Criteria for Sharia-Compliant Private Equity Funds
I have been managing Sharia-compliant funds for about 10 years. At that time, we structured the first Sharia-compliant fund in Germany for a Saudi investor. The business area performed very well from around 2002 to 2009. The vehicles were partly German designs, partly off-shore. I have supervised four of them. The investments take place in Germany and Europe. Investors were primarily private equity funds, family offices investment banks from the GCC ( Gulf Council Cooperation). In the investment region of Europe, there are likely to be perhaps a little more than two dozen such funds.
Fund constructions are not very popular with Arab investors. Arabs much prefer to invest directly instead of entrusting money to a foreign fund manager. In other words, private equity activities are less often carried out via fund constructions, but more frequently on a deal-by-deal basis. Fundraising is then carried out for each investment.
Private equity is a good asset class for Sharia compliance with regard to the Quran, it can be well combined with its principles. One of the principles is roughly, there must be opportunities and risks. The prohibition of interest also applies, which plays a role in leverage design. Of course, the industries that are prohibited (see above) must be observed. This is easy to comply with. It’s a business area that’s doing well.
From the investor’s point of view, another point is crucial: if investments are made, technology transfer is desired in order to advance the region economically: Private equity funds always like to have a Shariah board, a board of directors that requires approval. All investments must pass through the Board, which then issues the “fatwa” (approval). There are about 30–50 people acting in funds worldwide, these are legal scholars from the Arab region with economic expertise. They sit on around 300 boards worldwide.
On the ground in GCC, private equity is doing it hard. There are only a few companies in which to invest. Demand is particularly strong for healthcare, cleantech, such as water treatment, and infrastructure. Venture capital is perfect in terms of Sharia. In the case of buyout and growth capital, the structuring of the investment in the target company becomes more complex.
Whether the number of funds will increase is hard to say. From my experience so far, I would say that previous investments have suffered due to the structural crisis in the region in 2009 (e.g. the baíl out of Dubai). However, some market participants have successfully established themselves and will continue to operate in the market.