Paper Sukuk Ijarah

MALAYSIA CAPITAL MARKET : SUKUK AL IJARAH MBA UKM
TABLE OF CONTENTS
ITEMS
PAGE
1.1 Concept & Definition

1.2 History of Malaysia Sukuk
1.0 INTRODUCTION 1.3 The Global Sukuk Market
1.4 Sukuk & Securitization
1.5 Sukuk & Conventional Bond : Comparison
2.0 TYPE OF SUKUK 2.1 Sukuk Certificate

STRUCTURES 2.2 Common Sukuk Structures
3.0 THE ISLAMIC LAW 3.4 Shariah Observation on Sukuk Al Ijarah

FRAMEWORK FOR 3.2 AAOIFI Standard
SUKUK 3.5 Central Bank of Malaysia (BNM) Standard
3.6 Malaysia’s Security Commission Guidelines
4.1 History & Overview

4.0 SUKUK AL IJARAH : 4.2 Definition
INTRODUCTION 4.3 Nature of Sukuk Al Ijarah
4.4 Ijarah Sukuk In Practice
5.1 Structure & Features of Sukuk Al Ijarah

5.0 SUKUK AL IJARAH : 5.2 Issuance of Sukuk Al Ijarah
APPLICATION 5.3 Step of Issuing Sukuk Al Ijarah
6.1 Global Sukuk Performance

6.0 SUKUK AL IJARAH : 6.2 Malaysia Global Sukuk Report
DATA & 6.3 Sukuk Al Ijarah Performance
PERFORMANCE
7.1 Risk of Sukuk Al Ijarah

ISLAMIC CAPITAL MARKET 1
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7.0 SUKUK AL IJARAH :

7.2 Challenges in Managing The Financial Risk
ISSUES & 7.3 Argument of Sukuk Implementation
CHALLENGES
8.0 SUKUK AL IJARAH : 8.1 The Recent Development of Sukuk Al Ijarah

GROWTH & 8.3 Prospect
PROSPECT
9.0 CONCLUSION
1.0 INTRODUCTION
A sakk (singular) is usually referred to as an “Islamic bond.” Sukuk (plural) are
actually more akin to “pass-through certificates,” “equipment trust certificates,” or

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“investment certificates,” due to ownership attributes, with each sakk representing

a proportional or undivided ownership interest in an asset or pool of assets.
1.2 History of Malaysia Sukuk
Malaysia initiated another landmark in 2002 by issuing the first Islamic securities
that complied with US Regulation S and Rule 144A formats that are used for
conventional global bonds. Prior to that in December 2001 Kumpulan Guthrie
Berhad, a Malaysian public listed company involved in the plantation and
construction sectors has offered a sukuk al-ijara issue in the US Regulation S format.
The company offered USD 150 million-sukuk issues with a floating rate return and
the tenor was divided into three years (USD50m) and five years (USD100m). The
sukuk was listed on the Labuan International Financial Exchange. The first sukuk to
be listed in the Luxembourg Stock Exchange was the Malaysian sukuk al-ijara and
rated by Standard & Poor's and Moody's. The USD 600 million sukuk was offered
globally to Islamic and conventional investors including "Qualified Institutional
Buyers" in the United States. The issue was highly successful and was twice
oversubscribed. The Malaysian sukuk was a significant development because it was
able to successfully fuse the concept of sukuk al-ijara with conventional bond
practices such as listing, ratings, dematerialized scripts and centralized clearance.

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1.3 The Global Sukuk Market

Globally, the sukuk market has experienced tremendous growth, averaging an
annual growth of 40%. The sukuk market issuances declined in 2008 as a result of
global market turmoil; however the long-term prospects for the sukuk market
remain strong. Sukuk issued globally in 2008 amounted to USD14.9 billion. Malaysia
leads the global sukuk market, represented by 61% of total global sukuk
outstanding as at end 2008. Despite the rebound, however, global Sukuk issuances
were still down on the record set in H1 2007 of $24 billion, according to a report by
London based IFIS (Islamic Finance Information Service). Southeast Asia continues
to dominate the Sukuk market with issuances worth $17.35 billion in H1 2010
compared to $8.89 billion in H1 2009 and $4.5 billion in H1 2008. Malaysia topped
the issuer countries in terms of the amount and the numbers of issuances with 310
issuances worth $15.4 billion, followed by Indonesia with 16 issuances amounting
to $1.75 billion. The GCC Sukuk market recorded zero issuances on the corporate
level, and only one Quasi Sovereign issuance for Saudi Electricity. IFIS says dollar-
denominated Sukuk issuances increased by 29 per cent to $2.72 billion while the
top currency was the Malaysian Ringgit (MYR), accounting for about 84 per cent of
total domestic issuances and 69.6 per cent of total issuances in H1 2010.
HSBC topped IFIS Global Sukuk Bookrunners Ranking in H1 2010, followed by CIMB
Group and Samba Capital. CIMB participated in underwriting more Sukuk than HSBC
but the latter underwrote the largest single deal in H1, Saudi Electricity’s $1.9
billion Sukuk. CIMB Group retook top position among arrangers, a slot it had lost to
AmInvestment in H1 2009 while HSBC was second with 15 issuances.
1.4 Sukuk & Securitization
Sukuk is the result of Islamic securitization of asset, Securitization is a form of asset

regulated by money supply, Securitization refers to a process of converting asset
into cash equivalent in the form of papers that are tradable in the secondary

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market, the process of packaging financial promises and Transforming them into a
form whereby they can be freely transferred among a multitude of investors.
Through securitization a liquid asset is transformed into a tradable security that

gives the liquid asset the liquidity feature by the deployment or creation of some
market mechanism that allows, the borrower to have direct access to the capital
market, also lenders/investors are able to liquidate their positions or to opt for
better investment opportunities Creating of secondary market that benefits both
borrower and investor.
1.5 Sukuk & Conventional Bond : Comparison

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2.0 TYPE OF SUKUK STRUCTURES

