Islamic Capital Markets
Global Financial Turmoil 1. Excess Recycled Money (US 72 t) and Asset Bubbles 2. Subprime Loans Yield in mortage > t-bills 3 Securitization 4. NPL and Burst of the Bubble 5 Bank Foreclosures 6 Credit Crunch US Recession 8 Drop in US imports = drop in Asian export 7 Fall in US business and consumer spending
Islamic Banking Challanges Products & Product Development (credit risk, rate of return risk, displaced commercial risk, Shariah risk)) Moral Hazard & Lack of Regulation (Operational risk) Bank Capital Risk Management Global economy (market risk)
Subprime Crises: Lessons for Islamic Finance Loan Origination Asset-Based – reduces speed of financing Reduces subprime BBA Securitization Shariah prohibits securitization of murabaha receivables Less sale of BBA mortgages PSIA Investment account holders can scrutinize mortgage financing Capital Adequacy
Islamic Financial Market Direct Financial Market (Capital Market) Sukuk 65% SC Screening Equity 85% SC Screening Indirect Financial market Bank 13% Takaful 5% Unit Trust Mutual Funds 7% Venture Capital
5 Basic Shariah Principles in Financial Transactions #1 Prohibition of Riba #2 Application of Al-Bay #3 Avoidance of Gharar #4 Prohibition of Gambling(Maisir) #5 Prohibition to engage in the production of commodities
Islamic Bonds BAIDS Mu. NIfs Asset-Backed Securities Sukuk Ijarah Sukuk Musharakah Hybrid Sukuks
"Sukuk Issuance Expected To Exceed $20 bn In 2008". Standard & Poor's $25 billion is reasonable in the current market environment. Securities Commission 2008 Sukuk Facts Malaysia pioneered the development of the global sukuk market with the launch of the first sovereign 5 year global sukuk in 2002. In 2007, 76% of bonds approved by the Securities Commission were sukuk.
Role of Sukuk in Economic Development Purpose of Sukuk Issuances Project Financing Refinancing Working capital
Corporate Finance – Demand for Capital Structure Debt Sukuk Equity
Cost of Capital Cost of capital Cost of Debt Cost of Sukuk Cost of Equity
Capital Structure Capital • Debt Structure • Equity I Capital • Debt Structure • Sukuk • Equity II
Sukuk – Moving Forward Strong base of domestic investors to anchor the distribution of a major sukuk issue Sukuk pricing for Malaysian-originated issues are highly competitive An established regulatory framework which meets both Shariah and legal requirements.
Shariah Compliance: Consistency is Critical ‘AQAD Principles LEGAL/CONTRACT DOCUMENTATION Protection of Rights MAQASID Benefits vs disbenefits FINANCIAL REPORTING AAOIFI/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 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 Mu. Nif Sukuk Ijarah Sukuk Musharakah Islamic Bonds
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 Aqad Agents of Contract Objective of Contract Subject Matter Offer & Acceptance
Sale (Al-Bay’) Buyer & Seller Transfer of Ownership from Buyer to Seller Property Price set on the spot
Contract of Sale • Example: Murabaha/BBA Sale 1. Buyer and Seller eg. Seller owns asset/subject matter before making sale 2. Subject matter eg. Mal mutaqawim – property with usurfruct 3. Price eg. Set on the spot 4. Offer & Acceptance eg. Verbal or in writing
Method #2: Maqasid al. Shariah/Objective of Shariah To protect the interest of the public (society)- maslahah alammah by: 1. removing the harm ( ibqa) 2. securing of benefits (tahsil)
#2 Maqasid Method Maqasid Shariah Removing the Harm Securing of Benefit
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). Mudarat Manfaat Sins Profits
Mudarat Riba Manfaat
Mudarat Al-Bay Manfaat
Mudarat ? Financing BBA Manfaat ?
Mudarat ? Plain BBA Manfaat ?
