58293101 Islamic Leasing Ijarah

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ijarah

Transcript of 58293101 Islamic Leasing Ijarah

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WHAt IS ISLAMIC FInAnCE? .................................................................................................. 5

Shariah (Islamic Law) ................................................................................................................ 6

Halal and Haram ....................................................................................................................... 6

Takaful (Islamic Insurance) ....................................................................................................... 6

Basic Principles of Islamic Finance ........................................................................................... 7

Support Institutions for Islamic Finance ................................................................................ 8

IJArAH (ISLAMIC LEASIng) .................................................................................................. 10

Introduction ............................................................................................................................ 10

Terms and conditions of the Ijarah Contract ........................................................................12

Standard Features of Ijarah Contracts Offered by Financial Institutions ......................... 14

Example of Ijarah Financing Calculations ............................................................................ 16

Comments on Differences and Similarities between Conventional Lease contracts and Ijarah ......................................................................................................17

Sale of the Leased Asset ........................................................................................................ 18

Independence of Ownership ................................................................................................ 18

Timing of Lease Payment........................................................................................ 18

Ijara of Non-existing Assets .................................................................................... 18

Period of Ijara .......................................................................................................... 19

Determination of Rent ............................................................................................ 19

Insurance and Maintenance Expenses .................................................................. 19

Securitization of Assets Subject to Ijarah Contract .............................................. 20

Legal Opinion Regarding Securitization ............................................................... 20

Table of contents

FocUSEd TooLkIT ISLAMIc LEASInG (“IJARAH”)

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Ijarah — Transactional Issues ................................................................................................ 20

AL-IJArAH tHuMMA AL-BAI (AItAB) ................................................................................. 21

Example of AITAB Financing Calculations ........................................................................... 22

Documentation for AITAB ..................................................................................................... 22

Comments on Differences Between Conventional Lease Contracts and AITAB ............. 23

Tax Benefits of AITAB ............................................................................................................ 23

Legal Issues to Consider ......................................................................................................... 23

Examples of the Impact of Shariah Rulings in Four Countries .......................................... 24

Shariah Supervisory Board (DPS) .......................................................................................... 27

Ijarah Transaction Examples .................................................................................................. 28

Example of Car Leasing ......................................................................................................... 28

Ijarah Home Finance .............................................................................................................. 30

Forward Ijarah (Real Estate Financing) ................................................................................ 32

Islamic Leasing for Micro, Small, and Medium Enterprises (MSMEs) ................................ 34

AAoFI ...................................................................................................................................... 35

IFRS vs AAOIFI and the Malaysian Accountings Standards Board (MASB) ....................... 35

Accounting under AAOIFI ..................................................................................................... 36

Malaysian Accountings Standards Board (MASB) ............................................................... 37

Accounting Treatment under AAOIFI .................................................................................. 39

Classification and Recognition of Ijarah under AAOIFI20 ..................................... 39

Four MAIn SCHooLS oF ISLAMIC tHougHt: HAnAFI/JA’FArI, MALIKI, SHAFIE, And HAnBALI ........................................................................................... 41

Sunni and Shi’a ....................................................................................................................... 42

Ijarah Under the Four Schools ............................................................................................... 42

Dispute Resolution ................................................................................................................. 43

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ProJECt FInAnCIng uSIng IJArAH ................................................................................... 43

Ijarah with Istisna ................................................................................................................... 44

Risks to Avoid in Project Financing ....................................................................................... 44

Project Financing Examples ................................................................................................... 45

IJArAH SuKuK ....................................................................................................................... 46

Sukuk ....................................................................................................................................... 46

Sukuk Trust Certificates ............................................................................................ 47

Disadvantages of the Ijarah Sukuk Structure ...................................................................... 48

Sukuk Trading Options ......................................................................................................... 48

Ijara and Project Finance .......................................................................................... 49

Sample Transaction Structure — Leasing Assets .................................................... 49

StAndArd & Poor’S rAtIngS oF IJArAH SuKuK .......................................................... 52

Ijarah Sukuk Ratings.................................................................................................. 52

Criteria Guidelines ..................................................................................................... 54

ISLAMIC FInAnCIAL SErvICES BoArd IFSB 9.0 ................................................................. 57

Guiding Principles on Conduct of Business for Institutions Offering Islamic Financial Services ....................................................................................................... 57

ISLAMIC FInAnCIAL gLoSSArY .......................................................................................... 58

rEFErEnCES ............................................................................................................................ 61

gEnErAL BIBLIogrAPHY ..................................................................................................... 63

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WHAt IS ISLAMIC FInAnCE?

“As a form of financial intermediation, Islamic finance incorporates several elements that guide the process of the mobilization and allocation of funds to generate productive economic activity and inclusive development. Fundamental to Islamic finance is the requirement that financial transactions must be supported by real economic activity. In addition, Islamic finance promotes profit sharing and hence risk sharing. These elements limit the extent of leverage and place emphasis on transparency and disclosure in the documentation of contracts. Embraced in its entirety, Islamic finance promises to enhance the discipline that contributes towards ensuring growth and financial stability.” — dr. Zeti Akhtar Aziz, Governor, Bank negara Malaysia 1

1 Please see end notes at the end of this focused toolkit

Unlike the segregation of duties and responsibilities that exists in the western, non-Muslim world, in the Muslim world there is no division between religion, business, the family, and the state. The values, morals, norms, behaviors, and ethics applicable in one situation permeate all the others, and this carries to the issues of finance. This construct binding the parts to create the whole is referred to as Shariah, which can be translated to mean “the way,” referring to the way Muslims should live. The way is well represented below in diagrammatic form in terms of its impact on financial issues.

Source: Islamic Finance and Global Financial Stability, 20102

2 Please see end notes at the end of this focused toolkit

Materiality and Validity of Transactions

• Economically productive underlying activities

• Avoidance of interest-based transactions

• No involvement in illegal and unethical activities

• Genuine trade and business transactions

• Avoidance of speculative transactions

Overarching Principles • Towards achieving the objectives of Shari’ah (Maqasid al-Shari’ah)

• Protection of religion, life, lineage, intellect and wealth • High ethical values—justice, fairness, trust, honesty and integrity • More equitable distributor of wealth

Mutuality of Risk Sharing

• Entitlement of profit confident upon risk taking

• Honouring both substance and form of contract

Embedded Governance Disclosure & Transparency

source: Islamic Finance and Global Financial Stability, 20101

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Shariah (Islamic Law)

According to the State Bank of Pakistan, Shariah is best explained as follows:3

Shariah lexically means a way or path. In Islam, Shariah refers to the divine guidance and laws given by the Holy Quran, the Hadith (sayings) of the Prophet Muhammad (Peace Be Upon Him) and supplemented by the juristic interpretations by Islamic scholars. Shariah embodies all aspects of the Islamic faith, including beliefs and practices. Islamic Shariah or the divine law of Islam is derived from the following four sources:

1. The Holy Quran

2. The Sunnah of the Holy Prophet (Peace Be Upon Him)

3. Ijma’ (consensus of the Ummah)

4. Qiyas (by analogy)

“Shariah compliance” refers to the decision to apply Islamic principles to financial transactions, whether in global markets or in Islamic-based markets. compliance is driven by national legislation generated by the the Accounting and Auditing organization for Islamic Financial Institutions (AAoIFI) standards, The Islamic Financial Services Board (IFSB), prudential and regulatory standards, and Internal Shariah boards or client directives.

3 Please see end notes at the end of this focused toolkit

Halal and Haram

Again according to the State Bank of Pakistan, the terms halal and haram can be explained as follows:

The validity of a transaction does not depend on the end result but rather the process and activities executed and the sequence thereof in reaching the end. If a transaction is done according to the rules of Islamic Shariah, it is halal even if the end result of the product may look similar to a conventional banking product.

It is the underlying transaction that makes something halal (allowed) or haram (prohibited) and not the result itself.

takaful (Islamic Insurance)

In a Takaful relationship, the participants jointly contribute to a pooled fund for the purposes of providing mutual indemnity and protection for any of the participants exposed to defined risk under the Takaful policy. Unlike conventional insurance, where there is the traditionally understood insurer-and-insured relationship, in Takaful all participants are insurers and insured at the same time.

A Takaful company or operator is responsible for managing the Takaful fund.

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BASIC PrInCIPLES oF ISLAMIC FInAnCE

• Prohibition of interest (riba). there is a prohibition against riba — a term that literally means “an excess” and is interpreted as “any unjustifiable increase of capital, whether in loans or sales.”

• Money as “potential” capital.money is not a commodity, but a medium of exchange, a store of value, and a unit of measurement. money represents purchasing power and cannot be utilized to increase the purchasing power without any productive activity. islamic finance advocates the creation of wealth through trade and commerce.

• Risk sharing.because interest is prohibited, suppliers of funds become investors, rather than creditors.

• Prohibition of speculative behavior. islamic finance discourages hoarding and prohibits transactions featuring extreme uncertainties (gharar) or gambling (maysir).

• Sanctity of contracts. islamic finance upholds contractual obligations and the disclosure of information as a sacred duty. this feature is intended to reduce the risk of asymmetric information and moral hazard.

• Shariah approved activities.only those business activities that do not violate the rules of the shariah qualify for investment. for example, any investment in a business dealing with alcohol or gambling is prohibited.

• Social justice. any transaction leading to injustice or exploitation is prohibited.

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SuPPort InStItutIonS For ISLAMIC

FInAnCE

The legal, regulatory, and accounting frameworks for Islamic finance and its institutions and products are continually evolving. In this regard, important institutions framing the development of the global industry are as follows:

Accounting and Auditing organization for Islamic Financial Institutions (AAoIFI)4

AAoIFI is an autonomous entity responsible for the formulation and issuance of accounting, auditing, ethics, governance, and Shariah standards for the international Islamic banking and finance industry. AAoIFI is a member of the International Accounting Standards Board (IASB.) AAoIFI standards seek to establish best practices on handling financial reporting issues specific to Islamic institutions.

the International Islamic Financial Market (IIFM)5

The IIFM is a nonprofit organization, established through the collective efforts of five countries—Bahrain, Brunei, Indonesia, Malaysia, and Sudan—and one multilateral institution, the Islamic development Bank. IIFM’s principal objective is to establish, develop, promote, and regulate the islamic capital and money market on the principles of Shariah. IIFM’s role is that of a developer and catalyst of the Islamic financial market, encompassing both the short-term money market and the long-term capital market.

the International Islamic rating Agency (IIrA)6

The International Islamic Rating Agency (IIRA), established in 2005, is the sole rating agency that provides capital markets and the banking sector in predominantly Islamic countries with a rating spectrum, one that encompasses the full array of capital instruments and specialty Islamic financial products, and that enhances the level of analytical expertise in those markets. IIRA offers Sovereign Ratings, credit Ratings, Shariah Quality Ratings, and corporate Governance Ratings.

4 Please see end notes at the end of this focused toolkit

5 Please see end notes at the end of this focused toolkit

6 Please see end notes at the end of this focused toolkit

Sovereign ratings and Credit ratings assess the likelihood that an entity will repay its debt obligations in a timely manner.

Shariah Quality ratings assess the level of compli-ance with the principles of shariah.

Corporate governance ratings are based on an entity’s practices, and assess the demarcation of rights and responsibilities among different stakeholders as well as their compliance with prevailing rules and procedures for making decisions.

a shariah quality rating differs from a credit rating in that the latter is an evaluation of the solvency of a financial institution and its capability and willingness to repay its obligations. a shariah quality rating, on the other hand, is not related to the solvency or financial capability of the institution or to the credit quality of its securities or financial products. rather, it represents an independent opinion about the shariah quality of a financial institution or of a security or financial product.

the Islamic Financial Services Board (IFSB)7

The Islamic Financial Services Board (IFSB), based in kuala Lumpur, was established in 2002. It serves as an international standard-setting body for regulatory and supervisory agencies that have a vested interest in ensuring the soundness and stability of the Islamic financial services industry, which is defined broadly to include banking, the capital market, and insurance. In advancing this mission, the IFSB promotes the development of a prudent and transparent industry by introducing new—or adapting existing— international standards consistent with Shariah principles and recommending them for adoption.

To this end, the work of the IFSB complements that of the Basel committee on Banking Supervision8, International organization of Securities commissions9, and the International Association of Insurance Supervisors10.

7 Please see end notes at the end of this focused toolkit

8 Please see end notes at the end of this focused toolkit

9 Please see end notes at the end of this focused toolkit

10 Please see end notes at the end of this focused toolkit

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As of november 2009, the 193 members of the IFSB include 49 regulatory and supervisory authorities as well as the International Monetary Fund, world Bank, Bank for International Settlements, Islamic development Bank, Asian development Bank, the Islamic corporation for the development of the Private Sector, Saudi Arabia, and 138 market players and professional firms operating in 39 jurisdictions.

Malaysia, the host country of the IFSB, has enacted a law known as the Islamic Financial Services Board Act 2002, which gives the IFSB the immunities and privileges that are usually granted to international organizations and diplomatic missions.

Shariah Board

one distinct feature of the modern Islamic banking industry is the role of the Shariah board, which forms an integral part of an Islamic financial institution. A Shariah board monitors the workings of the Islamic financial institution and has to clear every new transaction from a Shariah standpoint. These boards include some of the most respected contemporary scholars of Shariah, and the opinions of the boards are expressed in the form of fatwas. The International Association of Islamic Bankers, an independent body, supervises the workings of individual Shariah boards, while the association’s Supreme Religious Board studies the fatwas of the Shariah boards of member banks to determine whether they conform with Shariah.

Shariah law is open to interpretation, and Shariah boards often have divergent views on key Shariah issues. In this regard, there is no practical guide as to what constitutes an acceptable Islamic financial instrument. A document or structure may be accepted by one Shariah board but rejected by a different Shariah board.

MArKEt For ISLAMIC FInAnCE ProduCtS

Significant growth in Islamic Finance

� 23% of world population is Muslim

� Islamic Finance assets have grown to in excess of £800 bn

� The Sukuk bond market has grown to $70 bn

� Total wealth of HNWI1 in Middla East is about $1.4 trillion

� Growth in total wealth tracks increase in oil price

1 High net-worth Individuals

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IJArAH (ISLAMIC LEASIng)—

IntroduCtIon

The word Ijarah refers to a transaction that involves giving something on a rental basis. It can denote the paying of wages to employees (Ijarah Amal) as well as the renting of an asset (Ijarah Ain). As an introduction to the subject, in this part of the paper we will only address the second type of transaction, Ijarah Aina, and for simplicity’s sake shall refer to it as Ijarah. As we shall see, the transaction is similar to what we know as “leasing” in English. (Please note that all the Arabic terms used here are transliterations of the Arabic sounds into the Roman alphabet. The spellings of the same terms may vary from one text to another as you encounter them, since they are but approximations of the true sounds of the words in Arabic.)

In the Ijarah Aina contract, there is no option for the lessee to acquire the asset at the end of the lease. However, there is another type of Ijarah contract, referred to as Al-Ijarah Thumma Al-Bai (AITAB), wherein the lessee can acquire the asset at the end of the lease. This second type is addressed in the second part of this paper.

In Ijarah Aina (hereafter, Ijarah), the lessor rents the assets to benefit from their use without having ownership transferred to the lessor. The legal term for this arrangement in English is “usufruct,” and the price for this use is referred to as “rent.” There is no element of interest in the transaction, since ownership of the asset always remains with the lessor, and there is no option for the lessee to gain title to the asset.

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Since title (ownership) to the asset is not being transferred, there is no sale of a tangible asset, only the sale of an intangible asset, namely the right to its use for a specific period of time. This right to use or usufruct is known as manfaah in Arabic.

Unlike the conventional lease, an Ijarah is a “contract” whereby a financial institution, using Islamic principles, purchases and then leases the asset required by the client in exchange for a rental fee that is not related to interest. Under the contract, the lessor owns the property and may have the right to renegotiate the lease payments at various intervals agreed to in advance in the contract with the lessee, thereby ensuring that the rental payments are equal to the residual balance value of the asset as well as the opportunity cost of the lessor, that is, his forgoing the use of the assets. The risks of ownership of the asset stay with the lessor.

