Islamic Finance and Markets Law Review - Pillsbury Winthrop Shaw

Islamic Finance

and Markets

Law Review

Fifth Edition

Editors

John Dewar and Munib Hussain

lawreviews

the

Islamic Finance and Markets

Law Review

Fifth Edition

Islamic Finance

and Markets

Law Review

Fifth Edition

Editors

John Dewar and Munib Hussain

lawreviews

Reproduced with permission from Law Business Research Ltd

is article was rst published in October 2020

For further information please contact Nick.B[email protected].uk

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iii

PREFACE

...........................................................................................................................................................

John Dewar and Munib Hussain

Chapter 1 BAHRAIN

.............................................................................................................................

Salman Ahmed, Benjamin O’Brien-Mcqueenie and Helen Chen

Chapter 2 CAYMAN ISLANDS

..........................................................................................................

Anthony Oakes

Chapter 3 JAPAN

..................................................................................................................................

Naoyuki Kabata and Satoshi Kato

Chapter 4 LUXEMBOURG

.................................................................................................................

Frank Mausen, Yannick Arbaut, Evelina Palgan, Miao Wang and Zoa White

Chapter 5 MALAYSIA

..........................................................................................................................

Rodney Gerard D’Cruz and Murni Zuyati Zulkii Aziz

Chapter 6 NETHERLANDS

...............................................................................................................

Omar Salah

Chapter 7 OMAN

.................................................................................................................................

Mansoor J Malik, Asad Qayyum and Hussein Azmy

Chapter 8 PHILIPPINES

.....................................................................................................................

Rafael A Morales

Chapter 9 SAUDI ARABIA

................................................................................................................

100

Karim Wali and Zeyad Khoshaim

Chapter 10 UNITED ARAB EMIRATES

..........................................................................................

106

Amjad Ali Khan and Rahat Dar

CONTENTS

Contents

Chapter 11 UNITED KINGDOM

.....................................................................................................

122

John Dewar and Munib Hussain

Chapter 12 UNITED STATES

............................................................................................................

133

Mona E Dajani

Appendix 1 ABOUT THE AUTHORS

...............................................................................................

141

Appendix 2 CONTRIBUTORS’ CONTACTDETAILS

..................................................................

151

PREFACE

We are honoured to present the fth edition of e Islamic Finance and Markets Law Review.

e chapters that follow describe the manner in which Islamic, or shariah-compliant, nance

is practised in various jurisdictions throughout the world. Although each country will have

variations, one of the most striking features of Islamic nance as a legal discipline is that

it includes core concepts and structures that cross jurisdictional boundaries. Given the

importance and ubiquity of these concepts and structures, a short introduction to them is

in order.

i Sources of Islamic nance

Islamic, or shariah-compliant, nance is concerned with the conduct of commercial and

nancial activities in accordance with shariah, or Islamic, law. Islamic nance emphasises

productive economic activity over pure speculation, and encourages transaction counterparties

to share prots and losses to promote collaborative eorts. Islamic nance practices are based

upon a central core constituting:

a the Quran, the holy book of Islam;

b the Sunnah, words or practices instituted or approved by the Prophet Muhammad,

including the Hadith, which are oral traditions regarding the words and deeds of the

Prophet Muhammad, as compiled by the Sahabah (closest companions of the Prophet

Muhammad);

c ijma, or consensus of the independent Muslim jurists qualied to exercise ijtihad (a

mujtahid) on a particular interpretation of shariah; and

d qiyas, which is interpretation by analogical reasoning where one situation is measured

against another by the mujtahids, in each case subject to and in accordance with the

Quran, Sunnah and ijma.

e principles derived from the application of ijma and qiyas to shariah form the body

of jurisprudence known as qh (understanding and knowledge applied to any branch of

knowledge). e body of rules that underpin the derivation of qh is referred to as usul

al-qh.

Certain shariah principles may be ambiguous, not least because of the numerous

exegeses of the Quran, the voluminous Hadith and the mujtahids involved in the practice

of ijtihad, interpreting shariah in dierent (yet equally permissible) ways because of the

interpretation methodologies they may apply. is means that often there can be dierent

legal opinions (fatawa) on the same aspect of shariah. is dierence of methodology for

interpreting shariah, and the body of fatawa derived thereby, is one reason why there have

Preface

developed several schools of thought or qh (madhabs) to which a mujtahid would ordinarily

be aligned. e renowned madhabs are Hana, Maliki, Shaf’i and Hanbli.

ii Principles of Islamic nance

Akin to Western legal systems, in Islam there is a presumption that everything is permissible

