Tuesday, 4 November 2008

Sharia Bonds

I have this habit of walking into phone booths. Maybe because I've never actually used one. With a geek phone that almost makes me coffee, why should I? Maybe it's just my burning urge to make station-to-station calls to Alistair Darling, "This is Colonel Lionel Mandrake..."

Anyway, while I was walking on Parliament street, I remembered that a while back, when I was still at the LSE (doesn't time fly?!), I read an article in the FT that the Exchequer were going to issue Sharia bonds, or, in other words, Islam compliant bonds.

First of all, a bit of a background. A bond, is an I-Owe-You paper issued by the government to which certifies that the government owes the holder of the bond a certain amount of money, and that it agrees to pay a given amount of interest once the bond is mature. Mature, as in, when a bond is issued, it's issued over a certain period of time, up to seven years, and when the time is up, the government will pay you back the money with interest. Unlike stocks, bonds, are technically "risk-free" as in, it's highly unlikely that the government will default on the loan. (This is how a spread is calculated: the risk difference between a bond (risk free) and a stock (price changes, may default - bankruptcy).

But, what is important to this post is the interest part, to which, in Islamic law , or Sharia , is not allowed.

Sharia, is the law that governs Islam and how Muslims handle money. According to Sharia, no man can charge a fee just for lending another man a certain amount of money. i.e. interest. Islam preaches that every man has equal rights to do business, as long as there is equal opportunity to everyone, where in a perfect system, every man can either make a profit or loose, or what is called the "Halal" way of doing business. Charging interest, is banned, because technically, when someone gives someone else a loan, that man has to pay him back. If he is also paying an interest for that money, that means the lender is a partner (shareek as ther term is in arabic) in the profits, but not the loss. i.e. It is not an equal opportunity because he always emerges as a profiteer. It is taken to a further level of severity , that charging very high interest (like 10%+ of the loan amount) becomes what is called Ribba in Arabic. i.e. Immoral exploitation of the loaner.

Now, that creates a problem for muslims who may decide to purchase bonds, because they will be making a profit in terms of interest, when the government, basically doesn't loose, and consequently they are making money from money, guarranteed.

Luckily, there is a loophole to this. A bond, is usually backed by an underlying asset. i.e. the cash amount of a bond, technically (but not exactly) can be converted into a certain solid asset, such as gold, land, oil, etc... and a government bond, is backed by the Central Bank, which, is in turn backed by solid assets. Gold the government has, land etcetera. Now, the loophole, is that if these Sharia bonds (called Sukuk in Arabic) are backed by an underlying asset, such as a running business that can, in theory, loose money, so that means there is a possibility of loss.

Although the UK has stalled in issuing these bonds, Indonesia, the largest Islamic country by population (surprised it's not Saudi Arabia or Egypt?) , is leading the way and it has categorized how the Sharia bonds will be structured:

1) “Ijarah” : where the bond is a lease to rent a certain underlying asset.
2) "Mudharabah" : Mudarabah in Arabic means the ability to lower prices to compete in the market, thus sharing the profit.
3) "Musyarakah" : profit and loss sharing.
4) "Istisna" which, in Arabic, means exception, and in the finance context means an exceptional funding to fund a given project.

Regulation Regulation regulation! The one thing probably stalling the issue of these bonds in the United Kingdom, is that our beloved Chancellor isn't too satisfied with the suggested way to regulate them, and the FSA has been summoned to work on that. The issuing of these bonds, will widen the pool of financial products available to Muslims. Although, I guess Mr. Darling, with the cockup the bankers did in the credit shit, isn't being too sloppy with too loose of a regulation.

I personally think that it's not only to capture the local Islamic financial market, but also the global market, estimated at around $500bn. Now the credit crunch has attracted Islamic money, but they do drive a hard bargain. Prince Sultan Bin Nahyan, ruler of the Emirat of Abu Dhabi and co-head of the United Arab Emirates , invested £10 Bn for 30% share of Barclays, in an attempt to bail them out.....

Anyway, I do believe that the Middle East and the Arabs are up an coming when it comes to finance, but as long as they haven't grassped the fact that money is just another commodity like food, oil, wood etc. and interest is just how you make profit from this product, then they still got a long way to go. (Oh shit, did I just implicitly wink at financial derivatives? Ignore please).

I need to go to into a phone booth and call Dr. Strangelove. Enough blabbering.

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