FORWARD LEASE SUKUK

IN ISLAMIC CAPITAL

MARKETSStructure and Governing Rules

Ahcene Lahsasna, M. Kabir Hassan,

Rubi Ahmad

Forward Lease Sukuk in Islamic Capital Markets

Ahcene Lahsasna · M. Kabir Hassan Rubi Ahmad

Forward Lease Sukuk in Islamic Capital

MarketsStructure and Governing Rules

Ahcene LahsasnaSalihin Shariah AdvisoryKuala Lumpur, Malaysia

M. Kabir HassanDepartment of Economics

and FinanceUniversity of New OrleansNew Orleans, LA, USA

Rubi AhmadDepartment of Finance and Banking,

Faculty of Business and AccountancyUniversity of MalayaKuala Lumpur, Malaysia

ISBN 978-3-319-94261-2 ISBN 978-3-319-94262-9 (eBook)https://doi.org/10.1007/978-3-319-94262-9

Library of Congress Control Number: 2018947406

© The Editor(s) (if applicable) and The Author(s) 2018This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed.The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use.The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, express or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

Cover illustration: proxyminder, iStock/Getty Images Plus

This Palgrave Macmillan imprint is published by the registered company Springer International Publishing AG part of Springer Nature The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland

v

Preface

The present book focuses on one of the instruments in Islamic capi-tal market that is forward lease Sukuk also known as Ijarah mawsufah fi dhimmah. It discusses its structure, governing rules and analyse the Shari’ah issues along with the issuance process of this type of Sukuk. The present book adds value to Sukuk market and contributes to the growth and expansion of the Islamic capital market industry by presenting a comprehensive structure of forward lease which is regarded as innovative class asset. The idea of forward lease Sukuk is based on raising fund from non-existent asset where the subject matter does not exist during the time of the Sukuk issuance. This Shari’ah flexibility that exist in Ijarah makes Ijarah sukuk mawsufah fi dhimmah a dynamic financial instru-ment and resilient structure in the Islamic capital market that deserves to be promoted and encouraged in the related industry. The forward lease Sukuk related to tangible portfolio consists of Istisna and Ijarah; hence, it is a combination of two contracts where the rules of Ijarah in Islamic law will be applicable to Ijarah sukuk and the rules of Istisna will be applicable to Sukuk istisna. However, as overall structure the forward Ijarah sukuk is considered as a part of Ijarah sukuk portfolio that has more features and advantages that make it viable and dynamic instru-ments in Islamic capital market. Hence, the present book discusses the concept of forward lease Sukuk, in relation to its features, characteristics, structure, process of issuing, rules of trading in the secondary market, and other relevant issues and aspects. The book shows the significant fea-tures of forward lease Sukuk as a Shari’ah compliant instrument in the

vi PREFACE

capital market and its vital contribution to project construction and man-ufacturing within the expanding field of Islamic finance.

Objectives Of the bOOk

This book aims to discuss the concept, features, characteristics, structure, mechanism, process of issuing, trading in the secondary market, and other relevant issues and aspects that are relevant to Ijarah sukuk. Hence the book attempts to attain the following objectives:

1. To present a comprehensive structure of forward Sukuk as a promi-nent and promising instrument in the capital market.

2. To critically discuss the process of issuing and trading a forward lease Sukuk in the primary and secondary market.

3. To emphasize on the significance and importance of forward lease Sukuk in the Islamic capital market in terms of investment and fund mobilization.

4. Discuss and analyze different issues and challenges in forward lease Sukuk from the perspective of Shari’ah, law and marketability in the Islamic finance industry.

5. Identify the causes behind the low tendency toward issuance of Sukuk based on forward lease structure as compared to others types of Sukuk.

scOPe Of the bOOk

This book proposes to cover the various types and characteristics of the Sukuk be it debt-based, equity-based, or a hybrid of both. The book will be highlighting on the popular Sukuk with some analysis. It will focus on Ijarah sukuk as prominent Sukuk in the Islamic capital market. The concept of forward lease Sukuk is based on the theory of ijarah and istisna. As previously mentioned, it is important to discuss the basic rules of ijarah under Islamic law as it represents the underlying theory of Sukuk structure. In addition to that, the book will look into the dif-ferent types of ijarah, which includes the forward lease that represents the main concern of the present book. A cross comparison between dif-ferent types of Ijarah sukuk is needed to have an appreciation of the fea-tures and the different characteristics of forward lease Sukuk. It should

PREFACE vii

be noted that forward lease Sukuk is a part of Ijarah sukuk; however, there are special features in forward lease that makes it unique, flexible and a potential contract that can play a prominent role in the capital mar-ket. Furthermore, the structure of forward lease is different from normal Sukuk thus there will be some issues pertaining to forward lease Sukuk that are related to legal and Shari’ah aspects which the book will high-light and discuss in order to address the relevant solutions and to ensure the Shari’ah compliant procedure in forward lease Sukuk.

