August 27,2008 MIAN & SIBGHAT [email protected] 1 IN THE NAME OF ALLAH THE BENEFICIENT THE MERCIFUL

August 27,2008August 27,2008MIAN & SIBGHATMIAN & [email protected]@gmail.com

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IN THE NAME OF ALLAH THE BENEFICIENT

THE MERCIFUL

August 27, 2008August 27, 2008

MIAN & SIBGHATMIAN & [email protected]@gmail.com

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By

SIBGHATULLAH AHSAN

PartnerMIAN & SIBGHATAdvocates & Legal ConsultantsIslamabad.

Sukuk Sukuk and itsand its Legal and Legal and Regulatory Framework in Regulatory Framework in

PakistanPakistan


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ISLAMIC FINANCIAL SYSTEM- ISLAMIC FINANCIAL SYSTEM- AN INTRODUCTIONAN INTRODUCTIONBased on QURAN and SUNNAHDemands socio economic justiceProhibits all kinds of RIBAProhibits all forms of exploitationProvides equal opportunities to allCondemns accumulation of wealth in few

handsEncourages acts of benevolence


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PRINCIPLES OF ISLAMIC PRINCIPLES OF ISLAMIC FINANCEFINANCEProhibition of RIBAAlkharajo bil dhaman (entitlement to profit is

associated with corresponding risk)Prohibition of sale of goods before acquiring

ownershipProhibition of sale of food stuff before

possessionProhibition of debt for debtAvoidance of Gharar (uncertainty)


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PROHIBITION OF PROHIBITION OF RIBARIBA

QURAN– “ALLAH has permitted BAI’ (sale) and prohibited

RIBA” (Al Baqarah: 275)

– O you believers, fear ALLAH and give up whatever is left in lieu of RIBA if you are indeed believer, Watch out! If you do not obey this order (and give up all outstanding RIBA), then there is a declaration of war against you from ALLAH and HIS PROPHET. However, if you repent you have entitlement only to your principals. Neither you inflict zulm on others, nor the others should do zulm on you. (Al Baqarah: 278-9)


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PROHIBITION OF PROHIBITION OF RIBARIBA

SUNNAHObadah ibn Samit directly reports from the Prophet as saying: “Buy and sell gold for gold, silver for silver, dates for dates, wheat for wheat, salt for salt, and barley for barley on the like for like basis. Whosoever gave more or took more, verily he made a RIBA deal. However, trade gold for silver as you wish subject to the condition that the exchange be hand to hand (spot). Trade wheat for dates or barley for dates also likewise.


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EXCHANGE OF HOMOGENEOUS EXCHANGE OF HOMOGENEOUS COMMODITIES OR CURRENCIESCOMMODITIES OR CURRENCIES

Commodity A Commodity B

MEASURMENT: Must be same in amount / weight /

count

DELIVERY: Must be simultaneous / spot


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EXCHANGE OF HETEROGENEOUS EXCHANGE OF HETEROGENEOUS COMMODITIES OR CURRENCIESCOMMODITIES OR CURRENCIES

Commodity B Commodity A

DELIVERY: Must be simultaneous / spot

MEASUREMENT: May be different


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EXCHANGE INVOLVING EXCHANGE INVOLVING RIBA RIBA IN HOMOGENEOUS IN HOMOGENEOUS COMMODITIES OR CURRENCIESCOMMODITIES OR CURRENCIES

Commodity A Commodity B

MEASURMENT: Counter values are not equal

DELIVERY: Any one of the counter values

is delayed


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EXCHANGE INVOLVING EXCHANGE INVOLVING RIBARIBA IN HETEROGENEOUS IN HETEROGENEOUS COMMODITIES OR CURRENCIESCOMMODITIES OR CURRENCIES

Commodity B Commodity A

DELIVERY: Delay in any of the counter values would amount to RIBA (Delivery must be simultaneous / spot

