Cédric Raths, Director, Pandomus, Member of the Luxembourg Maritime Cluster
01 January, 2011
Stormy Times
Shipping companies are facing difficulties in obtaining bank financing, because the credit crisis has drastically reduced the appetite of conventional banks for this type of business. Several ship owners have been forced to cancel or postpone their orders for new vessels and therefore to delay the upgrade of their fleets.
The world’s economy relies on the shipping industry to transport the world’s trade. Shipping remains the most economical and effective means to carry much of the world’s goods; it is crucial for the global economy, so the demand for shipping services will always be strong and consequently the demand for financing to facilitate the construction and purchase of vessels.
Historically, ship finance was undertaken by banks based in the German port of Hamburg, but these banks have been hit so hard by the crisis that a few of them came close to bankruptcy. With the massive drop in tonnage prices in mind, the credit committees of most banks have drastically reconsidered their lending strategies in this area. Vessels, however, are by nature Shari’ah compliant investments, so this is an excellent opportunity for Islamic banks to step into the financing gap left by the conventional banks and to become a viable alternative.
Luxembourg’s Involvement in Shipping
In 1990 Luxembourg introduced the Maritime Act, which created the maritime public registry and the Commission for Maritime Affairs (Commissariat aux Affaires Maritimes, CAM - the Luxembourg supervising authority). CAM was the first Luxembourg administration to receive ISO 9001 certification and since 2004 it has been responsible to the Ministry of Economy and Foreign Trade. Currently more than 240 commercial vessels with a total tonnage of 1.9 million are registered in the landlocked duchy, perhaps encouraged by the favourable environment in terms of both tax and labour laws. In particular, Luxembourg has double tax treaties with countries such as Malaysia, Qatar, the United Arab Emirates and Indonesia, which allow profits to be repatriated to shareholders under favourable conditions.
Luxembourg’s Involvement in Islamic Finance
Despite being a non-Muslim country, Luxembourg has well-established experience in Islamic finance. The first steps were taken well before the maritime register initiative. In 1978, Luxembourg was the first western country to host an Islamic financial institution; in 1983, the first Shari’ah-compliant insurance company in Europe was established in Luxembourg; in 2002 Luxembourg was the first European stock exchange to list a sukuk and in 2009 the Luxembourg Central Bank was the first non-Muslim organisation to become a member of the Islamic Financial Services Board (IFSB).
On January 2010 the Luxembourg tax authorities released a circular clarifying the tax treatment applicable to instruments of Islamic finance. These were murabaha, musharaka, mudaraba, ijara, ijara-wa-iqtina, istisna and sukuk. The Luxembourg tax authorities defined the four instruments mainly used to finance shipping activities as follows:
• Murabaha: a sale based transaction whereby an investor acquires an asset (e.g. a vessel) for further resale to a client at a cost-plus profit. This is a financing arrangement where the cost-plus profit margin of the investor is determined in advance and may apply to all types of assets.
• Ijara: a leasing agreement by which the party contributing the capital (generally a bank) acquires an asset (e.g. a vessel) for its client and places it as his disposal in return for a rental payment for a fixed period. The bank owns the asset and transfers the usufruct to its client.
• Ijara-wa-Iqtina: a similar mechanism, where the client has the opportunity to buy the asset at the end of the contract.
• Istisna: a method of financing the production of a good (e.g. building of a vessel) that allows advance payment for a future delivery or deferred payment for a future delivery.
On June, 2010, the Luxembourg VAT administration released a circular clarifying the treatment of murabaha purchases and ijara leases for Luxembourg VAT and registration duty purposes. The circular confirmed that SPVs (Special Purpose Vehicles) incorporated in Luxembourg and created under murabaha or ijara agreements should qualify as taxpayers for VAT purposes.
A Malaysian View of Shipping Finance
Professor N Khalid of MIMA (Maritime Institute of Malaysia) commenting on the use of Shari’ah financing for shipping said, ‘In the last two decades or so, Shari’ah financing has grown in prominence in facilitating the growth in the shipping sector. Over the years, several high profile ship financing deals have been transacted using Shari’ah principles.
The increasing popularity of Shari’ah financing in ship financing stands testimony to its viability as a worthy, if not more attractive, alternative to its conventional counterpart. The framework of Islamic banking, financing, insurance, tax and other finance-related areas have been strengthened to such an extent that Shari’ah financing has emerged as a lucrative industry in its own right with its own high financing, accounting and ethical standards, which are highly regarded even by conventional financing practitioners.
Shari’ah financing has already developed a decent track record for itself as an alternative means of raising financing in shipping. While much of the financing raised in shipping is still interest-based, there is huge potential for Shari’ah financing, with all its attractions and strengths, to grab a bigger slice of the ship financing pie.
As more Shari’ah financing deals are successfully transacted in shipping, there will be growing confidence among ship owners and operators in the viability of ‘going Islamic’. Islamic bankers and financial dealmakers have proved to be skilful and adaptable in developing attractive financial structures and engineering innovative solutions to meet the funding needs of their clients in the shipping markets.
Shari’ah financing, which features highly transparent, no-surprises, pre-agreed financing structures and costs and known risks offers the opposite end of its conventional counterpart. The emergence of innovative and attractive financing structures based on Shari’ah principles in shipping in recent years augurs well for its continued contribution to the growth of global shipping and hence global trade and the world economy. When applied and structured judiciously and creatively, Shari’ah financing can no doubt stand shoulder to shoulder, if not taller, than conventional financing in raising adequate and competitive financing in shipping.’
Ijara Structures for Shipping
How does Islamic shipping finance work? The ship owner selects the vessel, which will meet his needs. The Islamic bank sets up an accredited maritime company in Luxembourg, which buys a vessel, then leases it to its customer, the ship owner. The accredited maritime company (lessor) applies for a bareboat, chartered-out registration of the vessel in Luxembourg and the customer (lessee) applies for a bareboat, chartered-in registration in the country of his choice. The lessor is the sole owner of the vessel (he retains the legal title on the vessel) until the end of the lease, the customer makes a series of lease payments until the end of the term of the ijara agreement and the customer can eventually exercise an option to buy the vessel, where the agreement is an ijara-wa-iqtina.
Under certain conditions, the lessor benefits from the favourable Luxembourg tax framework reserved to the accredited maritime companies and profits can be repatriated via an Islamic bank at competitive conditions. In practice, an accredited maritime company is set up for each vessel acquired.
The structure could be developed further by overlaying a Luxembourg fund vehicle to hold all the accredited maritime companies. The Islamic bank would then be able to distribute fund units to its clients and benefit from Luxembourg’s well-known reputation and expertise in the funds industry.
Luxembourg is rather unexpectedly, given that it is a landlocked state, a very significant maritime registry and one of the largest non-Muslim Islamic finance hubs in the world. Cédric Raths has a degree in economics from the University of Namur (Belgium) and holds a diploma in accountancy from the High School Robert Schuman of Libramont (Belgium). He is a member of the Luxembourg chartered accountants association (l'Ordre des Experts Comptables) and is a member of the Luxembourg Maritime Cluster.
Source : http://www.newhorizon-islamicbanking.com/index.cfm?action=view&id=10987§ion=features - Jan 2011
Source : http://www.newhorizon-islamicbanking.com
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