The Islamic Finance and Markets Law Review: Netherlands
Dutch banks were among the first banks to become active in the field of Islamic finance: at the beginning of the 20th century, the Netherlands Trading Society was established in Jeddah, Saudi Arabia, to provide interest-free money exchange services to pilgrims from Indonesia.2 Since the emergence of modern-day Islamic finance in the 1990s, however, there has been limited Islamic finance activity in the Netherlands. In 2004, the first European sukuk was issued by the German state of Saxony-Anhalt using a Dutch vehicle (a stichting) as the issuing entity, but the entire structure was initiated by the German state so this was in essence a German Islamic finance transaction. ABN AMRO and the Liechtensteinische Landesbank launched a structured investment product called LLB Top 20 Middle East Total Return Index Certificate in 2007, and Barclays launched three Amsterdam-listed Islamic investment products in 2008. Further, Rabobank studied the potential demand for Islamic banking among households in the Netherlands. In 2007, Minister Wouter Bos (a former Minister of Finance) also announced that the possibilities for Islamic finance in the Netherlands should be studied. Despite several studies that showed there is a potential demand for Islamic finance in the Netherlands,3 the Islamic finance market did not pick up. Hence, there have not been many Islamic finance transactions in the Netherlands and, in general, Islamic finance remains a novel and exotic form of financing for most Dutch financiers and borrowers.
Legislative and regulatory framework
i Legislative and regulatory regime
In 2008, the Dutch central bank (DNB) and the Dutch financial services regulatory authority (AFM) conducted a study on Islamic finance in the Netherlands. One of their conclusions was that the existing regulatory framework in the Netherlands can be applied to Islamic finance, but with respect to certain financial supervision-related matters (e.g., market entry, conduct of business, capital adequacy and provision of information) the Dutch regulatory framework may require amendments to specifically address Islamic finance products.4 However, no such legal amendments were introduced. Consequently, there is no legislative and regulatory regime that focuses exclusively on Islamic finance, but instead the existing legislative and regulatory regime for conventional finance also applies to Islamic finance.
The regulatory regime for banks and other financial undertakings (including Islamic banks and other Islamic financial undertakings) is based on both European regulations and Dutch national (financial supervision) laws. These laws are primarily codified in the Dutch Financial Markets Supervision Act (FMSA), which came into force on 1 January 2007. Banks (both conventional and Islamic) established in the Netherlands are required to obtain a banking licence from the European Central Bank (ECB), while the DNB processes licence applications. Further, if (Islamic) banks intend to provide investment services or perform investment activities in the Netherlands, they have to apply for a wider banking and investment firm licence. In general, Dutch branches of foreign (Islamic) banks with activities in the Netherlands are subject to the same licence requirements as banks with registered offices in the Netherlands. However, if the foreign (Islamic) banks have their registered offices in another eurozone country, they may conduct banking activities through their Dutch branches or on a cross-border basis in the Netherlands using their European passport: they may conduct banking activities under their ECB banking licence, provided that the ECB has been notified of this. A comparable regulatory regime applies to insurance companies (whether conventional or the Islamic takaful), which also have to obtain a licence in the Netherlands.
The FMSA establishes the rules for the offering of securities in the Netherlands, prospectus approval, public bids and the operation of regulated markets. These rules apply to both the issuance of conventional bonds and shares and the issuance of sukuk. The FMSA also contains extensive rules on the relationship between (Islamic) banks and their customers; (Islamic) banks must comply with certain conduct of business rules if they offer loans to customers. In addition, the Dutch Civil Code (DCC) and the Act on Consumer Credit govern the civil law relationship between (Islamic) banks and their customers: according to these laws, (Islamic) banks have to provide detailed information to their customers, there are specific requirements for the contents of loan contracts and customers have additional consumer protection rights to rescind loan contracts under certain circumstances. Chapter 2b of Book 7 DCC provides rules on creditworthiness assessments, obligations to provide information to consumers and customers having certain consumer protection rights in cases of early repayments, arrears and foreclosures. Further, Chapters 2a, 2b and 2c of Book 7 DCC provide rules on consumer credit, asset financing and loans for leasing contracts such as the ijarah and the ijarah wa iqtina, and for a purchase and sale of property in instalments such as the murabahah (as discussed further below); these provisions are only mandatory if the borrower or lessee is a consumer, but they are not mandatory for professional parties.
