Murābahah Sukūk

1. MurābahahSukūk Ali Saeedi Member of the board Securities & Exchange Organization Presented by:

2. Contents 1. Islamic Instruments and Contracts, • 2. Murābahah Contract, • 3. Murābahah Sukūk, • 4. Different Types of Murābahah Sukūk, • 5. Comparison of Murābahah & Ijārah Sukūk, 6. Shari'ah Considerations, 7. Regulations Considerations,

3. Islamic Instruments and Contracts

4. Behind Financial Instruments Capital market: A marketin which debtor equity securities are traded. Capital Market: A place for Contracts. Financial Instruments: Designed on the basis of different contracts, e.g. Murābahah Sukūk based on Murābahah contract, …

5. Murābahah Contract Definition Sale of goods with an agreed upon profit mark up on the cost. Murābahah sale is in two types: 1- In the first type, the Islamic bank purchases the goods and makes it available for sale without any prior promise by a customer to purchase it. 2- In the second type, the Islamic bank purchases the goods ordered by a customer from a third party and then sells these goods to the same customer. In the latter case, the Islamic bank purchases the goods only after a customer has made a promise to purchase them from the bank. Source: The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)

6. Murābahah Sukūk

7. Murābahah Sukūk • Murābahah Sukūk is securities in which the holders of which are the common owners of a financial asset (a debt) based on the Murābahah Contract. • These securities have a fixed yield and available for sale in the secondary markets. • Originator (or any other part) should be able to pay the installments via its own activities • Rate of profit and maturity date should be clarified in the contract.

8. The Elements of Murābahah Sukūk

9. Special Purpose Vehicle (SPV, SPE, SPC) • SPV is a legal entity which is authorized to raise funds by issuing securities through the conduct of transactions under the category of Islamic contracts. Base on Iranian regulations, SPV is a financial institution. • SPV and originator should be independent and should not be affiliated by originator: • 1- In order to prevent the conflict of interests, (SPV should be the agent of Sukūk holders and act on behalf of them), • 2- In case of bankruptcy, all assets of the originator including, SPV would be at risk (if SPV would be affiliated by originator), • 3- To execute transactions correctly (true sale) from the Shari'ah point of view.

10. SPVs structure in Iran Tehran Stock Exchange CDS Farabourse An Affiliated Co. of SEO Capital Asset Management Co. SPV2 SPV1 SPVn …………………….. • SPVs Should be Independent from Originators

11. Different Types of Murābahah Sukūk

12. Various Types of Murābahah Sukūk • 1. MurābahahSukūkfor Buyers Financing, • 2. Murābahah Sukūk for Sellers Financing, • 3. Mortgage Murābahah Sukūk, • 4. Liquidity Murābahah Sukūk.

13. 2 Common types of Murābahah Sukūk • Adopted by all Islamic schools of thought

14. SPV (as issuer) issues the MurābahahSukūk, collects the funds of the investors by investment banks services (the “Principal Amount”), and on behalf of investors buys the commodity needed by the originator from a commodity supplier in cash and sells it to the originator in form of a Murābahah contract over an agreed period of time and agreed rate of profit. Originator undertakes to pay to the SPV the price of the commodity (Principal + Profit) on due dates. • MurābahahSukūk for Buyers Financing

15. Murābahah Sukūk for Buyers Financing Regulator, Investment Banks, Rating Agencies, Auditors Originator (Buyer) 5. Selling Asset with Credit Payment (Spot Delivery) 6. SukūkProceeds (Deferred Price) 3. Spot Payment 1. Issuing Sukūk Investors Commodity Supplier SPV 4. Spot Delivery 2. SukūkSubscription

16. SPV (as issuer) issues the Murābahah Sukūk, collects the funds of the investors by investment banks services (the “Principal Amount”), and on behalf of investors buys the commodity of the originator and sell it to buyer in form of a Murābahah contract over an agreed period of time and agreed rate of profit. Buyer undertakes to pay to the SPV the price of the commodity (Principal + Profit) on due dates. • MurābahahSukūk for Sellers Financing

17. Murābahah Sukūk for Sellers Financing Buyer (Leasing Co.) 5. Selling Asset with Credit Payment (Spot Delivery) 6. SukūkProceeds (Deferred Price) 3. Spot Payment 1. Issuing Sukūk Investors Originator (Seller) SPV 4. Spot Delivery 2. SukūkSubscription

18. 2 other types of Murābahah Sukūk • Are not adopted by all Islamic schools of thought

19. SPV issues the Sukūk, collects the funds of the investors then acts on their behalf and buys from the bank (originator) mortgage facilities arising from the Murābahah Contracts. The originator undertakes to collect on the due dates the mortgage facilities assigned by the debtors and deliver them to the SPV. The SPV will give to the holders of the Sukūk the funds received from the Bank through the customer. The investors may wait until maturity dates and enjoy the interest arising on the Murābahah or otherwise sell the Securities in the secondary markets before the due dates. • Mortgage Murābahah Sukūk

20. Mortgage Murābahah Sukūk (Cont…) 3. Spot Payment for Bank’s Receivables/Debt 1. Issuing Sukūk Investors Bank SPV 4. Selling Debts 2. Sukūk Subscription Financial Facilities Receivers (Murābahah Based) 6. Paying Installments • If Bai al Dayn is accepted

21. SPV collects the funds of the investors, then acts on their behalf and buys in cash one of the Originators’ physical assets then sells the same asset at a higher price to the originator itself on credit terms. The originator undertakes to give the credit price of the assets to the SPV on due dates. The purchase and sale on credit terms (Bay al-inah) is prohibited by most of Shiite and Sunni scholars. • Liquidity Murābahah Sukūk

