11 August 2015 1

Sukuk Market and Its Recent Developments

Prof Azmi Omar

11 August 2015 2

◊ Evolution of Sukuk Market

◊ Some Key Observations from Sukuk Issuance

◊ Some recent developments in Sukuk Market

◊ Conclusion

Content

11 August 2015 3

◊ The debut of sukuk began in 1990 with the issuance of RM125 million

(USD 30 million) Al Bai’ Bithaman Ajil sukuk by Shell MDS Malaysia

◊ In September 2001, the State of Bahrain issued the world’s first sovereign

sukuk for USD 250 million. This Sukuk Al Ijarah carried a fixed lease

payment for 5 years

◊ In December 2001, Kumpulan Guthrie, a Malaysian government linked

company issued a USD 150 million Sukuk Al Ijarah with a floating rate of

return

Evolution of Sukuk Market

11 August 2015 4

◊ In 2002, the Federation of Malaysia issued a USD600 million Sukuk al

Ijarah that was listed in Luxembourg Stock Exchange and rated by

Standard & Poor’s and Moody’s

◊ This is a landmark sukuk as it is the first global sukuk that complied

with the US Regulation S and Rule 144A and meets conventional

bond practices such as listing, ratings, dematerialized scripts and

centralized clearance (Rafe Haneef, 2009)

11 August 2015 5

Source: Thomson Reuters, Sukuk Perceptions & Forecast Study 2015

11 August 2015 6

Corporate Sukuk Issuers

Source: Thomson Reuters, Sukuk Perceptions & Forecast Study 2015

11 August 2015 7

Source: IIFM, Sukuk Report 2014

11 August 2015 8

11 August 2015 9

Type of Sukuk 2001- 2008 2009 – 2012 Jan 2013 – July 2014

Sukuk Al Wakalah 1 27 34

Sukuk Al Salam 5 - -

Sukuk Al Musharakah 23 6 1

Sukuk Al Murabahah 1 5 13

Sukuk Al Mudharabah 13 0.002 4

Sukuk Al Ijarah 39 48 43

Islamic Exchangeable Sukuk 17 - -

Hybrid Sukuk 1 14 5

International Sukuk Issuances (%)

11 August 2015 10

Source: IIFM, Sukuk Report 2014

11 August 2015 11

11 August 2015 12

Type of Sukuk 2001- 2008 2009 – 2012 Jan 2013 – July 2014

Sukuk Al Wakalah - 1 1

Sukuk Al Salam 1 1 1

Sukuk Al Musharakah 30 11 8

Sukuk Al Murabahah 25 58 65

Sukuk Al Mudharabah 17 3 0.09

Sukuk Al Istisna’a 3 0.02 -

Sukuk Al Ijarah 20 17 14

Islamic Exchangeable Sukuk 0.39 - -

Hybrid Sukuk 7 2 9

Sukuk Al Bai’ Bithaman Ajil 11 7 2

Domestic Sukuk Issuances (%)

11 August 2015 13

◊ Early beginning: 100% asset-backed sukuk

At the initial development of sukuk, the thinking was to have a 100% physical

assets to cover for the sukuk issuance, in addition to the true sale

requirement of the underlying assets to sukuk holders

Given the constraints of finding suitable assets of sufficient value or

unencumbered assets, tax issues and legal restriction of sale of assets to

foreign investors, the 100% physical assets requirement and true sale of

underlying assets did not materialise

Some Key Observations from Sukuk Issuance (Source: Rafe Haneef, 2009 and Thomson Reuters, Sukuk Perceptions & Forecast Study 2014)

