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

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 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 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 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 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 May 2007

7. 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 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 May 2007

9. 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 May 2007

10. 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 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 May 2007

12. 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 May 2007

13. Asset Backed Securitisation3.
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 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 May 2007

15. 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 May 2007

16. 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 May 2007

17. 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 May 2007

18. 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 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 May 2007

20. 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 May 2007

21. 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 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 May 2007

23. 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 May 2007

24. (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 May 2007

25. 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 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 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.
Capital Market: Products & Instruments
CERT May 2007

28. 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 May 2007

29. 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 May 2007

30. 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 May 2007

31. 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 May 2007

32. 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 May 2007

33. 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 May 2007

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