Applied Shariah In Financial Transactions

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Applied Shariah In Financial Transactions

  1. 1. APPLIED SHARI`AH IN FINANCIAL TRANSACTIONS Associate Professor Dr Engku Rabiah Adawiah Ahmad Ibrahim Kulliyyah of Laws International Islamic University Malaysia rabiah@iiu.edu.my eradawiah@yahoo.com
  2. 2. INTRODUCTION Shari`ah law works in financial transactions (mu`amalat) by way of interpretative efforts (ijtihad) of the primary sources (Quran & Sunnah); & using various secondary sources & techniques of arriving at legal rules Shari`ah law declares that the original status of each and every contract is permissibility unless proven otherwise (al-asl fi al `uqud al-ibahah) This doctrine of permissibility gives flexibility and opens up opportunities for innovation and creativity in “Islamic financial engineering” and product development 2
  3. 3. CONTEMPORARY ISLAMIC FINANCIAL SERVICES Islamic Capital Islamic Banking Takaful Market Financing Equity Market Takaful Financing Equity Market Takaful Deposit & Deposit & Bond Market Retakaful Bond Market Retakaful Investment Investment Bank Negara Securities Commission Bank Negara IBA 1983 - Islamic Bank SCA 1993 Takaful Act 1984 BAFIA 1989 – Islamic CA 1965 Windows 3
  4. 4. KEY ISLAMIC COMMERCIAL CONTRACTS Gratuitous Trading Investment Supporting Gratuitous Trading Investment Supporting Contracts Contracts Contracts Contracts Contracts Contracts Contracts Contracts Gift Leasing Sale Mudarabah Kafalah Gift Leasing Sale Mudarabah Kafalah Waqf Musharakah Rahn Waqf Musharakah Rahn Bay` Bay` Operational Operational Loan Bithaman Hiwalah Bithaman Loan Hiwalah Lease Lease Ajil (BBA) Ajil (BBA) Ibra’ Wadiah Ibra’ Wadiah Financial Financial Murabahah Murabahah Lease Lease Wakalah Wakalah Salam Salam Jualah Jualah Istisna’ etc. Istisna’ etc. Muqasah 4 Muqasah
  5. 5. SALE CONTRACTS & SOME APPLICATIONS IN ISLAMIC FINANCIAL SERVICES Murabahah & Bay` bithaman Ajil (BBA) Application in Asset Financing Application in Sukuk issuance
  6. 6. MURABAHAH & BAY` BITHAMAN AJIL (BBA) Both contracts are contracts of sale and purchase (bay`) Sale and purchase is a contract of exchange (`aqd al mu`awadah) The exchange is between the two counter values, i.e., goods and price Sale and purchase presupposes the transfer of ownership between the parties (regardless of any formal registration of transfer) 6
  7. 7. SPECIAL FEATURES FOR MURABAHAH & BAY` BITHAMAN AJIL (BBA) Murabahah BBA • It is a sale and purchase • Sale where payment of price contract based on trust (bay` is deferred al amanah) • Final price should be • Full disclosure and contractually agreed and transparency between the known to both parties parties • Time and mode of payment • Cost and amount of mark-up should be ascertained are disclosed • No need to state the cost • Payment of price can be spot price and amount of mark-up or deferred, depending on the (if disclosed – also a agreement between the murabahah) parties (if deferred – also a BBA) 7
  8. 8. MURABAHAH & BBA (Modus Operandi for Asset Financing) Property Purchase Asset Owner Financier Purchase Price Asset STEP ONE 8
  9. 9. MURABAHAH & BBA (Modus Operandi for Asset Financing) Property Sale Financier Customer Sale Price (Purchase Price + Mark-up) Asset STEP TWO 9
  10. 10. OBSERVATIONS The Islamic banking practice in Malaysia tends to confine BBA to long term asset financing and Murabahah to short & medium term financing. This has nothing to do with any Islamic law requirement. BBA in Islamic law is simply a method of payment, i.e., “deferred payment” and thus, it applies to all kinds of sales where the payment is deferred whether on the basis of instalments or lump sum payment at the end of the tenor. 10
  11. 11. APPLICATION OF MURABAHAH/BBA IN SUKUK (BASIC STRUCTURE – MALAYSIA) Primary Subscriber pays 3 3 the Purchase Price Primary Primary Issuer Issuer Subscriber Subscriber 1 2 1 2 Issuer’s Assets Issuer Purchase of Assets by identified Assets the Primary Subscriber at Purchase Price 11
