Islamic Finance – Islamic Capital Market - Floating or fixed rent payments
The Sukuk Ijarah's structure allows for either a set or floating rental payment based on a benchmark that is updated prior to the start of a new rental period. Rental will be updated every six months in accordance with the London Interest Based Selling Rate for the Malaysian Global Sukuk Ijarah (LIBOR). As long as the lessee and the lessor consented to this benchmark before signing the lease agreement, it is acceptable according to Shari'ah principles. Despite the benchmark's conventional nature, the structure is still legitimate because it has no dealings with interests. The benchmark serves as simply a point of comparison when determining the fund's cost, which will serve as the foundation for the new rental. The framework contains neither payments nor interest charges.
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Islamic Finance – Islamic Capital Market – Sukuk Ijarah
The Sukuk Ijarah, which is based on a sale and leaseback idea, was the first Islamic fixed-income instrument or Islamic security to be recognised by the global market. The idea of asset-based securitization was first presented in 2002 when Sukuk Ijarah was developed through the Malaysian Global Sukuk Ijarah. These leased assets are represented by securities, also known as Sukuks, that are issued out of them. These securities reflect an undivided and proportionate beneficial ownership of the leased asset, and they can be traded if a willing buyer and vendor are present. A ground-breaking innovation in providing investors with Islamic fixed-income securities was the creation of Sukuk Ijarah. Sukuks are tradable on the secondary market free from any Shari'ah restrictions because they reflect the ownership right of the leased asset as opposed to Islamic bonds or notes, which only represent pure receivables. The Sukuk Ijarah's diagrammatic structure demonstrates that the originator, who is the owner of an asset, initiates the process of its issuance. In order to make the principal and rental payment to the investors, the originator leases the asset back from the SPV for an amount equal to (x + y). Because they contributed the funds to buy the asset from the originator through an SPV/issuer, the investors are considered to be the proprietors of this asset. In the sense that the asset has been packaged and divided into pieces, an asset-based securitization has now occurred. All ownership rights and a stake in the asset are being purchased by investors who bought these units. The investors are similarly eligible to receive the rental payment once this asset is leased back to the originator since they are the asset's owners and lessors. Islamic Finance – Islamic Capital Market - Islamic Sukuks' characteristics, categories, and method3/7/2023 Islamic Finance – Islamic Capital Market - Islamic Sukuks' characteristics, categories, and method
The structure of Islamic bonds, which are essentially distinct from Sukuks, was covered in the preceding chapter. Sukuks are monetary-denominated participation certificates of equal unit value given to investors, in contrast to an Islamic bond, which is essentially a debt certificate or a "IOU". Sukuks were created through securitization, just like Islamic bonds. A Sukuk's subject matter of securitization is neither an obligation/debt nor a payment, in contrast to Islamic bonds. When tangible assets, usufruct rights, or an interest in a project are combined into securities that represent proportionate ownership, the procedure is referred to as a sukuk. Receivables or financial assets are not involved in a Sukuk transaction. Each holder of a sukuk has an unequal beneficial stake in the underlying assets. Consequently, in the case of Sukuk Mudarabah and Sukuk Musharakah, holders of Sukuk are qualified to receive a portion of the income produced by the pertinent assets. Regarding Sukuk Ijarah, the lease rental payments made by the lessor/obligor to the issuer/SPV are what produce the revenues, which are then proportionately distributed to Sukuk Ijarah investors. It's critical to realise that Sukuks, unlike bonds, are not "IOU" or loan certificates. Sukuks are usually certificates that show an investment in an asset or a project, typically an asset or a project that generates income. Investor returns are neither fixed nor guaranteed; instead, they depend on how well the fundamental asset performs. Prior to the creation of Sukuk Ijarah, the Malaysian market in particular had a difficult time issuing Islamic bonds or notes because the trading of these securities was founded on the idea of selling debt. This is so that Riba transactions are avoided. These Islamic bonds are basically based on receivables securitization, and any trading of these securities must be based on par value. The majority of academics believe that receivables reflect financial assets. In order to prevent the Riba element, which calls for an equal quantity in the exchange of money, the trading of those securities must be based on face value. Islamic Finance – Islamic Capital Market - Malaysian conventional bonds verses Islamic bonds3/7/2023 Islamic Finance – Islamic Capital Market - Malaysian conventional bonds verses Islamic bonds
