10.1. Introduction
Liquidity is the ability to meet obligations as and
when due. Banking is a business of financial intermediary whereby money is
collected from depositors and provided to business and industry to meet short
and long term requirements. Deposits are collected under any of the three forms
of accounts including current account, profit and loss sharing account and
profit and loss fixed deposits. Except profit and loss fixed account depositors
are free to deposit and withdraw the amount according to their preferences and
financial plans, which creates uncertainty as for cash requirements of a bank
are concerned to return the money of depositors. This uncertainty of cash
requirements make the job of modern banker challenging because of required
skill in funds management to utilize the funds prudently keeping in view the
liquidity requirements as well as to earn normal rate of return for depositors
and share holders.
Liquidity risk management is a
challenging task for any bank including Islamic banks. Conventional banking has
numerous opportunities to mitigate and manage liquidity risk including
investment in short term interest based instruments issued by government and
corporate sector. The most secured form of short term investment is treasury
bills and other money market instruments. Likewise for medium to long term
investments interest based bonds are available to conventional banks with a
ready market for disposal without losing much in value of the underlying
security. Conventional banks have the opportunity to invest in equities through
stock exchange and earn return in the form of dividend and price appreciation,
at the same time to convert into cash as and when required. Another important
source of meeting the liquidity crisis is help from central bank in rainy days
by providing required hard currency for interest. Furthermore interbank balances
of conventional banks are also rewarded in the form of interest by each other.
Islamic banks cannot invest in any interest bearing instrument consequently all interest bearing money and capital market instruments based on interest are eliminated as for liquidity management of Islamic banks is concerned. Job of Islamic banking practitioner has become very challenging as for liquidity is concerned. Naturally in such circumstances Islamic bank has to be very prudent while deciding the ratio of reserve and availability of funds for investments and financing. In Pakistan central bank has directed through prudential regulations to all Islamic banks to maintain higher cash reserve with central bank as compared to conventional banks because conventional banks are allowed to maintain cash reserve in a combination of short term liquid securities and cash balance with central bank. Islamic banks can invest in any instrument of money or capital market if and only if it is based on variable return. Investment in equities through stock exchange is the only avenue of investment is left with Islamic banks as for liquidity management is concerned, however, as we know Islamic financial institutions are required to ensure Shari’a compliance in all of their operations, hence, IFIs are not free to invest in any security issued on profit and loss sharing basis. Shari’a compliance of the company issuing securities with variable returns is required. Ideally a security should have two features at least to be called as Shari’a compliant, including Halal business (business of the company should not consist of an activity which is prohibited by Islamic law e.g. liquor, pornography, pork, speculation, hoarding etc.etc.) and free from interest in its operations.(e.g interest received on bank deposits, interest paid on overdrafts and loans, discounting of bills of exchange, interest paid on bonds and even on preferred stocks are all interest based transactions and contradict with Shari’a compliant financial system). If we filter the investment opportunities available at hand with these two criterias, we will find none or a very minor number of companies meeting both criteria. Even if we found a small number of companies meeting both criteria, the issue of listing with stock exchange (which is vital for ready market to convert into cash) and low financial performance of these companies might hinder investment by IFIs.
Islamic banks cannot invest in any interest bearing instrument consequently all interest bearing money and capital market instruments based on interest are eliminated as for liquidity management of Islamic banks is concerned. Job of Islamic banking practitioner has become very challenging as for liquidity is concerned. Naturally in such circumstances Islamic bank has to be very prudent while deciding the ratio of reserve and availability of funds for investments and financing. In Pakistan central bank has directed through prudential regulations to all Islamic banks to maintain higher cash reserve with central bank as compared to conventional banks because conventional banks are allowed to maintain cash reserve in a combination of short term liquid securities and cash balance with central bank. Islamic banks can invest in any instrument of money or capital market if and only if it is based on variable return. Investment in equities through stock exchange is the only avenue of investment is left with Islamic banks as for liquidity management is concerned, however, as we know Islamic financial institutions are required to ensure Shari’a compliance in all of their operations, hence, IFIs are not free to invest in any security issued on profit and loss sharing basis. Shari’a compliance of the company issuing securities with variable returns is required. Ideally a security should have two features at least to be called as Shari’a compliant, including Halal business (business of the company should not consist of an activity which is prohibited by Islamic law e.g. liquor, pornography, pork, speculation, hoarding etc.etc.) and free from interest in its operations.(e.g interest received on bank deposits, interest paid on overdrafts and loans, discounting of bills of exchange, interest paid on bonds and even on preferred stocks are all interest based transactions and contradict with Shari’a compliant financial system). If we filter the investment opportunities available at hand with these two criterias, we will find none or a very minor number of companies meeting both criteria. Even if we found a small number of companies meeting both criteria, the issue of listing with stock exchange (which is vital for ready market to convert into cash) and low financial performance of these companies might hinder investment by IFIs.
