Islamic Finance – Islamic Capital Market - Sale and buy back agreements
Receivables resulting from a sale and buyback agreement have clearly been securitized, as is evident. The quantity of money that investors will be eligible to receive from the issuer is reflected in the bonds or notes issued under these two structures. This sum of money comprises of the principal as well as the non-dissociable profit margin. These assets can either be kept until they mature or sold to raise cash. Their secondary market market worth will affect the sale price. A holder will receive MYR1,050,000 in total at the maturity time, for instance, if the principal amount is MYR1,000,000 and the coupon amount is MYR50,000. They will receive a total of MYR1,030,000 if they sell their securities on the secondary market and the market worth of the principal is only MYR980,000. They will receive a total of MYR1,050,500 if the market worth is MYR1,000,500.
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Islamic Finance – Islamic Capital Market - Malaysian Islamic bonds and notes structure
In the Malaysian context, bonds and notes are distinguished from one another as was stated above. Bonds are typically issued for long-term funding, whereas notes, also known as Medium Term Notes (MTN) and Commercial Papers (CP), are typically issued for medium- and short-term financing. Market practise gives the Bay' Bithaman Ajil (BBA) contract, also known as the deferred payment sale for Islamic bonds, and the Murabahah contract, also known as the MTN and CP contract, respectively, for Islamic notes. These distinctions are not the result of a Shari'ah classification or requirement; rather, they are pushed by the market. It demonstrates that their "sell and buy-back" agreement is where the issuer's duty to reimburse the investor stems from. Also take notice that there is no SPV in either of the following diagrams, unlike the ones that came before. This is mainly due to the lack of separation between the roles of the originator and issuer in this situation, which places the SPV unnecessarily in the context of a BBA bond. BBA bonds are basically the issuer's obligations that are supported by an ongoing flow of receivables from compliant contracts of exchange. Investors are mainly exposed to the originator's credit risk. The Murabahah Commercial Paper has a comparable structure, but in this case a facility agent is in charge of managing and processing the short-term instrument's tendering process. In both of the aforementioned structures, the issuer—who would be the borrower in a standard bond—will choose an asset to be used in the sale and buyback deal. However, MCP uses a bidding procedure for the investors to purchase the asset. As a result, the issuer will ask the members of the tender panel to submit offers to buy the commodity. There is no Shari'ah requirement for this commercial activity. Prior to issuing the bonds under the BBA bond, investors are typically named. Contrary to Murabahah MTN or CP, which are founded on a tender panel member bidding process, this deal is referred to as a bought deal. Islamic Finance – Islamic Capital Market - Benefits of obtaining money through receivables securitization
The issuer will receive funds totaling $100 million as one of the advantages of using this method to raise money. These may be used as working capital or for any other shari'ah-compliant reason. Bonds will be given to the investors as proof of their eligibility or right to demand payment from the issuer. Due to the fact that it is a bond and can be freely traded in the secondary market, the Malaysian practise is not usually regarded favourably by other international investors. Many scholars believe that the trading of bonds, which are fundamentally based on debt, or a future obligation to pay investors or future receivables due to investors, contains an element of riba because a bond is considered to be money. Any exchange of currency must take place on an equitable footing and at face value. But market value serves as the foundation for bond selling in the secondary market. For the majority of academics who are not from Malaysia, selling bonds at any price above face value is equivalent to paying riba because the bonds reflect cash sums owed. The contention that these debts are produced by selling or leaseback contracts is at the heart of the justifications for this legality. According to Malaysian academics, these debts do not typically result from a loan (Qard/Hassan) contract. Unlike loans, debts that are the result of sales or leases, such as Istisna and Murabahah, can be purchased and sold for any amount because the assets that sustain these debts are the objects of sales or lease agreements. Islamic Finance – Islamic Capital Market - Malaysian Islamic bonds
The securitization of debts serves as the foundation for Islamic bonds in Malaysia. Usually, the issuer is a business looking to issue Islamic bonds in order to generate capital. A credit transaction is used to solve the problem because Islamic law prohibits borrowing in exchange for paying interest. The contracts known as Murabahah, "Inah," "Tawarruq," "Ijarah," "Salam," and "Istisna" are used to establish Islamic duties. In Malaysia, the selling and buyback agreement known as Bay al-'Inah is the most typical. In this structure, the issuer will choose a resource to offer to investors in exchange for money, let's say $100 million. The investors will then transfer the asset back to the issuer for $120 million, payable over the course of five years, at principal plus a markup. The issuer now owes the investors $120 million, which is made up of the original amount and the markup amount. The issuer will pay the investors the markup amount in fixed installments, such as twice a year, usually in the shape of a coupon. Only on the maturity date will the capital be returned. Islamic Finance – Islamic Capital Market – Technical Features of Conventional and Islamic Bonds/ Notes
The following are the technological characteristics of conventional and Islamic bonds: (a) Bonds issued to investors represent the right to receive payments from the bond issuer; they are also considered to be debentures, which are unsecured promises to pay backed only by the issuer's general credit. (b) While the issuer is the borrower/debtor, the investor is the lender/creditor. (c) For Islamic bonds, the return or coupon rate is typically fixed for the duration of the issuance; however, the investor may also benefit from the capital gains in the second Issuer failure risk, also referred to as credit risk, is typically a concern for investors. Islamic bonds, which are merely "IOU" certificates, do not have the potential to be subjected to investment risk or market risk. Islamic Finance – Islamic Capital Market - The characteristics, varieties, and process of Islamic bonds