2.1 Type Of Sukuk Certificate
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The proper classification of the asset classes will also determine the type of
certificates to be issued. It is imperative to note that these assets can be
prepared for the issuance of trust certificates in a number of ways conditional to
the need of the issuing entity.
2.1.1 Pure Ijarah Sukuk

These certificates are issued on stand-alone assets identified on the balance
sheet. The assets can be parcels of land to be leased or leased equipment such
as aircraft and ships. The rental rates of these Sukuk can be both fixed and
floating depending on the particular originator.
2.1.2 Hybrid/Pooled Sukuk

The underlying pool of assets can comprise of Istisna’, Murabahah receivables as
well as Ijarah. Indeed, having a portfolio of assets comprising of different classes
allows for a greater mobilization of funds as previously inaccessible Murabaha
and Istisna assets can comprise a portfolio. However, still at least 51 percent of
the pool must comprise of Ijarah assets. Due to the fact the Murabahah and
Istisna’ receivables are part of the pool, the return on these certificates can only
be a pre-determined fixed rate of return.
2.1.3 Variable Rate Redeemable Sukuk

The above mentioned two types of Sukuk would partially represent the strength
of the issuer’s balance sheet. Under some conditions, implementing Sukuk by
representing the full strength of an issuer’s balance sheet can prove to be
beneficial. Already, several corporate entities refer to these Sukuk as
Musharakah Term Finance Certificates (MTFCs). This can be considered as an
alternative to Sukuk because of its seniority to the issuer’s equity, its redeeming
nature and its relatively stable rate as compared to dividend payouts. MTFCs
have a few advantages. First, employing Musharakah returns is preferred from
the viewpoint of jurists as such an arrangement would strengthen the paradigm

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of Islamic banking that considers partnership contracts as the embodiment of

core ideals.
2.1.4 Zero-coupon non-tradable Sukuk

Another possible classification of Sukuk structures can be created where the
assets to be mobilized do not exist yet. Consequently, the objective of the fund
mobilization would be to create more assets on the balance sheet of company
through Istisna’. However, certificates of this nature would not readily be
tradable because of Shari’ah restrictions. The primary asset pools to be
generated would be of the nature warranted by Istisna and instalment
purchase/sale contracts that would create debt obligations. The certificate on
these debt arrangements can be termed as fixed rate zero coupon Sukuk.
2.1.5 Embedded Sukuk

These could be Sukuk whether zero-coupon, pure-Ijara or hybrid, with the
embedded option to convert into other asset forms depending on specified
conditions.
2.1.6 Expanded List of Sukuk

In response to the emergence of interest in issuances of Islamic asset-backed
financial instruments, the Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) released an exposure draft of its Shari’ah
standards concerning Sukuk in November 2002. According to the exposure draft:
“Investment Sukuk are certificates of equal value representing, after closing
subscription, receipt of the value of the certificates and putting it to use as
planned, common title to shares and rights in tangible assets, usufructs, and
services, or equity of a given project or equity of a special investment activity.
2.1 The Common Sukuk Structures

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3.0 THE ISLAMIC LAW FRAMEWORK FOR SUKUK

3.1 SHARIÀH OBSERVATIONS ON SUKUK AL IJARAH
Sukuk al Ijarah do not represent debts, it represents undivided proportionate

ownership of the leased asset. Thus, Sukuk al Ijarah can be bought and sold at
whatever price that the parties agree to. In this sense the Sukuk al Ijarah are not debt
instruments, but more of participatory certificates (similar to equities). Because the
Sukuk al Ijarah are not debts nor monetary, the Islamic legal difficulties in the sale of
monetary-debts with a discount do not arise.
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All these factors explain the almost worldwide endorsement of Sukuk al ijarah as
Shari'ah compliant securities. Issue: Would beneficial ownership be sufficient to
effect the ownership right over the leased property by the buyer/lessor? Or is legal
ownership a must before the buyer can lease the asset to the lessee Common law
jurisdictions recognize separation of beneficial and legal ownership under the
principle of equity. The trust concept is widely accepted in those jurisdictions. Sukuk
al Ijarah are not free from risks of, Investment - creditworthiness of the lessee on the
payment of rental, Ownership
Damage and loss of property
Credit risk, Guarantee on obligation to pay lease rental, Ownership risks?

Insurance/takaful costs and Maintenance costs are of the account of the investors.
Rental rate for ijarah could be either fixed or floating, though most issuance prefer
floating rate. Floating rate is approved by the AAOIFI Shari'ah Standard, provided -
the formula is fixed & agreed upfront. The formula can be based on conventional
benchmark OR LIBOR, Treasury bill, etc
In view of the expanding application of Sukuk worldwide, the public interest in them,
and the observations and questions raised about them, the Shari'ah Committee of
the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)
studied the subject of Sukuk issuance in three sessions; firstly, at Madinah on 12
Jumada al-Akhirah 1428 AH (27 June, 2007), secondly, at Mecca on 26 Shaban 1428
AH (8 September, 2007), and thirdly in the Kingdom of Bahrain on 7 and 8 Safar
1429AH (13 and 14 February, 2008). Following the meeting of the working group it
appointed on 6 Muharram 1429AH (15 January, 2007) at Bahrain which was attended
by a significant number of representatives from various Islamic banks and financial
institutions, the working group presented its report to the Shari'ah Committee.
Following its consideration of what took place at these meetings, and of the papers
and studies presented there, the Shari'ah Committee, while emphasizing all that has
been stated concerning Sukuk in the Shari'ah Standards, advises Islamic financial
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institutions and Shari'ah supervisory boards to adhere to what follows when issuing
Sukuk.
First:
Tradable Sukuk must represent ownership for Sukuk holders, with all of the rights
and obligations that accompany ownership, in real assets, whether tangible or
usufructs or services, that may be possessed and disposed of legally and in
accordance with the Shari'ah. All of this Accounting and Auditing Organization for
Islamic Financial Institutions (AAOIFI) should be in accordance with Shari'ah Standard
(17) on the subject of Investment Sukuk, articles (2) and (2/1/5). The manager of a
Sukuk issuance must establish the transfer of ownership of such assets in its books,
and must not retain them as its own assets.
Second:
It is not permissible for tradable Sukuk to represent either revenue streams or debt
except in the case of a trading or financial entity that is selling all of its assets, or a
portfolio which includes a standing financial obligation such that debt was incurred
indirectly, incidental to a physical asset or a usufruct in accordance with the
guidelines mentioned in Shari'ah Standard (21) on the subject of Financial Paper.
Third:
It is not permissible for the manager of Sukuk, regardless of whether the manager
acts as a mudarib (investment manager), or a sharik (partner), or a wakil (an
investment agent), to undertake to offer loans to Sukuk holders when actual earnings
fall short of expected earnings. It is permissible, however, to establish a reserve for
the purpose of covering such shortfalls to the extent possible, on condition that the
same be mentioned in the prospectus. There is no impediment to the distribution of
expected earnings on account, in accordance with Shari'ah Standard (13) on the

