Welcome back after the break. We are starting the new calendar year with the hope that through the concerted global efforts, we can say goodbye to the COVID-19 pandemic and disaster and accord a warm welcome to health and prosperity.
I do not have figures to substantiate but going by the indications so far, I do believe that the current pandemic has left the world poorer compared to the financial crisis of 2008. At the same time, I also believe in the resilience of the human race to bounce back after each predicament, be it natural, medical or financial. I have strong faith that the Creator of the universe will more than compensate us for the recent sufferings.
Returning to the current subject of Sukuk, the last article had a little debate whether it is in order to term the periodic distribution to the Sukukholders as a coupon, which is traditionally known and is defined as the interest payment on conventional bonds, and that the scholars tend to ensure that the major Shariah parameters are not compromised and they let go of such minor misnomers.
Here again, I would like to bring the discussion we had on the form or substance, or both. Therefore, if the substance in an Islamic financial transaction ticks all the boxes, it will be of lesser importance if the form remains to be perfected. Nevertheless, it may not be true vice versa.
As for using the conventional benchmark for Islamic financing transactions, readers may refer to the series I wrote on Ijarah starting from article 62 where it has been adequately explained.
Moving on, in Sukuk Ijarah, it is a Shariah condition that the lease rent must be fixed from day one either in the shape of a constant rate, or the rate based on a formula such as a certain margin added to a conventional benchmark floating rate for the relevant Ijarah period.
In this connection, the London Interbank Offered Rate (LIBOR) has widely been used for most internationally subscribed Sukuk transactions. However, with the slow death of LIBOR, expected latest by the middle of next year, the jury is still out on what shall be the basis for ascertaining the periodic profit distribution for the existing and new Sukuk in consortium and other Islamic financial transactions.
Several attempts were made and abandoned in the past by various industry stakeholders to invent an indigenous Islamic profit benchmark rate, away from borrowing the conventional rate floater, but nothing concrete has come out so far, nor is anything in sight as at the time of my writing of this article.
In the conventional financial market, LIBOR is being gradually replaced either by the Secured Overnight Funding Rate (SOFR) launched in the 2nd quarter of 2018 by the Fed in the US, or by the Sterling Overnight Index Average (SONIA) introduced by the Bank of England way back in 1997 but has recently become prominent for the same reason.
In my opinion, the Islamic financing transactions where LIBOR has been used as the profit benchmark shall also be migrating to either of the said conventional rates, or a combination thereof.
Why is it so difficult to develop a pure Islamic profit benchmark, or can such a benchmark be actually created in isolation from the conventional financial market? As per my own assessment, yes it is possible, and it will be good to have our own rate since it will have the potential to propel the size of global Islamic finance assets to new heights. I will share my thoughts on this point some other time. So stay tuned.
Pursuant to signing the lease agreement, the parties will also sign a servicing agency agreement the scope of which is for the originator of the Sukuk (the lessee) to take care of the Sukuk asset and keep it in good working condition for the entire lease term for and on behalf of the lessor and in the capacity as the lessor’s agent.
In the first Sukuk Ijarah issued in the UAE in 2004, the matter of major maintenance of the Sukuk asset came up for discussion among the scholars. They were presented with the situation that since the Sukuk asset is technical in nature, requiring regular upkeep and that the arranger banks do not have the capacity to undertake the regular maintenance, a Shariah solution may be provided to address this impediment.
It was unanimously agreed among the scholars advising on the transaction at the time that the most suitable party to undertake the major maintenance of the Sukuk asset is none other than the lessee. This is because the Sukuk asset has been in its possession as the owner and it has been servicing the asset and may continue to do so albeit in the altered capacity as the agent, instead of the owner. Nevertheless, the cost of all major maintenance shall be borne by the lessor (the Sukukholders represented by the trustee shell company).
Well, if the lessor was asked to bear the cost of all major maintenance to the Sukuk asset, how was the risk of diminution in the return to the Sukukholders addressed? I will defer it until the next article but would welcome any thoughts from readers. The hint is to refer to my articles on 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 the Sukuk procedures shall continue.