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Reserve Your Free Copy of Ethica’s 700 Page E-Book

“Ethica’s Handbook of Islamic Finance (2013 Edition)”…700 Pages of Practical, Usable Knowledge!

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“Ethica’s Handbook of Islamic Finance (2013 Edition)” is the industry’s first practical, user’s guide for implementing change. It may also be the only e-book in Islamic finance with a detailed and expansive subject index for your convenience. An indispensable desktop reference for practitioners and students alike, this book puts everything you need in one place.

TABLE OF CONTENTS
* We Believe: Ethica’s manifesto.
* Speech: Use this speech or the accompanying video at your conference, training session, bank or university.
* Petitions: Use these sample petitions to bring standardized Islamic finance into your community.
* Articles: Use these articles to inform yourself and others about the basics of Islamic finance.
* Meezan Bank’s Guide to Islamic Banking by Dr. Imran Usmani: Use this section for a more detailed understanding of the industry’s core products from one of its leading scholars.
* Islamic Finance Contracts: Use these sample contracts to educate yourself and your bank about various Islamic finance instruments.
* CIFE™ Study Notes: Use these study notes to help you prepare for Ethica’s Certified Islamic Finance Executive™ (CIFE™) program.
* Recommended Reading for Practitioners: Use this reading list to help develop your worldview on finance.
* Recommended Reading for Entrepreneurs: Use this reading list to help you jump start your Islamic finance idea.
* Islamic Finance Q&As: Use this database of 1,000+ scholar-approved answers to guide your commercial dealings.
* Glossary of Commonly Used Terminology: Use this section to understand the industry’s most commonly used terminology.
* About Ethica Institute of Islamic Finance
* About the Certified Islamic Finance Executive™ (CIFE™)
* Press Releases
* Contact Ethica
* Subject Index: Use this detailed index to quickly search the entire e-book.

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About Ethica Institute of Islamic Finance (www.EthicaInstitute.com)

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Winner of “Best Islamic Finance Qualification” at the Global Islamic Finance Awards, Ethica is chosen by more professionals and students for Islamic finance certification than any other organization in the world. With over 20,000 paying users in 44 countries, the Dubai-based institute serves banks, universities, and professionals across over 100 organizations with its 4-month Certified Islamic Finance Executive™ (CIFE™) program delivered 100% online. The CIFE™ is the only globally recognized certificate accredited by scholars to fully comply with AAOIFI, the world’s leading Islamic finance standard. To watch an Ethica training video click here.

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Could Islamic finance have prevented the global economic crisis?

Could Islamic finance have prevented the global economic crisis?

boat in lake

By: Saud Masud

A question that is often discussed is: if the global economic crisis triggered by the housing bubble burst and the sub-prime credit crisis in the US would have been averted if the Islamic finance framework were in place. It is a question that is asked often and one that has generated global interest.  The answer is that in principle, Islamic finance may have prevented the sub-prime crisis leading to the global economic crunch.

In my opinion, the very founding spirit of Islamic finance is anti-speculation and “anti-bubbles,” if you will. I would qualify that improper risk management and lack of execution of principles in any financial system conventional or Islamic can potentially lead to similar negative results. However, understanding the general concepts behind Islamic finance, one may begin to appreciate the positives of this form of banking that is one of the fastest growing in the world and stands at around $1 trillion.

Islamic finance prohibits usury or charging interest for the use of money (Riba in Arabic), investing in speculative financial products like certain derivatives and engaging in businesses, products and services that are considered forbidden (Haram) in Islam. Furthermore, Islamic banking emphasizes partnership (Musharakah) in profit and loss sharing, asset-backed investing and more importantly it is not restricted to Muslims. As a matter of fact several secular states including Singapore have seen an increase in demand for Islamic financial products. In essence under Islamic law (Shariah) one cannot lend money to make money or engage in predatory lending which leads to poor getting poorer and rich getting richer, i.e. exploitation is strictly forbidden. Also, debt cannot be taken on without collateral or an asset backing. One must refrain from gambling (Maisar) and uncertainty (Gharar), i.e. you cannot sell what you don’t own. Both buyer and seller are involved in the transaction with a no-pain, no-gain approach to making profits or sharing losses. This sounds common sense, ethical, trust-fostering and would appeal to most people.

