THIS ASSIGNMENT IS A PARTIAL FULFILLMENT FOR IB1006 Islamic Capital Market Chartered Islamic Finance Professional (CIFP) INCEIF June Semester 2012
Lecturer: Abdul Rashid Abdul Kadir
Student Name: FASHOLA OLAYINKA NURUDEEN Student ID: 1100275
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Question i:
Outline basic requirements, necessary steps to be taken, expected time line and all the important parties involved in the process of issuance of a sukuk.
Basic Requirements.
Just like any other Islamic Financial product – Sukuk must have the following basic requirements •
The issuance of the sukuk must be devoid of riba, gharar, rishwah, masyir and jahl and jahl
•
All funds raised through the sukuk issuance must only be used for halal or Shariah compliant activities.
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Where the funds raised are used to finance needed tangible assets, specificity of assets is important. That is, the asset(s) being financed should be clearly identified. This is because, sukuk because, sukuk , unlike bonds, cannot be used to fund general financial needs of the issuer.
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Income received by sukuk holders (investors) must be derived from the cash flows generated by the underlying asset, not from other sources external to the asset.
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Sukuk holders have a right to the ownership of the underlying asset and its cash flows. (Viewed from this perspective, a sukuk is essentially hybrid equity.)
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There should be clear and transparent specification of rights and obligations of all parties to the transaction, in particular the originator (mudarib (mudarib)) and sukuk and sukuk holders.
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As with all other Islamic finance instruments, there should be no fixity of returns.
Steps to be taken
Outlined below are the steps to be taken for the issuance of a sukuk.
Company, that is, the originator seeks advice from Investment Bank regarding sukuk; assets are identified and pooled together.
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Company creates SPV – SPV – Special Special Purpose Vehicle with a legal entity, the SPV is legally separate and is bankruptcy remote, in that it has no part in the originator’s liabilities.
The company then injects or transfers the asset which will become the underlying asset of the sukuk the sukuk , to the newly established SPV.
The SPV issues sukuk to investors against these assets;
SPV collects funds from investors;
SPV pays to Company the sale price of Assets;
Company buys back Assets on deferred payment basis, it could also be leased this is dependent on the underlining contract.
SPV receives payments by company in future;
SPV passes on payments by company to investors’ base investors’ base on the underlining contract.
The parties.
Outlined below are the parties involved in the issuance of sukuk •
Originator/Mudarib: o
•
Regulator o
•
These set of individuals manage and administer the SPV
Vendor/Manufacturer o
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Government for GLCs, third party for others
Trustee – o
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A legal entity for a common representation of the subscribers
Credit Credit Enh ancer ancer o
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This is the Securities Commission
Spe Special Pur pose pose Vehi Vehi cle o
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This could be government-sovereign or corporate
The makers of asset/machinery that is the object o f financing
Ratin g A gency gency o
Agency that rates and monitor the sukuk the sukuk performance performance Page 3 of 9
•
I nves nvestment tment bank – o
They structure the sukuk , ensure compliance, produce the prospectus and bring the offer to the market.
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Shar iah Advisor Advisor s o
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They ensures that the offer is Shariah compliant
Suk uk I nves nvestor o
The general public who subscribers to the investment.
Question ii.
Proposed structure of sukuk for the above projects. Discuss on shariah principles to be applied in the structure, draw-up the illustration on the process flow of the sukuk and highlight the main concern of the originator, issuer and investors
Proposed Structure and Shariah principles.
For the case in question IJarah Sukuk structure would be used to facilitate/ the underlining contract of the sukuk, below are the Shariah principles as it relates to Ijarah Sukuk for the the case in question.
-al-ijara are sukuk that represent ownership of equal shares in a rented real estate or or Sukuk -al-ijara the usufruct of the real estate.
These sukuk give their owners the right to own the real estate, receive the rent and dispose of their sukuk in a manner that does not affect the right of the lessee, i.e. they are tradable.
The holders of such sukuk bear all cost of maintenance of and damage to the real estate. Ijara sukuk are the securities representing ownership of well defined existing and known assets tied up to a lease contract, rental of which is the return payable to sukuk holders.
The rental rates of returns on these sukuk can be both fixed and floating depending on the particular originator. Page 4 of 9
The SPV-mudharaba SPV-mudharaba issues sukuk-al-ijara to investors; raises fund and utilizes it for purchase of the assets (required for use by the company).
The assets are then given on lease to the company in exchange for periodic rentals.
It is necessary for an ijara contract that both the assets being leased and the amount of rent are clearly known to the parties at the time of the contract.
If both of these are known, ijara can be contracted on an asset or a building that is yet to be constructed, as long as it is fully described in the contract, provided that the lessor should normally be able to acquire, construct or buy the asset being leased by the time set for its delivery to the lessee.