While the conclusion of the DNB and AFM study in 2008 was that legal amendments to the FMSA would have been preferred to further facilitate the supervision of Islamic finance products in the Netherlands, no such amendments are required for the structuring of Islamic finance products under Dutch commercial (civil, contract and property) and corporate laws. Dutch commercial and corporate laws are compatible with the structuring of Islamic finance transactions. Partnership contracts such as the musharakah and mudarabah can be structured through a limited partnership contract or a general partnership contract, but also by incorporating stock companies such as a public limited liability company (NV) or a private company with limited liability (BV).5 The contract of murabahah qualifies as a purchase and sale of property in instalments pursuant to Article 7:84(3) DCC. In addition, leasing contracts such as the ijarah can be structured under Dutch law. The ijarah qualifies as a rental agreement under Article 7:201 DCC. Depending on how the ijarah wa iqtina is structured in practice, it may qualify as a rental agreement or as a hire purchase agreement under Articles 7:84(3) and 7:101 DCC. As mentioned above, no mandatory rules under Book 7 DCC that may conflict with Islamic law apply to the murabahah, ijarah and ijarah wa iqtina if these contracts are concluded between professional parties, as will be the case in most Islamic finance transactions (e.g., corporate lending, real estate transactions and debt capital market transactions such as sukuk issuances). If, however, an Islamic bank contemplates offering these Islamic finance products to consumers, certain mandatory rules in Book 7 DCC (e.g., rules on rebate in cases of early repayment) have to be assessed carefully to ensure shariah compliance while structuring these products under Dutch law.
One of the main challenges for sukuk under Dutch law is the lack of trust laws in the Netherlands. In practice, often English law trusts are used in sukuk structures to accommodate the Islamic law requirement that sukuk holders must hold some form of ownership in the underlying asset of the sukuk structure. For example, in the case of a sukuk al-ijarah, whereby a tangible asset is sold and leased back by the originator to a special purpose vehicle (SPV) that issues sukuk, the SPV holds the underlying asset (which is leased back to the originator) in trust for the sukuk holders. As a result, the SPV holds the legal ownership of the underlying asset, while the sukuk holders hold its beneficial ownership. This is market practice in most sukuk structures, and the main rationale for the use of English law trusts is, as stated, to meet the Islamic law requirement that sukuk holders must hold some form of ownership. However, the concept of a trust is not accepted under Dutch law. As a matter of fact, Article 3:84(3) DCC contains a 'fiducia prohibition', which prohibits the use of fiduciary security and holding fiduciary title to an asset.
In practice, this may be solved by creating an English law trust that will be recognised in the Netherlands on the basis of the Hague Trust Convention on the Law Applicable to Trusts and their Recognition (Hague Trust Convention). The Netherlands is a party to the Hague Trust Convention. Consequently, it is obliged to recognise certain elements of a trust created under English law. However, if the significant elements of the trust are more closely connected to the Netherlands then, under Article 13 of the Hague Trust Convention, the Netherlands is not bound to recognise an English law trust. In cases of this kind, there are alternative ways under Dutch law to deal with the Islamic requirement that sukuk holders must hold some form of ownership of the underlying asset. This may require further explanation to a shariah supervisory board that may be dealing with a sukuk issuance in the Netherlands for the first time (which will be the case, given that so far there have been no sukuk issuances in the Netherlands). If one looks very closely at the Islamic requirements for sukuk, one will notice that the Islamic shariah requires sukuk holders to hold some form of ownership in the underlying asset so that the sukuk holders trade in that asset instead of trading in debt claims while trading their sukuk in secondary markets (which would, otherwise, lead to a violation of the Islamic shariah prohibition on the bay al-dayn). However, under Islamic shariah, the use of trusts or the division of the right of ownership (milkiyyah) into legal and beneficial ownership is not prescribed as a prerequisite for sukuk structures.6 As stated, the use of English law trusts emerged – and has been accepted – in Islamic finance practice.
In the Netherlands, the Islamic shariah requirement of ownership of sukuk holders can be met – in the case of unsecured sukuk (which are predominantly issued globally) – by transferring the economic ownership of the underlying asset to the sukuk holders. As a result, the sukuk holders do not acquire any in rem rights in the underlying asset, but will contractually be entitled to the economic benefits of the underlying asset.7 In the case of secured sukuk, the aforesaid may be accompanied by the creation of a collective security arrangement that provides the sukuk holders with security over the underlying asset.8
ii Regulatory and supervisory authorities
There is no regulatory or supervisory authority that deals exclusively with Islamic finance in the Netherlands: the regulatory and supervisory authorities dealing with conventional products also cover Islamic finance products. The supervision model in the Netherlands focuses on system and prudential supervision, and conduct of business supervision. The ECB and DNB are responsible for system and prudential supervision, while the AFM is responsible for conduct of business supervision.
System supervision mainly boils down to ensuring the stability of the financial system as a whole. As regards prudential supervision, this covers the granting of licences and being responsible for prudential and integrity supervision of banks, insurers, investment firms, clearing institutions, payment services providers and trust companies. Under the Single Supervisory Mechanism, the ECB is the central prudential supervisor of financial institutions in the eurozone. The ECB is responsible for the prudential supervision of the most significant banks in the Netherlands, while the DNB is responsible for less significant banks.
