Islamic Syndicated Financing: An Underdeveloped Method Of Shari'a-Compliant Financing

With the growth of the Islamic finance industry, there have been significant developments in the structures used to effect Shari'a-compliant financings as well as in the techniques used to implement these structures, including balance sheet and off balance sheet financings. Islamic syndicated financing is one of these techniques.

This Note:

Examines Islamic syndicated financing and its similarities to and differences from conventional syndicated financing. Explains the techniques used to structure Islamic syndicated loans. Analyzes the issues to consider when structuring an Islamic syndicated loan transaction and developing a strategy for a successful syndication. Examines the future of Islamic syndicated financing. Similarities to and Differences from Conventional Financings

Generally, Islamic syndication has the same conceptual foundation and takes into account the same commercial considerations as conventional syndication, but there are material differences between the two transactions that must be considered.

Similarities to Conventional Syndicated Financings

To better understand Islamic syndicated financing, it is important to examine what this concept means in its more entrenched conventional equivalent. In a conventional syndicated financing, the loans to the borrower are shared among two or more banks or other financial institutions (collectively, the lenders). The syndication may be structured either as a:

Fully underwritten deal. In this case, the lead bank (also referred to as the arranger) commits to fund 100 percent of the loan whether or not it is able syndicate part of the loan to other lenders. Partially underwritten deal. In this type of deal, the arranger commits to use its best efforts or commercially reasonable efforts to arrange a syndicate of lenders that will make the loan but has no obligation to fund any part of the loan itself. If the loan is fully syndicated, the arranger may fund a small portion of the loan. If the loan is not fully syndicated, its terms are either renegotiated or the loan does not close. Arrangers often prefer to use the "commercially reasonable efforts" standard because it is believed to be a slightly more lenient standard than "best efforts" (which, while not a clear standard, is believed by practitioners to require extraordinary measures). Similar to conventional transactions, an Islamic loan transaction may be syndicated before or simultaneously with financial close or after financial close (and earmarked for distribution in the primary market or the secondary market). However, unlike conventional financings, there are timing issues that must be considered.

Islamic syndicated financings are derived from the same concepts and must take into account the same commercial considerations and provide the same protections as conventional syndicated financings from the perspective of both the borrower and the participating lenders. These include:

Allowing lenders to mitigate their exposure by sharing the borrower's credit risk Allowing lenders to participate in more transactions than they may have otherwise and thereby diversify their loan portfolios because they are only taking a portion of each loan transaction. Enabling the borrower to raise more capital than it may have otherwise if it had only one lender. Differences with Conventional Syndicated Financings

While there are a few differences between Islamic syndicated loans and conventional syndicated loans, the principal difference is the philosophical underpinning of these transactions. In conventional loan syndications, commercial and legal considerations are generally the only issues that determine the terms and forms of these transactions and the rights of the parties. By contrast, Islamic loan syndications:

Must comply with Shari'a principles including the prohibitions against Riba, Gharar, and Maisir. Cannot invest in products and services that are Haram. For example, the borrower cannot be involved in the manufacture, production or sale of tobacco products, pork or alcohol or involved in providing gambling or pornographic activities or services. Require the approval of Shari'a scholars or the Shari'a committees of the lenders. However, Islamic finance institutions are as interested in protecting their investments and making a return as their conventional counterparts. So while an Islamic syndicated transaction must abide by the conditions set forth above, it must also make financial sense. As a result, any structure that is ultimately adopted must give the lenders the same rights, benefits, and protections as they would have in a conventional syndicated financing. This is especially important in transactions involving conventional lenders or the Islamic windows of conventional financial institutions who may not be as aware or sensitive to Shari'a principles.

Structuring the Relationship Between the Arranger and the Other Lenders

In an Islamic syndication, the relationship between the arranger and the syndicate is structured in the same way as conventional financings. Typically the arranger, known in an Islamic syndicated financing as the investment agent or Wakeel, enters into an investment agency agreement with the other lenders under which it is given the authority to act as the lenders' agent. In this capacity, the investment agent:

Negotiates with the borrower and coordinates the drafting and preparation of the loan documents. Monitors the transaction and the borrower's compliance with its obligations under the loan documents. Manages the relationship with the borrower, including receiving notices and responding to queries. Keeps the other syndicate banks apprised of developments at the borrower. In exchange for performing these services, the Wakeel, like a facility agent in a conventional syndicated financing, would expect to receive administrative or other appropriate fees.

Structuring the Loans to the Borrower

Generally, any Shari'a-compliant structure may be used to document the loan. The structure used depends on:

The purpose of the financing. The assets that will be used to repay the loans. The nature of the borrower's business. The amount of flexibility the parties require. The lenders' view of the Shari'a-compliant nature of the transaction. The structures most commonly used to effect to an Islamic syndicated financing are:

Murabaha. Commodity or reverse Murabaha (commonly referred to as Tawarruq). Mudaraba. Musharaka. Ijara. Istisna'a. Murabaha

Commonly referred to as "cost-plus financing," Murabaha is frequently used in trade financing arrangements and...