The Rise of Sharia Compliant Investment Solutions

In recent years, the global financial landscape has witnessed a surge in demand for ethical and faith-based financial products. Among these, access to asset-based finance exposures in a Sharia-compliant format via structured solutions has emerged as a compelling alternative for investors and borrowers seeking to navigate the investment landscape in accordance with Islamic law. This insight report explores what this entails and how it differs from conventional private credit arrangements.

The Evolution and Growth of Islamic Finance

Islamic finance, whilst rooted in principles dating back over 1,400 years, is a relatively modern phenomenon in its contemporary institutional form. The first Islamic bank, Dubai Islamic Bank, was established in 1975, marking the beginning of the modern Islamic banking era. The development of Sharia-compliant financial products accelerated through the 1980s and 1990s, with Malaysia and the Gulf Cooperation Council countries leading the way in creating regulatory frameworks and innovative structures.

The Sharia-compliant finance market has experienced remarkable growth over recent decades. Today, the global Islamic finance industry is valued at approximately $4 trillion in assets across over 80 countries, spanning banking, capital markets and insurance (takaful). From 2018 to 2023, the sector recorded a compound annual growth rate of 10.72%, and industry projections suggest the market is expected to surpass $5 trillion by the end of 2025, with continued strong growth anticipated thereafter. This expansion is driven by several factors: increasing wealth in Muslim-majority countries, growing awareness among Muslim populations globally, the appeal of ethical finance principles to non-Muslim investors and supportive regulatory developments in both traditional Islamic finance hubs and new markets including the United Kingdom, Luxembourg and South Africa.

Despite this impressive growth, exposure to privately originated asset-based finance in adherence with Sharia principles remains a nascent segment within the broader Islamic finance ecosystem. The private credit market, which has grown substantially in conventional finance, represents a significant opportunity for Islamic finance to develop innovative solutions that meet the capital needs of businesses whilst adhering to Sharia principles.

What are Sharia-Compliant Investments?

Sharia-compliant investments are assets that have been screened according to a set of principles commonly associated with Sharia law. These principles encompass risk sharing between parties to financial transactions, the limitation of unnecessary uncertainty in business or financial contracts, a prohibition on interest (Riba) and hoarding of capital with no productive intention, whilst simultaneously emphasising property rights and fair treatment of employers, employees, customers and other stakeholders.

When screening companies for compliance with Sharia principles, the screening process typically involves two distinct dimensions:

Business Activity: This dimension assesses whether the company engages in activities that are deemed haram (forbidden) by Islamic law. Specifically, it evaluates whether the company has any significant exposure to revenue sources that are prohibited, such as selling goods or services related to gambling, weapons, alcohol, tobacco, pork products or other prohibited offerings.

Financial Screening: This dimension focuses on the tolerance limits for investments and debts that are considered haram (forbidden) by Islamic law. It assesses whether the company’s financial structure complies with the permissible limits for interest-based investments, interest-based debts, liquidity and other forms of prohibited income.

Key Principles of Sharia-Compliant Finance

• Prohibition of Interest (Riba): All forms of interest are forbidden, so credit must be structured without interest charges
• Risk Sharing: Parties involved in a financial transaction must share risks and rewards fairly
• Asset-Backed Transactions: Financing must be linked to tangible assets or services, rather than speculative activities
• Ethical Investment: Investments must avoid sectors considered harmful or unethical, such as alcohol or gambling

Governance, Oversight and Sharia Compliance

One of the defining characteristics of Islamic finance is its robust governance framework, which ensures that financial products and transactions comply with Sharia principles. This oversight mechanism is fundamentally different from conventional finance and represents both a strength and a complexity of the industry.

The Role of the Sharia Supervisory Board

At the heart of Sharia compliance lies the Sharia Supervisory Board (SSB), an independent body of Islamic scholars with expertise in fiqh al-muamalat (Islamic commercial jurisprudence) as well as knowledge of modern finance. Every Islamic financial institution is required to have an SSB, which typically comprises three to seven scholars. The SSB’s responsibilities include reviewing and approving new financial products, monitoring ongoing transactions to ensure continued compliance, issuing Sharia rulings (fatwas) on financial matters and providing guidance on the purification of income (disposing of any non-compliant earnings to charity).

