islamic capital markets. global financial turmoil 1. excess recycled money (us72t) and asset bubbles...

Islamic Capital Markets

Global Financial Turmoil

Islamic Banking Challanges

Subprime Crises: Lessons for Islamic Finance

Islamic Financial Market

5 Basic Shariah Principles in Financial Transactions

#1 Prohibition of Riba

Islamic Bonds

Role of Sukuk in Economic Development

Corporate Finance – Demand for Capital

Cost of Capital

Capital Structure

Sukuk – Moving Forward

Shariah Compliance: Consistency is Critical

‘AQADPrinciples

LEGAL/CONTRACT DOCUMENTATIONProtection of Rights

MAQASIDBenefits vs disbenefits

FINANCIALREPORTINGAAOIFI/IFSB/IFRS

Shariah Compliant Parameters

• Aqad-based – Contract-based• Maqasid al-Shariah (purpose of the Law) –

impact on society• Financial Reporting – actual strength and

performance of companies• Legal documentation – identification and

recognition of rights and obligations of contracting parties.

Approved Islamic Finance Products• BBA Home Financing• Bay Inah Home Financing• Bay Inah Personal Financing/Overdraft/credit card• Tawaruk munazam personal financing• Commodity murabaha• Ijarah thumma al-bay• Bai-bithaman Ajil Islamic Debt Securities (BAIDS)• Discounted Bay al-dayn MuNif• Sukuk Ijarah• Sukuk Musharakah

Challenging issues in AQAD-based Islamic Finance Products

• Benchmaking profit rate against interest rate (LIBOR,KLIBOR).• Profit Equalization Reserve (PER) – displaced commercial risk• Sale with condition to buyback at predetermined price

between two and three parties.• Profit generated over installment payments – time value of

money• Penalties on delayed payments• Benchmaking sukuk rates against LIBOR• Musharakah with Purchase undertakings – fixed profit to

one party only.• Ijarah Sukuk - Sale with repurchase agreement at par value

and not mark-to market• Ijarah Sukuk – Ownership of asset by SPV• Profit-rate swaps – speculation or gambling?

#1 AQAD Method

Contract of Sale• Example: Murabaha/BBA Sale

1. Buyer and Sellereg. Seller owns asset/subject matter before making sale

2. Subject mattereg. Mal mutaqawim – property with usurfruct

3. Priceeg. Set on the spot

4. Offer & Acceptanceeg. Verbal or in writing

Method #2: Maqasid al-Shariah/Objective of Shariah

To protect the interest of the public (society)- maslahah al-ammah by:

1. removing the harm ( ibqa)2. securing of benefits (tahsil)

#2 Maqasid Method

Objective of Shariah

Islamic financial products as defined by AQAD methodology, should contain more benefits (masalih) and less or no harm (madarah).

“ in gambling (maisir) and liqour (qimar), there are some sins and some profits. But the sins are greater than the profits” (Al-Baqarah: 168).

“ in Gambling (maisir) and Liqour (qimar), there are some sins and some profits. But the sins are greater than the profits” (Al-Baqarah: 168).

FinancingBBA

Downside (Madarrah) of Credit-Financing

MACRO MICRO

Economic Bubbles Bankruptcy

Subprime Loans Foreclosure

Financial Turmoil Unemployment

The upside (Manfaat) of Credit-Financing

MACRO MICRO

Allocation of Capital Wealth creation

Economic Growth Rich becoming richer

Leisure, luxury and lifestyle

Maqasid

• To analyse(theoretical) and measure( empirical) impacts of financial intermediation based on aqad-based Shariah compliant products.

1. Efficiency studies2. Profitability studies3. Studies on Consumer welfare and protection4. Studies on Financial stability

Maqasid – protecting public interest.

• Aqad-based products (ABP) SHOULD contain more benefits and less harm.

• What if, it was proven than they (ABP) contain more harm than good?eg. Abandon projects – customer cannot make recourse against bank as selling party?Defaulted BBA customer are required to make settlement based on the selling price.Sale with no transfer of ownership.Giving away clean inah personal financing at high profit rates– a way towards subprime inah?

Conflict between Aqad and Maqasid?

