UPDATE-How can Islamic finance support the needs of the shipping industry?

Photo: A ship is moored while its containers are unloaded at the Jebel Ali port in Dubai June 27, 2006. REUTERS/Regi Varghese (UNITED ARAB EMIRATES)

*Updates Nabilah Karbal comments regarding enforceability of contracts and creativity to replicate instruments

With the rise of global maritime hubs such as Dubai that also play an important role in the Islamic Economy, the intersection of shipping finance and Islamic finance offers a potentially lucrative opportunity to those willing to engage in this space.

The global shipping industry involves substantial use of capital, much of which has come from banks. In 2008, 84 percent of ship finance came from banks, and in 2014, banks still made up 63 percent of ship finance.

Although estimates for the overall global shipping market size are difficult to obtain, one way of grasping the scale of the market is to look at banks’ shipping finance portfolios.

In 2014, the top 40 banks involved in global shipping finance made $391 billion in ship finance-related loans, according to Greece-based Petrofin Research. As these 40 banks represent 82 percent of the total market, we can conservatively estimate the total market to be worth around $477 billion. Clearly, the global shipping finance market is a substantial one.

ISLAMIC FINANCE AND THE SHIPPING INDUSTRY

As shipping finance is a broad area, a number of Islamic finance instruments may be used, depending on the financing purpose. For example, one of the common Shariah-compliant instruments used to finance working capital for ships are murabahah-based (cost plus profit) contracts, including tawarruq, or reverse murabahah.

Other Islamic finance contracts used frequently for Shariah-compliant shipping finance include istisna’ (to finance construction of ships), sukuk, and less commonly, musharakah (equity partnerships).

There are several intrinsic features of Islamic finance that make it well-suited to shipping finance. “With asset-backed transactions, Islamic finance products theoretically have higher liquidity and enable institutions to manage risk more effectively than non-asset backed conventional finance transactions,” Nabilah Karbal, an Associate at Dubai-based law firm Karbal & Co and a specialist in Islamic finance, told Salaam Gateway.

Karbal stressed that the way certain Islamic finance instruments share risk of loss between parties makes it attractive for many investors in shipping finance.

As with conventional shipping finance, major providers of Shariah-compliant shipping finance include commercial banks. Some of the well-known ones that provide Shariah-compliant shipping finance are CIMB (Malaysia), DNB (Norway), and HSBC (UK).

Owing to Dubai’s status as a global maritime hub, many of the banks in the United Arab Emirates offer Islamic finance services to businesses within the maritime industry. These include Abu Dhabi Islamic Bank, one of the most active in the global Shariah-compliant ship finance industry, as well as Noor Bank, Dubai Islamic Bank and Abu Dhabi Commercial Bank. Some international banks in the region, such as Standard Chartered, also offer Shariah-compliant ship finance.

Apart from banks, there are other financial institutions that are active in the sector. “There are also asset management companies such as ABCIB Islamic Asset Management and private equity financiers which provide Shariah-compliant financing and raise funds based on Islamic financing concepts,” Nazery Khalid, Honorary Secretary of the Association of Marine Industries of Malaysia told Salaam Gateway.

CHALLENGES AND OPPORTUNITIES

However, Shariah-compliant shipping finance still faces notable challenges.

Foremost is the ability to enforce contracts in multiple jurisdictions, a fundamental requirement for trade.

"One of the most prevalent investor concerns relates to the enforceability of Islamic finance contracts in western jurisdictions," explained Karbal.

“Precedent indicates that in the event that Shariah law and the laws of a western jurisdiction govern the contract, certain courts in western jurisdictions, such as the UK, may be reluctant to enforce general principles of Shariah law if Shariah law is merely stipulated in a choice of law clause.”

Karbal further states that “it is advisable that the rules of Islamic finance transactions are explicitly drafted into the contract in order to render the terms of the contract enforceable in the event of a dispute, i.e., obligations of each party.”

Additional challenges include innovation and awareness.

"The development of Islamic finance instruments requires creativity in order to replicate instruments of conventional finance while complying with the rules governing Islamic finance," said Karbal.

But even before encountering any issues of innovation, Khalid points out there must first be awareness of what Islamic financial institutions and the shipping industries can offer each other. “There is a low degree of awareness among shipping market players of how Islamic finance can meet their financing needs, and a lack of understanding among Islamic bankers and financiers on the nature of shipping, which clouds their view of how attractive the shipping industry may be, and how they price financing structures for it.”

There are several areas of opportunity across the shipping industry for Shariah-compliant financing. 

According to Khalid, the top opportunities include the financing of offshore structures. Currently, structures such as oil rigs, topsides, floaters (FPSO, FLNG), pipelines and wind turbines are primarily financed using conventional finance, and this presents an opportunity for Shariah-compliant shipping finance to make inroads.

Other opportunities arise from the use of Shariah-compliant structures that are already commonplace in industries such as aviation.

Khalid also sees the need to further refine existing Shariah-compliant finance contracts that are currently used in shipping finance. "Opportunities exist in the exploration of off-balance sheet financing structures in Shariah financing of ships such as ijarah contracts that can be structured as either an operating lease or a finance lease (ijarah wa iqtina)." 

Sukuk could also be a very useful instrument due to its ability to raise significant sums of capital that suits the capex intensive nature of shipping. 

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