In this structure, Ijarah’s legal characteristics are similar to those of a sale-and-purchase transaction, with the exception that the physical asset is not transferred and there is a specific time limit on the use of the asset. It should be noted that the source of funds used by the financial institution to finance Ijarah transactions must be halal.

Ijarah can be contracted on an asset that is yet to be constructed or manufactured, as long as it is fully described in the contract, provided that the lessor should normally be able to acquire, construct, manufacture, or buy the asset being leased by the time set for its delivery to the lessee.

types of Ijarah

Islamic financial institutions use the lease for the usufruct as an instrument of financing. They purchase the assets and rent them out to customers in return for rental. They use two models, namely Ijarah and Al-Ijarah Muntahiya Bittamleek.

Ijarah: Similar to an Operational Lease

In this type of Ijarah, the financial institution purchases and maintains assets that have a high degree of marketability. It rents these assets to other parties on terms and conditions agreed upon for a specific time. After the termination of that period, the asset will be returned to the financial institution. The institution then leases the same asset to a new lessee and at the same time bears the risk of recession or diminishing demand for the asset. At the end of the lease, it may choose to scrap or dispose of the asset.

This type of Ijarah is suitable for expensive assets, such as airplanes, ships, industrial equipment, and agricultural machinery. In addition, these assets take a longer time to manufacture, due to the fact that there is an increasing demand for leasing them. The financial institution benefits from the transaction by retaining ownership of the asset while at the same time getting a return by leasing it. The lessee also benefits from the transaction, since it meets his immediate need and saves him from buying the asset at a much higher cost.

Al-Ijarah Muntahiya Bittamleek (IMB): Similar to a Finance Lease

This type of Ijarah is one that ends with ownership. Here the financial institution purchases the asset based on a promise from a customer. Because the customer promises to own the asset, the asset will not be returned to the financial institution at the end of the lease period, as it is in the case of an operational lease, but instead will be bought by the lessee. The rental is calculated based on the value of the asset, which is financed based on the amount of profit and the period of financing.

The first type of Ijarah is different from IMB in that the former does not offer an option to the customer to buy the leased asset at the end of the lease period while in the latter the option is offered via a secondary contract. If the lessee chooses to buy the asset, a new contract will be concluded. All the lease rentals previously paid will constitute part of the price.

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normal steps in the transaction of an Ijarah contract are as follows:

1. The client of the financial institution approaches a seller or vendor of an asset, and obtains price and product details.

2. The client then approaches the financial institution with the asset price and details and negotiates with the institution to use the Ijarah contract. The client promises the institution to execute the Ijarah contract, which contains the terms that will apply after the institution buys the asset.

3. The financial institution buys the asset from the seller based on the information provided by the seller to the client. The institution pays cash, and ownership of the asset transfers to it.

4. The seller delivers the asset to the client of the financial institution according to the terms and conditions agreed to by the institution and submits proof of delivery, with the acceptance of the client, to the institution.

5. The client pays the agreed rental, based on the payment plan in the Ijarah contract, to the financial institution.

6. Upon expiration of the time limit specified in the Ijarah contract, the client returns the asset to the financial institution.

The legality of this type of combined structure, under Islamic Shariah law as interpreted by fatwas, needs to be carefully considered depending upon the jurisdiction in which the contract is developed and entered into.

tErMS And CondItIonS oF tHE

IJArAH ContrACt

To qualify as meeting Islamic requirements and thus as a true Islamic financial product, the Ijarah contract has certain required and certain prohibited characteristics, which are detailed below.

required and Prohibited terms and Conditions

Lessee and lessor

1. The lessor (mujir) must be legally sane and able to enter into the contract (“aqil”)

2. The lessee (mustajir) must be an adult, not a minor, or in Islamic terms must have reached puberty (baligh)

3. The lessee must be intelligent as defined by Sharia Law.

4. It is prohibited for the lessor or lessee to be coerced into entering into a contract.

5. It is prohibited for the lessee or lessor to be bankrupt or to be wasteful or spendthrift.

Asset Being Leased

1. The asset must be capable of being described in detail.

2. The financial institution must be the owner of the asset during the life of the lease.

3. The asset being leased must be lawful.

4. The seller must be able to deliver the asset to the lessor.

5. The asset must be useful and valuable to the lessor.

6. The full details about the asset must be known by both the seller and the buyer.

7. The risk of ownership of the asset rests with the lessor.

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Benefits (Usufruct)

1. A value to the lessee for the benefits of using the asset can be established.

2. The lessor must have the legal right to use and lease the asset.

3. The use of the asset and the asset itself must be permis-sible under Islamic law.

4. The way that the lessor of the asset will use the asset must be known.

5. The duration of the lease must be clearly defined.

6. It is prohibited for benefit to be derived from the con-sumption of any material part of the asset; benefit may be derived only from its use.

Rental (Lease) Payments

1. The lease or rental amount, as well as currency of pay-ment, must be clearly stated and known by both lessee and lessor.

2. different amounts of rent or lease payments can be set for different parts of the rental agreement.

3. The lease period begins upon delivery of the asset to the lessor. whether the lessor is using the asset or not is irrelevant.

4. It is prohibited for the lessor to unilaterally increase the rent or lease payment.

Contract (Aquad) Issues

1. The contract needs to be written in clear and definite language using the past or present tense, not in the future tense.

2. The acceptance of the offer of the contract must be agreed upon with the offer, and the offer and acceptance must be made at the same time in the same meeting.

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StAndArd FEAturES oF IJArAH

ContrACtS oFFErEd BY FInAnCIAL

InStItutIonS

general terms

The Ijarah leasing contract transfers the benefits or use of an asset acquired by the financial institution (FI) for the use of the lessee at an agreed price or rental amount payable for an agreed period of time (lease period). The total amount of the lease or rental paid over the life of the contract includes the original cost of the asset to the financial institution (including all related costs) and the institution’s “profit margin.” Below is a diagram that shows the standard Ijarah transaction.

Vendor

Islamic Financial

Institution (FI)

Customer (Lessee)

Ijarah InstallmentsPayment of Purchase Price

Transfer of Title to the FI

Assets Leased to Customer Title

does not pass at end of Lease Term

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Examples of Leased Assets

1. Production machinery and equipment

2. consumer goods, such as computers and furniture

3. Automotive equipment

4. Fixed assets and buildings

5. other acceptable assets

Acceptable Lessees

1. Individuals

2. Sole proprietorships

3. corporations

4. Government entities

5. clubs, societies, and associations

Legal Documents Prepared

1. The undertaking to enter into the Ijarah contract whereby the asset is acquired by the financial institution for the use of the lessee.

2. The Ijarah contract, which has the required characteris-tic noted earlier, such as description of the Ijarah asset, the schedule of the rentals, and the receipt of the asset by the lessee.

Rental Payments and Term

1. The financial institution defines rental payments that may be either fixed or variable. normally, if variable payments are included, the payment amount increases by a certain amount at a certain time. In some cases, the Ijarah contract is for a relatively short period of time with a renewal option that allows the financial institu-tion to re-price the costs and thus adjust the profits of renting the asset to the lessee.

2. Generally the rental amounts are based on equal installments.

3. The terms of the lease or rental agreement can be for up to seven years and vary from institution to institution.

Incidental Fees and Charges

Incidental costs borne by the lessor in providing the asset to the lessee are to be paid by the lessee.

Rebates and Penalties

1. In the case of late payments, fees may be charged, but the lessor must not “benefit“ from the penalties paid by the lessee, which must cover only actual costs incurred by the lessor.

2. Rebates on early redemption are not allowed by the Sharia boards.

Termination

If the terms of the contract are not met by the lessee, the lessor has the right to unilaterally terminate the contract. However, if there are no defaults, the lessor cannot terminate the lease without mutual agreement.

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ExAMPLE oF IJArAH FInAnCIng

CALCuLAtIonS

Generally, the financial institutions calculate the rental amounts as follows:

Assumptions:

1. The financial institution determines that it wants to have a profit rate (PR) of 10 percent.

2. The purchase price (PP), including all costs, is $1,000,000 (cost borne by the financial institution).

3. The term (T) of the lease is 5 years.

Calculations:

1. Profit (P) = Purchase price x profit rate x period of financing

$1,000,000 x 0.10 x 5 = $500,000

2. Total lease rental = Purchase price plus the profit

$1,000,000 + $500,000 = $1,500,000

3. Monthly rental = Total lease rental divided by the term (in months)

$1,500,000/(5 x 12 months) = $25,000 per month

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CoMMEntS on dIFFErEnCES

And SIMILArItIES BEtWEEn

ConvEntIonAL LEASE ContrACtS

And IJArAH

differences

cost bearing—In Ijarah, the lessor is required to bear all the costs incurred in the process of purchasing the asset, although these costs may be included in the calculation of the rental amount payable by the lessee. These include items such as registration charges, import expenses, and customs duties.

loss responsibility—The lessor is fully responsible for losses that are beyond the control of the lessee, while the lessee is only responsible for losses to the asset from misuse or negligence.

late payments—The lessor may charge late-payment penalties, but these may only be amounts that cover the lessor’s costs due to the late payment. The lessor cannot benefit from the late payments.

insurance—The costs of insuring the leased asset are borne by the lessor, and the insurance used is Islamic insurance or Takaful.

Similarity

The rental or lease payments under the lease start when the lessee takes possession of the asset being leased, not from the date the lessor purchases the asset for the lessee. The lessee is not liable

for the rental payments during the period of the asset’s delayed delivery to the lessee.

Lesson Learned: Warranties (Express or Implied)

In a conventional lease, most lease agreements handle warranties as follows:

1. The agreement contains language stating that the lessor makes no express or implied warranty as to the suitability or merchantability of the equip-ment.

2. All warranties issued by the equipment supplier will flow through to the lessee.

As we have seen, in an Ijarah transaction the lessor is responsible for the adequate operation of the equipment, except for equipment breakdowns resulting from the lessee’s negligence or oversight.

Regardless of the lessor’s responsibilities under an Ijarah transaction, the lessee will want to have the benefit of the supplier’s express and implied warranties relating to the goods or equipment, and the lessor will want to be sure that his customer is looking to the supplier, rather than to the lessor, should the customer seek to make claims under those warranties. In an Ijarah transaction it is generally possible to transfer (contractually) the benefit of the supplier’s warranties from the lessor to the lessee. This last issue should be addressed during the lessee’s preliminary dealings with the supplier and also in the purchase contract that is eventually signed between the lessor and the supplier; otherwise the warranties will end up benefitting only the lessor.

Similarly, the financial institution will seek to eliminate any warranty claims that might be made against it by the lessee. Although it is generally possible to disclaim warranties, such disclaimers, especially in a consumer context, are generally not favored and would probably be strictly construed against the lessor.

Generally, any disclaimer of warranties must be conspicuous, and the language used must clearly call the customer’s attention to the exclusion. In addition, the disclaimer of certain implied warranties, such as merchantability and fitness for a particular purpose, requires specific language to be enforceable.

warranty disclaimers that fail to meet those requirements may be held to be invalid.

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Sale of the Leased Asset11

An Ijarah contract in Shariah does not restrict the right of the lessor to sell the leased asset. Since the lessor remains the owner, the fact that the asset is leased to somebody else does not restrict the owner’s right to dispose of the asset in any form as long as it does not hinder the delivery of the usufruct to the lessee. In other words, the leased asset can be sold, provided the new owner will honor the existing Ijarah contract. This characteristic of Ijarah is essential for securitization of leased assets.

Independence of ownership

An asset whose ownership is shared by many people can be leased, either individually by each owner leasing his or her owned share of the asset or together by all the owners in one contract and under the same conditions.

Persons who share the ownership of a leased asset can dispose of their property, for example by selling it to new owners, individually or collectively, as they may desire. In other words, the owner of a share of an asset can sell that share, or part of it, to a new person independently of the other owners. This characteristic of Ijarah also facilitates the securitization of leased assets, and allows benefitting from the market conditions with regard to the negotiability of the bonds.

11 Please see end notes at the end of this focused toolkit

timing of Lease Payment

Unlike a sale, an Ijarah contract is flexible regarding the timing of rent or lease payments. Payments can be made to coincide with the units of time by which the usufructs of the asset are defined. For instance, they could be at the beginning or at the end of each period of the lease, and rents could be payable monthly, yearly, etc., as per the terms of the agreement.

The rent payment may also be unrelated to the periods of usufruct. An asset may be given on lease for 10 years, while payment of rent may be spread over a period of 12 years, or vice versa. Additionally, the payment of rent may begin before or after the beginning of a lease. For example, an Ijarah contract can be arranged for a bridge whose construction takes three years, at a cost of $10 million, and which is leased to the government for 24 years after the construction is completed, at a total rent of $24.3 million (=24 x $1,012,500). The payment of rents may be spread over 27 years at a rate of $0.9 million per year beginning from the end of the first year, that is, the bond holders make a 9% yearly return on their investment.

Ijara of non-existing Assets

Shariah does not require that the asset/subject of the Ijarah contract should be in existence at the time of the contract. one may lease an asset that is only described and defined in detail at the time of the contract. Such an asset may exist in a place that is far away from the place of the contract (such as a building in another town), or it may be an asset that is only described and does not exist at all at the time of contract (as in the case of leased manufacturing equipment that is yet to be manufactured). The important and necessary conditions, in this connection, are as follows:

1. The asset should be clearly described in a way that does not create any ambiguity or controversy about it, and

2. The lessor should normally be able to acquire, construct, or buy the leased asset by the time set for its delivery to the lessee, that is, the lessor should be able to fully carry out the commitment made in the lease contract.

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Period of Ijara

An Ijarah contract is not restricted to the short, medium, or long term. It can be set to any term, as long as the asset which is its subject remains in existence and renders its usufruct for the duration of the contract. For example, assets for which a suitable amortization schedule could be made may be given on lease for a period of one year, renewable permanently, because the assets are replenished through the amortization funds. Similarly, for land, the Ijarah may be for one year renewable on a permanent basis.

determination of rent

In an Ijarah contract, the rent must be made known. There are many ways to put a known rent into an Ijarah contract. For instance, actual rent payable by the lessee may increase, decrease, or remain constant as long as the formula for increments, or subtractions, is known either at the beginning of the renewal period for which the increase or decrease applies or at the time of contract.

The rent may also be determined for the first period. For each subsequent period, rent may be related to a variable that will be known before the beginning of the renewal period, such as a periodically announced price index, rate of return on capital, or any other variable.

Insurance and Maintenance Expenses

In the Ijarah contract, according to Shariah the lessor is required to maintain the leased asset in a condition that allows the lessee to extract from it the contracted usufruct. This implies that maintenance expenditures related to the basic characteristics of the asset are the responsibility of the owner, while maintenance expenses related to its operation, for example regular oil changes in automotive equipment, are to be taken care of by the lessee. In addition, as stated earlier, notwithstanding the lessor’s responsibility to maintain the equipment, in an Ijarah transaction the benefits emanating from expressed or implied warranties offered by the vendor may be transferred from the lessor to the lessee.

Maintenance expenses that fall to the owner are of two kinds. First, predictable periodical or quasi-periodical expenses, such an overhaul of the leased machine (e.g., an aircraft) after a certain number of hours of work or operation. These and similar expenses that can be predicted in advance may actually be charged to the lessee as a part of the rent. As a result, all predictable maintenance and insurance expenses can be included in the rent in such a way that rent would then consist of cash payments made by the lessee to the owner, plus predetermined maintenance and insurance expenses made by the lessee on behalf of the owner.

Shariah permits making the lessee responsible for all predictable maintenance and insurance expenses of the asset. However, some maintenance expenses might not be predictable, and these would be placed on the account of the lessor. There may also be unpredictable changes in the cost of insurance, which would also become the responsibility of the lessor.

Any maintenance or insurance expenses for which the owners may remain responsible can be undertaken by the lessee on the basis of wakalah, that is, on behalf of the owner, and the owner (for example a bondholder) would then be charged by the lessee for his outlays.

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Securitization of Assets Subject to the Ijarah Contract12

The idea of an Ijarah bond stems from the ability to transform leased assets into financial assets. Securitization means using certain income-generating physical assets as a base of, or a guarantee for, the issuance of securities that are financial assets.

A financial asset is always regarded in Shariah in association with the asset(s) it represents, that is, a security cannot be considered as totally or completely separable from the assets it represents.

