Sukuk Innovations by: Wan A Rahim Kamil ICM Consultant, Securities Commission Malaysia.
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Transcript of Sukuk Innovations by: Wan A Rahim Kamil ICM Consultant, Securities Commission Malaysia.
Sukuk Innovationsby:
Wan A Rahim KamilICM Consultant, Securities Commission Malaysia
Capital Market: Products & Instruments
CERT 22-23 May 2007 2
Sukuk as a consequent of Islamic securitisation
• Also known as Islamic bonds - but better described as “Trust Certificates” or “Participation Securities”• “ Grant investor a share of an asset along with the
cashflows and risk commensurate with such ownership”
• Prescribed as “securities” under the Islamic Securities Guidelines to give wider definition
• Can be consistent with conventional asset-backed securities (ABS) or conventional unsecured lending – depending on the structures
Capital Market: Products & Instruments
CERT 22-23 May 2007 3
Issuance of Sukuk must be supported by an underlying asset
• From Shariah perspective, Islamic financing should only be raised for trading in specified and identified Shariah compliant assets
• In general, trading of indebtedness is prohibited, unless it is traded at par• Middle East and some other jurisdictions only allow
debt trading at par• Malaysia – trading of indebtedness is permissible at
any value provided the underlying contract is Shariah e.g. Bai’ Bithaman Ajil / Bai’ Dayn
• Return for investment in sukuk in most cases are linked to cash flows and performance of underlying assets
Capital Market: Products & Instruments
CERT 22-23 May 2007 4
Possible Contracts for Project Funding Needs
• Consider a rental of the asset instead of a sale:• Project rents it from outsourced party;
• Actually investors purchased the asset and rents it to the project, thus:
• Objective of use of asset achieved;• Investors subject to similar cash-flow risk if
it had gone into a murabahah contract;• At end of period, project company could opt
to purchase the asset, considering that it would have already paid in full.
Capital Market: Products & Instruments
CERT 22-23 May 2007 5
• Best achieved through an Asset Backed Securitisation (“ABS”) exercise:• What qualifies as assets?
• Investment entries through Participatory Contracts;• Need to comply with guidelines or regulations on
ABS.
Capital Market: Products & Instruments
CERT 22-23 May 2007 6
Definition of Assets
• Under the shari’ah the assets must meet the necessary conditions:• Must exist physically (land, building, machinery)• Must be pure;• Must have use (however restricted to halal use
and not for example for operations of casino or alcohol sales outlet);
• Must be owned by the seller;• Must be free from encumbrances;• Must be known by specifications, descriptions,
location, etc.
Capital Market: Products & Instruments
CERT 22-23 May 2007 7
What are Participatory Contracts? Such as …
Participatory Contracts
(risk participation)
Mudharabah or Trust Loan-Investments:
Contract between fund owner and entrepreneur whereby returns are pre-agreed based on profit achievements but losses borne just by capital provider. Entrepreneur only provides management expertise.
Musharakah or Joint Participations:
Pooling of capital resources among several parties based on pre-agreed proportions of profit distributions and losses borne according to equity contributions.
Capital Market: Products & Instruments
CERT 22-23 May 2007 8
Applications
• These are extensions to equity-related instruments.• Musharakah is close to joint participations;• Mudharabah is a semi-equity semi-debt
instrument.• Can be applied to needs normally raised under
subordinated debt structures.
Capital Market: Products & Instruments
CERT 22-23 May 2007 9
Participatory Contracts
Participatory Contracts of:1. Musharakah or general partnership under
profit-loss sharing formula. Partners:Share profits in accordance with pre-agreed proportions and not necessarily based on capital investment;Bear losses in proportion to capital contribution.Partners might forgo rights to management to other partners.
Managing partner liable for losses due to mismanagement or wrong business judgments.
Capital Market: Products & Instruments
CERT 22-23 May 2007 10
2. MudharabahTrustee investment contract that is semi-equity
and semi-debt in nature.• Marriage between capital and entrepreneurship;• Profit sharing contract whereby:
• one party, the capital provider or rabb al mal provides the necessary capital for the venture,
• The other party, the mudharib, provides the expertise for the venture.
• Profit sharing not based on capital but based on pre-agreed proportion of achieved profits.
• Genuine business losses borne in entirety by rabb al mal.
Capital Market: Products & Instruments
CERT 22-23 May 2007 11
• Asset Backed Securitisations:• Create new opportunities to popularise
mudharaba or qirad, and/or musharkah contracts,
• Ability to ring-fenced risks with more secured contracts such as ijarah, murabaha, salam or other compounded contracts of exchanges, whereby
• Risks mitigated through secured cash-flow streams and with lesser operational and credit risks,
• More shari’ah compliant due to Special Purpose Vehicle involved in direct investments or business activities – avoidance of Bai’ al Dayn issues.
