Steven J. Adelkoff, Jonathan Lawrence, Remsen M. Kinne IV June 23 2009

1. CELESQ Webinar Attracting and Using Middle Eastern Money - Investing in Real Estate in a Shariah Compliant Way Steven J. Adelkoff, Jonathan Lawrence, Remsen M. Kinne IV June 23 2009

2. Attracting and Using Middle Eastern Money - Investing in Real Estate in a Shariah Compliant Way • Introduction • Basic Shariah Rules

3. What is Shariah? • “O you who believe! Stand out firmly for Allah, as witness to fair dealing, and let not the hatred of others to you make you swerve towards inequality and depart from justice.” Qur’an 5:8 • In the business context, Shariah is a means of conducting business through a distinct set of rules designed to facilitate fairness. • High correlation between Shariah compliant investing and socially responsible investing

4. Where are Shariah rules codified? • Interpretations of the Qur’an from various Islamic schools of thought • Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) • The fact remains: Shariah mandates are not always consistently applied from Scholar to Scholar. Information is asymmetric, and Shariah Advisers and lawyers skilled in the area become useful to work through the counter-intuitive results

5. Shariah terms • Halal – that which is permitted or compliant • Haram – that which is not permitted • Riba – charging of interest • Gharar – the taking of unreasonable risk; gambling • Sukuk – Shariah compliant debt • Ijara – Shariah compliant lease • Takaful – Shariah compliant form of insurance • Maduraba/Musharaka – forms of partnership • Murabaha – a form of Shariah compliant forward sale for commodities that is used as a fixed income substitute

6. Industry prohibitions • Gambling • Pork production or consumption • Adult Entertainment • Banking and finance • Alcohol production or consumption • Weapons production • Tobacco production or use

7. Shariah-compliant investment screens • Screens haram industries • Screens use various ratios to determine if a company is too leveraged • AAOIFI Shariah Standard No. 21 forms the basis of the theoretical underpinnings for screens and ratios. • Debt to assets of 30% or less (3/4/2 of Standard 21) • Impermissible income of 5% or less (3/4/3 of Standard 21) • Many companies are now failing the total debt to market capitalization ratio test

8. Riba • The charging of sums for borrowed money (i.e. interest) is forbidden • But the pledging of Halal assets, the guarantying of obligations and the leasing of property under what we might consider a finance lease (or ijara) is permissible • Murabaha is the selling of a commodity at an agreed upon mark-up, and is used in Shariah as a fixed income investment substitute.

9. Riba Things to Watch Out For: • Default Interest • Administrative fees for late payments • Consideration in respect of third party guaranties (see AAOIFI Shariah Standard No. 5) • Preferred Shares are generally not permitted (AAOIFI Shariah Standard No. 21); but dividends distributed from profits are permitted.

10. Gharar • The act of taking on unreasonable uncertainty • Examples of Gharar: • Gambling • Insurance • FX Trading • Options on stock (AAOIFI Shariah Standard No. 21, paragraph 16 of Appendix B)

11. Attracting and Using Middle Eastern Money - Investing in Real Estate in a Shariah Compliant Way • Conventional Leasing v Shariah Compliant Leasing (Ijara)

12. Ijara • Literal translation: providing goods or services for temporary use against a wage • Qur’an legitimacy: “said one of them, ‘O my father engage him on wages’” (Qur’an Surah al-Qasas verse 26) and “if you had wished, surely you could have exacted some recompense for it” (Qur’an Surah al-Kahf verse 77)

13. Ijara (cont’d.) • Sunnah legitimacy: “whoever hired a worker must inform him of his wages” and “ give a worker his wages before his sweat is dried” • Scholar reasoning: Ijara is a convenient means for people to acquire the right to use assets that they do not own since not all people may be able to own tangible assets • AAOIFI Standard No. 9

14. Lease terms • Amendments to terms • Duration • Commencement date • Deposit monies to secure the lease • Two contracts for same asset for same period • Sub-leases • Sale and leaseback

15. Use of the real estate • Prohibitions: • Gambling • Alcohol • Pork • Western style insurance and banking • Defence industry • Adult entertainment • Controlling sub-leases and assignments

16. Treatment of rent • Fixed for life of lease or adjusted periodically • Rent variation via reference to benchmark based on clear formula • Payment by lump sum or instalments • Late payment • Lease repricing • Rent acceleration

17. Obligations of lessors and lessees • Maintenance • Major repairs • Insurance cost • Property defects • Lessee misconduct • Insurance