This led the Shari’a experts and
finance professionals to pay due consideration to underlying problem of
liquidity management by IFIs and come up with solutions. Any of the solution to
the problem through financial engineering is deemed fit if it is not violating
basic principles of Islamic financing. In the following sections I have
explained the solutions offered as for investments of IFIs are concerned into
readily convertible securities.
10.2. Investment in Equities
10.2. Investment in Equities
Following
is the established criteria for checking Shari’a compliance status of a
security prior to investment by an IFI. This Shari’a compliance criteria is
consist of six tests and meeting of all requirements is essential by a security
prior to qualify for investment in its equity by an IFI (KMI-2010).
1. Halal Business of the Investee Company: Core business of the company must be HALAL and in-line
with the dictates of Shari’a. Hence, investment in securities of any company
whose principal activity consists of a haram (unlawful) business, e.g. dealing
in conventional banking, conventional insurance, alcoholic drinks, tobacco,
pork production, arms manufacturing, pornography or related un-Islamic
activities, is not permissible.
2. Interest Based Financing: Interest based debts
to asset ratio should be less than 40%. Debt, in this case, is classified as
any interest bearing debts. Zero coupon bonds and preference shares are, both,
by definition, part of debt[1].
3. Shari’a
Non-compliant Investments: The
ratio of non compliant investments to total assets should be less than 33%.
Investment in any non-compliant security shall be included for the calculation
of this ratio.
4. Purification of Shari’a Non-complaint
Income: The
ratio of Shari’a non-compliant income to total revenue should be less than 5%.
Total revenue includes Gross revenue plus any other income earned by the
company. This amount is to be cleansed out as charity on a pro rata ratio of
dividends issued by the company.
5. Net
Liquid Assets to Share Price: The
market price per share should be greater than the net liquid assets per share
calculated as: (Total Assets – Illiquid Assets – Total Liabilities) divided by number
of shares. A liquid asset mean the asset which cannot be traded except at par
value as per Shari’a rulings and includes cash, bills receivables, promissory
notes, accounts receivables, bonds, preferred shares etc.
6. Illiquid
Assets to Total Assets: The ratio of
illiquid assets to total assets should be at least 20%. Illiquid assets, here, is defined as any asset that
Shari’a permits to be traded at value other than the par and includes physical
assets (land, building, furniture, machinery, computer, office equipment
etc) inventory (raw materials, work in
process and finished goods), equity investments (ordinary shares, PTCs, TFCs
and Skuk etc), intangibles (goodwill, patents and copy rights etc).
In
order to understand the impact of these tests let us look at the available
equity securities in the capital market. All securities of financial sector
including conventional banking, insurance companies, specialized financial
institutions, leasing companies etc. and securities of all companies engaged in
haram businesses e.g. liquor, pornography, pork, speculation, hoarding,
tobacco, casinos, night clubs, adultery etc. are excluded through test one.
We left with halal businesses of real sectors
including manufacturing, trade and services sectors, however, a large number of
companies may not be able to qualify second test restricting interest based
debts to total assets ratio less than 40%. Practically many large firms employ
a huge amount of debts to meet the expansion, growth and asset replacement
requirements. One of the strongest motivations to employ interest based debt
financing by firms is the tax incentive. It is very interesting to note that as
per accounting practices and national taxation laws (almost in every country)
interest charge on debts is treated as pre tax cost and deducted from revenue
to calculate income tax. It means regulator himself is promoter of interest
based financing in firms. Had we not have this incentive of interest based debt
financing, firms would lose the benefit and motivation to employ debt financing.
With the application of second test IFIs lost a reasonable number of
financially sound and profit generating firms.
Tests three and four
deal with a portion of investment and revenue generated through haram sources.
Ideally answer of test three and four should be zero, however, except a small
number of firms, results are always positive and it is really difficult for
firms to avoid Shari’a non-compliant investments and revenue till the maturity
of Islamic financial system (e.g. reach of Islamic banking in Pakistan is limited in the economy with
branch network of 684, covering around 7% of market share in assets and
deposits and only around 5% in financing and investments by the end of
September 2010 (SBP-2010).
Tests five and six are about the
mixture of liquid and illiquid assets and market to book ratio of net liquid
assets. Meeting of these criteria is not very difficult for a large number of
firms because almost every firm in business of manufacture, trade and service
can easily qualify both tests of having illiquid assets more than 20% and price
to book ratio of net liquid assets more than one.
