Islamic Finance: Structure and Instruments
Ankara, Turkey
29 September 2011
SUKUK: SHARIAH CONTRACTS
AND OPERATIONS
Mohd Radzuan Tajuddin
Islamic Capital Market
PRESENTATION OUTLINE
PART A
OVERVIEW OF THE GLOBAL SUKUK
MARKET
PART B
MAIN
DRIVERS
FOR
SUKUK
DEVELOPMENT AND GROWTH
PART C
BUILDING BLOCKS FOR SUCCESSFUL
SUKUK MARKET
PART D
CONTRACTS AND STRUCTURES
PART E
ROLE OF THE SECURITIES COMMISSION
MALAYSIA IN THE SUKUK MARKET
PART D
© Securities Commission
CHALLENGES AND ISSUES
2
PART A
OVERVIEW OF THE
GLOBAL SUKUK MARKET
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Evolution and Growth of the Sukuk Market
1990s
• Introduction and
market
familiarisation
• Developments of
markets, players and
products
• Limited growth
• Confined to some
countries only
• Limited structures –
mainly debt-based
e.g. murabahah, Bai’
Bithaman Ajil
© Securities Commission
2000
• Growth in market
size and players
• Additional product
features/structures
e.g. Istisna’, Ijarah,
Salam
• Introduction of
sukuk in the global
market e.g.
Malaysian Global
Sukuk, Qatar Global
Sukuk etc
• Stronger growth of
Sukuk market
globally
2004
• Accelerated growth
in market size and
players
• Broader and deeper
market
• Better market
understanding
• Innovative and new
product structures
e.g. mudharabah,
musharakah, ABS,
exchangeable sukuk
2008
• Maturing and
globalisation
• More breadth and
depth
• More accelerated
growth
• Moving towards
globally accepted and
highly competitive
structures
• Activating the
secondary market for
sukuk liquidity
• Unlocking new asset
classes
• Development of
sukuk yield curve and
pricing benchmark
4
Global Sukuk Issuances
US$ billion
• Sukuk issuances hit a record of
US$47.78 billion in 2010,
surpassing 2007 level
(US$44.76 billion).
• Growth attributed to substantial
issuances by government and
government-related entities.
• Among notable issuances in
2010:
– USD1.25bil 1Malaysia Global
Sukuk
– USD1.1 bil Khazanah Sukuk
– USD1.34 bil Celcom
Transmission Sukuk
– USD750 mil QIB Sukuk
– USD750 mil Abu Dhabi
Islamic Bank Sukuk
– USD500 mil IDB Sukuk
– USD100 mil Nomura
Holdings Sukuk
– USD100 mil KT Turkey
Sukuk
Source: Islamic Finance Information Service (IFIS), Kuwait Finance House (KFH)
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Global Sukuk Market
1.34%
2.89%
2.37% 1.11%
4.71%
6.65%
Malaysia accounted for 72.5% of
global sukuk issuances by domicile
in 2010
8.43%
72.5%
2% 2%
3%
6%
6%
8%
8%
© Securities Commission
65%
Malaysia accounted for 65% of global
sukuk outstanding by domicile as at
December 2010
Source: IFIS, KFH
6
Malaysian Sukuk Market
• The Malaysian sukuk market
has experienced rapid
growth
• Compounded annual growth
rate (CAGR) of 22.2% from
2000-2010
• Sukuk market plays a key
role in financing country’s
economy
• Growing demand for sukuk
among issuers and investors
2010
USD95.35 billion
2000
USD10.42 billion
• Double digit growth
expected for 2010-2020
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Malaysian Sukuk Market (cont’d)
• Sukuk now constitutes more than 50% of total corporate bonds
Outstanding (USD billion)
Approved (USD billion)
© Securities Commission
Issued (USD billion)
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PART B
MAIN DRIVERS FOR SUKUK
DEVELOPMENT AND GROWTH
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Main Drivers for Sukuk Development and Growth
Growing preference
for Shariah
compliant products
A wide range of products engineered to meet the requirements of investors
and borrowers, including a product that performs a similar function to a
bond
Growing wealth
Within Islamic world
Enhanced by greater understanding of sukuk instruments and clarity of
documentation as well as ratings from international agencies
Massive liquidity
looking for Shariah
compliant products
High levels of surplus savings and reserves in Asia and the GCC looking for
Shariah-compliant instruments.
Government policies
Muslim and non-Muslim countries have introduced relevant legislations in
their respective countries to enable sukuk issuance
Economic
diversification away
from oil and gas
Large surpluses channelled into the real estate/property, construction and
Infrastructure/utilities sectors leading to increased sukuk issuances
Infrastructure
development
© Securities Commission
Infrastructure spending in Asia and GCC helped push the demand for sukuk
Given the growing preference for sukuk as a source of cash flow and
Financing for companies
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PART C
BUILDING BLOCKS FOR
SUCCESSFUL SUKUK MARKET
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Building Blocks for Successful Sukuk Market
1. Tax Framework
2. Legal and
Regulatory
Framework
4. Government
Support
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3. Shariah
Governance
Framework
5. Diverse pool of
players
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Building Blocks for Successful Sukuk Market
(cont’d)
1. Tax Framework
(a) Tax neutrality provisions – for tax purposes:

