No credit? Consider a shariah-compliant fund

Primarily, this demand is originating from investors who reside in the Gulf Co-operative Council region looking to assemble investment portfolios to include Shariah compliant instruments. This demand has fostered the growth of Shariah compliant investment funds that invest in a wide range of sectors - real estate, private equity, infrastructure (most notably power projects) and food products.

Some of these funds have been accepted for trading on the more established stock exchanges, such as Dublin as well as the newer stock exchanges of Dubai and Bahrain. The key to an investment being Shariah compliant is the concept of "halal" - permissible. Halal, at least when applied to food products is the Islamic "cousin" of kosher to orthodox Jews.

So, what exactly is halal, and why is it attracting so much attention and investment?

Halal, an Arabic word meaning permissible, refers to foods and other items which are allowed under Islamic law. It forbids the consumption of pork, blood and alcohol and stresses that investments must meet ethical Islamic standards, and avoid industries that involve gambling.

According to the Halal journal, the global industry is worth around $600bn, with the halal food industry growing at 7 percent annually. With 1.8b Muslims worldwide, it is estimated the halal food and non-food industries could reach $2.3 trillion.

Unlike modern common and civil Law, Shariah is not represented by a formally codified body of law. By nature and derivation, Shariah is subject to development and interpretation. Its elegance is in its adaptability to changing circumstances and means, while retaining the purity of its foundation.

Upon emergence of a new issue on which the position of the Shariah is unknown, it is possible to seek a legal opinion (Fatwa) from a religious scholar (Mufti). The opinion of different Muftis may vary on the same issue depending on which of the five major Islamic juristic schools they belong to and according to their individual interpretation of the Shariah.

Murabaha and Ijara
Two of the most prevalent structures for a Shariah compliant deal are Murabaha and Ijara. Murabaha is a type of ’cost-plus’ financing. Typically the fund in question will acquire goods and will resell them to a third party at their cost plus a fixed profit.

As such the fund will not own tangible assets but will instead consist of obligations owed to it by third parties. The costs and profit margin must be agreed in advance. However, a Murabaha fund should always be closed-ended, since the fund will not actually own any tangible assets as such, and cash/debts are not classified as negotiable instruments by Shariah.

An Ijara fund will usually be established for the purpose of purchasing assets (property, machinery etc) and then leasing those assets to third parties in return for rental income. Wide use of this structure is made by real estate funds. Legal ownership of the assets remains with the fund as does the responsibility for the management of such assets.

A management fee will normally be paid to the manager. It is important to bear in mind that with an Ijara fund, the assets that are leased out must be used in a halal manner. Furthermore, the leasing arrangement put in place between the fund and the lessees must comply with Shariah.

Ijara is quite similar to lease financing and lease/purchase arrangements. A lessee (usually a financial institution) will purchase an asset, and rent it to a lessee for a specific time period at an agreed rental or in exchange for receiving a share of the profits generated by the asset.

Two main types of leases exist under the Ijara structure. The first involves a longer term lease that usually ends with the transfer of ownership of the asset to the lessee (Ijara wa lqtina) along the same lines as in a financial lease. The second type of lease is for a shorter term and will usually conclude with the financial institution retaining ownership of the asset, as in an operating lease.

The rental income in this second type of lease will take into account the ordinary wear and tear of the asset. Obviously, to comply with Shariah, the leased assets must not be prohibited items (for example, machinery for the manufacturing of alcohol), casinos, or electronic gambling machines, and must be used in ways deemed lawful by Shariah.

In times like these when conventional financing is difficult to find, one should seriously consider use of one of these Shariah compliant funding vehicles for any type of halal corporate purpose.

© 2009 Gary S. Lachman

* Gary Lachman is an international lawyer formerly with the U.S. Department of State, real estate developer, and associate professor at the Johns Hopkins University with a consulting practice in Istanbul. He can be contacted at glachman@lachmanyeniaras.com.