Method #3: Financial Reporting• Proper recording of transactions to evident TRUE SALE.• BBA – bank must put BBA asset on balance sheet prior to

sale. I week, 1 month it depends.• Once sold, it is recorded as BBA receivables.• AITAB assets should be on banking book as leasing assets

but now treated as “financing and advances”.• External auditors (PWC, KPMG etc.) are not required by

the authority to conduct Shariah audit. And they may not be not capable to do so.

Conflict between AQAD and financial reporting?

Islamic Bank Average Balance SheetAssets Liabilities

Murabaha/BBA Wadiah Dhamanah deposits

AITAB Profit Sharing Investment Acct

Islamic Securities/Sukuk Capital

Assets Liabilities

FIXED ASSET

1. BBA asset

1. 1/9/2008 Bank purchases Property from Vendor for $200,000

1. 15/9/2008 Bank Sells Property to Customer for $280,000

Assets Liabilities

CURRENT ASSET

2. BBA Receivables

1st October 2008

15 October 2008

BBA Legal Documentation

1. Sale and Purchase Agreement (SPA)2. Property Purchase Agreement (PPA)3. Property Sale Agreement (PSA)4. Deeds of assignment/Charge

2. Bank do not have legal + beneficial ownership of property to make a valid sale

‘Do not Sell what you don not Own” Hadith (Sahih Bukhari)

High Court Judge Datuk Abdul Wahab Patail says that the sale element in BBA sale is not a bona fide sale

1. No transfer of title from Customer to Bank

Basel II and IFSB

• High risk-weights for Musharakah Financing to imply that bank bears business risk and the general investment account holders (GIA) do not.

• Recent PSIA guidelines will test risk appetite of depositors.

Method #4: Legal Documentation

• BBA should be documented as a true sale and not as a loan. (Dato’ Nik vs. BIMB)

• Ijarah should be documented as operating lease and not a loan (Tinta Press vs. BIMB)

• Islamic bank has not practice fairness compared with conventional bank (Affin bank vs Zulkifli).

Conflict between AQAD and documentation of AQAD?

BBA Legal Documentation

1. Sale and Purchase Agreement (SPA)2. Property Purchase Agreement (PPA)3. Property Sale Agreement (PSA)4. Deeds of assignment/Charge

2. Bank do not have legal + beneficial ownership of property to make a valid sale

‘Do not Sell what you don not Own” Hadith (Sahih Bukhari)

High Court Judge Datuk Abdul Wahab Patail says that the sale element in BBA sale is not a bona fide sale

1. No transfer of title from Customer to Bank

Shariah Compliance: Consistency is Critical

‘AQADPrinciples

LEGAL/CONTRACT DOCUMENTATIONProtection of Rights

MAQASIDBenefits vs disbenefits

FINANCIALREPORTINGAAOIFI/IFSB/IFRS

Islamic Finance

Islamic Way of Life in Business

Against Islamic Norms

Islamic Bonds and Sukuk

Why Islamic bonds?

• Muslim Faith• Project finance, refinancing• Economic growth.• Reduce dependency on bank loans• Mopping up excess liquidity in Islamic banks

and other IFIs.• All markets can buy – Muslim and non-Muslim

markets

Conventional Securitization

• Securitization is the conversion of assets in marketable securities.

• Involving a true sale• Asset – financial assets such as loan

receivables.• Fixed income and capital protection

Islamic securitization

• IPDS - conversion of physical asset into marketable securities.

• No true sale• Fixed income and capital protection• Contract – bay al-inah• Redemption – bay al-dayn at par value• Trading bay al-dayn at discount

BAIDS

Al-Bai-Bithman Ajil Islamic Private Debt securities

BAIDS -ISLAMIC COUPON BOND (5) Bay Al-Dayn - Redemptions of Primary and Secondary Notes at Par Value

• (3)Sells back the underlying assets for $124 million

04/21/23

ISSUERS INVESTORS

(1) Sells underlying assetsto investors for $100 million

(2)Cash Payment $100 m

(4)Bay al-Dayn Issuance of Primary and Secondary Notes at Par ValuePrimary Notes (Principle): $100 millionSecondary Notes (profits): $24 million

