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Monday, 23 January 2012

Malaysia: Infrastructure sukuk receives a major boost

Infrastructure sukuk has received a major boost when Projek Lebuhraya Usahasama Berhad (PLUS Berhad) last week closed a record landmark RM30.6 billion sukuk issuance program comprising both government guaranteed (GG) and non-government guaranteed AAA-rated (AAA) issuances of varying tenors, sizes and expected returns and yields to maturity (YTMs).
The issuance was through PLUS Malaysia Sdn Bh, which is a jointly-owned special purpose company of UEM Group Berhad and the Employees Provident Fund (EPF), which was set up to acquire the Malaysian business and undertakings including the assets and liabilities of PLUS Expressways Berhad, the major provider of expressway operation services in Malaysia, under a privatization exercise (proposed acquisition). Following the completion of the proposed acquisition, PLUS Malaysia's wholly-owned subsidiary, PLUS Berhad will acquire all the assets and liabilities of the respective concession companies via the issuance of the GG Sukuk and AAA Sukuk Musharaka.
The program, according to lead arranger and Principal Adviser, CIMB Investment Bank, comprised RM11 billion of GG issuances and RM19.6 billion of AAA issuances and are based on a bought deal and private placement basis. The non-government guarantee component could be increased to RM23.35 billion.
It is no secret that national road agencies from several countries, especially those in emerging countries, have been watching the PLUS offering closely with the hope of attracting investors to participate in their own road expansion and rehabilitation programs with the strong interest and therefore possibility of issuing Sukuk to do this against toll roads operated by these agencies.
Countries with huge areas such as Saudi Arabia, Turkey, India, South Africa, China, Pakistan, Iran, Egypt and do on, whose road infrastructure needs further development and rehabilitation, in particular could use competitive financing alternatives such as Sukuk to fund these needs based on innovative and fair revenue models.
Two national road agencies — one from a Muslim country and the other from a non-Muslim country — have in fact confirmed that they have initiated feasibility studies and preliminary discussions to issuing sukuk as part of their source of funding diversification strategies. The major problem is lack of familiarity about the structures of Sukuk; issues relating to prohibitive demands on collateral and guarantees; lack of legal infrastructure in the domicile of the potential new issuers; and concern over the Shariah compliance of such issuances. 
One of the national road agencies stressed that it has had discussions in the past with several potential lead managing suitors for a potential sukuk, but discussions did not progress because of legal limitations over asset ownership.
With the difficult global bond market conditions, there are signs that infrastructure companies are seeking to diversify to other funding sources in addition to the traditional equity and government budget financing. Sukuk is emerging as an attractive and viable alternative.
A few months ago, for instance, Syarikat Prasarana Negara Berhad, the Malaysian public infrastructure company wholly-owned by the Ministry of Finance, successfully closed its RM2 billion Sukuk Al-Ijarah offering under its RM4 billion nominal value sukuk program, whose proceeds will be used mainly to part finance the Kelana Jaya and Ampang LRT Line Extension Project and other infrastructure improvement initiatives by Prasarana. The issuance is guaranteed by the Malaysian government. 
Prasarana usually issues only conventional bonds to finance its activities. The company was set up to facilitate, undertake and expedite public infrastructure projects approved by the government and together with its group of companies are also asset-owners and operators of several public transport providers, namely the Ampang and Kelana Jaya lines, KL Monorail system, bus operations in Klang Valley and Penang, as well as the cable car services in Langkawi.
This RM2bn issuance was the first time that the company tapped the Islamic capital market with a sukuk issuance, and according to Prasarana Chief Executive Officer Shaipudin Shah Harun, there will be further finance raising forays in the future to fund the company's expansion plans, and Parasarana is committed to contribute to the further development of the Malaysian sukuk market. This issuance was actually structured in 2009 by joint lead managers and arrangers AmInvestment Bank and CIMB Investment Bank, with Bank Islam Malaysia acting as co-manager. But the issue was delayed due to the impact of the global financial crisis which badly affected pricing and yields in both the conventional bond and sukuk markets.
Sukuk and infrastructure should be a natural fit. While the sukuk market has flourished over the last four years, these have concentrated more on raising finance for balance sheet purposes; refinancing existing more expensive debt including very often conventional finance debt; overcoming the mismatch between short-term deposits and longer term liabilities by raising longer term financing; and providing working capital and funds for expansion.
Sukuk for development and infrastructure projects such as pure project sukuk have been hardly a feature of the sukuk landscape, although there have been a few exceptions. This is surprising given the estimated multi-trillion dollar infrastructure spend in the IDB member countries over the next decade or so.
The latest PLUS Sukuk Program, whose issuer and obligor is provides an ambitious financing conduit for the toll road services operator, which some observers stress would only be possible in a country such as Malaysia where the government is a proactive supporter of involving Islamic finance in the economy together with conventional financing options under its economic transformation program (ETP).
The GG issuances comprised two tranches of RM5.5 billion each — the one with a tenor of 26 years with a periodic distribution rate of 4.86 percent and the other with a tenor of 27 years and 353 days with a periodic distribution rate of 5 percent respectively.
The AAA issuances, which are Sukuk Al-Musharaka, comprised a total of 21 tranches with tenors ranging from 5 years to 25 years with a periodic distribution rate ranging from 3.9 percent to 5.75 percent respectively.
PLUS Expressways operates and maintains 973 kilometers of inter-urban toll expressways in Peninsular Malaysia, stretching from the border of Thailand in the north to the border of Singapore in the south, linking all major cities on the west coast of Peninsular Malaysia.
(Arab News/15-Jan-2012)