Now lets examine what caused the sub-prime crisis. Coming out the dot-com bubble crash the central bank kept interest rates low in order to stimulate growth in the economy. So far so good. At low interest rates however banks started engaging in sub-prime lending with adjustable rate mortgages or ARMs. Simply put, you extend a house loan to someone with high credit risk at low interest rates but as the rates adjust upwards, which means the monthly mortgage payments shoot up the same high risk borrower becomes a “very high risk” borrower. While these loans were being issued innovation kicked in and several financial institutions repackaged the very same loans and sold them as “bundled” debt or MBS (Mortgage Backed Securities) to other investors. Rating agencies continued to rate these bundles of debt as relatively safe and high grade, which turned out not to be the case. To make this even worse based on these ratings many investors bought these securities and some also bought credit default swaps or CDS as insurance against these loan packages. On the other side insurance companies and other financials took on the credit default risk, i.e. if the loans went bad these insurance companies would pay for the shortfall. Recall these insurance companies were also relying on ratings agencies on the credit worthiness of the loans. With all of this playing out over several years leading up to 2006 as the markets started recovering from the dot-com bubble, interest rates now started going up. That in turn led to a trigger in sub-prime mortgage defaults, which in turn led to severe drop in MBS prices or the value of bundled loans, which further led to insurance companies having to pay for the shortfall. All of this led to freezing up of credit and money markets as capital was getting destroyed and investors just didn’t know how bad this could get. We saw markets collapse fairly quickly and while we have seen a global recovery since the 2007/2008 period. I am still not very convinced if we have fully averted the global crisis just yet. The US economy is still witnessing a jobless recovery for the most part with unemployment at 9.5% and the European Union crisis seems to have a revolving door, first with Greece and now with Ireland needing a bailout.

By no means should one assume that as an alternative, Islamic finance framework alone would be a 100% water-tight solution as the regulation and execution within the system is just as important as its underlying principles. However if we just examine the sub-prime crisis chain of events and the level of leverage and speculation not to mention lack of regulatory oversight, we may deduce that under Islamic finance principles much of the excess would have been “checked at the door” and not have come about at several times during the birth of the crisis. For example under Islamic banking regulations loans would not have been repackaged and traded as MBS and CDS would not be linked to these speculative products thus mitigating the chance for a ballooning effect. While Islamic finance continues to evolve rapidly the recent economic crisis has bought it some market share! In the end market decides the value of any goods and services and over last five years the Dow Jones Islamic Index is up 18% compared to the S&P 500 down 8%.

Source: http://www.elanthemag.com/index.php/site/blog_detail/could_islamic_finance_have_prevented_the_global_economic_crisis-nid35879827/

Saud Masud is the CEO of SM Advisory Group, LLC. a consultancy firm focused on Middle East, North Africa and South Asia region (MENASA). Previously, Mr. Masud was the Head of Investment Research at UBS for Middle East and North Africa based in Dubai. In addition to overseeing the research platform he was also a Sr. Analyst covering Real Estate sector for the Middle East region. Before moving to Dubai Mr. Masud was a Sr. Analyst for 5 years covering the tech sector for UBS in New York. Prior to Wall Street Mr. Masud ran an Internet start-up, Synapse Worldwide and engaged in management roles at Lucent Technologies based in New Jersey. Mr. Masud holds both a Bachelor of Science in Electrical Engineering and MBA in finance from Virgina Tech. Mr. Masud has often appeared as guest on TV and radio including CNBC, Bloomberg, CNN, BBC, Voice of America, etc. and has been frequently quoted in business news outlets like Wall Street Journal, Financial Times, TIME, Reuters, etc.

4 Principles of Islamic Finance

4 Principles of Islamic Finance

Islamic finance refers to a system of finance that is based on the principals of Islamic law (Sharia). As per the Sharia, the payment and the acceptance of interests for loans of money, lending money on interest (Riba), as well as investing in businesses that provide goods or services that are forbidden in Islam (Haram) , are all prohibited. The concept of Islamic finance is more accurately that money has no intrinsic value. It believes that since money has no value of its own, there should be no charge for its use. Although Islamic finance is as old as the religion itself, modern Islamic finance originated in the 1960’s.

Some of the main principles of Islamic finance are as follows.

1. Prohibition on interest: As per the laws of Islamic finance the taking or the receiving of interest at exorbitant rates is prohibited. This however does not preclude a rate of return on investments.

2. Sharing of risks: As per the Islamic finance the risks involved in any transaction must be shared at least between two parties. This is so that the business risk gets shared between the party that is providing the capital and the entrepreneur, for a share in the profit.

3. Speculative behavior not permitted: Speculative behavior (Gharar) is prohibited. This implies that gambling and other such extreme uncertainty or risks are forbidden. That is why the disclosure of information and the contractual obligations are considered to be sacred duty as per the Islamic law.

4. Violation of the rules of Sharia is forbidden: All investments in businesses related to unethical things as per the Islamic law are forbidden. These businesses would include businesses related to alcohol, pork related products, conventional financial services and entertainment. Under entertainment would fall gambling and casinos, hotels, pornography and music. These are businesses that are advised against by Sharia boards. Some Sharia boards also object to investing in businesses related to tobacco, defense or weapons.