The Fatwa: The Foundation of Sharia Compliance

The fatwa, or religious ruling, is the cornerstone of any Sharia-compliant financial product. Before any product can be offered to the market, it must receive a fatwa from qualified Islamic scholars confirming its compliance with Sharia principles. The fatwa process involves detailed examination of the product structure, documentation review to ensure language and terms align with Islamic principles, assessment of the economic substance versus legal form and consideration of the maqasid al-Shariah (higher objectives of Islamic law).

A fatwa is not merely a rubber stamp; it represents a considered scholarly opinion that the product structure genuinely reflects Islamic principles rather than simply mimicking conventional products with cosmetic changes. Scholars will often require modifications to structures to ensure true compliance, and ongoing monitoring ensures that implementation matches the approved structure.

Standards and Harmonisation

The challenge of varying interpretations of Sharia across different schools of Islamic jurisprudence has led to the establishment of several standardisation bodies. The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), established in 1991 and based in Bahrain, has issued over 100 standards covering Sharia, accounting, auditing, ethics and governance. The Islamic Financial Services Board (IFSB), founded in 2002 and based in Kuala Lumpur, focuses on regulatory and supervisory standards for the Islamic financial services industry.

These organisations work to create consistency across markets, though differences in interpretation still exist. Some jurisdictions, such as Malaysia, have created centralised Sharia advisory councils at the national level, whilst others rely on institution-level SSBs. This diversity can create challenges for cross-border transactions but also reflects the rich scholarly tradition within Islamic jurisprudence.

Verification and Audit

Beyond the initial fatwa, Sharia compliance requires ongoing verification. Many institutions employ internal Sharia audit functions that work alongside conventional internal audit teams. External Sharia audits are also becoming increasingly common, providing additional assurance to stakeholders. These audits examine documentation to ensure it reflects Sharia-approved structures, review actual transaction flows to confirm compliance, assess whether profits and losses are being shared according to agreed principles and verify that any non-compliant income has been properly identified and purified.

Transparency and Disclosure

Islamic financial institutions typically provide detailed disclosure about their Sharia governance arrangements in annual reports, including the composition of their SSB, summaries of fatwas issued, information about Sharia audit findings and details of any income purification undertaken. This transparency is crucial for building trust with customers and investors who rely on these institutions to uphold Islamic principles.

Common Structures in Sharia-Compliant Credit Structures

To provide credit without interest, Islamic finance employs a range of innovative structures:

• Murabaha (Cost-Plus Financing): The lender purchases an asset on behalf of the borrower and sells it to them at a marked-up price, payable in instalments. The profit margin replaces the interest
• Ijara (Leasing): The lender buys an asset and leases it to the borrower for a fixed period. The lease payments serve as the lender’s return
• Mudarabah and Musharakah (Profit and Loss Sharing): These partnership models allow the financier and the entrepreneur to share profits and losses according to pre-agreed ratios

What are ‘Sukuk’ Bonds and How Do They Differ from Conventional Fixed Income?

Sukuk are Sharia-compliant equivalents to conventional fixed-income securities. These securities are typically issued by governments, corporations, supranational entities and other entities to raise capital. Whilst they differ from conventional fixed-income securities, the Sukuk market exhibits similar dynamics to conventional fixed-income markets and emerging market bonds.

Sukuk bonds exhibit a high correlation with their conventional counterparts, characterised by low average credit spreads. These metrics serve as reliable indicators of investor sentiment regarding interest rates and credit risk for Sukuk compared to conventional bonds. Whilst periods of volatility, such as the pandemic of 2020 and the broad market sell-off of 2022, caused temporary fluctuations in spreads, the spread differentials have consistently narrowed over the years.

Conventional bonds are instruments where the issuer has an obligation to pay bondholders cash flows in the form of interest and principal on certain specified dates. In contrast, Sukuk are based on the ownership of a share of an asset, as well as the associated cash flows and risks. In practice, investors are considered as part owners rather than creditors given the transfer of ownership of certain assets. Every Sukuk bond is generally tied to a tangible asset or project.

Additionally, conventional bonds pay interest – this is not permitted by Sharia law, so the periodic payments of Sukuk instruments are structured from the profits from the underlying assets. Sukuk issuers ensure that funds that are raised are invested in areas that do not contradict Sharia law.

Overall, Sukuk can be considered as Sharia-compliant versions of conventional bonds, although there are differences in the way they are structured.

