Law Gazette - Singapore Law Society

1. Bener Law Office is a full service Turkish law firm
with a strong international practice. Our results
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We are committed to serving our clients’ needs
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We provide high caliber legal services with our
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Bener Law Office Islamic Private Equity Funds
Yapi Kredi Plaza C Blok Kat 4 Paul WOUTERS
34330 Istanbul – Turkey
Tel + 90 212 270 70 50
Fax + 90 212 270 68 65
Email info@bener.av.tr
Website www.bener.av.tr
excerpt from Law Gazette –An official publication of the
Law Society of Singapore – March 2009
Full copy available http://www.lawgazette.com.sg

2. Islamic Private Equity Funds
An introduction in to the religious principles that
undergird Islamic finance.
The Author Paul WOUTERS
From origin a Belgian lawyer
specialized in international financial
regulations and corporate consulting, Bener Law Office – Istanbul Turkey
Paul WOUTERS has been resident in
Istanbul-Turkey for years, where he is
counsel to Bener Law Office.
(excerpt from Law Gazette –An official publication of the Law Society of
Focusing on Islamic finance and Singapore – March 2009 – full copy available at
contract law, he has introductions http://www.lawgazette.com.sg/2009-3/default.htm)
from the GCC over Turkey to South
East Asia. Paul is amongst others .
Member of the Advisory Board of
Islamic Finance News and consults, Introduction
lectures and writes on ethical and
legal aspects with respect to the
Islamic finance sector.
In the USA, venture capital typically refers to early stage investments, while
He can be reached at Bener Law Office private equity is usually related to financial involvement at later stages
or at pwouters.law@gmail.com (management buy-out or management buy-in, etc.). Most jurisdictions do not
have specific guidelines for setting up and managing an Islamic Private
Equity Fund ('IPEF'). An exception is Malaysia; the reader can refer to the
guidelines issued by the Securities Commission of Malaysia: Guidelines and
best practices on Islamic Venture Capital - May 2008. Other sources of
additional information can be found at the Accounting and Auditing
Organization for Islamic Financial Institutions AAOIFI (Bahrain) and the
Dubai Financial Services Authority DFSA (U.A.E.) and the Islamic Financial
Services Board IFSB (Malaysia).
In essence, Islamic finance strives to promote the real economy by means of
:
1 risk/profit and loss sharing partnerships ('PLS'); and
2 trade finance contracts (murabaha, ijara , salam).

3. It is equity (or asset)-based instead of debt-based. The lending of money with prepare a Memorandum and Executive Summary to introduce the investors
interest is prohibited. Islamic finance with the PLS principle appears to be properly in the setup. He would then try to attract the interest of prospective
destined to be directed towards private equity investment. investors, respecting local regulations for such offerings.
Investors in IPEFS
Basic IPEF- fund structure The pooling of investors allows a more substantial concentration of capital.
This gives access to a wider range of investments then would be accessible
to each investor individually. It also spreads the risk and allows the
introduction and maintenance of the services of specialized investment
managers.
Islamic investors usually are grouped as shareholders / participants into
corporations or special investment funds, the so-called IPEFs. The structure
can be open ended (easy outflux of existing investors and additional influx of
other investors) or closed ended, though the latter often is avoided and a
lock-in is opted for.
The ultimate vehicle can vary from a stand alone corporation (with general
assembly of shareholders / investors and Boards of Directors) with an
internal or external management team to a real fund / trust structure that
contains the funds and that can be managed by an outside management
team (either a company or real persons).
1. Investors fund the IPEF
2. Shari’ah Adviser or Shari’ah Supervisory Board SSB sets the Shari’ah Any agreements between the IPEF and its managers will be structured
statement of policy around the nominated Islamic Mudaraba and Musharaka partnership
3. Management Team MT identifies and acquires equity in the Target concepts (and sometimes Wakala). The IPEF will invest in the underlying
Companies TC on behalf of the IPEF Target Companies and will at the exit thereof incur losses or gain profits. The
4. SSB monitors the statement of policy at the level of the IPEF and the MT IPEF will then distribute net capital gains (or losses) back to the underlying
5. MT monitors the TC for the IPEF - Shari’ah irregularities discovered in that Investors.
reporting from the Target Companies will be reported by the Shari’ah
Compliance Officer to the SSB Please note that the organisation and functioning of those vehicles must be
6. MT keeps the Investors updated on the development of the TC Shari'ah compliant. This means that the Shari'ah Adviser will guide the
7. On decision of the IPEF, the MT ultimately executes the exit out of the TC hopefully experienced legal advisers to model the clauses and mechanisms
throuhg IPO / sale ... used. Some Advisers do not mind what type of vehicle is used as long as the
8. The profits / losses of that exit flow back to the IPEF that distributes them vehicle satisifies the haram and financial ratios screening tests and does not
to the Investors contravene the basics of the Mudaraba and Musharaka PLS partnerships.
Malaysia for instance allows the use of corporations.
Investors
Some Shari'ah scholars however oppose to the use of Western style
companies and only accept the Mudaraba and Musharaka PLS partnerships
Investors in IPEFs can be real or legal persons. It depends on their local or legal structures that emulate and closely look the same (mostly common
regulations whether and how they may be marketed for an investment in the law style Limited Partnerships (LP), where the investors - mostly consisting
IPEF. Investors in private equity are typically high net worth individuals, of high net worth individuals and institutional investors - will be grouped as
family trusts, corporations and institutions. A promoter of an IPEF would limited partners.

