Sukuk can be issued through various securitization structures. Securitization involves pooling assets and repackaging them into marketable securities known as sukuk. A special purpose vehicle (SPV) is typically used to hold the assets and issue the sukuk. The sukuk represent undivided ownership interests in the underlying assets, with profits distributed from the assets' revenue. Common asset-based sukuk include those backed by murabahah contracts, ijarah contracts through asset sale-leaseback, and receivables. The SPV provides bankruptcy protection for investors if the originator entity encounters financial problems.

1. Modes of Issuing Sukuk
By: Camille Paldi
CEO of FAAIF

2. Securitization and Sukuk
• Sukuk are issued under several forms based on securitization.
• Securitization plays an important role in structuring of sukuk and drivers are
liquidity, risk transfer, and capital needs.
• Securitization allows banks and also non-financial institutions to obtain
liquidity from assets, which cannot be sold in financial liquid markets.
• It is a process of pooling financial assets for making a new asset-backed
security, which is then divided into units.

3. Securitization and Sukuk
• Risk assessment is done by a reputed rated agency and then is sold to
investors as sukuk.
• It is also termed as structured finance in the investment banking community.
• The returns from sukuk can be fixed or variable, which depends on the
securitization process and underlying structure.
• It has to be ensured that Islamic securitization comply with the Shari’ah and
be free from Riba (interest), Gharar (uncertainty), and Maysir (gambling).

4. Securitization and Sukuk
• Islamic securitization must involve the tangible underlying asset with the risk-
reward sharing spirit and it places paramount importance on the real
economy through undertaking real project activities.

5. Securitization and Sukuk
• Securitization is widely practiced by financial institutions, as it enables them
to efficiently remove assets from their balance sheet based on the concept of
asset monetization.
• The funds generated, corresponding increase in their equity capital.
• This is also practiced widely to raise cheaper capital for business expansion.
• This process also attracts tax savings in some jurisdictions.
• An ideal technique for Shari’ah compliant securitization.

6. Asset-Based Sukuk
• That evidences indebtedness that originates from contract of exchanges of
murabahah, bai bithamin ajil or istisna’a, arising from back to back sale of
the issuer’s assets. Such sukuk gives the holders the rights to the obligations
attached to the indebtedness;
• Arising from ijarah contracts through sale and leaseback or lease of third-
party held acquired assets with purchase option obligations (financial lease);

7. Asset-backed Sukuk
• Asset-backed sukuk refers to sukuk backed by income generating assets
sold/transferred by an originator.
• The originator sells the assets to a special-purpose vehicle (SPV) that holds them
and issues the sukuk.
• The repayment to sukuk holders is from the revenue generanted through underlying
sukuk assets.
• Investment sukuk refers to sukuk where the SPV is not required for issuing the
sukuk.
• Investment sukuk is issued directly by the originator of the venture to the investors.

8. Securitization in Special Purpose Vehicle (SPV)
• An SPV is a legal entity created by the sukuk sponsor or originator, to fulfill a
temporary objective of the sponsoring firm.
• SPVs have no purpose other than the transaction(s) for which they were created,
and they can make no substantive decisions;
• The rules governing them are set down in advance and carefully circumscribe their
activities.
• SPVs are used in structured finance transactions such as securitization.
• SPVs can be created through entities such as trusts, corporations, limited
partnerships, and limited liability corporations.

9. Securitization in SPV
• SPV is an independent entity with no direct connection with the originator, and
such an entity is known as orphan SPV rather than a subsidiary of the originator.
• The SPV will normally have a very minimum share capital and staff as it is a mere
tool to facilitate the transfer and issuance of the sukuk. It is not supposed to
conduct any real business activities.
• Their administrative functions are performed by a trustee who follows pre-specified
rules with regard to the receipt and distribution of cash; there are no other
decisions.

10. Securitization in SPV
• Assets held by the SPV are serviced via a servicing arrangement;
• They are structured so that, as a practiced matter, they cannot become
bankrupt.