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subject of Mudarabah, article (8/8), or to obtaining project financing on the account

of the Sukuk holders.
Fourth:
It is not permissible for the mudarib (investment manager), sharik (partner), or wakil
(investment agent) to agree to purchase assets from Sukuk holders or from whoever
represents them for a nominal value of those assets at the time the Sukuk are
extinguished at the end of their tenors. It is permissible, however, to agree to
purchase the assets for their net value, or market value, or fair market value, or for a
price agreed to at the time of their purchase, in accordance with Shari'ah Standard
(12) on the subject of Partnership and modern partnerships, Article (2/6/1/3) and
with Shari'ah Standard (5) on the subject of Accounting and Auditing Organization for
Islamic Financial Institutions (AAOIFI) Guarantees, Articles (1/2/2) and (2/2/2). It
should be understood that the Sukuk manager acts as guarantor of [investor] capital
at its nominal value in cases of negligence or mala fides or non-compliance with
stated conditions, regardless of whether the manager is a sharik (partner), wakil
(agent), or mudarib (investment manager). If, however, the assets of a Sukuk al-
Musharakah, or Mudarabah, or Wakalah, are of lesser value than assets leased by
means of a lease ending in possession (ijarah muntahiya bi't-tamlik), then it will be
permissible for the Sukuk manager to agree to purchase those assets at the time the
Sukuk are extinguished for the remaining lease payments on the assets, by
considering these payments to be the net value of those assets.
Fifth:
It is permissible for the lessee in a Sukuk al-Ijarah to agree to purchase the leased
assets when the Sukuk are extinguished for their nominal value, as long as the lessee
is not also an investment partner, mudarib, or agent.
Sixth:

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Shari'ah supervisory boards must not consider their responsibility to be over when
they issue a fatwa on the structure of Sukuk. Rather, they must review all contracts
and documentation related to the actual transaction, and then oversee the ways that
these are implemented in order to be certain that the operation complies at every
stage with Shari'ah guidelines and requirements as specified in the Shari'ah
Standards, and that the investment of Sukuk proceeds and what those proceeds are
converted to takes place in accordance with one [or another] of the approved
Shari'ah methods of investment as stated in Shari'ah Standard (17) on the subject of
Investment Sukuk, Article (5/1/8/5). In addition to all this, the Shari'ah Committee
advises Islamic Financial Institutions to decrease their exposure to debt-related
operations and to Accounting and Auditing Organization for Islamic Financial
Institutions (AAOIFI) increase their operations based on true partnerships and the
sharing of risk and reward and thereby achieve the higher purposes of the Shari'ah.
3.2 AAOIFI Standard

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3.3 BNM Standard

Ijarah Sukuk and Shariah Compliant Securities as Underlying Asset in Tawarruq
Transaction.
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There is a proposal to use ijarah sukuk and Shariah-compliant securities as

underlying asset in tawarruq transaction or murabahah to manage liquidity in
Islamic financial system. The proposed characteristics of ijarah sukuk include ijarah
sukuk which is backed by tangible asset, financial asset and a combination of both
tangible asset and financial asset. For Shariah-compliant securities, the proposed
characteristic is that the securities must be endorsed as Shariah compliant. The
issue here is whether the use of financial asset like sukuk and securities instead of
commodity in tawarruq transaction is permissible in Shariah.
Resolution
The Council in its 58th meeting held on 27th April 2006/ 28th Rabiul Awal 1427
resolved that the use of ijarah sukuk a n d Shariah-compliant securities a s
underlying asset in tawarruq o r murabahah to manage liquidity in Islamic financial
system is permissible. However, such ijarah sukuk must be backed by tangible asset
and not financial asset.
3.3 Security Commision

Shariah-compliant securities are securities (ordinary shares, warrants and
transferable subscription rights) of a Bursa Malaysia-listed company which have
been classified as Shariah permissible for investment, based on the company's
compliance with Shariah principles in terms of its primary business and investment
activities. The Shariah-compliant securities list was introduced in June 1997 by the
Shariah Advisory Council (SAC) of the SC. The List is updated twice a year, in May
and November, by reviewing the companies' annual financial reports, responses to
a survey aimed at obtaining detailed company information and through specific
inquiries made to the respective company's management.
In the process of determining the Shariah status of listed securities, the SAC
developed several basic Shariah criteria as guidance. The criteria were based on the
Quran and the Sunnah, as well as the general principles of Syara'. In this process,

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the SAC focused on the core activities of the companies, such as goods and services
that were offered to their customers. The SAC gave further consideration to
companies that were involved in both Shariah-compliant and non-compliant
activities by applying the concept of maslahah (public interest) and umum balwa
(common plight). For this purpose, specific benchmarks and additional criteria, such
as interest income and image were formulated to enable the SAC to determine the
Shariah status of such companies. In such cases, where the financial contributions
from the non-permissible activities fall below the benchmark level, the SAC will
classify the securities of these companies as Shariah-compliant.
The release of the list has, to large extent, given investors the necessary guidance,
opportunities and also confidence to choose and invest in listed securities that
comply with Shariah principles. The list also stimulates the development of other
Shariah-compliant products and services.
4.0 SUKUK AL IJARAH : INTRODUCTION

Al-Ijarah (al-ajr) (sale of usufruct)

Literal meaning: To compensate.

