By Bakampa Brian Baryaguma
[Dip. Law (First Class)–LDC; Cert. Oil & Gas–Mak; LLB
(Hons)–Mak]
bakampasenior@gmail.com;
www.huntedthinker.blogspot.ug
June
2022
1.
Introduction
Islamic financing is concerned with the conduct of
commercial and financial activities in accordance with Islamic law. Islamic
financing has moved from being a mere niche to the mainstream, thanks to the
economic prosperity of Middle Eastern countries where it is prevalent, but also
the growing trend of governments,[1] financial institutions, and
individual Muslims worldwide investing in a manner which is consistent with Islam.
2.
Sources of
Islamic Financing
Islamic law is a manifestation of the divine will of Allah
and finds its expression in the Qur’an and Sunnah (words or acts) of Prophet
Muhammad. The law contained in the Qur’an and Sunnah is known as the Sharia’a which reflects a
compilation of the values, norms and rules which govern all aspects of a
Muslim’s life (such as family life and economic activities). A Muslim is therefore obliged to comply with Sharia’a at all times and
in all respects. Sharia’a law is
accordingly the source of Islamic financing.
At the moment, the application of Sharia’a law is largely case and entity-specific, in the sense that
there are no harmonized internationally recognized standards. There are efforts,
however, to systematize, regulate and globalize Islamic finance standards, mainly
led by the Accounting and Auditing Organization for Islamic Financial Institutions,
the International Islamic Financial Market and the Islamic Financial
Services Board, so as to instill investors with confidence to invest in Sharia’a-compliant
products.
3.
Principles of
Islamic Financing
In Islam, there is a presumption that everything is permissible (halal) unless there is
an express law which rebuts that presumption by declaring it
as forbidden (haram). The pertinent Sharia’a principles that relate to Islamic finance are that the
following are avoided in any transaction:
(a)
riba (excess or increase) –
This means any excess paid or received on the principal or an
additional return received on the principal derived by the mere passage of time.
It includes interest as charged in conventional loans because Sharia’a 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 such that it cannot therefore derive a profit either from the exchange
of money of the
same denomination or due to the passage of time. Riba is forbidden in Qur’an, Surah Al Baqara 2:275,
Qur’an, Surah Al Baqara 2:276-280, Qur’an, Surah Al-Imran 3-130, Qur’an, Surah
An-Nisa 4:161, and Qur’an, Surah Ar-Rum 30:39. It is also forbidden in the
Sunnah Majma al-Zawa’id, Ali ibn Abu Bakr al-Haythami (vol 4, 117).
It should be understood however, that Sharia’a does
not prohibit the making of profit per se; it only scrutinizes the basis upon
which profit is made as, for example, charging interest could exploit the client
in a time of hardship whilst the financier’s wealth is increased by no effort
of its own. Islam instead empowers the financier to derive a profit by
investing its money or other consideration directly (or indirectly through a
joint venture arrangement, for example) in real assets.
(b)
gharar
(uncertainty) –
It can be defined
as the sale of probable items whose existence or characteristics are uncertain
or speculative (maisir), the risk of which makes it akin to gambling (qimar).
The rationale for prohibiting gharar and maisir stems from the
belief that bargains should be based upon contractual certainties as far is
possible in order to bring about transparency and avoid conflict over key terms
of a contract such as the object, the quality of goods, the time for delivery
and the amount payable. Contemporary examples of gharar include: the sale of an object prior
to it coming into existence, which subject to certain exceptions, would render
the contract as void; where the object is unknown; where the specifications of
the object are unknown; and where the price or rent cannot be ascertained with
certainty.
(c)
maisir (speculation) –
See (b) above.
(d)
qimar
(gambling) –
Refer to (b) above.
(e)
prohibition
on investing in or being involved with haram
products and activities (such
as alcohol, pork and gambling establishments);and
(f)
prohibition
of
becoming
unjustly enriched.
4.
Techniques of
Islamic Financing
The bedrock of Islamic financing is profit and loss sharing
since Islam perceives that the ideal relationship between contracting parties
should be that of equals where profit and losses are shared. This priority is facilitated by
the following financing techniques.
(a)
Mudarabah
This is an investment fund arrangement under which the
financiers act as
the capital providers
(rab
al-mal) and the client acts as the mudareb (akin to an
investment
agent) to invest the capital provided by the rab al-mal and manage the
partnership. The
profit of the venture, which is based on the amount yielded by the
fund that
exceeds the rab al-mals’ capital investment, can be distributed between
the parties at a
predetermined ratio but with any loss (subject to whether the loss is
caused by the mudareb’s negligence)
being borne by the rab al-mal. The fund is controlled by the mudareb with the rab al-mal as a silent partner.
(b)
Musharaka
In a Musharaka,
the financing arrangement is similar to a Mudarabah except that the
losses are borne in proportion to the capital invested by both the client and
the financier. Each party to the Musharaka has the right to participate in the affairs of the enterprise
but each can also choose to waive that right and instead be a silent partner as
in a Mudarabah. The silent partner however, will then only be entitled
to profits in proportion to its capital investment and not more. There are two
types of Musharaka:
(i)
Continuous Musharaka
Here, each partner retains its share of the capital until the end
of the project.
