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					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


                             Islamic
                              Bonds



                  Asset-Backed                      Sukuk      Hybrid
BAIDS   MuNIfs                     Sukuk Ijarah
                   Securities                     Musharakah   Sukuks
 "Sukuk Issuance Expected To      $25 billion is reasonable in the
   Exceed $20bn In 2008".          current market environment.
      Standard & Poor's             Securities Commission 2008



                          Sukuk Facts

     Malaysia pioneered the
development of the global sukuk   In 2007, 76% of bonds approved
 market with the launch of the      by the Securities Commission
  first sovereign 5 year global              were sukuk.
          sukuk in 2002.
Role of Sukuk in Economic
      Development

             Purpose of
               Sukuk
             Issuances



  Project                  Working
             Refinancing
 Financing                 capital
  Corporate Finance –
  Demand for Capital

         Capital
        Structure

Debt     Sukuk      Equity
      Cost of Capital

           Cost of
           capital

Cost of    Cost of   Cost of
 Debt      Sukuk     Equity
    Capital Structure
 Capital    • Debt
Structure   • Equity
    I

 Capital    • Debt
Structure   • Sukuk
    II      • Equity
       Sukuk – Moving Forward


                                                An established
  Strong base of
                       Sukuk pricing for          regulatory
domestic investors
                          Malaysian-          framework which
  to anchor the
                     originated issues are   meets both Shariah
 distribution of a
                      highly competitive           and legal
major sukuk issue
                                                requirements.
Shariah Compliance: Consistency is Critical

                            „AQAD
                           Principles



                                              LEGAL/CONTRACT
     MAQASID                                   DOCUMENTATION
 Benefits vs disbenefits                       Protection of Rights



                           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 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


                      Aqad

Agents of    Objective       Subject     Offer &
Contract    of Contract      Matter    Acceptance
                            Sale (Al-Bay’)


                   Transfer of
                                                    Price set on the
Buyer & Seller   Ownership from          Property
                                                          spot
                  Buyer to Seller
              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 al-
   ammah by:

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

      Maqasid
      Shariah


Removing   Securing
the Harm   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   Manfaat




Riba
Mudarat   Manfaat
        Mudarat?   Manfaat?




Financing
BBA
Mudarat?   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
•    To analyse(theoretical) and measure(
     empirical) impacts of financial
     intermediation based on aqad-based Shariah
     compliant products.
1.   Efficiency studies
2.   Profitability studies
3.   Studies on Consumer welfare and protection
4.   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
                            1st 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.       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
1. No transfer of title from Customer to Bank    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.       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
1. No transfer of title from Customer to Bank    of property to make a valid sale
Shariah Compliance: Consistency is Critical

                            „AQAD
                           Principles



                                              LEGAL/CONTRACT
     MAQASID                                   DOCUMENTATION
 Benefits vs disbenefits                       Protection of Rights



                           FINANCIAL
                           REPORTING
                           AAOIFI/IFSB/IFRS
       Islamic Finance

              Risk

  Core
                       Return
Activities


             Shariah
Islamic Way of Life in Business



      No Risk    No Return
Islamic Way of Life in Business



                    Making
  Taking Risk
                    Returns
 Against Islamic Norms


                 Making Returns
Taking No Risk   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

iPDS     i-ABS      Sukuk

                      Sukuk
 BAIDS      BAIDS
                      Ijarah

                     Sukuk
 MuNif
                    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)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
7/27/2011                   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 $100m



                    2) Cash
                    Payment
Issuer              $100m
                                               Financiers
                   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
                   1) Sells asset X to financiers for $800m



                   2) Cash
                   Payment
  Issuer           $800m
                                               Financiers
                   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




7/27/2011
            Al-Bai-Bithaman Ajil Notes Issuance Facility (BAIDS)

                                          1st Stage
                              Cost of financing : $100 million
                                  Annual profit rate: 8%
                            Underlying asset: Land and building
                              Issue Date : 5th February 1999
                               Maturity: 5th. February 2002

                                         Tenure: 3 years

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

                                       2nd Stage
                       Number of Primary notes : 100,000 units
                   Price per unit = $100,000,000/100,000 = $1000
                     Number of Secondary notes = 500,000 units
                     Price 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


7/27/2011
         Sells back x for $120m




         (2) Pays $120m

Issuer                            Financier


         (1) Lends $100m




         (a) Sells X for $100m
               Exercise #1 BAIDS
• Company = ABC
• Facility =$500m
• 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 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 $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
           (4) Pays $100m lump-sum at
           maturity


          (1) Sells X for $95m


Issuer                             TPM (Investors)



          (2) Pays $95m cash




            (3) Sells back X for $100m
         Instrument #2
Islamic Asset-Backed Securities
   ISLAMIC ASSET BACKED SECURITIZATION
   THE BASICS


