Prospects for Islamic financing in Russia
- Author: Vladislav Zabrodin
- Date: 06.05.2013
Vladislav Zabrodin, Managing Partner of Capital Legal Services
Anna Leksashova, Associate of Capital Legal Services
Muslims comprise around 15% of the Russian population and the country has vast potential for Shariah compliant finance across its multiple and varied territories. VLADISLAV ZABRODIN and ANNA LEKSASHOVA discuss the increasing level of Islamic activity occurring across its retail, capital and corporate finance markets.
Russia is among the top 10 economies in the world, and its position continues to strengthen. Russia’s gold and foreign currency reserves remain the third largest in the world after Japan and China, which serves as additional protection of the economy from financial turmoil. Russia dominates in the volume and diversity of natural resources and by volume is the third ranking trading partner of the EU and its key energy supplier. The consumer market in Russia is the largest and fastest-growing in Europe.
Sustainable economic growth, high investment profitability and the public’s consumption index make Russia an extremely attractive site for foreign investment. Russian politics remain on a stable course, government authorities are actively implementing a policy aimed at improving the investment climate by decreasing administrative barriers for business, creating a favorable tax climate, and introducing new investment mechanisms (special economic zones, public-private partnerships).
Despite the fact that the oil and gas industry and the mineral production industry have for a long time remained the most attractive investment sector, the actively developing non-resource sectors, including consumer sector projects, retail networks, transport and communications, transactions with real estate and financial activities are of main interest for private investments in Russia. In other words, the Russian economy is diversifying its industrial structure, relying less and less on the resource sector, while developing its real and financial sector.
The Russian economy is open for reconsideration of available financial institutions and development of new financial mechanisms. Russia, in particular, has all the necessary traits and great potential for developing Islamic financial institutions and products that have lately become such widespread practice in the world. The interest in Islamic financing in Russia is determined by both economic and cultural factors.
Loan rates offered by local traditional banks are rather high and institutions usually do not take active involvement in project implementation, which may lead participants of the financial market to consider alternative ‘cheaper’ and more commercially active financiers. Besides the economic component, the interest in Islamic financial products is also determined by cultural aspects of the Russian society. Muslims comprise approximately 15% of Russia’s population. In certain regions, for example, in the regions of Tatarstan and Bashkortostan, Muslims comprise as much as half of the population. Therefore, creation of settlement and financial institutions in compliance with Shariah will be well received by the Islamic segment of Russia’s population.
Notwithstanding the above factors, Islamic financial institutions have yet to achieve proper expansion in Russia. It is fair to say that there are several reasons for this. It appears that the main difficulty lies in the low level of the public and business community awareness of Islamic financial products and, subsequently, particular concerns with respect to implications and success of implementing them on the Russian market. At the same time, taking into account the interest in developing Islamic financial products in Russia, the existing difficulties, in our opinion, are easy to eliminate. Objectively speaking, there are no economic, political or legal hindrances to the development of Islamic financing.
On the contrary, the Russian legislation encourages investment activity and provides its participants with a high level of economic freedom. Despite the fact that the sphere of Islamic finances is practically not addressed by Russian laws, Islamic financial products may be implemented on the Russian market owing largely to the discretionary nature of the Russian corporate, financial and contract law.
The main forms of investing cash in compliance with the requirements of the Russian legislation and Shariah may include the institutes of shareholder (participation in company capital), project (partnership) and debt financing through contractual structures.
Considering the prospects of developing the institute of shareholder financing, one should note the possibility of entering into shareholder agreements, restraining legal capacity of the company and its executive authorities and, as a consequence, the possibility of using a special-purpose vehicle (SPV) in commercial activities in the optimum manner, as stipulated by the Russian corporate legislation.
Attracting project financing to the Russian market, including in the form of Musharakah and Mudarabah traditional transactions, and debt financing in the form of Murabahah, Ijarah, Istisnah, Salam and other transactions, should encounter no hindrances either. The fundamental principle of Russian civil law is the freedom of contract principle, which provides for the right of the parties to determine at their discretion the terms and conditions of an agreement and enter into an agreement that is either covered by law or not covered by law, or contains elements of several types of agreements (a mixed agreement).
In addition to choosing transaction structure, the Russian legislation allows parties to independently determine the applicable law and to agree on the jurisdiction for settling disputes arising from the agreement. However, the parties should take into account the imperative regulations of the Russian substantive and procedural law, including those regarding the exclusive jurisdiction of Russian courts as concerns disputes with respect to title to real estate located in the Russian Federation. Furthermore, the parties must make sure that the decision of the respective court can be implemented (i.e. that there is a procedure for accepting and implementing such decision), otherwise the practical value of a court decision made in a foreign jurisdiction is reduced to null.
