islamic banking: an opportunity for...

Islamic Banking:

An opportunity for Belgium?

December 5, 2013

Introduction Michel Vermaerke,

Chief Executive Officer of Febelfin

Islamic Banking: An opportunity for Belgium? | December 5, 2013

Introduction

Welcome

Context and the history of this colloquium

Objectives of this colloquium

European involvement

Islamic finance as a participative banking model


Programme


09:00 Welcome

09:30 Introduction

Michel Vermaerke, Chief Executive Officer of Febelfin

09:40 Islamic banking in theory and practice

Professor David Bassens, VUB & Geert Bossuyt, CEO of Khalij Islamic

10:20 Close experience in Islamic Banking - The case of Luxembourg and of France

Rachid Ouaich, Président de l'IFPA (Islamic Finance Professionals Association) - Luxembourg

& Gilles Saint Marc - Lawyer Gide Loyrette Nouel A.A.R.P.I - Paris

11:00 Break

11:15 Detailed Legal and Tax analysis of Islamic Banking in Belgium

Dominique Blommaert - Lawyer & Imane Karich, Consultant in Islamic finance

12:00 Closing note

12:10 Q & A

12:20 Networking lunch

Islamic banking in theory and

practice Professor David Bassens, VUB

Geert Bossuyt, Chief Executive Officer of Khalij Islamic


Outline

What is Islamic finance?

Islamic retail banking model

Geographies of Islamic finance

European involvement

Prospects for Islamic retail banking in Belgium


What is Islamic finance?

Islamic finance = “halal” finance = Shari’a-compliant finance = faith-based banking,

finance, and insurance in line with the Shari’a, an interpretation of Quran & hadiths by

Shari’a scholars

The Shari’a generally prohibits:

• Riba: ‘growth’, generally interpreted as all forms of interest

• Gharar: ‘uncertainty’ in contracts, legal risk

• Maysir: ‘gambling’, unnecessary risk taking (= speculation)

• Investment in haram products/sectors: (e.g. weaponry, pork meat, pornography,

and alcohol)

Islamic economy: prevent unequal distribution of risk & wealth in society via profit-and-

loss-sharing, while encouraging entrepreneurialism

Islamic finance: no pure debt-trading, but asset-backed/asset-based products

• Wholesale: no to bonds, derivatives, short selling, etc.; yes to stocks & sukuk

• Retail: mudarabah deposits & Islamic mortgages


Islamic retail banking model

In theory two-tiered equity investments (cf.“profit-and-loss sharing”); in practice one-

tiered model with “mark-up” products that circumvent interest-prohibition


Liabilities Assets

Mudarabah:

- Transaction deposits (nominal

value guaranteed, no returns)

- Investment deposits (nominal

value not guaranteed, PLS)

1. Two-tier mudarabah

- Mudarabah financing (PLS)

2. One-tier mudarabah

- Musharakah financing (PLS)

- Murabahah (mark-up)

- Ijarah (mark-up)

- Salam (mark-up)

- Al-Istisna (mark-up)

Qard al-Hasanah (benevolent

loans)

(Bassens et al., 2011)



Distribution of “Shari’a-compliant assets” in 2012

(adapted from The Banker, 2012)

World Region 2011 (US$ ml) 2011 (%) 2012 (US$ ml) 2012 (%)

Non-GCC MENA 390,960 40 487,427 42

GCC 358,242 36 404,897 35

Asia 170,310 17 208,482 18

Australia/Europe/North America 53,391 5 54,717 5

Sub-Saharan Africa 10,753 1 10,733 1

Total 983,613 100 1,166,256 100



International Financial Centres involved in Islamic finance

(Bassens et al., 2010)

“European” involvement

Wholesale: Mostly a UK business!

• UK: London as a global centre for sukuk structuring & listing, Shari’a-compliant

funds, recent plans to issue a sovereign sukuk and offer Shari’a-compliant index

• German: issuance of a sovereign sukuk (Saxony-Anhalt sukuk)

• Luxembourg: sukuk listings and funds

Retail markets: UK again

• UK: 1 full-fledged Islamic bank (Islamic Bank of Britain) and conventional banks

with Islamic windows (e.g. HSBC) -> level-playing field (e.g. licence non-interest

paying banks, cut double stamp tax)

• Some developments in France & declaration of intention in The Netherlands, but

stymied by regulatory issues


Prospects for Islamic retail banking in Belgium

Belgian opportunities: underserviced, but entrepreneurial (urban) Muslim

population in Belgium (e.g. Islamic deposits & Islamic mortgages & SME

finance)

Belgian challenges: • Limited demand, nothwithstanding potential because of low awareness of Islamic

products and idea of necessity (“darura”)

• Limited success of investment products (e.g. Islamic funds) because of socio-

economic status of target groups (e.g. halal fund Fortis, 2007)