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Qatar Islamic banking directive to set example for other markets

The deadline of Dec. 31, 2011, as per the directive issued by the Central Bank of Qatar (CBQ) in January 2011 requiring the country's conventional banks which have opened Islamic banking windows to close them down, has passed almost unnoticed.
Despite the initial outcry at the time of the announcement of the directive stressing that it was too arbitrary and the grace period was too tight, there has been no upheaval of the Islamic finance industry in the emirate. Some Islamic bankers are now arguing that the move was required to stem the alleged rampant co-mingling of conventional and Islamic funds at some of the Islamic banking windows, and that the Qatari Islamic banking sector has been successfully re-aligned and consolidated.
The successful implementation of the directive in Qatar could well have implications for other markets in the region and beyond where Islamic banking windows are prevalent. The clear message of the directive is that dedicated standalone Islamic banks are preferable to half-way houses where co-mingling and all sorts of compromises are possible if not the norm. They also give greater legal, regulatory and Shariah compliance clarity and comfort to those depositors and investors interested in Islamic finance.
The affected banks included the Al-Islami window of Qatar National Bank (QNB), the largest bank in the emirate; Commercial Bank of Qatar; Doha Bank; HSBC Amanah; Ahli Bank; Al-Khaliji Bank and International Bank of Qatar (IBQ), which between them had 16 Islamic banking branches in Qatar.
On Jan. 1, 2012 it became clear that only one such window, Al-Yusr of International Bank of Qatar, was acquired by two local Islamic banks — the retail banking assets and business was acquired by Barwa Bank, the newest of the Qatari Islamic banks, while the corporate banking assets and portfolio was acquired by Qatar Islamic Bank (QIB), the largest Islamic bank in the emirate.
The other banks had wound down their Islamic banking window operations complete with removing all signage and of course not opening any new accounts or businesses. Existing Islamic banking customers were in some cases given the option of switching to the banks' conventional banking business or in other cases to continue payments until affected Islamic financing facilities matured.
An unrepentant CBQ Gov. Sheikh Abdullah bin Saud Al-Thani as late as mid December 2011 warned the affected banks that the directive was "irreversible" and that they must comply with its provisions. In his keynote speech to the 8th International Conference on Islamic Economics and Finance (ICIEF) which was held in Doha in December 2011, Al-Thani articulated the reasons behind the central bank's directive, which he confirmed is irreversible.
The Islamic Banking Windows, according to Gov. Al-Thani, made it difficult for the banking regulator to effectively implement its monitoring and supervision of these windows.
This issue could not have been highlighted more aptly during the acquisition of Al-Yusr's Islamic Retail Banking business. As the first such transaction to be closed in the region, albeit under Qatari law, there were some legal and other regulatory challenges which UK law firm, Eversheds, which acted for Barwa Bank, successfully navigated through within the provisions of existing Qatari legislation.
"The IBQ window was not a separate legal entity. As such, its assets and liabilities were a part of the conventional bank. We therefore had to consider how best to separate and then package and transfer these assets and liabilities. There were also challenges concerning transition services that were required post completion to serve the transferring customers," explained Amjad Hussain, partner and head of Islamic Finance at Eversheds, in a recent interview.