Mudarat > Manfaat HARAM
Mudarat < Manfaat HALAL
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 • 1. 2. 3. 4. To analyse(theoretical) and measure( empirical) impacts of financial intermediation based on aqad-based Shariah compliant products. Efficiency studies Profitability studies Studies on Consumer welfare and protection 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 Sheet Assets Liabilities Murabaha/BBA Wadiah Dhamanah deposits AITAB Profit Sharing Investment Acct Islamic Securities/Sukuk Capital
1 st October 2008 Assets Liabilities FIXED ASSET 1. BBA asset 15 October 2008 Assets Liabilities CURRENT ASSET 2. BBA Receivables 1. 1/9/2008 Bank purchases Property from Vendor for $200, 000 1. 15/9/2008 Bank Sells Property to Customer for $280, 000
‘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 BBA Legal Documentation 1. 2. 3. 4. Sale and Purchase Agreement (SPA) Property Purchase Agreement (PPA) Property Sale Agreement (PSA) Deeds of assignment/Charge 1. No transfer of title from Customer to Bank 2. Bank do not have legal + beneficial ownership of property to make a valid sale
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?
‘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 BBA Legal Documentation 1. 2. 3. 4. Sale and Purchase Agreement (SPA) Property Purchase Agreement (PPA) Property Sale Agreement (PSA) Deeds of assignment/Charge 1. No transfer of title from Customer to Bank 2. Bank do not have legal + beneficial ownership of property to make a valid sale
Shariah Compliance: Consistency is Critical ‘AQAD Principles LEGAL/CONTRACT DOCUMENTATION Protection of Rights MAQASID Benefits vs disbenefits FINANCIAL REPORTING AAOIFI/IFSB/IFRS
Islamic Finance Risk Core Activities Return Shariah
Islamic Way of Life in Business No Risk No Return
Islamic Way of Life in Business Taking Risk Making Returns
Against Islamic Norms Taking No Risk Making Returns with certainty (by contract)
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
Islamic Bonds i. PDS BAIDS Mu. Nif i-ABS BAIDS Sukuk Ijarah Sukuk Musharaka
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 (2)Cash Payment $100 m ISSUERS Bay’ al-’Inah (1 -4) INVESTORS (1) Sells underlying assets to investors for $100 million • 3/19/2018 (3)Sells back the underlying assets for $124 million (4)Bay al-Dayn Issuance of Primary and Secondary Notes at Par Value Primary Notes (Principle): $100 million Secondary Notes (profits): $24 million
Bay’ Al-’Inah Islamic Bonds (BAIDS) 1 & 2 = Asset Purchase Agreement (APA) = cash sale 3 & 4 = Asset Sale Agreement (ASA) = credit sale 1) Sells asset X to financiers for $100 m Issuer 2) Cash Payment $100 m Financiers 3) Sells X for $124 m 4) Deferred payments $124 m (DAYN BBA) Issuance of PN $100 m and SN$24 m as IOUs
Bay’ Al-’Inah Islamic Bonds (BAIDS) (Sale Buyback) – NO Asset Securitization, only OIUs 1) Sells asset X to financiers for $800 m Issuer 2) Cash Payment $800 m Financiers 3) Sells X for $820 m 4) Deferred payments $820 m (DAYN BBA) Issuance of PN $800 m and SN$20 m 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 3/19/2018
Al-Bai-Bithaman Ajil Notes Issuance Facility (BAIDS) 1 st Stage Cost of financing : $100 million Annual profit rate: 8% Underlying asset: Land building Issue Date : 5 th February 1999 Maturity: 5 th. February 2002 Tenure: 3 years Total profit: $100, 000 x 8% x 3 = $24 million Selling price = cost of financing + profit margin = $124 million 2 nd Stage Number of Primary notes : 100, 000 units Price per unit = $100, 000/100, 000 = $1000 Number of Secondary notes = 500, 000 units Price per unit = $24, 000/500, 000 = $48 Semiannual profit payments = $3. 98 1 $0 m 3/19/2018 6 $4 m 12 $4 m 18 $4 m 24 $4 m 30 36 $4 m + $100 m
Sells back x for $120 m (2) Pays $120 m Issuer Financier (1) Lends $100 m (a) Sells X for $100 m
Exercise #1 BAIDS • Company = ABC • Facility =$500 m • Underlying asset = Land • Profit rate = 5% per annum • Tenure = 10 years • Face value = $1000 per unit a) Find total value of PN b) Find total value of SN c) Find number of PN
Exercise #2 • How an Islamic bond that gives fixed income and capital protection is structured in Malaysia?
