Spotlight On...
Islamic Finance in the U.S.
SPOTLIGHT ON...
Contact John Vogel
Email:
jvogel@pattonboggs.com John Vogel, Patton Boggs
Islamic finance has developed in the United States along two distinct paths -- retail financing products and equity investment.
Retail Financing Products The offering of Sharia-compliant retail products to U.S. consumers remains limited largely to residential financing. These financings in the United States are often structured using one of the following Islamic finance techniques:
a. Murabaha. In this structure, customer identifies the property he wishes to purchase and agrees on a price with the seller. Customer informs his Islamic financial institution (IFI), and IFI acquires the property from the seller at the agreed price. IFI then sells the asset to customer for the original purchase price plus an agreed profit, and customer pays this new, higher purchase price in installments to IFI.
b. Ijara. In an ijara transaction, IFI purchases a property which customer has identified. Then, IFI leases the property to customer in exchange for rental payments. As part of the transaction, customer promises to buy the property from IFI at the end of the ijara lease. Customer then makes periodic rental payments to IFI which are used to purchase the property from IFI.
The regulatory groundwork for Sharia-compliant residential
mortgage products in the U.S. was
established with the approval by the Federal Reserve Board and the Office of the Comptroller of the Currency in the 1990s. These agencies concluded that such ijara and murabaha transactions should be permitted because such transactions are substantively equivalent to conventional mortgages, and the risks posed to an IFI in making available such financing are credit risks of the same type as those regularly assumed and managed by conventional mortgage institutions.
Equity Investments While the regulatory issues that arise in structuring Sharia-compliant retail financing products do not generally apply to equity investments, an equity investment should satisfy the following tests to be Sharia-compliant:
• The core business of the company in which the investment is being made must be halal, or permitted by Sharia law.
• The company’s liquid assets should not exceed 20% of its total assets.
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• The ratio of all interest-based debt (including preferred stock) should not exceed 40% of the company’s total assets.
• The ratio of the company’s non-Sharia-compliant investments to total assets should not exceed 33%.
• Revenues from non-Sharia-compliant investments should be less than 5% of the company’s total revenues. Any excess must be “purified” by donation to appropriate charities.
• The company’s market price per share should be greater than the net liquid assets value per share.
The most commonly used structure to finance the acquisition of U.S. commercial assets is an ijara wa’iqtinah. In this structure, a special purpose entity (SPE) acquires an asset from a seller. Simultaneously, SPE enters into an ijara lease with respect to the asset with an entity (Investor) established for that purpose by IFI and any investors. The ijara requires Investor to make an advance “rental” payment to SPE, which represents the equity investment made by Investor in the asset. SPE also enters into a conventional loan with a U.S. bank (Lender) and the proceeds of that financing, together with the advance rental payment, are used by SPE to pay the purchase price for the asset being acquired. Investor, as master lessee of the asset, becomes the landlord in relation to the tenants physically using or occupying the asset.
Investor
secures its obligations under the lease by assigning to SPE its rights under the tenant leases and by granting to SPE a security interest in any other assets Investor may have. SPE, in turn, secures its obligations under its conventional loan with an assignment to Lender of its rights under the lease with Investor and all other collateral it receives from Investor.
Since
payments by Investor under the ijara are substantially equivalent to the debt service obligations of SPE under its conventional loan, any payment default by Investor under the ijara is likely to result in a payment default under SPE’s conventional loan.
to be treated as the “tax owner,” SPE typically retains Investor (or its affiliate) under a separate agreement to handle the performance of these responsibilities on behalf of SPE.
The Future of Islamic Finance in the Unites States
In order to overcome the impasse currently
preventing Islamic financing from broadly flourishing in the U.S., U.S. regulators, politicians, bankers and consumers must be educated as to the advantages and equitable nature of Islamic finance. Foreign investors must be educated as to the banking, securities and tax regimes in the U.S.
The U.S. regulatory authorities must simplify,
consolidate and coordinate financial, tax and securities regulations governing Islamic finance structures in order to broaden the capital markets and attract foreign investments to the U.S. In this manner, there may well be room for greater financial innovation, such as the recent U.K. government- issued sukuk, to provide an alternative long-term financing methodology for infrastructure projects and resulting growth and economic stability in the U.S.
About John Vogel
Mr. Vogel is a Senior Partner at the international law firm of Patton Boggs LLP, specializing in international financing, both conventional and Islamic and cross-border project development and finance.
Moreover,
the conventional loan documents likely contain an explicit cross-default provision such that a default by Investor under the ijara constitutes a default by SPE under the conventional loan. The ijara will require that certain tasks associated with ownership of the property, such as major repairs and property insurance, be handled by SPE as the lawful “title owner” of the asset. However, in order for Investor
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