islamic capital market, an overview
TRANSCRIPT
ISLAMIC CAPITAL
MARKET A Complete Overview
ABSTRACT Islamic Capital Market (ICM) is the result of
growing need for Islamic finance. This paper
discussed various topics related to capital market
and their Islamic appraisal. The sukuk market
have been discussed in more detail. A global
scenario have been highlighted and Islamic
finance in Bangladesh have been discussed with
problems and prospects.
Mohammad Shiblu
www.fb.com/amar.kotha.barta
Executive Summary
Islamic Finance is a growing industry. Islamic Capital Market (ICM) is the result of
worldwide Islamic finance growth. ICM can be called as a capital market according to
Islamic Shari’ah. However, as a new industry, it has some limitations, problems that
should be overcome.
In the first part of this report, conventional capital market is viewed from risk and return
perspective. Functions of a conventional capital market are discussed. Also, the main two
items of capital market i.e. stock and bonds are discussed in very brief before going into
discussion about ICM. In the second part of the report, Justification for establishing a ICM
is given and why we need a Islamic Capital Market have been discussed. Also, the risk and
return from Islamic perspective have been discussed in brief.
In the third part, Islamic equity market is discussed. The contractual form between the
firm and shareholders are discussed with the concept of limited liability from Islamic
perspective. Different screening criteria are discussed that are being implemented
throughout the word. Also, the permissibility or prohibition about short selling is
discussed in some detail with the topic of speculation.
In the fourth part, the most important part of Islamic capital market, the sukuk market
are discussed. The types of sukuk with some innovative model like GDP-Linked sukuk,
Commodity-Linked sukuk have been discussed. These model have solved some problem
with present sukuk structures. Also, the tradability of different sukuk and a practical
example of ADIB sukuk issuances are given. Some shari’ah concerns about present sukuk
practices are also discussed. A snapshot of current global sukuk market have been given,
it have been seen that sukuk market is growing very fast though some setback occurred
in 2008 in the time of global economic crisis. Sukuk market have crossed USD 100 billion
milestone.
In part 5, derivatives market instruments like options, futures, forwards, swap etc have
been discussed from Islamic perspectives. The Islamic alternatives like bai al arbun, bai
al salam have some features of derivatives. In 6th part, the paper is concluded by
discussing some problems and prospects of Islamic finance industry in Bangladesh.
Contents
Contents Pages
1.Overview of the capital market 2
1.1 Functions of capital market 2
1.2 Risk & Return 3
1.3 Bond 3
1.4 Stocks 4
2. Overview of Islamic capital market 6
2.1 Justification of ICM 7
2.2 Risk & Return 7
3. Overview of Islamic equity market 9
3.1 Contract form 9
3.2 Stock Screening 10
3.2.1 Issues in screening process 12
3.3 Short selling 12
3.3.1 Eligibility of stocks to be a subject matter of a loan contract 13
3.3.2 Bai al-mad’um (selling what the seller doesn’t own) 13
3.3.3 Issues of benefitting from a loan contract 14
3.4 Speculation 15
4. Overview of the Sukuk Market 17
4.1 Types of Sukuk 17
4.1.1 Mudarabah Sukuk 17
4.1.2 Musharaka Sukuk 17
4.1.3 Wakala Sukuk 17
4.1.4 Muzara’a (Sharecropping) Sukuk 18
4.1.5 Musaqa (irrigation) Sukuk 18
4.1.6 Mugharasha (Agricultural) Sukuk 18
4.1.7 Ijarah Sukuk 18
4.1.8 Istisna Sukuk 18
4.1.9 Murabaha Sukuk 18
4.1.10 Salam Sukuk 19
4.2 Innovative Sukuk 20
4.2.1 GDP-Linked Sukuk (GLS) Model 20
4.2.2 Commodity Linked Sukuk (CLS) Model 20
4.4 Secondary Market of Sukuk (Tradability) 22
4.5 Global Sukuk Market – A Snapshot 22
4.5.1 Distribution of Sukuk Issuance by Issuer States 23
4.5.2 Distribution of Sukuk Issuances by Structure 25
4.5.3 Distribution of Sukuk Issuances by Region 27
4.6 A Case Study – Abu Dhabi Islamic Bank (ADIB) Example 27
4.6.1 Abstract 27
4.6.2 ADIB Sukuk Explanation 28
4.7 Sharia’h Concerns in Sukuk 29
5. Overview of the Derivative Instruments 31
5.1 Forward & Futures 31
5.1.1 Islamic appraisal 31
5.2 Options 32
5.2.1 Islamic Appraisal 32
5.3 SWAP 32
5.3.1 Islamic Appraisal 32
5.4 Islamic Alternatives 33
5.4.1 Bai al Salam 33
5.4.2 Bai al Arbun 33
6. Problems & Prospects of Islamic Finance in Bangladesh 35
6.1 Problems of Islamic Finance 35
6.1.1 Absence of Islamic Money Market 35
6.1.2 Absence of Suitable Long-term Assets 35
6.1.3 Shortage of Supportive and Link Institutions 35
6.1.4 Organizing Relationship with Foreign Banks 36
6.1.5 Long-term Financing 36
6.2 The Future of Islamic Finance in Bangladesh 36
6.2.1. New banking philosophy for the Islamic Banks 36
6.2.2. Banking Policies and practices should be modernized 36
6.2.3. Policy and Strategy should be formulated 36
6.2.4. Stepping for Distributional Efficiency 37
6.2.5. Allocating Efficiency should be promoted 37
6.2.6. Government and Central bank's Responsibilities 37
6.2.7. Inter-Islamic Bank Co-operation and Perspective Plan 37
Bibliography 38
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01. Capital Market (CM)
1. Overview of capital market
1.1 Functions of the capital market
1.2 Risk & Return
1.3 Bond
1.4 Stocks
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1. Overview of the capital market
The Collection of markets, institutions, laws, regulations and techniques through which
various forms of financial instruments / assets are traded and financial service offered by
financial intermediaries constitute a financial system. In a financial markets, the surplus
units of the society and deficit units of the society meets. Financial markets help to flow
cash from surplus to deficit units. Almost All kinds of financial market do this task.
