Islam and the Armies of Mammon
Jeremy Harding returns to the subject of high finance in the Islamic world
The first part of Jeremy Harding’s piece on Sharia finance can be read here.
The rules that govern Islamic banking and finance are non-negotiable, cast in tradition, as good as stone. A finance house that sticks to the plot will not come to grief in a credit crisis; neither will its clients. Yet once large sums are involved – sums beyond the reach of modest customers – Islamic entrepreneurs, corporate and institutional investors take risks with the principles that sharia-compliant finance is meant to embody, by colonising conventional areas where the promise of riches and power looks irresistible but the path is forbidden. The challenge here is technical as much as moral. Faith-accountable fund managers and devout privateers in Malaysia and the Gulf may want a stake in Western wealth creation, but they must try to stick to Islamic principles when they intrude on the money. ‘Leveraging’, ‘derivatives’, ‘shorting’: the ambient glamour of these operations, like the terminology itself, seems dangerous in the new light of day, yet cautious capitalists still find them serviceable and inventive theorists of sharia-compliance are intrigued by them.
In the Square Mile, compliant financing techniques are available if enough money and intellectual resources are put into a project. In 2007 there was a star turn: a sharia-compliant leveraged buy-out of Aston Martin Lagonda, then part of Ford, and a glamorous accessory in the not so compliant 007 range. (The cars themselves are ‘compliant’, someone involved in the deal assured me.) For the purposes of the acquisition, two investment management companies in Kuwait formed a third company with Aston Martin’s CEO and a retired British rally driver. The financial gadgetry involved was impressive, though by the standards of Bond’s MI6 boffin, the phlegmatic Q, hardly spectacular. AML was bought for about £480 million. To work around the problem of interest payable on the money that had to be raised – from banks – the buyers pressed a compliant dashboard button known as the ‘commodity murabaha’: rather than lending money directly to a borrower, a bank agrees to buy a commodity and sell it on to him (immediately) with a fee added into the sale price; the borrower sells the commodity in the markets (immediately), but his repayment to the bank for the commodity it bought on his behalf is deferred for a period of time agreed by the parties.
The Kuwaitis had already raised the bulk of the money for the purchase; the remainder, in the order of £200 million, was put up by a syndicate of banks, led by the London office of the German commercial bank WestLB, which bought on the London Metal Exchange to the value of the sum required, sold the metal warrants to the purchasing company on the same day, with a mark-up, after which the company sold them on, as the model requires. The deal committed the new owners of AML to a single repayment, five to eight years later. Phased debt repayments, the norm in this kind of arrangement, were avoided, as was the distinction between senior debt (which gets priority repayment) and subordinate debt; Islam is unhappy with different classes of debt, as it is with different classes of stock. Five to eight years seems a long time, but the timing was based on an analysis of AML’s business cycle – high-end toys like Aston Martins are slow earners – and found favour with the Kuwaitis, the banks and the sharia advisers.
Two of the WestLB people who handled the buy-out were satisfied by the impression it made in the City and in the Gulf. It was evidently a lot of work for Eva Bigalke, the bank’s executive director of Islamic Finance, who managed the legal underpinnings of the deal. These were vast as well as intricate: when I asked her for an idea of the size of the legal file, she raised her hand some way from the table, not far short of Proust. It seemed to her that this was the moment when sceptics had to concede that sharia-compliance could find a way to the real money, which was only accessible to conventional entrepreneurs a few years ago.
The AML deal is scarcely mind-boggling; around $25 billion was raised for the acquisition of RJR Nabisco at the end of the 1980s and, as Bigalke’s colleague Harvey Hoogakker remarked, the Alliance Boots buy-out in 2007 involved about £12 billion. Both were the work of the private equity monster Kohlberg Kravis Roberts, with whom a couple of flush Kuwaiti investment companies bear no comparison. Hoogakker, WestLB’s executive director of leveraged finance, described the Aston Martin buy-out as a modest ‘mid-market deal’, whose significance, he felt, had to do with an ‘emerging’ trend having finally, startlingly emerged. There was, Bigalke added, a thoroughgoing change in the way the Middle East was thinking about its wealth. The sudden repatriation of Islamic money after 9/11, and the long period that preceded it, when wealthy Arabs would invest away from petrochemicals only if they saw a real-estate opportunity – anywhere from Knightsbridge via Dubai to the property showrooms of Kuala Lumpur – is over. In its place is a more inquisitive, aggressive approach to non-Islamic wealth creation, and a wish to see it customised in compliant forms. The AML deal, Bigalke reports, was approved by ‘a large constituency’ in the world of Islamic finance as an acceptable customisation of a conventional technique. Clearly it opens up an array of possibilities to devout entrepreneurs, including asset-stripping – and how devout is that?
The commodity murabaha can be used to organise currency swaps or profit swaps between institutions, but many futures and options pose a bigger challenge because Islam is cautious about the buying and selling of contracts. A contract that can be sold on, or one that confers a right, rather than an undertaking to buy, introduces the worry of uncertainty. A contract for a contract, which is what many derivatives amount to, is a sign for a sign, not a sign for a thing; it introduces clutter and congestion into the realm of signs – a realm of solemnity for practising Muslims – and erodes consensus on the value of underlying assets, just as riba (or interest) earned on a principal, like on like, turns money from a counter into an agent, to the detriment of authentic counters and legitimate agents. Islam’s reticence about derivatives means that investors have difficulty reaping the benefits (and incurring the risks) of exposure to hedge funds. The sticking point here is the indispensable feature of the short sale: most sharia scholars agree you can’t sell a thing you don’t own. Then, too, there’s the fact that selling short is a gamble, and you stand to lose if the price of your chosen security starts to rise.
The first step, for Muslims who wish to come to terms with the paradox of the halal (or permissible) derivative, is to admit that even if money isn’t all in the mind, that’s where it likes to spend its time in the West. It’s no use pretending that this is an entirely worthless and precarious arrangement: virtual money may or may not be its own undoing one day, but it isn’t threatened yet by dissident peoples huddling in the forest with their tangible assets. The next step is to find an instrument that makes it possible to go around a haram (or prohibited) transaction and reach the desired consequence by a different route, a bit like avoiding an open drain, with obedience to your faith intact. One might think of this as cynicism or hypocrisy, but the process is not so different from drawing up a complicated legal agreement, and the results can be quite impressive to sharia scholars with a taste for intellectual risk.
You might, for example, invest in a fund that uses your money to buy up sharia-compliant shares. That fund then swaps the returns on the shares for the returns on a conventional fund tied, say, to the performance of a stock-market index. The intention of the compliant swap is to give a little moral leeway to the pious client. Even conscientious Islamic investors, the argument goes, have to draw a line under their misgivings at some point, just like investors in a secular Socially Responsible Investment fund, who know that no returns on their capital are squeaky clean given that the companies in any fund portfolio operate in a non-SRI trading environment.