Reflections on the Dubai Financial Crisis

By Fakihah Azahari

‘A missing part of the puzzle is the role of
Sharia Advisors in the issuance of these sukuk in mega infrastructure and
superfluous projects.’


Financial and
economic analysts including Islamic finance players have offered many plausible
explanations for the financial debacle besieging Dubai. Their writings suggest
that they are unanimous in the opinion that the fundamental basis is due to
excesses whether in ambition, spending or debts. The Quran have warned Muslims
of the dangers of excesses in Surah 26:128 which states “Do you build a
landmark on every high place to amuse yourselves, and that you get for
yourselves fine buildings as though you may live forever. And when you exert
your power, you exert it like tyrants
”. In Surah 89:6-14, the Quran went on
to warn “Have you not seen how your Lord dealt with the ‘Ad? Of the city of
Iram, with lofty pillars. The like of which was never created in any land. And
the Thamud, who hewed out rocks in the valley…

The ancient tribes
of Ad and Thamud were people who overbuilt huge landmarks like palaces and
castles. The folly of their actions was admonished by the Prophets sent to
them. To the tribe of ‘Ad, Prophet Hud questioned the need for them to build
unnecessarily huge infrastructures. To Thamud, Prophet Salleh said to them that
God facilitated them to build palaces and castles on the plains of the earth so
that they may be just towards their people and grateful to God. Instead, their
monuments only made them more arrogant and insolent. Thus, they were destroyed
by God.

Although Dubai is
saved from natural disasters so far, the financial crisis is a clear
manifestation of the abuses of their excesses and the vulnerabilities of an
open economy. For the last ten years, the pillars of Dubai’s economy have been
based on foreign direct investment, real estate construction including mega
infrastructure projects and luxury tourism. Financial instruments such as sukuk
were raised to develop these sectors to cater for the aspirations of Dubai to
be the tourist, capitalist and financial hub of the Emirates. Examples are the
uncompleted and already physically sinking Dubai World project, the Al Burj
hotel, the yet to be constructed tallest building, fancy skyscraper hotels and
other statement related infrastructures.

The issues faced by
investors now are whether they would be able to enforce a claim on the assets
underlying the sukuk. Nakheel, the subsidiary of Dubai World and its largest
debtor, promised investors returns for its sukuk based on the implicit
sovereign guarantee and assumptions that completion of the projects are a
foregone conclusion. As nervous investors are finding out now, there is no
explicit sovereign guarantee by the Dubai government and the sukuk is an asset
based sukuk instead of an asset backed sukuk; meaning that investors do not
have legal recourse to the underlying asset.

These issues have
pushed Islamic finance to the spotlight where Islamic finance practitioners are
grappling with clear answers to deflect blame. One CNN newscaster boldly
suggested that the crisis is due to the Quranic injunction of prohibiting the
imposition of interest in Islamic financial instruments. We know this idea is
unrealistic and too simplistic as the subprime crisis demonstrated the effects
of high and compounded interest, although no reference was made to that by CNN.

Nay, the Quran is
not to be blamed here. It is really a case of bad corporate governance and it
breaches all fundamentals of Islamic economics. The key fundamental of Islamic
economics is that economic and financial activities are linked to real and
sustainable economic sector activities and productive resources. Financial
instruments may be structured in varied ways as long as the financing raised
are for beneficial projects that meet the needs of the state and society. The
structures should be backed by tangible assets instead of conventional methods
where transactions may not be backed by any real asset.

Amongst industry
players that address the issue of providing adequate protection for investors
in sukuk issuance was Dr. Armen Papazian, head of Islamic Finance at UBS
Investment Bank who structured Dubai’s Islamic bond sale early this year at the
6th Annual Kuala Lumpur Islamic Finance Forum. At the Forum he
suggested the formation of a Central Islamic Trustee entity that will hold the
assets backing the sukuk in a charitable trust that will provide legal recourse
for all parties especially the investors.

A missing part of
the puzzle is the role of Shariah Advisors in the issuance of these sukuk in
mega infrastructure and superfluous projects. What were the legal maxims relied
on for their Shariah approval?. If we can dissect the Shariah rationale for the
sukuk, it will certainly provide more clarity for the industry and a move away
from excesses. To quote Ibn Khaldun, “When people no longer do business in
order to make a living and when they cease all gainful activity, the business
of civilization slumps and everything decays

Fakihah Azahari graduated in Law from the International Islamic University Malaysia in 1991. She was called to the civil court and the Shariah Court in 1992. She has been in practise for sixteen years and her areas of interest are in Halal industry and Islamic finance.