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Shariah Compliant Funds in Ireland October 2008
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es barrier-free access to a market of over illion consumers. This, in addition with
al other factors has led to over 1,000 anies from all over the world to choose d as their European base from which to ct their business.
Ireland?
• In Ireland today there are over 11,000 people employed directly in the investment fund industry
• Ireland is the leading global hedge fund administration centre, servicing 37 per cent of the total global industry
• Seven of the top ten hedge fund administrators in the recent HedgeFund.net survey on administrators have operations in
Contents • Introduction
• Why Ireland?
• Irish legal and regulatory framework
for Shariah funds
• Ireland welcomes Shariah Funds
• PricewaterhouseCoopers approach
to investment management
• Contacts
Islamic Finance is growing in global importance as an alternate, humane and ethical financial system. Through the prohibition on interest, and the focus on equity financing and trade of tangible assets, Islamic Finance provides a viable alternative to conventional finance, but with a significant focus on social responsibility and inclusive profit making. The Islamic Finance industry is growing globally, with billions of dollars already invested in Shariah investments. Ireland is renowned globally as being one of the premier locations for establishing and administering investment funds. According to the Irish Funds Industry Association (IFIA) there are in excess of 7,000 funds with a net asset value of over Euro 1.4 trillion serviced in Ireland. As a democratic republic, a committed member of the European Union and the OECD, Ireland
provid490 msevercompIrelancondu
Why
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Ireland, additionally there are more than 340 international fund promoters
• There are now over 4,400 funds and sub-funds listed on the Irish Stock Exchange, making it the largest exchange in the world for funds listing
• 24 hour approval process available for Qualifying Investor Funds (QIFs)
• Flexible, proactive regulatory environment
• Market driven alternative investment product solutions
• Extensive industry experience and expertise
• Location – optimum time zone to ensure global coverage, English speaking, Euro currency
• Corporate tax rate of 12.5 per cent, one of the lowest in Europe for administrators
• Fund activities are exempt from Irish taxation
With Ireland’s experience within the funds industry and the receptive attitude of the Irish Financial Regulator to new entrants to the market, the Irish regulatory framework provides a favourable environment for the establishment of Shariah compliant long-only funds and for the development of Shariah compliant hedge funds.
Irish legal and regulatory framework for Shariah Funds
1. The appointment of a Shariah Board 2. Fundamentals of Islamic Finance/Shariah
Investments 3. The purification of income 4. Types of Islamic financial instruments 5. Irish Fund Structures 6. Taxation of Irish funds 7. Shariah Financial Reporting & Standards
1. Appointing a Shariah Board Shariah funds are set up similarly to other Irish funds. They can avail of any of the legal structures available for the establishment of investment funds in Ireland, such as, an investment company, unit
The Irish regulatory framework provides a favourable environment for the establishment of Shariah compliant funds
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trust, common contractual fund or investment limited partnership.
They also appoint a board of directors and an investment manager or advisor who manages the investments of the Fund and advises the board.
The main difference with Shariah funds is the necessity for these types of funds to appoint a Shariah board which provides guidance to the directors of the Fund and to the investment manager on matters of Shariah law and in particular whether the proposed investments of the fund are Shariah compliant.
The Shariah board should consist of experts on matters of Islamic law and practice. The Accounting and Auditing Organisation of Islamic Financial Institutions (AAOIFI), has stated that a Shariah board consist of at least three Shariah scholars. The board should be appointed early in the process of structuring the fund, as one of its
functions is to review material contracts and to approve the funds structure. The Board is also empowered to issue fatwa’s which are religious rulings issued after an examination of fund rules and investments made by a fund which in effect certifies that the fund is ‘Shariah compliant’. The fatwa is an important precondition in order for a fund to be marketed to prospective investors as Shariah observant.
The role of the Shariah board therefore includes the following tasks:
1. Initially advising on the fund set-up and on the core documents.
2. Providing ongoing advice on the monitoring of the Shariah element of the fund investments.
Profit in Islam Islam does permit the making of a profit. In fact, profit forms basis of the Islamic Financial system, in that it allows for the making of profit by the party providing the capital, as well as the party using the capital. There are, however, conditions on the manner in which the profit is made, and Islam does not encourage making of profit in a way that violates religious law or is harmful to the stakeholders inherent in the business or economic activity. The acceptance of the profits in terms of Shariah will depend on couple of basis rules: 1 – The profit or loss that will incur in an investment will be shared on a pro rata basis. The principle amount invested and the rate of return (Halal Profit) can not be guaranteed.