BBA Islamic debt securities (BAIDS) Issuer’s debt = dayn BBA “ 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)
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 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 school strives 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 $95 m through bidding process. Issuer to choose the lowest yield. Say 5% (par value = $100 m) • TPN pays Issuer cash $95 • TPN sells back asset to issuer for $100 m • Issuer issues MCPs, say 12 months evidency obligations to pay
MCP/Mu. Nif (4) Pays $100 m lump-sum at maturity (1) Sells X for $95 m Issuer TPM (Investors) (2) Pays $95 m cash (3) Sells back X for $100 m
Instrument #2 Islamic Asset-Backed Securities
ISLAMIC ASSET BACKED SECURITIZATION THE BASICS (1) Sells financial asset SPECIAL PURPOSE VEHICLE ORIGINATOR (6) Payments from cash proceeds TRUE SALE : (1) & (6) (4) Sells asset on credit (5) Issuance of IABS as evidence of indebtedness (3) Sells asset on cash basis INVESTORS (7) Redem ption of IABS
Shariah Issues • AQAD 1. B & S 2. Subject matter 3. Price • What constitutes Al-Mal? • Physical/tangible asset • Usurfruct/manfaat • Rights • Credit enhancers 1. Third party guarantee 2. Reserves
Ambang Sentosa Islamic Asset-Backed Securitiy (IABS) The first Islamic asset-backed debt securities (IABS) worth RM 986 million were issued on 26 th 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 (Ba. IDS). 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 Ba. IDS issuance by Ambang Sentosa was able to issue Ba. IDS 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 (5) Buy asset for RM 400 m (1) Passing Asset to SPV as hibah SPV ORIGINATOR Asset : Housing debt receivables RM 500 m BANKS (2) Sells Asset to Investors for RM 400 m on cash basis (6) Collects RM 500 m From banks (3) Sells Asset to SPV at RM 465 m on deferred payments (BBA) INVESTORS (4) Issuance of RM 465 m BAIDS as evidence of indebtedness
Instrument #3 Sukuk Al-Ijarah
Al-Ijarah Munthahia Bithamleek (Leasing ending with ownership) (Lessor must hold ownership title ) (3) Leasing of asset Banks- Syndication (lessor) (2) Cash Payment (1) Delivery of Asset Supplier of Asset (Owner of Holdiko Plantation) Guthrie Pte. (lessee) (4) Rental payments With a Put Option. (7) Revenues Stage 1: Sydication of banks (lessor) purchase Holdiko on cash basis Stage 2: Banks leased Holkifo plantation to Guthrie. . (6) Application of Asset Holdiko Plantation Project with cash flow
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 $500 m 10/6/02 • Qatar Global Ijara Sukuk – US$700 m 10/9/03 • Sudanese Government Investment Sukuk – Sudanese Dinar 6 billion • Bahrain Monetary Agency (BMA) - US$250 m 18/2/04 • Islamic Development Bank – US$400 m 11/8/03
Corporate Global Sukuk • Dubai Department of Aviation Ijara Sukuk $US 750 m • Sukuk Al- Intifaa Makkah - $US 390 m • Solidarity Trust Certificates IDB - $US 400 m • Guthrie Corporation – US$150 m • Tabreed Global Ijara Sukuk – US$150 m
Sovereign Sukuks – Basic Structure • Incorporation of Special Purpose Vehicle (SPV) • SPV purchases 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
Sovereign Sukuks – Basic Structure • Model 1: All obligations paid periodically 1. Purchase Agreement 2. Master Ijara Agreement Eg. Qatar Global Ijara Sukuk
Sovereign Sukuks – Basic Structure Model 2: Some obligations paid periodically and some lumpsum 1. Purchase Agreement – SPV buys asset from government 2. Master Ijara Agreement – guaranteed returns 3. 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 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-Ijarah a. b. c. d. Guarantees Sale and Repurchase agreement Pricing of Sukuk Ownership of asset – latest!!! 2. Sukuk Al-Musharakah a. Purchase undertakings
Sukuk Al-Ijarah a. Guarantees – Sale and Repurchase Agreement c. Pricing of Sukuk d. Ownership of asset – latest!!!
