Sukuk

1. SUKUK FROM A
MEDITERRANEAN
PERSPECTIVE
By: Camille Paldi
CEO of FAAIF
Presentation for Malta Institute
of Management
Recent Trends and Development
in Islamic Finance
October 24, 2014

2. INTRODUCTION: THE ORIGIN OF
SUKUK Sukuk is derived from the word sakk, which can mean
legal instrument, deed, and cheque. Sakk can also
mean to strike a seal on a paper document.
The first sukuk transaction took place in Damascus,
Syria in the Great Mosque of Damascus (Umayyad
Mosque) in the 7th Century AD. Syria is a treasure
house of culture and history.

3. SHEIKH ZAYED MOSQUE, ABU
DHABI

4. SUKUK LINGUISTIC ORIGIN AND
DEFINITION
Tawriq (from wariq) means to render something into
cash. Taskik (from Sakk) is also used as securitization though
literally refers to the process of dividing the assets into papers
(Sukuk).
Tawriq is defined as: “transforming a deferred debt for the
period between the establishment of the debt and the maturity
period into papers, which can be traded in the secondary
market.” (in Majallah Majma ‘Al Fiqh’)

5. AAOIFI AND IFSB DEFINITIONS OF
SUKUK
AAOIFI in its Shari’ah Standard 17(2), defined
investment sukuk (Sukuk Istithmar) as “certificates of equal value
representing undivided shares in ownership of tangible assets,
usufruct and services, assets of particular projects or special
investment activity.”
The IFSB, in its Capital Adequacy Standard (IFSB 2), defined sukuk as
“Certificates that represent the holder’s proportionate ownership in
an undivided part of an underlying asset where the holder assumes
all rights and obligations to such asset.”

6. MAIN FUNCTION OF SUKUK
The main function of sukuk is to provide an alternative to
conventional bonds, in other words, to provide the benefits
associated with conventional bonds, but in a Shari’ah
compliant manner.

7. SUKUK V BONDS
A conventional bond is a contractual debt obligation whereby the
issuer is contractually obliged to pay to bond holders, on a certain
specified date, interest and principal.
Under a Sukuk structure, the Sukuk holders each hold an undivided
beneficial ownership interest in the underlying assets.
Sukuk holders are entitled to a share in the revenues generated by
the Sukuk assets.
In sum, Sukuk are monetary denominated participation certificates of
equal unit value to be issued to investors to represent their
proportionate share in the ownership of the underlying assets and a
pro- rata share in the income generated by those assets.

8. SUKUK V BONDS
While bonds represent pure debt obligations from the issuer to the
investors or bondholders, the sukuk represent ownership of a well-defined
asset.
The sale of sukuk, both in primary and secondary markets, is a sale
of a share of an asset, while selling a bond is basically the sale of
debt.

9. SUKUK V BONDS
In terms of pricing, sukuk prices are market driven and depend on
the fluctuation of the market value of the underlying assets. In the
case of the issuer’s default, sukuk holders will possess the asset and
they can sell it to other buyers or keep it as an asset.
On the other hand, bondholders depend solely on the
creditworthiness of the issuer without any specific assets to be relied
on. Therefore, in the case of the issuer’s failure, unsecured
bondholders will be jointly seeking the assets of a bankrupt company.

10. SUKUK V BONDS
The aim of bond traders usually is to make capital gains as fixed-interest
bond prices rise when variable market interest rates fall.
Bond trading is therefore largely about exploiting interest rate
developments and trading in paper that is usually unrelated to the
value of any underlying asset.

11. SUKUK V BONDS
The major risk for holders of conventional bonds is of payments
default, but this risk is usually assessed solely on the basis of credit
ratings, with the ratings agency rather than the bond purchaser
estimating the risk.
Hence, the bonds are regarded as mere pieces of paper with third
parties estimating the risk and the purchaser, at best, only making a
risk/return calculation without any reference to the business being
financed.

