An Interesting Question

At Cue Ball’s most recent annual meeting of our limited partners, I introduced one of our most exciting new investments – Wahed. I was later approached with an interesting question about Wahed’s business, which is the subject of this post.

Wahed is the world’s first Halal, SEC-regulated and ethically-focused online investment platform. I had mentioned to the group that Wahed offered the Muslim world the ability to construct a truly diversified portfolio – including an array of Shariah-compliant equity, fixed income, real estate, commodity, and emerging market investment products.

This prompted one of our limited partners to ask a very interesting question:

“I understand the ethics of it, but as a practical matter, how do you make a debt instrument without interest?”

Sukuk Definition and Context

Islamic bonds are called Sukuk.

The Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) defines Sukuk as: “certificates of equal value representing undivided shares in the ownership of tangible assets, usufructs, and services or (in the ownership of) the assets of particular projects or special investment activity.” (Usufruct, by the way, is the right to derive income from someone else’s property). This is not the most user-friendly definition, but I will provide an example and compare and contrast the features with conventional bonds later in this post that will make the meaning much clearer.

Sukuk issuers include sovereigns as well as corporates. Sovereign issuers include those from Muslim-majority countries but also non-Muslim ones. The Euro 100 million Islamic Eurobond issued by the German state of Saxony-Anhalt in 2004, or the 1 billion USD Sukuk issued by Hong Kong in 2017 are such examples. Similarly, corporate issuers include those from the Muslim world, such as Saudi Aramco or the Malaysian bank CIMB. But they also include issuers such as General Electric and Goldman Sachs, whose $500mm Islamic bond issuance in 2014 was 3x oversubscribed.

The global Sukuk market is not that big, but it is significant and growing. According to S&P, in 2017, there was $97.9 billion of global Sukuk issuance, which represented 45.3% increase over the 2016 issuance amount.

Islamic Finance Principles and Sukuk Contrasted with Conventional Bonds

Islamic finance prohibits investment in certain sectors or activities, including alcohol, gambling, adult entertainment, pork, tobacco, illegal drugs, weapons, and military equipment.

Most people also know that Islamic finance also prohibits the payment of interest (or Riba). The reason for this is that it is considered exploitative and usurious. Rather, Sukuk is based on the concept of shared risk between the investor and borrower.

The table below provides a high-level description of key differences between conventional bonds and Sukuk.

Sukuk Structures and an Example

There are several different creative and innovative Sukuk structures, including those based on equity partnerships, joint-ventures, deferred payments, leases, and project finance.

The illustrative example below is one based on equity partnership (called “Mudaraba Sukuk”). Here the investor (and SPV) is a silent partner, and the borrower is the working partner. In this case, the profit from the venture is shared between the investor and obligor based on some agreed to amount (i.e., such as 90% to the investor, and 10% to the obligor). What is different from conventional bonds is that should the venture lose money, the loss will be borne by the investor (absent any fraud or negligence on behalf of the obligor). In a sense, this is fair because the obligor will have lost their time and effort through their work on the venture.

In the diagram above:

1. The investor gives cash to the SPV, which then gives it to the obligor.
2. In return for this cash, the investor gets Sukuk certificates.
3. The obligor splits the profits of the venture with the SPV according to the agreed upon formula (sometimes net of a fee).
4. The SPV distributes these proceeds to the Sukuk investors on a periodic basis.

Our Investment in Wahed

This brings us back to what prompted the question about Sukuk – our investment in Wahed. There are many aspects of the Wahed investment that excite us, including:

• An incredibly large market approaching ~2 billion Muslims globally. According to PEW Research, the global Muslim population is expected to grow by 73% between 2010 and 2050. (The second highest growing religious segment is Christians, whose population is expected to grow at 35% during this same period.)
• A very young demographic with 80% of the world’s Muslims between 0 and 44 years old with a median age of 24. This demographic is digitally-oriented and receptive to a technology-first financial services offering.
• Structural barriers to entry for Western and conventional financial institutions as well as established Islamic firms. Conventional and Western financial institutions are not able to offer truly Shariah-compliant products due to the fact that their parent companies are involved with prohibited activities. Wahed also has a branding/marketing advantage. Furthermore, traditional Islamic financial institutions do not have strong core competencies in technology.
• A relatively green-field opportunity with a dearth of financial technology currently serving the Muslim world. This comes with a host of advantages including lower customer acquisition costs.
• The ability to launch other adjacent products including Takaful (Halal insurance) to create a diversified digital-first financial institution for Muslims globally.

With this investment, we are thrilled to partner with Wahed’s dynamic founder and CEO Junaid Wahedna. We are also delighted to partner with an excellent set of investors including Amir and Dany Farha of BECO Capital and the talented Khalid Al Jassim of Afkar Holdings – among others.

We look forward to supporting Wahed as it embarks on its next phase of growth.