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Sukuk Market in Malaysia: Issues of
Structuring
By Prof Dato’ Dr. Mohd Azmi Omar and Dr Azman
bin Mohd Noor
International Islamic University Malaysia
Content
2
Introduction
Definition of Sukuk
Tradeability of sukuk
Shariah principles used in different types of sukuk
Shariah and legal issues and challenges
17 Full fledge Islamic Banks
10 Conventional banks with ‘Islamic window’
4 International Islamic Banks
Islamic Finance in Malaysia
Financial System in Malaysia Conventional
Banking
Islamic Banking
Takaful Islamic Money
Market
Islamic Capital Market
Insurance Money Market
Capital Market
Islamic Banking Takaful
12 Takaful Oprators
4 Retakaful Operators
Money Market for Islamic Banks
Daily Transactions RM 1 billion Bursa Suq Al Sila’ as a platform
for Commodity Murabahah trading
Money Market Capital Market
88% halal counters/stocks traded at Bursa Malaysia
57% of private debt securities are sukuk
14 Islamic Fund Management institutions
152 Islamic funds 36 Islamic Fund Management
Institutions with Islamic mandate
Labuan Offshore FSA
Islamic Banking – 6 Islamic Banks and 9 Conventional banks with ‘Islamic window’. 3.8% of total banking industry.
Takaful & Retakaful– 7 retakaful and 9 conventional reinsurance with ‘Islamic window’
0
50,000
100,000
150,000
200,000
250,000
300,000
350,000
400,000
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Average total asset growth (2001-2010): 20.3% (asset)
The Growth of Islamic Banking in Maaysia
Asset : 20.8% (RM351b)
Financing : 22.7% (RM223.3b)
Deposit: 22.6% (RM277.5b)
Average Profit of Islamic Banking 15.4%
* Sumber: BNM Sistem Statistik Institusi Kewangan
RM
‘ 0
00
mil
lio
n
Asset Financing Deposit
Total Asset, Financing & Deposit of Islamic Banks (2001- 2010)
Singapore
0.1%
UAE
4%
Bahrain
2%
Saudi Arabia
7%
others
1%
Ofshores
17%
Indonesia
4%
Malaysia
65%
(USD 96 bilion)
Growing Financial Market
Malaysia the largest
sukuk issuer in the
world
Total Immatured Global Sukuk a
USD 148 bilion
Immatured Private Debt Securitiies (as of Dec 2010)
Islamic
57%
Conventional
43%
* Source: FAST
RM 323 b (USD 96b)
Definition of Sukuk
Sukuk is defined by Accounting and Auditing Organization for
Islamic Financial Institutions (AAOFI) as
“certificates of equal value representing undivided shares in
ownership of tangible assets, usufruct and services”
6
Nature of Sukuk
A ‘Sukuk’ is a Shari'ah-compliant variant of a conventional bond -
investor returns are derived from ownership of a business/assets
rather than interest-based debt obligations.
The Sukuk holders share profits from the business/assets.
7
Nature of sukuk
Economic characteristics similar to that of a conventional bond, key difference being that a Sukuk is not a debt instrument.
It represents a proportionate ownership in the underlying asset, giving the holder the ownership and accordingly the right to the benefits of the income stream of the underlying asset.
The yield is usually linked to a return on an underlying asset through an Islamic structure e.g. lease.
8
9
Types of assets eligible for Sukuk
Issuance
The type of assets eligible for Sukuk issuance or securitized
must be Shariah compliant . These are:
Existing tangible assets
Land, building
Future tangible assets
Bai al salam/Istisna'a/Ijarah Mausufah Fi Dhimma (forward/advance lease)
10
Financial assets/instruments/Intangibles
Ordinary shares
Intellectual Property? (see Islamic Fiqh Academy resolution No.43 (5/5)
Debts – account receivables ? Lease receivables ?
Contracts awarded by government, i.e, concession, construction, supply and
services
Usufructs/manfa`ah (financial benefits)
Note that the tangible or intangible assets or future tangible
assets may be owned or leased
Tradeability of Sukuk in secondary market
Sukuk Type Tradability
Sukuk of Freehold
Existing Assets
Acceptable
Sukuk of Existing Assets
Subject to Head Lease
Acceptable
Sukuk of Future
Tangible Assets
Can be traded only after the asset is created and identified. No
trading allowed while the asset is constructed except at par value
Sukuk of Existing
Specified Services
Acceptable prior to sub-leasing (selling) such services. Reason:
when we sub-lease, the sukuk represents rent receivables which
cannot be traded except at par value
Sukuk of Described
Future Services
Can be traded after the source of service is identified and
available. No trading allowed while the service is yet to be
available except at par value
11 Note: Adapted from (1) Adam, N and (2) Ayub, M. 2007.
Tradeability of Sukuk in secondary market
Sukuk Type Tradability
Sukuk Murabaha
Acceptable before sale of goods/commodity to the end buyer.