Kuala Lumpur, Malaysia New Orleans, USA Kuala Lumpur, Malaysia

Ahcene Lahsasna M. Kabir Hassan

Rubi Ahmad

ix

cOntents

1 Introduction to Sukuk 11.1 Introduction 11.2 An Overview on Sukuk 11.3 Sukuk as an Investment Certificate 21.4 Sukuk Versus Bonds 51.5 The Common Features Between Sukuk and Bonds 61.6 Sukuk Versus Shares 61.7 Sukuk Versus Securitization 81.8 Conclusion 9References 9

2 An Overview of Islamic Capital Market (ICM) and Sukuk Industry 112.1 Introduction 112.2 General Introduction to Islamic Capital Market

(ICM) 122.3 General Overview on Sukuk Market in Islamic Finance 192.4 The Growth of Sukuk Industry and Its Challenges

in the Current Global Financial Market 232.5 An Analysis of Sukuk in Islamic Capital Market 272.6 Key Milestones in Sukuk Market 302.7 Selected Notable Sukuk Issued 302.8 Conclusion 34References 35

x CONTENTS

3 Sukuk in Islamic Capital Market 373.1 Introduction 373.2 Definition and Concept 373.3 Characteristics of Investment Sukuk 383.4 Shariah Rulings and Requirements for Sukuk 393.5 Shariah Foundation and Risk Factors in Sukuk 423.6 Conclusion 47References 47

4 Types of Sukuk, Their Classification and Structure in Islamic Capital Market 494.1 Introduction 494.2 Types of Sukuk 494.3 Calcification of Sukuk Based on Shariah Contract 684.4 Conclusion 85References 85

5 Theory of Ijarah, Securitization and the Concept Financial Certificate 875.1 Introduction 875.2 Ijarah in Islamic Finance 875.3 Securitization and the Financial Certificate 955.4 Ijarah Sukuk in Islamic Capital Market 1015.5 Conclusion 110References 110

6 Forward Ijarah Sukuk: Concept, Issuance, Structuring and General Governing Rules 1116.1 Introduction 1116.2 Forward Lease 1126.3 Issuance of Forward Lease Sukuk 1346.4 Illustration of the Process and Phases of Sukuk

Issuance (The Structure of Forward Lease Sukuk) 1376.5 Structuring Forward Sukuk al-Ijarah and Steps

Involved 1386.6 General Rules of Forward Leasing 1396.7 Issues in Forward Ijarah Sukuk 1406.8 Conclusion 147References 147

CONTENTS xi

7 Major Principles, Terms and Conditions Governing Ijarah Sukuk Issuance as Practiced in the Islamic Capital Market 1497.1 Introduction 1497.2 The Description of Islamic Structure

of the Issuance 1497.3 The Important Shariah Aspects of the Structure

of Ijarah Sukuk 1537.4 Important Shariah Aspects in the Legal

Documents 1577.5 Other Terms and Condition in Ijarah Sukuk Issuance 1597.6 Conclusion 170

8 Forward Lease/Ijarah Sukuk: Issues, Challenges and Shariah Compliance 1718.1 Introduction 1718.2 Shariah Issues in Forward Lease Sukuk 1718.3 The Principles Terms and Conditions (PTC)

in the Sukuk Issuance 1728.4 The Legal Documentations/Transaction

Documents in Sukuk Issuance 1738.5 The Structure of the Sukuk Issuance 1768.6 The Trading Issue in Sukuk 1818.7 Legal Issues in Forward Ijarah Sukuk 1818.8 Industry Challenges of Forward Ijarah Sukuk 1828.9 Industry Acceptance of Forward Ijarah Sukuk 1838.10 Future Direction of Sukuk Issuance Based

on Forwards Lease Sukuk 1848.11 The Sukuk That Have Been Issued Based

on Forward Lease Sukuk 1848.12 Conclusion 185

9 Ijarah Sukuk and Forward Lease Sukuk—Case Study 1879.1 Introduction 1879.2 Ijarah Sukuk 1879.3 Forward Lease Sukuk Case Study 1979.4 Conclusion 204References 205

xii CONTENTS

10 Conclusion, Recommendation and Policy Implication 20710.1 Importance of Sukuk and Ijarah Sukuk 20710.2 Forward Lease Sukuk as Innovative Structure 20810.3 Forward Lease Sukuk Regulatory Guidelines 20810.4 Forward Lease Sukuk Issues and Challenges 20910.5 Forward Lease Case Studies 21110.6 The Underlying Asset in Forward Lease Sukuk 21110.7 Shariah Compliance Features