  12. 12. APPLICATION OF MURABAHAH/BBA IN SUKUK (BASIC STRUCTURE – MALAYSIA) Cont’d… Murabahah/BBA Creation of the Debt Resale of the assets at the Selling Price 1 Primary 1 Primary Issuer Issuer Subscriber Subscriber 3 3 Trading Murabahah/BBA Murabahah/BBA IDS/Bonds IDS/Bonds 2 2 Secondary Secondary Market Market The issuer issues the sukuk evidencing the debt (sale price) arising from the second leg of the sale of assets (which is a Murabahah/BBA) The Securitization 12 process
  13. 13. COMMENTS Murabahah/BBA sukuk are just tradable in Malaysian domestic market or perhaps some regional markets that adopt the Malaysian fatwa on bay` al `inah and bay` al dayn Not suitable for global / GCC market 13
  14. 14. IJARAH CONTRACT & SOME APPLICATIONS IN ISLAMIC FINANCIAL SERVICES Ijarah – Islamic lease Application of Ijarah as Operating Lease Application of Ijarah as Lease followed by Purchase (AITAB) Application of Ijarah in Sukuk Issuance
  15. 15. IJARAH – ISLAMIC LEASE Ijarah contract is a form of exchange contract (`aqd al mu`awadah) – usufruct vs rent. Ijarah is a contract that results in the transfer of the right to use (usufruct). The ownership of the asset remains with the owner cum lessor. In practice, ijarah can be used as operating lease or lease contract with an option to purchase – al ijarah thumma al bay` (AITAB). 15
  16. 16. OPERATING LEASE (Modus Operandi) Purchase Agreement Supplier Financier Purchase Price Asset STEP 1 16
  17. 17. OPERATING LEASE (Modus Operandi) Lease Agreement Customer Financier Rental Payment Asset STEP 2 17
  18. 18. AL IJARAH THUMMA AL BAY’ - AITAB (Modus Operandi) Purchase Agreement Supplier Financier Purchase Price Asset STEP 1 18
  19. 19. AL IJARAH THUMMA AL BAY’ - AITAB (Modus Operandi) Lease Agreement / 2nd Schedule HPA 1967 Customer Financier Rental Payment Asset STEP 2 19
  20. 20. AL IJARAH THUMMA AL BAY’ - AITAB (Modus Operandi) Sale Agreement Customer Financier Sale Price Asset STEP 3 20
  21. 21. APPLICATION OF LEASE TO SUKUK (ISLAMIC SECURITIES) Nature of Sukuk al Ijarah: represents a share in a leased asset (pro-rata ownership by the sukuk holders of the leased asset) share entitles to economic benefits under the lease (enables the sukuk holders to enjoy rental income & capital gain from disposal of the leased asset, if any) subject to the obligations / liabilities (to bear the risk of loss and damage of the leased asset) 21
  22. 22. MALAYSIAN GLOBAL SOVEREIGN SUKUK: TRANSACTION SUMMARY Malaysian Global Sukuk Inc. Issuer Baa2 (Moody’s) and BBB (S&P) Rating USD 600 million Size Reg-S Format Sukuk al Ijarah (floating rate) Type Tenor 5 year bullet USD LIBOR + 95 bps Yield & Coupon Bahrain, Luxembourg & Labuan (LFX) Listing June 2002 Launch/Pricing Date 51% Mid-East; 30% Asia; 15% Europe; Investor Distribution 4% US 22
  23. 23. USD600m MALAYSIAN GLOBAL SOVEREIGN SUKUK: TRANSACTION STRUCTURE Government of Government of Malaysia Malaysia 6. Payment of rentals 2. Lease of land parcels 9. Exercise price at dissolution 8. Sale at dissolution 10.Dissolution Amount 7. Periodic rental payments 1. Sale & Transfer of 3. Sukuk issuance Beneficial Title for USD600m Federal Lands Sukuk Holders Federal Lands Sukuk Holders SPV: Malaysian SPV: Malaysian Commissioner (Investors) Commissioner (Investors) Global Sukuk Inc. Global Sukuk Inc. 5. Proceeds 4. Payment of Proceeds from sale of sukuk 23
  24. 24. PARTNERSHIP CONTRACTS & SOME APPLICATIONS IN ISLAMIC FINANCIAL SERVICES Musharakah Application of Musharakah in Project Financing Mudarabah Application of Mudarabah in Project Financing Application of Musharakah & Mudarabah in Sukuk Issuance
  25. 25. MUSHARAKAH Meaning of “musharakah”: “an arrangement whereby two or more persons contribute to the capital with their property for the purpose of trading with the joint capital, the profit of which, shall be shared among the partners” 25