Once the goods are sold then trading is only accepted at par
value
Sukuk Salam Not acceptable except at par value
Sukuk Istisna'a Acceptable if funds are converted into assets and before sale to
party ordering the project
Sukuk Mudarabah,
Musharakah and
Wakalah
Acceptable after commencement of activity for which the funds
were raised
12 Note: Adapted from (1) Adam, N and (2) Ayub, M. 2007.
Types of Sukuk
13
Leased-based Sukuk – Sukuk Ijarah
Sukuk of Freehold Existing Assets
Sukuk of Existing Assets Subject to Head Lease
Sukuk of Future Tangible Assets (Mausufah Fi Dhimma (advance
lease)
Sukuk of Existing Specified Services
Sukuk of Described Future Services
Partnership-based Sukuk
Sukuk Mudaraba
Sukuk Musharaka
Sukuk Wakala
Types of Sukuks
14
Sale-based Sukuk
Murabaha
Istisna'a
Salam
Hybrid Sukuk
Sukuk Al Istithmar
Cagamas Sukuk al-Alim
Ijarah
A contract involving the transfer of the usufruct of an
underlying asset by the owner of the said asset to another
party, for an agreed tenure, at an agreed consideration
Lease period shall commence from the date on which the
underlying leased asset is delivered to the lessee
Subject matter of the lease must have valuable use and the
benefit from the lease must be lawful in Shariah
Relation between parties to Ijarah
Corpus of the leased asset remains in the ownership of the
lessor and only its usufruct is transferred to the lessee
15
Expenses
Liabilities arising from the ownership of the leased asset remains
with the lessor whilst the liabilities from the usufruct of the
leased asset shall be borne by the lessee i.e., liable to the wear
and tear of the asset normally occurs during its use
The lessee is responsible for any loss caused to the asset due to
his misuse and/or negligence
Lessor may delegate the task of performing major maintenance
and/or procurement of insurance to the lessee. However, cost
would still be borne by the lessor
Rental period within the lease tenure must be determined
clearly
16
Rental arising from the lease must be determined at the time
of contract for the whole rental period
The rental must be specified upfront, either as lump sum
amount covering the entire lease period or by installments for
parts of the duration of the lease rental period
Variable rental is allowed by way of referring the rental to a
predetermined benchmark
Security
Ijarah contract may include security arrangement allowed by
Shariah, to secure the rental payments or as security against
negligence and/or misuse of the leased asset by the lessee,
including charge over the assets, assignments of rights over the
leassee’s assets, amongst others
17
Common Ijarah Structures
Ijarah Muntahiah Bitamlik – Sale or hibah by
upon maturity,
Ijarah Mausufah Fi Dhima –
Forward/Advance Lease
Lease and Leaseback
18
Ijarah Muntahiah Bitamlik
Sale and leaseback of completed asset
3 steps process flow:
1. Financiers to purchase asset
2. Financiers to lease asset and receive lease rental
3. Financiers to sell the asset at nominal cost upon maturity of
the lease, via the Sale Undertaking (call option) and/or
Purchase Undertaking issued by the Lessor
Normally involve sale of beneficial ownership, whereby the
legal title of the asset shall remain with client at all times
Asset to be charged as security
19
Sukuk al-Ijara
20
As an owner of the leased assets, lessor could securitise
the ownership of the leased assets which could be
affected through a trust structure.
Through the securitisation of the ownership, the lease
receivables are also indirectly securitised.
The ijara backed securities are known as Sukuk al-
Ijara.
Sukuk al-Ijara
21
The issuer of these certificates is selling a proportionate
ownership of the leased asset
The subscribers are buyers of the asset.
The mobilised funds from subscription are the purchase
price of the asset, and the certificate holders become the
owners of the assets jointly with its benefits and risks.
Certificates of ownership of usufructs of existing assets
Essential Condition
22
“It is essential that the Ijarah certificates
are designed to represent real ownership
of the leased assets, and not only a right to
receive rent.”
