijara lease terminates
Partial destruction: Lessor liable for damage or destruction of leased asset unless result of lessee’ misconduct or negligence
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Termination, expiry and renewal
Termination by mutual consent Unilateral termination Breach of lease terms Death of a party Total destruction of real estate Expiry at term Continuation for good cause Renewal by agreement or automatically
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Leases that end in lessee ownership
Ijara Wa Iqtina Resolution of the International Islamic Fiqh Academy No. 110 (4/12)
Finance lease Unilateral promise of ownership transfer by lessor at end of lease term
Unilateral promise with purchase schedule Purchase at end of lease term or in stages Lessor may not force lessee to buy
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Leases that end in lessee ownership (cont’d) Ijara Mawsoofa Bil Thimma
Often used in project finance Redeemable lease which buys out completed project
Agreed in advance with initial construction deal
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Attracting and Using Middle Eastern Money - Investing in Real Estate in a Shariah Compliant Way Sukuk - Shariah Compliant Leverage
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Underlying principles
Asset backing Entrepreneurial investment Defined credit participation Specific real business risk (vs. guaranteed interest-based return)
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Definition of Sukuk (cont’d)
Participation certificates Evidence investors’ right to return based on profitable investment
Return results from actual asset ownership
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Structure
Shariah-compliant underlying asset Originator/sponsor sells asset to special
purpose vehicle Asset sale transaction may be, for example, a
lease back or a sale-repurchase Concurrent transaction by SPV with asset
user, for example lease and purchase SPV issues securities to investors Investors hold direct ownership interest in
underlying asset through SPV Pass-through payments
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Other key issues
Bona fide purpose Return from profitable activity only Return not from debt, cash or other prohibited assets
Insurance Credit enhancement, liquidity support, limitations of prepayment risks, guarantees
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Governance and Regulatory Considerations Shariah rulings Commercial securities, taxation laws Regulatory organizations
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Attracting and Using Middle Eastern Money - Investing in Real Estate in a Shariah Compliant Way Shariah Scholars and Advisers Anti-Money Laundering
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Shariah scholars
Part Judge, Part Jurist Usually operates in Shariah Boards of three or more
Issues a Fatwa (Fatawa in the plural) No particular governing body or rules, just schools of thought and AAOIFI
High demand and short supply Certain Scholars are exceedingly influential in certain countries
There are no standard setting bodies, and Scholars have latitude. Information is asymmetrical. But sometimes Scholars disagree.
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Shariah advisers
Has relationships with various Scholars Has structuring expertise and knows what the Scholars will accept
Is the bridge builder between conventional structuring of equity, debt or investment partnerships and Shariah
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Purification
The act of purging oneself of impure profit, by contributing the profit to charity
A function of the Shariah Board is to tell investors what percentage of their profit is subject to purification
Shariah Boards use to recommend the charities to contribute Haram profits; modern practice is simply to allow investors to contribute impure profits to the charity of their choosing
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Tales of anti-money laundering Compliance in Shariah
The Challenges of AML-KYC in Shariah Investing
Who mandates which charities may receive purification dollars?
The home address of “Two Oak Trees down the long road, and take a left at the Big Stone”
When utility bills are in Arabic
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Further resources
www.aaoifi.com Accounting and Auditing Organization for Islamic Financial Institutions
www.islamic-finance.com www.securities.com/ifis Islamic Financial Information Services (subscription required)
www.shariahcap.com Shariah Capital www.sii.org.uk/web5/infopool.nsf/html/qintifq Securities & Investment Institute: Islamic Finance Qualification
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