• Specific regulatory challenges: obligation to give interest as a “bank”; double stamp

tax for Islamic mortgages

Belgian solutions: • Jump-start via Islamic windows: cross-subsidization by large conventional banks to

dilute risk now located in target groups

• Go beyond the niche: address broader demand for safe & ethical deposit and

investments with Belgian middle-classes -> “mainstreaming” Islamic finance


Practical differences between Islamic and

conventional finance

Conventional finance and Islamic finance are very similar as the financial

needs are similar

For any conventional concept/contract there is an Islamic comparable contract Murabaha: the most common form of lending. If done with banks then equivalent to deposits/money

markets

Ijara: medium – long term financing. If done as a financial lease then equivalent to fixed income

asset class/bonds. If publicly traded/securatised then becomes known as Sukuk

Arboon: can be used as call and put option, or for short sale

Mudaraba: investment management where fees are profit based, can be used as a framework for

Sukuk type instruments

Wakala: also fund management and brokerage

Istisnaa: project finance

Musharaka: management partnership close to preference share, managing partner can earn fixed

fee as salary and larger share of profit

Role of Scholars/fatwa and ethics

The contradictio in terminis

Islamic banking is about banking


Facts and Figures


The Islamic market is still relatively small: Shari’a compliant assets worldwide total close to an estimated $1500bn (depending on source) and

have been growing at around 15% per year over the last ten years, placing Islamic finance as a global

asset class all on it own

Only about 12% of Muslims banks according to Shari’a principles

Geographically main centres are Middle East and Malaysia while highly populated countries as

Indonesia, Pakistan, parts of India, Nothern Africa…. still lag behind

However, the potential is huge: There are about 1.5-2 bn Muslims in the world and Islam is the fastest growing religion of all major

religions (by 2030-35 one third of world population is expected to be a Muslim)

Wealth of Muslims is fastest growing

It is expected that Islamic banks will account for 40 – 50% of total savings of Muslim population

worldwide in 8 -10 years

Belgium counts about 900.000 people of Muslim descent (roughly 8% of total population)

What is driving the growth of Islamic finance?


90%

10%

65%

35%

“Shari'a Compliance does not matter”

“ Shariah compliance is important” “ I would buy Shari’a compliant products only if I don’t have to compromise return

or service quality”

“ I would use Shari’a compliant products even

if I have to compromise some return or

service quality”

Source: McKinsey Report

The caring minority-and not the indifferent majority- will dictate the shape of the market. Kosher chips in the USA Halal beef in the UK

The future of Islamic finance


Short term future: Muslims will become more and more aware of the possibility to bank according to Shari’a principles

and hence will ask more and more for such products. Muslim world: International financial players will further expand in the ME and Muslim countries in general. Their product range will

be adapted to the local needs. Conventional local banks will expand in Islamic finance or convert to an Islamic bank The (retail) market will become ‘Islamic” rapidly

Western world: Western banks will (need to) recognize more and more the importance of Islamic finance and adapt product range Islamic banks will be further set-up (though face economies of scale disadvantages)

Long term future: The “Islamic” market will become the “conventional” market in most Muslim countries and lose its

differentiating feature Deposit market in Malaysia Sukuk market

Over time, all Western banks will have an Islamic product range (or a conventional product range that is Islamic as well ) and compete with Islamic banks

My thoughts vis a vis Belgium


Islamic finance is an opportunity: Market is not yet fully mature; growth rate is high Pool of liquidity Pool of new clients/better client satisfaction

Islamic finance is a necessity: The trend towards Islamic finance is irreversible Staying at the side-line while others react also gives a signal

Islamic finance is ‘easy’: Also conventional bankers can do Islamic finance (Islamic banking is in the first place about banking) The amount of rules and regulations to be adapted to create a level playing field is relatively limited

Close experience in Islamic Banking -

The case of Luxembourg and of France Rachid Ouaich, Président de l’Islamic Finance Professionals

Association - Luxembourg

Gilles Saint Marc, Lawyer Gide Loyrette Nouel

A.A.R.P.I - Paris

Luxembourg – Hub for Islamic Finance

Content

- Luxembourg: A history of innovation in the European Islamic Finance market

- Luxembourg: Leading European center for Islamic finance

- Broad choice of investment vehicles in Luxembourg

- Sharia Compliant Fund Structuring in Luxembourg

- Islamic Products in Luxembourg

- Taxation of Islamic Finance Products

- Sukuk Opportunities in Luxembourg

- Initiatives (IFSB, IILM, Islamic Bank,…)



A history of innovation in the European Islamic

Finance market


• 1978 – First Islamic finance institution established in a western country

(Islamic Banking System)

• 1982 – First life insurance company (Takafol SA)

• 1983 – First Sharia compliant insurance company in Europe

(Bahraini Solidarity Group)

• 2002 – First European stock exchange to enter Sukuk market

(Malaysia Global Sukuk)

• 2009 – Deutsche Bank domiciles the Platform “Al Mi’yar”

(Sharia compliant securitization vehicle)

• 2009 – Luxembourg Central Bank became member of IFSB

• 2010 – Luxembourg Central Bank became member of IILM

• 2012 – FWU German and Luxembourg based insurer launched debut corporate sukuk (USD 55

million)

• 2013 – IILM launches first sukuk

• 2014 – Launch of first Eurozone fully fledged Islamic Bank with head office in Luxembourg