In this section I have elaborated valuation of
securities under Shari’a compliant financial system. As IFIs are entering into equity market for investment hence guidance in
the field of risk and return trade off and security pricing under Shari’a
framework is required. Risk taking (but not Gharar) in business is accepted by
Shari’a; and experts in business/finance are in consensus about positive
relationship of risk and return. Islamic Law discourages risk free return by
banning charging of interest. Security pricing is at the heart of financial
literature and numerous valuation models have been developed so for including
cash flows discount models and technical models. There is a need to analyze the
existing security pricing models within the filter of Shari’a compliance,
document any mismatching with Shari’a financial system and suggest alternatives
where required.
Important question for an investor is how to determine
the rate of return (profit) to be used in determining the intrinsic value of a
security. Certain answers from literature are provided hereunder.
10.2.2.1. Opportunity Cost
First and foremost is the
opportunity cost of the project at hand should be used as required rate of
return. Opportunity cost is the reward foregone, attached with second
best alternative of investment with same risk level (because first best option
of investment is exercised by rational investor). To illustrate, an investor with a fund of Rs;
100,000 and with a risk preference of only 10% (standard deviation) short
listed two securities A & B with return of 12% and 10%. Naturally a
rational investor will go for security A being carrying superior return. The only
option left is security B, hence opportunity cost of A is the reward forgone
attached with B, so the required rate of return/discount rate/profit rate is
10% in this case. After deciding the discount rate the second step is to
determine the intrinsic value of security A. Suppose after one year price of
security A is expected to be Rs;25, without any dividend during the year, the
current value of the security becomes Rs;22.72. If prevailing market price of
security is less than or equal to intrinsic value, it is recommended to invest
in the security.
10.2.2.2. Weighted Average Cost of Capital
10.2.2.2. Weighted Average Cost of Capital
Second method to determine
the required rate of return on an underlying investment is weighted average
cost of capital (WACC). Following is the basic equation of WACC. (1)
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10.2.2.2.1. Capital Asset Pricing Model
Capital asset pricing model (CAPM)
developed by Nobel Laureate William Sharpe (1961), states that expected return on
an asset is the linear function of expected risk. According to the model total
risk of a security is distributed between systematic risk and unsystematic
risk. Whereas unsystematic risk can be reduced/ eliminated through efficient
diversification while systematic risk is priced by the market. As the total
risk of a security is measured by standard deviation while systematic risk is
measured by Beta hence the Beta is relevant measure of risk for expected
return. Beta measures the co movement of the security with the market. Beta is
calculated by applying the formula:- (2)
Whereby
is the Beta of security x;
is the covariance of returns of security x
with the market returns; and
is the variance of market returns. Once the
Beta of a security is determined required return is calculated by applying
following equation:- (3)
CAPM
advocates; investors need to be rewarded in two ways: firstly for time value of
money and secondly risk associated with the security. First half of formula
represents risk free return (RF) that compensates the investors for placing
money in any investment over a period of time. The other half of the formula
represents [β(Rm-Rf)] risk premium for bearing additional risk.
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10.2.2.2.2. Arbitrage Pricing Theory
Arbitrage pricing theory was developed
by Ross in 1976. Unlike CAPM theory of arbitrage pricing advocates, that,
multifactor are contributing in security risk hence during calculation of
required return one should not rely on single risk factor. Following is the
basic equation depicted from Reilly, and Brown, (2003):
(4)
In the equation
represents the intercept/ constant
which is like risk free return in CAPM while
to
represents the risk premium of each factor and
to
represent sensitivity of the security with
relevant risk factor.The
original theory has not specified either identity or number of risk factors to
be included while determining required return. Identification of factors
relevant to a security or portfolio had left with the investor. Factors used in
testing the multifactor models by researchers are grouped by Reilly, and Brown,
(2003), as Macroeconomic based risk factors and microeconomic level factors.
10.2.2.2.3. Shari’a Compliant Asset Pricing Model
10.2.2.2.3. Shari’a Compliant Asset Pricing Model
What is the
essence of asset pricing models (CAPM, APT)? These help in determining the
profit rate (required) on an investment. Under Shari’a frame work profit
charging is allowed in business. Practically profit rate is determined by
market forces of demand and supply of underlying commodity offered for sale.
Investment in equities (shares) is the ownership right of an investor and, of
course, price of a share is also determined by demand for and supply of the
underlying security. Demand and supply of shares is also affected by futures,
forwards and short selling which have turned equity investment into speculative
businesses. As for Islamic financial system is concerned; ownership, possession
and existence of a commodity, to be sold, is required except for Salam and
Istisna’a. Whether Salam and Istisna’a sale is applicable to equity shares?
Contract of Istisna’a sale is permitted for only the goods which require
transformation of material through manufacturing process into finished goods
and also Istisna’a contract cannot be executed on already manufactured goods.
As for application of Salam sale in share trading is concerned, it is expressly
prohibited in Shari’a standard # 21. The essence of Salam is dealing in
agricultural products and of Istisna’a is dealing in manufactured commodities.
