Sukuk Al Ijarah

In sukuk ijarah, unlike sale contracts that the transfer of ownership happens instantly.Ijarah

contracts do not transfer ownership on its own. It is‘transfer of the usufruct of an asset to

another person in exchange for a rent claimed from him’ or, more literally, a “lease”. The

most common structure of sukukijarah applied in the market is a sale and leaseback structure.

Thus, an issuer that wants to raise sukuk would have to identify assets to sell and leaseback.

For example, in case of Malaysia Global Sukuk, sale of beneficial title transfer to sukuk

holder and SPV (Federal Land Commision ) holds the legal title in order to ensure benefit of

the investors.

In order to generate returns for investors,sukuk structures rely upon either the

performance of an underlying asset or a contractual arrangement with respect to that asset.

The ijara is particularly useful in this respect as it can be used in a manner that provides for

regular payments throughout the life of a financing arrangement, together with the flexibility

to tailor the payment profile - and method of calculation - in order to generate a profit. In

addition, the use of a purchase undertaking is widely accepted in the context of sukuk al-ijara

without Shari’a objections. These characteristics make ijara relatively straightforward to

adapt for use in the underlying structure for a sukuk issuance.

Overview of Structure:

Issuer SPV issues sukuk, which represent an undivided ownership interest in an

underlying asset or transaction. They also represent a right against Issuer SPV to payment of

the Periodic Distribution Amount and the Dissolution Amount.

The Investors subscribe for sukuk and pay the proceeds to Issuer SPV (the

“Principal Amount”). Issuer SPV declares a trust over the proceeds (and any assets acquired

using the proceeds) and thereby acts as Trustee on behalf of the Investors.

Originator enters into a sale and purchase arrangement with Trustee, pursuant to

which Originator agrees to sell, and Trustee agrees to purchase, certain assets (the “Assets”)

from Originator. Trustee pays the purchase price to Originator as consideration for its

purchase of the Assets in an amount equal to the Principal Amount.

Trustee leases the Assets back to Originator under a lease arrangement (ijara) for a

term that reflects the maturity of the sukuk. Originator (as Lessee) makes Rental payments at

regular intervals to Trustee (as Lessor). The amount of each Rental is equal to the Periodic

Distribution Amount payable under the sukuk at that time. This amount may be calculated by

reference to a fixed rate or variable rate (e.g. LIBOR or EIBOR) depending on the

denomination of sukuk issued and subject to mutual agreement of the parties in advance.

Usually issuer SPV pays each Periodic Distribution Amount to the Investors using the

Rental it has received from Originator.

Upon an event of default or at maturity (at the option of Trustee under the Purchase

Undertaking); or the exercise of an optional call (if applicable to the sukuk) or the occurrence

of a tax event (both at the option of Originator under the Sale Undertaking),

Trustee will sell, and Originator will buy-back, the Assets at the applicable

Exercise Price, which will be equal to the Principal Amount plus any accrued but unpaid

Periodic Distribution Amounts owing to the Investors.

Payment of Exercise Price by Originator (as Obligor).

Issuer SPV pays the Dissolution Amount to the Investors using the exercise price it

has received from Originator.Trustee and Originator will enter into a service agency

agreement whereby Trustee will appoint Originator as its servicing agent to carry out certain

of its obligations under the lease arrangement, namely the obligation to undertake any major

maintenance, insurance (or takaful) and payment of taxes in connection with the Assets. To

the extent that Originator (as Servicing Agent) claims any costs and expenses for performing

these obligations (the “Servicing Costs”) the Rental for the subsequent lease period under the

lease arrangement will be increased by an equivalent amount (a “Supplemental Rental”). This

Supplemental Rental due from Originator (as Lessee) will be set off against the obligation of

Trustee to pay the Servicing Costs.

