Shari’a Compliance and Conventional Credit Structures: An Oxymoron?

Conventional private credit investments and Shari’a principles are intrinsically at odds. Or are they? Interpretation and implementation are key to answering that question.

While private equity, real estate, infrastructure and venture capital have always been favoured by investors looking for Shari’a compliant investing options (provided the underlying strategies generally align with Shari’a principles), the last several years have seen a noticeable shift to credit asset classes.

However, while regular income products are enticing, interest-based products are strictly prohibited in Shari’a compliant investments.
Fortunately, options to provide structured solutions do exist; one just needs to know their audience and what the acceptable norms are in the market.

Key Shari’a Prohibitions

• Riba (interest):This is a fundamental prohibition. When discussing credit solutions, it is a key barrier.
• Certain activities are prohibited (see below).
• Gharar (uncertainty/speculation):Any transaction that is contingent on events and that is excessively risky.

Key Guidelines

• When investing, Shari’a investors will be focused on investments that meet the following criteria to be deemed fully compliant:
• No prohibited sectors: Avoid investing in products or industries that relate to alcohol, gambling (maysir), hotels, conventional financial services (which is key in the context of credit structures), weapons, tobacco, adult entertainment, music/streaming, and pork retailers/manufacturers, among others.
• Adhering to financial ratios: Ensuring debt to asset and interest-bearing securities to total assets remain at 30 percent or one-third, depending on the scholar.
• Minimise tainted income: Income from non-compliant sources must remain below 5 percent per investment, and any income that is non-compliant is channelled to charity.
• No conventional hedging/interest-bearing accounts or financing lines.

Who Are the Key Stakeholders

• Shari’a sensitive investors: They are crucial. Understanding their jurisdiction, which influences their interpretation of Shari’a principles, and determine early on what types of products and solutions they are comfortable with.
• Shari’a advisory firms: Engage these firms early for opinions on the compliance or noncompliance of any solution or product you intend to market.
• Shari’a scholars: These boards issue fatwas (opinions) certifying that an investment aligns with Shari’a principles, often a requirement for Shari’a investors.
• Legal advisers: Appoint counsel experienced in this market to draft contracts and set up vehicles, ensuring a seamless process.

What Are the Solutions

Credit investments in the Western world are based on interest-generating instruments — such as direct lending, bonds, CLOs and BDCs. To enable Shari’a investors to access these products, the following solutions are often used:

• Wrappers: These have fallen out of favor with many investors and Shari’a advisors due to a shift toward stricter compliance. Wrappers don’t require much oversight of the underlying investment or strategy if enough distance exists between the Shari’a investor and the product—achieved through certain Shari’a financing arrangements.
• Structured solutions: These go deeper into the objectives of the vehicles and assets, requiring overlays or amendments to interest-bearing instruments. This demands education and understanding from managers and advisors. These solutions don’t need to be fully Shari’a-compliant at every level, which allows flexibility in areas like hedging, interest-bearing accounts, leverage, and thresholds for prohibited sector investments, however they are perceived as more in line with Shari’a principles.

What Should You Expect

Products and solutions for credit type investments are not flawless. However, there has been a noticeable shift among managers who are now more open to discussions —largely driven by demand. If the price is right, the associated time and cost to deliver a solution becomes more palatable.

From the perspective of Shari’a advisory firms and scholars, the goal is to educate and bridge the gap between Western managers and the concept of Shari’a. As barriers break down and misconceptions fade, the conversation may shift toward how fully Shari’a-compliant structures can be implemented—including replacing interest-bearing instruments with profit-based ones that meet all Shari’a guidelines.