I don’t care about the Shar-eye-ah stuff! Just get me the waiver!
New York-based acquisition finance banker on a conference call, October 2005
Another Islamic finance conference, another unimaginative selection of corporate drones on the question and answer panel, each one of them chosen by the conference organizers for their acquiescent blandness, always on message and never controversial. From the floor, an elderly gentleman dressed in a dishdasha and ghutra – a long white robe topped by a red-and-white chequered headdress – stands up to address the panel with a question. The microphone trembles slightly in his hands and his voice is hoarse. Perhaps his thick Arabic accent and halting English knocks his confidence a little, surrounded as he is by these urbane captains of industry.
‘Why do we have conventional institutions selling us Islamic products?’ he asks. ‘Why should we allow them in?’ The hint of a titter ripples through the audience and the panellists smile indulgently. The old man baulks a little but carries on. ‘Why should we trust them? They only want to make money out of us.’
Across from the main hall is a ‘breakout’ room in which a technical workshop is taking place on the Tahawwut Master Agreement. As if to reinforce the old man’s point, a treasury banker is asking how he can replicate credit default swaps in a Sharia-compliant manner.
Over at the Qatar Central Bank, scholars are wising up to the dangers of allowing conventional bankers to drive the direction of the Islamic finance industry. They urge government mandarins to stem the influx of conventional institutions into the Islamic market. They are concerned that the banks are co-mingling depositors’ funds with the banks’ other – haram or impermissible – business activities, and want to see a clear separation of Islamic and conventional money. The QCB ponders the issue, its finger hovering over the red button that will ban all conventional institutions from selling Islamic products.
At the Dubai International Financial Centre, a messiah from the US is preaching his gospel of a new beginning in Islamic finance. A conventional banker himself – with no previous history of Islamic finance – he convinces the DIFC investment arm to back his venture, a shadowy Islamic finance boutique that proclaims it has invented a revolutionary financing tool that will change the face of the industry. Two years later, the venture fades into obscurity.
Rich pickings from a massive and under-penetrated customer base have brought the opportunists to the surface. Now a cut-throat industry moving faster than its conventional counterpart, Islamic finance has witnessed the rise of technocratic rocket scientists and aggressive sales staff from Western banks, relegating the idealists to supporting departments or ‘back office’ compliance positions.
Sulaiman has had enough.1 An unassuming and contemplative young man with a piercing intellect, he wonders whether his work of the past few years will weigh favourably in his balance when he dies. When his fellow Samadiites brainstorm their latest deal, he remains silent, sifting through the details of the transaction in his mind. Is it true to the spirit of Sharia, or is it another ‘reverse engineered’ financial product?
Sulaiman’s path to advising on Islamic finance transactions has been an unusual one. Intellectual academic pursuits have taken priority over career. A junior lawyer at one of the leading English law firms, he reasons that his appointed rizq, or providence from God, has been pre-ordained for him. Although he is an expert in classical Arabic and has a sound understanding of the jurisprudence of commercial transactions in Sharia, his English law training has come a little later than his peers and not without struggle. Despite being called to the Bar as a barrister at Lincoln’s Inn, he opted to study Sharia for two years, then taught Arabic before studying for an LLM, the Master of Laws degree, in the fashionable though unhelpful area of international law and human rights – unhelpful because, as he says, ‘Law firms look for a certain type of intelligence. They don’t want people to look out of the window and wonder if they’re doing the right thing.’ Introspection and self-reflection are not prized in the commercial world. These elite English law firms, the so-called ‘Magic Circle’, and their bulge bracket clients want left-brained go-getters and doers.
The timing was fortuitous, though. Just as Sulaiman was concluding his intellectual pursuits, the global Islamic finance industry was taking off in increasingly exotic areas such as derivatives and hedge funds. Within the industry, a few savvy partners at Magic Circle firms began to search for appropriately qualified trainees to help them put some legal flesh on these arcane mechanisms, and Sulaiman joined up hoping to make a difference.
What he saw distressed him. This wasn’t an industry devoted to offering financial services to Muslims in a manner compliant with their beliefs, he concluded. This was the reverse engineering of conventional products using template contracts that individually adhered to the tenets of Sharia, but in aggregate achieved something more dubious.
