Saqib Awan was working as an attorney at the global law firm DLA Piper when his firm was asked to advise a Saudi Arabian company as it structured a bond deal that would comply with Islamic law, also known as Sharia law. The type of bonds, called sukuk, usually involve placing assets into a special purpose vehicle (SPV) and then issuing certificates that give investors an ownership stake in the asset pool. Since Islamic law prohibits the charging or paying of interest, sukuk transactions often look more like equity than debt.

The problem was, Awan’s client didn’t want to move the underlying assets into an SPV. He didn’t want to pay the costs associated with moving the assets off of its balance sheet or suffer the risk that the assets might be lost. Awan’s firm told the client the assets had to be transferred on to the books of the SPV in order for the deal to be Sharia compliant. However, the company hired an Islamic scholar, who said such a move was not necessary. The company opted to keep the assets on its own books.

“If you asked 20 Sharia scholars, they would say this was not the way it’s supposed to be done. It was a bit odd,” says Awan, now a senior consultant to a sovereign wealth fund in the United Arab Emirates.

The deal highlights one of the main questions in Islamic finance today: What is compliant under Islamic law, and who gets to make that determination? These questions are becoming increasingly important as the Islamic finance sector flourishes.  

Islamic financial institutions worldwide hold about $1.8 trillion in assets—and are likely to sustain double-digit growth over the coming few years to reach about $3 trillion, according to a report this year by Standard & Poor’s.

The sukuk market alone has doubled in the last three years, with annual issuance rising sharply from less than $32 billion in 2010 to a record $118 billion at year-end 2014, according to Moody’s.

The deal involving Awan’s client underscores the dilemmas  faced by advisors and other professionals in this sector.

A fundamental concept in sukuk is that the holder can redeem his shares at any time and get his money back or get possession of the underlying assets on a pro rata basis. But in the case of Awan’s client, the assets weren’t even owned by the entity issuing the sukuk. They were still owned by the parent company. Not only was this a legal issue, but it was a breach of Sharia law, where it is prohibited to sell something you do not own.

“Either the issuer managed to convince the scholar that he could do this or … there was limited information presented to the scholar,” Awan says.  

Ideally, the scholar should be involved in the process throughout and sign off on all of the documents, Awan says, but in reality some Islamic scholars serve on dozens of Sharia boards.

“I highly doubt they can go through all of the documents on each deal and consider its individual merits,” Awan says.
Continued Growth
Growth in the Islamic finance sector is expected to continue this year, as oil-exporting countries in the Middle East and Southeast Asia tap the sukuk market to finance infrastructure projects, Moody’s says. Malaysia accounts for two-thirds of all global sukuk issuance, but in 2014, countries such as the Maldives, Senegal, South Africa and the U.K. also turned to this market to borrow funds. It costs a bit more to issue sukuk than conventional bonds, but experts say that could change as the market becomes more standardized and liquidity grows. A few corporations in the Middle East have issued sukuk for less than they would have paid to issue conventional bonds, according to S&P.

“We anticipate that the premium for sukuk issuance over conventional bonds rates would decline if sukuk documentation were more highly standardized and default resolution mechanisms clearer,” S&P analysts wrote in the report.

Demand for Islamic financial products has increased over the last decade—not just in the Gulf and Southeast Asia, but also in America. There are 5.7 million Muslims in the U.S. with $98 billion in disposable income, according to a report by DinarStandard, and many are looking for Sharia-compliant investments. The American Muslim population is younger than the national average and the education and income levels are on par with the average American household’s, says the study. And wealthy Muslims are looking for some of the same things rich American investors seek: capital preservation, education savings and retirement planning.

“Some are now software engineers and doctors, and they’re finding financial success and want to do something about their financing goals,” says Naushad Virji, CEO of ShariaPortfolio in Lake Mary, Fla. “Many of them are people whose parents and grandparents never had 401(k)s or worried about education savings.”

Virji says he receives inquiries from new Muslim investors daily, and his assets under management are growing at a rate of about $5 million a month.

“We have a team of 12 people and we’re still hiring to keep up with demand,” Virji says.

Ernst & Young estimates global Islamic banking assets will exceed $3.4 trillion by 2018. Even if Muslims represent just 10% of world GDP, their high saving rates means that wealth is being generated in the hundreds of billions of dollars each year, making the Muslim population worth noting for wealth managers, experts say. In Asia alone, more than 2.6 million high-net-worth individuals control an estimated $8.4 trillion in assets, according to the International Centre for Education in Islamic Finance.

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