(halal) unless there is an express law that rebuts that presumption by declaring it as forbidden

(haram). Islamic nanciers are therefore expected to carry out their activities subject to, and

in accordance with, shariah principles. e pertinent shariah principles that relate to Islamic

nance include:

a Riba (translated literally, excess): although shariah scholars debate the precise denition

of riba, essentially it represents unearned excess or prot charged in connection with

a transaction, and derived by the mere passage of time. is is generally thought to

include a prohibition against charging interest in connection with the use of money. e

philosophy behind the absolute prohibition of riba (which has the eect of rendering

any contract harbouring riba as being void) is that shariah regards money as having no

intrinsic value in itself (unlike commodities such as gold, silver, dates and wheat) and

is merely a means of exchange to procure goods and services. Money cannot therefore

derive a prot either from the exchange of money of the same denomination or as a

result of the passage of time, as is the case with interest.

b Gharar: this refers to undue uncertainty in a transaction. For example, the sale of an

object that a seller does not yet possess is considered to include gharar, because it is

uncertain whether the seller will be able to obtain the relevant object and complete

the sale transaction. Some shariah scholars assert that maysir and gharar prohibit life

insurance contracts and nancial derivatives.

c Maysir: this refers to impermissible speculation, meaning investments that depend

chiey upon chance for their outcomes. e prohibition of maysir does not prevent

parties from taking on risks normally connected with business transactions.

d Qimar: this refers to transactions tantamount to gambling.

Two other relevant shariah principles are the prohibition on investing in, or being involved

with, haram products and activities (such as alcohol and gambling establishments) and the

prohibition of becoming unjustly enriched.

In practice, Islamic nancial institutions and investors typically engage shariah scholars

to establish investment guidelines and parameters for investment activity, in a manner

consistent with the sources of Islamic nance, madhabs and Islamic nance structures referred

to above. Eorts have been made to increase uniformity among these shariah advisers,

in the hope of creating a more standardised market. For example, the Accounting and

Auditing Organization for Islamic Financial Institutions, a non-prot industry-sponsored

organisation, issues non-binding shariah standards developed in consultation with industry

practitioners. Other inuential bodies include the Fiqh Academy of the Organization of the

Islamic Conference, the Shari’ah Supervisory Board of the Islamic Development Bank and

the Islamic Financial Services Board in Kuala Lumpur. ese bodies, and individual shariah

scholars, provide the context for Islamic nance generally. e degree to which their rules are

incorporated into legal regimes varies between jurisdictions.

Preface

vii

iii Basic Islamic nance structures

Although structures dier across national boundaries, the basic structures outlined below

tend to be widely used by market participants. Prot and loss-sharing forms the bedrock

of Islamic nance, since Islam perceives that the ideal relationship between contract parties

should be that of equals in which prot and losses are shared. Shariah by no means prohibits

the making of prot, but it does scrutinise the basis upon which prot is made as, for

example, charging interest could exploit a client in a time of hardship whereas a nancier’s

wealth is increased by no eort of his or her own. Islam instead empowers the nancier to

derive a prot by investing money or another consideration directly (or indirectly through

a joint venture arrangement, for example) in real assets using one or more of the Islamic

nance structures discussed below. e nancier will then generate a prot and recoup the

principal sum invested in an asset by exercising his or her rights as an owner: using, leasing

or selling the asset. Here, unlike in conventional nance, the money itself has not yielded the

prot: instead the assumption of the risks and responsibilities as the owner of the asset, or

as a partner in the venture, has yielded the prot made by the nancier. is highlights the

preference of Islamic nance for equity over debt and seeking to deal in tangible assets. is

also explains why Islamic nance can be used as a form of both asset-backed nancing and

asset-based nancing.

Combinations of the following Islamic nance structures can be used in project nance

and other structured transactions. For example, a mudarabah or musharakah could be used to

invest in a venture to commission the manufacture of an asset under an istisnah, which, once

constructed, can be leased through an ijarah.

Ijarah (lease)

e ijarah is a form of lease nancing whereby the usage (usufruct) of an asset or the services

of a person are leased by the lessor to the lessee for rental consideration. e ijarah can take

eect as an operating lease, with the asset returning to the lessor at the end of the lease term,

or akin to a nance lease, with title to the asset being transferred to the lessee at the end of

the lease term or ownership units being transferred to the lessee during the term of the lease

(an ijarah wa iqtina). Although shariah does not permit a forward sale, the ijarah can become

eective at a future date provided the rent is only payable after the leased asset is delivered

to the lessee. is type of forward lease is called an ijarah mawsufa  al-dhimma and is most

prevalent in the project nancing context.