Key Features of the Underlying Structure:

The consideration (Rentals) must be at an agreed rate and for an agreed period; the subject of

the ijara must have a valuable use (i.e. things without a usufruct cannot be leased)

The ownership of the asset(s) must remain with the Trustee and only the usufruct right

may be transferred to the originator (therefore anything which can be consumed cannot be

leased by way of an ijara).

As ownership of the asset(s) must remain with the Trustee, the liabilities arising from

the ownership must also rest with the Trustee (as owner) - an asset remains the risk of the

Trustee throughout the lease period (in the sense that any harm or loss caused by the factors

beyond the control of the Originator is borne by the Trustee). Any liabilities relating to the

use of the asset(s), however, rest with the Originator (as lessee).

The Originator (as lessee) cannot use an asset for any purpose other than the purpose

specified in the ijara (or lease) agreement (if no purpose is specified, the Originator can use

such asset for the purpose it would be used for in the normal course of its business). The

asset(s) must be clearly identified in the ijara (and identifiable in practice).

Rental must be determined at the time of contract for the whole period of the ijara.

Although it is possible to split the term of the ijara into smaller rental periods where different

amounts of rent may be calculated for each such rental period, the amount of rental must be

fixed at the start of each such rental period and Shari’a will consider each rental period as a

separate lease.

If an asset has totally lost the function for which it was leased, and no repair is

possible, the ijara shall terminate on the day on which such loss (a “Total Loss”) has been

caused. If there has been a total loss, the trustee may have the right/ability to substitute or

replace the affected asset - although, in reality, it would only look to do so if the Originator

(as service agent) is able to use the insurance (or takaful) or any other total loss proceeds to

procure substitute or replacement assets.

If a total loss is caused by the misuse or negligence of the Originator, the Originator

will be liable to compensate the trustee for depreciation in the value of the affected asset, as it

was immediately before such total loss, and

In the event that an asset has only suffered partial loss or damage, the ijara will continue to

survive with respect to that asset.The above requirements are based on the principles set out

in Accounting and Auditing Organization for Islamic Financial Institutions (the “AAOIFI”)

Shari’aStandard No. 9 (Ijarah and IjarahMuntahiaBittamleek) and other established principles

relating to Ijara.

Sukuk al-Istisna:

Istisna is a contractual agreement for manufacturing goods and commodities,

fallowing cash payment in advance and future delivery or a future payment and future

delivery. A manufacturer or builder agrees to produce or build a well described good

or building at a given price on a given date in the future. Price can be paid in

installments, step by step as agreed between the parties. Istisna can be used for providing the

facility of financing the manufacture or construction of houses, plants, projects, and

building of bridges, roads and highways (Shaukat, 2010).

In addition, Istisna sukuk are certificates that carry equal value and are issued with the

aim of mobilizing the funds required for producing products that are owned by the certificate

holders. The issuer of these certificates is the manufacturer (supplier/seller), the subscribers

are the buyers of the intended product, while the funds realized from subscription are the cost

of the product. The certificate holders own the product and are entitled to the sale price of the

certificates or the sale price of the product sold on the basis of a parallel Istisna, if any. Istisna

Sukuk is quite useful for financing large infrastructure projects (Nisar, 2005). Istisna' sukuk

for the finance of their development projects and this could be executed in two forms:

Parallel Istisna

Originator establishes an intermediary (SPV) and transfers the functions of finance and

executing the project via an Istisna contract then pays the price of the contract by Istisna

sukuk with certain maturity dates. Issuer of securities also, according to a different Istisna

contract orders those particular projects to the contractor and undertakes to pay for the price

of the contract in due course. SPV also sells the Istisna sukuk to the investors via an

investment bank and pays its debt to the contractor.

Istisna and Ijarah Al-muntahi Bi-ttamlik

In this model, originator establishes an intermediary firm (SPV) and undertakes to receive

a particular commodity or project supplied by this firm in form of Ijarah Al-muntahi

Bittamlik.

