Using sharia structures for humanitarian giving
A landmark fundraising last year for the International Committee of the Red Cross that linked investor returns to delivery on humanitarian targets could just be the start for charitable funding, with considerable scope to build on the humanitarian impact bond structure.
The Red Cross SFr26m HIB, although called a bond, is actually a private placement. It uses the SFr26m investment from the private sector to fund the construction and operation of rehabilitation centres in the Democratic Republic of Congo, Mali and Nigeria. At the end of a five-year period, the performance of each centre will be evaluated for efficiency in terms of concrete figures (for example, the number of prosthetic devices fitted or patients seen) and compared with other specified ‘baseline’ centres operated by the ICRC.
The “Outcome Funders” – in this case the governments of Belgium, Switzerland, Italy, the UK and the “la Caixa” Foundation – will then pay the ICRC based on the results, and these funds will be passed through to the HIB buyers. If the centres perform poorly the HIB holders could lose part of their original investment, but if they succeed they could receive a competitive return.
This arrangement provides assurance that any payment is linked to the achievement of the desired outcomes whilst allowing the ICRC to access funding from, and pass the risk of performance to, the private sector.
A NATURAL FIT
Socially responsible investment is becoming increasingly popular as investors hope to earn a return while also making a positive social impact. This can take many forms, with Green bonds and investment in sustainable industries receiving considerable attention.
SRI also includes ethical investment, which avoids investment in companies that produce or sell undesirable products, such as alcohol or tobacco, or those that promote gambling.
In this regard, Islamic finance has always been a form of ethical investment because it bans investment in alcohol, arms and gambling.
Yet Islamic finance goes further, and its core principles also forbid exploitation and require sharing profit and risk and generating real wealth for the benefit of the community, rather than hoarding money. In these principles, Islamic finance matches SRI in its focus on using investments to produce a positive social impact.
Charitable donations in the form of zakat are one of the five pillars of Islam. Zakat literally means purification, and the payment of zakat is mandated for Muslims to purify their wealth and benefit the community. Global zakat funds need ethical forms of investment, and adapting the HIB to a sharia-compliant context could attract their interest.
Despite this, there have not yet been many examples of engaging ethical finance in Islamic finance. With many parts of the Muslim world are facing conflict, from the war in Syria to the Rohingya crisis in Bangladesh, the HIB may enable investors help to have an impact, as it would provide a means for international charities to use private sector funding to expand their activities.
WORKING IN PARTNERSHIP
Islamic finance would be well suited to this style of funding through, for example, the musharaka (partnership) structure.
An entity (such as the ICRC) seeking finance (the project manager) would establish a special purpose vehicle and agree with the SPV that it commits existing assets to a musharaka for the purposes of generating a return. In this case, the contribution could be the physical buildings of the rehabilitation centres or the land on which they are to be constructed.
The SPV would then offer sukuk to social investors willing to invest in the musharaka. As the principal, the SPV would enter into a management or governance agreement with the project manager to manage the musharaka on the basis of a business plan agreed between the parties. The plan would set out how the return is to be generated, for instance through the achievement of the outcome objectives set by the project manager, and payment by the outcome funder would comply with that business plan.
In terms of obtaining a fatwa to confirm the sharia-compliance of the structure, the religious make-up of the population to be served by the project would not be a factor. A sharia-compliant HIB could be used to fund projects for non-Muslim and Muslim populations, as it is the purpose of the investment that matters from a sharia standpoint, not the religious identity of the beneficiaries.
To make the structure accessible to as wide a base as possible, a sharia-compliant HIB could also be described without using Arabic terms. For example, the structure could be referred to as a partnership rather than a musharaka.
An advantage of this structure is that the project manager, which would likely be an international organisation such as the ICRC, would have a real stake in the success of the project, as it would lose money if the project failed. The focus on measurable results would also provide comfort to investors as well as benefiting the project.
This pioneering development impact structure could be a vital tool in matching private investors to development institutions. Its requirement for projects to produce verifiable results should be attractive to the private sector, and would promote efficiency and accountability in the charitable sector. In addition, a sharia-compliant form of the structure should be of particular interest to organisations seeking to improve conditions in Muslim countries facing conflicts, and Muslim organisations seeking ethical outlets for investment.