Istisnah

An istisnah is used for the manufacture or development of an asset. Under this structure, one

party engages a counterparty to construct an asset in accordance with agreed specications, and

agrees to purchase or lease the asset upon completion. e manufacturing party must nance

the manufacture or construction of the asset, although it may require a down payment or

progress payments from its counterparty, or both. e manufactured asset must be accepted

by the counterparty if it meets the given specications. Once the asset has been constructed,

title to the asset must be transferred by the manufacturing party to the counterparty, who

will then either sell the asset or lease the asset to a counterparty pursuant to an ijarah. is

structure may be employed for project nance, among other purposes.

Preface

viii

Murabahah

A murabahah is an asset purchase transaction in which a party purchases an asset from a third

party at the request of its counterparty, and then resells the asset to that counterparty. e

sale price payable by the counterparty equals the original acquisition price paid by the rst

party plus an agreed return (i.e., cost-plus), and is payable on a deferred basis. Under this

technique, the counterparty is able to acquire an identied asset, but can pay the purchase

price for it over time. A murabahah can be used to nance the acquisition of a variety of

assets, and its versatility makes the structure a favourite among market participants.

Mudarabah

A mudarabah is an investment fund arrangement under which one party (the rab-al-mal)

provides capital to an enterprise while a second party (the mudarib) contributes work. e

mudarib manages the enterprise’s capital, and in doing so usually has wide discretion. In

return, the mudarib often earns a fee. e mudarabah parties also share any prots of the

enterprise according to agreed percentages. However, only the rab-al-mal bears the risk of

losing money on the enterprise. Guarantees of the capital by the mudarib are not permitted,

as this would depart from the principle that the rab-al-mal bears the risk of any loss. In Dana

Gas PJSC v. Dana Gas Sukuk Ltd & Ors ([2017] EWHC 2928),

Dana Gas attempted to

(but ultimately was unable to) render its mudarabah sukuk unenforceable on a number of

grounds, one of which was that the sukuk were not shariah-compliant because they featured

what appeared to be a guarantee from the mudarib of the face amount of the sukuk contrary

to the risk-sharing methodology reecting a traditional mudarabah. e mudarib’s risk should

solely be that its time and eort will not produce a return. Among other uses, a mudarabah

may be employed for investment funds that make shariah-compliant investments.

Musharakah

A musharakah is a partnership arrangement in which transaction parties contribute cash or

property, or both, to a collective enterprise. e parties share prots according to agreed

percentages (as with a mudarabah), but also share losses in proportion to their capital

investments. All musharakah parties may exercise control of the musharakah, although

in practice there is usually a designated control party. Under diminishing musharakah

(musharaka muntahiya bittamleek), one or more of the musharakah parties have the ability

to buy out the interests of the other musharakah parties over time for an agreed price. e

musharakah structure is considered the most ideal for prot and loss sharing.

Sukuk

Although sukuk (plural of sakk) are often referred to as Islamic bonds, they are more akin

to Islamic trust certicates representing an undivided benecial ownership interest in an

underlying asset where the return is based on the performance of that underlying asset. A

sukuk issuer pays an agreed amount of the revenue produced by the sukuk assets to the sukuk

holders. A distinction is made between asset-backed sukuk, which provide sukuk holders

with a claim to the subject assets, and asset-based sukuk, which derive cash from the assets,

but do not grant sukuk holders direct rights in the assets. Sukuk do share certain features

1 Dana Gas PJSC v. Dana Gas Sukuk Ltd & Ors ([2017] EWHC 2928).

Preface

with conventional bonds, such as being in certicated form, being freely transferable on

the secondary market if the sukuk is listed, paying a regular return and being redeemable at

maturity, but conventional bonds are also tradable debt, which shariah prohibits.

iv Conclusion

Islamic nance has grown rapidly during the past 20 years in terms of market participants,

structuring expertise and transaction types. Islamic nance is vibrant, and has proven its

competitiveness with conventional nancing products, often featuring alongside, or as an

alternative to, conventional nancing products. e chapters in this book illustrate the

dynamic manner in which Islamic nance has adapted and continues to develop globally,

and we recommend them to you.

We would like to thank the writers who have taken the time to contribute their insights

on Islamic nance practice, and to the editors who made publication of this book a reality.

