8/3/2019 Islamic Fin, REPORT
1/20
SECURITIZATION OF ASSETS
For a Lay man, Securitization is the process of transforming a non-liquid asset into a
marketable security that has the ability to generate cash. It has such ability because
securities are tradable financial instruments therefore these are more liquid than the
underlying asset against which it has been generated. For example, a bunch of
consumer loans are changed into a publically issued debt security. Securitization of
assets is done to reduce risk, to create and improve liquidity, and for improving
economic efficiency or marketability.
When Companies go for Securitization of Assets they issue certificates of ownership
against a pool of investment. It is the process of transforming a loan or mortgage into a
tradable market security by issuing a bill of exchange or other negotiable paper in place
of it.
This process, in conventional banking, Securitization indicates sale of such assets that
create cash flows from the company that owns them, to another institution whose only
job is to issue notes against these assets. The notes issued by this second institution
are backed by the cash generated by the original assets of prior company.
The first company, owner of the cash generating asset, is called the originator. The
other company mentioned in this explanation which purchases the cash flow generating
assets is known as the Special Purpose Vehicle (SPV). The SPV shall hold the assets
purchased from the originator as collateral for the securities issued and sold to theinvestors.
8/3/2019 Islamic Fin, REPORT
2/20
ISLAMIC SECURITIZATION
The basics of Islamic securitization are specifically described as a legal structure that
meets with the conditions of the basics of Islamic Finance and also fulfills the economic
traditional objective of an asset-based securitization structure. In the conventional
securitization process the rights of ownership on revievables are shifted from the
originator to an SPV. This SPV, further releases notes that can be sold to investors
then.
Whereas Islamic Finance relates to the transfer of assets from an originator into a trust
or similar SPV with the issuance of a fund under the name ofSukuk and the return on
this Sukukresulting from the cash inflow from the transferred assets.
Here there is a similarity observed in the Islamic and conventional securitization, these
can follow the same principle. As we know, in Islamic finance most transactions areasset based, the basic concept of securitization and its economic aspect is particularly
in harmony with the basic concepts of Islamic Finance. The underlying asset pool or a
combination of receivables, in an Islamic securitization must be according to the
accepted Islamic financing schemes. For instance, conventional mortgages and credit
cards, which are typical conventionally securitized assets, do not comply with Sharia, as
they are interest-bearing loans. For a structure to comply with Sharia, some degree of
ownership must be transferred to the investor. Transfer of registered title is not
necessary, rather a collection of ownership rights that would allow the investors to
perform duties related to ownership (if desired) or rights granting access (subject to
notice) over the asset would be sufficient to satisfy Sharia.
The assets placed in the securitization pool generate some profits or losses that are
shared by the investors. Since the core concept of Islamic Finance does not allow
financing that is interest-based, the investors can support or invest on the basis of
partnership, but not on the basis of interest
So Islamic Securitization is the creation of securities (orSukuk) that enables investors
to participate in a pool of tangible assets, or in a pool of combination of both, tangible
and intangible assets, that creates cash flow along with the rights or other specifications
that promises the servicing or timely distribution of proceeds to the security holders.Further, the terms of security holders transfer into cash after a specified and limited
period of time.
8/3/2019 Islamic Fin, REPORT
3/20
After a brief definition, we now would like to move on with the structure of Islamic
Securitization. While talking about the structure, we will also try to put the differences
between the conventional and Islamic securitization structures and by doing so; we will
be seeking the answer of the question Why there is a need for Islamic securitization
while we already have quite improved securitization structures?
STRUCTURE OF ISLAMICSECURITIZATION
There are a number of parties involved in the securitization of assets, the key players
involved are as follows:
ORIGINATOR: The originator or the issuer ofSukuk, who sells its assets to the
SPV and uses the realized funds. Originators are mostly governments or big
corporations, but they could be banking or non-banking Islamic financial
institutions. The issuers may charge a fee or commission or a consideration for
servicing for the arrangement of this issue.