in Forward Lease Sukuk 21210.8 The Legal Documentation in Forward

Lease Sukuk 21210.9 The Expert of Sukuk Market and Forward

Lease Sukuk 213References 213

Appendix A: Securities Commission Malaysia Guidelines on Sukuk 215

Appendix B: IFSB Requirements on Sukuk Issuance 221

Appendix C: DFM Standard for Issuing, Acquiring and Trading Sukuk 237

Appendix D: Glossary 269

Bibliography 273

Index 281

xiii

abbreviatiOns

AAOIFI Accounting and Auditing Organization for Islamic Financial Institutions

BNM Bank Negara MalaysiaEL Expected LossFIs Financial InstitutionsIAIB International Association of Islamic BanksIDB Islamic Development BankIFSB Islamic Financial Service BoardIOSCO International Organization of Securities CommissionersIRTI Islamic Research and Training InstituteLIBOR London Inter-bank Offered RateOIC Organization of Islamic ConferencePLS Profit-and-Loss SharingPPFs Principal Protected FundsSC Securities Commission MalaysiaSPV Special Purpose Vehicle

xv

List Of figures

Fig. 2.1 Global Sukuk issuances: Sukuk report, IIFM (2009) 25Fig. 2.2 International Sukuk issuances: Sukuk report, IIFM (2009) 26Fig. 2.3 Medjool Sukuk Wakalah (Source Author) 32Fig. 2.4 DIB Sukuk Mudharabah (Source Author) 33Fig. 2.5 Saudi Electricity Company Sukuk bai istijrar (Source Author) 34Fig. 4.1 Asset-based Sukuk structure (Islamic debt securities) 51Fig. 4.2 Asset-backed securitisation process (Source Author) 54Fig. 4.3 Cagamas Mortgage backed Sukuk (Source Author) 55Fig. 4.4 Golden Crop Return Berhad—GCRB (Source Author) 56Fig. 4.5 Exchangeable Sukuk issuance (Source Author) 59Fig. 4.6 Exchangeable mechanism (Source Author) 60Fig. 4.7 Khazanah exchangeable Sukuk 2006 (Source Author) 62Fig. 4.8 Step 2 Periodic payment (Source Author) 63Fig. 4.9 Step 3 Dissolution amount upon maturity (Source Author) 64Fig. 4.10 Hybrid Sukuk (Source Author) 65Fig. 4.11 IDB Trust Certificate Issuance Program (2009) (Source

Author) 67Fig. 4.12 Sukuk mudarabah (Source Author) 70Fig. 4.13 AABAR mudarabah Sukuk (Source Author) 70Fig. 4.14 Sukuk musharakah (Source Author) 72Fig. 4.15 Imtiaz Sukuk Berhad (Source Author) 72Fig. 4.16 MAS Junior Sukuk (Source Author) 73Fig. 4.17 Sukuk salam (Source Author) 74Fig. 4.18 Bahrain Sukuk salam (Source Author) 75Fig. 4.19 Sukuk istisna (Source Author) 78Fig. 4.20 Durrat Sukuk Sukuk Bahrain (Source Author) 79

xvi LIST OF FIGURES

Fig. 4.21 Two parties parallel istisna (Source Author) 80Fig. 4.22 Tripartite istisna’ arrangement (Source Author) 80Fig. 4.23 Arcapita Bank murabahah issuance (Source Author) 82Fig. 4.24 Sukuk murabahah via tawarruq with SPV (Source Author) 83Fig. 4.25 Sukuk murabahah via tawarruq without SPV

(Source Author) 84Fig. 5.1 Ijarah sukuk (Source Author) 104Fig. 5.2 Malaysia Global Sukuk (Source Author) 105Fig. 5.3 WAPDA Ijarah sukuk (Source Author) 107Fig. 5.4 Types of Ijarah sukuk (Source Author) 108Fig. 6.1 Ijarah structure (Source Author) 137Fig. 6.2 Istisna’ structure (Source Author) 138Fig. 7.1 Ijarah sukuk structure (Source Author) 151Fig. 9.1 The Malaysia global Sukuk structure (Source Global Sukuk

and Islamic Securitization Market, Financial Engineering and Product Innovation, p. 172) 189

Fig. 9.2 Pakistan International Ijarah sukuk 191Fig. 9.3 Saxony-Anhalt Sukuk structure 192Fig. 9.4 IDB Trust Certificate Structure 196Fig. 9.5 The Zam Zam Tower al-Intifa’a Sukuk structure 199Fig. 9.6 Transaction flow of USD200m TABREED SUKUK 2006

(Istisna’ Stage) (Source Author) 201Fig. 9.7 Transaction flow of USD200m TABREED SUKUK 2006

(Ijarah Stage) (Source Author) 202Fig. 9.8 Transaction flow of USD200m TABREED SUKUK 2006