John Dewar and Munib Hussain

Milbank LLP

London

September 2020

133

Chapter 12

UNITED STATES

Mona E Dajani

I OVERVIEW

Islamic nance in the United States dates from the 1980s, when two institutions opened

on the West Coast. eir services were limited to investment and home nance and were

available only regionally. From the late 1990s, the market size grew signicantly, paralleling

the growth of the Muslim population in the US: from 50 per cent in the 1990s to 66 per

cent in the 2000s. In an ironic twist, while Islamic nance abides by the goals and objectives

of Islam – namely the shariah – these same goals overlap with environmental, social and

governance (ESG) considerations and the broader aim of sustainable nance. Although this

may sound obvious, the ESG, especially the social aspects, have until now been less obvious.

While the global covid-19 pandemic severely stressed the global Islamic nance industry,

most industry participants believe there will be a mild recovery in 2021 followed by a gradual

signicant recovery due to the strong performance in 2019 pre-covid coupled with new ESG

interests and a dynamic sukuk market. Trillions of dollars in play over the next decade will

accelerate the economic recovery, and investors are showing interest in new performance

and Islamic-based ESG and sustainability-linked debt products (SLDs), with North America

following Europe’s and the Middle East’s lead.

At the same time, we see a tipping point pivoting to a turning point for accelerating and

unlocking the long-term potential of the industry. Stakeholders are realising the importance

of standardisation, as access to sukuk remains time-consuming and has higher transaction

costs than conventional instruments. Lockdown measures have also shown the importance of

leveraging AI technology. Furthermore, industry players have been discussing the potential

use of Islamic SLDs to help companies and individuals economically aected by the

pandemic. With the right coordination between dierent Islamic nance stakeholders, we

believe the industry could create new avenues of sustainable growth that serve the markets.

From experience in helping strategise and structure several major recent deals using these new

instruments, Islamic nance-based SLDs will speed up this transition.

ere are currently 25 Islamic nancial institutions in operation in the US, the top

three of which, according to asset size, are the American Islamic Finance House, University

Bank (through its subsidiary University Islamic Financial) and the Harvard Islamic Finance

Project. In 2013, JP Morgan started to oer Islamic banking services. Investment banks

such as Standard Chartered Bank followed and now oer Islamic banking products in Asia,

Europe, the Middle East and the US. Recently, in the US commercial real estate sector, banks

such as Malaysia-based Maybank, Kuwait-based Warba Bank and National Bank of Kuwait,

1 Mona E Dajani is a partner at Pillsbury Winthrop Shaw & Pittman LLP.

United Sates

134

Italian bank Intesa Sanpaolo and MASIC, a Saudi private equity investment rm controlled

by the Al Subeaei family together with asset manager, Boubyan Bank, have participated in

commercial Islamic nance transactions in the US in connection with commercial real estate.

Retail banks operate in several states:

a University Islamic Financial (a subsidiary of University Bank), based in Ann Arbor,

Michigan, is the rst and only exclusively shariah-compliant bank in the US;

b Devon Bank in Chicago regularly oers Islamic nance services;

c Guidance Residential, in Reston, Virginia, is the biggest non-bank nancial institution

that oers Islamic nance services; and

d another large Islamic mortgage lender is Lariba, in California, which also provides

business nancing.

Shariah requirements have made further proliferation of Islamic nance dicult. Possibly

because US investors are still unfamiliar with shariah-compliant products, the secondary

market for Islamic nancial products is smaller in general. e result has been that Islamic

mortgage lenders have had diculty in remaining liquid, stemming further growth of the

market. Starting in 2001 and 2003 respectively, Freddie Mac and Fannie Mae, the US

housing agencies, had bought Islamic mortgage products to provide extra liquidity in the

US Islamic nance market. ey have now grown to become the main investors in Islamic

mortgages: by 2007, Guidance Residential had been relying on Freddie Mac for more than

US$1 billion in nancing.

II LEGISLATIVE AND REGULATORY FRAMEWORK

i Legislative and regulatory regime

Unlike the United Kingdom, where there is a plethora of Islamic nancing services, there

are no US laws specically addressing Islamic banking in the US. Moreover, the US market

for Islamic nancial products is much smaller than that of the United Kingdom, where

there is US$19 billion worth of assets owned by Islamic nancial institutions, and more

than 20 banks, six of which exclusively provide shariah-compliant products. e number

of Islamic nance services in the United Kingdom is also larger than in the US. Five of the

services in the United Kingdom are shariah-compliant and are behind some of the biggest

building projects in London (including the Shard, the Olympic Village, Chelsea Barracks,

the Battersea Power Station site), the north-west and the Midlands (more than 6,500 new

homes). In fact, although Islamic nance transactions constitute only 1 per cent of global

nancial assets, about a quarter of the world’s population is Muslim, which is a leading

indicator of the growth potential in the US. Another unexpected leading indicator that has

already shown signs of an uptick in the US market is Brexit, whereby London’s euro clearing

market is expected to cut almost 40,000 jobs in its banking industry.

e same stringent licensing and supervision standards that are applicable to the

conventional US nancial institutions also govern nancial institutions oering Islamic

United Sates

135

nance services. erefore, Islamic nancial institutions (IFIs) operate as state-chartered

entities subject to state and federal laws regulating corporate governance and banking and

insurance operations.

