The term “Shariah bond” has been in frequent use lately in Indonesia following the issuance of Sukuk by countries like Qatar, Bahrain and Malaysia. In English, Sukuk means Islamic bond. The term “Sukuk” is Arabic, which means certificate or letter. Sukuk has the meaning of a note, which is a financing instrument made based on certain Shariah transactions that oblige the issuer to pay income in the form of profit sharing or profit margin or service payment (Ujrah) as determined in the contract and repay the fund as stated in the Sukuk certificate on the due date of the Sukuk to the Sukuk holder.
The translation of Sukuk into Shariah bond in Indonesia has not always been appropriate. As explained later on, there are differences between Sukuk based on the contract of Ijarah as issued internationally and Ijarah bond as known in Indonesia.
Government Regulation No 4 Year 1998 defines “Obligasi” (the Indonesian term for bond) as “a long-term debt security, with obligation to pay interest on a certain period and settle the principal amount as stated in (the) bond certificate”. Such definition is no longer thought to conform with Shariah principles. So, Muslim legal scholars have made a breakthrough to accommodate the aspiration of investors and those who seek additional capital yet do not want to violate Shariah principles.
At a glance, the term Shariah bond sounds contradictory. As mentioned above, Obligasi connects to payment obligation over interest of debt in addition to the same over the principal amount. On the other hand, Islamic law prohibits any transaction that contains the element of interest. Here, the innovative opinions (fatwa) of experts on Islamic jurisprudence can play an instrumental part in enabling the issuance of Obligasi (bond), but still remain compliant with Islamic law.
Sukuk can be issued by a corporation or government. Until today, the government of Indonesia has not issued Sukuk, pending the implementing regulation on this matter. Only corporations have issued Sukuk (in Indonesia, Sukuk is known as “Obligasi Shariah”). Governments of countries like Malaysia, Qatar, Bahrain and Pakistan have issued international Sukuk as a means to boost state revenue budgets.
The issuance of international Sukuk has been continuously increasing year to year, not to mention the aftermath of drastic increases in oil prices, which invited additional millions of dollars into the oil-producing countries, especially those in the Middle East. The fact is that such additional sums have opened up opportunities for cooperation in financing between investors and those additional capital seekers who wish their transactions to comply with Islamic law.
Such opportunity shall be responded to positively by the Indonesian government, which is under the pressure of economic hardship. Bearing in mind the issuance of corporate Sukuk, which has shown a positive trend domestically and overseas, and the issuance of international Sukuk by the governments of other countries, it is recommended that the government review regulations on bonds issued by the government.
In the meantime, the issuance of Sukuk by domestic corporations has rapidly increased. At end-July 2005, there were 16 Sukuk with the issuance value of IDR 2 billion (US$212,600). This means the number of corporate Sukuk has grown by 23% and its issuance value has grown in 143, 25%, compared to end-2004.
The basic principles
Islamic teachings cover not only ritual (ibadah) aspects that instruct interaction with God, but also social aspects that teach how people should interact (Muamalat).
Islamic jurisprudence provides the following principle: “All kinds of Muamalat are permissible, unless otherwise prohibited by a text” (al-ashlu fi al-mu’âmalâti al-ibâhatu illâ an yadulla dalîlun ‘alâ tahrîmihâ). Therefore, in principle, all kinds of transactions are allowed unless there is a reason (nash) that prohibits them.
A Muslim can perform a transaction on business cooperation, investments, loans, borrowings or sale and purchase with other members of the community as long as the transaction does not have any prohibited content. Further, in the context of Muamalat, Islamic law does not discriminate against the rights and obligations between Muslims and non-Muslims. Each has the right and obligation pursuant to what has been agreed. In connection with this, Imam Ali bin Abi Thalib a.s. said that: “In Muamalat, their obligations are ours and their rights are also ours.”
From the Muamalat aspect, Islam provides the following basic principles that shall be considered by every Muslim:
1) Do not make a living from any prohibited things, either in terms of their substance or method of their obtaining and do not use them for things that are also prohibited;
2) Do not oppress and do not be oppressed;
3) A necessity of being fair/honest;
4) The transaction shall be done on the basis of mutual sincerity;
5) There is no element of riba (on top of a principal debt, with no legitimate transaction as the basis);
6) There is no element of maysir (gambling);
7) There is no element of gharar (uncertainty/vagueness).