Leading European centre for Islamic finance


33 regulated Sharia compliant Funds and Sub-Funds with AUM of USD 1,95 billion

(CSSF statistics July 2013)

Total assets under management in Sharia compliant investment vehicles is getting to

USD 4 billion (unregulated vehicles included)

16 Sukuk with a combined value of USD 7.3 billion listed at the Luxembourg Stock

Exchange (Bourse de Luxembourg)

3rd domicile for Sharia compliant funds in the world with 111 funds following

Malaysia (263), Saudi Arabia (163) => Thomson Reuters/Lipper Global Islamic Asset

Management Report 2014


N°1 fund international servicing centre in Europe and the 2nd worldwide

147 Banks (N°1 location in EU for private banking)

High quality regulated framework for UCITS and non UCITS funds

Worldwide leadership in cross border distribution of financial products /

World leadership in cross border distribution with 75% on the market /

700 Luxembourg domiciled funds are registered in Bahrain.

Flexible and tax efficient structures (SIF, SICAR, SOPARFI)

Committed to develop Sharia compliant solutions. Stable and predictable environment

Compatible with Sharia Law, Tax Circulars, Large Double Tax Treaties

Large Double Tax Treaty Network : 64 DTT’s in force; 21 DTT’s pending (eg UAE,

Bahrain, Qatar, Malaysia, Kuwait, Morocco, Lebanon, Turkey, Kazakhstan, Saudi

Arabia, Oman, Tunisia, Indonesia)

Leading European centre for Islamic finance



Broad choice of investment vehicles



Luxembourg investment requirements must prevail as imposed by the December 10th

2010 Law or SIF Law 13th February 2007

Compliant with written guidelines relating to the Sharia investments principles

The fund will be run within the Sharia principles interpreted and laid down by the

Sharia Board under the responsibility of the Board of Directors or the Management

Company

Role and functioning of Sharia Board to be described in the Prospectus. In case the

Sharia scholars have an executive power equivalent to those of the Board of

Directors, this has to be pre-approved by the CSSF.

Sharia Compliant Fund Structuring



Murabaha deposits, Murabaha on shares

Wa’ad (underlying : FX or equities)

Islamic Funds (Equity, Real Estate, Private Equity, etc,...) using Murabaha, Ijara,

Istisna and Musharaka structure

Takaful

Sukuk using securitization structure

Islamic Products in Luxembourg


Islamic products that can be set up within the existing legal and

tax framework of Luxembourg – the full range including:


Liberal approach to Islamic transactions

Pragmatic and open minded position

Confirmation of compatibility of the Luxembourg Tax framework with Islamic Finance

requirements

Tax Circular 12th January 2010 in relation to direct taxes applicable to Murabaha

agreements and Sukuk transactions

Tax Circular 17th June 2010 issued by the Luxemburg indirect Tax authorities

providing guidance regarding registration duties (real estate transfer taxes) and

certain VAT aspects applicable to Murabaha and Ijara transaction in relation to

Luxemburg real estate

Taxation of Islamic Finance Products



SUKUK

Yield on sukuk treated as interest payments on conventional debt instruments

Applies even though the yield on the instrument is directly contingent on the

income earned on the underlying asset

Yield will be tax deductible at the level of the sukuk issuer in the same way as

interest on a conventional debt obligation

No withholding tax applies on such a yield under Luxembourg domestic law

(implications of EU savings directive should be fairly limited given the nature of

the instruments and the residency of the investors)

Taxation of Islamic Finance Products Tax Circular 12th January 2010 (Direct Taxes)



MURABAHA “Substance over Form” approach

Income assimilated to interest from a tax point of view

Taxation of the income can be deferred over the term of the transaction.

Treatment granted if the following conditions are satisfied:

• Finance provider acquires the goods with the aim of reselling them (maximum period of six

months following the initial acquisition)

• Predetermined mark-up as remuneration for the services provided, known and accepted by

both parties

• The remuneration must be deferred for accounting and tax purposes in the finance provider’s

books (based on a straight-line method)

Taxation of Islamic Finance Products Tax Circular 12th January 2010 (Direct Taxes) – cont’d



Registration duties and certain VAT aspects applicable

to Murabaha and Ijara agreements

Registration duties (transfer tax)

Taxation of Islamic Finance Products Tax Circular 17th June 2010 (Indirect Taxes)


When a property is acquired in order

to be resold: Increase in the tax rate

from 6% to 7.2%, or 9% to 10.8%

• Refund of 4% or 6% if the resale

takes place within four years

following the acquisition

• Refund of 5% or 7,5% if the resale

takes place within two years

following the acquisition

Only the difference between the

transfer tax due and the transfer tax

refundable is due on the first sale

(from the client to the operator)

When the deeds of acquisition and

resale are presented to the

authorities simultaneously




Registration duties (transfer tax) – Cont’d


Non-application of transfer tax on

“capitalised interests”

Conditions:

- The client must take immediate

possession of the property;

- the delay between the purchase of

the property and its resale to the

client must not exceed ten days;

- the contract for the original

purchase of the property must

contain a clause stating that it is a

Murabaha, and a copy must be

attached to the notarial deed.

