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Sun 1 Oct 2006 04:00 AM

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Financial times

As the aviation industry diversifies its financing options, can Islamic finance overtake the popularity of traditional leasing methods?

The range of finance packages aimed at the aviation industry is constantly increasing. Whilst traditional leasing methods maintain their popularity, the concept of Islamic finance is also on the rise, gaining the support of heavyweights such as Emirates Airline and the Dubai Department of Civil Aviation.

The process of conventional financing involves a bank or other financial institution providing a loan, which must be repaid by the customer, together with a certain amount of interest.

However, explains Andy Beyer, business development manager at Dubai Aerospace Enterprise, this procedure is not compliant with Shari’ah principles, as Islam prohibits interest being charged to customers. “To avoid this conflict, the financer owns the aircraft for the duration of the lease, but allows the customer to keep everything by paying rental instalments,” he says.

During the early 1990s, the availability of Islamic financing was limited, with the aviation industry expressing some confusion about how the process worked. However, companies have since educated themselves about the benefi ts of purchasing aircraft through Shari’ah compliant packages. Indeed, with Middle East airliners expected to invest billions over the next decade to increase their fleets, experts believe the popularity of Islamic finance could potentially skyrocket.

“Islamic financing has become very popular, not only in the Middle East, but worldwide,” says Chris Walsh, a consultant at the international law firm Ince & Company. “There’s been an explosion in demand for such schemes and the aviation industry is experiencing extra liquidity for the purpose of Islamic finance.”

Walsh was involved in the legal aspects of Emirates Airline’s financing deals between 1990 and 1996. He claims that 85% of the international carrier’s fleet was financed at the time, with the remaining purchased through company profits.

“Most aviation companies borrow money on a long-term basis to purchase their aircraft,” he says. “This creates opportunities for Islamic finance companies to capitalise on the market, especially in the Middle East, where the business community is more familiar with the concept.”

Emirates has used Islamic finance on numerous occasions and believes the concept can provide a competitive alternative to traditional leasing packages. However, warns Nigel Hopkins, the company’s executive vice president for service delivery, companies need to educate themselves before commiting. “The learning curve for new users is steep, because of the structural issues necessary for Shari’ah compliance,” he says. “For Emirates, the standards for Islamic lease documentation have been established over the last couple of years and structuring is now relatively straightforward. One of the main issues is finding longer-term investments to match the maturities in traditional aircraft financing.”

Although Emirates continues to use conventional financing methods, Hopkins believes it has been “in the forefront of sourcing Islamic funding in the aviation industry,” raising over US$1 billion to date. This includes over $600 million financing the acquisition of seven aircraft, as well as the first ever Sukuk (Islamic bond) held by an airline, valued at $550 million.

“There are no specific restrictions in the aviation industry in terms of availability for Islamic funds, other than the usual credit review process,” says Hopkins. “It has become a reliable, sustainable source of funding and should help finance some of our future fleet expansions.”

Emirates’ success provides an interesting case study for other airlines to analyse, highlighting the benefits that Shari’ah compliant loans can offer. Major international manufacturers, such as Airbus, have also flagged the market as one to watch.

“Some carriers are known to have a mixture of financing vehicles, including Islamic financing,” says Justin Dubon, regional press officer at Airbus in the Middle East. “Over the years, Islamic financing has become more and more sophisticated in structure. Although Airbus does not normally get involved in aircraft financing itself, we believe Islamic financing provides customers with a competitive alternative to conventional methods. Perhaps, one day, we may even see a non-Middle Eastern carrier benefiting from Islamic finance too.”

“Most aviation companies borrow money on a long-term basis to purchase their aircraft. This creates opportunities for Islamic finance companies to capitalise on the market, especially in the Middle East”

- Chris Walsh

“Over the years, Islamic financing has become more and more sophisticated in structure. We believe it provides customers with a competitive alternative to conventional methods”

- Justin Dubon


Islamic beliefs are governed by the body of Islamic jurisprudence, generally referred to as Shari’ah. This law is open to different interpretations. Accordingly, many financial institutions have a religious board or adviser to ensure compliance with the principles of Shari’ah and provide an informed opinion, when required. These principles include:

Interest: The charging of any interest, or riba, is strictly prohibited – any return on money should be linked with the profi ts of an enterprise. The concept of riba extends beyond interest and can be described as the prohibition of unfair exploitation by a party owning money or capital, which another party wishes to acquire.