Activities of Muamalat in the capital market must comply with the above provisions. Activities of the Shariah capital market may not involve prohibited things like distribution of funds to build an alcoholic-drinks factory, fund prostitution or gambling resorts. All transactions must be done on the basis of mutual sincerity, there can be no forceful element, no party shall be allowed to oppress or be oppressed by another, no elements of riba are allowed, no gambling transactions are allowed and all transactions must be done transparently.
Definition of bond
Bond shall mean debt evidentiary certificate, issued by a limited liability company or certain institution, either government or other institution in the frame of obtaining fund/capital (funding). A company pays interest upon the bond on the dates as periodically determined and redeems the debt on the due date by repaying the principal amount of loan plus any indebted interest.
Law No 8 of 1985 regarding the capital market (Capital Market Law) classifies bond as a group of tradable securities in the capital market. Article 1.5 of the Capital Market Law defines securities as “promissory notes, commercial paper, shares, bonds… Participation Units of collective investment contract, futures contract related to Securities and all derivatives of Securities”.
In short, a bond shall consist of commercial papers issued by a limited liability company or a certain institution, which obliges the issuer to pay interest on a periodical basis and repay the principal debt on the due date to the party providing additional capital (bondholder).
Based on this definition, it is certain that the issuance of bond does not conform with the basic principle of Islamic law since there is an element of interest. This matter is also affirmed in the consideration of the fatwa of the National Board of Shariah No 32/DSN-MUI/IX/2002 regarding Shariah bond dated the 14th September 2002 (Fatwa of DSN [Dewan Shariah Nasional, or the National Shariah Board]) on Shariah bond).
Fatwa of DSN on Shariah bond provides the following definition: “Shariah bond is a long-term Shariah-based securities issued by the issuer to the Shariah bondholder, which obliges the issuer to pay income to the Shariah bondholder in the form of sharing/margin/fee and repay the fund of bond on the due date”.
The issuance of a Shariah bond can be based on various kinds of contracts, such as cooperation contract of profit sharing, sale purchase contract or lease contract. The fatwa on Shariah bond mentions that the following contracts can be used in the issuance of a Shariah bond: Mudarabah, Musharakah, Murabahah, Salam, Istisnah and Ijarah.
Mudarabah and Musharakah are categorized as sharing cooperation contracts. A bond under a Mudarabah or Musharakah contract will provide the returns, whose amount is not fixed due to the performance that generates income.
Murabahah, Salam and Istisnah are categorized as sale-purchase contracts where the principal price is added to a certain agreed profit margin. Ijarah is a lease contract. Bonds that are based on such contracts will provide fixed returns, though an Ijarah-based bond may also give returns gradually pursuant to the arrangement stated in the contract.
In addition, the fatwa on Shariah bond also mentions the type of business the issuer is involved in may not contravene the principles of Islamic law. DSN provides guidance on the type of businesses that are contrary to the principles of Shariah, among which are:
a) Gambling and other related businesses classified as gambling or prohibited trading;
b) Interest-based financial institution business, including conventional banking and insurance;
c) Businesses that produce, distribute and trade prohibited foods and beverages; businesses that produce, distribute and/or provide moral hazardous goods or services, and those that have bad influences.
Shariah bond based on Mudarabah contract, which is known as Mudarabah bond, has already been provided in the Opinion of DSN No 33/DSN-MUI/IX/2002 on Mudarabah Bond (fatwa on Mudarabah Bond). As mentioned earlier, Mudarabah is a business cooperation contract whose parties consist of the investor (Shahibul Mậl) and the investment manager (Mudarib), with the business profit being split between them based on a mutually agreed percentage (nisbah). The characteristics of Mudarabah bond are as follows:
1. It is the most suitable form of funding for investment in big numbers and in a relatively long term;
2. It is usable for public funding, like working capital funding;
3. Security upon certain assets is not absolutely necessary, since Mudarabah is a kind of cooperation between an investor and an investment manager. Mudarabah is different from a sale and purchase contract, which requires security upon assets being financed.
4. There is a global trend to use Mudarabah or Ijarah contract in the issuance of Sukuk.
The fatwa on Mudarabah bond not only provides the basic principles of Shariah-based transactions, but also the following:
1. Percentage of sharing (nisbah) shall be agreed upon prior to issuance.
2. If an issuer fails and/or breaches the terms of the agreement and/or is being excessive, the issuer shall guarantee to repay Mudarabah fund to the holder of the Mudarabah bond and the holder of the Mudarabah bond may request the issuer to execute a letter of debt acknowledgment.
3. Ownership of the Mudarabah bond can be transferred to the other party as long as agreed by the parties in the contract.