  26. 26. MUSHARAKAH PROJECT FINANCING Contract of Musharakah Capital contribution – X:Y Financier // Bank Company Financier Bank Company • Profit: shared according to agreed ratio or X% according to ratio Capital of capital contribution • Loss shared according to ratio of capital Y% contribution Invests in Invests in Project Project project project Revenue Revenue 26
  27. 27. MUDARABAH Meaning of mudarabah: “an arrangement whereby the owner of some property (termed as rabb al mal) gives a specified amount of capital to another person (termed as mudarib) who is to act as the entrepreneur to trade with the capital, the profit of which will be shared between the two parties according to the terms of their agreement. The losses will be borne by the rabb al mal as the financier, whilst the mudarib suffers the frustration of a fruitless effort” 27
  28. 28. MUDARABAH PROJECT FINANCING Contract of Mudarabah Financier Company Financier Company Profit Sharing ratio – X:Y (Rabb al Mal) (Amil // Mudarib) (Rabb al Mal) (Amil Mudarib) Y% to rabb al mal CAPITAL Profit shared in accordance to pre-agreed proportions X% to mudarib (X:Y) Project Project Invests in Invests in Revenue Revenue project project Loss borne Totally by 28 rabb al mal
  29. 29. BASIC STRUCTURE OF MUSHARAKAH SUKUK Issues sukuk Investors Issuer Investors Issuer Contract of Musharakah Capital contribution – X:Y • Profit: shared according to agreed ratio or X% according to ratio Capital of capital contribution • Loss shared according to ratio of capital Y% contribution Revenue Revenue Invests in Invests in of of Project Project Project Project 29
  30. 30. ASSAR SENARI RM150m MUSHARAKAH SUKUK: TRANSACTION STRUCTURE Sukuk Sukuk Company Issue Sukuk Musyarakah Company 1 1 Holders Holders (Investors) (Investors) Invest Capital Invest Capital 1 1 (87%) (13%) 5 5 Musyarakah Musyarakah Lease Venture User Venture User completed Agreements Agreements Owned by IOT (RMXXX Million) (RMXXX Million) 2 2 Profit sharing (Starts 2nd Year) Trustee Trustee Company Investors X% Y% Project Manager (As Agent of Trustee) Completed IOT Completed IOT 3 Construct & Lease Oil 3 Oil 4 4 Companies Companies IOT Construction period 12 – 18 Months 30
  31. 31. WINGS FZCO: TRANSACTION STRUCTURE Emirates as obligor Emirates as lessee Emirates as lessee Emirates as obligor Emirates as lessee Emirates as lessee Lease of New Emirates Lease of New Rental Group Headquarters Rental Engineering Centre Exercise Price MUSHARAKAH MUSHARAKAH Sale of units Wings FZCO Emirates Wings FZCO Emirates as partner as partner as partner as partner Land parcels Proceeds: valued at USD550m USD100m Emirates Wings FZCO Emirates Wings FZCO a) Issues Sukuk – evidence proportionate share in Musharakah d c b a d c b a b) Proceeds – USD550m: used for construction of Group Headquarters & Engineering Centre c) Periodic Distribution Amount Investors Investors 31 d) Dissolution Distribution Amount
  32. 32. BASIC STRUCTURE OF MUDARABAH SUKUK Issues Mudarabah Sukuk Investors Issuer Investors Issuer Contract of Mudarabah (Rabb al Mal) (Amil // Mudarib) (Rabb al Mal) (Amil Mudarib) Y% to rabb al Profit shared mal in accordance CAPITAL to pre-agreed proportions (X:Y) X% to mudarib Outcome Outcome Invests in Invests in of of project project project Loss borne project Totally by rabb al mal 32
  33. 33. PG MUNICIPAL MUDARABAH SUKUK Security Trustee Rabb al Mal 1 Sukuk Holders Profit sharing 1st Mudarabah - Invest Capital (Bond SPV Investors Issue Mudarabah X% Y% Proceeds) – RM80 m Bonds (AAA – RAM) PG Municipal Mudarib 1 Profit (SPV) & Rabb al Mal 2 2nd Mudarabah PG Local Authority (Administrator) Profit sharing Administrator Investors Mudarib 2 X% Y% Profit from Tax Collection Manage and Administer Tax Collections 33
  34. 34. ISLAMIC DEPOSIT SERVICES PRODUCTS: SOME APPLICATIONS Islamic Deposit Services Products Islamic Savings / Current Account – Wadi`ah Islamic Accounts – Mudarabah Islamic Deposits – NIDC Islamic Deposits – Murabahah Commodity
