Islamic Sukuk-Introduction
Bonds are important part of overall financial system. Well developed bond markets ensures stable financial system as it minimize over-reliance on financing from the banking sector.
The development of the bond market allows for access to funding with the appropriate maturities, thus avoiding the funding mismatches. It also allows for the diversification of risks by issuers and investors.
Islamic Sukuk-Introduction
Dealing in Bonds is not permissible according to Shariah because of two aspects.
Firstly, they represent a portion of Debt payable by the issuer. Earning any kind of profit falls under the category of RIBA as defined in the Hadith
Islamic Sukuk-Introduction
Second aspect pertain to the trading of Bonds. Shariah prohibits trading of debts (Bai Dayn) as it involves Gharar.
Islamic Sukuk-Introduction
Sukuks( Bonds. ) are developed as alternative of
A Sukuk represents proportionate actual or beneficial ownership in an Asset or a Pool of identified assets.
For a defined period the Risk and Return associated with such Assets belong to Sukuk holders which makes their return permissible for the holder.
Islamic Sukuk-Introduction
Trade of such Sukuks is permissible, because it will be equivalent to the sale/ purchase of holders proportionate share in the assets. However, trading of Murabahah and Salam Sukuks is not permissible.
Represents the direct pro The bond stands for a loan rata ownership of the holder repayable to the holder in in the assets of the pool. any case, and mostly with interest. Sukuk holder generally earn return from income generated through the asset
The Middle East and in Asia, two of the fastest growing regions in the global economy are expected to spend $500 billion and $1 trillion respectively on infrastructure over the next five years Islamic capital market, in particular the sukuk market, will serve as an important avenue to meet these funding requirements.
Source: Dr Zeti Akhtar Aziz, Governor, Bank Negara Malaysia, Sukuk Summit 2007, London Khaleej Times (June 22, 2007)
Islamic Sukuk-Types
The issuance of Sukuk requires an exchange of a Shariah compliant underlying asset for a financial consideration through the application of various Islamic commercial contracts such as the Mudarabah, Musharakah, Ijarah, Istisna, Salam and Murabahah.
The equity-based nature of Mudarabah and Musharakah Sukuk exposes investors to the risks connected with the performance of the project for which the financing is raised.
Islamic Sukuk-Types
In contrast, issuance of Sukuk on principles of Ijarah and Murabahah yields deterministic receivable and hence result in predictable and somewhat fixed returns for the prospective investors.
Sukuk Al Ijarah
Ijarah Sukuk concept is one of the most popular concepts among issuers of global Islamic Sukuk. A simple process is explained next.
ABC Ltd. wishes to purchase a new asset and plan to raise finance through issuance of Islamic Sukuk.
Supplier
Supplier
ABC Ltd.
Supplier
ABC Ltd.
Issuer Payment made to SPV Supplier (LLC Title is transferred to 100% SPV owned ABC Ltd.)
Sukuks
Investors
Proceeds
SPV issues certificates and receives proceeds which are used to purchase asset from the supplier
SPV holds Asset as Trustee and leases the plant to ABC Ltd. as per rules of Ijarah
Issuer SPV
ABC Ltd.
Issuer SPV
Investors
ABC Ltd. (Lessee) pays periodic rentals to SPV for tenors & amounts matching the coupon & tenor of the Sukuks
Redeems the Trust Certificates at dissolution ABC Ltd (Lessee) give the SPV an irrevocable purchase undertaking to purchase the Asset at maturity. Exercise Price = Initial Purchase Price of Asset + service costs.
Asset is transferred back on maturity, upon payment of the Exercise Price to the SPV / Sukuk Holders.
Ijarah Sukuk represents the holder's proportionate ownership in the leased asset.
The holder will assume the rights and obligations of the owner/lessor to the extent of his ownership. As owner the holder will have the right to enjoy a part of the rent according to his proportion of ownership in the asset.
In the case of total destruction of the asset, holder will suffer the loss to the extent of his ownership.
SPV rules in Pakistan does not allow SPV to hold actual tangible assets, therefore, the asset is shown on the books of the client itself instead of SPV.
Its essential that the Ijarah Sukuks are designed to represent real ownership of the leased assets, and not only a right to receive rent.
In Pakistan essentialy the same structure has been used to develop Sukuks based on Diminishing Musharakah.
There are two basic differences in Diminishing Musharakah Sukuks: Underlying Assets is jointly owned by investors and issuer according to specified percentage. Ownership is also transferred periodically to the issuer.
Security
Through this Agreement, all Participating Islamic Financial Institutions ('Investors') appoint a Bank/FI as 'Investment Agent' to carry out all actions (including entering into all Sukuk related Transaction documents) for and on behalf of all Investors in respect of Sukuk Issue.
Investment Agent (acting for and on behalf of Investors) and Issuer will enter into a Musharakah Agreement to jointly own Musharaka Assets.
Each Investors entitlement to the Musharakah Assets will be undivided and shall for the purpose of more particular determination constitute of Sukuk Units. Share of each Co-Owner will be specified in the Musharakah Agreement.
Issuer is appointed 'Service Agent' via signing of Service Agency Agreement between Investment Agent (acting for and on behalf of Investors) and Issuer.
Service Agent will be responsible for:
Investment Agent (acting for and on behalf of Investors) will allow Issuer to use Investors' share of the Musharakah Assets against periodical KIBOR-benchmarked Rental Payments in terms of the Payment Agreement.