Capital Market: Products & Instruments
CERT 22-23 May 2007 12
Special Purpose Vehicle(“SPV”)(Mudharib)
Mudharaba or Musharakah
Certificates
Pool of Investors(Rabb al Mal or Musharkah
Partners)
Subscription for Certificates
($)
Direct Investments through ijarah,
murabahah or otherreal estate businesses or
trading activities
Cash-flow stream ($)
Profit Distribution
Expenses for m
eeting operational requirem
ents
1
2
3
4
5
6
7
3
Capital Market: Products & Instruments
CERT 22-23 May 2007 13
Asset Backed Securitisation
1. Sale of asset to the SPV – True Sale
2. SPV issues asset-backed securities to investors
3. Proceeds from the sale of ABS go to the Originator
4. (Interest) & principal repayments to Investors
SPV Investors
1.
2.
3.
Originator
3a.
4.
Capital Market: Products & Instruments
CERT 22-23 May 2007 14
Islamic Asset-Backed Sukuk adds a new dimension to ICM products
• True sale – legally belong to SPV• Non-recourse sukuk / ABS - credit risk performance is
determined solely by underlying asset• SPV – bankruptcy remote (independent)• Correspondence of income streams with actual income
and value of the assets• Ratings are primarily dependent on a risk analysis of
the assets or performance of assets• Unilateral purchase undertaking (if any) – at market
value
Capital Market: Products & Instruments
CERT 22-23 May 2007 15
AmbangSentosa
Originator
Investor
2.Investor purchase asset (gift)
4. Sale of asset on deferred payment (BBA)
5. ASSB issue BAIDS to investor
3. Cash
Identified Asset:Rights, title and interest over the
balance sales proceeds of two development projects
1. Hibah (Gift) Aqad Asset
Proceeds from BBA transaction used to purchase Identified asset
Ambang Sentosa BBA (ABS) –domestic version of Islamic securitisation
Underlying assets to execute BBA are assets awarded by 3rd party – need tangible assets to avoid debt-for-debt transactions which is prohibited both in Msia and international
Cash flow is still based on receivables
Capital Market: Products & Instruments
CERT 22-23 May 2007 16
Cagamas Sukuk Musyarakah (RMBS) - does it comply with international Shariah standards ?
Cagamas(Transaction
Administrator & Administrator)
Cagamas MBS
GOM(Originator &
Servicer)
Sale of GSHFs
Purchaseconsideratio
n
Investors
Sukuk issued
to investors
Proceeds from sukuk
Trustee
Represent Sukukholders
Sale of Islamic house financing receivables
Debt trading – sold at discount not at par
Although investors formed as musyarakah venture
Capital Market: Products & Instruments
CERT 22-23 May 2007 17
Golden Crop Sukuk Ijarah (ABS) – compliance with international Shariah standards
Share Trustee
Golden Crop Returns(Issuer)
Sukukholders
Boustead Group
(Originators)Trustee
LTATSukuk Ijarah
Originator sell the plantation asset
to the Issuer
Issuer leases back the plantation asset
to the Originator
Subordinated Musyarakah facility with LTAT
Capital Market: Products & Instruments
CERT 22-23 May 2007 18
Islamic Asset Backed Securities issued in Malaysia
Issuer FacilityIssue Size
RM (million)
SC Approve
d
Ambang Sentosa Sdn Bhd
BBA986.00 29-May-03
Musyarakah One Capital Berhad
Sukuk Musyarakah 2,500.00 7-Mar-05
Cagamas MBS Berhad Sukuk Musyarakah 2,500.00 6-Jul-05
Golden Crop Returns Bhd Sukuk Ijarah * 442.00 27-Oct-05
ABS Logistics Bhd Sukuk Ijarah * 300.00 6-Jul-06
Nepline SPV Sdn Bhd Sukuk Ijarah * 170.00 21-Jul-06
Total Islamic ABS 6,898.00 * International Shariah compatible structure
Capital Market: Products & Instruments
CERT 22-23 May 2007 19
Majority of sukuk has been on simple “ijarah” structure – unsecured financing / asset-based
• Originator seeking financing “sells” the assets to SPV for a value equal to financing required and lease it back
• SPV – subsidiary of originator;
• Lease payments provide fixed income stream which may be benchmarked to an index / LIBOR +;
• Conducted on non true-sale basis so repayment and risk/performance is not asset backed but originator based;
• Purchase undertaking of asset at maturity with pre-determined value;
Capital Market: Products & Instruments
CERT 22-23 May 2007 20
• Ratings are primarily dependent on the riskness of the borrower / sponsor / originator / lessee;
• Assets only used to facilitate Shari’ah compliance.
Capital Market: Products & Instruments
CERT 22-23 May 2007 21
Sukuk Al-Ijarah - Asset Based Transaction
SPV
Sukuk
Originator
Sukuk Sukuk
Sukuk
Sale of asset
Sukuk proceeds
Lease & repurchase payments for assets
Sukuk proceeds
Asset repurchase
Periodic payments:
Lease flows and principal (via amortisation/repurchase)
Non-true sale – condition to repurchase at maturity
Payment of rental / profit can be derived from ijarah or other sources
Capital Market: Products & Instruments
CERT 22-23 May 2007 22
Sukuk Al Ijarah – Asset Backed
• There are also structures of sukuk al ijarah under an Asset Backed Scenario.• True sale, though• The ownership of the SPV is transferred to the originator or
the lessor at end of lease. Original underlying sale has been true sale.
