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Insights and Commentary from Dentons

On March 31, 2013, three pre-eminent law firms—, Fraser Milner Casgrain, and SNR Denton—combined to form Dentons, a Top 10 global with more than 2,500 lawyers and professionals worldwide.

This document was authored by representatives of one of the founding firms prior to our combination launch, and it continues to be o ered to provide our clientsG withro thewing information with they need to do business in an increasingly complex, interconnected and competitive marketplace.

The role of government has never been more critical Cross-border - - - ). ). Is Maliki, fiqh Hanafi, www.practicallaw.com/6-501-4862 . On a practical level, this means . that, this means On level, a practical fiqh mujtahid. The process of reasoning is performed fiqh are divided into Sunni (majority) and Shi’a Should be free from unjust enrichment. Must be free from any major uncertainties. Must be based on the true consent of all parties. Must be an integral part of a real trade or economic activity such as a sale, lease, manufacture or partnership. Analogy (qiyaas). Reaching a decision based on the public good. Public need or necessity (permitting short-term violations of Public need or necessity Sharia rules). Combination of contracts. Deviation from strict Sharia rules. „ „ „ „ „ „ „ „ „ Shafi and Hanbali. The Ithna ‘Ashari is the main Shi’a school. lamic scholars carry it out. While there are many areas of consen of areas many are there While out. it carry scholars lamic of method their on depending opinions different have scholars sus, or of school reasoning the under terms contractual certain allow may scholars some while unacceptable. be to terms these find may scholars other Sharia, The schools of (minority). There are four main Sunni schools: The Sharia encourages trade, investment and freedom of con- tract. It links lawfulness of gain to risk-sharing: gain is morally justified only when a person shares the risksparty fromone anif enterprise unjust is It counter-party. or partner person’s that with has all the risk of loss while both parties share in any gains. The Sharia stresses ethical and equitable dealings between the par ties and fairness in the transactional process. Interpreting Sharia is known as Islamic jurisprudence ( To be Sharia-compliant an investment transaction: To Principles of Sharia compliance What is the Sharia? The Sharia means the path or the sources Divine of Law. the There Sharia: are the two Quran and the for Sunnah. Muslims is The the word of Quran Allah (God) revealed to Prophet - Mu hammad (pbuh) through Archangel Jibril (Gabriel). The Sunnah means Prophet Muhammad’s (pbuh) statements, acts and ap- provals. specific with deal to interpreted been have sources primary These process the as to referred commonly is This issues. and situations of reasoning (Ijtihad) which is undertaken by a qualified person, who is called a through: „ „ „ „ „ „ „ „ „ Cross-border Investment Funds 2011 2011 Funds Investment Cross-border PLC and is reproduced with the permission of the publisher, Practical Law Company. Company. Law Practical publisher, the of permission the with reproduced is and © This article was first published in the the in published first was article This © ompliant fund? c haria- S

What is the Sharia? Principles of Sharia compliance. Structuring a Sharia-compliant investment fund. Marketing a Sharia-compliant investment fund. What a Sharia-compliant fund is. Allowable investments for Sharia-compliant funds.

„ „ „ „ „ „ This chapter considers the following: Innovative structures have also developed, including funds, exchange traded funds and listed real estate funds. funds of Before the credit crunch there was evidence of the appetite increasing for geographical diversification, with global mandates growing from 19% in 2006 to 34% in 2007. An article entitled “Key Trends in Islamic www.eurekahedge.com Finance states the 2008” overall on assets under manage - ment in Islamic funds are roughly US$59 billion non-reporting funds). The average fund (considering size in Saudi Arabia now million. US$100 is this Kuwait in and million US$170 at stands In contrast, the average fund size is US$44 million and US$10 million in Malaysia and Indonesia respectively. According to the May 2009 Ernst & Young Islamic Funds & - In vestments Report, Sharia sensitive investable assets in 2008 in the Gulf Cooperation Council (GCC) and Asia touched US$736 This EUR0.7). about was US$1 2010, November 1 at (as billion translates into a potential annual revenue pool of US$3.86 bil- lion for the Islamic asset management industry. While many Middle Eastern investors are still willing to put mon- put to willing still are investors Eastern Middle many While ey into conventional investment funds, there has been a marked growth in the numbers of investors who wish only Sharia-compliant investment funds. to invest in Sharia funds and Sharia-compliant investments are of increasing increasing of are investments Sharia-compliant and funds Sharia interest to global Islamic investors and financiers (both Sharia- compliant and conventional). In particular, financiersand funds wealth sovereign at aimed products create to potential see the high net-worth individuals in the Middle East and other Islamic countries. This section considers: What is a A fund is Sharia-compliant if a Sharia board has issued an Is- lamic juristic opinion (fatwa) declaring that it is compliant (see box, Sharia supervisory boards).