(9) Payment (8)Sale of asset (5) Lease to Originator (6) Rental payments (1) Sells physical asset ORIGINATOR (4) Payments from cash proceeds Sukuk Al-Ijarah SPECIAL PURPOSE VEHICLE (3) Payments (2) Issues Sukuks (7) Payments of dividends INVESTORS (10) Redem ption of IABS
Malaysian Sukuk/Trust Certificate • • • Issuer: Malaysian Global Sukuk Inc. Amount: USD 600 m due 2007 Issue Date: 3 rd July 2002 Issue Price: Issued at par Periodic distributions: Each certificates will receive monies received from Trust assets at LIBOR + 95 bps 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 USD 1000. Land parcels: 1. Hospital Selayang 2. Hospital Tengku Ampuan Rahimah Kelang; 3) Jalan Duta govt. Quarters complex and 4. Jalan duta govt. Office complex.
(9) Payment (8)Sale of asset (5) Lease to Originator (6) Rental payments (1) Sells physical asset ORIGINATOR (4) Payments from cash proceeds Sukuk Al-Ijarah SPECIAL PURPOSE VEHICLE (3) Payments (2) Issues Sukuks (7) Payments of dividends INVESTORS (10) Redem ption of IABS
Sukuk/Trust Certificate • Lease agreement: Master Ijarah Agreement, Issuer as lessor and FOM as Lessee agrre to execute consecuitive semiannual leases to lease the land parcels to FOM during the facility period. FOM indemnifies Issuer on the use of the land FOM responsible or ordinary maintenance and repair Issue 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 Baa 2 by Moodys
Malaysian Sukuk/Trust Certificate • Transaction documents: Purchase agreement Lease agreement seller’s declaration of trust Service agency agreement insurance/takaful aggreemnt Purchase 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. Par b. 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 Vehicle Owner? Issues Sukuks Payments Investors Owner? ?
AAOIFI June 2007 1 st Statement 1. Sukuk, to be tradable, must be owned by Sukuk holders, with all rights and obligations of ownership, in real assets, whether tangible, usufructs or services, capable of being owned and sold legally as well as 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 Investment 1 2.
2 nd 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 + Beneficial Ownership Legal Ownership (Customer) Beneficial Ownership (Bank)
Sale on Cash Basis • Buyer hold complete ownership Legal Ownership (Customer) Beneficial Ownership (Bank) Complete Ownership Milkiyah Mutlakah
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 + Beneficial Ownership Legal Ownership (Customer) Beneficial Ownership (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 guarantee 1. Government a. private sukuk – not permissible b. 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 – IDB 2. 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 (3) At maturity Sells x (1) Sells x SPV Originator (4) Payments $600 m (2) Payments $600 m Investors $600 m Payments For Redemptions Of Sukuk
Musharakah Sukuk Musharakah al-Aqd – profit sharing Musharakah al-milk – not for business
Musharakah sukuk (MS) SPV enters into Musharakah agreement with Originator. SPV represents Sukuk. Holders 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 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 Purchas e Price for Project Land Sale of Project Land Issuer (SPV) Sukuk Issue Sukuk Proceeds Investors Purchase Undertaking Manager of Sukuk Assets RAKIA
RAKIA Sukuk Ongoing Maturity or Dissolution Sukuk Assets Income Liquidity Payments Income Exercise Price Issuer (SPV) RAKIA Incentive Fees Periodic Distribution Sukuk Redemption Investors RAKIA
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 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$125 m 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 $824 million. • Landmark musharakah sukuk – Dubai ports, Customs and Free Zone Corporation (PCFC) for $2. 8 billion • Subscribers 1. 70% banks 2. 7% high net worth individuals 3. 13% fund managers
Malaysian Musharakah Sukuk Khazanah Exchangeble Sukuk KL Sentral Sukuk
Khazanah Exchangeable Sukuk Investors Sukuk Proceed Sukuk Cash Payment Purchase Right Deed Cherating Capital (Issuer) Khazanah Nasional (Obligor) Purchase Undertaking Deed Sale Price (Nomina) Sale of Equity Pool Sale Price (Nominal) Cempaka Capital (SPV) Sale of Equity Pool Plus Expressway Berhad
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
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• How will you structure an Islamic bond that gives you a fixed profit as well as capital protection.
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