Sukuk Issuance
Financing SPV shall declare a trust transferring the beneficial
ownership of the asset and rights under the Ijarah arrangement
(sukuk assets) to the investors (sukuk holders)
SPV will issue sukuk to raise proceeds from the sukuk holders
to pay for the acquisition of the beneficial ownership of the asset
from client
SPV will be appointed as the agent to manage the sukuk assets
on behalf of sukuk holders
23
Why Shari'ah Compliance ?
24
Sukuk do not represent debt owned by the issuer/
certificate holder.
Sukuk do not issue for a pool of receivables.
As such, it distinguishes sukuk from shares and bonds.
Since Sukuk al Ijara evidence the undivided pro-rata
ownership of the underlying asset, it is freely tradedable
at par, premium or discount.
Malaysia Global Sukuk
Issuer Malaysia Global Sukuk Inc (“SPV”) in June 2002
Obligor Government of Malaysia (as lessee of Leased Assets)
Issue size US$600 mil
Leased assets Selayang Hospital, Tengku Ampuan Rahimah Hospital, Jalan Duta Government living quarters, Jalan Duta Government Office Complex
Issue rating BBB (S&P) / Baa2 (Moody) in line with the sovereign ceiling
Maturity 5 years with bullet payment (June 2007)
Yield Benchmarked on 6-month USD Libor plus credit spread
Listing Luxembourg SE, Bahrain SE & Labuan IFE
25
Malaysia Global Sukuk
26
GOM
Malaysia Global
Sukuk Inc
Secondary
Market
Primary
Subscribers Assets Sukuk
1. The Federal Land Commissioner sells
beneficial interest in land parcels to SPV for
USD600 m
2. SPV enters into a Master Ijara Agreement
with GOM
3. SPV declares a trust transferring the
beneficial ownership of the assets & rights
under the Ijarah agreement to the investors.
SPV issues Sukuk representing undivided
proportionate ownership in the leased
assets which gives rise to rights to share
the rental payments in the Master Ijara
arrangement (this satisfies the Shari'ah
requirement for ownership)
Purchase
Undertaking Sale undertaking
Malaysia Global Sukuk -Documentation
Document Parties Purpose
1. Asset Sale Agreement GOM & SPV To transfer the beneficial ownership of
the Assets from GOM to SPV.
2. Asset Lease Agreement SPV & GOM To lease the Assets to GOM.
3. Purchase Undertaking From GOM to SPV GOM undertakes to buy the Assets at
maturity or if it defaults under the lease.
4. Sale Undertaking From SPV to GOM SPV undertakes to sell the Assets to
GOM at maturity.
5. Service Agency Agreement Between SPV and GOM SPV appoints GOM as the Service Agent
for the Assets.
6. Trust Deed By SPV SPV declares a trust over the Leased
Assets in favour of the Sukuk-Holders.
Issues Sukuk to the Primary Subscribers.
7. Security Trust Deed Between the SPV and a
Professional Trustee
SPV appoints a Professional Trustee to
hold and manage the Trust Assets for the
Sukuk-Holders.
27
Document Parties Purpose
1. Asset Sale Agreement GOM & SPV To transfer the beneficial ownership of the
Assets from GOM to SPV.
2. Asset Lease Agreement SPV & GOM To lease the Assets to GOM.
3. Purchase Undertaking From GOM to SPV GOM undertakes to buy the Assets at
maturity or if it defaults under the lease.
4. Sale Undertaking From SPV to GOM SPV undertakes to sell the Assets to GOM
at maturity.
5. Service Agency Agreement Between SPV and GOM SPV appoints GOM as the Service Agent
for the Assets.
6. Trust Deed By SPV SPV declares a trust over the Leased Assets
in favour of the Sukuk-Holders. Issues
Sukuk to the Primary Subscribers.
7. Security Trust Deed Between the SPV and a
Professional Trustee SPV appoints a Professional Trustee to
hold and manage the Trust Assets for the
Sukuk-Holders.
Malaysia Global Sukuk- Highlights
28
First Sukuk to be rated by international rating agencies
BBB/Baa2 in line with sovereign ratings
First Sukuk to be distributed under Reg. S and Rule 144A
Endorsed by International Islamic Financial Market (Bahrain)
Order book more than twice oversubscribed at USD1.1 billion.
Broad geographical distribution
new investors accounting for 65% of overall deal
balance between liquidity-orientated and buy-and-hold investors
balance between Islamic and conventional accounts to ensure liquidity
Malaysia Global Sukuk- Highlights
29
The transaction was announced on 10 June 2002 with the release of preliminary offering circulars to investors on that day.