(additional feature) (Source Author) 203

xvii

List Of tabLes

Table 2.1 Key milestones in Sukuk market 31Table 4.1 Asset-based Vs Asset back Sukuk 57Table 4.2 No conversion/exchange Vs conversion/exchange 58Table 5.1 Tradability of Ijarah sukuk in the secondary market 107Table 6.1 Risk mitigation & Area of risk 133Table 9.1 Summary of the Malaysia Global Sukuk 188Table 9.2 Pakistan Ijarah sukuk 190Table 9.3 Summary of the Saxony-Anhalt Sukuk 193Table 9.4 Summary of the IDB Trust Certificates Sukuk 195Table 9.5 Summary of the Zam Zam Tower al-Intifa’a Sukuk 198Table 9.6 Summary of the Tabreed Sukuk 2006 200Table 10.1 Tradability of Ijarah sukuk in the secondary market 209

1

1.1 intrOductiOn

In recent years the Sukuk market has grown tremendously; it has become one of the fastest growing sectors in Islamic finance industry. Sukuk is regarded as a dynamic instrument for capital mobilization in both Islamic and conventional capital markets. In conventional finance, sources of funds or financing are obtained either through equity or debt. Equity financing is raised through the issuance of shares while debt is raised through the issuance of bonds. In Islamic finance, there are vari-ous sources of funds and Sukuk represents one of them.

1.2 an Overview On Sukuk

From a technical point of view, Islamic bond (or Sukuk) is defined as cer-tificates of equal value representing ownership over an underlying asset. Thus, they represent common shares and rights over the underlying assets or over usufruct (benefits derived from an underlying asset) and services. Sukuk have been structured and placed in the market according to different contracts such as ijarah, mudarabah or musharakah. Ijarah sukuk remains the most robust and solid instrument structure, and is considered as the most Shari’ah compliant compared to other types of Sukuk. Ijarah sukuk consists of a wide range including, usufruct, services for an existing asset or based on forward leasing known as ijarah mawsu-fah fi al dhimmah. Ijarah sukuk are asset-backed, provides consistent and

CHAPTER 1

Introduction to Sukuk

© The Author(s) 2018 A. Lahsasna et al., Forward Lease Sukuk in Islamic Capital Markets, https://doi.org/10.1007/978-3-319-94262-9_1

2 a. Lahsasna et aL.

stable income to the investors, are tradable in the secondary market and is represented by Shari’ah compliant trust certificates. They represent ownership of equal shares over an underlying asset or over usufruct of real estate. The return on the Sukuk is derived from the yield generated by the client’s lease of the asset. It gives their owners the right to own the real estate, receive the rent and dispose their Sukuk in a manner that does not affect the right of the lessee. The Sukuk holders bear all cost of maintenance and damages that may occur to the real estate

This present book aims to specially focus on forward leasing Sukuk under Ijarah sukuk with specific focus to forward lease. Hence there are specific features for forward lease Sukuk that make the structure more dynamic and flexible to accommodate current business models, and at the same time meeting the requirements of the modern finance in fund dissemination and mobilization.

This book also focuses on the concept of forward lease Sukuk with refer-ence to its concept, structure, mechanism, governing rules, along with the process of issuance with emphasis on the various Shari’ah issues. The book adds value to current academic literature as it represents the first study that looks into the forward lease Sukuk as the main item of interest, discussing its concept and governing rules. The book also contributes to the growth of the Islamic capital market industry by addressing the legal and Shari’ah issues along with the discussion on some cases as practiced in the market.

The idea of forward lease Sukuk is based on raising fund from a non-existent asset. A forward lease can accommodate projects such as building, construction or manufacturing where the subject matter does not exist at the beginning of the contractual agreement. This condition makes Ijarah sukuk mawsufah fi al dhimmah an attractive and dynamic financial instrument in the Islamic capital market. Forward Sukuk is con-sidered as a part of Ijarah sukuk that have features and advantages that make them a practical financial instrument for the Islamic capital market.

1.3 Sukuk as an investment certificate

Sukuk is an investment certificate of equal value representing after closing subscription, receipt of the value of the certificates, and putting it to use as planned; thus, it represents common shares and rights in the under-lined assets or their usufructs and services (AAOIFI Shariah Standards, 2010). The characteristic of Sukuk and its benefit attract many financial institutions to subscribe to the exercise of issuance and investing.

1 INTRODUCTION TO SUKUK 3

The main benefits of Sukuk are as follows:

• Investment Sukuk are documents issued in equal value in the name of the owner to establish the right of the certificate owner or rights and obligations. Therefore, there is a direct right associated with Sukuk.

• Investment Sukuk represent a common share of ownership of assets available for investments which generate a return to the Sukuk holders.

• Investment Sukuk are issued on the basis of Shari’ah compliant contracts; therefore, the return is legitimate and permissible from Shari’ah perspective because there is no element prohibited by Shari’ah such as riba.

• Sukuk are tradable Shari’ah compliant capital market products pro-viding medium to long-term fixed or variable rates of return. The tradability of the Sukuk in the secondary market make them very liquid instrument.

• Sukuk are assessed and rated by international rating agencies which investors use as a guideline to assess the risk and return parameters of a Sukuk certificate.