The difference between the

acquisition price and the resale

price is not liable to transfer tax.

The resale price which the client

pays the operator (usually an

SPV) will in principle be higher

than the acquisition price paid by

the operator.

The Circular states that this

difference should be analysed as

“capitalised interests”





VAT

- SPVs used to operate deals under Murabaha or Ijara mode are

subject to VAT (VAT registration)

- SPVs benefit from exemptions linked to real estate transaction (e.g.

VAT on rents for Ijara)


Listing of Sukuk with the Luxembourg Stock Exchange

Sukuk can be structured under the Securitization Law of

22nd March, 2004

Tax efficient capital market investments and transactions

Sukuk in Luxembourg



To raise issuers profile in Europe by accessing the global debt market with its fast

business growth and expansion.

Cost efficiency

The issuer should seek to benefit from all the advantages that Luxembourg Capital

market is offering:

• An attractive international listing market place for securities

• Support of international clearing and settlement entities

(Clearnet, Euroclear, Clearstream)

• A gateway to international issues and securities

Why listing Sukuk in Luxembourg ?



Securitization Law – Main features

Securitization vehicle as a company or a fund (with a management co)

SV not supervised by CSSF unless it issues securities continuously to the public

All assets can be securitized such as: mortgages, trade receivables, commercial credits, current

accounts, shares, debenture loans, buildings, etc…

No withholding tax on interest or dividends

Expenses and payments to SV holders are tax deductible

VAT exempt

No Luxembourg wealth tax

Benefit from DTT for Securitization companies

Can be listed on the Luxembourg Stock Exchange

Possibility to have segregated compartments

Sukuk & Securitization Law



Asset-backed securities in accordance with article 2.5 of the Commission Regulation

809/2004 (the “Prospectus Regulation”) if they are securities (a) representing

interests in assets, including rights intended to assure financial servicing or receipt by

the holder of such assets of payments ensuring timely discharge of payment

obligations under the sukuk, or (b) secured by assets where the terms of the sukuk

provide for payments related to payments or reasonable projections of payments

calculated by reference to identified or identifiable assets, or

Debt securities guaranteed by a third party pursuant to article 23.2 and Annex VI of

the Prospectus Regulation, provided that principal and periodical distribution are paid

independently of the performance of the underlying asset(s)

Disclosure – CSSF regulation as per 26th January 2011

Asset Backed vs Asset Based Sukuk



- October 2010: Set up of International Islamic Liquidity Management Corporation based in Kuala

Lumpur

- Collaborative effort by 10 central banks or monetary agencies including Central Bank of Luxembourg,

as well as one multilateral organisation to assist institutions offering Islamic financial services in

addressing their liquidity management

- The regulators collaborating for the setup of IILM are the shareholders of the initiative

- Main objective is to address the major weakness in Islamic Finance : shortage of highly liquid,

investment-grade financial instruments which banks can use to manage their short-term funding

- August 2013: IILM auctioned its debut issue of Islamic bonds, selling $490 million of three-month

sukuk => priced at 30 basis points over LIBO and issue fully subscribed

- Future issuances to be listed in Luxembourg

- Several Luxembourg banks are primary dealers on the IILM sukuk

Central Bank of Luxembourg part of IILM initiative

(2010)



- First Eurozone fully fledged Islamic Bank

- Head office : Luxembourg

- Dedicated to retail, corporate and private banking

- USD 80 million capital

- Shareholders : Private investors from Gulf Arab countries, including a royal family

from the United Arab Emirates and a supranational financial organization

- License procedure ongoing and to be obtained end of Q1 2014

- Operations to start Q4 2014

- Branches to be opened in Brussels, Paris, the Netherlands and Frankfurt

Eurisbank : First Eurozone Islamic Bank



LFF and ALFI working groups : Islamic Finance Task Force

Education: IFBL – Islamic Finance educational program

IFPA: Islamic Finance Professionals Association

CSSF (Regulator) revised its website to include a part dedicated to Islamic Finance

Luxembourg governmental sukuk?

Other initiatives


Rachid Ouaich

Islamic Finance Professionals Association (IFPA)

Chairman

Wafra Capital Partners L.P.

Head for European Investments

Email: [email protected]


mailto:[email protected]

Islamic Banking : An opportunity for Belgium ?

Gilles Saint Marc

Partner, Gide Loyrette Nouel A.A.R.P.I


Table of contents


1. France’s interest and approach of Islamic Finance

France’s interest in Islamic Finance

The French approach

2. France, a Shariah-friendly legal and tax environment

Common principles

Adequate general legal structures

Dedicated law and regulations

− Mutual fund - principles

− Mutual fund – technical clarifications

− Issue of Sukuk - Principles

− Issue of Sukuk – French compatibility

− Issue of Sukuk – Example of a structure

− Issue of Sukuk – Technical clarifications

− Issue of Sukuk – Tax clarifications

− Assets financing

− Projects financing

3. Islamic Finance in France today


1.

France's interest and approach of Islamic Finance

France’s interest and approach of Islamic Finance France’s interest in Islamic Finance Consequences of the economic and financial crisis of 2008

Economic and financial crisis: credit crunch and need for liquidity to finance

the French economy

− Will the credit and bond markets return to normal reduce appetite for

Islamic Finance?

