Islamic trade finance gets crucial industry standard
The Bankers Association for Finance and Trade (Baft) and International Islamic Financial Market (IIFM) have released a global industry standard document for buying and selling Islamic trade-related risk.
The jointly-created master participation agreement (MPA) is intended to support the growth of Islamic trade finance business.
The trade finance industry already has an MPA for conventional trade finance distribution, introduced by Baft 10 years ago, and revised last year. The advantage of such a framework documentation is that it reduces the need to carry out much of the expensive and onerous groundwork in ensuring an agreement meets capital rules requirements and other regulatory compliance. According to Baft, the standard has been critical in supporting global trade growth, enabling banks with strong distribution networks to generate additional financing for clients.
Having worked together since March, Baft and IIFM are now seeking to repeat the success in the Islamic trade finance space, having seen a great need for standardisation in Islamic trade finance. IIFM is a standard-setting body in the Islamic financial services industry.
Put simply, Islamic finance complies with sharia – Islamic law – which prohibits earning interest on loans and is based on the principles of risk and profit sharing. It means it requires special structuring for Islamic banks to be able to invest in trade finance assets.
As such, the MPA for Islamic trade finance is different from Baft’s MPA for conventional trade finance in a number of ways. For example, it includes two separate standards covering unfunded and funded arrangements, and there is also a difference in the way fees are shared by the grantor with the participants, explains Ijlal Ahmed Alvi, CEO of IIFM.
“In Islamic finance, the fee is not paid in the manner done for conventional finance, but the fee-sharing – especially for unfunded transactions and upfront fee for funded – is based on certain services to be performed by participants. These kinds of procedures are clearly defined in the relevant clauses,” he tells GTR.
The standard has been created in consultation with financial institutions and other market participants in various jurisdictions and has been approved by IIFM’s sharia board of 12 scholars from across the regions.
The moves could bring a crucial boost to the Islamic trade finance market, with Fitch Ratings having previously labelled the lack of standardisation as one of the greatest obstacles standing in the way of the growth of the sector. Currently, different jurisdictions interpret sharia differently and there is variation in how Islamic finance products are structured.
“The biggest challenge faced by many banks was – in addition to getting the business practitioners to agree on standard terms – to get a framework for sharia compliance that could be standardised,” Tod Burwell, president and CEO of Baft, tells GTR. “In practice, there are not only variations going from jurisdiction to jurisdiction, but in many cases, even within the same jurisdiction, you may have a sharia board from one institution that has different interpretation than another institution, and that was frustrating the growth, specifically for Islamic trade. So that’s what we were trying to solve for.”
According to Alvi at IIFM, the lack of standards has caused many institutions to hold back from engaging in Islamic trade finance transactions in the past.
“We have received a lot of enquiries from major and regional banks asking when this will be published, so hopefully we will see a lot more activity taking place in Islamic trade finance now the standards are out. Some institutions may have been reluctant to take part in Islamic participation transactions because standardised global documentation was not available,” he says.
“We have seen from other IIFM documentation and product standards that the standards greatly help to create more liquidity, provide cost-savings and efficiency to the market participants, particularly financial institutions, as well as creating legal certainty and sharia harmonisation.”
The move comes at a time when a growing number of trade finance players are embracing Islamic trade finance. FCI, the global representative of the factoring and receivables finance industry, announced last year that it had amended its ruleset to support sharia-compliant factoring, meaning that Islamic banks and factoring companies now have a standard framework they can refer to for such transactions.
This was followed by the announcement in October by trade finance marketplace LiquidX that it had opened its platform to sharia-compliant transactions, having developed a structure together with the Bank of London and the Middle East (BLME), a UK-based Islamic bank.
Speaking to GTR at the time, Zane Baring, director at LiquidX in London, said the solution would offer a new way for corporates to source liquidity they couldn’t previously access. “There is so much liquidity in Islamic finance, and there aren’t enough products out there for them to invest in,” she said.
As for the Baft-IIFM MPA for Islamic trade finance, the challenge is now to ensure wide adoption in the market, including from institutions that did not participate in the consultation process, Burwell at Baft explains.
“Similarly to how the Baft MRPA grew in popularity; if you have some of the largest and most significant actors in the market who can get comfortable with it, then oftentimes they are able to get their counterparts comfortable with it as well,” he says.
IIFM will now look to develop standards for Islamic trade finance-related products, particularly post-shipment financing, with the aim of creating wider acceptance of such products in the market.