Financial markets can connect directly the surplus and deficit units i.e. capital market or
indirectly i.e. bank and insurance. This is shown in the below diagram.
Kinds of Financial Markets 1
Financial assets are traded in financial markets like stock, bonds etc. Financial assets are
the claims on future cash flow. Financial assets that have longer maturity generally more
than one year are traded in capital market. Capital market can be divided into two types,
when the securities are offered for the first time, it is called primary market, all the
subsequent trading are occurred in the secondary market.
1.1 Functions of capital market
Capital market play very important functions in the financial system that listed below.
Increasing liquidity
Construction of diversified portfolios is possible
Financial markets
Direct market
Capital market
Debt marketEquity market
Derivative market
Indirect market
Commercial Banks
Insurance Unit trustMerchant
Banks
Deficit unitsSurplus
units
P a g e 3 | 39
Mobilizing the capital
Provides risk management tools
Reduce transaction costs (through efficient pricing)
Measuring economic performance
Management evaluation
1.2 Risk & Return
Risk is the possibility of incurring a loss in financial transaction. Risk is measured through
variance or standard deviation. Risk are two types, one can be minimized called
diversifiable risk or unique risk and another is market risk that affects all the stocks in
the market measured by beta. [1] Risk can be diversified through creating portfolio of
negatively correlated securities. The optimal portfolio can be selected from efficient set
of portfolios. The objective here is to minimize risk and maximize return. Risk and return
goes hand in hand, the higher the risk, the higher the return.
1.3 Bond
A bond is a debt instrument in which an investor loans money to an entity (typically
corporate or governmental) which borrows the funds for a defined period of time at a
variable or fixed interest rate. [2] The short term government debt instrument is called
Treasury bill and corporate debt instrument is called commercial paper. Bond is valued
by below formula.
C = Coupon payment
r = Discount rate
F = Face value
t = remaining time to maturity
1 Beta is the Sensitivity of a stock’s return to the return on the market portfolio. 2 http://www.investopedia.com/terms/b/bond.asp?layout=infini&v=5B&orig=1&adtest=5B [Accessed on 8th may, 2016].
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1.4 Stocks
A stock is a type of security that signifies ownership in a corporation and represents a
claim on part of the corporation's assets and earnings. [3] Stock can be common stock or
preferred stock. Preferred stock have similarity with both equity instrument and debt
instrument. Stock can be valued by discounting future dividends, by using dividend
discount model. If the dividends growth rate is constant, dividends can be measured
through below formula.
𝑃 = 𝐷1
𝑟 − 𝑔
D1 = Forward dividend
r = Discount rate
g = Growth rate
3 http://www.investopedia.com/terms/s/stock.asp?layout=infini&v=5B&orig=1&adtest=5B [Accessed on 8th may,2016]
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02. Islamic Capital Market (ICM)
2. Overview of the Islamic Capital Market
2.1 Justification of ICM
2.2 Risk & Return
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2. Overview of Islamic capital market
ICM refers to a market where the transactions and other activities are carried out in a
way that comply with Shariah principles. Allah says in the Qur’an, “Then We pun you, [O
Muhammad], on an ordained way (Shariah) concerning the matter [of religion]; so follow
it and do not follow the inclinations of those who do not know.” [Al Qur’an 45:18]. Shariah
has a say on every matter relating to human life. The components of shariah are depicted
below.
In the matters of Ibadah, Shariah gives detailed rulings, However in case of Muamalah (i.e.
transactions) shariah provides general rulings. [4] So, a basic system of Islamic legal
system is that an activity or a commodity that is not prohibited through the shari’ah texts
is permissible. Thus, man has to observe the prohibition only. [5] However, the law is not
end itself, shari’ah has the objectives (Maqasid) behind the law. For example, in the
Qur’an after giving ruling concerning properties abandoned by enemy without a war
effort, Allah states, “..so that it will not be a perpetual distribution among the rich from
among you..” [Al Qur’an 59:7]. So, one of the maqasid in islamic economy is redistribution
4 Dr. Bilal Philips, The Evolution of Fiqh p.34 5 Muhammad Ayub, Understanding Islamic Finance, p.38
P a g e 7 | 39
of wealth and equity or distributive justice, so that wealth is not circulated among the
riches. To maintain this equity and promote justice, all tools of injustice is made haram in
Islamic commercial law depicted below.
Islamic Commercial Law 1
2.1 Justification of ICM
ICM plays the same role as capital market in conventional framework i.e. mobilizing
capital. However, the method and objectives must differ because of two different
worldviews.
2.2 Risk & Return
Business transactions have inherent risk in it that can’t be avoided is acceptable in Islam.
The characteristics of this type of risk is it is unintentional, unavoidable and insignificant.
Two legal maxims worth mentioning here are ‘with profit comes liability’ and ‘no profit
without risk’. However, risk associated with eating others wealth is gambling, business is
not a zero sum game, however, gambling is a zero sum game, one party wins and another
party loses.
General Principles of Islamic
Commercial law
Freedom of contract
Avoid
Ribah Gharar Maysirillicit goods i.e.
pork
Mutual consent
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03. Islamic Equity Market
3. Overview of the Islamic equity market
3.1 Contract form
3.2 Stock screening
3.2.1 Issues in stock screening
3.3 Short Selling
3.3.1 Eligibility of stocks to be a subject matter of a loan
3.3.2 Selling what the seller doesn’t own
3.3.3 Issue of Benefitting from a loan contract
3.4 Speculation
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3. Overview of Islamic equity market
Islamic capital market is the natural outcome of the growing Islamic finance industry. The
very initial entrants in the field of Islamic finance were Islamic savings and investment
companies at small level. Mit Ghimar Bank (1961) in Egypt is earliest example of this.