Conventional banking institutions typically use their subsidiaries for Islamic nance

transactions. e principal challenge faced by Islamic nance service providers in the US is

therefore to oer products that comply with both shariah and the applicable state and federal

banking regulations. However, unlike conventional US banking regulation, regulation of

Islamic nance in the US is market-driven; federal and state regulators respond on a case-by-

case basis to applications and inquiries from IFIs that want to oer Islamic nancial products

in the US. Consequently, any organiser of a shariah-compliant bank in the US must confront

the challenge of introducing new nancial products or services to regulators, and must meet

signicant creditworthiness requirements.

Another regulatory challenge might be the limited number of permissible investments

that commercial banks are allowed to make. In the US, any investment made by banks must

be limited to xed-income, interest-bearing securities, which shariah prohibits. Moreover,

US consumer credit laws require that commercial banks have reporting and disclosure

requirements that may be inconsistent with shariah. For instance, the Truth in Lending

Act of 1968 requires that banks disclose annual interest percentage rates, which is strictly

prohibited by shariah law. On the other hand, a US nancial institution may have a hard time

employing murabahah or ijarah structures to nance the purchase of an asset (e.g., a car or

home) if required under the state law to qualify as a licensed leasing company or auto lender.

ii Regulatory and supervisory authorities

As stated above, both federal and state laws regulate the banking industry in the US whether

conventional or Islamic. e national regulators include the Board of Governors of the Federal

Reserve System (Federal Reserve), the Federal Deposit Insurance Corporation (FDIC) and

the Oce of the Comptroller of the Currency (OCC), and the state regulators are responsible

for banking activities in each state. A bank in the US must be licensed by either the OCC or

an applicable state banking authority and is supervised by the Federal Reserve and the FDIC.

All deposit accounts oered by US banks are required to be insured by the FDIC, which is

intended to ensure the overall safety and stability of nancial institutions.

US regulators have issued certain opinions applicable to the Islamic nance industry.

Preliminarily, while the Federal Reserve approved shariah-compliant retail nancing products

in the US, the Federal Reserve focused on the substance of the products. e Federal Reserve

subsequently inuenced the OCC to issue opinions aimed at reconciling apparent conicts

between shariah and the federal and state laws, and their respective regulations. For example,

the US National Bank Act of 1864 prohibits US nancial institutions wishing to oer

shariah-compliant lending services from purchasing, holding legal title to or possession of

real estate to secure debts with terms over ve years. e OCC issued two interpretive letters,

which addressed the special concerns of clients who would otherwise be forced to choose

either their religion or their home or business.

2 See the US chapter in Getting e Deal rough: Islamic Finance & Markets, 2017 (contributing editor

John H Vogel), at 55.

3 e rst two paragraphs here were adopted from the US chapter of the rst edition of e Islamic Finance

and Markets Law Review, written by Andrew M Metcalf.

United Sates

136

Although certain types of murabahah and ijarah nancing are allowed under US laws,

the OCC reconciled musharakah and mudarabah’s apparent violation of federal regulations

that prohibited commercial banks from forming partnerships or holding common stock.

e OCC allows commercial banks to take ‘as consideration for a loan a share in the prot,

income or earnings from a business or enterprise of a borrower’.

is interpretation creates

an opportunity for commercial banks to derive equity return from a loan deal without relying

on interest, despite the still-intact prohibition against making true equity investment. US

credit unions have also adopted a communal or partnership model that complies with shariah.

Savings associations can form joint ventures and own properties through a subsidiary

servicing company. ese institutions may easily obtain real estate nancing through

murabahah and ijarah structures as well as limited joint venture possibilities through

musharakah and mudarabah transactions.

III COMMON STRUCTURES

i Home and other retail nance

Retail Islamic nance has been well established in the US since the OCC approved the ijarah

structure for home lending in 1997 because it is ‘functionally equivalent’ to conventional

secured real estate lending.

