Feline Pride

  • 12 Jan 2012 at 6:52 PM


In for a penny, in for a pound on the sacrilege front, so let’s talk metaphysics for a minute. Last night a reader who knows more than us about Islamic finance sent us a thoughtful email about the somewhat broken Goldman Sachs sukuk deal, saying in part:

The Shari’ah scholars listed in the base prospectus were described as “expected” to rule on the Shari’ah-compliance of the sukuk, so GS has an out. However, there is a big caveat here that makes it more problematic than it first appears. In Islamic finance, particularly in sukuk issued by Western financial institutions, the “nameworthiness” of the scholars on the board is viewed as important for selling the sukuk. While there are a few hundred scholars qualified to rule on the Shari’ah-compliance of financial instruments, there are about 10 that are internationally recognized and who are the most high profile. Goldman listed almost all of them …. There are a few exceptions, but when I first read the Prospectus, I thought they had just gone overboard with the number of top-name scholars. …. Goldman was basically name dropping as many top scholars to gain credibility but, they were found out.

Again, oops. And strange and amusing. But it also helped me clarify why I find the whole situation so interesting. That description is, with a few small differences of detail, exactly how you’d go build a financial product that is novel under U.S. tax or securities or whatever law. You’d have some people at a bank cook up a thing, and then you’d go call some lawyers to bless it. The more aggressive and high profile your thing is, the more important it would be to get (1) a whole bunch of (2) very prominent high profile lawyers to sign off on it.

When I worked designing financial products, I knew the informal list of outside lawyers who could sign off on the tax treatment or securities law approach or whatever of a novel structure. These were short lists, and something seriously borderline required multiple signoffs. This wasn’t, like, required by law or anything. I doubt it was even a written internal policy. It was just what everyone expected. There are some differences – there is a written policy, promulgated by an Islamic finance trade group, requiring three certifiable signoffs; and in US products you wouldn’t advertise all the lawyers who gave you informal opinions though you do advertise named advisors and some tax opinions in the prospectus. But basically the practices, of going to a smallish group of widely recognized independent experts and asking them to more or less formally sign off on the permissibility of what you’re up to, are very similar.

But the epistemology behind those practices differs in a maybe interesting way. Read more »

  • 07 Dec 2011 at 4:21 PM

With A Name Like Feline Pride It Has To Be Good

Sometimes it’s useful to be reminded that not all financial structuring is designed to get around capital requirements or defraud customers. Some is designed to get around taxes and defraud the treasury! One group of people who like to think about that kind of thing is the Congressional Joint Committee on Taxation, who took some time out from shouting about payroll taxes yesterday to have a geeky hearing about the state of financial instrument taxation. Short version is, they’re not all that happy about it.

The JCT staff generally say pretty smart stuff about tax policy, and they get that shit is fucked up and bullshit. Or as they put it more diplomatically:

The timing, character, and source rules apply differently to (and are sometimes uncertain for) equity, debt, options, forward contracts, and notional principal contracts. These five basic instruments can be combined in various ways to replicate the economic returns of any underlying asset. … The flexibility of financial instruments also creates great difficulties in the taxation of financial instruments. This report provides examples of taxpayers’ uses of financial instruments to achieve desired timing, character, and source outcomes and describes how the tax laws have or have not addressed this tax planning.

There are two useful takeaways here. One is kind of weird: there are a bunch of fairly basic things (exchange-traded notes, CDS) where nobody – not the IRS, not the JCT, nobody – knows how they’re supposed to be taxed. That … seems like a bad thing. And, I’m going to guess, not so much the fault of evil financial innovators.

The second takeaway, which is related but more satisfying to fulminate about, is that evil financial innovators can mix and match stuff until they get any tax result they want: Read more »