Reconciling the will of Allah and wealth management

Melanie Stern is Section Editor of Families in Business magazine.

The Holy Qu'ran makes no bones about the prohibition of debt or interest – but Western institutions are working with Islamic scholars to draw up a 'halal' financial market to solve this, reports Melanie Stern

Money and ethics – they don't immediately gel; look at the way so many smart at the perception of modern capitalism.

But the world's 1.1 billion followers of Islam have a strict moral duty to harmonise the two, and make their money work for society as a whole, both in their personal and business finances.

Allah's word is law
Under Shariah law (the financial and banking aspect of Islam), it is forbidden to deal with interest paid or received as it is always linked to some form of debt. Debt is prohibited in any form because the religion focuses on money from the rich being pooled to help the needy. To be paid interest is receiving money that should go to the needy, and to pay it is to feed the already rich financial institution or lender providing the underlying debt instrument. This is classed as usury in The Holy Qu'ran.

The prohibition of usury bans any kind of debt instrument as a result, from loans such as mortgages, credit agreements, securitisations and collateralisations, through to investment in capital market trading structures such as futures and options, bonds, derivatives, mutual and hedge funds. These instruments are often seen as gambling (futures contracts involve the 'right' but not the 'obligation' to pay for something at a specified price in the future, leaving both parties open to risk). All financial transactions must share the risk of loss and possibility of gain equally between all involved parties from the individual, to a company, to financial markets.

"Islamic banking could, in theory, be fairly straightforward," says Sabah M Ali Mahmoud, founder of London's Shariah finance and law advisory, Gulf Legal Services. "In accordance with Shariah, Muslims can trade and invest in anything that is accepted (halal) and not prohibited (haram) but the main difficulty arises in the classification of interest charged on funds in Shariah.

"While some Islamic jurists and scholars consider all types of interest as usury, others consider simple interest acceptable and only compounded interest to be prohibited. Although the argument on interest continues, Islamic banking is expanding and banks and investment funds based on Shariah banking are being established."

Paper (money) tiger
Islamic investors must ensure that any investments they make do not direct any money to causes that are unethical or that contravene strict Islamic moral codes. This runs from the more obvious pornography, alcohol, drugs and gambling, through to companies involved with pork and tobacco products, right down to hotels and entertainment centres, swimming pools and gyms (because they could promote mixing of the sexes). The onus is therefore on the Islamic investor, individual or organisation, to be fully aware of all their investments and the full journey their money takes as it passes through financial markets. It is not enough to take an institution's word for it, no matter how trustworthy the name. Upholding Islamic law at all costs is the driver for thorough research into all Shariah-compliant institutions and their products.

The developments
In recent years, leading financial institutions have begun consultation with Islamic scholars, banks and regulators in Islamic communities to develop a range of financial products that comply with these rules, and allow Islamic investors to get involved in global money markets. Shariah-compliant finance is on offer across the globe but the greatest advances have been in the Middle East, Malaysia, and the UK.

HSBC is currently the leading light, with its Amanah Finance division being one of the first to offer Muslim investors interest-free wealth management, trade corporate finance advisory and products, as well as a liquidity management facility to redirect excess cash into halal instruments. A board of esteemed Shariah economists oversee the division's activities, which span from the Middle East to Malaysia, the US and the UK.

Citibank and UBS have operations in the Middle East that purport to offer Shariah-compliant products too. Noriba Bank, part of UBS, offers Shariah-compliant family trusts and other investment structures alongside family office services, and halal equity investments listed on the Dow Jones Islamic Market Indices. Domestic Islamic banks like Noriba have offered halal investment and banking services for some time.

The family business influence
Market observers say that these initiatives have been chiefly funded by wealthy Arab investors with business families being the pre-eminent business model for Islamic regions. While some are concerned that they can never be sure any Western financial institution they invest in has no links to any of the aforementioned unethical activities in some way, incumbents have tried to answer this by setting up independently from their parent companies. HSBC, for instance, takes its parent brand but is understood to be totally financed by outside, halal sources of money, and has no operational links with the rest of the bank that could risk contaminating its activities.

As well as being the principal funders of this movement, Middle Eastern businesses and business families are also increasingly the biggest targets for new halal products. Wealth management and private client services such as trusts and family offices are a common feature of the incumbent offerings, aside from corporate and capital market products.

A halal bond?
Sukuks are Shariah-compliant and capital market-traded 'bonds', structured as an 'undivided proportionate ownership interest' in a halal underlying asset. They provide medium- to long-term fixed or variable rates of return and can be adjusted at various intervals. As a traded instrument, traders can exit the contract at any point by offering it for sale.

In a benchmarking move last year, the government of Qatar issued a seven-year $700 million Sukuk to finance the development of Hamid Medical City. They sold a parcel of land to the government via a purpose-built vehicle that was to lease the land out in return for periodic payments. The instrument was Shariah-compliant – 50% of which was bought up by non-Islamic investors, according to reports. As the beneficiaries of the bond were the patients of the future hospital complex, the reason for the issue and the means fell in line with Islamic ethics.

In the same year, the Saudi Economic & Development Company (SEDCO) launched the first ever Shariah-compliant hedge fund, something of a breakthrough since the key component of hedge funds is the short-selling or arbitrage of derivatives, futures and forwards contracts – all prohibited.

Another development, 'salam sales', essentially replace futures contracts, decreeing that a trader selling an item – usually a commodity – must deliver it at a specified date in the future, making the agreed payment at the time of signing the contract rather than at delivery. The salam can be used to buy an item in anticipation of disposing of it by way of another salam. Successive salams are sometimes referred to as parallel salams.

Financial return on ethical resolve
Late last year Noriba launched its Range Murabaha Investments (RaMI), Shariah-compliant structured yield alternative instruments that provide investors with the potential to earn higher than normal rates of return than previous Murabaha (Shariah-compliant trade finance) investments. It is one of the only products to provide capital preservation while allowing investors the opportunity to optimise risk-adjusted returns on short-term investments.

RaMI investors select their benchmark commodity or currency and its performance within a selected price band, planning for a higher overall return within a given time period. Periodic Murabaha trades are carried out over the life of the investment. Once the individual Murabaha deferred sales proceeds are due, any profit arising from the investment is paid to the investor. The original amount is then re-invested in another Murabaha transaction, and so it goes on.

The evolution of this market as a global concern signals the opportunity for Islamic businesses in the East to invest as any other commercial concern in the global capital markets. Beyond that, it allows business families to continue modernising their empires and their family finances, fostering more secure succession plans and wealth management, and maintaining their societal input.

Perhaps even more importantly for those businesses and families, a harmonised Islamic and non-Islamic global financial landscape will facilitate Western investment in the East and, in theory, pave the way for those investors to turn Middle Eastern sand to gold without compromising Allah's word.