Bay’ al-’Inah (1-4)

Bay’ Al-’Inah Islamic Bonds (BAIDS)1 & 2 = Asset Purchase Agreement (APA) = cash sale

3 & 4 = Asset Sale Agreement (ASA) = credit sale

Issuer Financiers

1) Sells asset X to financiers for $100m

2) CashPayment $100m

3) Sells X for $124m

4) Deferred payments $124m(DAYN BBA)

Issuance of PN $100m and SN$24m as IOUs

Bay’ Al-’Inah Islamic Bonds (BAIDS)(Sale Buyback) – NO Asset Securitization, only OIUs

Issuer Financiers

1) Sells asset X to financiers for $800m

2) CashPayment $800m

3) Sells X for $820m

4) Deferred payments $820m(DAYN BBA)

Issuance of PN $800m and SN$20m as IOUs

Structuring an Islamic Bond in Malaysia

Step 1:Bay al-’inah Securitization – Securitization of underlying assets using the contract of Bay’ al-’inah (bay’ mutlak

{spot sale} + al-murabahah {sale by deferred payments})

Step 2:New Islamic bond issues (IPOs)– Issuance or selling of Islamic debt certificate (Shahdah al-dayn) to investors

(at par value / at a discount)

Step 3:Trading of Islamic debt certificates in the secondary market– buying and selling of Islamic debt certificates in

the secondary market via the contract of bay’ al-dayn at a discount

04/21/23

Al-Bai-Bithaman Ajil Notes Issuance Facility (BAIDS)

1st StageCost of financing : $100 million

Annual profit rate: 8%Underlying asset: Land and building

Issue Date : 5th February 1999Maturity: 5th. February 2002

Tenure: 3 years

Total profit: $100,000,000 x 8% x 3 = $24 millionSelling price = cost of financing + profit margin = $124 million

2nd StageNumber of Primary notes : 100,000 units

Price per unit = $100,000,000/100,000 = $1000Number of Secondary notes = 500,000 unitsPrice per unit = $24,000,000/500,000 = $48

Semiannual profit payments = $3.98

1 6 12 18 24 30 36

$0m $4m $4m $4m $4m $4m + $100m

04/21/23

Issuer Financier

(2) Pays $120m

(1) Lends $100m

(a) Sells X for $100m

Sells back x for $120m

Exercise #1 BAIDS

• Company = ABC• Facility =$500m• Underlying asset = Land• Profit rate = 5% per annum• Tenure = 10 years• Face value = $1000 per unita) Find total value of PNb) Find total value of SNc) Find number of PN

Exercise #2

• How an Islamic bond that gives fixed income and capital protection is structured in Malaysia?

“ Issuer’s debt arising out of buying and selling transactions to be securitized via the issuance of

primary and secondary notes” (The Securities Commission

of Malaysia)

BBA Islamic debt securities (BAIDS)

Issuer’s debt = dayn BBA

Islamic bonds: Legal Documentation

• Asset Purchase Agreement (APA) • Asset Sale Agreement (ASA)• Trust Deeds• Issuing and Paying Agency Agreement

Islamic bonds:

Legal Documentation• Asset Purchase Agreement (APA) : The primary

subscribers will purchase from the issuer the underlying asset at the purchase price

• Asset Sale Agreement (ASA): The underlying asset sold to the subscribers at a selling price which shall be made up of the original price and profit margin to be imposed by the primary subscriber.

Shariah Advisory Council (SAC) of the Securities commission.

“ If the structure is based on securitization of Islamic debt, then the question of underlying asset is very crucial – definition and qualification of asset, free from any encumbrance, syariah complaint asset, asset that can be traded on deferred payment that creates indebtness, sale of asset and transfer of ownership, fixed income if the securities were to be traded at

the secondary market, on the basis of mudarabah or musyarakah”.

See Mohd Daud Bakar, Structuring Islamic PDS : Role of Independent Syariah Advisers, Securities Seminar of Islamic PDS, Commission, Malaysia 2001.