‘You spend every day helping very rich people get even richer’, he says in a clipped and quiet voice. ‘Do I want to lie on my deathbed thinking this is what I’ve done with my life?’ A project in Africa’s poorest countries illustrates his point: a European manufacturer of high-tech prefabricated concrete panels approached his firm to help them on a development aid programme. Their proprietary concrete panels would be used to build schools and small-scale developments using a carbon neutral technology. To complete the clean-tech, green and ethical dimension to this project, they would make the investment comply with Sharia.
But why sell this product to the world’s poorest? It was expensive and unnecessary – a green and ethical solution might instead have been proposed using traditional materials such as wood. It was clear what was happening. Under the terms of the aid programme, the Europeans were saying ‘We aid, you buy.’ Those African nations would not feel the benefit of the aid whilst they laboured under the additional burden of debt they had acquired.
‘We lack perception’, says Sulaiman. ‘We shut off this side of our thinking.’ Islamic finance was not about a holistic view of commerce, its practitioners were not interested in consequences for society and the individual. To Sulaiman it was a perpetuation of the failures of the conventional banking system: unbridled leverage, the trading of cash flows, the trading of unbundled credit and risk, a dislocation between the financial economy and the real economy, the pursuit of profit above all else.
Industry initiatives on standardization, such as the Tahawwut Master Agreement, seemed to be missing critical elements in their collective reasoning. Sulaiman found himself having fundamentally grave reservations about the replication of the conventional swaps and derivatives industry. ‘Get rid of them completely’, he suggests. ‘Instead create supra-national takaful [mutual insurance] pools – that is what organizations like AAOIFI are for, no?’ A real economy solution: a global pool of tangible assets dedicated to ensuring the participants are protected in a mutual cooperative against macroeconomic swings.
But why would the industry change the status quo?
Ignoring for a moment this philosophical question – whether an Islamic derivatives industry is desirable in the first place – Sulaiman was disturbed to note that there was an inconsistency in the approach of scholars. The Tahawwut initiative had been laborious and drawn out, and yet it had not reached a satisfactory conclusion. Close-out netting and the calculation of termination settlement amounts had been particularly vexatious discussions: scholars had insisted that a discount rate not be used in the calculation of the settlement amount, and yet they remained content to link the prices of the commodities underpinning the hedges to interest rates. In an attempt to fix the impasse, Sulaiman felt the scholars ignored the issue.
‘They have a phobia of the word “interest” or “discount rate”’, he says. ‘They seem more fixated on the semantics and not the reality. It’s a type of psychological trauma.’
The politics and intrigue of the corporate environment, though a fact of life for all those who work at large multinational firms, were a necessary trial for Sulaiman. Despite a predisposition to hayya2 – a traditionally valued Islamic notion of modesty or shyness – he learnt to develop a thick skin. As he observed his colleagues and clients become trapped by their material success, reluctantly complying with every demand of their employers but unwilling to leave the industry, he wondered if he would become like them. Perhaps outwardly he would project piety – long beard and white Arabic dress, the thawb, at Friday prayers – but he would be forced to practise his craft slyly. The interests of the firm would come first and he would have no right to refuse a transaction. ‘You become a being of that environment’, he reflects sadly. Sulaiman sought spiritual guidance. But rather than approach a scholar for guidance, he sought his guidance from the source, from God Himself.
Since the concept of a formal priesthood does not exist in Islam – nor the concept of vicarious atonement, for that matter – when guidance or forgiveness is sought, it is best sought from Allah. And so Sulaiman performed the salat ul-istikhara, the formal prayer of guidance performed in a manner similar to the five times daily prayers. The istikhara is a prayer for Allah’s favour in commencing on a course of action, or alternatively to have that course of action taken away from the supplicant, and to remain content with either outcome. His devotions completed, the next day Sulaiman handed in his resignation and felt a burden lifted. He would no longer work on commodity murabaha transactions and Sharia-compliant development aid projects.