Sharia debt Islamic bonds, as previously stated, have a similar basic structure to conventional bonds, with the exception that the obligation or debts to be securitized must come from an agreement that is valid in accordance with Islamic commercial law. These kinds of Islamic bonds are only popular in Malaysia because, they do not comply with worldwide Shari'ah standards. In a move started by Bank Negara Malaysia, this form of bond was first introduced in Malaysia in 1983. (Central Bank). The first Islamic bank to be founded in Malaysia was Bank Islam Malaysia Berhad (BIMB), which was unable to hold interest-bearing government securities because it was an Islamic institution. As a result, government investment certificates—not papers bearing interest—were distributed. These certificates, which stand in for a charitable credit or an interest-free loan (Qard/Hassan) to the government, could be purchased by BIMB (and other Islamic banks). On these assets, there was no set interest rate. Instead, the government would announce the rate of return at its sole judgement. However, because their sole purpose was to assist BIMB and other Islamic banks in meeting the statutory reserve and liquidity standards, these securities could not be traded. Islamic Finance – Islamic Capital Market - Conventional Asset Backed Securities
A product founded on asset-backed securitization has also been introduced to the traditional financial market (ABS). Securitization, in general, refers to an arrangement that transforms something into its securities-based cash counterpart. Both asset-backed and non-asset-backed securitization fall under this. What makes ABS special is that payments to investors are primarily made from the financial flows of the assets that were moved from the originator to the issuer, either directly or indirectly. Investors who purchase these assets will notice that the source of payment comes from a known cash flow that was present before the ABS was issued. The mortgage loans that the obligors, or customers, are expected to repay in this scenario serve as the cash flow. In other words, investors are completely aware that the income stream that has been transferred to the SPV will be used to pay the interest and principal on the bonds. The obligation to pay the bond is supported by this asset in the shape of receivables produced from mortgage loans, making it theoretically a more "secured" bond. The same structure could be used for Islamic ABS as long as the cash flow or asset being moved to the SPV complies with Shari'ah rules and the process for issuing the bond or Sukuk to the investors complies with Shari'ah rules as well. Bonds and notes that are guaranteed by asset pools or that are collateralized by revenue flows from a particular pool of underlying assets are known as asset-backed securities. Financial assets or receivables or physical assets may support the issue. Receivables securitization, also known as Tawriq, is the process of turning assets transferred to the SPV/issuer into securities known as Sanadat. Asset-backed securities, or Sukuks, can be used to describe the assets if they are physical assets. Let's use a ship leasing business as an illustration, which leased five of its vessels to an oil company as the originator. Assume that a five-year lease agreement between the leasing business and the oil company has been signed, and the rental receivables amount $700 million. The leasing firm may choose to sell these five vessels and its rental receivables to an SPV for $600 million under Islamic ABS. The SPV will receive the rental money from the oil firm and distribute it to the investors proportionately. Islamic Finance – Islamic Capital Market – Sukuk Ijarah
A entity that needs to raise money is the company. The business, or "originator," will choose an asset to transfer to a Special Purpose Vehicle in order to make this possible (SPV). The SPV will issue Sukuks in its capacity as the buyer in order to lend the asset back to the originator. Investors who subscribe to these Sukuks are regarded as the asset's real owners. The company/originator will be given access to the selling proceeds through the SPV for their use. The SPV will then lease the same asset back to the business/originator for a subsequent number of years at [cost of fund x spread], which will serve as the equivalent of the renting payment. Each Sukuk holder will receive a proportionate share of the rental payment profits. Islamic Finance – Islamic Capital Market - Asset-based deals using Sukuks
Taskik, asset-based transactions are unusual in Islamic banking. The procedure explains how proprietorship of material possessions, usage rights to those possessions, or both, are divided. It also applies to the rights to a project interest that has been divided into equal-valued units and subsequently made tradeable. Sukuks are securities arranged using this technique. Sukuks are "certificates of equal value reflecting undivided shares in ownership of a tangible asset, a usufruct and services, or in the ownership of the assets of specific projects or a special investment activity," according to the AAOIFI. Sukuks, which represent the proportionate ownership of the investors in a specific asset that is anticipated to produce income, are not the same as shares or bonds. Because the issuer has no responsibility to repay the principal, plus interest or profit, it is not a bond. The payment is based on the revenue this product generates. Sukuk also cannot be compared to shares because they only represent ownership of specific Sukuk assets as opposed to shares, which also represent ownership in the business. Asset-based securities don't deal with cash assets or receivables. Each holder of a sukuk has a separate ownership stake in the fundamental assets. As a result, Sukuk investors are qualified to receive a portion of the profits made by Sukuk assets. The assets could be physical, like a hospital or power plant, or they could be usufructs, like the right to a leased asset or any stake in a specific project, like building work. Islamic Finance – Islamic Capital Market -Islamic Bond
A conventional bond structure and an Islamic bond structure built on receivables securitization are similar. A simple "IOU" under which the issuer is required, by a written arrangement, to pay both the profit margin and the principal amount is what constitutes an Islamic bond, as in the case of Murabahah securitization. The only difference between traditional bonds and Islamic bonds is in the nature of the underlying arrangements. The Shari'ah-compliant contract that establishes this duty is a requirement for Islamic bonds. This applies to Ijarah, Istisna, and Murabahah. This type of securitization is known as a receivables-based securitisation because Islamic bonds in this context relate to holders' rights to receivables arising from either a Murabahah, Istisna', or Ijarah contract. |
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