The main difference with Shariah funds is the necessity to appoint a Shariah board
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2 – The routes of investments and the associated conditions agreed must be in accordance with the Shariah principles. 2. Fundamentals of Islamic Finance/ Shariah Investments A Shariah fund must ensure that the underlying business in which it holds securities is Shariah compliant.
The fund’s offering document will spell out the Islamic-based investment restrictions. The list below outlines some of the businesses that the Fund may not invest in:
• Businesses which manufacture sell or offer alcohol or pork-related products
• Gambling establishments
• Businesses which provide interest based financial services
• Nightclubs or businesses which are involved in pornography or adult orientated material.
In addition a Shariah fund may not invest in interest–bearing instruments and may not sell short. These restrictions have in the past been deemed to rule out Shariah compliant hedge funds. However, due to recent developments this can now be achieved through the use of Salaam contracts and Murabaha.
Salaam is a short term contract to make full prepayment for an asset prior to delivery. Murabaha contracts are a transaction where the bank buys an asset on behalf of the end user who then repurchases it over time. Total payment in such contracts would be more than the cost of the asset providing the bank with its profit margin and
also avoiding the concept of borrowing and interest. In addition, other fund promoters are looking at designing wrapper type products i.e. packaging existing investment products into Shariah compliant equivalents.
From an Irish regulatory prospective, the Shariah element is viewed very much as an overlay, comparable to a fund established with a ‘socially responsible’ investment ethos. What the Irish Financial Regulator will be concerned with is to seek to ensure is that the statements of policy and principle are transparent and clear and that the offering document is drafted in such a way that investors are able to clearly understand the basis on which they are investing.
From an Irish regulatory prospective, the Shariah element is viewed very much as an overlay
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3. The purification of income Income generated by a Shariah-compliant fund must also be ‘purified’ as it is often unavoidable that some of the income generated by the underlying companies in which a Shariah fund invests will include some form of interest.
The Shariah board’s input is again necessary in determining the types of income that need to be purified. The amounts purified should, under Islamic principles, be donated to charity.
There are a number of different ways to purify ‘tainted’ income:
- The ‘tainted’ income can be deducted prior to distribution of dividends
- Investors can be informed of the amount that should be deducted from their
dividends to achieve a Shariah – compliant return
4. Types of Islamic Financial Instruments There are a number of different Islamic financial instruments which can be used individually or in combination including:
Ijara - Leasing: Ijara involves a contract where a bank buys and then leases an item – perhaps a consumer durable – to a customer for a specified rental over a specific period. The duration of the lease, as well as the basis for rental, are set and agreed in advance. The bank retains ownership of the item, taking it back at the end of the contract.
Mudaraba - Profit sharing agreement: Mudaraba refers to an investment on your behalf by a more skilled person. It takes the form of a contract
between two parties, one who provides the funds and the other who provides the expertise and who agrees to the division of any profits made in advance.
Murabaha - Contract for purchase and resale: Murabaha allows the customer to make purchases without having to take out a loan and pay interest. A bank purchases the goods for the customer, and re-sells them to the customer on a deferred basis, adding an agreed profit margin. The customer then pays the sale price for the goods over instalments, effectively obtaining credit without paying interest.
Musharaka - Joint venture: Both the entrepreneur and the investor contribute to the capital of the operation in varying degrees and have a prearranged agreement in the sharing of risk and return.
Income generated by a Shariah – compliant funds must be ‘purified’
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Diminishing Musharaka – this entails one partner (or partners) buying out the interest of other partner(s) over time, so that the interest of the other partner(s) in the venture diminishes. Sukuk - Financial certificate that can be seen as the equivalent of the bond: Sukuk are securities that comply with Islamic law and its investment principles which prohibit the charging or paying of interest. Sukuk can be classified according to the extent of their tradability in the secondary markets. Takaful - Insurance: Takaful is a system of mutual insurance, which is based on mutual cooperation, responsibility, protection and assistance between groups of participants. Salam – this entails paying “now” for a commodity for delivery at some later, pre-agreed time.
Istisna – this entails paying “now” for delivery at some later, pre-agreed time for a commodity that has yet to come into existence.