As we part company, an early Christian comment on this subject may be illuminating. A third-century bishop of Carthage, St Cyprian, had himself despaired at the state of his fellow clergy:
Among the priests there was no devotedness to religion…Very many bishops who ought to furnish both exhortation and example to others, despising their divine charge, became agents in secular business, forsook their throne, deserted their people, wandered about over foreign provinces, hunted the markets for gainful merchandise, while brethren were starving in the Church…they increased their gains by multiplying usuries.3
Sulaiman’s experience of the past few years is nothing unusual. At the World Islamic Banking Conference, one banker described Islamic banks as trying to play water polo against teams whilst wearing the protective clothing of American football. Islamic institutions operate under the rules of central banks, the lenders of last resort in the fractional reserve banking system. Their methods and corporate philosophy have not developed in radically new directions, instead adopting and adapting those of their conventional counterparts. The simplest instruments they require to function and those that they sell to their customers are constrained by the norms of the wider banking industry. In the inter-bank money market, for example, whilst conventional banks may fund themselves in highly liquid instruments with maturities as short as one day, Islamic institutions seek to replicate these funding sources through the cumbersome commodity murabaha. Not only is the murabaha money market insufficiently well developed and illiquid, but the very Sharia compliance of it has come to be questioned, often by those very scholars Sulaiman laments. After all, how does it differ from an interest-bearing debt instrument?
The Sharia board of some banks, such as Abu Dhabi Islamic Bank, have taken a stance against the commodity murabaha and are increasingly looking at ‘purer’ forms of funding, involving the more equity-like structures of musharaka, mudaraba and wakala (an agency contract). But as long as such institutions remain tied to the same rules on capital adequacy and reserve ratios, as long as they are forced to operate within a financial system that rewards the use of debt over equity, and as long as they seek to provide the same services and products that conventional institutions provide, they will always be playing catch-up.
Perhaps Islamic finance missed its opportunity to carve its own path in the 1990s, when Gulf-based financial institutions entered the London market to offer retail products to Muslim customers. As a student at the turn of the decade, I attended a presentation by the sponsors of my university’s Islamic society, a Gulf-based bank with a branch in London. The society didn’t know much about the bank, nor about the business of Islamic finance, but we desperately needed the money to survive and they fitted the profile of a perfect sponsor. So we gave them a platform and they came, complete with exhibition-stand banners and cameras.
I wasn’t a finance or economics major and I didn’t understand a word they said. They spoke about musharaka, mudaraba and murabaha, but it might as well have been Serbo-Croat. I noticed a smartly dressed woman in the front row of the audience taking notes in a leather-bound Filofax. What was she doing here? She looked more town than gown, yet she seemed to be getting what they were saying, nodding her head and scribbling furiously. What were they saying? I had no idea and, to be honest, it didn’t seem very important. Other than the City banker in the front row, the audience didn’t connect with them – they seemed to have nothing relevant to say to us. It should have been a recruitment opportunity for them – just as HSBC’s Iqbal Khan would do much more successfully a few years later – but they seemed content to regurgitate the abstruse definitions of Islamic commercial contracts without any apparent depth of understanding. If only they had engaged us with questions such as: what did these bankers do that was different? What effect does doing business in an Islamic way have on society, on humanity? Why should we consider this subject important? Nothing. Just technical jargon and corporate blandness.
At the time, home financing was a particularly pressing need for the Muslim community, though the products that came to market were confusingly similar to their interest-bearing equivalents and considerably more expensive. Since tax authorities allow interest payments to be tax deductible, thus rendering interest-bearing debt a cheaper form of financing than equity shares, one Islamic bank resorted to using the very word ‘interest’ instead of ‘profit’ or ‘rate of return’. Opining on this apparent breach of Sharia, a prominent group of scholars was moved to issue a fatwa acknowledging the benefits that the British tax system gave to interest paid and received at a bank, stating:
Despite the fact that interest, as conventionally used in banking transactions, coincides precisely with Riba, which is forbidden in Sharia to pay or receive, and regardless of whether the underlying transaction is a consumption or production loan, we have found that there is no objection to the use of the term ‘interest’ in the cases related to those dealings with Al-Baraka Bank, London, aiming to benefit from the financial advantages given to interest in various cases of deposits and financing. In this regard, it is imperative to ensure that the term ‘interest’ in the sense described above is used only in the forms required by entities other than the bank, e.g. tax declaration forms for depositors, or special forms used in various financing cases. However, if the intention is to change the nature of the transaction to make it an interest-bearing loan, then such transaction will be fundamentally impermissible.4
But this would not wash with the majority of the Muslim community, many of whom would not have been aware of highbrow scholarly discussions behind locked doors, or the existence of the fatwa. All they saw was a piece of paper with the word ‘interest’ appearing regularly. And at other times, where a mortgage provider used the word ‘profit’, the financing agreement often looked like an amended version of a conventional loan agreement. More often than not, potential buyers of these mortgage products simply turned to their brand-name high-street bank instead, angry at the apparent fraud perpetrated on them by Islamic banks. The early entrants of the 1990s had simply left a bad taste in the mouth and spoilt the market for everyone.