The SPV also orders the commodity or project to a contractor to be manufactured according

to an Istisna contract and undertakes to pay the price in due course, then offers the Istisna

sukuk to the public via an investment bank and collects the funds and pays for its debts to the

contractor. The SPV receives the commodity or project from the contractor and gives it to the

originator in form of Ijarah Al-muntahi Bi-ttamlik on behalf of the owners of securities. The

secondary market for Istisna sukuk and Ijarah sukuk will be on the basis of trading a title

deed of a physical asset and there is no legal and jurisprudential problem (Musavian&

Zehtabian, 2009).

Istisna Sukuk in Practice

Tabreed’s five-year global corporate Sukuk (on behalf of the National Central

Cooling Company, UAE) provided a fixed coupon of 5.50%. It is a combination of Ijara

Istisna and Ijara Mawsufah fi al dhimmah (or forward leasing contracts). The issue was

launched to raise funds to retire some existing debt, which totals around US$136 million, as

well as to finance expansion.

The Durrat Sukuk will finance the reclamation and infrastructure for the initial stage

of a broader US$ 1 billion world class residential and leisure destination known as 'Durrat Al

Bahrain', currently the Kingdom of Bahrain's largest residential development project. The

return on the Sukuk is 125 basis points over 3 months LIBOR payable quarterly, with the

Sukuk having an overall tenor of 5 years and an option for early redemption. The proceeds of

the issue (cash) will be used by the Issuer to finance the reclamation of the land and the

development of Base Infrastructure through multiple project finance (Istisna) agreements. As

the works carried out under each Istisna are completed by the Contractor and delivered to the

Issuer, the Issuer will give notice to the Project Company under the Master Ijara Agreement

and will lease such Base Infrastructure on the basis of a lease to own transaction (Nisar,

2005).

General step involved in the structure.

1. SPV issues Sukuk certificates to raise funds for the project.

2. Sukuk issue proceeds are used to pay the contractor/builder to build and deliver the future

project.

3. Title to assets is transferred to the SPV.

4. Property/project is leased or sold to the end buyer. The end buyer pays monthly

installments to the SPV.

5. The returns are distributed among the Sukuk holders

Figure: 1 Structure of Sukuk Istisna

Key Features of the this Structure

Set out below is a summary of the basic requirements that should be considered when

using a combination of Istisna and forward leasing as the underlying structure for the

issuance of sukuk:

• The price and specifications for the good or asset need to be specified at the outset;

• It is quite common for the purchaser to split the purchase price (paid in advance)

into staged payments that correspond to certain milestones that are agreed upfront with the

contractor;

• Although it is not necessary to fix the time of delivery under the Istisna, the

purchaser may elect to fix a maximum time for delivery - this essentially means that, if the

contractor delays delivery after the scheduled completion date, the purchaser will not be

bound to accept the goods and to pay the price;

• Liquidated damages provisions may be included in order to incentivize the

contractor to deliver on schedule (and to mitigate late delivery risk);

• Although not universally accepted, the majority of Shari’ah scholars consider

forward leasing permissible on the understanding that: advance rentals are taken into account

(as rental which has been paid) and have to be refunded in full if the assets are never actually

delivered for leasing. Such matters have to be carefully addressed in the documentation in

order to ensure that the commercial deal is not disturbed: for example, by careful calculation

of any termination payments that are triggered if a termination occurs pre-delivery (DIFC,

2009).

Case study of zamzam sukuk:

Zamzam Tower is one of first Munshaat’s projectcs and one of the largest real estate

projects in the region. It is one of the biggest towers in the project of Abraj Al-Bait, within

the endowments of King Abdullaziz , assigned for serving the Two Holy Mosques – Ajyad

Castle. The project is established on a plot owned by the endowments of King Abdullaziz,

assigned the Two Holy Mosques. It is the first of it’s kind in Makkah Al-Mukarramah based

on the (B.O.T) system. The usufruct is for 25-Hijri years. The leased part of the tower is 33

floors, which includes 1315 residentials units. The tower is highly characterized by its

architectural design that matches the atmostphere of Makkah Al-Mukurramah, and the direct

view of the Holy Mosque. It is also only 150 metres away from King Abdulaziz’s gate.

