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May 1, 2008updated 12 Apr 2017 4:51pm

New money

As the cash-strapped West looks East for funding, Shariah financing is very much in the news UK lessors discuss how they can benefit from these new developments

By Paul Collett

As the cash-strapped West looks East for funding, Shariah financing is very much in the news. UK lessors discuss how they can benefit from these new developments.

 

The making or breaking of companies these days can depend on just how imaginative and flexible their approach is to raising funds. The need to do so is ever more evident as the economy continues to spin downwards. The British Chambers of Commerce’s quarterly economic forecast, for instance, is expected to report that Britain is heading into a technical recession of two or more quarters of declining GDP over the next six to nine months. s At leasing companies, for which liquidity is all, inventiveness is a particularly important route when it comes to surviving in today’s testing economic climate. Not surprising, then, that Islamic finance is increasingly being looked at to provide innovative solutions.

“Lease contracts originated during the Ottoman Empire to create and sustain wealth,” says Bank of London and Middle East’s director and head of corporate banking, Derek Weist.

“Leasing is nothing new, but the instrument needs liquid capital markets for sustenance. And Shariah-compliant financial instruments are nothing new; but what we are seeing is an increasing number of lenders looking to diversify funding sources through Islamic finance to keep the wheels of industry rolling in the current economic climate,” he adds.

Shariah-compliant financial services offer financial products to clients by developing transaction structures that comply with Shariah rules.

The mechanisms resemble conventional banking and finance products, the broad difference being no interest or late payment charges can be levied.During the last decade growth has been marked, with major financial institutions including Lloyds, Barclays, HSBC, Citigroup, Deutsche Bank and, most recently, Bank of London and Middle East (BLME) among those getting in on the Islamic act.

BLME opened its doors last year and is, if you like, one of the new kids on the block. That said, senior leasing managers Graeme Laing, Mark Jarvis (UK and US respectively) and Weist are traditional lessors and agree that Shariah structures are similar.

“The notable differences,” says Weist, “are the penalty clauses.

“It would be a legal minefield to remove them, so a percentage of any late payments goes to charity – leasing fits with the Islamic model of sharing risk and reward.”

However, the Middle East connection goes further than just Western banks – albeit new ones – engaging more intensely in Islamic finance. Sovereign funds have hit the news recently with blue chip GE Capital joint venturing with Mubadala, Abu Dhabi’s state investment vehicle, to set up an $8bn finance business.

This is nothing new, as “the deal with Mubadala comes after around four years of working together on a range of investment and energy projects”, says GE’s spokesperson, including a $1bn investment fund created in 2006 between GE, Credit Suisse and Mubadala, a joint venture that shows cross-border alliances are the norm.

What is interesting though is that while GE strikes deals in the Middle East and around the world, its Capital Solutions division – which deals with fleet management, equipment leasing and commercial distribution in the UK – is looking to shed jobs.

In Europe, GE’s Swiss operation has cut two-thirds of its workforce of around 200. It would appear that, following the review and the Abu Dhabi tie-up, GE is following the money to the Middle East, shifting its focus to big-ticket deals and leaving the SME sector.

“The new $8 billion fund will invest in a range of high-return financial services businesses and assets across all sectors. This is in line with new CEO Jeff Immelt’s strategy of investing in high-growth, high-return industries and geographies,” GE’s spokesperson adds.

Although GE aims to build its book to more than $40 billion during the next 12-18 months, concerns have been raised over a Middle Eastern financier owning half of the all-American behemoth.

“Politically, it could potentially be held up for some criticism,” says an insider in a reference to concerns some American companies have about engaging in business with Middle Eastern entities.

Richard Mintz, a spokesman for Mubadala, says it does not intend to file for a national security review with the Committee on Foreign Investment, the 12-agency US group authorised to recommend the White House block or alter terms of deals involving national security.