Muddassir Siddiqui, Rosali Pretorius and Richard de Belder Rosali Pretorius and Richard Muddassir Siddiqui, SNR Denton Sharia-compliant funds Sharia-compliant Investment Funds Handbook 2011 Handbook Funds Investment Cross-border „ „ „ „ „ „ Investment Funds Handbook 2011 Cross-border

Sharia supervisory boards A Sharia supervisory board usually comprises at least three Nonetheless, a structure and documents approved by one eminent scholars with expertise in finance and the Sharia. In Sharia supervisory board may not be acceptable to another. This some jurisdictions, it is a compulsory requirement that a Sharia- is because there are different Sharia schools of thought which compliant fund established in its jurisdiction has a Sharia interpret the Sharia in different ways. Therefore, it is important to supervisory board. If the fund is being promoted by an Islamic know the current position of the Sharia supervisory board members financial institution that already has its own Sharia board, there of an Islamic financial institution involved in a transaction before is an argument that it would be prudent to appoint a separate finalising a structure and preparing the draft documentation. Sharia supervisory board for the fund, although this often does not happen in practice. The fund prospectus will describe who the members of its Sharia supervisory board are. There will also be Sharia audits which will The role of Sharia supervisory boards is crucial for Islamic finance. The certify the investment manager has complied with the fund’s Sharia supervisory boards decide whether a structure or document is investment restrictions. Sharia-compliant. The fatwa of a Sharia supervisory board provides assurance to the Islamic financier, its customer and investors that Even where a fund’s constitutional documents restrict the fund’s they are entering into a permissible (halal) transaction. activities to Sharia compliant activities, the issue of a fatwa by a Sharia supervisory board does not guarantee that a structure, or A fatwa is a Sharia opinion issued by the Sharia supervisory board transactions under it, will be immune to challenge for not being that it considers the structure and documentation of a transac- Sharia compliant. In the recent English case The Investment Dar tion to be Sharia-compliant. Normally, it will list the documents Company KSCC v Blom Developments Bank Sal [2009] EWHC that it has reviewed and describe the structure and possibly any 3545 (Ch), The Investment Dar Company KSCC (TID) alleged key areas, especially those that are novel. The Sharia supervisory that a wakala structure, which had been approved by its Sharia board will also approve the investment guidelines to be used by supervisory board, did not comply with Sharia principles. As TID an investment manager and any changes the investment manager was prohibited by its constitutional documents from entering wants to make in the future. It is important, early on, to start into non-Sharia compliant activities, TID claimed that the wakala discussions with the members of the proposed Sharia supervisory structure was ultra vires and therefore unenforceable. The court board to ascertain their views and agree that there are no delays in held that TID had an arguable defence. The case, however, was getting the structure and documentation approved. procedural only and the issue was not determined by a full trial.

The Sharia scholars have worked to try and come to agreed positions on several matters. The most prominent forum is the AAOIFI, which produces standards on a range of Islamic finance instruments.

„„ Must not be used to promote businesses or activities which is viewed by the Sharia as lacking the mutual consent of are viewed by the Sharia as inherently harmful for human the parties. Therefore, the Sharia does not allow a contract health, human spirit or the social fabric. where the existence, price, quantity or characteristics of the goods for sale are unknown or unspecified. These objectives of the Sharia are carried out through regulating: Cross-border A contract will also be unacceptable if there is an obligation „„ Usury (riba) and other factors which promote financial that is conditional on an uncertain or ill-defined event oc- exploitation. Riba literally means increase, addition, expan- curring outside the control of the parties. Terms have been sion or growth. Most Sharia scholars consider the taking or struck down under this principle that oblige a party to pay giving of interest to be usury. Islam considers usury as in- extra amounts to take into account inflation (on the basis herently unjust because it allows a financier to gain without that the level of inflation is not known when the contract is sharing in the risks associated with the transaction. There- entered into). Under a strict interpretation of the Sharia, the fore, charging interest merely through lending is prohibited. principle of gharar and jahalah (also a form of uncertainty) However, a financier is allowed to increase its wealth if it would also cover contracts of insurance, credit derivatives shares in the risk of a trading or investment transaction and and other contracts where the subject matter does not exist takes on the opportunity to receive a profit or incur losses when contracting. arising out of that trade or investment. Every contract contains some uncertainty. How much un- Therefore, riba means any increase in a loan transaction or certainty is acceptable is left to the judgment of the Sharia a gain from a debt which merely arises through the passage scholars. Their decisions reflect changing times and the of time by reference to the use of money itself. customs of a particular trade.

