Restructuring Islamic Finance arrangements: Applying Shariah principles to distressed credit

Volume 65 Summer 2012
Restructuring Islamic
Finance arrangements:
Islamic finance has not been
immune from the woes faced by the
broader financial markets. On the
contrary, for the first time since
Islamic finance has matured into a
confronted issues of default,
insolvency and restructuring on a
significant scale and, in some cases,
on the global stage. The need of
In¬vestment Dar, and other Gulf
based investment and real estate
development firms, to restruc¬ture
billions of dollars in financing has
made headlines around the world.
made in Western nations have also
required restructuring, alongside
their conventional counterparts, due
to the economic downturn in these
Credit growth has also slowed in
many Middle Eastern nations due to
tightening liquidity, asset deflation
and short-term declines in petroleum
prices. Islamic finance, like conventional debt financing, has also been
slowed by the turmoil in the capital
markets. Since 2007, when almost
US$35bn worth of Sukuk were
issued worldwide, issuances have
slowed dramatically to approximately US$20bn in 2010. Other
forms of Shariah-compliant financings suffered a similar fate.
Applying Shariah principles
to distressed credit
In restructuring Islamic finance transactions, practitioners must adapt the best
practices under Western bankruptcy
regimes to Shariah principles. For
example, syndicated musharakah
structures interpose an investment
agent between the obligors and participant banks, meaning that individual
participant banks cannot seek direct
recourse against the obligors. This
potentially restricts creative solutions
to the restructuring of such obligations.
Moreover, Islamic financiers may
approach distressed credit with a
different mindset than the average
conventional lender: a conservative
Islamic financier is obliged under
Shariah principles to respect difficulties a borrower may face in repaying a
debt. This requires practitioners to be
responsive to, and anticipate, the
unique issues that arise in the Shariah
context in developing and implementing a restructuring strategy.
Example of One of the
Instrument: Murabaha
The Murabaha contract involves the
trading of an asset between two
parties where the seller of the asset
discloses to the purchaser the
original cost price of the asset. It is
usually referred to as a "cost plus"
contract. The transfer of the asset
under a Murabaha contract must be
immediate (although the price
payable by the purchaser is generally
Restructing Islamic Finance Arrangements 1
IAS Property Plant
Succession planning for Family
Owned Businesses in UAE
Does IFRS for SMEs and combined
financial statement timely needed in U.A.E.?
deferred). The introduction of
deferred payment terms involves the
provision of credit, and the profit
mark-up of the seller is invariably
benchmarked against a conventional
index such as LIBOR. In conventional banking if the equipment
finance is procured, this can be
replaced by Islamic Financing
wherein financial institution would
typically acquire an asset from a
vendor/conventional Bank and immediately sell the asset on to the client.
Although often referred to as a Murabaha contract (in the singular), the
financing effect is actually achieved
through the use of two separate
contracts. The way in which they are
executed must be carefully orchestrated to ensure compliance with
Risks associated with
restructuring Islamic
At a basic level, the issues associated
with restructuring an Islamic financing do not differ materially from
those associated with restructuring a
conventional debt financing: the
parties desire to restructure their
obligations in a manner that allows
Horwath Mak is an Independent Member of Crowe Horwath International
the parties desire to restructure their
obligations in a manner that allows
the defaulting debtor to operate and
meet its financial obligations while
permitting the finance provider to
retain its remedies to recoup its investment if the obligations continue to go
A restructuring affords the opportunity
to address these shortcomings in the
documentation to the extent appropriate, in order to meet the risk/reward
expectations of the participating
financial institutions, while remaining
true to the underpinnings of Shariah.
Practitioners must restructure keeping
in mind a future restructuring or
liquidation. The restructuring of an
Islamic finance transaction must take
into account the expectations of all
participant financial institutions,
which are also likely to be guided by
paradigms developed through experience with insolvencies in Western
Dr.Khalid Maniar
Founder & Managing Partner
IAS-16 Property,
Plant & Equipment
IAS-16 sets the outlines for its
accounting which seems straightforward but the devil lies in the detail.
PPE are tangible items having useful
life over one accounting period and
are held for use in the production or
supply of goods or services, for rental
to others or for administrative
purposes. E.g. Gold reserves held by
the Central bank for supply of
services (to stabilize the national
currency) meets the definition of PPE
& do not fall under IAS-2 or IAS-39.
Recognition and subsequent measurement.
The PPE on fulfilling the criteria shall
initially be recognized at cost and
subsequently valued either using cost
or revaluation model. Under revaluation model, the entire class of assets
should be revalued on regular
intervals depending on the frequency
and significance of change. Upon
revaluation the accumulated depreciation shall either be eliminated
against the carrying value of asset or
restated proportionately to bring the
carrying value of asset equal to its
revalued amount.
Revaluation increase or decrease
If previously any revaluation
decrease was recognized in the
statement of income then the subsequent revaluation increase will firstly
to be charged to statement of income
and any excess to revaluation
E.g. PPE purchased on July 01, 2010
for CU 140M however its fair value
as of December 31, 2010 and
December 31, 2011 becomes CU
125M and CU 150M respectively.
