A law firm and an Islamic finance advisory firm are working to adapt Italy's "mini-bonds" legislation to provide sharia-compliant funding options as an alternative to bank lending.

Three years of recession have limited funding for Italian companies, in particular for smaller firms, which is encouraging the use of less traditional funding sources such as those found in Islamic finance.

More than 95 percent of Italian companies have fewer than 10 employees and rely on banks for most of their financing; the government wants to encourage them to use the capital markets more.

Islamic finance has made only marginal inroads in continental Europe, partly because of a lack of a benign tax environment for its asset-based transactions, which are vulnerable to double taxation under conventional accounting methods. No Islamic finance deals have been publicly recorded in Italy.

But Italy's mini-bonds legislation could provide a way around the obstacles as it allows unlisted companies to use securitisation vehicles while extending tax breaks to the institutional investors that can buy such instruments.

The government introduced the legislation in 2012 to help smaller companies widen their funding options, with additional legislation in 2013 easing collateral restrictions and introducing tax incentives.

"We have decided to start working from what we already have in the law and make a little bit of reverse engineering in order to combine it with Islamic finance techniques," said Stefano Padovani, partner and head of banking and finance at Milan-based law firm Nctm Studio Legale.

Nctm hired Bahrain-based Syariah Review Bureau to help design the structure of a financing instrument that could be used in Italy.

"We are now at the end of the structuring phase of the instrument and once this will be certified, it will go live on the market, so that we would expect to have deals within this year - but this also depends on market conditions."

Italian firms issuing mini-bonds, which must have tenors greater than three years, might use them to attract Islamic investors from the Gulf region.

The structure will accommodate products with an equity or quasi-equity nature, Padovani said.

That suggests the products would be classified as hybrid instruments rather than sukuk (Islamic bonds) under the definition of the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), a key global standard-setting body.

If the instruments are successful, however, they could pave the way for developing sukuk structures, Padovani said.