Bay’ al-’inah : Real (Bathin) vs Declared (Zahir) Intention

SHARIAH DIVERGENCE:

1) Bay’ al-’inah is a legal sale in the Shafi’ school, in which it says the intention or niyyah is not a significant element in determining the validity of a contract. This is the viewpoint taken up by the the Shariah scholars in Malaysian Central Bank (BNM) and the Securities Commission.

2) The central issue here is none other than the distinction between real and declared intentions. According to Rayner, “It may be concluded that the Malikis and Hanafis give due effect to the real intention or niyyah of the parties, but that as regards illicit motives both schools are reluctant to make such an uncertain element as motive a dependent factor of a legal act. The Hanbali school however, always gives precedence to real intention over declared intention. In general, the tendency of Muslims law seems to be to give priority to the declared intention. Indeed, in the Shafi’ school, this is not just a tendency but a doctrinal stance”. This is because the methodology of Islamic law in the Al-Shafi schoolstrives to secure “the stability of contract”. The doctrinal stance however does not mean that the Shafie school endorses and promotes bay enah.

FORM OVER SUBSTANCE?

• SALE WITH CONDITION OF RESALE TO THE SAME PARTY AT A PROFIT – BAY ENAH

• BAY AL-DAYN – DISCOUTED SALE OF ISLAMIC SECURITIES

• PURCHASE UNDERTAKING IN MUSYARAKAH SUKUKS

Murabaha Commercial Paper (MCP)

• Issuer sells X to Tender panel members (TPN) for $95m through bidding process. Issuer to choose the lowest yield. Say 5% (par value = $100m)

• TPN pays Issuer cash $95• TPN sells back asset to issuer for $100m• Issuer issues MCPs, say 12 months evidency

obligations to pay

MCP/MuNif

Issuer TPM (Investors)

(1) Sells X for $95m

(2) Pays $95m cash

(3) Sells back X for $100m

(4) Pays $100m lump-sum at maturity

Instrument #2Islamic Asset-Backed Securities

ORIGINATORSPECIAL PURPOSEVEHICLE

INVESTORS

(1) Sells financial asset

(6) Paymentsfromcashproceeds

ISLAMIC ASSET BACKED SECURITIZATION THE BASICS

(3) Sells asset on cash basis

(4) Sellsasseton credit

(5)IssuanceofIABSasevidenceofindebtedness

(7)Redemptionof IABS

TRUE SALE : (1) & (6)

Shariah Issues

• AQAD 1. B & S2. Subject matter3. Price• What constitutes Al-Mal?• Physical/tangible asset• Usurfruct/manfaat• Rights• Credit enhancers1. Third party guarantee2. Reserves

Ambang Sentosa Islamic Asset-Backed Securitiy (IABS)

The first Islamic asset-backed debt securities (IABS) worth RM986 million were issued on 26th June 2003 by Ambang Sentosa Sendirian Berhad with Abrar Discount Berhad acting as lead arranger. Ambang Sentosa is a special purpose vehicle (SPV) whose main purpose is to raise funds from investors by the issuance of al-bai-bithaman ajil Islamic debt securities (BaIDS). Under the transaction, the Originator, namely Maxisegar Sdn Bhd will sell its right, title and interest over the Balance Purchase Price or receivables (the “Asset”) arising from a selected pool of sale-purchase agreements (SPAs) entered between the seller and the end-purchasers to the issuer. The payment to Maxisegar originated from the proceeds of BaIDS issuance by Ambang Sentosa. Ambang Sentosa was able to issue BaIDS to the investors from the sale and resale of the receivables it acquired previously from Maxisegar by way of gift (Hibah).

Asset-Backed Securitization: Ambang Sentosa

ORIGINATOR SPV

INVESTORS

(3) Sells Asset to SPVat RM465mon deferred payments(BBA)

(2) Sells Assetto Investorsfor RM400mon cash basis

(4) Issuance of RM465m BAIDSas evidence of indebtedness

(1) Passing Assetto SPVas hibah

Asset :Housingdebt receivables

RM500m

(5) Buy asset for RM400 m

BANKS

(6) CollectsRM500mFrom banks

Instrument #3Sukuk Al-Ijarah

Al-Ijarah Munthahia Bithamleek(Leasing ending with ownership)

(Lessor must hold ownership title )

Banks- Syndication

(lessor)Guthrie Pte.