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Technical meaning: A contract of proposed and known usufruct (manfaat) with a

specified and lawful return or compensation for the effort or work which has been
expended. Under the securitisation process, sukuk al-ijarah refers to an Islamic
bond for the buying and leasing of assets by the investors to the issuer and such
sukuk shall represent the undivided beneficial rights/ownership/interest in the
asset held by the trustee on behalf of the investors.
4.2 History & Overview
In December 2000, Kumpulan Guthrie Berhad (Guthrie) was granted a RM1.5

billion (US$400 million) Al-Ijara Al-Muntahiyah Bit-Tamik by a consortium of banks.
The original facility was raised to re-finance Guthrie’s acquisition of a palm oil
plantation in the Republic of Indonesia. The consortium was then invited to
participate as the underwriter/primary subscriber of the Sukuk Transaction.
US$350 million sukuk Trust Certificates by Sarawak Corporate Sukuk Inc. (SCSI)
Sarawak Economic Development Corporation (SEDC) raised financing amounting to
US$350 million by way of issuance of series of trust certificates issued on the
principle of Ijara sukuk. The certificates were issued with a maturity of 5 years and
under the proposed structure, the proceeds will be used by the issuer to purchase
certain assets from 1st Silicon (Malaysia) Sdn Bhd. Thereafter, the issuer will lease
assets procured from 1st Silicon to SEDC for an agreed rental price for an agreed
lease period of 5 years.
4.3 Nature of Sukuk Al Ijarah
These are sukuk that represent ownership of equal shares in a rented real estate
or the usufruct of the real estate. These sukuk give their owners the right to own
the real estate, receive the rent and dispose of their sukuk in a manner that does
not affect the right of the lessee, i.e. they are tradable. The holders of such sukuk
bear all cost of maintenance of and damage to the real estate. (AAOIFI)
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Ijarah sukuk are the securities representing ownership of well defined existing and
known assets tied up to a lease contract, rental of which is the return payable to
sukuk holders. Payment of ijarah rentals can be unrelated to the period of taking
usufruct by the lessee. It can be made before beginning of the lease period, during
the period or after the period as the parties may mutually decide. This flexibility
can be used to evolve different forms of contract and sukuk that may serve
different purposes of issuers and the holders.
4.4 Sukuk Al Ijarah : In Practice

The Sukuk is essentially a trust certificate. It serves to mobilize funds which are
then used to purchase the said properties. It is like a property trust fund. The
money pooled from investors is used to purchase the property like office and
residential properties. In the case of the Malaysian Sukuk, government properties
were sold by the government to the SPV. Unlike property trust fund where
incomes are derived from capital gains, the Sukuk focus on the leasing of property
to generate income. It is common practice to assume that property trust fund is
equity in nature. No apparent guarantees are given to income and capital
protection. Likewise, the Malaysian Sukuk is expected to adopt similar risk-return
features. Finally, transaction documents include the followings:
 Purchase agreement: Sale of properties by the Malaysian government to
the SPV
 Lease agreement: Leasing of properties to the Malaysian government
 Seller’s declaration of trust: Trust deeds to protect the interest of investors
 Service agency agreement: To undertake maintenance of properties by the
Malaysian government.
 Insurance/takaful agreement: Indemnity against loss due to pure risks.
 Purchase undertaking deed: Agreement to buy back the property at
original value.

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5.0 SUKUK AL IJARAH : APPLICATION

5.1 Structure & Features of Sukuk Al Ijarah
The common structure of sukuk al-ijarah duly adopted in Malaysian debt market
may be summarised as follows:

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Step 1 Under the ijarah structure, the seller will sell its assets to the issuer in
consideration of a purchase price being beneficial interest in the assets. The issuer
shall declare a trust via a trust declaration over the assets for the benefit of the
sukuk investors. The sukuk investors will therefore have a pro-rata undivided
beneficial ownership of the assets. Sukuk al-ijarah is one of the products in
Malaysian capital paid based on the value of the respective assets.
Step 2 To finance the purchase, the Issuer shall raise sukuks of equivalent amount
and in combination of both senior sukuk and junior sukuk. The senior sukuk shall
be subscribed by the investors whilst the junior sukuk shall be solely subscribed by
the seller. The sukuk shall represent the beneficial rights in the assets whereby the
sukuk holders shall have an undivided proportionate beneficial interest in the
assets.
Step 3 Subsequent to the purchase, the issuer shall lease the acquired assets to
the lessee under ijarah agreement(s) for an ijarah term of up to, e.g. eight (8)
years.

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Step 4 The lessee, shall make ijarah rental payments to the Issuer from the income
it will receive from the off-takers arising from the license agreement.
Step 5 The ijarah rental payments for the assets received by the Issuer from the
lessor will then be distributed to the sukuk holders as periodic income distribution
payment in proportion to their holdings in the sukuk.
Step 6 The seller, in its capacity as service agent, will enter into service agency
agreement with the issuer to provide major maintenance services and maintaining
insurances for the respective assets.
Features of Ijarah sukuk

It is necessary for an ijarah contract that the assets being leased and the amount
of rent both are clearly known to the parties at the time of the contract and if both
of these are known, ijarah can be contracted on an asset or a building that is yet to
be constructed, as long as it is fully described in the contract provided that the
lessor should normally be able to acquire, construct or buy the asset being leased
by the time set for its delivery to the lessee (AAOIFI, 2003: 140-157). The lessor
can sell the leased asset provided it does not hinder the lessee to take benefit
from the asset. The new owner would be entitled to receive the rentals.
Rental in ijarah must be stipulated in clear terms for the firs term of lease, and for
future renewable terms, it could be constant, increasing or decreasing by
benchmarking or relating it to any well-known variable. As per shariah rules,
expenses related to the corpus or basic characteristics of the assets are the
responsibility of the owner, while maintenance expenses related to its operation
are to be borne by the lessee. As regards procedure for issuance of ijarah sukuk,
an SPV is created to purchase the asset(s) that issues sukuk to the investor,
enabling it to make payment for purchasing the asset. The asset is then leased to

