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Islamic finance in the shipping industry

As the shipping industry continues to struggle with access to finance, Islamic finance may be a viable option for ship owners as other forms of finance remain scarce. Nevertheless, Islamic finance also brings its own challenges which are often misunderstood. This article will discuss the difficulties encountered in Islamic finance structures and the ways that they can be dealt with.

Ship finance
The situation with respect to ship finance globally and in the Middle East in particular remains challenging. The declined performance of shipping loans in the recent years have made the banks cautious in their lending strategy. From the ship owners’ perspective, it means that obtaining the finances necessary for survival or expansion of the business can be very difficult. Against this background, Islamic finance has historically been seen as an attractive form of financing because it is generally backed by tangible assets. The selectiveness of the Islamic banks has meant that many of them have fared better in the financial crisis than their conventional counterparts.

Prior to 2016, various shipping sukuk (a certificate of ownership similar to bonds) issuances have prompted more local banks to set up dedicated ship financing teams. This has been a positive move for the UAE ship financing sector and fortunately for ship owners this provides more options to raise funds.

The global growth of sukuks as a form of finance has been steadily increasing year on year. However, Islamic finance has its own uncertainties, which if misunderstood, can be off putting to the potential investors.

The challenges of Islamic finance
Historically, lack of standardisation in the fatwa (legal/shari’ah compliant declaration) obtained from Shari’ah scholars creates uncertainty. The lack of standardisation in documentation further contributes to the uncertainty as the mechanisms for default largely depend on the type of sukuk and the way the documents are structured. Usually the use of a Purchase Undertaking as part of the structure provides investors with an additional contractual recourse against the borrower.

These issues were recently at the centre of a UAE litigation debacle involving Sukuk Al-Mudarabah where investors were involved in a legal battle with the Mudarib (entrepreneur/business partner) who had challenged the Shari’ah compliance of the sukuks shortly before they were due for redemption. The Mudarib relied on their advisors’ opinions to challenge the Shari’ah compliance of their Sukuk albeit the fatwa obtained at the time when the transaction was structured had not raised similar concerns. The litigation sprawled to the English courts where the Mudarib used the same arguments to challenge the validity of a Purchase Undertaking which was subject to English law. The English Court found the Purchase Undertaking valid and enforceable as a matter of English law regardless of the sukuk’s status under Shari’ah (UAE Law). This finding was reassuring to investors and shows that the transaction can be structured with the help of the English law documents providing the level of certainty that most investors could be comfortable with. The case has been subsequently settled by the parties.

Nevertheless, the differences in the opinions and lack of standard documentation continue to prompt parties to “shop” for a suitable fatwa in their favour. As part of the evolution of Islamic finance, UAE had approved of the establishment of the Higher Shari’ah Authority back in 2016 whose mission is to issue fatwas and ensure the legitimacy of the products, services and activities of the institutions providing Islamic services.

The establishment of the Higher Shari’ah Authority is a welcome development as we expect that it will allow for nationally accepted Shari’ah principles to be implemented in a uniform manner across the UAE. That said, any documentation developed under the auspices of the Authority would still need to be negotiated by the parties and adapted according to the structure and type of the sukuk.

Comments
While recent litigation in the UAE may be causing some discomfort to investors, our view is that it is a temporary instability in an otherwise robust sector. The issues surrounding the above mentioned case are unique to the specific structure discussed. It is important to note that each of the different sukuk products in the market will have a tailored security package to give more comfort to investors. The general prediction is that the growth of Islamic finance will continue due to its adaptability to market conditions. This has been evident in the continuous development of new sukuk structures being introduced in the market in recent years. It is hoped that the shipping industry in the Middle East region and globally will be able to benefit from the continuous growth of Islamic finance.
Source: Ince & Co

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