Securitization and Structure of Sukuk (2)

Types of Sukuk

1. Mudarabah Sukuk

2. Musharakah Sukuk

3. Ijarah Sukuk

4. Istisna’ Sukuk

5. Salam Sukuk

6. Murabahah Sukuk

Mudarabah Sukuk

• According to AAOIFI: The issuer of mudarabah sukuk is the mudarib, subscribers are the owners of capital and the realized funds are the mudarabahcapital.

• The sukuk holders own the assets of mudarabah operation and profit share as per agreement.

• The sukuk holders also bear the loss, if any.

• Can be traded in the secondary market.

Mechanism of MudarabahSukuk

1. Company and investors (represented by SPV) enter into a mudarabah agreement

2. SPV (managed by Trustee) issues sukukevidencing proportionate participation in underlying mudarabah venture

3. Investors make proportionate payments to account of mudarabah capital

Diagram

Company(Mudarib)

SPV(Rabb al-Mal)Representing

investors

Investors

Mudarabahagreement

sukuk

$

Musharakah Sukuk

• Ultimately, the idea of musharakah is similar to a mudarabah except that in a msuharakah the intermediary party will be a partner of the group of subscribers represented by a body of musharakahsukuk holders.

• Both the originator and investors must contribute to the capital.

• The same structure as mudarabah sukukcan be applied.

Diagram

Company(Sharik)

SPV(Sharik)

Representinginvestors

Investors

Musharakahagreement

sukuk

$

Ijarah Sukuk

• In order to recover the cost of the asset purchase, the lessor, after entering into ijarah, can sell the leased asset partly to a number of individuals.

• The purchase of the portion of the asset by each individual may be evidenced by a certificate called ijarahsukuk.

• As the asset is already leased to the lessee, the individual new owners of the asset may also enjoy the rent payment proportionally.

• On top of that, the holder of ijarah certificate can sell it in secondary market.

Modus Operandi

• First the company sells certain leasable asset to SPV. The SPV issues sukuk to the investors to raise the required funds for its purchase of the asset. The SPV then leases back the asset to the company for a pre-fixed and specified amount and maturity. Therefore, each investor will have the right to earn the rent according to his proportion of ownership in the asset.

The Structure of Ijarah Sukuk

Company (Lessee)

SPV (Lessor)

Sukuk

Investors

Secondary Market

Istisna’ Sukuk

• Istisna’ is a sale of manufactured commodity delivered at a future date for a flexible method of payment.

• Istisna’ sukuk are certificates or documents that carry equal value and are issued with the aim of mobilizing the funds required for producing a certain item.

• The issuer of sukuk is the manufacturer (seller), while the sukuk holders are the buyers of the item to be produced.

Istisna’ Sukuk with SPV and its structure

Manufacturer

SPV

Company Sukuk

Investors

1. Istisna’ sale btw. SPV and Manufacturer

2. SPV issuing sukuk

3. Sukuk bought by investors

4. SPV delivers the product

Salam Sukuk

• Salam is a sale whereby the seller undertakes to supply some specific goods to the buyer at a future date in exchange of an advanced price fully paid on the spot.

• Salam sukuk are certificates of equal value issued for the sake of mobilizing capital that is paid in advance in the shape of the price of the commodity to be delivered later.

• The seller of the salam commodity issues the sukuk, while the subscribers are the buyers of the commodity, i.e. they are the owners of the commodity when delivered.

Application

• The Bahrain government sells alumunium to Bahrain Islamic Bank (BIB), which has been nominated to represent the other banks wishing to participate in the salam contract.

• BIB then appoints the government its agent to market the alumunium at the time of delivery at a price which provides a return to the sukukholders.

• Secondary market trading of salam is impermissible since the sukuk represent a share in the salam debt.

Murabahah Sukuk

• Murabahah creates receivables.

• Murabahah receivables cannot be securitized for sukuk creation, because they represent debt receivables which can be sold only at par value.

• Trading in sukuk based on murabahah will involve bay’ al-dayn – the debt trading at a discount.

Securitization of Murabahah Mixed Portfolio

• If a murabahah transaction is included in a mixed portfolio consisting of a number of transactions, including musharakah and ijarah, then this portfolio can be securitized based on certain condition.

• If the tangible assets of the fund are more than 51%, while the liquidity and debts are less than 50%, then the sukuk can be negotiated and traded.

Issue of Mixed liquid and illiquid assets

• In most cases, the assets of the project are a mixture of liquid and non-liquid assets.

• According to Hanafi school, whenever there is a combination of liquid and non-liquid assets, the certificate can be sold and purchased for an amount greater than the amount of liquid assets in the combination, in which case money will be taken as sold at an equal amount and the excess will be taken as the price of the non-liquid assets owned by the holders.

Example

• Suppose musharakah project contain 40% of illiquid assets i.e. machinery, plants etc. and 60% liquid assets i.e. cash and receivables. So the certificate having face value of £100 represents $60 worth of liquid assets, and £40 worth of illiquid assets. This certificate may be sold at any price more than £60.

Cont’d….

• If it is sold at £110, it will mean that £60 of the price are against £60 contained in the certificate and £50 is against the proportionate share in the non-liquid assets.

• It will never be allowed to sell certificate for a price of £60 or less, because in the case of £60 it will not set off the amount of £60, let alone the other assets.