I think I have discussed almost every aspects of a Sukuk transaction including the default situation. However, I based all of my explanations on Sukuk Ijarah.

What happens when an investor deals with Mudarabah, Musharakah, Wakalah or a hybrid Sukuk? How far are all those points that I have written about the Sukuk Ijarah true for these other Sukuk transactions as well? I will explain it one by one.

Sukuk Mudarabah
The formalities to the run-up to the issuance of Sukuk Mudarabah are akin to Sukuk Ijarah in that the originator/obligor shall appoint the banks for different roles, including the lead arranger or co-arrangers, paying agent and security agent. But before that, the obligor shall determine the extent of the issue amount and where it would like to deploy the proceeds. As explained before, the detailed prospectus bearing complete information serves as the invitation to investors. There is no comparison to this document which proves decisive in the board rooms while making an investment decision.

The difference between Sukuk Ijarah and Sukuk Mudarabah is that the former do have an identified asset for immediate lease to the obligor but in the latter, the Sukuk asset may or may not exist at the time of issuance of the Sukuk since it is permissible that the Sukuk Mudarabah proceeds can be utilized to develop the Sukuk Mudarabah asset from scratch, such as a green field industry or marine vessel or an aircraft for that matter.

Another variance in Sukuk Mudarabah is the way the profit is determined here. In Sukuk Ijarah, it is straightforward to fix the lease rent either at a constant rate or backed on a floater with margin, on an upfront basis for the entire lease term. Nevertheless, in Sukuk Mudarabah, the determination of profit for distribution among the Sukuk investors cannot be appraised on an upfront basis.

This is because while the Ijarah is considered as the sale contract where the usufruct is ‘sold’ by the lessor to the lessee for a specified known sum and term, the Mudarabah contract falls under the investment genre where the profit is realized in the future, the extent of which is unknown at the time of the Sukuk issuance. At best, the Mudarib can provide a cautious estimation, given its proficiency in the relevant field. The Mudarib cannot be held responsible if it failed to generate the projected profit, provided it was not negligent toward discharging its responsibilities.

Unlike Sukuk Ijarah, the return to investors in Sukuk Mudarabah could be lower than the projected profitability in which case, unlike Sukuk Ijarah, the Sukuk Mudarabah investors shall receive the actual profit, irrespective of how low it may be in relevance to the profit projected by the obligor in the prospectus. But if the actual Mudarabah profit is higher than the projection made by the obligor, the Mudarib shall only be liable to pay to Sukukholders the projected profit as demonstrated in the prospectus and shall retain the rest as its reward for good performance. For this purpose, the Mudarabah contract bears an incentive clause.

Another aspect different in Sukuk Mudarabah in relevance to Sukuk Ijarah is the amount of purchase undertaking provided by the obligor to the trustee shell company (representing the Sukuk investors). While the formula for the amount related to the purchase undertaking for Sukuk Ijarah is determinable at the time of its signing by the obligor, this is not the case with the purchase undertaking for Sukuk Mudarabah.

The reason for such a disparity may well be that while Sukuk Ijarah are based on a sale contract with the price of the usufruct related to the leased asset clearly known, the value of the Mudarabah asset at the time of exercising the put option by the trustee shell company (representing the Sukuk investors) cannot be ascertained at the outset, Mudarabah being the investment contract. In other words, the value of the Sukukholders’ investment can only be determined at the time of exercising the put option under the purchase undertaking by the trustee shell company in the future.

This is the reason that the purchase undertaking in Sukuk Mudarabah bears terms such as the ‘market value’ or ‘fair value’ or ‘agreed value’ determinable only at the time of exercising the put option. Readers may be aware of the market value and agreed value; however, what is ‘fair value’? The fair value in my opinion is the value of the Sukuk Mudarabah asset which is agreeable by both parties. Anyone to contest my opinion?

The question arises as to who shall determine the market, agreed or fair value of the Mudarabah asset. While the trustee shell company representing the Sukuk investors shall endeavor to receive the maximum price for the sale of its equity in the Mudarabah asset, the obligor shall try its best to curtail such a payment. Here, in case of a dispute, the role of independent assessors shall come into play who shall professionally evaluate the value of the Mudarabah asset. The cost of hiring the assessors shall be borne by the party objecting to the asset value.

In the next article, I will elaborate on the differences of Sukuk Ijarah with Sukuk Musharakah and Sukuk Wakalah. Until such time, enjoy a sumptuous Iftar, wherever you are.

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 Sukuk Wakalah in comparison with Sukuk Ijarah transactions shall continue.