The ijara rentals when received by SPV-mudharaba SPV-mudharaba from the company (as per the terms) are passed through to the holders of the sukuk the sukuk . Unlike murabaha, murabaha, the ijara instrument is not evidence of debt, but of a pro-rata (in proportion) ownership of the asset(s) that is on ijara. ijara.
Ijara sukuk are completely negotiable and can be traded in the secondary markets. Sukuk -al-ijara -al-ijara,, however, functions like any other debt instrument, since the periodic ijara rentals can be predicted with a reasonable degree of certainty.
However, the yield on some forms of ijara instruments may not be predetermined, since there might be some maintenance and insurance expenses that are not perfectly predictable in advance. Consequently, in such cases, the amount of rent given in the contractual relationship represented by the instrument represents a maximum return subject to deduction of this kind of maintenance and insurance expenditure.
If an asset has totally lost the function for which it was leased, and no repair is possible, the ijara shall terminate on the day on which such loss (a “Total Loss”) has been caused. If there has been a Total Loss, the Trustee may have the right/ability to substitute or replace the affected asset - although, in reality, it would only look to do so if the Originator (as service agent) is able to use the insurance (or takaful) or any other total loss proceeds to procure substitute or replacement assets;
If a Total Loss is caused by the misuse or negligence of the Originator, the Originator will be liable to compensate the Trustee for depreciation in the value of the affected asset, as it was immediately before such Total Loss. Page 5 of 9
In the event that an asset has only suffered partial loss or damage, the ijara will continue to survive with respect to that asset
Sukuk Holders
2a. Sukuk Proceeds
4b. Periodic rent and capital amount distribution
1. Transfer title to SPV
Company/ Originator as seller
4a. Periodic Rents and capital amount paymnet
Special Purpose Vehicle - SPV
Company/ Originator lease back asset
3. Lease Agreement.
2b. Sukuk Proceeds
Same Entity
Steps Involved in the structure
The company - Boraque Air-Lines (BAL) transfers the ownership of the land worth 100 Million to the SPV.
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The SPV raise the fund required to build the Group Headquarters and Engineering Centre at estimated cost of USD 550 million plus the cost by issuing Sukuk to the investing public.
The amount raised is used to build the property and its managed by the SPV
A lease agreement is signed between SPV and Boraque Air-Lines (BAL) for a fixed period of time, where the BAL leases back the assets as lessee
SPV receives periodic rentals from Boraque Air-Lines (BAL)
These are distributed among the investors i.e. the Sukuk holders
At maturity, or on a dissolution event, the SPV sells the assets back to the seller at a predetermined value. That value should be equal to any mounts still owed under the terms of the Ijarah Sukuk
Concern
The originator o
In case of flexible rate ijarah sukuk where the returns are tied to LIBOR, an increase in the benchmark rate will increase the payment obligations of the originator which may or may not be sustainable. This is more pronounced when the paying capacity of the originator depends largely on income from a pool of assets with substantial proportion earning fixed returns
The issuer o
Lack of regulatory framework
o
Limited number of qualified personnel well versed in capital market issues both from shariah and commercial perspective
The investors
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o
The investors would be the rightful owner of the real estate and is exposed to a lot of risk for the entire duration of time that the real estate is under the lease – lease – Ijarah Ijarah agreement.
o
No benchmark for portfolio monitoring as available to conventional bonds
o
Secondary market illiquid due to absence of Critical Mass and Market Makers.
o
If the underlying asset in the pool is denominated in terms of multiple currencies it reduces the foreign exchange risk of the investor.
o
Another concern for the investors is the credit risk that is delay in the payments or repayments from the originator.
Question: iii.
Explain summary of basic terms and conditions of the proposed sukuk Summary terms and conditions.
Below are the summary terms and condition for the Sukuk Al-Ijarah.
The property – property – Real Real Estate shall belong to the investors for the entire duration of the lease
The Investors shall be liable to maintain the property and bear the risk of any loss
The company – company – Originator Originator shall ensure that the lease payment is made at the agreed date and promptly.
The property will be transferred to the Originator at the end of the lease period at an agreed amount.
It is permitted for the owner of the Ijarah sukuk certificate to sell it on the secondary market to any buyer at a price agreed upon between them. It doesn’t matter if the price is the same as, less than, or more than the price at which it was bought. That is in consideration of the fact that the value of assets is subject to the market factors of supply and demand
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It is not permitted for the issuer or administrator of the sukuk to guarantee the value of the sukuk certificate itself or the revenue; and if the leased assets should be damaged or destroyed, it is the sukuk certificate holders who will be ar the loss.
Ijarah sukuk do not represent a fixed amount of money, nor are they debts owed by a certain entity―neither a natural nor a legal entity. They are only financial certificates that represent diffused/undivided shares in the ownership of a tangible asset being put to use, such as real estate, an airplane or a ship, or a pool of such assets, whether of the same or differing specifications, when they are leased and, thus, yield defined revenue as a result of the lease contract.
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