Beyond contention, though, is the rise of the economies of the Islamic nations to prominence on the world’s commercial stage. In addition to the demand for industrial and infrastructure investments across the Muslim world, this ascendancy owes greatly to the dramatic economic growth initiatives in the Arabian Gulf region. Petrochemicals and petroleum, predictably, remain liquid gold, and Qatar (see sidebar), long a medium-sized oil producer, is setting the gauge even higher as it fast consolidates its position as one of the world’s leading suppliers of natural gas.

“The deal flow in Qatar alone has steadily increased over the past five years,” says John Vogel, a partner in Patton Boggs’ Washington, DC, office with extensive foreign transactional experience, “including the history-making Qatargas II contract.” Valued at around $12 billion, this record-breaking project is one of several ambitious pipeline deals in the works, but as David Dunn notes, energy is not the region’s only action. “The Qatar government is dedicated to investing in knowledge and technology,” says Dunn, a Washington-based Patton Boggs partner with Middle Eastern transactional experience, “to properly prepare their people for the global economy.” And, extending that point, Leigh Hall, a Qatar-based partner who was principally involved in the Qatargas II and other area deals, cites significant investments in finance, tourism, real estate and other key service industries region-wide.

The remarkable promise of these opportunities, Dunn points out, is attracting developers, investors, professionals and laborers from around the world. And for the American and European contingents in particular, says Vogel, the increasing engagement with Islamic businesses is placing a growing emphasis on comprehending and complying with the economic principles of the Islamic law known as shari’ah.

While not statutorily required by secular law, the application of shari’ah principles to commercial transactions constitutes a conscious effort by Muslims to harmonize Islamic principles with their secular business activities. And as Vogel and his colleagues explain, understanding this ancient code is increasingly relevant for Western investors and developers, not just for doing business in the Islamic world, but in Europe and the United States, too. 

“MY NATION CANNOT AGREE ON AN ERROR”

Speaking at a conference in Qatar this February, Second Deputy Premier and Minister of Energy and Industry H.E. Abdullah Bin Hamad Al-Attiyah proclaimed that, “Qatar is blessed by having the world’s third-largest gas reserves and also having the single largest non-associated [gas alone] gas field.” Although hydrocarbon resources are dwindling in some locations within the Middle East region, shari’ah’s historical and ideological underpinnings are being applied generally in the context of the region’s commercial applications.

While unambiguous in theory, the interpretation and practice of shari’ah, like its spelling, can vary. Islamic and Western scholars alike debate its origins; local customs add differing meanings; liberal Islamic thinkers question its relevance; and more secular Muslim countries such as Turkey are less shari’ah-bound. Hall, who counsels foreign lenders, law firms and developers on local law in the Qatari capital of Doha—where Patton Boggs was the first and only American law firm to open an office—explains that shari’ah is founded on faith, not on codified law. As such, he notes, “shari’ah does not necessarily have to feature in a transaction, unless the parties so choose. When an Islamic financial institution is involved, though, as is increasingly the case, shari’ah is obligatory.”

As Vogel also points out, making that choice is prudent, if not necessary, for companies doing business in the region. “Islamic money, increasingly, is involved in consortium deals like Qatargas II,” he says. “Accordingly, the practice of integrating shari’ah financing tranches, or components, into conventional deals is growing.” And Hall’s admonition that securing the required blessing of an Islamic bank’s shari’ah supervisory board is often “unpredictable” only further underscores the value of understanding the nature of shari’ah-compliant financial instruments.

ANCIENT RULES, MODERN OUTCOMES

The principles behind shari’ah finance are as old as Islam itself. Since its beginning, Islam has followed the overarching concepts of justice and equity. Any act that is socially irresponsible or that infringes the rights of others is forbidden. Business-wise, says Hall, these tenets prohibit exploitation or unjustified advantage of any kind, governed by three principles. “Since lending money for gain constitutes unjust income,” he explains, “shari’ah forbids the receipt of riba, or interest income. In other words, you cannot make money from money—wealth has to derive directly from investment in tangible, productive assets.” In conventional terms, adds Vogel, riba is approximate to usury, or charging interest for lending money at an exorbitant rate.

Next, Muslim investors or lenders must act as partners. “In disallowing interest,” continues Vogel, “Islamic law provides no guarantee of a return on invested money. Unlike the conventional lender borrower relationship, therefore, a shari’ah contract is based on shared risk. Contributing capital and effort—in effect, making the transaction possible—affords the investor a proportional share of either profit or loss.” Lastly, Islamic aversion to uncertainty, or gharar, forbids any transaction involving speculation. Consequently, says Hall, parties must fully disclose and acknowledge all material aspects of a deal, including the price, up front.

In comparing the contracts derived from these principles with conventional methods, Vogel generally sees form over substance. “Futures, for example, are deemed too venture some under the gharar test and lack a shari’ah equivalent,” he notes. “Typically, though, while shari’ah contracts involve unique documentation, the pricing and outcomes are mostly similar to conventional instruments.”

