Shariah Compliant Funds Rising and Shariah Compliant Funds Rising and Shariah Compliant Securitization Shariah Compliant Securitization

April 24, 2012April 24, 2012Alhuda-CIBE TrainingsAlhuda-CIBE TrainingsAvari Towers, Karachi Avari Towers, Karachi

Abdul SamadAbdul Samad

Shariah AdvisorShariah Advisor

The Bank of KhyberThe Bank of Khyber

Rulings In IslamRulings In Islam

These 5 primary objectives follow by These 5 primary objectives follow by Shariah Shariah can be observed though the can be observed though the Al Al

Ahkam Ahkam (rulings) upon which (rulings) upon which Fiqh Fiqh (Islamic (Islamic Jurisprudence) rotate around. The rulings Jurisprudence) rotate around. The rulings

are categorized as follows: are categorized as follows: a. Wajib (obligatory)a. Wajib (obligatory) e. Haram (unlawful)e. Haram (unlawful)

b. Mustahab (recommended) (Sunnat) b. Mustahab (recommended) (Sunnat) c. Mubah (permissible) c. Mubah (permissible)

d. Makruh (disliked)d. Makruh (disliked)

Islam and ShariahIslam and Shariah

Islam

Aqidah(Faith & Belief)

Shariah(Practices & Activities)

Akhlaq(Morality & Ethics)

IBADAT(Man to God Worship)

Muamalat(Man to Man Activities)

Political Activities Economic Activities Social Activities

Banking & Financial Activities

Most Important Islamic Most Important Islamic Teaching Related To BusinessTeaching Related To Business

1.1. Elimination of Interest (Elimination of Interest (RabaRaba) ) 2.2. The prohibition of uncertainty (The prohibition of uncertainty (GhararGharar))3.3. The prohibition of Gambling (The prohibition of Gambling (QimarQimar))4.4. The precipitation of games of chance (The precipitation of games of chance (MaserMaser))5.5. Honesty and Fair Trade (Honesty and Fair Trade (Ghishsh Ghishsh and and KhilabahKhilabah))6.6. Spending in the Good CauseSpending in the Good Cause7.7. Buy Back Buy Back 8.8. Two Mutually Two Mutually Conditional ContractConditional Contract9.9. Entitlement to profit depends on liability for Entitlement to profit depends on liability for

riskrisk

Human Financial NeedsHuman Financial Needs

Fulfillment of Financial Needs

Own Capital Others’ Capital

Equity Financing Debt Financing

ShirkahShirkah

Scope of the PresentationScope of the Presentation

Terminology of Musharaka Terminology of Musharaka Types of Musharaka Types of Musharaka Structure of Musharaka Structure of Musharaka Rules of Musharaka Rules of Musharaka

Capital;Capital; Profit and loss;Profit and loss; TerminationTermination Security / Collateral in Musharaka Security / Collateral in Musharaka

Concept of limited liabilityConcept of limited liability Modern partnershipsModern partnerships Banking applicationBanking application Case in pointCase in point

MEANING OF SHAIRKATMEANING OF SHAIRKAT

The literal meaning of Musharakah is The literal meaning of Musharakah is sharing. The root of the word sharing. The root of the word "Musharakah" in Arabic is Shirkah, which "Musharakah" in Arabic is Shirkah, which means being a partner. means being a partner.

Under Islamic jurisprudence, Musharakah Under Islamic jurisprudence, Musharakah means a joint enterprise formed for means a joint enterprise formed for conducting some business in which all conducting some business in which all partners share the profit according to a partners share the profit according to a specific ratio while the loss is shared specific ratio while the loss is shared according to the ratio of the contribution. according to the ratio of the contribution.