Many experts have predicted that Islamic finance will grow further in the coming years. Thus is because of various reasons. One such reason is that Muslims worldwide are starting to choose those products that are compliant to the Sharia. These products were not available before but lately the increase in oil wealth is being channeled more into these products. Due to the growing competitiveness and the ethical focus of these products, they are drawing both Muslims and non Muslims.

Jason Holmes is a regular writer with Debt Consolidation Care and is also a contributory writer with other financial sites. His expertise is woven around various aspects of the debt industry and with his e-books he tries to impart to people the different situations and simple solutions to get out of difficult situations. Some of his works include e-books like ‘Credit Score The Quintessential Therapy for a Happy Pocket’, Take Creditors and Collection Agencies to Small Claims Court’ and, My Story- From Depression To a Smile’.

How Sukuk works: Introduction, structuring and application of Sukuk bonds

How Sukuk works: Introduction, structuring and application of Sukuk bonds

An excellent introduction to Sukuk bonds.

From: www.financeinislam.com
Author: Shariq Nisar

ISLAMIC BONDS (SUKUK): ITS INTRODUCTION AND APPLICATION

What is Sukuk

Sukuk in general may be understood as a shariah compliant ‘Bond’. In its simplest form sukuk represents ownership of an asset or its usufruct. The claim embodied in sukuk is not simply a claim to cash flow but an ownership claim. This also differentiates sukuk from conventional bonds as the latter proceed over interest bearing securities, whereas sukuk are basically investment certificates consisting of ownership claims in a pool of assets.

Sukuk (plural of word sak) were extensively used by Muslims in the Middle Ages as papers representing financial obligations originating from trade and other commercial activities. However, the present structure of sukuk are different from the sukuk originally used and are akin to the conventional concept of securitization, a process in which ownership of the underlying assets is transferred to a large number of investors through certificates representing proportionate value of the relevant assets.

Sukuk vs. Conventional Bonds

  • A bond is a contractual debt obligation whereby the issuer is contractually obliged to pay to bondholders, on certain specified dates, interest and principal, whereas, the sukuk holders claims an undivided beneficial ownership in the underlying assets. Consequently, sukuk holders are entitled to share in the revenues generated by the sukuk assets as well as being entitled to share in the proceeds of the realization of the sukuk assets.
  • A distinguishing feature of a sukuk is that in instances where the certificate represents a debt to the holder, the certificate will not be tradable on the secondary market and instead is held until maturity or sold at par.

Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) defines sukuk as being:

“Certificates of equal value representing after closing subscription, receipt of the value of the certificates and putting it to use as planned, common title to shares and rights in tangible assets, usufructs and services, or equity of a given project or equity of a special investment activity”.

Benefits and Features

  • Tradable shariah-compliant capital market product providing medium to long-term fixed or variable rates of return. Assessed and rated by international rating agencies, which investors use as a guideline to assess risk/return parameters of a sukuk issue.
  • Regular periodic income streams during the investment period with easy and efficient settlement and a possibility of capital appreciation of the sukuk.
  • Liquid instruments, tradable in secondary market.

Uses of Sukuk Funds

The most common uses of sukuk can be named as project specific, asset-specific, and 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 this case 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 Ijara-based Trust Certificates (TCs) were issued worth US$700 million due by October 2010. The annual floating rate of return was agreed at LIBOR plus 0.45 per cent.

2. Assets-specific Sukuk

Under this arrangement, the resources are mobilise by selling the beneficiary right of the assets to the investors. For example, the Government of Malaysia raised US$ 600 million 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 Ijara 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 Sukuk

An example of the balance sheet specific use of sukuk funds is the Islamic Development Bank (IDB) sukuk issued in August 2003. The IDB mobilised 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.

 

Types of Sukuk
Sukuk can be of many types depending upon the type of Islamic modes of financing and trades used in its structuring. However, the most important and common among those are ijarah, shirkah, salam and istisna. Among the fourteen eligible sukuks identified by the AAOIFI, following are more common:

1. Mudaraba Sukuk

These are investment sukuk that represent ownership of units of equal value in the Mudaraba equity and are registered in the names of holders on the basis of undivided ownership of shares in the Mudaraba equity and its returns according to the percentage of ownership of share. The owners of such sukuk are the rabbul-mal. (AAOIFI). Mudarba sukuk are used for enhancing public participation in big investment projects.