In its 4th Annual Plenary Meeting, the oIc Fiqh Academy, while discussing sanadat al muqaradah, put forward an important and essential rule that clarifies the position of Shariah about securitization, as follows.

Legal Opinion Regarding Securitization

decision no. 5 of the 4th Annual Plenary Session of the oIc Fiqh Academy, held in Jeddah 18-23/6/1408H (6-11/2/1988G), asserts that (a) any combination of assets can be represented in a written note or bond, and (b) this bond or note can be sold at a market price, provided that the composition of the group of assets, represented by the bond, consists of a majority of physical assets and financial rights, as compared to a minority of cash and interpersonal debts. Furthermore, the decision clearly mentions that assets that can be grouped together for the purpose of securitization may consist of any combination of the following four types of assets:

1. physical assets

2. financial rights (such as the usufruct in Ijara)

3. interpersonal debts, and

4. money.

12 Please see end notes at the end of this focused toolkit

IJArAH—trAnSACtIonAL ISSuES

The following is a point-form summary of Ijarah transactional issues:

collateral: The financial institution may accept land, buildings, or any other property as collateral.

guarantees: Guarantees that can be taken to support the transaction include both personal or individual guarantees and corporate guarantees.

margin of financing:

The margin may be up to 100% of the current price of an asset or the valuation price of an asset.

two parts of a lease term:

1. Primary lease period: Period for which the lessee (fi-nancing customer) has contracted to lease an asset.

2. Secondary lease period: This period commences if the lessee decides to exercise the option to con-tinue to lease the asset after the expiration of the primary lease period.

Prepayments in Ijarah

security deposit:

1 to 3 monthly installments are the norm.

advance rental:

First rental of the lease. Islamic banks may use the monthly lease rental to offset against the final rental of the lease.

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Calculation of the total lease rental:

1. Total lease rental = amount of financing + profit margin.

2. Total lease rental is determined using available methods of calculation, such as the constant rate of return (cRR) and Rule of 78’s (sum of digits).

use of asset: Assets leased may not be used for activities that contravene Shariah.

asset ownership:

ownership remains with the financial institution.

takaful coverage:

To reduce the burden if losses occur. Suitable coverage is a comprehensive ‘All Risks’ type.

AL-IJArAH tHuMMA AL-BAI (AItAB)

The instrument known as Al-Ijarah Thumma Al-Bai (AITAB), used extensively in Malaysia and also referred to as IMB or Ijarah wa Iqtina, encompasses the idea of leasing ending with an option to buy the asset, in which title to the asset is passed to the lessee when the contract terminated. It was essentially created by combining two Islamic contracts: the Al-Ijarah (leasing contract) and the Al-Bai (sale) contract.

In this hybrid mechanism, the Al Ijarah contract relates to the exchange of the use of the asset (the usufruct) for money, with the exchange of goods for money. To achieve this, the two contracts are sequential, Ijarah first and then Al Bai, and together are thus referred to as this third type of contract, AITAB. This construct is also referred to as IMB (translated as leasing ending with ownership) and is sometimes transliterated into English as Ijarah Muntahia Bittamleek.

As in many jurisdictions, different terms are used for the same or similar financial tools.

normal steps in the transaction of an Ijarah contract are as follows:

1. The client of the financial institution approaches a seller or vendor of an asset and gets price and product details.

2. The client approaches the financial institution with the asset price and details and negotiates with the institu-tion to use the AITAB contract structure. The client promises to execute the AITAB contract structure for an agreed time period and rental payment as well as buy the asset from the financial institution.

3. The financial institution buys the asset from the seller based on the information provided by the seller to the institution’s client. The institution pays cash and the ownership of the asset transfers to it.

4. The financial institution then enters into the Ijarah contract with the client, whereby the possession and right of specified use are given to the client. The contract identifies the asset, its benefit to the client, the rental amount, and the period.

5. The seller delivers the asset to the client of the financial institution on the terms and conditions agreed with the financial institution and submits proof of delivery, with the acceptance of the client, to the institution.

6. The client pays the agreed rental, based on the payment plan in the Ijarah contract, to the financial institution.

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7. when the time limit in the Ijarah contract expires, the financial institution enters into the al-Bai (sale) contract with the client, whereupon the institution transfers ownership of the asset to the client as either a gift or a sale, whichever are the terms of the original agreement. In some cases, the final payment of the Ijarah contract may be taken as the agreed sale price of the asset under the al-Bai contract.

The essential terms and conditions of the AITAB contract are the same as those of the Al-Ijarah contract, simply an agreement for sale and purchase as added (al-Bai).

Example of AItAB Financing Calculations

In this structure the financial institutions tend to use these calculations:

Assumptions:

The financial institution determines that it wants to have a profit rate (PR) of 10 percent.

The purchase price (PP) to the financial institution, with all costs, is $1,000,000.

The term (T) of the lease is 5 years.

Calculations:

Profit (P) = Purchase price x profit rate x period of financing

$1,000,000 x 0.10 x 5 = $500,000

Total lease rental = Purchase price + profit

$1,000,000 + 500,000 = $1,500,000

Monthly rental = Total lease rental divided by the term

$1,500,000/(5 x 12 months) = $25,000 per month

Sales price = amount agreed, as zero (i.e. gifted)—or equal to last month’s lease rental, or such other amount as agreed.

Lesson Learned

The difference between the profit calculation made under an AITAB contract and the profit calculation under a conventional lease (as described in Section III, Part 1, of the base toolkit—Leasing Mathematics) is this: The time value of money does not apply.

There is no return on money in Islam, therefore it is impossible to apply the “principles of the time value of money,” including net Present Value, to the profit calculation under an AITAB contract. Since the earning of interest (riba) is not allowed, the use of Internal Rate of Return to express yield does not exist in an Ijarah transaction.

documentation for AItAB

It is important to note that to meet Shariah principles the financial institution and its personnel must understand the instrument. The documentation must be handled in this sequence:

1. The letter of acceptance (aqad) between the financial institution and the client, executed by both parties.

2. The leasing agreement (Ijarah) between the financial institution and the client.

3. The sale and purchase agreement (al-Bai) between the lessor and equipment supplier.

At all stages, the full terms and conditions must be clearly explained and understood by the client and the financial institution.

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Lessons Learned

Use of Acceptance Letter In both AITAB and conventional lease transactions, use Acceptance Letters. Under both types of transactions there is no obligation on the part of the lessee until an Acceptance Letter is executed by the lessee. Therefore, in this particular case, the principal of “arm’s length” does apply.

Cancellation—Under AITAB, if the equipment is lost or destroyed the lease may be cancelled, regardless of whether or not the lessor has property or casualty insurance. when the equipment is lost or destroyed, the lessee is no longer able to generate usufruct from using the equipment, and the lessor must rely on Takaful insurance for compensation. Under conventional leasing in the west, leases are non-cancellable. As we have seen (in Part III of the Base Toolkit), the lessee is responsible for obtaining property and casualty insurance and naming the lessor as a “loss payee.”

Comments on differences between Conventional Lease contracts and AItAB

AITAB CONTRACT CONVENTIONAL LEASE

Nature of Contract Hybrid instrument, including both a lease contract (Ijarah) and the sale/purchase contract (al-Bai).

Same, with respect to lessee’s purchase option at the end of the lease term. Principle of “arm’s length” applies between lessor, lessee, and equipment supplier.

Calculation of Profit Lessor charges a fixed profit and no interest. Lessor’s profit is expressed as the difference between the present value of the lease payments minus cost of equipment (per Base Toolkit—Lease Math)

Charges Related to the Purchase of the Leased Asset

All charges are borne by lessor, without exception.

Some charges (shipping & installation, for example) may be borne by lessee.

Late Payments A fixed charge must be specified in the contract. Interest may be applied (1% per month, for example) to late payments.

Acceptance Letter (Aquad) Lessee must enter into an acceptance letter. Same.

Asset Being Financed Must be Shariah compliant. Shariah compliance not necessary.

Insurance Must be insured using Islamic Takaful insurance. Shariah compliance not necessary.

Warranties (Expressed or Implied)

May be transferred from lessor to lessee. Always for the benefit of the lessee.

Cancellation Lease can be cancelled if equipment is lost or destroyed.

Lease is non-cancellable.

tax Benefits of AItAB

depending on tax laws, which vary among nations where AITAB is offered, the “rental” or “Ijarah” payments can be offset against corporate tax by the lessee. Because the client renting or leasing the asset is not its owner, any wealth assessment for zakat will not include the asset.

Legal Issues to Consider

The need to conform to certain religious principles affects the structure and development of Islamic finance programs. It is essential, therefore, to seek approval from qualified Islamic scholars when implementing such programs, particularly before developing new financial instruments. Most Islamic financial institutions have standing religious boards and Shariah advisors for this purpose.

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A case in point is that the contractual structuring and the wording of the contracts must be such as to comply with Shariah law and with associated fatwas in the country of jurisdiction and operation.

Legal Precedent—drafting a Leasing Contract

in the republic of maldives, the court ruled against a leasing company (maldives finance leasing company, recorded in case no. 893/mc/2008 (MFLc v Mohamed naeem)), stating that a leasing contract that contained a right of the lessee to purchase the leased asset at the nominal price at the end of the lease term was void insofar as it violated Shariah provisions, in accordance with which one contract shall not contain two elements at the same time, a lease and a sale. There must be two contracts, and the process of presenting the documents and executing them is as important as the contracts themselves.

The court did not take into consideration the fact that the leasing agreement merely pointed out that a separate sale agreement would be entered into and the ownership would not be transferred under the leasing agreement itself.

ExAMPLES oF tHE IMPACt oF SHArIAH

ruLIngS In Four CountrIES

Four different approaches are being followed in Shariah rulings in different countries—Iran, Malaysia, Bahrain, and Indonesia—based on the countries’ regulatory approaches, as follows.13

Iran

Products that can be offered by banks have been defined in regulations issued by the council of Ministers under the Usury Free Banking Act 1983. The council of Guardians performs the function of a central Shariah board and provides guidelines to the central bank and commercial banks. commercial banks do not have a Shariah board for guidance and/or supervision in their day-to-day operations.

Malaysia

As part of the effort to streamline and harmonize the Shariah interpretations among banks and takaful companies, Bank negara Malaysia (BnM) established the national Shariah Advisory council on Islamic Banking and Takaful (nSAc) on May 1, 1997, as the highest Shariah authority on Islamic banking and takaful in Malaysia. Among nSAc’s primary objectives are these:

• To act as the sole authoritative body to advise BnM on Islamic banking and takaful operations

• To coordinate Shariah issues with respect to Islamic banking and finance (including takaful)

• To analyze and evaluate Shariah aspects of new products and schemes submitted by banking institutions and takaful companies.

The Shariah Advisory council (SAc)14 of BnM was established on May 1, 1997, as the authority for ascertaining Islamic law for the purposes of Islamic banking business, takaful business, Islamic financial business, Islamic development financial business, or any other business. It is based on Shariah principles and is supervised and regulated by Bank negara Malaysia. In Malaysia, the Islamic banks are advised and provided guidelines by SAc. As the reference body and advisor to Bank

13 Please see end notes at the end of this focused toolkit

14 Please see end notes at the end of this focused toolkit

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negara Malaysia on Shariah matters, SAc is also responsible for validating all Islamic banking and takaful products to ensure their compatibility with the Shariah principles. In addition, it advises BnM on the Shariah aspects of the operations of these institutions, as well as on their products and services.

The Malaysian Judiciary and the Regional center for Arbitration kuala Lumpur15 uses SAc as the reference point in the event of disputes involving Shariah issues on Islamic banking and finance. The central Bank of Malaysia Act of 1958 was amended in 2003 to enhance the role and functions of SAc, which was accorded the status of a sole authoritative body on Shariah matters pertaining to Islamic banking, takaful, and Islamic finance. To preserve its independence, members of SAc are not allowed to participate in any Shariah committee of any financial institution.

Shariah committees are formed internally by Islamic banking institutions. A Shariah committee plays a complementary role

15 Please see end notes at the end of this focused toolkit

to that of SAc. Its duty is to advise the banking institution on the Shariah compliance of its banking operations; however, the Shariah Advisory council is the ultimate arbiter. The Guidelines on the Governance of Shariah committees for Islamic Financial Institutions were issued by BnM in december 2004. These aimed at achieving uniformity of Shariah decisions, in addition to creating and expanding the pool of competent Shariah personnel in Islamic banking and takaful.

The guidelines set out the rules, regulations, and procedures for establishing a Shariah committee and the role and scope of duties and responsibilities of the committee, as well as the relationship and working arrangement between the committee and SAc. The requirement to establish the committee covers all Islamic banks and all banking institutions that participate in Islamic banking schemes, takaful operators, and development financial institutions that provide Islamic banking facilities. duties and responsibilities of a Shariah committee are as follows:

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• To advise the Board on Shariah matters in its business opera-tion

• To endorse Shariah compliance manuals

• To assist related parties on Shariah matters for advice, upon request

• To advise the Islamic financial institution to consult it on any Shariah matters that have not already been resolved or endorsed by SAc, and

• To record any opinion given.

In particular, the committee prepares written Shariah opinions in the circumstances (1) where the Islamic financial institution makes reference to SAc for advice; or (2) where the Islamic financial institution submits applications to Bank negara Malaysia for new product approval in accordance with guidelines on product approval issued by Banknegara Malaysia.

The Shariah committee is also expected to assist SAc on any matters referred by the Islamic financial institution. Upon

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obtaining any advice from SAc, the Shariah committee shall ensure that all of SAc’s decisions are properly implemented by the Islamic financial institution. with regard to the reporting structure, the Shariah committee reports functionally to the board of directors of the institution. This reporting structure reflects the status of the Shariah committee as an body that is independent of the Islamic financial institution.

Bahrain

The central Bank of Bahrain requires all banks to establish an independent Shariah Supervision committee complying with AAoIFI’s governance standards for Islamic financial institutions. All banks must comply with all accounting standards issued by AAoIFI as well as the Shariah pronouncements issued by the Shariah Board of AAoIFI. The national Shariah Board of the central Bank of Bahrain serves and verifies the Shariah compliance of its own products only. There is no restriction that the members of the national Shariah Board must serve any financial institution, and no limitation requiring them to serve only one institution. Each bank must have a separate Shariah review function to verify compliance, which may be located in the bank’s internal audit function.

Indonesia

In Indonesia, the national Shariah Board formed by the Indonesian council of Ulemas in 1999, is an independent body duly recognized by the Bank of Indonesia and is responsible for issuing Shariah rulings on the products of Islamic banks. The Bank of Indonesia issues regulations for Islamic banking products based on a fatwa issued by national Shariah Board.

The national Sharia council (dSn) possess the power of positive law. In 2005, the Bank of Indonesia also issued a regulation on Standards of contract, which is periodically evaluated to stay relevant with the Islamic banking industry. So far, the regulations (released in 2006) are concerned with Ijarah, Istisna’a, and Salam contracts. Apart from coordinating with the Bank of Indonesia, dSn also takes a role in the Shariah Supervisory Board selection process.

SHArIAH SuPErvISorY BoArd (dPS)

Every Islamic bank (or window) is obliged to have a Shariah Supervisory Board (SSB). The SSB also plays a critical role as partner of the Bank of Indonesia in Islamic banking supervision. The Bank of Indonesia has set up “fit and proper” criteria, which include a test for new SSB members that cover their understanding of Shariah principles and knowledge of Islamic banking and finance in general. Furthermore, to upgrade SSB’s roles, each Shariah supervisor is obligated to submit a report every six months on the finding of Shariah supervision to the Board of directors, the Board of commissioners, the national Shariah council, and the Bank of Indonesia.

The regulatory authorities of some countries, like Bahrain, Sudan, and Syria, have adopted Shariah standards issued by the AAoIFI, while some others use them as guidelines.

In Pakistan, the banks are authorized to offer products based on Islamic modes under the Banking companies ordinance of 1962. The Shariah Board of the State Bank of Pakistan (SBP)16 has approved Essentials of Islamic Modes of Finance and Model Agreements, which were previously issued as guidelines to all Islamic banking institutions and have now been made part of the recently issued instructions for Shariah compliance in Islamic banking institutions. Each Islamic banking institution is required to appoint a Shariah advisor, responsible to give approval regarding the Shariah compliance of all of the institution’s products and to issue Shariah rulings. SBP’s Shariah Board advises the bank in forming its regulations on Islamic banking. In case of any difference of opinion between SBP’s Shariah Board and the Shariah advisor of an Islamic bank, the ruling of SBP’s Shariah Board is final.

