WEL COME IN THE NAME OF ALLAH THE BENEFICIENT THE MERCIFUL MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

Sukuk and its Legal and Regulatory Framework in Pakistan By SIBGHATULLAH AHSAN Partner MIAN & SIBGHAT Advocates & Legal Consultants Islamabad. MIAN & SIBGHAT mslaw.pk@gmail.com August 27, 2008

ISLAMIC FINANCIAL SYSTEM- AN INTRODUCTION Based on QURAN and SUNNAH Demands socio economic justice Prohibits all kinds of RIBA Prohibits all forms of exploitation Provides equal opportunities to all Condemns accumulation of wealth in few hands Encourages acts of benevolence MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

PRINCIPLES OF ISLAMIC FINANCE Prohibition of RIBA Alkharajo bil dhaman (entitlement to profit is associated with corresponding risk) Prohibition of sale of goods before acquiring ownership Prohibition of sale of food stuff before possession Prohibition of debt for debt Avoidance of Gharar (uncertainty) MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

PROHIBITION OF RIBA QURAN “ALLAH has permitted BAI’ (sale) and prohibited RIBA” (Al Baqarah: 275) O you believers, fear ALLAH and give up whatever is left in lieu of RIBA if you are indeed believer, Watch out! If you do not obey this order (and give up all outstanding RIBA), then there is a declaration of war against you from ALLAH and HIS PROPHET. However, if you repent you have entitlement only to your principals. Neither you inflict zulm on others, nor the others should do zulm on you. (Al Baqarah: 278-9) Refer to IIIE blue print for ayat and ahadith. MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

PROHIBITION OF RIBA SUNNAH Obadah ibn Samit directly reports from the Prophet as saying: “Buy and sell gold for gold, silver for silver, dates for dates, wheat for wheat, salt for salt, and barley for barley on the like for like basis. Whosoever gave more or took more, verily he made a RIBA deal. However, trade gold for silver as you wish subject to the condition that the exchange be hand to hand (spot). Trade wheat for dates or barley for dates also likewise. MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

EXCHANGE OF HOMOGENEOUS COMMODITIES OR CURRENCIES DELIVERY: Must be simultaneous / spot Commodity A Commodity B MEASURMENT: Must be same in amount / weight / count MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

EXCHANGE OF HETEROGENEOUS COMMODITIES OR CURRENCIES DELIVERY: Must be simultaneous / spot Commodity B Commodity A MEASUREMENT: May be different MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

EXCHANGE INVOLVING RIBA IN HOMOGENEOUS COMMODITIES OR CURRENCIES DELIVERY: Any one of the counter values is delayed Commodity A Commodity B MEASURMENT: Counter values are not equal MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

EXCHANGE INVOLVING RIBA IN HETEROGENEOUS COMMODITIES OR CURRENCIES DELIVERY: Delay in any of the counter values would amount to RIBA (Delivery must be simultaneous / spot Commodity B Commodity A MEASUREMENT: May be different MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

Some principles derived from the Hadith General principles In a contract of sale counter values must be exchanged simultaneously Quantity /number/measure etc. should be same Exceptions Credit Sale Salam Qard-e-Hasanah MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

WHAT IS RIBA Simple definition Any delay or discrimination (regarding weight, measure or count) in any of the counter values in a contract of exchange is riba Any addition without a counter value is RIBA Every loan entailing an increase is RIBA MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

ISLAMIC CONTRACTS FOR COMMERCIAL TRANSACTIONS Musharaka (Profit and Loss sharing) Modaraba (Profit sharing) Musawamah (Bargaining sale) Ijarah (Leasing) Salam (Advance payment sale) Istisna’ (Contract of manufacturing) Murabaha (Cost plus margin sale) MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

MUSHARAKA Characteristics All parties share in the capital All parties share profits as well as losses Profits are distributed as per agreed ratio Loss is borne by the parties as per capital ratio Every partner is agent of other MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

MUSHARAKA May be in any agreed ratio PROFIT Rs. 100 Rs. 60 Rs. 40 PARTNER A PARTNER B VENTURE Rs.1000 Rs.1000 Rs. 50 Rs. 50 LOSS Rs.100 Must be according to capital ratio MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

MUSHARAKA May be in any agreed ratio PROFIT Rs. 100 Rs. 50 Rs. 50 PARTNER A PARTNER B VENTURE Rs.2000 Rs.3000 Rs. 40 Rs. 60 LOSS Rs.100 Must be according to capital ratio MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

