ISLAMIC PROJECT FINANCING Assoc Prof Dr Engku Rabiah

ISLAMIC PROJECT FINANCING Assoc Prof Dr Engku Rabiah Adawiah Engku Ali Ahmad Ibrahim Kulliyyah of Laws International Islamic University Malaysia rabiah@iiu. edu. my eradawiah@yahoo. com

Agenda p Project Financing: An Overview p Shari`ah Perspective on Project Financing p Islamic Project Financing – Instruments & Contracts p Track-record of Islamic Project Financing p Transaction Structures of Islamic Project Financing with Case Studies p Some Examples of Contemporary Islamic Project Financing p The Way Forward 2

Project Financing: An Overview p Definition: “The financing of an economic unit (i. e. project) in which the lenders look initially to the cash flows & other assets comprising the economic unit as collateral for the loan” p p Project financing – focus on the financing of projects in which the financiers look to the cash flows of the project for the repayment of the financing amount Project financing techniques – primary means for financing broad range of economic units world-wide, e. g. : power generation, oil & gas industries, mining, various infrastructure projects, manufacturing, etc. 3

Shari`ah Perspective on Project Financing p p Purpose should be for Shari`ah compliant projects/ activities – Islamic project financing Techniques & instruments – Shari`ah compliant n n n p Conceptually Structurally Documentation Modus operandi – execution & implementation Recovery mechanisms Cannot be a mere “debt-leverage” exercise like conventional project financing due to the Shari`ah prohibition of payment & receipt of interest (riba) 4

Islamic Project Financing – Instruments & Contracts Multi-level financing: p p p Syndication if needed) Bridging financing Main financing Tranches Securitization – Islamic securities Underlying Contracts: p p p p BBA / Murabahah Istisna` Bay` al `inah / Tawarruq Ijarah / ijarah muntahiyah bit tamlik Ijarah mawsufah fi dhimmah Musharakah / musharakah mutanaqisah Mudarabah 5

Track-record of Islamic Project Financing p p Started with only one / two instruments, e. g. : BBA & murabahah Developed further with various other instruments, e. g. : Ijarah, istisna`, mudarabah, musharakah etc. Latest trend: more complex, liquid & competitively priced instruments through securitization – Islamic securities Continuous potentials for new instruments / financing structures to be developed 6

ISLAMIC FINANCING: TRANSACTION STRUCTURES

Basic Transaction Structure for Project Financing: Parallel Istisna` Financier Company Istisna’ 1 – deferred payment (price = cost + profit) Istisna’ 2 – progressive payment (price = cost) Note: Both istisna’ are to construct the same “project” (e. g. real estate, airport etc. ) 8 Contractor

Basic Transaction Structure: Istisna` Sukuk 1 st Istisna’ contract (Construction Cost + Profit Margin) for deferred payment Issuer Financier Issues Istisna’ Sukuk Creates SPV Project Company (SPV) 2 nd Istisna’ contract (Construction Cost) 9

Case Study: Islamic Project Financing (SKS Tanjung Bin Istisna` MTN) STEP 1: Issuer and Financier will execute an Istisna’ Purchase Agreement, under which Issuer will agree to construct and deliver & sell to the Financier a specific asset (The Asset). FINANCIER (On Behalf of Investors) 4 3 1 STEP 2: The Istisna’ Purchase Price will be RMXXX Million and will be disbursed in one lump sum 2 ISSUER § The RM 5. 6 b SKS Power Istisna` MTN Transaction Structure STEP 3: The Financier and Issuer will execute an Istisna’ Sale Agreement, under which the Financier will agree to construct and deliver to Issuer the asset. Delivery to Issuer will take place upon the Financier taking delivery of the Asset under the Istisna’ Purchase Agreement. STEP 4: The Istisna’ Sale Price will be equivalent to the aggregate of the Istisna’ Purchase Price and profit thereto. The Sale Price will be payable according to an agreed payment schedule. STEP 5: The Issuer issues the Istisna’ Bonds to evidence the future payment of the Istisna’ Sale Price 10