The central bank also found that the coupling of conventional and Islamic banking activities at the same institution, undermined competition and transparency in the affected banks. At the same time, there is much confusion over the balance sheet treatment of the assets and liabilities of the Islamic banking windows in the financial reports of the conventional banks, which are not separated. As such this has implications for the risk management process of the institution.
Al-Thani gave the thumbs up to the Qatari Islamic banking industry which boasts four Islamic banks — Qatar Islamic Bank, Qatar International Islamic Bank, Masraf Al-Rayan and Barwa Bank. These banks, he added, have a crucial role in the country's banking sector and economy, in compliance with the objectives of the Qatar Vision 2030 and its first application through the First Strategic National Development Project 2011-2016.
He reminded Qatari Islamic banks of their partnership role in financing economic development and projects in the country, and stressed that he was confident that the Qatari Islamic banks will rise to and are capable of taking up this challenge together with their conventional counterparts. The Islamic banking sector has a 20 percent market share of the total banking industry in Qatar, which has four dedicated standalone Islamic banks.
It was way back in 2005 that the CBQ allowed conventional banks to launch Islamic Banking Units (IBUs), which have contributed to the growth of the sector and to the profitability of the banks, and which have attracted an estimated customer base of just under 100,000.
Eversheds' Hussain rejects any notion of arbitrariness in the action of the CBQ in issuing the directive. The action, he contended, is "part of a wider process of supporting and shoring up the banking industry in Qatar. You have to look at it in the context of the proactive approach of the central bank during the recession when it helped a number of local banks to remove some of the toxic debts that they had exposure to. The CBQ is also making sure that there are enough opportunities for all the market players."
Previously, the Islamic banking windows were barely competing because of co-mingling issues and because they were able to offset overheads through the conventional banks. There was a feeling that the market was not as transparent as it could be. In addition to regulatory issues, the central bank had to deal with two separate businesses dealing with different banking activities - Islamic and conventional.
"I believe competition was an issue, because the pure Islamic banks were seen to be at a disadvantage. The Islamic banking windows at the conventional banks were able to use backroom services in their banks. There were also regulatory and corporate governance concerning how manage different banking platforms under one roof which is what the conventional banks were trying to do. This resulted in a culmination of issues which the CBQ is trying to address in its efforts to improve out the banking sector," explained Hussain.
(Arab News/22Jan2012)
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AAOIFI's Shari'a Board Resolutions on Sukuk-English version

In the name of Allah, the Beneficent, the Merciful. 
Praise be to Allah, and peace and blessings on His Noble Prophet and on his family and Companions 

As to what follows: 
The Shari'ah Board of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), in view of the increased use of Sukuk worldwide, the public interest in them, and the observations and questions raised about them, studied the subject of the issuance of Sukuk in three sessions; first, in al-Madinah al-Munawwarah, on 12 Jumada al-Akhirah 1428 AH (27 June, 2007), second, in Makkah alMukarramah, on 26 Sh'aban 1428 AH (8 September, 2007), and third in the Kingdom of Bahrain on 7 and 8 Safar 1429AH (13 and 14 February, 2008).  