MUDARABA One partner (Rab al Mal) contributes capital and the other (Mudarib) contributes his skills or services to the venture Venture may for a fixed period or purpose Both share profit in pre-agreed ratio Loss is borne by Rab al Mal only, Mudarib loses his services MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

MUDARABA PROFIT 50 % 50 % VENTURE RABBUL MAL MUDARIB ALL MONETORY LOSS SERVICES CAPITAL RABBUL MAL MUDARIB ALL MONETORY LOSS LOSS OF SERVICES LOSS MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

MUDARABA PROFIT 60 % 40 % VENTURE RABBUL MAL MUDARIB ALL MONETORY LOSS SERVICES CAPITAL RABBUL MAL MUDARIB ALL MONETORY LOSS LOSS OF SERVICES LOSS MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

IJARAH Usufruct of an asset is passed to other party against a periodic rent payment The asset must have corpus (body) and be in existence The asset must not be consumable in nature (should not vanish if used) Ownership will remain with the lessor and he will bear all the risks related to ownership MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

IJARAH Use/ usufruct Only LESSOR Ownership LESSEE Asset Periodical payments/Rent MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

SALAM (Advance payment) It is an exception to the general principle of instant exchange of counter values in a contract of sale MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

SALAM (Advance payment) Full payment of purchase price, No deferment or installment in advance money allowed No loan adjustment is allowed Quality and quantity must be specified Date of delivery must be specified MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

MURABAHA Murabaha is sale of a commodity at cost plus margin; it must fulfill all the conditions of a valid sale It may be spot sale or a deferred/credit sale Deferred sale Murabaha is used as financing mode by Islamic Banks Deferred price becomes a debt and shall be dealt with as a loan transaction Price once settled at the time of sale can not be changed due to default of creditor, any thing above sale price would be RIBA MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

Conditions for Murabaha Since it is a sale contract; it must fulfill all the conditions of a valid sale The Bank should purchase the asset from a third party and not from the customer himself The Bank must own the asset before it sells to the customer The Bank must have possession (physical or constructive) i.e. it must come to its risk The seller must know and disclose the cost including freight, insurance and taxes etc. Profit may be fixed in lump sum or through agreed ratio to be charged over the cost MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

MURABAHA MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

CLASSICAL MURABAHA COST +MARGIN IMMIDIATE DELIVERY PRICE SELLER BUYER GOOD IMMIDIATE DELIVERY MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

BAI’ MU’JJAL (deferred sale) DEFERRED PAYMENT PRICE SELLER BUYER GOODS IMMIDIATE DELIVERY MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

MURABAHA WITH DEFERRED PAYMENT COST + MARGIN DELAYED PAYMENT PRICE SELLER BUYER GOOD IMMIDIATE DELIVERY MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

What is Sukuk? The word Sukuk plural of word Suk which means _______________ The Accounting and Auditing Organization for Islamic Financial Institutions defines Sukuk as: Certificates of equal value representing undivided shares in ownership of tangible assets, usufruct and services or (in the ownership of ) the assets of particular projects or special investments activity MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

Legal Definition of Sukuk Pakistani Law does not define the word Sukuk There is no particular legislation in Pakistan that governs a Sukuk by a company Then how to define a Sukuk and how to regulate a Sukuk issue in Pakistan Section 120 of the Companies Ordinance 120. Issue of securities and redeemable capital not based on interest. (1) A company may by public offer or], upon terms and conditions contained in an agreement in writing, issue to one or more scheduled banks, financial institutions or such other persons as are specified for the purpose by the Federal Government by notification in the official Gazette, either severally, jointly or through their syndicate, any instrument in the nature of redeemable capital in any or several forms in consideration of any funds, moneys or accommodations received or to be received by the company, whether in cash or in specie or against any promise, guarantee, undertaking or indemnity issued to or in favour of or for the benefit of the company MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

DIFFERENT KINDS OF SUKUK Sukuk representing ownership in tangible assets (mostly based on Sale and Lease back or direct lease). Sukuk representing Usufructs or Services (based on sublease or sale of services). Sukuk representing equity share in a particular business or investment portfolio (based on Musharakah/ Mudarabah). Sukuk representing receivable or future goods (based on Murabaha or Salam or Istisna’). MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

BASIC SHARIAH RULES All the rules of original contract on the basis of which Sukuk are created should be applied. The issuer cannot guarantee the face value of the certificate for the holder except in case of negligence/misconduct. In Sukuk based on sale and lease back, the issuer can unilaterally undertake that he will purchase the asset after one year for a certain price. MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