Similarly in 1999, the OCC approved the use of the murabahah

structure for home nancial products as it was deemed to be functionally equivalent to

conventional real estate mortgage transactions, or inventory or equipment lien agreements.

e OCC opined that under such structures a bank’s ownership of property is only

for ‘a moment in time’ because of the simultaneous nature of purchase and sale transactions.

erefore, Islamic contracts, the OCC concluded, avoid the type of risk that existing

restrictions aimed to limit. In terms of accounting, the bank records the loan as an asset on

its balance sheet. e borrower is required to maintain the property and pay all expenses.

If the borrower defaults, the bank may sell the underlying property to recover the amount

owed, as in a mortgage transaction.

Musharakah is also used for home nancing in the US. It is a rent-to-own nanced

sale of property, where the bank rst purchases the property and the customer pays the bank

over time the full price plus a cost. With each rent payment, the customer earns a portion

of the property’s ownership. Under this equity-based structure (also called ‘diminishing

musharakah’), when the customer sells or disposes of the property, losses are shared between

the customer and the bank as co-owners based on their percentages of ownership. e bank’s

return is taxable income to the bank and deductible by the borrower.

ii Insurance

Deposit insurance, which banks use for stability, is inconsistent with shariah because a

bank having insurance alters the risk-sharing structure required under shariah. erefore,

shariah, a cooperative form of reimbursement that comes from a fund to which entities

contribute regularly, does not work in the US. Reinsurance is necessary in the US because

4 Code of Federal Regulations of the United States of America, 12 CFR Ch. 1 (1-1-00 Edition), §7.1006.

5 OCC Interpretive Letter No. 806 (17 October 1997), [1997–1998 Transfer Binder] Fed. Banking L. Rep.

(CCH) 81-253 (Islamic Home Finance Leases).

6 OCC Interpretive Letter No. 867 (1 June 1999), [1999–2000 Transfer Binder] Fed. Banking L. Rep.

(CCH) 81-361 (Murabaha Financing Products).

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of high minimum capital requirements, but there are not many retakaful services. Although

structuring a product around this impediment in the US is technically possible, it has been

a strong enough practical impediment to prevent further growth of the Islamic insurance

market. Another serious obstacle to the successful introduction of takaful and retakaful

in the US is the Establishment Clause of the First Amendment to the US Constitution.

Establishment Clause challenges are analysed under a three-part test to establish that there is

a secular purpose, religion is neither advanced nor inhibited, and it does not foster excessive

government intervention.

Each state has its own licensing requirements for insurance companies operating in

the state, which generally prohibit the proliferation of takaful. To be licensed, an insurance

company must prove its experience, management capability and sound nances. It must

also justify its premium rates and meet or exceed the solvency requirements. Even after

it becomes licensed, an insurance company is often limited in choosing the types and

concentrations of xed-income investments that it must make with its reserves. Moreover,

if the insurer becomes insolvent, an emergency loan must be taken out of the shareholders’

fund to help meet obligations arising out of the insolvency. is could be a problem in takaful

insurance, because capital requirements imposed upon the insurance companies may not

accurately reect the separation between the fund for policyholders and that for shareholders.

Nonetheless, some takaful are subject to a lesser degree of oversight from the state insurance

regulators.

Despite the diculties associated with takaful, American International Group

Inc (AIG) rst started to oer Islamic homeowner takaful insurance in the US in 2008.

Currently, AIG’s underwriting subsidiaries, Risk Specialist Companies Inc and Lexington

Insurance Company, issue takaful. Zayan Finance, a New York-based Islamic nancial

services rm, is the exclusive broker that oers takaful in many states. AIG also maintains a

shariah board made up of Islamic scholars who have given legitimacy to the takaful alternative

to conventional insurance in the US market.

iii Real estate investment

Islamic nance has widely used real estate as a basis for shariah-compliant nancial structures.

Prime or trophy assets (e.g., hotels or large oce headquarter buildings) have been its focus.

anks to rental guarantees, stable demand and rising rental payments, dorms and other

student accommodation have also eectively attracted Islamic funds. Further developments

may be achieved by expansion of the scope of social infrastructure to include education,

healthcare and social housing sectors. Since 2010, however, Islamic funds and banks that

oer mezzanine nance have proliferated. Here, a conventional senior bank provides a loan

with interest, the investors provide the equity and the mezzanine nancing is placed in a

shariah-compliant way. e senior conventional bank and the shariah-compliant mezzanine

lender enter into an intercreditor agreement governing the way in which each of their loans

is treated while conforming to the mezzanine lender’s Islamic sensibilities.

