SPECIAL COMMENT: Missing Link in Islamic Finance Hubs: Islamic Venture Capital

By Rushdi Siddiqui, head of Islamic Finance, Thomson Reuters

Islamic world defined capitalism in 8th/9th century, but today’s Muslim country’s who have planted the Islamic finance hub flag are missing an important elemaent. The interplay between risk capital and innovative ideas for local benefit. The Chairman of Malaysia’s Securities Commission, Zarinah Anwar, stated in a keynote speech in 2007, ‘…how can Malaysia distinguish itself in the emerging market VC [venture capital] pool? Our belief is that Islamic VC provides that distinguishing factor.’

To date Islamic finance has missed two important opportunities: addressing the ‘have nots’ (micro-finance), and deploying the funds of the ‘haves’ into Islamic VC funds. Yes, VC is labor intensive requiring specialized skills, entails active risk capital as part of portfolio, and a long term play, much like Sukuk in hold to maturity portfolio. Its time for Islamic finance to ‘walk the talk’ of venture capital.

Indicator of Innovation

Patents are an indicator for innovation and knowledge based economy. A 2006 article in Dinarstandards, Intellectual Property Gaining Protection in the Muslim World, shows how Malaysia heads the list of OIC countries (Table 1) with 547 patents (granted in the US) during the 27 year period. Putting it in prospective, Japan had 547,865 patents granted out of total 3,101,719 during the same time period, and OIC countries (totaling 1,542) had a meager 0.05%. What can Islamic finance do to start closing the gap?
US Patents Granted to OIC Based Inventors

PATENTS 1977-2004

Malaysia 547

Saudi Arabia 212

Indonesia 162

Turkey 144

Kuwait 78

Egypt 69

UAE 42

Lebanon 42

Iran 32

Morocco 30

Nigeria 29

Pakistan 26

Jordan 20

Kazakhstan 16

Syria 14

Source: www.uspto.gov

State of Islamic VC
But, where is Islamic venture capital in the Muslim world? There are Islamic VC associations (Gulf Venture Capital Association or Malaysian Venture Capital and Private Equity Association (GVCA)), VC Funds (Musharaka Venture Management Sdn Bhd), and venture capital bank (VC Bank), etc. But results are under-whelming: 1. How many conferences have been on Islamic VC? According to GVCA website, its last event was March 2008, and even the weekly Islamic finance events have very little or no exposure dedicated to Islamic VC.

Two: How many high profile funds and investments have been announced in ICT (information, technology and communication or bio-technology) in the region? If one examines the latest newsletter from VCBank (Dec 2009), its more about private equity plays in areas like bank building to ease car-park congestion, hospital, etc., and less of pure-play VC investments. 3. How many articles on Islamic VC on the internet? Not many, and large gap dates between articles. Finally, there are more than 22 technology parks in the MENA region, either operational or building stage, but are they a real estate play?

Opportunity for IF to Lead
An opportunity exists for Islamic banks seeking to deploy some of their excessive liquidity, some exposure to venture capital, to finance some of the major concerns in the GCC: healthcare, desert farming with minimal water, alternative energy, carbon emissions, etc. Its about finding & financing tomorrow’s technology that have application today in the region.

The western PE industry players knows the addresses of GCC institutions, SWFs or HNWs, for raising funds, but their VC counter-parts and early stage companies do not have the GCC on their radar screen for fund raising. Now, if a real public/private initiative is established, including the Islamic Development Bank (IDB) and Awkafs, and a $3-5 Billion Islamic VC Fund established, to be managed professionally for the above sectors, it would cause VC market players and start-ups to ‘come knocking on local Islamic finance doors.’

India & Islamic finance
India, a country with 150 Million Muslims, but encountering many political challenges in accepting or adopting retail Islamic finance, may be the most ripe country in MENASA (MiddleEast-North Africa-South Asia) for Islamic VC! It has the right mixture of higher educational institutions, technology parks/culture, entrepreneurism, mature capital markets, regulations, etc. As Islamic finance looks for new markets and ideas, ie, diversification, in the post crisis environment, Banglore may offer better strategy for Islamic VC opportunity than Sandhill Road in Silicon Valley.

Beyond Depositors & Shareholders
To address the criticism of exporting capital and importing returns, the preconditions for access the proposed Islamic VC funds should include: establishing operations locally (incubating capital hungry companies), linking with the local [technical] universities for local for teaching, jobs and internships, accessing local ‘parts’ (where available), government encouraging trials (with all the safety precautions), and the preferred exit should for the local stock exchange listing, hence, adding breadth and depth. Thus, an infrastructure plan combined with availability of funds.

As Islamic finance moves beyond the pre-dominant risk averse Murabaha, it must think about financing ventures beyond their depositors and shareholders, to health of mankind and the stewardship of the environment. Yes, some ventures will not be successful, but the risk is only financial, not like today’s provisioning to realty estate exposure. Some ventures will be successful, and the upside is knowledge based contribution and its attribution to Islamic finance. Thus, Islamic finance can actually lead conventional finance in the region for venture capital.

Given that mudaraba has been a central element to Islamic financing for centuries, you may be mistaken in thinking that the Islamic venture capitalism is a fairly mature market with hundreds of institutional investors. The reality is almost the opposite. Venture capitalism is still fairly embryonic in the world of Islamic financing and there are few Islamic institutional funds involved at this time.

Prior to 1995, the majority of Islamic venture capital financings were undertaken by what are known as “angels”. Angels are essentially high net worth individuals who agree to invest in a business venture under the terms of Islamic financing set out above. There were few, if any, established Islamic venture capital funds at this time.

Post 1995 there was a boom in Islamic venture capital financing and today there are over a hundred funds lending in excess of a billion dollars to new start-ups. Following the development of Dubai as a major Islamic financing center, the Dubai International Finance Center (DIFC) was established and a number of leading Islamic venture capital funds are now regulated by the Dubai Financial Services Authority (DFSA).

Among the founding members of Islamic financing venture capitalists is the Dubai-based Injazat Capital Limited, who are also founding members of the Gulf Venture Capital Association (GVCA), a leading light in the world of Islamic venture capitalism. A newer entrant to the world of Islamic venture capitalism is the aptly named Venture Capital Bank BSC (c), which is rapidly becoming one of the larger Islamic venture capital funds in the Middle East.