  35. 35. DEPOSIT SERVICES PRODUCTS Negotiable Negotiable Current // Murabahah Sale and Buy Current Murabahah Sale and Buy Investment Islamic Investment Islamic Saving Commodity Back Saving Commodity Back Account Deposit Account Deposit Account Deposit Arrangement Account Deposit Arrangement Certificates Certificates Wadi`ah Yad Murabahah Wadi`ah Yad Murabahah Mudarabah Bay’ al `Inah Bay’ al Dayn Mudarabah Bay’ al `Inah Bay’ al Dayn Damanah & Tawarruq Damanah & Tawarruq Mudarabah Mudarabah 35
  36. 36. ISLAMIC SAVING & CURRENT ACCOUNTS Some Islamic banks use the concept of wadi`ah yad damanah (guaranteed safe custody) in their Islamic saving & current account Other Islamic banks use mudarabah contracts for Islamic savings & current accounts For Islamic investment accounts – normally mudarabah contract is used. 36
  37. 37. FEATURES OF WADI`AH YAD DAMANAH (GUARANTEED SAFE CUSTODY) The custodian (bank) is both a trustee and guarantor The deposit need not be separated/segregated The deposit can be used for trading, etc. The custodian (bank) has a right to any income derived from the utilization of the deposit Depositor can take back the deposited asset at any time Wadi’ah Yad Damanah is more like Qard (loan); thus, all principles of loan would be applicable Wadi`ah Yad Damanah (like loan) cannot generate any pre- agreed benefit/income to the depositor, over and above the principal amount of deposit. Failure to safeguard this may result in riba 37
  38. 38. MUDARABAH ACCOUNT (MODUS OPERANDI) CAPITAL Provide Work with capital capital RABB AL MAL RABB AL MAL MUDARIB MUDARIB (Capital provider- (Capital provider- (Manager-Bank) (Manager-Bank) depositors) depositors) Profit Losses Profit Losses • Shared between mudarib + rabb al mal • Born solely by rabb al mal • Profit sharing according to a contractually • Mudarib will only be personally agreed ratio liable if the loss is caused by his • Profit sharing cannot be a fixed amount/a fixed negligence 38 percentage of capital contribution
  39. 39. NIDC (MODUS OPERANDI) Sells asset Customer Customer Bank Bank (Depositor) (Depositor) (e.g. equipments for RM100,00) Method of payment: cash – “Islamic Deposit” Buys-back asset Customer Customer Bank Bank (Depositor) (Depositor) (e.g. equipments for RM100,00 + X%) Method of payment: deferred over a period of 5 years Bank also issues NIDC to evidence the indebtedness created by the deferred payment sale 39
  40. 40. MURABAHAH COMMODITY DEPOSIT-I Customer buys on a spot basis USD10 million worth 1 1 of LME metal warrants (“commodity”) from Broker A Customer Customer 3 3 Customer sells the commodity to the Bank at USD10 million plus a profit 2 USD10 million 2 margin payable on a LME Broker LME Broker deferred payment A A basis 5 USD10 million 5 LME Broker LME Broker Bank Bank B B Bank sells on a spot basis the Commodity 4 4 to Broker B for USD10 million 40
  41. 41. APPLICATION OF ISLAMIC CONTRACTS IN TAKAFUL Contract among Takaful Participants – Tabarru` Contract between Takaful Participants & Takaful Operator
  42. 42. CONTRACT AMONG TAKAFUL PARTICIPANTS: TABARRU’ Takaful Participants Mutual Indemnity Donation Mutual Indemnity Takaful Fund 42
  43. 43. CONTRACT BETWEEN TAKAFUL PARTICIPANTS & TAKAFUL OPERATOR Takaful Participants Donation Takaful Funds Possible Contract/s: • Mudarabah • Wakalah • Ju`alah • Wadi`ah yad Manage damanah Takaful Operator Investment Pay Claims Investment Pay Claims 43
  44. 44. CONCLUSION There is a wide range of contracts that can be applied in structuring & developing Islamic financial services products The choice of contracts depends on the purpose and needs of the parties (financial institutions & their clients) For example, sales contracts have been widely used for the purpose of financing, especially for asset financing Other contracts like leasing and partnership are also widely applied in project financing and securitization transactions Takaful industry uses more of donation, agency & investment contracts There is always room for more application & diversification of Islamic contracts in Islamic financial services products 44
  45. 45. THANK YOU Wassalam

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