Andreas A. Jobst
Monetary and Capital Markets Dept.
International Monetary Fund (IMF)
Sukuk – Quo Vadis?
Islamic Securitization After the Subprime Crisis
700 19th Street, NW, Washington, DC 20431, USA
E-mail: ajobst@imf.org
© A. Jobst, 2008
Overview
1. Macroeconomic Situation and Effect on
Islamic capital market instruments
2. Developments of the Sukuk Market
3. Islamic Securitization as the “Third Way”
4. Challenges and Outlook
© A. Jobst, 2008
Monetary and Capital Markets Department
© A. Jobst, 2008
Financial Sector Write-downs and Capital Infusions
(billions of U.S. dollars)
600
Write-downs by Region
600
Write-downs by Type
600
500
500
500
400
400
400
300
300
300
200
200
100
100
0
0
Americas
Europe
Asia
Infusions by Region
Capital Shortfall
 new funding,
dividend cutback
200
100
0
Mortgages
Other
Loans/Leveraged loans
Trading
Monolines
Americas
Europe
Asia
SIVs
© A. Jobst, 2008
General Impact of the Current Market Situation
• … but there are several factors driving up spreads
– series of measures announced by central banks (liquidity injections,
e.g. collateral framework, FX swaps, standing facilities) and
governments (asset purchases, capital support and debt guarantees)
• only supply-side effect on secured money markets
• failed to restore inter-bank lending and investment in creditsensitive assets
• externalities of Fed/ECB/BoE actions: currency premium, trading
bias towards “guaranteed banks”
– Keynesian deficit-spending: crowding out by govt debt  LT govt refinancing via debt issuance or higher taxes
– financial sector de-leveraging: large ST and MT asset supply  further
price depression and tight credit
– higher Sharpe ratio, currency option skew, etc.
© A. Jobst, 2008
The Credit Crisis and its Effect on Islamic Finance
• Islamic finance industry in expansionary phase: average
annual rates of about 15%
• >US$800 billion of deposits and investments in Islamic banks,
mutual funds, insurance schemes and Islamic branches of
conventional banks
• … but some factors exacerbate the impact of global credit
environment:
– “imported inflation”/de-pegging in GCC, and increased local currency
issuance/local investment in sukuk (Islamic “bonds”)
– asset-based concept of Islamic finance: sectoral concentration and little asset
diversity  slump in real estate
– “compliance risk” after recommendations by AAOIFI on sukuk structures (Feb.
2008)
© A. Jobst, 2008
Sukuk and Islamic Finance Principles
• sukuk transform bilateral risk-reward sharing between borrowers
and lenders into market-based refinancing of shari’ah-compliant
lending or trust-based investment in existing or future assets.
• sukuk do not pay interest, but generate returns through
commoditization of capital gains from actual transactions (i.e.,
asset transfer), such as:
– leasing (sale-leaseback): ijara (thumma al-bay)]
– cost-plus sale (sale-buyback): murabahah (bay al-inah)
– profit-sharing/”sweat capital”/trust: musharakah or mudarabah
 shari’ah-compliant assets, usufructs or services
• investors own the underlying asset(s) via SPV that funds unsecured
payments to investors from direct investment in real, religiouslysanctioned economic activity
© A. Jobst, 2008
Basic Sukuk Structure (w/ Third Party Assets)
Basic Sukuk Structure (murabaha and ijara)
(with Third-Party Assets)
User
ASSET
Expected Losses
1 cost-plus sale
2
(murabaha)
OR
lease (ijara)
1 deferred
issues debt securities
purchase price
OR
2 lease payments
Issuing
IssuingAgent/Conduit
Agent/Conduit
Asset Originator/
Sponsor
3 leaseback (ijara)
3
Commodity
OR
Reference
Portfolio
(“collateral”)
ASSET
transfer of collections
leaseback
payments
transfer
of assets
purchase
price
Trustee
Trustee
sale of
sukuk certificates
AA
Tranche
A Tranche
BBB
Tranche
disbursement of
revenue to investors
BB
Tranche
Equity
(FLP)
Junior
Single Asset/
(e.g.,
(e.g.,Special
Special
Purpose
PurposeVehicle
Vehicle(SPV))
(SPV))
distribution of
sukuk certificates
AAA
Tranche
Mezzanine
separate purchase contract
(ijara thumma al-bay)
Capital Market
Investors
Underwriter
Underwriter
Senior
Single Asset/
Commodity
OR
Reference
Portfolio
(“collateral”)
