ISLAMIC REPUBLIC OF AFGHANISTAN
Ministry of Rural Rehabilitation and Development
Afghanistan Rural Enterprise Development Program
Islamic Finance Product Development
Components A and B
“The Mushārakah Mutanāqisah Partnership”
for fixed-assets financing
prepared by Alberto G Brugnoni – ASSAIF
CONTENTS
INTRODUCTION

SMEs’ REQUIREMENTS AND ISLAMIC FINANCING
DEFINITIONS




MUSHĀRAKAH
MUSHĀRAKAH AS SHIRKAT AL-MILK
MUSHĀRAKAH AS SHIRKAT AL-’AQD
MUSHĀRAKAH MUTANĀQISAH PARTNERSHIP (MMP)
→ ORIGIN & DEFINITIONS
→ THE FIQH PERSPECTIVE
→ WHY THE MMP FULFILLS THE MAQĀSID AL-SHARĪAH
→ GRAPHICAL REPRESENTATION
IMPLEMENTATION
1.
THE MUSHĀRAKAH (JOINT OWNERSHIP) CONTRACT
→ MECHANISM & FEATURES
→ REGISTRATION OF THE PROPERTY UNDER THE CUSTOMER’S NAME
→ REGISTRATION OF THE PROPERTY UNDER THE BANK’S NAME
→ PROPERTIES UNDER CONSTRUCTION: THE MMP CUM ISTISNA‘
2
CONTENTS
→
→
2.
3.
LEGAL FRAMEWORK AND DOCUMENTATION
TAKĀFUL WRAPPING
THE IJĀRAH (LEASING) CONTRACT
→ MECHANISM & FEATURES
→ RENTING TO A THIRD PARTY
→ THE RENTAL RATE PEGGED TO INTEREST RATES
→ ACTUAL RENTAL RATE
→ VARIABLE RENTAL RATES
→ MISMATCHING ISSUE
→ DOCUMENTS
→ THE FORMULAS
THE BAY’ (SELLING) CONTRACT
→ MECHANISM & FEATURES
→ THE ALLOCATION OF UNITS
→ THE ISSUE OF PRICE
3
CONTENTS
4. THE WA’D (PURCHASE UNDERTAKING)
→ MECHANISM & FEATURES
→ THE EVENT OF DEFAULT
→ THE ISSUE OF THE SECOND PURCHASE UNDERTAKING
REDEMPTION & TERMINATION OF CONTRACT
RISK MANAGEMENT
ADVANTAGES OF MMP OVER BAY’ BI-THAMAN AJIL (BBA)
DIFFERENCES WITH A MORTGAGE LOAN
THE SECURITIZATION OF THE MMP’S FINANCIAL RECEIVABLES

SUKUK AL-WAKĀLA BIL-ISTITHMĀR (INVESTMENT AGENCY SUKUK)
BEST PRACTICES




BEST PRACTICE – MALAYSIA
BEST PRACTICE – PAKISTAN
BEST PRACTICE – AUSTRALIA
BEST PRACTICE – CANADA
4
SMEs’ REQUIREMENTS AND ISLAMIC FINANCING
 The Mushārakah Mutanāqisah Partnership (MMP), includes four relations (mushārakah,
ijārah, bay’ and wa’d), and is a cutting-edge, hybrid product with identifiable Islamic
features that set it aside from conventional financing products. These features, help
overcome some hurdles sometimes associated with the Islamic Finance proposition,
such as :
→ inertia
→ skepticism
→ doubt
→ fear
 The MMP aims at financing the balance sheets of MSMEs and is in full compliance with
recognized international Shariah norms and standards. If properly designed and
implemented, it offers competitive services with a competitive pricing.
 An important feature, is that the MMP lends itself particularly well to the securitization of
its financial receivables based on ijārah, through the issuance of a sukuk al-wakāla bilistithmār (investment agency sukuk) thus allowing the bank to shore-up its balance
sheet and off-load its commitments
5
MUSHĀRAKAH
 Beware: the following definitions are not a mere intellectual exercise as they may result
in differences in classification and hence in the Sharīah rules pertaining to a given
partnership and the contractual features of the ensuing product:
→ the term mushārakah is derived from the root word sharaka, meaning ‘one joining
others’. It literally means mixing one’s assets with another person’s assets until they
become unrecognizable
→ mushārakah (also: sharikah or shirkah) can be defined as a form of partnership
where two or more persons combine either their capital or their labour together to
share the profits, enjoying similar rights and liabilities
 There is a consensus of opinion among jurists of all schools of thought (Ḥanafīs,
Mālikīs, Shāfi’īs and Ḥanbalīs) that mushārakah is a valid and legitimate contract in
Islam. However, they are in dispute on the types of permissible mushārakah contracts
 It is known to jurists that there are two types of shirkah:
→ shirkat al-milk or al-amlāk
→ shirkat al-’aqd or ‘uqūd
6
MUSHĀRAKAH AS SHIRKAT AL-MILK
 Shirkat al-milk (al-amlāk) is a joint ownership on a non-contractual basis, or coownership. It is a state of diffused joint ownership with no contractual agreement
between the parties. Each of the parties has an individual ownership contract, either
voluntary or involuntary
 Shirkat al-milk can be divided into two types:
→ shirkat al-milk al-ikhtiyārī (voluntary co-ownership). This is a joint ownership of
something where two of more parties jointly purchase an asset, or someone gives
the partners an asset, or someone disposes to them an asset through a will, or
someone donates to them an asset. Thus if they accept the gift, or the will, or the
donation, they become partners of the asset without any contractual partnership
→ shirkat al-milk without the partners’ willingness (ğabriyyah). This is a joint
partnership between partners because of inheritance (mīrath)
 Shirkat al-milk has the following features:
→ the intention is limited to the ownership and usufruct and not to gain a joint profit
→ all partners are independent and gain profits from their own portions only. Each
partner shares in any income such as rent that is derived from the jointly owned
property and this must be equal to his/her share in the ownership. Responsibility for
losses is also distributed according to the shares in ownership
7
MUSHĀRAKAH AS SHIRKAT AL-MILK
→ it is permissible for one partner to give a guarantee to the other partner because
neither of them have any right of disposal in the other’s share
→ partners are independent in their transactions of their own portions. All agents are
outsiders to other people’s portions
→ it is permissible for one partner to promise to buy the other partner’s share at its
nominal value
8
MUSHĀRAKAH AS SHIRKAT AL-’AQD
 Shirkat al-’aqd (‘uqūd) is a contractual partnership. It comes into existence by the
enactment of a contract between two parties. It can be considered a proper partnership
because the parties concerned have willingly entered into a contractual agreement for
joint investment and the sharing of profits and risks
 According to the Ḥanafīs and Ḥanbalīs, shirkat al-’aqd can be divided into four types:
→ al-’inān (restricted authority and obligation): it is a contract where two or more
parties agree to become partners in the capital each has contributed and share their
efforts in a business. The profit and loss from the business must be determined at
the beginning of the contract. Therefore, al-’inān implies that all partners need not
be adults or have an equal share in the capital. Participation may either be on the
basis of wealth or labor or credit-worthiness and equality of contribution or legal
capacity is not necessary
→ al-mufāwaḍah (full authority and obligation): the partners are adults, equal in their
capital contribution, their ability to undertake responsibility and their share of profits
and losses
→ al-abdān (labour, skill and management): it is a contract among partners to share
their efforts in a business and share the profits of the business by proportions
agreed to before the commencement of the contract. Normally, without contributing
to the capital
9
MUSHĀRAKAH AS SHIRKAT AL-’AQD
→ al-wujūh (goodwill, credit-worthiness and contracts): a contract between partners to
purchase goods on credit and sell for a lump sum or by installments. Normally, the
partners use their goodwill and their creditworthiness for promoting their business
without contributing to the capital
 Shirkat al-’aqd has the following features:
→ the intention is to gain a joint profit
→ it is allowed for the partners’ share in any derived income or profit to be different
from their ownership shares. The partners are free to decide a ratio of the profit
→ the loss shall be borne by the partners according to their capitals
→ every partner is an agent for the other partners in investment activities as all the
partners benefit from the mushārakah business. The condition of agency is
automatically presumed to be in existence when a contract is made
→ it is not allowed for a partner to guarantee another partner’s profit or capital
→ it is not allowed for one partner to promise to buy the other partner’s share unless
the promise to buy is executed at market value. This is because a promise to buy a
partner’s share at its nominal value is the same as giving a guarantee, which is
prohibited
10
MUSHĀRAKAH MUTANĀQISAH PARTNERSHIP (MMP)
ORIGIN & DEFINITIONS
 Mushārakah mutanāqisah aka al-sharīkah al-mutānaqisah wa al-muntahiyah bi al-tamlīk
aka diminishing mushārakah partnership (MMP) it is not found in classical fiqh literature
as it is an innovative and a hybrid product consisting of three classical contracts:
→ implemented for the first time in Egypt by the Islamic banking division of a
commercial bank in partnership with a tourism company in order to own a fleet of
vehicles for transporting groups of tourists between Cairo and Aswan
→ implemented by Ansar Islamic Cooperative Housing Corporation in Toronto,
Canada in 1980, as their home financing product
→ discussed by Abu Ghuddah at the 15th session of the International Islamic Fiqh
Academy of the OIC, held in Muscat, Oman
→ approved for house financing during the workshop organised by the IRTI, Jeddah,
and the Sudanese Estates Bank, held in Khartoum in 1991
→ gaining traction in the last few years as a viable Islamic alternative for financing
11
MUSHĀRAKAH MUTANĀQISAH PARTNERSHIP (MMP)
 MMP is based on the classical mushārakah and is a partnership between the financier
and the customer to acquire property under an arrangement where the customer agrees
to rent the bank’s portion and pays rental on the bank’s share. Subsequently, the
customer gradually purchases the bank’s share in the partnership. As the customer’s
ownership in the property grows, the bank’s share diminishes until the customer has
fully bought the bank’s equity in the property
 MMP can be used for the purpose of financing fixed assets in many types of projects,
such as real estate projects, industrial projects (plant and machinery), educational
projects, agriculture land, cars, etc.
