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Islamic Finance: Sukuk – The Next Growth Market?. Securities & Investment Institute CPD Seminars Thursday, 14 th February 2008. Contents. The Islamic Market International Sukuk Universe Sukuk Issuer Demographics Sukuk Investor Demographics Islamic Financial Structures
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Islamic Finance: Sukuk – The Next Growth Market? Securities & Investment Institute CPD Seminars Thursday, 14th February 2008
Contents • The Islamic Market • International Sukuk Universe • Sukuk Issuer Demographics • Sukuk Investor Demographics • Islamic Financial Structures • Islamic Financing Techniques • Drivers For Secondary Market Liquidity • Islamic Finance In The UK • Conclusion
The Islamic Market • The Islamic market in terms of invested assets is estimated to be worth circa US$750 billion globally, and is growing at 10% to 15% p.a. • There are approximately 1.5 billion Muslims worldwide, accounting for 20% of the world’s population, of which 80% live outside the Middle East. • Forecasts predict that the global Muslim population will grow to 2.5 billion people over the next 20 years, representing 30% of the world’s population. • Current personal wealth in the Middle East is estimated to be US$1.5 trillion, and is the fastest growing sector in wealth management. • Sukuk (“Islamic bonds”) issuance is estimated to total in excess of US$98 billion globally (including Malaysia). Source: Standard & Poor’s and Bloomberg
International Sukuk Universe Currency Denomination International Sukuk Universe Profit Rate Profile Source: Bloomberg
Sukuk Issuer Demographics Source: Bloomberg
Islamic investors: Islamic banks HNWIs GCC institutional investors Conventional investors: Specialist convertible houses Hedge funds Investors demographics in selected Sukuk issues Nakheel ($3.52bn) : European (40%) Middle Eastern (38%) Rest of the world (22%) Aldar Properties ($2.53bn): International (70%) Middle Eastern (30%) Sukuk Investor Demographics
Islamic Financial Structures • It is acceptable for investors to make a financial return from: • Owning physical assets (e.g. commodities, real estate and manufactured goods) • Leasing or renting physical assets • Sharing of risk in a commercial venture • Principles to be kept in mind when determining the Islamic acceptability of financing techniques: • Speculation • Unjust enrichment/ exploitation • Interest • Uncertainty
Islamic Financing Techniques • Murabaha – The sale of goods with an agreed-upon mark-up on the cost (cost plus finance). • Tawarruq – The purchase of goods for deferred payment and their subsequent sale for cash to a buyer other than the original seller at a lower price for the purpose of raising cash. • Ijara – Islamic finance equivalent of leasing. Hybrid between conventional operating and finance lease. • Istisna – A contract of sale of specified goods to be manufactured (construction financing). • Salam – A contract for the purchase of a commodity for deferred delivery in exchange for immediate payment (financier pays in advance for the purchase of fungible assets). • Musharaka – Joint venture, partnership whereby each party contributes capital in equal or varying degrees to establish a new project or to share in an existing one. • Mudaraba – A partnership in profit between capital and work in which one partner contributes money and the other expertise, time and effort.
Sukuk Al Ijara • An ijara is a Sharia'a compliant lease. • In an ijara Sukuk, the obligor (originator) sells certain physical assets to the issuer, funded by cash raised from the issue of Sukuk certificates. • The issuer leases the asset to a third party, often the obligor itself, and enters into a management agreement with the obligor to manage those assets on its behalf. • The obligor pays lease rentals to the issuer, which in turn uses this cashflow to pay the profit on the Sukuk certificates. • The obligor gives a Purchase Undertaking to the issuer under which it promises to purchase the assets of the Sukuk at maturity in order for the Sukuk certificates to be redeemed. • The cash raised by the obligor from the sale of the asset can be used for general corporate purposes.
Obligor Sukuk Al Ijara (cont.) 4 Purchase Undertaking @ $100m 2 1 $100m $100m Issuer Sukuk holders Sale of Asset $100m Certificates 3 Lease Agreement and Management Agreement 1. Paying Agent 2. Investment Management
Sukuk Al Musharaka • Musharaka, also known as a joint venture or partnership. • Two distinct types of Musharaka arrangements:- • Sharikat al-aqd is an agreement between two or more parties to combine their assets, labour or liabilities for the purpose of making profits. • Sharikat al-milk arises when two parties pool their resources to jointly acquire/ own an asset. • Unlike the sharikat al-aqd, a partner in a sharikat al-milk can give a binding promise to buy all the assets (i.e. the other partners’ share of the asset (s)) at a fixed price (which may be the face value).
Musharaka Sukuk Al Musharaka (sharikat al-aqd) Purpose is to generate profits Profit Distribution 6 Profit Distribution 6 Management Agreement 3 2 2 $100m $100m Musharaka Management Agreement Partner Issuer 4 Purchase Undertaking [???] 5 Sukuk $100m 1 Sukuk holders
Sukuk Al Mudaraba • Mudaraba is a partnership in profit whereby one party, the rab al-maal, provides capital and the other party, the mudarib, provides labour. • The parties agree on a profit share. The profit is distributed according to the profit share agreement. • Final distribution should be made on the selling price of the assets after accounting for losses.
Sukuk Al Mudaraba Profit share agreement Mudarib Rab al-maal Mudaraba Expertise Funds
Drivers For Secondary Market Liquidity • Sharia’a jurisprudence • Environmental • Structural • Market dynamics • Price discovery
Islamic Finance In The UK • Finance Act 2003: SDLT applicable to individuals. • Finance Act 2005: Alternative finance arrangements - recognising mudaraba, and murabaha. • Finance Act 2006: Alternative finance arrangements - diminishing musharaka and wakala. SDLT on companies. • Finance Act 2007: Sukuk. • 2008: ???
Conclusion • A nascent market with significant growth potential. • Developments over the past year have been extremely positive. • Key to enhancing liquidity will be to embrace international best practice without compromising Sharia’a integrity. • Attract a wide range of investors (Islamic and non-Islamic). • Innovative liquidity management tools and structured alternative assets. • Develop uniform and standardised products and documentation. • Increase use of sukuk.
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