(ii)
Diminishing Musharaka
This is also
known as Musharaka
Muntahiya Bittamleek. Here, it is agreed at the outset that one of the partners will
purchase units in the Musharaka
from
the other partner at a pre-agreed unit price.
(c)
Murabaha
A simple Murabaha
transaction involves the purchase of an asset by the financier (on behalf
of the client) who then sells the asset to the client for the cost of the asset
plus a pre-stated margin on a deferred payment basis which may be pegged to a benchmark.
The profit margin earned by the financier is legitimate profit and not interest
because the financier acquires ownership of the asset (and therefore the risk
associated with ownership of the asset) before on-selling it to the client.
Upon acquiring ownership of the asset, the client may
go a step further and sell the asset to a third party for cost price so that
the client now
has the money it may have always wanted (rather than the asset) whilst it
remains liable to the financier to pay the cost-price of the asset plus a
pre-stated margin on a deferred payment basis.
(d)
Istisna’a
An Istisna’a is
a construction and procurement contract for the commissioned manufacture of a
specified asset and can be used during the construction phase of a project
financing. Here, following a request from the client, the financier procures
the contractor to manufacture an asset which meets the specifications of the
client for delivery by a specified date. Sharia’a requires that the
price payable for the asset is fixed at the outset (but not necessarily paid in
full at this point) and only altered if the specification of the asset is
amended by the client.
(e)
Ijarah
The Ijarah is
a form of lease financing pursuant to which the usage (usufruct) of an asset
or the services of a person are leased by the lessor to the lessee for rental
consideration. The nature of the asset or service must be precisely defined in
the lease. Under the Ijarah, the lessor (the financier) will purchase
the asset from the supplier and then transfer possession to the lessee (the
client) with the profit margin built into each lease payment over the term of
the lease. The
lessee may act as the lessor’s agent to purchase the assets from the supplier. It is also
possible for the lessee to own the asset which it sells to the lessor who, in turn, will
lease it back to the lessee. The lease can take effect as an operating lease, with the asset
returning to the lessor at the end of the lease term, or akin to a finance 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’a). The lease
will commence immediately upon execution of the Ijarah if the assets
have sufficient economic value and substance so that it can and is used for
the purpose intended. If the assets do not have sufficient economic value at the
time the lease is executed, then the rent will only become payable when such value and
substance does exist.
(f)
Sukuk
Sukuk are Islamic trust certificates representing an undivided beneficial
ownership interest in an underlying asset where the return is based on the
performance of that underlying asset. The key attributes of Sukuk are that they
are asset-based securities and any profit or benefit derived from the Sukuk must be linked
to the
performance of a real asset and the risks associated with ownership of that
asset. Hence, Sukuk are
distinguishable from conventional bonds which are bearer
negotiable debt securities that pay the holder fixed or floating interest
on a periodic
basis during the term of the bond. Sukuk do share certain features with
conventional bonds, such as being in certificated form, being freely
transferrable 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 Sharia’a prohibits.
5.
Islamic
Financing vis-à-vis Conventional Financing
The major difference between Islamic financing and
conventional financing pertains to charging interest; whereas the latter allows
interest charges, the former forbids interest levies.
But there can be moments of operational convergence of the
two systems, in the sense that it is possible to combine Islamic financing with
conventional financing on a single project. Consider, for example, a building
project. During the construction phase, the Wakala agreement
in the Wakala-Ijarah
tranche and the Istisna’a agreement in the
Istisna’a-Ijarah tranche provide
the construction financing for certain assets (referred to as the Islamic
assets), isolated from the overall project, up to the value of the financing to
be provided under the relevant Islamic tranche. The remainder of the project assets are financed
using the monies from the conventional tranches. This situation can be called separate combination.
Where cross-border projects are involved and affected by
multiple legal provisions, English law is usually chosen as the governing law.
But this raises several conflict of laws issues because the law of the
jurisdiction in which the project is located may have automatic jurisdiction or
the agreement may not be enforceable in the jurisdiction in which the
project is
located as the agreement may be inconsistent with its laws. Another issue,
which Sharia’a scholars are
more concerned with, is whether English law or Sharia’a law takes precedence in the event of a conflict between the
two sets of legal principles. From this flow the related issues of whether an English
qualified judge is qualified to adjudicate on a dispute relating to an Islamic agreement;
whether Sharia’a law or English law will be applied and if Sharia’a law, then which
particular school of thought (Madhab) will be applied. The approach of the English courts, in the main,
has been to distinguish between the Sharia’a and the contractual governing law of an Islamic agreement by
ruling that Sharia’a issues are not
justiciable in the English courts. That element of the agreement is
deemed as forming part of the commercial agreement (which English courts
will rarely interfere with) and not the legal agreement. Instead the
dispute will be
dealt with applying the ordinary principles of English law and an
English court
will avoid ruling or commenting on the compliance of the agreement
with Sharia’a, such as was
done in the case of Shamil Bank of Bahrain v. Beximco
Pharmaceuticals Ltd [2003] 2 All ER
(Comm) 849.
NOTES
1.
In
Uganda, the Financial Institutions Act,
2004 (FIA) was amended to cater for Islamic Finance in January 2016. The
amendment became effective on 4th February, 2016. Bank of Uganda as the
regulating Body is mandated to promote and ensure stability in the Islamic
Financing sector.
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