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Murbahah Sukk

Ali SaeediMember of the boardSecurities & Exchange OrganizationPresented by:1. Islamic Instruments and Contracts,2. Murbahah Contract,3. Murbahah Sukk,4. Different Types of Murbahah Sukk,5. Comparison of Murbahah & Ijrah Sukk,6. Shari'ah Considerations,7. Regulations Considerations,

Contents

Islamic Instruments and ContractsCapital market: A market in which debt or equity securities are traded.Capital Market: A place for Contracts. Financial Instruments: Designed on the basis of different contracts,

e.g. Murbahah Sukk based on Murbahah contract, Behind Financial Instruments Sale of goods with an agreed upon profit mark up on the cost. Murbahah sale is in two types:1- In the first type, the Islamic bank purchases the goods and makes it available for sale without any prior promise by a customer to purchase it.2- In the second type, the Islamic bank purchases the goods ordered by a customer from a third party and then sells these goods to the same customer. In the latter case, the Islamic bank purchases the goods only after a customer has made a promise to purchase them from the bank.

Source: The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)Murbahah Contract Definition

Murbahah SukkMurbahah Sukk is securities in which the holders of which are the common owners of a financial asset (a debt) based on the Murbahah Contract.These securities have a fixed yield and available for sale in the secondary markets.Originator (or any other part) should be able to pay the installments via its own activitiesRate of profit and maturity date should be clarified in the contract.

Murbahah Sukk

The Elements of Murbahah Sukk

SPV is a legal entity which is authorized to raise funds by issuing securities through the conduct of transactions under the category of Islamic contracts. Base on Iranian regulations, SPV is a financial institution.

SPV and originator should be independent and should not be affiliated by originator:

1- In order to prevent the conflict of interests, (SPV should be the agent of Sukk holders and act on behalf of them),

2- In case of bankruptcy, all assets of the originator including, SPV would be at risk (if SPV would be affiliated by originator),

3- To execute transactions correctly (true sale) from the Shari'ah point of view.Special Purpose Vehicle (SPV, SPE, SPC)

Capital Asset Management Co.SPV1SPV2SPVnTehran Stock ExchangeCDSAn Affiliated Co. of SEOFarabourse..SPVs structure in Iran

SPVs Should be Independent from Originators

Different Types of Murbahah Sukk1. Murbahah Sukk for Buyers Financing,2. Murbahah Sukk for Sellers Financing,3. Mortgage Murbahah Sukk,4. Liquidity Murbahah Sukk. Various Types of Murbahah Sukk

2 Common types of Murbahah SukkAdopted by all Islamic schools of thought

SPV (as issuer) issues the Murbahah Sukk, collects the funds of the investors by investment banks services (the Principal Amount), and on behalf of investors buys the commodity needed by the originator from a commodity supplier in cash and sells it to the originator in form of a Murbahah contract over an agreed period of time and agreed rate of profit.Originator undertakes to pay to the SPV the price of the commodity (Principal + Profit) on due dates.

Murbahah Sukk for Buyers FinancingMurbahah Sukk for Buyers FinancingRegulator, Investment Banks, Rating Agencies, Auditors6. Sukk Proceeds (Deferred Price)1. Issuing Sukk 2. Sukk Subscription3. Spot Payment4. Spot Delivery5. Selling Asset with Credit Payment (Spot Delivery)SPVInvestorsCommodity SupplierOriginator(Buyer)

SPV (as issuer) issues the Murbahah Sukk, collects the funds of the investors by investment banks services (the Principal Amount), and on behalf of investors buys the commodity of the originator and sell it to buyer in form of a Murbahah contract over an agreed period of time and agreed rate of profit.Buyer undertakes to pay to the SPV the price of the commodity (Principal + Profit) on due dates.

Murbahah Sukk for Sellers FinancingMurbahah Sukk for Sellers Financing1. Issuing Sukk 2. Sukk Subscription3. Spot Payment4. Spot DeliverySPVInvestorsOriginator(Seller)

Buyer(Leasing Co.)

5. Selling Asset with Credit Payment (Spot Delivery)6. Sukk Proceeds (Deferred Price)2 other types of Murbahah SukkAre not adopted by all Islamic schools of thought

SPV issues the Sukk, collects the funds of the investors then acts on their behalf and buys from the bank (originator) mortgage facilities arising from the Murbahah Contracts.The originator undertakes to collect on the due dates the mortgage facilities assigned by the debtors and deliver them to the SPV. The SPV will give to the holders of the Sukk the funds received from the Bank through the customer.The investors may wait until maturity dates and enjoy the interest arising on the Murbahah or otherwise sell the Securities in the secondary markets before the due dates.