Salient Features:

Following are the salient features of mudarba sukuk:

  • Mudarba sukuk (MS) represent common ownership and entitle their holders share in the specific projects against which the MS has been issued.
  • The MS contract is based on the official notice of the issue of the prospectus which must provide all information required by shariah for the Qirad contract such as the nature of capital, the ratio for profit distribution and other conditions related to the issue, which must be compatible with shariah.
  • The MS holder is given the right to transfer the ownership by selling the deeds in the securities market at his discretion.  The sale of MS must follow the rules listed below:
    • If the mudarba capital, before the operations of the project, is still in the form of money, the trading of MS would be like exchange of money for money. In that case the rules of bay al-sarf would be applied.
    • If muqarda capital is in the form of debt then it must satisfy the principles of debt trading in Islam.
    • If capital is in the form of combination of cash, receivables, goods, real assets and benefits, trade must be based on market price evolved by mutual consent.
  • The Manager/SPV who receives the fund collected from the subscribers to MS can also invest his own fund. He will get profit for his capital contribution in addition to his share in the profit as mudarib.
  • Neither prospectus nor MS should contain a guarantee, from the issuer or the manager for the fund, for the capital or a fixed profit, or a profit based on any percentage of the capital. Accordingly;
    • The prospectus or the MS issued pursuant to it, may not stipulate payment of a specific amount to the MS holder,
    • The profit is to be divided, as determined by applying rules of shariah; that is, an amount access of the capital, and not the revenue or the yield; and
    • Profit and Loss account of the project must be published and disseminated to MS holders.
  • It is permissible to create reserves for contingencies, such as loss of capital, by deducting from the profit.
  • The prospectus can also contain a promise made by a third party, totally un-related to the parties to the contract, in terms of legal entity or financial status, to donate a specific sum, without any counter benefit, to meet losses in the give project, provided such commitment is independent of the mudarba contract.

On the expiry of the specified time period of the subscription, the Sukuk holders is given the right to transfer the ownership by sale or trade in the securities market at his discretion.

Steps involved in the structure:

  • Mudarib enters into an agreement with project owner for construction/commissioning of project.
  • SPV issues sukuk to raise funds.
  • Mudarib collects regular profit payments and final capital proceeds from project activity for onward distribution to investors.
  • Upon completion, Mudarib hands over the finished project to the owner.

Mudaraba Sukuk in practice

Shamil Bank of Bahrain raised 360 million Saudi Riyal investment capital through the Al Ehsa Special Realty Mudaraba, representing an investment participation in a land development transaction with a real estate development company in the Kingdom of Saudi Arabia. The investment objective of the Mudaraba is to provide investors with annual returns arising from participation in the funding of a land financing transaction Profits due to investors will be accrued on the basis of returns attained from investing the subscriptions.

2. Musharaka Sukuk

These are investment sukuk that represent ownership of Musharaka equity. It does not differ from the Mudaraba sukuk except in the organization of the relationship between the party issuing such sukuk and holders of these sukuk, whereby the party issuing sukuk forms a committee from the holders of the sukuk who can be referred to in investment decisions (AAOIFI).

Musharaka Sukuk are used for mobilizing the funds for establishing a new project or developing an existing one or financing a business activity on the basis of partnership contracts. The certificate holders become the owners of the project or the assets of the activity as per their respective shares. These Musharaka certificates can be treated as negotiable instruments and can be bought and sold in the secondary market.

“These are certificates of equal value issued with the aim of using the mobilized funds for establishing a new project, developing an existing project or financing a business activity on the basis of any partnership contracts so that the certificate holders become the owners of the project or assets of the activity as per their respective shares, with the Musharaka certificates being managed on the basis of participation or Mudaraba or an investment agency.” (AAOIFI Standard 17, 3/6)

Steps involved in the structure:

Corporate and the Special Purpose Vehicle (SPV) enter into a Musharaka Arrangement for a fixed period and an agreed profit-sharing ratio. Also the corporate undertakes to buy Musharaka shares of the SPV on a periodic basis.

  • Corporate (as Musharik) contributes land or other physical assets to the Musharaka
  • SPV (as Musharik) contributes cash i.e. the issue Proceeds received from the investors to the Musharaka
  • The Musharaka appoints the Corporate as an agent to develop the land (or other physical assets) with the cash injected into the Musharaka and sell/lease the developed assets on behalf of the Musharaka.
  • In return, the agent (i.e. the Corporate) will get a fixed agency fee plus a variable incentive fee payable.
  • The profits are distributed to the sukuk holders.
  • The Corporate irrevocably undertakes to buy at a pre-agreed price the Musharaka shares of the SPV on say semi-annual basis and at the end of the fixed period the SPV would no longer have any shares in the Musharaka.

