GENEVA (Reuters) - Sharia-compliant financial products need a clearer legal framework to attract non-Islamic investors, after the Dubai World debt crisis battered perceptions of limited and prudently-managed risk, said one legal expert.
The crisis, sparked when Dubai’s Nakheel asked for three listed Islamic bonds worth $5.25 billion to be suspended pending restructuring, was made worse because it was not clear who the legally competent authorities were, said Sonya van de Graaff, a partner at law firm Brown Rudnick.
“While Nakheel 2009 was governed by English law, the entity is in Dubai and so are the assets, so to the extent an English judgment is delivered, investors would need to get it recognized and enforced in Dubai,” van de Graaff said at the Reuters Islamic Banking and Finance Summit.
“There is no guarantee the local or DIFC courts would do so. If it is regulated as a government entity, investors may not be able to sue, as Dubai law may give the entity immunity.”
Investors in the Dubai projects include several large western banks. They have been both spooked by the crisis and disgruntled by Dubai’s proposals to date on how to repay them.
The Islamic bonds, or sukuk, were used to finance massive and ambitious flagship projects like the Dubailand theme park, but when these sukuk were launched, it seems investors paid scant attention to how controversies might be resolved.
“Nobody has ever had to sue over a sukuk before, the legal framework had never been put to the test,” said van de Graaff.
“It seems buyers were not taking sufficient stock of the details of the transaction, and in particular, the income stream and the commitment and wherewithal to complete the project. There was no real plan detailed anywhere in the prospectus.”
The exit strategy was an initial public offering planned for December 2009, but that was impossible once property prices began to fall, and there was no real ‘plan B’, she said.
Sharia law is a series of concepts which hover above a transaction’s governing laws, said van de Graaff, so if a loan agreement is governed by English law, it may be necessary to change its structure to comply with Sharia principles.
The principles need to be integrated into the contract, but that doesn’t mean the contract is governed by Sharia law, she said, making it feasible to structure sharia-compliant deals that western investors can be comfortable with.
After the surfeit of leverage, risk taking and esoteric products that led to the financial crisis in western economies, some investors thought sharia principles could help asset managers to step back from financial engineering and shift toward risk- and profit sharing.
But investors drawn to sharia-compliant products by the concept of shared risk and focus on tangible assets should understand these attributes will not protect them against bad investments, van de Graaff said
The notion that Islamic Finance was immune to the excesses of the financial crisis was scuppered by Dubai World.
“There was sometimes the impression during the crisis that hit western economies from 2007 that the stretched loans-to-value at the root of the problem could never happen in Sharia finance because of restrictions on leverage limits,” said van de Graaff.
“Well, they did.”
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