In other countries, the rulings of the Shariah Supervisory Boards of Islamic financial institutions are binding on the respective institutions, and regulatory authorities do not intervene in these affairs.

Islamic financial institutions all over the world are generally using similar modes of Islamic finance and products, with minor differences of nomenclature according to their regional, legal, and other conditions. In addition to Ijara, the commonly used modes are murabaha, musharaka, mudaraba, diminishing musharaka, salam, istisna, wakala and kafalah. There is no difference of opinion among the world’s Shariah scholars about the permissibility of these modes. However, there are certain differences in application and modus operandi of the transactions among different countries.

There are differences of opinion among Shariah scholars on

16 Please see end notes at the end of this focused toolkit

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the permissibility of certain modes and practices, like bai al dain (debt trading), bai al inah, tawatruq, hibah on current accounts, and commodity murabaha.

IJArAH trAnSACtIon ExAMPLES

Example of Car Leasing

Shariah-Compliant Car Financing Based on the Principles of Ijarah Thuman Al-Bai (AITAB)17

margin of finance

Up to 90%

financing period

Up to 9 years

Benefits

• Based on the principles of the Ijarah contract (leasing/renting) and the bai contract (purchase)

• Extensive network of dealers nationwide

• Easy payment of installment via branches, ATMs, online

• Renewal of road tax and motor insurance

Types of goods financed

• new motor vehicles

• Second-hand motor vehicles

• Reconditioned motor vehicles

17 Please see end notes at the end of this focused toolkit

Who can apply

• Individuals ages 18 and above

• Sole proprietorships

• Partnerships

• Private limited and public limited companies

Terms of financing

Titled Vehicles—Margin of finance / Repayment period

new passenger car, 4Wd, mpV and suV (cbu and cKd units):

Maximum of 90% of seller’s invoice Maximum 108 months

second-hand passenger car, 4Wd, mpV and suV:

Maximum of 85% of seller’s invoice Maximum 108 months

unregistered reconditioned (imported) vehicle:

Maximum of 90% of seller’s invoice Maximum 108 months

*All terms and conditions are subject to the financing guidelines by Bank negara Malaysia and Maybank.Malaysia

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Required documents

• Photocopy of national Id

• Photocopy of driving license

• copies of last 2 years’ income tax returns (J form or EA)

• copies of latest 2 months’ salary slips

• confirmation of Letter of Employment (latest)

• Last 3 months’ bank statements (if self-employed)

• Photocopy of seller’s national Id and driving license (second-hand cars only)

• Photocopy of registration card (second-hand cars only)

• Pro-forma invoice from seller

For non-individual applications, other documents may be deemed necessary.

Repayments

Payments must be made for the complete installment amount. Partial payments or incomplete installment payments are not be accepted.

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IJArAH HoME FInAnCE18

How the Purchase Price of the Ijarah transaction Is determined

The purchase price that is agreed to in the Promise to Purchase is equal to the original purchase price less the down payment made by the customer plus $1.00. For example, if the value of the property is $200,000 and the customer makes a $40,000 down payment, then the initial amount the customer has to pay the investor for 100 percent ownership is $160,001. As the customer’s ownership increases, this amount decreases, until the final ownership payment of $1.00

18 Please see end notes at the end of this focused toolkit

How the Monthly Ijarah rent Payments Are Calculated

The initial Ijarah amount that is financed by the customer earns a profit for the investor through monthly rental payments. Traditional amortization calculations are utilized to determine the exact monthly payment. These mathematical formulas are acceptable since there are no Sharia issues connected with mathematical calculations. The major difference between a traditional mortgage amortization and an Ijarah transaction is that the Ijarah transaction is based on a reverse amortization calculation.

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the Basis of using a Percentage

while it may appear contrary to Sharia, it is in fact acceptable to describe the profit on an Islamic transaction as a percentage. The following example should clear up any confusion regarding the acceptability of quoting the profit as a percentage in an Ijarah transaction:

1. Suppose you have $100,000 in cash.

2. You purchase a home and pay cash for the home.

3. You rent the home to a tenant for $500 per month.

4. At the end of the year, you have collected $500 x 12 or $6,000 in rent.

5. That $6,000 in rent is a 6% return on your $100,000 investment.

Is that 6 percent to be regarded as rent or as riba? clearly it is rent, since it is based upon a business transaction. now let’s look at a traditional mortgage interest transaction:

1. Starting with the same $100,000 cash.

2. You give someone the money.

3. They proceed to purchase the same home with those funds.

4. They pay you the same $500 per month, or 6% a year for use of the money.

In this case, is the 6 percent riba? Yes, it is, since it is rent on money. The first example was rent on property. So it should be clear that from a Sharia perspective, it is acceptable to describe the profit on an Islamic Ijarah transaction as a percentage. Furthermore, it is also a requirement under the Truth in Lending Act/consumer Protection Act, that any profit earned on a residential real estate finance transaction should be described as a percentage so that a customer can clearly understand what the overall cost of the financial transaction is.

tenant or Homeowner?

In an Ijarah transaction, you are technically a tenant. You sign a lease that obligates you to a rent payment over a period of time. However, unlike in a typical rental property lease, you are responsible for all the maintenance of the property and you have all the rights and duties of a homeowner. You can sell the property any time you wish, you can remodel, decorate,

landscape, sublet, or basically utilize the property for any legal purpose that it is zoned for. The only exception may be if you engage in an activity that could harm the value of the property, such as demolishing a garage without rebuilding it. For all practical purposes, your role is the same as that of a homeowner, because once your have fulfilled your obligations under the lease or promise to purchase, you become the owner of the property.

Sharing of a gain or Loss

one of the basic Sharia compliance principles is that there should be a sharing of either a gain or loss in a financial transaction. The Ijarah transaction is structured in such a way that 100 percent of the gain is rightfully the customer’s. Under Shariah, the gain or loss is shared by the parties in a transaction according to their percentages of ownership. The Ijarah transaction abides by this principle, in that when the gain or loss is realized, there is only one owner of the property, and that is the customer. From a procedural perspective, at the time of sale

1. the Trust will transfer the title of the property to the customer,

2. the customer will then transfer the title to the new buyer,

3. the new buyer will then settle the transaction according to the agreement with the customer, and

4. then the customer will settle with the Trust according to the agreement between the customer and the Trust (the Ijarah documents).

The procedural steps above create a situation where the customer holds 100 percent title, albeit for a short time, and by doing so they entitle the customer to be the beneficiary of the difference between the two agreements, the sale to the new buyer and the original promise to purchase agreement with the Trust.

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ForWArd IJArAH

(rEAL EStAtE FInAnCIng)19

Sharjah Islamic Bank

Forward Ijarah is a form of lease which ends by transferring ownership of the asset (the subject of the contract) to the client upon maturity and upon the client meeting all its obligations under the contract.

If the subject of a contract, whether it is a full share or a common share of a property, does not exist when the Forward Ijarah contract is signed, it may be acquired by the bank under an Istisna sale contract or any other Shariah-compliant mode of finance.

However, the client may be a partner in a project (the property) contributing its share in the form of land and cash, while the bank’s share is putting financing at the project’s disposal for construction. In such as case, the bank will have a common share of the property, which will form the subject of the Forward Ijarah contract.

In any case, on completion of the construction, and based on the client’s request and promise to lease the asset, the bank, which has accepted the offer according to the terms and conditions set out in the Forward Ijarah, will lease the asset (or its share in the asset) to the client and the client will receive agreed rentals.

At the end of the lease period (i.e., on maturity) and upon meeting all its obligations under the Forward Ijarah contract, the bank will transfer the ownership of the property to the client for a nominal sale price under a separate sale contract.

details of the terms under which this product is offered are outlined below:

19 Please see end notes at the end of this focused toolkit

terms of Financing:

• Type of property: Freehold.

• cash contribution: Minimum of 40% to 50% of total project cost.

• Finance tenor: 10 years, including up to 2 years for the construction period.

• Mode of Repayment: Monthly, quarterly, semiannual, or annual terms available

• Sources of repayment: Primary: Rental income of the project. Secondary: other incomes.

• Floating rentals: Relevant EIBoR + bank’s margin with a minimum of certain rate.

• Security: First-degree registered mortgage on the plot and the building, in addition to the other terms of approval.

• Insurance: Insurance policy covering the property under construction to be assigned to the bank.

Qualified Assets:

Residential, office Buildings & Villa complexes

documentary Requirements:

1. copy of valid passport.

2. Full details of personal financial information sup-ported with documents.

3. Personal bank statements for the last six months.

4. completed finance application form.

5. copy of site plan.

6. copy of title deed.

7. comprehensive feasibility study prepared by reputed consultant.

8. Project specification and approved drawings.

9. copies of the consultant / contractor agreements.

10. copy of approval of electricity connection date.

11. Payment of the applicable fees for the project’s tech-nical assessment by the bank’s in-house engineers.

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IJArAH (EndIng WItH tItLE dEEd)

MuntAHIA BIttAMLEEK20:

Ijarah is a form of leasing where a property (commercial building / complex of villas) is leased by the lessor to the lessee in such a way that at the end of an agreed lease period, the lessee becomes the owner of the property by purchasing it from the lessor either during or at the end of the lease period at an agreed sale price.

Applying the above, upon the client’s promise to lease from the bank, the bank purchases, for itself and in its own name, a property specified in the promise and then leases it to the client on terms of financial lease. The lease rent is structured so that at the end of the lease period, the bank’s purchasing cost and profit are recovered and the bank can then transfer the ownership of the property to the client for a nominal sale price or as a gift, by either a separate sale or gift contract, at the end of the lease period.

details of the terms under which this product is offered are outlined below:

terms of Financing:

• Type of property: Freehold.

• Advance rent: Minimum of 40% to 50% of the purchase price.

• Financing tenor: Up to 8 years.

• Age of property: Should not exceed 20 years, includ-ing the repayment tenor.

• Mode of payment: Monthly, quarterly, semiannual, or annual terms are available.

• Sources of repayment: Primary: Rental income of the project. Secondary: other incomes.

• Floating rentals: Relevant EIBoR + bank’s margin with a minimum of a certain rate.

• Security: First-degree registered mortgage on the plot and the building, in addition to the other terms of approval.

• Qualified assets: Residential, office buildings, and villa complexes.

20 Please see end notes at the end of this focused toolkit

ISLAMIC LEASIng For MICro, SMALL,

And MEdIuM EntErPrISES (MSME)

In some Muslim communities, conventional interest-based microleasing, or microfinance, has been rejected, principally for its noncompliance with Islamic principles, particularly on the issue of paying interest or riba, which is forbidden under Shariah. This has contributed to the failure of government initiatives using conventional microleasing in these communities to overcome poverty and promote economic development. As a result, it is estimated that up to 72 percent of people living in Muslim-majority countries do not use formal financial services at all (Honohon 2007)21. The extent of the market opportunity is evident when one realizes that Islamic microfinance represents less than 1 percent of total global microfinance outreach (karim et al 2008)22.

These Muslim clients, who demand products consistent with Islamic financial principles, provide the base for Islamic Ijarah for MSMEs. Products used by these institutions include Ijarah and Al-Ijarah Muntahiya Bittamleek. The structures and terms of the Ijarah instruments are as outlined above.

Al-Ijarah Muntahia Bittamleek is thought to be more suitable for MSMEs, especially those in need of assets or equipment.

Microleasing or micro-Ijara serves as a mode of microfinance. All kinds of income-generating equipment and physical assets may be financed through this mode for the poor. They include carts, taxis to transport people, low-cost houses, shops to sell merchandize, and tools and machines to manufacture or produce products.

An important Shariah rule governing Ijarah as a tool of microfinance is that the risk and liabilities emerging from the ownership of the asset substantially remain with the lessor.

21 Please see end notes at the end of this focused toolkit

22 Please see end notes at the end of this focused toolkit

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AAoFI

Although AAoIFI standards are widely followed (without obligation) across many countries, they have been officially adopted only by Bahrain, the dubai International Financial centre (dIFc) in the UAE, Jordan, Lebanon, Qatar, Sudan, and Syria.

IntErnAtIonAL FInAnCIAL rEPortIng

StAndArdS (IFrS) vS AAoIFI And

tHE MALAYSIAn ACCountIngS

StAndArdS BoArd (MASB)

Comparison With the Conventional Lease

Financial Accounting Standard (FAS) no. 8, formulated by the Accounting & Auditing organization for Islamic Financial Institutions (AAoIFI), provides an accounting treatment for Ijara. This AAoIFI-recommended standard for Ijarah differs in many respects from the standard formulated for conventional leasing, known as International Accounting Standard 17 (IAS 17).

A ‘lease’, according to the International Accounting Standard, is an agreement whereby the lessor conveys to the lessee, in return for a payment or series of payments, the right to use an asset for an agreed period of time. According to IAS 17, a lease is classified as a finance lease if it “transfers substantially the risks and rewards incidental to ownership.” A lease is classified as an operating lease if it does not transfer substantially all risks and rewards incidental to ownership (see Base Toolkit, Part V, Accounting).

Ijara is defined as “ownership of the right to the benefit of using an asset in return for consideration.” However, the AAoIFI definition includes the additional condition that the benefit should be Shariah-compliant. Thus, Ijarah and a conventional lease differ in this respect: regarding the requirement to comply with Shariah rules. Shariah does not permit Ijarah for use of an asset for payment of interest or involving merchandise considered as haram, nor for unlawful transactions.

AAoIFI FAS 8 also embodies a classification of the instrument into two categories. If the contract refers to a promise that the legal title would ultimately pass on to the lessee (mustajir) at its expiration, it is referred to as Ijarah Muntahia Bittamleek (IMB) or ITAB. In IMB/ITAB, which is loosely considered as equivalent to the conventional finance lease, at the expiration of the term the passing of the legal title to the lessee could occur either

1. on transfer of the payment of the balance rentals

2. as a gift

3. on payment of a token or for an amount specified in the contract, or

4. on the gradual transfer of the title.

Following AAoIFI’s Juristic Rules on the fulfillment of a promise, for the transfer to be effective a contract distinct from the Ijarah contract should be executed. The lessee has an option, which he may or may not exercise. Thus IMB/AITAB would have the characteristics or the substance of a conventional lease only if the lessee exercises the option. otherwise, IMB/ITAB for all intents and purposes is an operating lease. Hence in both legal form and concept IMB/AITAB and a conventional finance lease are not identical.

The key distinction between the IMB/AITAB and the conventional finance lease is that in the Islamic version the lessor undertakes the full ownership risks of the corpus of the leased asset. In the Islamic version, the risks remain with the lessor (mujir). The passing of the risk to the lessee is a prerequisite for a lease to be classified as a finance lease under International Accounting Standards. one might view it this way: In Ijarah, the risk follows the legal title unless damage is caused by the negligence or misconduct of the lessor. Since IAS looks at substance over form for accounting purposes, when passing the risks and rewards of the asset to the lessee the asset is recorded in the books of the lessee coupled with the right to claim depreciation. Major repairs, maintenance, and insurance remain on the account of the lessor in an Ijarah contract, whereas these costs are passed on to the lessee in a conventional lease.

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ACCountIng undEr AAoIFI

The nature of Ijarah rental (or ujrah) is that it represents consideration for the right to use an asset. Ujrah does not consist of a capital component and an interest element. Hence the application of accounting methodology adopted for conventional lease rentals under International Accounting Standards, specifically the recording of ‘lease rentals receivable’ and ‘interest in suspense’ in the books of the lessor, would pose an issue in accounting for ujrah. The FAS 8 rule formulated by AAoIFI stipulates that assets rented on the basis of both Ijarah and IMB should be recorded in the books of the lessor (mujir). The two categories of assets should be shown in the Statement of Financial position, under the headings, “Investments in Ijarah Assets” and “Ijara Munthia Bitamleek Assets,” respectively, at cost on initial recognition and at book value thereafter.

