Islamic finance and markets in France

Overview

In general terms, what policy has your jurisdiction adopted towards Islamic finance? Are Islamic finance products regulated differently from conventional instruments? What has been the legislative approach?

Islamic finance started to emerge in France towards the end of the millennium. The publication of the Jouini-Pastré report of 2008 was an indicator that France had finally realised the potential of the market. That same year, at the second conference held on Islamic finance, the then Minister of the Economy, Christine Lagarde, announced: ‘We wish to make Paris a better market for Islamic finance, particularly in this background of crisis, credit excess, volatility and cupidity.’ The Jouini-Pastré report suggested several reforms such as greater publicity, establishing legal and fiscal certainty for Islamic finance instruments, a stock exchange index of Islamic funds created by NYSE Euronext similar to the US’s S&P Shariah Indices, a strategy for the collecting of savings, the creation of a secondary market for sukuk, the development of Islamic insurance with products such as takaful and retakaful, making it easier for IFIs to obtain banking licences and teaching Islamic finance in French universities.

The challenge was and still is to incorporate Islamic finance in the French legal system and still respect its religious principles. The French legal system is relatively shariah-friendly. The concept of contractual freedom facilitates the transfer of the core concepts of Islamic finance. As a result, no specific amendments to French regulations appear necessary to accommodate Islamic transactions. For example, the French legal requirement for a determinable object of the contract, in accordance with article 1163 of the Civil Code, is similar to the prohibition of gharar; the concept of haram is also very similar to the rule of ‘public order’, etc.

Decree No. 2016-131 dated 10 February 2016 reforming the French Civil Code (the Reform of the French Civil Code), which entered into force on 1 October 2016 and was subsequently ratified by Law No. 2018-287 dated 20 April 2018, has reaffirmed and specified some of the core concepts of French civil law. Good faith has always ruled business relationships and has been reasserted as the leading principle governing the negotiation, execution and performance of any civil law contract. Like the haram principle, the existing ‘public order’ rule has also been reasserted (new article 1102 of the Civil Code as amended by the Reform of the French Civil Code, in addition to the existing article 6 of the Civil Code) as a limit to contractual freedom, this rule governing the negotiation, content and purpose of the contract. The Reform of the French Civil Code also introduced a new rule, in line with the maysir principle, according to which a court can force the parties to an agreement, the enforcement of which has become substantially unaffordable for one of the parties, to renegotiate the agreement in order to find a new economic balance; otherwise, the parties can agree to terminate the contract (new article 1195 of the Civil Code). Also, the Reform of the French Civil Code, in its article 1163 of the Civil Code, reasserts that any civil contract will need to have content that is certain or at least determinable (by indicating, for a purchase contract for example, the quantity or the quality of the goods), which is a rule ad valitatem (a court would rule that any such purchase contract that does not sufficiently determine the elements of the purchase is null and void). All the above principles have values in common with Islamic finance rules. As a result, no specific amendments to French regulations appear necessary to accommodate Islamic transactions.

Further, in the context of international transactions, Islamic finance can be implemented in France through international agreements. Pursuant to the Rome I Regulation, international agreements can refer to any law, even non-state law, on condition that this law is publicly known and accessible and that the author is impartial. Some sources claim that shariah law is insufficiently precise and accessible, and does not fulfil the above conditions; others say it can be applied by judges ruling on international agreements, the same as international custom and the lex mercatoria.

Nevertheless, in practice, the above situation seldom arises because judges apply a foreign law that incorporates shariah law or that can contain the same principles.

Shariah can also be applied pursuant to article 1103 of the Civil Code, which states: ‘Agreements lawfully established serve as law for those who have entered into them.’

Yet obstacles exist to the incorporation of Islamic finance in France. First, a good public relations campaign is necessary to overcome reluctance in some areas.

Second, French courts are not bound by the parties’ characterisation of their agreement and may reclassify it as another type of contract. If, for example, a judge were to characterise an agreement as a lease-to-own agreement, how could one justify the absence of reference to any interest provision or to the global effective rate, failing which the lender’s remuneration might be nullified?