The AFM is responsible for conduct of business supervision. It supervises the operation of the financial markets and strives for efficiency therein. It covers the entire financial market sector (both retail and wholesale). Further, it is responsible for prospectus supervision, listing matters and the trading infrastructure. For example, the AFM would have to approve a prospectus for the issuance of sukuk in the Netherlands.
As mentioned above, Islamic finance has not picked up in the Netherlands (yet). Consequently, there are no commonly used structures. There have been only a handful of real estate shariah-compliant transactions. The funding for these transactions was often provided by (the Islamic windows of) foreign financial institutions. The structures that were used were based either on murabahah or ijarah contracts.
One of the structures used is based on murabahah. The murabahah contract used in Islamic finance transactions in the Netherlands is the commodity murabahah (also known as tawarruq). Shariah-compliant investors interested in real estate located in the Netherlands will incorporate a BV to acquire the real estate (PropCo). The PropCo will purchase and acquire the real estate from a potential seller. The purchase price will be funded partially through an equity investment from the shariah-compliant investors and partially through external funding (often, this is the largest part of the funding). The PropCo will approach a financier and enter into a murabahah facility with it. Under the murabahah facility, the financier purchases commodities for X price from a commodities broker and the financier sells those commodities to the PropCo for X plus profit margin. The sale from the financier to the PropCo is an instalment sale: the purchase price of X plus profit margin is deferred and will be paid in instalments. If the financier is providing secured funding, the PropCo will also create a right of mortgage on the real estate. Next, the PropCo sells (under the documentation it is, in fact, the financier acting as agent for the PropCo to sell) the commodities for X price to another commodities broker (which can then sell it on to the initial commodities broker). As a result, the PropCo obtains immediate funding equal to X and has an obligation to pay X plus profit margin to the financier in instalments.
The financier can be a bank, but it can also be an SPV (incorporated as a separate BV). In the latter case, the SPV will enter into a back-to-back facility agreement with a bank to obtain funding equal to X, and the interest paid under the facility agreement will be equal to the profit margin under the murabahah facility between the SPV and the PropCo. If the funding is secured, the SPV will create a right of pledge over its secured rights under the murabahah facility (including a right of mortgage) in favour of the bank.
The other structure used for shariah-compliant real estate transactions in the Netherlands is based on the contract of ijarah. In this structure, there will be one BV that will acquire the real estate (PropCo) and another BV through which shariah-compliant investors will invest (InvestCo). The PropCo will purchase and acquire the real estate from a third-party seller. The PropCo will be the legal owner of the real estate. The acquisition of the real estate will be partially funded by the shariah-compliant investors and partially through external funding. The PropCo will enter into a (conventional) facility agreement with a bank to attract external funding and, if it is a secured funding, create a right of mortgage in favour of the bank. Further, the PropCo will enter into an ijarah contract with the InvestCo pursuant to which the real estate will be leased to the InvestCo. This can be structured either in the form of a rental agreement under Dutch law, or by creating a right of long lease in favour of the InvestCo. The ijarah is a back-to-back lease to the conventional facility agreement, so that the lease payments are equal to the interest paid by the PropCo to the bank under the facility agreement. The InvestCo then, in turn, subleases the real estate to lessees and makes a return on it. The difference between what is received by the InvestCo from subleases and its obligations under the ijarah lease is distributed to the shariah-compliant investors.
There is no separate taxation regime for Islamic finance products in the Netherlands and such products are not afforded special treatment under Dutch tax law. Dutch tax law has an economic approach towards financial transactions (whereby the economic substance of a transaction prevails over its formal legal structure). Since most Islamic finance products mirror the economic effects of conventional finance products, Dutch tax law does not seem to raise major issues while structuring Islamic finance transactions.9 This especially holds true for wholesale and investment banking. In the case of retail banking, however, tax law has been flagged as an obstacle for the introduction of Islamic retail banking products in the Netherlands. Despite much debate on the matter, the Dutch tax authorities are of the opinion that the profit paid in Islamic mortgage transactions (e.g., the profit margin in the murabahah) does not qualify as interest. Therefore, it is not eligible for mortgage interest relief. This puts Islamic retail banking products at a disadvantage compared to their conventional counterparts, resulting in the lack of a level playing field for Islamic finance from a tax perspective. Despite this, the Dutch legislature has not introduced any legislative amendments in relation to Dutch tax law to facilitate Islamic finance transactions, in contrast to other European countries such as the United Kingdom, Ireland, France and Luxembourg.