Debit: Statement
of income
Credit: Statement
of Income
Credit: Revaluation
Succession Planning for
Family Owned Businesses
in UAE
Succession planning in a business
applies to most key positions in the
organization including the owners. A
smooth transition of the management
or ownership can happen only if
proper succession plan is in place.
Though a well thought and efficiently
charted plan is required for all key
positions in an entity, this article
focuses on the issues of succession
planning in UAE with respect to
planning is a tool to prepare the
organization for an event where the
key business leader dies or goes into
owned business is a very critical and
important and yet in most cases it
remains on the back burner in view
of its sensitive and emotional nature.
CU 15M
CU 15M
3rd generation. One glaring reason
CU 10M
for the same is lack of proficient
Transfer of revaluation
Research has shown that most family
businesses do not survive beyond the
succession planning or exit strategy.
businesses are family owned yet very
It will be transferred to retained
earning either entirely on disposal or
at each year with the amount of
incremental depreciation.
few of these businesses have a succes-
successor. Passing on the ownership
Each significant part of PPE will be
depreciated separately based on their
useful life. Any change in the useful
life will be treated as change in
estimate under IAS-8.
Nauman Ahmed
Senior Auditor
Audit | Advisory | Risk | Tax
sion plan. Reasons include resistance
from owners, fear of losing control
and even inability to find the right
is both complicated and highly
emotional which is one reason it is
ignored till it becomes inevitable.
The scenario in UAE is particularly
typical for an expatriate in case of a
succession. Succession planning is
important no matter whether the
entity is an LLC, proprietary or a free
offices in UAE.
Property and other
with other economic entity. Further,
zone company. Many UAE business-
assets held in UAE need a similar
the entities are jointly managed, and
men are unaware that the bank
loans are cross collateralized and in
fact, facilities with the banks are
accounts of a deceased person are
frozen immediately until the succes-
Atik Munshi
sion mandate is provided by the local
Managing Partner (Sharjah Branch)
UAE court. Such ruling by the court
accounts as well. In some cases even
the business bank account is frozen.
Business could be seriously disrupted
in such scenario as funds are not
available to run and operate the
business as bank accounts are frozen
for a period of time. Allocating some
time to formulate and design the
succession plan in advance with the
help of a professional could be a key
to the continuity of the business.
available for the expatriate to make
matters easier for their heirs in case
of an unfortunate event. Having a
structured and well designed legal
ownership pattern of their business
or businesses is a key to a smooth
transition. Usually a total overhaul of
the ownership structure is required to
protect the interest of the expatriate.
Hence an advance plan for the exit
strategy, in the event of the person’s
death, is necessary. Options includes
the shares of the entity to be held by
a company registered in a jurisdiction which recognizes the will and
desires of the person involved, preparation of a registered will, etc. As the
process is complicated and requires
a good amount of documentation it is
suggested that the persons should
take help of a professional company.
Combined financial statement is one
might take more than one year in
some instances. This applies to joint
Does IFRS for SMEs
and combined financial statement timely
needed in U.A.E.?
of the issues addressed in the IFRS for
Financial statements are the most
not listed publicly or a financial
widely used tool to communicate the
institution. Though, clear guidelines
financial information to the end users
are provided by IASB, the ultimate
such as investors, creditors, vendors
decision on which entities should
and banks, to name a few.
use the IFRS for SMEs will rest with
SMEs that is not covered in full IFRS.
IFRS for SMEs is intended to be used
by entities that are not publicly
entities’ debt or equity instrument are
Companies in U.A.E. are either
standard-setters of local jurisdictions.
formed in mainland and or in free
zones depending on the investors’
In U.A.E., for instance, the use of
preference of set up. Most of the
IFRS for SMEs is not widely recog-
investors owned more than one
nized, since local jurisdiction has not
entity that caters to various types of
business activities. The financial
condition of those entities is reflected
in financial statements. However,
most of the owners having more than
one entity that operates as a single
economic see the need for combined
financial information.
Separate financial statement of legal
entities might not provide accurate
financial information because those
entities often enter into transactions
with each other that are not necessary structured or price at an arm’s
length transactions. In such a case,
the transactions reported in the
separate financial statement reflect
Horwath Mak can offer its assistance
the internal transactions that are not
in the same through its various
transactions of the economic entity
Audit | Advisory | Risk | Tax
absence of promulgation for adapting the same. As businesses in U.A.E.
starting to peak up and lured more
investors to form companies, through
variety of schemes, the need for
simpler standards that are more cost
effective is highly essential.
Eugene Montemayor
Audit Manager
The prohibition of disobeying the mothers, asking questions excessively
and squandering the money
On the authority of Al Mughira Ben Shu’ba (may Allah be pleased with him) who reported that:
The Holy Prophet (may Allah bless him and grant him peace) had said:
“That Allah (the Exalted) prohibited you to disobey the mothers, to bury the daughters alive; to abstain from imparting to
others what Allah (the Exalted) had recommended giving them. Allah also disliked the talkativeness, the asking of too
many questions and the dissipation of moneys”.
This Hadith was narrated by Al-Bokhari.
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