A very early review and identification of shari’ah compliant stocks was undertaken in
1983 by Bank Malaysia Berhad., which lead to introduction of a centralized process of
such identification of Securities Commission of Malaysia in june 1997. The first equity
Index was first launched in Malaysia by RHB Unit Trust Management Berhad. in May
1996. It was followed by Dow Jones Islamic Market Index (DJIMI) in February 1999, Kuala
Lumpur Shariah Index (KLSI) in April 1999 and Financial Times Stock Exchange Global
Islamic Index (FTSE-GII). The next was DJMI Turkey Index in 2004 and many countries
have introduced shariah index. [6]
Investment in stocks of shari’ah compatible business always deemed fit in Muslim
societies. If a firm conducting halal business, sharing in it through stock is perfectly
legitimate. [7] The main shariah issues pertaining to trade in stocks are given below.
The business of the company whose stock are to be traded
The form of stock/share contract
Shari’ah compatibility of trading practices pertaining to stocks.
3.1 Contract form
The modern corporation is a legal entity, management is separate from ownership. The
shareholders are the real owners of the corporation who provides capital and elect board
of directors. Board of directors select management bodies who operate the business. The
relationship between shareholders can be considered as a partnership or musharaka
contract and the relationship between board of directors and management or
shareholders can be seen as wakala [8] or ijarah [9] contract.
However, the issue is about limited liability. Islamic norms is that the debtor will be liable
to the creditor for his debt and have to pay the full amount. OIC Fiqh Academy has
6 Salman Syed Ali, Islamic Capital Market Products: Developments and Challenges, p. 18 7 Salman Syed Ali, Islamic Capital Market Products: Developments and Challenges, p. 15 8 Agency contract 9 Lease contract
P a g e 10 | 39
approved investing in stock whose business is licit and accepted the two terms limited
liability and legal entity provided that the parties dealing with these companies limited
capacity to liability and presumably consent to it.
3.2 Stock Screening
Islamic prohibition to maintain justice and equity and prohibition against illicit activities
demand stock screening to find out the shar’ah compliant stocks. The business of the
company mustn‘t be involved in Ribah, Gharar, Maysir and illicit goods and services. The
majority of the assets should be in illiquid form for trading in secondary market because
of restrictions of trading in debt and money. The illicit income should be below the certain
level. There is no international single standards on screening process. The conditions
listed by Usmani (1999) may be guiding principles listed below.
1. The main business of the company doesn’t break the shari’ah rules.
2. If the main business of the company is licit, like automobiles, textile, etc. but they
deposit their surplus amounts in an interest-bearing account or borrow money on
interest, the shareholder must express his disapproval against such dealings,
preferably by raising his voice against such activities in the annual general meeting of
the company.
3. If some income from interest-bearing accounts is included in the income of the
company, the proportion of such income in the dividend paid to the shareholder must
be given in charity.
4. The shares of a company are freely negotiable only if the company owns some illiquid
assets.
These are the general criteria, each stock exchange have adopted different criteria for
sharia screening. Some stock exchange adopts both income statement and balance sheet
screening but stock exchange in Malaysia only adopts income statement screening. The
screening process can be divided into two steps.
1. The core screening: Here a stock is declared permissible when the issuing
company produces output that are free from elements prohibited by Shari’ah.
2. The financial screening: Computation of a set of financial ratios & compare them
against specified benchmarks.
P a g e 11 | 39
The comparisons of various stock selection criteria are given below. The first table
compares core screening and second table compares financial screening.10
Core Screening 1
Financial Screening 1
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Once shari’ah compliant securities may be declared non sharia compliant because of
leverage ratio or other ratio. The exchanges declare the lists of shari’ah compliant stocks
from time to time. If the stock is declared non shari’ah compliant which was shari’ah
compliant before, the fund managers and stock holders should immediately liquidate the
stock if the price is greater than investment price and wait until price increasing if the
price is below investment price. However, if the shareholder keep the share and sell it
later date the price increase between announcement date and selling date must channel
to charity. The fund managers must separate the non-permissible income portion from
the portfolio income and channel them to charity before distributing dividend, this is
called income purification.
3.2.1 Issues in screening process
Two issues are concerned in screening process. First is that some non-permissible
activity is tolerated i.e. interest income up to 5% to promote screening process, however,
this should be seen as a transitory process. Second is that there is no international
standard or criteria. Shari’ah compliant today doesn’t necessarily imply presence of good
business ethics. This criteria should be added to screening process.
3.3 Short selling [11]
One of the most popular and commonly used financial instruments in conventional
capital market is short selling. Many finance literature assert that short-selling provides
liquidity, drives down overpriced stocks and generally increases efficiency of the
markets, facilitates hedging. The demerits are that the possible loss from short selling is
theoretically infinite and the unrestrained short selling pressure could lead to collapse in
the share prices. Besides the debate of the merit and demerits of short selling, shari’ah
compliancy criteria is also included in Islamic finance. The issues concerning short selling
can be divided in three.
1. Eligibility of stocks to be a subject matter of a loan contract
2. Bai al-mad’um (selling what the seller doesn’t own)
10 Salman Syed Ali, Islamic Capital Market Products: Developments and Challenges, p. 18-22 11 Short selling is the sale of a security that is not owned by the seller, or that the seller has borrowed. Short selling is motivated by the belief that a security's price will decline, enabling it to be bought back at a lower price to make a profit.
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3. Issue of Benefitting from a loan contract [12]
3.3.1 Eligibility of stocks to be a subject matter of a loan contract
With the exception of Hanafi jurists, most jurists (the Malikis, Shafi`is and Hanbalis) ruled
that loans are permissible for all goods eligible for forward sale (salam). This includes
fungible goods (mithli) and non-fungible goods (qimi). This view is supported by the
below hadith.