„„ Uncertainty in speculative activities (gharar). Transactions „„ Gambling. involving excessive gharar, the sale of risk itself, gambling „„ Risk sharing. (maisir) or any other zero sum transaction in which one party must lose for the other to make a gain are all banned „„ Anything which hinders equality between contractual parties. under the Sharia. „„ Wrongdoing such as fraud, duress or deception. Any contract that has a prohibited degree of uncertainty

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able investments for alcohol; tobacco; gambling; weapons; and insur conventional financial services such as banks ance companies. w „ „ „ „ „ Prohibited industries, including: (such as debt Investment in interest-bearing instruments or futures. securities), or financial products like options Therefore, no conventional hedging is allowed. Some funds have copied traditional hedging techniques using wa’ad this is an area of intense and reverse murabaha. However, debate between Sharia scholars. - of the Muslim com conditions and affairs The prevailing from the to remove them ) and the need munity (Ummah in conventional employed and oppression of riba unjustness structures. investment „ „ „ „ „ llo „ „ „ Due to these restrictions, many Sharia-compliant funds tend to focus on the technology, telecommunications, real estate, phar maceutical and oil and gas sectors. Strictly applied, the restriction on investment in companies car rying out non-Sharia-compliant activity would rule every out company, since most almost companies have some form of non- Sharia-compliant borrowing, even if it is only an interest-bearing overdraft. Therefore, Sharia scholars have developed “screening screen- various the between differences some are There criteria”. ). investment equity for methods Screening box, (see methods ing The set of screening criteria that a particular fund will follow de- board. Sharia its of approach the reflects best set which on pends Investment in real estate Sharia-compliant a in used be must buys fund the estate real Any manner. This means there can be problems in that activities business undertaking are occupants the buying where erty a prop- or gambling as (such Sharia the with accordance in be not would the sale of alcohol). A be Sharia-compliant, To a investment guidelines fund’s strategy, investments the that ensure to designed be must restrictions and are compatible with Sharia principles, a is What above, (see gambling and uncertainty interest, on tions including the prohibi- Sharia-compliant fund: Principles of Sharia compliance). These to continue and made, first is investment the when apply criteria holds the investment. apply while the fund investment and investment equity to apply considerations Different section this addition, In below. considered are which estate, real in and fund, a by received income “purifying” of issue the considers level. fund the at leverage interest-bearing of issue particular the Equity investment be- Sharia-compliant, inherently considered is investment Equity cause ownership of a share in a company is considered to be a proportionate share in the ownership of the underlying business and assets of the company. However, the consequence of view is this that it is not permissible to invest in a company that car such as: ries on a non-Sharia-compliant activity, pliant funds „ „ „ - - - about this publication, please visit please publication, this about ). will haram about Practical Law Company, please visit visit please Company, Law Practical about al-inah’ contract. In this see above, Principles see of above, Principles Sharia see box, Sharia supervisory boards supervisory Sharia box, see ). However, it must be stressed that the prohibited action action prohibited the that stressed be must it However, ). pornography; kill the innocent sales of arms which indiscriminately and the guilty alike; casinos/gambling. alcohol; pork-related products; tobacco; services; conventional financial „ „ „ „ „ „ „ not be Sharia-compliant. Any financing for materials or activities which are which activities or materials for financing Any The need to develop Islamic finance (which is still in its infancy) as an alternative and viable financing system within the legal constraints derived from the applicable governing law in Muslim and non-Muslim countries alike. Harmful and socially offensive activities (haram). Sharia socially offensive activities Harmful and materials or activities. in certain goods, forbids trading Examples include: „ „ „ „ „ „ „ „ „ For more information more For Islamic finance may allow a deviation from strict Sharia rules in certain circumstances. This is because of: Deviation from strict Sharia rules sory board will need to provide guidance on whether structuring the the structuring whether on guidance provide to need will and board sory principle this infringe would transaction a in documents a in various result would contracts Sharia-compliant two of combination the ( transaction prohibited An example of such a contract is an supervi Sharia applicable the transaction, each with that, likely is It Combination of contracts The combination of contracts can give rise to particular issues: the Sharia allows one Sharia-compliant contract to be combined with another Sharia-compliant contract but only if this combina- tion does not result in a prohibited transaction. contract the buyer buys something from the seller on a deferred payment basis at an agreed price. The buyer then sells the item to the seller at a lower cash price which is payable immediately. Although the Sharia allows both buying and selling for cash or deferred payments, combining these two contracts results in the buyer receiving an immediate payment of cash from the seller in return for the seller being paid more cash on a deferred basis. The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) has issued Standard No. 25 dealing with this subject. (The AAOIFI is based in Bahrain. It has statutory standing in Bahrain and in some other countries. But it is con- sidered by the Islamic finance industry as setting benchmarks should structures and transactions finance Islamic which against be judged, regardless of whether it has statutory standing in the country whose laws govern those transactions and structures.) It may be possible to deviate from Sharia rules in certain circum in rules certain Sharia from It to may deviate be possible Public need or necessity to returning to view a with and resort last a as done be only should possible. as soon as limits Sharia the of implementation strict the stances, for example because of public need or necessity. This al This or need necessity. of public because for example stances, and time limited a for and circumstances extreme in person, a lows to purpose, a violate Sharia rule ( compliance Investment Funds Handbook 2011 Handbook Funds Investment Cross-border „ „ Investment Funds Handbook 2011 Cross-border