12. SUKUK V BONDS
SUKUK BONDS
Ownership in Assets No ownership in assets
Pricing by profit share Pricing by interest rate
Profit after risk-sharing Interest: fixed or variable
Pay-Off After Income Earned No risk-sharing
No asset-backing or asset-based = no
funding
Interest payable even if no profit earned

13. SUKUK V SHARES
Sukuk is an undivided ownership share in specific assets while
holding shares means holding an ownership share in a corporation or
a company.
In sukuk, the assets should be Shariáh compliant and a minimum of
51% are tangible assets.
Ordinary shares do not require the company to be Shariáh compliant
and the percentage of tangible assets is not determined.

14. SUKUK V BONDS V SHARES
Comparison Sukuk Bond Stock
Type of Security Share of revenue stream Debt Ownership in a corporation
Type of Return Profit sharing specified Coupon specified Dividends Unspecified
Priority in Paying Principle First Priority First in Priority Less in Priority
Risk Lower Lower Higher
Voting Rights Not Entitled Not Entitled Higher Entitled

15. TYPES OF SUKUK
Leased-based sukuk, i.e., sukuk al ijarah.
Partnership-based sukuk, i.e., sukuk mudharabah and sukuk
musharakah.
Sale-based sukuk, i.e., sukuk murabahah, sukuk istisnaá, and sukuk
salam.

16. SUKUK HISTORY
In 1990, in Malaysia Shell (MDS Sdn Bhd) issued a sukuk ijarah worth
RM 125 million.
Issuances grew 145% in 2006 compared to 2005 to reach US$27
Billion.
In 2010, the sukuk market reached US$121.5 billion and In 2013, the
market topped US$269.4 billion.
Ernst and Young predicts the sukuk market will reach US$900 billion
in 2017.

17. SUKUK FACTS
Some estimates suggest that conventional investors may account for
between 40% - 60% of any individual sukuk offering.
New sukuk issuances are often oversubscribed.
I.e. The US$500 Million Goldman Sachs Sukuk of September 2014
(New York, USA) had an order book of US$1.5 Billion and the
September 2014 Luxembourg Sukuk had an order book, which was
oversubscribed by two times. The June 2014 UK 200 Mn Euro Sukuk
had an order book of 2 Bn Euros.

18. SUKUK AND MALTA
Malta can tap into the billion dollar sukuk market to raise funds for its
businesses and government and attract Foreign Direct Investment.
All Malta’s government debt is funded domestically. Indeed, Malta has
never yet tapped the international market.
Sukuk and Bonds are considered an important channel for
governments, companies, and institutions to provide the necessary
liquidity to finance its projects at relatively low cost.
In addition, the Sukuk and Bonds market will enable investors to
diversify their investments and provide financial protection for their
portfolios with lower risk tools, which ensure a safe and periodic
return for the investor.

19. BENEFITS OF SUKUK - TAQI
USMANI
Sukuk are among the best ways of financing large enterprises that are
beyond the ability of a single party to finance.
Sukuk represent an excellent way of managing liquidity for banks and
IFI’s.
Sukuk may enable equitable wealth distribution across society.

20. BENEFITS OF SUKUK – TAQI
USMANI
When banks and IFI’s are in need of disposing of excess liquidity they
may purchase sukuk; and when they are in need of liquidity, they may
sell their sukuk into the secondary market.
Sukuk are a means for the equitable distribution of wealth as they
allow all investors to benefit from the true profits resulting from the
enterprise in equal shares.
In this way, wealth may circulate on a broad scale without remaining
the exclusive domain of a handful of wealthy persons.

21. MALTA AS THE DISPUTE
RESOLUTION CENTER FOR GLOBAL
SUKUK DEFAULTS
Malta can also attract millions in funds through creating an Islamic
Finance Bankruptcy Court to handle all Sukuk defaults worldwide.
It is possible to attach a Standardized Dispute Resolution Contract to
all Sukuk Transactions naming the Islamic Finance Bankruptcy Court
in Malta as the Governing Law of the contract.
This will generate revenue for Malta as well as solve the problem of
how to deal with investor and creditor rights in terms of sukuk
defaults and near –defaults and create investor confidence in the
global sukuk market.