Reforms would be useful to easily avoid double taxation.

Moreover, it appears that implementation of Islamic products or contracts can be effected through existing types of contracts. The only drawback is that it sometimes appears that the implementation of a shariah-compliant product under French law leads to a sophisticated structure, and this may increase the transaction costs compared with those incurred for their equivalent conventional products. This is why Islamic finance is, at this stage, an industry that needs to be further tested to be accepted and standardised.

How well established is Islamic finance in your jurisdiction? Are Islamic windows permitted in your jurisdiction?

Initially, French banks (Société Générale, BNP Paribas, Crédit Agricole) developed Islamic financial products respecting investors’ and regulators’ requirements outside France (for instance, Crédit Agricole financed a power station project in 2003 in Saudi Arabia using an Islamic contracting concept and Société Générale announced in 2013 that it would launch a US$300 million Islamic bond programme in Malaysia to acquire assets in Dubai; in 2017 Société Générale also started to offer Islamic finance services to private individuals in Morocco). We believe that Moroccan Chaabi Bank is the only Islamic banking institution acting in France for the time being, offering, inter alia, a deposit account service and real estate products.

In recent years, however, there have been a number of innovations introducing shariah-compliant products to the French market:

• in 2010 the first lease-to-own agreement was made by Groupe 570;
• since 2010, easi570 (part of Groupe 570) has provided advice in real estate, savings and insurance;
• in 2011 France Sukuk Courtage, a French company created by Xavier Merten, introduced a savings product;
• in 2011 a subsidiary of Morocco’s Groupe Banque Populaire, Chaabi Bank, introduced an account agreement named Harmonis;
• in July 2012, Swiss Life created Salam-Epargne & Placement, an insurance contract;
• in 2013, XL Group created insurance for companies;
• in 2013, Vitis Life created Amâne Exclusive Life, life insurance dedicated to French residents;
• in 2014, Easi Up (created by easi570) and Aon set up the first crowd-funding shariah-compliant platforms in France;
• in 2015 Azurite Courtage created takaful insurance products for French residents; and
• during 2016 and 2017, Noorassur, a company that used to offer online shariah-compatible products, opened several offices around the country; Noorassur offers takaful insurance products (the protection can cover the Hajj) and shariah-compatible savings (for weddings, study, pensions, etc).

It is possible in France to invest in haram products provided they abide by the ‘public order’ rule (new article 1102, paragraph 2 of the Civil Code amended by the Reform of the French Civil Code: ‘Contractual freedom cannot derogate to the public order’).

The first Islamic funds, created by two banking groups’ subsidiary firms, were approved by the Financial Markets Authority in 2007. On 17 July 2007, the authority published a report authorising, under certain conditions, the creation in France of Islamic undertakings for collective investment in transferable securities (UCITS) (amended on 9 January 2013). More precisely, French UCITS may:

• take into account non-financial requirements for the selection (by developing, for instance, indices management based on shariah-compliant indices such as the Dow Jones Islamic Index, FTSE Islamic Global Index or the S&P Shariah Index);
• erase the ‘impure’ part of dividends by donating to organisations serving the public interest (Institut du Monde Arabe) for up to 10 per cent of their income; and
• ask for shariah boards to give an opinion on the securities chosen by the UCITS management company on condition that the board does not affect the company’s autonomy.

Following this report, BNP Paribas created the first indexed Islamic UCITS under French law.

An Islamic fund may also take the form of an alternative investment fund.

Islamic finance has also been promoted in France to attract Muslim capital from abroad. Thus the management company La Française AM launched a shariah-compliant property investment mutual fund in May 2012 to respond to the requirements of a Kuwaiti bank that wanted to acquire offices rented to France Télécom. Furthermore, in April 2018, the group La Française continued its efforts to establish a long-term presence in the Middle East through its affiliate La Française Forum Securities, which launched its first mandate dedicated to shariah-compliant real estate investment.

Nowadays, shariah funds make up a significant part of ethical funds in France.

