law

how do you solve a problem like sharia? As Islamic financial products become increasingly popular, Kai Schneider of Latham & Watkins explains how to make a fund Sharia-compliant.

Despite the current the Sharia paradigm. The standard cinema, music and publications); economic crisis, there management structure of a private and weapons or military equipment. continues to be strong equity fund is permissible under However, the application of these demand for Islamic financial Sharia. The management fee is investment restrictions is subject products, including Sharia- considered an agency arrangement to differing interpretations. compliant private equity funds. The (where the fee is either a fixed While a Sharia-compliant fund Islamic finance market is currently amount, a percentage of capital may engage in leverage through estimated to be around $750bn commitments or a net asset the use of Islamic financing (¤600bn) globally and is expected value) and the carried interest instruments, it may not obtain to reach $1trn by 2010. Muslims, or performance fee is viewed as or provide conventional loans or who now number close to 1.3 billion a mudaraba agreement (a silent otherwise invest in conventional worldwide, are increasingly seeking partnership where one party Due to their interest-bearing instruments, religiously acceptable products in provides capital and the other including convertible debt which to invest. Conventional provides expertise and management investments securities. Cash held by a fund private equity fund managers have in return for a share of the profit). may only be invested in Sharia- the opportunity to access this Sharia-compliant private equity in equity and compliant, short-term investment growing investor base by offering funds are normally structured as products, such as Islamic money fund products that comply with limited partnerships. Since Sharia risk-sharing market instruments. Similarly, a Islamic principles. prohibits investments in preferred Sharia-compliant fund is subject Sharia, literally meaning “the shares, a corporate vehicle is between to restrictions on the amount of way”, is based on the Quran (the typically not feasible due to the conventional leverage permitted religious text in Islam), hadith (the existence of separate management investors and at the portfolio company level. sayings and actions of the Prophet and participating classes of shares. It is usually possible to purify Mohammed), ijma (the consensus As a result of their unique management, any haraam earnings of a fund by of Sharia scholars), qiyas (reasoning operating and investment separating them from the fund’s by analogy) and centuries of restrictions, fund managers also private equity legitimate profits and donating interpretation and precedent. frequently establish the Sharia- them to an approved charity. Sharia is also supported by other compliant fund as a parallel fund, funds fit A Sharia-compliant fund must principles advocating risk-sharing, which invests proportionately appoint a Sharia consultant or individual rights and duties, in portfolio investments on nicely within supervisory board that reviews property rights and the sanctity of substantially the same terms and proposed investments and contracts. Generally, in the context at the same time as a separate the Sharia operations, and issues opinions as of commercial activities, Sharia conventional fund. While the to their compliance with Sharia. prohibits riba (the collection and parallel fund will have the same paradigm They would also routinely review the payment of any predetermined fund manager and investment focus fund’s activities and produce a report guaranteed rate of return, such as the conventional fund, such a regarding ongoing Sharia compliance as interest) and investments in structure allows the fund manager (usually on an annual basis). industries that are haraam to provide a Sharia-compliant The interest in Sharia-compliant (against Islamic values). investment vehicle for investors funds from investors in the Muslim Sharia law does not have a without restricting the operations world will continue to grow. Fund uniform set of standards and of the conventional fund. managers seeking to access this interpretations. While some investor base will need to ensure institutions, such as the Bahrain- Investment Restrictions that their funds comply with their based Accounting and Auditing In order to qualify as Sharia- principles. While Sharia compliance Organisation for Islamic Financial compliant, a fund’s investment adds an additional layer of Institutions, work to unify the policy must contain restrictions complexity to a fund, traditional various interpretations and that prohibit investments in private equity funds are uniquely opinions of scholars, they have industries considered haraam. positioned to take advantage of no enforcement power. Haraam areas include conventional this growing market. Due to its investments in equity financial services; gambling and and risk-sharing between investors casinos; alcohol or pork products; kai schneider is corporate and management, the traditional certain entertainment, such as associate in the Dubai office private equity fund fits nicely within pornography (but often including of Latham & Watkins.

38 REALDEALS 27 November 2008