hrough the second quarter of 2007, the global issuance of Islamic bonds, or sukuk, had reached a record level of US$24.5 billion, and showed no signs of slowing, after totaling $7 billion as recently as 2004. What do these asset-backed instruments mean for industrial and infrastructure projects in the growing economies of nations such as Indonesia, Malaysia, Saudi Arabia and the United Arab Emirates? To be Shariah-compliant, there must be no payment of interest, or riba. And the projects and properties cannot be connected to prohibited projects or uses such as gambling, pornography, alcohol or tobacco.
   Saudi Basic Industries Corp. (SABIC), the petrochemcial giant that just acquired General Electric's plastics business, in August launched its second sukuk, following a series of major projects in its home country that were financed in groundbreaking fashion.
   The company's Yansab project was recognized as the Euromoney Magazine Middle East Petrochemicals Deal of the Year in 2006, featuring the largest ever Islamic financing (US$847 million) in any multi-sourced project financing globally.
   SABIC plans to invest approximately $20 billion in capacity expansions across Saudi Arabia over the next two years.
   Reached in his Dubai office on the last day of Ramadan, Oliver Agha, partner, global head of Islamic finance and head of finance in the Middle East for DLA Piper, says the past few years have produced a perfect storm of conditions for these instruments to flourish: excessive liquidity in the Gulf based on oil prices; demand for infrastructure projects in the region; and the post-9/11 atmosphere driving Islamic investors to invest close to home.
   Agha has been studying Shariah law for over 10 years. DLA Piper maintains a team of 40 people worldwide in the specialty, including 11 in Dubai.
   "Islamic banking is a spiritual choice, for a person to invest in a societally responsible way, in a way that doesn't create adversarial relationships between banks and borrowers," he says. "From the Islamic perspective, if you give money to someone and hold on to the capital without risk, you're burying it in the sand," he says. "The idea is to use it for some productive purpose."    Central to that goal is creating structures that signify partnership, not loans.
   "These entities effectively purchase a portion of these project assets, and then lease these assets to the project company," he explains. "The project company pays a lease rental which is a return to the Islamic financiers. The owners are the Islamic financiers, so they're taking the risk, and because of that, they're entitled to a reward for their risk.
   "Traditional banking seeks to minimize risk," says Agha, "whereas Islamic finance seeks to accept a portion of the risk and allocate it more equitably between the parties."
   SABIC's $5-billion Yansab greenfield project was financed by two tranches, including traditional debt and then Islamic financiers. Agha says it's not uncommon for such a parallel structure to take place, accompanied by a slew of documents detailing procurement, forward lease and service agency agreements to reallocate a portion of the risk back to the project company.
   "Through the spate of documentation, what is attempted is an allocation of risk that more closely approximates the risk of banks with loans," Agha explains. "It can't be too close, because if it is, it's not Islamic financing. If it is, you've turned the grapes to wine, and that's too bad."
   Agha says multinationals should expect Islamic financing structures to be a natural part of their growth in the region. The Gulf region alone expects to see hundreds of billions of dollars in infrastructure projects in the next decade.
   "With that sort of money coming in, you're likely to have a fair bit of that Islamically financed," says Agha. "If, for example, a U.S. chemical company were getting involved in Saudi Arabia, it's very important to understand it, even if [the project] is conventionally financed."
   Asked if the society-conscious aspect of Islamic financing dovetails well with the worldwide push for facilities that are environmentally aware, he says that's a natural fit, just as Shariah compliance also matches up well with the renewed emphasis on corporate governance.
   "It would be incongruous to expect to have an Islamic project and not maintain environmental standards," he says. "In all of these areas, there is a high expectation to be managing this in the right manner."    Shariah-compliant capital is looking for opportunities throughout the world, including a rash of new deals in the U.K. and the United States. During one week in September, Grosvenor Investment Management (GIM) acquired the 81,000-sq.-ft. (7,525-sq.-m.) Research Center Plaza in Carlsbad, Calif., and the 150,000-sq.-ft. (13,935-sq.-m.) Discovery Lakes complex in Orlando, Fla., both on behalf of a Middle Eastern client. As of year-end 2006, Grosvenor Fund Management (including GIM) had total funds under management of over $5.3 billion internationally.
   Doug Callantine, president of GIM and a director of Grosvenor Fund Management, says his firm tries to take advantage of financing markets, but staying Sharia-compliant in the process.
   "The financing structure uses a leasing structure through special-purpose entities, and the terms mimic what the mortgage provisions would be," he says. "A variety of lenders are willing. There may be additional costs because of the structuring, but depending on size, it's not a significant component of the property acquisition cost."
   GIM has used the services of Atlanta-based law firm King & Spalding on virtually all such transactions. The nearly $150-million office fund GIM created with Kuwaiti investors has purchased five properties, and will buy one or two more before the end of the year. He says the properties provide an attractive return, with an expected hold period of seven years.
   Some funds, like Dubai-based Istithmar, have invested billions in other areas like luxury and retail in the U.S. Another fund from a large Islamic bank in Kuwait has focused on senior housing, purchasing 15 properties. And some have predicted the first Islamic REIT in the near future.
   Callantine says GIM is in the process of creating a senior care fund, as well as one focused on residential land. He says GIM is not active in the industrial arena with the Islamic financed funds, but it would be an attractive sector for Shariah-compliant investment, provided it steered away from certain prohibited uses like financial services and from prohibited products (such as pork, alcohol or tobacco) in warehouses. Callantine says GIM's office investments have performed well, "but the financial services sector represents 25-30 percent of any given geographic market, so it has limited our ability to buy buildings in some locales."
   GIM's first Islamic-financed transactions were unleveraged equity investments in residential land in 1999. "Since that time, the legal community and Shariah advisors have been able to come up with a compliance structure that makes it much easier to leverage these types of investments."
   For economic developers trying to do a broad-based approach, Callantine says Shariah-compliant investors may not be a good target because of the need to avoid the potent financial services sector. But he estimates only 10 percent of industrial properties would have compliance issues.
   "I think it should be viewed as another source of capital that can compete very well with conventional capital," he says of Islamic funds. "It's priced competitively. We've found they're very sophisticated. They spend time in these markets, and are able to react in a timely fashion."