4. Management Teams 4 Conventional insurance;
The composition of the management team - which may consist of either 5 Entertainment activities that are non permissible according to the Shari'ah;
natural persons or a separate legal entity - is crucial to the success of the
whole venture. Where there is a mix of Shari'ah compliant as well as 6 Manufacture or sale of tobacco-based products or related products;
conventional activities, then it has to be checked whether or not the
strategies need too much adaptation to meet the Shari'ah standards.
7 Stockbroking of share trading in Shari'ah non-compliant securities; and
Sound and transparent
8 Hotels and resorts.
Some common terms explained reporting to the investors
during the lifetime of the IPEF
should imperatively be By ijtihad the Shari'ah adviser may also deem other activities as non-
Halal Lawful or permitted acquired. Things often do not permissible. Careful attention should also be given to all companies that
Haram Unlawful or prohibited happen suddenly and timely could derive partial income from such haram activities such as: supermarket
Ijara Lease intervention with additional chains, airlines, hotels, restaurants, etc. For investments in public listed
Murabaha Sale at mark up – can be funding can save many a companies, it is more or less generally accepted that any haram income of a
spot or deferred payment mishap. non-compliant target company that does not exceed 5 % of overall gross
Mudaraba Partnership with one or income is considered marginal or accidental. The target company will still be
more financial investors and one or acceptable, provided there is sufficient cleansing according to the guidelines
Investment strategy set forth by the Shari'ah Adviser or the SSB (for example, if those haram
more working partners investing
activities are isolated or the proceeds from such activities given to charity).
labor The investment strategy However, the cleansing would have a detrimental effect on the end profit on
Musharaka Two or more partners should be clearly defined and the investment for the compliant investors.
invest labor and finance manageable by the
Riba Usury, generally perceived as management team, which
Financial Ratios
interest should obviously have specific
Salam Forward sale business knowledge in the
Wakala Agency fields of activities of the target In the present state of the economies, it is extremely difficult to find target
companies and not only have companies that are completely 'interest free' and not too 'liquid'. The Shari'ah
financial expertise. scholars have accepted this and allowed cooperation for the general benefit.
The strategy will also be bound by the list of haram activities and financial Rules of thumb have been developed that have been applied amongst others
ratios that the target company will face, as explained infra. by Market Index Institutions (for instance Dow Jones in their DJIM Index
'Dow Jones Islamic Market Index') and that roughly can be summarized to
the following criteria :
Target Companies 1 Total debt: Excludes investments when total debt divided by 12 month
average market capitalisation exceeds (or is equal to) 33 per cent.
Provided that the activities of a target company are not haram and the 2 Total interest bearing securities and cash: Excludes investments when total
financial ratios stay within the accepted borders, any activity could be open cash and interest bearing securities divided by 12 month average market
for financing. Here is a non-exhaustive list of what is haram - as is used by capitalization exceeds (or is equal to) 33 per cent of the revenues.
the Securities Commission of Malaysia - of possible elimination criteria,
subject to fine tuning by the Shari'ah Adviser or Shari'ah Supervisory Board 3 Accounts receivable: Excludes investments in Target Companies if
SSB: accounts receivable divided by total assets is greater than (or equals) 45 per
1 Financial services based on riba (interest);
cent of the revenues.
2 Gambling and gaming;
3 Manufacture or sale of non-halal products or related products;