 Definitions that are highlighting different features include the following:
→ a partnership or co-ownership culminating in legal ownership of the underlying asset
by one of the partners, usually the customer (Bendjilali & Khan, 1995, p. 49)
→ a partnership in which one of the two partners promises to gradually buy the other
partner’s stake until he owns the entire project (AAOIFI Sharī’ah Standard No. 12,
2008 pertaining to partnership and modern companies)
→ a partnership in which the bank gives its partner the right to acquire the bank’s
stake in the company gradually or at one go, according to the terms agreed upon
(Ezzedine Khojah, Adawat al-Istithmar al-Islami)
12
MUSHĀRAKAH MUTANĀQISAH PARTNERSHIP (MMP)
→ a partnership to which the bank contributes capital and promises to relinquish its
rights by selling its share in the partnership to its partners. The partners, on the
other hand, promise to buy the bank’s share in the partnership in one go or
gradually, as per the terms agreed upon (‘Abdullāh ‘Abdul-Rahim al-’Abādī, The
Academic and Practical Encyclopedia of Islamic Banks, Chapter 5, Sharī’ah
Section, page 325)
→ an agreement between two parties to establish joint ownership (sharīkat al-milk)
between them in a project, real estate or a manufacturing plant, etc., to be
terminated by gradual transfer of one partner’s share in the partnership to the other
through separate and successive sale contracts (Nazīh Hammād, Majallat Majma’
al-Fiqh al-Islāmī)
→ the involvement of the bank in a project with income-generating potential as a
partner who provides all or part of the project’s capital. It is agreed that the bank will
receive a percentage of the real net income and also have the right to hold the
entire balance of the net income that belongs to its partner, or any part of it agreed
to, as a payment by the bank’s partner to acquire the bank’s share in the
partnership (my definition)
13
MUSHĀRAKAH MUTANĀQISAH PARTNERSHIP (MMP)
 In a nutshell: MMP is a kind of contractual partnership in which the partners join together
with their contributions for the common objective of undertaking business and trade in
accordance with the principles of Sharī’ah. It has three main features:
→ joint ownership of the bank and customer
→ leasing of the share of the bank to the customer
→ gradual redemption of the share of the bank by the customer
 MMP involves four relations (activities), each with its own documents and contracts
carried out by the partners. To be noted that:
→ the four transactions cannot be combined in a single arrangement, they have to be
executed independently and they cannot be the linked conditions for an enforceable
contract
→ it is a well-settled rule of Islamic jurisprudence that one transaction cannot be made
a precondition for another
→ instead of making the transactions a pre-condition for one another there can be
one-sided promises from one party to another
→ however, the joint purchase and the contract of lease may be joined in one
document whereby the financier agrees to lease his share, after joint purchase, to
the customer. This is permitted because ijārah can be effected for a future date
14
MUSHĀRAKAH MUTANĀQISAH PARTNERSHIP (MMP)
THE FIQH PERSPECTIVE
 The mushārakah mutanāqisah transaction combines four relations that are permissible
in Sharī’ah: hence there is nothing in it that violates any Sharī’ah rule or conflicts with
any comprehensive principle in Islamic jurisprudence
 Differences (that bear consequences in the structuring of products) may emerge in the
classification of the contract:
→ in the financing of residential properties, mushārakah mutanāqisah appears to be a
shirkat al-’aqd; although some researchers consider it to be a form of shirkat al-milk
(Nazīh Hammād, Majallat Majma’ al-Fiqh al-Islāmī, Issue No. 13; 2:513-51)
→ other researchers consider it to be a form of shirkat al-milk for home financing and
shirkat al-’aqd in the context of investments (Muhammad Taqī ‘Uthmānī)
→ still other researchers consider it to be an entirely new form of sharikah; i.e., it is
neither a pure contractual partnership nor a pure joint-ownership partnership (‘Ujayl
al-Nashmī, Majallat Majma’ al-Fiqh al-Islāmī, Issue No. 13, 2:568)
15
MUSHĀRAKAH MUTANĀQISAH PARTNERSHIP (MMP)
 In particular, home financing cannot be considered permanently as shirkat al-milk as at
some stages it shares the following features with shirkat al-’aqd:
→ the intention is not limited to the ownership and usufruct as the financier’s intention
is not to own and use it, but to invest by leasing it in order to get a profit. Also, the
client may lease back the property to another lessee, thus gaining profit from the
property
→ the partners are not independent in their transactions as they are already tied to an
earlier arrangement
16
MUSHĀRAKAH MUTANĀQISAH PARTNERSHIP (MMP)
WHY THE MMP FULFILLS THE MAQĀSID AL-SHARĪ’AH
 The attention being paid to the different kinds of partnerships, including MMP, is
consistent with the issued recommendations of the Islamic Fiqh Academy to reduce the
use of murābahah lil āmir bi shira’ as much as possible, and expand the use of various
risk-sharing investment methods such as mudhārabah and mushārakah
 The importance of the MMP for both financing and investment by means of assets, lies
in the fact that it epitomizes the nature of the Islamic economy, which is a ‘partnershipbased economy’, in contrast to the conventional ‘interest-based economy’. In particular,
it features:
→ the achievement of Sharī’ah-compliant returns and profits for both the financier and
its clients through the investment of capital, assets and human efforts
→ the achievement for the financier of periodical real returns from the investment of its
funds and throughout the investment period
→ the encouragement for the client to make halal investment
→ the realization of the client’s ambition to solely own the project in the medium run as
the financier gradually gives up its share in the project
→ the search for new investment and development opportunities in medium to longterm projects that can benefit people and develop the community
17
MUSHĀRAKAH MUTANĀQISAH PARTNERSHIP (MMP)
→ the balancing out of the economy by developing positive [risk-sharing] relationships
rather than negative [risk-transferring] relationships, thus bringing about justice in
distributing economic production
18
MUSHĀRAKAH MUTANĀQISAH PARTNERSHIP (MMP)
GRAPHICAL REPRESENTATION
19
1. THE MUSHĀRAKAH (JOINT OWNERSHIP) CONTRACT
 The customer enters into a partnership (mushārakah) agreement with the bank to coown the asset being financed:
→ all schools of fiqh expressly allow the creation of a joint ownership in property
→ for home financing, it is considered a shirkat-al-milk
→ for investment projects, it is considered a contract of partnership based on agency
(shirkat al-’inān)
MECHANISM & FEATURES
→ customer identifies the property that he/she wants to purchase and signs a Sales
and Purchase (S&P) agreement with the developer/seller and pays a deposit
→ customer approaches the bank for a MM financing facility. Inter alia, determines the
duration of the contract
→ bank assesses the application and approve it (= feasibility study)
→ in case of an investment project: assessment of its implementation stages and
related expenditures (including the appointment of a supervisor)
→ once approved, customer and bank will enter into a MMP arrangement where the
purpose of the co-ownership is to acquire a property/fixed asset
→ the initial deposit/down payment made by the customer at this stage will be his/her
contribution towards the MMP venture while the bank’s contribution will equal the
financing amount. In this way both of them pay their respective shares to the seller
of the asset
20
1. THE MUSHĀRAKAH (JOINT OWNERSHIP) CONTRACT
→ the client may have to give guarantees. The mortgage of the financed property is
possible and any additional security as may be determined by the bank. This
mortgage is not to guarantee the bank’s share in the partnership but to fulfill all the
bank’s rights relating to this contract. In case of investment project, full pledge of a
piece of land/asset is possible
→ the income tax (as well as start-up expenses, such as architectural and consultation
fees, licensing fees and mortgage documentation fees, if any) will be paid by either
the bank or the client, and whatever is paid will be considered as an additional
contribution by that party to the partnership
→ in case of construction, costs in some instances may exceed the financing amount
contributed by the bank. When faced with such a situation, the bank may increase
its share in the partnership by covering the extra cost, or the client may cover the
extra cost, as per previously stipulated conditions in the contract. In either case, the
share of the payer [in the project] will be increased accordingly
21
1. THE MUSHĀRAKAH (JOINT OWNERSHIP) CONTRACT
REGISTRATION OF THE PROPERTY UNDER THE CUSTOMER’S NAME
 The customer and bank are co-beneficial owners of the property but the customer
becomes the registered proprietor of the property as well as a trustee for the two cobeneficial owners:
→ at this stage, the customer is a registered proprietor, a trustee for the customer and
the bank (both as beneficiaries) and one of the two beneficiaries
→ the bank is the second beneficiary
→ the beneficial owner of an asset is the person for whose benefit it is being held.