Screening methods for equity investment

Dow Jones Islamic Market Index „„ 3/4/2 The collective amount raised as loan on interest - whether long-term or short-term debt - does not exceed 30% This provides an index for acceptable companies for investment. of the market capitalisation of the corporation, knowingly that For a company to appear on the index, each of the following raising loans on interest is prohibited whatever the amount is. amounts must be less than 33%: „„ 3/4/3 The total amount of interest-bearing deposits, „„ Total debt divided by trailing 12-month average market whether short-, medium- or long-term, shall not exceed capitalisation of the company. 30% of the market capitalisation of total equity, knowingly „„ The sum of the company’s cash and interest-bearing that interest-bearing deposits are prohibited whatever the securities divided by trailing 12-month average market collective amount is. capitalisation of the company. „„ 3/4/4 The amount of income generated from prohibited „„ Accounts receivable divided by trailing 12-month average components does not exceed 5% of the total income of market capitalisation of the company. the corporation irrespective of whether the income is being generated by undertaking a prohibited activity, by owner- Accounting and Auditing Organization for Islamic Financial ship of a prohibited asset or in some other way. If a source Institutions (AAOIFI) of income is not properly disclosed then more effort is to The AAOIFI has issued its own Standard (item 3 of Sharia Stand- be exerted for identification thereof giving due care and ard No. 12), which describes the permitted limits: caution in this respect.

„„ 3/4/1 The company that has issued the shares does not „„ 3/4/5 For the determination of these percentages, recourse state in its memorandum of association that one of its is to be had to the last budget or verified financial position. objectives is to deal in interest, or in prohibited goods or materials like pork (swine) and the like. There are other screening methods, such as those issued in Malaysia.

Various screening rules can be used to analyse what proportion of pliant income does not exceed 5% of the total income of the fund income from a property is non-Sharia-compliant, but is still suf- or portfolio company. ficiently acceptable for the underlying property investment to not be regarded as “tainted” (see above). Therefore, many Islamic Some scholars believe the same concept of purification also ap- real estate funds invest in real estate where the chances of these plies to capital gains, to the extent that the market price of the problems arising are limited, such as: stock incorporates any distinct element of interest.

