Are Islamic Trade Services Missing the Point?
Shari’ah compliant instruments are a growth area for structured trade services. This is to be welcomed. Yet solutions providers should not lose sight of the primary objective – to facilitate trade.
Certainly, anyone dealing with trade in the Middle East, North Africa or Islamic Asia will, by now, be familiar with the growth in Islamic trade services. Shari’ah compliant instruments are in greater demand than ever before, and the market has responded by offering an ever-greater variety of trade services instruments that comply with the principles of Islamic law.
Indeed, the list is now close to comprehensive. Letters of credit, guarantees, promissory notes, buyer and supplier credits, receivables and inventory finance, commodity finance, equipment finance, forfaiting and factoring, non-recourse finance, structured trade finance, stock and warehouse financing, tolling, counter trade and barter, leasing and asset financing, and credit insurance can all be structured to become Shari’ah compliant. Also, more and more players are offering Islamic solutions – whether as dedicated specialist Islamic entities or as discreet Islamic departments within conventional financial institutions.
However, this growth in Islamic trade services and instruments – and especially the delivery of Islamic solutions – somewhat misses the point, especially in flexibility and approval timeframes.
To explain, trading entities approach trade services suppliers seeking specific, bespoke solutions to their import and export needs. They present the elements of the deal, which can include the commodities – as well as the volumes and prices – the counterparties, the delivery schedules and any risk mitigations such as insurance or guarantees. Invariably, what the trading entity seeks is a solution that will, a) enable the trade to happen fast, b) perhaps allow for a leveraging of volumes, c) maximise the margins, and d) through structuring, remove certain risks they find unacceptable. They may or may not then request an Islamic solution.
Yet the trade comes first. The key for the solutions provider is to solve the problems – or fulfil the opportunities – they are presented with using the best trade instruments available for the job. The central role of the solutions provider is to remove the trading constraints of its clients and to improve their cashflow. And, as far as I am concerned, the Islamic element of a transaction is one part of the term sheet, albeit an important one.
Given the attention on Islamic instruments at the moment, this sounds harsh. Yet that is not my intention. I have the greatest respect for the needs of the Islamic trade community and believe Shari’ah compliant instruments are an important part of the mix with respect to trade facilitation. Yet I would state that solutions that aim first to meet Islamic laws and only then address the need to remove trading constraints and improve cash flow are most likely to cost more and fit badly. Certainly, clients that seek an Islamic product as their only goal will be accommodated by the myriad of compliant offerings on the market. Yet the solution may fall short of their requirements with respect to trade facilitation. As a trade specialist, my view is that trade-based problems require, first and foremost, a trade based solution.
However, trading companies wanting the optimum solution – that is also Islamic – are in luck. Prioritising the optimum solution, rather than the Shari’ah compliant solution, is in fact easier with trade finance than most other areas of finance. This is because many trade finance instruments either already conform, or are close to conforming, to Islamic strictures.
To be Islamic, financial instruments have to be structured in a way that declares the profit margin upfront – with no changes made throughout the lifetime of the facility. Also, they must operate on a shared profit rather than an interest rate basis, share the risk between the counterparties, and have no hidden costs.
This means solutions such as forfaiting, which can operate on a discounted principal value basis, or stock financing and commodity trading, which operate by buying and reselling goods, or credit risk insurance, which charges premiums, or structured finance, which can take the form of an assignment against future export receivables, either comply or can be easily made to comply.
Another principle of Islamic finance holds that any financing activity must be supported by an underlying asset. This again represents an inherent conformity for trade services with Shari’ah law – making equipment finance, export credits, documentary credits and pre-export finance all within reach of compliance, but for a few adaptations. Indeed, it is the proximity of trade instruments to Islamic finance that partly explains the depth of the Islamic offering in this area.
Certainly, the proximity means that solutions providers can get on and structure deals to meet their client’s required goals in the knowledge that Shari’ah compliance is highly possible, and may well be applicable once the primary needs of the trade have been satisfied.
So where does this leave the current market offering for Islamic solutions? Islamic structured trade services are currently offered by two types of provider – both putting Islamic compliance at the very centre of their business models. First there are dedicated providers – usually banks with the word Islamic in their titles. And then there are the specialist Islamic windows from conventional banks and service providers – both locally based and international.
Both these providers have added enormously to the supply side of Islamic finance. Indeed, many of these operations have entered the market with a minimal capital base of US$1bn, with market rumours putting the capitalisation of one new Islamic bank as high as US$100bn. This is money they will need to invest, injecting market liquidity that creates its own demand.
This is both a threat and an opportunity for the trade services industry. Certainly, these providers can support additional facilities – facilitating or leveraging trade that may not have been previously possible, or scaleable. Yet the solutions they offer will be Islamic, which may mean they are somewhat commoditised – excellent at accommodating Shari’ah, but failing to fully satisfy a client’s trading needs.
This is where independent trade services specialists can be useful, as they are focussed on facilitating trade and improving cashflow. They treat the need for an Islamic solution as a parameter – a structuring requirement as well as an opportunity to diversify the funding source.