Islamic Finance in the Nigerian Capital Market

By

Ogonna Chinedu-Eze

Senior Associate

Udo Udoma & Belo-Osagie

Scope of Scope of PresentationPresentation OVERVIEW OF ISLAMIC

FINANCE

ISLAMIC FINANCE IN THE NIGERIAN CAPITAL MARKET

ISLAMIC FUND MANAGEMENT

SUKUK

CONCLUSION

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Methodology - a descriptive approach

Islamic Finance – What is it all Islamic Finance – What is it all about?about?

Islamic finance involves the transaction of banking business, engagement in trading, investment and commercial activities as

well as the provision of financial products and services “in accordance with Shariah principles and rules of Islamic

commercial jurisprudence”.

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Fundamental Principles

Prohibition of Riba (Interest)

Riba literally means increase or addition i.e. usury or rent on money in all form and intent.

Money is not a commodity, just a medium of exchange .

Principle of Profit and Loss Sharing

Difference between Islamic Difference between Islamic Finance and Conventional Finance and Conventional FinanceFinance

The basic underlining difference between Islamic finance and conventional interest based financing is in the understanding and treatment of money. While the conventional interest-based finance holds that money has intrinsic value of its own and as such can generate return without recourse to asset creation, Islamic finance recognises no intrinsic utility for money except where such is used in the creation of assets.

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Other Essence of Islamic FinanceOther Essence of Islamic Finance

Prohibition of involvement in “haram” or non-permissible transactions or economic activities such as alcohol, non-halal food, pork production, gaming/number forecasting, prostitution

Prevention of excessive leveraging

Strong direct linkages to productive economic activities

Avoidance of maisir i.e. speculation or gambling

Avoidance of gharar i.e. preventable uncertainty or ambiguity in transactions

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Other Essence of Islamic Finance Other Essence of Islamic Finance (contd.)(contd.)

Deterrence of zulm i.e. oppression and exploitation

Introduction of safety net mechanisms for the benefit of the poor and the less privileged through zakat (tithe or Islamic tax, sadaqah (alms), waqaf (trust) and qard hassan (benelovent loan)

Upholding universal social, moral and ethical values with emphasis on maslahah (public interest)

Achieving adalah i.e. justice and musawah i.e. fairness in the distribution of resources

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Applicable Shariah Contracts and Applicable Shariah Contracts and Financial ProductsFinancial Products

Leased based contracts Ijara - leasing

Equity based or profit sharing contracts Mudarabah- profit sharing and loss bearing Musharakah – profit and loss sharing

Sale based contracts Murabahah – cost plus

Contracts to manufacture or produce  Istisna – manufacturing agreement

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Applicable Shariah Contracts Applicable Shariah Contracts and Financial Products (contd.)and Financial Products (contd.)

Benevolent contracts Qard Hassan – interest free loan

 

Service based contracts Wadiah – safe custody

Wakalah – agency

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Regulatory ApproachRegulatory ApproachSingle Regulatory SystemDual Regulatory SystemUnified Regulatory System

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The regulatory approach of the SEC to Islamic finance is proactive and prescriptive in nature such

that an Islamic product is required not only to comply with the applicable SEC Rules, but also with Shari’ah

law.

Regulatory Requirements for Regulatory Requirements for Islamic Fund Management under Islamic Fund Management under the SEC Rulesthe SEC RulesTrust deed of every Islamic fund to state

that the Islamic fund aims to operate in accordance with Shari’ah principles.

Fund manager offering Shari’ah compliant portfolio management to ensure that its investment activities are limited to Shari’ah-compliant investments and products.

Appointment of Shari’ah adviser.

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Regulatory Requirements Regulatory Requirements (contd.)(contd.)Fund must have adequate employees

with necessary qualifications, expertise and experience.

Provide adequate and sufficient training for employees and representatives.

Ensure Shari’ah adviser is well versed on Islamic fund management and capital markets.

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Regulatory Requirements Regulatory Requirements (contd.)(contd.)Investment committee shall include at least

one person knowledgeable in Islamic finance.

Investment in trade securities should comply with AAOIFI and OIC Fiqh Academy.

Segregation of Islamic assets and accounts from the other accounts of the fund manager.

Internal audit to monitor Shari’ah compliance.

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DisclosuresDisclosuresDetails of Shari’ah advisers to the SEC.

Annual written disclosure by the fund manager to its board and the trustee that it is in compliance with the Shari’ah principles.