11. Securitization in SPV
• The originator sells the assets to the SPV and receives cash and removes the
assets from its balance sheet.
• The SPV then issues sukuk to finance the purchase of the assets;
• These bonds can be traded in the marketplace and are referred to as
securitized products.
• The underlying assets purchased by the SPV are then grouped into tranches
and sold to meet the credit risk preferences of a wide range of investors.

12. Securitization in SPV
• Tranches are number of related sukuk offered as part of the same transaction.
• The SPV holds the assets on trust for the benefit of the holders of the sukuk, using
the income from the assets to make periodic payments to the sukuk holders.
• Offshore SPVs are often used for purchasing assets for certain tax advantage,
foreign exchange preference, and for speed factor in issuing sukuk.
• Offshore = Less tax.

13. Securitization and SPV
• Labuan, Cayman Islands, Bermuda, BVI, Luxembourg, Jersey, Singapore, and
Hong Kong.
• The Labuan Financial Exchange had 11 sukuk listings totaling $8.6 Billion in
2013 including Nomura and SGI-Mitabu Sukuk.

14. Asset-Based Securitization: Debt Securitization
• The structuring of financial obligations into capital market securities adds
value in terms of credibility and liquidity to the indebtedness (portfolio of
Islamic financing receivables).
• Traditionally, securitization has been used as a mode of financing by
converting the illiquid pool of assets into more liquid marketable securities,
but contemporary structuring is also motivated by higher returns,
diversification, hedging objectives apart from plain vanilla funding.

15. Asset-Based Securitization: Debt Securitization
• Asset-based sukuk under this structure represents cash flows that include
profits on the basis of either being fixed or variable for maturities that can be
fixed, revolving, either long term or short term.
• As a credit enhancer, the underlying asset in the initial contract of exchange
transaction is taken as collateral for the securities.

16. Asset Basis Sukuk: Financial Ijarah
• Another instance of asset-based sukuk is under the sale and leaseback or
lease of third party asset, with a purchase option obligation given to the
lessee.
• The underlying asset in this transaction is the leased asset and in view of the
structure being a finance lease, the ultimate ownership of the asset will be
passed to the lessee through pre-agreed settlement consideration, upon the
maturity of the lease.

17. Malaysian Global Sukuk
Under this transaction, the investors pool their capital by way of subscribing to
the sukuk issued by the SPV.
The proceeds will be utilized to purchase the land parcels, under a true-sale
transaction, from the Federal Land Commissioner.
The relationship between investors will be under a collective investment
arrangement.

18. Malaysian Global Sukuk
• The SPV, upon having the beneficial title to the land parcels transferred to it,
then enters into an ijarah contract with the Government of Malaysia.
• The SPV is the lessor and the Government is the lessee.

19. Malaysian Global Sukuk
• The SPV, having the beneficial title to the land parcels transferred to it, then
enters into an ijarah contract with the Government of Malaysia. The SPV is
the lessor and the Government is the lessee.
• Upon expiry of the ijarah contract, the SPV – as the lessor – will transfer
ownership of the SPV and beneficial title to the land parcels to the Lessee.
The pre-agreed Dissolution Amount will be equivalent to the face value of
the sukuk.

20. Asset-Backed Sukuk
• Asset-backed sukuk is a securities formation process, in the form of capital market
instruments i.e. sukuk, of equal value that represents an undivided interest in the
ownership of an underlying Shari’ah compliant cash flow generating asset.
• A SPV held and managed by trustees, legally will be under the control of the
holders of the securities or sukuk will acquire the asset under a true-sale
arrangement.
• The function of the SPV is to hold the assets on behalf of the investors or Sukuk-
holders, by way of a trust deed created over the assets.

21. Asset-Backed Sukuk
• The relationship between the sukuk investors is in the form of a collective
investment contract of musharakah or mudharabah.
• The originator, i.e. the entity seeking to transfer or dispose of its asset to the
SPV must not hold any equity stake directly or indirectly in the SPV i.e.
bankruptcy-remote.
• This structure differentiates the concept from asset-based securitization due
to the true-sale of the asset by the originator to the SPV and the insulation
of the investors from insolvency risks arising from the originator.

