WORLD - FUNDAMENTAL DEBATE - Goldman Sachs : genuine or Ribawi Sukuk in the making?

A) The deal on paper : a plain vanilla Murabaha Facility

The above inserted graphic reflects the most used practice of the Murabaha-to-the-Purchase-Order.  The reader will be familiar with this.

The Base Prospectus stipulates repeatedly: " whereby  the Trustee  will, at the request of GSI,  use the proceeds of the issuance of the Series to purchase certain commodities  from a third party Seller on immediate delivery and immediate payment terms and  will  immediately sell such commodities  to the GSI on immediate delivery terms but with payment on a deferred basis." And  further Mr. Asim Khan - MD and head of structuring for Dar Al Istithmar -  stated that the paperwork "clearly shows  that Trustee, as seller, sells the commodity to GSI, as purchaser. Thats it...."    and further that:  "Once  the commodity is sold to GSI, its then at GSIs discretion to do what it wants  to with the commodity".  This looks like a plain, even boring Murabaha Facility. Yawn

Mr. Khan further states that: "the legal documents  ... have been reviewed and approved by leading scholars in the Islamic finance industry ..." and suggests that Mr. Mohammed Khnifer   did not fully read or grasp the contents of the available documentation.   It is however clear that Mr. Khnifer did read the documentation sufficiently and that he did grasp the implications thereof very well.  Actually, Mr. Khnifer voices a concern of a not unimportant part of the industry.

Simple review of legal documentation is hardly convincing.  One must go have a look at the intentions of the parties concerned and their factual behavior.  It was this look that originated the 'Tawarruq-debate' in the first place.
(Source) or (rest of story hereunder) (softcopy available on demand)

B) Is this an unlawful  Tawarruq ?

GSI most likely has no intention to  keep for $2 billion commodities on its account - that actually makes no sense  - but likely intends sell them immediately down and use the proceeds  in its day-to-day business: "USE OF PROCEEDS - The net proceeds  of each Series issued under the Programme will be applied by ... GSI ... for its  general corporate purposes and to meet its financing needs".

It  is clear that there is a second leg attached to the Murabaha and since we talk  about the sale of $2 billion, it would be rather nave to say that this is not premeditated  / organized seamlessly.  But would that mean it is unlawful?  As Mr. Khan opined: "Once the commodity is sold to GSI, its then at GSIs discretion to do  what it wants to with the commodity". As it would be the case for any  other Client, for that matter.  So it  seems.

In  a Regular Tawarruq, the Client (GSI) buys the commodities / assets from the IFI/Financier  (the Trustee) with a deferred payment but with the explicit intention to immediately  re-sell them for cash.  The Tawarruq  actually is a simple cash generating structure whereby money is converted to an  asset / commodity and then back to cash with a deferred payment.  This is deemed lawful as such by most  scholars.  The OIC Fiqh Academy has declared  it however unacceptable for IFI to organize such cash-structures.

Since the Client  usually is not familiar with commodities markets, the IFI indeed used to offer  this structure as an organized package.   The Client had nothing to do but be there at the set date and sign some  paperwork in order to walk out with cash and a deferred payment at a cost.  The IFI often even imposed a Selling Agency  on its behalf to make sure that all would go as to plan.  The client was reduced to a mere spectator with benefits.


There  is no dispute that the IFI is involved in the second leg of this type of  structure: after the Murabaha: it operates as agent for the Client in order to  sell the commodity down to the Buyer.
Now  let us have a look at the probable intention hidden in the GSI-variation.



Here, the IFI (the Trustee) is NOT involved in the second sale.  But there also is another difference.  Except for the legal issues (signing of papers and legal title), the Trustee is not even involved in the first buy ... that operational right is exclusively transferred to the Client (GSI) : choice of Seller (it is not a buy in the market), negotiation of price and quantity ..  Though it is the same as in a Murabaha-to-the-Purchase-Order (usually for individualized assets), it evidently feels different in this particular setup (genus commodities) with obvious intention of re-sale.  Where is the need for the GSI to interfere? The Trustee could simple buy the genus commodities in the market and then sell down to GSI.  Unless GSI is actually 'organizing' the two legged structure by itself and wants full control? It is the old substance-and-form debate bubbling up again.
Let us use a different visual approach and 'walk' through the structure.



The Trustee is only there because GSI has incorporated him and then tied him down: GSI has dictated the Murabaha Facility, the Murabaha conditions and the exclusive agency.  If it were not for the formal Shari'ah compliance only, the Trustee would not be there at all.  GSI is professional enough to run both legs of the structure all by itself (buy / sell).  Actually, the structure is superfluous.  Instead of walking over the conversion cash - commodity - cash, GSI (already in FULL control) could simply take the money from the Trustee at a cost and book it into its accounts for further use...  We hereby assume that GSI will not keep the $2 billion commodities in its accounts, but that it will sell them down in order to use the cash.

