Ban On Securitised Debt Trade Curbs Sharia Finance Rise

By Simon Archer
The vast majority of sharia experts view the sale of debt as non-permissible, as it can be used as a way of paying or charging interest (riba).

In Malaysia, the sale of debt has been deemed permissible in some circumstances, e.g. mortgage-backed securities where the mortgage is based on a credit sale contract. But I believe that this structure is not used much now as such mortgage-backed securities are not considered as tradeable internationally.

The above would apply to any sale of debt. Debt may be transferred at face value.
The inability to trade securitised debt assets or to have a secondary market in bank debt does constrain the development of Islamic finance, but also prevents abuses such as those arising from "originate-to-distribute" structures.

Securitisations need to be based on ijara lease or lease-to-buy contracts or on partnership structures (musharaka or mudaraba). The former have some fixed-income characteristics as the rental income is fairly predictable, but origination requires a supply of leasable assets.

The latter may have income streams more similar to equity instruments and may be more difficult to market; hence income smoothing techniques may be used, some of which are not considered by respected authorities to be sharia compliant as they involve transactions which infringe sharia prohibitions (such as interest-free loans used to pay returns to security-holders that are in excess of the income earned in order that the payout meets some benchmark, which are repaid when income exceeds the amount needing to be paid according to the benchmark).

On the other hand, we have seen how sale of debt may lead to moral hazard (passing the risk of originated assets to third parties in a non-transparent way) and unstable structures.
With regard to sharia compliance, while there is consensus between sharia experts on issues of principle and on the majority of issues of practice, differences remain on certain issues of practice.

Given the rapid development of Islamic finance and the absence of any overall sharia authority, such differences are inevitable.

One may expect, however, that over time there will be a growing consensus, and one can already see the beginning of consensus against some of the more egregious practices (such as the income-smoothing techniques in securitisations mentioned above and the use of synthetic sale-based structures to create leverage).

From Guardian