What is the main legislation relevant to Islamic banking, capital markets and insurance?

To date, no specific set of rules in France concerning Islamic finance has been issued. France’s legal system is secular and governed by a principle of non-discrimination. However, Islamic banking operators and transactions are regulated by French banking law (mainly provided for under the Monetary and Financial Code). Regulations applicable to insurance operators and transactions are stipulated within the Insurance Code. Capital market transactions and operators are subject to the regulations provided in the Monetary and Financial Code and the Financial Markets Authority’s General Regulation.

European regulations relating to banking, insurance and capital markets are also applicable.

Supervision

Which are the principal authorities charged with the oversight of banking, capital markets and insurance products?

The Financial Markets Authority is in charge of supervision of investment service providers (asset management, etc).

The Prudential Supervisory Authority is in charge of supervision of banking institutions and insurance enterprises.

Identify any notable guidance, policy statements or regulations issued by the regulators or other authorities specifically relevant to Islamic finance.

Non-mandatory rules have been enacted to promote Islamic finance in France.

On 17 July 2007, the Financial Markets Authority adopted a notice, ‘Extra financial requirements for the selection of securities: situation of UCITS declaring themselves shariah-compliant’. This notice was amended on 9 January 2013. Another notice, regarding the ‘Relevant criteria for sharing UCIs’, was adopted on 7 November 2012.

It also published guidelines on ‘Admission to trading of Islamic notes (sukuk) on the French regulated market’ on 2 July 2008 and a ‘Q&A pertaining to the articulation of sukuk prospectuses and practical procedures for securing approval for the admission to trading on a regulated market’ on 27 October 2010.

The ‘Code of transparency’ for socially responsible investment funds open to the public may also apply when the criteria of the fund comply with those of socially responsible investments.

Tax directives were enacted on 25 February 2009 (replaced by further directives dated 23 July 2010, published on 24 August 2010) to clarify the tax regime for certain Islamic products and to assure Islamic institutions wishing to operate in France that they will receive the same treatment as conventional financial institutions.

Is there a central authority responsible for ensuring that transactions or products are shariah-compliant? Are IFIs required to set up shariah supervisory boards? May third parties, related parties or fund sponsors provide supervisory board services or must the board be internal?

No regulation imposes the obligation to establish a shariah board in an Islamic bank, or an insurance or market services institution. As a matter of French law, each could validly exist without any shariah supervisory board.

If a shariah board is established, companies must ensure that the creation or functioning of the board will not breach any mandatory rule. For example, in the investment services sector, board members will need to clear any potential conflict of interest with the asset management company. In addition, the independence of the management company must be preserved in all circumstances.

Do members of an institution’s shariah supervisory board require regulatory approval? Are there any other requirements for supervisory board members?

There are no specific provisions for shariah boards under French law.

What are the requirements for Islamic banks to be authorised to carry out business in your jurisdiction?

Islamic banks must be licensed to operate by the Prudential Supervisory Authority pursuant to article L511-10 of the Monetary and Financial Code, unless they can rely on a European passport and would thus be registered as such.

To be licensed, Islamic banks must fulfil the requirements set out in the Monetary and Financial Code, in particular to achieve their objectives without distorting the correct functioning of the banking system and depositor protection.

May foreign institutions offer Islamic banking and capital markets services in your jurisdiction? Under what conditions?

Islamic banking and capital market services are not the subject of a specific set of rules, and therefore need only comply with the requirements applicable to the type of product marketed (banking or investment services). Foreign institutions may enter the banking or capital market services market on the condition that they are licensed to operate (see question 10).

Pursuant to article 2 of Law No. 2008-496 of 27 May 2008 and article 225-1 of the Penal Code, Islamic finance shall not lead to any discrimination. For example, in the UCITS sector, relations between investors must not be the subject of a discriminatory condition relating to religion, proven or suspected, between them. Distribution falls under article 225-2 of the Penal Code, which states that it is an offence to provide or refuse to provide a good or service based on religion. The Financial Markets Authority clarified its position in 2000: article 225-2 also applies in the context of cross-border marketing of UCITS shares, as article 19 of the Treaty on the Functioning of the European Union establishes the principle of non-discrimination.

