TO WHOM IT IS ADDRESSED

We target the following types of Investors:

• Private parties
• Institutional Investors
• Unlisted Funds
• Listed Companies and Funds
• Banks
• Insurance Companies
• Companies
• Consulting Companies

Asset type

It applies to all types of assets, movable and real estate.

Islamic Finance: Definition

Islamic Finance was born in the sixties and seventies and mainly refers to all that economic sphere that includes banking institutions, practices, financial contracts and transactions that are in accordance and compatible with the principles of the Islamic faith, and more specifically with the Islamic law, namely the Sharia and the law, the fiqh.

With the term Islamic finance in the economic context, we mean the respect of the Islamic rules of the Sharia, i.e. that set of rules that are taken from the Koran and the Sunna, the prophetic tradition, inherent to the economic and contractual world.

The biggest difference between the classical Western economic-financial system and the Islamic Sharia-compliant one is based on the concept of riba, which in fact can be translated in more economic terms as interest. Shariah, and also in Abrahamic Monotheism, Judaism and Christianity, has always considered interest, that is lending an amount of money and asking for more in return, to be "usury", and therefore a sin.

This is a principle of real economics where capital cannot have a value in itself, but only when employed in concrete and real activities. Therefore, the fundamental difference is that in the Sharia-compliant finance, interest cannot be considered, but rather participation in the concept of profit sharing: a kind of operation which, instead, the Koran allows.

(From Borsa Italiana, Il Sole 24 Ore)

THE PRINCIPLES OF ISLAMIC FINANCE:

• Ribā: Prohibition of interest payments
• Maysìr: Prohibition of Speculation
• Ghàrar: Presence of risk and uncertainty that is considered unethical
• Harām: Prohibition of distribution and production of alcohol, drugs, tobacco, weapons, pork, pornography and gambling
• Zakat: alms, instrument of purification.

JUSTICE AND FAIRNESS

The rationale behind these prohibitions corresponds to:

• the correct relationship between the contracting parties or counterparties (risk and profit sharing, profit participation / business risk)
• Virtuous circulation of wealth: stakeholders (shareholders, customers, employees, suppliers, the community with which the organization interacts)
• Corporate Social Responsibility
• Countering the generation of contractual, economic, information asymmetry
• Transparency of economic activity.

THE UNDERLYING TANGIBLE: REAL ECONOMY

Money or capital, as we have said, does not have a value in itself, but only for its usefulness, that is if it is joined with very precise work, with a tangible, an enterprise, or a productive activity.

Each transaction is therefore based on a tangible asset, supported by a real asset that guarantees its traceability.

SHARIA-COMPLIANT CONTROL BODIES

The proximity between conventional economics and finance and Islamic finance meant that the latter had to be equipped with institutions and profiles of supervision that would allow interaction with the banking system, real estate and Western stock markets. Here are the main institutions:

• The control and supervisory body, the Sharia Supervisory board is an ethics committee that oversees economic and financial activities, often within the banks governance system
• In 1991, the AOOIFI Accounting and Auditing Organization for Islamic Institution was founded in Bahrain, with the aim of defining Sharia-compliant accounting and governance rules.
• IFSB (Islamic Financial Services Boards) essentially has the same objectives as the Basel Committee on Conventional Banking
• LMC (Liquidity Management Centre) has the task of promoting the creation of an interbank money market, where Islamic operators can invest surplus liquidity
• IIFM (International Islamic Financial Market) aims to create and standardize tradable and transferable financial instruments (such as sukuk) and promote the related secondary market.

ACCESS TO CREDIT

In Islamic finance and economy, access to credit is not based on criteria linked to solvency and the applicant’s repayment guarantees, but on the positive evaluation of the project to be financed.

It will be the goodness of the project, the operational reliability of the entrepreneur, the clarity and financial traceability, the investment in real, tangible, non-speculative or random activities that will determine the criteria for a positive evaluation.