Beneficial ownership arises when an asset is owned by one person (the ‘legal
owner’) who has a duty to use it on behalf of another; one person holds assets as
trustee for another. Or: is a legal term where specific property rights (‘use and title’)
in equity belong to a person even though legal title of the property belongs to
another person
→ it is widely used by the industry
 As security for the performance of its payment obligations (to protect the bank’s portion
and to cover any expenses to dispose of the asset in the event of default) the customer
pledges his/her share of the beneficial ownership of the property to the bank
22
1. THE MUSHĀRAKAH (JOINT OWNERSHIP) CONTRACT
 However, given that the property is registered in the name of the customer in his/her
capacity of trustee for the customer and bank (as beneficiaries), both beneficiaries
agree that the customer in his/her capacity of trustee should register a charge over the
whole property in favour of the bank as security:
→ a charge is defined as a security interest in property; it transfers neither title nor
possession
→ registration confers upon chargee the power of foreclosure upon default of
repayment of the debt and confers upon him/her a legal interest in the property.
Thus, a legal charge is an encumbrance on the property which prevents any further
dealings whether by way of sale and transfer of that land or the grant of a second
charge without the consent of the first chargee
→ in theory, the trustee should only charge the customer’s portion of the property to
the bank and not charge the bank’s portion as well
→ in practice, most National Land Codes only allow a charge on the whole, but not on
a part only, of any alienated land. Hence, the trustee, with the consent of the bank,
charges the whole property in favour of the bank
23
1. THE MUSHĀRAKAH (JOINT OWNERSHIP) CONTRACT
→ if the customer defaults and fails to remedy the default, the bank will sell the
property through the charge provision under the National Land Code. If the sale
leads to a surplus, the customer will get the surplus. If there is a shortfall, the
customer will be liable to pay the shortfall amount to the bank, based on a wa’d
obligation assumed by him/her. This position is also comparable to the charge
foreclosure position under a conventional loan
 In the rare case the charge is found to be invalid, the bank may have recourse to an
equitable charge:
→ definition: “If an agreement be made to grant some interest in existing or future
property for the purpose of securing the payment of a debt, that agreement to give
the security confers an equitable security or charge, though all the formalities
necessary to create the actual security have not been complied with”
→ hence: what is necessary for an equitable charge to exist is a valid contract that
grants interest in existing property for the purpose of securing the payment of a debt
→ in addition: the bank can lodge a caveat which operates as notice to the entire world
that the registered proprietor’s title is subject to the equitable interest alleged in the
caveat
→ double check: what if the customer becomes a bankrupt? Can the official assignee
challenge the Islamic bank’s equitable charge?
24
1. THE MUSHĀRAKAH (JOINT OWNERSHIP) CONTRACT
REGISTRATION OF THE PROPERTY UNDER THE BANK’S NAME
 The Islamic bank is registered as the legal owner and holds the property on trust for
itself and the customer:
→ at this stage, the bank is a registered proprietor, a trustee for the two co-beneficial
owners and one of the two beneficiaries
→ the customer is the other beneficiary
→ currently practiced by Kuwait Finance House (KFH)
 To evidence the trust, a trust deed is executed and stamped, and it is registered
 If the customer defaults and fails to remedy the default, the underlying asset will be sold
in the market and the proceeds will be shared between the co-partners according to the
latest ownership share ratio - after all the outstanding costs and payments, such as
outstanding rents and legal fees, are covered:
→ however, having the bank own the property may not be viewed favourably in the
market as the customer’s perception is shaped by conventional mortgage practice
where the customer is always the registered owner
→ also, there is the issue of the possible liability linked to the ownership of the property
by the bank in the event there is a tortuous claim
25
1. THE MUSHĀRAKAH (JOINT OWNERSHIP) CONTRACT
PROPERTIES UNDER CONSTRUCTION: THE MMP CUM ISTISNA‘
 When it comes to properties under construction, the current practice is very similar to
the MMP methods explained above. The only difference is that Islamic banks charge
advance rental from the customer for the period during the construction. This advance
rental is known as ijārah mawsūfah fī al-dhimmah (forward lease). See below.
→ however, if the property is abandoned (property yet to be constructed due, to say,
the developer’s default) the bank has to pay back the advance rentals to the
customer and bear the risk according to the financing
→ indeed, the bank cannot invoke the wa’d against the customer and ask the
customer to pay the full amount disbursed by the bank as this mechanism would not
be in compliance with the Sharī’ah
 A possible solution to mitigate the construction risk is the use of a modified MMP with an
istisna’ structure:
→ the MMP venture will enter into an istisna’ agreement with the customer - whereby
the customer will agree to procure the construction of the property for the MMP
venture
→ the customer in turn will enter into a Sale and Purchase Agreement with a
developer to contract the istisna’ obligations to a developer of his choice
26
1. THE MUSHĀRAKAH (JOINT OWNERSHIP) CONTRACT
→ in this way, the customer is legally responsible to the MMP venture to procure the
construction and delivery of the property. If the customer fails to deliver in
accordance with the istisna’ agreement, then the MMP venture has a full right to
claim the outstanding amount owed by the customer to the MMP venture
→ if the property is not completed under the istisna’, the bank will be required to repay
to the customer the advance rentals paid by the customer (as lessee) to the bank
(as lessor) during the construction stage. The bank can mitigate this risk by seeking
compensation from the customer (as the procurement party) under the istisna’ for
failing to deliver the property as per the istisna’ terms
→ for the sole purpose of computing this compensation, the quantum of compensation
can be equal to the amount of advance rental repayable to the customer
 Beware:
→ the MMP facility which does not expose the bank to the construction risk enjoys a
50% risk weight on capital requirements and consequently it is priced on par with a
comparable conventional mortgage which does not expose the conventional bank to
any construction risk
→ on the other hand, any construction risk exposure to the bank would increase the
risk weight to 400% (allocate a higher percentage of the capital to back the MMP
facility) and this would increase the overall cost to the customer by a manifold
amount
27
1. THE MUSHĀRAKAH (JOINT OWNERSHIP) CONTRACT
Mushārakah mutanāqisah cum istisna'
28
1. THE MUSHĀRAKAH (JOINT OWNERSHIP) CONTRACT
 Please, refer to the presentation themed ‘The Bay’ Istisna’’ for details of this contractual
relationship, including the following:
WHAT IS MEANT BY ISTISNA’
THE LEGITIMACY OF THE ISTISNA‘ CONTRACT
SHARI‘AH PARAMETERS - CONCLUSION OF CONTRACT
SHARI‘AH PARAMETERS - ASSETS
SHARI‘AH PARAMETERS - PRICE
SHARI‘AH PARAMETERS - EXECUTION OF CONTRACT
SHARI‘AH PARAMETERS - DELIVERY OF THE PRODUCT
DIFFERENCES BETWEEN ISTISNA’ AND IJARAH
DIFFERENCES BETWEEN ISTISNA’ AND SALAM
APPLICATIONS OF ISTISNA’ IN ISLAMIC BANKS
29
1. THE MUSHĀRAKAH (JOINT OWNERSHIP) CONTRACT
LEGAL FRAMEWORK AND DOCUMENTATION
 The modern business concerns being run on the basis of mushārakah may be a:
→ partnership: regulated either by rules framed by the government or business
practices prevailing in the business community
→ limited company: regulated by the statutory rules framed by the government though
its commercial activities are influenced by the business practices (‘urf)
→ co-operative society: governed by statutory rules. Its commercial activities are
influenced by the practices prevailing in the business community
 Documentation needed:
→ application form
→ documents from the client (address verification, personal information, income
estimate, business information, property documents, etc.)