"It was narrated by Rafi` that the Prophet (pbuh) borrowed a young camel, and then received
a charity of camels and ordered Rafi` to repay the man another young camel, Rafi` said that
the closest he could find was a six year old camel (which is more valuable). Then the Prophet
(pbuh) ordered him to give it to the man, and added “the best among you is the one who is
the best in repaying his debts” [13]
The Hanafies, on the other hand, argue that homogeneous (mithli) properties are the only
proper object for the loan contract. They argue that a loan contract cannot validly be
concluded with regard to non-homogeneous (qimi) properties at it is almost impossible
to find an equivalent good to repay the loan. [14]
Based on the above, according to all jurists including the Hanfis, since stocks satisfy the
homogeneous (mithli) properties, they are qualified to become the subject matter of a
loan contract.
3.3.2 Bai al-mad’um (selling what the seller doesn’t own)
According to Imam ibn Taymiyya [15] and his student ibn Qayyum16, what was narrated in
the Hadith is the prohibition of sales with excessive risk and uncertainty (gharar), where
the object may be undeliverable, whether it exists or not (e.g. a runaway horse or camel).
They assert that the emphasis of the Hadith is on the seller’s inability to deliver, which
entails excessive risk and uncertainty.
12 Dusuki and Abozaid , Fiqh Issues in Short Selling as Implemented in the Islamic Capital Market in Malaysia, p. 65 13 Sahih Muslim, Abu Dawud, Tirmidhi, Nasa’I, Ibn Majah. 14 Dusuki and Abozaid , Fiqh Issues in Short Selling as Implemented in the Islamic Capital Market in Malaysia, p. 15 Ibn Taymiyya was a prominent scholar, died in 1328 CE. 16 Ibn Qayyum was the student of Ibn Taymiyya, died in 1350 CE.
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In general, selling what the seller does not own at the time of sale in a non-salam contract
is valid only according to Ibn Taymiyah and Ibn Qayyim, while it is invalid according to
the majority of jurists. The majority scholars of Islamic jurisprudence assert the rationale
(`illah) of prohibiting sale prior taking possession (qabd) was mainly due to the presence
of gharar (excessive risk and uncertainty), which may lead to dispute amongst the
transacting parties. This was because of the concern that the goods might not be delivered
due to damage or other factors. Thus Islam prohibits any transactions involving bay`
ma`dum since the delivery of the subject matter cannot be effected and this brings about
the prohibited element of gharar.17
According to Shariah Advisory Council of Malaysia’s view, the issue of gharar can be
overcome and hence eliminated in Regulated Short Selling (RSS) with the inclusion of
Securities Borrowing and Lending (SBL) principles. In other words, the introduction of
SBL can increase the probability that the shares sold will be delivered. When the
probability of delivery is high, then the element of gharar will no longer be significant.
Consequently, when an obstacle that hinders the recognition of a certain activity as
Shari`ah compliant is overcome, then that transaction or activity can be classified as
Shari`ah compliant. [18]
3.3.3 Issues of benefitting from a loan contract
In short selling, the lender gets certain percentage of return as a profit from lending. For
example: in Malaysia, this is 2%. However, this is clearly ribah, any stipulated excess from
the loan constitute ribah.
Finally, there is a debate about whether short selling is permitted or not. Opponents
argues based on the literal meaning of the hadith, ‘don’t sell what you do not possess’.
17 Dusuki and Abozaid , Fiqh Issues in Short Selling as Implemented in the Islamic Capital Market in Malaysia, p. 72 18 Their arguments are based on a well-known fiqh maxim: “When an issue that impedes (the permissibility) is removed, then the activity which was initially forbidden becomes permissible”.
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3.4 Speculation
Much of the issues about short selling is about speculation. Some of the arguments about
speculation is given below.
The proponent’s argument are-
Speculation reduces price fluctuations
Speculation activates the market as it encourages the circulation of large amounts
of stocks or goods, increases liquidity.
The speculator seeks to obtain a personal profit and there is nothing wrong with
that.
The opponent’s argument are-
Speculation aggravates price fluctuations as it originally relies on such
fluctuations and it finds no room if the prices stayed stable
The brokers and the well-informed speculators are the ones who benefit from the
intense heat produced by speculation
Speculation does not differ from gambling but rather it is one of its modern forms
(it does not encourage production…)
More losers than gainers (the experienced ones)
Speculation is zero sum game.
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04. Sukuk Market
4. Overview of the Sukuk Market
4.1 Types of Sukuk
4.2 Innovative Sukuk
4.2.1 Commodity Linked Sukuk (SLS) Model
4.2.2 GDP Linked Sukuk (GLS) Model
4.3 Sukuk Al- Istithmar vs Conventional Instruments
4.4 Secondary Market of Sukuk (Tradability)
4.5 Global Sukuk Market - A Snapshot
4.6 A Case Study- ADIB example
4.7 Shari’ah Concerns in Sukuk
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4. Overview of the Sukuk Market
The early Muslims have used the word Assakk, which means certificate or order of
payment. And the plural of this ‘Arabic term is Sukuk. They used Sukuk in those early days
as a form of papers representing financial obligations originating from trade or any other
commercial activities. However, in the modern day Islamic financial system, Sukuk are
known as instruments of the Islamic capital Market and it is one of the best financial
instruments and mechanisms that are commensurate with the needs of
issuers/originators and investors. [19]
According to AAOIFI “Investment Sukuk (Sukuk al Istithmar) are certificates of equal
value representing undivided shares in ownership of tangible assets, usufructs and
services or (in the ownership of) the assets of particular projects or special investment
activity”. [20]
4.1 Types of Sukuk
AAOIFI identified fourteen types of sukuk. Each of these sukuk is formed according to
known Islamic transaction contracts such as wakala, mudarabah, ijarah etc. Some of them
are described here.
4.1.1 Mudarabah Sukuk
These are certificates that represent project or activities managed on the basis of
Mudarabah by appointing one of the partners or another person as the mudarib for the
management of the operation.
4.1.2 Musharakah Sukuk
These are certificates representing projects or activities managed on the basis of
Musharaka by appointing one of the partners or another person to manage the operation.