• Sukuk provide regular periodic income streams during the invest-ment period with easy and efficient settlement and a possibility of capital appreciation of the Sukuk.

• The owners of these certificates share the return as stated in the subscription prospectus and bear the losses, each according to his respective share of ownership.

Al-Amine (2012) has mentioned some benefits of Sukuk too that can be summarized as follows:

• Sukuk is a new source of funding for both sovereign and corporate entities including multinational corporations, multinational devel-opment institutions, and government agencies. The role of Sukuk is multifaceted whereby it meets different funding needs from large developmental and infrastructure projects to the needs of busi-ness expansion. This is of special importance for the economies in emerging markets.

• Sukuk offers a solution to one of the core problems in Islamic finance that has hindered its growth; the problem of liquidity

4 a. Lahsasna et aL.

management. Sukuk is believed to be a long-term solution for the liquidity management of Islamic banks through a range of maturity instruments.

• It is the cornerstone for the development of deep Islamic capital markets. Whereas funding from an Islamic bank may not be possible always, Sukuk can be issued under relevant Shari’ah principles.

• As more and more Sukuk are issued, it will create a platform for the trading of Sukuk in which case the Sukuk holders would not be worried about the liquidity of the instruments they hold.

• Many Islamic institutions have great surplus cash that is waiting to be tapped by new financial instruments that are Shari’ah compliant. Sukuk offers one such opportunity.

• In Middle East in particular and many other jurisdictions in general, there is a need for an active bond market to strengthen the capital market and consequently the overall economy. Indeed, Sukuk can play a very vital role in the realization of this dream.

• Sukuk market is broader than the conventional bond market in the sense that prominent international conventional banks have been very active in Sukuk issuances. Institutions like HSBC, Citigroup, Barclays, UBS, BNP Paribas, and Deutsche bank have acted as lead managers for different Sukuk issues. This denotes that Sukuk have become a part of the global financial landscape and joining of hands by leading conventional institutions will soon lead to a greater inte-gration of Islamic finance in the global markets.

• Sukuk market is broader in one other dimension too. These instru-ments can be offered to both Muslim and non-Muslim investors alike. Thus, it not only satisfies the Muslims’ needs to adhere to their religion, it also appeals to conventional investors in economic terms.

• Sukuk provides a new source of funding for countries that are involved in offering this new instrument. This source is vital for infrastructure development and utilization of the funds for local economy’s benefit.

• Investors that invest in Islamic instruments are in need to diversify their investment portfolio. Sukuk provide them a chance to do this diversification in a complaint manner.

• The merging Muslim economies of the world have a bright pros-pect in terms of Sukuk. Sukuk offer them excellent opportunities to manage their capital requirements in a way that is not contradictory

1 INTRODUCTION TO SUKUK 5

to Islamic teachings and at the same time fulfills the needs of global investors.

• The growth of Sukuk will lead to the growth of many Islamic insti-tutional investors including Takaful operators, Shari’ah compliant companies and Islamic assets managers.

• The competitive prices of Sukuk are yet another bright prospect. When compared with fund-raising in conventional market, Sukuk market offers 10–20 basis points lower than conventional bonds. This is exactly the reason that Sukuk are oversubscribed in a range of two to thirteen times continuously.

1.4 Sukuk versus bOnds

A bond is a contractual debt obligation whereby the issuer is contractu-ally obliged to pay to bondholders, on certain specified dates, interest and principal, whereas Sukuk holders claim an undivided beneficial own-ership in the underlying assets. Sukuk holders are entitled to share in the revenues generated by the Sukuk assets as well as being entitled to share in the proceeds of the realization of the Sukuk assets. The claim embod-ied in Sukuk is not simply a claim to cash flow but an ownership claim and it confers a beneficial interest to the holder in terms of holding a proportional ownership of the underlying asset as well as the income that it generates. The Sukuk holder also assumes all rights and obligations for the maintenance of the asset.

The relationship between the parties in Sukuk is governed by the rel-evant contracts selected by the obligor upon the issuance of Ijarah such as sukuk, mudarabah, etc. Therefore, the parties can have a partnership relationship if the contact is musharakah, or lessor and lessee relationship if the contract is ijarah. Hence the certificates holders who are the inves-tors stand as the owners of the underlying asset, whereas in bonds the relationship between the certificate holders and the issuer is creditor and debtor. The liability of the issuer investors depends on the performance of the underlying asset; in ijarah, for example, it depends on the demand and supply of the leased asset in the market, whereas in bond there is no liability. The return in Sukuk is either fixed or floating depending on the selected structure by the issuer; for example, the return is fixed if the structure is based on ijarah and not fix if the structure is equity-based, whereas the return of the bond is always fixed according to the agreed fixed coupon upon the issuer of the bond.

6 a. Lahsasna et aL.