                  (1) Sells financial asset

                                                    SPECIAL
   ORIGINATOR                                       PURPOSE
                                                    VEHICLE
                  (6) Payments
                  from                                                (7)
                  cash                                                Redem
                                        (4) Sells         (3) Sells   ption
                  proceeds
                                        asset             asset       of IABS
                                        on credit         on cash
                                                          basis
                           (5)
TRUE SALE : (1) & (6)      Issuance
                           of
                           IABS
                           as                       INVESTORS
                           evidence
                           of
                           indebtedness
                  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 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
                   (5) Buy asset for RM400 m


                       (1) Passing Asset
                       to SPV
                       as hibah
ORIGINATOR                                     SPV

                                                       (3) Sells Asset to
                             (2) Sells Asset           SPV
                             to Investors              at RM465m
 Asset :Housing
                             for RM400m                on deferred
debt receivables
                             on cash basis             payments
   RM500m
                                                       (BBA)


                         (6) Collects
                         RM500m
                                           INVESTORS
   BANKS                 From banks                          (4) Issuance of RM465m
                                                             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      (4) Rental payments
                                                           Guthrie Pte.
           (lessor)        With a Put Option.               (lessee)

                                                     (7) Revenues       (6) Application
(2) Cash               (1) Delivery of
                       Asset                                                of Asset
Payment
                            Stage 1: Sydication of banks        Holdiko
         Supplier of
                            (lessor) purchase Holdiko on       Plantation
           Asset
                            cash basis                        Project with
      (Owner of Holdiko
                            Stage 2: Banks leased              cash flow
         Plantation)
                            Holkifo 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
  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



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.   Guarantees
b.   Sale and Repurchase agreement
c.   Pricing of Sukuk
d.   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                                       SPECIAL
                                                    PURPOSE
                                                    VEHICLE
                  (4) Payments
                  from                                                  (10)
                  cash                                                  Redem
                                        (3) Payments       (2) Issues   ption
                  proceeds
                                                          Sukuks        of IABS

Sukuk Al-Ijarah           (7)
                          Payments
                          of
                          dividends
                                                    INVESTORS
    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.
                        (9) Payment

                        (8)Sale of asset
                          (5) Lease to Originator

                         (6) Rental payments

                  (1) Sells physical asset

   ORIGINATOR                                       SPECIAL
                                                    PURPOSE
                                                    VEHICLE
                  (4) Payments
                  from                                                  (10)
                  cash                                                  Redem
                                        (3) Payments       (2) Issues   ption
                  proceeds
                                                          Sukuks        of IABS

Sukuk Al-Ijarah           (7)
                          Payments
                          of
                          dividends
                                                    INVESTORS
          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 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 Baa2 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 1st 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.
            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
                                          Ownership
                                          (Customer)
     Legal + Beneficial
        Ownership
                                           Beneficial
                                           Ownership
                                            (Bank)
               Sale on Cash Basis
• Buyer hold complete ownership



     Legal            Beneficial        Complete
  Ownership           Ownership         Ownership
  (Customer)           (Bank)       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
                                          Ownership
                                          (Customer)
     Legal + Beneficial
        Ownership
                                           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

                                            SPV
                  (1) Sells x


   Originator                                        $600m
                                                     Payments
                                                     For
                              (4) Payments $600m     Redemptions
                                                     Of Sukuk




        (2) Payments $600m

                                         Investors
    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 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
                                         RAKIA
Manager of Sukuk


                            Purchas                  Sale




                                                                   Undertaking
                                e                     of




                                                                   Purchase
                            Price for               Project
                            Project                  Land
Assets




                             Land

                                         Issuer
                                          (SPV)


                   Sukuk Proceeds                    Sukuk Issue




                                        Investors
                          RAKIA Sukuk
        Ongoing                                                                  Maturity or
                                                                                 Dissolution



                                         Sukuk Assets


                               Incom                       Incom
                               e                           e

                  Liquidity
                  Payments                                            Exercise
                                                                       Price
                                              Issuer
RAKIA                                                                                      RAKIA
                                               (SPV)
                  Incentive
                    Fees

                               Periodic                    Sukuk
                              Distribution               Redemption




                                             Investors
       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
• 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                                             Khazanah Nasional
                  (Issuer)                                                      (Obligor)
                                                    Purchase Undertaking
                                                           Deed
Sale Price (Nomina)         Sale of Equity Pool


                                                   Sale Price (Nominal)

              Cempaka Capital                                              Plus Expressway
                  (SPV)                                                         Berhad
                                                    Sale of Equity Pool
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

  Wassalam
www. 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.

				
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Description: Sale Agreement with Guarantee document sample