Certificate of compliance by the Shari’ah advisory board to the directors of the fund manger and the trustee of the fund.

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Challenges of Islamic Challenges of Islamic Finance in NigeriaFinance in Nigeria

Dart of instruments for liquidity management

Double taxationConsent and registration issues

in Land TransactionsReliefs on Shari’ah compliant

financing debt instruments Availability of knowledgeable

employees and Shari’ah adviser

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What is a Sukuk?What is a Sukuk?

Rule 569 of the SEC Rules, defines “sukuk” as:

“ investment certificates or notes of equal value which evidences undivided interest/ownership of tangible assets, usufructs and services or investments in the assets of particular projects or special investment activity using Shariah principles and concepts approved by the SEC”.

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•Similar to your typical collective investment schemes•Requires credit rating

Benefits of Sukuk InvestmentBenefits of Sukuk Investment

 The sukuk is usually referred to as Islamic bond and has been used by several sovereign bodies in place of the conventional debt issuance programme.

It is a veritable tool for liquidity management by sovereigns and financial institutions and has been structured in certain jurisdictions to take the place of treasury bills and other money market instruments.

Sukuk generally have better risk profile.

Sukuk are tradable and fill the existing need for Shari’ah compliant tradable instruments.

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Ijarah Sukuk StructureIjarah Sukuk Structure

 SPV/Issuer issues sukuk to raise funds from investors. SPV purchases the asset from supplier/manufacturer. SPV leases the asset to company (obligor). The obligor gives a purchase undertaking to ensure

redemption of sukuk. obligor makes periodic rental payments for the use of the

asset. SPV distributes rental payments to investors. This is

equivalent to coupon payments under conventional bonds. Upon maturity, purchase undertaking is exercised and

asset is transferred to company.  At maturity, or on a dissolution event, the SPV sells the

assets to the SPV at a predetermined value. That value should be equal to any amounts still owed under the terms of the Ijarah Sukuk which in the equivalent of conventional bonds is your redemption price.

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Ijarah SukukIjarah Sukuk

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Musharakah SukukMusharakah Sukuk SPV/Issuer issues sukuk to raise funds from investors. SPV enters into a partnership (musharakah) with obligor. Equity is contributed in pre-agreed ratio. The monies is used to purchase asset which will be jointly

owned by the SPV and the obligor. Obligor will rent the asset and make periodic payments for

the use of the assets. SPV distributes rental payments to investors. This is

equivalent to coupon payments under conventional bonds.  At maturity, or on a dissolution event, the SPV sells its

share of the jointly owned asset to the SPV at a predetermined value.

Alternatively obligor can make instalmental payments to purchase shares of the jointly owned assets – diminishing musharakah.

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Musharakah SukukMusharakah Sukuk

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Mudarabah SukukMudarabah Sukuk Investors (rab al-mal) will enter into

a mudharabah arrangement with the issuer (mudharib) to invest in a business venture which is Shari’ah-compliant.

Profit sharing ratio will be agreed upfront. Typically in a mudharabah sukuk, the Issuer will make a

Trust Declaration over Trust Assets for the benefit of the sukuk-holders who are participating in the business venture. The subscription of the mudharabah sukuk represents the investors’ undivided beneficial interest in the Trust Assets pursuant to their participation in the relevant venture.

The Issuer will also grant a purchase undertaking to the Trustee whereby the Issuer will acquire the sukuk upon maturity or dissolution event.

Income from the mudharabah venture will be distributed periodically as agreed.

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Mudarabah SukukMudarabah Sukuk

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Istisna SukukIstisna Sukuk Issuer or SPV issues sukuk to raise funds

from investors.SPV uses the sukuk proceeds to pay the

contractor under the istisna’ contract to build and deliver the project.

SPV sells the asset to the end user under another istisna’ contract.

End user makes periodic payment.SPV distributes payments to investors.Upon completion, the asset is delivered to

end user.

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Istisna SukukIstisna Sukuk

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ConclusionConclusion

Islamic finance though an emerging area of finance especially in Nigeria is one that cannot easily be ignored.

The sukuk can easily pass for one of the most innovative creation of Islamic finance which has bridged the gap and filled a lot of vacuum that may have existed in Islamic finance generally.

As capital market solicitors, it is essential that we are abreast with Islamic finance products and regulations generally so that we can bring added value in ensuring not only financial but Shari’ah compliance of these products .

That way, the Nigerian capital market will continue to grow.

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It has been a pleasure…

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