Islamic capital markets and products : managing capital and liquidity requirements under Basel III
ISLAMIC CAPITAL MARKETS AND PRODUCTS – Book Samples
Criticisms of Sukuk Issuance Practices
During the course of 2007, Sheikh Taqi Usmani, the chairman of the Shari’ah board of the AAOIFI (Accounting and Auditing Organization for Islamic Financial Institutions), criticised a number of sukuk structures used in the market, in particular certain equity sukuk structures (mudaraba, wakala and musharaka) on the basis that, in his view, they were not Shari’ah-compliant.
For example, in sukuk mudaraba, in order to achieve the economic result of the investors receiving a predetermined amount on redemption and periodic profit distri-butions in the interim, a combination of a purchase undertaking and liquidity facility was used. The liquidity facility received criticism as it was felt to run contrary to the principle that the investor (rab-al-maal) should solely bear the loss on the investment.
In effect, the combination of the purchase indemnity and the liquidity facility were seen to serve to grant a guarantee in favour of the rab-al-maal and therefore negate the risk to which the rab-al-maal should be exposed. There was also criticism of the ‘incen-tive fee’ for the mudarib being linked to a benchmark, rather than to profits based on the skill exercised by the mudarib with respect to investments made.
Another area of criticism was that without the investment plan specifying that the proceeds are required for the purposes of investment in physical assets, the money invested by the rab-al-maal amounts to a loan.
Criticism was also extended to the use of purchase undertakings from the obligor in other Shari’ah structures for the same reasons regarding negating risk, because the purchase price is pre-agreed on the issue date of the sukuk instead of it being deter-mined at the time of sale in the future by reference to the market value of the asset.
For a period of time there was uncertainty as to the Shari’ah ruling in respect of sukuk that had previously been issued in the market. AAOIFI soon clarified in dis-cussions with market participants that sukuk which had been approved previously, together with the fatwas relating to such sukuk, remained intact.
Furthermore, in February 2008 the AAOIFI Shari’ah board, having met on various occasions both among themselves and with a number of market participants, issued the following guidance on sukuk issuance2In its first Shari’ah Roundtable, the International Islamic Liquidity Management Corporation (IILM) agreed with the participating Shari’ah … Continue reading
Sukuk must represent ownership in real or physical assets which may also include services or usufruct. The originator/obligor must be able to prove the transfer of title in its records and may not retain title to its assets sold or transferred under the sukuk structure;
- ◾ Sukuk may not represent receivables or debts unless as part of a sale of all assets by a financial or commercial institution;
- ◾ The obligor (be it mudarib, partner in a musharaka or agent/wakeel) may not pro-vide a liquidity facility;
- ◾ A mudarib, partner in a musharaka or agent (wakeel) may not undertake to pur-chase the mudaraba or musharaka assets at the face value of the sukuk but such purchase must instead be at the market value or a value to be agreed upon at the time of purchase; and
- ◾ A lessee in an ijarah sukuk may redeem the sukuk by purchase of assets at a pre-agreed price provided the lessee is not a mudarib, partner in a musharaka or agent.
The issue of this AAOIFI guidance has resulted in current sukuk being struc tured to conform to the guidance, except for sovereign issuances where legal title to the assets is retained by the sovereign and the issuer SPV receives beneficial title in an ‘asset-based’ structure. In particular, the market has moved away from the once- prevalent 100 percent ijarah structure towards hybrid structures, which for instance combine ijarah assets with a smaller proportion of murabaha assets within a wakala- or mudaraba-based structure to give more flexibility with respect to the types of assets that can be used.
These have the additional advantage of allowing a commodity mura-baha transaction to form part of the asset base, up to a maximum percentage (less than 50 percent) of the total asset value. As a result, issuers are able to issue sukuk on a more ‘asset efficient’ basis than previously.
The Criteria for sukuk to be included in a Shari’ah-compliant Index comprise the following:
◾ The issuance is certified by a reputable Shari’ah supervisory board.
◾ The issue must comply with the standards for tradable sukuk laid down by AAOIFI.
◾ The underlying assets to be securitised in sukuk must be screened for Shari’ah principles.
S&P Dow Jones has a trio of bond and sukuk indices aimed at MENA and Islamic investors. They include the S&P MENA Bond & Sukuk Index and two sub-indices, the S&P MENA Bond Index and S&P MENA Sukuk Index.
The S&P MENA Bond & Sukuk Index comprises a universe of USD-denominated debentures that seeks to measure the performance of bonds and sukuk in the MENA region. This region incorporates Algeria, Bahrain, Egypt, Iran, Iraq, Jordan, Kuwait, Lebanon, Libya, Morocco, Oman, Palestine, Qatar, Saudi Arabia, Syria, Tunisia, UAE and Yemen.
The S&P MENA Bond Index comprises a universe of USD-denominated deben-tures that seeks to measure the performance of bonds issued by companies domiciled in the MENA region. This index is, however, not Shari’ah-compliant.
The S&P MENA Sukuk Index is designed to provide exposure to sukuk issued by companies domiciled in the MENA region and is Shari’ah-compliant.
To be eligible for inclusion in these indices, each security must have maturity greater than or equal to one year from the rebalancing date and a minimum par amount of USD200 million at each rebalancing. Fixed or floating rate coupon instruments are eligible. The minimum credit rating for inclusion is BBB− / Baa3 / BBB−.
Sukuk Trust Certificate Programmes
A sukuk trust certificate programme allows the issuer to issue multiple tranches of trust certificates at the same time based on the same programme documentation. The issuer may also may issue certificates with different features such as:
◾ Fixed or floating profit rate
◾ Callability and puttability
◾ Currency flexibility
Due to their flexibility and repeatability of issuance, the economics of these
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References / Footnotes
|⇧01||2In its first Shari’ah Roundtable, the International Islamic Liquidity Management Corporation (IILM) agreed with the participating Shari’ah scholars that there should be a difference in the guidance on sukuk issuance between sovereign assets, which back all the IILM short-term sukuk, and corporate assets.|