Speculation: The Shari’ah does not permit speculation or gambling, or maisir. As a result, many Islamic financial institutions feel unable to enter into derivative transactions such as swaps, futures, options or contracts that insure for a profit.

Prohibited investments: Investments involving certain products, such as pork, alcohol or armaments, and activities such as gambling, are prohibited. Islamic institutions may, depending on the view taken by their Shari’ah committees, encounter difficulties with investments in businesses such as hotels and the entertainment industry.

Profit: Profit cannot be assured and an Islamic financial institution must assume at least part of the risk of a given transaction. There can be no guarantee of a fixed return. Equally, depositors with Islamic institutions may not invest on the basis of a guaranteed return. However, taking security is permitted in order to guard against negligence, wilful wrongdoing or breach of contract by parties to the contract.

Uncertainty: The existence of uncertainty, or gharar, in a contract is prohibited, as it requires the occurrence of an event that might not occur. When entering into a contractual relationship, there must be “full disclosure” by both parties. Any type of transaction where the subject matter, the price or both are not determined and fixed in advance will be viewed with suspicion under Shari’ah law.

Hoarding: Trade and enterprise, which can generate real wealth for the benefit of the community as a whole, are encouraged between partners sharing profits and losses. Hoarding money is improper; money is merely a means of exchange and should not be treated as a commodity.


Islamic financing institutions have developed a wide range of techniques allowing them to uphold Shari’ah principles, whilst offering viable fi nancial products. These techniques include:

Ijara (operating lease)
The Islamic financial institution (or a subsidiary) purchase the asset in question and leases it to the customer for an agreed rental, which may be fixed in advance or subject to occasional review. Attitudes of Islamic financial institutions towards insurance of the asset vary, as some Shari’ah committees may feel that imposing an obligation on the lessee to insure the asset is not permissible. Premiums are likely to be paid by the Islamic fi nancial institution, even if they are recovered through rentals or otherwise.

Ijara wa iqtina (finance lease)
A leasing structure coupled with a right to purchase the asset at the end of the lease period (Bay’ al-Wafa). The lessee makes payments into an Islamic investment account, to be used towards financing the ultimate purchase of the asset.

Sukuk (bond issue)
Essentially a commercial paper which provides the subscriber with ownership or part ownership in the asset. Typically, a special purpose company will purchase the asset and lease it to the purchaser. It will issue Sukuk certificates, entitling the holders to pro-rata ownership of the asset and a right to receive a proportion of the rental payments.

Murabaha (cost-plus financing)
The Islamic financial institution either purchases the necessary goods directly or through a third party and then sells them to its customer at cost, plus a reasonable profit. All the contracts are undertaken at the request of the customer. Deferred payment terms may be agreed and the arrangement may be secured. Such arrangements are not considered to be contrary to Shari’ah law as the bank is assuming a risk, which entitles it to some profit.

Bai Salam (payment for future delivery)
The purchaser is able to acquire the assets by advance payment at a discounted price and subsequently sells the assets upon delivery, either back to the seller or to a third party for a profi t. However, there are different Islamic opinions as to when the assets subject of a Bai Salam transaction should be made available to the market.

Arbun (pre-purchase right to acquire asset)
The purchaser provides a deposit for the assets, on the understanding that, should the sale not proceed, the seller can retain the deposit. A clear understanding of the Islamic requirements for this mode of financing are required to ensure it satisfies the principles of Shari’ah and is not held to be speculative or uncertain.

Musharakah (equity financing)
Similar to the Mudarabah contract, except the Islamic financial institution and the customer provide financing for a specified project in agreed proportions. In the event of profit or loss, the amount is split in proportion to each party’s respective contribution.

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