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Omega Airlines1

Sukuk al Ijarah vs Sukuk al Mudaraba in Aircraft Financing

Isra Ahmed

Sarwat Ahson2


This case study revolves around Omega Airlines, a carrier being introduced by the newly established
subsidiary of Octus Group in Pakistan, Omega Air (Pvt) Limited. Omega wished to purchase two new
aircraft by issuing either Sukuk al Mudaraba or Sukuk al Ijarah.

Omega’s management was inclined towards Shari’ah compliant financing for this purchase. Hence, they
were not in favour of utilising Riba based instruments like lease, bonds and bank loans. Sukuk issuance
met the required Shari’ah compliance criteria, provided a more diverse funding base and allowed access
to a larger volume of capital. Favourable tax waivers introduced by the Government of Pakistan on
Sukuk in September 2016 also provided Omega with an added incentive to issue Sukuk. Although Omega
Air (Pvt) Limited was completely new in the industry, it was backed by one of the strongest multinational
conglomerates of Pakistan, with a net worth over PKR 100 billion. Octus Group had an impeccable track
record with banks and, therefore, Omega had no trouble convincing banks to provide assistance in
Sukuk issuance.

Omega’s management started negotiations with Bank Muamalat and Bank Al Saadiq, two leading Islamic
banks in the country, for Sukuk issuance. One suggested issuing a 10 year Sukuk al Mudaraba, while the
other suggested a Sukuk al Ijarah. Now it was up to the management to decide which one was more
suitable for the company.

Disclaimer: The companies and events depicted in this Case Study are fictitious. Any similarity to any event,
corporation, organization and person living or dead is merely coincidental. Some narrative material utilizes real
locations and real news organizations to make the Case Study seem real. The real entities referred to in this
context have never actually commented on any of the fictitious companies.
Isra Ahmed is Research Associate and Sarwat Ahson is Program Manager at IBA Centre for Excellence in Islamic Finance

Omega Airlines, a new short-haul air carrier, wanted to start operations in Pakistan in 2016. It also
aimed to launch international services if domestic operations were successful. The company initially
wanted to purchase two planes with a capacity of 110 passengers each. This was the minimum legally
acceptable number of aircraft that Omega could have in its fleet to commence operations in the
country. Second hand Bombardier planes, in excellent condition, could be purchased at a cost of PKR
600 million each. Omega could also import maintenance kits and associated parts of aircraft duty free.

Once purchased, the planes were to be put to service immediately, earning revenue for the airline. Each
plane was expected to generate minimum net profit of PKR 100 million per year. The remaining useful
life of each plane was 25 years. However, the company planned to decommission and sell the planes for
scrap value after 10 years as per the requirements of National Aviation Policy (NAP) 20153.

Initially Omega aimed to conduct flights in 7 major cities of Pakistan: Karachi, Islamabad, Lahore,
Peshawar, Sukkur, Quetta and Multan. Omega’s management felt that the company should focus on
operating a larger number of cheaper flights daily, without incurring additional costs of on-flight food
and refreshments. This would help increase revenue by attracting more passengers due to lower than
average industry fares.

International service could officially be started after one year of successful domestic operations but the
management intended to launch international flights in the 5th year of operations.

Aviation Industry of Pakistan

Pakistan’s airline industry had significant potential for development. Major airlines operating in
domestic routes include Pakistan International Airlines (PIA), Shaheen Air and Air Blue. PIA controlled
51% of the domestic market share, whereas Shaheen Air and Air Blue controlled 27% and 13%
respectively (Figure 1).