Benefits of Sharia-Compliant Credit Structures

• Ethical Alignment: Offers a financial solution that aligns with Islamic values and principles, appealing to Muslim investors and borrowers
• Stable and Transparent: Asset-backed and risk-sharing structures often result in greater transparency and stability
• Growing Market: With the increasing demand for ethical investment products globally, Sharia-compliant finance is no longer limited to Muslim-majority countries but is gaining popularity worldwide
• Robust Governance: The oversight provided by Sharia Supervisory Boards and the fatwa process adds an additional layer of governance and ethical scrutiny

The Convergence of ESG and Sharia-Compliant Investing

For investors and institutions already incorporating Environmental, Social and Governance (ESG) principles into their investment processes, Sharia-compliant finance offers a natural extension of ethical investing frameworks. Both Islamic finance and ESG finance are founded on core principles of ethics and morality, creating significant overlap between the financial instruments offered through each form of financing Market Data Forecast.

The alignment begins with negative screening processes. Sharia-compliant investing requires the exclusion of certain industries such as tobacco, alcohol and gambling, whilst ESG investing similarly uses negative screens to omit companies whose activities are not aligned with the investment mandate Research And Markets. Beyond these exclusions, both approaches share deeper philosophical similarities: an emphasis on risk sharing rather than speculative activities, a requirement for transparency and accountability, a focus on long-term sustainable value creation rather than short-term profit maximisation and the principle that investments should generate positive social impact alongside financial returns.

Research from Refinitiv’s database covering over 6,500 publicly listed companies shows a clear link between Sharia compliance screening and stronger ESG performance, with Sharia-compliant companies having ESG scores that are on average 6% higher than non-compliant ones, particularly for environmental (7.3% higher) and social (7%) scores Research And Markets. This complementarity has driven innovation in the market, with ESG sukuk issuance reaching record levels and Islamic ESG funds multiplying in number Research And Markets.

However, it is important to recognise that whilst ESG and Sharia-compliant investing share common ground, they are not identical. ESG investing is fast evolving and proactive, with a focus on creating sustainability through continuing investor-company engagement, whilst Islamic finance is faith-based, reliant on tried and tested principles with an established governance structure and a focus on rules-based avoidance of harm Mordor Intelligence. For institutions seeking to bridge both frameworks, the opportunity lies in certification and standardisation efforts that make these two forms of responsible investing mutually recognisable and trusted.

Challenges and Considerations

Whilst promising, Sharia-compliant credit structuring comes with its own set of challenges:

• Complexity: Structuring deals to comply with Sharia can be more complex and may require additional legal and financial expertise, as well as approval from qualified scholars
• Regulatory Landscape: Differences in interpretation of Sharia between jurisdictions can affect product design and approval
• Market Awareness: There is a need for greater education and awareness amongst investors, borrowers and financial professionals
• Governance Costs: Maintaining Sharia Supervisory Boards and conducting regular Sharia audits adds to operational costs
• Standardisation: Whilst progress has been made, the lack of universal standards across all markets can create challenges for cross-border transactions

Looking Ahead

As the appetite for ethical and faith-based finance continues to grow, Sharia-compliant credit structuring is poised for significant expansion. Financial institutions, asset managers and fintech platforms are increasingly looking to tap into this market, developing innovative products that blend religious values with modern financial needs. The continued development of governance frameworks, greater harmonisation of standards and increasing sophistication of market participants all point to a maturing industry ready for substantial growth.

For both investors and borrowers, this represents a unique opportunity to build resilient portfolios and access capital in a manner that respects core ethical and religious principles. As the market evolves, we can expect to see more sophisticated private credit structures, greater institutional participation and continued innovation in how Islamic finance principles are applied to modern financial challenges.

References

AlHuda Centre of Islamic Banking and Economics (CIBE). (2024). The Outlook of Islamic Finance in 2025 Appears Promising. Retrieved from https://alhudacibe.com/pressrelease237.php

This report provides the market size figures ($4 trillion in 2024, expected to surpass $5 trillion in 2025), the historical CAGR of 10.72% (2018-2023), market concentration data by country and details on Islamic banking assets ($2.37 trillion representing 70.21% of the overall Islamic financial services industry).

About Channel

Channel is a leading global alternative asset manager with deep industry expertise that deploys private capital across asset-based lending solutions to the innovation economy and specialty finance sectors. Since 2007, our investing expertise has served the financial return needs of our clients and provided businesses with innovative debt capital solutions for growth. As of September 30, 2025, Channel had approximately $26 billion in cumulative capital invested and facilitated financing in over 35 countries. For more information, please visit www.channelcapital.io.