5. In general - and since most IPEFs will target unlisted companies - the FTSE On the other hand, preference to profits might be construed within limits
screening ratios that are based on total asset values appear to be a sound when attached to common stock. Also, certain convertible and exchangeable
tool. The Shari'ah Adviser or the SSB will here again set rules and may structures have been approved. Vesting techniques can also be used. This
decide on delays for compliancy before or after the acquisition can be made. means that some stock only accrues for the entrepreneur (or key employees)
after agreed periods have elapsed or benchmarks have been reached. This
helps to retain their interest for the business or it simply makes them wait for
value creation before the actual transfer. Lock-in
agreements also have been approved.
Financial Screening Ratio’s
Debt Receivables Cash + Non Permissible Contractual restrictions and even insertion of the target
Ratio Ratio Interest Income / Total company's by-laws are suggested to ensure compliance.
Bearing Ratio Income Indeed, good covenants with the management team and
1
DJIM 33 % 33 % 33 % ≤5% the target company (reporting, board meetings, financial
2
FTSE 33 % 50 % 33 % ≤5% follow up, etc.) are necessary to ensure that the venture
3
33 % 49 % 33 % ≤5% is being managed according to plan and to the agreed
S&P
guidelines are essential. It also has to be taken into
MSCI 4 33.33 % 70 % 33.33 % ≤5%
account that nuances in the personal perspectives on
5
Parsoli 33% 45 % 33 % ≤ 10 % Shari'ah might prevent the individual compliant investors
HKIslamic 33 % 49 % 33 % ≤5% from participating in certain concrete investment
6
Index proposals. Opt-out clauses will therefore most probably
1 1
Trailing 12 Months Average Guide to DJIM Indexes November 2007 be inherent parts of the commitments. Such issues
2
Market Capitalization Ground Rules for the Management of FTSE Shari’ah should be taken sufficiently into consideration at the
2 setup of the structure in order to avoid problems later on.
Total Assets Global Equity Index Series Version 1.2 March 2008
3 3 For the same reason it could be advised that the
Market Value Equity S & P Shari’ah Indices Index Methodology June 2007
4 4 compliant and non-compliant investors be pooled in
Total Assets Morgan Stanley MSCI Islamic Index Series different investment units that may or may not decide to
Methodology April 2007 (co-)invest in the various target companies. Otherwise it
5 5
Trlng 12 Mnth Av Market Cap Parsoli Islamic Equity Index PIE will become more complicated (and costly) to settle
6 6
Trlng 12 Mnth Av Market Cap Hong Kong Islamic Index accounts at exit.
Legal Challenges Islamic Liquidity Management
The contents of the legal documentation have to be compliant with Shari'ah A substantial part of the available cash needs to stay liquid for some time.
and will have to be fit in the legal environment of the chosen jurisdictions. That money cannot be parked at interest-bearing bank accounts for obvious
Whilst Shari'ah principles strictly require that any loss is born by the riba reasons. It can be invested through Islamic compliant means, for
participants in proportion to their invested capital, profit can be shared at instance, through available Shari'ah compliant liquidity management
agreed upon levels, stipulated in equitable financial agreements. For products or compliant stock.
instance, preferred stock - insofar as giving the holder the right of pay out of
investment before the common stock - is prohibited. So any existing cascade Even means of short term trade finance contracts can be envisaged either by
of equity classes with different subordination is not acceptable. Guaranteed the IPEF or a special SPV, either to the Target Companies or to third parties,
liquidation pricing (in a way securing profit and excluding the risk of sharing a provided local business and company laws and regulations and tax rulings
loss) is also contrary to Shari'ah. Sometimes parties wrongly want to allow this in a profitable way.
negotiate a minimum price (initial investment or even a multiple thereof).
Evaluation of fair market value and company performance are to be
preferred.

