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Well developed bond markets ensures stable financial system as it minimize over-reliance on financing from the banking sector. The development of the bond market allows for access to funding with the appropriate maturities, thus avoiding the funding mismatches. It also allows for the diversification of risks by issuers and investors.
Dealing in Bonds is not permissible according to Shariah because of two aspects. Firstly, they represent a portion of Debt payable by the issuer. Earning any kind of profit falls under the category of RIBA as defined in the Hadith
Second aspect pertain to the trading of Bonds. Shariah prohibits trading of debts (Bai Dayn) as it involves Gharar.
topped
the
Malaysia became the No. 1 issuing country with 54.1% of the value of sukuk issued. The dollar made a partial comeback but local currencies were the denomination of choice for sukuk issuance. Big new players tapped the market like General Electric Capital Corp. and International Finance Corporation.
The UK Treasury and the Financial Services Authority (FSA) have prepared an amendment in Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (S.I. 2001/544) to remove barriers and uncertainty in the regulation of alternative finance investment bonds (sukuk). Following consultation with the industry, the statutory instrument, the Financial Services and Markets Act 2000 Order 2010, was sent to the House of Commons in midJanuary, and the Brown government is confident that the new regulations will come into effect by the end of February. These measures will reduce compliance and legal costs for these instruments, and facilitate the issuance of corporate sukuk in the UK.
Luxembourg took an important first step toward developing the Duchy into the latest European hub for Islamic finance, especially Islamic capital markets, when it published a new tax circular on the treatment of a whole range of Islamic finance products including Murabaha, Musharaka, mudarabah, istisna, ijarah, ijarah wa Iktina and sukuk (Islamic bonds). The circular confirms the classification of sukuk as debt for Luxembourg tax purposes. Consequently, yield payments under the sukuk are treated under domestic tax law as deductible interest expenses at the level of the paying entity.
Under the Finance Bill 2010, which came into effect in January 2010, the Irish Ministry of Finance has introduced significant amendments to facilitate Islamic finance transactions in Ireland. The legislation clarifies that the Sukuk Certificate should be considered a security and confirms that the investment return on that certificate should be treated as interest on a security for the purposes of the Taxes Act (subject to restrictions).
The bill also introduces amendments to the stamp acts to ensure that no stamp duty will arise on the issue, transfer or redemption of a sukuk certificate.
The Strategy and Finance Committee of the Korea's National Assembly (Parliament) is set to approve a bill aimed at facilitating tax neutrality for the issuance of sukuk in Korea during its next sitting at the end of February 2010.
In Pakistan, the first Islamic Sukuk was issued in 2002 when Sitara Chemicals Industries issued its MTFC. However, the market really started in FY 2005 and since then Sukuks worth at least Rs. 30 billion has been issued or are in the process of issuance. Market is growing at a very healthy rate as large corporates and conglomerates such as WAPDA, Engro Chemicals, PEL, EDEN Developers, Maple Leaf Cement, etc are using Sukuk to fund their requirements.
The issuance of Sukuk requires an exchange of a Shariah compliant underlying asset for a financial consideration through the application of various Islamic commercial contracts such as the Mudarabah, Musharakah, Ijarah, Istisna, Salam and Murabahah. The equity-based nature of Mudarabah and Musharakah Sukuk exposes investors to the risks connected with the performance of the project for which the financing is raised.
Sukuk Al Ijarah
Ijarah is an Islamic alternate of conventional leasing. Issuing certificates of ownership of assets, leased to a particular customer is known as Sukuk Al Ijarah or simply Ijarah Sukuk. Ijarah Sukuk concept is one of the most popular concepts among issuers of global Islamic Sukuk. A simple process is explained next.
If a Company requires, for example, Rs. 500 million for the purchase of land, real asset, equipment etc it can issue Ijarah sukuk equaling that amount in small denominations, say Rs. 500,000 each. After collection of funds from the investors the company either purchases the asset on behalf of the Sukuk investors or transfers the ownership of the already acquired asset to sukuk holders usually by establishing a Special Purpose Vehicle (SPV), which owns the underlying assets.
The investor or sukuk holders owns the asset held by SPV as Trustee in the form of Sukuk. The asset is then leased to the firm and the lease proceeds from the asset is distributed to the sukuk holders as return/dividend. The returns on the sukuk certificates could be either fixed or floating. As the expected returns (pre-determined rental payments) are fixed and can be treated as predictable like the coupon payments of a conventional bond.
ABC Ltd. wishes to purchase a new asset and plan to raise finance through issuance of Islamic Sukuk.
Supplier
Ltd.
Supplier
ABC Ltd.
SPV issues certificates and receives proceeds which are used to purchase asset from the supplier
Supplier
Payment made to Supplier Title is transferred to SPV
ABC Ltd.
Investors
SPV holds Asset as Trustee and leases the plant to ABC Ltd. as per rules of Ijarah
SPV holds Plant/ Asset as Trustee
Issuer SPV
ABC Ltd.
