Cayman Islands: Where Desert Sands Meet Cayman Shores

Last Updated: 30 May 2009
Article by Appleby  

The size of the Shari'ah financial industry has grown tremendously over the last four decades. The Cayman Islands has had a pivotal role in these transactions, and is currently the jurisdiction of choice for vehicles used in the various types of Islamic financing transactions.

Recognising this, the Cayman Islands legislature has pioneered legislation that allows the registration of companies with both English and Arabic names. This has greatly enhanced the position of the jurisdiction in the world of Islamic finance, as has the initiative of several Cayman Islands service providers who have established a presence in the Middle East thereby making themselves more accessible to their clients.

The principles of Shari'ah law are based upon the Qur'an and the teachings of the Prophet Mohammed, and have existed for more than 1,400 years. The renewed interest in Islamic financing concepts in recent years has provided access to Islamic funds, otherwise unavailable in the financial markets, through the use of financial instruments that are compliant with the principles of Shari'ah law.

This is achieved by apportioning any profits earned directly to the risk undertaken in the investment thereby removing the concept of returns without risk. Riba, which is the equivalent of conventional interest, is prohibited by the Qur'an.

There are several methods of Islamic financing, the most common forms of which are Musharaka (joint venture), Mudaraba (profit sharing), Murabaha (cost plus), Ijara (leasing) or Wakala (agency). These may be used to finance various types of assets or to provide access to funds. Access to such funds may be gained mainly through the capital markets or through both Islamic and conventional banks.

Sukuk

Access to financing through the capital markets is done through Sukuk transactions where the issuer, usually a Cayman Islands exempted limited liability company, issues Sukuk or trust certificates to investors in exchange for subscription money. The money received from investors by the issuer is used to acquire an acceptable asset or assets either through Musharaka (joint venture), Mudaraba (profit sharing), Murabaha (cost plus) or Ijara (leasing), from the entity which is raising the financing (usually called the obligor), thereby creating a partnership whereby the potential for both risk and profit are shared. The shares of the issuer are held on trust for the investors through a Cayman Islands charitable trust. Income generated by the assets, in some cases by leasing the assets back to the obligor, is used to make payments to the investors or sukuk holders.

Cayman special purpose entities play an increasing role in Islamic financing through banks in areas such as acquisition financing, real estate financing and asset financing for ships and aircraft.

Acquisition Financing

Acquisition financing may be done through Wakala, which is similar to Mudaraba. Under Mudaraba, however, the parties divide any profit between themselves while under Wakala the investor receives an agreed ratio against its investment.

Under the Wakala, the Wakeel, usually a Cayman Islands special purpose entity set up by a syndicate of banks pursuant to the terms of an Investment Agency (Wakala) Agreement, invests certain amounts received from an investor. The Wakeel's obligations are secured by the granting of various forms of security in favour of the Islamic syndicate. Under Mudaraba, the Mudareb becomes legally indebted to the investor; however, the Wakeel is acting as an agent, so the funds never become the property of the Wakeel.

The Shari'ah supervisory board of financiers have declared a pronouncement (Fatwa) of compliance in respect of syndicated Islamic financing structures using monies contributed to a Cayman incorporated Wakeel.

Real Estate Financing

Shari'ah compliant financing of both commercial and residential property is also common. It should be noted that Islamic investors will not finance property to be used for purposes that are not religiously permissible or haram, such as property to be used for the sale of alcohol, pornography or for gambling, for example.

Murabaha financing is the most common method of Islamic financing used by banks in real estate transactions. This is essentially a 'rent-to-own' arrangement whereby the financier purchases the property for the client and re-sells it to them on a deferred basis for the original purchase price, plus a reasonable, pre-agreed profit margin and any other costs incurred. The sale price is then repaid in installments.

The Musharaka structure is a joint venture partnership whereby two or more partners invest capital for the purpose of generating a return, three Cayman Islands companies are typically used. In Musharaka, any profit sharing ratio may be agreed beforehand, but losses must be proportionate to the amount invested. In this type of transaction the funding company purchases the property from the vendor and leases it to the end user. The funding company then enters into a joint venture agreement with a partner company that in turn enters into a joint venture or Musharaka agreement with a project company. The shares of both the funding company and the partner company are owned by a Cayman Islands charitable trust on trust for the Islamic investors while the shares in the project company are owned by the Islamic investors.

The Ijara structure for financing commercial property involving the Cayman Islands typically sees the use of two companies and involves the purchase and lease back of the property. In this structure, the property is sold by the vendor to a funding company and is leased to a project company which in turn leases the property to the end user. The end user pays rent to the project company which in turn pays rent under the Ijara lease to the funding company. The rent paid by the project company to the funding company includes a premium for the grant of the Ijara lease. The shares in the funding company are owned by a Cayman Islands charitable trust and the shares in the project company are owned by the Islamic investors. As in conventional leasing, an option to buy the property at the end of the Ijara may be built into the contract.

Vessel Acquisition

Shari'ah compliant financing has become popular for vessel acquisition, with the most frequently used structures being Mudaraba and Ijara. Usually in a limited recourse Shari'ah compliant financing, a Cayman Islands company will be formed to act as Mudareb, which carries out the management of the Mudaraba. A non-Cayman vessel owner will usually transfer beneficial (not legal) interest in a vessel to the Cayman company, the company then leases back the interest in the vessel to the owner. The acquisition by the company of the beneficial interest is usually financed by a syndicate of banks who acquire the beneficial interest in the vessel and lease it back to the company in return for rent. Once all payments are made the beneficial ownership may be transferred to the company.

In addition to providing registered office services to the Cayman companies involved in these various transactions, trust companies such as Appleby Trust will also normally provide trustee services whereby they act as trustee of the trusts that hold the shares of the relevant Cayman companies. They also provide directors or a secretary or assistant secretary for the relevant Cayman companies, as well as client accounting services.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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