The Shariah risk is not so much in the initial structure but in what it can potentially become, writes consultant Badri Ahmed.
Obviously,Goldman Sachs did not choose the most consensual structure. In the meantime, alively debate has been sparked especially concerning the possible risks of non-Shari'a compliance. These risks are not induced by the initial structure as it has been confirmed by Shari'a Scholars,but by what this structure can potentially become.
Thisis a summary analysis to highlight three key concepts of the structure of Goldman Sachs's Sukuk, namely: Thetype of structure, the liquidity, and the ownership of the Sukuk holders. This synthesis follows other articles(1) on the same subject and, it is not intended to be a definitive analysis, it could be supplemented by other experts or researchers in this field.
Itis important, first, to specify the entities involved in the Sukuk structure, namely:
- Goldman Sachs Group, Inc. (GSGI): Parent guarantor
- Global Sukuk Company Limited (GSCL): Incorporated in the Cayman Islands."Seller" in the Master Murabaha Agreement,Issuer of Murabaha trust certificates(Sukuk), and trustee.
- Goldman Sachs International (GSI): "Buyer" in the Master Murabaha Agreement.
Type of structure: Murabaha or Tawarruq(2)?
First and foremost, it is indeed a Sukuk al-Murabaha structured type,according to a base prospectus filed with the Irish Stock Exchange. It is this structure which has been validated by the Shari'aadviser(3) of the programme. However, there is a high probability that thisstructure takes the form of Sukuk al-Tawarruq. Indeed, if the ownershipof the underlying assets (commodities) is retained by GSI as a buyer, the Murabaha structure will be maintained. On the other hand, if the commodities are sold toa third party, then the structure will be classified as Tawarruq. This hypothesis is clearly stated in the prospectus: "the Purchaser may hold the Commodities as inventory or elect to sellthe Commodities in the open market provided that where the Purchaser elects tosell the Commodities, it shall sell the Commodities to a third party buyer thatis not the initial Supplier". Although opinions are diverse between Shari'aScholars on Tawarruq, it is not in any way the main problem. Assumingthat some scholars agree that the Tawarruq be valid, allowing companies tomeet liquidity needs, another issue of Shari'acompliance appears at once, and thus it may that Shari'a Scholars are ofa consensus in disfavour of the structure. If the structure of Tawarruq is effective, then it isimportant to ask the following question:
Who will be the beneficiary of the flows of liquidity?
Inthis case, it is Goldman Sachs International (GSI), namely a conventional bank. Itis important to note that, to date, Goldman Sachs has not developed Islamicbanking, while, moreover, other banks such as Citigroup, HSBC, StandardChartered, BNP Paribas or CIMB, have developed Islamic windows. Remember thatconventional banks generally have a net banking Income composed of interestrates and speculation activities that clearly exceed the 5% allowed by the ratiosof screening(4). The next sentence of the prospectus "The net proceeds of each Series issued under the Programme will beapplied by the Trustee and GSI in the manner described in "StructureOverview - Murabaha Arrangements" and, in respect of GSI only, for itsgeneral corporate purposes and to meet its financing needs.(5) ", based on a Tawarruq structure will not benefit theconventional banks, except in violation of the Shari'a compliance.
Inaddition to liquidity and ownership risks that this structure induces, the Shari'arisk, which does not exist a priori,is not only latent but entirely justified. This is a problem for all conventionalfinancial institutions that choose a Sukuk al-Murabaha type of structure.These difficulties are caused by this structure in particular, and do not applyto Sukuk in general.
However,there are some possible solutions to overcome these difficulties and toreassure investors. Amongst these are the following:
- Goldman Sachs should prove that thisstructure remains a Sukuk al-Murabaha structure throughout the life ofthe contract until maturity. That is to say that the underlying assets(commodities), of Master MurabahaAgreement, must not under any circumstances be resold to a third party by GSI.
- Otherwise, the bank must prove that theobjective is dedicated solely to finance Shari'a compliant activities. And,as such, present the activities that will be funded, justify the existence of adedicated information system, and also have separate accounts for tracing thesetransactions. This is to allow Islamic funds not be mixed with "non-Shari'a compliant"activities.
Liquidity:
Infact, in an industry where operators are tending to move gradually towards"liquid" instruments, including the needs for asset-liabilitymanagement (ALM), the structure chosen by Goldman Sachs is surprising. Indeed,this structure goes against the current trend, as Sukuk al-Murabaha are, by nature, "illiquid" on thesecondary market. The reasons for this "illiquidity" are numerous,not only due to the morphology of the market with demand greatly exceedingsupply, but also due to the need for compliance with Shari'a; raised by the international standards' of the AAOIFI(6).According to the fore mentioned organization, the structure chosen by GoldmanSachs, based on a debt instrument (shahadaal-dayn), does not allow such Sukukto be traded on the secondary market. Otherwise, these transactions might becalled "trade of debt" (bai'al-dayn) and so, at the same time, risk losing their compliance to Shari'a. Therefore, subscribers will bein a position of investment such as "buy and hold" and this will bebrought about by "obligation" rather than "determination".