Musharaka Sukuk in Practice

US$550 million sukuk transaction for Emirates airline, the seven-year deal was a structured on a Musharaka contract. The Musharaka or joint venture was set up to develop a new engineering centre and a new headquarters building on land situated near Dubai’s airport which will ultimately be leased to Emirates. Profit, in the form of lease rentals, generated from the Musharaka venture will be used to pay the periodic distribution on the trust certificates.

Sitara Chemical Industries Ltd, a public limited company, made a public issue of profit-and-loss sharing based term finance certificates (TFC’s) worth Rs 360 million which were subscribed in June 2002. The TFC’s had a fixed life tenor of five years and profit and loss sharing was linked to the operating profit or loss of the Chemical Division of the company.

Kuwait Finance House (KFH), Liquidity Management Center (LMC) and Al Muthanna Investment Company (MIC), the mandated lead arrangers launched US$ 125 million Lagoon City Musharaka sukuk to support the Lagoon City residential and commercial real estate development as part of Kheiran Pearl City project.

3. Ijara Sukuk

These are sukuk that represent ownership of equal shares in a rented real estate or 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. (AAOIFI)

Ijarah 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. Payment of ijarah rentals can be unrelated to the period of taking usufruct by the lessee. It can be made before beginning of the lease period, during the period or after the period as the parties may mutually decide. This flexibility can be used to evolve different forms of contract and sukuk that may serve different purposes of issuers and the holders.

Features of Ijarah sukuk

  • It is necessary for an ijarah contract that the assets being leased and the amount of rent both are clearly known to the parties at the time of the contract and if both of these are known, ijarah 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 (AAOIFI, 2003: 140-157). The lessor can sell the leased asset provided it does not hinder the lessee to take benefit from the asset. The new owner would be entitled to receive the rentals.
  • Rental in ijarah must be stipulated in clear terms for the firs term of lease, and for future renewable terms, it could be constant, increasing or decreasing by benchmarking or relating it to any well-known variable.
  • As per shariah rules, expenses related to the corpus or basic characteristics of the assets are the responsibility of the owner, while maintenance expenses related to its operation are to be borne by the lessee.
  • As regards procedure for issuance of ijarah sukuk, an SPV is created to purchase the asset(s) that issues sukuk to the investor, enabling it to make payment for purchasing the asset. The asset is then leased to third party for its use. The lessee makes periodic rental payments t the SPV that in turn distributes the same to the sukuk holders.
  • Ijara sukuk are completely negotiable and can be traded in the secondary markets.
  • Ijara sukuk offer a high degree of flexibility from the point of view of their issuance management and marketability. The central government, municipalities, awqaf or any other asset users, private or public can issue these Sukuk. Additionally, they can be issued by financial intermediaries or directly by users of the leased assets.

Steps involved in the structure

  • The obligator sells certain assets to the SPV at an agreed pre-determined purchase price.
  • The SPV raises financing by issuing sukuk certificates in an amount equal to the purchase price.
  • This is passed on to the obligator (as seller).
  • A lease agreement is signed between SPV and the obligator for a fixed period of time, where the obligator leases back the assets as lessee.
  • SPV receives periodic rentals from the obligator;
  • 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 amounts still owed under the terms of the Ijara sukuk.

Ijara Sukuk in Practice

In December 2000, Kumpulan Guthrie Berhad (Guthrie) was granted a RM1.5 billion (US$400 million) Al-Ijara Al-Muntahiyah Bit-Tamik by a consortium of banks. The original facility was raised to re-finance Guthrie’s acquisition of a palm oil plantation in the Republic of Indonesia. The consortium was then invited to participate as the underwriter/primary subscriber of the Sukuk Transaction.

US$350 million sukuk Trust Certificates by Sarawak Corporate Sukuk Inc. (SCSI) Sarawak Economic Development Corporation (SEDC) raised financing amounting to US$350 million by way of issuance of series of trust certificates issued on the principle of Ijara sukuk. The certificates were issued with a maturity of 5 years and under the proposed structure, the proceeds will be used by the issuer to purchase certain assets from 1st Silicon (Malaysia) Sdn Bhd. Thereafter, the issuer will lease assets procured from 1st Silicon to SEDC for an agreed rental price for an agreed lease period of 5 years.

4. Murabaha Sukuk

In this case the issuer of the certificate is the seller of the Murabaha commodity, the subscribers are the buyers of that commodity, and the realised funds are the purchasing cost of the commodity. The certificate holders own the Murabaha commodity and are entitled to its final sale price upon the re-sale of the Commodity. The possibility of having legally acceptable Murabaha-based sukuk is only feasible in the primary market. The negotiability of these Sukuk or their trading at the secondary market is not permitted by shariah, as the certificates represent a debt owing from the subsequent buyer of the Commodity to the certificate-holders and such trading amounts to trading in debt on a deferred basis, which will result in riba.