LEGITIMACY OF SHIRKATLEGITIMACY OF SHIRKAT

Allah- Subhana- o-Ta’ala has Allah- Subhana- o-Ta’ala has declared that He becomes a declared that He becomes a party in a business between two party in a business between two Musharakain until one indulges Musharakain until one indulges in cheating or breach of trust in cheating or breach of trust (Khayanah) with other in (Khayanah) with other in Musharakah.”Musharakah.” (Sunan-i-Abi Daud, (Sunan-i-Abi Daud, Kitabul Buyuo)Kitabul Buyuo)

Types of ShirkahTypes of Shirkah

ShirkahShirkah

Shirkat-ul-MilkShirkat-ul-Milk(Co- ownership)(Co- ownership)

Shirkat-ul-AaqdShirkat-ul-Aaqd(Contractual Partnership)(Contractual Partnership)

Shirkat-ul-MilkShirkat-ul-Milk (Joint ownership)(Joint ownership)

• Joint ownership of two or more persons in a particular property/ asset with out any business intention.

• This comes into being as a result of joint purchase, joint acceptance of gift or a bequest and inheritance of joint property etc.

Types of Shirkat-ul-MilkTypes of Shirkat-ul-Milk

Shirkat-ul-Milk Optional (Ikhtiari)Shirkat-ul-Milk Optional (Ikhtiari) This comes into operation through

the act of parties e.g., purchase of asset with mutual consent.

Shirkat-ul-Milk Compulsory (Ghair Shirkat-ul-Milk Compulsory (Ghair Ikhtiari) Ikhtiari)

This comes into operation without any action on the part of parties e.g., ownership of heirs on the inherited property.

Shirkat-ul-AqdShirkat-ul-Aqd (Joint venture/partnership).

Shirkat-ul-AqdShirkat-ul-Aqd or Contract Partnership or Contract Partnership is an Agreement between two or more is an Agreement between two or more parties to combine their assets or to parties to combine their assets or to merge their services or obligations and merge their services or obligations and liabilities with the aim of making profit.liabilities with the aim of making profit.

It can also be referred to as a joint It can also be referred to as a joint commercial enterprise or activitycommercial enterprise or activity

Difference between Difference between Shirkat-ul-Aqd and Shirkat-ul-MilkShirkat-ul-Aqd and Shirkat-ul-Milk

In Shirkat ul Aqd both parties create partnership for sharing profit earned by Shirkah asset, while in Shirkat ul milk both partners do not intend to earn profit from Shirkah asset.

In Shirkat ul Aqd, each partner is an agent of others while in Shirkat ul Milk each partner is stranger with respect to other’s share.

Shirkat-ul-WojoohShirkat-ul-Wojooh(Credit Partnership)(Credit Partnership)

Shirkat-ul-AamalShirkat-ul-Aamal(Work Partnership)(Work Partnership)

Shirkat-ul-AmwalShirkat-ul-Amwal(Investment /Capital Partnership)(Investment /Capital Partnership)

Kinds of Shirkat-ul-AqdKinds of Shirkat-ul-Aqd

Shirkat-ul-AmwalShirkat-ul-Amwal

Where all the partners invest some capital into a commercial enterprise and share its profits according to agreement.

Shirkat-ul-Aamal Shirkat-ul-Aamal

Where all the partners jointly undertake to Where all the partners jointly undertake to render some services for their customers, render some services for their customers, and the fee charged from them is distributed and the fee charged from them is distributed among them according to an agreed ratio. among them according to an agreed ratio.

For example, if two persons agree to For example, if two persons agree to undertake tailoring services for their undertake tailoring services for their customers on the condition that the wages customers on the condition that the wages so earned will go to a joint pool which shall so earned will go to a joint pool which shall be distributed between them be distributed between them

Shirkat-ul-WujoohShirkat-ul-Wujooh

Where the partners have no investment at all, they purchase commodities on deferred price by their goodwill and sell them on spot. Their capital is their credit worthiness and reputation.

