Transcript Document
Tapping the capital markets the Islamic way: the Sukuk phenomenon
Alberto G. Brugnoni
Introduction
An historical perspective: the IFSI as the continuation of a millennium-long wave A general consideration on today’s IFSI A distinguishing feature of IFSI: funding of trade in, or production of, real assets
IFSI market size $ 500bn to ... $ 1000bn
REGIONAL AND GLOBAL GROWTH TOTALS $m 2007 GCC Non-GCC MENA MENA Total Sub-Saharan Africa Asia Australia/Europe/America Global Total Source: Maris Strategies & the Banker 178,129 176,822 354,951 4,707 119,346 21,475 500,481 2006 127,826 136,157 263,984 3,039 98,709 20,300 386,033 % change 39.35% 29.87% 34.46% 54.90% 20.91% 5.79%
... and its returns on Assets
Rank by RoA
1 2 3 4 8 9 10 11 5 6 7
Institution
El-Nilein Ins.
Tamweel Int. Leasing Karafarin Ins.
Islamic Ins.
First Invest. Co.
United Insurance First Takaful Al-Madina Al-Safat Inv. Co.
Unicorn
Source: The Banker Country Return on assets
Sudan 37.27
UAE 35.10
Kuwait 33.51
Iran 21.03
Sudan 20.91
Kuwait 20.58
Sudan 18.72
Kuwait 16.90
Kuwait 16.52
Kuwait 15.49
Bahrein 13.62
Rank by RoA
12 13 14 15 16 17 18 19 20 21 22
Institution
AREF Invst.
Bank al-Jazira Bank Perusahaan Sheikan Ins.
National Inv.
Arabia ACE Arabia ACE Markaz Al-Ain Ahlia Ins.
Int.Inv.Group
Ithmaar Bank
Country Return on assets
Kuwait 13.24
SA 13.21
Malaysia 13.19
Sudan 13.06
Pakistan 12.78
Bahrein 12.59
SA 12.59
Kuwait 12.01
UAE 11.93
Kuwait 11.53
Bahrain 10.82
Percentages of SCA to total assets
Country Rank Country
1 2 3 4 5 6 7 8 9 10 11 Iran Saudi Arabia Malaysia Kuwait UAE Brunei Bahrain Pakistan Lebanon UK Turkey
Source: The Banker SCA in $m SCA/ Assets Rank
154,616 69,379 65,083 37,684 35,354 31,535 26,251 15,918 14,315 10,420 10,065 100% 12
31% 25% 37% 29%
13 14 15 16 100% 17
31%
18
25%
19 75% 20
0.10%
21 100% 22 Qatar Sudan Bangladesh Egypt Jordan Indonesia Switzerland Algeria Yemen Tunisia Palestine
SCA in $m
9,459 4,467 4,331 3,852 2,635 2,223 813 564 339 279 219
SCA/ Assets 25%
100% 58%
6%
100% 3%
0.07%
100% 100% 100% 100%
Sukuk: a traditional instrument …
In classical period sakk (sukuk) meant any document representing a contract or conveyance of rights, obligations or monies done in conformity with the Shariah (Sukuk al- Bada’i, Imam Malik ...) Empirical evidence shows that Sukuk were extensively used during medieval Islam for the transferring of financial obligations originating from trade and other commercial activities Sakk is at the origin of the European root cheque/check
... fit for a contemporary use ...
Malaysia re-introduced Islamic bonds in the 1990’ and they were termed as Bai bi-thaman Ajil Bonds In the Middle East, Bahrain re-introduced the Sukuk al- Ijara instrument to the Islamic market in September 2001 and Malaysia pioneered the global Sukuk al-Ijara issue in June 2002 The Middle Eastern Islamic bond market evolved gradually with the support of top-tier issuers like the Islamic Development Bank, the States of Qatar and Dubai, the Republic of Pakistan ...
