legal guide09.indd - Islamic Finance News

Structuring Shariah Compliant Funds
By Nabil A Issa and James Stull
While 2009 has presented challenges for the funds
industry amidst the global economic downturn,
a large number of investors in the Middle East
still see the value of pooling money into a fund to
acquire companies and properties globally that are
undervalued and available. Many investors in the
Gulf Cooperation Council (GCC) countries prefer to
make investments in a Shariah compliant fund rather
than a conventional fund for religious reasons.
As the Sukuk market has slowed and the amount
of available financing has receded, real estate and
private equity firms are increasingly turning towards
Shariah compliant funds to secure the capital from
these investors needed to acquire a stake in these
new investment opportunities.
However, while being Shariah compliant does
impose certain restrictions, in our experience, a
Shariah compliant fund is more marketable than a
conventional fund in the GCC. In particular, investors
in Kuwait and Saudi Arabia have a strong preference
for investing only in a Shariah compliant manner.
In general, nothing prevents a non-Muslim investor
from investing in a Shariah compliant fund. Therefore,
forming and offering a Shariah compliant fund opens
the fund to a wider pool of potential investors. In fact,
many potential non-Muslim investors appreciate
that such investments are being made ethically and
will not involve high-risk financial products.
A Shariah compliant fund operates like a conventional
fund, but several key differences exist:
• inability to make investments in companies in
sectors that are not Shariah compliant (haram),
• certain requirements that investors be treated
equally,
• inability to utilize conventional financing or invest
in companies highly leveraged with conventional
debt and
• requirement for oversight of fund activities and
investments by a Shariah board.
Restricted investments
Whether an investment fund is Shariah compliant
or not makes a significant difference as to how and
where the fund may invest its capital. A Shariah compliant
fund cannot invest in companies or assets that
are themselves not Shariah compliant.
Careful consideration must be paid to target
investment companies that could derive partial
income from unlawful or haram activities, such as
supermarkets, airlines, hotels and restaurants that
may sell pork or alcohol.
It is generally accepted that any haram income of a
non-compliant target company that does not exceed
5% of overall gross income is considered marginal
or incidental. The target company would then be
considered acceptable, provided sufficient cleansing
or income purification occurs in accordance with the
guidelines set forth by the Shariah board.
Restricted investments should not be a foreign
concept to most investors as most private equity
and real estate funds require diversification and
entirely restrict investments in certain arenas (or at
least restrict them to a percentage of commitments
to such fund).
Equal rights for investors
One of the key tenets of Shariah involves risk
sharing between the fund manager and investors
and amongst the investors themselves. One of the
fundamental principles of Shariah is that any loss by
the fund be borne by the investors proportionally
to their invested capital regardless whether the
investors hold different classes of shares in the fund.
However, it is possible to have a Shariah compliant
fund in which profits are not shared proportionally
to invested capital.
Shariah compliant financing
Avoiding interest (riba) and conventional debt is
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