Might Islamic banks have entered the market differently? Advocates of home financing via mutual cooperatives point out that such a model remains true to Islamic principles of equity participation. The members of the cooperative are the funding base, taking true real estate risk, both the upside and the downside.
Ansar Finance Group in the city of Manchester in north-west England is a rare example of this model. Billing itself as ‘the most Sharia compliant home finance model in the UK and beyond’,5 it approached the issue of Islamic home financing by first considering the spirit of the Sharia, not just its letter. Other Islamic mortgage providers had adopted models such as the sale and leaseback transaction, in which the bank buys the property and leases it back to the customer. The customer repurchases the bank’s share of the property over time with principal repayments alongside their rent – much like principal and interest repayments in a conventional mortgage, although of course the form is very different. Alternatively, and more heinously, Islamic mortgage providers would offer the commodity murabaha.
Let’s leave aside the commodity murabaha structure as evidently dubious, since to many observers including the conservative Sheikh Hussain Hamed Hassan it looks like a loan, smells like a loan and acts like a loan. Let’s instead focus on the sale and leaseback, otherwise known as an ‘ijara plus diminishing musharaka’, a structure that has come to be accepted by much of the industry as Sharia credible since it involves the transfer of title deed of the property to the bank.
In one such structure used by a UK-based bank as well as the majority of home financing institutions in the Gulf, the bank purchases the customer’s property, registering it under its own name. A partnership contract between the bank and its customer (the end buyer of the house) splits a beneficial interest in the property in proportion to the principal amounts advanced by each party for the original purchase from the vendor. For example, the bank may finance half of the value of the property, the customer the other half, and the partnership agreement will reflect this initial split in ownership. As the bank has legal title to the property, the customer – the end buyer financing the home – becomes the tenant under the lease, paying periodic rental amounts to the bank. At each rental repayment date, the customer also makes a principal repayment in order to buy the bank’s beneficial interest in the partnership until such a point that the customer has acquired the full interest in the partnership, hence a diminishing musharaka or partnership. In our example, the bank would start with 50 per cent ownership and end with zero ownership by the maturity of the agreement. Instead of a borrower in a conventional mortgage paying principal plus interest to the bank, in this case the home buyer has paid the bank to repurchase ownership ‘units’ in the property plus a rental payment for the portion of the property that he or she doesn’t own. The economics of the two types of transaction may be the same, but in the Sharia-compliant version the bank has taken a real asset on its books.
Of particular note is the fact that the purchase by the customer of units in the investment partnership is made at a price that has been set at the beginning of the financing period. In other words, if the house costs $100,000 to purchase and each unit is $1,000, then the customer would repurchase every unit from the bank at a cost of exactly $1,000, irrespective of which direction house prices are moving. This has come in for criticism from some scholars in a discussion similar to the debate on whether a purchase undertaking in a sukuk transaction to buy back the sukuk at its maturity should be at par value (set at the same price as the original sukuk amount) or at market value at the time of repurchase.6
What if the customer was required to purchase units in the partnership at a price determined by the market at the time of purchase? Thus, if the value of the property rises, then the tenant would be required to purchase beneficial interest in the partnership at a higher value than the original purchase price by the bank. In our example above, if house prices move 10 per cent upwards a year after purchase of the property, then the next set of units to be repurchased by the customer from the bank would cost the customer $1,100 each. Conversely, if the value of the property falls, then a valuation would lead to a reduced unit price in the partnership. No Sharia scholar to date has objected to such a structure, and indeed that is the model used by Ansar Finance Group.
