Over the course of this article series, we have explored Islamic finance predominantly from a commercial perspective. However, in this final article we will take a closer look at its principles while correcting some common misconceptions.
“Islamic finance is only for Muslims”
One of the most common misconceptions about Islamic finance is that it is only meant for Muslims. Rather, Islamic finance is simply rooted in the choice to conduct business based on some ethical guidelines, much like certain ESG frameworks and responsible business models, such as the B Corporation guidelines. Muslims believe the Quran and the Prophet Muhammad, peace be upon him, were sent as guidance to humanity and, as a result, the business practices endorsed by them will benefit not just Muslims, but wider society. Islamic finance can therefore be seen as a commitment to conduct finance, and by extension trade, in accordance with the following core values:
Avoiding interest
In Islam, money is seen as being a mirror. It reflects the value of goods and services without being intrinsically valuable itself. For this reason, Islam sees charging for the use of money as a form of mismatch between the value given and that which is returned. Hence, currency can only be exchanged for the same amount and settled immediately, insofar as is possible. This principle is arguably the most important of those espoused by the philosophy underpinning Islamic finance.
Avoiding Gharar (gross contractual uncertainty and trading in risk)
At its simplest, this principle seeks to ensure that parties know exactly what they are contracting for. In a similar spirit to English law, Islamic law generally considers contracts with excessively uncertain terms to be unenforceable. This is primarily to reduce the chances of a dispute arising. However, Islamic law goes a step further by nullifying most contracts where the value being exchanged is contingent on an uncertain event and prohibiting most sales where the seller does not own or possess the asset in question. Such principles are geared towards creating synergy between contracting parties and guaranteeing fair value exchange.
The importance of trust and keeping promises
Muslims are instructed by Allah (God) to affirm their contracts and failing to keep promises is seen as a sign of hypocrisy. In fact, the Prophet Muhammad was known among his people to be trustworthy and many left items with him for safekeeping during his time in Makkah. As such, a businessperson subscribing to Islamic values should be honest, transparent and keep to their word. This principle underlies Islamic agency (Wakala) law, which forms the basis of several Islamic finance and investment contracts.
Centrality of charity and responsible business
One of the five pillars of Islam is Zakah, which entails Muslims paying 2.5% of their wealth in alms tax each year if their savings surpass a certain threshold. This alone generates more than £262m from Muslims in the UK each year which goes towards charitable causes.
Islamic financial institutions are no exception to this, and many make provisions for Zakah in their annual budget and take note of it in their Islamic financial statements. Furthermore, Islam places great importance on the concept of long-lasting charity, the development of the Waqf being a good example.
A Waqf is an irrevocable donation of property and is intended to be a form of perpetual charity that outlives the donor. Historical examples have included water fountains, arable land and all its produce going forward and rental properties (with all yields being reinvested into the Waqf to maximise its impact). Some Waqf institutions have also been set up specifically to provide Islamic finance similar to many community development finance institutions. These are just some examples of how Islamic business ethics promote responsible business and giving back to the community.
Are Islamic finance contracts treated differently in English courts?
Another misconception which does require consideration is the contention that the courts of England and Wales apply the law differently when it comes to Islamic finance disputes. This conflates the longstanding English law concept of freedom of contract with what some may perceive to be special treatment.
To explain, English law is seen by many around the world as the law of choice because of the repeated reluctance of the commercial courts to depart from what parties have agreed, so long as they abide by overriding laws and regulations. In other words, parties can almost always sign on the dotted line knowing that what they see is what they will get.
Furthermore, in a globalised world where business relationships stretch across borders, parties are even given the chance to choose the law which governs their contracts, including where and how they would like to resolve disputes. It is therefore conceivable to have a, say, German law-governed contract to be recognised in English courts and for a firm with little to no business presence in the UK to be wound up by an English court.
Consequently, agreements embedding Islamic principles can fit comfortably within English contract law without much friction and will always be subject to overarching UK laws and regulations. Further, considering the different schools of thought and the fact that no country currently adopts Islamic law in its entirety, courts have been reluctant to recognise clauses purporting to make the general law of Islamic finance the governing law of a contract (see Beximco Pharmaceuticals Ltd and others v Shamil Bank of Bahrain EC [2004] EWCA Civ 19).
As a result, parties must agree on which Shari’ah persuasion they are willing to adopt and reflect those in the terms of the contract. This is done by a combination of inserting clauses into the contract which make effective Shari’ah-compliant structures and disclaiming prohibited entitlements, such as judgment interest.
In sum, the English law of contract can comfortably accommodate most Islamic finance structures while such contracts remain subject to other overriding legislation and regulations. Where potential difficulty arises regarding such laws, Islamic finance market participants must follow the same process as every other subject of the law in seeking to have it changed.
Does alternative finance legislation give undue privileges to Islamic finance users?
Speaking of changing legislation, some have concluded that laws which implicitly recognise Islamic finance products are targeted at securing special privileges for the Muslim population. The reality is quite different.
As set out in the second article to this series, the lobbying which has taken place over the last few decades has always been in favour of securing equal treatment for Islamic finance products when compared to their conventional counterparts. At the heart of this initiative is recognising the fact that Islamic finance customers want the same outcomes as everyone else. Be that buying their first ever family home, studying at a dream university or owning their first car. As such, they should not have to face additional tax, legal or regulatory burdens to secure the same opportunities as everyone else.
Additionally, many of these lobbying efforts have actually created more diversity and competition within the UK’s financial industry, resulting in better choices and outcomes for consumers and financiers alike. There are two great examples of this: first, the range of conventional lenders which we have personally seen develop their own Shari’ah-compliant product lines, and second, the fact that Islamic banks tend to pay out some of the highest returns on savings deposits in the country. And, as mentioned earlier, these opportunities are not limited to Muslims alone.
Anyone can make use of the alternative finance legislation to structure a range of financial products. Therefore, the movement which has lobbied for the recognition of alternative finance products has made great strides in achieving what it was set out to: securing financial inclusion for all at the cost of none.
Summary
Most of the misconceptions considered above are based on genuine concerns and often originate from a sincere misunderstanding of the sector and its governing principles. In that regard, this article considers the core values of Islamic business ethics, which include the avoidance of interest and trading with excessive uncertainty, keeping to one’s words and giving back to the community. Notably, Islamic finance contracts face the same scrutiny as any other commercial contract in the English courts. It is due to and not in spite of English law, through the principle of freedom of contract, that such Islamic finance products can comfortably exist. However, where certain laws are likely to result in financial exclusion, efforts have been made to ensure otherwise. This has culminated in the introduction of an entire body of law to formally recognise alternative finance, thereby increasing financial inclusion, encouraging greater product variety and improving outcomes for consumers.
Zahir Nayani is a partner and Adnan Shafi is a trainee solicitor at Foot Anstey
Read more:
Leading light: Islamic finance explained
Regulating the Islamic finance industry
Islamic finance: Key asset classes and trends
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