... with a contemporary added value
The essence of this product, in the modern Islamic perspective, lies in the concept of asset monetization - the so called securitization - that is achieved through the process of issuance of sukuk (taskeek) His great potential is in transforming an asset’s future cash flow into present cash flow
The legitimacy of Sukuk
Qur’an - Sura 2:282 The Islamic Jurisprudence Council decision n° 5/1988 to uphold the issuance of sukuk: representation of assets in a note or bond salability of the written note or bond AAOIFI’s “Shariah standards on investment Sukuk”, Bahrain May 2003
Sukuk: a definition
Sukuk are asset-backed trust certificates evidencing ownership of an asset or its usufruct These certificates are, in turn, based on Islamic traditional financial structures that have been in use for the last 1500 years Sukuk are not a completely new asset class. They are securities that employ existing financial engineering techniques (securitization structures) that create ‘asset backed’ bond that are also Shari’ah-compliant
Sukuk share similarities (?) with bonds …
Marketability: sukuk are monetized real assets that are liquid and (easily?) tradable Rateability: sukuk are easily analyzed and rated by international and regional agencies Enhanceability: different sukuk structures may allow for credit enhancements or wraps that broaden their appeal to risk-averse investors Versatility: structuring across legal and tax domains of products that meet diverse financing need
... and differences as well
Sukuk represent actual and legal ownership stakes in assets and services and are not monetary documents relating to receivables The Sukuk holder share the return and bear the losses and he is not a creditor Sukuk are valid only if issued after receipt of the value of the sukuk and the employment of the funds Sukuk are issued and traded according to shari’a nominated contracts The prospectus document should provide complete transparency. Inherent right to information
A primary condition: tangibility
Existence and identification of suitable assets Returns and cash flows must be linked to assets purchased or those generated from an asset once constructed (project finance) Borrowers to raise compliant financing will need to utilize assets in the structure. Borrowers that provide the assets are commonly referred to as originators This requirement has consequential effects for derivatives
More on tangibility
Equity. It is an asset: equity financing is Shari’ah compliant and fits well with the risk/return concepts Receivables. Their trading for anything other than par is not permissible. However, some Shariah boards have accepted that, as long as such receivables are a small (?) portion of the overall income flows, their presence is acceptable in Sukuk Malaysia does not place receivables in the category of money and hence allows Sukuk to be 100% backed by receivables. This is a major difference with GCC countries
Asset-backed Sukuk
Sukuk can be consider to be asset-backed or asset secured, and therefore sharia compliant, only if the key securitization elements are in place These elements should ensure that the Sukuk holders have beneficial title and realizable security over the assets with no encumbrances (no claw back clauses ...). The SPV role The credit risk ratings of these Sukuk depends solely on the underlying assets. The standard methodologies on securitized assets apply
Unsecured Sukuk: are they Sharia compliant?
Such analysis becomes irrelevant if the legal structure does not support Sukuk holders’ rights to the underlying assets and to their cash flows In fact, an analysis of the commercial terms and legal structures shows that for some Sukuk performance is not governed by the assets and that the credit risk is really that of the originator The ratings of these Sukuk depends on the riskiness of the originator
Sukuk asset classes
Sukuk may be issued on existing as well as specific assets that may become available at a future date. This ‘non-exhaustive’ list includes: Sukuk al-ijarah: securitization of existing tangible leased assets Sukuk ijarah mowsufa bi-thima: mobilization of the acquisition cost of tangible to-be-leased assets Sukuk manfaa ijarah: securitization of the usufruct of existing leased assets
Sukuk asset classes
Sukuk manfaa ijarah mowsufa bi-thima: securitization of the usufruct of assets to be acquired and leased Sukuk milkiyat al-khadamat: pre-sale of the cost of services and their expected benefits Sukuk al-salam: pre-sale of future delivery of goods or commodities Sukuk al-istisna’a: mobilization of the cost of construction and manufacturing of specific assets
Sukuk asset classes
Sukuk al-murabaha: mobilization of the acquisition cost of goods to be sold under a murabaha Sukuk al-musharaka: sale of capital participations into a partnership Sukuk al-mudharaba: mobilization of funds from capital providers Sukuk al-wakala: mobilization of capital to acquire certain goods that are entrusted to an agent
Sukuk asset classes
Sukuk al-muzra’a: mobilization of funds for the cultivation of land Sukuk al-musaqa: mobilization of funds for the irrigation and maintenance Sukuk-al-muqarasa: mobilization of funds for the maintenance of land and crops
Sukuk al-Ijara
Ijara (lease) is a contract according to which a party purchases and leases out equipment required by the client for a rental fee Sukuk al-Ijara are securities representing the ownership of defined and known assets that are tied up to a lease contract
Sukuk al-Ijara structure
Sukuk holders 2.Sukuk proceeds 4.Periodic rentals and capital amount distributions Obligator as seller 1.Title to asset 2.Sukuk proceeds 4.Periodic rentals and capital amount payments SPV Issuer/Lessor 3.Lease agreement Obligator leases back assets as lessee
1.