4.1.3 Wakalah Sukuk
These are certificates that represent projects or activities managed on the basis of an
investment agency by appointing an agent to manage the operation on behalf of the
certificate holders.
19 IIFM Sukuk Report (3rd edition) : A Comprehensive Study of the Global Sukuk Market, p. 3 20 IIFM Sukuk Report (3rd edition) : A Comprehensive Study of the Global Sukuk Market, p. 4
P a g e 18 | 39
4.1.4 Muzara’a (Sharecropping) Sukuk
These are certificates of equal value issued for the purpose of using the funds mobilised
through subscription for financing a project on the basis of Muzara’a so that the certificate
holders become entitled to a share in the crop according to the terms of the agreement.
4.1.5 Musaqa (irrigation) Sukuk
These are certificates of equal value issued for the purpose of employing the funds
mobilized through subscription for the irrigation of fruit bearing trees, spending on them
and caring for them on the basis of a Musaqa contract so that the certificate holders
become entitled to a share in the crop as per agreement.
4.1.6 Mugharasha (Agricultural) Sukuk
These are certificates of equal value issued on the basis of a Mugharasa contract for the
purpose of employing the funds for planting trees and undertaking the work and
expenses required by such plantation so that the certificate holders become entitled to a
share in the land and the plantation.
4.1.7 Ijarah Sukuk
These are certificates of equal value issued either by the owner of a leased asset or a
tangible asset to be leased by promise, or they are issued by a financial intermediary
acting on behalf of the owner with the aim of selling the asset and recovering its value
through subscription so that the holders of the certificates become owners of the assets.
4.1.8 Istisna Sukuk
These are certificates of equal value issued with the aim of mobilizing funds to be
employed for the production of goods so that the goods produced come to be owned by
the certificate holders.
4.1.9 Murabaha Sukuk
These are certificates that represent equal value issued for the purpose of financing the
purchase of Murabahah commodity and therefore, the certificate holders become the
owners of the purchased commodity.
In this transaction, the issuer of these certificates is the seller of the Murabahah
commodity, the subscribers are the buyers of that commodity and mobilized funds are
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the purchasing cost of the commodity. The certificate holders own the Murabahah
commodity and are entitled to its sale price.
4.1.10 Salam Sukuk
These are certificates of equal value issued for the aim of mobilizing Salam capital so that
the goods to be delivered on the basis of Salam contract are owned by the certificate
holders.
In this transaction the issuer of these certificates is the seller of the Salam goods, the
subscribers are the buyers of the goods and the mobilized funds are the purchase price
of the commodity, which is the Salam capital. Thus, the certificate holders are the owners
of Salam goods and they are also entitled to the sale price of the certificate or the sale
price of the Salam goods sold through a parallel Salam, if any.
Types of Sukuk 1
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4.2 Innovative Sukuk
In this section, some innovative sukuk models are provided that solve the present
shari’ah problem of the sukuk practice around the world.
4.2.1 GDP-Linked Sukuk (GLS) Model
This model is based on forward ijarah where return is linked to the GDP of the issuing
country. It is a model for sovereign [21] sukuk where actual economic indicator is used to
calculate return on non-income generating government assets or projects. Here, Return
is linked to GDP that measures the actual performance of a economy, so it matches the
payment obligation to payment ability. The investors share the economic performance
risk of the issuers. The return is calculated through below formula.
𝑅𝑒𝑡𝑢𝑟𝑛 = 𝑥𝑘% = 𝐼𝑘 × 𝑋0%
𝐼𝑘 = 𝐺𝑘
𝐺0
Xk = The rate of return at kth year, after issuance
Gk = is the growth rate of GDP at year k
G0 = is the growth rate of GDP agreed upon by contracting parties.
4.2.2 Commodity Linked Sukuk (CLS) Model
This model is also based on forward ijarah. Government can raise funds for non-income
generating projects where return is linked to price index of a basket of issuing countries
export commodities. The model also matches the payment obligation to payment ability.
The investors share the risk arising from the volatility of the commodity market. This
model constitute a hedging components.
𝑅𝑒𝑡𝑢𝑟𝑛 = 𝑥𝑘% = 𝐼𝑘 × 𝑋0%
𝐼𝑘 = 𝑃𝑘
𝑃0
21 Sovereign sukuk are Sukuk issued by a national government. The term usually refers to Sukuk issued in foreign currencies, while Sukuk issued by national governments in the country’s own currency are referred to as government Sukuk.
P a g e 21 | 39
Ik = Basket Price Index
Pk = The price of the commodity in the basket, in the year k
xk% = Annual Profit Rate in the Year k
4.3 Sukuk Al- Istithmar vs Conventional Instruments
Sukuk Al-Istithmar is characterized with many features that distinguish them from the
non Shari ‘ah complaint bonds. These features include:
(a) Sukuk Al-Istithmar are certificates of equal value issued in the name of investor
therefore, a legitimate claim of its owner/investor over the financial rights and
obligations represented by the certificate can be established.
(b) It represents a common share in the ownership of the tangible assets earmarked for
investment, usufructs, services etc. and hence, it does not represent debt as in the case of
non Shari ‘ah compliant bonds.
(c) It is issued on the basis of known and acceptable Shari ‘ah investment contracts and
in accordance with Shari ‘ah principles which governing its issuance as well as its trading.
(d) Investors in Sukuk Al-Istithmar share the profit according to the agreement set forth
in the prospectus and also bear the losses if any, based on the percentage/proportion
owned by each investor.
The fundamental difference between bonds and sukuk is that while bonds are fixed-
income securities, sukuk Al-Istithmar are not fixed – income securities, because they do
not represent debts between the issuer and the investors. Rather, the investors share
Sukuk returns and proceeds according to percentages stated in the prospectus, and bear
losses in proportion to the number of the Sukuk certificates held by them.