MEASUREMENT: May be different


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Some principles derived from Some principles derived from the the HadithHadithGeneral principles

– In a contract of sale counter values must be exchanged simultaneously

– Quantity /number/measure etc. should be same

Exceptions– Credit Sale– Salam– Qard-e-Hasanah


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WHAT IS WHAT IS RIBARIBA

Simple definition– Any delay or discrimination (regarding

weight, measure or count) in any of the counter values in a contract of exchange is riba

– Any addition without a counter value is RIBA

– Every loan entailing an increase is RIBA


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ISLAMIC CONTRACTS FOR ISLAMIC CONTRACTS FOR COMMERCIAL TRANSACTIONSCOMMERCIAL TRANSACTIONSMusharaka (Profit and Loss sharing)Modaraba (Profit sharing)Musawamah (Bargaining sale)Ijarah (Leasing)Salam (Advance payment sale)Istisna’ (Contract of manufacturing)Murabaha (Cost plus margin sale)


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MUSHARAKAMUSHARAKA

Characteristics– All parties share in the capital– All parties share profits as well as losses– Profits are distributed as per agreed ratio– Loss is borne by the parties as per

capital ratio– Every partner is agent of other


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MUSHARAKAMUSHARAKA

PARTNER A PARTNER BVENTURERs.1000 Rs.1000

PROFIT Rs. 100

LOSSRs.100

Rs. 60 Rs. 40

Rs. 50 Rs. 50

May be in any agreed ratio

Must be according tocapital ratio


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MUSHARAKAMUSHARAKA

PARTNER A PARTNER BVENTURERs.2000 Rs.3000

PROFIT Rs. 100

LOSSRs.100

Rs. 50 Rs. 50

Rs. 40 Rs. 60

May be in any agreed ratio

Must be according tocapital ratio


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MUDARABAMUDARABA

One partner (Rab al Mal) contributes capital and the other (Mudarib) contributes his skills or services to the venture

Venture may for a fixed period or purposeBoth share profit in pre-agreed ratioLoss is borne by Rab al Mal only, Mudarib

loses his services


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MUDARABAMUDARABA

RABBUL MAL MUDARIBVENTURE

SERVICES CAPITAL

PROFIT

LOSS

50 %50 %

ALL MONETORY LOSS LOSS OF SERVICES


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MUDARABAMUDARABA

RABBUL MAL MUDARIBVENTURE

SERVICES CAPITAL

PROFIT

LOSS

40 %60 %

ALL MONETORY LOSS LOSS OF SERVICES


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IJARAHIJARAH

Usufruct of an asset is passed to other party against a periodic rent payment

The asset must have corpus (body) and be in existence

The asset must not be consumable in nature (should not vanish if used)

Ownership will remain with the lessor and he will bear all the risks related to ownership


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IJARAHIJARAH

LESSOR LESSEEAsset UsufructUsufruct

Ownership

Periodical payments/Rent

Usufruct

Use/ usufruct Only


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SALAM (Advance payment)SALAM (Advance payment)

It is an exception to the general principle of instant exchange of counter values in a contract of sale


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SALAM (Advance payment)SALAM (Advance payment)

Full payment of purchase price, No deferment or installment in advance money allowed

No loan adjustment is allowedQuality and quantity must be specifiedDate of delivery must be specified


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MURABAHAMURABAHA

Murabaha is sale of a commodity at cost plus margin; it must fulfill all the conditions of a valid sale

It may be spot sale or a deferred/credit sale Deferred sale Murabaha is used as financing

mode by Islamic Banks Deferred price becomes a debt and shall be dealt

with as a loan transaction Price once settled at the time of sale can not be

changed due to default of creditor, any thing above sale price would be RIBA


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Conditions for MurabahaConditions for Murabaha

Since it is a sale contract; it must fulfill all the conditions of a valid sale

The Bank should purchase the asset from a third party and not from the customer himself