Sukuk al-Ijara structure
The Originator/Obligator seeking financing make a true sale of its asset to the Sukuk SPV for a value equal to the financing provided 2.
The SPV issues Sukuks and ...
2.
... with the proceeds pays the Originator/Obligator 3.
The Originator leases the asset back and ...
4.
... makes lease & repurchase payments to the SPV 4.
The SPV distributes these periodic rentals among the Sukuk holders
Sukuk al-Ijara: beware!
It is an asset-backed Sukuk if there is a correspondence of the income streams with the actual rental and the market value of the asset It is an unsecured Sukuk if this correspondence does not exist. In this case the asset only exists to facilitate its Shari’ah compliance
Sukuk al-Ijara characteristics
Risks related to lessee and market Returns not always predetermined Full negotiability Highly flexible Sukuk holders bear responsibility to the property
Sukuk al-Musharaka
Under a Musharaka contract the parties agree by mutual consent to share profits and losses in a joint business 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 pre agreed ratios and the loss is borne by every partner in proportion to their respective capital contributions
Sukuk al-Musharaka structure
Originator/ Corporate 3b.Periodic profits +incentive fees 1.Physical
asset contribution 0&5. Musharaka Arrangement +Undertaking to buy Musharaka shares of the SPV on a periodic basis Investors Musharaka 3a.Periodic profits SPV 2b. Sukuk proceeds 2a. Sukuk proceeds 4. Periodic distribution of profit
1.
Sukuk al-Musharaka structure
The Originator/Corporate contributes some specific assets and management skills 2. a&b The Sukuk issuer (usually a SPV) contributes the investor’s Sukuk proceeds 3. a&b The Originator/Corporate runs the JV, operates the assets and invests the funds. It distribute the profits 4.
Sukuk holders are entitled to the Issuer’s rights in the JV whatever they are 5.
The Corporate irrevocably undertakes to buy at a pre-agreed price the Musharaka shares of the SPV
Sukuk al-Musharaka: beware!
The precise description of the profit distribution and business plan is key part of the offering documentation Should the cash flows generated by the assets under the business plan of the JV not be sufficient to fund these payments, the Issuer may have the option to call the purchase undertaking
Sukuk al-Musharaka characteristics
Documents of equal value issued with the aim to establish/develop a project on the basis of a partnership contract The certificate holders become the owners of the project as per their respective shares Full negotiability
Sukuk al-Mudharaba
In a Mudharaba agreement one of the two parties provides the capital (rabb al-mal) and the other (mudharib) the work The profit is to be shared between them according to a pre-agreed ratio Losses are borne by the capital providers (rabb al mal) only
Sukuk al-Mudharaba structure
Project 3. Capital proceeds and profits collection 4. Project handed over upon completion 3. Capital proceeds and profits distribution Project owner 1. Agreement SPV as mudharib Primary subscriber 2. Sukuk issues and Sukuk proceeds Secondary market
Sukuk al-Mudharaba structure
1.