Sukuk have very similarity with conventional securitization process. However, the
Shariah compliance condition for the transaction requires the presence of Shariah
advisory board in the process. Furthermore, the prohibitive stance of the majority of
Muslim scholars towards the sale of debt makes it inoperative to securitize a pool of asset
composed of a majority of receivables.
P a g e 22 | 39
4.4 Secondary Market of Sukuk (Tradability)
Some sukuk can be traded where some can not. The deciding factor here what the sukuk
represents. If sukuk represent the ownership in the underlying assets, it can be traded.
However, if it represent the debt obligations, it can not be traded as debt can not be traded
without the face value what is called Hawala. [22] The tradability of various sukuk is given
below.
Tradability of Sukuk 1
4.5 Global Sukuk Market – A Snapshot
Sukuk market is in an expansionary phase. New market have been emerging from
different side of the world. The deeper market was created in Malaysia and Bahrain, the
hub of Islamic finance. The other GCC23 countries and new countries from Europe and
22 Hawalah means transferring debt obligation by making another responsible for it. 23 Gulf Cooperation Council (GCC), political and economic alliance of six Middle Eastern countries—Saudi Arabia, Kuwait, the United Arab Emirates, Qatar, Bahrain, and Oman.
P a g e 23 | 39
Africa have issued sukuk. The entry from Turky in global sukuk market is also appealing.
The global sukuk market have crossed USD 100 billion milestone. [24]
Source-IIFM Sukuk Report (4th Edition) 1
4.5.1 Distribution of Sukuk Issuance by Issuer States
The financial crisis of 2008 had some negative impact in sukuk market. Though before
2008, corporate issuances comprised larger part of global sukuk issuance, after 2008
sovereign and quasi-sovereign [25] comprised the larger part of global sukuk issuances.
After 2013, the corporate [26] issuances are increasing and sukuk market is emerging as a
new sector in Islamic capital market and in Islamic financial system.
24 IIFM Sukuk Report (4th edition), p.4 25 Quasi sovereign sukuk are Sukuk issued by a public sector entity that is like sovereign Sukuk. It may carry explicit or implicit government guarantee. 26 Corporate sukuk is a Sukuk issued by a corporation as opposed to those issued by the government. It is a major way for companies to raise funds in order to expand its business or for a specific project.
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013GrandTotal
Series 1 1172 1371 7057 9465 13698 33837 50041 24264 37904 52978 92403 137499 138170 599861
0
100000
200000
300000
400000
500000
600000
700000
Total Global Sukuk Issuance (2001-2013)
Series 1
P a g e 24 | 39
Source: IIFM Sukuk Report (4th Edition) 1
15%
12%
73%
International Sukuk Issuance (2001-2008)
Sovereign Quasi Sovereign Corporate
33%
26%
41%
International Sukuk Issuance (2009-July 2014
Sovereign Quasi-Sovereign Corporate
P a g e 25 | 39
4.5.2 Distribution of Sukuk Issuances by Structure
Sukuk Al Ijarah is the most popular and widely used structure for International Sukuk
issuances while at domestic level Sukuk Al Murabahah continues to be the most used
30%
1%
69%
Domestic Sukuk Issuance (2001-2008)
Sovereign Quasi-Sovereign Corporate
71%
7%
22%
Domestic Sukuk Issuance (2009-July 2014)
Sovereign Quasi-Sovereign Corporate
P a g e 26 | 39
structure both in terms of value and volume and the reason for this is due to issuance by
certain larger market share countries. Sukuk Al-Wakala is becoming popular in
international sukuk issuances day by day though it was not popular in time 2001-2008.
In the case of domestic issuances, Sukuk Al-Musharaka was popular in the past phase
(2001-2008), but later Murabaha Sukuk became very popular in domestic market.
International Sukuk Issuance (2001-July 2014)
Salam Sukuk
Musharaka Sukuk
Murabaha Sukuk
Wakalah Sukuk
Ijaraha Sukuk
Bai Bithaman Ajil
Hybrid Sukuk
Islamic Exchangeable Sukuk
Mudarabah Sukuk
Istisna Sukuk
Domestic Sukuk Issuance (2001-July 2014)
Salam Sukuk
Musharaka Sukuk
Murabaha Sukuk
Wakalah Sukuk
Ijaraha Sukuk
Bai Bithaman Ajil
Hybrid Sukuk
Islamic Exchangeable Sukuk
Mudarabah Sukuk
Istisna Sukuk
P a g e 27 | 39
4.5.3 Distribution of Sukuk Issuances by Region
Asia is dominant in issuing sukuk because of the deeper market in Malaysia and
Indonesia. GCC countries specially Bahrain, Saudi Arabia, Qatar is becoming active. Turky
is the new country in issuing sukuk.
4.6 A Case Study – Abu Dhabi Islamic Bank (ADIB) Example
4.6.1 Abstract
This case study intends to highlight on the successful issuance of the Shirkat-ul-Milk
structure based Sukuk worth US $ 500 million issued in November 2011 by Abu Dhabi
Islamic Bank (ADIB) a top tier Islamic financial services group in the United Arab
Emirates (UAE). The issuance of this Sukuk has been a successful step towards
diversifying and lengthening funding sources for Islamic financial institution.
Sukuk Summary
SPV ADIB Sukuk Company Ltd.
Structure type Al Ijara
Issue size USD 500,000,000
22%
2%3%
73%
Global Sukuk Issuances-Regional Break-up (2001-July2014)
GCC & Middle East Europe & Others Africa Asia & Far East
P a g e 28 | 39
Issue Date 30-Nov-11
Maturity date 11/30/16
Return 3.78%
Fix or Variable Fixed
Return frequency Semi Annual
Pricing =Spread (over mid-swaps) 245bp
Book Runners HSBC, Citigroup, NBAD, Standard
Chartered Bank, Nomura Securities
Listing London S.E.
ISIN RegS XS0711035286
4.6.2 ADIB Sukuk Explanation
ADIB Sukuk Diagram
P a g e 29 | 39
1. On the Issue Date, the certificate holders will pay the issue price to ADIB Sukuk
Company (as Issuer/Trustee).