SPV: The SPV is an entity set up specifically for the securitization process and
for managing the issue. The basic function it serves is the purchase of assets
from the originator and funds the purchase price by issuing Sukuk. It is also
called as Issuer at few occasions.
INVESTMENT BANKS: These banks serve as issue agents. These serve the
functions of underwriting; lead managing and book-making services for Sukuk
against any agreed-upon fee or commission. These services are provided by
syndicates of Islamic banks and big multinational banks operating Islamic
windows.
INVESTORS: Subscribers ofSukuk mostly central banks, Islamic banks and
non-bank financial institutions and individuals who subscribe to securities issued
by the SPV.
This list shows us the fact that an Islamic securitization structure perfectly mimics a
conventional securitization in relation to the parties involved.
8/3/2019 Islamic Fin, REPORT
4/20
EXAMPLE:
A widely used Islamic securitization structure, which also illustrates the exact same
structure with the Sukuk issue made by the German state of Saxony-Anhalt in
2004,170would resemble the following scenario:
The originator of the assets (e.g. the owner of office buildings) sells the assets toan SPV.
The SPV raises financing to purchase the assets by issuing Ijara Sukuk171(i.e.
leasing bonds) to investors. The amount raised by issuing the Sukuk is equal to
the purchase price.
The Ijara Sukukrepresent equity interest in the SPV, and in turn, in the assets.
The SPV leases the assets back to the seller/originator. The seller makesperiodic lease payments to the SPV, which should match the SPVs obligations
under the Ijara Sukuk.
At maturity, the SPV sells the assets back to the originator (i.e. lessee or
previous seller/owner of the assets). The amount should cover any liabilities
owed by the SPV under the Ijara Sukuk.
The figure below illustrates how an Islamic securitization structure based on ijara
basically works:
8/3/2019 Islamic Fin, REPORT
5/20
COMPARISON OF ISLAMIC ANDCONVENTIONAL SECURITIZATION:
The cash flow produced is similar to any bond. The lease payments are similar tocoupons and the repurchase proceeds paid at the end of the term constitute the
principal.
Unlike conventional securitization, the implementation of Islamic securitization requires
a two-stage fundamental verification process, which assesses the Sharia compliance
of (i) the type of assets in the underlying reference portfolio and the generation of
investment returns, and (ii) the transaction structure, which includes the configuration of
credit enhancement (and other forms of credit and liquidity support) and the form of
ownership conveyance.
Securitization under Islamic law bars interest income and must be structured in a way
that rewards investors for their direct exposure to business risk, i.e., investors receive a
share of profits commensurate to the risk they take on the basis of pre-determined
interest. However conventional securitization, which originated in non-Islamic
economies, invariably involves interest-bearing debt. Note holders would typically hold
(secured) contingent claims on the performance of securitized assets, which entitle
them to receive both pre-determined interest and the repayment of the principal amount.
Apart from that, one should know that equity in contrast to interest-bearing bonds
appears to be a permissible financial asset that can form part of the pool, such equity
must not represent ownership of an institution dealing with interest or manufacture of
any prohibited (haram) items, such as alcohol or gambling. For Islamic institutions,
underlying assets that can be securitized include lease financing (e.g. of housing,
aircraft, equipment, household items, cars etc.), equity ownership (in Sharia compliant
assets) and, in certain cases, Murabaha receivables (provided that the Murabaha
receivables comprise less than 50% of any asset pool).
The relationship between an underlying obligor and the originator should fall within one
of the usual accepted Islamic financing schemes (Murabaha, Mudaraba, Ijara, Istisna,
etc.)
It should also be noted that to comply with Sharia principles, for a traditional Sukuk
issuance, the structure to be used must involve a transfer of minimum level of
ownership in the assets before Sharia scholars can be satisfied and approve the
issuance.
8/3/2019 Islamic Fin, REPORT
6/20
To sum up, securitization in Islamic Finance is better referred to as monetization of the
underlying assets. While the sale of conventional receivables is a sale of debts, the sale
ofSukuk is a sale of shares of an asset. However, irrespective of religious conditions,
Islamic securitization offers the same economic benefits conventional structured finance
promises to generate.