− Developing the idea of a Great Sukuk to finance capital expenditure of the

State and local authorities without jeopardizing the French State’s national

debt


France’s interest and approach of Islamic Finance France’s interest in Islamic Finance

Integrating factor of a modern and moderated Islam: France concentrates the

largest Muslim population in Europe (6 millions)

− 3 times bigger than Muslim population in the UK

Islamic Finance: an alternative means of financing

− Simplicity and practicality vs. unnecessary complexity

− Long-term financing: matching maturity of long-term investment

− Participative financing in the performance of the underlying assets: the capital provider acts as a partner of the company and its remuneration is only based on the cash-flows generated by the financed assets

− Asset-based financing: financing based on tangible assets (project finance, shipping, car fleet, aircraft, goods, machinery) vs. financial assets (derivatives, CDO etc.), which limits the risk of bubbles and of excessive leverage

− Transparency: Sharia-compliancy of the financing provided that the use of funds be Sharia-compliant itself


France’s interest and approach of Islamic Finance France’s interest in Islamic Finance

Principles underlying Islamic Finance are not the monopoly of Islam

− Money is not an end in itself but an instrument to facilitate the exchange of goods and

services

− As such, money shall not be remunerated by the mere lapse of time (prohibition of riba).

The remuneration is only legitimate if its derives from the profit made by an investment in

productive activities. The capital provider is not a passive creditor of the company but an

active partner associated to the profits and losses (with no guaranteed remuneration)

− Idea already stated by Aristotle and the Franciscans in the 13th century and found in the

Middle Ages with la commande and le prêt à la “grosse aventure”, then in the industrial

revolution with capitalism. Interest bearing loans have only been accepted by the

Catholic Church in 1917 and the usury remained prohibited between professionals in

France until 2003

− Reaction to the financial speculation from the 70s that Islamic finance has made the

herald

− It only belongs to the conventional finance to come back to basics: finance the real

economy and receive remuneration only if the investment or the company is profitable


France’s interest and approach of Islamic Finance The French approach

Development of Islamic Finance vs. secularism of the French State

− Secularism: state neutrality with respect to the private spiritual sphere, but

not promoting agnosticism or atheism (the French Minister of the Interior

is also Minister of Religions)

− The French legal system is inherited from the Judeo-Christian religion,

and does not take into account the specificities of Islam: reverse

discrimination against 6 millions of French nationals?

− Less than a failure to secularism, encouraging the communitarianism that

does not correspond to the French republican model of integration

(crucible as opposed to the Anglo-Saxon model of juxtaposition of several

communities)?

− But is integration in a community not the necessary intermediate step prior

to integration in the Republic?



State law vs. Shariah principles ?

• Case Shamil Bank of Britain EC vs. Beximco Pharmaceuticals Ltd (Court

of Appeal, 28 January 2004): The governing law cannot be English law

subject to Shariah principles

• French position: To ensure higher security, it was decided to recommend

that contracts be governed by national law (e.g. French law)

The question of the compatibility of the transaction and the contract with

Shariah is a separate issue from legal validity and enforceability, and must be

dealt with separately in the fatwa issued by the Shariah board (which can be

appendixed to the contract)



Strong political determination of Christine Lagarde (former French Minister of finance): "We will

adapt our legal environment so that the innovation and stability of our financial sector can benefit to

Islamic Finance and make its activities as welcome in Paris as they are in London and other places "

(International Financial Meetings Paris Europlace July 2, 2008)

Creation of the Islamic Finance Committee of Paris Europlace January 2008

Assignment letter: identifying the legal and tax obstacles to the development of Islamic Finance in

France and making proposals to remedy the identified obstacles

Conclusions of the Islamic Finance Committee in June 2008: 3 statements

− Similar principles

− Adequate general legal structures

− Necessity for technical and tax adjustments:

• Collective Management: Recommendation of the AMF of July 2007

• Sukuk: Recommendation of the AMF of July 2008, operational guide NYSE - EuroNext Oct.

2009 ; tax instruction of August 2010

• Murabaha transactions: tax instruction of August 2010

• Ijara transactions: tax instruction of August 2010

• Istisna'a transactions: tax instruction of August 2010



Importance of simultaneous dissemination of what Islamic Finance is about

− Memorandum of Understanding with the AAOIFI (Accounting and Auditing

Organization for Islamic Financial Institutions): Normalizing organism

headquartered in Bahrain

− Nearly 60 legal and accounting standards established (Figure-type

contracts)

− Translation of more than 20 standards of literary Arabic into French

− Teachings of the principles of Islamic finance at several universities:

Strasbourg, Dauphine, Paris I, Paris II, Sciences Po

− Multiplication of seminars on the subject



2.