→ legal opinion
→ property valuation
→ credit approval & sanction letter
→ account opening
→ signing of house finance agreement
30
1. THE MUSHĀRAKAH (JOINT OWNERSHIP) CONTRACT
TAKĀFUL WRAPPING
The property buyer must take out an insurance (takāful) policy for the whole building with a
clause covering the risk of the bank (the co-owner) as well. How the share of the bank in the
premium will be adjusted to the installment payments is a matter of contractual agreement
 Aim: to insure Islamically the property through a wakālah contract
 Features:
→ insured amount is capped at a fixed rebuilding cost
→ the rebuilding costs are agreed upon by the chosen retakaful company. The market
value is not taken into consideration, as it can be inflated
→ the takāful policy insures Islamically the property (never the credit) against events
such as: fire, explosions, lightening, falling parts of aircrafts (light and commercial),
etc.
→ surplus refund mechanism for the product, but must get retakaful company to chip in
the surplus to refund
31
2. THE IJĀRAH (LEASING) CONTRACT
 The bank leases its share in the asset ownership to the customer under the contract of
ijārah. The customer rents the bank’s undivided share or portion in the property and
pays the rental payment (if he/she needs to make use of it during the period in which he
is acquiring its ownership, which is usually the case):
→ all Muslim jurists agree on the permissibility for one party (even if it is the client) in
mushārakah mutanāqisah to lease the other party’s share (even if it is the financier)
for a known rental and for any specified period of time
→ there is difference of opinions only on leasing one’s share to a third part (Abū
Ḥanīfa v Mālik, Shāfi’ī, Abū Yūsuf)
MECHANISM & FEATURES
→ the practice among the banks is to only lease their share in the property to the
customer. In this case, all the rental payment goes to the bank
→ the bank’s portion of the rental income is similar to a financing profit earned by a
conventional bank
32
2. THE IJĀRAH (LEASING) CONTRACT
RENTING TO A THIRD PARTY
→ in case of a an investment project, the right to utilize the usufruct of the building
(project) is delegated to the bank (the manager of the project, as per the conditions
stipulated in the mushārakah contract). Therefore, the bank has the right to
conclude leasing contracts on the project and collect rentals. Leasing contracts that
stipulate the agreed terms and conditions are to be signed by the bank and the
lessees. However, the bank can discuss with the client/partner and get his opinion if
the leasing contract is concluded with a person other than the bank’s client
→ it is also possible for the client to have his signature on these contracts too. The
leasing contracts contain a special provision which extends the enforcement of the
stipulated conditions after the bank exits the partnership
→ the bank will handle the follow-up with the tenants to collect the rentals on their due
dates according to the agreed conditions and the rental amounts will be jointly
shared between the customer and the bank according to the percentage share
holding at the particular times which keeps changing as the customer purchases the
financier’s share
→ the client’s share of the income will be determined and credited to a special account
with the bank for the purpose of buying the bank’s share. It is also possible that the
bank will give the client for his personal use part of his share in the income that has
been saved in the special account
33
2. THE IJĀRAH (LEASING) CONTRACT
→ each partner will continue to be responsible for the basic maintenance of its share at
all times
THE RENTAL RATE PEGGED TO INTEREST RATES
 The formula used for the MMP calculation is similar to the standard formula used in
conventional financing for present value of annuities to compute for the monthly
payments (see slides below):
→ an obvious advantage from this similarity is that the conventional formulas, and
therefore the conventional financial calculators and spreadsheets like Excel can be
used for the MMP computations and the preparation of amortization schedules
thereof
 Though scholars have argued that setting rental levels in line with market interest rates
is not in itself haram:
→ this is the current practice by some Islamic banks in the UK whereas the rents are
linked to LIBOR
34
2. THE IJĀRAH (LEASING) CONTRACT
ACTUAL RENTAL RATE
 To be truly Sharī’ah-compliant, the interest rate in the MMP formula must be replaced
with the actual rental rate. This may represent an hurdle for the bank as
→ the bank’s cost of funds is likely to be tied to market interest rates
→ the interest rate may be higher than the rental rate
→ tracking rentals can be cumbersome and impose additional costs particularly if
services of independent valuers are sought, unless there are already national or
regional rental indices
 The use of actual rental value that reflects the real property value in the market as a
benchmark is most suited for use in Islamic finance since it is measured from the true
usufruct of the asset, unlike interest charges that are apparently not tied to the asset’s
usufruct:
→ hence the rental rate can differ among houses within a same row of houses or
among different floors within a condominium block and reflects the real property
value in the market
→ the rental can be tied to some economic variables like Rental Index, House Price
Index, etc.
→ If the customer cannot afford to pay the new rental and choose to continue paying
the old rental, the duration of the remaining contract would be extended
35
2. THE IJĀRAH (LEASING) CONTRACT
VARIABLE RENTAL RATE
 A further improvement: (Taqi Usmani, An Introduction to Islamic Finance, 2004) Rental
must be determined at the time of contract for the whole period of lease. It is permissible
that different amounts of rent are fixed for different phases during the lease period,
provided that the amount of rent for each phase is specifically agreed upon at the time
of affecting a lease:
→ if the rent for a subsequent phase of the lease period has not been determined or
has been left at the option of the lessor, the lease is not valid
→ to estimate the rental, some MMP operators use the services of independent real
estate agents to provide them with the estimates; sometimes using average of as
many as three agents’ estimates in order to be more just. But all these can impose
additional cost on bank and the customer
→ the use of rental indices or house price indices in order to estimate the new rentals
without having to bear the cost of using the services of real estate agents is
admissible. If a particular index is used, it would be specified in the contract and
acceptable to both the customer and bank to avoid gharar
→ nonetheless, using indices would cause the loss of some accuracy: while an index
may give the average rental in a locality, specific factors should also be taken into
consideration in order to get a better rental estimate fair to both sides
36
2. THE IJĀRAH (LEASING) CONTRACT
→ prices and rental of real estate properties are sensitive to many factors. Even within
the same locality, particular location can affect prices and rentals. Other than
characteristics of the property (floor size, number of rooms, single storey or double
storey, corner or intermediate etc.) its location relative to school, shops, hospital,
mosque, sewage etc. can also affect prices and rentals
MISMATCHING ISSUE
 If the cost of funds to the bank is based on variable rates while the MMP contract’s
rental rate is fixed for the entire tenor, then the bank may face liquidity risk problems.