Compliance with this legal provision is to be tested at different levels: first, the distributor of UCITS shares may not give preferential treatment to Muslim clients, or reserve the investment in shares to Muslim clients or, conversely, refuse to allow non-Muslims to invest in shares or even impose conditions relating to religious practice.

Second, publishers of promotional material must also adhere to this principle and not suggest that the funds are reserved for Muslim investors.

Finally, this principle must be complied with when determining the fees required from investors for the purchase or sale of their shares.

What are the requirements for takaful and retakaful operators to gain admission to do business in your jurisdiction?

Since, under French law, takaful should be considered an insurance product, takaful and retakaful providers would presumably be considered as operating in the insurance and reinsurance sector. As a result, they must be licensed in accordance with the Insurance Code, and comply with the constraints imposed on any insurance or reinsurance enterprise.

How can foreign takaful operators become admitted? Can foreign takaful or retakaful operators carry out business in your jurisdiction as non-admitted insurers? Is fronting a possibility?

Assuming takaful can be compared to insurance, takaful or retakaful operators must be admitted as insurers or reinsurers. However, a distinction must be made between foreign takaful operators established in a member state of the European Union and non-EU enterprises.

Foreign takaful operators having their head office in the EU, and licensed to operate in a member state, benefit from European passports and may operate in other member states within the limits set out in their licence. They are only required to inform the regulator about their plans for doing business in France. This also applies to takaful operators licensed in EEA member states.

Foreign takaful operators whose head office is located outside the EU must comply with another regime. If they are licensed in Switzerland, they need to establish themselves in France, meaning that the free provision of services rule is not applicable. Those located outside the EEA need to establish themselves in France and be licensed by the Prudential Supervisory Authority.

Are there any specific disclosure or reporting requirements for takaful, sukuk and Islamic funds?

No, they need only comply with the regulations applicable to any operator in the relevant sector.

What are the sanctions and remedies available when products have been falsely marketed as shariah-compliant?

Pursuant to article L533-12 of the Monetary and Financial Code, the management company of Islamic funds must ensure that all information is true, clear and reliable. The provisions of this article were completed by Decree No. 2016-827, in effect since January 2018, providing further that the management company shall also ensure that such information is comprehensible to potential investors so that they can properly understand the nature of the investment and assess the underlying risk. Thus, and regarding the above duties, if the marketed religious information is false or unreliable the company can face administrative penalties (disciplinary, monetary or both) adjudicated by the Financial Markets Authority Disciplinary Commission.

Further, the management company can also be responsible for non-pecuniary harm when investors’ religious beliefs are undermined.

An investor that has suffered harm should be entitled to require the rescission of the shares’ subscription on the grounds of non-performance of the delivery obligation resulting from the agreement of the parties, or its nullification on the grounds of errors concerning essential qualities (defined in the new article 1132 of the Civil Code) or fraud.

When a shariah board has falsely marketed a product as shariah-compliant, and should the management company that had applied the board’s recommendations be held liable by a court, the management company may, as a consequence, seek compensation before a court from the board.

Which courts, tribunals or other bodies have jurisdiction to hear Islamic finance disputes?

According to the French core principles, any dispute (whether Islamic or not) is to be brought before the state courts. The court being competent to hear the dispute is determined as per the rules of territorial and subject-matter competence. However, based on our experience, most arrangements related to Islamic finance transactions governed by French law include an arbitration provision.

Contracting concepts

Mudarabah - profit sharing partnership separating responsibility for capital investment and management.

Mudarabah can be implemented under French law through a limited partnership (governed by article L222-1 of the Commercial Code), whereby the sleeping partner (ie, the rab-al-mal, the investor) brings the equity funding and the other party, the active partner (ie, the mudarib, the manager), brings expertise.

Murabahah - cost plus profit agreement.