Among the most common shari’ah-compliant contracts (see sidebar), those following the conventional sale and leaseback model are the most viable. “With Islamic finance presently concentrated in real estate development and large-scale infrastructure projects,” says Vogel, “the technique of murabaha, or cost-plus financing, is prevalent. On a client’s behalf, an Islamic bank purchases equipment or goods from a third-party supplier and then resells the asset to the client for an agreed-upon mark-up. The mark-up substitutes profit for interest, satisfying the riba prohibition and creating the profit-loss relationship.

Also popular is ijara, or lease financing, where a lender or a specially created entity leases acquired equipment or real property to its client for a flexible fee adjusted to prevailing market rates, with an accompanying option to purchase. Vogel also describes the growing embrace of the sukuk, equivalent to a corporate bond. “The profit return again supplants the interest,” describes Vogel, “but the sukuk otherwise operates like a conventional bond, issued by a special purpose company and having a 10- to 12-year term.”

Knowing the contractual covenants is one thing, but before negotiations can begin, a shari’ah-based deal must be sanctified by an advisory board, and Vogel notes there can be “incredible differences” in interpretation from deal to deal.

IN AFIQH STATE OF MIND

As Hall confirms from his post in Qatar, the resolution of Islamic financing disputes is based on a “fairly standard commercial code, rooted in Napoleonic and Egyptian law.” However, even before a deal is contracted, it must meet the advance approval of Islamic scholars, or ulama. Typically experienced in financial transactions, these scholars form committees or advisory boards within all Islamic financial institutions and are responsible for reviewing, refining, and ultimately blessing contracts and deal documentation. However, says Vogel, uniformity of opinion can prove elusive.

The ulama must reach fiqh, or a human understanding of divine law, leading to a fatwa of approval and consent. While divinely based, fiqh decisions themselves are not divine and cannot be held as indisputable. “Islamic law is everything to those who choose to follow it,” says Vogel, “but not every Muslim chooses to follow the law the same way. From board to board, then, there can be great variety in opinions concerning the same subject matter.”

The ulama must be satisfied as to the deal’s particulars, as well as the four prescribed conditions for validity. “Islamic law forbids investments in haram, or anything offensive to the faith,” says Vogel, “most notably pork and alcohol, or speculative activities such as gambling. Additionally, the parties must agree on the contract price, free of coercion or duress; they must possess the legal capacity to understand and undertake the contract; and there can be no ambiguity as to the contract’s subject matter.”

Some scholars are highly conservative in their interpretations, while others are more liberal. “Negotiations can be fairly straightforward,” says Hall, “but in the stricter situations, the process becomes more involved, adding time, complexity and expense to the deal.” Committees can comprise one or several ulama, and interpretations can vary with prevailing political climates. “Both Dubai and Abu Dhabi are in the United Arab Emirates (UAE),” notes Vogel, “which closely neighbors Iran, but business in Dubai, like the city itself, can be more liberal, whereas business in the more cautiously minded Abu Dhabi tends to be more conservative.”

AN INTERNATIONAL PHENOMENON

Conservatism and subjectivity aside, Vogel believes that the growing volume and complexity of deals will influence a more standardized approach to shari’ah finance, as well as innovations that will bring the Islamic and secular worlds closer together. “The constraints are there,” he says, “such as with mortgages, or rahn, which are limited by the prohibition on securitized collateral such as debt or commercial paper. However, discussions are under way in the UAE regarding offshore securitization options, which in turn might pave the way for Fannie Mae- and Freddie Mac-style secondary market financing.”

Project financing is king, says Hall, but fund management is fast emerging in the Gulf region, too, capitalizing on the area’s ample liquidity. “To date,” he says, “heavy regulations have limited fund development, but now the Doha and Dubai financial centers in particular (see p. 3) are encouraging fund registration.” Vogel acknowledges the complexities of bringing hedge funds to the region, involving deeply layered tax, business, management and advisory issues, but emphasizing the evolutionary significance of such developments. “Funds are a natural outgrowth of having so much money on hand,” he says, “and that capital is naturally attracting serious European and U.S. financial interests.”

Islamic money and shari’ah finance are by no means confined to Islamic countries, either. “It is a growing phenomenon,” says Vogel, “but shari’ah finance is featuring in both the European and U.S. high-end financing markets, and there is a growing trend in the U.S. retail industry towards Islamic home, auto and business financing.” Only last May, in fact, a Federal Reserve Bank of Chicago newsletter identified nine Islamic finance providers in the U.S., including a prominent bank in New York, which form the lending base of a growing grassroots movement. “While there is no provision for the establishment of a true national Islamic bank in the United States,” notes Vogel, “the Office of the Comptroller of the Currency has approved certain types of Islamic finance.”