Sukuk Al-Ijarah in Islamic Finance

Sukuk Al Ijara

Introduction to the selected Sukuk Structure (Sukuk Al Ijara)

Sukuk Al Ijara is considered to be the most regularly employed sukuk structure centered on the amount of issuances. The attractiveness and admiration of this structure can be linked to different elements. For instance, a number of critics and reviewers have termed it as the standard sukuk structure from which all of the other sukuk structures have come about from while others point out on how simple and straightforward the structure is; it is also because it is favored by Sharia academics and intellectuals. The term Ijara in accordance to Islamic finance is largely considered to have the meaning of the transference of a particular asset to another individual with attainment of rent in exchange. In simple terms it is considered to be a lease (Islamic Banker, 2015).

Theoretical Aspects

In theory, this particular sukuk structure provides the owner with the right to actually own the underlying assets, to obtain rent from the asset, and also to dispose the sukuk devoid of any effect on the issuer's right to use the asset. The following are a number of the theoretical aspects of the sukuk al Ijara.

i. As a result of the existence of maintenance and insurance costs that cannot be effortlessly recognized beforehand, the expected return on a number of kinds of Ijarah sukuk cannot be absolutely fixed and ascertained at the start of the contract (Jabeen and Jayed, 2007).

ii. Ijarah sukuk is entirely negotiable and can be traded in the secondary market (Jabeen and Jayed, 2007).

iii. Ijarah sukuk offers a great deal of flexibility which is resultant from the method to issuance administration and marketability. The rules of flexibility in sukuk ijarah imply that the securitization of the Ijarah contract is the main aspect to resolving the problem and issue of liquidity management. For this reason, the sukuk Ijarah not only has the characteristics but also the essential conditions to be a successful and thriving security (Jabeen and Jayed, 2007).

iv. The bonds for sukuk Ijarah can be traded in the financial market at prices which are determined by the forces in the market such as the economic conditions, the opportunity cost, the condition of the market as a whole and also the price of the real investment. The Ijarah bond is also cause to experience risk linked to the capability and wish of the lessee or borrower to pay the rental lease payment, and the market risk emanating from the potential fluctuations in asset valuing, maintenance and insurance expense (Jabeen and Jayed, 2007).

How do they did it -- discuss in details the structure of the Sukuk

In detail the structure of the sukuk Ijarah functions and can be described as follows:

Sukuk 1

3b

Borrower (Lessee)

SPV

Sukuk Holder (Lessor)

Asset Seller 2 2

4 5b

5a 3a

1 1 3b 7b

6

7a

1. The borrower or lessee purchases the asset from the seller and thereafter sells it to the special purpose vehicle (SPV). In another alternative manner, the SPV purchases the asset directly from the seller in accordance to the needs and requirements of the borrower.

2. The special purpose vehicle (SPV) issues sukuk to sukuk holders in order to pay for the acquisition.

3. a. The sukuk holders pay the sukuk proceeds to the special purpose vehicle

b. The SPV allocates the incomes attained from sukuk holders to the borrower to recompense for the asset acquirement. If the SPV purchases the asset from the seller, the earnings are employed to recompense the purchase payment to the asset seller.

4. The SPV leases the asset back to the lessee who is also the borrower

5. a. The lessee gives out lease payments regularly to the SPV as a return on the lease transaction

b. The SPV allocates the lease payments back to the sukuk holders as the distribution amount for the interval or period. This amount is equivalent to the lease payment that is attained from the lessee who is also the borrower.

6. When the sukuk finally gets to its maturity, the lessee repurchases the asset back from the SPV

7. a. The lessee reimburses the repurchase price to the Special Purpose vehicle

b. The SPV allocates the repurchase price attained from the lessee to sukuk holders as a dissolution circulation amount.

A different kind of Ijarah sukuk is one that is devoid of any SPV or financial intercessors who can issue the financial instrument. The lessee or the borrower issues Ijarah sukuk in order to purchase the asset. The ownership of the asset is thereafter transferred to sukuk holders and on the other hand the issuer or the borrower comes to be the beneficiary of the user of the underlying asset or the Ijarah sukuk. In this kind of Ijarah sukuk, there is no form of premium that is paid to an Islamic intercessor, but the issuer might end up taking payment in the contract from the transaction (Al-Amine, 2001).

Critical Analysis of the Sukuk structure

There are a number of drawbacks with regards to the Sukuk Ijarah structure. To start with, in the structure, not every potential issuer has the accessibility to the fundamental asset that is required. In addition, Ijarah sukuk also has very high costs of transactions which include expenses such as costs for insurance and also maintenance. This is for the reason that Shariah necessitates the underlying asset to be operable, or else the lease will be postponed up until the asset is fixed. What is more, the fees and audits for Shariah are not only very costly but are also time consuming (Rohmatunnisa, 2008). There are also fines or penalties rendered to the lessee if the regular payment for the lease is not done on good time. Nonetheless, the main disadvantage or criticism of Sukuk Ijarah structure is linked to the use of the interest rate as point of reference, because it is every so often the case that the yield of Ijarah sukuk is benchmarked to London Inter-Bank Offer Rate (LIBOR) on U.S.$ funds, or the equivalent local rate of issue. Even though the rate of interest in employed for pricing, the close relationship between riba and the pricing that is centered on the interest rate is a great worry to intellectuals and professionals. Islamic academics do not distinguish any dissimilarity between real interest rates and the nominal rates of interest (Yean, 2009). Nevertheless, in the process of enunciating a projected rate of profit for the supposed rate of investment, in the end, Muslims integrate and include implicit inflation suppositions when they place profit expectancy as a function of other predictable capital market returns on equivalent risk (Rohmatunnisa, 2008).

How other market players are structuring (discuss other sukuk structures) i.e. Comparison of other Sukuk Structure

There are other kinds and types of sukuk which include Sukuk al- Murabaha, Sukuk al-Salam, Sukuk, al-Musharaka, Sukuk al-Mudaraba, and Sukuk al-Istisna all which function in a different manner from Sukuk al-Ijara.

Sukuk Al-Mudaraba

Sukuk Al-Ijara

Sukuk Al-Musharaka

Structure Base

Equity based

Asset based

Equity based

Similar Structure

Business

Conventional bond

Business on the basis of partnership agreements

Regulations

Profit cannot be allocated on pre-determined lump sum or centered in percentage of ownership between the firm and the investor

Numerous asset regulations. For instance, the asset ought to have utility and ought not to be consumable

All of the providers of capital are in their own right permitted to take part in management but essentially mandated to do so. The profit generated is allocated amongst the different partners in the ratios initially agreed at the start of the contract

Loss bearer

The Investor

The firm

Every partner austerely in proportion to individual capital contributions