„„ Office space (although City of office space can be a Islamically compliant leverage problem when the tenant is a conventional financial institution). The use of interest-bearing leverage at the fund level is obviously „„ Commodity warehouses. problematic for Islamic investors, given the use of debt finance in most typical buyout structures. Therefore, any leverage used by In some GCC countries it is not possible for non-residents to in- the fund must be provided in a Sharia-compliant manner. vest in real estate other than, for example, hotels. However, the Cross-border Sharia requires that all investors take a risk in the underlying as- While funds can make direct equity investments funded by us- sets. This represents a real dilemma for a Sharia-compliant fund ing traditional Sharia-compliant finance techniques, there are which wishes to market investment in GCC real estate to GCC and also some Sharia-compliant leverage structures that adapt these foreign investors, and has caused some debate among scholars. techniques to enable conventional leverage. The choice of struc- ture will typically depend on tax and commercial considerations. Purification Lease (ijara) structures can be used in leveraged buyouts, but Screening criteria are not intended to sanction prohibited activi- cost-plus financing (murabaha) structures have also been used. ties. Islamic investors are under a duty to object to the use of interest-bearing debt. Some Sharia scholars take the strict view Structuring a Sharia compliant that if an Islamic investor gains control of a portfolio company, it investment fund must undertake to repay all the company’s interest-bearing debt within three years of the acquisition. The AAOIFI defines investment funds as follows: “Funds take the form of equal participating shares/units, Despite applying screening criteria, income received by the fund which represent the shareholders’/unitholders’ share of the (and, in some scholars’ view, capital gains on investments) must assets, and entitlement to profits or losses. The funds are man- still be “purified”: a process that involves quantifying the amount aged on the basis of either a mudaraba or wakala contract.” attributable to non-Sharia-compliant elements (such as surplus cash invested in interest-bearing temporary investments) and giv- In practice, funds are usually structured as a wakala but can also ing that amount to a charity. This can be done either by the fund be structured as a mudaraba. or, often, by investors themselves. To the extent that a fund or a portfolio company conducts Sharia-compliant activities, most The International Fiqh Academy of the Organisation of Islamic Islamic investors will tolerate income where the non-Sharia-com- Conferences has defined a share in a company as evidence of the undivided ownership of the shareholder in the assets of the