The Bank must own the asset before it sells to the customer The Bank must have possession (physical or constructive)

i.e. it must come to its risk The seller must know and disclose the cost including

freight, insurance and taxes etc. Profit may be fixed in lump sum or through agreed ratio to

be charged over the cost


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MURABAHAMURABAHA

MURABAHA

CLASSICAL / SPOT DEFERRED

with LUMP SUM PAYMENT

DEFERRED with INSTALLMENT

PAYMENT


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CLASSICAL MURABAHACLASSICAL MURABAHA

SELLER BUYER

GOOD

PRICE

IMMIDIATE DELIVERY

IMMIDIATE DELIVERY COST +MARGIN


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BAI’ MU’JJAL (deferred sale)BAI’ MU’JJAL (deferred sale)

SELLER BUYER

GOODS

PRICE

IMMIDIATE DELIVERY

DEFERRED PAYMENT


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MURABAHA WITH MURABAHA WITH DEFERRED PAYMENT DEFERRED PAYMENT

SELLER BUYER

GOOD

PRICE

IMMIDIATE DELIVERY

DELAYED PAYMENTCOST + MARGIN


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What is What is Sukuk?Sukuk?

The word Sukuk plural of word Suk which means _______________

The Accounting and Auditing Organization for Islamic Financial Institutions defines Sukuk as:

Certificates of equal value representing undivided shares in ownership of tangible assets, usufruct and services or (in the ownership of ) the assets of particular projects or special investments activity


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Legal Definition of SukukLegal Definition of Sukuk Pakistani Law does not define the word Sukuk There is no particular legislation in Pakistan that governs a Sukuk

by a company Then how to define a Sukuk and how to regulate a Sukuk issue in

Pakistan Section 120 of the Companies Ordinance

– 120. Issue of securities and redeemable capital not based on interest.(1) A company may by public offer or], upon terms and conditions contained in an agreement in writing, issue to one or more scheduled banks, financial institutions or such other persons as are specified for the purpose by the Federal Government by notification in the official Gazette, either severally, jointly or through their syndicate, any instrument in the nature of redeemable capital in any or several forms in consideration of any funds, moneys or accommodations received or to be received by the company, whether in cash or in specie or against any promise, guarantee, undertaking or indemnity issued to or in favour of or for the benefit of the company


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DIFFERENT KINDS OF SUKUKDIFFERENT KINDS OF SUKUK

Sukuk representing ownership in tangible assets (mostly based on Sale and Lease back or direct lease).

Sukuk representing Usufructs or Services (based on sublease or sale of services).

Sukuk representing equity share in a particular business or investment portfolio (based on Musharakah/ Mudarabah).

Sukuk representing receivable or future goods (based on Murabaha or Salam or Istisna’).


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BASIC SHARIAH RULESBASIC SHARIAH RULES

All the rules of original contract on the basis of which Sukuk are created should be applied.

The issuer cannot guarantee the face value of the certificate for the holder except in case of negligence/misconduct.

In Sukuk based on sale and lease back, the issuer can unilaterally undertake that he will purchase the asset after one year for a certain price.


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BASIC SHARIAH RULES (CONT..)BASIC SHARIAH RULES (CONT..)

Different types of reserves (e.g. profit equalization reserve) or takaful pool can be created.

Only those Sukuk can be traded that represent proportionate ownership of tangible assets, usufructs or services.

Trading or redemption of Sukuk is allowed after closing subscription, allotment of Sukuk and commencement of activity.

Sukuk of usufructs can be traded before the assets are sub-leased.

Sukuk of services can be traded prior to passing the services to the user.

In Sukuk of Musharakah/Mudarabah, the issuer can redeem the certificates on the market price or the mutually agreed price.