The table above demonstrates how structurally comparable Malaysian Islamic bonds are to conventional bonds. The only difference between conventional bonds and Malaysian bonds is that in Malaysian bonds, the obligation to pay the investor results from Islamic contracts, and the coupon payable to investors represents the profit margin or mark-up resulting from a sale contract rather than an interest payable under a loan contract. This is the most basic Islamic security framework that mimics the behaviour of traditional bonds. The fundamental component of Islamic bonds, in contrast to the Sukuk framework, is the securitization of receivables. Receivables rights are represented by the securities issued, which can be sold or passed to third parties on the secondary market. Debentures, which are basically unsecured promises to pay a sum backed by the overall creditworthiness of the issuer, are what Islamic bonds are. The grade of the issuer is used to let investors know whether the issuer has the financial resources to make timely principal and coupon/profit payments. It is evident that the Islamic contracts have imposed obligations on the issuer who receives cash funding in some manner. The issuer will use the proceeds from these contracts to support general working capital needs or any other purposes, provided that the use of these proceeds complies with Shari'ah. The trading of these securities, which is founded on the Bay al-Dayn principle of the sale of debt, is very divisive on the international market. Islamic Finance – Islamic Capital Market – Istisna bond
Bonds of Istisna The Istisna' bond, used in Malaysia, has been modelled after the same idea. Istisna' is essentially a buy order contract for a future-delivery of an asset. The asset's selling price, delivery date, and method of payment can all be agreed upon by the buyer and seller. Due to the fact that the financier (investor) is neither the contractor/manufacturer nor the final user/buyer, parallel Istisna' appears to be more practical in contemporary Islamic finance than simple Istisna'. This is because, as was already discussed in chapter one. The (ultimate) buyer, the financier, and the manufacturer must all be autonomous participants in a parallel Istisna' arrangement. Sukuk Istisna, a Malaysian custom, is founded on two parties. Therefore, it remains subject to a "Inah contract," which is not recognised globally. In accordance with this arrangement, the project owner or party that has been granted a construction contract (the issuer) will engage into an Istisna' sale contract with the investors for a price of "x," which is payable either up front or dependent on the project's progress. This sum is equal to the quantity of financing that the issuer needs. The issuer will sell a good (to be supplied in the future to investors) at a price of "x" under the terms of this first Istisna' contract. The investor(s) will then engage into another Istisna' contract to sell the same asset to the issuer at "x+y" to be paid in the future using Istisna' Sukuks/bonds, as required by the first Istisna' contract. It goes without saying that since this securitization is based on receivables, trading in securities derived from this structure is not permitted on a global scale. Global Shari'ah issues are also raised by the use of a "Inah contract" in this construction contract rather than a true parallel Istisna contract, which would involve three different parties. Islamic Finance – Islamic Capital Market - Inah Contract
The "Inah" deal is what gives rise to the receivable. In accordance with this agreement, the issuer sells the investor an asset for a fixed price, "X," payable immediately, and the investor agrees to buy back the asset at a higher price, "X+Y," payable later. This can be interpreted as either the issuer having a future responsibility to pay "x+y" or as the investor having a receivable that is due and payable. This receivable's liability to be paid has been transformed into securities that investors can purchase. The contract of 'Inah is only recognised in Malaysia in terms of Shari'ah. The Securities Commission (SC) of Malaysia views a 'Inah as a valid contract that could result in the creation of securitized Islamic debt. According to the Shafi'i school of law, which also happens to be the official school of law in Malaysia, Malaysian scholars and authorities have primarily relied on the formal requirements of a valid contract without considering the purpose or content of the contract. According to this methodology, the "Inah contract" is considered to be a valid contract because it includes all necessary components, including an offer and acceptance, an offeror and an offeree, a topic matter, and a consideration. This school of law does not take into account the parties' desire to enable cash financing rather than buy an asset. 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. 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. |
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