Back in Britain, “the UK government is supportive of Islamic Finance and is planning a UK Shariah-compliant bond issue [or sukuk]”, notes Warren Edwards, CEO Delphi Risk Management, and governor of The Institute of Islamic Banking and Insurance.

“But some divisive elements of the press have alleged a link between Islamic finance and terrorism,” he adds, “and it will be interesting to see if government backtracks in its support of Islamic finance in the UK.”

How at ease the government is with Islamic finance and its alleged connotations could be summed up by the fact that the proposed bonds are currently known as ‘alternative finance’.

For BLME though, it is pretty much business as usual, reports Weist: “We have not found the source of our finance a hurdle. The fact that we are a fully FSA regulated UK bank quells most concerns that a potential customer may have.

“But no, we have not come across any prejudice once we have explained a bit more about the bank and its shareholders. What we find very encouraging is that our book is strong and growing both here and in the States, where it could be perceived as more of a problem.

“Twelve months ago BLME had nothing on its book. Today, in the UK, we will have written some £30m worth of deals by the end of this year, while in the States the figure stands at $170 million, and both markets are growing.”

Weist hopes to double the figures next year, saying, “we have the funding and we’re asset acquisitive”.

The high octane world of Premier League football is also benefitting from Islamic funds. Richard Price, the managing director of New Century Finance, a strategic financier and lessor, is about to close the first transfer deal under Shariah law.

“Yes, by the time this article is printed the deal will be done with Manchester City for around €1.5 million,” he says. “The deal will form a template for future robustly structured transactions, both here and in Europe, and I don’t foresee any ethical issues.”

Concerns have been raised by scholars in some quarters that up to 80 percent of Shariah deals do not conform to Shariah law. In particular, Shariah law dictates sukuks must be able to link the returns and cash flows of the financing to the assets purchased or the returns generated from an asset purchased. This is because trading in debt is prohibited under Shariah.

As such, financing must only be raised for identifiable assets – which must be tangible rather than cash flow.

“However, what the scholars are trying to do is make sukuk asset-backed rather than just asset-based,’’ says Arul Kandasamy, the Dubai-based head of Islamic finance for Barclays Capital.

This is a hardline stance, as outlined by a statement released by the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI): “Blemishes have crept in that the industry must now rid itself of.”

As much as 80 percent of sukuk sold to date may not comply with all the precepts of Shariah, the AAOIFI board stated. f

If there is a lack of conformity, it could make it tricky for companies to leverage Islamic finance at a time when borrowing is already shrinking because of the global credit crisis. Jebel Ali Free Zone, Dubai’s state-run operator of a business park adjoining the Jebel Ali port, raised $2 billion in the biggest sale of sukuk from the Gulf in the past six months.

The sukuk certificates were issued by JAFZ Sukuk and were sold to investors in the Middle East, Asia and Europe. The certificates have been rated A1 by Moody’s and A+ by Standard & Poor’s. However, buyers of the bonds have no legal claim on the underlying assets, rather they have an “implicit guarantee” the issuer will cover any payment shortfalls.

According to analysts, the likely impact is that either the sukuk market becomes more based on Islamic securitisations or it splits, with some sales becoming truly asset-backed and other issuers choosing to continue with existing structures.

Meetings last month between Leasing Life and a number of smaller UK lessors and lease brokers revealed that Islamic finance is, for the first time, passing their radars in a serious way. Historically they might have been turned off by the fact that most Islamic leasing deals have been big ticket.

The fact BLME and New Finance are signing comparatively small equipment deals using Islamic finance structures reveals a sea change is happening – one many lessors might do well to consider tapping into.

This move in Islamic finance leasing to equipment – as opposed to a past presence in ship and aircraft – has been in the offing for some time.

Last October, for instance, we reported that Islamic funds are increasingly looking to European assets for investment opportunities. At the time, fund managers were looking for real estate projects and also moveable assets, not least those used by the public sector that are government secured. While this has not yet happened, the prospect seems more and more likely.

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