Roadshow was conducted in East Asia, Middle East and Europe
Conventional accounts required more guidance on the transaction structure
Middle Eastern credits required more guidance on the Malaysian credit
Initial price guidance released on 20 June 2002 at US$LIBOR + 95 bps
Interest from Asia grew to US$600 million on same day
Price guidance revised to US$LIBOR + 95 - 98 bps due to market volatility
Deal was priced on 25 June 2002 at US$LIBOR + 95 bps
Deal closed oversubscribed at US$1.1 billion in orders from 51 accounts
Deal upsized to US$600 million
Source: Arshad Ismail
Why Sukuk Al-Ijarah is Highly Demanded?
30
Elimination of Bay Al-Inah & Bay A-Dayn elements in sukuk issuance. These 2 elements are regarded as non-Shari'ah compliant (trading debt paper or debt obligation - riba based financing) by most of scholars particularly Middle Easterns.
Shari'ah compliance - sukuk do not represent debt owned by the issuer/ certificate holder & sukuk do not issue for a pool of receivables.
The strength of the Malaysian sovereign credit and opportunity for stable risk diversification the BBB-rated deal will offer Middle Eastern-based accounts.
High Yield – 6 month USD Libor + credit spread.
Why Sukuk Al-Ijarah is Highly Demanded?
31
Listed on established International Exchanges i.e. Luxembourg,
Bahrain & Labuan.
Competitive pricing in line with conventional bond issues.
Ability to trade at premium – data show more buyers than sellers in
the market.
Priority in liquidation, similar to Secured Creditors as it is backed by
assets.
Sukuk holders have pro-rata undivided beneficial ownership of the
leased assets held in trust, as such entitled to the income streams from
the leased assets.
Hybrid Sukuk- Sukuk Istithmar
In a hybrid Sukuk, the underlying pool of assets can comprise
of Istisna'a, Murabaha receivables as well as Ijara. Having a
portfolio of assets comprising of different classes allows for a
greater mobilization of funds.
However, as Murabaha and Istisna'a contracts cannot be
traded on secondary markets as securitised instruments at
least 51 percent of the pool in a hybrid Sukukmust comprise
of Sukuk tradable in the market such as an Ijara Sukuk. Due
to the fact the Murabaha and Istisna'a receivables are part of
the pool, the return on these certificates can only be a pre-
determined fixed rate of return.
32
Sukuk Istithmar structure
1.Islamic finance originator transfers tangible assets as well as
Murabaha deals to the SPV.
2.SPV issues certificates of participation to the Sukuk holders
and receive funds. The funds are used by the Islamic finance
originator.
3.Islamic finance originator purchase these assets from the
SPV over an agreed period of time.
4.Investors receive fixed payment of return on the assets.
33
Sukuk Istithmar
34
35
Islamic Development Bank (IDB) Trust
Certificates – Sukuk Al Istithmar (2003)
US$400 million issued in 2003 with maturity in 2008
Securitization of Sukuk Ijara (65.8%), murabaha
receivables (30.73%) and Sukuk Istisna'a (3.4%)
contracts of IDB with a minimum of 51% of Ijara assets
The certificate holders will be entitled to receive
periodic profit distribution
Challenges
Fully subscribe, become “illiquid.”
Resemblances of conventional bonds in generating fixed income.
Non-completion risk and remedies
(a) Istisna'a’, (b) Musharakah (c) Mudarabah
Securitization of asset/project vis-à-vis securitization of receivables.
Force majure position and what constitutes force majure in commercial
perspective.
Collateral and securities
(a) Charge
(b) Assignment
(c) Put option
(d) Purchase undertaking
(e) Sale Undertaking 36
Foreign ownership of certain assets / in certain
jurisdictions
Liquidated damages vs. penalty/compensation charges
Events of default.
Insurance and maintenance obligations.
AAOIFI pronouncements on Sukuk in February 2008:
Tradeable sukuk must represent real ownership for sukuk
holders in assets whether tangible or usufruct that can be
possessed and disposed according to Shariah
Not permissible for sukuk to represent either revenue
stream or debt stream
37
Not permissible for manager of the Sukuk to offer loans to
sukuk holders when actual earnings fall short from expected
earnings
Not permissible for the issuer to promise to purchase assets
from the sukuk holders at a nominal value at the end of the
sukuk tenor
Permissible for the lessee in a Sukuk Ijarah to agree to purchase
the leased assets when the sukuk are extinguished for their
nominal value, as long as the lessee is also not an investment
partner, mudarib, or agent
38