The profit is not guaranteed in Sukuk. Therefore, there is a possible loss in the Sukuk, because the profit and the success of the business are based on the performance of the underlying asset. The profit or loss do not depend on the ability of the issuer to pay, but on the ability of the underlying asset to sustain, whereas in bonds there is no loss expected, because the return is guaranteed where the issuer pays the principal along with the fixed profit regardless of the performance of the under-lying asset of the bond. The certificate in Sukuk is an evidence of own-ership. Therefore, Sukuk issuance results in transfer of the ownership of the asset from the issuer to the investor. The asset will be held by the SPV or the trustee to secure the interest of the investor, whereas in bond issuance there is no process of transfer of ownership and the certificate demonstrates an evidence of debt only.

1.5 the cOmmOn features between Sukuk and bOnds

Beside the difference between Sukuk and bond, there are common fea-tures between them as follows:

• Both Sukuk and bond represent a certificate of investment• Certificate holders of Sukuk and bonds are investors• Both Sukuk and bond represent financial instrument for investment

in capital market• Both represent a means to raise capital• Both generate return• Ijarah sukuk and bond have fix income return• Both Sukuk and bond are subject to rating agency• Both are subject to default• Both are subject to restructuring

1.6 Sukuk versus shares

There is a close relationship between Sukuk and shares. A brief compari-son between them is highlighted as follows:

A share represents a single unit of ownership in a company, organ-ization, or any other entity. Shares are normally part of joint stock Company listed on the stock exchange where the company divides its

1 INTRODUCTION TO SUKUK 7

capital into shares which are offered to the public and investors to raise capital. The issuance process is governed by terms and conditions that determine the relationship between the shareholder/stockholders of the shares and the company in terms of rights and obligations and other related matters. Thus, a share is an indivisible unit of capital, expressing the proprietary relationship between the company and the shareholder. The denominated value of a share is its face value: the total capital of a company is divided into a number of shares.

Sukuk represent a certificate representing ownership of the underly-ing asset whereas shares represent a certificate of ownership in company listed on the stock exchange. With regard to ownership, both Sukuk and shares claim ownership by virtue of the certificate which demonstrates this fact. However, Sukuk are issued for sophisticated investors which are the various financial institutions in the market place, whereas shares are issued for both sophisticated investors and normal investors such as individuals which represent the mass public and retails market. As for the return in case of Sukuk, it is determined according to the per-formance of the underlying asset such as project whereas in shares the return is determined by the performance of the company. If the company performs well and generates good business, it will have impact on the shareholder when the dividends are distributed. From the relationship perspective, both Sukuk holder and shareholder are investors looking for return. However, in case of share the underlying contract is governed by musharakah, whereas is Sukuk there are different types of contracts used like ijarah, mudarabah, musharakah, tawarruq, etc. Hence the shares and Sukuk meet in the same contract and are governed by the same Shari’ah rules.

With regard to liability, both Sukuk and shares depend on the per-formance of the underlying asset. In Sukuk the underlying asset is the specific project and in shares it is the company listed in the stock With regard to return, in Sukuk it can be fixed if the contract used is ijarah, and can be floating in case of musharakah contract, whereas in shares it is floating because shares are issued based on musharakah contract. However, there are some Shari’ah mechanisms that have been imple-mented to smoothen the return through reserve created for that pur-pose. This reserve will smoothen the return and convert it from floating to fix. However, despite those mechanisms, the return of Sukuk can be offered on both options depending on the contract selected for the

8 a. Lahsasna et aL.

issuance, whereas for shares the assumption is that return is always float-ing because the dividend distribution is driven by musharakah rules based on the performance and profitability of the company in the real market place.

1.7 Sukuk versus securitizatiOn

In addition to the discussion above, securitization in mainstream finance is the process of pooling different types of contractual debt such as the debt of mortgage, car loan, credit card loan, etc., and sell-ing them as consolidated debt such as bond to potential investors. The investors will be the holders of the bonds who are entitled to receive the principles and the interest regularly. In the Securities Commission (SC) report 2002, asset securitization can broadly be defined as the process whereby loans, receivables, and other financial assets are pooled together, with their cash flows redirected to support payments on securities issued to purchase such assets. These securities, which are generally referred to as “asset-backed securities” or “ABS” are issued and sold to investors for the benefit of the owners of the assets, who utilize securitization to source financing for their business activities. (Report on asset securitization in Malaysia, the way forward for the Malaysian market, 2002.) According to SC, securitization transaction means an arrangement which involves the transfer of assets or risks to a third party where such transfer is funded by the issuance of debt securities or Islamic securities to investors. Payments to investors in respect of such debt securities are principally derived, directly or indi-rectly, from the cash flows of the assets. (Guidelines on the offering of asset-backed securities, 2004.) On the other hand, Sukuk is a pro-cess of liquiditation of assets such as building and sell it to the inves-tors who will assume the ownership of the underlying asset and entitle respectively to get return such as rental (in case the asset is leased out to third party). The difference between Sukuk and secuitization is that Sukuk are processed in such a way that avoid the Shari’ah non- compliance elements such interest, or selling pure debt at discount, unless it is mixed portfolio based on specific ratio between the debt and asset. The Sukuk benefited from the securitization process in Shari’ah compliance manner to expand the boundary of the Islamic financial market.