Mortgage Murbahah Sukk 1. Issuing Sukk2. Sukk Subscription3. Spot Payment for Banks Receivables/Debt4. Selling DebtsSPVInvestorsBankFinancial Facilities Receivers(Murbahah Based)6. Paying InstallmentsMortgage Murbahah Sukk (Cont) If Bai al Dayn is acceptedSPV collects the funds of the investors, then acts on their behalf and buys in cash one of the Originators physical assets then sells the same asset at a higher price to the originator itself on credit terms.The originator undertakes to give the credit price of the assets to the SPV on due dates.The purchase and sale on credit terms (Bay al-inah) is prohibited by most of Shiite and Sunni scholars.Liquidity Murbahah Sukk 1. Issuing Sukk2. Sukk Subscription3. Spot Payment4. Spot DeliverySPVInvestorsOriginator5. Selling Asset as Credit Payment6. Paying ProfitLiquidity Murbahah Sukk (Cont) SPVInvestorsOriginator7. Sukk Proceeds (Deferred Price)

Comparison of Murbahah & Ijrah Sukk Ijrah Sukk is most widely used among other Islamic financial instruments; however, after global downturn in Sukk issuance in 2008, issuance based on Murbahah Sukk increased by nearly 60.4%.Since, Murbahah Sukk can be used for working capital financing, and also it is fixed income Sukk, so it has some advantages in comparison with the other types of Sukk such as Ijrah and Mudrabah.

Murbahah Sukk & Ijrah Sukk Asset Backed & Asset BasedMurbahah Sukk is asset based, but Ijrah Sukk is asset backed. In asset-backed Sukk, investors are legal owners of the asset but in asset-based, investors has beneficial owners or owners of cash flow generated by asset.

Debt or Equity InstrumentMurbahah Sukk can be considered as a debt instrument, but Ijrah Sukk is none of them and both of them. Investors in Ijrah Sukk are owners of the asset and also based on the nature of Ijrah contract which is binding, it is similar to debt instrument. But in fact, Ijrah Sukk can not be classified in none of the two groups.

ComparisonRisk ProfileMurbahah Sukk is a debt instruments and risk of Sukk does not focus on asset risk, but rather on credit risk of the originator & Ijrah Sukk

Underlying AssetIn Murbahah Sukk, the underlying asset can be a consuming asset such as materials and spare parts, or long term asset such as real estate and machineries. In Ijrah Sukk, the underlying asset should have long term life cycle to be qualified for leasing. Comparison (Cont)MarketabilityBased on different jurisdictions, Murbahah Sukk can have secondary market or not. Based on Shi'a and Shafei schools of thought, debt sale is accepted, so secondary market is available but scholars of other jurisdictions do not accept it.If debt sale is accepted, marketability will exist, unless it will not be a liquid security.Comparison (Cont)

Shari'ah Considerations

From a Shari'ah angle, agency agreements (Wuklah) [between SPV and investors], cash transaction and credit transaction of a tangible asset [between SPV and originator] is accepted by all schools.But, there is a divergence of views on contracts for purchase of debt (Bai al Dayn) [between investors].According to opinions of renowned Shi'a and Shafei scholars it is permissible and according to opinions of Sunnite scholars it is rejected.

Shari'ah Considerations

If debt is discounted in a deferred payment [Bai al Dayn bi addayn], it will be rejected by all schools.

If debt is discounted spot by third party, it will be very controversial: Hanafiyah, Hanabelah, some of Shafeiyah and some of Shi'a scholars do not validate it, Most Shiit scholars, some other of Shafeiyah, Ibn Taymiyah and Ibn Qayyem have validate it,The rest of Shafeiyah validate it provided that:a. Debtor is wealthy and confess to have such a debt or his debt is proved by evidence.b. Debt is confirmed (Mustaqar)c. The substitute is delivered at the session of contract.

Shari'ah Considerations (Cont)

Why is it accepted by some schools?If investor A can discount debt, investor B can take his place in secondary market, and if it is not permissible, both primary and secondary transactions are not permissible.

Why isnt it accepted by other schools?They believe that discounting has the same nature of Riba, any increase and decrease of debt [Qardh] is not permissible. Murbahah is an exception.

Shari'ah Considerations (Cont)

Regulations ConsiderationsBased on IFSB definition, Sukk are certificates with each sakk representing a proportional undivided ownership right in tangible and intangible assets, monetary assets, usufructs, services, debt or a pool of predominantly tangible assets, or business venture,In asset-based instrument, originator typically transfers only the beneficial ownership of asset, so investors have no recourse to the assets.Based on IFSB standards, asset-based Sukk should have credit rate, Credit enhancement is needed (such as third party guarantee, over- collateralization, excess spread, cash collateral),Regulations Considerations

Tax regulation is very crucial, each transaction has its tax expenses and if transaction would be taxable, cost of financing will increase and instrument can not be used in practice.Underling asset must be clearly identifiable (may be in a specific project or investment activity) and Shari'ah complied.The asset should be available when issuing the certificates or the conditions for its delivery should prevail at the periods of time fixed by the originator (unless it becomes Bay al-kali).Types of acceptable assets: land buildings and installations machinery and equipment means of transport materials and goods.

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Regulations Considerations (Cont)

In the event that asset is in the form of materials, Murbahah Sukk is short term instrument, but if asset is in the form of long term asset, Murbahah Sukk is long term instrument.

Providing other documents and deeds relating to the asset should be mentioned in regulations (such as: commodity standard certificate, proforma invoice, warehouse receipt, )Regulations Considerations (Cont)

In the event that asset is in the form of materials, distribution of specific series of Murbahah Sukk in a step by step method should be allowed in regulation, but intervals should be determined in prospectus and should not be too long. Anyway, total contract price should be mentioned and registered.

Iranian capital market rules and regulations are available in the following website (English Version):http://rdis.ir/Rules.asp

Regulations Considerations (Cont)

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