(lessee)

Supplier ofAsset

(Owner of Holdiko Plantation)

(1) Delivery ofAsset

(2) CashPayment

(3) Leasing of asset

(4) Rental paymentsWith a Put Option.

HoldikoPlantation

Project with cash flow

(6) Application of Asset

(7) Revenues

Stage 1: Sydication of banks (lessor) purchase Holdiko on cash basisStage 2: Banks leasedHolkifo plantation to Guthrie..

GLOBAL SUKUKS

Global Sukuks – Basic features

• Asset-backed• Shariah compatible trust certificates • Stable income but not fixed• Tradable • Investors hold risk of asset ownership and

income loss.• Guaranteed by government

Sovereign Global Sukuks

• Malaysian Global Ijara Sukuk -US $500m 10/6/02• Qatar Global Ijara Sukuk – US$700m 10/9/03• Sudanese Government Investment Sukuk – Sudanese

Dinar 6 billion• Bahrain Monetary Agency (BMA) - US$250m 18/2/04• Islamic Development Bank – US$400m 11/8/03

Corporate Global Sukuk

• Dubai Department of Aviation Ijara Sukuk - $US750m

• Sukuk Al- Intifaa Makkah - $US390m• Solidarity Trust Certificates IDB - $US400m • Guthrie Corporation – US$150m• Tabreed Global Ijara Sukuk – US$150m

Sovereign Sukuks – Basic Structure

• Incorporation of Special Purpose Vehicle (SPV)• SPV purchases land and landed properties from government• SPV resells the properties to the buyers of Sukuks (i.e.

investors).• On behalf of the investors, SPV leases the properties to the

government.• Rental payment to investors by the government refers to

LIBOR + the margin.• Returns are guaranteed


• Model 1: All obligations paid periodically1. Purchase Agreement2. Master Ijara Agreement

Eg. Qatar Global Ijara Sukuk


• Model 2: Some obligations paid periodically and some lumpsum

1. Purchase Agreement – SPV buys asset from government

2. Master Ijara Agreement – guaranteed returns3. Sale Agreement – Capital guarantee – SPV sells

asset to government

Eg. Malaysian Global Sukuk Ijara

What is a Trust Certificate?

• Certificate issued by the Trustee (custodian) of Purchased asset (SPV).

• SPV serves as a trustee to investors in so far as management of asset is concerned.

• SPV as a trustee manages the asset to generate earnings for the investors.

• SPV leases asset to government to generate rental income for investors.

Sukuk Musharakah

• The originator or the company looking to expand its operation, own some assets (land etc) and is looking forward to develop it through the issuance of Sukuk and approach the market in order to secure the needed capital by entering into musharakah with the Issuer of the Sukuk and a trustee of the Sukukholders

Sukuk Musharakah• A SPV representing the Sukukholders through the issuance of Musharakah sukuk (MS) will

enter into a Musharakah agreement with the Originator.• The SPV company that issues the MS will contribute x% of the capital in cash while the

Originator will contribute y% of the capital in kind in the form of vehicles, real estates or any other kind of assets which be valued at their actual value.

• The proceeds of the MS will be used by the SPV to make its contributions to the Musharakah• Profits will be distributed among partners in proportion to respective capital contributions• The Originator will undertake management of the Musharakah under separate management

agreement• In case if the profit exceed certain percentage agreed upon in the management agreement,

the Manager is entitled to such excess amount to bonus or incentive fees in consideration for its good management.

• The Originator will give an irrevocable undertaking to purchase the Units of the SPV in the Musharakah pool under the declining Musharakah concept or at maturity in a way that the entire Musharakah units are eventually owned by the Originator at a price equivalent to the original contribution of the SPV to the Musharakah pool.

• Originator to buy the units from the SPV in Musharakah at face value at pre-agreed price and not the market price has raised differences of opinion among Jurists.

Opponents of MS

• Under partnership, partner A cannot guarantee the capital of partner B, yet through the purchase undertaking at face value of Musharakah Sukuk structures effectively just do that.