Murabahah is the most popular type of structure used for real estate investment in

the US. A typical murabahah structure contains an unconditional contract of sale with a

cost price, markup and payment date predened. e prot from the marked-up sales price

is paid in instalments. One of the largest examples of recent real estate investments done

7 Known as the ‘Lemon test’: Lemon v. Kurtzman, 403 U.S. 602 (1970).

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under murabahah is the US$219 million syndicated construction loan for 45 Park Place,

a luxury condominium tower in Manhattan, New York.

It was led by Malaysia’s Maybank

and Kuwait’s Warba Bank; Italy’s Intesa Sanpaolo and MASIC, the investment arm of Saudi

Arabia’s Al Subeaei family, also participated.

One advantage of murabahah is that it may not require credit support. Here, the bank

pays the seller for the property for immediate sale to the buyer for the cost plus a prot

pursuant to a murabahah agreement. A murabahah transaction has also been used to renance

a conventional loan to allow the borrower to withdraw cash to pay o interest-bearing

obligations, subject to the advice of shariah scholars. For US tax purposes, the prot piece of

the purchase price in a murabahah transaction is deemed to be interest, such that it is taxable

to the IFI and deductible by the customer.

An ijarah is a lease structure used in acquiring real estate as well as in other acquisition

nance contexts (e.g., aircraft, ship or project nance). Under ijarah, a bank purchases a

property and places the ownership over the property in a holding subsidiary and then leases

it to the buyer for its use pursuant to the ijarah lease. Typically, title to the property is only

transferred to the borrower after full payment of the cost of the property. e customer

pays rent to the bank, which consists of, among other things, the purchase price and the

prot. Unlike in a conventional nance lease transaction, the bank, acting as an owner and a

lessor, has obligations to insure and undertake major maintenance of the leased asset. ese

obligations may, however, be contracted out to the borrower, who acts as a lessee. e lessee

is responsible only for payment of the rent while the lessee continues to use the asset, so the

ijarah structure cannot become eective before completion of the leased facility construction.

Unlike in conventional leases, under an ijarah, if there is a total destruction or condemnation

such that the property cannot be used for its intended purpose, the rent payment will cease.

e lease-to-purchase model (i.e., ijarah wa iqtina) is also frequently used in real estate

investment in the US. Under the laws of most states, the transaction can be simplied by

having the client immediately take title to the property at the initial purchase.

iv Investment funds

A mudarabah agreement is formed between two partners, with one contributing capital

to invest in some form of commercial enterprise, while the other provides the expertise

and management experience. e capital contributor is known as the rab-al-mal and the

managing partner is known as the mudarib. is type of structure is typically used for funded

participating arrangements and establishment of an investment fund. e rab-al-mal and the

mudarib share the prot generated from the investment in accordance with pre-agreed prot

sharing ratios. However, any loss of capital is assumed by the rab-al-mal.

8 Anna Nicolaou, ‘Manhattan tower secures $219m in sharia-compliant nancing’, Financial Times

(19 May 2016), https://www.ft.com/content/cf6c3a88-1c4d-11e6-b286-cddde55ca122.

9 id.

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v Other areas

ere have been two major sukuk issuances in the US: the East Cameron gas sukuk, the rst

sukuk al-musharakah in the US, which was backed by oil and gas assets, and the General

Electric sukuk al-ijarah, which was backed by aircraft leases. e East Cameron sukuk has

gone into bankruptcy, but the General Electric sukuk is performing well. Both Illinois and

New York have begun eorts to enact legislation to recognise sukuk.

For commodity trading, tawarruq is used, which essentially is a reverse murabahah.

Under this structure, a bank buys freely tradable commodities such as platinum and copper

(other than gold and silver, since they are considered currency) at market value for spot

delivery and spot payment, and then immediately sells them, at an agreed price that contains

the prot, to the customer on a spot delivery and deferred payment basis. e customer

immediately sells the commodities at market value to a third party for spot delivery and spot

payment. e end result is that the customer has received a cash amount and has a deferred

payment obligation for the purchase price to the bank. Under the tawarruq structure, the

prot piece of the purchase price also takes into account the bank’s commodity risk and

third-party supplier risk, in addition to the creditworthiness risk of the customer.

vi Combining conventional and shariah-compliant nancing capital stack

A shariah-compliant lender may participate in a capital stack structure in a transaction that

uses both shariah and conventional nancing by delineating the assets and the cash ows in

the transaction.

