Opportunities in Islamic Private Equity

By Rafi-uddin Shikoh

Mr. David Rubenstein, founder of the worlds largest private equity firm The Carlyle Group, has in his many industry presentations cited Christopher Columbus (the famous early voyager to the Americas) as a first in Private Equity! To fund his voyage to discover the “new world,” Columbus pitched his plans to Queen Isabel of Castille for the $10,000 he was trying to raise. The Queen after three years of ‘due diligence' finally made the deal with Columbus promising him 10% of the profits, 5% of the gold, reimbursement for all expenses in advance, and a title of admiral for life. Nice deal!

Similarly, as a reflection of the historic role Arab voyagers and traders have played in world civilization, Mr. Arif Naqvi, CEO of one of the largest Private Equity funds in the MENA (Middle East North Africa) region, has also been referencing the voyages of Sinbad the Sailor and the early Arab seafarer traders and the spice routes carrying frankincense from Yemen. This historical role is certainly being manifested today as well in the form of the economic boom the MENA region is experiencing.

An Industry Emerges

Driven by a three-fold oil price increase in the last four years, the Gulf Cooperative Council (GCC) nations have experienced extraordinary economic boom clocking an average 6.1% GDP growth in the last three years and liquidity estimated by KMPG to be in excess of US$2.3 trillion.

At the same time, the Islamic Finance industry continues to grow un-abated with an estimated US$ 750 billion in global assets growing 15-20% annually – with the GCC accounting for 2/3 rd of its size (S&P and HSBC analysis.)

The result of these two trends is a boom in Private Equity investments in the GCC and the broader MENA (Middle East & North Africa) which includes a growing trend of Islamic Private Equity funds as well. According to the 2007 Dow Jones Private Equity report, the MENA region has raised $16 billion since 1994 out of which $10 billion were raised in 2006. $1.1 billion are estimated to be Islamic Private Equity funds.

Today – local Private Equity players Abraaj Capital, Global Investment House, Millenium Finance Corp.(MFC) and even the global PE behemoth Carlyle Group have setup mega funds in excess of $1 billion focused on the region. Of these mega funds, the MFC funds are marketed as Islamic PE funds.

So what is Islamic Private Equity anyway? What is driving this trend and what is the impact of this trend?

Convergence of Islamic Finance & Private Equity

Commenting on Islamic Private Equity, Mr. Fuad Al-Shehab, General Manager of Investment Group at Kuwait based Boubyan Bank which together with Ryada Capital recently launched the $150 million Ryada Islamic Private Equity Fund said, “Private Equity is a natural fit for Islamic investors since at the core of Shari'ah principles money should be directed to the real economy through investing in businesses that offer ethically acceptable products and services. This means that returns should be earned through active involvement and participation in the business risk in Shari'ah compliant investments.”

There's certainly a growing realization that private equity amongst its other benefits is quite compatible with Islamic finance.

To understand the principles that are driving this convergence it's important to understand some core underlying principles. Aamir A. Rehman, a former Global Head of Strategy at HSBC Amanah, and Boston Consulting Group consultant, explains that Islamic finance is more than just financial contracts. He has identified the following core basic tenets of Islamic finance that Sharia' scholars draw upon:

If something is immoral, one cannot profit from it
To share reward, one must also share risk
One cannot sell what he or she does not own
In any transaction, one must clearly specify what he or she is buying or selling and one price is being paid

Mr. Rehman says that as the Islamic Finance industry is growing it is also maturing in terms of its richness of products being offered—from commercial banking, insurance to structured products, the Industry has near like-for-like parity with conventional offering. However, he points out that the Industry still needs to deepen and address a variety of investment product gaps. As real estate and equity assets have matured, and structured products and cash management products are maturing--sophisticated products such as Private Equity, Fixed income or hedging products are just emerging in the markets.

Mr. Rehman sees the Islamic private equity sector specially poised for expansion. He bases the natural partnership between Islamic Finance and Private Equity on conceptual and commercial grounds.

Conceptually, he contends that Islamic finance ethos actually seeks “real economy” impact which Private Equity is geared to deliver. Infact he says that the Private equity model represents classic Mudarabah with the GP / LP structure being a strikingly pure example of what a Mudarabah is envisioned to be. Meanwhile, he says that the traditional “Banking” model is inherently constraining with risk-free deposit and lending, and limited equity positions resulting in clients not sharing the upside.

Commercially, Mr Rehman highlights the growing interest and comfort within family businesses to seek private equity in rationalizing their assets. At the same time Sharia compliance is also becoming an important ‘exit' consideration. Another commercial aspect is the affect of the GCC markets that have severely corrected themselves giving private equity additional prominence.