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A transaction apparently complying with Islamic finance rules which dismays most Muslims who look at it

The "Shariah conversion technology" underlying the transaction appears to violate any purposes which underlie Islamic finance.


Posted 19 February 2018

Is Islamic finance simply finance conducted in accordance with rules set by Shariah Scholars, or is there something underlying, beyond rules compliance, that makes particular finance transactions Islamic?

People new to Islamic finance often ask this or similar questions when they see that the economics of an Islamic mortgage are essentially the same as the economics of a conventional mortgage. (In the UK they are also more expensive. See "Why Islamic mortgages normally cost more than conventional mortgages.")

However with mortgages the simple answer is that conventional mortgages and Islamic mortgages both fulfil the same benign purpose, namely enabling people to buy houses to live in while spreading the cost over an extended future period.

The purpose question arises much more sharply with the structure discussed in my February 2018 "Letter from Amin" column in the magazine Islamic Finance News, which is reproduced below.

To put it very simply, for religious reasons, I do not buy shares in breweries because I believe that I should not be in the business of brewing alcohol. If other people want to brew alcohol, I have no wish to stop them; however I don't want to own shares in a brewery.

Using the structure below, I could achieve the same economic results as buying some brewery shares, using a transaction that has been signed off by Shariah scholars. I find this unsatisfactory.

"The “Doomsday Fatwa” and the purpose of Islamic finance"

At a Muslim conference recently, one of the sessions I attended was about Islamic finance. I found myself transported back in time by about a decade!

In 2007, Deutsche Bank (DB) published on its website something with the neutral sounding name “Deutsche Bank Academic Paper.” At the same time, on 30 January 2007, DB issued a press release “Deutsche Bank publishes White Paper to increase supply of Sharia compliant alternative investments.” When writing this column, I managed to find the press release on the DB website, with a link to the paper, but clicking through goes to a default DB website page, not to the paper. However, the paper can easily be found via the Google search “Deutsche Bank Academic Paper.” Today nothing published on the internet ever disappears completely!

The paper is quite short, 15 pages. It outlines a structure which I will summarise as follows:

  1. An Investor transfers money (say $1m) to DB, and in exchange DB issues investment instruments to the investor, which I will call sukuk.
  2. DB invests the $1m in Shariah compliant investments, such as Shariah compliant listed equity shares, which are fully segregated from DB’s other assets.
  3. The sukuk carry full rights to the income and capital value of the Shariah compliant investments.

At this stage, all one has created is a pool of Shariah compliant shares, whose ownership is expressed through the sukuk instruments.

  1. DB pays $1m to acquire an asset, called Reference Asset A.
  2. The investor gives a unilateral promise (Wa’d in Arabic) to DB that if DB requests, investor will sell the sukuk which investor owns to DB for a price equal to the Formula Price.
  3. DB gives a unilateral promise to investor that, if investor requests, DB will buy the sukuk which investor owns, for a price equal to the Formula Price.
  4. The Formula Price is equal to $1m pus all of the income paid by Reference Asset A during the period of the structure’s existence, plus any growth in the value of Reference Asset A, or less any reduction in the value of Reference Asset A, as appropriate.

The overall effect is that, using the language of conventional finance, Investor has entered into a total return swap with DB, whereby DB will earn the total return on the (initially $1m) pool of Shariah compliant investments, while Investor will earn the total return on the (initially $1m) Reference Asset A.

Nothing in the structure requires Reference Asset A to be Shariah compliant. Nor does the Investor ever own Reference Asset A.

Effectively, if a Muslim investor believes that, say, the shares of a particular brewery would be a good investment, but does not wish to own brewery shares for religious reasons, this structure allows the investor to achieve the economic results of investing $1m in those brewery shares without ever owning any. That is why I have been dismissive of the structure since I first encountered it.

If there is any purpose underlying the Shariah scholars’ rules on what shares Muslims should invest in, how can a structure which sidesteps those rules be approved by Shariah scholars?

I had however never previously encountered the name the conference speaker gave this paper. He called it “The Doomsday Fatwa”; presumably because it raises the purpose question so severely. Of course, the same purpose question is raised, albeit less severely, by most of the other structures in Islamic finance since they achieve the same economic outcomes as conventional finance but using Shariah compliant contracts.

Further reading

The essence of the structure is the use made of unilateral promises, (wa'd in Arabic). There is an interesting detailed analysis of the Islamic jurisprudence on unilateral promises in the 2013 article "Deutsche Bank and the use of Promises in Islamic Finance Contracts."

In 2007 Yusuf Talal DeLorenzo wrote a strong critique of the structure: "The Total Returns Swap and the 'Shariah Conversion Technology' Stratagem."


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