2. The proceeds will be used by ADIB Sukuk Company to purchase a co-ownership
interest in a portfolio of Ijarah assets from ADIB (as Seller) under a Purchase Agreement.
3. ADIB (as Managing Agent) agrees to maintain the co-owned Ijarah assets through a
Management Agreement.
4. ADIB will pay to the Issuer an amount representing its share of profit in respect of the
co-ownership as sets on each Periodic Distribution Date. If the profit returns are
insufficient to fund the periodic distribution payment, ADIB will make up for the shortfall
by providing Shari‘ah compliant funding to ADIB Sukuk Company. However, if profit
returns are more than the amount needed to pay the relevant periodic distribution, the
excess will be paid to ADIB as an incentive fee.
5. The Issuer will sell its co-ownership interest in the co-ownership assets to ADIB (as
Purchaser) on the Maturity Date, pursuant to a Purchase Undertaking.
6. The Exercise Price paid by ADIB is intended to fund the dissolution amount payable by
the Issuer under the Trust Certificates.
4.7 Sharia’h Concerns in Sukuk
The sukuk issuances so far raises some shari’ah concerns that need to be addressed and
solved. The guarantee in annual payment to investors make sukuk almost like
conventional debt. It is difficult to find some neutral third party who guarantee the
payment to the investors. Another issue is about purchasing the sukuk at face value or
pre-agreed price that is almost like Bai-al inah. The combination of different contracts to
make a sukuk issuance is also cumbersome and sometimes the investor doesn’t
understand the mechanisms. Scholars should look on this topic to solve the problem and
make a shari’ah complient sukuk market.
P a g e 30 | 39
05. Derivative Market
5. Overview of the Derivatives Instruments
5.1 Forward & Futures
5.2 Options
5.3 SWAP
5.4 Islamic Derivative Instruments
5.4.1 Bai Salam
5.4.2 Bai al-Arbun
P a g e 31 | 39
5. Overview of the Derivative Instruments
Most popular derivative instruments are forward, futures, options and recently swap
contracts. These instruments have different versions also. These are called derivatives
because they derive their value from underlying assets. Derivative instruments are used
for hedging [27] against price risk, exchange risk, interest rate risk etc, for arbitraging [28]
and for speculating [29]. In this section we will appraise all these instruments from Islamic
perspectives with the probable Islamic alternatives like salam and arbun contracts.
5.1 Forward & Futures
A Forward contract is a customized arrangement between two parties to carry out a
transaction at a future date but at a price determined today. Forward contracts have some
limitations like multiple coincidence of needs, potential for price squeeze, counterparty
or default risk etc. that leads to the emergence of futures that solved the problem. Future
contract are organized and exchange traded forward contracts.
5.1.1 Islamic appraisal
Forwards and futures are rejected by many shari’ah scholars including Mufti Taqi Usmani
on the basis of gharar, maysir etc. The reasons are given below.
The issue of non-existence of the subject matter (bay' al ma'dum) at the time of the
conclusion of the contract.
The issue of selling debt for debt which means both the price and goods are deferred.
Imam Ahmad Ibn Hanbal reported a consensus on its prohibition.
Derivatives markets are mostly used for speculative transaction, so it is a zero sum
game.
The underlying assets may not be halal.
However some scholars like Hashim Kamali accepts forwards and futures with the
assumptions that underlying assets are halal. There arguments are given below.
The essential element of a sale is delivery of the thing sold, and if the seller is unable
to deliver, this becomes garar.
27 Hedgers are the players whose objective is risk reduction by taking long or short position. 28 Arbitraging are the players whose objective is to profit from pricing differentials/mispricing. 29 Speculators are the players who establish positions based on their expectations of future price movements.
P a g e 32 | 39
The hadith reporting selling debt for debt is weak according to some jurists.
Futures and forwards are halal if underlying assets are halal based on maslahah
(public welfare) and darurah (needs).
5.2 Options
Options give the holders the right to buy and sell the assets at exercise price in future
date. However, options doesn’t create obligation, it give options to exercise.
5.2.1 Islamic Appraisal
When viewed solely as a promise to buy or sell an asset at a predetermined price within
a stipulated period, shari’ah scholars find nothing objectionable with options. It is in the
trading of these promises and the charging of premiums that objections are raised. And
based on this two issues, some scholars disapproved options. Conventional options have
some similarities with two concepts in the Islamic commercial law, namely: al-Khiyar[30]
and al-urbun.
5.3 SWAP
Swaps are customized bilateral transactions in which the parties agree to exchange cash
flows at fixed periodic intervals, based on an underlying asset.
5.3.1 Islamic Appraisal
It is one of the principles of the Shariah that two financial transactions cannot be tied
together in the sense that entering into one transaction is made a precondition to
entering into the second. In interest rate swap, one party pays the difference to another
for nothing.
In foreign exchange swap, parties involved want to change currency in future with rate
that is fixed by today and contract sealed today. This doesn’t fulfill the sale of Currency
(bay` al sarf) condition, that is, it should be exchanged by using spot rate.
30 The concept of al-khiyar arises in exchange contracts. These options may provide the contracting parties a right, either to confirm or to cancel the contract within a stipulated time period [e.g. option as a condition or stipulation (khiyar al-shart); option for defect (khiyar alayb); option of determination or choice (khiyar altayeen); option of inspection (khiyar al-ruyat); and option of acceptance (khiyar al-majlis)].
P a g e 33 | 39
5.4 Islamic Alternatives
Two contracts in Islamic finance have derivatives features. These are bai al salam and
bai al arbun. These two are described below.
5.4.1 Bai al Salam
Bai al Salam is a contract where one party (buyer) pays in advance where the
commodity is deferred to a future date. Bai salam is almost like conventional forward
contract, the big difference between the two is that in bai salam price is paid in advance,
commodity is deferred, where in forward both are deferred. Bai salam have also default
risk, the seller may not provide the commodity in time. The buyer can take security to
minimize the risk.