The problem is matching the short duration deposit funds with long duration of the
financings. The MMP can be made more flexible by requiring the review of rental
periodically, say every five years
DOCUMENTATION
 Monthly payment agreement (rent agreement)
37
2. THE IJĀRAH (LEASING) CONTRACT
THE FORMULAS
 The standard formula for present value of annuities to compute for the monthly
payments used by conventional financing is the following:
Pmt
PV = ̶ ̶ ̶ ̶ ̶ ̶
i
1
1- ̶ ̶ ̶ ̶ ̶ ̶ ̶ ̶
(1+ i )n
which gives:
i (1+i)n PV
Pmt = ̶ ̶ ̶ ̶ ̶ ̶ ̶ ̶ ̶ ̶ ̶ ̶ ̶ ̶ ̶
(1+i)n - 1
→ PV = present value of the monthly or periodic installments, which is the loan amount
itself
→ Pmt = the monthly or periodic installments (principal and interest)
→ i = the monthly or periodic interest rate
→ n = the number of months or periods
38
2. THE IJĀRAH (LEASING) CONTRACT
 The formula used by the MMP is the following:
x (1+x)n B0
M= ̶̶̶̶̶̶̶̶ ̶̶̶̶̶̶̶
(1+x)n - 1
→ M = the monthly or periodic payments to the bank, that comprises the rental amount
and the additional amount being paid in order to redeem the asset early
→ x = rental rate, e.g. monthly rental divided by the original asset price
→ B0 = the initial contribution of the bank in the purchase price
→ n = the number of months or periods for the customer to fully own the asset
39
2. THE IJĀRAH (LEASING) CONTRACT
 Please, refer to the presentation themed ‘The Ijarah muntahiya bi-tamleek’ for details of
this contractual relationship, including:
ESSENTIALS OF IJARAH
ESSENTIALS OF IJARAH MUNTAHIYA BI-TAMLEEK
SHARIAH LEGITIMACY AND AAOIFI SHARIAH STANDARD
CONVENTIONAL V. IJARAH
DOCUMENTATION OF IJARAH
THE TRANSFER OF THE LEGAL TITLE OF THE ASSET
CURRENT APPLICATIONS OF IJARAH IN ISLAMIC BANKS
ACCOUNTING ISSUES
KEY DIFFERENCES BETWEEN IFRS AND AAOIFI
40
3. THE BAY’ (SELLING) CONTRACT
 The customer has entered into a purchase undertaking to buy the financier’s share in
stages:
→ he/she gradually and periodically buys through a sale contract (bay’) the units
representing the bank’s share at an agreed upon portion until the asset is fully
owned by the customer
→ the sale and purchase of the partnership’s share must not be stipulated as a
condition in the mushārakah (partnership) contract. Indeed, a partner’s promise to
sell or purchase must be separated from the partnership contract, and the
transaction will be exercised through a separate contract. It is not permitted to link
either contract with the other by a stipulated condition (AAOIFI, Sharī’ah Standard
No. 12, clause 1/5)
→ it is not allowed to conclude any sale contract in advance because a sale cannot be
concluded to take place in the future
MECHANISM & FEATURES
→ throughout the tenure of the lease, at agreed time intervals, the customer will buy
units representing the bank’s share in the property from the bank. This is
implemented by the customer paying an additional amount in addition to the rental
payment to purchase the bank’s share in the property
41
3. THE BAY’ (SELLING) CONTRACT
→ the share of the bank will be reduced by every purchase of the units by the
customer, i.e.: ownership of the asset is gradually transferred to the customer upon
payment of asset price
→ in case of an investment project: at the end of tenure of the lease, when the client
has fully purchased the bank’s share by means of his share of the rental income,
the MMP will be liquidated and the property will be wholly owned by the customer
and the full ownership title will be transferred to him. In other worlds, the client
undertakes to allocate his portion of the partnership’s profit or income to acquire a
percentage of the bank’s share in the partnership
→ in case of an investment project: losses - if any - will be borne by each partner
according to his/her share in the capital. In each period of the partnership, the losssharing ratio will be adjusted in proportion to any changes in the partners’ shares in
the capital (AAOIFI, Sharī’ah Standard No. 12, Clause 5/4)
→ in case of an investment project: all leasing contracts and rights will be transferred
to the client on that date. Thereafter, the client will be the only one authorized to
collect rental fees
42
3. THE BAY’ (SELLING) CONTRACT
THE ALLOCATION OF UNITS
 It is fine to organize the acquisition of the bank’s share by its partner in any way that
achieves the goals of both parties; for example:
→ the subject of the partnership is divided into shares (units), of which the bank’s
partner periodically acquires a certain number until he manages to acquire the
entire portion, which will make him the sole owner of the subject of the partnership
→ units may be worked out by dividing bank’s financed amount by the number of
months financed
→ the client may purchases different units of the undivided share of the financier
THE ISSUE OF PRICE
 If two parties co-own the asset and share its rental income, they should also share the
asset’s price appreciation (if any)
→ hence: there is no guaranteed rate of return on the investment of the financier
 The Sharī’ah standards of AAOIFI prohibit the purchase of shares in a MMP at a price
that is fixed in advance:
→ this is on the basis that partners in a contractual investment (in this case, a rental
property) must share any losses on their investments in proportion to their capital
contribution
43
3. THE BAY’ (SELLING) CONTRACT
 “It will be preferable that the purchase of different units by the client is effected on the
basis of the market value of the house as prevalent on the date of the unit, but it is also
permissible that a particular price is agreed in the promise of purchase signed by the
client” (Usmani 2005, p. 90)
 “It is not permissible to the partners to agree with the price of another partner’s portion
on the basis of its face value or premium value, but it is permissible to purchase the
partner’s portion at the agreed price at dissolution day, or transaction day, or market
price, or the price that is determined by experts” (Majmū’ah al-Barakah al-Maṣrafiyyah,
2007):
→ hence: the share is sold at its market value or at the price agreed upon at the time
of the purchase or at the price that is determined by experts
→ it is not permissible to stipulate sale of a share at its nominal value because that is
tantamount to guaranteeing the shares of the partnership by one of its partners
 Beware: the sharing of the asset’s price appreciation involves few issues:
→ the MMP involves the gradual and constant redemption of the financier’s equity by
the customer. Hence, by the end of the MMP financing the customer has already
acquired the full ownership of the asset and any price appreciation at that moment
fully belong to the customer
44
3. THE BAY’ (SELLING) CONTRACT
→ on the other hand, it is also true that an asset should be valued only when there is a
sale of the property which would involve the full transfer of ownership. Otherwise
the appreciation or depreciation of value would only be on paper
→ valuation of the asset within the duration of the MMP contract may not be
appropriate since a full transfer does not take place at the moment of valuation as
the MMP involves gradual transfer of ownership along the entire duration of the
MMP
→ if periodic valuation of the asset, just like the rental, is agreed upon then it should
involve both appreciation and depreciation and normally, banks do not want to take
this risk
 In practice: 1st way. Valuation of the property during the contract tenor done at the times
agreed upon:
→ the capital appreciation (at the day of evaluation) is shared according to the
ownership ratios of the customer and the bank (at the day of evaluation)
→ this will impact the equity of the customer and the bank that will increase
accordingly
→ at the new equity value, the rental (which most probably will also have increase) will
result in a different rental rate
→ a new amortization schedule will be drawn
45
3. THE BAY’ (SELLING) CONTRACT
 In practice: 2nd way. Valuation of the property at the end of the contract tenor:
→ in a lump payment
→ sharing gains or losses in the capital value of the house in a pre-agreed ratio when
the nominal partnership comes to an end
46
4. THE WA’D (PURCHASE UNDERTAKING)
 The customer signs the wa’d (purchase undertaking) agreement whereby he/she agrees
to buy the outstanding share from the bank on installments at a stipulated time
MECHANISM & FEATURES
→ it is separate but concurrent with the previous contracts
→ the promise of the client to buy the share units of the financier is one-sided without
any quid-pro-quo and should not be reciprocated with a binding promise from the
other partner (who maintains the right not the obligation). This is to avoid a binding
bilateral promise, which would cause the process to resemble a sale contract, for it
is known that a sale contract cannot be concluded to take place in the future
→ it is also possible for the bank (though unusual) to make such a binding promise to
the client; hence, it is permissible for one party to make a binding promise to allow
the other party to gradually own his shares in the partnership through a sale
contract concluded at the time of [each] purchase
→ in Sharī’ah, a promise to do something creates in general only a moral obligation on
the promisor, which cannot be enforced through the courts of law, albeit there are
juridical differences on the point. For example, the Ḥanafī position is that promises
can be enforced in cases/times of need on the principle of bay’ al-wafa’
47
4. THE WA’D (PURCHASE UNDERTAKING)
THE EVENT OF DEFAULT
 Where the customer has provided a wa’d (purchase undertaking) to the bank at the
outset of the MMP (and the bank exercise it) the customer is obliged to acquire the
bank’s remaining (outstanding) share:
→ this creates a debt to be paid by the customer to the bank equal to the amount of
purchase price payable plus the amount of unpaid rental
→ if the customer fails to honour the wa’d (which is generally the case), the MMP will
be terminated and the bank ends up selling the property under the charge at auction
to obtain the capital
→ the selling price of the house could be higher, lower, or equal to the amount claimed
and the bank would be able to claim any shortfall from the customer as an
unsecured debt