Following the meeting of the working group, appointed by the Board, which met in Bahrain, on 6 Muharram 1429AH (15 January, 2007), which was also attended by a significant number of representatives from various Islamic banks and financial institutions, the working group presented its report to the Shari'ah Board.

After taking into consideration the deliberations in these meetings and reviewing the papers and studies presented therein, the Shari'ah Board - while re-affirming the rules provided in the AAOIFI Shari'ah Standards concerning Sukuk - advises Islamic financial institutions and Shari'ah Supervisory Boards to adhere to the following matters when issuing Sukuk:

First: Sukuk, to be tradable, must be owned by Sukuk holders, with all rights and obligations of ownership, in real assets, whether tangible, usufructs or services, capable of being owned and sold legally as well as in accordance with the rules of Shari'ah, in accordance with Articles (2)1 and (5/1/2)2 of the AAOIFI Shari'ah Standard (17) on Investment Sukuk. The Manager issuing Sukuk must certify the transfer of ownership of such assets in its (Sukuk) books, and must not keep them as his own assets.

Second:  Sukuk, to be tradable, must  not represent receivables or debts, except in the case of a trading or financial entity selling all its assets, or a portfolio with a standing financial obligation, in which some debts, incidental to physical assets or usufruct, were included unintentionally, in accordance with the guidelines mentioned in AAOIFI Shari'ah Standard (21) on Financial Papers.

Third:  It is not permissible for the Manager of Sukuk, whether the manager acts as Mudarib (investment manager), or Sharik (partner), or Wakil (agent) for investment, to undertake to offer loans to Sukuk holders, when actual earnings fall short of expected earnings. It is permissible, however, to establish a reserve account for the purpose of covering such shortfalls to the extent possible, provided the same is mentioned in the prospectus. It is not objectionable to distribute expected earnings, on account, in accordance with Article (8/8)3 of the AAOIFI Shari'ah Standard (13) on Mudaraba, or to obtaining project financing on account of the Sukuk holders.

Fourth:  It is not permissible for the Mudarib (investment manager), sharik (partner), or wakil (agent) to undertake {now} to re-purchase the assets from Sukuk holders or from one who holds them, for its nominal value, when the Sukuk are extinguished, at the end of its maturity. It is, however, permissible to undertake the purchase on the basis of the net value of assets, its market value, fair value or a price to be agreed, at the time of their actual purchase, in accordance with Article (3/1/6/2)4of AAOIFI Shari'ah Standard (12) on Sharikah (Musharaka) and Modern Corporations, and Articles (2/2/1)5 and (2/2/2)6 of the AAOIFI Shari'ah Standard (5) on Guarantees. It is known that a Sukuk manager is a guarantor of the capital, at its nominal value, in case of his negligent acts or omissions or his non-compliance with the investor's conditions, whether the manager is a Mudarib (investment manager),  Sharik (partner) or Wakil (agent) for investments.  In case the assets of Sukuk of al-Musharaka, Mudarabah, or Wakalah for investment are of lesser value than the leased assets of "Lease to Own" contracts (Ijarah Muntahia Bittamleek), then it is permissible for the Sukuk manager to undertake to purchase those assets -  at the time the Sukuk are extinguished - for the remaining rental value of the remaining assets; since it actually represents its net value.

Fifth: It is permissible for a lessee in a Sukuk al-Ijarah to undertake to purchase the leased assets when the Sukuk are extinguished for its nominal value, provided he {lessee} is not also a partner, Mudarib, or investment agent. Sixth:  Shari'ah Supervisory Boards should not limit their role to the issuance of fatwa on the permissibility of the structure of Sukuk. All relevant contracts and documents related to the actual transaction
must be carefully reviewed {by them}, and then they should oversee the actual means of implementation, and then make sure that the operation complies, at every stage, with Shari'ah guidelines and requirements as specified in the Shari'ah Standards. The investment of Sukuk proceeds and the conversion of the proceeds into assets, using one of the Shari'ah compliant methods of investments, must conform to Article (5/1/8/5)7 of the AAOIFI Shari'ah Standard (17).  Furthermore, the Shari'ah Board advises Islamic Financial Institutions
to decrease their involvements in debt-related operations and to increase true partnerships based on profit and loss sharing in order to achieve the objectives of the Shari'ah.

