ISLAMIC RESEARCH & TRAINING INSTITUTE (IRTI)(A member of)

ISLAMIC DEVELOPMENT BANK GROUP (IDBG)

Dr. Turkhan Ali Abdul ManapSenior Economist (IRTI)

Prepared forThe 2nd Kazan Sukuk Conference, April 9, 2015, Kazan© TAAM 2015

Tapping the Full Spectrum of Investors: The Sukuk Way

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Introduction

Capital Market and Economy

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The Five Pillars of Islamic Finance1) Prohibition of interest2) Prohibition of speculation3) Prohibition of the financing of illicit sectors (pork,

weapons, alcohol,…) 4) Profit & Loss sharing principle5) Asset backed principleHowever:Islamic finance is not restricted to Muslims (the “natural” clients) as some of its principles may attract non-Muslim clients.

What makes Islamic finance different?

◊The plural of the Arabic word Sak, literally translated as title deed

◊Financial certificates structured to comply with Shariah prohibition on the charging or paying interest(Riba) that grants an undivided interest or share in an underlying asset along with the profit, cash flow and risk commensurate with such ownership.

◊Technically, Sukuk refers to securities, notes, papers or certificates, with features of liquidity and tradability (except for salam and murabahah sukuk)

What is Sukuk

◊AAOIFI Definition

“Investment sukuk are certificates of equal value

representing undivided shares in ownership of

tangible assets, usufructs and services (in the

ownership of) the assets of particular projects or

special investment activity”

Accounting And Auditing Organization For Islamic Financial Institutions (AAOIFI)

◊The fundamental of Islamic Finance requiresAll contract arrangement must be

Transparent clear to all parties

No any unfair punitive clauses

With proper alignment of interest

Transaction must not involve excessive risk speculative due to uncertainty

Investments should have a social and ethical benefits to the society

No involvement of unethical business actives

◊Which implies that ……

How do Sukuk Differ from Bond

◊Sukuk constitute partial ownership in Receivables (sukuk al Murabaha)A lease (sukuk Al Ijara)A project (Sukuk Al Istisna)A business or partnership (Sukuk Al mudaraba / Musharaka)Investment (sukuk)

◊So Sukuk represents ownership of a real asset not like conventional bonds own debt.

How do Sukuk Differ from Bond

Comparing SUKUK to BONDSSukuk Bonds

1. Holder owns assets 1. Holder owns cash flow only

2. Use a variety of contracts to create financial obligations between issuer and investors; e.g. Sale, lease, equity partnership, joint-venture etc.

2. Simply use a loan contract to create indebtedness

3. Return linked to profit elements in-built in the sale, lease or partnership

3. Return linked to interest charged out of the loan contract

4. Instrument may be equity or debt depending on underlying contract

4. It is a Debt instrument

5. Tradability of the sukuk depends on the nature of the underlying asset

5. No restriction on the tradability

6. Investment in Shari`ah-compliant activities 6. Proceeds are invested in any business without restrictions

◊ sukuk transform bilateral risk-reward sharing between borrowers and lenders into market-based refinancing of shari’ah-compliant lending or trust-based investment in existing or future assets.

◊ sukuk do not pay interest, but generate returns through commoditization of capital gains from actual transactions (i.e., asset transfer), such as:

leasing : ijara cost-plus sale : murabahah profit-sharing/”sweat capital”/trust: musharakah or mudarabahshari’ah-compliant assets, usufructs or services

◊ investors own the underlying asset(s) via SPV that funds unsecured payments to investors from direct investment in real, religiously-sanctioned economic activity

How do Sukuk Differ from Bond

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Sukuk Market At A Glance

◊ Increasing appeal in non-core markets (UK, Turkey, Maghreb HK. UK and others)

◊Sukuk issuance soared over the last decades in response to growing demand for alternative investments

◊Outstanding sukuk globally exceeded US$1.8 trillion at end of 2013

◊Total issuance in 2014 equivalent to roughly a quarter o f conventional securitization in EM but only two percent of conventional (local and foreign) bond issuance

Development of Sukuk Market

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◊ Significant slowdown of Sukuk issuance in 2008 because of market conditions.

◊ Apparent recovery in the recent past

◊ Reportedly healthy pipeline

◊ 2014 Global Sukuk Market bounces back from 2013 low with almost $116.4 billion

sukuk issued in the first nine months

TOTAL GLOBAL SUKUK ISSUANCES (JAN 2001 – DEC 2014, USD MILLIONS)

0

20000

40000

60000

80000

100000

120000

140000

1172137170509645

13698

33837

50041

24264

37904

52978

92403

137499

111300116400

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◊ Murabaha and Ijarah structure are still the

preferred choice

◊ By structure, Murabahah and Ijarah remain popular

choices among issuers in 2014 with 58% and 15%

respective shares for each structure in total sukuk

issuances

Sukuk Insurance by Structure (2014)

Murabaha59%

Ijarah15%

Musharaka7%

Wakala5%

Salam1%

Bai' Inah4%

Bai' Istijrar1%

Istithmar0%

Others5%

Bai' Bithamin Ajil 2%

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Sukuk Insurance by Region

Malaysia67%

Suadi Arabia10%

United Arab Emirates

5%

Indonesia 4%

Turkey3%

Qatar3%

Bahrain2%

Others 6% Malaysia has

taken the lead but GCC is still contributing significantly.