→ the customer, however, would be entitled to any surplus from sale proceeds if the
property price appreciates
48
4. THE WA’D (PURCHASE UNDERTAKING)
 If no wa’d has been procured from the customer (or is not exercised by the bank) then
the underlying asset will be sold in the market for the prevailing price and the proceeds
will be shared between the partners according to the latest ownership share ratio:
→ after all the outstanding costs and payments, such as outstanding rents and legal
fees, are covered
→ if there is a surplus, it will be shared between the parties based on the profit-sharing
ratio. On the other hand, if there is a loss, it will be shared according to the capital
share of each party in the property
 The problem with the no-wa’d approach is that if the value of the property has
depreciated, the bank does not have recourse to the purchase price payable by the
customer under the wa’d. In fact, if there is no wa’d, the only debt due and payable by
the customer to the bank is the unpaid rental:
→ it is recommended that the bank choose one of the two options at the beginning of
the contract and not be given freedom to decide whether to take the wa’d option or
the direct sale option (without wa’d) at the time of default
→ in commercial practice most banks use the wa’d (purchase undertaking)
49
4. THE WA’D (PURCHASE UNDERTAKING)
THE ISSUE OF THE SECOND UNDERTAKING
 As an element of additional capital guarantee/protection, some banks have come to
require the customer to sign a second wa’d to buy the financier’s share in the event of
default. It has two features:
→ granting the right to the bank to oblige the customer to buy the bank’s share on
credit in the event of default, or
→ granting the right to the bank to purchase the customer’s remaining share
 In the first case, the customer shall buy the bank’s share on credit at the price that
covers the bank’s remaining share and unpaid rental for the period before the imposing
of the binding undertaking to purchase, and other expenses:
→ an indebtedness of the customer is created and the property is in the position of a
collateral for the customer’s obligation
 In the second case, the bank purchases the customer’s share at a pre-determined price
and the payment of the price shall be set-off against the default rental fee:
→ the property will be solely under the bank’s ownership
→ the bank shall auction the asset to obtain the capital. The proceeds of the auction
will be used to pay the default amount of rental and payment of the credit sale. If
there is any balance, the bank shall return it to the customer
50
4. THE WA’D (PURCHASE UNDERTAKING)
 The goal of this second undertaking is to protect the financiers from ownership risk when
disposing of the assets, such as the depreciating value of the asset. In this case, the
financier’s portion of the price may not be sufficient to top up the financier’s capital, or
the customer’s portion of the price may not be able to cover both unpaid lease payments
and the financier’s capital
 It is claimed that the second undertaking is permissible as the current ‘urf tijārī
(customary practice) needs this kind of protection for financial institutions and Islamic
law recognises custom as a secondary source of law:
→ in reality, the first feature is prohibited as it facilitates the capital guarantee concept
which is ḥarām in both coownership and contractual partnership contracts
→ if one partner forces another to buy his/her shares at a pre-determined price, he
may effectively be able to protect himself against loss, thus violating the principle of
loss sharing that must apply if an Islamic partnership is to be valid
→ the second feature, is permissible. However, the majority of scholars suggested that
the price should be at market price, or at a fair price
51
REDEMPTION & TERMINATION OF CONTRACT
 In the case of early redemption where the customer does not intend to leave the house,
the redemption amount will be based on the balance outstanding and revaluation of
property is thus not needed
 A revaluation of the property would take place when the customer intends to leave the
house. The revaluation price will be used to offset the outstanding amount and the
residual amount will be shared between the customer and the bank based on the
prevailing profit sharing ratio
 In the case of death of the partner, law of inheritance would apply and this can be
further mitigated through takaful policy
52
RISK MANAGEMENT
 A thorough scrutiny process on the customer’s capability to pay, such as credit scoring
 Inclusion of certain risk premiums prior to deciding the musharākah profit sharing ratio
and lease payment
 Customary recourse and execution of charges
53
ADVANTAGES OF MMP OVER BAY’ BI-THAMAN AJIL
 The bay’ bi-thaman ajil (BBA) concept based on murābahah has raised many negative
issues such as bay’ al-’īnah, possession, high selling prices in the event of default, legal
disputes, etc.
 On the other hand, the MMP - based on a combination of mushārakah and ijārah
contracts - has several advantages over the BBA:
→ the MMP is accepted internationally as Sharī’ah-compliant whereas the BBA is
recognized predominantly in the east, i.e. in Malaysia, Indonesia, and Brunei, etc.
Thus the MMP is suited for contracts across national borders. The BBA can prove
problematic for international financing applications
→ unlike under BBA, the value of the house under MMP always reflects the market
price and the rental is determined by the market rental values or at a price agreed
at the time of acquisition
54
ADVANTAGES OF MMP OVER BAY’ BI-THAMAN AJIL
→ the return to the BBA is based on a fixed selling price (that uses the prevailing
interest rate as the benchmark). But under MMP, the financer need not be tied to a
fixed profit rate throughout the financing tenor. This is because the rental rate can
be revised periodically to reflect current market conditions. Indeed, the rental can be
tied to some economic variables like Rental Index, House Price Index etc. If a
particular index is used, it would be specified in the contract and acceptable to both
the customer and bank to avoid gharar
→ the financier can manage the liquidity risks better as rental payments can be
adjusted at the end of each subcontract period. This is not possible under the
current fixed-rate BBA as the profit rate is a constant throughout the entire tenor of
financing
→ even compared with a floating-rate BBA, the MMP still differs in the balance of
financing at any point in time before the end of the contract. Under MMP, the
balance can never be larger than the original price/finance of the house. Rebates
for early redemption under BBA cannot be specifically stated in the contract
55
ADVANTAGES OF MMP OVER BAY’ BI-THAMAN AJIL
→ the MMP is a more flexible financing structure than the BBA as the customer can
own the property earlier by redeeming faster the principal sum of the financier,
without the need to compute rebates (which is at the discretion of the bank since
fixing the rebate upfront is not allowed in Sharī’ah) as in BBA
→ in the event of payment defaults, the penalty charges under BBA can be
challenged, while under MMP, defaults will cause the equity of financier to remain
constant and therefore entitled to higher rental portions when payments made later
→ if the property is auctioned off due to default, the amount sold would depend on the
highest bidder which can be lower than the balance outstanding owed by the
customer. In the case of MMP, bank will ensure that the property is sold at a
reasonable value as a lower amount would also affect its own position
→ currently many customers opine that the BBA is similar to the conventional loan with
some disadvantages for the customer particularly for early redemptions
→ figure 1 and 2 in the following slide illustrate the different relationships and flows for
MMP and BBA
56
ADVANTAGES OF MMP OVER BAY’ BI-THAMAN AJIL
57
DIFFERENCES WITH A MORTGAGE LOAN
 A MMP contract in which a customer pays ‘Rent plus Acquisition Payments’ periodically
may, at first sight, resemble a conventional mortgage schedule. The Rental Payment
corresponding to ‘Interest Payment’ in a conventional mortgage while the Acquisition
Payment corresponding to the ‘Principal Payment’ in a conventional mortgage
 In reality, the MMP differs fundamentally from a mortgage loan by the nature of the
transaction, in particular in view of the relationship established between the parties
involved:
→ in a loan transaction, the lender advances funds to the borrower in exchange for a
future repayment of the funds plus interest. This amounts to an exchange of cash for
a greater amount of cash in the future and is prohibited in the Sharī’ah
→ in a MMP transaction, the relationship between the financier and the customer is
that of co-owners in a property and not that of lender-borrower. The initial financing
provided by the financier is applied to acquire a share in the property and not to
provide a loan
→ the monthly Acquisition and Rental Payments are applied respectively to acquire the
financier’s share in the property and for the customer’s exclusive use of the whole
property. These payments do not constitute a repayment of a loan with interest
58
DIFFERENCES WITH A MORTGAGE LOAN
 Another essential difference between the Sharī’ah-compliant modes of financing and
loans that incorporate interest is that the financier is not permitted to profit from the
financial distress of the customer:
→ no interest may be charged on late payments except that expenses incurred in the
collection of such payments may be charged to the customer
 Hence, the MMP is designed to provide benefits to customers that are equivalent to
what is offered by a conventional mortgage, but in a manner that complies with the
tenets of the Sharī’ah:
→ the concept allows customers to acquire their homes at their own pace through predetermined monthly payments and ensures the integrity of the transaction by
respecting the rights and obligations of the two parties in the agreement
59
SUKUK AL-WAKALA BIL-ISTITHMAR
 This structure allows the bank to off-load from its balance sheet its commitments by
securitizing the financial receivables
