Commentary :: The US, the UK, and the Model of Competitive Equality

This commentary, by SHARIAsource U.A.E. and Malaysia editor Paul Lee, examines the U.S. and the U.K. as an example of a model of competitive equality for the regulation of sharīʿa compliance in Islamic finance.

The regulation of Islamic finance has generally been an area to which Western jurisdictions have devoted limited attention, and courts and regulators have been forced to step in ad hoc to fill necessary gaps. This post examines relevant amendments and rulings in the United States and the United Kingdom, and argues that they espouse a rationale of competitive equality between conventional and Islamic finance.[1] While such a model removes penalties or prohibitions against the practice of Islamic finance, it may lack sensitivity to additional requirements that may be necessary to ensure sharīʿa compliance when contrasted with more comprehensive models of regulation.

Parties seeking to practice Islamic finance in Western jurisdictions are likely to face challenges from three main areas: (1) functional prohibitions on activities undertaken by certain financial institutions, like banks, (2) duplicate taxation due to the multiple steps involved in certain Islamic financial contracts that are not present in their conventional counterparts, and (3) judicial enforcement of contracts that attempt to follow sharīʿa principles. Unless such issues are adequately addressed, Islamic finance will not be on equal footing with conventional modes of finance.

In the U.S. and the U.K., various amendments and regulatory rulings make certain types of Islamic financial contracts permissible. For example, the Office of the Comptroller of the Currency (OCC) Interpretive Letters #806 and #867, as well as N.Y. Department of Financial Services Banking Interpretations from 1999 and 2001, permit ijārah– and murābaḥah-based home financing, with the OCC also permitting murābaḥah-based commercial equipment and inventory financing.[2] These interpretations confirm that properly structured ijārah and murābaḥah transactions can be included in the “business of banking.”[3] Relatedly, a U.S. bankruptcy court has approved in one instance a murābaḥah-based transaction as a source of exit financing (financing allowing a bankrupt debtor to exit bankruptcy).[4]

Similarly, in the U.K., the Financial Services Authority (“FSA”) has regulated murābaḥah-based home financing as Regulated Mortgage Contracts since 2004,[5] and ijārah– and diminishing mushārakah-based financing has been under regulation as Home Purchase Plans since 2007.[6] Additional amendments in 2010 allowed certain Islamic finance structures to avoid unintentionally being labelled a “collective investment scheme,” thereby restricting to whom such products could be offered.[7]

The above rulings and amendments create some clarity about the permissibility of certain Islamic finance activities and brought them within the purview of regulators.[8] More important to the success of Islamic finance in these jurisdictions, however, is the removal of certain adverse tax consequences. For example, ijārah and murābaḥah transactions involve multiple sales of the same asset to create a sharīʿa-compliant structure. As such, those transactions would be taxed twice, whereas their conventional finance equivalents involve only a single asset sale and would be taxed once. This is an important consequence for home-financings, where each sale of a house incurs real estate transfer tax (called Stamp Duty Land Tax in the U.K.). Both the U.S. and U.K. have provided for tax relief in various instances to allow Islamic finance contracts to be taxed in the same manner as their conventional equivalents.[9]

Parties to an Islamic finance contract must also ask whether the contracts they have entered into are enforceable on the terms that they intended. Given that the legislative body has explicitly played a role, the U.K. may be seen as adopting a more sophisticated approach to the issue of Islamic finance than the U.S;[10] however, in this one respect, the U.K. has at times created considerable uncertainty. U.K. courts have provided that a contract could not choose both U.K. law and sharīʿa, nor could Islamic law qualify as a valid choice of law given that the Rome Convention applies to the choice between “laws of different countries.”[11] However, parties were at least able to create a triable issue by arguing that a contract which is not sharīʿa-compliant is invalid by way of being ultra vires, given that under U.K. law the powers of a corporation are governed by the place of incorporation (in this case, Kuwait).[12] Conversely, where U.K. law is unambiguously applied, parties must be comfortable with the fact that a contract, once formed, may be enforced on its terms even where those terms appear to violate well-established principles of sharīʿa.[13]

