My last article ended on a question to which none of the readers sent any response. It could be due to a paucity of time during Ramadan, especially in the last 10 days when Muslims strive for greater reward.

Anyhow, let me explain as to why the Shariah scholars do not agree with providing the face value in the purchase or sale undertaking in the investment-based Sukuk transactions viz. Mudarabah, Musharakah and Wakalah.

I had explained much earlier in this space while introducing the Shariah nominate contracts that in Shariah, the main difference between the sale and investment-based contracts is that the seller comes to know of the profit (or loss) it is making while concluding the sale and purchase transaction. Examples are Murabahah, Istisnah and Salam where the seller knows fully well as to the resultant surplus or deficit it is incurring upon completion of the transaction.

As for Ijarah, which too is a kind of ‘sale’ since the usufruct attached to the asset has changed hands, it is possible for the lessor to ascertain while fixing the rent for a certain period whether the variable element of rental it will receive shall benefit or undermine its coffers.

Another aspect is that the cost of the asset or commodity being traded in sale contracts is known, or fixed, and the profit is added to it (or the loss is deducted from it). The element of certainty of the cost of the asset in Sukuk Ijarah allows the use of the face value in the purchase undertaking — and in turn in the exercise notice to the obligor in the event of a default situation.

On the contrary, the investment contracts in Shariah are a different breed in that the value of the original equity keeps fluctuating based on the health of the market at any given point of time. If the line of business of a Mudarabah entity is in demand, the equity value shall register a rise over the originally invested amount, and vice versa.

For example, if the Mudarabah entity invests US$1 million in real estate and the value of the investment registers a healthy increase owing to a buoyant market, the worth of the original equity will not remain US$1 million but will grow correspondingly. The reverse shall be true in gloomy market conditions.

In view of the foregoing, it will not be possible to use the face value of the Sukuk in the purchase undertaking provided by the obligor in the investment-based Sukuk transactions. Hence, the scholars’ position to use the market, fair or agreed value is regarded as the best possible option and this fact ought to be properly narrated in the Sukuk prospectus.

Sukuk Wakalah
The launch steps in Sukuk Wakalah are an imitation of Sukuk Ijarah, Sukuk Mudarabah or Sukuk Musharakah. The low-risk proposition of the Wakalah model in comparison with Sukuk Mudarabah and Sukuk Musharakah must be adequately highlighted in the prospectus.

Like the Sukuk Mudarabah and Sukuk Musharakah, the Sukuk Wakalah may or may not have an asset to start with. In the absence of an asset, the Sukuk Wakalah proceeds shall be utilized to develop the same.

Also, the periodic return for Sukukholders cannot be pre-advised as is done in Sukuk Ijarah, though it can be a symptomatic range which should be explained in the prospectus. I have already covered in the previous article the approach to capture this important element in a Shariah compliant manner through the business plan.

I wrote in the last article that the underlying asset in the Sukuk Musharakah can be leased by one partner to the other. Let me explain this technical point. If the obligor and trustee shell company (representing the Sukuk investors) have jointly purchased a Musharakah asset for US$100 million whereby the former’s contribution is US$20 million, the partners shall undividedly own the asset jointly in the ratio of 20:80 respectively.

It is permissible in Shariah that the trustee shell company may lease its 80% share in the jointly owned asset to the obligor for the entire duration of the Sukuk either on a financial or operating lease basis provided they sign a lease contract separate from the Musharakah agreement. Also, the lease agreement must be signed pursuant to the parties entering into the Musharakah.

Through the leasing of their part of the undivided pro-rata ownership of the Musharakah asset to the obligor, the Sukuk investors are able to mitigate the ownership/equity risk, rate of return risk and the performance risk.

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 transactions shall continue.