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mudaraba, wakala will usually be considered the investors’ can be paid its share of profits“on account” but, at mudarib should be compensated. Economically, per wakil can carry out its activities only in accordance with is entitled to a pre-determined fee. As a Charging interest to investors who fail to pay drawdowns of Charging interest to investors who fail to pay commitments. If payment is treated as a fee, the UK manager will be taxed If payment is treated as a fee, the UK manager 50%. at income tax rates which can be as high as (capital), If the payment is received as a “carried interest” at 18%. then the UK manager will generally be taxed investors obtain Equalisation mechanisms under which new buying out a por an interest in existing assets of a fund by tion of the existing investors’ interest at cost plus interest. tion of the existing investors’ interest at cost wakala is a contract under which someone appoints another mudarib wakil „ „ „ „ vestment manager of a either a pre-agreed fixed fee or fee calculated as a percentage of the of NAV the fund. Again, the fee can be paid on account but a reconciliation must be made on winding-up. The investment manager can also be paid an incentive fee. Similar to the Sharia Mudaraba), investors must own the fund assets or have the right principles for The them. of dispose to the of breach or negligence misconduct, own its from arise these terms of the wakala. age funds in accordance with its professional expertise. A It is however possible to discourage late payments by levying a Shar a levying by payments late discourage to possible however is It charity. to given be then must which fee, payment late ia-compliant net current the on based investors new introduce to possible is It asset value (NAV) but there are difficulties in dealingapproach. interest withplus cost new a on based fund existing an in money Certain other common features of private equity funds are not riba: considered Sharia-compliant as they involve Wakala A to act as their agent (wakil) on some matter on be- that person’s half. This matter can only be something which can be dealt with and contracts financial of types all includes This agency. through dealings which a person can The perform investment personally. manager of a wakil. A the instructions given to it. This contrasts with a fund which has been set up as a „ „ „ „ the end of the fund, when it is known exactly how much profit has has profit much how exactly known is it when fund, the of end the undertaken. be to have would exercise reconciliation a made, been Tax considerations must be taken into account when choosing how the formance fees and carry structures work in much the same way. But the tax implications for the manager can structured usually be is compensation reason huge. the fund, conventional With a as an allocation of profits (at least where the manager is in the UK) is that the tax treatment is more favourable than is structured when as a it fee. This is because of the differing rates for capital gains and income in the UK: fee if certain agreed hurdles are achieved. An incentive fee would would fee incentive An achieved. are hurdles agreed certain if fee - alloca an than rather fund the of expense an be to considered be to the mudarib. tion of profits A - - about this publication, please visit please publication, this about mudar mudaraba about Practical Law Company, please visit visit please Company, Law Practical about should present a busi- mudarib rabb ul-maal and the managing mudarib to be paid an incentive must follow. Investors in a a in Investors follow. must mudarib is not allowed to guarantee that mudarib gets nothing. Losses are shared negligence or default caused them. If the mudarib mudarib. The bears some resemblance to a limited part- limited a to resemblance some bears mudaraba mudarib’s ). The investors are solely responsible for losses for responsible solely are investors The mudarib). mudarib can share in the profits, as compensation for his Choice of jurisdiction. Structuring liquidity arrangements for the fund. Structuring liquidity arrangements for the Minimising tax leakage. The mudaraba. The wakala. activity, which the the which activity, mudaraba involves one or more people contributing funds to a bears some resemblance to a limited partnership but partnership limited a to resemblance some bears mudaraba „ „ „ „ „ For more information more For party is called the venture that is to be managed by another party (which contributes (which party another by managed be to is that venture its knowledge and entrepreneurial expertise). Each investor who provides the capital is called a A A there are also important differences which must be considered when structuring a Sharia-compliant fund, and working out the fees that will be payable to the manager. Mudaraba nership). It includes a consideration of issues relating to: nership). It includes a consideration of issues This section analyses the usual contractual obligations for an Is- lamic structure, which differ from English contractual structures a (although Some scholars believe, because of the principles of Sharia com- pliance (in particular, the regulation of risk sharing (see above, Principles of Sharia compliance)), that mean it would this as is fund, one not within shares permissible of classes two to include management includes This equally. treated not are investors that shares. Others take the view that this is acceptable provided the management shares do not attract a portion of the distributable treated are class each of shareholders the and fund, the of profits equally among themselves. company. It also held that owning shares in a company carrying on on carrying company a in shares owning that held funds also It Therefore, company. permissible. is activities business Sharia-compliant The companies. limited as up set be can investors Islamic at aimed issue. this with dealing No.12 Standard issued also has AAOIFI Investment Funds Handbook 2011 Handbook Funds Investment Cross-border „ „ „ „ „ Under Sharia principles, the investors remain the owners of the custo- the in or of, name the in registered are they if (even assets the of, dy ib’s if even the losses investment, of their to the extent liable are only business. the of assets the exceed business the by caused unless the vestors must not be involved in the day-to-day management of the management day-to-day in the be involved not must the vestors on limits general set can investors the However, venture. As with a limited partner in an English limited partnership, the in the partnership, limited English an in partner a limited with As ness plan and a feasibility study to the investors. fund makes a loss, the the expertise. However, the investors will receive a certain level of profits or the return of their capital. Profits, if any, are to be shared according to a pre-agreed ratio, after the investors have been paid all of their capital. It is also possible for a The on a proportional basis among the investors based on their invest- their on based investors the among basis proportional a on ment contributions. The mudarib is not responsible for losses, because he is not considered the owner of the assets. Investment Funds Handbook 2011 Cross-border