Sukuk-Definition

Investment Sukuk are certificates of equal value representing undivided shares in ownership of tangible assets, usufruct and services or (in the ownership of) the assets of particular projects

Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)

Sukuks & Common Stocks

Common Stocks Sukuks

Investment Sukuk are certificates of equal value representing undivided shares in ownership of tangible assets, usufruct and services or (in the ownership of) the assets of particular projects

“No guaranteed Income and Capital Preservation”“Al-Kharaj bil Daman” “Al-Ghorm bil Ghonm”

Two Prominent Sukuk Structures

1. Sukuk Al-Ijaraha. Guaranteesb.Sale and Repurchase agreementc. Pricing of Sukukd.Ownership of asset – latest!!!

2. Sukuk Al-Musharakaha. Purchase undertakings

Sukuk Al-Ijarah

a. Guarantees – Sale and Repurchase Agreement

c. Pricing of Sukukd. Ownership of asset – latest!!!

ORIGINATOR SPECIAL PURPOSEVEHICLE

INVESTORS

(1) Sells physical asset


(2) IssuesSukuks

(3) Payments

(7)Paymentsof dividends


(5) Lease to Originator

(6) Rental payments

(8)Sale of asset

(9) Payment

Sukuk Al-IjarahSukuk Al-Ijarah

Malaysian Sukuk/Trust Certificate• Issuer: Malaysian Global Sukuk Inc.• Amount: USD600m due 2007• Issue Date: 3rd July 2002• Issue Price: Issued at par• Periodic distributions: Each certificates will receive monies received from Trust

assets at LIBOR + 95bps p.a.• Redemption of certificates and dissolution of trust: The certificates will be

redeemed. 1. on the scheduled dissolution date 2. at the dissolution amount 3. the trust dissolved.

• Form and delivery of certificate• Clearance and settlement• Denominations: Minimum of USD$10,000 and integral multiples of USD1000.• Land parcels: 1. Hospital Selayang 2. Hospital Tengku Ampuan Rahimah Kelang; 3)

Jalan Duta govt. Quarters complex and 4. Jalan duta govt. Office complex.

ORIGINATOR SPECIAL PURPOSEVEHICLE

INVESTORS

(1) Sells physical asset


(2) IssuesSukuks

(3) Payments

(7)Paymentsof dividends


(5) Lease to Originator

(6) Rental payments

(8)Sale of asset

(9) Payment

Sukuk Al-IjarahSukuk Al-Ijarah

Sukuk/Trust Certificate• Lease agreement: Master Ijarah Agreement, Issuer as lessor

and FOM as Lessee agrre to execute consecuitive semi-annual leases to lease the land parcels to FOM during the facility period.FOM indemnifies Issuer on the use of the landFOM responsible or ordinary maintenance and repairIssue responsible for major maintenance but will appoint FOM as service agent under the service agency agreement.Semi annual lease rentals calculated at LIBOR + margin.

• Listing: Luxembourg Stock Exchange and Labuan Financial exchange

• Rating: BBB by standard and Pooers and Baa2 by Moodys

Malaysian Sukuk/Trust Certificate

• Transaction documents:Purchase agreementLease agreementseller’s declaration of trustService agency agreementinsurance/takaful aggreemntPurchase undertaking deed.

Capital Protection: Bay al-Wafa

• Bay al-wafa: Seller (Ali) agree to sell X to Buyer (Ismail) with a condition that if Buyer (Ismail) wishes to sell X later, Buyer (Ismail) must sell X to Seller( Ali).

• But at what price and who sets the price?a. Parb.Mark-to market

Pressing Issue : Ownership of Underlying Asset

Who Own Underlying Assets?More than 80% of current Sukuks do not comply with

the Ownership Requirement.

Special Purpose VehicleOwner?

InvestorsOwner??

Issues SukuksPayments

AAOIFI June 2007 1st Statement1. Sukuk, to be tradable, must be owned by Sukuk

holders, with allrights and obligations of ownership, in real assets,

whether tangible,usufructs or services, capable of being owned and sold

legally as wellas in accordance with the rules of Shari'ah, in accordance

with Articles(2)1 and (5/1/2)2 of the AAOIFI Shari'ah Standard (17) on

Investment1 2.