Murabahah is treated under French law as a credit transaction, and the murabahah financier must first be licensed to pursue credit transactions in France (or allowed to pursue them with its European passport), and particular attention must be paid to the financier’s compliance with the regulations for financial institutions, credit transactions and the package securing the repayment.

The main uncertainty derives from the tax treatment of the transaction as, in principle, each transfer should be subject to taxation (for both the seller and buyer). However, as regards transactions over real estate or securities representing real estate, transfer taxes are almost neutralised, since from the financier’s perspective the transaction can be completed under the special regime of property trading. In this case, the purchase transaction by the bank is subject to a registration fee of 0.715 per cent and is exempt from tax duty of about 5 per cent. Further, murabahah over securities representing real property are exempted from registration fees. However, the investor will still incur registration fees upon the purchase of the securities from the financier.

Concerning the financier’s remuneration, a tax directive dated 23 July 2010 (4 FE/S1/10) provided useful clarification as to the murabahah’s tax regime, stating in particular: ‘Currently, the financier’s payment is comparable to interest owed in a conventional financing.’ The rules relating to the taxation of interest should be complied with accordingly. The other components of the price are still taxable pursuant to the general rules. As a consequence, the financier’s revenue and commissions are not characterised as a capital gain from a tax perspective.

The financier may benefit from this regime only if licensed to operate in France as a credit institution or an investment service provider. Therefore, the government’s position allows Islamic financial institutions to be treated the same way as conventional banks.

Payment deferral can be validly secured by collateral.

Musharakah - profit sharing joint venture partnership agreement.

Under French law, a musharakah can be implemented through a joint venture type arrangement or a partnership company. The partnership company meets the principles of sharing profit and loss and of equal treatment. It may also be implemented by way of a common law equity loan, as provided by article 313-13 of the Monetary and Financial Code.

Specific attention should be paid to the implementation of a diminishing musharakah through a partnership, as the repurchase of the shares may only be reached through a shareholders’ agreement.

Ijarah - lease to own agreement.

Ijarah can be implemented under French law through a leasing transaction. If the lessee is granted a call option over the asset or if it undertakes to purchase the asset, the transaction shall be classified as a credit transaction as per article L313-7 of the Monetary and Financial Code. Therefore, the financier should be licensed to operate as a credit institution in France (including through a European passport under certain conditions). Furthermore, French case law has recently been stricter with lessors. A decision rendered on 13 April 2018 by the French Supreme Court (Cour de Cassation) considered that if the asset does not comply with the lessee’s order (in a non-consumer transaction) the sale agreement would be considered null and void and the leasing agreement would follow, without any indemnification for the lessor, whose last resort would be to hold the original seller liable in tort for any damage suffered.

In the event that an ijarah is completed in favour of a consumer, there are contractual structures that are prohibited under French consumer law. In addition, the mandatory provisions of the Consumer Code, which also govern the content of the agreement itself, must be complied with in all circumstances.

A sale with retention of title is perfectly feasible under French law. In such case, the financier agrees to immediately sell the asset while retaining its ownership until full payment. If made on a habitual basis, it will be a credit transaction. The drawback is that, as per case law, the seller would be liable for any hidden defect notwithstanding any provision to the contrary even in the context of a transaction with a non-consumer.

The ijarah tax regime has been clarified by the tax directive dated 23 July 2010 (4 FE/S3/10).

Wadiah - safekeeping agreement.

A wadiah can take the form of a deposit agreement governed by the Civil Code. It is ‘in essence’ a gratuitous contract (article 1917 of the Civil Code). Hence, it may validly be agreed that the depositary merely undertakes to return the asset; the depositor bears the risk of loss or profit. The parties can validly agree that the depository must make a gift (hibah) in lieu of remuneration.

The return of the asset to the depositor (or more precisely the indemnification obligation owed where the asset is finally not returned) may be secured by collateral.

Wadiah can be structured through a French trust. In this case, the trustee would hold the asset in a special purpose reserve that is bankruptcy-remote. In the event of a breach or misuse of funds, the trustee could be held liable to the grantor.