18. Guarantees and rental income • Security to secure rental payments and against misuse of the property • Instalments may be accelerated on failure to pay one instalment • No increase in rental due to delay • Charitable donation in lieu of penalty payment • Future rental payments may not deducted from security enforcement

19. Selling of or damage to the leased asset • Termination of Ijara lease on sale of property to lessee • Lessee’s consent not necessary for sale to third party • Total destruction: Ijara lease terminates • Partial destruction: Lessor liable for damage or destruction of leased asset unless result of lessee’ misconduct or negligence

20. Termination, expiry and renewal • Termination by mutual consent • Unilateral termination • Breach of lease terms • Death of a party • Total destruction of real estate • Expiry at term • Continuation for good cause • Renewal by agreement or automatically

21. Leases that end in lessee ownership • Ijara Wa Iqtina • Resolution of the International Islamic Fiqh Academy No. 110 (4/12) • Finance lease • Unilateral promise of ownership transfer by lessor at end of lease term • Unilateral promise with purchase schedule • Purchase at end of lease term or in stages • Lessor may not force lessee to buy

22. Leases that end in lessee ownership (cont’d) • Ijara Mawsoofa Bil Thimma • Often used in project finance • Redeemable lease which buys out completed project • Agreed in advance with initial construction deal

23. Attracting and Using Middle Eastern Money - Investing in Real Estate in a Shariah Compliant Way • Sukuk - Shariah Compliant Leverage

24. Underlying principles • Asset backing • Entrepreneurial investment • Defined credit participation • Specific real business risk (vs. guaranteed interest-based return)

25. Definition of Sukuk • Sukuk terminology • Shariah-compliant securitized credit financial instruments

26. Definition of Sukuk (cont’d) • Participation certificates • Evidence investors’ right to return based on profitable investment • Return results from actual asset ownership

27. Structure • Shariah-compliant underlying asset • Originator/sponsor sells asset to special purpose vehicle • Asset sale transaction may be, for example, a lease back or a sale-repurchase • Concurrent transaction by SPV with asset user, for example lease and purchase • SPV issues securities to investors • Investors hold direct ownership interest in underlying asset through SPV • Pass-through payments

28. Sukuk documentation • Documentation issues

29. Other key issues • Bona fide purpose • Return from profitable activity only • Return not from debt, cash or other prohibited assets • Insurance • Credit enhancement, liquidity support, limitations of prepayment risks, guarantees

30. Governance and Regulatory Considerations • Shariah rulings • Commercial securities, taxation laws • Regulatory organizations

31. Recent Developments • Principal guarantees/repurchase agreements • Accounting standards

32. Attracting and Using Middle Eastern Money - Investing in Real Estate in a Shariah Compliant Way • Shariah Scholars and Advisers • Anti-Money Laundering

33. Shariah scholars • Part Judge, Part Jurist • Usually operates in Shariah Boards of three or more • Issues a Fatwa (Fatawa in the plural) • No particular governing body or rules, just schools of thought and AAOIFI • High demand and short supply • Certain Scholars are exceedingly influential in certain countries • There are no standard setting bodies, and Scholars have latitude. Information is asymmetrical. But sometimes Scholars disagree.

34. Shariah advisers • Has relationships with various Scholars • Has structuring expertise and knows what the Scholars will accept • Is the bridge builder between conventional structuring of equity, debt or investment partnerships and Shariah

35. Purification • The act of purging oneself of impure profit, by contributing the profit to charity • A function of the Shariah Board is to tell investors what percentage of their profit is subject to purification • Shariah Boards use to recommend the charities to contribute Haram profits; modern practice is simply to allow investors to contribute impure profits to the charity of their choosing

36. Tales of anti-money laundering Compliance in Shariah The Challenges of AML-KYC in Shariah Investing • Who mandates which charities may receive purification dollars? • The home address of “Two Oak Trees down the long road, and take a left at the Big Stone” • When utility bills are in Arabic

37. Further resources • www.aaoifi.com Accounting and Auditing Organization for Islamic Financial Institutions • www.islamic-finance.com • www.securities.com/ifis Islamic Financial Information Services (subscription required) • www.shariahcap.com Shariah Capital • www.sii.org.uk/web5/infopool.nsf/html/qintifq Securities & Investment Institute: Islamic Finance Qualification

38. Attracting and Using Middle Eastern Money - Investing in Real Estate in a Shariah Compliant Way • Conclusion • Any questions?