Zamzam Tower is supported by 36 elevators to work according to smart advanced systems.

The background of the Special Purpose Vehicles:

Munshaat Real Estate projects Co. (K.S.C.C)

Munshaat Real Estate projects Co. (K.S.C.C) was established on the 8th of April

2003, with a current paid up capital of KD 32.2 Million, divided into 322 Million shares, by

its main founders AREF investment Group and The International Leasing and investment

Company (ILIC). The business of Munshaat mainly focus on the local and international Real

Estate industry through the professional development and management of real estate

products, managed in a professional and specialized manner targeting lucrative and non-

traditional markets and employing the best investment tools which comply with the Islamic

essential, in addition contributing in the investment projects through B.O.T basis.

Why did the issuer decide to select a forward Ijarah contract?

In the case of sukuk zamzam tower, munsha’t company has issued sukuk forward Ijarah and

the proceeds will be used to fund infrastructure projects on land neighboring to the Holy

Mosque in Makah. This strcture according to time-sharing financing and its future-use was

the first in the Kingdom and the region. This project gained the support of the Saudi Council

of Ministers and the Shoura Council. . All contracts and agreements come under Saudi law

and have been scrutinized by both Saudi and international law firms. The law of Saudi Arabia

does not allow for foreigner to own land or property that is located on the holy city Makah.

This was the main obstacle and challenge facing munsha’t company to start their project

under this law hence the foreigner investors cannot invest in this project under the popular

transaction on that time which it depend on assets-backed. Because of this issue munsha’t

company start looking for another alternative that can underling this project can be complied

with sharia’h law and in the same time Saudi Arabia law.

One of the unique contracts on the Islamic law of contract is forward Ijarah, this contract is

combined from two transactions one is Istisna and the other is Ijarah. Using this transaction

was the solution of the issue of ownership to enable the foreigner investor to invest and enjoy

the stay at the holy city for all Muslim around the world. Under this transaction munsha’t

company has issued sukuk al_intifa’ which enable the local and foreigner investors to hold

this sukuk which give them beneficial ownership and not real ownership of the estate.

Issues and the opinion of scholars regarding to Forward Ijarah Zukuk:

The forward Ijarah contract is similar to Istisna’ contract in terms of conditions but the only difference with this contract is the subject matter not real estate but only usufruct.

The opinion of shria’h scholars on the validity of forward Ijarah:

Hanafi: They did not accept this type of contract, because firstly, they do not consider ad recognize USUFRUCT as a subject matter. The usufruct is not in existence The subject matter in not exist in time of the contract.

Based on this opinion, who considered this type contract might fall into the debt that cannot be tradable and negotiable.

The rest of schools of thought in consensus of opinion that they approve this contract some of them

differ in the matter of payment, they emphasize on the immediate payment because they are

justifying the impact of deferred payment may lead to sale debt for debt, which is not allowed in

islam, while other allowed deferred payment based on basis of analogy of Istisna contract. In the

other hand some scholars claiming that this Sukuk is only money and still not backed by asset, so it

is still jus tradt money as a result cannot be tradable that comes within prohibitation riba. This Sukuk

cannot be tradable until the project is completed.

First issue is that the lessor have to ensure that scholars are consensus of opinion that, if the lessor failed to facilitate the benefit of lease meaning benefit of enjoying his right, lessor has

to pay compensation. In this case, we see the exercise of this ruling when munshaat failed to complete the project within two years as mentioned in the contract, they extend the period for two more years.

Second issue that enabling the Lessee to benefit from the usufruct enjoyment on the agreed time is considered as one of the main condition of the validity of this contract and any break or delay on enabling the lessee to use that assets the lessor will be obligated to compensate the lessee.

