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Prospects for Islamic financing in Russia.

Summary: Vladislav Zabrodin, Managing Partner of Capital Legal Services, and Anna Leksashova, Associate of Capital Legal Services explore Russia's potential for Islamic finance

The Russian economy is open for the development of new financial mechanisms, and Russia has great potential for developing Islamic financial institutions and products. 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 per cent 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 Shari'ah will be well received by the Islamic segment of Russia's population.

LACK OF AWARENESS

Notwithstanding the above factors, Islamic financial institutes 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 awareness of Islamic financial products and, subsequently, particular concerns about the 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, Russian legislation encourages investment activity and provides its participants with a high level of economic freedom. Despite the fact that Islamic finance 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 Shari'ah 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.

FREEDOM OF CHOICE

Attracting project financing to the Russian market, including traditional Musharakah and Mudarabah transactions, and debt financing in the form of Murabahah, Ijarah, Istisna, 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. Furthermore, the parties must make sure that the decision of the respective court can be implemented, 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 per cent, value added tax is 18 per cent, individual income tax is 13 per cent; 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 choosing the country with the most acceptable tax regime to close the transaction.

Therefore, the majority of standard Islamic financing transactions may be used in the Russian Federation with no adverse legal consequences.

SUKUK SPACE

Russia is also a prospective site for 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 recognised 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 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 Memorandum of Understanding with Kuwait Finance House Bank (Malaysia) and Amanah Raya on issuing sovereign Sukuk for the Republic of Tatarstan. Tatarstan announced issuance of a $1-2 million sovereign Sukuk through the offshore territory of Luxemburg and/ or Malaysia. The issuance of 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.

ISSUES

However, 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. Second, the Russian legislation establishes a direct prohibition on participation of a credit organisation in manufacturing, trading and insurance activities, which eliminates the possibility for them to carry out such transactions as Murabahah, Istisna'a and Salam.

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.

Russia is already home to a handful of 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. OJSC Bank Express (Dagestan) also offers Halal financial products, and OJSC ISK Euro-Policy has been offering Takaful products since 2012.

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. Since 2005 Russia has been an observer of the Organization of Islamic Cooperation. Round tables, forums, annual conferences, summits (for example, International Islamic Conference, Kazan Summit) and seminars are dedicated to the issue of developing Islamic financing.

Such activities confirm Russia's interest in alternative financial tools, and Islamic finance has a promising outlook on the Russian market.

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Publication:Islamic Business & Finance
Geographic Code:4EXRU
Date:May 30, 2013
Words:1279
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