Sukuk
Sukuk is an Islamic investment product that is not very old to the market. It was first
introduced in 2002 in Malaysia, when they introduced a government-backed Sukuk, the
first of its kind.
Sukuk is derived from the plural of the word Sak, or Sanadat, that means certificate of
investment or simply a certificate. These are certificates that represent the holdersproportionate ownership in an undivided part of an underlying asset where the holder
assumes all rights and obligations to such asset.
The Accounting and Auditing Organization for Islamic Financial Institutions
("AAOIFI") has issued the Standard for Investment Sukuk. Under the AAOIFI Sukuk
Standard, Sukukare defined as certificates of equal value put to use as common shares
and rights in tangible assets, usufructs, and services or as equity in a project or
investment activity. The AAOIFI Sukuk Standard carefully distinguishes Sukuk from
equity, notes, and bonds. It emphasizes that Sukukare not debts of the issuer; they are
fractional or proportional interests in underlying assets, usufructs, services, projects, orinvestment activities. Sukukmay not be issued on a pool of receivables. Further, the
underlying business or activity, and the underlying transactional structures (such as
lease), must be Sharia-compliant (that is, the business or activity cannot engage in
prohibited business activities). To sum up, the AAOIFI standard stipulates that Sukuk
must demonstrate that:
Any income generated must derive from the underlying activities for which
the funding has been used, and not simply comprise of interest;
The Sukuk must be backed by real underlying assets and these assetsmust be Halal [that is, allowable under Sharia] in nature and will be
utilized as part of a Halalactivity; and
There must be full transparency as to rights and obligations of all parties.
8/3/2019 Islamic Fin, REPORT
7/20
It is important to note that, contrary to popular perception, whilst a securitization
can be achieved via Sukuk, most Sukuk that have been issued to date are not
securitizations.
Types of SukukUntil now there have been 14 different types ofSukukstructures most common ones of
which are Sukuk al-Ijara, Sukuk al-Istisna, Sukuk al-Murabaha, Sukuk al-Musharaka
and Sukuk al-Mudaraba. The list of 14 different types ofSukukis not an exhaustive list
since other forms ofSukukcan be issued such as by copyright owners, so continuing
innovation in this field is expected.
IJARA SUKUK:
Ijara (lease) is a contract according to which a party purchases and leases outequipment required by the client for periodic rental payment. The duration of the rental
and the amount payable are agreed in advance, and ownership of the asset remains
with the lessor.
If a lessor, after executing an Ijara contract, wishes to recover his cost of
purchase of the asset to get liquidity or for the purpose of profit, he can sell the leased
asset wholly or partly, either to one party or to a number of individuals. The purchase of
proportion of the asset can be evidenced by issuing certificates, which may be called
Ijara certificates or Sukuk. The certificates must represent ownership of the pro rata
undivided parts of the asset with all related rights and obligations. Hence, Ijara Sukuksare the securities representing ownership of well-defined and known assets tied up to a
lease contract, rental of which is the return payable to the Sukukholders.
Unlike some otherSukuktypes, Ijara certificates can be negotiated and traded freely in
the market and can serve as an instrument easily convertible into cash. Sukuk
representing tangible assets or usufruct of such assets can be traded in the secondary
market, depending upon the quality, risk and profitability of the securitized assets.
Ijara Sukuk Structure: A single or a group of assets that are admissible for
ijaracontract are selected. The originator creates an SPV with separate independent
legal personality to whom it sells the asset(s) with the understanding that the originator
will lease back the asset(s) from the SPV. Rent is negotiated and a term specific lease
contract is signed. The SPV then securitizes its assets by issuing ijara Sukukfor sale to
investors. These are certificates of equal value representing undivided shares in
ownership of tangible assets. The Sukuksale proceeds provide funds to SPV to pay for
the asset(s) purchased from the originator. A rent-pass-through structure is adopted by
8/3/2019 Islamic Fin, REPORT
8/20
the SPV to pass on the rents collected from the originator-cum-lessee to Sukukholders.