There is no separate insolvency regime for Islamic finance products in the Netherlands and such products are not afforded special treatment under Dutch insolvency law. In general, the treatment of an Islamic finance product under Dutch insolvency law will depend on the type of Islamic finance contract and its qualification under Dutch law.
It is, however, important to bear in mind that where the concept of economic ownership is used under Dutch law (e.g., for sukuk structures) as a Dutch alternative to the English law trust, the economic owners do not hold any in rem rights under Dutch law. For example, if the issuer of an unsecured sukuk provides the economic ownership of an underlying asset to sukuk holders under Dutch law, the sukuk holders only have a bundle of contractual rights that entitle them to the economic benefits of the underlying asset. If the issuer of a sukuk is declared bankrupt by a Dutch court, the relevant asset will fall into its bankruptcy estate (contrary to trust assets, which are separated from the insolvency estate of a trustee under English law). Sukuk holders, as the economic owners of the underlying asset, only have a contractual claim to the benefits of the underlying asset, which they can file with the bankruptcy trustee.
Dutch courts have jurisdiction to decide on disputes involving shariah-compliant products, assuming there is no clause on submission to jurisdiction of another court and no arbitration clause in the relevant Islamic finance contract. In the Netherlands, there are no separate shariah courts with jurisdiction over Islamic finance products.
There have been no (significant) cases that have been decided by the Dutch courts on or in respect of Islamic finance products and structures.
Within the Netherlands, significant Dutch banks such as Rabobank, ABN AMRO, ING and de Volksbank have not entered the Islamic finance market yet, but have been looking at it with some interest. However, these significant Dutch banks are, or have been, active in the Islamic finance market outside the Netherlands: for example, in South East Asia and the Middle East.
Certain banks, and in particular foreign Islamic banks, have been looking with interest to the Dutch Islamic finance market for retail banking. The entrance of these banks will be a game changer for the development of Islamic finance in the Netherlands. In addition, various small organisations are currently assessing the possibility of offering the first shariah-compliant mortgage loans in the Netherlands, possibly with the cooperation of larger institutions. At the same time, mortgage interest relief may be phased out over time in the Netherlands. If mortgage interest relief is completely abolished, this will undoubtedly be regarded as a positive development for Islamic retail banking from a tax law perspective, as it will place Islamic retail banking products on a level playing field with their conventional counterparts. It will give the smaller Dutch organisations an incentive to continue their efforts to provide the first shariah-compliant mortgage loans in the Netherlands.
Another interesting development is that various Dutch multinational companies are expanding globally and encountering Islamic finance as a form of financing for their activities in South East Asia and the Middle East. Given the continuing growth of these multinational companies, one would expect their exposure to Islamic finance to increase. By contrast, inbound investments from Islamic countries into the Netherlands may be preferred on a shariah-compliant basis (i.e., shariah-compliant investors looking to invest and finance themselves on a shariah-compliant basis). Given that the Dutch legislative framework perfectly assists Islamic wholesale banking, there are no impediments to facilitating transactions of this kind.
In conclusion, the outlook for the development of an Islamic finance market in the Netherlands remains challenging. Although the legislative framework is there and there are certain developments that may contribute to the Islamic finance market in the Netherlands, in general there are no major incentives to structure financial products in a shariah-compliant manner (instead of on a conventional basis). The entrance of more parties with a clear preference for shariah-compliant funding may change these prospects. If and when that happens, it is helpful to note that the Dutch legislative and regulatory framework will not impose any impediments on those parties wishing to conduct business and attract funding on a shariah-compliant basis.
1 Omar Salah is a partner at Norton Rose Fulbright LLP.
2 O Salah, Sukuk Structures: Legal Engineering Under Dutch Law, Eleven International Publishing 2014, pp. 5–6.
3 See, among others, B Verhoef, S Azahaf and W Bijkerk, 'Islamic finance and supervision: An exploratory analysis', DNB Occasional Studies 2008-6/3, pp. 21–24.
4 B Verhoef, S Azahaf and W Bijkerk, 'Islamic finance and supervision: An exploratory analysis', DNB Occasional Studies 2008-6/3, pp. 35–36.
5 For a discussion of the musharakah as a BV, see O Salah, Sukuk Structures: Legal Engineering Under Dutch Law, Eleven International Publishing 2014, pp. 73–82.
6 O Salah, Sukuk Structures: Legal Engineering Under Dutch Law, Eleven International Publishing 2014, pp. 24–25 and pp. 56–60.
7 ibid., pp. 122–128.
8 ibid., pp. 128–142.
9 See A Rozendal and A Westhoff, 'Een alternatief voor de financiering van Nederlands beleggingsvastgoed?', in O Salah (ed), Islamitisch bankieren: Van religieuze principes naar financiële transactiestructuren, Wolf Legal Publishers 2011, pp. 89–98.