LIBOR transition: challenges for Islamic finance transactions

Abstract

Purpose To examine the implications of the cessation of LIBOR in the context of Islamic finance transactions and to suggest potential solutions for the Shari’ah-compliant use of near risk-free reference rates (RFRs) in such transactions. Design/methodology/approach Provides an overview of the main regulatory changes by the UK’s Financial Conduct Authority (FCA) to LIBOR, a review of the key details regarding the cessation of LIBOR and specific risk factors, a discussion of core concepts of Islamic finance and the unique challenges that the models face considering the LIBOR reforms, and an outline of several innovative solutions that can be utilized by organizations and institutions to overcome the potential complexities of the LIBOR reforms. Findings The financing component of a seller’s profit margin in a murabaha transaction may be calculated using LIBOR, a forward-looking rate. LIBOR as a financing rate benchmark is being replaced by RFRs, which are backward-looking rates. A possible way to use RFRs in a murabaha transaction might be to recalculate the seller’s profit margin depending on actual RFRs during the financing period with the seller offering appropriate rebates to the buyer. Originality/value Expert guidance from experienced corporate, financing, investment, and Islamic financing lawyers.