In line with Sharia requirements for correct apportionment of asset risk, and in contrast to some lease-based home financing products, the Ansar product requires maintenance and insurance costs to be shared between the customer and Ansar pro rata to their ownership in the partnership. In addition, so that customers are not heavily disadvantaged against conventional mortgage products if the real estate market is rising, capital gains may be biased in favour of the customer, though naturally the full gain will not accrue to the customer. Hence, in a rising market, the conventional high-street mortgage will always be commercially more attractive. The compensation for this cap on the upside is that the customer is able to purchase units in the partnership at a reduced cost in a falling market, since the losses are also shared in proportion to the ownership. In the economic climate of 2007 onwards, this may have been a significant attraction of the product.
A true profit-and-loss-sharing home financing product, then. According to the scholar who approved the product, ‘the scheme adopts a unique system of joint ownership that fulfils the aims and objectives of Islamic finance. I urge both Muslims and non-Muslims to study it objectively and thoroughly in order to realise how true Islamic finance deals fairly with all parties to a transaction, both the weaker and the stronger…I would like to encourage Muslims and non-Muslims who dream of building a fair society, free from oppression by debt and its detrimental consequences, to try their best to ensure that schemes such as this are successful.’7
And yet, human nature being what it is, homebuyers typically feel optimistic when buying a property, and expect their asset to rise in value over time. Faced with the option of keeping the upside to themselves through conventional products (or through diminishing musharaka products with a repurchase price fixed in advance), take-up of this equity-like financing product has not been as strong as hoped for by some in the industry. Alas, leverage is a hard habit to break.
Had a sufficient mass of buyers opted for such a model at a time when Islamic products did not exist in the UK, and Islamic banks were making tentative forays into that market, might the Muslim community in the UK have turned into a poster child for the global Islamic finance industry? The few isolated attempts to turn a community home-financing need into a viable business fell flat in the 1990s, perhaps because such a model disturbed the comfortable holding pattern that the traditional Islamic banks were accustomed to. Perhaps without the industry’s help, the community of Muslim professionals – doctors, high-street lawyers, owners of small businesses – who proposed these initiatives found themselves unable to lobby the right legislative bodies with any credibility, or to muster the right infrastructure. It wasn’t their fault that initiatives such as Ansar were poorly marketed – they had patients and clients to attend to, small businesses to run. Nor were they demographically significant enough to lobby the big institutions effectively.
So if the Islamic banks are playing water polo in football gear, should Muslims be looking to the conventional banks instead? Can they offer a wider array of products at more competitive terms and with greater adherence to Sharia standards? Despite the turmoil of the credit crisis, global investment banks remain Petri dishes of innovation, deploying vast armies of intellectually capable product specialists to develop ever mutating financial instruments. Their sales tentacles stretch across all markets, burrowing into every corner of the investor universe. Give them a set of parameters and, if the opportunity is lucrative enough, they will develop a product to satisfy those parameters. They build a machine around that product to mechanize its delivery, enabling it to flow out of the door.
In recent years, scholars began to recognize the merit of fast-tracking the development of Islamic products in partnership with these technically proficient flow monsters. Where once Islamic institutions had developed the industry at their own pace, they now had a fierce competition on their hands. The game was changing – its new entrants were stronger, faster and more ruthless. Their water cooler conversations were peppered with ‘market share’, ‘run rates’, ‘wallet size’ and ‘value at risk’. They touched down on runways shimmering in the desert heat, strolley in one hand and bulging laptop bag slung over the shoulder, sprinting to the front of immigration queues, their British and European passports meriting no more than a perfunctory glance.
Islamic finance was an intellectual curiosity for them. Once upon a time, they structured tax-efficient investment products domiciled in Luxembourg for the benefit of Belgian dentists, that archetypal high-income European retail buyer of financial product. Now their target was richer – the ultra high net worth Gulf prince – and the parameters within which they operated even more inscrutable. They lived to create and sell product as fast as possible, as if it were manufactured on a factory conveyor belt. Standardization initiatives and product ‘platforms’ – generic programmes to industrialize the production of vast quantities of financial products, especially high-value derivatives – were their obsession. The local and regional banks didn’t stand a chance.
Perhaps the old man at the conference was right to be suspicious. If he believed that the big conventional firms intended to suck the life out of Islamic finance, he might have found plenty of supporting evidence. That said, if he looked hard enough, he might have found as much evidence among the Islamic banks themselves. In private, bankers and lawyers were willing to talk freely about the sharp practices they were witness to, not just by conventional international institutions but also by regional Islamic ones.