Products

Sukuk - Islamic securities. Have sukuk or other Islamic securities been structured and issued in your jurisdiction to comply with Islamic principles, such as the prohibition of interest?

The French government, as well as the Financial Markets Authority, has promoted sukuk-type securities to attract Islamic investors. To our knowledge, only a few transactions have been completed in France to date and no sukuk sovereign issuance has been accomplished by the French government. A 2010 tax directive clarified the tax regime applicable to sukuk (4 FE/S2/10).

Although France can certainly be considered an emerging market, sukuk can be structured in compliance with both French law and shariah principles, particularly the prohibition of interest rule. Participative bonds, which share characteristics with equity shares, meet this requirement.

At present, the discussion around compliance with shariah principles is focused on the needs for the sukuk holders to have an interest in the underlying assets. In this respect, the French trust has been considered unsatisfactory on the grounds that the beneficiaries would only benefit from a jus ad rem as opposed to a direct interest in the asset. However, it has been observed that the nature of the rights of the beneficiary of a trust of common law jurisdictions is still debated, scholars sometimes maintaining that it holds a mere jus ad rem, while sukuk created through a trust appears to be shariah-compliant and, according to shariah principles, it would be sufficient for sukuk holders to hold an ‘indirect’ right of ownership over the underlying asset, which would mean that a mere jus ad rem would comply with such principles. In our opinion, the requirements of Islamic law should be analysed in the light of the French principles of personal and real property, which are significantly different from common law jurisdictions in particular.

What is the legal position of sukuk holders in an insolvency or a restructuring? Are sukuk instruments viewed as equity or debt instruments? Have there been any court decisions or legislation declaring whether sukuk holders are deemed to own the underlying assets?

From a French tax perspective, sukuk should be structured as debt instruments. Their position would be better off than under an equity instrument structure. Should sukuk be structured though a French trust structure (see question 20), this would then allow the sukuk holders to have a priority right over the underlying assets.

To our knowledge, no court decision relating to this matter has been rendered in France to date.

Takaful - Islamic insurance. Are there any conventional cooperative or mutual insurance vehicles that are, or could be adapted to be, shariah-compliant?

The emergence of takaful products in France is still questionable. Unless the market can be convinced that takaful is able to meet a specific demand (for ethical products or investments), conventional insurance will probably remain the most attractive option for the client.

Which lines of insurance are currently covered in the takaful market? Is takaful typically ceded to conventional reinsurers or is retakaful common in practice?

The takaful market exists on French territory but it is very limited.

Miscellaneous

What are the principal regulatory obstacles facing the Islamic finance industry in your jurisdiction?

As Islamic finance is an emerging market in France, there are currently no regulatory obstacles in place that would affect the development of this industry.

On the contrary, as banking institutions in France do not currently cover all of the finance market demands, the system is structured to enable and facilitate Islamic investors.

In what circumstances may shariah law become the governing law for a contract or a dispute? Have there been any recent notable cases on jurisdictional issues, the applicability of shariah or the conflict of shariah and local law relevant to the finance sector?

See question 1.

Are there any special considerations for the takeover of an Islamic financial institution, outside the requirements of the general merger control regime?

No.

Are there any notable features of the Islamic finance regime and markets for Islamic finance products in your jurisdiction not covered above?

With nearly 6 million French Muslim citizens, France is the European country that has the biggest growth potential in terms of Islamic retail banking. In particular, in recent years, numerous French real estate properties - mostly in Paris, but also in the French Alps and on the French Riviera - have been financed by Islamic products (generally offered by foreign banks). Most of the investors, acting through Islamic finance products in the French real estate market, are Middle Eastern residents. However, French residents are also more and more active in this market - for instance, investors working in the sport or media industries. In view of this situation, various foreign Islamic banks are considering establishing a direct subsidiary in France, especially in the context of Brexit.

Updates and trends

Are there any proposals for new legislation or regulation, or to revise existing legislation or regulation? If so, please give a reference to any written material, whether official or press reports. Are there any other current developments or trends that should be noted?