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third party for its use. The lessee makes periodic rental payments t the SPV that in
turn distributes the same to the sukuk holders.
Ijara sukuk are completely negotiable and can be traded in the secondary markets.
It also offer a high degree of flexibility from the point of view of their issuance
management and marketability. The central government, municipalities, awqaf or
any other asset users, private or public can issue these Sukuk. Additionally, they
can be issued by financial intermediaries or directly by users of the leased assets.
5.2 Issuance of Sukuk Al Ijarah
In December 2000, Kumpulan Guthrie Berhad (Guthrie) was granted a RM1.5

billion (US$400 million) Al-Ijara Al-Muntahiyah Bit-Tamik by a consortium of banks.
The original facility was raised to re-finance Guthrie’s acquisition of a palm oil
plantation in the Republic of Indonesia. The consortium was then invited to
participate as the underwriter/primary subscriber of the Sukuk Transaction.
US$350 million sukuk Trust Certificates by Sarawak Corporate Sukuk Inc. (SCSI)
Sarawak Economic Development Corporation (SEDC) raised financing amounting to
US$350 million by way of issuance of series of trust certificates issued on the
principle of Ijara sukuk. The certificates were issued with a maturity of 5 years and
under the proposed structure, the proceeds will be used by the issuer to purchase
certain assets from 1st Silicon (Malaysia) Sdn Bhd. Thereafter, the issuer will lease
assets procured from 1st Silicon to SEDC for an agreed rental price for an agreed
lease period of 5 years.
In 2002 the Malaysian Global Sukuk Incorporated issued a USD$600 million Islamic
bonds known as Global Sukuk Al-ijarah in Labuan. It is an attempt to motivate
market players to raise funds via the bond market using instruments readily
accepted by Islamic investors, especially from the Middle-East. The sukuk is listed
at the Luxemborg Stock Exchange.

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The Global Sukuk does not apply bay’ al-‘inah and bay’ al-dayn. No fictitious goods
exist in the contract. The Sukuk is structured and arranged by Dubai’s Hong Kong
and Shanghai banking Corporation (HSBC) and issued in Labuan. It uses the asset-
backed securitization model. The assets being used in this structure are not
financial assets such as mortgage and rental receivables but physical assets. The
Shariah advisory council consists of three prominent Shariah scholars (Fuqaha).
5.3 Step of Issuing Sukuk Al Ijarah
 The obligator sells certain assets to the SPV at an agreed pre-determined
purchase price.
 The SPV raises financing by issuing sukuk certificates in an amount equal to
the purchase price.
 This is passed on to the obligator (as seller).
 A lease agreement is signed between SPV and the obligator for a fixed period
of time, where the obligator leases back the assets as lessee.
 SPV receives periodic rentals from the obligator;
 These are distributed among the investors i.e. the sukuk holders.
 At maturity, or on a dissolution event, the SPV sells the assets back to the
seller at a predetermined value. That value should be equal to any amounts
still owed under the terms of the Ijara sukuk.
5.4 Documentation of Sukuk Al Ijarah
The transaction documents for Sukuk Al-Ijarah shall be subject to the negotiation
and requirements of all parties. The transaction documents will incorporate
clauses customary to transaction of this nature as advised by the solicitors and
agreed by the Lead Arranger and the Issuer. Such documents shall include, but not
limited to, the following:

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(I) ISSUE DOCUMENTS
1. Asset Purchase Agreement between the Seller and the Issuer.

This Agreement provides for the sale of the identified assets from the Seller to
the Issuer for a price called the “Asset Purchase Price”.
2. Ijarah Agreement between the Lessor and the Lessee.
This agreement provides for (amongst others):
- the structure of the Sukuk Al-Ijarah;
- the rights of the Lessor and the Lessee under the Ijarah arrangement.
3.Trust Deed between the Issuer and the Trustee, (acting for the Sukuk holders).
The Trust Deed provides for (amongst others):
- the obligation of the Trustee to hold the Asset;
- the denominations and tenors of the Sukuk; and
- the form of the Sukuk.
4. Service Agency Agreement between the Seller as the service agent and the
Issuer .
This agreement appoints the Seller as the service agent in respect of the
identified asset for the duration of the lease under the Ijarah Agreement.
Under this agreement, the Seller, as the service agent bears the responsibility
of maintaining the Asset.
5. Purchase Undertaking(s) by the Lessee
Unilateral, unconditional and irrevocable undertaking to purchase the assets

from the Issuer at the exercise price*)The Lessee will give undertaking to the
Issuer to purchase the identified assets from the Issuer on the occurrence of
Event of Default under the Sukuk documents.Upon the Trustee’s delivery of

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written notice which declares the Event of Default has occurred under the
Proposed Sukuk, the Lessee will purchase all the assets at the exercise
price(s).
6. Sale Undertaking(s) by the Issuer
(unilateral, unconditional and irrevocable undertaking to sell the assets to the

Seller at the Exercise Price). The Issuer will undertake to the Lessee to sell the
assets to the Lessee on the maturity date(s) of the Sukuk programme
(provided that all the outstanding Sukuk and expenses incurred (if any) have
been paid in full) at a nominal value of RM1.00.
7.Seller’s Declaration of Trust
The Seller, upon completion of the sale transaction under the Asset Purchase
Agreement, will declare that the Seller as bare trustee, shall remains as the
legal owner of the assets only for and on behalf of the Issuer, as the beneficial
owner of the assets for the purpose of facilitating the granting of the Ijarah.
8. Declaration of Trust by the Issuer
The Issuer shall declare that it shall act as an initial trustee and hold the assets
on trust, either in its name or an appointed nominee or jointly with any
person,absolutely for the benefits of the Sukukholders.
9. Other documents:
Deed of Covenants, Subscription Agreement, Depository and Paying Agency

Agreement, Issue Agency Agreement, Security Agency Agreement (other
documents as may be advised by Lead Arranger)
* Exercise Price: any amount to the nominal value of the Sukuk plus the
expenses (e.g. all outstanding expenses incurred by service agent).