offers credit and liquidity support,
hedging agreement
Credit
CreditEnhancer
Enhancer
(Third-Party
(Third-PartyCredit
CreditSupport)
Support)
© A. Jobst, 2008
Past Development of Sukuk Market
• increasing appeal in non-core markets (UK, Turkey, Maghreb)
• sukuk issuance soared over the last three years in response to
growing demand for alternative investments
• outstanding sukuk globally exceeded US$90 bn. at end-2007
• gross issuance of sukuk has quadrupled over the past two years,
rising from US$7.2 bn. in 2004 to close to US$39 bn. by end-2007,
and growth predicated at 15-25% p.a. owing in large part to large
infrastructure development plans in Middle East and financial
innovation
• total issuance in 2007 equivalent to roughly a quarter of
conventional securitization in EM but only two percent of
conventional (local and foreign) bond issuance
© A. Jobst, 2008
Current Development of Sukuk Market
•
moderate issuance in 2008, but
number of deals brought to market
has steadily increased (139 in 2008
vs. 161 in 2007 over same time)
Global Sukuk Issuance, 2005-2008
(In USD billions)
30
2008YTD
10
5
ce
na
ti
on
al
sti
c
In t
er
Do
me
Iss
ua
nc
e
Iss
ua
n
tes
ia
Em
ira
Ar
ab
Un
ite
d
Ar
ab
tar
Sa
ud
i
Qa
an
kis
t
Pa
ala
ys
ia
M
wa
it
Ku
es
ia
Ind
on
lam
0
ssa
other currencies (but USD, SAR and
MYR) hold largest share (approx.
US$7 bn.)
15
2007
rai
n
•
2006
Da
ru
issuance still concentrated in parts
of Asia and countries of the GCC
20
Br
u
•
2005
Ba
h
ijara structure now dominates
(>50%), followed by musharaka and
mudaraba sukuk
25
ne
i
•
sukuk volume dropped to
US$15.2bn (50% from
US$36.3bn.) in 2008 so far, while
structured finance volume dried up
with just US$387bn. issued (80%)
amid stable EM issuance
(US$310bn.)
US$ billion
•
Source: IFIS, Bloomberg, Dealogic, Datastream.
© A. Jobst, 2008
Prospects: Islamic Securitization as a “Third Way”?
Sukuk and Covered Mortgage Bonds
•
revitalize the secondary mortgage market
•
covered bonds:
– unsecured debt obligations, collateralized by a dedicated (“ring fenced”)
assets that are fully retained by the issuer
– interest payments guaranteed and independent of cover assets
– on-balance sheet treatment redress misaligned incentives that undermined ex
ante market discipline and led to demise of the structured finance
•
ijara sukuk:
– investors receive no institutional guarantee (and off-balance sheet)
– but have direct recourse to real assets that fund secured repayment from
profitable investment
© A. Jobst, 2008
Incentive Problems in Conventional Securitization
Capital Market
Investors
Asset Originator/
Sponsor
Arranger
Arranger
3
Warehouse
Warehouse
Lender
Lender
Arranger
Arranger
2
Issuing
IssuingAgent/
Agent/
Conduit
Conduit
(Special
(SpecialPurpose
Purpose
Vehicle
Vehicle(SPV))
(SPV))
cash
Reference
Portfolio
transfers
assets
servicing
fees
servicing
and
collection
5
transfer of
collections
cash
issues
securities
underwritten by
arranger
Servicer
Servicer
AA
Tranche
Asset
Asset
Manager/
Manager/
Trustee
Trustee
fee-based credit
and
liquidity support
Third-party
Third-party
Guarantor
Guarantor
disbursement
cash
distr. of
securities
7
A
Tranche
BBB
Tranche
BB
Tranche
Equity
(FLP)
Junior
Expected
Losses
4
6
9
Mezzanine
Creditors
Creditors
1
AAA
Tranche
Senior
temporary
funding
Credit
CreditRating
Rating
Agency
Agency
8
retention of equity interest
© A. Jobst, 2008
Islamic Securitization as a “Third Way”? (2)
Sukuk and conventional securitization – incentive problems
•
between asset manager and investor (principal-agent dilemma):
– religious prohibition of gambling (maisir) and speculation (gharar) commands clear
object characteristics/delivery results and restricts trading activity to bone fide
merchant transactions on real debt based on contractual certainty
– no issuer leverage on the underlying asset portfolio and excessive risk taking (asset
substitution)
• between originator and issuer:
– adequate disclosures underpinned by a solid foundation of religious standards
(supervised by a designated shari’ah board), which also curb and valuation problems
that had infested the conventional securitization market.