Despite being debt instruments, the Murabaha Sukuk could be negotiable if they are the smaller part of a package or a portfolio, the larger part of which is constituted of negotiable instruments such as Mudaraba, Musharaka, or Ijara Sukuk. Murabaha sukuk are popular in Malaysian market due to a more liberal interpretation of fiqh by Malaysian jurists permitting sale of debt (bai-al-dayn) at a negotiated price.

Steps involved in the structure:

  • A master agreement is signed between the SPV and the borrower
  • SPV issues sukuk to the investors and receive sukuk proceeds.
  • SPV buys commodity on spot basis from the commodity supplier.
  • SPV sells the commodity to the borrower at the spot price plus a profit margin, payable on installments over an agreed period of time
  • The borrower sells the commodity to the Commodity buyer on spot basis.
  • The investors receive the final sale price and profits.

Murabaha Sukuk in Practice

Arcapita Bank, a Bahrain-based investment firm has mandated Bayerische Hypo-und Vereinsbank AG (“HVB”), Standard Bank Plc (“SB”) and WestLB AG, London Branch (“WestLB”) (together the “Mandated Lead Arrangers”), to arrange a Five Year Multicurrency (US$, € and £) Murabaha-backed Sukuk. Sukuk will have a five-year bullet maturity and proposed pricing three month LIBOR +175bps.

5. Salam Sukuk

Salam sukuk are certificates of equal value issued for the purpose of mobilising Salam capital so that the goods to be delivered on the basis of Salam come to the ownership of the certificate holders. The issuer of the certificates is a seller of the goods of Salam, the subscribers are the buyers of the goods, while the funds realized from subscription are the purchase price (Salam capital) of the goods. The holders of Salam certificates are the owners of the Salam goods and are entitled to the sale price of the certificates or the sale price of the Salam goods sold through a parallel Salam, if any.

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 return for a promise to deliver a commodity at a future date. SPV can also 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 the Sukuk.

All standard shariah requirements that apply to Salam also apply to Salam sukuk, such as, full payment by the buyer at the time of effecting the sale, standardized nature of underlying asset, clear enumeration of quantity, quality, date and place of delivery of the asset and the like.

One of the Shariah conditions relating to Salam, as well as for creation of Salam sukuk, is the requirement that the purchased goods are not re-sold before actual possession at maturity. Such transactions amount to selling of debt. This constraint renders the Salam instrument illiquid and hence somewhat less attractive to investors. Thus, an investor will buy a Salam certificate if he expects prices of the underlying commodity to be higher on the maturity date.

Steps involved in the transaction:

  • 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 Sukuk holders.
  • Salam certificates are issued to investors and SPV receives Sukuk proceeds.
  • The Salam proceeds are passed onto the obligator who sells commodity on forward basis
  • SPV receives the commodities from the obligator
  • Obligator, on behalf of Sukuk holders, sells the commodities for a profit.
  • Sukuk holders receive the commodity sale proceeds.

Salam Sukuk in Practice

Aluminum has been designated as the underlying asset of the Bahrain Government al Salam contract, where by it promises to sell aluminum to the buyer at a specified future date in return of a full price payment in advance. The Bahrain Islamic Bank (BIB) has been nominated to represent the other banks wishing to participate in the Al Salam contract. BIB has been delegated to sign the contracts and all other necessary documents on behalf of the other banks in the syndicate. At the same time, the buyer appoints the Government of Bahrain as an agent to market the appropriate quantity at the time of delivery through its channels of distribution. The Government of Bahrain provides an additional undertaking to the representative (BIB) to market the aluminum at a price, which will provide a return to al Salam security holders equivalent to those available through other conventional short-term money market instruments.

6. Istisna Sukuk

Istisna sukuk are certificates that carry equal value and are issued with the aim of mobilising the funds required for producing products that are owned by the certificate holders. The issuer of these certificates is the manufacturer (supplier/seller), the subscribers are the buyers of the intended product, while the funds realised from subscription are the cost of the product. The certificate holders own the product and are entitled to the sale price of the certificates or the sale price of the product sold on the basis of a parallel Istisna, if any. Istisna Sukuk are quite useful for financing large infrastructure projects. The suitability of Istisna for financial intermediation is based on the permissibility for the contractor in Istisna to enter into a parallel Istisna contract with a subcontractor. Thus, a financial institution may undertake the construction of a facility for a deferred price, and sub contract the actual construction to a specialised firm.

Shariah prohibits the sale of these debt certificates to a third party at any price other than their face value. Clearly such certificates cannot be traded in the secondary market.