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While
the component of RF is not present in Shari’a compliant financial environment
so the original equation of required return after modification for Shari’a Compliant Asset Pricing Model (SCAPM) becomes
as documented by Tomkins & Karim
(5)
Whereby required return of investor depends upon
relationship of individual security with bench mark (e.g. stock market)
measured through beta and there is no minimum compensation in the form of Risk
free return.
Sheikh
(2010) proposed the linkage of debt servicing with nominal gross domestic
product growth rate and replacement of RF with Nominal Gross domestic product
growth rate. Under his proposed model equation of SCAPM turns into following
shape:- (6)
Whereby required return of investor depends upon two
components; Nominal GDP growth rate and risk premium measured through beta of a
security in relation to a bench mark (e.g. stock market).
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Whereby required return of investor depends upon two
components; return to cover Zaka and risk premium measured through beta of a
security in relation to a bench mark (e.g. stock market).
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Now the important
question is should there be minimum compensation (as RF in conventional frame
work) for investor in Shari’a compliant financial system. To answer this
question we have to look into composition and justification of RF in
conventional frame work. Nominal RF is composed of two things (1) is real RF
and (2) is inflation charge. Real RF represents time value of money. It is the
rent of money for use. According to Keynes’ liquidity preference theory it is
the compensation for sacrificing liquidity by investor. Under Shari’a frame
work money is medium of exchange and not commodity (which can satisfy any need
of humanity by its own….. like medicine cures the disease) hence deserve no
rent. Time value of money is not recognized by Shari’a scholars in the area of
finance. Money can be used in the utility creation process (production and delivery
of goods and services) and deserve return on profit and loss sharing basis.
Time value/ rent of money falls in the category of ‘Riba’ (interest) which is
forbidden in all known revealed religions including Judaism, Christianity and
Islam.
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Whereby Rj is
required return of a security; N is inflation charge; Rm average return on
market portfolio and Bj is beta of security (relationship of returns between
security and bench mark such as stock market). For inflation proxies of
Consumer Price Index (CPI), wholesale price index (WPI), Basket of selected
commodities or even basket of selected currency can be used.
Traditional CAPM was criticized on account of
relying on single factor as measure of risk (Beta) and multifactor models were
presented as an extension of CAPM including Arbitrage Pricing Theory (APT) by
Ross in 1976. Unlike CAPM theory of arbitrage pricing advocates, that,
multifactor are contributing in security risk hence during calculation of
required return one should not rely on single risk factor. Following is the
basic equation depicted from Reilly, and Brown, (2003).
Whereby E(R_i ) is the expected return/
required return of security and λ1 to
λk is the risk factors while bi1 to bik is the beta coefficients. However as
discussed earlier inflation impact is same for all investment opportunities,
hence, it should not depend upon riskiness of a security and must be accommodated
separately. If we delink the inflation charge from risk premium then original
equation of Ross (1976) remains intact with a slight modification as follow:- (10)
Whereby N is inflation while λ1 to λk represents the
risk premium of each factor and bi1 to bik represent sensitivity of the
security with relevant risk factor.
10.2.3. Trading
in Securities
In
this section summary of Shari’a rulings in respect of dealing in securities as
per Shari’a standard # 21, including acquiring a security as long term
investment, and/or held for sale (short term investment) is provided.
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Skuk market has got momentum under Shari’a
compliant financial system. According to ISI Emerging Markets[3],
approximately 2000 issues of Skuk were held with Global volume of around US $200
Billion by the end of June 2010. In addition to corporate Skuk, Sovereign Skuk
are also issued by the governments including Pakistan, Jordan, UAE, Thailand,
Malaysia, Turkey, Indonesia, Bahrain, Qatar, Cayman Islands, Singapore,
Germany, Brunei, Gambia and Kuwait.
Concept of Skuk is initially
developed to replace the conventional bonds having features of fixed return,
money back security/guarantee and ready market for liquidation. However under
Islamic financial system even Skuk cannot guarantee of all the features of
conventional bonds listed above. Different types of Skuk are offering varying
degree of feature(s) of conventional bonds. Objective classification of Skuk
places them into either fixed return Skuk or variable return Skuk. Variable
return Skuk are very much similar to equity securities
rather than conventional bonds, however fixed return Skuk are having some of
the features of conventional bonds. In the following sections an overview of different
types of Skuk is provided.