11 August 2015 14

In fact the number of asset-backed sukuk with true sale of underlying assets

remains insignificant until today

◊ The birth of asset-based sukuk

These constraints gave birth to asset-based sukuk, which does not require a true

sale but rather a sale of beneficial ownership of the underlying assets to sukuk

holders

The first example of asset-based sukuk was the 2002 USD600 million Federation of

Malaysia sukuk al Ijarah where the SPV holds the beneficial ownership of the

underlying assets on behalf of sukuk holders

11 August 2015 15

The assets used in the sukuk issuance were government building, hospitals

and civil service accommodation

In the event of default or dissolution, the sukuk trustee does not have the

power to retain or sell the assets to any 3rd party but rather to the

Federation of Malaysia

11 August 2015 16

◊ Next stage: Blended-assets sukuk

Given the constraints of having sufficient physical assets to cover the sukuk

isssuance, corporate as well as sovereign issuers came up with the

alternative of blended assets whereby the underlying sukuk assets comprise

of both physical assets and Shari’ah compatible receivables

Initially, the requirement was to have at least 51% or for some Shari’ah

scholars at least 66% of the portfolio must comprise of physical assets

11 August 2015 17

In 2005, however, the minimum physical assets requirement was set at 30% in a

mixed portfolio sukuk

◊ The emergence of asset-light sukuk

Given the attractiveness of sukuk, many corporates decided to tap the sukuk

market but were not able to meet the 30% physical asset requirement or have

sufficient Shari’ah compatible receivables

Two new sukuk structures were conceived at that time namely Sukuk al

Mudharabah and Sukuk Al Musharakah . They do not require any physical assets at

the time of sukuk issuance

11 August 2015 18

Many Shari’ah scholars criticised these two sukuk as they were structured to

effectively guarantee or protect the principal investment and the expected

return of the sukuk

In 2007 AAOIFI event and 2008 AAOIFI pronouncement effectively put an

end to the growth of asset-light sukuk issuances

11 August 2015 19

◊ Post 2008: Back to blended-assets sukuk

As shown in the above tables, Sukuk Al Ijarah and Sukuk Al Murabahah

remain the popular choice among issuers, although the issue of sufficient

physical assets in Ijarah and tradability in the secondary market for

Murabahah hinder their wider acceptance

Of late, Sukuk Al Wakalah has gained traction as a solution to the above

issues

11 August 2015 20

An e.g. of Sukuk al Wakalah was the 2011 USD2 billion dual tranche sukuk issued by

the Government of Malaysia

The underlying assets comprised leased assets and Shari’ah-compliant shares

(totalling 52%) and Murabaha receivables arising from Shari’ah-compliant

commodities (totaling 48%)

The obligor is appointed as agent (wakil) to invest and manage the sukuk proceeds

on behalf of the sukuk holders

The sukuk relies on a blended-assets structure which is based on the principle of

Khultah (mixture of assets). This structure had the added advantage of allowing

issuances above the value of available physical assets

21

Government of Malaysia’s USD 2 Billion Dual-tranche Wakalah Sukuk 2011

Source: HSBC Amanah

22

Wakala Sukuk: Government of Malaysia’s USD 2 Billion Dual-tranche Wakala Sukuk 2011

Source: HSBC Amanah

Some recent developments in Sukuk Market◊ Perpetual Sukuk, post 2012

11/8/2015 23

Source: RafeHaneef

Perpetual Sukuk – Structure Overview

11/8/2015 24

Source: RafeHaneef

11/8/2015 25

Perpetual Mudaraba Sukuk Cash Flow Illustration - USD100 million, 4% annual profit rate

Source: RafeHaneef

11/8/2015 26

◊ SRI (Sustainable Responsible Investment) Sukuk

International Finance Facility for Immunisation issues first Sukuk, raising US$ 500 million

Dubai, UAE, 27 November 2014 – The International Finance Facility for Immunisation Company

(IFFIm) today issued its inaugural Sukuk, raising US$ 500 million for children’s immunisation in

the world’s poorest countries through Gavi, the Vaccine Alliance. This landmark transaction is the

first socially responsible Sukuk with funds to be utilised for this purpose. This successful

transaction marks the largest Sukuk al-Murabaha issuance in the public markets and is also the

largest inaugural Sukuk offering from a Supranational.

The 3-year Sukuk – a financial certificate that complies with Islamic law – provides institutional

investors with a socially responsible investment that will help protect tens of millions of children

against preventable diseases.

Some recent developments in Sukuk Market…

11 August 2015 27

◊ Malaysia's Khazanah First Ethical Sukuk – Sukuk Ihsan

Published on 09 June 2015

RAM Ratings has assigned an AAA(s)/stable final rating to Ihsan Sukuk Berhad's (Ihsan) RM1 billion

Sukuk Ihsan Programme.

Ihsan is a trust-owned company established for the sole purpose of raising capital to support the corporate

and social responsibility efforts of Khazanah Nasional Berhad – the promoter of this exercise.

As the issuer, Ihsan will raise funds under the Islamic principle of Wakalah Bi Al-Istithmar and/or other

Islamic principles to be determined. The initial issue of Sukuk Ihsan will be based on the Islamic principle of

Wakalah where process raised will be used to purchase eligible sukuk investments. Khazanah will, in turn,

use the proceeds to fund Shariah-compliant eligible sustainable and responsible investment (SRI) projects, as

defined under the Securities Commission's sukuk guidelines revised and effective 28 August 2014.

Some recent developments in Sukuk Market…

11 August 2015 28

The sukuk will follow a unique "step-down" structure: coupon payments will

be reduced by 80 to 100 basis points from their fixed rate if the schools,

which are measured by their rate of expansion and the competency of their

teachers among other factors, meet the benchmarks set

Usage of the sukuk funding:

funding the purpose of education and a means for investors to fulfil their corporate

responsibility

raising money for affordable housing, the healthcare and environment sectors

11 August 2015 29

finance projects that conserve energy, use renewable energy such as wind and solar,

build public hospitals, schools or affordable housing, and develop awqaf properties.

(Awqaf operates social projects such as hospitals, mosques and schools with donations

received from Muslims in the form of land, cash or other valuables)

11 August 2015 30

Conclusion

Source: HSBC Amanah

Key considerations in structuring a sukuk

3111 August 2015

Contacts of the presenter Contacts of IRTI

Website: www.irti.org

Phone: +966 (0)

126466377

Fax: +966 (0) 126378927

P.O. BOX 9201 - Jeddah

21413

Kingdom of Saudi Arabia

3211 August 2015