The criteria in brief: economic and social efficiency; profitability; transparency; correct information;

In a word: real economy

Islamic Finance: Type of Operations

THE MAIN BANKING OPERATIONS OF ISLAMIC FINANCE:

Participation contracts:

• Mudàraba: profit-sharing contract. In the event of a loss, these shall be borne by only one of the two contracting parties
• Mushàraka: profit and loss sharing contract

Non-participating contracts:

• Muràbaha: purchase of an asset by, for example, a bank and resale to the customer at a premium
• Ijàra: similar to leasing, a contract for the rental of an asset
• Istisna: gradual financing to the customer according to the increase in productivity and progressive decrease in bank ownership
• Salam: advance payment and goods returned at a later stage

THE MAIN FINANCIAL TRANSACTIONS IN ISLAMIC FINANCE:

The main financial operations of Islamic Finance are:

• Sukuk: basically the Islamic bond. This transaction is similar to a securitization transaction. In fact, a special purpose vehicle (SPV) is created with its own legal entity and usually domiciled in a country with a favourable tax regime. The originator of the transaction provides the SPV with the assets against which it will issue certificates (sukuk notes) that will be subscribed by investors. Sukuk are basically divided into two categories:
  • Asset-based sukuk, i.e. securities that have an underlying that generates a predetermined return,
  • Equity-based sukuk in which instead the yield is based on the logic od profit loss sharing.
• Sharia compliant shares: with a prohibition to invest in companies directly or indirectly involved in: conventional banking, conventional insurance and reinsurance; production and sale of alcoholic beverages; breeding and processing of pork; arms trafficking; production and sale of tobacco; management of casinos, night clubs, hotels; pornography.

SUMMARY OF ETHICAL ASPECTS

Link economic actions to a value system.

Conception man in his entirety and not only as homo œconomicus.

Finance and economics conceived in the value perspective mean:

• real economy
• fiduciary transaction
• circulation of wealth

Islamic Finance: in Italy

In Italy, unfortunately, Islamic finance has lagged far behind countries such as the UK, where it was immediately established as a finance to complement the conventional one, and not only for Muslim investors.

With the Proposed Law of May 2, 2017 entitled "Provisions Concerning the Tax Treatment of Islamic Finance Transactions", an attempt was made to incentivize a review of this issue.

In Islamic Finance, since there is no longer the concept of interest, the financer becomes substantially an equity investor of the financed party, sharing  profits and losses and for this reason the approach becomes similar to Private Equity wherein it becomes important to evaluate the asset on which it is necessary to structure the operation.

Therefore, evaluation of the convenience of investing in an asset becomes in many cases a simulation on a spreadsheet, in which the economic aspects, the financial aspects (economic variables over time) and the system aspects (tax system, inflation, risk assessment, etc.) are considered.

POSSIBLE DEVELOPMENTS OF ISLAMIC FINANCE

According to the Consob report, Italy is almost totally closed to the growing Islamic finance sector, which today is worth about 2000 billion dollars, concentrated mainly in Iran, Saudi Arabia, Malaysia, Arab Emirates and Kuwait.

The economic advantages of their use would instead be immediate due to the greater liquidity of the system and  participation in the company capital.

Investing in Sharia compliant funds and companies? The requirements are:

• Qualitative (banned sectors: pork, alcohol, tobacco, weapons, pornography)
• Quantitative (level of indebtedness / interest-bearing assets and liabilities / the level of credit and liquidity).

TYPE OF TRANSACTIONS HANDLED:

In this context, the transactions we are going to discuss are:

• Certification of a Sharia-compliant Company in order to open its shareholding to Islamic investors
• Evaluation and management of Private Equity operations, according to the principles of Sharia, in order to be compliant for Islamic investors and therefore widen their business opportunities
• Evaluation and verification against Dow Jones Islamic Market parameters.

WHICH IT TOOLS SHOULD BE USED?

The tool adopted for the analysis and verification of the sustainability and profitability of an investment has been the spreadsheet for about 30 years, with all the conceptual limitations, which make it unreliable for such complex and systemic analyzes as the evaluation of an investment according to the principles of Sharia. We will see the reasons in detail.

THE LIMITS OF EXCEL SPREADSHEET TECHNOLOGY

Unfortunately, the answer is no, as the average reliability of any Predictive Model made with Excel spreadsheets technology, regardless of the skill of the analyst who made it, is on average 15-20%!

