There has always been room for disagreement within Islamic finance, but one issue has caused particular controversy in the past months.
At the recent Islamic Funds World conference held in Dubai, two top industry figures put forward opposing views on the wa’ad swap – the promise agreement with which returns from one basket of assets are swapped with returns from another. Increasingly, this mechanism is being used to give Shariah compliant investors exposure to returns from haram, or non-Shariah compliant, assets.
Supporters of the technique say that it is no different to issuing a sukuk, for example, against the LIBOR (London Inter-Bank Offered Rate) benchmark, which is widely used in pricing Islamic bonds even though it is an interest rate.
Shaykh Yusuf Talal DeLorenzo, chief Shariah officer and board member, Shariah Capital, is a staunch opponent of the wa’ad swap with haram returns.
“The purpose of this swap is to bring returns that are not compliant to Shariah investors – and everyone knows it,” he told the audience.
“It is a mistake to say that the haram basket is no more than a benchmark. All that happens is the non-Shariah basket of assets sets a benchmark and it’s no different from LIBOR – wrong.”
He said that the comparison with LIBOR was inappropriate, since the interest itself, rather than the benchmark rate, is the forbidden part.
“As a mere benchmark it has nothing to do with the transaction,” DeLorenzo said. “In a wa’ad swap it is what creates the returns, and that is the problem.
“LIBOR for ijara is totally unrelated to the ijara transaction. With the haram basket of assets, its performance is directly related to the return. The funding, whether it’s direct or indirect, is there.”
He pointed out that LIBOR has been approved by Shariah boards for use as a benchmark for Islamic returns.
“There is no participation by Muslim investors in LIBOR – it’s the business of the London banks,” he added.
DeLorenzo argued that a Muslim investor taking part in a wa’ad swap is implicated in every investment decision the bank subsequently takes with his funds.
“When you accept this investment product, you accept the whole series, whether you know it or not,” he said. “As the money moves, its character changes.”
DeLorenzo concluded by saying: “If you’re going to swap returns of one basket of performing assets for another, then you must insist that the assets in both baskets are halal.
“Only then can you be sure of receiving returns that are halal.”
Taking a slightly different view was Dr Hussein Hassan, director of Islamic finance structuring for Deutsche Bank UAE, which has pioneered Shariah compliant products that give Islamic investors exposure to non-Shariah returns.
Dr Hassan told the assembled delegates that Deutsche Bank keeps Islamic investors’ assets isolated from haram assets, something that is demonstrated in the regular Shariah audits carried out on the bank.
In the specific mechanism outlined in the white paper issued by Deutsche Bank last year, the wa’ad swap is an agreement between the bank and the investor to swap the returns from two baskets of performing assets, which are kept entirely separate and do not interfere with each other. When the assets are deposited with the bank, it agrees with the investor to hand over the return from the basket of haram assets at the due date, in return for the return from the basket of Shariah compliant assets. The Islamic investor therefore takes the risk that the Shariah compliant assets he deposited with the bank could outperform the haram returns he will receive when the swap is conducted. For this reason, two agreements need to be signed to ensure that both sides carry out their obligations on the due date.
Deutsche Bank is confident that the transactions it conducts are entirely compliant with Shariah law, regardless of what assets make up the haram side of the swap.
“We had discussions with Shariah scholars to discuss if we need to change anything we do,” said Dr Hassan. “They explained we don’t need to resort to blocking the means.”
He said that he expected a greater range of benchmarks to be available to the Islamic finance industry in future, making it easier to create Shariah compliant investment products that are linked to other assets.
Alka Banerjee, chairperson of Standard & Poor’s index committee, also argued that more Islamic benchmarks were necessary to develop the industry.
“Commodities is one that’s really crying out for indices,” she said. “That’s a no-brainer. They are a big source of revenue for most Islamic countries and we do not have a commodities index right now. All commodities indices are based on futures pricing and futures are not Shariah complaint, so until the scholars come up with an acceptable form of pricing that index, it’s waiting to happen.”
Banerjee added: “We are working with Islamic scholars to find a way, but we don’t have anything yet.”
She predicted that Islamic ETFs (exchange traded funds) would take off in the next two years, and called for more breadth and depth in the Islamic funds industry, something that was echoed by other participants.
Mohammad Shoaib, CEO of Al Meezan Investment Management in Pakistan said that the high levels of liquidity in the region meant that there was not necessarily an incentive for the industry to come up with innovative types of funds.
“There is lots of liquidity in the system, so it is very easy to come up with plain vanilla products and bring in a lot of money,” he said.
Syed Tariq Husain, CEO of Pakistan’s Emirates Global Islamic Bank, agreed. “We’re growing rapidly, but in terms of value rather than product diversification,” he told the audience. “We probably need to do more in terms of funds and Islamic investment opportunities available.
“In the GCC we have an excessive amount of liquidity chasing too few assets. The rate at which liquidity is coming into the system is so great that assets can’t keep up with it.”
He said that, having used negative screening to rule out assets that are not Shariah compliant, there may now be a case for fund managers to apply positive Shariah screening to assets.
However, other participants argued that product innovation should not come at the cost of customer relations.
Umer Majid, director, Halal Investment Bank in the UK, said that British Muslim investors were becoming distrustful of Shariah compliant investment products. “They feel they’re being conned,” he said. “They feel they are being given conventional products with Islamic labels.”
He added: “There was one sukuk fund very well promoted as halal by certain investment funds, but if you looked closely at the small print it promised a guaranteed return and that is haram,” said Majid.
“This has created a lot of mistrust and what I’m worried about is that the Islamic finance experiment might fail before it’s begun because people are trying to mimic conventional products.
“There needs to be something done about the legal documentation – it needs to be standardised.”
Majid called for an Islamic ombudsman which could authenticate even Islamic investment products that had already been approved by a Shariah board, and which could handle complaints from the public.
Generally, though, the outlook for the Islamic funds industry seemed to be bright, as long as the supply of new products is able to keep up with demand from a huge Muslim investor base.
Oliver Agha, global head of Islamic finance, DLA Piper Middle East, gave some perspective of the Shariah compliant investment opportunities that will be available. “There are $690 bn of projects expected in KSA in the next decade, most of which will be Islamically financed,” he told delegates.