In the last article, I had written about the differences between Sukuk Ijarah — which I had used as the default model while explaining various aspects of Sukuk — and Sukuk Mudarabah. Today, I will elaborate on how Sukuk Musharakah are different from Sukuk Ijarah.
Similar to Sukuk Mudarabah, the steps toward the launch of the Sukuk Musharakah are also a replica of Sukuk Ijarah. This has been explained in the last article, therefore, I will skip repeating them here. Also, I think I will not need to explain what Musharakah is all about, do I? So let us move on to Sukuk Musharakah issuance.
The structure diagram which appears in the Sukuk prospectus illustrates that Sukuk Musharakah are of a different genre than Sukuk Ijarah or Sukuk Mudarabah. An interesting element in Sukuk Musharakah is that the Musharakah asset can be leased by a partner to another but I will explain it later.
Similar to Sukuk Mudarabah, it is not necessary that the Sukuk Musharakah should have an asset for the purpose of launching the Sukuk. This contrasts with Sukuk Ijarah where the presence of a Shariah compliant asset is a must. In other words, the Sukuk Musharakah may or may not have an asset to start with. If the Sukuk Musharakah issuance does not have an asset to start with, the Sukuk can still be issued to develop one by utilizing the investors’ funds.
Similar to Sukuk Mudarabah, and in contrast with Sukuk Ijarah, the determination of a periodic profit to be paid to Sukuk investors cannot be pre-agreed; however, an indicative range for the return to Sukukholders can be specified in the prospectus. Normally, the estimated return is provided in the shape of the business plan attached with the Musharakah contract. It should also be available in the prospectus to be examined by prospective investors to be able to make an investment decision.
For the sake of clarity, based on its industry expertise, the obligor makes the projection of earning a certain amount of profit or indicates a range for the Musharakah profit. The Musharakah agreement then stipulates that the obligor shall be entitled to the incentive upon achieving the profit beyond a certain defined threshold for the investors which is the rate of return developed by the arranger banks through the bookbuilding process.
This Shariah compliant approach encourages public and private sector enterprises to opt for the issuance of Sukuk instead of bonds, providing them with a much wider investor appeal in traditional markets where Islamic finance is thriving. If they issue a conventional bond, they will miss-out on the huge surplus liquidity Islamic banks usually enjoy. As such, if these issuers are convinced that they will not be paying Sukuk investors more than what they could have paid to bondholders, they will certainly be happy to go for the Islamic paper.
I have already explained in the last article the delicate subject of the purchase undertaking and how it is different in Sukuk Mudarabah in comparison with Sukuk Ijarah. The same ruling of ‘market value’ or ‘fair value’ or ‘agreed value’ determinable only at the time of exercising the put option shall apply for Sukuk Musharakah too.
Let me explain an interesting point on the market value, fair value or agreed value. You know that in all investment contracts viz. Mudarabah, Musharakah and Wakalah, the obligor is Shariah-bound to return the capital to the investor upon the successful completion of the investment term.
If a situation arises where the obligor finds it difficult to keep up with the indicative profit level, it is required to immediately inform the investors (for Sukuk, it is the trustee shell company) and obtain a fresh instruction whether to continue with the investment with the expected return being lower than the one projected in the business plan or withdraw it in order to cut losses. If the obligor does not inform the trustee shell company (representing the Sukukholders), it will be considered as a breach and you know well if the obligor blinks first, it will have to cough up the original Sukuk amount together with the projected profit.
In both the situations I have enumerated above, the obligor must return the original capital to the trustee shell company for onward distribution among the Sukukholders. Now, I have a question for you. Keeping in view both situations where the obligor is required to return the original (face value) amount of the Sukuk to investors, why do Shariah scholars not allow to treat the purchase undertaking in the same manner as Sukuk Ijarah?
The purpose of this educative series and the article is not to hurt any religious or commercial sentiments either consciously or even unwittingly
Sohail Zubairi is an Islamic finance specialist and AAOIFI-certified Shariah advisor and auditor. He can be contacted at [email protected]
Next Week: Discussion on Sukuk Musharakah and Wakalah in comparison with Sukuk Ijarah transactions shall continue.