Lease-based Project Financing: Basic Transaction Structure Utilised to finance project costs 1 Sale of asset to financier for cash payment Company undertakes to redeem asset at the end of lease period Financier/Bank Company 2 Financier leases back asset to company in return of rental streams (inclusive of profits) 11

Project Financing: Basic Transaction Structure of Sukuk Al Ijarah Company as Lessee 6. Payment of rentals 2. Lease of asset 9. Exercise price at dissolution 8. Sale at dissolution 10. Dissolution Amount 7. Periodic rental payments 3. Sukuk issuance 1. Sale & Transfer of asset Company as Owner of asset To finance projects SPV 5. Proceeds Sukuk Holders (Investors) 4. Payment of Proceeds from sale of sukuk 12

Case Study: Sukuk al Intifa` 1 Ijarah Contract Land Owner 5 On Use of Land Evidenced by Sukuk Certificates 4 Payment For Lease of Land (SAR/US$) 2 Proceeds from Sukuk Sales 6 Developer Lease of Rights of Future Use of Units On Chosen Time Slots 3 Payments For Lease Rental (SAR/US$) SUKUK AL INTIFA’ Development Costs (SAR/US$) Commercial and Hotel Complex 7 “Time Use” By Sukuk Holders Sukuk Investors 4 13

Zam Tower Sukuk Al-Intifa’ p p The project manager i. e. Munshaat Real Estate Projects Co. has been awarded to construct one of the six towers on waqf land adjacent to the Grand Mosque of Mecca. Issues for preliminary deliberation n n p p Financing cost of construction. Restriction on ownership of non-Saudi of real property in Mecca/Medina. As for cost of financing, the contract of forward lease (al-Ijarah al-Mawsufah fi al-Dhimmah) was adopted. To avoid the issue of non-Saudis owning the property in Mecca, the concept of time-sharing is promoted. 14

Basic Transaction Structure: Mudarabah Project Financing Contract of Mudarabah Profit Sharing ratio – X: Y Financier (Rabb al Mal) Y% to rabb al mal Profit shared in accordance to pre-agreed proportions (X: Y) Loss borne Totally by rabb al mal Project Revenue Company (Amil / Mudarib) CAPITAL X% to mudarib Invests in project (e. g. real estate) 15

Basic Transaction Structure: Mudarabah Sukuk Issues Mudarabah Sukuk Investors (Rabb al Mal) Profit shared in accordance to pre-agreed proportions (X: Y) Contract of Mudarabah Y% to rabb al mal Issuer (Amil / Mudarib) CAPITAL X% to mudarib Loss borne Totally by rabb al mal Outcom e of project Invests in project (real estate) 16

Case Study: PG Municipal Mudarabah. Sukuk Security Trustee Rabb al Mal 1 Sukuk Holders Profit sharing SPV X% Investors Y% Issue Mudarabah Sukuk (rated/unrated) 1 st Mudarabah - Invest Capital (Sukuk Proceeds) PG Municipal (SPV) Profit Mudarib 1 & Rabb al Mal 2 2 nd Mudarabah Profit sharing Administrator X% PG Local Authority (Administrator) Investors Y% Profit from Tax Collection Mudarib 2 Manage and Administer Tax Collections 17

Basic Transaction Structure: Musharakah Project Financing Contract of Musharakah Financier / Bank • Profit: shared according to agreed ratio or according to ratio of capital contribution • Loss shared according to ratio of capital contribution Capital contribution – X: Y X% Project Revenue Company Capital Y% Invests in project (e. g. real estate) 18

Basic Transaction Structure: Musharakah Sukuk Issues Musharakah Sukuk Investors • Profit: shared according to agreed ratio or according to ratio of capital contribution • Loss shared according to ratio of capital contribution Contract of Musharakah Capital contribution – X: Y Issuer X% Revenue of Project Capital Y% Invests in Project (real estate) 19