Thereare ultimately some possible solutions to subscribers to transfer these Sukuk in a Shari'a compliant way: The method known as the "portfolio proportion" based on the ratios of screening(7) and the"reallocation" on nominal value (par value). These solutions areframed by Islamic law, but could allow operators to find a new way out of theirSukuk, if the need arises.
Registeredon the Irish Stock Exchange, it is noted that neither this Exchange nor GoldmanSachs are responsible for how these Sukukwill be traded on the secondary market. It is the responsibility of investorsto trade these Sukuk in a Shari'a compliant way.
However,this program will have the advantage of strengthening the trend towardsdiversification of the Sukuk market,in terms of types of contracts (Sukuk al-Murabaha),in terms of geographic diversification of issuers (Western issuer) and currencyof issuance (Multi-currencies). Thus, this could allow operators to diversifytheir portfolios and, at the same time, diversify the nature of the associatedrisks.
Ownership of Sukuk holders:
Fitch assigned "A+ / F1+, Rating Watch Negative" for this program. According to this agency, the rating of these Sukuk canbe enhanced either by the underlying assets, or any other type of collateral.This rating reflects the credit worthiness of Goldman Sachs group, Inc. (GSGI) asparent guarantor, and especially its credit quality.
Therefore, the Sukuk holders will not be considered as co-owners of the commodities. The ownership (ofthe commodities) is held at the completion of the Murabaha by GSI. Sukukholders will only be considered as co-owners of the deferred payments made byGSI in favor of GSCL, throughout the life of the Sukuk.
However, GSGI will have to guarantee the GSI's obligationsas a buyer, in the Master Murabaha Agreement, guaranteeing, among other things, the deferred payment to maturity. If cash flows are insufficient to fund the full periodic distribution, GSGI willprovide additional funding to GSCL to enable the full payment to be made. Theseobligations are unconditional and irrevocable according to Fitch. In addition,these obligations will be considered paripassu with senior unsecured obligations of GSGI.
It is not to say that the additional funding (liquidity facility) correspondingto the obligations of GSGI must also be Shari'acompliant.
Ignorance of these concepts may increase the risk oferrors in some operations.
However,it is important to note that the Islamic finance industry needs to strengthen itscontrol of Shari'a compliance throughout the life cycle of operations. Thevalidation process a priori is nolonger sufficient! The Shari'a Scholars should take into account theimportance of a posteriori Shari'a audits, because a loss of Shari'acompliance can result in reputational risk, including the Shari'a Scholars who validate these structures.
The specific nature of this offer should encourage operators to have somediscipline, prior to investment, to analyze the technical, legal and Shari'a aspects to identify, measure andprice associated risks.
- Ends -
Footnotes:
(1) Mohammed Khnifer: "Three likely flaws in Goldman Sach's milestonesukuk", Zawya, 30 Nov. 2011;
Badri Ahmed: "Goldman Sachs et lesGolden Sukuk", Oumma.com, 16 Nov. 2011 - French version
(2) Tawarruq (Simple): It is different from "Bai 'al' inah", "Reverse Murabaha" and "Organized Tawarruq". Unlike the Murabaha, the Tawarruq (simple) does not fund the acquisition of an asset. Ituses an offset of payments between the two operations to obtain liquidity. Thecustomer buys an asset with the intention of reselling it to a third party. Theterms of purchase are: "immediate delivery" and "deferredpayment"; those of resale are: "immediate delivery" and"immediate payment".
(3) Dar Al Istithmar Limited is the Shari'a adviser of the programme.
(4) Screening ratios: Dow Jones, FTSE, S&P, MSCI...
(5) Terms used in the prospectus of Goldman Sachs to justify the use ofProceeds.
(6) AAOIFI: Accounting & Auditing Organization of Islamic FinancialInstitutions. Organization, whose main activity is theestablishment of standards for the Islamic finance industry.
(7) Idem: Screening ratios: Dow Jones, FTSE, S&P,MSCI...
About the writer:
Badri AHMED is a senior consultant in Finance. Hegraduated from ESC Lille (Skema Business School) and Paris-Dauphine University- France. E-mail: badri_a@hotmail.com
© Zawya 2011