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(II) SECURITY DOCUMENTS
The Security Documents include, amongst others;
1. Debenture
A first ranking fixed and floating charge over the assets of the Issuer, both
present and future.
2. Memorandum of Deposit
A charge of all rights, benefits and interests of the Issuer in and to the relevant
designated account.
3. Assignment of Project Agreements
An assignment of all rights, interests and benefits of the Issuer under the
Project Documents.
4. Assignment of Insurance
An assignment of all rights, interests and benefits of the Issuer to and in the
insurance policies and proceeds therefrom taken out or to be taken out by the
Issuer under the project.
5. Assignment of Permits/Licence
An assignment of all rights, interests and benefits of the Issuer in and to all
applicable licences and permits related to the project

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6.0 SUKUK AL IJARAH : DATA & PERFORMANCE

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7.0 SUKUK AL IJARAH : ISSUES & CHALLENGES

7.1 Issues in Sukuk
This chapter will clarify the types of risks facing the Sukuk industry; market risk, credit
and counterparty risk, Shariah compliance risk, operational risk, and institutional
rigidity. Also, it will state the challenges facing the management of financial risks of
Sukuk that are challenge of institutional reorganization. In addition, it will talk about the
argument said that most of Sukuk implementation are not followed the Shariah rules.
7.2 Risks of Sukuk.
Unfavorable risks affect the competitiveness of the pricing of assets. Therefore, the
innovation of Sukuks essentially involves a higher exposure to certain market and
financial risks. These risks are market risk, credit and counterparty risk, Shariah
compliance risk, operational risk, and institutional rigidity.
7.2.1 Market Risk

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It is an important that is defined as the risk on instruments traded in well-

defined markets. Moreover, there are two categories of market risks are
identified; general (systematic) and firm specific (unsystematic). Furthermore,
Systematic risks can arise due to governmental and economic policy shifts
whereas unsystematic risk arises because different firm specific instruments are
priced out of correlation with other firms’ instruments. Market risk is composed
of profit rate risks, foreign exchange risks, equity price risks and commodity risks.
The profit rate risk is rate of return risk upon which Sukuk is based on fixed rates
that are exposed to this risk in the same manner as fixed rate bonds are exposed
to the profit rate risk. Moreover, an increase in market profit rates leads to a
decrease in the fixed-income Sukuk values. However, all fixed return assets
either from Ijarah, Istisna, Salam or any other origin will face this risk. This also
involves reinvestment risk and an opportunity cost of investing at the new rates,
particularly if the asset is not liquid as in case of the zero-coupon non-tradable
Sukuk. Also, undesirable changes in market rates will also unfavorably affect the
credit worthiness of the issues and will lead to the increase in the credit risk of
the issue. Furthermore, Sukuk certificates are exposed indirectly to profit rate
fluctuations through the widespread benchmarking with LIBOR in their financing
operations.
While the foreign exchange risk is a currency risk arises from unfavorable
exchange rate fluctuations which will have an effect on foreign exchange
positions. The challenge for Sukuk issuing corporate entities and sovereigns
becomes to devise an effective exchange risk management strategy congruent to
Shariah principles.
7.2.2 Credit and Counterparty Risk.
The Credit risk is the probability that an asset or loan becomes irrecoverable due
to a default or delay in settlements while the counterparty risk is the probability
that the counterparty retracts on the conditions of the contract if the
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relationship involves a contractual arrangement. The consequences can be

severe with a decline in the value of a bank’s assets. The credit and counterparty
risks inbuilt in Islamic finance are unique owing to the nature of Islamic financial
instruments that become the foundation of the Sukuk asset pools. Unlike
conventional financial institutions, Islamic banks do not have access to derivative
instruments and other credit risk management mechanisms due to Shariah
considerations.
7.2.3 Shariah Compliance Risk.
The Shariah compliance risk is the loss of asset value as a result of the issuers’
breach of its fiduciary responsibilities with respect to compliance with Shariah.
For example, if the Sukuk is based on a hybrid of Ijarah and Istisna assets, Ijarah
must always be more than Istisna’ in the pool, otherwise the Sukuk deed will
dissolve. Thus broadly speaking, Shariah compliance risk must be defined as a
rate of return foregone in comparison to the market rates, as a result of
complying with the Shariah. Moreover, fixed rate Sukuk faces serious market
risks. So, to match the market requirements of Sukuk to be floating rate, and the
Shariah requirements of rents to be fixed rate, the Ijarah Sukuk are based on a
Master Ijarah Agreement with several subordinate Ijarah agreements. However,
the investors could still face profit rate risk to a certain extent and since the
originator can only guarantee the fixed return on the underlying asset pools, the
issue of floating rate returns still remains contentious, particularly, in
pooled/hybrid Sukuk. Therefore, the association of Shariah supervisors with
Sukuk issues will ensure investor confidence
7.2.4 Operational Risk.

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The operational risk is in the sense that is inherent to the structure of the
issuances rather than the underlying Islamic principles. Furthermore, the risks
related specific to the operation are mirror to those existent in conventional
bond markets these risks are Default Risk, Coupon Payment Risk, Asset
Redemption Risk, Investor Specific Risks, and Risks Related to the Asset. First,
Default Risk is when each party has provisions for the termination of the
certificate in the event of a default by the obligor. Second, Coupon Payment Risk
is when the obligor may fail to pay the required coupons on time. Third, Asset
Redemption Risk is when the originator has to buy back the underlying assets
from the certificate holder. Fourth, Investor Specific Risks is when the certificate
holder is rendered to several risks relevant to Sukuk structures such as liquidity
management issues in Islamic finance. Fives, Risks Related to the Asset is when
the underlying assets of the Sukuk certificates are subject to numerous risks such
that the risk of loss of the assets.
7.2.5 Institutional Rigidity.
The financial infrastructure is weak in most emerging economies’ countries but

the financial infrastructure in some of these countries such as Bahrain and
Malaysia are well developed However, Sukuk require unique Shariah compliant
structures which create a state that can be termed as one of institutional rigidity
and that cannot be removed in the short run and always increasing the risks of
Sukuks. Furthermore, the features of this state are lack of hedging and financial
engineering processes, nonexistence of inter-bank money markets, lack of best
practice uniform regulatory standards and regimes, weaknesses in litigation and
legal framework support, particularly, in the treatment of default, non-uniform
accounting, auditing and income and loss recognition systems, non-robust
investment appraisal, promotion and monitoring infrastructure, ineffective
external credit assessment systems, rudimentary state of financial markets, and
weak inter-segmental support and linkages.

