Mark Beckford explores the growing market for Sharia-compliant financial products.
Sharia-compliant financial products are making waves in the investment world these days. It is anticipated that these kinds of investments will continue to grow by about 15 to 20 percent over the next couple of years and will make steady inroads in the European and US markets.
‘Sharia law’ has its foundation in Islamic Law and dictates that an Islamic investor should always invest his assets in goods or services that are of benefit to society, as opposed to simply just gathering and keeping them close to himself. Consequently, an Islamic investor can invest in equipment, properties, water, gas and almost any service that is of value to the community, but is prohibited from investing in anything that involves gambling, pornography, alcohol, the manufacture of arms, or the sale of pork and tobacco.
Sharia law also prohibits the making of money from paying or charging interest (‘usury’) but does not prohibit the making of a return on capital if a person is willing to share in the profit or loss of his investments. Under this principle of risk-sharing, each investor can share (either positively or negatively) in the investment. For example, an investment house can accept money from an Islamic investor and invest the funds, say, in various real estate contracts and then share the growth (or the loss) with him. usually, a ‘Sharia Committee’ or ‘Sharia Supervisory Board’ (depending on the situation) is set up to make sure that the intended investments are not inconsistent with the principles of Sharia law.
Some major Sharia-compliant investments are:
This is basically a leasing arrangement in which an investment house uses the investor’s money to acquire an asset, such as a property. Rental income is collected and passed on to the investor. At the end of the contract, the properties are disposed of by the investor himself.
Ijara wa iqtina
This is very similar to the above arrangement; however, at the end of the contract period, the investor has the option to purchase the asset.
This is somewhat similar to an English/Cayman Islands trust structure (although the investment is carried out mainly through companies and not by setting up a trust). Essentially, a manager (trustee) accepts money and then invests according to investment guidelines agreed between the manager and the investor. The principal sum is later returned to the investor together with a share of the profits.
Several different types of Sukuk products have been created to meet different investor needs. This kind of investment, however, is the closest to conventional investment opportunities, whilst still remaining compliant with Sharia Law. Sukuk products belong to the family of asset-backed securities structures. The essence of a Sukuk is a securitisation whereby future cash flows from a pool of assets are capitalised by the issue of financial certificates to investors. It may be thought of as an Islamic equivalent of a bond, albeit the bond must not be interest-bearing.
This Sharia wave has also received a lot of attention recently from rating agencies. For example, Standard & Poor’s has created Sharia compliant versions of its S&P 500, S&P Europe 350 and S&P Japan 500 indices. No doubt, this move was specifically designed to rate Sharia compliant investments on the open market and to inform investors of the availability of Sharia-compliant products.
In addition to the S&P index, there is also the International Islamic Ratings Agency (IIRA), which pays particular attention to these kinds of investments. The IIRA began operating in 2005 and its objective is to assist in the development of Islamic financial markets through the rating services it provides. It is sponsored by multilateral finance institutions, several leading banks and other financial institutions, and rating agencies from different countries. The IIRA has its own Sharia Board.
As more and more Islamic institutions and individuals move into various regions of the world, it is only natural that they will want to invest, build homes and provide security for their descendants. This will cause an automatic need for banks and other institutions to cater to their requirements, leading to the development of new and enhanced Sharia-compliant investments. Over the past few years, UK lending institutions, for example, have developed Sharia-compliant mortgages as a means of capitalising on the influx from the Islamic community looking to purchase homes.
The Cayman Islands is proving to be an important domicile for the establishment of Sharia- compliant structures. This is driven by a number of factors, including the flexibility of its Companies legislation, which enables Sharia-compliant investments to be readily accommodated, the experience of certain law firms and other service providers with the nuances of these types of investment, and the overall political stability of the Cayman Islands.
Solomon Harris is seeing considerable interest in the use of Cayman vehicles in Sharia-compliant investment products—in particular, in leasing and real estate transactions—and we anticipate that this will continue to grow as the Sharia wave gains further momentum
Mark Beckford is an associate with Cayman Islands law firm, Solomon Harris. He can be contacted at: MBeckford@solomonharris.com.