6. Shari'ah Advisers and Shari'ah Compliance Officers general SSBs have advised to attain full transition (repayment of
conventional debt) within a maximum of three years after the acquisition. Too
The Shari'ah Adviser or the SSB will assume the responsibility for the much leverage should be restructured to Islamic debt at the soonest (using
Shari'ah compliancy of the IPEF, and eventually the target companies and compliant finance structures such as Ijara wa Iktina).
the management teams. As an example, here is a summary of the standing
Guidelines of the Securities Commission of Malaysia which advises to If the investors remain the minority, they will, attempt to demand compliance
appoint at least one Shari'ah adviser who will: where possible at the level of the target company at least with the above
1 Ensure that all aspects of the business are in accordance with the Shari'ah explained rules, and will strive for the introduction of additional compliant
(including portfolio management, trading practices, operational matters, modus operandi (such as Trade Finance tools, Islamic Banks) where
administrative matters, etc.); possible.
2 Provide Shari'ah expertise on documentation, structuring, investment When the compliant investors - through the IPEF - do not have a majority
instruments and ensure compliance with the general Shari'ah principles and stake in the target company, then special attention should be paid to the
the standards, regulations and resolutions of the regulator; redaction and enforceability of a strong shareholders' agreement that
guarantees Shari'ah compliance to the agreed upon standards at all times.
3 Scrutinise any compliance report or any investment transaction report
prepared by the Shari'ah Compliance Officer; and This being said, one should envisage the intermediation of local Islamic
Financial Institutions ('IFI's) to assist the target company in re-financing with
4 Provide written opinions of compliance from time to time or when needed Shari'ah compliant financial products where needed. The exposure to such
and at least annually to the Board of Directors of the IPEF. products would enhance the awareness of the target company to the
Shari'ah. Or, if so desired and useful and provided that local regulatory and
Both for the IPEF and the management team, Malaysia also encourages tax regulations are favourable, one could even envisage setting up an
assisting Trade Finance Company ('TraFiCo'). The use of a TraFiCo or the
appointing a Shari'ah Compliance Officer, who will on a daily basis:
guarantee of sufficient compliant funding from an Islamic Bank could maybe
1 Ensure full compliance of the activities;
influence the conventional investors and the target companies to commit to
the compliant project.
2 Report any non-compliance to the Shari'ah Adviser;
Conclusion
3 Assist the Shari'ah Adviser in certifying that the business is compliant; and
Private equity confirms a social commitment to the real economy in the real,
4 Maintain the compliance records. tangible sense of the word and therefore has to be encouraged. The money
will help creative entrepreneurs to develop optimal businesses. It is a direct
Shari'ah awareness cooperation between money and labour on a fair and equitable foundation.
And that is exactly what the Islamic economy and partnerships stand for.
It will be clear that not only the SSB should be monitoring the need for the Investors however do not necessarily have the time and the knowledge
IPEF and the target company to stay compliant at all levels and at all times. (business lines, financial structuring and cultural or legal know-how) to enter
The management team, as the link between the investors and the target those markets in the different geographical locations and to manage the
Company, should provide for sufficient awareness amongst its members and ventures closely. This certainly is the case when the investments need to be
keep close contact both with the target company and the SSB. diversified into several target companies to spread the risk.
Coexistence with Conventional Finance The IPEF are perfect conduits for PLS. One may use the traditional
mudaraba or musharaka PLS partnerships. However, venturing / investing
Private equity injections would place compliant investors directly at the core outside of the Islamic world sensu stricto will lead to different, but still
of the target company, exposed to possible non-compliant situations. When Shari'ah compliant vehicles and probably also will lead to permissible
they form the majority, they would be able to implement full compliance. In cooperation with conventional financiers. There is hardly a better way

7. available to make the conventional business world aware of the Islamic
ethical standards and respect them in a positive and inviting way.
Paul Wouters1
Antwerp Bar Association (Belgium)
Counsel to Bener Law Office (Istanbul - Turkey)
The information contained in this article is provided for general information
purposes only. It is intended to highlight issues and not to be comprehensive,
nor to address the circumstances of any particular individual or entity. Data
and figures can be subject to changes and are for illustration only. Every
situation is different and needs specific counseling. Professional (legal)
advice should be sought before taking (or refraining from) any decision or
action as a result of the contents of this article.
Notes
1 This article is an excerpt of an original article 'Islamic Private Equity Funds'
published by the Islamic Finance News (www.islamicfinancenews.com) - A
free copy of the full text thereof can be obtained at the website or at the
author: pwouters.law@gmail.com