Let's see the reasons, discovering that, in addition to the lack of Reliability, there is also a lack of Opportunity and Profitability for investments managed with Business Plans made with Excel.

LACK OF RELIABILITY

The average reliability of Islamic finance transactions carried out using Excel spreadsheet technology, independently from the competence of the analyst who elaborates it, has been measured on a large number of elaborated BP, created for "Corporate Finance" operations and has been found to be around 15-20%.

An approximation of about 20%, in the best case scenario, means that each result obtained has a reliability of 20% or, in other words, has a margin of error equal to its complement, i.e. 80%. This means, for example, that a Cash Flow value of €1,000,000, calculated in this way, ranges from a value of €1,000,000+/- 800,000, i.e. €200,000 to €1,800,000. 

This type of approximation highlights the problem of reliability of the result of the Islamic finance operation, but even more so of precariousness, to make the correct decisions.

We see the structural reasons for the inadequacy of the Excel Sheet for the limited opportunities it can offer in the management of the different operations of "Islamic Finance":

LACK OF A SYSTEMATIC APPROACH:

due to the inability of Excel spreadsheet technology to take into account all the variables inherent in a given context such as, for example:

Cash that is always positive, on an annual basis, may, in fact, turn out to be negative for most months with the need to cover it with Bank Lines or a capital increase. The NPV values obtained are therefore unreliable. 

An annual cash flow prevents you from viewing the payment of taxes and dividends in specific months, preventing you from having evidence of liquidity criticalities, which become essential for obtaining preventive financial coverage.

LACK OF A SYSTEMATIC APPROACH:

due to the inability of Excel spreadsheet technology to take into account all the variables inherent in a given context such as, for example:

The VAT rates associated with each variable that enters the model.

Payment/collection days 

The tax rates

The variables of risk, not taken into due consideration, which are fundamental for consideration in Islamic finance.

VAT MANAGEMENT PROBLEM:

is in most Business Plans handled incorrectly or insufficiently, due to the inability of Excel technology to take it into account.

A striking case was when, in a BP relating to the acquisition of shares made by an investment fund, VAT was considered as an accounting clearing entry, but not a financial one. Obviously, the investor was in serious trouble..

In many of the BP cases analysed, we found only vertical VAT compensation, but not horizontal compensation, meaning investors waited a long time for receive VAT refunds, resulting in financial distress 

PROBLEM OF THE LACK OF CERTIFICATION OF THE ALGORITHMS USED:

due to the lack of reference to sources stating their correctness, which is an important element that every investor should require. Certification is required for wine, for oil, but not for BPs, which decide on the analysis of investments worth millions of euros.

In a Due Diligence it was asked which algorithms were used and by whom they had been certified. It turned out that different algorithms were used for the same function and, moreover, when asked what the sources were, the answer was: the experience of the person who had drawn up the Business Plan. Of course, the deal was off.

COMPLEXITY-RELATED ERROR PROBLEM:

due to the fact that the more complete you make the BP model on the Excel sheet, the more the probability of error (of formula, of not connected cell, of calculation, etc.) increases, making the results unreliable.

Two well-known professors at MIT drew up the three-year plan of works to be done for a major government department. Unfortunately, a university student at MIT, after a few months, disavowed the BP/PEF for having found a trivial calculation error, but one that rendered the calculations unreliable, and also causing serious damage to the image of the government and the two distinguished professors. 

THEREFORE, TO MAKE BUSINESS PLANS FOR "ISLAMIC FINANCE" OPERATIONS, THE EXCEL SPREADSHEET IS THE FIRST RISK, EVALUATED AT AROUND 80-85%.

LACK OF OPPORTUNITY

The possibility to manage the different cases that Islamic Finance operations,  such as certification of a Sharia compliant Company, evaluation and management of operations of Private Equity, according to the principles of the Sharia,can offer in a flexible manner, is very limited with  Excel spreadsheet technology, as this technology does allow models to be developed that can thoroughly simulate the different economic and financial aspects of reality.

In fact, to reproduce the different assumptions on Excel spreadsheets, means re-customizing the model each time, with consequent time-wasting, making operativity impossible.

