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. When you design deals under U.S. law to get favorable tax treatment, and you get an opinion from a respected and widely recognized U.S. tax firm, you don't get that opinion because that firm is respected and widely recognized. You get that opinion because you think it will be a good prediction of what the U.S. law will be - what the IRS or a court will actually do when confronted with the legal question of whether your Feline Pride is a cat or a dog. If your lawyer's opinion is right, then you avoid taxes. If it's wrong, then you pay taxes. The fact that your lawyer was highly respected doesn't matter - with a few fairly small exceptions. What matters is that your lawyer was right about what a court ultimately does. The court's decision, not your lawyer's reputation, is what matters.
The sukuk procedure works the same way, but no court will ever pass on it. Courts can of course get their hands on sukuk disputes, but in the GS case those would be issues of contract law handled under English or New York law - "how much should the trust pay me?" rather than "are they paying me interest or commodity brokering fees?" No formal court with the power to force people to follow its orders will ever rule on whether the GS sukuk complies with Shari'a principles. There is no ultimate decisionmaker in this lifetime. (Afterwards ...) So you choose the advisers not because you think they will correctly predict what some other body of rulemakers will do, but because of their authority by itself.
My random musings about Islamic finance have had occasion to refer to the contamination principle and the notion that potential future states of the world leak back to affect other, present states of the world: if the payoff of a thing in some potential future goes up, then the market value of that thing in the actual present should also go up. Situations - like, maybe, the Goldman sukuk, insofar as it's not allowed to trade at a price other than par - where that does not fully apply are weird and interesting.
But the process for constructing sukuks is arguably a good, abstract illustration of the outer bound of the principle. Because, look, when a bank designs a novel structure for a deal to achieve some tax or securities law end, and had it blessed by a respectable firm, the odds of the IRS or the SEC or the courts actually questioning or rejecting it are actually pretty low. More deals are done than the IRS has time to sue about. So the opinion of a prominent law firm is for many purposes self-executing: what banks and investors want is not for a structure to be "not taxable," but for it to get a "will" opinion from Davis Polk. The legal realism that says "the Davis Polk opinion is only valuable insofar as it correctly predicts what a court will rule" is true as a theory of where Davis Polk's authority comes from, but it is sort of askew as a description of banking industry practice. What you want is the opinion. The opinion raises your expectation of the contingent probability that a court will come down on your side in the unlikely event that it comes down to that - and, by the magical workings of the contamination principle, that effects your happiness in the present.
In the GS sukuk, too, they want that opinion. But rather than drawing a theoretical link to what a court would do, the opinion works on its own as a statement, correct or not, of what the religiously correct answer is. There is no future state of the secular world that reaches back to validate it. Its value is uncontaminated by future states of the world; it is purely religious and metaphysical. And the fact that those two different sources of value lead to strikingly similar practical procedures says, I think, something interesting about the metaphysical groundings of much of our secular financial system - and about how abstract the connection between those practices and their justifications may sometimes be.
Or not, whatever. Next time, charts.