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TRADABILITY OF TRADABILITY OF SUKUKSUKUK

Tradable SukukSukuk representing tangible assets or proportionate ownership of a business or investment portfolio are tradable. For e.g. Sukuk of Ijarah or Musharakah / Mudarabah

Non-Tradable SukukSukuk representing receivables of cash or goods are nontradable. For e.g. Sukuk of Salam or Murabaha


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Legal Nature of Legal Nature of SukukSukuk Is it a debenture? or It’s a stock/share? or something else? to ascertain we need to know what is debenture and what

is stock/share.– Debenture is not defined as a word in the Companies

Ordinance or any other law but as per company law it includes debenture stock, bonds, term finance certificate and any other securities, other than a share, of a company, whether constituting a charge of the assets of the company or not

– “share” means ‘a share in the share capital of a company’ (S.2 (1) 35 of the Companies Ordinance)

Sukuk is neither equity nor debenture or bond or a debt instrument


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Asset Backed Securitization RulesAsset Backed Securitization Rules These Rules provide mechanism for securitization and

define securitization as:

The Sukuk does not fall in the definition of actionable claim or receivables therefore Sukuk can not be issued under these Rules

"Securitization" means a process whereby any Special Purpose Vehicle raises funds by issue of Term Finance Certificates or any other instruments with the approval of the Commission, for such purpose and uses such funds by making payment to the Originator and through such process acquires the title, property or right in the receivables or other assets in the form of actionable claims


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Nature of Nature of Sukuk Sukuk

As discussed Sukuk is a security of its own kind, not provided by any law in Pakistan.

We may classify it as redeemable capital


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How to Issue How to Issue SukukSukuk Presently most of the Sukuk are issued

under private placement which does not require any regulatory compliance

Companies are issuing privately placed Sukuk when they get syndicate financing from financial institutions to meet their financing requirements

Most of the Sukuk are based on Ijarah These Sukuk are being issued under S. 120

of the Companies Ordinance through an agreement between the issuer and the financial institutions


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How to Issue How to Issue SukukSukuk to Public? to Public?

There is no specific provision in Pakistani law for Sukuk therefore we will resort to some provisions of the Companies Ordinance that govern issue of securities, debentures and redeemable capital

Again the Sukuk will be issued under S. 120 of the Companies Ordinance.

However, for guidance on public issue we will look at the guide lines issued for Term Finance Certificates (TFCs)


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PUBLIC ISSUE OF PUBLIC ISSUE OF SUKUKSUKUK

Once we consider that Sukuk is a security in the form of redeemable capital then we can issue Sukuk public through circulating and publishing prospectus under section 57 of the Companies Ordinance,1984

An independent trustee shall be appointed and the assets will be transferred in the name of the trustee who will hold the same for the benefit of the investors/Sukuk holders

For issuing Sukuk general public a company will file an application to SECP


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Approval from SECPApproval from SECP i) In case of a new project, Expansion or Balancing,

Modernization & Replacement (BMR), a feasibility study should be conducted and a report should be prepared.

ii) Pre-IPO placement of should be finalized. iii) Underwriting arrangements, if any, should be

completed. iv) Credit rating of the entity as well as the instrument

from any rating agency should be carried out. v) Trustee, Bankers to the Issue, Balloters, Registrar

(Transfer Agent) and Legal Adviser to the Issue should be appointed.

vi) Clearance of the prospectus from the concerned stock exchange(s) should be obtained.

vii) Auditor’s certificates as to profit and loss and dividend or returns on securities issued in previous 5 years


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Contact:Contact:

Sibghatullah AhsanAdvocate High Court MIAN & SIBGHAT Advocates & Legal ConsultantsOff. 102-A, 1st Floor, Azeem Mansion, Block 87-E, Fazal-e-Haq Road, Blue AreaIslamabad.Ph. 92-51-4309208, 4319884Fax. 92-51-2802542Email. [email protected]

Documents

August 27,2008 MIAN & SIBGHAT [email protected] 1 IN THE NAME OF ALLAH THE BENEFICIENT THE MERCIFUL