Open-ended or closed-ended? est in the fund will be taxed in the hands of the investors is an Care also needs to be taken when deciding on the liquidity arrange- important factor in choosing a jurisdiction for the fund. The Cay- ments for the fund. Generally speaking, it is not considered Sharia- man Islands have emerged as a jurisdiction with which investors compliant for investors to be paid a share of profits if they have not in the GCC countries feel comfortable. They are often used by been realised. The Sharia concern is that if this happens it could international (rather than GCC-based) sponsors. lead to there being a mere trading in money, which is haram. Having chosen an offshore jurisdiction, the next challenge for the promoters of the fund is to ensure the fund is not brought within So, for example, a common view is that a murabaha fund can- the net of onshore tax because of the relationship between the not offer redemptions until deferred payment prices in relation offshore fund and its service providers. This will of course depend to individual murabaha contracts have been paid. (A murabaha on the jurisdiction in which the service providers (but in particu- fund is a fund investing in murabaha contracts - which means a lar the investment manager) are established. fund buys assets (often commodities) at a spot price and on-sells them on a deferred payment basis. The deferred price is usually In particular, the central management and control of the fund higher than the spot price in consideration of the end buyer pay- must not be exercised within the UK (or other high-tax jurisdic- ing later.) At that point, redemptions are permitted to the extent tion). Factors that will be considered to determine where the cen- the unit or share represent actual profits that have been realised tral management and control is operated include: from the receipt of deferred payment prices. „„ The residence of the directors. A majority of the board of However, some Sharia boards do allow interim or “on account” the offshore company should not be in an onshore jurisdic- profit distributions pending, and subject to, a final audit. tion, and a prescribed number of directors should be in the offshore jurisdiction. Minimising tax leakage „„ The conduct of board meetings. These should not be in the An overarching principle when structuring a fund is to ensure that UK or other high-tax jurisdiction, and preferably should be investors are not in a worse tax position by investing in the fund in the country of incorporation. The board should also meet rather than investing directly in the underlying assets. This prin- regularly (two to four times a year, as a minimum). ciple is the same for Islamic funds as it is for conventional funds. „„ The location of the offshore company’s bank accounts and Any tax costs at the fund level such as a direct tax charge on the corporate documents. income and gains of the fund will reduce the investors’ return on their investment. Therefore it is common for the fund to be: Marketing a Sharia-compliant fund „„ Set up in a no tax/low tax jurisdiction (an offshore jurisdic- tion) such as the Cayman Islands or Jersey (see below, Certain principles apply to the marketing of Sharia-compliant Choice of jurisdiction). funds. This section concerns disclaimers, representations about Sharia compliance, and local marketing restrictions. „„ A tax transparent entity like an English limited partnership where the tax authorities will look through the fund so the Disclaimers income and gains of the fund are taxed as if they arose directly at the investor level. Funds are often marketed to get soft commitments before the fatwa is issued. Any documents must include a statement that „„ An entity such as a UK authorised unit trust which can the structure may have to change to consider the views of the benefit from certain tax reliefs or exemptions to minimise or fund’s Sharia supervisory board, and that investors accept this. It Cross-border avoid a tax charge at the fund level. is also prudent to add a disclaimer to all marketing material, in- cluding slides, draft prospectus or information memorandum and The legal form of the fund vehicle and the jurisdiction in which the final information memorandum, that investors should seek the fund is established will largely be dictated by the class of their own advice as to the fund’s compliance with the Sharia. assets the fund will invest in and the class of investors the fund will be marketed to. It is common, for example, for funds invest- Representations about Sharia compliance ing in UK real estate to be structured as a limited partnership or Another approach, used by some product developers, is to set up an offshore company. Limited partnerships are also the favoured the fund so it should be possible to get a fatwa, but not to go to choice for private equity funds. the expense of appointing its own Sharia supervisory board to get a fatwa. Instead, each investor is told the decision whether a fund Any of the vehicles traditionally used for funds to minimise tax is Sharia-compliant rests with them. leakage can generally be used for an Islamic fund. To be Sharia- compliant, the investors must contribute money to a joint pool to This approach does not always find favour with investors and is earn halal profits generated by the fund investing in Sharia-com- unlikely to be used when the product developer is an Islamic fi- pliant assets, and to share losses. Sharing in losses is necessary nancial institution. Risks involved in going down this route should to agree the fund is compliant. be considered carefully. When the sponsors represent that a fund is Sharia-compliant without the benefit of afatwa from a respect- Choice of jurisdiction ed scholar or group of scholars, if later there is disagreement As with conventional alternative investment funds, some fac- as to whether a fund is Sharia-compliant investors may try and tors will drive the choice of jurisdiction for an offshore corporate rescind the investment contract (whether subscription agreement fund vehicle. These issues are no different for Islamic-compliant or partnership agreement) based on misrepresentation. In Eng- funds. This will depend on the location of the assets of the pro- land, courts have generally given effect to contracts held out as posed fund as well as the location of the investors. How an inter- Sharia-compliant, even if they were not in fact compliant, on the

about this publication, please visit www.practicallaw.com/about/handbooks For more information about Practical Law Company, please visit www.practicallaw.com/about/practicallaw Cross-border First Real Estate Fund. Fund. Estate Real First ijara rosali pretorius SNR Denton t +44 20 7246 7181 f +44 20 7246 7777 e [email protected] W www.snrdenton.com www.practicallaw.com/about/practicallaw www.practicallaw.com/about/handbooks