22. HOW TO GET INVOLVED IN THE
SUKUK MARKET
Malta can introduce a legislative and regulatory framework enabling
sukuk transactions if necessary. Some are in the view that Malta has
a sound framework already.
I.E. Recently, the state of New York and Illinois in the USA and Cyprus
have initiated such legislation.
Malta can host training workshops on Sukuk for banking, legal, and
government professionals through MIM and Finance Malta.

23. ENGAGE WITH OTHER NATIONS
The Malta Financial Services Authority can engage in mutual
recognition agreements with the regulatory bodies of other countries.
I.E. The DFSA has signed a Mutual Recognition Agreement with
Malaysia’s SEC model, which helps to facilitate the cross-border flow
of Islamic funds.
This opens the investment space between the Gulf and Malaysia as
well as increases the accessibility of issues and enables mutual
recognition of products and services.

24. MFSA CONSULTATION DOCUMENT
ON ISLAMIC FINANCE
Malta Financial Services Authority issued the MFSA Guidance Note for
Shariáh Compliant Funds in 2009.
To provide guidance to fund promoters considering setting up a
Shariáh fund under the Investment Services Act.
And To set out the issues, which Shariáh funds in Malta must address
as part of their licensing conditions.

25. MFSA CONSULTATION DOCUMENT
ON ISLAMIC FINANCE
Sharia’h funds in Malta must comply with the Standard License
Conditions set out in the MFSA’s Investment Services Rules for Retail
Collective Investments Schemes or for Professional Investor Funds.
In addition, the fund must comply with the Shariáh Funds Guidance
Note and will need to seek MFSA prior approval for any deviations
therefrom.

26. GENERAL INTRODUCTION
The principal categories of collective investment schemes that can be
set up under this common framework are the following:
Retails Investment Schemes: UCITS and non-UCITS
Professional Investor Funds: Experiences Investor Funds; Qualifying
Investor Funds; Extraordinary Investor Funds.

27. LICENSING FRAMEWORK
Shariáh compliant funds will be expected to follow the risk-spreading
principle except when this can be waived in terms of the proviso to the
definition of collective investment scheme in the Act.
The managing body of a Shariáh fund (Board of Directors in the case of a
corporate fund) will be responsible for ensuring that the fund satisfies the
relevant Shariáh principles and requirements as disclosed in the fund’s
prospectus and other investor information documentation.
Except for the applicability of this Guidance Note, Sharia’h funds set up as
retail funds (UCITS or non-UCITS) or Professional Investor Funds, will be
regulated in the same manner as non-Shariáh compliant funds falling under
the same category.

28. LICENSING FRAMEWORK
The selected extra-financial criteria (Shariáh Guidelines, which the
fund will adopt) must comply with all prevailing regulatory and
statutory requirements.
No specific difficulties arise provided that the extra-financial criteria
do not infringe regulatory principles.

29. APPOINTMENT OF A SHARIÁH
ADVISORY BOARD
The Manager of the fund shall appoint a Shariáh Advisory Board
composed of at least two internationally recognized Shariáh Scholars
to ensure that the fund meets Sharia’h compliance standards in the
management of its assets.
Members of the Shari’ah Advisory Board are to be independent of the
Manager.
The Role of the Shariáh Board is spelled out in Section A, Page 3 of
the MFSA Document.
Section B spells out the Disclosures in the Prospectus and Section C
details the Disclosure in the Audited Financial Statements of the
Shariáh Fund.