Profits (in relation to Shariah transactions) are treated
similar to that of interest. Implications:





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Profits associated with Islamic finance will be taxable, just like
interest income under conventional financing;
Profits will be deductible if the funding has been used to
generate business income or to purchase asset to generate
income;
All other tax rules relating to “interest” such as withholding tax
on interest and tax exemption will also equally apply to profits.
Sale of assets or leases to be ignored – any additional tax as
a result of the underlying transaction would not arise;
Exemption of stamp duty to ensure that any additional
stamp duty as a result of underlying asset transaction will
be exempted.
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Building Blocks for Successful Sukuk Market
(cont’d)
1. Tax Framework (cont’d)
(b) Tax incentives

Issuers:



Investors


© Securities Commission
Tax deduction on expenses incurred in the issuance of sukuk
Tax exemption on income received by SPV and tax deduction
on issuing costs incurred by the SPV
Institutional - tax exemption and withholding tax exemption on
profits received by non-resident investors from investment in
sukuk
Individuals- tax exemption and withholding tax exemption on
profits received by non-resident investors from investment in
sukuk, stamp duty exemption on investing and trading of
sukuk
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Building Blocks for Successful Sukuk Market
(cont’d)
2. Legal and Regulatory Framework




Established legal and regulatory framework in accordance
with international standards and best practices.
2-tier regulatory approach:
 Single legislation to govern the issuance of both
conventional bonds and sukuk.
 The issuance of sukuk is governed by specific
guidelines i.e. Islamic Securities Guidelines (Sukuk
Guidelines)
Common regulatory approach to regulating sukuk e.g.
same liability on the part of intermediaries (due diligence,
representation)
Disclosure, transparency and governance apply equally to
conventional bonds and sukuk, hence same legal and
regulatory protection
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Building Blocks for Successful Sukuk Market
(cont’d)
3. Shariah Governance Framework
 National Shariah Advisory Council (SAC)
 Established under legislation
 Acts as a reference point for the industry
 Resolutions and rulings provide certainty, clarity and
consistency to market participants
 Resolutions and rulings published for the benefit of
the industry
 Shariah Committee/Adviser at the industry level
 Mandated by regulations
 To advise, review and endorse compliance of sukuk
(structure and documentation) to Shariah
requirements
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Building Blocks for Successful Sukuk Market
4. Government Support



The government being a regular issuer providing market
with benchmark sukuk (tenure, pricing)
Facilitates the administrative, infrastructure and fiscal
policies
Continuous liberalisation policies – participation from
foreign corporations, multinational corporations and
multilateral agencies
5. Diverse pool of players and instruments
Diversity of issuers – local and foreign issuers
Local and international players - conventional and Islamic
Experience and proven track record in structuring and
advising
 Money market products, short, medium and long-term
tenured sukuk
© Securities Commission



