IB 1006 Islamic Capital Market
Islamic Project Financing
Prof. Saiful Azhar Rosly,
Banking Department, International Center for Education in Islamic Finance
There are a number of things one should look for to properly understand what
exactly is Islamic project financing. Most are interested to examine closer the
nature of Islamic bonds and sukuks issued by the project company.
Structuring an Islamic bond is becoming more challenging and popular in
investment banking. Most common are the al-bai-bithaman ajil bonds (BAIDS)
and murabahah commercial papers (MCP). Ijarah based bonds such as the
Global Sukuks issued by Malaysian and Qatar governments are structured
along the asset-based securitization model. Musharakah sukuks have also
made their way into project finance. The bond proceeds are used to pay for
many things. Some are used for refinancing purposes while others to finance
infrastructure projects for economic development of the country concerned.
Some infrastructure project finance is given below:
1. Kuala Lumpur International Airport (KLIA): This RM2.2 billion al-baibithaman ajil (BBA) notes issuance facility is fully guaranteed by the
Malaysian government. In essence it uses bay’ al-‘inah. The issuer sells
an underlying asset (i.e. contract concession evidencing equipment and
machineries) to the investors in return for the RM2.2 billion cash
payment. Using BBA, the investors simultaneously sells back the
underlying asset to the issuer inclusive of the profit margin.
2. Hub River power project: This US$92 million project uses istisna’. The
financier purchases turbines on istisna’ and sells them to the project
company on murabahah. Funding was provided by Al-Rajhi Banking &
Investment Company of Riyard.
3. Equate petrochemical plant in Kuwait: The Equate project uses both
conventional and Islamic financing. Of the total US$2,000 million
financing requirement, US$200 million was structured along Islamic
contract, namely ijarah (leasing). Equate is jointly sponsored by Union
Carbide Corporation, Petrochemical Industry Company and Bubiyan
Petrochemicals Company.
However there are also other aspects in project financing that the Shariah
must be vocal and decisive. Before doing so, let’s look closer at the definition of
project financing.
Project financing can be defined as financing of a particular project in which an
investor is satisfied to look initially to the cash flows and earnings of that
project. This cash flow constitutes the source of funds from which the
financing can be repaid while the assets of the project are used as collateral for
the financing.
It is when the goal of project financing is put in place that the Shariah must
provide clear rulings on certain aspects of project finance. In project financing,
the goal is to assemble funding for a project whose benefit will go to the
sponsor. However, the sponsor wants to be protected from recourse so as to
shield its credit standing or balance sheet. To do this, the sponsor uses a third
to support the transaction.
In this way, studies on Islamic project financing can be categorized into two
main components, namely:
a.
Concept and structure of Islamic instruments: Here the underlying
principles are clearly stated in Islamic law, that the instrument must be free
from interest (riba), ambiguities (gharar) and gambling (maisir). The
requirement of ownership (milkiyah) is paramount to see that ownership
risk (daman milkiyah) is rightly observed by the selling parties and lessors.
Sponsor
Stock
ISLAM IC
PROJECT FINANCING
Project
Company
(SPV)
Underlying
Assets
Islamic bond
Investors
Trustee
Figure 1 Islamic Project Financing
Participants of project financing: Issuances of Islamic instruments such
as equity or debt usually involve many parties. They are expected to fully
observe the Shariah principles in all aspects of project financing. In general
participants of project financing consists of the followings:
1. Contract Awarder:
In infrastructure project financing, the
government awards project by open tender. The project can be
based on build- transfer (BT), build-operate-transfer (BOT) and
build-own-operate (BOO), build-lease-transfer (BLT). Sometimes
the government provides guarantees to debt obligation of the
issuing party.
2. Sponsors: A party interested in supporting a project financing. It
can be both individuals and corporation who provide credit
enhancement to support the project. They prepare the financial
modeling, negotiate finance documents etc. Sponsors include
consortium of interested parties such as contractors, suppliers,
purchasers or users of the project’s products or facilities.
3. Special Purpose Vehicle [SPV]; A company that will operate the
project and issues the securities. This project company is also a
bankruptcy remote entity. It is legally distinct from its sponsor
with a purpose to immune itself from any problem and risks faced
by the sponsor. The Shariah perspective of the SPV must deal with
both issues. Firstly, how SPV serves the interests of investors and
secondly, how it serves the interests of sponsors.
4. Trustee: Acts for and behalf of the financiers and ensure that the
issuer truly observed the trust deed. The trust deed is a contract
defining the obligation of the issuer and appointing a trustee to
represent the interests of financiers. It will conduct reasonable
diligence to ascertain no breach of the covenants, terms and
provisions of the Trust deed has taken place.
5. Financiers (Investors): Financier usually consists of institutional
investors such as banks, insurance companies, mutual funds,
corporations as well as individuals.
6. Underwriters: Purchasing instruments directly from the issuer
before disposal to the investing public in case the issuance is
undersubscribed. In the case of Malaysian Islamic bond, it may
implicate bay’ al-dayn since bonds are bought at a discount prior
to initial public offers. Underwriting common shares is permissible
(halal) since shares are considered property (al-mal) and not debt
(dayn).
7. Guarantors: The contract of al-rahn is applied here. For muqarada
bond, al-rahn is applicable to provide capital protection in case of
negligence coming from mudarib. Guarantors and collaterals are
essential requirements in Islamic private securities (IPDS) although
the securities are supported by some underlying assets equivalent
to the value of the facility.
8. Rating agencies: On Islamic debt issues, rating agencies serve to
assess the likelihood of timely repayment of principle and payment
of profit over the term of maturity of such debts.
9. Regulatory authorities including Shariah Supervisory Board: In
Malaysia, issuance of IPDS must conform to section 32 of the
Securities Commission Act 1993 (SCA 1993) where IPDS are
considered synonymous to debentures.
10.
Arrangers and Dealers: administer the issuance of the
securities. They coordinate paper documentations with the
lawyers. They also coordinate the underwriters, guarantors and
trustees. All these work are fee-based. The contract of wakalah
(agency) is relevant here.
Project finance involving property and residential development has
become more popular especially in the oil-rich United Arab Emirate
(UAE), Bahrain, Qatar and Kuwait. Financial instruments are
structured along musharakah principles as well as hybrids.
Projects such as the Palm in Dubai and Rakia in Ras Al Khaimah
in the UAE are financed by sukuks.