As per the National Aviation Policy (NAP) 2015, calendar age of any commercial aircraft operated by Pakistani airlines cannot
exceed 12 years at the time of induction, and must have a minimum of 35% remaining operational life. Aircraft older than 20
years, being operated by Pakistani operators, shall not be allowed to continue operations in Pakistan. The existing operators
had to meet this requirement within 2 years of the release of the NAP 2015. – JCR-VIS Aviation Sector Update 2016.
However, collectively these 3 airlines
Figure 1: Pakistan Aviation Industry Market Share
had less than 100 aircraft, which was
not enough to cater to an estimated
population of 220 million people.
Air Blue
There was still untapped potential in 22% Shaheen Air
the domestic market and airlines
were encouraged to start business on
domestic routes. 51%

Domestic and international passenger

traffic reached 15.1million in 2015, showing growth of 5.3% over a span of 5 years (2010-2015). As per
the forecast of International Air Transport Association (IATA), air traffic within Pakistan was expected to
grow at 9.9% over the next 20 years, more than twice the 4.1% projected annual world growth rate in

The government of Pakistan made several efforts to promote investment in the local aviation industry.
The National Aviation Policy (NAP) was developed in 2015 keeping in mind the objective of developing a
safe and robust air transport structure for Pakistan that would help spur GDP growth and create jobs. To
provide a level playing field for national airlines, NAP 2015 offered a bilateral ‘Open Skies Policy’, and
market access. The aviation sector was allotted more business freedom as markets could determine
price, quality, frequency and range of air services options.

NAP 2015 also aimed to promote business opportunities and improve economic activities through better
resource utilization. This was done by making the import or lease (wet/damp/dry) of all general aviation
aircraft tax and duty free. Duties on maintenance kits and associated aircraft parts were also abolished
in this policy. Overall, taxes and duty structures were rationalized and brought in line with international
best practices.

High Business Risk: The aviation industry of Pakistan posed high business risk due to several reasons.
This industry was cyclical in nature and was vulnerable to economic shocks. It was also highly capital
intensive; significant costs increased inherent business risk. Operating costs included aircraft lease
charges, capital and labour, fuel charges as well as expenses incurred due to regulations, safety
protocol, maintenance, restrictions on routes, landing rights and slots. Airlines that used operational
leases to purchase aircraft also had high adjusted leverage. Poor customer experiences and security
concerns also played a role in promoting negative sentiments about the aviation industry in Pakistan.
Against this backdrop, airlines operating in the country were vulnerable to fluctuations in profitability
and major losses in case of accident.

Furthermore, Pakistan’s domestic aviation market was characterised by stiff competition. Two state
owned airlines together controlled almost 80% of the market. Growing competition from foreign
airlines, expected entry of new players and heightened focus of government to help revive PIA could
also increase competition in Pakistan’s aviation industry.

Octus Group

Octus Group was a conglomerate, headquartered in Karachi, Pakistan. The group was an investment
holding company with well diversified strategic investments and a net worth grossing over PKR 100
billion. Core businesses of subsidiaries included production of fertilizers, bottled water, manufacturing
and export of leather products in addition to real estate development.

Octus owned 60pc of Avicenna (Pvt) Limited, the Pakistani franchiser of the international bottled water
brand ‘Aqua Pura’. Avicenna had a 40% share in the international bottled water market, and had
emerged as one of the leading brands in Pakistan in this category. It was second only to Nestle Pure Life
and competed directly with Pepsi Co.’s Aquafina and Coca-Cola’s Kinsley to capture the remaining
market share in Pakistan.

Other major subsidiaries included Octus Real Estate, a leading real estate development firm in Pakistan,
and Octus Leather which dealt in manufacturing and export of leather products. Octus Leather’s global
presence spanned Central Europe and Gulf Regions, along with United States and Canada.

Despite the high business risk, Octus planned on venturing into the aviation industry which showed
significant growth prospects in the foreseeable future. Octus felt that there was a good chance of first
capturing the Pakistani aviation market with proper strategic vision and planning, which could then be
followed by international growth. For this purpose, a private limited company was created in September
2015 by the name of Omega Air (Pvt.) Limited, as a subsidiary of the Octus Group. Octus had a 75pc
stake in this company.
Omega’s Aircraft

Even though it was a new airline, Omega could easily secure financing for the aircraft since Octus Group
was well-established in Pakistan and had an impeccable track record with banks. However, due to the
religious mind-set of its owners, Shari’ah compliant financing was preferred to purchase these aircraft.
Therefore, conventional financing options like bank loans, leases and bonds were not favoured as these
involved dealing in Riba (interest).