The Main Features of Zamzam Tower Sukuk:

Country Makkah, Saudi Arabia

Sukuk Name Zamzam Tower Sukuk

Name of Issuer Munshaat Real Estate projects Co.

Name of Originator/Obligor Binladin Group

Date of Issue

Issue size USD 390 millions

Tenor (years) 24 years

Listing Status Registered Listing in the Stock Exchange

Shariah Principle Used sukuk

issuance

Forward Ijarah Sukuk

Profit/Coupon 26 percent per annum

Underlying/ Identified assets The King Abdul Aziz Waqf

Structure of Zamzam Tower Sukuk:

Step 1: The Binladin Group signs Ijarah contract with The King Abdul Aziz Waqf on the

basis of Build-Operate-Transfer agreement for 28 years. Under this agreement, the Binladin

group will build a shopping complex, four towers and a hotel.

Step 2: The Binladin Group appoints Munshaat Real Estate Projects KSC as Special Purpose

Vehicles (SPV) to finance the construction and operate the project and then transfer it to the

Waqf at the end of the 28-years lease period.

Step 3: The Binladin Group signs Forward Ijarah contract with Munshaat Real Estate

Projects KSC to construct the required asset for its customer.

Zamzam Sukuk Structure

Land Owner(gov KSA)

Proceeds from sukuk issuanceProceeds from sukuk issuance

The complex

SukukInvestorSukukInvestor

Sukuk al-intifa`

1.Ijarah contract on use of land (BOTconcept)

2.Sells of right of future use of the unit3. Payments for lease rental

(forward leasing)

4.Issuance of sukukAl-intifa’

5. Payment for lease of land

6. Development cost

7. Right to use (time-use) by the sukuk holders

THE DEVELOPER

Step 4: Munshaat Real Estate Projects KSC packages the Forward Ijarah’s

Asset into the Sukuk Unit for issuance to potential investors.

Step 5: Munshaat Real Estate Projects KSC issues the Sukuk Certificates to investors at

fixed profit rates

Step 6: Investors subscribe to Sukuk for future benefits

Step 7: Sukuk subscription generates required cash proceeds valued USD 390 Millions

Step 8: Munshaat Real Estate Projects KSC disburses progress payments to Contractor and

Consultants

Step 9: Contractor delivers completed asset to Munshaat Real Estate Projects KSC on behalf

of the investors on the agreed date

Step 10: Investors have the right to use the property or sell this right to the third party

References:

1. Adam, Nathif. (2005). Sukuk: A Panacea for Convergence and Capital Market. Development in The OIC countries. Conference paper. Indonesia.

2. Dubai International Financial Centre Sukuk Guidebook. 2009. UAE.

3. Jhordy Kashoogie Nazar. 2010. Regulatory and Financial Implications of Sukuk’s Legal Challenges for Sustainable Sukuk Development in Islamic Capital Market. 8th

International Conference on Islamic Economics and Finance

4. Mughees Shaukat. 2005. COMMON STRUCTURES OF SUKUK, Published in the GLOBAL ISLAMIC FINANCE MAGAZINE-United Kingdom, DECEMBER 2010 issue- Also available at http://instituteofhalalinvesting.org/Articles/Mughees-Shaukat.htm

5. Musavian S. Abbas and Mostafa Zehtabian. 2009, “Operational Models for Ijarah, Istisna and Murabahah Sukuk from Islamic point of view”, Working Paper.

6. Shariq Nisar. 2005. Islamic Bonds (sukuk): Its Introduction and Application.

7. Dr. Aznan Hasan 2010, Ahmad Ibrahim Kulliyyah of Laws,International Islamic University Malaysia.

8. Arab News, 16 February 2004, Zam Zam Tower and Timeshare BondMushtak Parker, London. http://archive.arabnews.com/?page=6&section=0&article=39601&d=16&m=2&y=2004 LONDON, 16 February 2004