The right to claim depreciation follows the recording of the asset in the books of the lessor. Unlike in a conventional finance lease under IAS, the depreciation entitlement for both forms is vested in the lessor. while the depreciation of Ijarah assets will be based on the depreciation policy of the lessor, in calculating the depreciation of Ijarah Bitamleek assets the residual value will be taken as zero if the lessee’s acquisition of ownership at the end of the period is made through gift. on the other hand, if the transfer to the lessee is at a token amount specified in the contract, the said amount should be subtracted in determining the depreciable cost.

Installments of both forms, Ijarah and IMB, should be presented in the income statement of the lessor as “Ijara Revenue” on an accrual basis and allocated proportionately according to the term of the lease recognized in the period in which they are due. where the lessee acquires title through gradual sale, the revenue decreases progressively.

The Ijarah installment paid is presented in the lessee’s income statement as “Ijara Expense,” allocated over the lease period recognized when due under both forms of Islamic leases.

LESSonS LEArnEd—tAx ISSuES

InvoLvIng IJArA

Application of Stamp duties/notary Fees

The cost of Ijarah in comparison to a loan may be high due to the associated transactional taxes on additional steps involved. The legal / notary fees and stamp duty involved in the dual transfer of title (in IMB) and the property transfer tax may increase the cost of the entire structure in many jurisdictions.

value Added tax (vAt)

The exposure of the Ijarah rentals to VAT, as opposed to the VAT exemption enjoyed by interest, is another factor that may have an impact on the pricing. Though interest paid on a loan from a bank does not attract any withholding tax under most of the tax systems found in the world, Ijarah rental would be exposed to withholding tax.

depreciation Allowance

In certain countries, like Sri Lanka, though the local tax statutes do not explicitly allow the lessor to claim capital allowances under operating and finance leases, nevertheless under the presumption that the leased assets are deemed to be used in the lessor’s business of leasing, the lessor enjoys the right to claim capital allowances. In these countries, the same status quo ought to prevail for Ijarah and IMB regarding capital allowances. In a scenario involving a cross-border Ijara, the lessor (mujir) should also be cautious about possibily creating a permanent establishment in the lessee’s (mustajir’s) jurisdiction.

source: © islamic finance today—pioneer publications (pvt) ltd23

23 Please see end notes at the end of this focused toolkit

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MALAYSIAn ACCountIngS

StAndArdS BoArd (MASB)

Malaysian Accounting Standards Board (MASB) has come out with Financial Reporting Standards 1, a rule for the Presentation of Financial Statements of Islamic Financial Institutions, which states that all companies practicing Islamic banking must disclose their Islamic banking activities separately from their conventional activities. This became effective in January 2004. However, conventional methods of accounting should be followed in the absence of any specific standards in the Islamic Accounting Standards. currently, MASB is actively looking for the best practice of accounting methods to suit all Islamic banking operations.

AAoIFI has also issued an accounting standard, Financial Accounting Standard no. 8, on Ijarah and IMB. It discussed the treatment of an Ijarah transaction on the books of the lessor as well as the lessee. Unlike the MASB or FRS standards, which are mandatory to follow, the AAoIFI standard is merely a voluntary action for Islamic financial institutions to follow.

the treatment of Leases under FrS 11724

In Malaysia, the accounting standard that prescribes accounting treatments for leases is FRS 117.11 FRS 117 should be applied for annual periods beginning on or after october 1, 2006. However, early adoption is encouraged. Any entity that applies FRS 117 for a period before the commencement date should disclose that fact. In addition, the accounting treatment for Islamic hire-purchase, or AITAB, will be similar and follow the general guidelines of FRS 117.

FRS 117 is applicable to all leases except the following: Lease agreement for exploration of natural resources; and lease agreements for such items as motion pictures, plays, and copyrights.

FRS 117 is also not applicable to the measurement issue in relation to the following: Lease agreements for investment property (which are to be covered under FRS 140, Investment Property), and lease agreements for biological assets (covered under IAS 41, Agriculture)

24 Please see end notes at the end of this focused toolkit

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Classification and recognition of Leases under FrS 117

FRS 117 classifies all leases, for accounting purposes, into two broad categories:

1. operating leases, and

2. Finance leases.

FRS 117 Leases, A Practical Guide to Financial Reporting Standards (Malaysia), p. 307.

Para 2, FRS 117, Malaysian Accounting Standards Board 2005.Para 8, FRS 117, Malaysian Accounting Standards Board 2005.

The criterion used in the classification is the extent to which risks and rewards incidental to the ownership of a leased asset lie with the lessor or the lessee. Risks incident to ownership include the possibility of losses from idle capacity or technological obsolescence and variations in return due to changing economic conditions. Rewards incident to ownership may be represented by the exception in value.

Under FRS 117, a lease is classified as a finance lease if, regardless of its legal form, it transfers substantially all the risks and rewards incident to ownership from the lessor to the lessee. A lease that does not transfer substantially all the risks and rewards in this way is classified as an operating lease.

FRS 117 does not detail the concept of “transfer of substantially all risks and rewards incident to ownership.” However, it does provide examples of situations where a lease would normally be classified as a finance lease, as follows:

• where the lease transfers ownership of the asset to the lessee by the end of the lease term;

• where the lease contains a bargain purchase option;

• where the lease term is for the major part of the useful life of the asset;

• where the present value of the minimum lease payments (excluding execution costs) is greater than or equal to sub-stantially all of the fair value of the asset; and

• where the leased assets are not of a specialized nature such that only the lessee can use them without major modifica-tion being made.

FRS 117 further lists indicators of situations which individually or in combination could lead to a lease being classified as a finance lease, as follows:

• If the lessee can cancel the lease, the lessee’s losses associated with the cancellation are borne by the lessee;

• If gains or losses from the fluctuation in the fair value of the residual value fall to the lessee; and

• If the lessee has the ability to continue the lease for a second-ary period at a rent which is substantially lower than market rent.

The journal entries to record the lease in the lessee book for the period would be as follows:

Beginning of the transactions:

dR Leased equipment

cR Lease payable

(Record the finance lease)

At the End of The Accounting Period:

dR Lease payable

dR Interest expense

cR cash

(Record lease payment)

dR depreciation expense

cR Accumulated depreciation

(Record depreciation expense)

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The journal entries to record the lease in the lessor book for the period would be as follows:

Beginning of the transactions:

Para 7, FRS 117, Malaysian Accounting Standards Board 2005.

Para 8, FRS 117, Malaysian Accounting Standards Board 2005.

Para 10, FRS 117, Malaysian Accounting Standards Board 2005.

Para 10, FRS 117, Malaysian Accounting Standards Board 2005.

dR Lease receivable

cR Unearned interest income

cR Machinery

(Record the finance lease)

At the end of the accounting period:

dR cash

cR Executory expenses payable

(Record receipt of executory costs)

dR cash

cR Lease receivable

(Record receipt of lease payment)

dR Unearned interest income

cR Interest income

(Recognize interest income)

ACCountIng trEAtMEnt undEr

AAoIFI

The Accounting Standards committee has reviewed a number of alternatives, in particular the alternatives proposed in the preliminary study for adoption in the accounting treatments of Ijarah and IMB. The committee recommended the adoption of the alternatives, which it considered to be in compliance with the provisions of both Statements of Financial Accounting no. 1 (Statement of objectives) and no 2 (Statement of concepts).

Classification and recognition of Ijarah under AAoIFI 20

An “operating Ijarah” is an operating lease that does not include a promise that the legal title in the leased asset will pass to the lessee at the end of the lease, whereas IMB (also known as Ijarah wa Iqtina) is a lease that concludes with the legal title in the leased asset passing to the lessee at the end of the contract period. IMB allows different kinds of asset transfer, including these:

1. Ijarah Muntahiah Bitamleek through gift (transfer of legal title for no consideration.

2. Ijarah Muntahiah Bitamleek through transfer of legal title (sale) at the end of a lease for a token consideration or other amount as specified in the lease.

3. Ijarah Muntahiah Bitamleek through transfer of legal title (sale) prior to the end of the lease term for a price that is equivalent to the remaining Ijarah installments.

4. Ijarah Muntahiah Bitamleek through gradual transfer of legal title (sale) of the leased asset.

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The journal entries to record the lease in the lessor book in the AAoIFI for the period would be as follows:

dR Equipment

cR cash

(cash purchase of equipment for Ijarah financing)

dR Ijarah Financing Asset

cR Equipment

(Provides Ijarah financing to lessee)

dR cash

cR Profit & Loss

(Repayment received from lessee and income recognition)

dR Profit & Loss

cR depreciation

(depreciation cost of Ijarah financing asset)

the Findings

The differences in the accounting treatment of Ijarah between the Financial Reporting Standard (FRS) and the Accounting and Auditing organization for Islamic Financial Institutions (AAoIFI) is an interesting topic worth discussing.

FRS 117 clarifies that the financial statements of lessees, in the initial recognition, shall recognize finance leases as assets and liabilities in their balance sheets at amounts equal to the fair value of the leased property or, if lower, the present value of the minimum lease payments, each determined at the inception of the lease. Any initial direct cost to the lessee is added to the amount recognized as an asset. A finance lease gives rise to depreciation expenses for depreciable assets as well as finance expense for each accounting period.

By contrast, the financial statements of lessors, during the initial recognition shall recognize assets held under a finance lease in their balance sheets and present them as receivables at an amount equal to the net investment in the lease. costs incurred by manufacturers or dealers in connection with negotiating and arranging leases shall be recognized as expenses when the selling profit is recognized.

Under the AAoIFI, in the case of initial direct cost, two alternative treatments were proposed for the Islamic bank’s share of the initial direct cost (as a lessor or a lessee):

1. charging these costs as a period expense to the period in which they occur, or

2. Recording these costs as deferred costs to be allocated (equally) over the lease term.

Alternative (2) has been chosen, because it is consistent with the concept of matching revenues and expenses, which is stated in the Statement of concepts. However, if the initial direct costs were immaterial, the entire amount would be charged to the period in which it occurred. This is consistent with the materiality concept. Unlike the materiality concept in conventional accounting, the materiality concept in Islamic accounting is not subject to any minimum amount that can materially affect the company transaction. Materiality in Islamic accounting must disclose even small or insignificant amounts received or related to non-halal income or expenditure.

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Four MAIn SCHooLS oF ISLAMIC

tHougHt25

HAnAFI/JA’FArI , MALIKI, SHAFIE, And

HAnBALI

There are four main schools in classical Sunni Islamic legal thought: Hanafi/Ja’fari, Maliki, Shafie, and Hanbali. The schools, named after their main contributing thinkers, were developed largely in order to provide rigor, predictability, and hierarchical structure to Islamic lawmaking (or fiqh) at an early point in the Islamic empire’s history. while there are few major theological or ideological differences remaining between the four schools today, they continue to hold geographic

25 Please see end notes at the end of this focused toolkit

dominance in particular parts of the Muslim world and do create subtle differences in codified texts, marriage and family law, and some criminal punishments.

The main school of thought in the Shi’a school is the Ja’fari school. Legal doctrinal differences between the Ja’fari and Hanafi schools are mostly of the same order as those between the Hanafi school and other Sunni schools, with the chief exception being constitutional and inheritance law.

The Hanafi school prevails in Turkey, Syria, Lebanon, Iraq, Jordan, Egypt, and the Sudan.

Maliki has governed the Muslim populations of north, west, and central Africa.

Shafie has prevailed in East Africa, Malaysia, and the southern part of the Arabian Peninsula.

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Hanbali is the basis for the codified law of the kingdom of Saudi Arabia.

Sunni and Shi’a

After the death of the Prophet Muhammad in 632, the first generation of Muslims established the order of succession by caliphs (caliph meant deputy, or successor, of Muhammad, that is, his successor as the secular leader of the community). The first three caliphs, Abu Bakr, ’Umar, and ’Uthman, retained the seat of authority in Medina, created a small, nascent Islamic polity, and expanded that polity beyond the Arabian Peninsula into the Byzantine territories of the Syrian littoral in the eastern basin of the Mediterranean Sea. As the result of the assassination of the third caliph, ’Uthman, and the disputed claim of ’Ali to be the fourth caliph (’Ali was both kin and

son-in-law of the Prophet), a civil war erupted. That conflict was ultimately settled by the assassination of ’Ali, with the consequence that Islam fractured into two components: Sunni and Shi’a (or Shi’i). The latter were the followers of ’Ali.

Ijarah under the Four Schools

Ijarah comes from the root word ajr, which means compensation and, at the same time, means the sale of usufruct.

Hanafi School—Ijarah is defined as a contract that enables possession of a particular intended usufruct of the leased asset (ayn) for a consideration. Some jurists have stipulated that the usufruct from the leased asset should be intended, while others explained that what is meant by it are considered intentions in light of Shariah and reasoning, and not merely intentions.

Maliki School—The Maliki school of fiqh defines Ijarah as a contract that relates to permissible usufructs for a particular period and a particular consideration not arising from usufruct.

Shafie School—The Shafie school of fiqh defines Ijarah as a contract for a defined intended usufruct liable to utilization and accessibility for a particular recompense.

Hanbali School—The Hanbali school of fiqh defines Ijarah as a contract for a particular permissible usufruct that is taken gradually for a particular period and a particular consideration.

Although there are various definitions of Ijarah given by the scholars of Islamic jurisprudence via their various schools of thought, it is agreed among them that Ijarah is a contract on the use of benefits or services in return for compensation.

The definition of Ijarah according to AAoIFI (FAS 8) is “the ownership of the right to the benefit of using an asset in return for consideration.” while in Financial Reporting Standard 117 (“FRS 117”), a lease is “an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time.”

In summarizing all the definitions, Ijarah may be regarded as a leasing of property pursuant to a contract under which a specified permissible benefit in the form of a usufruct is obtained for a specified period in return for a specified permissible consideration.

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dISPutE rESoLutIon

Islamic finance cases are adjudicated by the state courts of various countries, thus falling under the purview of national law. There are countries where Shariah is (a) a supreme source of law, as for example in Saudi Arabia, Iran, Sudan, and Pakistan, (b) one of the sources of law, as in Malaysia, kuwait, and UAE, or (c) not part of the legal system.

The issues arising in relation to Islamic dispute resolution vary depending on the category to which the country belongs.

The majority of legal systems are not based first and foremost on Shariah and, as a result, courts will apply Shariah law in the context of its interplay with the national laws. This raises issues both in relation to the status of Shariah law within the contract and in the court adjudication process and also in relation to the enforcement of overseas judgments.

In the Middle East, many Islamic finance transactions name the courts of England and wales as the applicable forum and the law of England and wales as the governing law. The English courts have addressed the extent of applicability of Shariah law to certain contracts.

In cases where parties are considering choosing a specific national law, the legal system of which includes Shariah law, they must ensure that there is a reciprocal enforcement treaty in place between both countries.

However, in certain circumstances, even when such arrangements are in place, a successful enforcement may be impossible. For example, if the decision of a foreign court involves payment of interest, such a decision will not be enforced in Saudi Arabia, since it contravenes the basic precepts of Shariah.

Thus, submitting an Islamic finance matter to a state court of any jurisdiction may evince various challenging issues, include challenges in enforcement, adjudication in accordance with Shariah law, lack of competent training of judges, and conflicts among laws.26

26 Please see end notes at the end of this focused toolkit

ProJECt FInAnCIng uSIng IJArAH27

The most common form of Islamic project finance uses the Ijarah strucure. This is similar to leasing-and-hire purchase arrangements. Many Islamic investment funds principally invest in these types transactions.

Ijara can accommodate variable profit margins: the lease payment is made, for example, every six months, and when the payment is made the profit margin for the following period is determined (generally on the basis of a reference such as six-month LIBoR, plus a fixed fee).

In addition to retaining ownership over the asset that is financed, the financial institution builds in additional security through the payment by the lessee of an amount to be mutually agreed upon by the parties as a security deposit. The lessor can use this in any manner it wishes in case of a rent default. To ensure timely payment, “liquidated damages” are included in the contract, specifying extra payments that need to be made for any day of delay.

As discussed in detail earlier, in an Ijarah contract a financial institution purchases goods on behalf of a client and leases them to the client for a rental fee while maintaining ownership. The rental fee and the duration of the lease are agreed in advance. In one form, referred to in this report as AITAB (Al-Ijarah Thumma Al-Bai) but also known as Ijarah wa Iqtina, the client purchases the goods from the financial institution at the end of the lease period for a predetermined price. This instrument has been frequently used for the financing of major assets, such as aircraft.