5.4.2 Bai al Arbun
Bai al-’urbun refers to a sale in which the buyer deposits earnest money with the seller
as part of part payment of the price in advance, but agrees that if he fails to ratify the
contract, he will forfeit the deposit money, which the seller can keep. While the three
schools of law (Hanafi, Maliki, and Shafii), consider al-urbun as an invalid contract, the
Hanbali school held that it is a legal contract.
P a g e 34 | 39
06. Islamic Finance in Bangladesh
Problems & Prospects
P a g e 35 | 39
6. Problems & Prospects of Islamic Finance in Bangladesh
6.1 Problems of Islamic Finance
6.1.1 Absence of Islamic Money Market
In the absence of Islamic money market in Bangladesh, the Islamic banks cannot invest
their surplus fund i.e., temporary excess liquidity to earn any income rather than keeping
it idle. Because all the Government Treasury Bills, approved securities and Bangladesh
Bank Bills in Bangladesh are interest bearing. Naturally, the Islamic banks cannot invest
the permissible part of their Security Liquidity Reserve and liquid surplus in those
securities. As a result, they deposit their whole reserve in cash with Bangladesh Bank.
Similarly, the liquid surplus also remains uninvested. On the contrary, the conventional
banks of the country do not suffer from this sort of limitations. As such, the profitability
of the Islamic banks in Bangladesh is adversely affected.
6.1.2 Absence of Suitable Long-term Assets
The absence of suitable long term assets available to Islamic banks is mirrored by lack of
short term tradable financial instruments. At present there is no equivalent of an inter-
bank market in Bangladesh where banks could place, say, over-night funds, or where they
could borrow to satisfy temporary liquidity needs. Trading of financial instruments is also
difficult to arrange when rates of return are not known until maturity. Furthermore, it is
not clear whether Islamic banks in Bangladesh can utilize more exotic instruments, such
as derivatives, that are becoming increasingly popular with conventional banks.
Obviously, these factors place Islamic banking in Bangladesh at a distinct disadvantage
compared to its conventional banking counterpart.
6.1.3 Shortage of Supportive and Link Institutions
Any system, however well integrated it may be, cannot thrive exclusively on its built-in
elements. It has to depend on a number of link institutions and so is the case with Islamic
banking. For identifying suitable projects, Islamic banking can profitably draw the
services of economists, lawyers, insurance companies, management consultants, auditors
and so on. They also need research and training forums in order to prompting
entrepreneurship amongst their clients. Such support services properly oriented towards
Islamic banking are yet to be developed in Bangladesh.
P a g e 36 | 39
6.1.4 Organizing Relationship with Foreign Banks
Another important issue facing Islamic banks in Bangladesh is how to organize their
relationships with foreign banks, and more generally, how to conduct international
operations. This is, of course, an issue closely related to the creation of financial
instruments, which would be simultaneously consistent with Islamic principles and
acceptable to interest-based banks, including foreign banks.
6.1.5 Long-term Financing
Islamic Banks stick very closely to the pricing policies of the government. They cannot
benefit from hidden costs and inputs, which elevate the level of prices by certain
entrepreneurs without any justification. On the other hand, Islamic banks as financial
institutions are even more directly affected by the failure of the projects they finance. This
is because the built in security for getting back their funds, together with their profits, is
in the success of the project. Islamically, it is not lawful to obtain security from the partner
against dishonesty or negligence, both of which are very difficult if not impossible to
prove.
6.2 The Future of Islamic Finance in Bangladesh
6.2.1. New banking philosophy for the Islamic Banks
There seems to be a gap between the ideals and actual practice of Islamic banks in
Bangladesh. In their reports, booklets, bulletins and posters their banks express their
commitment to striving for establishing a just society free from exploitation. Study shows
that a little progress has been achieved so far in that direction.
6.2.2. Banking Policies and practices should be modernized
Islamic banks, with a view to facing the growing competition either fellow-Islamic banks
or the conventional banks which have launched Islamic banking practices, will have to
adapt their functioning in line with modern business practices.
6.2.3. Policy and Strategy should be formulated
The first action that deserves immediate attention is the promotion of the image of
Islamic banks as PLS banks. Strategies have to be carefully devised so that the image of
Islamic character and solvency as a bank is simultaneously promoted.
P a g e 37 | 39
6.2.4. Stepping for Distributional Efficiency
The task is more challenging for Islamic banks, as they have to promote their
distributional efficiency from all dimensions together with profitability, Islamic banks,
step by step, have to be converted into profit loss-sharing banks by increasing their
percentage share of investment financing though PLS modes.
6.2.5. Allocating Efficiency should be promoted
The Islamic banks can improve their Allocative efficiency by satisfying social welfare
conditions in the following manner. First, they should allocate a reasonable portion of
their investible funds in social priority sectors such as agriculture (including poultry and
fishery), small and cottage industries and export-led industries like garment, shrimp
cultivation. Secondly, when the percentage shares of allocation of investible funds are
determined among the sectors of investment financing, profitability of projects should be
the criterion for allocating investment funds. The criterion would be best satisfied if more
and more projects were financed under PLS modes.
6.2.6. Government and Central bank's Responsibilities
Government should think actively for the promotion of Islamic banking in Bangladesh
considering its pre-development role. Bangladesh Bank should develop some Islamic
Monetary and saving instruments and create separate window for transactions with the
Islamic banks and a full-fledged Islamic banking Department for analyzing, supervising,
monitoring and guiding purpose, thereby facilitating Islamic banks for their smooth
development in Bangladesh.
6.2.7. Inter-Islamic Bank Co-operation and Perspective Plan
All Islamic banks should come forward to help each other’s and adopt a perspective plan
say for 27 years for Islamization of the banking system of Bangladesh. To actualize this
mission, they should set-up immediately an Apex Research Academy and Training
Institute designed with modern tools.
P a g e 38 | 39
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