Islamic Financing - Sukuk Al Murabaha, Sukuk Al Musharaka and Sukuk Al-Wakala
Islamic Finance is financing which is compliant with the requirements of the Shari'ah. While the concepts are centuries old, the foundations of Islamic banking and the modern financial tools which have been developed as compliant with Islamic law are relativity recent; early development seen to start in earnest in Egypt in the 1960's (Khan and Mirakhorv, 2005). The evolution of Islamic finance has resulted in numerous instruments for both commercial and consumer purposes, structured to be fully compliant with the Shari'ah. Three of these are Sukuk al murabaha, Sukuk al musharaka and Sukuk al-Wakala. The aim of this paper is to examine these three different tool, looking first at the common characteristics and then at the differences and uses of the tools.
Sukuk translates as a legal instrument or deed and refers to financial certificates (El-Gamal, 2006). The term is used to refer to instruments which are the equivalent of bonds. There are different types of Sukuk; while each has different characteristics and is used for different purposes they will all share a number of common characteristics as they will be compliant with the six standard requirements of all Islamic finance and banking. The first requirement in compliance with the Shari'ah is the prohibition of interest, also referred to as riba (Iqbal, 1997). This is prohibited in sections 278-279 of the Quran, where interest is defined as "any positive, fixed, predetermined rate tied to the maturity and the amount of principal," also stating that it is due regardless of the performance of the underlying asset (Iqbal, 1997). Notably, Islamic scholars, argue that this definition does not only incorporate usury, but also the way in which the Western banking industry will charge interest (Iqbal, 1997).
Other requirements include the concept that risk should be shared, that money should only be treated as potential capital, only becoming capital when pooled with other resources on being used in a productive manner (Hassan and Lewis, 2007; Iqbal, 1997). There is also the requirement to avoid speculative behavior, the concept of the sanctity of contracts were all parties are required to disclose relevant information and uphold their obligations under a contract, and finally the requirement that any activities which are undertaken through the instruments are those approved by the Shari'ah (Hassan and Lewis, 2007).
These are characteristics which are required for all Islamic financial tools, and therefore found with in the three instruments discussed in this paper. However, with a wide range of different financial requirements, a number of different tools have emerged. In order to appreciate differences the various characteristics and uses of the three sukuk may be considered individually.
Sukuk al murabaha
Sukuk al murabaha may also be referred to as cost plus, or a deferred payment sukuk. Murabaha is one of the most commonly used financial tools within Islamic finance; it is an equity-based partnership and deals with the concept of a cost plus arrangement. Investors undertake to purchase goods required by the borrower, and then resell those goods at a higher price, with a mutually agreed profit margin for the investor (Iqbal, 1997). It is estimated at 75% of all Islamic financial transactions utilize Murabaha (Hassan and Lewis, 2007). Murabaha are typically shorter term arrangements. The Murabaha arrangement which requires there to be the specific identification of underlying assets, where this is not the case and assets can be specifically identified the utilization of a sukuk al-ijara. The same characteristics of marabaha are found with in a sukuk al-mudaraba, with one partner providing the capital, while the other provides the management skills, these are referred to respectively as the Rab al Maal and the Mudarib (Islamic Banker, 2013). The issuance of the sukuk would see each unit purchased representing an equal value in the total mudaraba capital. The names of the investors will be registered a certificate holders, based on an undivided share ownership (Islamic Banker, 2013). Returns and by the investors will be based on the profits which are realized, which will be allocated on a predetermined ratio agreed between the various investors and the management (Islamic Banker, 2013). There have been a number of sukuk al-mudaraba issuances, including the U.S. $200 million issued by IIG Funding Limited, issued in June 2007, and listed on the NASDAQ Dubai (Islamic Banker, 2013).
At maturity there will be the dissolution of the mudaraba enterprise created under the sukuk. The trustee will exercise a prearranged purchase undertaking, which requires the originator to purchase the mudaraba at the market value, with the proceeds then been utilized to satisfy the amount outstanding to the investors (Islamic Banker, 2013; Hassan and Lewis, 2007). The investors would gain a return which is based pro rata on their investment and the liquidated market value along with the profit it is being generated by the mudaraba during the period of the sukuk (Islamic Banker, 2013; Hassan and Lewis, 2007). The priority of the capital allocation would be based firstly to return capital that was contributed by the investors, and then any surplus returns using the same pro rata approach (Islamic Banker, 2013; Hassan and Lewis, 2007). This distribution is a manifestation of the profit-sharing requirement, and also facilitates the requirement for risk in terms of the way the losses may be shared.
The profits may be technically distributed at the maturity of the sukuk al murabaha, but the structure of the agreement has allowed for periodic distributions which are issued as "advance profits."
Sukuk al musharaka
Musharaka is akin to a joint-venture agreement, or partnership, where capital is provided by both parties to the agreement; investor(s) and the entrepreneur(s) or manager(s). The contributions of capital may be in cash, but there may also be in the form of other assets, classified as an investment in kind (Hassan and Lewis, 2007). Musharaka are very similar in concept to mudaraba, but are often utilized for longer term agreements, for example a traditional masharaka may be used as a financial tool to support the purchase of a long-term business asset (Iqbal, 1997).
A sukuk al musharaka may be perceived as a joint-venture which remained unincorporated, but still has its own legal identity. In common with mudaraba, the parties to the agreement will agree to share profits and losses at a prearranged level; proportional to the capital investment they have made (Islamic Banker, 2013).
The sukuk al musharaka may be structured in differing ways, but to structures are most common when a sukuk al musharaka is issued. These are the Shirkat al-'Aqd and the Shirkat al-Melk. The Shirkat al-'Aqd is also called a "business plan musharaka," as this is an agreement where the capital provided by the investor and the trustee is utilized to pursue a common objective. The Shirkat al-Melk is also called a co-ownership musharaka, as it is undertaken with the goal of the investor and the trustee, purchasing an asset together, or with the originator liquidating some ownership interests in the asset to the trustee resulting in a situation of co-ownership (Islamic Banker, 2013). Therefore, the structure of the musharaka will be dependent upon the aim of the agreement and the activities which will be undertaken. On the creation of the sukuk al musharaka the purpose was existence will be specified, and the remit of those involved cannot extend beyond those specifications. Within the requirement is necessary for the investors to have a degree of tangibility, which may be calculated as asset-backed ratio. The actual requirement may depend upon the interpretation of the Shari'ah by different scholars, but is usually interpreted as between 33% and 50% (El-Gamal, 2006). The parties; both the originator and the trustee, have the potential to terminate the agreement at any time giving the relevant notice, the termination process and distribution is similar to that of the sukuk al-mudaraba (Islamic Banker, 2013).
Sukuk al-Wakala is one of the more recent finance tools developed within the Islamic banking industry. The structure is based on that of a wakala, a literal translation sets of this is an "arrangement whereby one party entrusts another party to act on its behalf" (Islamic Banker, 2013). Wakala may be compared to an agency agreement, in which the investor appoints an agent, also referred to as a wakeel, to make investments on their behalf. The investment is placed into a pool, with the wakeel utilizing their expert knowledge to manage the investments, for a specified term with the aim of creating a mutually agreed profit (Islamic Banker, 2013). The ways in which the wakeel is appointed, the scale of the fees for the wakeel (if any are provided), and the scope of the services they provide will all be specified with in the agreement (Islamic Banker, 2013).
There are some major structural similarities with the former tools discussed, but a major difference exists in the way the profit is shared; investors will only receive the profit which was agreed at the beginning of the sukuk, any excess…