The bank can issue Ijara bonds for placement with Islamic investors, as a way to refinance itself. Alternatively, special Islamic funds can be set up to engage in Ijarah financing. Much of the recent growth in Islamic finance has been through the creation of such funds.

There are differences in the way that Ijarah operates from country to country. For example, more conservative Shariah boards stipulate that management, insurance, and maintenance are the responsibility of the lessor (the financial institution), unlike in conventional operating leases. This arrangement leaves the lessee with little incentive to properly manage and maintain the assets, however. To overcome this problem, strong undertakings are required in the lease contract.

Banks can also combine Islamic financing instruments. This can be particularly useful for the financing of expensive assets:

27 Please see end notes at the end of this focused toolkit

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the construction part can be financed through an istisna (see the next section), and once the asset/project is finished, the bank can lease it or sell it on deferred payment terms to the company that will operate it. This is similar to the back-to-back istisna, but with the important difference that the buyer can make his final payments after the asset has been constructed and delivered to him.

As an example, this structure was used in a deal for $77 million in project financing for the Bakri Group to build two chemical tankers that were to be chartered by Saudi Basic Industries corporation. The first tranche of the financing consisted of disbursements under an Istisna, and this was replaced by an AITAB on delivery of the tankers.

Ijarah with Istisna

Istisna/Istisna’a is a contract of sale of specified goods to be manufactured with an obligation on the manufacturer to deliver them on completion. It is a condition in Istisna that the seller provides either the raw material or the cost of manufacturing the goods.

Istisna is often used for large, longer-term financings (e.g. infrastructure, electricity projects, transport equipment, pipelines). In general, in this mechanism the buyer (or investor) approaches the financial institution, providing all relevant information, including details of the security offered (government, bank, or parent company guarantees). If the financial institution agrees, buyer and seller have to deposit security bonds, and the buyer can order (as agent for the financial institution) the equipment.

The Islamic financial institution may pay the manufacturer an advance. The manufacturer has to provide a performance bond as well as a guarantee to refund the progress payments made by the financial institution if he fails to make delivery, or if he delivers non-conforming goods. He also has to assign the insurance for the assets under construction to the financial institution. Then, for the regular payments on the work in progress, the bank would ask the manufacturer to open a letter of credit in favor of the supplier of the materials that the manufacturer is using, to control the actual use of its funds. Alternatively, the financial institution can reimburse the manufacturer for the expenses he already made. The buyer, through his own bank, would reimburse the Islamic financial institution, most likely in installments.

Istisna financing can be syndicated, it can contain financing tranches of different maturities and with different profit rates,

and it can also be structured as a securitization.

Banks often use back-to-back transactions:

• Under the first Istisna, a customer agrees to purchase an asset from the Islamic bank upon completion. The purchaser can pay the financial institution in advance, at completion, or over time based on a set of predetermined completion milestones.

• Under the second Istisna (the “hire to produce” contract), the Islamic financial institution agrees to pay the manu-facturer to build the asset in question. As an intermediary, the Islamic financial institution accepts the manufacturer’s performance risk and the buyer’s payment risk.

• Back-to-back with the Istisna with the manufacturer (con-tractor), the bank could also use an Ijarah (lease) contract with the buyer, if he wishes the buyer to pay in installments after delivery of the assets.

risks to Avoid in Project Financing

when engaging in an Ijarah project finance, financial institutions have to avoid certain possible problems, described next.

risk of Loss/destruction

Taking out property insurance may be difficult for Islamic financial institutions, depending on the specific interpretation of the relevant Shariah court. Still, in order to classify as an Ijara, the risks of loss or destruction have to stay with the bank, unless when caused by the lessee. If the bank can take out insurance, this should be paid (in advance) by the lessee.

The risk of loss or destruction has to be carefully evaluated. It should also be noted that under “western” leases, the lessee has to continue paying even if the assets have been destroyed; under Islamic finance, this is not possible. As in Islamic finance, the lessee cannot be asked to continue paying under the lease if the property has been destroyed or otherwise loses its economic value. ways to deal with such problems have to be built into the contract with the lessee. normally, the way this is done is by requiring the lessee to purchase the leased property (with all obligations, liabilities and insurance policies attached to the property). However, the Shariah principle is that the purchase price should be the fair market value, and this value for a destroyed property is not very high. So in practice, this remains a very difficult issue to deal with. normally, the Ijarah contract

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requires detailed undertakings by the lessee that it will use the leased goods for normal business use, that it will ensure that the use of the goods will not vitiate the insurance policy, that it will not sublease or hire out the goods, that only properly trained personnel will use the goods, that the goods will be properly operated and maintained, and that it will return the goods at the end of the lease in good condition, fair wear and tear excepted.

timing of Payments

Like most western leases, payment under the Ijarah can only start once the good (or at least, an economically useful part thereof) is effectively transferred to the lessee.

Legal Liability

As the owner and lessor of the goods, the financial institution is exposed to certain legal risks. The financial institution should include in the contract a disclaimer, to the extent possible.

At least, it should limit its own liability by the indemnities received from the seller. Also, in the Ijarah contract, the lessee should agree to indemnify the lessor for all costs, liabilities, and obligations linked to the goods, whether or not due to its fault.

Project Financing Examples

The dolphin Gas Project28, which includes natural gas production in Qatar and a pipeline to the United Arab Emirates, represents one of the largest Islamic financings of a Persian Gulf oil and gas project to date. It involved a $1 billion Ijarah and Istisna component alongside a $2.45 billion conventional debt offering.

An example of government-related financing in the Middle East is the $50 million pipeline financing in Pakistan, which used a five-year Ijarah facility.

28 Please see end notes at the end of this focused toolkit

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IJArAH SuKuK

What is Sukuk?29

Sukuk30 is the plural of sakk, which means “legal instrument, deed, check,” so sukuk is the Arabic name for a financial certificate, though it can also be understood as an Islamic equivalent of bond. However, fixed-income, interest-bearing bonds are not permissible in Islam, hence sukuk are securities that comply with Shariah and its investment principles, which prohibit the charging or paying of interest.

Financial assets that comply with the Islamic law can be classified in accordance with their tradability and non-tradability in the secondary markets. This concept was used during the medieval period of Islam, when it was related to the recording of financial and other obligations. The word sakuk, with this same meaning, was also used in western Europe during the period, and later evolved to what is presently known by the English words “cheque” and “check.”

In modern Islamic financial terms, sukuk is defined as an Islamic or Shariah-compliant bond. Another Arabic term for sukuk, when translated, is Islamic investment certificate.

29 Please see end notes at the end of this focused toolkit

30 Please see end notes at the end of this focused toolkit

According to AAoIFI Standard no. 17, investment sukuk are certificates of equal value representing, after closing subscription, receipt of the value of the certificates and put to use as planned. They therefore represent common shares and rights in the underlying assets or their usufructs and services5. AAoIFI has classified sukuk into 14 types, depending on the contracts used. Among them, Sukuk Al-Ijarah (lease-based certificate) is the most widely used type of sukuk.

Introduction to Ijarah Sukuk31

Sukuk al-Ijarah are issued on a sale and lease-back arrangement (Ijara) of an asset. The issuer applies the Sukuk proceeds to purchase the asset from the originator and then leases it back to the originator. The originator undertakes to repurchase the asset at maturity or upon early settlement at the original purchase price.

The issuer is required under Shariah to undertake the major maintenance of the asset, but it will often appoint the obligor to carry out such activity on its behalf (see diagram below).32

31 Please see end notes at the end of this focused toolkit

32 Please see end notes at the end of this focused toolkit

Originator Issuer Investors

Purchase undertaking

Sale undertaking

Originator as lessee

Rent Lease

Subscription proceedsSubscription proceeds

Title to assetsRent and redemption

proceeds

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Sukuk trust Certificates

A good example of successfully adopting the Ijarah structure for a truly global capital market issue was the Malaysian government’s issue of Sukuk Trust certificates in August 2002. The structure used for the transaction was clean and simple in order to appeal to the broadest possible base of investors. In this instance, a special purpose company was incorporated in Labuan called the Malaysian Global Sukuk Inc. (MGS). (See illustration below.)

MGS is owned by a Malaysian state entity. MGS issued Sukuks to investors and used the funds thus raised to purchase parcels of land in and around kuala Lumpur from another Malaysian state entity. MGS then leased those parcels of land to the Federation of Malaysia. At the expiry of the term of the lease, the Malaysian government has agreed to purchase the parcels of land from MGS at the face value of the initial issue amount of the Sukuks.

Pursuant to a declaration of Trust, the land parcels are held by MGS in favor of the Sukuk holders. All returns made on the land parcels are conveyed to the Sukuk holders, including lease payments and the final repurchase proceeds to be paid by the Federation of Malaysia. The cash flow produced is similar to any bond cash flow. The lease payments are like coupons and the repurchase proceeds paid at the end of the term are like the principal component of a bond.

The MGS issue was rated by Moody’s and by Standard and Poor’s33. and the Sukuks were listed on the Luxembourg Stock Exchange. The lease payments are determined based on a spread over LIBoR. Islamic scholars are comfortable with the use of LIBoR as a lease pricing reference mechanism but not as a means of calculating interest. A floating lease price has been considered acceptable by Islamic scholars, since landlords and tenants (in the traditional sense) can agree on raising or lowering lease payments on land over the period of a tenancy.

Ijara Sukuks are freely tradable. As trading in debt above or below par would obviously breach the Islamic finance principle of not charging interest and the ability to trade freely in capital market instruments is critical to investors, there is a potential further problem. However, since the Ijarah Sukuks represent an interest in the underlying assets and not debts, they can be traded above or below par freely without breaching any Islamic principles.

33 Please see end notes at the end of this focused toolkit

Malaysian Federal Lands Commisioner

Malaysian Global Sukuk

Inc.

Federation of Malaysia

Malaysia will purchase the land parcels at the end of the term

Sukuk holders

& Sukuks

Lease PaymentsPurchase price for land parcels

Land parcels Lease of Land

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disadvantages of the Ijarah Sukuk Structure

As the preceding makes abundantly clear, Islamic scholars have broadly accepted the Ijarah structure. nevertheless, despite its simplicity and broad acceptance, Ijarah sukuk suffers from some major commercial disadvantages for the issuer, namely:

• not all potential issuers have access to the necessary underly-ing asset for such a transaction.

• Even if a potential issuer does have access to an appropriate underlying asset, depending on the jurisdiction where the as-set is located, stamp duty and taxation costs associated with introducing the asset into the structure could make such a transaction unviable.

• Since the asset is tied up for the term of the transaction, the owner of the asset cannot divest it freely and there could be negative pledge implications in putting the asset into the transaction.

• There could be ongoing Shariah audits in connection with the asset. This can be time consuming and costly for the issuer.

Sukuk trading options

A simple diagram of the sukuk structure is shown below. In the issuance of Ijarah Sukuk, a special purpose vehicle (SPV) or company is created to purchase the asset(s). In turn, this SPV issues Sukuk to the investors, enabling them to make payments for purchasing the asset. The asset is then leased to a third party for its use. The lessee makes periodic rental payments to the SPV, which then distributes the payments to the Sukuk holders. The instruments created in this Ijarah Sukuk are completely negotiable and can be traded in the secondary markets, as follows.

Sukuk Al-Ijarah—The owner of an existing tangible leased asset may sell such assets through Sukuk.

Sukuk Ijarah Mowsufa Bithima—The owner of a tangible asset to be acquired and subject to a lease contract may mobilize the acquisition cost of such an asset through Sukuk issues.

Sukuk Manfaa Ijarah—The owner of leasehold rights of existing leased assets may sell the usufruct of such assets through Sukuk issues.

Sukuk Manfaa Ijarah Mowsufa Bithima—The owner of leasehold rights of an asset to be acquired and subject to lease contract may sell the usufruct of such an asset through Sukuk issues.

Originatoras seller

Trust Certificate

Issue

Sukuk holders

(3) Issued Trust Certificate

(1) Sell certain titles of land to SPV

(7) Payments made by SPV to Obligator

(6) Payments received from investors by SPV

SPV

(2) Leased the assets to obligator

(8) Obligator make periodic lease

payment to SPV

(9) SPV pays coupon to Investors

(4) Trust Certificate issued to Investors

(5) Investors made payments

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Stage 1: Contract for cash sale (Bay’ Mutlakah)

• SPV purchases property (e.g. hospitals) from obligator (government). (1)

• The assets purchased by the SPV are funded by the issuance of sukuk (trust certificates) which represents beneficial own-ership in the assets and the lease. (3)

• Government receives cash proceeds. (7)

Stage 2: Contract for leasing (Ijarah)

• SPV rents property to the government for specified period. (2)

• SPV collects rentals. (6)

Stage 3: During the tenure …

• SPV passed the rentals to investors (9) and makes periodic distributions/coupons

Stage 4: At maturity …

• SPV sells the property to the government at an agreed price.

• Government pays cash to SPV.

• SPV simultaneously pays investors cash for sukuk redemp-tion.

IJArA And ProJECt FInAnCE

Islamic financing structures are increasingly used in the project finance domain, particularly in projects in the Middle East. In most Islamic financing, incorporated within a multi-sourced project financing, the Islamic financing element of the project is provided pari passu with the other senior debt. Istisna and Ijarah elements are frequently used. The following is an example of a transaction structure.

Sample transaction Structure: Leasing Assets

The finance providers under the Islamic facility (the Islamic finance providers) have established an Islamic SPV to operate as their financing vehicle to own certain project assets and lease them to the borrower. The Islamic finance providers and the Islamic SPV appointed an Islamic bank as facility agent (the Islamic facility agent) to perform each of their respective obligations under the Islamic financing documents, which included the following:

Credit Agreement

This credit agreement sets out the terms and conditions precedent, representations and warranties, covenants, events of default, and payment provisions on broadly identical terms to the obligations in the non-Islamic-compliant documents, other than for the payment of interest and procurement of insurance.

In the example, this agreement operated during the construction phase. The borrower agreed to develop, construct, and deliver the project assets according to certain specifications and to sell the project assets to the Islamic SPV.

Islamic SPV

The Islamic SPV agreed to pay for the project assets by phased payments (equivalent to advances of finance) to the borrower. If the borrower failed to deliver the project assets by the due date, it was liable to pay liquidated damages.

Subject to the inter-creditor agreement (and therefore the relationship with the non-Islamic financing documents), acceleration of the Islamic facility agreement would lead to termination of the Istisna.

Upon termination, the borrower was to reimburse to the Islamic SPV all payments received less the amount of any liquidated damages paid, and the Islamic SPV was to waive all its rights and claims to ownership and title to the assets.

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The Ijarah would also not come into effect. This operated after completion of the construction.

Following delivery of the project assets under the terms of the Istisna, the Islamic SPV agreed to lease the project assets to the borrower for the period of the lease and the borrower agreed to pay lease payments (equivalent to debt service) to the Islamic SPV. As owner of the assets, the SPV had de facto security over them.

Akin to the restrictions and covenants placed upon the borrower according to conventional debt facilities, the borrower undertook to use the leased project assets solely for the purposes contemplated in the Islamic facility agreement. Furthermore, The Islamic SPV and the Islamic facility agent made no representation or warranty as to the project assets so that risk of title, defects, and so on all rested with the borrower, who waived any claim caused by the project assets. The Islamic SPV’s rights to take any enforcement action (e.g., remedies following events of default) were governed by the terms of the inter-creditor agreement.

The borrower was entitled to terminate the Ijarah voluntarily by giving notice. Upon termination, including payment of the final lease payment (i.e., maturity), the Islamic SPV was to sell the project assets to the borrower according to the sale undertaking (see below) and the Islamic facility agreement. Subject to the terms of the inter-creditor agreement and the other non-Islamic documents, the Ijarah could be terminated following certain events of default.

during the term of this Ijara, the ownership of the project assets remained with the Islamic SPV. The borrower could require the

Islamic SPV to repair, reinstate, or replace project assets that were damaged or destroyed, save to the extent that such damage or destruction was caused by the borrower’s willful misconduct or gross negligence.

