A boutique Gulf investment bank has sourced millions of dollars of sharia-compliant funding for a Brazilian sugar and ethanol maker, in a deal that shows how smaller firms are creating new investment possibilities for the Gulf’s wealthy Islamic lenders.
The deal, brokered by Abu Dhabi Equity Partners, will finance an unnamed chemical alcohol producer in the Brazilian state of Mato Grosso do Sul, while at the same time creating a three-month investment opportunity for the undisclosed Gulf-based lender.
The transaction highlights how small banks are seeking to make up for the growing shortage in Islamic investment products, as large international financial institutions turn away from the sector.
“We’re looking at something bigger,” says Muneef Tarmoom, a founder of Abu Dhabi Equity Partners, of the deal. “We have a region with energy surpluses and capital – and they have a big market there that’s not got a lot of that.”
Islamic banking encourages asset-backed dealmaking, forbids the acceptance of interest, and steers away from activities deemed as sinful in Islam, such as drinking and gambling. Although the Brazilian company produces ethanol – the scientific name for what is generally known as alcohol – the deal has been deemed sharia-compliant because the product is not being made for human consumption.
Smaller firms such as Abu Dhabi Equity Partners appear to have more appetite for new types of financing than their larger competitors. Over the past years, international banks such as HSBC, Morgan Stanley, Barclays and Deutsche Bank have reduced their dedicated Islamic finance capabilities in Dubai, one of the region’s hubs for the industry.
Many of those bankers have now joined smaller firms or set up their own banking boutiques to advise on Islamic deals.
“Boutiques are carving out a space,” as innovators and catalysts of new products and services, says Iqbal Khan, chief executive of Fajr Capital in Dubai, and one of the pioneers of HSBC’s Islamic business.
But as a complex, bespoke product, Abu Dhabi’s Equity Partners’ transaction is not for everyone. The deal sees the lender buy the ethanol, which is then sold by the producer after a three-month period. As a result of the sale, the lender is returned the original funds at a fixed profit rate. After that, any profit on the sale will be returned to the farmer.
While the size of the transaction was not disclosed, a typical inventory financing transaction may be from about $5m to $25m. The ethanol involved in the deal is enough to fuel 500,000 cars for one week, says Mr Tarmoom. The fuel ethanol is increasingly being used to power vehicles worldwide.
Although the deal is complex, Mr Tarmoom says it highlights the desire of investors to lend against physical underlying assets. This transaction allows the lender to physically view the asset in a warehouse by camera.
But smaller boutique firms such as Mr Tarmoom’s may face challenges to keep costs down and such transactions profitable, bankers say.
“These boutiques have to deal with the challenges of having a credible and focused proposition which provides a service at cost effective prices,” says Mr Khan. “They also need to have a business model and governance structure, which gives their clients the confidence to know that they can do what they are saying,” he adds.
As international investment banks scale down due to demands on their capital from elsewhere, the region’s budding Islamic boutiques may also face competition from each other.
As Yavar Moini, managing director of M Capital and a former executive director at Morgan Stanley says: “An increasing proliferation of such firms can lead to internal competition which in the absence of scale can have severe adverse effects.”