BASIC SHARIAH RULES (CONT..) Different types of reserves (e.g. profit equalization reserve) or takaful pool can be created. Only those Sukuk can be traded that represent proportionate ownership of tangible assets, usufructs or services. Trading or redemption of Sukuk is allowed after closing subscription, allotment of Sukuk and commencement of activity. Sukuk of usufructs can be traded before the assets are sub-leased. Sukuk of services can be traded prior to passing the services to the user. In Sukuk of Musharakah/Mudarabah, the issuer can redeem the certificates on the market price or the mutually agreed price. MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

TRADABILITY OF SUKUK Tradable Sukuk Sukuk representing tangible assets or proportionate ownership of a business or investment portfolio are tradable. For e.g. Sukuk of Ijarah or Musharakah / Mudarabah Non-Tradable Sukuk Sukuk representing receivables of cash or goods are nontradable. For e.g. Sukuk of Salam or Murabaha MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

Legal Nature of Sukuk Is it a debenture? or It’s a stock/share? or something else? to ascertain we need to know what is debenture and what is stock/share. Debenture is not defined as a word in the Companies Ordinance or any other law but as per company law it includes debenture stock, bonds, term finance certificate and any other securities, other than a share, of a company, whether constituting a charge of the assets of the company or not “share” means ‘a share in the share capital of a company’ (S.2 (1) 35 of the Companies Ordinance) Sukuk is neither equity nor debenture or bond or a debt instrument MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

Asset Backed Securitization Rules These Rules provide mechanism for securitization and define securitization as: The Sukuk does not fall in the definition of actionable claim or receivables therefore Sukuk can not be issued under these Rules "Securitization" means a process whereby any Special Purpose Vehicle raises funds by issue of Term Finance Certificates or any other instruments with the approval of the Commission, for such purpose and uses such funds by making payment to the Originator and through such process acquires the title, property or right in the receivables or other assets in the form of actionable claims MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

Nature of Sukuk As discussed Sukuk is a security of its own kind, not provided by any law in Pakistan. We may classify it as redeemable capital MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

How to Issue Sukuk Presently most of the Sukuk are issued under private placement which does not require any regulatory compliance Companies are issuing privately placed Sukuk when they get syndicate financing from financial institutions to meet their financing requirements Most of the Sukuk are based on Ijarah These Sukuk are being issued under S. 120 of the Companies Ordinance through an agreement between the issuer and the financial institutions MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

How to Issue Sukuk to Public? There is no specific provision in Pakistani law for Sukuk therefore we will resort to some provisions of the Companies Ordinance that govern issue of securities, debentures and redeemable capital Again the Sukuk will be issued under S. 120 of the Companies Ordinance. However, for guidance on public issue we will look at the guide lines issued for Term Finance Certificates (TFCs) MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

PUBLIC ISSUE OF SUKUK Once we consider that Sukuk is a security in the form of redeemable capital then we can issue Sukuk public through circulating and publishing prospectus under section 57 of the Companies Ordinance,1984 An independent trustee shall be appointed and the assets will be transferred in the name of the trustee who will hold the same for the benefit of the investors/Sukuk holders For issuing Sukuk general public a company will file an application to SECP MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

Approval from SECP i) In case of a new project, Expansion or Balancing, Modernization & Replacement (BMR), a feasibility study should be conducted and a report should be prepared. ii) Pre-IPO placement of should be finalized. iii) Underwriting arrangements, if any, should be completed. iv) Credit rating of the entity as well as the instrument from any rating agency should be carried out. v) Trustee, Bankers to the Issue, Balloters, Registrar (Transfer Agent) and Legal Adviser to the Issue should be appointed. vi) Clearance of the prospectus from the concerned stock exchange(s) should be obtained. vii) Auditor’s certificates as to profit and loss and dividend or returns on securities issued in previous 5 years MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

JAZAKUMULLAH KHAIR AND THANK YOU MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008

Contact: Sibghatullah Ahsan Advocate High Court MIAN & SIBGHAT Advocates & Legal Consultants Off. 102-A, 1st Floor, Azeem Mansion, Block 87-E, Fazal-e-Haq Road, Blue Area Islamabad. Ph. 92-51-4309208, 4319884 Fax. 92-51-2802542 Email. mslaw.pk@gmail.com MIAN & SIBGHAT mslaw.pk@gmail.com August 27,2008