legal guide09.indd - Islamic Finance News

Transportation Finance
By Paul Jarvis
Shariah prohibits a financier from making a return
based solely on the time value of money, regardless
of how that return is described. The fundamental
principle is that money should be used for a proper
economic purpose and that it is not acceptable for
money to be treated as a commodity on which a
return (interest) can be generated just by reference
to a passage of time.
However, if financing is an integral part of a
transaction involving trade of an asset, such as a sale,
lease, construction or other trading-based activity,
then the time value of money can be realized.
Accordingly, Islamic financiers provide funds by
financing the purchase of an asset or financing a
business rather than lending money at interest to
enable its customers to buy the asset or finance the
business.
With this in mind, the transportation industry is a
perfect fit for Islamic finance because it is an assetbased
industry. This article focuses on aviation and
shipping; however, the techniques described are
equally applicable to other asset classes.
In order to meet Shariah rules, the Islamic financier
is required to have true ownership interest in the
assets it is financing. A genuine compliance with this
carries additional risks and costs which a conventional
financier does not face. As such, an Islamic financier
is put at a competitive disadvantage compared to a
conventional financier. For instance, in a lease-toown
contract (Ijarah) many of the risks associated
with the ownership of an asset cannot be passed
on by the Islamic financier to the customer. It is the
requirement of true ownership rights, coupled with
ongoing ownership risks, that is the most striking
difference between conventional and Islamic finance
as practiced today.
These additional ownership risks become more
acute when the transaction involves complex capital
assets such as aircraft and ships, as the potential
exposure faced by the Islamic financier can be very
significant. This is especially true when the financing
involves assets that carry potentially harmful cargo,
— for instance oil tankers
Consumers, whether Islamic or others, always care
about the cost of goods and services they acquire
and the businesses they engage in and many are
not amenable to the argument that, as the Islamic
financier is taking on more risks, it should receive a
greater reward. Accordingly, transactions tend to be
structured so that the overall risk/reward matrix is, to
a large extent, the same as conventional financing.
Finance leasing is a well-understood concept in the
world of aviation and shipping. However, Shariah
scholars only recognize an operating lease and treat
the financier (lessor) and not the customer (lessee)
as the true owner of the leased asset for legal and
accounting purposes.
As such, the Shariah lease-to-own contract (Ijarah
Muntahiya Bi Tamleek), is split into two separate
contracts; an operating lease and a contract (gift or
sale) transferring the title to the customer (lessee)
upon making the final rental payment.
Given that the Islamic lease (Ijarah) forms a central
part of many Islamic finance structures, it is no
surprise that most Shariah compliant aviation and
shipping deals tend to use an Ijarah. Conceptually,
therefore, in many ways an Ijarah finance structure
(viewed in its entirety) is not that different to a
conventional lease. This makes the transition from
conventional finance to Islamic finance relatively
painless for ship owners and airlines.
Understandably, Islamic financiers are often
concerned about the risks associated with owning
an asset directly. To ring-fence the Islamic financier
from some of these risks, it is not uncommon for a
bankruptcy remote special purpose company (SPC)
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