Ijarah Skuk are further
subdivided into two types. (1) Certificate of ownership in leased asset(s) or
asset(s) to be leased on promise (2) certificate of ownership in usufruct of
existing asset(s) or asset(s) to be made available in future. Under first case Skukholders
are the buyers of asset(s) and funds mobilized are the purchase price of the
asset(s).The Skukholders jointly owns the asset(s) through an undivided
ownership sharing the profits and losses on the basis of partnership. Under
second case Skukholders are buyers of usufruct, while funds mobilized are the
purchase price of the usufruct. The certificate holders are become joint owners
of the usufruct sharing its benefits and risks. Ijarah Skuk are very much similar to conventional bonds
offering fixed return subject to sharing ownership risks. Under Ijarah Skuk
after giving the asset on rent IFIs can sell the Skuk to investors bearing
fixed return because amount of rent is known with certainty. However stipulated
redemption at par value and guarantee of return by issuer is not allowed. It is
allowed to redeem the Skuk at market price or an agreed price at the time of
redemption. It is however permitted that an independent third party provides the
guarantee free of charge. Issuing document of Skuk (prospectus) must state that
each owner of a certificate participates in the profit and bears a loss in
proportion to the financial value represented by his certificate.
Skuk issued under Salam, Istisna’a, Murabaha, Musharaka, Mudaraba, are all carrying variable returns.
Salam Skuk: Issuer of the Skuk is a seller
of the goods of Salam and Skukholders are buyer of the goods, while funds
realized are Salam capital. The Skukholders are owner of the Salam goods and
are entitled to the sale price of the certificates or the sale price of the
Salam goods through a parallel Salam or sales revenue at maturity of Salam
contract.
Istisna’a Skuk: The issuer is manufacturer
(supplier/seller), the subscribers are buyers of the intended product(s), while
the funds mobilized through subscription are the cost of the product(s). The Skukholders
own the product and are entitled to the sale price of the certificates or the
sale price of the product(s) sold on the basis of parallel Istisna’a or disposed
off otherwise.
Murabaha Skuk: The issuer is seller of
commodity and subscribers are buyers and realized funds are cost of underlying
commodity. Skukholders are entitled to the sales revenue of Murabaha sales.
Musharaka Skuk: The issuer is a person (firm)
inviting to partnership in project or activity, and subscribers are partners,
while realized funds are contribution in Musharaka capital. Skukholders own the
equity stake in Musharaka and share profits and losses.
Mudaraba Skuk: The issuer is mudarib and
subscribers are the partners while realized funds are capital of the entity. Skukholders
share profits and bear losses.
Rule.1. Issuing document (Prospectus) of
Skuk must contain the following:-
1. It must include all contractual conditions,
information about participants in the issue along with their rights and
obligations; including issue agent, issue manager, originator, investment
trustee, guarantor (of capital, returns), payment agent and any other related
party along with conditions of appointment and dismissal.
2. It must include the identification of the
contract, on the basis of which Skuk are launched i.e. Ijarah, Murabaha, Salam etc.
3. It must clearly mention the Shari’a compliance of
issue duly certified by Shari’a board.
4. It must clearly state that investment of realized
funds will be taken through Shari’a compliant modes of investment.
5. It should state that each owner of a certificate
participates in profits and losses.
6. It must not include the guarantee of capital or
return by issuer to Skukholders except in cases of negligence. However it is
allowed to an independent third party to provide guarantee free of charge.
Rule.2. Underwriting is allowed without
any charge. Skuk of any duration are allowed including short
term, medium term, long term and indefinite period of time. Risk mitigation
through profit equalization reserve and permissible insurance is allowed.
Rule.3. Trading in Skuk and redemption
on profit/loss is allowed after closing subscription, allotment of Skuk and
commencement of activity. However in following cases rules of debts and
currency trade shall be applicable in trading and redemption of Skuk.
1. Ijarah Skuk (ownership in
asset), after subleasing of the underlying asset by lessee.
2. Ijarah Skuk (ownership in
usufruct), before ascertainment of asset to be leased.
3. Istisna’a
Skuk, when price paid in parallel Istisna’a contract and/or manufactured goods are delivered to ultimate purchaser.
4. Salam Skuk (cannot be
traded except on par as per rules of trading of debts).
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6. Prior
to commencement of activity. (Conversion of cash into assets).
7. Liquidation
of activity and assets converted into receivables.
Rule.4. Redemption of Skuk by issuer at
market price or an agreed price at the time of redemption is allowed, however
it is not allowed to stipulate in the prospectus by issuer as of redemption at
nominal value.
Rule.5. It is permitted, immediately
upon issue and up to the date of maturity, but after the passing of ownership
of the asset(s) to the Skukholders, to trade in Skuk that represent ownership
of existing leased assets or assets to be leased on promise.
Abstract From Prospectus of
JAFZ Skuk Limited
Term: 5Years Value AED 7.5 Billion
Parties
Issuer JAFZ Sukuk
Limited, a limited liability company, incorporated on 23 May 2007 in
accordance with the laws of
the Cayman
Islands (the ‘‘Issuer’’).