 The Sukuk al-Wakāla bil-Istithmār structure is a flexible product that can be used by
corporate clients or banks. Be aware that only Sharī’ah-compliant assets can be utilised
 The Islamic Development Bank (IDB) pioneered this structure with its first Sukuk issue in
June 2005 and used it again in its USD850m benchmark issue in September 2009,
issued under its USD1.5bn Trust Certificate Programme
 It is possible to structure an issue utilising certain eligible assets, either a single asset or
a pool of assets:
→ for the IDB programme, at least 51% of the assets must constitute tangible assets,
which for these purposes would comprise ijārah (leasing) contracts, Sharī’ahcompliant equity instruments and/or Sukuk certificates (in each case, together with
the underlying assets)
 It enables a client wishing to raise funds to utilise more than one source of eligible
assets in order to create a Sharī’ah-compliant, asset-backed Sukuk issue:
→ it will always be possible, of course, to structure an issue utilising a single asset if
appropriate, e.g. a commercial property; in this case, however, it may be more
appropriate to utilise a simple ijārah structure
60
SUKUK AL-WAKALA BIL-ISTITHMAR
 The most likely eligible component of the asset portfolio will be ijārah (lease) assets,
and these could include property but also other tangible assets from ships to tool
machinery
 The structure can be used for a one-off standalone issue or, as is the case with the IDB,
as the basis for a programme:
→ the IDB’s Trust Certificate Programme allows it to approach Islamic investors on a
regular basis either via a benchmark issue or by means of a private placement to
one or more selected investors
61
SUKUK AL-WAKALA BIL-ISTITHMAR
Islamic bank
5 Liquidity Facility
(for Periodic Distributions)
Liquidity Facility
Agreement
Servicing
Agreement
Islamic bank
as Servicing Agent
4 Servicing Agreement
6 Periodic Payments
Islamic bank
as Asset Originator
2 Sale of assets
Islamic bank
as Asset Originator
Issuer/Trustee
7 Purchase of Assets
3 Issue Proceeds
8 Purchase Price
9 Payment
1 Issue Proceeds
Trust Deed
Issue date cash flows
Certificate holders
Repayment date cash flows
Lifetime cash flows
62
SUKUK AL-WAKALA BIL-ISTITHMAR
1. Certificate holders subscribe for Sukuk certificates and the Issuer/Trustee declares a
trust over the issue proceeds in their favour. Issuance is in USD/AFG
2. The Bank sells the Assets (i.e. the real estate asset or other lease assets) to the
Issuer/Trustee (the “Asset Portfolio”):
→ the Asset Portfolio must constitute at least 51% eligible assets – most likely to
comprise ijārah assets, shares and asset-backed Sukuk (i.e. where Sukuk holders
have an ownership right in the underlying assets)
→ debt-equivalent products such as murābaḥah and istisna’ cannot be more than
49% of the Asset Portfolio
3. The Issue Proceeds (USD/AFG) are paid by the Issuer/Trustee to the Bank as the
originator of the Asset Portfolio
4. The Issuer/Trustee appoints the Bank as its wakeel (or Servicing Agent) with respect to
the Asset Portfolio, for the Servicing Agent to service the Asset Portfolio and collect
income arising from them:
→ NB: it is important to define the Servicing Agent’s services as narrowly as possible.
The Bank can in addition delegate these responsibilities to one or more agents to
act on its behalf in this capacity
63
SUKUK AL-WAKALA BIL-ISTITHMAR
5. The Bank enters into a Liquidity Facility Agreement with the Issuer/Trustee, the purpose
of which is (i) to cover the Issuer/Trustee’s set-up costs and (ii) to make good any
shortfall of revenue on any periodic distribution date
6. Periodic distributions will be made to Sukuk holders out of the income generated by the
Asset Portfolio:
→ all such income will be placed into a collection account for the benefit of the
Certificate holders
→ any income in excess of the amount needed to make the next periodic distribution
will either (i) be placed into a separate reserve account or (ii) where the excess
income has been generated because a portfolio asset has matured, be used to
purchase replacement assets to be added to the Asset Portfolio
→ if on any periodic distribution payment date the funds standing to the credit of the
collection account and the reserve account fall short of the amounts then due to
Certificate holders, then the Bank Liquidity Facility will be drawn down to cover the
amount of any such shortfall
→ NB: amounts drawn down under the Liquidity Facility will be subordinated to all
amounts due to Certificate holders prior to full repayment of the Sukuk Certificates
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SUKUK AL-WAKALA BIL-ISTITHMAR
→ an asset top-up mechanism will also be needed during the lifetime of the Issue to
ensure that (i) the net asset value of the Asset Portfolio does not fall below the
nominal amount of the Issue, and (ii) the necessary portfolio ratios are maintained,
i.e. that at all times the Asset Portfolio is comprised of not less than 51% ijārah or
other eligible assets (including shares and asset-backed Sukuk)
7. The Asset Portfolio is sold by the Issuer/Trustee to the Bank for an Exercise Price equal
to the aggregate of (i) the face value of the Sukuk Certificates and (ii) accrued but
unpaid periodic distribution amounts
8. The Exercise Price (USD/AFG) is paid by the Bank to the Issuer/Trustee
9. The Issuer/Trustee repays (USD/AFG) the Sukuk holders out of (i) the proceeds of the
Exercise Price and (ii) all amounts standing to the credit of the collection account and
the reserve account:
→ any excess remaining in the reserve account is to be paid to the Bank
65
BEST PRACTICE - MALAYSIA
Name
Product
RHB Islamic Bank
Equity Home Financing-i works
For completed and
under construction
Maybank Islamic
Home equity-i
For completed and
under construction
Kuwait Finance House
(KFHMB)
Musyarakah Mutanaqisah
Home Financing-i
For completed and
under construction
OCBC Al-Amin
Property Financing i
For completed and
under construction
Citibank
Home Partner i
For completed and
under construction
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BEST PRACTICE – MALAYSIA (KFHMB)
KUWAIT FINANCE HOUSE MALAYSIA BERHAD (KFHMB)
 the 1st first foreign Islamic bank to operate in Malaysia - started offering the mushārakah
mutanāqisah concept for home financing as a new product in Malaysia in 2005. KFH
Sharī’ah advisory board did not recognized BBA and ‘inah as valid contracts
 Financing at KFHMB through mushārakah mutanāqisah involves three parties, namely:
→ KFHMB as financier and partner
→ customer as partner
→ the supplier of good
STEPS
 Customer wishing to obtain mushārakah mutanāqisah financing identifies the home
he/she wants to buy. Once satisfied with the home specifications, he needs to get a
Sale and Purchase Agreement or Purchase Receipt Booking Form from the developer
as evidence for submission to the bank when applying for financing. The S&P
Agreement must be in the name of the customer and KFHMB (from which has received
previous agreement):
→ KFHMB offers financing products for both under construction or completed houses
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BEST PRACTICE - MALAYSIA (KFHMB)
 After approval, the customers will sign the mushārakah mutanāqisah document as
agreed (including the ratio of ownership which is usually 80-20%, the tenure, duration
etc.):
→ the tenure depends on the buyer's background: as for Malaysians the maximum
period is 30 years while for non-Malaysians is 20 years maximum
 Customer will eventually occupies the house and make lease payments in accordance
with current lease rates. Rental payments are usually aggregated in one monthly
installment that includes payments for the purchase of equity owned by KFHMB on the
house
 After due and proper payment of installments made by the customer the transfer of
ownership will be executed
 The initial payments for the financing of homes still under construction is counted as
advance rental payment based on the concept of ijarah mausufah fi zimmah. After the
house is completed the advanced rental payments is calculated as the rent for the first
months after the house is occupied. In this financing, bank obtains the promise to
complete the house directly from the developer and not from the customer
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BEST PRACTICE – MALAYSIA (KFHMB)
FEATURES
 In case of property still under construction and the failure of the developer to complete it,
KFHMB will reimburse the full advance payment and rentals and will deal with the
developer directly
 Cash facilities can be obtained by the customer by selling back shares of the home he
co-owns with the bank. Customer does not exit the contract and remain an occupant
and rent the house. This facility makes the product very competitive in the market
 Early settlements are possible at any time with a term of a month
 Absence of a ceiling rate (cap rate) for KFHMB
 If the customer fails to make installment payments during the period specified, KFHMB
will impose a penalty of 1% credited to a welfare fund and not used in the calculation of
their profits
 If customer fails to make installments payment for six consecutive months, KHFMB will
resort to customary recourse
69
BEST PRACTICE – MALAYSIA (KFHMB)
KFH IJARAH MAUSUFAH FI ZIMMAH ASSET ACQUISITION FINANCING-i:
 Nature of the product. This Islamic Home and Property Financing facility is offered to
individuals for purchase of under construction landed or non-landed residential
properties such as terrace/link house, semi detached house, bungalow, apartment,
condominium and bungalow lots for dwelling or for business purposes. The financing is
calculated based on the fixed or variable rate as determined by the bank from time to
time and the home and property financed will be pledged as a security of the financing
 Applicable Sharī’ah concept. Ijarah Mausufah fi Zimmah means an ijarah contract which
is executed for an asset undertaken by the lessor (bank) to be delivered to the lessee
according to accurate specifications, even if the asset is not owned by the lessor. During
the period that the leased asset/property is under construction, the lessor may ask the
lessee (customer) to pay a certain portion of pre-agreed lease rental as a forward lease.