Capital Market: Products & Instruments
CERT 22-23 May 2007 23
SPV
Certificates of Investments
Investors
1.Offer for Sale
of securities
2.
Asset Provider
3. Sale & Purchaseof Asset (payment ofasset acquisitionCost US$) Asset
4. Transfer of Ownership of
Asset to SPV
1st Transaction: SPV and Asset Provider1st Relationship: SPV and Investors
Step 1
$
Creation of Sukuk al Ijarah
Capital Market: Products & Instruments
CERT 22-23 May 2007 24
SPV Project Owner1. Execution of al
ijarah contract
ASSETASSET
2. Rental of Asset on fixed term and fixed rental basis
Ijarah Rental ObligationCertificates
(evidence of obligations)3. Issuance of ijarah rental Obligations Promissory Notes to
SPV implying cash flow stream on asset.
Step 2
Capital Market: Products & Instruments
CERT 22-23 May 2007 25
SPV Project Owner
1.Regular Ijarah Rental Payments
Asset
5. Asset transferred to Project Owner
Investment Certificates
Holders2. Scheduled Distributions of Coupon Payments to Holders Of Investment Certificates issued by SPV
3. Final Repayment Representing Total Settlement equal to Initial Purchase PriceOf Asset by SPV
4. Payment of Final Amount being final settlement of Obligations under Ijarah Contract
Capital Market: Products & Instruments
CERT 22-23 May 2007 26
• Assets purchased by the SPV are funded by the issuance of floating rate Trust Certificates, representing beneficial ownership in the assets and having beneficial rights on the lease;
• Upon maturity of the lease, SPV sells asset to the Project Owner at the original price. Proceeds from this sale will be utilised to meet the final payment to investors.
Capital Market: Products & Instruments
CERT 22-23 May 2007 27
• Sukuk al Ijarah can be:• short term facility instruments i.e. as per
structure of sukuks issued by the Bank Negara and/or Government of Malaysia to replace T-Bills; or
• Medium to long term facilities but with rental settings made every scheduled periods of say 3 or 6 months each year.
CERT 22-23 May 2007 28Capital Market: Products & Instruments
PROJECTCo.
Ijarah SPV
Rental of Equipment
6. Ijarah contract
Musharakah Investors2. Musharakah Investment Agreement
3. $ for Working Capital Needs $ Income Stream
7. $ Ijarah RentalPayments
7. $ Profit Payments & Repurchase or Redemption of MPS
Ordinary Equity
SukukMudharabah
Financial Investors
5. $ ParticipationInto Mudharabah
1.
4.
8. $ Mudharabah ProfitPayments Project Funding through
COMBINATION OFPARTICIPATORY AND
IJARAH CONTRACTS
9.$
Dividends
MUSHARAKAH PREFERENCE
SHARES (‘MPS’)
Capital Market: Products & Instruments
CERT 22-23 May 2007 29
Khazanah Exchangeable Sukuk(Asset Swap)
Khazanah & Other Sellers
Issuer Rafflesia
Khazanah
SPV II Sukuk
Sukuk
Proceed ($)
Sale of
Equity Pool
Sale Price
(Principal)
($)
Sale Price
(Principal) ($)
Sale of
Equity Pool
Cash Settlement
Purchase Right DeedDefault / Maturity
Purchase
Undertaking Deed
Investors
$
Capital Market: Products & Instruments
CERT 22-23 May 2007 30
Some notable Sukuk issued in the global markets
Issuer FacilityIssue Size
USD(mil)Manager
Nakheel Development Convertible Sukuk Ijarah 3,520.00Barclays
Capital, DIB
ADIB Sukuk Co Sukuk Ijarah 800.00 HSBC
Rafflesia CapitalExchangeable Sukuk
Musyarakah750.00
CIMB, HSBC Amanah, UBS
Aabar SukukExchangeable Sukuk Mudarabah
460.00 Deutsche
Capital Market: Products & Instruments
CERT 22-23 May 2007 31
Tabreed 06 Financing Corp
Sukuk Istisna’ 200.00
CIMB, HSBC, Dreer
Kleinwort Wassertein
East Cameron Gas Co Asset backed Sukuk 168.00Merrill Lynch International
Issuer FacilityIssue Size
USD(mil)Manager
Capital Market: Products & Instruments
CERT 22-23 May 2007 32
Asset-Based Sukuk vs Asset Backed Sukuk
Asset based Sukuk Asset backed Sukuk
Feature Using Shariah compliant assets/business ventures to facilitate issuance of Sukuk
Asset backing Shariah compliant assets/business ventures which form PRIMARY source of income /return to investor. Issued in various Shariah principles
Key Accounting Concept/ treatment
ON balance sheet (for originator/obligor)
OFF balance sheet (for originator)True sale criterion: legal & off balance sheet accounting
Capital Market: Products & Instruments
CERT 22-23 May 2007 33
Funding Cost Market driven mainly depending on originator/issuer credit rating/standing
Mainly based on the strength of the asset cash flow
Rating Corporate rating of issuer/obligor
Strength of cash flow
Asset based Sukuk Asset backed Sukuk