Shirkat-ul-AmwalShirkat-ul-Amwal Shirkat-ul-WojoohShirkat-ul-WojoohShirkat-ul-AamalShirkat-ul-Aamal

Shirkat-ul-Shirkat-ul-MufawadahMufawadah Shirkat-ul-IShirkat-ul-Inannan

All the three are further divided in to two types:All the three are further divided in to two types:

Types of Shirkat-ul-AqdTypes of Shirkat-ul-Aqd

Subdivision of Shirkat-ul-Subdivision of Shirkat-ul-AqdAqd

1-Shirkat-ul-Mufawadah:1-Shirkat-ul-Mufawadah: Where capital, profit, loss and management

are equal among the partners.

2-Shirkat-ul-Inan2-Shirkat-ul-Inan: : Partners’ share capital, management, profit Partners’ share capital, management, profit

and risk are not equal and may differ for each and risk are not equal and may differ for each partner. This is common type of partnership.partner. This is common type of partnership.

SHIRKAH

Shirkat-ul-Aqd

Shirkat-ul-Milk

Shirkat-ul-Amwal

Shirkat-ul-A’mal(Shirkat-

ul-Abdan)

Shirkat-ul-

Wajooh

Shirkat-ul-Mufawada

h

Shirkat-ul-Inan

Shirkat-ul-Mufawadah

Shirkat-ul-Inan

Shirkat-ul-Mufawadah

Shirkat-ul-Inan

OptionalCompulsor

y

Rules of Shirkat-ul-MilkRules of Shirkat-ul-Milk

Each partner is a stranger with respect to the share of the others.

The partners are not allowed to undertake any act of disposal with respect to the other’s share except with the latter’s permission.

Each partner can sell his own share without the other partners’ consent, except in cases where share of one partner can not be distinguished from the other.

Rules of Shirkat-ul-MilkRules of Shirkat-ul-Milk

Profit & loss will be according the ratio of ownership.

Expenses related to ownership will be borne by all partners according to the ratio of ownership.

Every partner has the right to sale/gift/lease to the extent of his share.

One partner can promise to purchase the share of other partner at any price, may be at face value, market value or pre-agreed price.

Shirkat-ul-AmmwalShirkat-ul-Ammwal

Definition: Definition: It is an agreement between two or

more persons to invest a sum of money in a business and share its profits according to agreement. The investment of this partnership consists of capital contributed by the partners.

SHIRKAT-UL- AMWAL: SHIRKAT-UL- AMWAL:

Capital of MusharakahCapital of Musharakah It should be known, ascertained and available at

the time of contract. The value should be agreed upon in case of kinds;The value should be agreed upon in case of kinds; Capital paid in different currencies should be valued into Capital paid in different currencies should be valued into

the currency of Shirkah;the currency of Shirkah; Capital advanced by the parties. Should be

uniform (currency of partnership). Share capital in a Musharakah can be contributed

either in cash or in the form of commodities In the letter case the market value of the

commodities shall determine the share of the partner in the capital.

Capital of MusharakahCapital of Musharakah

Capital of partnership is Amanat in the hands of partners. If loss occurred due to negligence, the partner responsible for loss, will compensate the loss.

Management of Management of MusharakahMusharakah

Each partner has right to take part in Musharakah Each partner has right to take part in Musharakah management.management.

The partner may appoint a managing partner by The partner may appoint a managing partner by mutual consent.mutual consent.

One are more of the partners may decide not to One are more of the partners may decide not to work for the Musharakah and work as a sleeping work for the Musharakah and work as a sleeping partner.partner.

It is not allowed to specify a fixed remuneration to a It is not allowed to specify a fixed remuneration to a partner Musharaka who manages funds or provides partner Musharaka who manages funds or provides some form of other services, such as accounting;some form of other services, such as accounting;

However, it is permissible to give him a greater However, it is permissible to give him a greater share of profit than he would receive solely on the share of profit than he would receive solely on the basis of his share in the partnership capital;basis of his share in the partnership capital;

