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Paul Wouters, Lawyer, Antwerp Bar Association Senior Foreign Counsel, AZMI & Associates CEO, PT Senturiyon Global


S. S. B.



Investors In principle, both Muslim and non-Muslim investors qualify to participate in an Islamic Private Equity Fund. However, since the investments will have to follow the Islamic rules, all have to agree to the compliant project as described in Shariah Guidelines of the Prospectus. Sometimes, and in order to avoid stalmates or divergences within the conventional investor group, it has prooven to be e cient to split the compliant and non-compliant investors into two groups, each with its own ‘fund’ that then – on common consultation may or may not participate to a speci c investment. Investment fund Some Islamic Scholars still opt for the traditional Islamic partnership contracts, that resemble the common law and continental ‘Limited Partnerships’, but do not always t in the domestic legislative framework. The use of legal persons (trusts, funds and even regular company structures) has been adopted however by most Islamic Scholars, provided terms and conditions are tailored as much as possible to Islamic standards. The Common Law ‘trust’-concept that holds Investors (the Limited Partners) and Management Team (the General Partner) and that emuAllEquityFunds PERCIS

TC 1

TC 2

TC 3

TC 4

1. Investors fund the IPEF 2. Shari’ah Adviser or Shari’ah Supervisory Board SSB sets the Shari’ah statement of policy 3. Management Team MT identi es and acquires equity in the Target Companies TC on behalf of the IPEF 4. SSB monitors the statement of policy at the level of the IPEF and the MT 5. MT monitors the TC for the IPEF - Shari’ah irregularities discovered in that reporting from the Target Companies will be reported by the Shari’ah Compliance O cer to the SSB 6. MT keeps the Investors updated on the development of the TC 7. On decision of the IPEF, the MT ultimately executes the exit out of the TC through IPO / sale... 8. The pro ts / losses of that exit ow back to the IPEF that distributes them to the Investors



The introduction of Islamic nancial structuring into the domestic Russian legal landscape is essential for several reasons: • Activation of the growing available Islamic compliant nancial resources in a market where private equity (the quintessence of Islamic compliant risk-sharing investment) historically underperformed. • Pronounced visibility and status recognition of the ethical demands of the present Muslim population. • Attraction of foreign funding FDI that is abundant in mostly GCCbased jurisdictions hosting important Muslim populations. As will be shown hereunder, the industry screening (haram / halal) and nancial ratios (no over exposure to debt and interest based nancial products) will not contradict most conventional private equity practices, certainly when aimed at start up and mid-tier companies. Both Islamic and conventional investment models can cooperate or at least side by side without problem. Some creativity might be needed when the Target Company would not have a ordable Islamic nance providers at competitive pricing available in the local market and probably also for rewarding e orts at exit proceedings, where the Islamic model provides more justice for everybody but may con ict somewhat with the practices of contemporary conventional structuring.

lates the traditional Islamic partnership2 concept close therefore has been widely used. The Anglo-Saxon Common Law system did play a dominant role in the traditional Islamic jurisdictions (Malaysia, GCC, ...) and those concepts therefore are the most ‘tested’ in global Islamic nance. It does not mean however that the continental legal framework would be less suitable per sé as it can be argued that Civil Code and lawbased systems are more akin to the Shariah (starting from a source and no binding precedents) than the Common Law. Setting aside the Common Basic IPEF - fund structure