France: A Shariah Friendly legal and tax environment

France, a Shariah-friendly legal and tax environment Similar principles

French and Islamic Laws: an analogous tradition sharing similar principles

− Prohibition of remuneration by the mere lapse of time: Riba

− Prohibition of speculation and uncertainty of situations: Garhar, Maysir

− Prohibition of investments into specific activities: haram activities


France, a Shariah-friendly legal and tax environment Adequate general legal structures

Existing legal structures suitable to Islamic finance concepts:

− Ijarah Leasing regime applicable to moveable assets or real estate assets

(leasing regime of articles L.313-7 and seq. of the French Monetary

and Financial Code)

− Mudarabah Participating loans (regime provided by articles L.313-13 and seq. of

the French Monetary and Financial Code)/AIF and UCITS

− Sukuk Issue of bonds:

subordinated bonds (French Commercial Code, art. L.228-97)

subordinated instruments (French Commercial Code, art. L.228-37);

and

ability to provide for an index-based remuneration (articles L.112-2

and L.112-3 of the French Monetary and Financial Code which allow

for the indexation to the performance of the issuer of the interest paid

to bondholders)

Implementation of a French equivalent to Anglo-Saxon trust: Fiducie

Outside these existing structures: freedom to contract subject to:

− Compliance with French rules of public order

− Absence of tax discrepancy: conventional finance and Islamic finance need to be on an equal

footing regarding tax law


France, a Shariah-friendly legal and tax environment Dedicated law and regulations Mutual fund - principles

The ideal contractual type for investment funds: the mudaraba

Similar to a limited partnership, a party (rab

al maal) provides the funds, other provides

the know-how (mudarib)

Under French law, this structure

corresponds to the regime applicable to

any mutual fund (UCITS and AIF)

Two requirements :

only invest in halal activities,

only invest in companies whose debt ratio

is below 33%

Investor

(Rab al maal)

Investment Fund

Management

Company

(1) Deposit (2) Profits

and losses

(3) Provision

of know-how (4)

Remuneration


France, a Shariah-friendly legal and tax environment Dedicated law and regulations Mutual fund – Technical clarifications

Recommendation of the AMF July 17th, 2007 regarding UCITS

− This recommendation provides that UCITS may :

• use extra-financial criteria (developing for example an index management

based on a Shariah compliant index, Dow Jones Islamic Index, FTSE Global

Islamic Index, S&P Shariah Index , etc.).

• purify the impure part of their dividends by making donations to public utility

foundations (such as the Institut du Monde Arabe), within the limit of 10%

• use the services of a Shariah board, provided that it does interfere in the

management of the affairs of the UCITS which is managed by the management

company

− It is the first provision which expressly refers to Islamic Finance in France. On its

basis, BNPP has obtained an approval in July 2007 for the first Shariah compliant

fund

− Other Shariah funds have emerged since then (real estate, monetary funds)


France, a Shariah-friendly legal and tax environment

Dedicated law and regulations Issue of Sukuk – Principles The sukuk al ijara/sukuk al musharaka

Sukuk (saak in singular) are financial instruments similar to asset-backed securities. The remuneration received by the investor depends on the cash flows generated by the underlying asset and not to the mere lapse of time (prohibited)

Conditions for the issuance of sukuk (Notice of AAOIFI February 2008) :

The assets of the issuer must be tangible assets, either the assets themselves (e.g. car fleet) or the usufruct (e.g. flow rents of a car fleet assigned by a third party who remains the owner: standard 17 AAOIFI)

Assets cannot consist in interest-bearing receivables

The originator / manager / guarantor cannot repurchase the assets of the issuer at par value (no transfer of risk to investors) but only for their market value or, for property leased, for their remaining rental value

The remuneration of sukuk may be fixed or variable. It shall not be paid if the underlying asset does not generate the expected cash flows

The Shariah board shall upon the issue of its fatwa validate the structure but also review all contractual documentation. It shall also ensure the compliance of the transaction throughout its life

Investors

(5) Redemption

Final

Buyer

Seller

Financer

(1) Transfer of

the ownership of

the asset

(3) Rent of the assets

(4) Payment of rent

Investors

(0) Sukuk subscription

(5) Redemption

Entrepre-

neur

Financer

Company /

Project

(1) Capital

inflow

(3) Profits and

losses (2) Contribution in kind

(3) Profits and losses

(2) Cash payment

(0) Sukuk subscription


France, a Shariah-friendly legal and tax environment Dedicated law and regulations Issue of Sukuk – French compatibility

The compatibility of the French law :

− The bond issuance

• It is possible to make all types of bonds, including participating notes (Article

L.228-97 and Article L.228-37 of the French Commercial Code)

− Indexation of the remuneration

• Articles L. 112-2 and L. 112-3 of the French Monetary and Financial Code permit

the indexation of the remuneration paid to bondholders on the economic

performance of the issuer

− The possibility of higher remuneration

• The stipulation of a usurious interest rate is no longer prohibited among

professionals

Legal regime of sukuk under French law (Paris Europlace Meeting with AAOIFI in

November 2010): two structures under current French law has been validated by

AAOIFI.


