3 questions to smart minds

Criteria for Sharia-Compliant Private Equity Funds

For this 3 questions to T. Gierath

Reed Smith Attor­neys at Law
Photo: T. Gierath | Reed Smith Attor­neys at Law
6. June 2012

TVM Capi­tal was able to announce the closing of its first Sharia-compli­­ant fund (see FYB-news). Congra­tu­la­ti­ons for this. And ask what distin­gu­is­hes such a fund from other private equity funds. — A Sharia-compli­­ant (Islam-compli­­ant) invest­ment is subject to certain invest­ment crite­ria. For exam­ple, an Islam fund is prohi­bi­ted from inves­t­ing in certain sectors or segments. These include the alco­hol and tobacco indus­tries, gambling and betting, erotica and the music indus­try, as well as conven­tio­nal banking, insu­rance and the arms trade. The prohi­bi­tion of inte­rest on money is based on the realiza­tion that money in itself does not create added value; it cannot realize a return on its own without conside­ra­tion. Ther­e­fore, the money must be inves­ted in the real economy.

For this 3 ques­ti­ons to Lawyer, tax advi­sor and part­ner at Reed Smith Attor­neys at Law in Munich

1. What comple­xi­ties do Sharia-compli­ant funds bring? How many Sharia-compli­ant funds are there now?

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.

2. How would you describe a Sharia-compli­ant private equity fund?

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.

3. How do you assess the deve­lo­p­ment of your busi­ness with Sharia-compli­ant funds in Arab countries?

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.

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