One Samadi lawyer described a client of his, a Middle Eastern Islamic bank, buying a real estate loan portfolio, a conventional portfolio with conventional leverage. The Western-trained management of the bank instructed the lawyer to change the transaction documents to replace the word ‘interest’ with ‘profit’. They would buy the loan portfolio regardless and put it on the bank’s books for the benefit of the bank’s own balance sheet, otherwise known as the prop trading desk. The Sharia board needn’t be involved, and if any future acquisitions of assets under that loan book were to be flagged in the Sharia certification process, the deals would be disguised to look compliant. In short, the bankers were defrauding their scholars and their shareholders.
Another Samadi lawyer reserved his contempt for the conventional institutions for whom he set up offshore fund and sukuk vehicles. ‘Conventional banks have no love for Islamic finance’, he said. ‘How can you possibly assume they want to develop true Islamic finance? That would remove them from the equation. Islamic finance would destroy them, so for example they create bond-like structures and call them sukuk. Even Islamic banks now accept this debt-like instrument, and sukuk is killing Islamic finance.’
A quarter-to-quarter focus on turnover hasn’t helped the banking industry’s cause in winning the hearts and minds of the Islamic investor community. Appointing conventionally trained managers to develop Islamic business, or setting strategies in this marketplace without understanding the mind of the Muslim customer, have proven to be their downfall.
At the Masjid Al-Samad in Dubai’s executive expatriate heartland, a group of British-born Samadiites have been keeping a close eye on the British Islamic banking industry. Although they haven’t yet forsaken their chosen vocation, unlike their fellow worshipper Sulaiman, they nevertheless have deep reservations. Until 2011, not one of the UK’s five FSA-registered Islamic banks had yet appointed a Muslim to the position of CEO, and all five banks had barely moved out of the comfort zone of the commodity murabaha.
‘You need cultural affinity’, says one Samadi banker. ‘It isn’t enough to be merely a solid banker.’
Another concurs, though his focus is on Islamic windows at conventional banks:
A non-insider is suddenly thrust into the limelight to develop the Islamic business of a conventional bank or a key division of an Islamic bank. He fronts their activities at conferences and sets their product strategy. His loyalties are firstly to his bonus and secondly to his shareholders. But the products he understands are conventional ones and he just wants to replicate them. He doesn’t get the whole ‘Sharia compliant’ versus ‘Sharia based’ debate. Muslims do. But the moment they start to openly question the ethics of their profession, they’re out of a job. Meanwhile the secular, politically astute operator with a background in conventional banking continues to run the industry.
Perhaps as long as the Islamic finance industry continues to borrow both resources and ideas from the conventional industry, and is forced by legislation, regulation and tax authorities to operate as a moneylender and not a merchant, then the debate around ‘Sharia compliant’ versus ‘Sharia based’ will remain biased in favour of the former. In other words, Islamic financial products will remain reverse engineered from their conventional equivalents – like the commodity murabaha home mortgage – instead of based on a purer structure – like Ansar’s profit-and-loss-sharing mortgage. And in perpetuating Sharia-compliant instead of Sharia-based products, the holistic approach demanded by the Sharia in regulating one’s worldly affairs is lost. Considerations about the environment, labour practices or societal improvement are put to one side as otherwise conventional corporations use Islamic instruments such as sukuk as a means to chase shareholder return.
And whilst the immediate effect of appointing technically proficient executives is a ramping up of research and development, leading to a rapid increase in product innovation, innovation can soon turn sour. Initially, new markets are created and customer brand loyalties cemented. No clearer example of this can be found than in the case of Deutsche Bank. It burst onto the Islamic scene with previously unimagined transactions such as the Safa Tower and the PCFC sukuk, and singlehandedly invented the Islamic derivatives industry.
With its commitment to innovation and quality, Deutsche Bank turned itself into the de facto industry leader. But did it care for the industry and its customer base? If the economic tide turned, would it and its international competitors tough it out with their customers or would they row back out to sea? How far would these conventional banks go to close profitable transactions? Would they be willing to uphold the Sharia, come what may, or would they find ways to bypass the constraints and obligations expected by their customer base and scholars?
