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08 June 2005 Muamalat Institute, Jakarta 1
Islamic Debt - Based Securities1
Prof. Dr. Sayyid Tahir
IIIE, International Islamic University
Islamabad
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What is debt?
Debt is obligation of one party in favor of another,to be discharged by the former as per agreementbetween the two.
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How may debt arise?
(i) Through a loan (I.O.U.)
(ii) Due to a sale on credit
(iii) In lieu of purchase on order
(iv) On the basis of order to manufacture
Forms of Debt
Debt may be monetary or in the form of goods. The case of services is ignored here.
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Debt-Based Securities
Sale on Credit t t t
Purchase on Ordert
Order to Manufacture
Murabahah FinancingSecurities
Salam CertificatesIstisna Securities
Basis The Securities
Debt-Based Securities in Vogue:
Malaysian Islamic Private Debt Securities
Salam Sukuks
Istisna Sukuks (only on drawing board)
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Murabahah Financing Securities(Islamic Debt Securities)
Case 1: A multinational company JJ needs anexecutive jet with a hefty price tag ondeferred payment basis.
The supplier SS is interested in cash in
order to recover his sunk costs.An Islamic bank IB can help in the
acquisition of the plane by JJ provided itseconomic interests are protected and
payment arrangements give it flexibility ofearly recovery of its tied funds.
Case 2: The same example with a consortium ofIslamic banks IBC in the picture.
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Case 1: Murabahah Financing Securitieswith a Single Bank
SS IB JJ
1. Cash Payment
2. Jet (spot purchase) 3. Jet
4. S1, S2, S3 . . .
The Main Points:
Purchase transaction of IB with SS. Sale transaction between IB and JJ, and Delivery ofthe Jet by SS to JJ in JJs capacity as agent of IB fordelivery matters.
Acknowledgement of payment obligations by JJ in the
form of debt securities issued by JJ against itself.
Delivery
The Basic Idea:
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Case 1 The Case Analysis
Primary transactions at the bank level:
Purchase and Sale
Other Important Considerations: Compliance with all the Shariah requirements
for both the purchase and the sale
Securitization of debt only after formalization
of the sale transaction Right of recourse for secondary buyers of
securities
No repurchase of securities once sold
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1. JJ approaches IB.
2. IB structures the deal (takes fee, works out thedetails, prepares prospectus, gets necessaryapprovals and takes a down payment).
3. IB sings purchase agreement with SS (incl.permission for onward sale of the Jet beforemaking full payment to SS and taking actual
possession).4. IB signs sale agreement with JJ (authorizing it to
take the Jet directly from SS).
5. JJ signs and hands debt securities over to IB.
Case 1 The Steps Involved
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Specimen of a Murabahah Financing Security
Murabahah Financing Security S1JJ hereby accepts its obligation to pay to the Islamic Bank or the bearer of thissecurity a sum of Rs.3 million (three million rupees) on 31stAugust 2006 in lieuof the installment due on that date, towards the price of Rs.25 million (twenty-five million rupees) for purchase of the plane, against order no. abd00001dated 07 June 2005, on the following terms and conditions:
1. In case of payment default by JJ on 31 August 2006, the bearer ofthe security shall have right of recourse to his immediate seller who, inturn, may exercise a similar right against the transferor to him going backto the Islamic bank.2. If a party holding the security in its favor, transfers its collection rights,that party shall not re-acquire the same rights either in its name or n favorof an entity related to it.
Signed and Stamped by: JJ (through its representative)
Registration No. ########### Counter-stamped by an official body
Back Flap ofS1
---- Endorsements to successive parties that acquire ----
the collection rights in their favor
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Case 2: Involvement of a Consortium ofIslamic Banks
Differences from Case 1:
1. One or more of the banks act as leadmanager(s).
2. All banks agree on the parts of financing thatthey will provide, and also on the particularsecurities they would pick up.
3. The securities are to be issued by JJ in favor of
the respective banks.4. Right of recourse is to be exercised against the
respective original owner of the securities, notthe lead manager(s).
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Murabahah Financing Securities:Some Further Issues - 1
The Right of Recourse:
1. To be exercised by the bearer of a defaulted
security against his immediate seller within aprescribed time from the maturity date of thesecurity.
