Islamic Finance Trends in France

At the very end of last year, France issued new taxation guidelines to make it possible for Islamic finance transactions to be treated more fairly from a revenue perspective. The two most common Shariah-compliant financial instruments – the sukuk and murabaha – which hitherto attracted tax penalties because of the structuring that sought to avoid riba, or ‘usury’, were now recognised differently, in order to secure the growth of Islamic financing in France.

The international market itself is growing at a phenomenal rate. Before the present worldwide financial downturn, estimates were that Islamic finance offerings of all types totalled between US$700-900bn last year – and one analyst predicted investment was set to top US$2 trillion in 2010 (although that figure is now likely to be revised downward as the Gulf investment market has slowed somewhat – although nowhere near as much as other western markets).

France began its identification and implementation of ways to attract Islamic finance institutions to the country in 2007 and the pace accelerated last year. France recognised that the UK had been for some years developing a financial and regulatory climate which assisted Islamic finance to flourish. In February 2007, the first building block was put in place. A law¹ was enacted creating fiducie or fiduciaries and was intended to bring into French law the Common Law concept of a Trust. In August 2008, the framework was made even more flexible in the law of the modernisation of the economy^.2 Now, both natural persons and legal entities will be allowed to constitute a fiducie. Lawyers will also be allowed to act as fiduciaries.

The Sénat, the upper house of the French legislature, held a series of roundtable discussions with key international players in May 2008 about the ways that France could become integrated into the global network of Shariah-compliant finance. They looked at the ways that French companies can work with Islamic funds and, most crucially, the ways that tax laws and regulation would need to be altered in order to arrive at a fair taxation policy that did not penalise Islamic financial instruments. The Financial Times quoted Arnaud de Bresson, managing director of Paris Europlace, who said: “The senate’s initiative to organise a high-profile event on Islamic finance is a sign that the authorities are paying increased attention to this market.”

The market statistics are impressive. France’s Muslim population is conservatively estimated at six million. A survey carried out in 2007 by the French Institute of Public Opinion (IFOP) said that half a million Muslims in the country would be interested in Islamic finance. Add to this the Muslim populations in francophone countries and the potential banking and other Islamic finance products for French-based Islamic finance operations is huge. Around the Mediterranean are key French speaking countries, such as Morocco with 34 million, Algeria with 33 million, Tunisia with 10 million and Lebanon with two million. In francophone Africa, countries such as Senegal and Mali alone add more than 21 million to a total francophone Muslim population of more than 44 million.

The country’s politicians moved fast to implement Islamic finance, drawing on the conclusions reached by the Sénat report and other sources. The French finance minister, Christine Lagarde, made a ministerial statement that France was indeed serious about stimulating Islamic finance. In July, she publicly briefed Gulf investors that they should expect changes to the French tax system that would make their activities as welcome as they are in London or elsewhere.

The Autorité des Marchés Financiers (AMF) is France’s financial regulator. It also played its part in recognising Islamic instruments. In July 2008, the body outlined its rules for admission of two main types of the sukuk Islamic bond onto the French regulated market:

1. Sukuk for which the periodic distributions and reimbursement rely primarily on underlying assets and which therefore, by virtue of their construction, are equivalent to securitisation (i.e. an asset backed securities issue).
2. Sukuk for which the periodic distributions and reimbursement are based on underlying assets, but for which investors rely primarily on the undertaking of one or more entities for part of or all payments in respect of the sukuk.

The AMF also set out some further rules – for example, sukuk that are issued in the context of a private and/or international placement will be admitted to the professional segment of the French regulated market, due to the inherent nature of the investors.

The compliance of the issue with Shariah rules does not fall within the remit of the AMF. It is the responsibility of the issuers, with assistance from their advisers, to incorporate into the prospectus the relevant elements, including appropriate details of the Shariah board involved in the transaction, which provide the necessary information to enable investors to make an informed decision.

The AMF’s objective is to ensure that the prospectus has been prepared in accordance with European laws and regulations. As the European regulation does not include any specific annexes for Islamic bonds, article 23.2 of this Regulation stipulates that, where a prospectus for a security which is not the same as, but is comparable to, the various types of securities mentioned in the European Regulation, the issuer shall add the relevant information items from another securities note schedule provided for in the annexes of the European Regulation.

This addition shall be done in accordance with the main characteristics of the securities being offered to the public or admitted to trading on a regulated market. It is therefore the issuer’s responsibility to define the precise contents of the prospectus in accordance with article 23.2 of the European Regulation, taking into consideration the financial characteristics of the sukuk which it plans to list.

The issuer will inform the AMF when filing the draft prospectus with the Authority of the type of sukuk being listed and the relevant annexes of the Regulation with which it is complying.

As an example, the AMF will consider that in the first case mentioned above, where the periodic distributions and reimbursement rely primarily on the underlying assets, the prospectus is prepared on the basis of the annex XIII with regards to the terms and conditions of the issue (in so much as the nominal amount of the bond is equal to, or greater than, €50,000), and the annexes related to ‘asset backed securities’, with regards to the issuer and the assets (annexes VII and VIII of the European Regulation).

In the second case, where investors rely primarily on the undertaking of one or more entities for the payments in respect of the sukuk, the description of the securities follows annex XIII of the Regulation (in so much as the nominal amount of the bond is equal to, or greater than, €50,000).

In addition, the principle stated in article five of the Prospectus directive, which requires the disclosure of any material information which enables an investor to make an informed decision, can be generally satisfied with the structure being described:

• Either on the basis of annexes VI and IX, with the appropriate disclosure of the underlying contracts.
• Alternatively on the basis of annexes VII and VIII (considering that the underlying contracts are the relevant assets for this purpose), with the appropriate disclosure of the entities that have given an undertaking for part of or all payments of the sukuk, on the basis of item 2.2.11 of annex VIII.

By late December 2008, the French government was ready to publish firm tax guidelines to cover both the sukuk and murabaha contracts.

For the murabaha contract, in which a party necessarily acquires and resells an asset including in the latter transaction the cost of financing, taxation on the sale is recognised not just in one year but over a number of years (subject to certain other conditions). If the asset is real property then normal taxation rules on such a disposal are suspended and the gain is treated in murabaha as interest with VAT therefore not applied to the sale transaction.

In the sukuk, the new taxation guidelines address the issue of whether the remuneration of the sukuk is a tax-deductible item for the issuer. The position of the French tax authorities is that the sukuk is a debt instrument and that the remuneration of the sukuk becomes interest expenses for the issuer. Therefore, French tax rules on the limitation of interest deduction may apply.

Conclusion

France has now put the building blocks place for companies and institutions to implement products and make investments that obey the rules of Shariah. However, observers say that the moves in December 2008 are just a beginning.

France is acknowledged to have the largest home market in Europe for retail products of Islamic finance. It has unrivalled access to a huge international market of countries with political and cultural links with France that are second to no other nation. France has a stable and well-regulated banking system and above all France welcomes Islamic financial services companies from around the world.

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