Ownership of
the Issuer The
authorised share capital of the Issuer is US$50,000 consisting of 50,000
shares with a nominal value of US$1 each. 250 of the Issuer’s shares have
been issued and are held by Maples Finance Limited on trust for charitable
purposes.
Company Jebel Ali Free
Zone FZE, a Jebel Ali Free Zone Establishment established on 5 March 2006 in
the Jebel Ali Free Zone under Implementing Regulations No. 1/92 issued
pursuant to Law No. 9 of 1992 (the ‘‘Company’’).
Trustee The Issuer will
act as trustee in respect of the Trust Assets (as defined below) (the ‘‘Trustee’’)
for the benefit of Certificateholders in accordance with the Declaration of
Trust (as defined below) and the Conditions.
Musharaka
Partners The
Company and the Trustee.
Managing Partner
The
Company (in such capacity, the ‘‘Managing Partner’’).
Obligor The Company (in
such capacity, the ‘‘Obligor’’).
Joint Lead
Managers Barclays
Bank PLC, Deutsche Bank AG, London Branch, Dubai Islamic Bank PJSC and Lehman
Brothers International (Europe) (together the ‘‘Joint Lead Managers’’).
None of the Issuer, the Trustee, the Joint Lead
Managers and the Delegate are responsible for the performance or the
profitability of the Musharaka or the Musharaka Assets or for the share and
amount of the distributions (if any) made to the Trustee pursuant to the
Management Agreement. Further, none of the Issuer, the Trustee, the Joint
Lead Managers and the Delegate make any representation or accept any
responsibility as to the feasibility of the Business Plan or whether its
objectives can or will be achieved.
Musharaka
Profit Distribution The
objective of the Musharaka, pursuant to the Business Plan, is to generate
profit by utilising the Musharaka Assets in accordance with the Business
Plan. The Musharaka is expected to yield, net of Taxes, a minimum profit of
EIBOR plus 1.31 per cent. per annum on the capital of the Musharaka. The
profit generated by the Musharaka shall be distributed by the Managing
Partner two Business Days prior to each Periodic Distribution Date. Such
profit will be distributed in accordance with the following proportions:
Trustee: 99% Company: 1% If the profit payable to the Trustee is greater than
the relevant Periodic Distribution Amount, any surplus profit distributable
to the Trustee over the Periodic Distribution Amount will be recorded by the
Managing Partner in the
Musharaka
Accounts as a credit to the line item entitled ‘‘Musharaka Profit Reserve
Amount’’. Any amount standing to the credit of the Musharaka Profit
Reserve Amount column in the Musharaka Accounts on the Musharaka End Date
will, subject to the terms of the Musharaka Agreement, will be paid to the Company
as an incentive fee for acting as Managing Partner. The Managing Partner may,
however, prior to the Scheduled Redemption Date use the amounts standing to
the credit of the Musharaka Profit Reserve Amount (an ‘‘Advance Incentive
Fee’’) so long as any amounts deducted from the Musharaka Profit Reserve
Amount prior to the Scheduled Redemption Date are recredited in the event
that on a Periodic Distribution Date the aggregate of (i) the funds available
to the Musharaka for distribution to the Musharaka Partners on that date,
plus (ii) the amounts then standing to the credit of the Musharaka Profit
Reserve Amount, is less than the relevant Periodic Distribution Amount. If
such profit is less than the relevant Periodic Distribution Amount or if for
any other reason the funds available in the Transaction Account on the
Periodic Distribution Date are not sufficient to enable the Trustee to pay
the relevant Periodic Distribution Amount due on the relevant date, in full
for any reason, the Managing Partner will deduct such shortfall from the
Musharaka Profit Reserve Amount. If the amounts standing to the credit of the
Musharaka Profit Reserve Amount are insufficient (after the Managing Partner
has re-credited any Advance Incentive Fee), the Managing Partner shall meet
the shortfall through the provision of Shari’a compliant financing and in the
event this is not possible it will provide an interest free loan to the
Trustee which shall be repayable solely from profits of the Musharaka.
Management
Agreement The
Musharaka Partners will each appoint the Company as Managing Partner of the
Musharaka under a management agreement (the ‘‘Management Agreement’’).
The management responsibilities of the Managing Partner will be set out in
the Management Agreement and will entitle the Managing Partner to take all
necessary or desirable action on behalf of the Musharaka to achieve the
Musharaka’s objectives.