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7.3 Challenges in Managing the Financial Risks of Sukuk
Sukuk certificates serve to replicate the functions of conventional bonds and tradable
securities in resources mobilization from markets and injecting liquidity into the
enterprise or government and in providing stable resource of income for investors.
Moreover, investing in Sukuk issuances involves the funding of trade or production of
tangible assets. So, this section will state the challenges facing the management of
financial risks of Sukuk that are the challenge of institutional reorganization.
7.3.1 Challenge of Institutional reorganization
Public Debt Management upon which the fixed income markets in developing
countries is dominated by government bonds. Therefore, the single most
important reorganization of the markets can come from the reorganization of
the public debt management. Second, the introduction of derivative markets has
further consequences on market and financing dynamics. Furthermore, markets
stabilizing role of futures and options markets depends on the speculator’s
information Futures and options markets can also serve to stabilize the value of
underlying assets by acting in an insuring role and this can occur if these markets
allow investors to pool risks more efficiently and share them.
Therefore in short, the evolutionary changes of financial innovation,

deregulation, globalization of financial services and introduction of novel
financing instruments warrants the adoption of supporting risk management
mechanisms, viable secondary markets and relevant regulatory bodies. Third,
securitization, the emergence of the market for asset backed securities over the
past two decades has permitted banks around the world to free their capital by
re-packaging and reselling portfolios of loans, assets and other receivables. This

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adjusts the criteria for lending by forcing financial institutions to meet the
market’s standards for loan quality and sufficient pricing for risk. It helps
decrease funding risk by diversifying funding sources.
Financial institutions also employ securitization to purge profit rate mismatches.

Also, it creates more complete markets by introducing formerly remote asset
classes that better suit investor risk preferences and by increasing the potential
for investors to achieve the benefits of diversification. Therefore, by meeting the
needs of different market segments, securitization transactions can generate
gains for both originators and investors. The same benefits can be attributed to
Sukuk certificates. They allow the institution to manage balance sheet
mismatches to securitize longer term assets. Moreover, investors are also given
the option to invest in asset grades that are suitable for their investment needs.
Also, financial markets are more complete as previously and untapped assets are
now available for public sector resource mobilization.
Liquidity and secondary markets, Islamic savers and investors, like conventional
ones, portray varying risk preferences and a secondary market should be
developed to reflect this. Sukuk certificates are unique in that the investor
becomes an asset holder and is directly tied in to the nature and functioning of
the underlying asset pools so Sukuk certificate holders carry the burden of these
unique risks. The primary concern of an Islamic secondary market is its
marketability. All things being equal, a certificate holder would rather participate
in a well structured and well regulated secondary market instead of trading in a
poorly run market. However, the challenges remain to provide increased risk
management mechanisms, increase market liquidity, create a truer bond yield
benchmark as well as widening the issuer and investor base.
7.4 Argument that most of Sukuk implementations are not followed the Shariah rules.

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Based on Mohammed Taqi Othmani (2008) stated that 85 % of Sukuk at GCC is not
followed the Shariah Standards. For that, AAOIFI may change the rules of Sukuk issuing
industry. Moreover, AAOIFI may put more restrictions on rules in order to make
borrowers avoiding signing agreements for buy back upon which the issuing of most
Sukuk that attract investors from word wide looking for opportunities in GCC.
These restrictions will govern the structures of Sukuk very well but it will need time to
attract those foreign investors who looking for opportunities in region. Furthermore,
most of Sukuk sold with a promise to buy back from the borrowers “Sukuk issuers”
which is a promise from the borrowers to give back the initial value “capital” of Sukuk in
case either of due date or fail of paid the payments that represent a traditional bonds
which is questionable in following the Sharia rules and standards because it break the
concept of sharing the risk and return.
The promise of give back the Sukuk capital is disagreeing with the idea of sharing risk
and return that must be a base for Sukuk so the risk is unshared and the return is
unshared according to the agreed standards of Sukuk and for the 85% of them are like
that . Moreover, bankers said that any Fatwas prohibit the buy back promise will make
serous troubles for Sukuk Industry since the buy back promise or purchase undertaking
at fixed price is not there, the returns will be based on underling assets’ profits of Sukuk
which will make some of Sukuk issuers and investors looking for fixed returns not buying
Sukuk
In addition the study done by Mohammed AL-Qarri(2009) said that some of supervisory
board let the promise of buy back to pass in order to develop the Sukuk industry before
but now they will agree on alternative mostly to a promise to buy back soon instead of
prohibiting it. Therefore, this alternative will encourage more Islamic investors to
purchase Sukuk

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8.0 SUKUK AL IJARAH : GROWTH & PROSPECT

The Sukuk market was not spared the effects of the global credit crisis. Based on data
from Zawya’s Sukuk Monitor for H1 2009 global Sukuk issuance in 2008 dropped by 55
per cent to $15.4 billion from 2007. Issuance continued to decline, standing at $7.4
billion for H1 2009, 33 per cent less than H1 2008.
The data shows that the decline is most significant in the GCC. South East Asia is leading
in new issues with total issuance reaching $6.25 billion, representing 84 per cent of total
global Sukuk issuance for H1 2009. Only 16 per cent of H1 2009 issues came from the
GCC with a total value of $1.15 billion.
GCC Sukuk issues picked up in Q3 2009 with Saudi Electricity and Islamic Development
Bank issues totalling $2.7 billion. Malaysia retains its lead as top issuer in Q3 2009 with a
total of $4.55 billion issued representing 54 per cent of the total issuance in that quarter
including the notable $1.5 billion Petronas Global Ijarah Sukuk issued in August 2009.
For the 12 months ended September 2009, Malaysia dominates the global Sukuk market
with around 60 per cent of the total issued. The notable Petronas Global Ijarah Sukuk
issue reinforces Malaysia’s place as one of the leaders of Islamic finance. It is notable for
being of a significant issue size and is structurally innovative.
The issue received overwhelming response and was oversubscribed several times with a
significant amount being subscribed to by investors from Asia. It is interesting to note
that the capacity and appetite of Asian investors for Sukuk have gained prominence as
seen with the Petronas issue as well as the $850 million Islamic Development Bank
Sukuk which also attracted a significant number of Asian subscribers.

