Structured Islamic Finance in Brazil

By Fehmy Saddy, PhD, President, FS Partners SA

Food security has emerged as a global concern in the context of world population growth. World population is projected to increase from its current level of 7 billion to 9 billion by 2050. A recent article by Lester R. Brown on the “New Geopolitics of Food” reveals the prospect of future wars over food resources.

Lubna Al Qasimi, UAE’s Minister of Trade reported recently that food imports of the GCC region could more than double over the present decade. They would grow from $25.8 billions in 2010 to $53.1 billions in 2020. Projections were based on the expected population growth of the GCC region, which could reach 50 millions by the end of the decade. The Minister concluded: “for a region such as the Gulf, there is the added urgency to secure food sources that are safe and sustainable”

Brazil is the largest producer and exporter of commodities. However, four Western companies, namely, ADM, Bunge, Cargill and Dreyfus, better known by their acronym ABCD, control 70%-80% of the world food market due to their large-scale farming and financial strength. They are referred to by Brazilians as the “Four Mothers”, a designation reminiscent of the “Seven Sisters,” the infamous oil cartel that controlled oil production and pricing until the creation of OPEC in 1960.

MENA countries depend on these Western multinational companies for their food. In GCC countries, the situation is even more acute as imports amount to over 90% of their needs. Therefore, there is a growing concern that dependence on the food multinationals has far reaching ramifications on their social, political and economic development.

Islamic Finance of Agriculture

The prohibitive interest rates charged by Brazilian banks make Islamic financial instruments ideal financing tools. There are two areas where Islamic financial institutions can use Islamic financial instruments in Brazil: agriculture production and trade. They could finance acquisitions of farms and agro-industries, and support corporate borrowers. Consider the following:

1. Buy and Lease back farmlands

Brazilian farms are typically large with thousands of hectares cultivating diverse crops: corn, soybeans, sugarcane, coffee, sorghum, cotton, etc. These farms fall regularly behind on their payment of high-interest loans, and file for judicial protection from creditors, or bankruptcy. Islamic financial institutions could use the sukuk instrument to replace conventional bank loans, with a mortgage on the farm.

In most cases, it is attractive to purchase the farm and lease it back to the owner or to agricultural funds, with fixed lease payments. The lease contract would provide an exit option to sell back the farm at maturity at market value. Historically, Brazilian farmlands have increased in value by 10-12% per annum. In most cases, an acquirer with ready cash can negotiate a reduction of existing loans by at least 50% of their face values.

2. Acquisition of agricultural industries

Some agro-industries face the same problem of high interest loans and fall back on their payment. Islamic financial institutions could use the above mechanisms to replace conventional loans with a sukuk instrument, or acquire the company under a buy and lease back contract. There are several opportunities to purchase sugar refineries, for example, with their proper agricultural farmlands for a nominal price, and defer payment of loans over a period of 5-8 years, and even more for obligations due to government entities.

3. Contracting Farmers for a percentage of the crops

One of the oldest forms of Islamic finance is Muzara’a, a profit-sharing scheme that is widely used in the MENA region and much of the Muslim world, whereby an investor advances a certain sum to the farmer for a percentage of the crops. The low cost of production and higher productivity of Brazilian farms, provides higher returns. Islamic banks could use this mechanism for the account of clients. In any case, they have no difficulty selling the commodities in their home markets.

4. Contracting Farmers for the production of commodities

Another from of agricultural financing is to advance certain sums to farmers to enable them to pay for seeds, fertilizers and other plantation expenses, in exchange for certain crops at pre-determined prices. The sums advanced would be secured by a mortgage on the farm. Indeed, the food multinationals referred to above, use this ancient Islamic financing method to control production and markets.

5. Islamic Commodities Trading

A controversial issue in Islamic finance today is the synthetic commodity contracts used by Islamic banks to support their Treasuries. In its basic form, an Islamic bank (in fact, a borrower) purchases the commodity contract at certain price, with a delayed payment date, and sells it back immediately to the same seller (or a sister company) at a lower price for cash, without ever taking delivery of the underlying commodity or asset. The difference in price is, of course, the time cost of money, essentially an interest payment. Most Islamic scholars consider this method as a legal “Hyla” (“Trick” in English), which does not qualify as genuine form of Murabaha.

Islamic financial institutions could undertake genuine Murabaha transactions by financing actual commodities sale contracts to actual buyers in the MENA or GCC regions. Islamic financial institutions dealing with such contracts may develop an inter-banking Murabaha platform among themselves to generate liquidity for their own treasuries. Under this platform, Islamic financial institutions would buy and sell commodities contracts at prices that reflect different maturity dates and delivery schedules.

In conclusion, there are numerous opportunities in Brazil suitable for Islamic financing of agriculture, as well as in other sectors. Islamic financial institutions could use Sukuk to support corporate borrowers in other vibrant sectors and benefit from high returns secured by real assets. However, two issues are always on the minds of financial institutions: exit strategy, and currency risk. With respect of the former, the Islamic methods of financing discussed above would include exit options in a highly liquid market. With respect of currency risk, lease payments are adjusted annually to the Brazilian Government deposit rate, currently around 10%, and inflation, estimated at 6.5% for 2012.