Mudharib enters into an agreement with project owner for construction/commissioning of the project 2.
SPV issues Sukuk to raise funds 3.
SPV collects regular profit payments and final capital proceeds from project activity for onward distribution to investors 4.
Upon completion, mudharib hands over the finished project to the owner
Sukuk al-Mudharaba characteristics
The issuer of the Sukuk is the mudharib whereas the subscribers are the rabb al-mal They have the right to receive their capital at the time the Sukuk are surrendered and an annual proportion of the realized profits as agreed but bear the losses A Sukuk holder is entitled to all rights, which have been determined by Sharia upon his ownership of the Mudharaba bond
Sukuk al-Murabaha
Murabaha is basically the sale of goods at a price comprising the purchase price plus a margin of profit The margin of profit must be negotiated and agreed upon by both parties to the transaction
Sukuk al-Murabaha structure
Investors 1.Master
agreement 6.Sale price + profits 2. Sukuk issues and Sukuk proceeds 3. Spot payment Issuer SPV 3. Commodity 4. Murabaha Commodity 4. Deferred payment 5. Commodity ‘Borrower’ 5. Spot payment Commodity supplier Commodity buyer
Sukuk al-Murabaha structure
1.
A master agreement is signed between the SPV and the ‘borrower’ 2.
SPV issues Sukuk to investors and receive proceeds 3.
SPV buys commodity on spot basis from the supplier 4.
SPV sells the commodity to the ‘borrower’ at the spot price plus a profit margin payable on installments 5.
The borrower sells the commodity to the commodity buyer on spot basis 6.
The investors receive the final sale price and profits
Sukuk al-Murabaha characteristics
The Sukuk holders become owners of the Murabaha commodity The issuer of the certificate is the seller of the Murabaha commodity The Sukuk murabaha are not negotiable under Shari’a ...
... unless they are a small part of a package The Malaysian exception
Sukuk al-Istisna’
Istisna’ is a contractual agreement for manufacturing goods and commodities It allows cash payment in advance and future delivery or a future payment and future delivery
Sukuk al-Istisna’ structure
Sukuk holders (investors) 1.Sukuk proceeds 5. Distribution of returns Contractor/builder 2.Payments
3. Title to assets SPV 4.Monthly
Payments 4. Title to assets End buyer
Sukuk al-Istisna’ structure
1.
SPV issues Sukuk to investors and receive proceeds 2.
Sukuk 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 5.
The returns are distributed among the Sukuk holders
Sukuk al-Istisna’ characteristics
Issued with the aim of mobilizing the funds required for producing products owned by the certificate holders The issuer of these certificates is the manufacturer (supplier/seller) The subscribers are the buyers of the intended product The certificate holders own the product and are entitled to the sale price of the certificates
Legal environment
Most GCC have a Civil Code and commercial disputes tend to fall before a commercial court As in any new jurisdiction, there may be a lack of precedent and uncertainty regarding matters of law. The legal framework in many countries remains untested. No precedent with regards to bankruptcy practices Country markets ’ s domestic risks: political risks, legal uncertainties and the efficiency of the local financial Many of existing transactions are governed by UK or New York laws due to their creditor friendly nature
Legal environment and Sha’riah
While Shari’ah is acknowledged as one source of law, it is not the law enforced in the courts. Shari’ah takes usually precedence only for personal matters The only operational Shari’ah court exists in Saudi Arabia. It is unlikely that such court would be familiar with complex financial structures which first require all documents to be translated into Arabic The problem of Shari’ah a non-compliance: the secondary market issue
Rating Sukuk
Two Aspects Of Rating Sukuk: Sharia compliance and Transaction Security The determination of the bond’s legal enforceability Sharia boards disagreement not to affect the obligation’s enforceability but perhaps its liquidity