The forward lease rental payment will be considered as a debt to the lessor until the
delivery of the leased asset to the lessee. Ownership will be transferred to customer at
the end of leasing period (or upon full settlement) by way of ‘gift’ or ‘sale’
70
BEST PRACTICE – MALAYSIA (KFHMB)
 The obligations. Customer is required to pay a monthly lease rental amount which is
calculated on either a fixed rate or a floating rate mechanism based on the package
provided by the bank:
→ for properties under construction, customers are required to pay the advance lease
rental according to the progressive payment made during the construction period.
The lease rental payment is calculated either on fixed rate or floating rate mechanism
based on the package provided by the bank and in the event of a floating rate
mechanism, the monthly lease rental payments may vary due to fluctuations of the
Islamic Base Financing Rate
 Failure to fulfill the obligations. •Compensation charge (ta’widh):1% p.a. on the overdue
installment or any other method approved by Bank Negara Malaysia or the Association of
Islamic Banking Institutions in Malaysia (AIBIM):
→ •right to set-off: the bank has the right to set off any credit balance in the account
maintained with the bank against any outstanding balance in this financing account
→ •revision of financing rate: the bank may revise the financing rate which will result in a
higher installment amount to be paid due to restructuring or reschedulement of
financing repayment
71
BEST PRACTICE – MALAYSIA (KFHMB)
→ reporting to local credit bureau: any adverse records of the payment history will be
reported to the local credit reference bureau which may have serious adverse effect
on the future financial standing and the ability to obtain future credit and banking
facilities
→ legal action: (i) legal action will be taken for any outstanding amount due. As a result
of these legal proceedings, charges will be incurred to the customer. This legal action
will have an effect to the credit rating in order to apply for future credit and banking
facilities (ii) the customer may also face bankruptcy proceedings and be adjudged a
bankrupt if the outstanding amount reaches a certain limit. Repercussions of being a
bankrupt will result in freezing and confiscation of the assets
 Settlement of the financing before its maturity:
→ lock in period: depending on the package, it varies from 3 years to 5
years. •Customers are required to pay early settlement charges if the financing is fully
settled within the lock in period. The information about the lock in period will be
disclosed in the legal documents
→ early settlement charges: 3.0% of the financing amount. The amount will be imposed
on the total approved financing amount at the time of full settlement depending on
the package
→ customer has the right to make early settlement of the facility by giving thirty-day
written notice to KFH Malaysia
72
BEST PRACTICE – MALAYSIA (KFHMB)
→ rebate (ibra’) is not applicable as this is not a sale based contract. However, rebate
may be granted to customer as determined by KFH Malaysia at its sole and absolute
discretion
 Risks. This product is offered to customers with a fixed or variable or combination of both
rates. The installment amount is also fixed throughout the tenor for fixed rate and varies
for variable rates:
→ in circumstances where the market rates are lower or higher than the agreed fixed or
variable rates, customers are bound to pay a higher installment amount
comparatively
→ the installment amount paid may be higher than the previously agreed
→ furthermore, the customers do not have an option to convert the rates to the market
rates whenever they want as the agreement has been made as a fixed or variable
rate throughout the tenor
73
BEST PRACTICE – MALAYSIA
MAYBANK2YOU – MALAYSIA MUSHARAKAH MUTANAQISAH TERM FINANCING-I
 Purpose: asset acquisitions and refinancing such as landed properties, plant and
machinery, vessels and commercial vehicles
 Tenure: up to 20 years
 Pricing: fixed percentage; floating percentage; combination of fixed percentage and
floating percentage
 Features: customer’s monthly installments for the financing paid to the bank will
increase customer's ownership of the asset/property. The ownership of the
asset/property will progressively move towards the customer and the financing ends
when the customer owns 100% of the asset/property
 Eligibility: new and existing commercial and corporate customers, local and foreign
RHB AZ-ZAHRA – MALAYSIA Equity Home Financing-i
 Purpose: enables to enter into a co-ownership agreement with the bank to acquire and
own a house. As one of the mushārik, the share of ownership will progressively
increase, until holding the full ownership of the house
 Benefits: flexible payment plans, longer mushārakah tenure, convenience of payment.
Attractive financing packages
74
BEST PRACTICE - PAKISTAN
ASKARI - HOME MUSHARAKAH
 Features: maximum financing limit: up to Rs. 50 million (circa USD 526M)
 Financing tenure: 3 to 20 years; 85% of the property cost. Clubbing of family income
 Eligibility: Pakistani national; earning at least two times more than monthly car ijarah
rentals; between 21 to 65 years; permanent employment with at least six months of
service with present employer; a self employed individual with at least 3 years of
business track record; income verification / documents required
 Personal information: copy of ID card; two passport-size colored photographs of
applicant; copy of rental documents (if applicable); copy of last paid utility bills
(electricity/ gas/ telephone); bank statement last 6 months
 Income Information: original or certified copy of recent pay slip; employer’s certificate
including date of joining/current designation/ salary; bank statement of business-last one
year; copy of management accounts (if applicable)
 Business / Professional Information: 3 years proof of business (e.g. tax return / bank
certificate); partnership deed (in case of partnership); professional association
membership certificate / practice license
 Flows: step 1: application form & processing fee payment; step 2: submission of
required documents; step 3: address verification & income estimation; step 4: legal
opinion, property valuation; step 5: facility approval; step 6: signing of Askari Home
Mushārakah agreement; step 7: transfer of property & disbursement
75
BEST PRACTICE - AUSTRALIA
MUSLIM COMMUNITY CO-OPERATIVE (AUSTRALIA) LIMITED
 Established in 1989, originates AUD 100 million a year in Islamic home financing
 Its MMP product attempts to some degree to share gains or losses in the capital value of
the house among the partners (in a pre-agreed ratio) when the nominal partnership
comes to an end. Steps are the following:
→ step 1: the vendors sell the property directly to MCCA in whose name the legal title to
the property is vested. MCCA pays the full purchase price of the property to the
vendors
→ step 2: MCCA and the customer enter into a partnership agreement to co-own the
property. MCCA and the customers agree at the start that their respective shares in
the property shall be pro-rata in proportion to their contributions towards the purchase
price paid to the vendors.
→ step 3: both parties also agree that during the course of their partnership, which has
an agreed date of termination, the customers will purchase the MCCA’s share in the
property in installments and for the price that the MCCA had paid for such share on
the initial date of acquisition. As the customers increase their share in the property,
the MCCA’s share correspondingly decreases by the same amount
76
BEST PRACTICE - AUSTRALIA
→ step 4: parallel to the MMP agreement, the MCCA grants to the customers a lease in
respect of its share in the property. The lease is effective for as long as the MCCA
has a share in the property
→ step 5: as security for the customers’ obligations to make payments of rent under the
lease and acquire the MCCA’s share in the property at a fixed price under the MMP
agreement, the customer charges by way of security in favour of the MCCA, their
interests in the property under the lease and the MMP agreement
 The price of share purchases is related to the market value of the underlying property at
the time of the purchase and such purchases are not forced upon the customer
contractually
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BEST PRACTICE - CANADA
ANSAR CO-OPERATIVE HOUSING CORP - CANADA
 Managed by a board of seven volunteers who are elected every two years
 Types of membership:
→ prospective home buyers
→ home buyers with interest based mortgages
→ simple investors
→ home buyers under co-op scheme
→ institutional investors
→ children

Members commitments:
→ pay $75 membership fee to join
→ buy 6 shares of $100 each annually
→ invest first and buy shares
→ 20% of 1st $100,000 cost of house
→ 25% of up to the next $100,000 cost of house
→ 30% of over $200,000 cost of house
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BEST PRACTICE - CANADA
 Members:
→ pay proportionate rent
→ increase their ownership when can (every month or every second month or so on)
→ rent decrease as ownership ratio increases
→ share gain/loss 10% with the co-op
→ legal ownership remains in the name of the housing co-op till 100% ownership
shares are purchased by the member
 Sharing of gain or loss:
→ as a result of sale/transfer of the housing unit any gain or loss realized will be divided
as follows: (i) if at this time the member has more than 50% shares, 10% to the Coop and 90% to the member; (ii) if the member has 50% or less shares, 20% to the
Co-op and 80% to the member
→ the capital gain or loss will be shared after making an adjustment for authorized
improvements, expansions and certain legal expenses incurred by the member.
79