1 INTRODUCTION TO SUKUK 9

1.8 cOncLusiOn

Sukuk has been regarded as important instrument in ICM, it is defined as certificates of equal value representing ownership over an underlying asset. Sukuk represent common shares and rights over the underlying assets or over usufruct (benefits derived from an underlying asset) and services. Sukuk has some similarities with conventional bonds, shares and securitization, however Sukuk still have its own features that distinguish it from bonds.

references

AAOIFI. (2010). Shariah Standards. Accounting and Auditing Organization for Islamic Financial Institutions, Kingdom of Bahrain.

Al-Amine, M. A. (2012). Global Sukuk and Islamic Securitization Market: Financial Engineering and Product Innovation. Leiden, NL: Koninklijke Brill NV.

11

2.1 intrOductiOn

Islamic capital market (ICM) is a market that is free from non-Shari’ah compliant activities such as usury, gambling, and uncertainty. It is a mar-ket where shares, stocks, and permissible financial instruments are being traded through buying and selling according to the principles of Islamic law. The ICM plays a significant role in the development of the economy. In respect of that, a lot of development has taken place in the Muslim and non-Muslim countries. This market deals with a very important class of products which is Sukuk (securities) that are certificates which represent the value of an asset or usufruct. The ICM does not function actively without the issuance of Sukuk and their trading in the primary and secondary market. Sukuk industry plays an active role in ICM activ-ities; thus Sukuk are complementary instruments beside other products and instruments offered in ICM. This is to provide a comprehensive marketplace that has wider range of products and instrument based on Shariah compliance for the investors who seek Shariah compliant invest-ment because ICM products should differentiate itself from conventional ones in term of transactions and activities that are carried out in the market.

Today, ICM is growing very fast due to Muslim population that rep-resents 24% of total population of the world; this size can be estimated around 1.5 billion people with respect to the total population of the world which is around 6.3 billion. This growing awareness is also due

CHAPTER 2

An Overview of Islamic Capital Market (ICM) and Sukuk Industry

© The Author(s) 2018 A. Lahsasna et al., Forward Lease Sukuk in Islamic Capital Markets, https://doi.org/10.1007/978-3-319-94262-9_2

12 a. Lahsasna et aL.

to demand of Muslim investors to invest their wealth in the investment funds that are in conformity with the principles of Islamic law on the global scale. Moreover, ICM is flourishing all over the world because of increasing wealth in hands of Muslim investors who are participating in corporate and business activities. This is obvious in Islamic funds which stand at USD1.3 trillion in global financial institutions; on the other hand, Islamic financial market is at USD230 billion. This development of ICM can also be due to gathering information from various interna-tional Islamic organizations to examine and promote alternative ICM for Muslim investors. These Islamic organizations include the Islamic Financial Services Board (IFSB), the International Islamic Financial Market (IIFM) and the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). One of the factors that make ICM distinguished from other markets is that ICM is an unlimited mar-ket in which anyone can participate to create depth and breadth in global Islamic financial market in order for it to work as a parallel market to conventional one. Presently, there are more than 250 Islamic financial institutions which are carrying out their activities in around 75 coun-tries all over the world. These institutions manage more than 100 assets of Islamic equity funds which are more than USD5.0 billion (Bursa Malaysia, Islamic Capital Market 2011).

From the foregoing, one can conclude that ICM is an axiomatic mar-ket in Islamic financial market all over the world. It plays a crucial role in development of economy of a country particularly a Muslim country because of the increasing wealth in the hands of Muslim investors who are seeking a market which is free from any activity, which is prohibited by Shariah to invest their wealth. Therefore, ICM and Sukuk industry are working together; without Sukuk transaction in the market the activities of the market do not perform in a comprehensive manner, while without ICM Sukuk industry cannot develop its instruments in order to meet the needs of market and investors.

2.2 generaL intrOductiOn tO isLamic caPitaL market (icm)

Today, the growth of economy of any Muslim country is based on its ICM force. It works as a parallel market to conventional capital market for investor capital seekers and capital providers who want to invest and transact in the market in a Shariah compliant manner. In addition to

2 AN OVERVIEW OF ISLAMIC CAPITAL MARKET (ICM) AND SUKUK INDUSTRY 13

that, ICM extends its scope of activities which are not confined to equity and securities only but to the extent of some financial instruments that have the same proceeds as conventional instruments, such as exchange-traded funds, derivatives, swaps, unit trusts, real estate investment trusts (REITs), commodity funds, and a range of Islamic indices and index products. These instruments carry out their activities in the active pri-mary and secondary markets that deal with the instruments which are in conformity with the principles of Shariah (Noordh 2002).