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PART D
CONTRACTS AND STRUCTURES
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What is Sukuk?
•
‫ صكوك‬Sukuk, plural of ‫ صك‬Sakk is the Arabic term for certificates.
• Sukuk are instruments issued with the purpose of raising capital.
• Sukuk evidence ownership and/or investment in the underlying
asset using Shariah principles.
• In Malaysia, the concepts and Shariah principles in structuring
sukuk must be approved by the Shariah Advisory Council of the SC
• Sukuk holders each hold an undivided beneficial ownership in the
underlying assets.
• Consequently, sukuk holders are entitled to share in the revenues
generated by the sukuk assets as well as being entitled to share in
the proceeds of the realization of the sukuk assets.
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Comparison between Sukuk and conventional bonds
Sukuk
Conventional Bonds
Asset in exchange for monies
Paper in exchange of monies
Profit/income from assets
Interest
Ownership of undivided share in asset
Creditor’s right against issuer
Trade – sale of asset
No sale of asset
Utilisation of proceeds for Shariah compliant
purposes
No restriction on utilisation of proceeds
Typical requirement of investors in bond
 Fixed Rate
Can be structured by way
}
of Islamic contract i.e. by
 Floating Rate
Typical requirement of investors in bond
 Fixed Rate
 Floating Rate
using Murabahah, Ijarah
Value added Islamic structure
 Ownership of underlying asset
 Partnership features
 Distribution of risk
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Application of Shariah Contracts and Principles
Application of Shariah contracts and
principles
Contract of
Exchange
• Bai
ajil
bithaman
Contract of
Participation
• Musharakah
Contract of
Agency
 Wakalah
• Mudharabah
• Murabahah
• Istisna’
• Ijarah
• Salam
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Types of sukuk
Types of sukuk
Normal
(Asset-based)
Sale-based
Lease-based
 BBA
 Ijarah
 Murabahah
 Ijarah
Muntahiyah
Bi Tamlik
 Salam
 Istisna’
Asset-backed
Partnershipbased
 Musharakah
 Mudharabah
Agencybased
Hybrid
Convertible
Exchangeable
 Wakalah Bi
Istithmar
 Ijarah
Mawsufah Fi
Dhimmah
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Sukuk Murabahah
 A contract that refers to the sale and purchase transaction
for the financing of an asset whereby the cost and profit
margin are made known and agreed by all parties involved.
 The settlement for the purchase can either be on a
deferred lump-sum basis or on installment basis, and is
specified in the agreement.
 Murabahah in simple terms means cost plus profit.
© Securities Commission
Sukuk Murabahah
Sale of assets to investors at purchase price on cash basis
1
Payment of proceeds
(equivalent to purchase price)
Issuer
Investors
2
Investors resell asset to issuer at selling price
(purchase price + profit) on deferred basis
3
Issuer issues sukuk to evidence the indebtedness
of the issuer arising from step 3
Murabahah
Sukuk
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Sukuk Ijarah
 Ijarah is a manfaah (usufruct) type of contract whereby a
lessor (owner) leases out an asset or an equipment to its
client at an agreed rental fee and pre-determined lease
period upon the ‘aqad (contract).
 The ownership of the leased equipment remains with the
lessor.
 Sukuk Ijarah is a certificate that shows the ownership of
the investors on the leased asset and the rights to receive
the income/rental from the leased assets.
© Securities Commission
Sukuk Ijarah
SPV issues sukuk to investors that represent
beneficial ownership of the assets
Sells assets to SPV at purchase
price on cash basis
2
1
Proceeds
Originator
3
SPV
(Issuer)
Ijarah
Sukuk
Proceeds
3
Investors
Distribution of rental payment
(profit to sukuk holders –
investors)
Leases the asset to originator
4
6
Rental payment
5
At maturity : SPV sells the asset back
to the originator
7
Proceeds from the sale of the asset will be used to repay the investors,
in term of the principal amount of the sukuk
8
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Sukuk Musharakah
 Musharakah is a partnership arrangement between two
parties or more to finance a business venture whereby all
parties contribute capital either in the form of cash or inkind.
 Any profit derived from the venture will be distributed
based on a pre-agreed profit sharing ratio, but a loss will
be shared on the basis of equity participation.
 In simple terms, Musharakah means profit and loss
sharing.
© Securities Commission
Sukuk Musharakah
Upon maturity : issuer repurchase musharakah sukuk/musharakah asset
(exercise purchase undertaking)
7
Profit payment to investors
6
Purchase undertaking – promise to buy back the sukuk or asset
upon maturity of the sukuk