Distribution of ProfitDistribution of Profit The ratio of profit distribution must be agreed The ratio of profit distribution must be agreed

at the time of execution of the contract.at the time of execution of the contract. It is not necessary for sharing profit according It is not necessary for sharing profit according

to proportionate capital contribution;to proportionate capital contribution; It is not allowed to defer the determination of

profit until realization of profit. The ratio must be determined as a proportion The ratio must be determined as a proportion

on the actual profit earned by the enterprise.on the actual profit earned by the enterprise. Not as percentage of partner’s investment.Not as percentage of partner’s investment. Not in lump sum amount.Not in lump sum amount.1. It is not allowed to defer the determination of profit

until realization of profit.2.2. A sleeping partner cannot share in the profit more A sleeping partner cannot share in the profit more

than the percentage of his capital.than the percentage of his capital.

Rules of Profit Determination/Distribution

• No guarantee can be given by the partners for the payment of profit or capital.

Different partners may be given different weightings according to amount and period of their investment.

Tiered profit sharing ratios can also be agreed.Tiered profit sharing ratios can also be agreed. Profit ratio can either be fixed or variable according to Profit ratio can either be fixed or variable according to

the tiers;the tiers; Both partners can agree that first 6-month profit

e.g. will be distributed at ratio of 50% : 50% and next 6-month profit will be distributed at ratio of 30% : 70%.

Rules of Loss Determination/Distribution

Sharing of Loss:Sharing of Loss: As a matter of principle the loss has to be shared As a matter of principle the loss has to be shared

according to the ratio of capital contribution;according to the ratio of capital contribution; Partners are not allowed to adopt any other Partners are not allowed to adopt any other

mechanism except the mechanism that ensure mechanism except the mechanism that ensure distribution of loss among partners on pro rata basis;distribution of loss among partners on pro rata basis;

Any other arrangement, even agreed upon by partners, Any other arrangement, even agreed upon by partners, will be invalid and void.will be invalid and void.

It is not allowed to hold one partner or group of partners liable for entire loss.

- All partners in Shirkah maintain the assets of the partnership as a trust.

- No one is liable except in cases of breach of the contract, misconduct or proven negligence.

- Negligence will be considered to have occurred in any of the following three cases: (i) A partner does not abide by the terms and conditions of the contract; (ii) A partner works against the norms of the concerned business; and (iii) The established ill-intention of a partner.

- The profit or even capital of any partners cannot be guaranteed by the co-partners.

- One partner can demand from another partner to provide any surety, security or pledge to cover the case of misconduct and negligence.

Guarantees in Shirkah ContractsGuarantees in Shirkah Contracts

Rules of Musharakah – terminationRules of Musharakah – termination Musharakah terminates in any of the following event:Musharakah terminates in any of the following event:

Death of a partner during the Musharakah;Death of a partner during the Musharakah; Heirs of the deceased partner have option either to draw the Heirs of the deceased partner have option either to draw the

share of the deceased from the business, or to continue with share of the deceased from the business, or to continue with the contract of Musharakah;the contract of Musharakah;

If any one of the partners becomes insane or otherwise If any one of the partners becomes insane or otherwise becomes incapable of effecting commercial transactions, the becomes incapable of effecting commercial transactions, the Musharaka stands terminated.Musharaka stands terminated.

In normal course of business, every partner has a right to In normal course of business, every partner has a right to terminate the Musharakah at any time after giving notice to other terminate the Musharakah at any time after giving notice to other partner;partner;

In this case, if all the assets of the Musharakah are in cash form In this case, if all the assets of the Musharakah are in cash form then they will be distributed pro rata between the partners;then they will be distributed pro rata between the partners;

In case they are mixed assets the partners may agree either on:In case they are mixed assets the partners may agree either on: Physical distribution of the assets among partners; orPhysical distribution of the assets among partners; or Liquidation of the assets in open market (market price); orLiquidation of the assets in open market (market price); or Internal liquidation i.e. purchasing from one partner share of Internal liquidation i.e. purchasing from one partner share of

other at any agreed price between them;other at any agreed price between them;