Purchase
Undertaking The
Company (acting in its capacity as Obligor and not as Managing Partner) will
execute the Purchase Undertaking dated on or about the Closing Date in favour
of the Trustee. Under the Purchase Undertaking, the Obligor will undertake
that upon the Trustee exercising its right to oblige the Obligor to purchase
all (or, as the case may be, a pro rata part) of the Trustee’s Units, the
Obligor shall purchase the same on the relevant Exercise Date following the
delivery of an exercise notice (an ‘‘Exercise Notice’’) by the Trustee
under the Purchase Undertaking, in the form prescribed by the terms of the
Purchase Undertaking.
Summary of the
Certificates
Certificates AED
7,500,000,000 Trust Certificates (Sukuk Al-Musharaka) due 2012 (the ‘‘Certificates’’).
Closing Date 27 November
2007.
Scheduled
Redemption Date 27
November 2012.
Issue Price 100 per cent.
of the aggregate principal amount of the Certificates.
Status Each
Certificate will evidence an undivided beneficial ownership interest in the
Trust Assets and will rank pari passu, without any preference, with
the other Certificates. The Certificates will be limited recourse
obligations of the Issuer as described below.
Periodic
Distribution Dates 27
May 2008 (the ‘‘First Periodic Distribution Date’’) and each 27 November
and 27 May thereafter up to and including the Periodic Distribution Date
falling on 27 November 2012.
Periodic
Distributions On
each Periodic Distribution Date, Certificateholders will be entitled to
receive the Periodic Distribution Amount (as defined in Condition 5.1) from
moneys received in respect of the Trust Assets (representing a defined share
of the profit in respect of the Trust derived from payments made to the
Trustee under the Management Agreement).
Scheduled
Dissolution Unless
previously redeemed, the Certificates shall be redeemed in full by the
Trustee on the Scheduled Redemption Date at an amount equal to the
Dissolution Distribution Amount (as defined below) as of such date and the
Trust shall be dissolved following such payment in full.
Dissolution
Distribution Amount
means as of any Redemption Date (other than the Change of Control Put
Date), the
aggregate principal amount of the Certificates outstanding plus the aggregate
of all accrued and unpaid
Periodic
Distribution Amounts as of such date and, in the case of the Change of
Control Put Date, the aggregate
principal
amount of the Certificates to be redeemed plus the aggregate of all accrued
and unpaid Periodic Distribution
Amounts, in
respect of the Certificates to be redeemed, as of such date.
Use of Proceeds
The
proceeds of the sale of the Certificates will be applied as the Trustee’s
Cash Contribution to the Musharaka. See ‘‘Musharaka Agreement’’.
Listing Applications
have been made for the Certificates to be listed on the primary exchange of
the Dubai International Financial Exchange and the Official List of the UK
Listing Authority and to be admitted to trading on the London Stock
Exchange’s Gilt-Edged and Fixed Interest Market.
Ratings The Certificates
have been rated ‘‘A+’’ by Standard & Poor’s and ‘‘A1’’ by Moody’s. A
rating is not a recommendation to buy, sell or hold securities and may be
subject to suspension, reduction or withdrawal at any time by the assigning
rating agency.
Clearance and
Settlement Holders
of the Certificates must hold their interest in the Global Certificate in
book entry form through Clearstream, Luxembourg. Transfers within
Clearstream, Luxembourg will be in accordance with its usual rules and
operating procedures. See ‘‘Clearance and Settlement’’.
Denominations The
Certificates will be issued in minimum denominations of AED 500,000 and
integral multiples of AED 100,000 in excess thereof.
|
10.3.4. Skuk Process
In order to issue Skuk normally issuer creates a
special purpose vehicle (SPV) and transfers the ownership to it which
ultimately passes on to Skukholders in the form of certificates. Bank collects
the amount from users of facility (in case of Ijarah Skuk) on behalf of SPV and ultimately return is
distributed to certificate holders. Depending upon the circumstances some or
all of the following parties participate in the process including issuer,
arranger, underwriter, rating agency, auditor, and guarantor. Following (figure
10-1) is an illustrated process of Ijarah Skuk. Suppose three depositors A,B,C
deposited amount with bank. Bank after maintaining reserve invested into
physical asset and transferred asset on lease. Further bank issued Skuk of
equal value through a special purpose vehicle (SPV) to investors, for value of
assets and transferred ownership. As the rent is known to bank hence investors
know their return. Job of bank is now to collect the rent and distribute among
the investors through SPV. These Skuk are trade able in secondary market. Although
return is fixed however not like conventional bonds because risk of ownership
is to be borne by investors. Sometimes an independent party may guarantee
return to investors without any charge to create confidence among investors.
Most important document in Skuk issue is the prospectus (offering document). It includes overview of issue, business plan, parties involved, management of Musharaka, terms of Musharaka, payment procedure, expected return to skukholders, listing, sale and purchase of Skuk, clearing procedure, applicable laws, redemption of certificates on due date, premature dissolution of Musharaka and redemption of certificates, rating of the issue, risk analysis etc. although prospectus includes business plan which incorporates expected return, however such returns cannot be guaranteed by issuer, however an independent person (organization) can g guarantee of such returns to investors in order to build confidence among investors in the issue. Such guarantee must be without any charge or interest in the issue.