4
Partner 1
(Issuer)
Issuer issues sukuk musharakah to evidence
participations in the musharakah venture
3
Musharakah
Sukuk
Capital contribution
1
Return
Partner 2
(Investors)
Capital contribution
Musharakah
venture
2
5
Proceeds from the sale of musharakah sukuk/asset will be used to
repay the investors (principal of sukuk)
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Sukuk Mudharabah
 Mudharabah is a contract which is made between two
parties to finance a business venture.
 The parties are an investor who solely provides the capital
(rabb al-mal) and an entrepreneur who solely manages the
project (mudharib).
 If the venture is profitable, the profit will be distributed
based on a pre-agreed ratio. In the event of a loss, the
loss shall be borne solely by the provider of the capital.
 A Mudharabah contract may involve two or more parties.
 The difference between a Mudharabah and Musharakah
contract is that, in the latter all parties contribute capital
and services.
© Securities Commission
Sukuk Mudharabah
Upon maturity : issuer repurchase mudharabah sukuk/mudharabah asset
(exercise purchase undertaking)
7
Profit payment to investors
6
Purchase undertaking – promise to buy back the sukuk or asset
upon maturity of the sukuk
4
Mudharib
(Issuer)
Issuer issues sukuk mudharabah to evidence
participations in the mudharabah venture
3
Mudharabah
Sukuk
Entrepreneurship
1
Return
Rabb al-mal
(Investors)
Capital contribution
Mudharabah
venture
2
5
Proceeds from the sale of mudharabah sukuk/asset will
Be used to repay the investors (principal of sukuk)
© Securities Commission
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Global Sukuk Issuances by Structure (2010)
Wakalah
(9.03%)
Combination
(2.81%)
Musharakah
Others
(6.25%)
(1.53%)
Ijarah
(27.33%)
Murabahah
(53.05%)
Source: IFIS, KFH
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PART E
ROLE OF THE SC IN
THE SUKUK MARKET
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Role of the SC in the Sukuk market
• The sole approving authority for corporate sukuk issuances by local and
foreign entities
• Formulates the legal and regulatory framework governing the corporate
sukuk market
• Supervises other relevant market intermediaries such as rating agencies,
trustees and pricing agencies
• Supervises primary and secondary market activities
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Role of the SC in the Sukuk market (cont’d)
A comprehensive set of issuance guidelines for the corporate sukuk market
• Private Debt Securities Guidelines – 2011 (revised)
• Islamic Securities Guidelines (Sukuk Guidelines) – 2011 (revised)
• Trust Deed Guidelines – 2011 (revised)
• Guidelines on the Offering of Asset-Backed Securities – 2002
Prior to 2000
Facilitate access to
sukuk market via clear
and transparent
guidelines
Post 1 July 2000
Type of Submission
Merit based
Disclosure based
Utilisation of proceeds
Subject to internal criteria on
productive purposes
No restriction on utilisation of proceeds, but
disclosure must be made
Underwriting
requirement
Must be fully underwritten
Decided by issuer and adviser
Minimum credit rating
requirement
BBB and P3/MARC3
No minimum rating requirement, but ratings remain
mandatory
Disclosure requirements
-
Stringent due diligence for investor protection
Posting of PTC, IM and TD on the SC website
Time frame for approval
1 to 3 months
Deemed approval for qualified issues
Otherwise, 14 working days for PDS/ABS issues
© Securities Commission
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Other regulators for the Sukuk market
Bank Negara Malaysia (Central Bank)
• Manages public debt and issues Malaysian Government Securities
(MGS) and Government Investment Issues (GII) on behalf of the
Government
• Operates and maintains the market infrastructure
• Fully Automated System for Issuing/Tendering (FAST) – issuing
and tendering system
• Real Time Electronic Transfer of Funds System (RENTAS) –
clearing and settlement system
Bursa Malaysia (stock exchange)
• Regulates and monitors listed bonds and sukuk
• Operates and maintains Electronic Trading Platform system – trading
and reporting platform
• Provides liquidity management infrastructure i.e. Commodity trading
platform
© Securities Commission
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PART F
CHALLENGES AND ISSUES
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Challenges and Issues
1. Legal certainty and
rights of sukukholders
2. Asset-backed versus
asset-based
4. Fixed-income
framework
© Securities Commission
3. Differing Shariah
views/opinions
5. Human capital
37
Thank you
Securities Commission Malaysia
Tel: 60.3.62048718 | Fax: 60.3.62015082 | www.sc.com.my
© Securities Commission
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