In certain circumstances, shariah-compliant and conventional lenders may enter into

a formal intercreditor agreement that sets out the priority of payments and the ranking of

security. is is most likely to occur when the structural subordination is not possible and

the borrower under both the conventional and shariah-compliant nance is the same entity.

e intercreditor agreement between shariah-compliant and conventional lenders is likely

to address many similar matters covered in such an agreement between solely conventional

lenders. Matters that could be addressed may include:

a allocation of the borrower’s operating income;

b allocation of proceeds following acceleration on default;

c disputes and governing law; and

d what the dierent lenders can and cannot do in respect of their facilities.

IV TAXATION

Islamic nance raises many US taxation issues, including strong tax incentives for debt over

equity, the tax treatment of sales and additional layers of transactions in certain instruments.

In addition, dierences in the tax treatment of Islamic and conventional nance could cause

cross-border spillovers and encourage international tax arbitrage. For instance, the Internal

Revenue Service has yet to issue ocial guidance on tax deductibility of the payments

made under ijarah and mudarabah structures and on partial treatment of such payments as

interest. Real estate transfer taxes and mechanic’s liens present another challenge because the

shariah-compliant nancing structures often require multiple transfers of the property with

heavy fees incurred by parties with each transfer (e.g., property being purchased by the bank

rst and then transferred to the borrower). e state of New York has abolished these fees

for transactions executed under ijarah and mudarabah structures, but many other states do

still charge.

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V OUTLOOK

Globally, Islamic nance has grown in terms of asset size by more than 20 per cent annually

since the 2007–2008 nancial crisis. Islamic banks are not outperforming other banks as

a rule, since what they gain in safety, largely as a result of restrictions placed by shariah

principles, they may lose in eciency. It is during crises that the dierences appear to have

a material eect on performance. Two independent studies by the International Monetary

Fund and the Islamic Financial Services Board found that Islamic banks demonstrated

superior performance following the 2007–2008 crisis.

Nonetheless, while the covid pandemic has slowed the Islamic nance market, many

stakeholders in the Islamic nance industry are prioritising sustainability. According to

Citi’s Asia Pacic chief executive ocer, Peter Babej, ‘If there’s one lesson to be learned

from the covid-19 pandemic, it is that our economic and physical health and resilience, our

environment and our social stability are inextricably linked’. e opportunity cost for the

US dollar, especially in light of covid and Brexit, is quite large in not participating in this

global market and opportunity at this moment in time. It is recommended that the US takes

steps to introduce the rules and regulations required to engage in worldwide Islamic nance,

sukuk and takaful business. Interest-free nancing modes may enhance the system currently

in use in the US and oer a chance for Americans to diversify their portfolios, attract global

investors, enhance liquidity and compete in the global village.

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Appendix 1

ABOUT THE AUTHORS

MONA E DAJANI

Pillsbury Winthrop Shaw & Pittman LLP

Ms Dajani leads Pillsbury’s Middle East practice, energy and infrastructure projects practice,

and renewable energy practice.

Based in both New York and London, Ms Mona E Dajani has for over 20 years been

counsel to many of the world’s most prominent development and investment companies in

connection with hundreds of successful infrastructure, real estate and energy transactions, and

projects in conventional and Islamic equity and debt transactions. She represents sovereign

wealth funds, private equity funds, export credit agencies, investment funds, governments,

banks, developers, institutional investors, lenders, pension fund advisers, contractors and

asset management companies with respect to a wide range of shariah-compliant nance and

investment transactions across the core practice areas of banking, project nance, capital

markets, restructuring, M&A, investment funds and dispute resolution. She has expertise in

structuring, documenting and negotiating complex transactions and developing innovative

shariah-compliant techniques, including nance, regulation, project and asset nance,

hedging and swap transactions, funds and other structures, including sukuk issues.

Ms Dajani has repeatedly been recognised as a leading lawyer by e Legal 500,

IFLR1000, e Best Lawyers in America (2013–2020) and other publications, and is hailed as

a rising star by Law360. She was elected to the board of directors for the American Council

on Renewable Energy in 2015.

Ms Dajani is a regular contributor and commentator for CNN radio, POLITICO,

Bloomberg New Energy Finance, Fox News, e New York Times, e Washington Post,

National Public Radio and USA Today, among others.

About the Authors

142

PILLSBURY WINTHROP SHAW & PITTMAN LLP

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New York

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Tel: +1 212 858 1000

Fax: +1 212 858 1500

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London EC2N 1HQ

United Kingdom

Tel: +44 207 847 9500

Fax: +44 207 847 9501

mona.dajani@pillsburylaw.com

www.pillsburylaw.com

ISBN 978-1-83862-473-6

the

Islamic Finance and Markets

Law Review

Fifth Edition