Rules of Musharakah – Rules of Musharakah – termination with one partnertermination with one partner

In case a partner wishes termination of the Musharakah, In case a partner wishes termination of the Musharakah, while others do not, this can be achieved by mutual while others do not, this can be achieved by mutual consent;consent;

The partners who wish to run the business may purchase The partners who wish to run the business may purchase the share of the other partner who wants termination;the share of the other partner who wants termination;

The reason is that the termination of Musharakah with one The reason is that the termination of Musharakah with one partner does not imply its termination between other partner does not imply its termination between other partners;partners;

However, in this case, the price of the share of the leaving However, in this case, the price of the share of the leaving partner has to be determined by mutual consent;partner has to be determined by mutual consent;

In case of dispute on the valuation of the share the leaving In case of dispute on the valuation of the share the leaving partner may compel other partners on the distribution of partner may compel other partners on the distribution of the assets;the assets;

However, if they are not divisible then the partner may an However, if they are not divisible then the partner may an arbitrator to solve the dispute;arbitrator to solve the dispute;

Musharakah – banking applicationMusharakah – banking application Musharakah is top preferable mode of financing Musharakah is top preferable mode of financing

recommended by Islam;recommended by Islam; It one of the important factors that help in achieving It one of the important factors that help in achieving

‘distribution of wealth’ which is a key feature of Islamic ‘distribution of wealth’ which is a key feature of Islamic financial and economic system;financial and economic system;

As Mudarabah, Musharakah is also not a vastly practiced As Mudarabah, Musharakah is also not a vastly practiced Islamic mode of financing by Islamic banks due to certain Islamic mode of financing by Islamic banks due to certain reasons;reasons;

However, Musharakah could easily be used as a vast However, Musharakah could easily be used as a vast mode of financing for almost every financial need;mode of financing for almost every financial need;

Below are some fields where this mode can easily be Below are some fields where this mode can easily be applied:applied: Long-term Finance;Long-term Finance; Running Finance (limited scope);Running Finance (limited scope); Investment Banking;Investment Banking; Project Financing;Project Financing; Private Equity Investment;Private Equity Investment; Redeemable capital investment.Redeemable capital investment.

Islamic securitisation

Transforms bilateral risk sharing between borrowers and lenders into market-based refinancing of one or more underlying Islamic finance transactionsScholar verification process: (i) type of assets; and (ii) transaction structure including credit enhancement and ownership conveyance

Conditions

Real purpose behind fund raising; type of asset identified and not consumableInvestor pay-off from profitable ventures onlyCollateral assets must not be debt, cash or haram No interest generationInvestors hold unconditional, unsecured payment obligation (no guaranteed promissory note)Ownership element

SukukSukuk Most popular ABS structure within Islamic Most popular ABS structure within Islamic

finance, legitimised in February 1988 finance, legitimised in February 1988 Financial instruments / trust certificates Financial instruments / trust certificates

representing undivided ownership share in representing undivided ownership share in underlying asset or interest held by issuer underlying asset or interest held by issuer

Most sponsored by sovereign and quasi-Most sponsored by sovereign and quasi-sovereign issuers in Islamic countriessovereign issuers in Islamic countries

Right to share in profits and asset Right to share in profits and asset realisationsrealisations

Bought and sold in secondary market and Bought and sold in secondary market and used in conjunction with other structuresused in conjunction with other structures

Sukuk al IjaraSukuk al Ijara

CERTIFICATE HOLDERS

SELLER SPV ISSUER LESSEE

Purchase price (issue proceeds)

Issue proceeds

Sells assets

Return Issues Sukuk

Leases assets

Rent

Sukuk al MusharakaSukuk al Musharaka

CERTIFICATE HOLDERS

SPV ISSUER

VENTURE

ORIGINATOR

Return Issues Sukuk

Issue proceeds

Cash contribution

Contribution in kind (at least 30%)

Share in profit and losses

Share in profits and losses

QUESTIONS??QUESTIONS??