It must also be noted that despite the fiscal nature of the tax policy, the level of tax rates in Russia is significantly lower than in many other countries. In particular, at present, the general profit tax rate (corporate tax) in Russia comprises 20%, value added tax is 18%, individual income tax is 13%; and a system of tax benefits and deductions with respect to VAT is in effect. Moreover, Russia has double taxation treaties with 77 countries, which allows the choice of the country with the most acceptable tax regime to close the transaction.
Therefore, the majority of standard Islamic financing transactions, including those mentioned above and their hybrid schemes may be used in the Russian Federation with no adverse legal consequences. This is confirmed by successful investment by OJSC AK BARS Bank of syndicated financing funds attracted in the amount of US$60 million within an Islamic Murabahah transaction. This transaction was recognized as the European Deal of the Year 2011 according to Islamic Finance news.
Russia is also a prospective site for Islamic securities – or Sukuk - which could be used as a business tool for attracting major investors to infrastructure projects. Russia’s advantages in this field include a large amount of assets for an asset-backed Sukuk, as well as the interest of investment banks in issuing it on a government level. Taking into account that in Russia the securities are only recognized as securities if they are classified as such by the legislation of the Russian Federation, the question concerning the possibility to issue Sukuk within the country remains open. Nevertheless, it is possible to issue Sukuk backed by Russian assets through SPVs in offshore territories. Russian law practically does not contain any prohibitions on foreign legal entities owning assets (such as real estate). The existing prohibitions concern mainly agricultural land and land in Russia’s border zones.
The Government of the Republic of Tatarstan has signed a respective MoU with Kuwait Finance House Bank (Malaysia) and AmanahRaya on issuing sovereign Sukuk bonds for the Republic of Tatarstan. For purposes of this MoU, Tatarstan announced the issuance of a sovereign Sukuk (issued by the region) from US$100-200 million through the offshore territory of Luxemburg and/or Malaysia. The issuance of debut Islamic bonds (Sukuk) on one of the Islamic financial markets – Asian or Middle East markets – was also announced by the VTB financial group. These transactions should demonstrate the possibility of placing a Russian issuer on the Islamic securities market and stimulate other participants of the Russian market.
The implementation of Islamic finance on the Russian market is possible through banking and non-banking financial institutions, including banks, non-bank credit organizations, SPVs, investment companies, mutual investment funds, leasing and insurance companies. However, when speaking of the prospects of developing Islamic banking in Russia, one cannot ignore the following issues.
First, the Russian banking system is based on the bank obtaining its revenue in the form of interest on the transaction amount, while the fundamental principle of Islamic banking is prohibition of interest (Riba). Second, the Russian legislation establishes a direct prohibition on participation of a credit organization in manufacturing, trading and insurance activities, which eliminates the possibility for them to carry out such transactions as Murabahah, Istisnah and Salam that are traditional for Islamic banking.
At the same time, these circumstances do not represent insurmountable barriers, since the banking legislation contains no restrictions with respect to bank participation in the charter capital of other companies engaged in manufacturing, trading and insurance activities. Therefore, an Islamic bank may operate in Russia without any credits or deposits, but with project financing and investment accounts as an investment and settlement bank, and apply Islamic financing tools by investing in projects through SPVs.
The prospects of developing Islamic financing in Russia are not strictly theoretical, as they are confirmed by successful examples of creating and operating Islamic financial institutes and products. The Tatarstan International Investment Company (a joint venture of Russia and Islamic Development Bank), Open Mutual Investment Fund BKS – Halal Fund (Kazan) and AMAL Financial House (Kazan) have already been created in the course of implementing the Islamic financial infrastructure in Russia. Within an Islamic window, OJSC Bank Express (Dagestan) offers halal financial products, OJSC ISK Euro-Policy has started to offer Islamic insurance products (Takaful) since 2012, and so on. The interest of the government, business community and Russian people in Islamic finances has been on the increase year after year.
For the last couple of years the government and major participants of the Russian financial market have been paying great attention to developing Islamic finance in Russia and establishing close trade and economic relations with the Middle East and Asia. Since 2005 Russia has been an observer member of the OIC, which has facilitated significant improvements on the political, economic and cultural arenas and closer relations with Islamic countries. Round tables, forums, annual conferences, summits (for example, International Islamic Conference, Kazansummit) and seminars are dedicated to the issue of developing Islamic financing. Such activities indirectly confirm Russia’s interest in alternative financial tools, and Islamic financing which focuses on real economic activity instead of speculative activity, has a promising outlook on the Russian market. Thanks to the abundance of a resource base, the amount of Muslim population and geographical proximity to the countries of Central Asia and Middle East, Russia has the potential to become one of the major Islamic financing markets in Europe. We expect these prospects to become reality in the foreseeable future.