• between originator/servicer and issuer/asset manager:
– contract certainty rules out potential of inflated, back-loaded (and variable) servicer
expenses (and cannot be prioritized)
4-6
– fixed, ex ante premium for transfer of “asset obligations” to servicer
• between borrower and originator:
– no predatory lending due to sanctioned exploitation (and unilateral gains); no moral
hazard of “walking away” or debt modification (prohibited under shari’ah); social benefit
as public interest and system of distributive justice (maslaha)
7
2
1
© A. Jobst, 2008
Incentive Problems in Conventional Securitization
Capital Market
Investors
Asset Originator/
Sponsor
Arranger
Arranger
3
Warehouse
Warehouse
Lender
Lender
Arranger
Arranger
2
Issuing
IssuingAgent/
Agent/
Conduit
Conduit
(Special
(SpecialPurpose
Purpose
Vehicle
Vehicle(SPV))
(SPV))
cash
Reference
Portfolio
transfers
assets
servicing
fees
servicing
and
collection
5
transfer of
collections
cash
issues
securities
underwritten by
arranger
Servicer
Servicer
AA
Tranche
Asset
Asset
Manager/
Manager/
Trustee
Trustee
fee-based credit
and
liquidity support
Third-party
Third-party
Guarantor
Guarantor
disbursement
cash
distr. of
securities
7
A
Tranche
BBB
Tranche
BB
Tranche
Equity
(FLP)
Junior
Expected
Losses
4
6
9
Mezzanine
Creditors
Creditors
1
AAA
Tranche
Senior
temporary
funding
Credit
CreditRating
Rating
Agency
Agency
8
retention of equity interest
© A. Jobst, 2008
AAOIFI Recommendations (Feb. ’08) (1)
Key recommendations relate to the role of asset ownership, investment
guarantees, and the shari’ah advisory and approval process in sukuk
origination and trading
 maintain tenet of risk-reward sharing (otherwise interestbearing loan)
 Entrepreneurial investment: investors become legal owners (with all of the
rights and obligations) rather than nominal holders of the securities
 transforms pari passu asset-based sukuk into tranched assetbacked securities (ABS).
 Credit support: must not offer loans to investors in case of profit shortfall
 Compliance of collateral: no revenue streams or debt
 Shari’ah certification: review of all contracts/documentation
© A. Jobst, 2008
AAOIFI Recommendations (Feb. ’08) (2)
 Purchase price guarantee: issuer/agent (wakil), partner (musharik) or
manager (mudarib) cannot guarantee principal through re-purchase of
underlying assets or guarantee except:
–
–
–
–
repurchase at net value or fair market value, or a price agreed at the
time of purchase
ijara sukuk (remaining lease payments or nominal value)
trust guarantees to cover cases of negligence, misconduct or breach
of contract (representations and warranties)
alternatives:
• amortizing clause for underlying assets (cf. Villamar sukuk) or
• (separate) voluntary guarantee agreement by agent in
mudarabah/musharaka sukuk
© A. Jobst, 2008
Current Economic and Regulatory Challenges
• origination and servicer risk from narrow asset supply poses
challenges to investor diversification
• poor asset diversity given narrow range of deal types and
maturities
• future development could be arrested by insufficient
supervisory harmonization and the ongoing controversy
about financial innovation
• Islamic jurisprudence neither definite nor bound by precedent
and no universal recognition and enforceability of rulings
– cross-referencing of fatwas
– regional diversity of secondary sources: ijtihad (independent analytical
reasoning), ijma (consensus) and qiyas (deduction by analogy)
© A. Jobst, 2008
References
Čihák, Martin and Heiko Hesse, 2008, “Islamic Banks and Financial
Stability: An Empirical Analysis,” IMF Working Paper 08/16
(Washington: International Monetary Fund).
Hesse, Heiko, Andreas A. Jobst and Juan Solé, 2008, “Trends and
Challenges in Islamic Finance,” World Economics (April-June).
Jobst, Andreas A., Peter Kunzel, Paul Mills and Amadou Sy, 2008, “Islamic
Bond Issuance – What Sovereign Debt Managers Need to Know,”
International Journal of Islamic & Middle East Finance and
Management, Vol. 1, No. 4.
Jobst, Andreas A., 2007, “The Economics of Islamic Finance and
Securitization,” Journal of Structured Finance, Vol. 13, No. 1 (Spring),
1-22.
Solé, Juan, 2007, “Introducing Islamic Banks into Conventional Banking
Systems”, IMF Working Paper 07/175 (Washington: International
Monetary Fund).
© A. Jobst, 2008