These returns along with low risk and exit possibility through secondary market
(liquidity) constitute the incentives for investors to buy Sukuk. At the expiry (or
termination) of the lease deed the flow of rents would stop and ownership of the asset
pool would be with the Sukuk-holders as a group. The Sukukcontract embeds a put
option to the Sukuk-holders that the originator is ready to buy the Sukukat their face
value on maturity or dissolution date.
The figure below well explains the concept of an ijara Sukuktransaction
MUDARABA SUKUK:
Mudaraba means an agreement between two parties according to which one of the two
parties provides the capital (capital provider) for the other (mudarib) to work with on the
condition that the profit is to be shared between them according to a pre-agreed ratio.
These types ofSukukplay a vital role in the process of development financing, because
these are related to the profitability of the projects.
Mudaraba Sukuk can be instrumental in enhancing public participation in investmentactivities in any economy. These are certificates that represent projects or activities
managed on the Mudaraba principle by appointing any of the partners or any other
person as Mudarib for management of the business. As regards the relationship
between the parties to the issue, the issuer of Mudaraba certificates is the Mudarib,
subscribers are the owners of the capital and the realized funds are the Mudaraba
8/3/2019 Islamic Fin, REPORT
9/20
capital. The certificate holders own the assets of the Mudaraba and the agreed upon
share of the profits belongs to the owners of capital and they bear the loss, if any.
The figure below illustrates how Mudaraba Sukukstructure works:
This type of sukuk is of interest to originators who do not have assets that they can
easily make available for an ijara SukukorMusharaka Sukuk, but which needs finance
for additional business investments or activities. It is critical for Sharia compliance that
the mudarib is entitled to a share in the profits rather than a flat fee. A mudarib can also
be paid an incentive fee.
Mudarbah Sukuk Structure:
Steps involved in the structure:
The Sukuk issuer enters into a Mudaraba agreement with the project manager
(mudarib) for construction/commissioning of a project;
The SPV issues Sukuk to raise funds, the proceeds of which are given to the
mudarib;
The mudarib undertakes the project and collects regular profit payments from the
activity for onward distribution to investors; and
Upon completion, the mudarib, in its capacity as obligator, purchases the assets
of the project from the issuer.
Islamic Financial Institutions can offerMudaraba Sukukor certificates to the investors
who would subscribe and participate in the investment transactions. The funds
8/3/2019 Islamic Fin, REPORT
10/20
mobilized would be the variable capital (class B share) of any bank to be marketed
regionally through the selling of the issued Mudaraba Sukuk.
Mudaraba Sukuk may be issued by an existing company (which acts as mudarib) to
investors (who act as partners, or rab al-mal) for the purpose of financing a specific
project or activity, which can be separated for accounting purposes from the companysgeneral activities. The profits from this separate activity are split according to an agreed
percentage amongst the certificate holders. The contract may provide for future
retirement of the Sukuk at the then market price, and often stipulates that a specific
percentage of the mudaribs profit share is paid periodically to the Sukuk holders to
withdraw their investment in stages.
MUSHARAKA SUKUK:
In a Musharaka transaction, partners contribute capital to a project and share its risks
and rewards. Profits are shared between partners on a pre-agreed ratio, but losses areshared in exact proportion to the capital invested by each party. Thus a financial
institution provides a percentage of the capital needed by its customer with the
understanding that the financial institution and customer will proportionately share in
profits and losses in accordance with a formula agreed upon before the transaction is
consummated.
In securitizing a Musharaka arrangement, every subscriber can be given a participation
certificate, which represents his proportionate ownership in the assets of the venture or
project for which financing is being raised. Subsequent to the acquisition of substantial
non-liquid assets, these Musharaka certificates can be treated as negotiableinstruments and can be bought and sold in the secondary market.
Musharaka Sukukwhich is based on an underlying Musharaka contract is quite similar
to mudaraba Sukuk. The only major difference is that the intermediary will be a partner
of the group of subscribers. Almost all of the criteria applied to a Mudaraba Sukukare
also applicable to the Musharaka Sukuk.