Malaysia 351494 1388Brunei 60903 113Indonesia 21890 65Qatar 19655 17Bahrain 12545 226Pakistan 7669 17UAE 6855 11Sudan 2868 26Gambai 194 401Hong Komng 1000 1South Africa 500 1UK 340 2Luxembourg 272 1Yemen 250 2Senagal 200 1Singapore 193 5Germanay 123 1Nigeria 71 1

◊ issuance still concentrated in parts

of Asia and countries of the GCC

◊ Sovereign issuances dominated the

global Sukuk market

◊ Government and related entities are

driving the growth of the market

compared with FI and corporates in

the past.

◊ This trend should help the

construction of a yield curve against

which issuers can benchmark

themselves.

Sovereign Sukuk Issuance (2004-2014)

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Sukuk Structure

Sukuk Basic Structure

Main Sukuk Types

Main Type of Sukuk

Basic Structure of Ijarah Sukuk

Basic Structure of Murabaha Sukuk

Basic Structure of Commodity Murabaha Sukuk

Basic Structure of Musharaka Sukuk

Basic Structure of wakala Sukuk

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The Way Forward…..

◊ Islamic finance has become increasingly important in the global financial market, registering exponential growth over the past few years.

◊Compared with a size of only US$700 billion in 2008, the global Islamic financial industry has expanded remarkably to an estimated US$1.8 trillion by the end of 2013, representing an annual average growth rate of 21%.

◊According to market estimates, there is a huge potential for further growth, with Islamic financial assets expected to reach US$6.5 trillion by 2020

Why Russia Needs to Develop Islamic Finance and Sukuk

◊ Sukuk market is the major growth area for Islamic finance◊ Ten years ago, new sukuk issuance was only a modest US$5

billion. In just ten years' time, annual sukuk issuance has already surpassed US$100 billion, amounting to US$117 billion in 2013 which was more than 20 times higher than the figure in 2003

◊ The current account surpluses in the Gulf Cooperation Council (GCC) countries are estimated to be more than US$300 billion

◊ while assets under management by sovereign wealth funds in those countries amounted to as much as US$2 trillion

◊ Islamic investors in the Middle East and other Islamic countries generally have a preference for investing in Shariah-compliant assets. 

Why Russia Need to Develop Islamic Finance and Sukuk

◊sukuk are becoming a mainstream asset class in the global financial system.

◊Financial innovation and tax reform in major international financial centers have made sukuk largely comparable to conventional bonds.

◊Apart from Islamic investors, sukuk are increasingly appealing to conventional investors as a way to diversify their investment portfolios.

Why Russia Need to Develop Islamic Finance and Sukuk

◊ build a conducive platform for sukuk issuance◊ sukuk are no different from conventional bonds in terms of

economic substance, enabling issuers to raise funds while giving investors interest-like return.

◊ However, the more complicated structure of sukuk, which involves the setting up of a special purpose vehicle and multiple transfers of underlying assets, had led to additional tax liability for sukuk issuers.

◊ Tax law amendments need to overcome this obstacle by removing the additional profits tax and stamp duty charges incurred in issuing sukuk as compared with conventional bonds.

◊ Therefore , level the playing field between sukuk and conventional bonds with tax framework changes .

What Russian Needs to do

◊ To play a lead-off role for by Issuing Sovereign Sukuk To demonstrate to the global financial markets that the legal,

regulatory and taxation frameworks in Russian can well accommodate sukuk issuance.

To Encourage and attract more investors. ◊ Government sukuk could play a catalytic role, paving

the way for local and international fund-raisers, no matter from the public or private sector, to follow suit.

◊ Make Kazan as a gateway of IFC to Russia’s access to global financial markets

Matching the needs of fund raisers and investment demand of investors among Russia, the Middle East, and other parts of the world interested in Islamic financial products

What Russian Needs to do

◊ There are at least two ways to kick-off sukuk insurance ◊ 1) Gradual approach:

A though legal and tax framework adjustment to cattle the Sukuk insurance but takes long time

◊ 2) Fast track Off shore insurance Location of SPV

Withholding tax (20%) – Non residents in Luxembourg and Netherlands

VAT tax (18%) – Non-resident leasing out asset such as aircraft to Russian do

not need pat VAT

Property Tax (2.5) – Basically are exempted if the asset is immovable asset.

The way forward …...

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Thank You

ISLAMIC RESEARCH & TRAINING INSTITUTE(A member of)

ISLAMIC DEVELOPMENT BANK GROUP

Contact Dr. Turkhan Ali Abdul ManapSenior EconomistResearch Division Islamic Research & Training Institute P. O. Box 9201, Jeddah 21413Kingdom of Saudi Arabia Email: turkhanali@isdb.orgwebsite: www.irti.orgTel: + 966 12 646 6329Fax: + 966 12 637 8927