From Shariah perspective, this is basically an Ijarah Agreement. The tenor of the Payment Agreement will be matched with the Musharakah tenor.
Undertaking to Purchase Sukuk Units is a promise undertaken by Issuer in favor of the Investment Agent for:
(i) the periodical purchase of Sukuk Units (representing Investors' undivided beneficial ownership in the Musharakah Assets); and (ii) the purchase of all outstanding Investors' Sukuk Units in case of an Event of Default.
Undertaking to Sell Sukuk Units is a promise undertaken by the Investment Agent in favor of Issuer granting a call option to Issuer to purchase all or part of the Sukuk Units. In SLB cases, purchase/sale of Sukuk Units will only start after at least one year from the Musharakah Commencement Date/Asset Purchase Date.
Trust Deed will be executed between Trustee (appointed by Investors for the Sukuk Issue) and Issuer detailing the responsibilities of the Trustee during the tenor of the Sukuk Issue.
Letter of Hypothecation and Other related Security Documents will be executed by Issuer in favor of Trustee for security purposes.
Sukuk Al Salam
In this transaction, various banks may participate in the Sukuk and one Bank would act as trustee nominated to represent other banks wishing to participate in the Al Salam contract.
Salam Sukuk represent investors shares in the Advance Price paid to the seller. Since its a dayn, it cannot be traded in the secondary market.
Murabahah Sukuk represent investors shares in receivable from the purchaser Since its dayn, it cannot be traded in the secondary market.
Sukuk Al Musharakah
Profit earned by the Musharakah is shared according to an agreed ratio between the Issuer and Investors at an agreed ratio. Loss is shared on pro rata basis. Profit & Loss is shared between the investors as per investment ratio only.
All the assets of the Musharakah should not be in liquid form. At least 20% of the value of Portfolio should be invested in non-liquid assets.
Issuer
Total Issue Size
Public Issue
Tenor Profit Payment
Based on profit and loss sharing on the Operating profits of the Chemicals Division
Issue Value of Rs 360 Mn PSR for 1st Rs 100 Mn Operating Profit Level -1 MTFC Holders 100% O/S 43% Company
For each Subsequent Rs 100 Mn of Operating Profit
Company
56.8%
92.8%
28.9% 14.3%
71.1% 85.7%
4.8% 2.4%
95.2% 97.6%
Actual profit entitlement rate = (Actual Operating profit/ Rs.100 million)* 12%
Rs. 100 million then: Profit entitlement rate=(Actual operating profit/Rs. 100 Million) * 2%
Islamic Sukuk-Standardization
AAOIFI has also issue Shariah standards for Sukuks and its expected that issuance of these standards would help reducing differences in fatwas issued for Sukuks.
Islamic Sukuk-Criticism
Some Sukuks are criticized for their resembelence with conventional bonds. close
Many times these closeness is created to adhere to the tax and other regulatary laws of the country. For example, in Pakistan SPVs cannot hold actual assets. For this reason assets cannot be carved out from the balance sheet of the issuer which creates complexities in identification of the assets and only a hypothecation charge ensures bank's benefical ownership in the Musharakah assets. .
Islamic Sukuk-Criticism
Similarly, concept of the Diminishing Musharakah financing is not there in the stamp duty laws of Pakistan, which compels banks to sell share in assets without any legal registration.
It should be noted that concept of Diminishing Musharakah is recognized in British stamp duty laws since April 2003.
Nevertheless, not all of this criticism is incorrect, and therefore it should be ensured that unesseccary usage of artificial structures should be avoided as much as possible.
Islamic Sukuk-Criticism
The problems could be resolved by Shariah rating systems This will help investors in making informed decisions regarding the authenticity of the Shariah structure of the Sukuk.
Islamic Sukuk-Benefits
Sukuk can be used very effectively as a halal alternate to conventional bonds for provding funding for matching maturities and without relying too much on commerical banking sector. Another aspect of Sukuks which make them more effective than bonds is there ability to mobilize and motivate investors to work for the overall benefit of the issuer. .
Islamic Sukuk-Benefits
Sukuks for Government Projects
Sukuks based on Ijarah can be used very effectively to finance Government projects. If general public is involved in the construction of these project through issuance of Sukuks, it can give them sense of ownership. Effective usage of such Sukus would increase the ratio of success and ratio of sustainbility of the projects by many folds. .
Islamic Sukuk-Benefits
Sukuks by Private Sector
Corporate Sector can also benefit from unique characteristic of Sukuks. Musharakah Sukuks can be used to associate general customer with the company. Sense of ownership and share in the profit of the company can be used as a marketing tool for the products of the company especially in FMCG sector.
Islamic Sukuk-Benefits
Sukuks by Private Sector
The more company earns the more return investor would get concept can revolutionalize sales. Even Sukuks Al Ijarah would help the companies to position themselves as an caring member of the society by involving community in the business of the company.
Islamic Sukuk-Conclusion
Sukuks can be used very effectively to obtain Shariah Compliant funding which surely bring Allah's blessing and barakah for the business. Issuers can also benefit from the huge increase in liquidity in the Islamic world, and can tap on these new sources of funds. Raising funding from the Islamic bond market in the current environment has been 10 to 20 basis points lower than mainstream bonds.
Islamic Sukuk-Conclusion
...And whosoever fears Allah and keeps his duty to Him, He will make his matter easy for him... (Surah Al Talaq Ayat 04)