In the structure shown below, the parties respective interests in the Musharaka are
represented by contractual units held by each party. The issuer will make a funding
contribution to the Musharaka from funds it raises from the Sukuk issue. The
Musharaka party will make an in-kind contribution to the Musharaka (usually includingsome tangible assets). The issuer and the Musharaka party also enter into a purchase
undertaking pursuant to which the issuer can require the Musharaka party to purchase a
set amount of units on set dates during the term of the Sukuk. The issuer will receive
profit distributions from the Musharaka and proceeds from sales of the units to the
Musharaka party. The amounts received are distributed to the Sukuk holders in
8/3/2019 Islamic Fin, REPORT
11/20
accordance with a set formula. This structure is viable when the Musharaka party can
use its in-kind contribution for a profit-generating venture. 219
The figure below is an illustration of how Musharaka Sukukstructure works:
8/3/2019 Islamic Fin, REPORT
12/20
After the project is started, these Musharaka certificates can be treated as negotiable
instruments. Certificates based on Musharaka/Mudaraba can be bought and sold in the
secondary market, subject to the condition that the portfolio of Musharaka comprises
non-liquid assets valuing more than 50 %. Profit earned by the Musharaka is shared
according to an agreed ratio. Loss is shared on a pro rata basis. Whenever there is a
combination of liquid and non-liquid assets, it can be sold and purchased for an amount
greater than the amount of liquid assets in the combination or in the pool.221
The Musharaka structure is considered more equitable and also safer for the investors
than the Mudaraba structure, as it involves both profit-and-loss-sharing between the
fund manager and the Sukuk holders, not only profit-sharing. In addition, Musharaka
Sukukholders will have added comfort and security from the cushion provided by the
managers participation in the Musharaka capital. 222
An example of Sukuk al-Musharaka is as follows: Emirates, Dubais national airline,
issued a $550 million Sukuktransaction for seven years. The deal was a structured on aMusharaka basis. The Musharaka, or joint venture, was set up to develop a new
engineering centre and a new headquarters building on land situated near Dubais
airport which was ultimately leased to Emirates. Profit, in the form of lease returns,
generated from the Musharaka were used to pay the periodic distribution on the trust
certificates. Emirates then purchased the leased assets on maturity of the transaction.
223
3.3.1.4 Murabaha Sukuk
Murabaha Sukuk are issued on the basis of murabaha sale for short-term and
medium-term financing. As mentioned earlier, the term murabaha refers to saleof goods at a price covering the
purchase price plus a margin of profit agreed upon by both parties concerned. The
advantage of this mode of financing is that, if the required commodity in the murabaha
is too expensive for an individual or a banking institution to buy from its own resources,
it is possible in this mode to seek additional financiers. The financing of a project costing
$50 million could be mobilized on an understanding with the would-be ultimate owner
that the final price of the project would be $70 million, which would be repaid in equal
installments over five years. The various financiers may share the $20 million murabahaprofit in proportion to their financial contributions to the operation.224
A commonly accepted view among Sharia scholars in a number of Islamic jurisdictions
is that murabaha debt cannot be securitized, thus making Sukuk backed by pools of
murabaha debt impermissible. This is because the sale of a document representing
8/3/2019 Islamic Fin, REPORT
13/20
money is akin to the trading of monies, which is prohibited under the rules of riba.
