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Sharia compliant investments in private equity – An IFN Special Report

Published July 19, 2022 | By Dr Saliba Sassine

Special Reports (Https://Www.Islamicfinancenews.Com/News-Categories/Special-Report)
(https://www.islamicfinancenews.com/contributor/zabidi-abdullah)
Dr Saliba Sassine (Https://Www.Islamicfinancenews.Com/Ifn_authors/Dr-Saliba-Sassine)
19/07/2022

Private equity (PE) often reigns supreme in the high-return investment market. Dr Vladimir Malenko wrote :“In the time of volatile interest rates, doubtful and inconsistent performance of hedge funds, and increasing popularity of index tracking funds (rather than actively managed ones), the astute investors flock to private capital placement opportunities.” DR SALIBA SASSINE explores.(https://www.islamicfinancenews.com/a-newinvestmentscheme-that-can-destroy-shariah-compliant-private-equity.html)

The top 10 GCC (https://www.islamicfinancenews.com/glossary/gcc)  institutional investors have more than US$3.7 trillion of combined assets under management, but only a small percentage of these funds are Shariah (https://www.islamicfinancenews.com/glossary/shariah-2) compliant. At first glance, this PE investment option for Islamic investors looks rather limited. But Islamic finance professionals are both dynamic and inventive in their search for structured solutions.

Before exploring the options available for investors who want to invest in a Shariah (https://www.islamicfinancenews.com/glossary/shariah-2) compliant manner, let’s set out the main restrictions in Shariah (https://www.islamicfinancenews.com/glossary/shariah-2) -based investing. These are not numerous but are very important:

Having set out the main restrictions that apply, the following are some of the options available to investors in PE who wish to comply with Quranic restrictions.

  1. Investments in Shariah (https://www.islamicfinancenews.com/glossary/shariah-2) compliant PE funds

This is by far the most logical option, but one that faces a major obstacle — there are just not enough Shariah (https://www.islamicfinancenews.com/glossary/shariah-2) compliant funds to serve the universe of Islamic investors.

Most Shariah (https://www.islamicfinancenews.com/glossary/shariah-2) compliant PE funds are structured as limited partnerships, combining a Mudarabah (https://www.islamicfinancenews.com/glossary/mudarabah) arrangement (covering the carried interest element of general partner (GP) compensation) with a Wakalah (https://www.islamicfinancenews.com/glossary/wakalah) (for the GP’s management fees).

  1. Investments with an opt-out option

Islamic investors may decide to invest in a conventional PE fund but opt out from making cash calls to fund non-Shariah (https://www.islamicfinancenews.com/glossary/shariah-2) compliant projects. This way, the investors avoid funding the projects they do not agree with, and accordingly forego any Haram (https://www.islamicfinancenews.com/glossary/haram) profits associated with such projects. This solution is straightforward but not very practical:

  • Not too many PE funds agree to such investment optionality, and
  • Only large investors with tickets of US$100 million or more may enjoy this discretionary approach.

III.            Investments in Shariah (https://www.islamicfinancenews.com/glossary/shariah-2) compliant Murabahah (https://www.islamicfinancenews.com/glossary/murabahah) participation notes

The notes are based on the principle of Murabahah (https://www.islamicfinancenews.com/glossary/murabahah). Shariah (https://www.islamicfinancenews.com/glossary/shariah-2) compliant investors invest in SPV A in return for participation notes. With the received funds, SPV A buys commodities on the London Metal Exchange (https://www.islamicfinancenews.com/company/london-metal-exchange) (or equivalent exchange) through a commodity broker and sells them via a Murabahah (https://www.islamicfinancenews.com/glossary/murabahah) contract with deferred payment terms to SPV B. SPV B would act as the fund’s limited partner which, in turn, acts on instructions from Islamic investors. This limited partner is large enough to opt out of Haram (https://www.islamicfinancenews.com/glossary/haram) investments that may be earned by the conventional PE fund. In this way, the profits are taken care of. But what if the fund makes losses? The losses can easily be dealt with by a Waad (a unilateral promise) to enter into a Musawwamah (https://www.islamicfinancenews.com/glossary/musawwamah) transaction.

This is a neat transaction structure, but which has a significant drawback, namely that the upside is limited by the amount fixed in the Murabahah (https://www.islamicfinancenews.com/glossary/murabahah) agreement.

  1. Investments in Shariah (https://www.islamicfinancenews.com/glossary/shariah-2) compliant Mudarabah (https://www.islamicfinancenews.com/glossary/mudarabah) participation notes

The issuance process is similar to the one described above, but the transaction is structured as a Mudarabah (https://www.islamicfinancenews.com/glossary/mudarabah), a Musharakah (https://www.islamicfinancenews.com/glossary/musharakah) or a Wakalah (https://www.islamicfinancenews.com/glossary/wakalah) to preserve the upside due to an investor.

This option does not have the drawbacks associated with the first three versions set out above and retains the spirit of Islamic law as it applies to investments.

Thus, with proper structuring, an Islamic investor does not need to forego the superior returns offered by conventional PE and venture capital funds.

Dr Saliba Sassine is the founding managing director of BlueMount Capital Group in Australia. He can be contacted at saliba.sassine@bluemountcapital.com.(https://www.islamicfinancenews.com/company/bluemount-capital)

 Volume19.Issue29

(https://www.islamicfinancenews.com/newsletter-issue/volume19-issue29)