International Banks: advising a range of international banks on issues relating to derivative contracts under UAE law. Dubai Islamic Bank: advising Dubai Islamic Bank and a syndicate of UAE banks on an Islamic redeemable par- ticipation (sharikat al aqt) and leasing (ijara) facility for a Sharjah-based shopping mall. Amlak Finance PJSC: Advising on its its on Advising PJSC: Finance Amlak Residential ABS CI (1) Limited: advising as lead Tamweel oating rate partner in a ground-breaking US$210 million fl secured notes Sukuk. Amiri Capital LLP: advising and assisting on setting up, and Amiri Capital LLP: advising and assisting on of, a Sharia-com- provided regulatory advice to the sponsors in the UK. pliant fund for distressed property investments Limited: advising on commodity murabaha Dubai Tradition and other trading arrangements with Islamic banks and their clients. Baring Asset Management (Barings): advising on several ce outsourcing contracts, including back and middle offi services for derivative trading and fund administration services and advising on their standard derivative trading documentation and custody and fund administration agree- ments with major international investment banks.

there are no special rules for Sharia-compliant investment funds. investment Sharia-compliant for rules special no are there conventional a like just treated usually are they purpose, this For fund. investment It is usually possible to market alternative investment funds high to also sometimes and investors, sophisticated and professional The net-worth individuals. in selling restrictions the infor- fund’s promoters the jurisdictions the cover should memorandum mation advis- is it funds, investment alternative For to. market to likely are nal fi or draft receive who investors the all of a record keep to able copies of the information memorandum. This will help to show restrictions. marketing local the with compliance

recent transactions „ „ „ „ qualified. South Africa and England & Wales hedge, including funds, investment Alternative practice. of areas private nancial real equity, estate and Sharia-compliant funds; fi derivatives. markets regulation; commodities trading; recent transactions „ „ „ about this publication, please visit please publication, this about about Practical Law Company, please visit visit please Company, Law Practical about Contributor details muddassir siddiqui SNR Denton t +971 4 405 4323 f +971 4 331 0201 e [email protected] W www.snrdenton.com riChard de belder SNR Denton t +44 20 7246 7326 f +44 20 7246 7777 e [email protected] W www.snrdenton.com . This should fatwa be clearly stated on all Islamic fi nance and investment; investment funds. investment investment; and nance fi Islamic Islamic fi nance and investment; investment funds. investment investment; and nance fi Islamic Islamic Development Bank: senior lawyer, internal Sharia Sharia internal lawyer, senior Bank: Development Islamic the of Committee Sharia the of co-ordinator and supervisor delibera- the in Participating Bank. Development Islamic the of review Sharia the and IDB of Board Sharia the of tions for Auditing, Standards. Board’s Service Financial Islamic activities. nancial fi IDB’s the purposes, compliance Sharia Central Banks: participation in conducting courses and Central Banks: participation in conducting nance and advising on implementing seminars on Islamic fi Islamic Finance within their jurisdictions. Limitless: advising the Creditor’s Committee on restructur- Limitless: advising the Creditor’s nancing. ing of a Mudarabah fi

recent transactions qualified. Supreme Court of Registered the foreign State lawyer of 2008 Authority, with New York, English 1983; Regulation practice. of areas „ „ „ For more information more For local marketing restrictions local marketing restrictions market to anyone allow not do world the around jurisdictions Most alternative investment funds to retail ling investors a without fi prospectus complying with certain contents criteria. In the UK, Therefore, it is crucial that investors be told whether the promot- the whether told be investors that crucial is it Therefore, ers intend to get a in conversations with potential investors. marketing material and basis that this the may parties not signed the contract. However, be the view of courts of other jurisdictions (especially those that arbitrators. legal systems) or of the Sharia into their incorporate Investment Funds Handbook 2011 Handbook Funds Investment Cross-border areas of practice. practice. of areas England and Wales, 1978; California, 1985 qualified. England and Wales,