However, the prevailing view among Malaysian scholars (in contrast to Sharia advisers
in more conservative jurisdictions) is that so long as the underlying receivable is
connected to a true trade transaction or to a commercial transfer of a non- monetary
interest, such a receivable can be traded freely for purposes ofSharia. 225
However, it is generally accepted that a pool of receivables consisting of only
Murabaha receivables cannot be securitized for creating negotiable Sukukto be traded
in the secondary market. The purchaser on credit in a Murabaha transaction signs a
note or paper to evidence his indebtedness towards the seller. That paper represents a
debt receivable by the seller. Transfer of this paper to a third party must be at par value
and subject to the rules ofHawala 226, meaning that its assignment also has to be at
face value. A mixed portfolio consisting of a number of transactions, including
Murabaha, may issue negotiable certificates subject to certain conditions. For this
purpose, the pool of the assets should consist ofIjara or other fixed assets valuing more
than 50% of its total worth. However, if the Hanafi227 view is adopted, trading will beallowed even if the non-liquid assets are more than 10% of its total worth
Now, let us see how a direct murabaha Sukukstructure works:
8/3/2019 Islamic Fin, REPORT
14/20
1. Company seeks advice from Investment Bank regarding issue of securities; an
SPV is created for the purpose;
2. SPV issues securities to investors;
3. SPV collects funds from investors;4. SPV pays to Vendor for purchase of Assets;
5. Company as agent of SPV takes delivery of Assets;
6. Company purchases Assets from SPV on deferred payment basis and makes
payment of installments to SPV;
7. SPV passes them on to investors after deducting mudarib share/wakala229
fee for itself.230
The following constitutes a practical example how a negotiable murabaha Sukukcan be created: Arcapita Bank B.S.C (Bahrain) issued five-year multicurrency
Murabaha-backed Sukuk in 2005 with a five-year bullet maturity. The proceeds of the
Sukukare used for sale and purchase of assets via a series of commodity Murabaha
transactions. As Murabaha may yield a fixed return, the Sukuk holders have been
offered a return equivalent to three-month LIBOR + 175 bps. The SPV will have full
recourse to Arcapita and, therefore, the Sukukare a freely transferable instrument on
the basis of a mechanism approved by Arcapitas Sharia supervisory board. It is
presumed that the SPV will be maintaining a sufficient amount of inventory or fixed
assets, making its Sukuknegotiable. 231
3.3.1.5 Salam Sukuk
As we noted earlier, a salam is deferred delivery contract. It is essentially a
forward agreement where delivery occurs at a future date in exchange for spot payment
of price.
Salam Sukuk are certificates of equal value issued for the sake of mobilizing
capital that is paid in advance in the shape of the price of the commodity to be delivered
later. The seller of the Salam commodity issues the certificates, while the subscribers
are the buyers of that commodity, i.e. they are the owners of the commodity whendelivered. Salam sale is attractive to the seller, whose cash flow is enhanced in
advance, and to the buyer, as the Salam price is normally lower than the prevailing spot
price.232
Salam-based securities may be created and sold by an SPV under which the funds
mobilized from investors are paid as an advance to the company SPV in lieu of a
8/3/2019 Islamic Fin, REPORT
15/20
promise to deliver a commodity at a future date. All standard Sharia requirements that
apply to salam contractalso apply
to salam Sukuk, such as, full payment by the buyer at the time of effecting the
sale, fungibility or standardized nature of underlying asset, clear enumeration of
quantity, quality, date and place of delivery of the asset and the like. At the same timethe SPV can appoint an agent to market the promised quantity at the time of delivery
perhaps at a higher price. The difference between the purchase price and the sale price
is the profit to the SPV and hence, to the holders of Sukuk. Such Sukuk obviously
involve market risk as the price of the underlying asset may go down instead of moving
up in future.233The steps involved in Salam Sukuktransaction may be summarized as
follows:
1 SPV signs an undertaking with an obligator to source both commodities
and buyers. The obligator contracts to buy, on behalf of the end-Sukuk holders, the
commodity and then to sell it for the profit of the Sukukholders.
2 Salam certificates are issued to investors and SPV receives Sukuk
proceeds.
3 The Salam proceeds are passed onto the obligator who sells
commodity on forward basis
4 SPV receives the commodities from the obligator
5 Obligator, on behalf of Sukukholders, sells the commodities for a profit.
6 Sukukholders receive the commodity sale proceeds.234
The market risk or price risk for the investors can be mitigated if a third party
makes a unilateral promise to buy the commodity at a predetermined price at a future
time period. Since the SPV representing investors need not participate in the market, it
would be insulated from price risk. This third party may be one of the prospective
customers of the company. The unilateral promise is binding on this customer. Once therights resulting from the promise are transferred to the SPV, it assumes the role of seller
to the third party customer at the specified future date. The SPV is able to realize a
higher predetermined price without participating in the market. The risk mitigation can
some times come through sovereign guarantees, as is the case with recent issue of
Sukuk-al-salam by the Bahrain Monetary Agency (BMA)
8/3/2019 Islamic Fin, REPORT
16/20
3.3.1.6 Istisna Sukuk
We already mentioned that istisna is a contractual agreement for manufacturing
goods, allowing cash payment in advance and future delivery or a future payment and
future delivery of the goods manufactured, as per the contract.
