By Asim Khan
Goldman Sachs’ maiden foray into capital-raising utilizing sharia-compliant mechanisms has understandably generated a lot of interest. However, as in the case of some other conventional banks before it, the market reception in certain quarters has been somewhat skeptical, mainly due to the misunderstanding surrounding the nature of the sukuk structure adopted and how this relates to Goldman Sachs’ operations. This article seeks to address some of the information gaps in the marketplace which seem to have contributed to such misunderstandings.
Some of the broader misconceptions arising from the sukuk issuance process are rooted in the assumption that Goldman Sachs is a conventional bank and will use such funding to lend interest-based money to its clients.
This is far from the truth. Goldman Sachs, as an investment bank and as a proprietary commodity trader, has invested billions of dollars in commodities and will use the murabaha commodities in its commodity trading business, which will partly replace the conventional funding with Islamic finance. The sukuk company (GSCL) is restricted to using proceeds of the sukuk to buy commodities on a spot basis and selling the same to the purchaser (GSI) on a murabaha basis with deferred payment terms. The prospectus is littered with such clarifications. For instance, on page 36, it states:
“The proceeds from the issuance of each Series of Certificates will be applied by the Trustee on behalf of the Certificateholders, in accordance with the terms of, inter alia, the Master Murabaha Agreement…”
Therefore, to condemn this sukuk for the alleged unscrupulous use of murabaha proceeds is not fair.
Murabaha or Tawarruq?
The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) defines murabaha as a sale of goods with an agreed-upon profit mark-up on the cost.
There can be two types of murabaha sale. In the first type, the bank purchases the goods and makes them available for sale without any prior promise from a customer to purchase them. In the second type, the bank purchases the goods ordered by a customer from a third party and then sells these goods to the customer. In this case, the bank purchases the goods only after a customer has made a promise to purchase them. Once the seller sells the goods, its only entitlement is to the purchase price, either spot or deferred. The purchaser is then at liberty to either hold the goods or, at its sole discretion, sell them at any point of time to an independent third party unrelated to the original supplier, i.e. in the open market.
The Goldman Sachs 1-year murabaha sukuk transaction is a murabaha of the second type where GSCL, a sharia-compliant special purpose entity, is the seller and GSI, a subsidiary of Goldman Sachs Group, is the purchaser. GSCL uses the murabaha sukuk proceeds to purchase on spot from a third party supplier sharia-compliant commodities requested by GSI and is entitled to receipt of the deferred purchase price (defined as the Deferred Payment Price) from GSI for the benefit of the sukuk holders, who are entitled to all of the Trust Assets which include the Deferred Payment Price, all rights and benefits under the Transaction Documents, all cash on account, any other assets, rights, cash or investments as may be specified from time to time, and all proceeds of the foregoing.
For this to be a tawarruq transaction, it would require the presence of additional elements: a) GSI (not GSCL, as above) buying the commodities solely with the intention of immediately selling the commodities to a third party to generate cash, and/or b) GSI must sell the commodities back to the original supplier or its nominee. Neither of these elements is present in the transaction under reference. There is no indication or expression whatsoever of GSI’s intention of immediately selling the commodities to a third party to generate cash. One would have to stretch one’s imagination a bit too far to label such a vanilla murabaha transaction as a tawarruq.
The sukuk is listed on the Irish Stock Exchange in order to take advantage of regulatory and tax benefits. Such a listing in itself does not constitute an act repugnant to sharia and such interaction between Islamic structures and conventional frameworks is a reality in which Islamic finance currently exists alongside the broader universe of conventional finance.
Though the act of listing theoretically allows the sukuk to be traded, from a sharia perspective there is no prohibition on trading per se of a murabaha sukuk subject to the absolute pre-requisite that it can only be traded at par value. This renders it impractical in the present context for the sukuk to be traded in a sharia-compliant manner by investors who have been informed that “the Certificates can only be traded in the secondary market at par value (that is, in relation to Certificates of a particular Series, the amount of the pro rata Deferred Payment Price relating to such Certificates) and on a spot basis in order to comply with Shari’a principles,” and have been explicitly forewarned that there is not expected to be a secondary market in the instrument.
It bears repetition that the transaction structure has received approval of leading scholars in the contemporary Islamic finance industry after extensive scrutiny and examination of all aspects of the transaction and a thorough review of the legal documentation involved, as re-confirmed by the following statement recently issued by the Chairman of the Sharia Supervisory Board that approved the structure.
“We have reviewed the structure and legal documents of the Goldman Sachs 1 year Sukuk Al Murabaha program, and after carefully reviewing the same found them to be in compliance with the AAOIFI standards and the generally accepted Sharia guidelines. I welcome well established conventional industry players such as Goldman Sachs in the Islamic finance world evidencing the growth of the Islamic Finance industry and wish them every success with this product and their future Islamic financial initiatives,” Hussain Hamid Hassan, chairman, Dar Al Istithmar Sharia Supervisory Board.
There is a marginal, albeit louder, section of the community that sees commodity murabaha as a “shallow attempt to mimic conventional debt structures” even though deferred-payment commodity murabaha establishes a clean obligation which qualifies for classification anywhere between a zero and 100 percent risk weighting under Basel and IFSB standards (depending on the rating of the counterparty), while most other sharia-compliant contractual instruments such as wakala, mudaraba and musharaka qualify for up to a 400 percent risk weighting. Though this presents a conundrum and disincentive for both Islamic and conventional banks engaging in such types of structures, it also explains why murabaha continues to be the most commonly used instrument across the Middle East and southeast Asia, including Saudi Arabia and Malaysia.
Ironically, the use of real commodity-based murabaha in the Goldman Sachs sukuk is distinct from traditional commodity murabaha activities (sometimes up to 90 percent of the asset book) conducted by Islamic banks to manage their liquidity or provide corporate/trade financing. Most investor-depositors in Islamic banks do not necessarily expect the Islamic banks to risk their deposits in equity-based investments but expect protection of their funds from depletion. Without structural changes to the regulatory framework for Islamic banks and the development of a broader-based institutional investor community, one cannot expect equity-like structures to be as prominent as debt-like structures.
A broader issue that has crept into this discourse is the issuance of a sukuk by a purely conventional bank. The entry of a bulge-bracket investment bank (not a commercial bank) into the Islamic capital markets is a welcome development, if it is based on the generally accepted sharia guidelines developed by the Islamic finance industry. The benefits of a large investment bank’s foray into Islamic banking could be significant. For years, the Islamic finance industry has struggled with a few critical issues that affect the structural sustainability of the industry, including issues such as liquidity management and lack of a critical mass of institutional funds. Bulge-bracket banks such as Goldman Sachs can bring to Islamic finance their sophistication and depth of experience in liquidity management and equity/quasi-equity investment, which can take Islamic finance closer to its true ideals, so long as they adhere to the generally accepted sharia principles. So far there is no basis to speculate otherwise.
Asim Khan, managing director at Islamic finance advisory firm Dar Al Istithmar, is a sharia advisor to Goldman Sachs in its $2 billion Islamic bond program, announced in October.