Steps involved in the structure:

  • SPV issues Sukuk certificates to raise funds for the project.
  • Sukuk issue proceeds are used to pay the contractor/builder to build and deliver the future project.
  • Title to assets is transferred to the SPV
  • Property/project is leased or sold to the end buyer. The end buyer pays monthly installments to the SPV.
  • The returns are distributed among the Sukuk holders.

Istisna Sukuk in Practice

Tabreed’s five-year global corporate Sukuk (on behalf of the National Central Cooling Company, UAE) provided a fixed coupon of 5.50%. It is a combination of Ijara Istisna and Ijara Mawsufah fi al dhimmah (or forward leasing contracts). The issue was launched to raise funds to retire some existing debt, which totals around US$136 million, as well as to finance expansion.

The Durrat Sukuk will finance the reclamation and infrastructure for the initial stage of a broader US$ 1 billion world class residential and leisure destination known as ‘Durrat Al Bahrain’, currently the Kingdom of Bahrain’s largest residential development project. The return on the Sukuk is 125 basis points over 3 months LIBOR payable quarterly, with the Sukuk having an overall tenor of 5 years and an option for early redemption. The proceeds of the issue (cash) will be 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 are completed by the Contractor and delivered to the Issuer, the Issuer will give notice to the Project Company under the Master Ijara Agreement and will lease such Base Infrastructure on the basis of a lease to own transaction.

7. Hybrid Sukuk

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 securitised instruments at least 51 percent of the pool in a hybrid Sukuk must comprise of Sukuk tradable in the market such as an Ijara Sukuk. Due to the fact the Murabaha and Istisna receivables are part of the pool, the return on these certificates can only be a pre-determined fixed rate of return.

Steps involved in the structure:

  • Islamic finance originator transfers tangible assets as well as Murabaha deals to the SPV.
  • SPV issues certificates of participation to the Sukuk holders and receive funds. The funds are used by the Islamic finance originator.
  • Islamic finance originator purchase these assets from the SPV over an agreed period of time.
  • Investors receive fixed payment of return on the assets.

Hybrid Sukuk in practice

Islamic Development Bank issued the first hybrid Sukuk of assets comprising 65.8% Sukuk al-Ijara, 30.73% of Murabaha receivables and 3.4% Sukuk al-Istisna. This issuance required the IDB’s guarantee in order to secure a rating and international marketability. The $ 400 million Islamic Sukuk was issued by Solidarity Trust Services Limited (STSL), a special purpose company incorporated in Jersey Channel Islands. The Islamic Corporation for the Development of Private Sector (ICD) played an intermediary role by purchasing the asset from IDB and selling it to The Solidarity Trust Services Limited (STSL) at the consolidated net asset value.

Conclusion

The market for sukuk is now maturing and there is an increasing momentum in the wake of interest from issuers and investors. sukuk have confirmed their viability as an alternative means to mobilise medium to long-term savings and investments from a huge investor base.

Different sukuk structures have been emerging over the years but most of the sukuk issuance to date have been ijara sukuk, since they are based on the undivided pro-rata ownership of the underlying leased asset, it is freely tradable at par, premium or discount. Tradability of the sukuk in the secondary market makes them more attractive. Although less common than Ijara sukuk, other types of sukuk are also playing significant role in emerging markets to help issuers and investors alike to participate in major projects, including airports, bridges, power plants etc. The sovereign sukuk issues, following Malaysia’s lead, are enjoying widespread and positive acclaim among Islamic investors and global institutional investors alike.

Islam’s approach to ethical investment

Islam’s approach to ethical investment

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Given that many ethical funds have similar characteristics as Islamic funds, it is important for ethical investors attracted by the appeal of Islamic principles as well as the performance of Islamic investments to understand that there are additional prohibitions that must be applied on the products offered.

These restrictions which are essentially self-imposed based on belief and conviction act a moral compass; the monitoring of the prohibitions by a Religious (Shari’ah) Supervisory Board may have prevented Islamic financial institutions to deviate from a faith-based system and absorb the shocks within the conventional financial system.

The important principles for Islamic financial instruments for participation and investments that require strict adherence, while providing good returns, are:

*Investments must be free of interest, speculation and gambling, all are considered as forms of exploitation

*Investments are made in permissible activities

*Investments must be separately approved by an independent Shari’ah supervisory board to ensure Shari’ah principles are strictly adhered to and deviations and wayward business practice penalised, for example in Islamic finance requires penalties to be paid to charity

“The ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service,” the Vatican’s official newspaper Osservatore Romano said in an article its latest March 2009 issue.

Shariah authenticity

Shaikh Yusuf Talal DeLorenzo, Islamic scholar, position is that unless a financial product or service can be certified as Shari’ah compliant by a competent Shari’ah supervisory board, that product’s authenticity is dubious. At that point, it will be the responsibility of the individual investor or consumer to determine on his or her own that the product complies with the principles and precepts of the Shari’ah.

