So, yeah, juvenile of me, but it's just a little hard to keep an entirely straight face about the fact that Goldman Sachs is the first U.S. bank to venture into the world of Islamic finance. And it's not going so hot:
Goldman Sachs' controversial $2 billion Islamic bond programme faced a fresh challenge on Wednesday as it emerged that at least two scholars named as potential approvers had not even seen the prospectus.
Asim Khan, an adviser to Goldman on the issue which needs approval from sharia scholars to proceed, confirmed media reports that three of the eight scholars listed as potential approvers had not responded to requests to endorse the issue, but he said their lack of co-operation had no bearing on its sharia credentials.
I went and found the prospectus and it's fascinating for someone, like me, whose understanding of Islamic finance basically comes from Wikipedia. Now, even I know that the basic idea of a sukuk is to replicate a fixed income, or let's say not-quite-common-equity-anyway, financial instrument without the use of "interest," because interest is forbidden under Shari'a law. This, actually, is a topic close to my heart, because it turns out that in regular old American law sometimes "interest" is also forbidden, and by "forbidden" I mean "taxed," which means that people who do what I used to do have certain incentives to turn things that look like taxable interest into things that look like non-taxable equity returns and vice versa. One thing you learn in that line of work is that it's in large part the business of defeating substance with form: you pay for the use of money over time, but fall into some category of "paying for money over time" that isn't what that is normally called, viz. "interest." There are ways to do that in American tax law (one is called "option premium," true story), and there are apparently ways to do it under Islamic law (one is called "murabaha," which is what GS is aiming at here, and it's basically the equivalent of "getting paid a fee for brokering a commodity transaction with forward settlement").
It's unclear if Goldman achieved that here. People have said that the Goldman sukuk does and does not* comply with Islamic law, and I am the last person in the world to weigh in on that, so whatevs. Apparently there's at least controversy. And here's the thing: when you are in a line of work that exists to privilege form over substance, you really really have to get the form right. Implying that you've gotten signoff from people who you haven't gotten signoff from is ... unhelpful.
It's particularly unhelpful here. Here is a risk factor you don't see so much under American law:
Investors must make their own determination as to Shari'a compliance
Members of a group of advising Shari'a scholars have issued a fatwa in respect of the Certificates and the related structure and mechanism described in the Master Murabaha Agreement and the Transaction Documents and their compliance with Shari'a principles. However, a fatwa is only an expression of the view of the Advising Scholars based on their experience in the subject and is not a binding opinion. There can be no assurance as to the Shari'a permissibility of the structure or the issue and the trading of the Certificates and none of the Trustee, the Delegate, GSI, GSG, the Arranger nor the Dealers make any representation as to the same. Investors are reminded that, as with any Shari'a views, differences in opinion are possible. Questions as to the Shari'a permissibility of the structure or the issue and the trading of the Certificates may limit the liquidity and adversely affect the market value of the Certificates. The Shari'a scholars advising on this Base Prospectus are of the view that the Certificates can only be traded in the secondary market at par value (that is, in relation to Certificates of a particular Series, the amount of the pro rata Deferred Payment Price relating to such Certificates) and on a spot basis in order to comply with Shari'a principles. Investors are advised to obtain their own independent Shari'a advice as to whether the structure meets their individual standards of compliance and make their own determination as to the future tradeability of the Certificates on any secondary market.
In addition, prospective investors are reminded that the enforcement of any obligations of any of the parties under the Transaction Documents would be, if in dispute, the subject of court proceedings under the laws of England and Wales and, in the case of the Guarantee, the laws of the State of New York,
USA. In such circumstances, the judge may first apply the relevant law rather than Shari'a principles in determining the obligations of the parties.
There are things to unpack here! "Members of a group of advising Shari'a scholars have issued a fatwa" is a wonderful three-quarters-truth: some members of the group listed in the prospectus have apparently signed off, so it's technically true, though if you read it fast you might interpret it to mean that all of them had, which I guess is false. Also the choice of law warning is a thing you'd want to keep an eye on what with Americans being really into their courts not using Shari'a law.
But my favorite bit is: "Questions as to the Shari'a permissibility of the structure or the issue and the trading of the Certificates may limit the liquidity and adversely affect the market value of the Certificates. [Oh, by the way,] The Shari'a scholars advising on this Base Prospectus are of the view that the Certificates can only be traded in the secondary market at par value ..."
Catch that? If there's controversy about the structure - and there is - it might make the certificates trade down. But they can't trade down, because if they did then that would violate Shari'a law. (Because if you bought at like 98 or whatever you'd be getting basically 2 points of OID interest and interest is what you're trying to avoid.) So you've got a neat binary: you'll either be able to sell these things at par, or no one will take them off your hands ever. (Actually, not quite true: that relies on the premise that you care about Shari'a compliance. If you don't care, you can sell them at 98 to your heart's content, and someone else who doesn't care about compliance can buy. Let's assume that most of the buyers here actually do care, and that Goldman's advisors are right that selling below par would violate Shari'a.) The normal market mechanism that accounts for uncertainty, dubious value, contingency of claims - a fluctuating price - breaks down a bit here.
We talked a bit yesterday about the contamination principle, which "means roughly that if there is a possible spot in time and space capable of bringing a profit, then the areas surrounding it need to account for that effect." That is a good guide for life. It's fun to see examples where it doesn't hold. The Goldman sukuk, strangely, may be one of them.
* The title of this article is "Goldman Sucks," which is not exactly original to him, but we'll allow it because in the "sukuk" context he's scoring a rare triple entendre.