Istisna contracts can be securitized to raise funds on the basis of the rental
income that the asset (for example, a building or bridge) will generate. In that case it will
generate fixed return securities, or it can be securitized on the basis of variable income
(such as a toll tax on the bridge), generating variable-return securities.241
241 Khan, M. Fahim, Islamic methods for government borrowing and monetary
management, Handbook of Islamic Banking, ed. by Hassan, M. Kabir, Lewis, Mervyn
K., Edward Elgar Publishing, Inc., 2007, p. 294 242 Obaidullah, Islamic Financial
Services, supra, p. 165 243 Mannan, Islamic Capital Markets, supra, p. 111
Under such a scheme the SPV representing investors becomes seller-contractor-manufacturer of an asset to a buyer (say, the government) and uses back-to-back
istisna for creation of the facility. In other words, the SPV takes upon itself the legal
responsibility of getting the facilities constructed, and sub-contracts the work to
manufacturers/contractors. The deferred price that the buyer will pay may be in the form
ofSukuk that are an evidence of indebtedness whose total face-value exactly equals
the total deferred price. These Sukuk may have different maturities to match the
installment plan that has been agreed upon by the two parties. They represent buyers
debt and hence, Sharia precludes sale of these debt certificates to a third party at any
price other than the face value of such certificates. Steps involved in the structure:1 The SPV issues Sukukcertificates to raise funds for the project;
2 Sukuk issue proceeds are used to pay the contractor/builder to build and
deliver the future project;
3 Title to assets is transferred to the SPV;
4 Property/project is leased or sold to the end buyer. The end buyer pays
monthly installments to the SPV; and
5 The returns are distributed among the Sukukholders.243
The prohibition ofriba precludes the sale of these debt certificates to a third party at any
price other than their face value. Therefore, such certificates, which may be cashed only
on maturity, cannot have a secondary market. As noted above, they can be transferred
at face value to a third party.244
8/3/2019 Islamic Fin, REPORT
17/20
244 Ayub, Introduction to Islamic Finance, supra, p. 405 245 Mannan, Islamic Capital
Markets, supra, p. 111 246 Ibid, pp. 111-112
An example ofSukuk al-istisna is as follows: The Durrat Al Bahrain, a $1 billion world-
class residential and leisure destination situated in the Kingdom of Bahrain, issued the
Durrat Sukuk to finance the reclamation and infrastructure for the initial stage of theproject. The Sukukwas structured to provide quarterly returns with an overall tenure of
five years and an option for early redemption. The proceeds of the issue (cash) were
used by the issuer to finance the reclamation of the land and the development of base
infrastructure through multiple project finance (istisna) agreements. As the works carried
out under each istisna were completed by the contractor and delivered to the issuer, the
issuer gives notice to the project company under a Master Ijara Agreement to lease
such infrastructure on the basis of a lease to own transaction. During the istisna period,
the istisna receivable (amounts held as cash) was only subject to trading at par value.
Later, upon completion of the istisna period and when lease agreements were put in
place, the Sukukbecame tradable. 245
3.3.1.7 Hybrid
Considering the fact that Sukuk issuance and trading are important means of
investment and taking into account the various demands of investors, a more diversified
Sukuk - hybrid or mixed asset Sukuk - emerged in the market. In a hybrid Sukuk, the
underlying pool of assets can comprise of Istisna, Murabaha receivables as well as
Ijara. Having a portfolio of assets comprising of different classes allows for a greater
mobilization of funds. However, as Murabaha and Istisna contracts cannot be traded on
secondary markets as securitized instruments at least 51 percent of the pool in a hybridSukukmust comprise ofSukuktradable in the market such as an Ijara Sukuk.