However, not managing them means not being able to translate the entrepreneur's ideas into reliable financial economic data to find the best solution.

What does this limit mean for the investor? It means missing out on business opportunities that can range from a few thousand to millions of Euros.

Let's look at the structural reasons for the inadequacy of the Excel Spreadsheet due to the limited number of Opportunities it can offer in the drafting of a Business Plan:

DIFFICULTY/IMPOSSIBILITY IN BREAKING DOWN A BUSINESS MODEL INTO ITS BUSINESS UNITS 

due to the complexity that would be induced in the Excel model to handle them. In fact, the Business Unit represents the minimum unit of analysis with its investments, costs and operating revenues, used to break down the company model into its operating divisions in order to allow the entrepreneur to decide priorities in investments, on which business units to focus attention and operate.

 A Private operation of about 7 million euros, elaborated with Excel spreadsheet technology, turned out to be overestimated in the determination of the sources of investment, due to the inability to manage self-financing, which would have been obtained with the breakdown into Business Units.

DIFFICULTY/IMPOSSIBILITY OF ANALYSING A BUSINESS MODEL IN ITS VARIOUS SCENARIOS

based on the different assumptions, having to work on the formulas which is time consuming and increases the possibility of errors.

We cite the case of a Venture Capital project, elaborated on a spreadsheet, in which the calculated scenarios did not correspond to the economic/financial reality that later emerged, with serious problems for the investor. 

DIFFICULTY IN EXAMINING COMPLEX OPERATIONS

which, with Excel spreadsheet technology, would become so approximate as to be unreliable.

It was not possible to perform a complex company acquisition operation on Excel, which implied the breakdown of the company into its divisions, the analysis of investments, the reduction of costs, the analysis of  revenues, the restructuring of debt and the analysis of three possible Industrial Plans, the respect of Islamic Finance parameter, but it was possible to examine it successfully with "Finance Atena".

DELEGATION DIFFICULTIES

due to the fact that in the BP created using spreadsheets, the data are wired with formulas and therefore only the person who has drawn up the Economic Financial Plan can work on it with all imaginable limits and cannot delegate to other departments.

In acquisition processes, time is of the essence and therefore having delegated possibilities of loading data into the analysis model becomes important.

LACK OF PROFITABILITY

An Islamic Finance financial operation, elaborated with the spreadsheet, drawn up using a spreadsheet, besides having a Reliability of 15-20% and therefore not significant to seriously analyze a financial operation of hundreds/millions of euro, of great impact on the investor, presents this recurring issue:

OVERESTIMATION OF SOURCES TO COVER INVESTMENTS (EQUITY, BANK LINES, SHAREHOLDER FINANCING)

due to Excel technology, because it does not allow financial optimization of cash flows, which is instead possible by breaking down the Company Model into Business Units, by managing flows on a monthly basis and by managing self-financing, which is too complex to reproduce using Excel technology. This causes an investor to waste useful capital that he could use in other ventures and also reduces the project’s profitability, decreasing the shareholder NPV.

For this problem, an acquisition of a stake was overestimated by an extra 3 million Euros, calculating an unreliable shareholder NPV.

SUSTAINABILITY IS ALWAYS CRITICAL

because it doesn't take into account all the financial variables involved. The reasons for these results are mainly due to the fact that a predictive financial economic analysis is a very complex analysis and it is inadequate to try to translate it on an Excel spreadsheet due to its structural limitations, due to the problem posed.

Sustainability on an annual basis is critical in most cases as it does not take into account cash flows on a monthly basis, creating unrealistic expectations and, ignoring the necessary hedges, leading to an underestimation of the debt.

UNFULFILLED PROFITABILITY

due to Excel technology that leads easily to calculate NPV and IRR values, but the problem is not obtaining these values, that are obtained very simply using Excel functions, the problem is upstream, from which cash flows they were obtained. Precisely for this reason, the values obtained never correspond to reality, constituting a problem for everyone, first and foremost for the investor.

Profitability is always overestimated compared to the reality of the facts, always disappointing the expectations of the investor who pronounces the fateful phrase at the end of the operation: "I thought I would earn more, or, the accounts don’t add up, etc..