France, a Shariah-friendly legal and tax environment Dedicated law and regulations Issue of Sukuk – Example of a structure

Participatory notes (all kind of assets financing)

• Remuneration depending on the corporate issuer’s

performance (income or profit)

• Repayment of the certificate: value of the assets paid

by the Corporate or, in case of default, by a third party

purchaser on the market

Investors

SPV Issuer

Corporate

Participatory

notes

Investment

100 % held

subsidiary

Management

Company

Lease +

undertaking

to purchase

Rents +

repurchase

price

100% held subsidiary


France, a Shariah-friendly legal and tax environment Dedicated law and regulations Issue of Sukuk – Example of a structure

Comments on the structure

− The investors invest in specific assets held by a specific SPV which will be set up for the

purpose of the investment. The SPV Issuer is a 100% held subsidiary of the Corporate.

− A Management Company will be responsible for the management of the financed assets. It will

receive a small annual management fee.

− The SPV Issuer will lease the financed assets to the Corporate against payment of rents. At the

maturity of the participatory notes, the Corporate will undertake to purchase the leased assets

from the SPV Issuer against payment to the SPV Issuer of a purchase price equal to the market

value of the leased assets. The legal form of the participatory notes will be bonds (obligations).

Their economic characteristics would be similar to preferred shares.

− In case the Corporate fails to perform its purchase undertaking, the Management Company will

take care, on behalf of the SPV Issuer, of disposing of the financed assets on the market and

allocate the proceeds to the repayment of the investors, potentially with a loss or a gain if the

market value of the financed assets is, respectively, less or higher than the amount initial

subscribed by the investors.

− In the event a capital gain is realized upon the sale of the assets, the Management Company

will receive an exceptional fee corresponding to most of the capital gain.


France, a Shariah-friendly legal and tax environment Dedicated law and regulations Issue of Sukuk – Technical clarifications

Sukuk :

− Recommendation of the AMF on 2 July 2008 for listing of the Sukuk on Euronext

Paris:

• Sukuk are assimilated to debt instruments and not equity

• Acknowledges that Sukuk issues may be structured either

• as asset-backed or

• as asset-based

• Provides information on level of disclosure to be set out in offering circulars

• A target remuneration ("expected profit rate") is indicated to the Sukuk holders

− Practical guide issued by NYSE-Euronext (Oct. 2009) regarding the listing of

Sukuk on Euronext

− Practical guide issued by AMF (October 2010) regarding the format of a Sukuk

prospectus


France, a Shariah-friendly legal and tax environment Dedicated law and regulations Issue of Sukuk – Tax clarifications

Tax treatment of Sukuk transactions and assimilated debt instruments such as indexed loans or bonds

(Tax Instruction of 24 August 2010):

− Sukuk are assimilated to debt instruments for tax purposes provided that they comply in particular

with the four following requirements

• Sukuk must rank senior to any shareholders of the SPV

• Sukuk must not entitle the holders to any shareholders rights like voting rights in the SPV,

right to liquidation surplus etc.

• Remuneration under Sukuk must be based on the assets’ performance or on the results of

the SPV and must be subject to a predetermined cap (Euribor, Libor), plus margin

• When the value of the financed assets exceeds the par value of the Sukuk or the amount of

the loan, the repayment may exceed the amount of the principal pursuant to the indexation

rule provided for in the contract

− As a result thereof, the remuneration under Sukuk:

• is deductible from the taxable result of the SPV under similar conditions than interests (at

expected profit rate)

• is exempted from withholding tax when paid to non French tax residents (except in case of

payment to non cooperative territories)


France, a Shariah-friendly legal and tax environment Dedicated law and regulations Assets financing

The contractual ideal type for assets financing: the murabaha

This is a cash purchase followed by resale with a deferred payment, with a margin ("profit return") corresponding to the economic interest (vendor-financing)

The Financer has some risks on the Buyer (in

case of bankruptcy of the latter), which owns the property financed

To reduce its exposure related to the quality of owner, the Financer creates a special purpose vehicle (SPV)

The Buyer undertakes to indemnify the Financer for all costs incurred by the transaction (however, always a risk of buyer-credit)

Final Buyer

Seller

Financer

(1) Transfer of the

ownership of the asset

(2) Cash

payment: 100

(3) Transfer of the

ownership of the asset

(4) Deferred

payment : 100 +

20 (margin)



The contractual ideal type for assets financing: the ijara

This is a lease, possibly with a purchase option of

the property at the end (wa-ik-tina'a ijara)

The Financer is the owner of the property

financed and transmits it at the expiration date of the lease

To reduce its exposure related to the quality of owner, the Financer creates a special purpose vehicle (SPV)

Often, the Financer delegates to the lessee the

burden of the maintenance and the insurance of the property financed. Assets are generally insured by a takaful

Final Buyer

Seller

Financer

(1) Transfer of the

ownership of the

asset

(2) Cash payment

(3)The rent of the

asset

(4) Payment of the rent

(with a purchase

option)



No immediate taxation of the Murabaha profit (Tax instruction of 24 August 2010)

− Assimilation of Murabaha profit realized by the SPV (financier) to interest payments and

therefore taxation of such profit on an accrual basis over the life of the transaction, notably

provided that:

• the Murabaha contract provides that the asset is acquired by the SPV with the intention to

retransfer it to the investor within a short period of time not exceeding 6 months

• the Murabaha contract mentions (i) the acquisition price by the SPV; (ii) the acquisition

price by the investor; (iii) the distinction between the Murabaha profit corresponding to the

remuneration for the purchase price being payable over the time and the consideration of

the SPV for the intermediation service it provides.

