But, do you have a fatwa for that fish?

I was recently asked at a conference: "who provided the fatwa for Blossom's first Blockchain retail sukuk?"

My answer: Blossom doesn't have a fatwa and we don't feel we need a fatwa.

I've worked in capital markets for 25 years, including 15 years in Islamic Finance. The Blossom team team, and I agree completely: the simplicity and transparency of our recent microfinance sukuk makes buying a fatwa unnecessary.

How simple is it? Our mudarabah structure fits easily on a single page. Here's the key two elements:

  • true variable profit sharing (mudharaba) income, with no reference to any interest rate benchmarks (eg LIBOR, SONIA etc) in setting the profit
  • real-economy portfolio of real-asset backed murabaha (no commodity murabaha)

Even non-scholars can understand our simple structure and this is how we believe it should be. We believe that high quality investments should be universally accessible to mainstream retail investors from all faiths and all nations.

The Legacy of Capital Markets Sukuk

Of the US$500 billion or so of sukuk outstanding almost all highly complex in their legal structure. They involve hundreds of pages of English Law documents. This complexity is typically a byproduct of "form over substance" compliance with Islamic (eg non-interest based) investment principles.

"Form" in this case means the 'appearance' of the transaction involved. The appearance usually shows profits and assets, but the assets actually have no bearing on the risk or returns of the Sukuk. The contracts and transactions should comply with the Islamic ethical rules and investment principles—such as the key prohibition of lending with interest (riba). But in practice, debt capital markets are obviously designed for debt-link securities. So how do traditional sukuk reconcile this discrepancy?

Financial Engineering creates Sukuk Complexity

In order to reconcile a system designed for debt with ethical rules that prohibit debt, traditional sukuk create a series of transactions to superficially eliminate debt but in reality just mimic debt. Taken together, these transactions achieve their objective of visually conforming with Sharia principles.

One of the objectives of sukuk are to comply with Shariah finance principles. Transactions you make in your every day life are relatively easy to understand in terms of whether they are halal. However, when an investment becomes complex (such as traditional sukuk involving a myriad of parties and transactions), it is extremely difficult to understand if it still conforms to the Islamic ethical investment principles.

Because of the complexity, issuing a sukuk typically involves hiring a panel of paid experts - or scholars - to review the investment. This panel of experts issues a fatwa which is the formal opinion of the Shariah scholars. In this model, fatwas are commissioned (purchased) to ensure that investors feel comfortable that their investment is indeed halal in its form.

Conflicts of Interest and Fatwa Governance

A conflict of interest is when someone (a person or an organization) has potentially competing incentives or obligations. Such conflicts occur everywhere in life where two parties have different goals, they cannot be avoided, so what is key is the the conflicts are understood and managed fairly to ensure the best outcome for both parties.

One conflict of interest highlighted by the 2008 financial crisis was the one for the credit rating agencies. A rating agency is entrusted with providing a credit risk opinion (ie a rating) for companies, investments, or even governments. Like scholars they are paid money to give an opinion and it later became clear that payment for the opinion was compromising their judgement. In some cases they did not want to give negative rating for fear of losing business.

Even with the purest of intentions and motives, when a Shariah scholar is paid by the seller of a product to issue an fatwa stating that item is halal, this is a clear example of a conflict of interest.

There is nothing wrong in being paid for a skilled opinion but where a conflict exists, like the credit rating agencies it must be disclosed with extra transparency, detail and governance around the process. Key decision drivers and opinions provided should be shared to ensure fatwa integrity.

Although Blossom believes universal law and finance education is important, we still believe that matters of shariah compliance are best left to the scholars. Fortunately, the work of many scholars has been generously shared. A vast and easily accessible knowledge base already exists and this enables a commonplace understanding of the key principles.

Debt Replication

As an analyst at Moody's and the also their first Global Head of Islamic Finance and Head of the GCC Banks, my team and I likely rated over $40 billion of conventional bonds (more than 100 issuances), and sukuk (more than 60). We also rated roughly 40 conventional banks and 15 Islamic banks, with aggregate assets of around $2 trillion.

In this role, I agnostically and objectively assessed risk for both conventional and Islamic instruments. This required reading tens of thousands of pages of legal documents and opinions written by some of the best law firms in the world. Many of these documents were also approved by some of the most famous scholars in the industry.

During this time, I assessed that around 95%+ of sukuk replicated interest (riba), both economically in terms of returns and of risk. The assets in those sukuk structures had limited bearing on the performance or the profit rates paid. Note that our team reviewed rated, public market sukuk, most such sukuk are rated.