5. Irish Fund Structures There are a number of different fund structures available in Ireland; UCITS, non-UCITS, PIFs, QIFs, hedge funds, FOHFs etc. The most popular structures are UCITS and the QIF.
UCITS The UCITS brand is recognised globally and UCITS funds are distributed heavily in Asia, the Middle East and South America as well as in Europe.
A UCITS fund which must be open ended can avail of a “single passport” throughout the above mention countries for the sale of its units/shares.
For example, this means that UCITS funds established in one member state of the EU can be sold to the public in all of the EU’s member states once the appropriate notifications have been made. They are the ideal vehicle for promoters who wish to distribute their funds on a global scale without having to obtain authorisation from each individual country.
Ireland as one of main locations for UCITS funds has an abundance of experience and expertise with these types of funds. The UCITS structure is one of the commonly used structures for retail Islamic Equity Funds.
The UCITS structure is one of the commonly used structures for retail Islamic equity funds
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Qualifying Investor Funds (QIFs) Qualifying Investor Funds (QIFs) are designed for high-net worth individuals or institutional investors, borrowing and investment restrictions do not apply. The basis for QIFs is that the investor must have a high degree of knowledge and experience in the relevant markets along with a detailed understanding of the investment risks involved. QIFs can now be authorised by the Irish Financial Regulator within 24 hours of the submission of relevant documentation to the Financial Regulator.
Some of the main aspects of the QIF are listed below:
• There are no investment restrictions for a QIF, however, if they invest in more than 50% they are considered to be feeder type investments
• QIFs may invest in up to 100% in unregulated schemes subject to a maximum of 50% in any one unregulated scheme.
• Redemptions: While open-ended QIFs may provide for dealing on a quarterly basis, the Financial Regulator requires that the time between submission of a redemption request and payment of settlement proceeds must not exceed 90 calendar days. This period can however be extended to 95 calendar days in the context of a QIF feeder or fund of funds scheme, including a QIF which provides for dealing on a more frequent basis (e.g. monthly, weekly etc.) In such circumstances, a prominent statement highlighting the fact that while the scheme deals, for example, on a monthly basis
there may be times when redemption proceeds are paid on a quarterly basis.
As the range of assets eligible for the QIF is very flexible, it is an ideal product for structuring funds for the Islamic market.
6. Taxation of Irish Funds
All Irish regulated investment funds available to the public are exempt from tax on their income and gain, irrespective of where their investors are resident. Taxation of Irish funds is very favourable and is considered to be one of the key areas of competitive advantage.
No Irish tax arises in respect of distribution or redemption payments made to investors who are neither Irish resident/Irish ordinary resident and
As the range of assets eligible for the QIF is very flexible, it is an ideal product for structuring funds in the Islamic market
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who have made the necessary declaration to that effect to the fund. Ireland has extensive double taxation treaties with 44 countries, which include most of the world's major economic powers and all the EU Member States. Irish collective investment funds are not obliged to charge VAT and most of the services provided to a fund are exempt from VAT.
7. Shariah Financial Reporting & Standards The quality and transparency of financial reporting in the Islamic financial industry differs significantly across jurisdictions. Frameworks in place for leading IFI countries include IFRS, AAOIFI
(Accounting and Auditing Organisation for Islamic Financial Institutions), Malaysian Accounting Standards and some local GAAPs which are influenced by a combination of IFRS, AAOIFI and local central bank reporting guidelines. Being relatively young, the Islamic finance sector is lacking in a common framework, although there are number of bodies who continually work on creating standards and best practices for Islamic Financial Institutions. The following are some of the main bodies which work on the guidance and promotion of Islamic finance: Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) Established in 1991 to develop accounting and auditing standards for Islamic institutions, the
Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) has made commendable effort to formulate relevant standards of practice. Another key contribution is its compilation of Shariah standards for institutional governance and related contract standards. For Islamic markets, the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) sets standards on accounting, auditing, governance, ethical and Shariah compliance for its members. AAOIFI is a self-regulatory organization with members composed of market participants as well as regulatory and supervisory bodies from 24 countries. Islamic Financial Services Board Islamic Financial Services Board (IFSB) serves as an international standard setting body of regulatory and supervisory agencies that have vested interest
The quality and transparency of financial reporting in the Islamic financial industry differs significantly across jurisdictions
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in ensuring the soundness and stability of the Islamic financial services industry. It focuses on introducing new, or adapting existing international standards consistent with Islamic Shariah principles, and recommends them for adoption. So far the board has developed and issued guiding principles on corporate governance, risk management and capital adequacy standards for Islamic financial institutions. The board also arranges summit /conferences / workshops on various issues relating to Islamic banking. Shariah scholars Over the years, Shariah scholars have made significant contributions by ensuring an appropriate balance between advances within the sector and Shariah standards. Forums such as the Fiqh Academy, established by the 57-member Organisation of the Islamic Conference, have helped promote the sector, and scholars have
ensured that common standards are adopted. Minor differences of opinion about interpretation have proved to be healthy for the sector.