An important observation about Skuk issued so for is redemption of certificates at issue price and payment of returns as IBOR plus certain basis points. Ideally returns on Skuk should be provided on the basis of actual returns generated from the business. An Ijarah Skuk should provide the return to holders on the basis of actual rent of assets and Musharaka Skuk should distribute profit on the basis of actual profit earned instead of IBOR plus certain basis points. Likewise redemption price of Skuk should be decided on the basis of actual market value of assets, instead of redeeming at par. If value of assets against which Skuk were issued has been decreased (usually in case of Ijarah Skuk) or increased (usually in case of Musharaka Skuk) then redemption at par value must be discouraged. It is very valid view that return on Skuk should be at least at par with conventional bonds; however, the objective can be achieved through higher rentals in case of Ijarah Skuk. In case of Musharaka Skuk, these are equity units and should be served on the basis of actual results. Market itself will decide the intrinsic value of securities and should be called for redemption on market price in order to promote the real essence of Islamic finance i.e. sharing of risk and reward.
Suggested Readings
Most important document in Skuk issue is the prospectus (offering document). It includes overview of issue, business plan, parties involved, management of Musharaka, terms of Musharaka, payment procedure, expected return to skukholders, listing, sale and purchase of Skuk, clearing procedure, applicable laws, redemption of certificates on due date, premature dissolution of Musharaka and redemption of certificates, rating of the issue, risk analysis etc. although prospectus includes business plan which incorporates expected return, however such returns cannot be guaranteed by issuer, however an independent person (organization) can g guarantee of such returns to investors in order to build confidence among investors in the issue. Such guarantee must be without any charge or interest in the issue.
An important observation about Skuk issued so for is redemption of certificates at issue price and payment of returns as IBOR plus certain basis points. Ideally returns on Skuk should be provided on the basis of actual returns generated from the business. An Ijarah Skuk should provide the return to holders on the basis of actual rent of assets and Musharaka Skuk should distribute profit on the basis of actual profit earned instead of IBOR plus certain basis points. Likewise redemption price of Skuk should be decided on the basis of actual market value of assets, instead of redeeming at par. If value of assets against which Skuk were issued has been decreased (usually in case of Ijarah Skuk) or increased (usually in case of Musharaka Skuk) then redemption at par value must be discouraged. It is very valid view that return on Skuk should be at least at par with conventional bonds; however, the objective can be achieved through higher rentals in case of Ijarah Skuk. In case of Musharaka Skuk, these are equity units and should be served on the basis of actual results. Market itself will decide the intrinsic value of securities and should be called for redemption on market price in order to promote the real essence of Islamic finance i.e. sharing of risk and reward.
Suggested Readings
[1 ] AAOIFI. 2004. Shari’a
Standards. P.O. Box 1176, Bahrain.
[2 ] AAOIFI.2003. Accounting and
Auditing Standards for Islamic Financial Institutions, International
Institute of Islamic Economics, Islamabad, Pakistan.
[3 ] Hanif, M., (2011). Differences
and similarities in Islamic and conventional banking. International Journal
of Business and Social Sciences 1:5, pages
[4 ] Khan, M.A., (1989). Economic
Teachings of Prophet Muhammad: A Select Anthology of Hadith Literature on
Economics, chapter 6:2, page 72. International Institute of Islamic
Economics, P.O. Box 1647, Islamabad, Pakistan.
[5 ] KMI-Broacher 2008. Available at
KSE.com accessed on 14/10/2010.
[6 ] Lau & Quay, (1974). The Tokyo
stock exchange and the capital asset pricing model. The journal of finance, Vol. 29, No. 2, pp .507-514
[7 ] Reilly, F.K., & Brown, K.C.,
(2003). Investment Analysis & Portfolio Management 7th edition,
South-Western, 5191 Natorp Boulevard, Mason, Ohio 45040.
[8 ] Sheikh, S.A., (201). Corporate
Finance in an Interest free economy: An alternate approach to practiced Islamic
Corporate finance. Available at http://www.accountancy.com.pk/articles.asp?id=190 accessed on 8/2/2011.
[9 ] Siddiqi, M.N., 2004. Riba, Bank interest
and the rationale of its prohibition. Islamic Research & Training Institute
Jeddah.
[10 ] Tomkins, & Karim, R.A.A, (…….).
The Shari’ah and its Implications for Islamic Financial Analysis: An
Opportunity to Study Interactions among Society, Organization and Accounting.
Available at http://www.financeinislam.com/article/1_39/1/420 accessed on 9/2/2011.
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