Omega’s management considered issuing a Sukuk. Over the years, Sukuk had gained immense
popularity as a Shari’ah compliant investment avenue. Global Sukuk issuance had grown significantly in
the past ten years, almost tripling from US $45 billion in 2010 to US $ 118.8 billion in 2014. 4 Despite a
fall in 2015, global Sukuk issuance increased by 13.2pc in 2016 and stood at US $ 74.8 billion. Since
Pakistan’s entry in the Sukuk market in 2005, 74 Sukuk valued over PKR 620 billion were issued, with 59
of those being from corporate or quasi-sovereign entities.

To encourage liquidity in Pakistan’s Islamic capital markets, Government of Pakistan (GoP) also granted
Islamic bonds tax neutrality in September 2016. This was done by providing tax exemptions to Sukuk
that were earlier available only to conventional term finance certificates (TFCs). Prior to these
amendments, income of SPVs (Special Purpose Vehicles) issuing TFCs was completely exempt under
Section 136 of the Second Schedule of Income Tax Ordinance 2001. Certain withholding tax exemptions
under sections 151, 153 and 233, were also applicable on the SPV and the TFC originator. On the other
hand, both the originator of Sukuk and the SPV were subject to extra taxes since the underlying assets in
Sukuk are fixed and depreciable assets. Taxes were imposed on gain of transfer of assets from originator
to SPV, on rental income earned by the SPVs. Withholding taxes were also applied on proceeds of sale
by SPV to the originator against transfer of assets and on rental payments by the originator to SPV, to
name a few. Therefore, Sukuk incurred extra costs due to these taxes. Tax neutrality granted to Sukuk
brought both the instruments at par in terms of cost, increasing the attractiveness of these Shari’ah
compliant instruments, especially for corporates.

Omega’s management was also happy with the above mentioned step taken by the Federal
Government; it could not have come at a better time for the company. After consulting various Shari'ah
Scholars, the management realised that Sukuk are Shari’ah compliant because they provide holders with
partial ownership in the underlying assets. Furthermore, as opposed to basic Ijarah, the Islamic alternate

MIFC 2015
to leasing, Sukuk provided a more diversified funding source. Issuing Sukuk also ensured access to larger
volume of capital and a potential to provide liquid capital to investors.

Funding through Sukuk

Omega’s management intended to issue Sukuk for a tenor of 10 years. The group’s Islamic banks were
contacted and Omega shortlisted two options.

Bank Muamalat suggested the airline opt for Sukuk al Mudaraba, as it would work in its favour in the
growth years. They were willing to structure this Sukuk through a consortium and suggested that Omega
appoint them as the lead arranger. Sukuk would be listed on Pakistan Stock Exchange and the entire
issue would be offered to retail investors. If Omega opted for this Sukuk, the profit sharing ratio
between Sukuk holders and Omega was proposed as 70:30.

Bank Al Saadiq suggested issuing a Sukuk al Ijarah because this would be advantageous for the company,
particularly from a cost perspective. Sukuk would be privately placed and would be subject to a profit
rate of 11%, inclusive of Takaful charges.

For both Sukuk options, legal title of the aircraft would be transferred to Omega upon settlement of all

With both these options in mind, Omega’s officials got to work on deciding which mode of financing was
more suitable.

1. What are the advantages and disadvantages for Omega in opting for Sukuk instead of bonds for
purchase of aircraft?
2. Why is sale of Sukuk Shari’ah compliant while that of a bond is not?
3. Illustrate diagrammatically the structures of Sukuk al Ijarah and Sukuk al Mudaraba.
4. If you were a financial consultant to Omega, what funding choice would you recommend, Sukuk
al Mudaraba or Sukuk al Ijarah? Support your answer with relevant calculations. Please also
comment on underlying risks in both structures.
5. If a floating rate had been proposed for Sukuk al Ijarah, how would Omega be protected against
abnormal rise in benchmark i.e. KIBOR (Karachi Interbank Offer Rate)?
6. In Sukuk al Mudaraba, is it possible for Omega to cap the profit amount that would be shared
according to the pre-agreed ratio i.e. 70:30?