2nd Statement

The Manager (SPV) issuing Sukuk must certify the transfer of ownership of such assets in its (Sukuk) books, and must not keep them as his own assets.

Sukuk Ijarah

• SPV holds legal and beneficial ownership• Legal ownership – title of asset ownership

registered under buyer’s name.• Beneficial ownership – right of disposal/right

to sell the assets by owner.

Interest-bearing Loan

• Decoupling of legal ownership from beneficial ownership.

• Borrower holds legal ownership of the property.

• Bank puts a charge on the property and holds beneficial right.

Interest-Bearing Loans

• Decoupling legal ownership from beneficial ownership.• Borrower holds legal ownership of the property.• Bank puts a charge on the property and holds beneficial right.

Legal + BeneficialOwnership

LegalOwnership(Customer)

BeneficialOwnership

(Bank)

Sale on Cash Basis

• Buyer hold complete ownership

CompleteOwnership

Milkiyah Mutlakah


BeneficialOwnership

(Bank)

Sale on credit basis – Murabahah/BBA

• Decoupling legal ownership from beneficial ownership.• Buyer holds legal ownership of the property.• Bank puts a charge on the property and holds beneficial right.

Legal + BeneficialOwnership


BeneficialOwnership

(Bank)

Guarantees

Profit + Principle

1. Sukuk Al-Ijarah• Guarantee on Sukuk Issues• Originator establishes SPV that will issue the Sukuk.• Originator provide a guarantee against any shortfalls.• Fiqh academy resolution 30(3/4) – third independent party

(ie independent to the contract) to guarantee at no consideration (ie free of charge).

• AAOIFI Shariah Standard no.17 – “the prospectus must not include any statement to the effect that the issuer of the certificates accepts the liability to compensate the owner of the certificate up to the nominal value of the certificates in situations other than torts and negligence not that the guarantee a fixed percentage of profit.

Guarantee the Principle

• Third party guarantee1.Government

a. private sukuk – not permissibleb. government sukuk - permissible

1.Private company No text prohibiting a guarantee from a third party.

Guarantees - Examples

1. Islamic Development Bank Sukuk• Trust certificates issued by Solidarity Trust

Services Limited (SPV)• Originator – IDB2. Malaysia• Trust certificates issued by SPV Malaysian

Global Sukuk• Originator – Ministry of Finance

Guarantees of Principle by Sale and Buy-Back Structure

• Bay al-Wafa• Allowed by minority but rejected by the

majority and Islamic Fiqh Academy resolutions passed in 1992.

• Sale and leaseback is bay al-inah – Rejected by Islamic Fiqh Academy.

Sale with Repurchase Agreement

SPV

Investors

Originator

(3) At maturity Sells x

(4) Payments $600m

(1) Sells x

(2) Payments $600m

$600mPaymentsForRedemptionsOf Sukuk

Musharakah Sukuk

Musharakah al-Aqd – profit sharingMusharakah al-milk – not for

business

Musharakah sukuk (MS)• SPV enters into Musharakah agreement with Originator.• SPV represents SukukHolders through issuances of MS.• SPV contributes $X cash• Originator contributed $land,equipment,building,vehicles• Proceed of MS will be used by SPV as its capital contribution $X.• Profit distributed according to respective capital contribution.• Originator will undertake management role as Manager under

separate agreement.• Profit that exceeded certain % belongs to the Manager• The Originator gives an irrevocable undertaking to purchase the

units of the SPV in the Musharakah face value at pre-agreed price (and not at market price). -Purchase Undertaking Contract

Musharakah Sukuk

Middle-East - GCC

RAKIA Sukuk

Extract of Termsheet:– Issuer: RAKIA Sukuk Company Limited– Issue purpose: The proceeds to be used in part to

purchase the Project Land and in part for the completion of the Works

– Issue size: US$325 million– Maturity: 5 years– Profit: 3 month LIBOR + 150 bps– Guarantor: Government of Ras Al Khaimah

RAKIA Sukuk

The development will consist of four islands of varied sizes in addition to a peninsula together measuring 2.30 million square metres. The development will extend four kilometres linearly into the sea and approximately three kilometres along the coast of Ras Al Kh aimah. The ‘‘Peninsula’’ and ‘‘Island 1’’ are intended to form the hospitality gateway to the development, covering an area of 0.26 million square metres and 0.12 million square metres respect ivel y. ‘‘Island 2’’ is envisioned as being residential in nature. The total area of ‘‘Island 2’’ will be 0 .50 million square metres. ‘‘Island 3’’ is intended to contain sports and commercial facilities covering an area of 0.35 mil lion square metres. ‘Island 4’’ has been designated for hotel and resort developments covering an area of 1.07 million square metr es.

