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ISLAMIC BONDS (SUKUK) CASE STUDY US $ 400 million Islamic Development Bank Sukuk: Hybrid Sukuk Case Abstract An Islamic bond (S ukuk) has economic characteristics similar t o those of a conventional bond, but is structured so as to be compliant with Shari?a law and can b e sold to Islamic investors who are prohibited by Shari?a law from investing in conventional debt securities. The IDB is a multilateral development financing institution founded in December 1973 by the first conference of the Finance M inisters of the Organization of t he Islamic Conference (OIC). It officially began operations in 1975 with the purpose of fosteri ng the economic development and social progress of member countries and Muslim communities ind ividually as well as jointly in ac cordance with the principles of the Shari?a. Mobilization o f resources has remained one of the greatest challenges fa cing the IDB. The emergence of S ukuk has provided the IDB a novel dimension through which to face this challenge and in Augus t, 2003 the bank issued US $400 million worth of trust certificates due in 2008. Islamic Development Bank (IDB) The IDB is a multilateral development financing institution founded in December 1973 by the first conference of the Finance Ministers of the O rganization of t he Islamic Conference (OIC). It officially began operations in 1975 with the purpose of fostering the economic develop ment and social progress of member countries and Muslim communities ind ividually as well as jointly in accordance with the principles of the Shari?a. Mobilization o f resources has remained one of the greatest challenges fa cing the IDB. The emergence of S ukuk has provided the IDB a novel dimension through which to face this challenge and in Augus t, 2003 the bank issued US $400 million worth of trust certificates due in 2008. Each of the certificates represents an undivided interest for the certificate holder in the Trust Assets. These assets are held by Solidarity Trust Service s Limited which is a bankruptcy remote trustee crea ted solely for the purpose of this S ukuk issuance. The unique feature of this arrangement is in the portfolio of Trust Assets. Each certificate holder is granted the right to receive payments arising from the Trust Assets that include ijarah (leasing) cont racts, murabah (conditional sale) contracts, and istisna? (conditional sale of item to be manufactured) contracts. These returns are calculated on the basis of a fixed return of
3.635% per annum on 12th of February and 12th of August e ach year until August 2008 when they will be redeemed in full. Murabaha and Istisna? ? Securitization problems Murabaha and istisna? are contracts that cannot be traded on s econdary markets as securitized instruments. They represent debt arrangements and the subse quent trading of such contracts would typify the exchange of money. According to Shari?a principles, money can only be traded at par value and not for any profit. However, if murabaha and istisna? are proportions of a portfolio consisting of at least 51% t angible assets, then the s ecuritized certificates of this portfolio may be traded on secondary markets. This is the case with the IDB S ukuk issuance where ijarah contracts make up 51% of the trust assets; a ratio that must be maintained. However, there are provisions for exceptional circumstances where the composition of ijarah contacts can be temporarily reduced to a minimum of 25% of the total pool of assets. If at any time the proportion of ijarah contracts falls below 25% then th e arrangement will be di ssolved and the IDB will be obliged to purchase all the assets owned by the trustee at the time of the dissoluti on event. The structure of the S ukuk assets will vary over the life of the contract as the trustee will employ principal collections for the S uk uk assets to acquire rights in further ijara?a contracts and invest in murabaha contracts. However, further investments in istisna?a contracts are envisaged. Under the conditions of the prospectus, the trustee purchases t he portfolio of assets from The Is lamic Corporation for the Development of the Private Se ctor (ICD). The ICD serves as a wakala and delegates its servicing undertakings to the IDB. A wakala agreement serves to designate the business of the originator (IDB) to another agenc y (ICD) whose pri mary objective is to abate the consequences of information asymmetries. The principal and the agent are bound by equivalent contracts to the same wakil (agent). The trust certificates have been given a rating of AA by Fitch Ratings Ltd, and a AAA by Standard and Poor?s Rating Services. These ratings highlight t he probability that certificate holders will obtain all the relevant payments they have subscribed for.
The structure of the IDB S ukuk issuance is described in Figure 1.