This  inversion of powers and organization is moreover fundamentally different from  the regular Murabaha Facility where the Financier/IFI is in control, and where  Client/IFI will use the proceeds to extend compliant financing to its underlying  clients or the Client/Company either uses the proceeds to buy real economy  assets or to generate cash for use in its real economy operations.  Then again, GSI is a conventional Ribawi lender  without Islamic window, also through its clients involved in financing haram  industries against interests, so special caution is needed.

The  organized Client/GSI became the organizer and the Financier/Trustee is  painstakingly aware of that, being reduced to a mere puppet for signatures  only, but nevertheless plays along.  The  community and time will tell if such inversion in the organization, surrender  and declared innocence are sufficient to escape the OIC Fiqh Academy ruling and  if the rest of the Scholarship is willing to validate.

C) The use of the proceeds

But  what happens afterwards with the proceeds of that cash?  All that we know is that $2 billion  disappears out of sight into the cellars of the accounting and wheelings and  dealings of a conventional banker, to be used "only, for its general corporate purposes and to meet its financing  needs".   "Thats  it."    Whatever that may be: the acquisition of  furniture, the paying of rent or salaries of personnel to even granting  end-of-year bonuses.  With some flexibility, that might however  also be conventional financing against interests, even mixed with haram  industries.    Without suggesting any  intentional wrongdoing at GSI from an Islamic compliance point of view at all,  it does not take rocket science to evaluate the possibilities for a creative  mindset, even acting in good faith.
Certainly  when we take the seeming absence of isolation in an Islamic window/unit into  consideration, that vagueness causes concern, next to the fact that the writer did  not find in the Base Prospectus:

1. A written commitment of GSI to treat the proceeds of the transaction in a fully compliant way and/or to fully isolate them out of the day-to-day routine as a conventional banker
 
2. A statement from the Shari'ah Board that there is constant monitoring, reporting, isolating, cleansing ... at the level of GSI.  The statement that whatever happens with the commodities after GSI walks out of the Murabaha is their business, is worrying in this respect.

The  seeming absence of ring-fencing of the monies inside a conventional financier could  create a situation where there is no guarantee that the Sukuk and subsequent  the Sukuk holders will not be serviced with Ribawi revenues (eventually even  originating from haram industries).  The simple  fact that the question can be posed at all rests problematic for any Islamic  investor.   This could have been avoided.

D) Listing on the Irish Stock Exchange

The  same casual approach is displayed in the Listing on the Irish Stock  Exchange.  The official position is  brief:  "...the offering circular clearly states in several places that the  certificates can only be traded on a spot basis and at par value if they are to  be Shari'ah compliant ... hence the listing can, practically speaking, only have  a taxation and regulatory benefit without impinging on Shari'ah principle in  any manner."

This  appears to be - with all due respect - slightly beside the point.  Indeed, the only practical intention and result from a listing is that financial  instruments actually get traded.  And we  know for sure that the practicality will materialize where non-compliant Sukuk holders will trade supposedly  non-tradable Sukuk on the Irish Stock Exchange at a discount and hence Ribawi.  We do not even want to imagine a compliant  investor submit to the temptation to buy/sell at discount on that market.  Here is a strong precedent that might set the  pace towards new horizons, "to boldly go  where nobody has ever gone before".

Before  long, non-tradable Sukuk might be tailored for non-compliant investors, maybe  even targeting haram business and for monies used in Ribawi and non-compliant  purposes and we might even see parallel markets develop. With the non-compliant  Sukuk market (sic!) in non-tradable Sukuk (sic!) outgrowing the real Islamic  market (limited to tradable Sukuk and subject to all the other Shari'ah  impediments) and maybe even setting the pace and trying to dictate conditions  (given their potential volume).  Such  parallel universe can hardly be the intention of Islamic finance.

The  writer is not a Scholar or regulator so the reflection and decision on this  issue is not his to make.  But the prima  facie feeling is that that door should be closed.  Non-compliant investors should accept all the  pre-set conditions of Islamic finance or stay out.  To keep the market consistent, it appears to  be unacceptable that the rights and duties of parties should depend on their religious  conviction.  Those rights and duties  should be incorporated in the paper and Issuers and Investors should abide by  those rules and not offer non-compliant solutions, whatever the cost.