Law jurisdictions (choice of law and con ict jurisdiction) would probably give impetus to the development of more Shariah based structures. Regular ‘fund’-structures with an in-house or outsourced Management Team and even company structures (sometimes combined with an outsourced Management Team) also are used - all subject however to the basic rules of the Islamic law. Civil Law based Luxembourg can be named as such a ‘fund-based’-jurisdiction that can hold elements of inspiration. Since most of the time several di erent jurisdictions are involved (investors, fund, targeted companies etc.), the structuring often requires a transnational approach and therefore a professional international team of legal and tax experts has to be set in place. This is moreover so when local regulations treat foreign portfolio investors di erently from domestic ones. Investment strategy : additional industry / nancial screening Every conventional private equity fund will have an investment strategy that will handle the following criteria, usually focusing on speci c target industries: • Geographical diversi cation • Business and industry sectors involved • Currency risk • Term of investment • General risk pro le • Projected return İslamic structuring will introduce two new screening concepts: there are certain standards in quality (unlawful business trade/practices) further called ‘industry screening’ and quantity (unlawful ‘contamination’ with interest based activities) further called ‘ nancial screening’. Industry screening The Shariah Advisor will draft a speci c list of the industries that should be avoided and that might look as follows: • companies producing, slaughtering, selling, trading or distributing pork (or pork-related) products / blood • companies engaging in pornography or obscenities in any form • companies whose core business is in entertainment ( lms, video, theatre, cinema, etc.) • companies engaging in gambling, casino’s, lotteries and related forms of betting and activities such as bookmakers, • companies active in non-compliant nance or insurance, weapon industry, defence etc. • companies producing / distilling / selling / trading or distributing alcoholic beverages or related products • companies producing / growing / selling / trading or distributing intoxicants or related products (drugs, tobacco) • by ijtihad, the Shariah adviser may deem other activities as nonpermissible The Target Company could only have some very minor unlawful activity / revenue and therefor gettolerated by the Shariah Adviser. It is more or less generally accepted that any unlawful income of a company not exceeding 5 % of the overall gross income is considered marginal or accidental. The Target Company will still be eligible for investment, provided the pro t undergoes su cient cleansing according to the guidelines set forth by the Shariah Adviser (where unlawful money is isolated and given to charity). Understand correctly: the company then is ‘permissible’ but not yet fully ‘compliant’. Most lucrative contemporary businesses (the so-called dotcom’s and most other industries and services) are prone to compliant investment, provided that they are not too much interest-indebted, as we will see hereunder. Financial screening As aforementioned, the Target Company may have some unlawful bindings with the ‘interest based world’ (in the form of outstanding loans and non-compliant going contracts). This will be accepted, provided again that certain tresholds are not surpassed. When the IPEF holds a majority stake in the Target Company the interest / Riba based nancing will be granted a certain period (usually up to 2-3 years) in order to be replaced with compliant nance products.

The availability of Islamic banking in the jurisdiction is an important asset in this respect. Sometimes the investors go so far as to erect additional nance vehicles to support the Target Companies where needed with Shariah compliant nance. Then again exemptions are more fargoing and allow conventional nance with restricted debt management, all depending on local circumstances. Although several sets of criteria have been developed and the Shariah Advisor will set the precise limits for the speci c IPEF fund, several standards and guidelines have been developed by di erent institutions and have been sanctionned by Shariah Scholars worldwide. The criteria withheld by the Shariah Advisor might very well resemble those from the FTSE: Total debt Excludes investments when total debt divided by total assets exceeds (or is equal to) 33%. Total interest bearing securities and cash Excludes investments when total cash and interest bearing securities divided by by total assets exceeds (or is equal to) 33 %. Accounts receivable Excludes investments in Target Companies if accounts receivable divided by total assets is greater than (or is equal to) 50 %. Financial Screening Ratios Receivables Ratio
33 % 50 % 49 % 70 % 45 % 49 %
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Debt Ratio

Cash + Interest Bearing Ratio
33 % 33 % 33 % 33.33 % 33 % 33 %

Non Permissible Income / Total Income
≤5% ≤5% ≤5% ≤5% ≤ 10 % ≤5%


33 % 33 % 33 % 33.33 % 33% 33 %

MSCI4 Parsoli5 HKIslamic Index6
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Trailing 12 Months Average Market Capitalization Total Assets Index Series Version 1.2 March 2008 3 Market Value Equity 4 Total Assets 5 Trlng 12 Mnth Av Market Cap 6 Trlng 12 Mnth Av Market Cap

Guide to DJIM Indexes November 2007 Ground Rules for the Management of FTSE Shari’ah Global Equity

S & P Shari’ah Indices Index Methodology June 2007 Morgan Stanley MSCI Islamic Index Series Methodology April 2007 5 Parsoli Islamic Equity Index PIE 6 Hong Kong Islamic Index
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It will be obvious that more immature companies will be less ‘infected’ by interest based debts and are therefore easier targets for compliant investment. Managing debt levels to acceptable Islamic maxima (outstanding debt at 20 % of asset is not uncommon), means that Target Companies will function less leveraged (debt) and more equity based than their conventional counterparts. As numerous studies have prooven in the mean time3, more debt makes a company more prone to insolvency (interest has to be paid with or without pro ts) and does not in uence in positive way the capacities of the manager. Pro table business requires a good leader and su cient equity. More conventional debt nance leads to moral hazard and excessive risk taking. Until the leveraging issues are solved in compliant ways, Islamic Private Equity Funds IPEF therefore at this moment tend to target more the start up to midtier companies. Given the present environment where strategic sell-down outweighs IPO’s and management buy outs by far, this ts perfectly in the overall Russian investment landscape. Governance – Shariah Advisor and Shariah Compliance O cer It is advised to appoint at least one Shariah Adviser (or even a Shariah Advisory Board) who will: • draft the General Shariah Guidelines / Manifest that will dominate the investment and exit procedures and overall investment management • ensure that all aspects of the private equity fund are in accordance with the Shariah (including portfolio management, trading practices,