It should be noted that ICM produces similar products to conven-tional capital market products in the form but they are Shariah com-pliant in substance, which means that the ICM products are governed by Shariah rules and principles which make them in accordance with Shariah. The ICM is not confined or limited to Muslim capital seekers and investors only but is open to non-Muslim as well, whether individu-als or institutions.

2.2.1 Definition of Islamic Capital Market

Capital market is a market which deals with long-term debt instruments and shares that are issued by companies or government. It is defined as a market where debt and equity are traded in order to provide an ave-nue for the investor or to increase capital and provide financial needs for a project. Each instrument in that market entitles the shareholders and issuers a bundle of rights and obligations (Kamil 2007). Therefore, ICM is a market where the activities carried out in the market do not contradict the principles of Islamic law and the transactions in the mar-ket are free from any element which is not in conformity with the prin-ciples of Islamic law, such as the elements of riba, maisir and gharar (Noordh 2002).

From the above definitions, conventional capital market can be defined as a market which deals with any kind of instrument as long as it can bring benefit to shareholders and issuers. This is unlike ICM which does not deal with any element which is not in accordance with the prin-ciples of Islamic law. The activities carried out in the market should not contain any element or transaction which is not approved by Shari’ah. Therefore, the transactions concluded are expected to be in compliance with Shari’ah rules whether dealing with debts, stocks or other busi-ness activities. The Shari’ah boards have the mandate to supervise the products and instruments offered in the ICM to ensure their Shari’ah

14 a. Lahsasna et aL.

compliance, the mandate of the Shari’ah board is both at the institu-tion level and the regulator level such as the Securities Commissions in Malaysia.

2.2.2 Types of Islamic Capital Market

The activities of both Islamic and conventional capital markets are car-ried out in two markets. These are primary market and secondary mar-ket, which represent the Islamic Capital Market place for both Islamic and conventional, as both operate side by side:

1. Primary market is a market where a company or government issues their securities to provide or increase capital for their compa-nies or projects. According to Frank & Franco the primary mar-ket involves the distribution to investors of newly issued securities. (Frank & Franco, 2009).

The primary market plays a key role in the economic activities of the country by providing platform for investment and liquidity activities through the issuance of securities and its trading. The wealth accumulated through saving will be invested in the capital market place in the various instruments and products.

Among the prominent features of the primary market are as follows:(a) Primary market is considered as one of the important platform

to invest the national saving funds.(b) Primary market is regarded as a source of funds for government

and corporate.(c) Primary market is the platform for issuers of securities.(d) The primary market is platform that creates opportunities for

investment and innovation of products and instrument for Islamic capital market.

(e) The two markets primary and secondary market are applicable for conventional Capital market and Islamic capital market.

Hence, the primary market plays a key role in providing capital for any project or company. It is also the main source for movement of saving funds into investment funds.

2. Secondary market is a market where securities issued by a govern-ment and company in primary market are traded. The provides

2 AN OVERVIEW OF ISLAMIC CAPITAL MARKET (ICM) AND SUKUK INDUSTRY 15

liquidity through the trading of the securities that have been issued in the primary market. According to Frank and Franco the key dis-tinction between a primary market and secondary market is that in the secondary market the issuer of the asset does not receive funds from the buyer, rather, the existing issue changes hands in the sec-ondary market and funds flow from buyer of the asset to the seller (Frank & Franco, 2009).

In short, when a market is organized, it is called Bursa where companies under this organization trade their securities and shares. In other words, Bursa is an organized market where securities, shares and bonds are traded under supervision and control of an organization. Both Islamic and conventional capital markets conduct their commercial transactions on the Bursa under rules and regulations of an organization that control the movement of activities carried out in the market (Bursa). However, the difference between ICM and conventional capital market is the issue of interest charge. In ICM, the transactions are based on risk sharing. There is no guarantee for principal amount or profit, while in conven-tional capital market, the transactions are based on interest. The principal amount and profit are guaranteed.

ICM not only plays a significant role in economic growth of a coun-try but also plays the same role in movement of saving funds and pro-viding capital for capital seekers as well as the role of financing projects. Without capital market, it is difficult to finance big projects which an individual would not be able to provide for its capital. It is, therefore, obvious that capital market plays a prominent role in the economic development and the growth of capital of a country in general. ICM is growing rapidly in Muslim countries due to the various instruments pro-vided for market players and investors, which ensure Shariah compliance products and services.

2.2.3 Islamic Capital Market in Malaysia

Malaysia is pioneer in Islamic finance particularly ICM. It has contrib-uted to spurring the growth of ICM not only at national level but also at international level. This is due to the efforts of Malaysia International Islamic Financial Center which plays a crucial role in regulations and development of ICM which helps in rapid growth of the ICM. This is also due to its Shari’ah compliant products and services collecting from