The Islamic SPV remained responsible for the major maintenance (maintenance of a capital nature) of the project assets so that they continued to provide the service for which the borrower rented them, although it was acknowledged that these maintenance obligations (and the procurement of insurance) would be subcontracted to the borrower under the service agency agreement (see below).

As with the operational covenants contained in conventional financing of this nature, the borrower was responsible for ordinary maintenance, such as inspections of the project assets, maintenance of the assets in good and serviceable repair, and maintenance of records.

The Islamic finance providers and the Islamic SPV authorized the Islamic facility agent to act on their behalf to exercise their respective rights and perform their respective obligations under the Islamic finance documents.

The Islamic finance providers, the Islamic SPV, and the borrower acknowledged that the payments made by the Islamic facility agent directly to the borrower (sourced from the Islamic finance providers under the Islamic facility agreement) were payments satisfying the Islamic SPV’s obligation to pay consideration for the project assets under the Istisna agreement.

The Islamic SPV owned the assets and appointed the borrower as its service agent to operate and maintain the leased project assets, keep such assets fully insured, and pay any applicable ownership taxes, thereby restoring certain of the risks of asset ownership to the borrower.

The Islamic SPV undertook to sell the leased assets to the borrower upon payment of a lease termination payment (a discharge of all outstanding amounts owed, effectively allowing prepayment of the Islamic facility and release of the rights of the Islamic finance providers upon discharge of the Islamic financing).

The borrower undertook to purchase the leased project assets from the Islamic SPV upon payment of a lease termination payment (effectively an acceleration of the Islamic facility).

Given the principles behind Islamic financing outlined above, the Islamic finance providers were not party to the other finance documents. However, each of the Islamic finance providers was, through the Islamic facility agent, bound by the inter-creditor agreement with the non-Islamic lenders and was

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therefore subject to the inter-creditor provisions governing the relationship between the lenders. These provisions included the method of voting and decision-making; arrangements for joint consultation and actions regarding approval rights and waivers; limitation of the parties’ rights of enforcement upon default; and the application of proceeds upon enforcement.

This Islamic facility agreement contained various representation and warranties, covenants and events of default by the borrower.

Unlike conventional financing, the Islamic facility agreement did not provide a guaranteed interest rate of return, as the prohibition of interest is a significant principle of Islamic financing. As an alternative, the Islamic finance documents provided for advance amount payments (providing an effect similar to interest calculated on the outstanding principal on or before the lease began) and a lease variable element (providing an effect similar to interest calculated at any time after the lease began).

while the Islamic finance documents did not contain any express provision for the payment of default interest, failure by the relevant party to pay any amount owing under the applicable Islamic finance document resulted in an obligation

to make a payment connected to the delay. If an Islamic finance provider received a payment that was solely attributable to the borrower’s delay in payment, that participant was required to hand over the net amount (after deducting the actual costs and expenses suffered or incurred by it as a consequence of the borrower’s failure to comply with the applicable Islamic finance document) to such charitable foundation or scientific or medical institution as it selected.

The diagram below illustrates a typical project finance transaction that incorporates an Islamic financing structure.

construction phase 1—The borrower develops, constructs, and sells project assets to the Islamic SPV. As consideration, the Islamic SPV makes phased payments to the borrower (equivalent to loan advances).

Post-construction phase 2—The Islamic SPV leases project assets to the borrower. The borrower makes lease payments (equivalent to debt service).

Islamic finance providers

Non-Islamic lenders

Intercreditor agreement

Project assets

Islamic facility agent

Islamic SPV

Borrower

Islamic facility

agreement

Investment

agency

agreement

Purchase undertaking

Sale undertaking

Service agency agreement

Istisna’a

Ijara

Construction phase1

Post-construction phase2

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StAndArd & Poor’S rAtIngS

oF IJArAH SuKuK

As the above makes clear, Ijarah Sukuk are financial obligations issued by a lessor and backed primarily by a lease stream from a credit lessee. Since Shariah frowns on the payment of interest, Ijarah Sukuk transactions work by passing a lease stream through to the holder of the Ijarah Sukuk, rather than being structured as an interest-bearing loan secured by a pledge of assets.

Ijarah Sukuk are one of many forms of Sukuk (notes) compliant with Shariah on the provision and use of financial products and services. It should be noted that only an appropriate Islamic body may recognize the compliance of the terms of any Sukuk issuance with Shariah and that individual investors should make adequate inquiries as to Shariah compliance. Standard & Poor’s rating process does not address Shariah compliance.

Ijarah Sukuk ratings

Background

This section describes ratings of Ijarah Sukuk, typical transaction configurations, and factors affecting the ratings. These factors include the status and responsibilities of the special purpose entity (SPE) typically found in Ijarah Sukuk,

the adequacy of the lease payment stream that will service the rated Ijarah Sukuk, and, where the underlying obligor is a government, its commitment to such transactions as an important and continuing source of financing.

Standard & Poor’s has rated Ijarah Sukuk transactions backed by various types of underlying credit lessees, including sovereign governments, regional governments, corporations, and multilateral lending institutions. Standard & Poor’s also rates financial institutions that provide Islamic banking and insurance services.

In most cases, Standard & Poor’s has assigned Ijarah Sukuk the same ratings as it assigns to the lessees creating the payment stream. This practice reflects the unconditional, irrevocable nature of the lease, any third-party lease guarantees, sale and purchase agreements, and/or financial hedges that are found in the transaction. Ratings lower than those given to the lessee are assigned where there are diminished recovery prospects, greater risks associated with lease payments, or other factors supporting such a distinction. Higher ratings are unlikely without additional risk-mitigating features, in the case of sovereigns, although for corporates Ijarah Sukuk may resemble certain characteristics of secured loans and be notched up accordingly.

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How do Ijarah Sukuk ratings compare with those of the lessee?

Ijarah Sukuk should receive the same rating as the underlying lessee if the transaction cash flows survive reasonable stress scenarios short of a payment default by the lessee, if the lessee views Ijarah (leasing) financing as indistinguishable in terms of priority with conventional debt-based financing, and if recovery prospects are similar to those in a debt-based transaction. where there is a material risk of government appropriation, as is the case for government leases in a variety of jurisdictions, or other financial or operating risk, the rating of the Ijarah Sukuk may be below that of the lessee.

Standard & Poor’s does not exclude the possibility of rating Ijarah Sukuk above the rating of the lessee. This is most likely to occur when the lessee has a ratable corporate credit profile and the credit characteristics of the Ijarah Sukuk resemble, for credit purposes, those of secured debt, allowing the rating to be notched up above that of the lessee, depending on the strength of the security. To notch up the rating where the lessee is a sovereign entity (or where the lessee seeks a rating above that of the sovereign of domicile), some features of the transaction would have to mitigate the risks posed by a potential sovereign default, including the risk of the sovereign restricting access by the issuer to foreign exchange needed for payments to the holders of the Ijarah Sukuk. In such an instance, an offshore mechanism for collecting cash flows generated by the assets is likely to be necessary for the Ijarah Sukuk to achieve a rating higher than that of the sovereign of domicile.

How are most rated Islamic financings configured?

Standard & Poor’s has rated two broad types of Islamic financing: (1) Ijarah Sukuk, where the whole transaction, including the ownership structure as well as the notes, is Shariah-compliant; and (2) the ‘ownership’ Shariah-compliant structure, where the bonds are issued by an unaffiliated SPE with the proceeds used to acquire the assets from the lessee/seller, combined with a put/tender feature. In this second configuration, the securities themselves may not necessarily be Shariah-compliant.

Most Ijarah Sukuk that Standard & Poor’s has rated are set up in the following manner:

1. The seller sells certain assets, such as an office build-ing, land, or an airport, to a special purpose vehicle (the SPV) that may be affiliated or unaffiliated with the seller (depending on the degree of compliance with Shariah)

for a determined price (the purchase price).

2. The SPV raises financing to purchase the assets by issu-ing Ijarah Sukuk to investors in an amount equal to the purchase price. The Ijarah Sukuk represent an equity interest in the SPE’s assets, which may be indirect or direct depending on the type of SPE.

3. The SPV then leases the assets to the lessee, an affili-ate of the seller, or directly back to the seller itself, in exchange for periodic lease payments. These lease pay-ments should match the obligations of the SPE under the Ijarah Sukuk.

4. At maturity, or on a dissolution event, the SPE sells the assets back to the seller at a predetermined value. That value should be equal to any amounts still owed under the terms of the Ijarah Sukuk.

other transaction configurations are possible. For example, the SPE may sublease back to the lessee the assets that have been first leased to the SPE by the same lessee. Typically, the head lease has a longer maturity than the sublease. Such configurations do not include the sale of assets and may be preferred when the sale of an asset is difficult, either legally or for political reasons (for example, a sovereign may not wish to sell the country’s main airport).

Additionally, depending on the extent of Shariah compliance, prior to maturity the lessee may have the right to call for the assets upon certain amounts due under the Ijarah Sukuk as well as other expenses, and the SPE might have the right to tender the assets back to the lessee. The lease may also be supported by affiliate guarantees. currency or other hedges may also play a part in transaction dynamics.

Do Standard & Poor’s ratings address Shariah compliance?

Standard & Poor’s bases its credit rating opinion on the compliance of an Ijarah Sukuk transaction with applicable commercial law, and the rating therefore does not reflect the compliance of the transaction with Shariah. English law, new York State law, and the commercial codes of the countries where the assets are located have, in part, governed transactions rated by Standard & Poor’s.

Various scholars charged with interpreting the Holy Qur’an and other fundamental Islamic writings offer opinions on the conformity of transactions with the principles of Shariah. were a transaction to be governed solely by Shariah, such a transaction might be difficult to rate because of the lack of predictability

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of outcomes in a Shariah court, with the possibility of Shariah principles overriding otherwise valid commercial contractual obligations. Indeed, certain Shariah-compliant transactions have specifically disavowed Shariah jurisdiction as a matter of form, although they may satisfy Shariah requirements as a matter of substance.

What are the rating implications if Islamic authorities do not recognize a transaction as Shariah-compliant?

If a sovereign or an Islamic legal authority declares (at the time of issuance or during the life of the Sukuk) that Ijarah Sukuk do not comply with Shariah, there might not necessarily be any credit implications, although such a result could influence market liquidity. Most Ijarah Sukuk transactions involve contractual agreements, subject to commercial law; the enforceability of the transaction in a commercial court should not be affected by any adverse determination by a Shariah court. Most, if not all, conventional debt structures from Islamic nations do not comply with Shariah, yet this has not curtailed their bond issuance.

However, to the extent that Ijarah Sukuk are governed by Shariah and are subject to the jurisdiction of the Shariah courts (which is not the case with any Ijarah Sukuk currently rated by Standard & Poor’s), then a declaration by such a court that the Ijarah Sukuk do not comply with Islamic law could render the Ijarah Sukuk void and unenforceable.

Criteria guidelines

Standard & Poor’s criteria for rating Ijarah Sukuk take into consideration four main elements, which can be expressed in the form of questions, as follows.

1. Do the lease and repurchase payments from the lessee to the SPE have the same credit quality as the lessee’s conventional debt?

Standard & Poor’s analyses the lease and repurchase obligations to determine whether they are timely, irrevocable, and unconditional. If a government is the lessee, Standard & Poor’s also gauges appropriation risk (the risk that the legislature will allocate funds to meet the lease obligation). An important factor in determining if the Ijarah Sukuk may be rated the same as the lessee’s conventional debt is whether the lease and other relevant obligations rank on an equal basis with the lessee’s conventional debt. Should the lease obligation be subject to budgetary appropriation or other risks that, by comparison, weigh less heavily in issuances of conventional debt, Standard & Poor’s might notch the Ijarah Sukuk down from the credit rating of the lessee. other factors that suggest lower credit quality include these:

• Situations under which the lessee may not have to redeem outstanding principal by repurchasing the assets at matu-rity or in a dissolution event; and any other conditions that allow exceptions for timely payment or for lower recovery prospects.

• The essentiality of the asset to the lessee is also considered when assessing the lessee’s repurchase commitment.

2. Is the SPE a single-purpose pass-through vehicle between the lessee and the holders of Ijarah Sukuk?

creditworthiness might be impaired relative to the lessee’s rating if the issuer is not an SPE, for example, or if it has purposes other than engaging in the bare necessities for implementing the transaction. Loans to the issuer from parties other than the holders of the Ijarah Sukuk are of particular concern, especially if the third parties could interfere with the lease payment stream destined for the Ijarah Sukuk. Furthermore, if the issuer maintains a sinking fund, the credit exposures of the SPE will be considered.

ownership and management of the issuer is also evaluated. Finally, if the lessee owns the issuer and there are potential conflicts of interest, these would be taken into account in the

analysis.

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3. Do the transaction’s cash flows provide for the full and timely payment of the obligations to holders of Ijarah Sukuk?

Standard & Poor’s compares the terms and conditions of the asset lease and those of the Ijarah Sukuk, analysing how potential shortfalls are covered in the transaction. For example, shortfalls that might arise from foreign currency exposure can be covered by the lease (as supplemental rent), by a lease guarantee from another creditworthy entity, or by a hedge. Usually, government lessees agree to cover, on a timely basis, any additional expenses related to taxes, levies, duties, fees, and charges, whenever they arise. Another important credit consideration is whether the sold assets are free of any lien, pledge, mortgage, security interest, deed of trust, charge, or other encumbrance.

Risks to the leased assets from loss or damage can be mitigated by insurance, though the terms and exceptions, as well as risk of insurer’s default, must be examined carefully.

4. If the lessee is a government, is its commitment to its Ijarah Sukuk similar to its commitment to other types of debt financing?

‘willingness-to-pay’ considerations are of particular importance for sovereign lessees. Historically, financially distressed sovereign lessees have occasionally discriminated among their pari passu financial obligations. Standard & Poor’s examines the extent to which the government includes Ijarah Sukuk in government accounts as debt obligations, indistinguishable in terms of priority from conventional debt. ‘willingness’ considerations are supported by Ijarah Sukuk financing being designed to target investors interested in Shariah-compliant instruments, rather than to create a new stratum of obligation.

ConCLuSIon—nEW ProduCt

dEvELoPMEnt

There are an estimated 1.61 billion Muslims worldwide, making Islamic banking one of the fastest growing segments of the financial industry.

According to Standard and Poor’s surveys, 20 percent of the customers in the Gulf region and Southeast Asia would choose an Islamic banking product over a similar conventional product. There are significant middle-class urban and suburban populations that already use conventional banking, and therefore present ripe opportunities for Islamic banks.

Most important to note, outside of the religious and political allure of Islamic banks, is that people are choosing their services for the safety they are perceived to offer.

However, in order for Islamic financial institutions to be competitive with conventional products and attractive to customers, Islamic financial products must meet the risk/reward profiles of investors and issuers, while fulfilling the tenets of Sharia and remaining sufficiently cost-effective. Additionally, Islamic financial institutions must educate their personnel to understand the tenets of Islamic law that pertain to finance, and must train them to comply with Sharia as they serve their Islamic customer population.

while the size of Islamic finance and banking activities, estimated to range from $500 billion to $1 trillion, is still a fraction of conventional banking and finance activities, estimated annual growth rates of 10 to 15 percent seen in recent years emphasize the potential market for such activities. Amidst this growing market opportunity there are several inherent risks, not the least of which is the attraction of “reverse engineering” traditional financial products to become Islamic financial products. If this is done by personnel not well versed in the Islamic financial system, then risks abound.

The most well-known aspect of an Islamic financial system is the prohibition against paying or receiving interest (riba) on capital. Essentially, any positive, fixed, predetermined rate tied to the maturity and the amount of principal, which is guaranteed irrespective of the performance of the investment, is considered riba and is therefore prohibited.

This prohibition is not to be confused with a rate of return or profit on capital, since earning and sharing profit is very much encouraged within Islam. Moreover, profit, determined ex post, symbolizes the creation of additional wealth through successful entrepreneurship, whereas interest, determined ex ante, is a cost that is accrued irrespective of the outcome of business operations, and may create wealth even if there are business losses.

It is within this context that one should consider the development of new Ijarah products.

To provide further clarity in terms of development of new products as well as new institutions to market Ijarah products one should take into consideration IFSB 9.0.