Tricky Terminology

To address this issue, the industry came up with the term "asset-based". In my opinion a useless and unhelpful term that sounds semantically similar to "asset-backed" but actually means 'unsecured' or no asset risk at all.

"Backed" in finance typically implies a form of real and enforceable security ie you effectively own the asset and its profits (and losses). Asset backed security (ABS) markets issued $1 trillion in 2019 alone. The sukuk market is around $500 billion total outstanding after 25+years. Although it should be highlighted that much of the ABS are financial versus physical assets.

Why create a new term? To any objective observer, this term is an attempt to confuse the market (or perhaps even confuse themselves?) into the idea that it is asset-backed, when in fact, it is not.

The Market 'Need' for Debt

Why has the sukuk market (and much of Islamic banking) evolved this way? Because both parties involved - those with the money (Investors) and those without the money (Issuers/borrowers, such as corporates, banks, sovereigns, etc.) - want debt.

Islamic retail customers are the foundation of the industry. Ordinary customers simply want to consume today and pay tomorrow (debt). The culture of consumption is almost the opposite of sustainability. The [bank] actors involved are servicing their customers with debt to fuel consumption. But this mood seems to be changing….

A Growing Paradigm Shift

One example of a growing paradigm shift is with money itself. After 2008, central banks effectively printed money in the hope of stimulating borrowing, consumption and economic growth. This process (technically known as Quantitative Easing)  usually destroys the value of money through inflation, although sentiment and confidence is so weak that inflation is still absent.

This value destruction of fiat currencies is driving the appeal of alternative money systems, such as cryptocurrencies. specially in more challenging emerging market countries where financial system governance is poor. Rising inequality, the excess of global debt, and the leverage (borrowing) over the last decade is highlighting structural problems with current economic models better than Islamic Finance ever could. Endless; debt-fueled consumption is simply an unsustainable means of growth.

Time for a New Model

Investing, equity, asset-BACKED finance, real economy, financial inclusion, shared prosperity, risk/profit sharing, and even ESG (environmental, social, and corporate governance): these are all key themes of sincere Islamic finance publicly promoted by most scholars I have met or heard over the last 15 years. Yet the bulk of the $2 trillion Islamic finance industry sadly revolves around debt replication. In my opinion, this means that the current Islamic finance industry adds limited extra value industry beyond conventional banks  - sadly it just adds more cost and more frictions to the Shariah-sensitive customer. The current market is a great first step for the industry - but should really serve as the foundation to build a more socially oriented and inclusive system.

Despite the social underpinnings, this highly profitable industry currently does little to help those on low incomes (let us not even consider the sizable under utilization and performance of awqaf, which is a collectively gargantuan pool of Islamic social endowments.

Fulfilling the Promise of Islamic Finance

With Blossom's sukuk we are more closely following the Islamic investment principles publicly promoted by scholars to help revolutionize the sukuk and the Islamic finance industry at the retail level.

For example, the sukuk issued in October 2019 by KSPPS BMT Bina Ummah and arranged by Blossom pays a genuine 60% / 40% profit share from a murabaha portfolio of micro enterprises. It's currently expected to yield 12 to 13% on a gross annualized basis. The sukuk capital risk is also taken by investors. This was a world first from many angles.

Financial Inclusion

Blossom firmly believes that financial inclusion is not just about financing and debt, it's about investments and wealth. Wealth creation should not be limited to those on middle and higher incomes. Wealth creation should be open to people at all levels of society, along with tools that help increase financial literacy.

Technology is now enabling retail participation in investing. The global phenomenon of crowdfunding is very compliant with Islamic investment principles. Blossom takes this trend and extends it with Sukuk to make such investments more accessible and ultimately tradable.

The Benefit of Blockchain

Blossom uses technology to raise funds for organizations and projects making a positive social impact. The ERC20 token standard provides a digital certificate of ownership, so that investments in social impact projects become tradable sukuk instruments. This is the ultimate essence of sukuk: certificates representing an undivided ownership over some asset.

For Blossom, sukuk doesn't mean highly structured investments, but rather simple profit sharing arrangements that are easily understood by scholar and layman alike.

So... err...  why the fish?

I once asked a young scholar about the need for fatawa and halal certification. He said how some in the industry felt in very strong terms that halal certification and fatwa provision was becoming too much of a profit driven enterprise which was needlessly creating excessive certification where none was previously needed to further their own interests.

He answered my question with another question: "Do you need halal certification for a fish?"

His point was clear: for some things, the permissibility is clear and self-evident. It should be the same for Islamic finance with simplicity, transparency, and investments that do not replicate debt and display clear profit sharing and asset finance attributes.

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