In the end, all praise is due to Allah, Lord of all the Worlds!


2. Definition of Sukuk: Investment Sukuk are certificates of equal value representing undivided shares in ownership of tangible assets, usufruct and services or (in the ownership of) the assets of particular projects or special investment activity, however, this is true after the receipt of the value of the Sukuk, the closing of the subscription and employment of funds received for the purpose for which the Sukuk were issued.
5/1/2  It is permissible to issue certificates for (to securitize) assets that are tangible assets, usufruct and services by dividing them into equal shares and issuing certificates for their value. As for debts owed as a liability, it is nor permissible to securitize them for the purpose of trading.
 8/8 The Mudarib is entitled to a share of profit as soon as it is clear that the operations of the Mudaraba have led to the realization of a profit. However, this entitlement is not absolute, as it is subject to the retention of interim profits for the protection of the capital. It will be an absolute right only after distribution, i.e. when actual or constructive valuations take place. It is permissible to distribute the realized profit among the parties on account, in which case the distribution will be revised when actual or constructive valuation takes place. The final distribution of profit should be made based on the selling price of the Mudaraba assets, which is known as actual valuation. It is also permissible that the profit be distributed on the basis of constructive valuation, which is valuation of the assets on the basis of fair value. Receivables shall be measured at the cash
equivalent, or net realizable, value, i.e. after the deduction of a provision for doubtful debts. In measuring receivables, neither time value (interest rate) nor discount on current value for extension of period of payment
shall be taken into consideration
 3/1/6/2 It is permissible for a partner to issue a binding promise to buy, either within the period of operation or at the time of liquidation, all the assets of the Sharika as per their market value or as per agreement at the date of buying. It is not permissible, however, to promise to buy the assets of the Sharika on the basis of face value.
2/2 Guarantees in trust (fiduciary) contracts
2/2/1 It is not permissible to stipulate in trust (fiduciary) contracts, e.g. agency contracts or contracts of deposits, that a personal guarantee or pledge of security be produced, because such a stipulation is against the
nature of trust (fiduciary) contracts, unless such a  stipulation is intended to cover cases of misconduct, negligence or breach of contract. The prohibition against seeking a guarantee in trust contracts is more stringent in Musharaka and Mudaraba contracts, since it is not permitted to require from a manager in the Mudaraba or the Musharaka contract or an investment  agent or one of the partners in these contracts to guarantee the capital, or to promise a guaranteed profit. Moreover, it is not permissible for these contracts to
be marketed or operated as a guaranteed investment.
 2/2/2 It is not permissible to combine agency and personal guarantees in one contract at the same time (i.e. the same party acting in the capacity of an agent on one hand and acting as a guarantor on the other), because
such a combination conflicts with the nature of these contracts. In addition, a guarantee given by a party acting a an agent in respect of an investment turns the transaction into an interest-based loan, since the capital of the investment is guaranteed in addition to the proceeds of the investment, (i.e. as though the investment agent had taken a loan and repaid it with an additional sum which is tantamount to riba). But if a guarantee is not stipulated in the agency contract and the agent voluntarily provides a guarantee to  his clients independently of the agency contract, the agent becomes a guarantor in a different capacity from that of agent. In this case, such an agent will remain liable as guarantor even if he is discharged from acting as agent.
5/1/8/5 The prospectus must state that the investment of the realized funds and the assets into which the funds are converted will be undertaken through Shari’ah-compliant modes of investment.


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