Shari’ah supervisory board (Religious Board)

Islamic financial institutions must adhere to the best practices of corporate governance however they have one extra layer of supervision in the form of religious boards. The religious boards have both supervisory and consultative functions. Since the Shari’h scholars on the religious boards carry great responsibility, it is important that only high calibre scholars are appointed to the religious boards.

Islamic financial institutions that offer products and services conforming to Islamic principles must, therefore, be governed by a religious board that acts as an independent Shari’ah Supervisory Board comprising of at least three Shari’ah scholars with specialised knowledge of the Islamic laws for transacting, fiqh al mu‘amalat, in addition to knowledge of modern business, finance and economics.

They are responsible primarily to give approval that banking and other financial products and services offered comply with the Shari’ah and subsequent verification that of the operations and activities of the financial institutions have complied with the Shari’ah principles (a form of post Shari’ah audit). The Shari’ah Supervisory Board is required to issue independently a certificate of Shari’ah compliance.

The day-to-day application of Shari’ah by the Shari’ah Supervisory Boards is two-fold. First, in the increasingly complex and sophisticated world of modern finance they endeavours to answer the question on whether or not proposals for new transactions or products conform to the Shari’ah. Second, they act to a large extent in an investigatory role in reviewing the operations of the financial institution to ensure that they comply with the Shari’ah.

The concept of collective decision-making, in other words, decisions made by more than one scholar, is especially important. Shari’ah Supervisory Boards function is to ensure that decisions are not unilateral, and that difficult issues of finance receive adequate consideration by a number of qualified people.

Source: Institute of Islamic Banking and Insurance (IIBI)

www.IslamicAdvisory.com: 2 minute tour

2 minute tour of IslamicAdvisory.com

Introduction to Islamic Finance: Interview with Rod Ringrow of State Street Global Advisers

Introduction to Islamic Finance: Interview with Rod Ringrow of State Street Global Advisers

State Street Global Advisers senior vice president and managing director of the Doha Office, Rod Ringrow, tells Business Spectator’s Isabelle Oderberg how Islamic finance works and why it is set for enormous growth amid the meltdown of western style financial systems.

Isabelle Oderberg: I was wondering if just to start with for some of our readers who aren’t familiar with Islamic finance if you could just go through the fundamentals of it?

Rod Ringrow: The underlying principle for Islamic finance is it’s based on Islamic law and there are a number of key tenets that are critical to how the whole thing hangs to together. So, there’s the underlying premise that social and economic justice go hand in hand. There is a ban on interest. There is a ban to the extent possible on uncertainty. There is the promotion and the concept of risk and profit sharing between the provider of the finance and the recipient. Ethical, socially responsible investments.

So for example, nothing in gambling, armaments, alcohol, pork, obviously for Muslims, and in almost all cases there’s an underlying financial and physical asset that go with the transaction, so the concept of money making money is really what’s behind what is prohibited. So, in many ways it appeals to the Muslim community and also I think a great number of non-Muslims, in the fact that it is back to basics almost in terms of Western finance where there’s a physical asset underlying it, there’s not excess of leverage, etc.

IO: So you can’t invest in, for instance, bonds or anything like that because they pay interest. What kinds of investments would an Islamic fund manager be making?

RR: Well, there’s short-term and longer-term and we’ll come to the bond concept later, but a good example of a short-term fund would be a trading transaction, so the promoter buys a shipment of sugar or iron ore and pre-sells it at a predetermined price, so you buy it at 100 and sell it for 120 and that’s considered acceptable, because as I say, there’s an underlying physical asset and you’re pre-financing that shipment. The uncertainty element’s gone, because you know what you’ve bought it at and you know what you’re selling it at. That’s one example.

You’re right in the true sense of a bond not being able to be invested in, but there are some instruments called sukuks, which are really referred to as ‘Islamic bonds’ and there’s been a huge interest in those. In 2007 there were US$47 billion issued. The market took a bit of a tumble in 2008, but there’s a lot of potential demand out there for sukuk issuance.

There are 14 different kinds of sukuks and that creates another problem which we can come back to later, but in the 14 kinds of sukuks, there’s one called an ijara and that’s more like a lease transaction. Again, there has to be a physical asset underlying the financing here, but that ijara is closest probably to a leasing transaction in western finance. So somebody buys the asset then leases it for a monthly fee to the user. There are bonds issued, backed by that kind of structure, and there are a number of fund management houses beginning to look at how to create investment funds using sukuk as the kind of underlying investment. The traditional sort of Islamic investment funds have traditionally been equity based investment.

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