SPV leases Plant to ABC Ltd. on Ijarah
Investor
Issuer SPV
Investors
ABC Ltd. (Lessee) pays periodic rentals to SPV for tenors & amounts matching the coupon & tenor of the Sukuks
Issuer SPV
Investors
Redeems the Trust Certificates at dissolution
ABC Ltd (Lessee) give the SPV an irrevocable purchase undertaking to purchase the Asset at maturity. Exercise Price = Initial Purchase Price of Asset + service costs.
Asset is transferred back on maturity, upon payment of the Exercise Price to the SPV / Sukuk Holders.
Its essential that the Ijarah Sukuks are designed to represent real ownership of the leased assets, and not only a right to receive rent.
Underlying Assets is jointly owned by investors and issuer according to specified percentage.
Ownership is also transferred periodically to the issuer. Ijarah is essential part of a Diminshing Musharakah transaction under Shirkatul Milk.
In SLB cases, purchase/sale of Sukuk Units will only start after at least one year from the Musharakah Commencement Date/Asset Purchase Date.
Trust Deed will be executed between Trustee (appointed by Investors for the Sukuk Issue) and Issuer detailing the responsibilities of the Trustee during the tenor of the Sukuk Issue.
Sukuk Al Salam
Government of Bahrain first issued Salam Sukuks as an alternate to short term government treasury bill.
The difference between Sale and Purchase price was the profit of the investors.
The asset would be purchased from its supplier and would be immediately sold to the issuer against deferred price. Profit earned from the transaction would be distributed among the investor proportionately.
Sukuk Al Musharakah
If a comapany required financing for any of its project through Musharakah it can issue Sukuks against which investors would provide funding as per the rules of Musharakah.
Profit & Loss is shared between the investors as per investment ratio only.
Soda In Pakistan.
Profit Payment
Six monthly
Based on profit and loss sharing on the Operating profits of the Chemicals Division
MTFC Holders
Company
MTFC Holders
Company
100% O/S
43%
56.8%
7.2%
92.8%
67% O/S
28.9%
71.1%
4.8%
95.2%
33% O/S
14.3%
85.7%
2.4%
97.6%
In case of no losses during TFCs tenor the amount contributed by the company and TFC holders will be paid on final settlement.
Islamic Sukuk-Standardization
AAOIFI has also issue Shariah standards for Sukuks and its expected that issuance of these standards would help reducing differences in fatwas issued for Sukuks.
Islamic Sukuk-Criticism
Some Sukuks are criticized for their resembelence with conventional bonds. close
Many times these closeness is created to adhere to the tax and other regulatory laws of the country.
For example, in Pakistan SPVs cannot hold actual assets. For this reason assets cannot be carved out from the balance sheet of the issuer which creates complexities in identification of the assets and only a hypothecation charge ensures bank's benefical ownership in the Musharakah assets.
Islamic Sukuk-Criticism
Similarly, concept of the Diminishing Musharakah financing is not there in the stamp duty laws of Pakistan, which compels banks to sell share in assets without any legal registration. It should be noted that concept of Diminishing Musharakah is recognized in British stamp duty laws since April 2003. Nevertheless, not all of this criticism is incorrect, and therefore it should be ensured that unesseccary usage of artificial structures should be avoided as much as possible.
Islamic Sukuk-Criticism
The problems could be resolved by Shariah rating systems This will help investors in making informed decisions regarding the authenticity of the Shariah structure of the Sukuk.
Islamic Sukuk-Benefits
Sukuk can be used very effectively as a halal alternate to conventional bonds for providing funding for matching maturities and without relying too much on commerical banking sector. Another aspect of Sukuks which make them more effective than bonds is there ability to mobilize and motivate investors to work for the overall benefit of the issuer.
Islamic Sukuk-Benefits
Sukuks for Government Projects
Sukuks based on Ijarah can be used very effectively to finance Government projects. If general public is involved in the construction of these project through issuance of Sukuks, it can give them sense of ownership. Effective usage of such Sukuk would increase the ratio of success and ratio of sustainability of the projects by many folds.
Islamic Sukuk-Benefits
Sukuks by Private Sector
Corporate Sector can also benefit from unique characteristic of Sukuks. Musharakah Sukuks can be used to associate general customer with the company. Sense of ownership and share in the profit of the company can be used as a marketing tool for the products of the company especially in FMCG sector.
Islamic Sukuk-Benefits
Sukuks by Private Sector
Islamic Sukuk-Conclusion
Sukuks can be used very effectively to obtain Shariah Compliant funding which surely bring Allah's blessing and barakah for the business. Issuers can also benefit from the huge increase in liquidity in the Islamic world, and can tap on these new sources of funds. Raising funding from the Islamic bond market in the current environment has been 10 to 20 basis points lower than mainstream bonds.
Islamic Sukuk-Conclusion
.And whosoever fears Allah and keeps his duty to Him, He will make his matter easy for him... (Surah Al Talaq Ayat 04)