30. PRIME MINISTER OF MALTA OPEN
TO SUKUK
Dr. Joseph Muscat, Prime Minister of Malta said, “As a country we are
actually considering whether we should issue a Sukuk ourselves, a
small one, to see what the reaction of the markets would be and to
give a political message that this is the sort of instrument we are in
favour of…”

31. THE TIME IS NOW FOR MALTA AND
SUKUK
All the while Malta has been contemplating the introduction of Islamic
finance, France, Germany, Spain, and Luxembourg have been working
in earnest to seize the opportunities.
Luxembourg has been very successful in attracting Islamic funds and
issuing sukuk.
In the meantime, Malta’s competing jurisdictions, Guernsey, Jersey,
the Cayman Islands, and Cyprus, are making significant progress.
Guernsey is becoming a reputable Islamic finance centre, the Cayman
Islands have managed to attract a number of special purpose
vehicles, and Cyprus has registered two Islamic banks.

32. MALTA FUNDS
Fund managers in Cyprus as in Malta are urging the state to consider
issuing Islamic bonds (Sukuk) similar to a 5-year issue by the UK
government and Luxembourg that each raised 200 mn Euros.
The Islamic funds market is estimated at about $2 trln, with an
annual growth rate of 5%.
Currently, there are 102 funds in Cyprus that manage about 3 bln
euros, 12,889 funds in Ireland with 2.5 trln under management, and
Malta catching up with 600 funds and 9.4 bln euros.

33. THE MALTA STOCK EXCHANGE
Enhance the stock exchange to facilitate sukuk transactions and
trading.
Launch a sukuk and bonds trading platform.

34. EXAMPLE OF SAUDI ARABIA
In an effort to attract international investors and improve liquidity in
the secondary trading in the Kingdom’s debt capital market, the
Tadawul, the Saudi Stock Exchange, launched the Gulf’s third sukuk
and bonds trading platform after Bahrain and NASDAQ Dubai.
There is a withholding tax levied on overseas investors and there is
also a requirement for international investors to have their own, rather
than a nominee, bank account in the Kingdom to undertake the
purchase of securities.
Therefore, the reality today is that international investors have a
preference for offshore issuances in major bond centres such as
London and Luxembourg.

35. THE MALTA STOCK EXCHANGE
INTERNATIONAL STRATEGY
One focus of the Exchange's international strategy has been to
achieve connectivity with other markets.
In this context, the first interoperable link was set up between
Clearstream Banking and the Exchange's own depository, which has
also led to the launch of the Exchange's custody business.
Also, the Exchange has launched a number of major technological
upgrades designed to bolster and support its international strategy,
chief amongst which are the adoption of the use of the XETRA trading
platform, supplied by Deutsche Bourse, AG in July, 2012.
Other recent key milestones were the launch of the Market Making
rules and the designation of the Exchange as a Designated Offshore
Securities Centre by the US Securities and Exchange Commission.

36. DESIGNATED OFFSHORE
SECURITIES MARKET
This makes it easier for US persons to trade and transact in Malta.

37. MALTA IS AN ATTRACTIVE
FINANCIAL DESTINATION
Malta was cited as a tax haven in a US Congressional report as
recently as January 2013, has a score of 48 points out of 100 on the
Financial Secrecy Index, and a google search for “offshore company
incorporation Malta” leads to multiple suppliers.
There are 27 stock exchanges which are designated offshore
securities markets including Malta, Frankfurt, London, Luxembourg,
Bermuda, and Zurich.

38. THE EXAMPLE OF CYPRUS
A new bill on Alternative Investment Funds has been approved by the
Council of Ministers and is now in parliament for review and final
approval, which in conjunction with the enactment of the Open-
Ended Undertakings for Collective Investment Law in June 2012, and
the Alternative Investment Fund Managers Law of 2013, will set up a
comprehensive framework for the management of the International
Collective Investment Schemes (ICIS).
Cyprus has been one of the first countries to adopt into law the
European Union’s Alternative Investment Fund Managers Directive
(AIFMD).
With this modern and new framework and the effective supervision of
the sector by CySEC, new opportunities will be created in Cyprus.

40. FEEL FREE TO CONTACT ME AT
CAMILLE@FAAIF.COM
The End