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In addition to heightened Asian investor interest, we are also seeing an increase in

issuer interest to tap into the Sukuk market from non-Islamic markets especially
following the global credit crisis e.g. the UK France and Korea. Though we have yet to
see any Sukuk issued from those markets their governments are making changes to
their various governing laws and regulations to facilitate Sukuk issuance. We believe
that it will not be long before those markets undertake fund raising through the Sukuk
market which would add further vibrancy to the global Sukuk market.
Issuance of Sukuk in Malaysia is regulated by the Securities Commission through the
framework provided under the Guidelines on the Offering of Islamic Securities with the
Shariah component being regulated by the Securities Commission’s Shariah Advisory
Council. The establishment of a clear and unambiguous Sukuk framework is critical in
the development of the Sukuk market which in turn promotes greater market
competition. The ringgit Sukuk market in Malaysia now dominates the domestic debt
securities market as pricing for Sukuk is more competitive than for conventional bonds.
In the promotion of greater governance and transparency, Bursa Malaysia introduced
new rules for the listing of Sukuk on the exchange. Under the new framework, Sukuk
denominated in ringgit and foreign currencies issued by local and international listed
and non-listed entities will be allowed to be listed on the exchange. Listing a Sukuk on
Bursa Malaysia is provided for under an ‘exempt regime’ which does not provide for the
paper to be quoted or traded over the exchange. This is based on a framework that is
compa- rable with practices in other exchanges that provide similar listing facilities.
The main proposition for a Sukuk listing on Bursa Malaysia is to promote transparency
and governance which is much sought after by investors in the wake of the global
financial crisis. The exchange will monitor the submission of annual financial accounts
annually to investors and will be able to query issuers on anomalies, if any. The listing of
a Sukuk is also aimed at facilitating greater profiling of the issuer particularly its
governance practices and credit worthiness which in turn will facilitate future fund
raising initiatives by the issuer.

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9.0 CONCLUSION

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MALAYSIA CAPITAL MARKET : SUKUK AL IJARAH MBA UKM

1.1 Concept & Definition

2.0 TYPE OF SUKUK 2.1 Sukuk Certificate

3.0 THE ISLAMIC LAW 3.4 Shariah Observation on Sukuk Al Ijarah

4.1 History & Overview

5.1 Structure & Features of Sukuk Al Ijarah

6.1 Global Sukuk Performance

7.1 Risk of Sukuk Al Ijarah

7.0 SUKUK AL IJARAH :

8.0 SUKUK AL IJARAH : 8.1 The Recent Development of Sukuk Al Ijarah

ISLAMIC CAPITAL MARKET 2

“investment certificates,” due to ownership attributes, with each sakk representing

1.2 History of Malaysia Sukuk

ISLAMIC CAPITAL MARKET 3

1.3 The Global Sukuk Market

1.4 Sukuk & Securitization

Sukuk is the result of Islamic securitization of asset, Securitization is a form of asset

ISLAMIC CAPITAL MARKET 4

Through securitization a liquid asset is transformed into a tradable security that

1.5 Sukuk & Conventional Bond : Comparison

ISLAMIC CAPITAL MARKET 5

2.0 TYPE OF SUKUK STRUCTURES

2.1.1 Pure Ijarah Sukuk

2.1.2 Hybrid/Pooled Sukuk

2.1.3 Variable Rate Redeemable Sukuk

ISLAMIC CAPITAL MARKET 7

of Islamic banking that considers partnership contracts as the embodiment of

2.1.4 Zero-coupon non-tradable Sukuk

2.1.5 Embedded Sukuk

2.1.6 Expanded List of Sukuk

2.1 The Common Sukuk Structures

ISLAMIC CAPITAL MARKET 8

3.0 THE ISLAMIC LAW FRAMEWORK FOR SUKUK

Sukuk al Ijarah do not represent debts, it represents undivided proportionate

Damage and loss of property

Credit risk, Guarantee on obligation to pay lease rental, Ownership risks?

ISLAMIC CAPITAL MARKET 11

subject of Mudarabah, article (8/8), or to obtaining project financing on the account

ISLAMIC CAPITAL MARKET 12

3.2 AAOIFI Standard

ISLAMIC CAPITAL MARKET 13

3.3 BNM Standard

There is a proposal to use ijarah sukuk and Shariah-compliant securities as

3.3 Security Commision

ISLAMIC CAPITAL MARKET 15

4.0 SUKUK AL IJARAH : INTRODUCTION

Al-Ijarah (al-ajr) (sale of usufruct)

ISLAMIC CAPITAL MARKET 16

Technical meaning: A contract of proposed and known usufruct (manfaat) with a

4.2 History & Overview

In December 2000, Kumpulan Guthrie Berhad (Guthrie) was granted a RM1.5

4.3 Nature of Sukuk Al Ijarah

4.4 Sukuk Al Ijarah : In Practice

ISLAMIC CAPITAL MARKET 18

5.0 SUKUK AL IJARAH : APPLICATION

ISLAMIC CAPITAL MARKET 19

ISLAMIC CAPITAL MARKET 20

Features of Ijarah sukuk

ISLAMIC CAPITAL MARKET 21

5.2 Issuance of Sukuk Al Ijarah