by: Wan A Rahim Kamil ICM Consultant, Securities Commission Malaysia Sukuk Innovations by: Wan A Rahim Kamil ICM Consultant, Securities Commission Malaysia

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

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

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

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

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

What are Participatory Contracts? Such as … (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

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

Participatory Contracts Participatory Contracts of: 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

2. Mudharabah Trustee 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

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

Special Purpose Vehicle (“SPV”) 3 3 Special Purpose Vehicle (“SPV”) (Mudharib) 7 Subscription for Certificates ($) 1 Expenses for meeting operational requirements 4 Direct Investments through ijarah, murabahah or other real estate businesses or trading activities Mudharaba or Musharakah Certificates 2 5 6 Cash-flow stream ($) Pool of Investors (Rabb al Mal or Musharkah Partners) Profit Distribution Capital Market: Products & Instruments CERT 22-23 May 2007

Asset Backed Securitisation 3. Originator 3a. SPV Investors 2. 4. 1. Sale of asset to the SPV – True Sale SPV issues asset-backed securities to investors Proceeds from the sale of ABS go to the Originator (Interest) & principal repayments to Investors Capital Market: Products & Instruments CERT 22-23 May 2007

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

Ambang Sentosa BBA (ABS) –domestic version of Islamic securitisation Originator Identified Asset: Rights, title and interest over the balance sales proceeds of two development projects Proceeds from BBA transaction used to purchase Identified asset Hibah (Gift) Aqad Asset 2.Investor purchase asset (gift) Ambang Sentosa Investor 3. Cash 4. Sale of asset on deferred payment (BBA) 5. ASSB issue BAIDS to investor 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

Cagamas Sukuk Musyarakah (RMBS) - does it comply with international Shariah standards ? (Transaction Administrator & Administrator) Trustee Represent Sukukholders Sukuk issued to investors GOM (Originator & Servicer) Sale of GSHFs Investors Cagamas MBS Proceeds from sukuk Purchase consideration 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

Golden Crop Sukuk Ijarah (ABS) – compliance with international Shariah standards Share Trustee Originator sell the plantation asset to the Issuer Boustead Group (Originators) Golden Crop Returns (Issuer) Trustee Issuer leases back the plantation asset to the Originator Subordinated Musyarakah facility with LTAT Sukukholders LTAT Sukuk Ijarah Capital Market: Products & Instruments CERT 22-23 May 2007

Islamic Asset Backed Securities issued in Malaysia Issuer Facility Issue Size RM (million) SC Approved Ambang Sentosa Sdn Bhd BBA 986.00 29-May-03 Musyarakah One Capital Berhad Sukuk Musyarakah 2,500.00 7-Mar-05 Cagamas MBS Berhad 6-Jul-05 Golden Crop Returns Bhd Sukuk Ijarah * 442.00 27-Oct-05 ABS Logistics Bhd 300.00 6-Jul-06 Nepline SPV Sdn Bhd 170.00 21-Jul-06 Total Islamic ABS 6,898.00 * International Shariah compatible structure Capital Market: Products & Instruments CERT 22-23 May 2007

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

Assets only used to facilitate Shari’ah compliance. 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

Lease & repurchase payments for assets Sukuk Al-Ijarah - Asset Based Transaction Originator SPV Sukuk Sale of asset Sukuk Sukuk Sukuk proceeds Sukuk Sukuk proceeds Asset repurchase Periodic payments: Lease flows and principal (via amortisation/repurchase) Lease & repurchase payments for assets 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

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

4. Transfer of Ownership of Asset Provider Investors 2. Certificates of Investments 3. Sale & Purchase of Asset (payment of asset acquisition Cost US$) Asset 1. Offer for Sale of securities SPV 4. Transfer of Ownership of Asset to SPV $ Step 1 1st Transaction: SPV and Asset Provider 1st Relationship: SPV and Investors Creation of Sukuk al Ijarah Capital Market: Products & Instruments CERT 22-23 May 2007

(evidence of obligations) SPV Project Owner 1. Execution of al ijarah contract ASSET 2. Rental of Asset on fixed term and fixed rental basis Ijarah Rental Obligation Certificates (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

SPV Project Owner Asset 1.Regular Ijarah Rental Payments SPV Project Owner 3. Final Repayment Representing Total Settlement equal to Initial Purchase Price Of Asset by SPV Asset 5. Asset transferred to Project Owner Investment Certificates Holders 2. Scheduled Distributions of Coupon Payments to Holders Of Investment Certificates issued by SPV 4. Payment of Final Amount being final settlement of Obligations under Ijarah Contract Capital Market: Products & Instruments CERT 22-23 May 2007

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

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. Capital Market: Products & Instruments CERT 22-23 May 2007

Ijarah SPV Musharakah Investors PROJECT Co. Project Funding through 2. Musharakah Investment Agreement Ordinary Equity Musharakah Investors 7. $ Profit Payments & Repurchase or Redemption of MPS MUSHARAKAH PREFERENCE SHARES (‘MPS’) 1. 3. $ for Working Capital Needs 9. $ Dividends $ Income Stream 7. $ Ijarah Rental Payments PROJECT Co. Ijarah SPV 6. Ijarah contract Rental of Equipment 4. 5. $ Participation Into Mudharabah Sukuk Mudharabah 8. $ Mudharabah Profit Payments Project Funding through COMBINATION OF PARTICIPATORY AND IJARAH CONTRACTS Financial Investors Capital Market: Products & Instruments CERT 22-23 May 2007

Khazanah & Other Sellers Khazanah Exchangeable Sukuk (Asset Swap) Khazanah Investors Khazanah & Other Sellers Cash Settlement Purchase Right Deed Sale Price (Principal) ($) Sale of Equity Pool Default / Maturity Purchase Undertaking Deed $ Sale of Equity Pool Sukuk SPV II Issuer Rafflesia Sale Price (Principal) ($) Sukuk Proceed ($) Capital Market: Products & Instruments CERT 22-23 May 2007

Exchangeable Sukuk Musyarakah Some notable Sukuk issued in the global markets Issuer Facility Issue Size USD(mil) Manager Nakheel Development Convertible Sukuk Ijarah 3,520.00 Barclays Capital, DIB ADIB Sukuk Co Sukuk Ijarah 800.00 HSBC Rafflesia Capital Exchangeable Sukuk Musyarakah 750.00 CIMB, HSBC Amanah, UBS Aabar Sukuk Exchangeable Sukuk Mudarabah 460.00 Deutsche Capital Market: Products & Instruments CERT 22-23 May 2007

Issuer Facility Issue Size USD(mil) Manager Tabreed 06 Financing Corp Sukuk Istisna’ 200.00 CIMB, HSBC, Dreer Kleinwort Wassertein East Cameron Gas Co Asset backed Sukuk 168.00 Merrill Lynch International Capital Market: Products & Instruments CERT 22-23 May 2007

Asset-Based Sukuk vs 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

Asset based Sukuk Asset backed Sukuk 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 Capital Market: Products & Instruments CERT 22-23 May 2007

END Thank You wark06@gmail.com Capital Market: Products & Instruments CERT 22-23 May 2007