RAKIA Sukuk

Issuer(SPV)

Investors

RAKIA

Sale of

Project Land

Purchase

Price for Project

Land

Sukuk IssueSukuk Proceeds

RAKIA Sukuk

Issuer(SPV)

Investors

Sukuk Assets

RAKIARAKIA

Income

Exercise Price

Sukuk Redemption

Periodic Distribution

Income

Liquidity Payments

Incentive Fees

Ongoing Maturity or Dissolution

Transaction Documents

• Bai (Sale)• Wakalah (Agency)• Wa’ad (promise)

(1) Sale and Purchase Agreement

• Seller (RAKIA) sold to the Issue, rights, interest and title over the project land.

• The Issuer part of the proceeds from the Sukuk issue to pay the purchase price for the project land.

(2) Management Agreement

• Between RAKIA and Issuer• Issuer appoints RAKIA as the managing agent

to procure the completion of the development of the project land and the works, and administer the sale of the project land to a third party.

(3) Purchase Undertaking

• Given by RAKIA in favour of the Issuer.• A key document because it allows the

investors to be paid either on early termination or on the redemption of the Sukuk.

• RAKIA agrees to purchase the issuer’s rights, interest and title over the assets at a specified price in an event of default or immediately before maturity date.

(4) Sales contract undertaking

• Undertaking given by RAKIA, in favor of the Issue where RAKIA guarantees that the work will have a value of US$125m following its completion.

(5) Guarantee Deed

• Issued by the government in favor of the Issuer, where the government irrevocably and unconditionally guarantees RAKIA’s payment obligations under the transactions.

Purchase Undertaking

• The Originator gives an irrevocable undertaking to purchase the units of the SPV in the Musharakah face value at pre-agreed price (and not at market price). -Purchase Undertaking Contract

• Through the Purchase Undertaking Contract, Partner A effectively guarantee capital of Partner B.

• In a Musharakah contract a Partner A cannot guarantee the capital of Partner B

Musharakah Sukuk

• Sukuk al-Musharakah issued in 2005 by Dubai Metals & Commodities Company (DMCC) Authority

• Proceeds of sukuk were used to build Almas Tower and the Au Tower and the AG Tower in the DMCC Free Trade Zones.

Musharakah sukuk

• Sukuk al-Musharakah issued by Wings FZCO on behalf of Emirates Airlines in 2005 $824million.

• Landmark musharakah sukuk – Dubai ports, Customs and Free Zone Corporation (PCFC) for $2.8 billion

• Subscribers1. 70% banks2. 7% high net worth individuals3. 13% fund managers

Malaysian Musharakah Sukuk

Khazanah Exchangeble SukukKL Sentral Sukuk

Khazanah Exchangeable Sukuk

Investors

Cherating Capital(Issuer)

Cempaka Capital(SPV)

Khazanah Nasional(Obligor)

Plus ExpresswayBerhad

Sale of Equity Pool

Sale Price (Nominal)

Sale of Equity PoolSale Price (Nomina)

Sukuk ProceedSukuk

Cash PaymentPurchase Right Deed

Purchase Undertaking Deed

KL Sentral Sukuk

Conclusion

• Compliance Issue must move beyond AQAD methodology.

• Sale without Ownership transfer• Sale with Ownership transfer to the Wrong

Party.• Sukuk Ijarah: Capital Protection via Sale and

Repurchase Agreement.• Sukuk Musharakah: Capital Protection via

Purchase Undertaking

Thank You

Wassalamwww. inceif.org

• Dhawa taajal• Hiwalah• Bay al-dayn

• How will you structure an Islamic bond that gives you a fixed profit as well as capital protection.