The Murabaha profit must be spread over the life of the transaction on a accrual basis for tax

purposes, whatever the effective payments are, and strictly in accordance with the accounting

treatment of the transaction and the payment schedule appendixed to the Murabaha contract

Absence of withholding tax

− If the SPV is not a French tax resident, Murabaha profit paid by a legal entity which is tax

resident of France is exempted from withholding tax (except in case of payment to non

cooperative territories)



Murabaha over property

− The SPV will benefit of the regime applicable to the purchase of the real-

estate assets for the purpose of resale provided by Article 1115 of the

French general tax code pursuant to which the acquisition by the SPV of

the real estate is subject to reduced registration duties at a global rate of

0.815% (instead of 5.09%)

Murabaha over shares in a property company

− Pursuant to the regime applicable to the purchase of real-estate assets for

the purpose of resale provided by Article 1115 of the French general tax

code, the acquisition of shares in real-estate companies by the SPV would

not be subject to registration duties (instead of 5%). Only the subsequent

sale to the investor would be taxable under the standard rules


France, a Shariah-friendly legal and tax environment Dedicated law and regulations Projects financing

The combination of contractual ideal types for projects financing : istisna / ijara

Funding of the construction phase:

the Istisna is a form of financing for

future asset in construction

Funding of the operating phase:

ijara by the Financer to the Project

Company

Construction phase : istisna

Manufacturer

Project company

Financer

(1) Provision of funding

with successive

payments under the

istisna

(2) Purchase of an

asset to build

Operating phase : ijara

Project company

Financer

(4) Rents of the asset

with a purchase

option


(3) Transfer of the

ownership of the

asset

France, a Shariah-friendly legal and tax environment Dedicated law and regulations Projects financing

Two new tax instructions of 24 August 2010 set forth the tax regime applicable

to Ijara (lease) and Istisna’a (equivalent to the sale of property for future

completion).

With respect to Ijara, the instruction specifies that if the Ijara contract complies

with the conditions of a leasing transaction as defined under the French law,

all the legal regime and the administrative doctrine concerning leasing

transactions will be applicable mutatis mutandis to Ijara transactions.

With respect to Istisna’a, the instruction specifies that the income received by

the financier as result of the deferred payment can be assimilated, for fiscal

purposes, as interest payments.

A useful clarification for project finance combining a construction phase

(Istisna’a) and an operating phase (Ijara).



3.

Islamic Finance in France today

Islamic Finance in France today

More than 6 billion of commercial real estate financing since 2006

Banks : 3 major French banks have Islamic windows in the Gulf. Several Islamic banks

are approved in the UK and can offer their Islamic products in France on the basis of

the European passport

Concerns of the Bank of France to approve an Islamic bank : the issue of liquidity

(Achilles heel of Islamic finance) and the accounting of transactions (and by extension

of the application of prudential standards Basel 3)

Chaabi Bank (a subsidiary of the Banque Populaire du Maroc) was established in

France since August 2011 two retail products relating to deposits and residential

mortgage

Insurance: The Scor has a reinsurance company in Malaysia called Retakaful, an

insurance product called Takaful has been distributed in March 2012

Collective Management : BNPP Sicav in July 2007, Société Générale Sicav distributed

in Reunion Island, several REITS


ALGER

BRUXELLES

BUCAREST

BUDAPEST

CASABLANCA

HANOI

HÔ CHI MINH VILLE

HONG KONG

ISTANBUL

KIEV

LONDRES

MOSCOU

NEW YORK

PARIS

PÉKIN

SHANGHAI

TUNIS

VARSOVIE

Gide Loyrette Nouel A.A.R.P.I.

22 cours Albert Ier

75008 Paris

tél. +33 (0)1 40 75 60 00

[email protected] - gide.com

Gilles Saint-Marc

Partner

tél. +33 (0)1 40 75 29 34

[email protected]

Detailed Legal and Tax analysis

of Islamic Banking in Belgium Dominique Blommaert, Lawyer

Imane Karich, Consultant in Islamic finance


Brussels Chaussée de La Hulpe, 187

Terhulpsesteenweg 187

1170 Brussels - BELGIUM

Tel. : + 32 2 675 30 30

Fax : + 32 2 675 30 31

Nivelles Place Albert 1er, 13

1400 Nivelles - BELGIUM

Tel. : +32 67 21 79 95

Fax : +32 67 21 72 45

Gent

Congreslaan, 27

9000 Gent - BELGIUM

Tel. : +32 9 240 77 20

Fax : +32 9 244 51 81

60 years of solutions

Dominique BLOMMAERT

Advocaat Vennoot

Wetenschappelijk medewerker Inst. Financieel recht. U.Gent

Tel : + 32 2 663 07 53

Fax : + 32 2 675 64 29

[email protected]

www.janson.be




Closing note Arnaud Lecocq

Moderator

Q & A


Thank you!


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