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.
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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. Islamic Finance – Islamic Capital Market - Bonds and notes are basic securities.
Bonds and notes, which are essentially "IOU" certificates that state the issuer owes the holders an obligation, are examples of plain securities. At a later time, or at maturity, the issuer is required to pay the principal and interest (in the shape of a coupon). Various countries use the terms bonds and notes. Bonds are used for issues with a longer maturity term in some markets. Notes are those with a shorter issuance time. In other markets, there is no longer a difference between bonds and notes, and both are used regardless of the maturity term. The right to demand payment at a specific time in the future is represented by bonds or notes. The securitization of receivables is where these securities got their start. The process of converting debt and its maturity into papers that can be sold on the secondary market is known as tawriq in Arabic. Securitization is the use of Islamic bonds and notes, which are legal in some countries, including Malaysia. Holders of Islamic bonds and notes must come from agreements that have been sanctioned by Islam, such as murabahah, istisna, and ijarah. Some academics refer to these assets as Sanadat, which are debt certificates. A conventional bond is a "IOU" that is issued after borrowing money from buyers. The bond gives investors the right to recoup set payments made by the issuer at predetermined intervals. Due to the fact that it is founded on a loan transaction, the issuer is obligated to pay the investor for both the principal amount, which will be paid at maturity, and interest payments, which will be paid at predetermined intervals, such as every two years. Three elements make up a bond's fundamental properties: A bond has a maturity date, at which point the bondholder gets the bond's par value. B. The interest payment is the interest rate that the bond's issuer pledges to pay the bondholder in exchange for the bondholder using the borrowed funds. c) Principal repayment, which the issuer pledges to make at the maturity date; this refers to the securitization of receivables. Islamic Finance – Islamic Capital Market - Islamic finance and securitization
Securitization is also viewed in Islamic banking as the process of gathering assets and putting them together into tradeable securities. Either Taskik or Tawriq can be used to execute the securitization process in Arabic. • The Shari'ah Standard on Investment Sukuk (Shari'ah Standard No.17) of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) defines taskik as the division of ownership of tangible assets, usufructs, or both into units of equal value and the issuance of securities in accordance with their value. • Tawriq is the transformation of a deferred debt into papers that can be traded in the secondary market for the time between the creation of the debt and the maturity period. These two definitions clearly allude to two different underlying assets being the subject of securitization, despite the fact that they both describe the same common procedure. Securitization in Islamic finance is essentially the process of turning something into papers that can subsequently be traded on the secondary market, whether it be receivables, usufructs, or tangible assets. Securitization, both in conventional and Islamic banking, is fundamentally the transformation of something that is illiquid. The primary difference between Islamic and conventional securitization is the type of securities being securitized. Islamic Finance – Islamic Capital Market - advantages to securitization
Securitization has the following advantages: • Because the securities it produces are capital market instruments, the issuer, who is also the borrower, borrows money from capital market investors when it issues securities like bonds; the lenders are not financial institutions; through securitization, the issuers/borrowers have direct access to capital market investors and can therefore borrow at a relatively low interest rate. • Investors can invest using instruments that are liquid in nature. They can liquidate their investment to choose other investment options quickly and affordably. If the market is favourable at the time of liquidation, investors may also realise capital gains. Islamic Finance – Islamic Capital Market - Securitisation
The process of turning an asset into cash or its cash equivalent in the shape of papers that can be traded on the secondary market is known as securitization. A usually illiquid asset can be converted into a more liquid form with the aid of securitization. Securitization essentially packages financial pledges and converts them into a form that permits free transfer among numerous investors. With the structured funding of mortgage pools in the 1970s, securitization got its start. Banks were basically portfolio lenders before the advent of this kind of financial engineering, holding loans or receivables until they matured or were settled. Deposits and debt, which was a direct duty of the bank, were the main sources of funding for these loans. Inadvertently, this limited banks' ability to make loans. The concept of securitization emerged in order to appropriately package the specified pools of loans or receivables, such as mortgage loans. These bundles would then be dispersed to investors in the form of securities or loans that are secured or collateralized by the underlying receivables pool. These assets are tradeable in the sense that holders or investors may offer to sell them on the secondary market to another interested party. Through this process, the leasing receivables are changed from an illiquid asset—a future cash flow—to instant cash funds for the business, or originator. Additionally, it will convert these packaged leasing receivables into securities that investors can purchase and subsequently liquidate at market value at any moment during the issuance period. The fixed yield paid from the cash flow and the rise in price of these papers when interest rates fall will both help investors who purchase these securities. |
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