The structure To implement the transaction, the IDB sold a portfolio of Islamic - compliant assets (at closing approximately 66% of the assets were ijara contracts) to The Islamic Corporation for the Development of the Private Sector (ICD), which is a member of the IDB group. The ICD in turn assigned the portfolio to Solidarity Trust Services Limited (Trustee). The Trustee purchased the portfolio with the proceeds of the issue of certificates. The innovation of this transaction is the inclusion of murabaha c ontr acts and istisna contracts, which traditionally have not been assignable in accordance with Shari?a principles, as they ar e contracts which represent an interest in a stream of paymen ts unlike ijara contracts which represent an interest in the underlying a ssets. The Boards were prepared to accept the inclusion of such ass ets in the pool assigned to the ICD as long as the pool was primarily made up of ijara contracts. Compliance with this requirement was achieved by including, as a dissolution event (which w ould trigger the IDB?s repurchase obligation) the circumstance where ijara contracts cease to constitute more than 25% of the portfolio held by the Trustee. It was generally contemp lated that ijara contracts will at all times constitute more than 50% of th e portfolio, although they can in very specific cases and for very limited durations drop to as low as 25%. Having assigned the portfolio of assets to the ICS, the IDB gua ranteed to the Trustee, through the ICD, the performance of the obligors under the v arious contr acts constituting the portfolio assets. It should be noted that IDB does not guarantee the payment by the Trustee of the profit participation to the certificate holders. The IDB also promi sed to repurchase the Trustee?s portfolio (which may not be identical with the portfolio originally so ld to it) for the original sale price upon the maturity date of the certificates or following ce rtain ?dissolution events?. The certificates are not redeemable except at maturity or upon a dissolution event. Th e IDB also provides a liquidity facility to the Trustee to ens ure that the Trustee is able to make the required periodic distributions of profit shares to the cer tificate holders. If the IDB is required to provide funds to the Trustee under this facility, rep ayment to the IDB is made prior to further distributions to the certificate holders. The ICD was appointed by the Trustee as Wakeel or agent to m anage the portfolio and the ICD in turn sub - delegated its obligations as Wakeel to the IDB. The IDB does not have a direct relationship with the Trustee with respect to the management or servicing of the portfolio.
In addition to the original portfolio, the Trustee is expected to ac quire further Shari?a - compliant assets with profits in excess of required distri butions to certificat e holders and funds required to meet other costs. These assets are expected to principally be addi tional ijara contracts purchased from the IDB, through the ICD. However, if the IDB h as insufficient ijara contracts that it can assign t o the Trustee at any particular time, the Tr ustee may, on the advice of the ICD, directly enter into further murabaha contracts. The Tru stee will not purchase murabaha contracts or istisna contracts from the IDB after the closing date. A groundbreaking t ransaction The IDB S ukuk was groundbreaking in a number of ways. Not only was the IDB S ukuk only the second global securities issue that took a Shari?a - compliant form , it was also IDB?s first foray into the global capital markets and the first issue that include d a range of instruments in the pool of assets supporting the S ukuk. Both the Kingdom of Malaysia offering and the offering by the Stat e of Qatar relied for cash flow on the revenue from leases of real estate assets. These assets were purchased from the relevant State and then leased back under ijara (lease) contracts. In the case of the IDB S ukuk, the asset base includes ijara c ontracts, interests in murabaha (cost plus profit sale) contracts and istisna (construction or manufacture) contracts. This structure was approved by the Shari?a Boards of the IDB, Citi Islamic Investment Bank and The Islamic Corporation for the Development of the Private Sector. In their pronouncement approving the structure, the Shari?a Boards expressly took in to considerati on ?(i) the legal constraints under which [this] product is being developed; (ii) the need to further develop the emerging Islamic finance industry as an alternative and viable fina ncing system; (iii) the need to facilitate and bring ease to Islamic financ ial institutions and oth ers who are determined to raise financing according to Shari?a principles ...?
Paper#9210421 | Written in 27-Jul-2016Price : $22