2. To be exercised separately for each security.
That is, default on security one should not betaken to imply default on the other securities.
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The Hadith on Bai Al-Kali (or, Bai Al-Dayn) doesnot apply to these securities, BECAUSE:
1. Every Murabahah Financing Security represents
genuine and well-defined rights of it originalowner. He can, therefore, exercise his propertyrights, of course, within the Shariah limits such as right of recourse).
2. Riba does not arise as long as the restriction ofno direct or indirect repurchase of oncetransferred collection rights is respected.
3. The arrangement is equivalent to that alreadyapproved by the Shariah scholars.
Murabahah Financing Securities:Some Further Issues - 2
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The Issue of Riba:
1. In principle, when does riba arise?
2. Difference between settlement of debt andtrading of debt (bai al-dayn)
3. When may bai al-dayn occur in the case ofMurabahah Financing Securities?
Example: A is initial holder of a securitywith face value of Rs.1 million.
Murabahah Financing Securities:Some Further Issues - 3
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Murabahah Financing Securities:Some Further Issues 3 (contd.)
Transfer of CollectionRights
(from to)
Payment(Rs. Millions)
Practical Position if Settlementtakes place without further
Transfer of Collection Rights(Rs. Millions)
1st
Leg: A to B(A is initial holder) 0.875 (to A) Loss of A = 0.125Gain of B = 0.125
2nd Leg: B to C 0.895 (to B)Loss of A = 0.125Gain of B = 0.020Gain of C = 0.105
3rd Leg: C to B 0.950 (to C)
Loss of A = 0.125Gain of C = 0.055Gain of B = 0.070 [= 0.020 at Leg 2
& 0.050 at Leg 3]
Final Settlement: While the debtor may be paying Rs.1 million,
the creditor in standing, B, will be getting Rs.(1+0.895-0.
95).
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Review of Islamic Debt Securities in Vogue
Malaysia is the only country that recognizes Bai Al-Dain.More specifically, we look at the Islamic Debt Securitiesin Malaysia.
There are Islamic Zero Coupon Bonds. Like theconventional zero-coupon bonds, they are sold at adiscount. But they are generated through a sale contract.
Example: Khazanah Islamic Benchmark Bonds
There is a Bai Inah in the background, the bond holdersbid for the price payable to them.
Islamic Debt Securities (ABBA or BaIDS or Munif)
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A Malaysian Case Study
The Case of Munif, ABBA or BaIDS(Al-Bai Bithaman Ajil Islamic Debt Security)
1. A Customer needs $100 million over3 years.
2. The investors seek 8% per annum simple rate ofreturn on their investment a total of $24 million.
3. The arrangement is worked out such that the investorsget their return biannually in equal installments, and
with the last installment their investment is alsoredeemed.
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Malaysia Islamic Debt Securities
1. The Issuer identifies an asset worth $100 million.
2. The Issuer sells that asset for $100 million cash toInvestors.
3. The asset is simultaneously sold back to the Issuer for
$124 million (= $100 million plus 8% for three yearsSecuritization is done as follows:
1. 100,000 debt certificates (Shahadah Al-Dain) orPrimary Notes (PNs) redeemable at par value
sold to the Investors.The denomination of each PN is $1000.
They guarantee repayment of capital to Investors.
The above is called BBA sale, and the zero coupon
bonds are called ABBA, BaIDS or MunNif.
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2. The goal of paying $24 million over a period of3 years isaddressed through issuance of Secondary Notes (SNs).
Rosly states that SN are sold at par valueredeemable annually or semiannually. But it is not clearagainst what the sale is taking place. The process seemsto be as follows:(i) Suppose target is to pay $4 million every six months
to the Investors.(ii) The ratio of SNs to PNs is fixed at 1:5. Thus against
the 100,000 PNs, 500,000 PNs are issued.The face value of each SN is $24 million divided
by 500,000 or $48.Maturity period of 20% of the SNs is six months,
that of another 20% is one year, and so on.
At the end of the 3-years period, the Investors get $4million in lieu of the SNs and also en-cash the PNs attheir face value.
Malaysia Islamic Debt Securities