Historically, Islamic financing structures have not been widely utilized in large-scale project financings. SAJJAD KHOSHROO examines how this situation is rapidly changing.
By 2014, it is estimated that a sizeable portion of the total project finance market in the Middle East will be financed in accordance with Shariah principles. The typical infrastructure and development objectives of project finance make it a suitable candidate for Islamic finance.
The rapid growth of Islamic project finance in the Middle East has been helped by: (i) the capital-intensive nature of the mega-projects undertaken in the region, where project sponsors have needed to draw on all available funding sources; (ii) growth in dedicated Islamic finance institutions offering a full range of Shariah compliant products capable of utilising a project’s underlying tangible and intangible assets; (iii) increase in the liquidity of the Islamic finance institutions allowing them to participate in projects with longer tenors; (iv) political and cultural desire in certain projects (especially mega-projects with national significance) to promote Islamic finance; and (v) broader consumer demand for Shariah compliant financial services and products.
Islamic project finance products
Istisnah-Ijarah and Wakalah-Ijarah: The Istisnah-Ijarah has emerged as the most common Islamic project finance structure for large and long-term financings. This structure is a combination of the Istisnah — a contract for the procurement of an asset during the project’s construction phase; and the Ijarah —a forward lease whereby the procured asset is leased to the project company.
The Istisnah-Ijarah is now a settled structure and a measure of standardization has been achieved in its documentation. It has been used in Barzan (Qatar 2011), SATORP (Saudi Arabia 2010) and Sohar (Oman 2006). It is often used alongside the Wakalah-Ijarah structure, which is substantially similar and is preferred by some local banks. This was the case in the Riyadh PP11 and Rabigh IPP power plants (Saudi Arabia 2010 and 2009).
These products are suitable for project finance as they offer the certainty of regular payments throughout the life of the financing with the flexibility of tailoring payments in a manner that allows Islamic financiers to achieve profit margins comparable to that of conventional financiers.
Murabahah & Tawarruq: Another common Islamic project finance structure is the Murabahah and Tawarruq. Murabahah changes what is effectively similar to a loan into a trade transaction. The Islamic financier purchases an asset (often through an agent) and then sells the asset to the project company at cost plus a fixed profit. Payment by the company is usually deferred and made in instalments. The company requires the asset being purchased for its own use. In project financings, intangible assets (such as airtime) are used as the Murabahah’s underlying assets (such as Mobily (Saudi Arabia 2007)).
In a Tawarruq (which is a more versatile variation of the Murabahah), the Islamic financier purchases an asset at market value for immediate delivery and spot payment, and immediately sells it on to the project company at a pre-agreed price for immediate delivery and on a deferred payment basis. On acquiring title to the asset, the company immediately resells the asset on a spot payment and immediate delivery basis to a third-party and receives cash. Unlike in a Murabahah, in a Tawarruq, the project company does not require the asset for its own use and is only interested in its resale value. The Tawarruq structure is often viewed as a synthetic form of Islamic finance and has been frowned upon by Shariah scholars. It is seldom used as the main financing instrument in project financings, but is often used to provide equity bridge financing and working capital facilities (such as Riyadh PP11 (Saudi Arabia 2010)).
Project Sukuk: Project Sukuk are a recent addition to Islamic project finance instruments, but are set to grow rapidly. The SATORP Sukuk (Saudi Arabia 2011), the first ever project Sukuk issued, was over-subscribed by almost 3.5 times. The SATORP Sukuk had a 14-year tenor, which is typical for project financings, but longer than usual Sukuk tenors (which tend to be between five and seven years). The recent issuance of the Sadara Sukuk (Saudi Arabia 2013) is also expected to perform well.
Strong demand from regional and domestic investors, lower cost of issuance compared to conventional bonds, attractive pricing, increased standardization and political commitment to develop the region’s capital markets have all contributed to the growth of Sukuk in general, and project Sukuk in particular.
Interface with conventional finance
Given the magnitude of large-scale project financing, these products are typically used alongside conventional finance sources raised from export credit agencies, commercial banks and development funds. The Islamic financiers (directly or through an agent) will be party to the Common Terms Agreement and the Intercreditor Agreement, where they share in the security and benefit from any sponsor support. Certain restrictions are also placed on the ability of the Islamic financiers to deal with the assets to bring their rights in line with those of the conventional financers. As the Islamic financiers are the owners of the assets, this puts them in a better position compared to conventional financiers, who are usually only beneficiaries of security granted to a security agent. The aim is to achieve the same commercial terms for the conventional and Islamic financiers —reaching the same destination through a different route.
Sajjad Khoshroo is an associate at White & Case in London and a teaching fellow at SOAS, University of London. He can be contact at