In the U.S., although results would likely differ from state to state, at least one court has decided a case according to Islamic law. In that case, parties previously agreed to a Saudi Arabian choice of law, and the court found a Saudi Arabian court would apply Islamic law and ruled that the principle of gharar precluded expectation damages since the contract was one whose expected value was uncertain.[14] However, the more direct route to enforcement in the U.S. appears to be the use of sharīʿa-based arbitration[15] because courts will generally enforce agreements to arbitrate and arbitral awards. For instance, an agreement to arbitrate “according to the Islamic rules of law” before the Texas Islamic Court was upheld,[16] and similar agreements in other states are likely to be upheld as well.[17]

Thus, although judicial enforcement of contracts sometimes poses problems for Islamic finance, the general approach in the U.S. and the U.K. is that Islamic financial transactions should be treated in a manner equal to their conventional finance equivalents. As with the systems-based model of the DIFC (see author’s previous post) and the centralized model in Malaysia (read more here), such an approach has both advantages and disadvantages (see in-depth discussion here) vis-à-vis other models of Islamic finance regulation. Investors, issuers, and regulators would be well advised to carefully consider what approach best suits their needs.

[1] For instance, the U.K. Financial Services Authority (“FSA”) describes its goal as promoting a “‘level playing field’ in dealing with applications from conventional and Islamic firms.” Financial Services Authority, Islamic Finance in the U.K.: Regulation and Challenges at 11 (Nov. 2007). The term competitive equality is borrowed from the regulation of banks in the U.S., where the law recognizes a principle that state-chartered and federally-chartered banks should have equal competitive footing. Seee.g., Daniel R. Fischel et al., The Regulation of Banks and Bank Holding Companies, 73 Va. L. Rev. 301, 335-37 (1987).

[2] Interpretation (Apr. 12, 1999), NY DFS Banking Interpretation (Aug. 27, 2001). In an ijārah contract, the lender purchases the property and leases it to the borrower at a rate that economically resembles a conventional loan. At the end of the lease, the lender transfers the property to the borrower. Seee.g., Mahmoud A. El-Gamal, Islamic Finance: Law, Economics, and Practice at 98-99 (2006). In a murābaḥah contract, the lender purchases the property and resells it to the borrower at a mark-up, to be paid in instalments, that economically reflects conventional interest rates. Id. at 67-68. OCC Interpretive Letter #806 (Dec. 1997), OCC Interpretive Letter #867 (Nov. 1999), NY DFS Banking.

[3] Under 12 U.S.C. §24(7), which lays out what activities are permissible for federally chartered banks (“national banks”) to engage in, and N.Y. Banking Law §96(1), which does the same for N.Y. state-chartered banks.

[4] In re Arcaptia Bank B.S.C. et al., 2013 WL 3789388 (Bkrtcy. S.D.N.Y., May 27, 2013).

[5] See Mortgages Conduct of Business Rules, ann. 1 (as amended 31 Oct., 2004). The rules were promulgated pursuant to authority granted in Financial Services and Markets Act 2000 (Regulated Activities) Order 2001, art. 25B & 61 (as amended 2014).

[6] See Mortgages and Home Finance: Conduct of Business Sourcebook ch. 2.6A (as amended Apr. 6, 2007). The rules were promulgated pursuant to authority granted in Financial Services and Markets Act 2000 (Regulated Activities) Order 2001, art. 25C & 63F. See also Financial Services Authority, Just the Facts About Home Purchase Plans (Sept. 2007), available at In a diminishing mushāraka contract, the lender and the borrower purchase property as a partnership with the lender owning the bulk of the partnership interest, and the borrower buys out the lender over time in payments that economically resemble a conventional loan. Id.

[7] This was done by creating a category of Alternative Finance Investment Bonds that would be exempt from the definition of collective investment schemes. Financial Services and Markets Act 2000 (Regulated Activities) Order 2001, art. 77A. See also Clifford Chance LLP, Regulating Sukuk in the U.K.: The New Framework (Jan. 27, 2010) available at

[8] Muḍārabah-based deposit accounts have generally presented more problems for regulators due to the loss-sharing nature, given that banking laws generally provide that depositors are entitled to a return of the full amount of their deposits. See Financial Services Authority, supra note 1 at 14. See also Victoria Lynn Zyp, Islamic Finance in the United States: Product Development and Regulatory Adoption at 18 (Apr. 21, 2009) (unpublished M.A. thesis, Georgetown University) available at

[9] See N.Y. State Department of Taxation and Finance Advisory Opinion TSB-A-08(2)R (28 Apr., 2008); Finance Act 2003, art. 71A, 72, & 73B (as amended by Finance Act 2007). These amendments also removed the potential for a third tax when the lender sells or assigns their interest in the mortgage. See also Norton Rose Fullbright, UK Sukuk Issues and Shariah-Compliant Securitization: Tax Aspects (Jun. 2008) available at

[10] See also Financial Services Authority, supra note 1 at 13-14 (discussing the potentially different treatment of sharīʿa scholars on Sharīʿa Supervisory Boards based on the scope of their roles; such scholars may be treated as simple advisors, or as directors of an authorised firm subject to fit and proper tests.)