At  first sight therefore and without having had access to the full documentation  it will be clear that Goldman Sachs has delivered a controversial structure,  specifically measured towards the needs of the non-compliant Investor and ditto  Client and that is to be regretted, since it would not have been too difficult  to find common grounds for the industry as a whole:

 
1. On paper, the structure indeed is a plain vanilla Murabaha Facility, following which GSI for its own account enters into what could be seen as a non-organized (and therefore for most Scholars permissible) Tawarruq;
 
2. De facto however, this resembles strongly to a non-typical variation of a an Organized Tawarruq- where the power balance got distorted, shifting the usual control of the Islamic banker/financier towards the underlying client whilst the Islamic financier decides to play along;  As said : the market will be divided on its acceptance or refusal;
 
3. The seemingly non-guaranteed isolation of funds in the hands of a conventional banker appears to be even more troublesome. The Sukuk       holder may be serviced by the revenues out of unclear income streams that hence might be Ribawi or even stem from haram industries;
 
4. The listing on a stock exchange of non-tradable Sukuk maybe is the most interesting milestone. To open the door to parallel Sukuk markets for the sake of tax advantages might end up to be highly controversial and is potentially extremely consequential.  Here lies an even more fundamental debate;

About Paul Wouters
Lawyer Antwerp Bar Association (Belgium)- CEO PT Senturiyon Gobal (Jakarta - Indonesia)
Senior Foreign Counsel Azmi & Associates Law Office (Kuala Lumpur  Malaysia / Singapore)
for EU Regulations and Islamic Wealth Management pwouters.law@gmail.com 
 
References

• Page i of the Base Prospectus, but language repeated several times throughout that document.  The original denominations of the parties involved have been altered here in order to follow the logic of this article -  please do consult the original text for the original wording.
  
• Interview Mr. Asim Khan with The Islamic Globe: Controversy dogs GS Sukuk edition Dec 8, 2011, page 8
  
• Interview Mr. Asim Khan with The Islamic Globe: Controversy dogs GS Sukuk edition Dec 8, 2011, page 8
  
• Interview Mr. Asim Khan with The Islamic Globe: Controversy dogs GS Sukuk edition Dec 8, 2011, page 8
  
• Khnifer, Mohammed (2011).Disclosure of 3 Flaws in Goldman Sachs' $2 Billion Islamic Bonds' , http://reading.academia.edu/MohammedKhnifer/Papers
  
• Interview Mr. Asim Khan with The Islamic Globe: Controversy dogs GS Sukuk edition Dec 8, 2011, page 8 he probably meant to say that the whole structure was reviewed for Shari'ah compliancy and not only the legal documents (what is somewhat different)
  
• Khnifer, Mohammed (2011).Disclosure of 3 Flaws in Goldman Sachs' $2 Billion Islamic Bonds' , http://reading.academia.edu/MohammedKhnifer/Papers
  
• Base Prospectus page 60
  
• The Base Prospectus actually regulates the modus operandi thereof : : Upon completion of the sale of the Commodities by the Trustee (in its capacity as Seller) to the GSI, the latter may hold the Commodities as inventory or elect to sell the Commodities in the open market provided that where GSI elects to sell the Commodities, it shall sell the Commodities to a third party buyer that is not the initial Seller  - Base Prospectus page 16. 
  
• Interview Mr. Asim Khan with The Islamic Globe: Controversy dogs GS Sukuk edition Dec 8, 2011, page 8
  
• The issue also plays in the various Commodity Murabaha structures that find their ways to the markets for reasons of liquidity management.  Opinions are divided, that much is clear. the OIC fatwa can be accessed here: http://www.isra.my/fatwas/topics/treasury/interbank/tawarruq/item/262-oic-fiqh-academy-ruled-organised-tawarruq-impermissible-in-2009.html - For a good understanding : not everybody in the industry validates this decision without reservation.  See for instance the Albaraka Fatwa http://www.isra.my/fatwas/topics/treasury/interbank/tawarruq/item/265-tawarruq-with-a-conventional-bank.html - Some scholars are even outright and public defender of (organized) Tawarruq.  The debate is far from closed.
  
• Base Prospectus page 60
  
• Interview Mr. Asim Khan with The Islamic Globe: Controversy dogs GS Sukuk edition Dec 8, 2011, page 8
  
• An estimated US$ 10 billion this year 2011
  
• Once the commodity is sold to GSI, its then at GSIs discretion to do what it wants to with the commodity.  - triggers the implicit : or the proceeds thereof - Interview Mr. Asim Khan with The Islamic Globe: Controversy dogs GS Sukuk edition Dec 8, 2011, page 8
  
• Interview Mr. Asim Khan with The Islamic Globe: Controversy dogs GS Sukuk edition Dec 8, 2011, page 8
  
• The easiest way to end a temptation is to submit to it and the temptation just has been created.