22. Liquidity Murābahah Sukūk (Cont…) 3. Spot Payment 1. Issuing Sukūk Investors Originator SPV 4. Spot Delivery 2. SukūkSubscription 5. Selling Asset as Credit Payment Investors Originator SPV 6. Paying Profit 7. SukūkProceeds (Deferred Price)

23. Comparison of • Murābahah & Ijārah Sukūk

24. Murābahah Sukūk & Ijārah Sukūk • Ijārah Sukūk is most widely used among other Islamic financial instruments; however, after global downturn in Sukūk issuance in 2008, issuance based on Murābahah Sukūk increased by nearly 60.4%. • Since, Murābahah Sukūk can be used for working capital financing, and also it is fixed income Sukūk, so it has some advantages in comparison with the other types of Sukūk such as Ijārah and Mudārabah.

25. Comparison • Asset Backed & Asset Based • Murābahah Sukūk is asset based, but Ijārah Sukūk is asset backed. In asset-backed Sukūk, investors are legal owners of the asset but in asset-based, investors has beneficial owners or owners of cash flow generated by asset. • Debt or Equity Instrument • Murābahah Sukūk can be considered as a debt instrument, but Ijārah Sukūk is none of them and both of them. Investors in Ijārah Sukūk are owners of the asset and also based on the nature of Ijārah contract which is binding, it is similar to debt instrument. But in fact, Ijārah Sukūk can not be classified in none of the two groups.

26. Comparison (Cont…) • Risk Profile • Murābahah Sukūk is a debt instruments and risk of Sukūk does not focus on asset risk, but rather on credit risk of the originator & Ijārah Sukūk • Underlying Asset • In Murābahah Sukūk, the underlying asset can be a consuming asset such as materials and spare parts, or long term asset such as real estate and machineries. In Ijārah Sukūk, the underlying asset should have long term life cycle to be qualified for leasing.

27. Comparison (Cont…) • Marketability • Based on different jurisdictions, Murābahah Sukūk can have secondary market or not. Based on Shi'a and Shafei schools of thought, debt sale is accepted, so secondary market is available but scholars of other jurisdictions do not accept it. • If debt sale is accepted, marketability will exist, unless it will not be a liquid security.

28. Shari'ah Considerations

29. From a Shari'ah angle, agency agreements (Wukālah) [between SPV and investors], cash transaction and credit transaction of a tangible asset [between SPV and originator] is accepted by all schools. But, there is a divergence of views on contracts for purchase of debt (Bai al Dayn) [between investors]. According to opinions of renowned Shi'a and Shafei scholars it is permissible and according to opinions of Sunnite scholars it is rejected. • Shari'ah Considerations

30. If debt is discounted in a deferred payment [Bai al Dayn bi addayn], it will be rejected by all schools. If debt is discounted spot by third party, it will be very controversial: Hanafiyah, Hanabelah, some of Shafe’iyah and some of Shi'a scholars do not validate it, Most Shi’it scholars, some other of Shafe’iyah, IbnTaymiyah and IbnQayyem have validate it, The rest of Shafe’iyah validate it provided that: a. Debtor is wealthy and confess to have such a debt or his debt is proved by evidence. b. Debt is confirmed (Mustaqar) c. The substitute is delivered at the session of contract. • Shari'ah Considerations (Cont…)

31. Shari'ah Considerations (Cont…) • Why is it accepted by some schools? • If investor A can discount debt, investor B can take his place in secondary market, and if it is not permissible, both primary and secondary transactions are not permissible. • Why isn’t it accepted by other schools? • They believe that discounting has the same nature of Riba, any increase and decrease of debt [Qardh] is not permissible. Murābahah is an exception.

32. Regulations Considerations

33. Based on IFSB definition, “Sukūk are certificates with each sakk representing a proportional undivided ownership right in tangible and intangible assets, monetary assets, usufructs, services, debt or a pool of predominantly tangible assets, or business venture”, In asset-based instrument, originator typically transfers only the beneficial ownership of asset, so investors have no recourse to the assets. Based on IFSB standards, asset-based Sukūk should have credit rate, Credit enhancement is needed (such as third party guarantee, over- collateralization, excess spread, cash collateral), • Regulations Considerations

34. Regulations Considerations (Cont…) • Tax regulation is very crucial, each transaction has its tax expenses and if transaction would be taxable, cost of financing will increase and instrument can not be used in practice. • Underling asset must be clearly identifiable (may be in a specific project or investment activity) and Shari'ah complied. • The asset should be available when issuing the certificates or the conditions for its delivery should prevail at the periods of time fixed by the originator (unless it becomes Bay al-kali). • Types of acceptable assets: land; buildings and installations; machinery and equipment; means of transport; materials and goods. • .

35. Regulations Considerations (Cont…) • In the event that asset is in the form of materials, Murābahah Sukūkis short term instrument, but if asset is in the form of long term asset, Murābahah Sukūkis long term instrument. • Providing other documents and deeds relating to the asset should be mentioned in regulations (such as: commodity standard certificate, proforma invoice, warehouse receipt, …)

36. Regulations Considerations (Cont…) • In the event that asset is in the form of materials, distribution of specific series of Murābahah Sukūk in a step by step method should be allowed in regulation, but intervals should be determined in prospectus and should not be too long. Anyway, total contract price should be mentioned and registered. • Iranian capital market rules and regulations are available in the following website (English Version): • http://rdis.ir/Rules.asp

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