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operational matters, administrative matters, etc.) and that the practices of the Target Companies stay within the boundaries that have been set • provide Shariah expertise on documentation, structuring, investment instruments and ensure compliance with the general Shariah principles and the standards, regulations and resolutions of the regulator • scrutinize any compliance report or any investment transaction report the day-to-day business • from time to time or when needed and at least on an annual basis provide written opinions of compliance to the Board of Directors of the Islamic Private Equity Fund. Since the Shariah Advisor will not be full time engaged in the daily life will monitor whether or not the lawful-criteria have been met and who will report any non-compliance to the Shariah Advisor. Shariah awareness If the compliant investors are a minority in the Target Company, then they will have to undergo the majority decisions of the other shareholders. mentionned criteria from the Shariah Advisor are constantly and strictly met. This will be guaranteed by insertions in the articles of association and through side-shareholders agreements and covenants. The compliant shareholders will furthermore regularly stress the need for compliance at shareholders’ meetings and so forth. When they have the majority however, the Shariah Advisor will set a time table in which the target company will have to be ‘cleaned’ from all years are adapted, as said above in order not to break the going concern. Liquidity in the company will preferrably be managed in a compliant market. Some legal challenges above, the contents and the form of the legal documentation drafted for the transactions themselves also have to be compliant with the Shariah. Indeed, also in structuring the private equity fund and the target company, the legal environment thereof will have to be tailored to meet the fundamentals of the Mudaraba of Musharaka PLS partnerships or at least Islamic contract and partnership standards. For instance, the Islamic principles require that any loss is borne by the investors in proportion to their invested capital and capital guarantee is excluded (actually turning an investment into a loan of money). again is exluded. right of one of the following preferred stock – often used in conventional private equity structuring - therefore could be problematic: nate the sharing of the risks and the losses) look like interest on investment and also could lead to the exclusion of loss sharing). be deemed acceptable and will have to be adjusted. The same goes for the conventional often negotiated guaranteed minimum exit pricing (in a way market value and company performance are to be preferred. attached to common stock. Also, certain convertible and exchangeable structures have been approved. Most of the usual vesting and motivational techniques entailing that stock only accrues for the entrepreneur (or key employees) after agreed pe1 2

riods have elapsed or benchmarks have been reached can be used. Lock-in agreements have also been approved. As every structure has its own particularities and local tax and company law regulations change from time to time, creativity and modelling to target. Conclusion The galaxy that is available for Islamic investments – as has been demonstrated – is vast. The ethical standards as imposed by the Shariah do not contravene the expectations of the conventional investors, what makes a co-habitation in one same or two parallel investment funds operating with a joint strategy more than workable. The money that is available in the oil producing countries and the other emerging markets for foreign direct investment – usually with predominant Muslim population, is abundant. There also is a need to mobilize opting for a compliant lifestyle. Establishment of more Islamic compliant investment vehicles will also trigger the regulator to recognize the (Islamic) private equity asset class more visible and might enhance the possibilities for a better introduction scape. It will facilitate the embedding of the Russian economic development in the ‘big move East’ of which the OIC based countries from Africa over the Middle East and Turkey to Southeast Asia from an important part, hosting burgeoning economies. It would be a strategical error not to participate in this part of the global future.

SPV and an Islamic SPV as Limited Partners



Private Equity Fund

Islamic Investors

.. S. S. B.

TC 1

TC 2

TC 3

TC 4

1. Conventional Investors commit funds to an SPV located in a friendly environment for ultimate investment in the Private Equity Fund as Limited Partners 2. Islamic Investors commit funds to an Islamic SPV located in a friendly environment for ultimate investment in the Private Equity Fund as Limited Partners but subject to Shari’ah screening by the SSB 3. The Management Team MT is the General Partner of the Private Equity Fund

The MT calls the funds at the Limited Partners in the Private Equity Fund The conventional SPV transfer the funds The Islamic SPV transfer the funds subject to Shari’ah approval The MT closes the deals and acquires the equity stakes in the TC The MT manages the investment on behalf of the Private Equity Fund as General Partner and then to the ultimate Investors 4. Reporting duties by the MT or Reporting Partner to all levels guarantees compliance with the Investment Policy and the Shari’ah

A more in depth booklet Islamic Private Equity Fund IPEF – introduction and basic observations, Islamic Finance News, 2008 can be obtained free of charge at the author: Paul WOUTERS – Managing partner or ‘Mudarib’ and capital partners or ‘Rab-al-Mal’ from the Islamic ‘Mudarabah’ 3 For instance and post crisis: Anuar Alias and Soi Tho C.Y., Performance analysis of Reits: comparison between M-Reits and UK-Reits, Journal of Surveying, Construction and Property, Vol.2 Special Issue 2011 and Christian Walkshausl and Sebastian Lobbe, Islamic Index Investing – the international evidence, November 2011 AllEquityFunds PERCIS



Islamic SPV