The mechanism of Mudarabah bond can be summarized as follows:
1. Issuer offers Mudarabah bond to prospective investors.
2. Contract of Mudarabah is made in trustee agreement of Mudarabah bond.
3. Percentage of sharing (nisbah) can be fixed based on the principle of revenue sharing being calculated from total revenue of fund management, or profit sharing being calculated from revenue after deduction of fund management expenses. However, the Opinion of DSN No 15/DSN-MUI/IX/2000 provides that it is better to determine the nisbah percentage on the basis of revenue sharing principle. This percentage must be stated in the agreement prior to the issuance.
4. Sharing can be done periodically and this must be stated in an agreement. If the issuer fails to pay part of the sharing, which is the right of Mudarabah bond holder on the agreed time, then a fine can be imposed on the issuer.
5. At the maturity date, the issuer is obliged to repay the fund of Mudarabah bond to the holders of Mudarabah bond.
6. Security is not a must in Mudarabah bond. However, the Opinion of DSN No 07/DSN-MUI/IV/2000 on Mudarabah financing permits security on a Mudarabah transaction. In addition, Articles 1131 and 1132 of the Indonesian Civil Code state that all assets of the debtor, either movable or immovable, either currently or which will be present in the future, shall serve as guarantee for all agreements that he or she has entered into. Nevertheless, if such certain guarantee is not bound in a security agreement, the lender has no preferential right to be given first choice upon the goods being made as the guarantee.
• Sukuk Ijarah
Besides Mudarabah bond, Sukuk Ijarah has been globally used. Sukuk Ijarah is different from Ijarah bond as it is known in Indonesia. This matter will be further described hereunder.
One of the examples of Sukuk Ijarah is the issuance of Qatar Global Sukuk by the Qatar government to build a medical center known as Hamad Medical City. The government of Qatar, together with Qatar International Islamic Bank and HSBC, first established a joint venture company (joint venture special purpose vehicle/SPV company), which then purchased some plots from the Qatar government.
The SPV company sold the right to use the land to the investors by issuing Sukuk. The money from the sale was used to build Hamad Medical City. The land was leased to the government of Qatar, which is obliged to pay the leasing fee (Ujrah). Ujrah was then distributed by the SPV company to holders of Qatar Global Sukuk.
In the issuance of Qatar Global Sukuk as mentioned above, the following contracts were involved:
1. Contract of Ijarah (lease) between the Qatar government and the SPV company as representative of holders of the Qatar Global Sukuk;
2. Contract of al-bay’ (sale purchase) between the Qatar government and the SPV company as representatives of holders of Qatar Global Sukuk;
3. Contract of Wakalah between holders of Qatar Global Sukuk and the SPV company.
Since at the end of the Sukuk period, land ownership will further be transferred to the Qatar government, the contract of Ijarah being made shall be the contract of Ijarah muntahiya bi at-tamlik (Ijarah with option to buy the ownership at the end of the Ijarah period). In this matter, the land utilized for Hamad Medical City is not used as a guarantee to Sukuk holders since within the period of Sukuk, the land is actually under the ownership of the Sukuk holders through the SPV company, and the ownership will only be further transferred at the end of the Sukuk period after the option to own is exercised by the Qatar government.
• Ijarah Bond in Indonesia
The mechanism used in Qatar Global Sukuk will certainly be impossible if applied in Indonesia. Following the sale by the Qatari government, the landowner is actually the holder of Qatar Global Sukuk. The holders of these Sukuk jointly become the landowners in accordance with the portion of Sukuk held.
In other words, the holders of Qatar Global Sukuk are the “beneficial owners” of the land. But formally, the purchaser of the land is an SPV company. Therefore, the SPV company is the “legal owner” of the land. This differentiation is not recognized under Indonesian law.
Problems will also occur since the title conversion will be made twice: first, from the issuer of Ijarah bond to the Ijarah bondholder at the beginning of the issuance of the bond; and second, from the Ijarah bondholder to the issuer at the end of the bond period.
The writer is of the opinion that the problems posed by the above mechanism in issuing Ijarah bond by a limited liability company in Indonesia can be solved by applying the principle of free contract as provided in Article 1338 of the Indonesian Civil Code, but still in the corridor of Shariah principles as mentioned above. The solution is for the land to be formally owned by the limited liability company.
However, from the perspective of Islamic jurisprudence (fiqh), the land shall be deemed to belong to Ijarah bondholders but is leased to the issuer of the Ijarah bond. The land will be used as guarantee, which will protect Ijarah bondholders from any breach of contract possibilities by the issuer of Ijarah bond.