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ISLAMIC FInAnCIAL SErvICES BoArd

IFSB 9.0

guiding Principles on Conduct of Business for Institutions offering Islamic Financial Services

The Guiding Principles on conduct of Business for Institutions offering Islamic Financial Services (hereafter Guiding Principles) are applicable to all institutions offering Islamic financial services (IIFS) in the banking, Takaful (Islamic insurance), and capital market segments, including windows of conventional firms. In accordance with the objectives of the IFSB, the Guiding Principles will not reinvent the wheel but will instead, wherever appropriate, reinforce the existing internationally recognized frameworks or standards for the conduct of business.

Principles of business conduct are defined as those principles that are intended to govern the activities of financial services firms with regard to (a) the protection of the interests of their customers, and (b) the integrity of the market. For IIFS, a code of ethical business conduct derives from principles of the Shariah as set out in the Holy Qur’an.

the guiding Principles

Principle 1: Truthfulness, Honesty and Fairness

An IIFS shall aspire to the highest standards of truthfulness, honesty, and fairness in all its statements and dealings, and must treat its customers fairly.

Principle 2: Due Care and Diligence

An IIFS shall exercise due care and diligence in all its operations, including the way it structures and offers its products and provides financing, with particular regard to Shariah compliance and to the thoroughness of research and risk management.

Principle 3: Capabilities

An IIFS shall ensure that it has in place the necessary systems and procedures, and that its employees have the necessary knowledge and skills, to comply with these principles and other IFSB standards.

Principle 4: Information About Clients

An IIFS shall take steps to ensure that it understands the nature and circumstances of its clients, so that it offers those products most suitable for their needs, as well as offering financing only for Shariah-compliant projects.

Principle 5: Information to Clients

An IIFS shall provide clear and truthful information both in any public document issued and to its actual and prospective clients, both during the sales process and in subsequent communications and reports.

Principle 6: Conflicts of Interest and of Duty

An IIFS shall recognize the conflicts of interest between it and its clients that arise from the type of products it offers, and either avoid them or disclose and manage them, bearing in mind its fiduciary duties to investment account holders as well as shareholders.

Principle 7: Shariah Compliance

An IIFS must be able to demonstrate that its operations are governed by an effective system of Shariah governance and that it conducts its business in a socially responsible manner.

IFSB 9.0 contains a model self-assessment questionnaire to ensure the institutions and its products are Shariah complaint.

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ISLAMIC FInAnCIAL gLoSSArY

al adl: A trusted and honourable person, selected by both parties to a transaction. A trustee.

al Maqasid al Shariah: The objective of Shariah.

amana/amanah: Literally means reliability, trustworthiness, loyalty and honesty, and is an important value of Islamic society in mutual dealings. It also refers to deposits in trust, sometimes on a contractual basis.

bai/bay: contract of sale, sale and purchase.

bai al-salam: Advance payment for goods. while normally the goods need to exist before a sale can be completed, in this case the goods are defined (such as quantity, quality, workmanship) and the date of delivery fixed. commonly applied in the agricultural sector where money is advanced for inputs to receive a share in the crop.

diminishing musharaka: A form of partnership that ends with the complete ownership of a partner who purchases the share of another partner in that project by a redeeming mechanism agreed between both of them.

fatwa (pl. al fatawa): An authoritative legal opinion based on the Shariah.

fiqh: Practical Islamic jurisprudence. can be regarded as the jurists’ understanding of the Shariah. There are four Islamic schools of jurisprudence: al-Shafie, al-Hanafi, al-Maliki and al-Hanbali.

gharar: Uncertainty in a contract or sale in which the goods may or may not be available or exist. Also, ambiguity in the consideration or terms of a contract—as such, the contract would not be valid.

hadith: The narrative record of the sayings, doings and implicit approval or disapproval of the Prophet.

halal: Permissible, allowed, lawful. In Islam, there are activities, professions, contracts and transactions that are explicitly prohibited (haram) by the Qur’an or the Sunnah. Barring these, all others are halal. An activity may be economically sound but may not be allowed in Islamic society if it is not permitted by the Shariah.

haram: Unlawful, forbidden (see halal). describes activities, professions, contracts and transactions that are explicitly prohibited by the Qur’an or the Sunnah.

hawala: Bill of exchange, promissory note, cheque or draft. A debtor passes on the responsibility of payment of his debt to a third party who owes the former a debt. Thus, the responsibility of payment is ultimately shifted to a third party. Hawala is used in developing countries as a mechanism for settling international transactions by book transfers.

ijarah/ijara: Lease, hire or the transfer of ownership of a service for a specified period for an agreed lawful consideration. This is an arrangement under which an Islamic financial institution leases equipment, a building or other facility to a client for an agreed rental.

ijarah muntahla bittamleek/ ijarah wa iqtina: A leasing contract used by Islamic financial institutions that includes a promise by the lessor to transfer the ownership of the leased property to the lessee, either at the end of the lease or by stages during the term of the contract.

ijtihad: Literally effort, exertion, industry, diligence. As a legal term, it means the effort of a qualified Islamic jurist to interpret or reinterpret sources of Islamic law in cases where no clear directives exist.

Istisna/istisna’a: A contract of sale of specified goods to be manufactured with an obligation on the manufacturer to deliver them on completion. It is a condition in istisna that the seller provides either the raw material or the cost of manufacturing the goods.

maisir/maysir: The forbidden act of gambling or playing games of chance with the intention of making an easy or unearned profit.

manfa’a: A form of contract in which one party gains the right to use or benefit from the use of an asset.

mudaraba/mudarabah: A form of contract in which one party (the rab-al-maal) brings capital and the other (the mudarib) personal effort. The proportionate share in profit is determined by mutual consent, but the loss, if any, is borne by the owner of the capital, unless the loss has been caused by negligence or violation of the terms of the contract by the mudarib. A mudaraba is typically conducted between

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an Islamic financial institution or fund as mudarib and investment account holders as providers of funds.

mudarib: The managing partner or entrepreneur in a mudaraba contract (see above), see also rab almal.

murabaha: A contract of sale with an agreed profit mark-up on the cost. There are two types of murabaha sale: in the first type, the Islamic financial institution purchases the goods and makes them available for sale without any prior promise from a customer to purchase them, and this is termed a normal or spot murabaha. The second type involves a promise from a customer to purchase the item from the financial institution, and this is called murabaha to the purchase order. In this latter case, there is a pre-agreed selling price that includes the pre-agreed profit mark-up. normally, it involves the financial institution granting the customer a murabaha credit facility with deferred payment terms, but this is not an essential element.

musharaka/musharakah: An agreement under which the Islamic financial institution provides funds that are mingled with the funds of the business enterprise and possibly others. All providers of capital are entitled to participate in management but are not necessarily obliged to do so. The profit is distributed among the partners in a pre-determined manner, but the losses, if any, are borne by the partners in proportion to their capital contribution. It is not permitted to stipulate otherwise.

qard al hasan/qard hassan: A virtuous loan in which there is no interest or mark-up. The borrower must return the principal sum in the future without any increase.

rab-al-maal: The investor or owner of capital in a mudaraba contract (see above).

rahn: A mortgage or pledge.

riba: Interest. Sometimes equated with usury, but its meaning is broader. The literal meaning is an excess or increase, and its prohibition is meant to distinguish between an unlawful exchange in which there is a clear advantage to one party in contrast to a mutually beneficial and lawful exchange.

riba al-buyu: A sale transaction in which a commodity is exchanged for the same commodity but unequal in amount or quality, or the excess over what is justified by the counter-value in an exchange/business transaction.

sadaqa: Voluntary charity.

salam: A contract for the purchase of a commodity for deferred delivery in exchange for immediate payment.

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Shariah /Shari’a/Shari’ah: In legal terms, the law as extracted from the sources of law (the Qur’an and the Sunnah). However, Shariah rules do not always function as rules of law as they incorporate “obligations, duties and moral considerations that serve to foster obedience to the Almighty.”

shirkat al-aqad: A joint-venture partnership.

shirkat al-milk: A co-ownership partnership.

saak: Participation securities, coupons, investment certificates.

sukuk: Plural of saak (see above).

Sunnah: The way of the Prophet Muhammad including his sayings, deeds, approvals, and disapprovals as preserved in the hadith literature. It is the second source of revelation after the Qur’an.

Takaful: A Shariah-compliant system of insurance based on the principle of mutual support. The company’s role is limited to managing the operations and investing the contributions.

tawarruq: Literally monetisation. The term is used to describe a mode of financing, where the commodity sold is not required by the borrower but is bought on deferred terms and then sold to a third party for a lower amount of cash, so becoming “monetised”. The reverse of murabaha.

ummah: The community or nation. Used to refer to the worldwide community of Muslims.

urf: The customs of a community.

wa’d: A promise or unilateral undertaking.

wadiah: A deposit.

wakala: Agency, an agency contract that generally includes in its terms a fee for the agent.

wakeel al-Istithamr: An investment agent.

waqf: A charitable endowment.

zakah/zakat: A tax that is prescribed by Islam on all persons having wealth above an exemption limit at a rate fixed by the Shariah. Its objective is to collect a portion of the wealth of the well-to-do and distribute it to the needy. The way it is distributed is set out in the Qur’an. It may be collected by the state, but otherwise it is down to each individual to distribute the zakat.

Shariah compliance

The Islamic finance industry has adopted the practice of appointing Shariah scholars to determine compliance with Shariah. Since Shariah can in certain areas be general and implicit, appropriately qualified scholars are relied upon to determine the relevant rules for financial transactions. These scholars are appointed to the Shariah Supervisory Boards of financial institutions and investment funds to approve Islamic product lines and individual transactions as well as to audit these institutions and funds to ensure continuing compliance. Recently, Shariah consultancies have been established to provide a similar service.

Shariah Supervisory Boards (or, for smaller operations, a single Shariah Scholar) evidence their opinion on compliance by issuing a fatwa (an Islamic legal opinion). Fatwas are important documents and are often a condition precedent to the effectiveness of a transaction. Indeed, many offerings, such as Islamic funds or Sukuk (see section 7.5) sometimes append the fatwa issued to the relevant offering documents.

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rEFErEnCES

1) dr. Zeti Akhtar Aziz, Governor, Bank negara Malaysia — ’Islamic Finance: An Agenda for Balanced Growth and development’ Publication: EnP newswire date: Monday, october 18, 2010 http://www.allbusiness.com/trade-development/trade-development-finance-banks/15205013-1.html

2) Islamic Finance and Global Financial Stability, 2010 http://islamicfinancenews.files.wordpress.com/2011/01/ifsb-irti-idb2010.pdf Graphic Page 15

3) State Bank of Pakistan, http://www.sbp.org.pk/

4) Accounting and Auditing organization for Islamic Financial Institutions (AAoIFI), www.aaoifi.com/keypublications.html

5) The International Islamic Financial Market (IIFM), www.iifm.net

6) The International Islamic Rating Agency (IIRA), www.iirating.com

7) The Islamic Financial Services Board (IFSB), www.ifsb.org

8) Basel committee on Banking Supervision, http://www.bis.org/bcbs/

9) International organization of Securities commissions, http://www.iosco.org/

10) International Association of Insurance Supervisors, www.iaisweb.org

11) Source: Islamic Research and Training Institute, Islamic development Bank.http://www.irtipms.org/PubdetE.asp?pub=213&search=ijarah&mode=allwords, http://www.irtipms.org/PubdetE.asp?pub=216&search=ijarah&mode=allwords

12) Miles, Adrian (1993), “An Introduction to Securitization of Lease” in Adrian Hombrook, Studies in Leasing Law and Tax, London: Euromoney Publications, p.15.

13) decision no. 5 of the 4th Annual Plenary Session of the oIc Fiqh Academy, held in Jeddah 18-23/6/1408H (6-11/2/1988G) — International Islamic Fiqh Academy, www.fiqhacademy.org.sa

14) Shariah Advisory council, Bank negara Malaysia, http://www.bnm.gov.my/index.php?ch=7&pg=715&ac=802

15) Regional center for Arbitration kuala Lumpur, http://www.rcakl.org.my/

16) State Bank of Paksitan, Shariah Rulings, http://www.sbp.org.pk/departments/pdf/StrategicPlanPdF/Appendix-c%20Shariah%20compliance.pdf

17) Shariah compliant Ijarah car Financing, Maybank Malaysia, http://www.maybank2u.com.my/mbb_info/m2u/public/personalList04.do?channelId=LoA-Loans&programId=LoA03-carLoans&chcatId=/mbb/Personal/LoA-Loans, http://www.maybank2u.com.my/mbb_info/m2u/public/personaldetail04.do?channelId=LoA-Loans&cntTypeId=0&cntkey=LoA03.02&programId=LoA03-carLoans&chcatId=/mbb/Personal/LoA-Loans, http://www.maybank-ib.com/services/islamicproducts.html

18) Shariah compliant Ijarah Home Financing, Ahli United Bank, http://www.iibu.com/buy_home/ijarahow.aspx

19) Forward Ijarah, dubai Islamic Bank, http://www.dib.ae/en/personalbanking_home_finance_forward_ijarah.htm

20) Ijarah (Ending with Title deed) Muntahia Bittamleek, dubai Islamic Bank, http://www.dib.ae/en/realestate_lease.htm

21) Honohon, Patrick. 2007. “cross-country Variations in Household Access to Financial Services.” Presented at the world Bank conference on Access to Finance, washington, d.c., 15 March.

22) karim, nimrah, Michael Tarazi, and Xavier Reille. 2008. “Islamic Microfinance: An Emerging Market niche.” Focus note 49. washington, d.c.: cGAP, August.

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23) Islamic Finance Today, http://www.sailanmuslim.com/news/ijara-a-more-compassionate-form-of-leasing-suresh-r-i-perera-llb-attorney-at-law-acma-director-tax-regulatory-kpmg-sri-lanka/

24) 13 Para 8, FRS 117, Malaysian Accounting Standards Board 2005,

a) FRS 117 Leases, A Practical Guide to Financial Reporting Standards (Malaysia), page307,

b) Para 2, FRS 117, Malaysian Accounting Standards Board 2005.

c) Para 8, FRS 117, Malaysian Accounting Standards Board 2005

d) http://www.masb.org.my/

e) http://www.masb.org.my/index.php?option=com_content&view=article&id=321%3Afrs117-pg3&catid=6%3Amasb-exclude-private&Itemid=32

25) Four Main Schools of Islamic Thought, http://www.islamic-banking.com/islamic-jurisprudence.aspx

26) The law firm of Agha & Shamsi, UAE , http://www.aghashamsi.com/mediacentre-publications.htm

27) Islamic Project Finance, chadbourne and Parke LLP, Islamic Project Finance: Structures and challenges, February 2010, http://www.chadbourne.com/files/Publication/c4ae820b-24ba-4e5b-9f7d-186814289e7e/Presentation/PublicationAttachment/20d7847a-8644-4b0f-b3e7-19a496eebf22/pfn_Intl_0210.pdf

28) dolfin Gas Project, khaleej Times, Sept 12, 2005, http://www.khaleejtimes.com/displayarticle.asp?xfile=data/business/2005/september/business_september257.xml&section=business

29) Sukuk, Islamic Bonds (Sukuk): Its Introduction and Application, By Shariq nisar, http://www.financeinislam.com/article/8/1/546

30) Sukuk, http://www.inceif.org/_system/media/pdf/global_forum/speech_badlisyah.pdf

31) Ijarah Sukuk, operatonal Models for Ijarah, Shariah Board Resolutions, Securities and Exchange organization, Iran, www.rdis.ir, http://www.rdis.ir/RdFiles/IslamicFin/operational_models_for_Ijarah46.pdf

32) Ijarah Sukuk Model Project Finance, Innovation in the Structuring of Islamic Sukuk Securities, Professor Rodney wilson durham University, Institute for Middle Eastern and Islamic Studies, http://www.assaif.org/content/download/586/4393/file/Innovation%20in%20the%20Structuring%20of%20Islamic%20Sukuk%20securities.%E2%80%A6.pdf

33) Standard and Poors Ratings, http://www.standardandpoors.com/ratings, also How Standard and Poors Rate Ijarah Sukuk, http://www.zawya.com/Story.cfm?id=ZAwYA20050221073726&pagename=SukukMonitor

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