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Challenges for Islamic finance in the USA
The biggest challenge is the First Amendment of the US Constitution
March 14, 2017: With proper regulation, legislation, and dispute resolution, Islamic finance, sukuk (Islamic bond) and takaful (Islamic insurance) have tremendous possibilities in the United States at this moment in time. Modes of Islamic finance, including musharakah, mudharabah, murabahah, tawarruq, salam, and istisna’a, can enhance the capitalist performance of the USA and help Americans compete with the rest of the world.
Sukuk or Islamic bonds may be utilised to gain capital for businesses, the state and federal government, and individual entrepreneurs. Islamic finance is gaining popularity around the world and it is time for the United States to tap into the global Islamic finance, sukuk, and takaful markets and compete on the global stage.
As of date, East Cameron Gas [$165,670,000 (2006)], General Electric [$500,000,000.00 (2014)], and Goldman-Sachs [$500,000,000.00 (2014)] have issued sukuk. The states of Illinois and New York have both tabled legislation allowing for sukuk transactions. Ernst and Young predicts that the sukuk market may reach $900 billion worldwide by 2019.
The sukuk instrument is growing in popularity around the world as an innovative financing instrument and a way to raise funds for various projects and business expansion, and increased competitiveness, which attracts ethical and creative investors worldwide. The UK recently announced that it is the first Western nation to issue a sukuk (£200 million). The USA should join the competition.
The topic of Islamic finance is being taught at Drake University, American University, Pebble Hills University, Harvard University and the University of Pennsylvania Wharton School of Business. All major US banks and law firms now have Islamic finance departments, usually with staff from overseas and/or located in other countries. There exists an opportunity now for Americans in Islamic finance.
This short article aims to briefly discuss the regulatory and legal aspects of Islamic finance, sukuk, and takaful in the United States.
In order for the sukuk business to thrive in the USA, each state should pass a law enabling sukuk transactions. Islamic finance and sukuk should be incorporated into federal commercial law. In addition, as each state regulates the insurance industry, each state should also pass a takaful or Islamic insurance law. Takaful should also be incorporated into federal insurance regulations and laws.
Furthermore, dispute resolution in the United States may need to be adjusted in order to accommodate Islamic finance, takaful and sukuk as well as sukuk bankruptcies. The East Cameron Gas sukuk bankruptcy was successfully settled through the US judicial system. However, additional adjustments may be necessary in order to successfully adjudicate Islamic finance transactions, including takaful and sukuk bankruptcies inside the United States.
In terms of the takaful business, the US has a state-regulated insurance system whereby each state determines its own licensing requirements for insurers. In order to obtain a licence, a company must demonstrate that it has the experience and management capability to run the company and show that it is financially sound. Insurers are also required to justify their premium rates. In addition, companies must fulfil the solvency requirements set by the state. Furthermore, there may be limits on the types and concentration of investments made with ‘held’ reserves. These issues should be addressed in the state and federal takaful laws.
The biggest challenge in introducing takaful, sukuk and Islamic finance in the US is the First Amendment of the US Constitution, which prohibits the making of any law respecting an establishment of religion or impeding the free exercise of religion as well as the Establishment Clause. In Murray v Geithner, a case was filed against the Federal government challenging the permissibility of bailout money provided to AIG under the Emergency Economic Stabilization Act (EESA) legislation saying it violated the Establishment Clause. The Act gives the Treasury the ability to purchase troubled assets from any institution.
In this case, EESA was used to purchase $40 billion in AIG shares. AIG conducts takaful business in Bahrain and the US. The plaintiff alleged that tax dollars were going towards the financing of Shari’ah products and activities.
The court found that the EESA legislation and the AIG bailout were created for a secular purpose and did not violate the First Amendment of the Constitution. Although there is a green light for Islamic finance in the USA, Islamic financial institutions may be at a disadvantage in possibly not being able to gain access to federal funds. Islamic institutions may also experience compliance issues as well as legal challenges. Islamic finance is currently offered by Devon Bank, University Bank, LARIBA, Whittier Bank and Guidance Residential all across the United States.
According to CNBC, Islamic banks’ capital grew from $200 billion in 2000 to close at $3 trillion in 2016. This figure is expected to grow to $4 trillion in the 2020s. There are now more than 300 Islamic banks and 250 Islamic mutual funds globally. Islamic finance constitutes approximately 5-6% of the global financial system, and growing. Ernst and Young predicts that Islamic finance will grow 19.7% annually through 2018.
At this point, there are 25 Islamic financial institutions operating in the USA with the top three being The American Islamic Finance House, University Bank’s subsidiary University Islamic Finance, and Harvard Islamic Finance Program. J P Morgan started Islamic banking in 2013. Standard Chartered conducts Islamic finance worldwide through its Islamic ‘Saadiq’. These banks are overseen by federal regulators, such as the Federal Reserve System, and must also comply with local regulations.
The Islamic bank LARIBA Bank of Whittier (CEO: Yahia Abdul Rahman), operating in California, has assets of $10.6 million and offers banking and home financing across the USA. Saturna Capital, an investment advisor and fund management company, manages more than $3.5 billion in assets, which are invested in Shari’ah compliant mutual funds.
The opportunity cost for the USA in not participating in this global market is quite large. On the other hand, the United States could introduce the rules and regulations required to engage in the worldwide Islamic finance, sukuk, and takaful business. Interest-free financing options may enhance the system currently in use in the United States and offers a chance for Americans to diversify their portfolios, attract global investors, enhance liquidity and compete in the global village.
Camille Paldi is CEO of the Franco-American Alliance for Islamic Finance (FAAIF)
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