If at the end of the period, all obligations of the Ijarah bond issuer towards Ijarah bondholders have been complied with, then the ownership of the land will be returned to the Ijarah bond issuer without any further title to conversion process.
In the issuance of Ijarah bond by PT Berlina Tbk (as the issuer), the fund of Ijarah bond is used to purchase machines as assets. The machine becomes the object of Ijarah and at the same time, a guarantee if the issuer breaches the contract in making payment over Ijarah fee and fund of Ijarah bond on the maturity date. The scheme shall be as follows: The issuer (which, in terms of Islamic jurisprudence/fiqh, is acting as the representative of Ijarah bondholders) purchases a machine.
The machine then serves as an object of Ijarah (being leased to issuer), which obliges the issuer to pay the fee of Ijarah to Ijarah bondholders. However, in writing, the machine shall belong to the issuer and so it can be used as guarantee if the issuer breaches a contract in paying fee of ijarah and fund of bond on maturity date.
Unlike in the issuance of Ijarah bond by PT Berlina Tbk, in the issuance of Ijarah bond by Matahari Putra Prima, the object of Ijarah and the guarantee were two different things. In the trust agreement on the Ijarah bond of Matahari Putra Prima, whose purpose of issuance was for fund-raising to lease a business space, the issuer in fiqh terms will act as representative of the Ijarah bond holder to carry on a lease contract upon the said business space from its owner. Benefit upon the said business space will then be enjoyed by the issuer. Upon the use of such benefit, the issuer will make payment of Ijarah fee and fund of Ijarah bond to Ijarah bondholders as determined in the trust agreement. In order to provide more guaranteed payment upon all funds of Ijarah bond and Ijarah fee, the issuer shall also provide special guarantee in the form of issuer’s assets (land, building and apartment unit in Makassar) in the interests of the Ijarah bondholder.
In this matter, the object of Ijarah is a business space that belongs to a third party, whereas the guarantee is that the land belongs to Matahari Putra Prima in Makassar. In relation to that matter and in line with the fatwa on Ijarah bond, the issuer agrees to execute a debt acknowledgment letter in the interest of Ijarah bondholders in the amount of fund of the Ijarah bond, Ijarah fee and damages compensation due to delay, if any.
In this mechanism, the issuer shall not necessarily make prior sale over its assets to Ijarah bondholders to obtain funds and further leaseback from Ijarah bondholders as applied in Sukuk Ijarah internationally.
If the mechanism of Sukuk Ijarah as applied internationally is to be applied in the issuance of state commercial papers in Indonesia, then another problem will arise since it is not possible to sell or guarantee state assets. The more appropriate mechanism for the issuance of state commercial papers shall be Sukuk Manafi’ (“Manafi’” means “benefit”). In this matter, the government transfers utilization of a state asset to its appointed legal entity (state-owned company BUMN). But since the procurement and development of such state assets involve funds from the holder of the state commercial papers, holders of these papers also have the right to acquire some of the result of utilization over the said state asset in the form of an Ujrah (fee). Under Sukuk Manafi’, there is no state asset being sold or guaranteed.
On the 4th March 2004, DSN issued Opinion No 41/DSN-MUI/III/2004 on Ijarah Bond (Ijarah Bond opinion). The opinion not only provides reference over substance of the previous opinion on Ijarah, but also provides, among others, the following:
1. Issuer in its position as Ijarah bond issuer may issue such bond for the existing assets or assets that will be provided for lease.
2. Bondholder as owner of the asset or benefit must lease his or her rightful asset or benefit to the other party through the issuer as representative.
3. Issuer may lease for itself or lease to other party.
4. If issuer leases for itself, then it shall pay the lease in the agreed amount and period as compensation in the same amount as when the lease is being applied to the other party.
5. Ownership of Ijarah bond is transferable if agreed by the parties in the contract.
Unlike Mudarabah bond, whose returns cannot be fixed due to the fluctuation of profit from the fund management, Sukuk Ijarah provides more stable returns, even gradual returns pursuant to the agreement. In 2004, Indonesia saw seven issuers acquiring statement of effective from the authority to issue Ijarah bond with total issuance value of IDR 642 billion (US$68 million).
Sukuk is considered to be closer to the parties’ sense of fairness. In Sukuk Mudarabah, the issuer would obtain additional funds from the investors who are the holders of Sukuk Mudarabah, with the obligation to make payment over sharing from the profit of the project funded from Sukuk Mudarabah, and repay the fund of bond on its maturity date.