[11] Beximco Pharmaceuticals Ltd. et al. v. Shamil Bank of Bahrain E.C. (2004) EWCA Civ 19, ¶¶ 40, 43 (emphasis added). See also Convention 80/934/ECC 1980 O.J. (L 266) 1, art. 1.1 & 3.1. This leaves open the question of whether a party could choose sharīʿa law by choosing the law of a country where sharīʿa law is in force. Furthermore, it should be noted that the Rome Convention has since been amended and the reference to “the laws of different countries” no longer appears in art. 1.1. Commission Regulation 593/2008, 2008 O.J. (L 177) 6, art. 1.1. See also Julio C. Colón, Choice of Law and Islamic Finance, 46 Tex. Int’l L.J. 411, 424-27 (2011).

[12] The Investment Dar Company KSCC v. Blom Development Bank SAL (2009) EWHC 3545, ¶16. The Investment Dar Company was incorporated in Kuwait and one of its articles of incorporation stated the company could not practice any non-sharīʿa compliant activities. Id. at ¶3. However, even if the plaintiff ultimately lost the issue of whether the contract in question was intra vires, it would have had little outcome on the case since he would have been entitled to a restitutionary remedy. Id. at ¶21.

[13] For instance in a murābaḥah transaction where the lender had purchased diamonds for the borrower and the diamonds were lost in transit to the borrower, the lender was nevertheless entitled to instalment payments from the borrower because the contract provided that the borrower would remain obligated to pay even in the event of a failure to deliver; such a result would normally contravene the notion that the lender must retain the risk of asset ownership until sold to the borrower, which is what makes the murābaḥah transaction permissible under sharīʿa. Islamic Investment Company of the Gulf (Bahamas) Ltd v. Symphony Gems N.V. & Ors, 2002 WL 346969. See Kilian Bälz, A Murābaḥah Transaction in an English Court: The London High Court of 13th February 2002 in Islamic Investment Company of the Gulf (Bahamas) Ltd. v. Symphony Gems N.V. & Ors, 11 Islamic L. & Soc. 117 (2004).

[14] The court used a well-known ḥadīth as a basis for its decision, stating that: “it is clear to this Court that in Saudi Arabia, the Board of Grievances would not award damages based on Plaintiff’s valuation of the Projects Department. To do so would be equivalent to placing a value on fish in the sea, or purchasing food that has not yet been weighed.” Nat’l Grp. for Commc’ns & Computers, Ltd. v. Lucent Technologies Int’l, Inc., 331 F. Supp. 2d 290, 301 (D.N.J. 2004). The court did not, and this paper will not, address the argument that the application of a religious law by a court violates the First Amendment. See Colón, supra note 11 at 429-30.

[15] See Colón, supra note 11.

[16] Jabri v. Qaddura, 108 S.W.3d 404, 412 (Tex. App. 2003). See also Colón, supra note 11 at 427-28.

[17] Although Jabri was based on a Texas arbitration statute, Tex. Civ. Prac. & Rem. Code Ann. § 171.001 (West), other states are likely to rule the same way since state legislation not enforcing arbitration is pre-empted by the Federal Arbitration Act. 12 U.S.C. §2; Southland Corp. v. Keating, 465 U.S. 1 (1984). Recently, there have been many instances of states trying to, and several instances of states passing, amendments “banning” foreign law; however, such amendments are unlikely to substantially alter the status quo since they are generally qualified by references to existing statutory and constitutional rights, and because of the pre-emption issue. Seee.g., the Alabama constitution stating that “[a] court, arbitrator, administrative agency . . . shall not apply or enforce a foreign law if doing so would violate any state law or a right guaranteed by the Constitution of this state or of the United States.” Ala. Const. § 13.50. See also Liz Farmer, Alabama is the Latest State to Try to Ban Foreign Law in Courts, Governing the States and Localities (Aug. 29, 2014) available at