Men like Sheikh Nizam Yaquby had recognized the benefits to the development of the industry of bringing in the global banking behemoths, embracing their entry into the market. But, of late, he and his fellow scholars had gradually started to pull back on the special permissions they had once granted in the early days ‘for the good of the growth of the industry’. Having been given this kick-start, the industry was now thriving and financial legislation was now more inclusive. Commodity murabaha was gradually becoming a structure acceptable only when no alternatives were available – when, for example, tax authorities might penalize an alternative structure. And, even then, its usage could not be justified as a precedent for future similar deals. Sheikh Hussain, too, would watch his wa‘d creation like a hawk, realizing that the barbarian hordes had been unleashed from the gates of the flow monsters. Without inherent checks and balances, this nascent industry would die before adolescence unless the standard bearers stood up to dubious structures.
As we saw in earlier chapters, Deutsche Bank courted controversy over the wa‘d structure, and its Islamic structuring team began a painful process of disbanding as the post-2007 economic downturn played out. Within the team, disagreement surfaced over the use of the wa‘d to replicate non-compliant trading strategies. With a factory now in existence to issue Islamic structured products, most of the dedicated Sharia structuring input was no longer required, and even dedicated Islamic sales staff were caught in the redundancy crosshairs, leaving their conventional colleagues to manage relationships with Islamic banks. Why retain Islamic specialists when conventional bankers can do the same job and won’t have the same moral objections? By early 2011, as markets debated whether the world would enter a double dip recession, not a single dedicated Islamic structurer or salesperson remained at Deutsche. Islamic finance had become ‘a luxury the bank can’t afford’.8
Where once Islamic finance had been viewed as a strategic project, as the economic climate deteriorated global investment banks changed tack and opted to sell Islamic product opportunistically. A holistic approach was no longer required: product platforms had been set up in the boom years and the banks could simply churn out product off the back of those platforms. Fatwas from several years ago would simply be reused for new products. Islamic finance had turned into a curiosity, an intellectual game, and its star players had no love for it.
Investment banks were not alone in their attitudes towards the industry. Private equity firms briefly flirted with Sharia-compliant funds in the hope of diversifying away from their traditional investor base. But, by and large, they too merely mirrored the conventional banks’ opportunism. The head of one of the Middle East’s leading private equity firms, when asked why he had pursued only one Sharia-compliant fund and then subsequently reverted to launching conventional funds, replied: ‘I made my niyya [voiced my intention to God], performed wudu [ritual ablution before prayer], prayed, but God did not answer.’ Having sold a substantial portion of units in his Islamic fund to conventional investors such as large US pension funds and Asian banks, he felt that the additional effort to attract Islamic Gulf and Malaysian money had not been worth it.
In February 2011, the governor of Qatar Central Bank suddenly and unexpectedly instructed conventional lenders to close down their Islamic operations in the country by the end of the year.9 Only two months earlier, he had been inaugurating the Doha branch of HSBC Amanah, HSBC’s Islamic banking arm. At first bankers assumed some awful scandal had been perpetrated, prompting this draconian demand, yet none was uncovered. The more cynical fell back on the conspiracy theory, suggesting that leading figures in the Qatari financial community had taken stock positions in the country’s Islamic banks with prior knowledge of the announcement. Yet although shares in Doha’s Islamic banks jumped as much as 10 per cent following the announcement, and conventional lenders fell commensurately, there was no hard evidence to substantiate this.
One Qatari columnist for the newspaper Al Sharq was moved to launch a scathing attack on the QCB by suggesting it should learn from the experiences of foreign regulators in monitoring the activities of banks with ‘mixed operations’.10 ‘It’s a harsh and imprudent measure to take’, he wrote, suggesting a reform of wrongdoing banks rather than a complete closure of their activities. ‘The QCB move threatens to undermine the development of the Islamic banking industry in Qatar. It would lead to a monopoly of the full-fledged Islamic banks and they would not be bothered about improving their services. They wouldn’t be taking their customers seriously.’
The QCB countered by stating that alternative capital adequacy rules were in the pipeline for Islamic institutions, and that conventional institutions would not be able to follow both sets of rules simultaneously.11 It also suggested that it was too difficult to supervise and monitor both Islamic and conventional operations of commercial banks, since depositor funds would get ‘mixed up’. It acknowledged that the basic financing methods used by Islamic institutions were inherently equity-like and therefore more risky: the Islamic institution deploying products based on mudaraba, musharaka, istisna and ijara contracts was acting as a merchant, not a lender. ‘It is difficult to fully protect the rights of depositors.’ So the QCB was acknowledging the inherently unbalanced playing field in which Islamic institutions were operating, and was attempting to level that field.