Case Study: Assar Senari RM 150 m Musharakah Sukuk Holders (Investors) 1 Invest Capital (87%) 1 Invest Capital (13%) Musyarakah Venture Owned by 2 Profit sharing (Starts 2 nd Year) Company X% Investors Y% Construction period 12 – 18 Months 5 Lease completed IOT User Agreements (RMXXX Million) Trustee Project Manager (As Agent of Trustee) Completed IOT 4 Company Issue Sukuk Musyarakah Construct & Lease IOT 3 Oil Companies 20

Case Study: Wings FZCO Emirates as obligor Emirates as lessee Lease of New Emirates Group Headquarters Exercise Price Rental Emirates as lessee Lease of New Engineering Centre Rental MUSHARAKAH Sale of units Wings FZCO Emirates as partner Proceeds: USD 550 m Land parcels valued at USD 100 m Wings FZCO d c b Investors a Emirates a) Issues Sukuk – evidence proportionate share in Musharakah b) Proceeds – USD 550 m: used for construction of Group Headquarters & Engineering Centre c) Periodic Distribution Amount d) Dissolution Distribution Amount 21

Case Study: Vastalux Musharakah Sukuk Active Partner Sukuk Holders (Investors) 2 Musharakah Mutanaqisah Company 1 Invest Capital (90%) 1 agency 2 agency Issue Sukuk 3 Invest Capital (10%) 2 SPV Service Contract (RMXXX Million) Profit sharing 7 Company X% Investors Y% Musyarakah Revenue (RMXXX Million) 6 • Case study of RM 200 m Vastalux Musyarakah Sukuk 4 Musyarakah Venture Assignment 5 4 Servicing Oil Companies 22

SOME EXAMPLES OF CONTEMPORARY ISLAMIC PROJECT FINANCING Islamic Project Financing through Securitization p Islamic Project Financing: Istisna’ Bonds p Islamic Project Financing: Musharakah Sukuk p Islamic Project Financing: Sukuk al Intifa’ p

Recent Islamic Project Financing via Islamic Securities Issuances (Malaysian) Year Issuer Syariah Principle Project Size of Issues (RM mil) 2006 Sarawak Power Generation Sdn Bhd (two issues) Musharakah Electricity 215 2006 Mukah Power Generation Sdn Bhd (two issues) Mudarabah Electricity 950 2006 Penang Bridge Sdn Bhd Istisna` Bridge 695 2005 Jimah Energy Ventures Sdn Bhd Istisna' Electricity 4, 847 2005 IJN Capital Sdn Bhd Musharakah Hospital 209 2005 Penang Port Ijarah Port facilities 100 2004 Kapar Energy Ventures Sdn Bhd BBA Electricity 3, 402 2004 Sarawak Specialist Hospital & Medical Centre Sdn Bhd Istisna` Hospital 425 24

Recent Islamic Project Financing via Islamic Securities Issuances (Global) Year Issuer Syariah Principle Project Size of Issues (USD mil) 2007 Aldar Properties, UAE Mudarabah Abu Dhabi Property Devpt. 2, 530 2006 Nakheel Development Ltd, UAE Ijarah Dubai waterfront Property Devpt. 3, 520 2006 Aabar Sukuk Ltd, UAE Mudarabah Petroleum & energy 460 2005 Gold Sukuk DMCC, UAE Musharakah DMCC Free Zone Property Devpt. 2005 Emirates Airlines, UAE Musharakah Construction of Emirates HQ & Engin. Centre 650 2004 Dubai Department of Civil Aviation, UAE Ijarah Airport Expansion 1, 000 25

The Way Forward… p p Better, competitive & more efficient Islamic project financing instruments Truly Syariah compliant Transparent deals – disclosure, accounting & auditing Global acceptance & recognition 26

Thank You Wassalamualaikum wrt wbt