22. Asset-Backed Sukuk
• The true sale and the restriction of the originator from being an owner or
shareholder of the SPV results in the asset transfer being a bankruptcy remote
transfer.
• What it means is that the transfer of the assets by the originator to the SPV is such
that even if the originator were to go bankrupt, or get into other financial
difficulties, the rights of the investors on the assets held by the SPV is not affected.
• In other words, the investors would continue to have a paramount interest in the
assets irrespective of the difficulties, distress, or bankruptcy of the originator.

23. Asset-Backed Sukuk
• This concept of securitization may be applied to any asset that has a
reasonably ascertainable value, or that generates a reasonably predictable
future stream of revenue.
• It can therefore be applicable as well to receivables or debt for as long as the
transfer is a genuine transfer, and not as a mere paper transaction.
• In other words, the transfer of receivables has to be a true sale of the
receivables, and not merely a financing against the security of the receivables.

24. Asset-Backed Sukuk
• Asset-backed securitization thus is an asset-based transaction in which the
funding for the acquisition of the asset is derived from investments
evidenced by the sukuk issued by the SPV.
• The asset is purchased from the originator under a true sale arrangement.
• The true sale isolates the asset completely from the originator and at the
same time all rights and obligations in the said asset are transferred to the
SPV.

25. Asset-Backed Sukuk
• However, all obligations on the sukuk i.e. the income stream attached to it
shall rest upon the originator who now plays the role as servicer i.e. the entity
that is undertaking to administer the assets or perform such other services
on behalf of the SPV as may be required in the said securitization
transaction.

26. Asset-Based v Asset-Backed Sukuk
Asset-Based Asset-Backed
Feature Shari’ah compliant assets or
business venture to facilitate
issuance of sukuk.
Shari’ah compliant assets or
business venture form primary
sources of income or return to
investors.
Accounting Treatment On-balance sheet (for
originator/obligator).
Off-balance sheet (for
originator/obligator- true sale
criterion).
Funding Cost Market driven – mainly
depending on originator/issuer
credit rating.
Mainly based on the strength of
the asset cash flow.
Rating Corporate rating of
issuer/obligator.
Strength of the asset cash flow.

27. Investment Sukuk
• Unlike an asset-backed securitization where the sukuk is issued by the SPV,
Investment sukuk is issued directly by the originator of the venture to the
investors.
• In the case of mudharabah, the originator will be the managing partner of
the venture without contributing any capital, but only his skills and expertise.
• In the case of musharakah, the originator can be an equity partner to the
venture that will be formed by contributing capital in the form of cash or
kind, to it.

28. Investment Sukuk
• In Malaysia, the issuance of Investment Sukuk is guided by the Guidelines on the Offering
of Islamic securities.
• The sukuk issued by the originator, to the investors – normally in the form of musharakah
sukuk or mudharabah sukuk – represents evidence of their capital contributions to the
investment activity, and their rights to the cash flow from this activity.
• The sukuk structure normally involves the provision of additional protection to investors
against late payment of obligations, potential risks on loss under events of default, or
occurrence of termination events by the sukuk issuer, in the form of credit and/or liquidity-
enhancement schemes, such as stand-by liquidity facilities or purchase undertakings under
the principle of wa’ad (promise).

29. Investment Sukuk Structures
• Musharakah or Mudharabah between investors.
• Musharakah between investors and the originator or issuer for undertaking
special projects.
• Musharakah between investors and the issuer for participation in the issuer’s
business operations.

30. Musharakah or Mudharabah Between Investors
• Under the concept of musharakah or mudharabah, financiers form a
collective investment agreement among themselves for purposes of investing
in a venture.
• This is normally termed as Isthimar bil-wakalah or Investment through an
agent under the AAOIFI standard.
• An example is the Nucleus Avenue (M) Berhad’s (“Nucleus”) Sukuk
Musharakah.