Bankers were furious, claiming that the decision had been unilateral, unfair and irrational – that competition would be reduced and the consumer would suffer. Product innovation would be paralysed and customer choice would dry up. There would be no incentive on Islamic institutions to improve.
And yet some in the industry – just a handful, mind – felt that this was perhaps a move the industry needed. First to level the playing field and, second, to restore credibility. Unknown to most, regulators and scholars had been having closed door discussions in the lead up to the ban. The scholars were wising up to structured product platforms that gave the investor no legally enforceable security interest in the Islamic assets; or that allowed for the bank to reuse those assets for its own purposes without permission of the investor; or commodity murabaha transactions to finance real estate assets because the credit risk management departments of conventional banks couldn’t envisage any financing that didn’t look like, smell like and act like an interest-bearing loan; or products that engaged in non-compliant hedges on the other side of the trade, because the Islamic investor couldn’t see the hedge; or, at its most basic, the simple co-mingling of Islamic depositors’ funds in centralized pools of money where returns were smeared into one homogeneous whole.
Around about the same time, another much larger scandal was brewing on Wall Street. One of the world’s largest brokerage firms, MF Global, suffered a spectacular implosion as a result of an improper transfer of over $891 million from apparently segregated customer accounts to one of MF Global’s own broker-dealer accounts to cover trading losses at the firm.
The outspoken trends forecaster and publisher of the Trends Journal, Gerald Celente, did not see this one coming. Despite his much publicized earlier predictions of global turmoil and open criticism of Wall Street excesses, he was caught napping and lost what he claimed were his life savings in the collapse of MF Global.12 A well-known ‘gold bull’, Celente had built up a position in gold by buying coins, bullion and gold futures through brokers on commodities futures exchanges. On these exchanges, he would buy a ‘future’ position on gold, by paying now and taking physical delivery on a pre-specified future date.
On 30 October 2011, a unit of MF Global reported to the Chicago Mercantile Exchange and the Commodities Futures Trading Commission that there was a material shortfall of hundreds of millions of dollars in segregated customer funds. MF had been using customer funds to ‘meet liquidity issues’ in the days prior to its bankruptcy. It had mixed customer funds and used them for its own account, transferring them out of the US. When these apparently intraday loans were not returned by the end of the day, panic ensued, and the loans from customer accounts just got bigger. Customer accounts were frozen and the following day, the company filed for bankruptcy.
Celente was furious, demanding to know why MF Global’s CEO, Jon Corzine, a former CEO of Goldman Sachs, Governor of New Jersey and a US Senator, would not be going to jail over this.
‘I found out they took all my money – all my money – out of my account and put it in the hands of a trustee…I said you mean Meyer Lansky and Al Capone decided to take my money…?’ ranted Celente, referring to two of the most infamous names in organized crime.13
He had a point. His New York mannerisms and language were a little more colourful than most of MF’s customers, and perhaps his reputation as an unrepentant eschatologist and economic doom-monger did his cause few favours, but many co-investors might have agreed when he suggested that the ‘M’ in MF should stand for Mother and the ‘F’ should…well, you get the picture.14
‘This guy’s sitting at the casino, making bets, 36 to 1!’ he yelled at a news anchor, referring to Corzine and his firm’s usage of customer funds for allegedly making leveraged bets on European government bonds.15 ‘He’s cleaned out and ruined a lot of people!’
The lack of separation between customer funds and a firm’s own money had caused the largest Wall Street meltdown since Lehman Brothers in September 2008. It was no leap of logic to see that the conventional financial services industry continued to risk the health of the world’s economy by allowing investment bankers to play with money that didn’t belong to them.
Will Islamic finance head the same way? Will it, too, replicate the conventional industry to such an extent that it, too, may mingle depositors’ funds with the institution’s own funds? Or will it recognize the real economy role that money must have – attachment to real assets and segregation of ownership?
Perhaps, rather than being the kneejerk reaction of a hysterical regulator, the Qatar Central Bank had instead taken a bold leap forward in protecting the interests of Islamic depositors. Perhaps it was in fact reclaiming the ethical values of the Islamic finance industry.