Steps involved in a hybrid Sukukstructure are as follows:
1 Islamic finance originator transfers tangible assets as well as
Murabaha deals to the SPV.
2 SPV issues certificates of participation to the Sukuk holders and
receive funds. The funds are used by the Islamic finance originator.
3 Islamic finance originator purchases these assets from the SPV over an
agreed period of time.
4 Investors receive fixed payment of return on the assets.
A prominent example of such mixed portfolio Sukuk are Islamic Development Banks
(IDB) Solidarity Trust Sukuk for $ 400 million issued in 2003. Solidarity Trust Services
8/3/2019 Islamic Fin, REPORT
18/20
(STS) served as trustee to issue the fixed-rate trust certificates that were issued to
purchase a portfolio ofSukukassets comprising Ijara, Murabaha and Istisna contracts
originated by the IDB. Each certificate represented an undivided beneficial ownership in
trust assets and rankedpari passuwith other trust certificates. Most of the assets (over
50 %) would, at all times during the period, comprise Ijara assets. If, at any time, the
proportion of assets evidenced by Ijara contracts fell below 25 %, a dissolution event
would occur, and IDB, by virtue of its separate undertaking, would be obliged to
purchase all of the assets owned by the trustee pursuant to the terms of the purchase
undertaking deed. Profit on Sukukassets, net of expenses of the trust, would be used
to give a periodic return to the certificate holders. Certificates would be redeemed at
100% of their principal value. In the case of any early dissolution event, the redemption
would be according to adjustment, keeping in mind the return accumulation period.
Principal amounts ofSukuk would be reinvested in Ijara and Musharaka contracts to
form a part ofSukukassets.
The modus operandi of issuing mixed portfolio Sukuk is an effective tool for converting
non-marketable and illiquid assets to negotiable instruments having a secondary
market, particularly suitable for investment banks and development finance institute.
USES OF SUKUK FUNDS
There are three major categories where Sukuk funds are used. These are
1. Project specific
2. Asset specific
3. Balance sheet specific
1. PROJECT-SPECIFIC SUKUK
Under this category money is raised through sukuk for specific project. For
example, Qatar Global sukuk issued by the Government of Qatar in 2003 to
mobilize resources for the construction of Hamad Medical City (HMC) in Doha. In thiscase a joint venture special purpose vehicle (SPV), the Qatar Global sukuk QSC, was
incorporated in Qatar with limited liability.
This SPV acquired the ownership of land parcel that was registered in the name of
HMC. The land parcel was placed in trust and Ijarah-based Trust Certificates
(TCs) were issued worth US$700 million that were due by October 2010. The annual
floating rate of return was agreed at LIBOR plus 0.45 per cent.
8/3/2019 Islamic Fin, REPORT
19/20
2. ASSETS-SPECIFIC SUKUK
Under this arrangement, the resources are mobilize by selling the beneficiary right of
the assets to the investors. For example, the Government of Malaysia raised US$ 600million through Ijara sukuk Trust Certificates (TCs) in 2002. Under this arrangement, the
beneficiary right of the land parcels has been sold by the government of Malaysia
to an SPV, which was then re-sold to investors for five years. The SPV kept the
beneficiary rights of the properties in trust and issued floating rate sukuk to investors.
Another example of Asset-specific sukuk is US$250 million five-year Ijarah sukuk issued
to fund the extension of the airport in Bahrain. In this case the underlying asset was the
airport land sold to an SPV.
3. BALANCE SHEET-SPECIFIC SUKUKAn example of the balance sheet specific use of sukuk funds is the Islamic
Development Bank (IDB) sukuk issued in August 2003. The IDB mobilized these funds
to finance various projects of the member countries. The IDB made its debut resource
mobilization from the international capital market by issuing US$ 400 million five-year
sukuk due for maturity in 2008.
8/3/2019 Islamic Fin, REPORT
20/20
Top Related