Ireland welcomes Islamic Funds The Islamic finance industry, although still a relatively young industry, has transformed into a sizeable alternative financial management system. Muslim countries want Islamic finance to be part of the global financial system and are keen for these types of funds to be available worldwide. Additionally they are keen to adopt many of the more innovative practices and products relating to financial transactions as long as they comply with Islamic law. The proactive attitude of the Irish financial services industry towards new opportunities ensures that
the entrance of the Islamic finance industry to the Irish market place would be a welcome development. The regulatory authorities in Ireland have also adopted an “open door” policy in their willingness to meet with project promoters and discuss issues directly with them. There are opportunities for Ireland, either in servicing or managing Shariah funds. Building on the experience and expertise developed in the mutual & alternative funds industries, Ireland is well placed to take on this new challenge of adopting these Islamic funds.
Constant innovation in financial services has been encouraged in Ireland. This commitment is epitomised by the manner in which regulatory and tax legislation has been amended to improve Ireland attractiveness as a domicile for many different types of funds.
Ireland welcomes the opportunity to service Shariah compliant funds
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Ireland as not simply a funds domicile, but a fund administration centre of excellence with US $1.4 trillion assets under administration as of Fitzrovia, at 30th June 2007, is well equipped to service these growing Shariah funds. Ireland’s financial service industry employs in excess of 20,000 people working across a variety of service providers in administration, custody/trustee, promoters, legal, tax, audit, consultancy etc.
Ireland’s experience and position in the funds industry is well established and Ireland welcomes the opportunity to service Shariah compliant funds.
PricewaterhouseCoopers Approach to Investment Management PricewaterhouseCoopers is the leading professional services firm in Ireland. At 30 June 2007, we maintained the lead across all funds audited, with 1,949 funds serviced in Dublin. We audit a majority of the larger funds in the industry and we have been actively involved in the development and promotion of the Irish Financial Services Centre in Dublin since its inception in 1986. PwC also provides a full range of business advisory services for both large organisations and independent advisors entering the investment fund business. Our business advisory services team can assist clients in making strategic assessments of the investment business, preparing business plans and economic analyses as well as advising
on the structure of both the investment advisor and the underlying fund. Irish funds continue to grow and are now in excess of Euro1.4 trillion, illustrating the enthusiasm of international promoters to continue to choose Ireland as their base in Europe and PricewaterhouseCoopers is confident is supporting this growth. Audit Market Share by assets Source: Fitzrovia 30th June 2007 PwC
57%KPMG
21%
E&Y17%
Deloitte4%
O ther1%
PwCKPMGE&YDeloitteO ther
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Contacts Olwyn Alexander Tel: +353 1 792 8719 Email: [email protected]
Pat Candon Tel: +353 1 792 8538 Email: [email protected] Fiona DeBurca Tel: +353 1 792 6786 Email: [email protected]
Patricia Johnston Tel: +353 1 792 8814 Email: [email protected]
Andrea Kelly Tel: +353 1 792 8540
Email: [email protected] Joanne Kelly Tel: +353 1 792 6774 Email: [email protected] Vincent MacMahon Tel: +353 1 792 6192 Email: [email protected]
Damian Neylin Tel: +353 1 792 6551 Email: [email protected]
Andy O’Callaghan Tel: +353 1 792 6247 Email: [email protected]
Jonathon O’Connell Tel: +353 1 792 8737 Email: [email protected]
Marie O’Connor Tel: +353 1 792 6308 Email: [email protected]
Ken Owens Tel: +353 1 792 8542 Email: [email protected]
Tony Weldon Tel: +353 1 792 6309 Email: [email protected]
