Shariah finance refers to a system of finance that is consistent with the principles of Islamic law, which generally prohibits the payment or acceptance of interest fees for the lending and accepting of money respectively, as well as investing in businesses that provide goods or services considered contrary to its principles. Among the most popular types of funds that can be established, there are:
- Equity funds: profits in these funds are normally made through capital gains and dividends paid by investee companies. Under Shariah law, there are some limitations as to the type of companies in which the equity fund can invest
- Ijarah funds: these funds are usually established for the purpose of purchasing assets like property and machinery, and then leasing those assets to third parties in return for rental income
- Commodity funds: these funds derive their income from the purchase and resale of commodities.
- Murabaha funds: these funds make their profits through ‘cost-plus’ financing by buying goods and reselling them at a profit margin.
In recent years, Malta has sought to establish a legal and regulatory framework that makes it possible for Shariah funds to be established as such under the Investment Services Act.
On the 24th March 2010, the MFSA has published a Guidance Note for Shariah Compliant Funds. In order for a Shariah-compliant fund to be licensed as such, it needs to comply with the legal and regulatory framework generally applicable to normal funds, as well as with the MFSA Guidance Note for Shariahcompliant funds. Any deviations from the Guidance Note will be only be allowed if there is the express approval of the MFSA.
Generally speaking, Shariah-compliant funds can be set up either as retail funds (UCITS or non-UCITS) or as PIFs. However, in the specific case of Ijarah funds, Commodity funds, and Murabaha funds, these can only be set up as PIFs, due to the largely non-conventional assets in which these funds invest.
The fund manager of a Shariah-compliant fund needs to appoint a Shariah Advisory Board. The Board should be composed of at least two Islamic Shariah scholars that are recognized internationally, and needs to be independent of the fund manager. The Advisory Board has various functions and responsibilities, among which it needs to:
- provide guidance and ensure that the fund meets Shariah compliance standards;
- approve the fund structure and the investment methodology of the investment manager, including the Shariah Guidelines that will be followed in the management of the fund;
- approve Shariah Guidelines as these may be changed from time to time by the investment manager;
- generally supervise the operations of the fund in all aspects to ensure that it remains in line with the Shariah Guidelines;
- make an annual report in the funds audited financial statements, expressing its opinion regarding the extent of Shariah compliance by the fund.
The fund needs to operate within the requirements of Shariah as these may be interpreted by the Advisory Board. In this respect, the interpretation of the Board is authoritative, and in the case that it comes to the conclusion that any investment made by the fund is non compliant with Shariah principles, then the fund will have to liquidate that investment within the terms set out by the Advisory Board. It is useful to note that the Advisory Board will not give specific investment recommendations to the fund or its manager; this means that it will be the manager itself who will remain responsible for the investment management of the funds assets. Moreover, the ultimate responsibility for compliance with Shariah principles disclosed in the prospectus of the fund rests with the fund directors and manager, not with the Advisory Board.
The prospectus or the offering memorandum of the fund needs to make certain disclosures that are over and above those that need to be made by funds that are not Shariah-compliant. It should set out the details of the Shariah Advisory Board and of the compliance review carried out by the Board prior to the launch of the fund. Reference also needs to be made to any adverse factors that are the result of compliance to the Shariah Guidelines such as:
- restrictions in the investment strategies and opportunities that the fund may pursue;
- the fact that compliance with Shariah Guidelines may lead to increased costs on the part of the fund;
- any lower returns and increased volatility as a consequence of following the Shariah-Guidelines;
- risks of any liquidation that may need to be made in case any investment made by the fund is subsequently declared not to be Shariah compliant.