31. Nucleus Sukuk
• Nucleus’s sukuk programme involves a combination of a RM600 million
commercial papers/medium-term notes programme and a RM5.6 billion
medium-term notes programme (also collectively known as the senior sukuk)
and a RM1.7 billion cumulative non-convertible Islamic sukuk (junior sukuk).
• Both the senior and junior sukuk had also been issued under the musharakah
principle.

32. Nucleus Sukuk
• The investors in this case form a musharakah among themselves, to invest in
the sukuk issued by Nucleus, a musharakah venture company, i.e. a vehicle
created to own certain income-generating trust assets.

33. Nucleus Sukuk
• Nucleus’s issuance of the musharakah sukuk and investments by the investors are
simultaneously conducted.
• The latter are classified as Senior and Junior investors, and are entitled to Senior
Sukuk and Junior Sukuk, respectively.
• The sukuk in this case are trust certificates that represent the sukuk holders
proportionate undivided ownership in the trust assets.
• Nucleus will issue unilateral wa’ad as purchase undertaking for relevant portions of
the trust assets, upon maturity of the sukuk or upon occurrence of dissolution
events, at pre-agreed redemption amounts.

34. Nucleus Sukuk
• Under the terms of the investments, the income generated by the trust assets
must be distributed to the sukuk holders, based on pre-agreed ratios.
• Under the above sukuk issuance, the issue of the Senior and Junior Sukuk
will be simultaneously conducted by Nucleus.

35. Musharakah between investors and originator
or issuer to undertake special project
• Assar Chemicals Sdn Bhd’s (Assar) RM 150 million Serial Sukuk Musharakah
(Assar Sukuk), issued in 2005.
• Under the Assar sukuk transaction, the investors and the originator
established a musharakah venture under style of Assar Senari Sdn Bhd
(ASSB), with respective equity contributions of 87% and 13%.
• The business objective of ASSB is to develop an independent oil terminal
(IOT) for the storage and delivery of petroleum products within the
Kuching area in Sarawak, Malaysia.

36. Assar Sukuk
• Upon completion of said terminal, the musharakah will lease the facility to
Assar for a period of up to 9 years.
• The terminal will then be used to cater to the storage and delivery
requirements of 2 major petroleum companies operating out of Kuching.

37. Assar Sukuk
• Assar issues musharakah sukuk, capital injections into ASSB;
• Trustee appointed to manage the IOT project;
• Ijarah agreement executed between Assar and the Trustee, acting on behalf
of ASSB; to commence upon commissioning of the IOT;
• Completed IOT handed over to ASSB, as the owner.

38. Assar Sukuk
• In a musharakah between investors and issuers, capital contributions from
investors will be in the form of cash; that from the issuer will be either cash
or kind.

39. Musharakah Between Investors and Issuer to
Participate in the Issuer’s Business
• This enables investors to participate in the business of the issuer, but way of
a preferential participation process.
• A close comparison to such musharakah is the issuance of preference shares
by companies.
• An example of musharakah between investors and issuer for participation in
the issuer’s business is AmIslamic Bank Berhad’s (“Am Islamic”) sukuk.
• Subordinated sukuk musharakah for an issuance of up to RM400.0 million.

40. Musharakah Between Investors and Issuer to
Participate in the Issuer’s Business
• The issuer issues subordinated musharakah sukuk to investors in
consideration of their capital contributions to the musharakah venture.
• The musharakah venture involves the participation of investors or sukuk
holders in the general Shari’ah compliant financial services business of the
issuer.
• AmIslamic, the issuer, is the musharakah manager for this musharakah
venture.

41. AmIslamic Sukuk
• The creation of the trust in favor of the sukuk holders will, inter alia, evince the
following:
• Creation of the trust relationship between the issuer and the sukuk holders, under
which the trust will hold the trust asset (i.e. the sukuk account and permitted
investments from funds in the said account) for the benefit of the sukuk holders.
• The issuer’s obligations under the musharakah venture.
• Sukuk holders share the income from the musharakah venture, based on their
respective proportions of the face amount of the sukuk; losses will be based on and
limited to each musharakah partner’s respective capital contribution to the
musharakah capital (equivalent to the amount of issued sukuk).

42. THE END