1

PERPETUAL SUKUK: A PRELIMINARY SHARIAH ASSESMENT

BY

MUHD RAMADHAN FITRI ELLIAS* MUHAMAD NASIR HARON

**

AHMAD FIRDAUS KADIR***

NUR HIDAYAH SALIM****

1.0 INTRODUCTION

Perpetual sukuk (“Perpetual Sukuk”) is among the latest innovative structures in the market.

The development of this instrument has been driven by its commercial advantages as well as

new regulatory requirements particularly in the financial sector. It is called Perpetual Sukuk

because of its distinctive features compared to normal sukuk where as it carries no maturity

date and treated as equity (from an accounting standpoint) rather than debt. While this

innovation is commendable, it deserves Shariah observation on some of structural and

operational issues of the Sukuk. This brief paper would attempt to analyse such issues and

highlight justifications provided by the respective Shariah advisers in approving the Sukuk

structure. The paper begins with an overview of perpetual Sukuk, its common features and

basic requirements and in respect of additional tier 1 capital instruments by financial

institutions, specific requirements according to Basel III. Subsequently, the study will

illustrate several current structures of perpetual Sukuk issued in Malaysia, namely Malaysia

Airline System Berhad’s Perpetual Junior Sukuk (2012) and Malaysia Airports Holdings

Berhad’s Perpetual Subordinated Sukuk (2014) and global, namely Abu Dhabi Islamic Bank

PJSC’s Additional Tier 1 Capital Securities (2012). Finally, the paper will highlight on

potential Shariah issues that might arise and discuss it from Shariah perspective. The

discussion and analyses of most of the issues in this paper, however, are neither conclusive

nor exhaustive.

This paper is presented for the Shariah Forum, Kuala Lumpur Islamic Finance Forum (KLIFF), 3 December

2015, The Royal Chulan Hotel, Kuala Lumpur. Views expressed in this paper do not necessarily represent

the views of the respective organisations of the authors.

* Muhd Ramadhan Fitri Ellias is Executive Vice President & Head of Shariah Management at Maybank

Islamic Berhad, Malaysia. He can be contacted at ramadhan@maybank.com.my. **

Muhamad Nasir Haron is Researcher of Shariah Management at Maybank Islamic Berhad, Malaysia. He

can be contacted at mnasir.h@maybank.com.my. ***

Ahmad Firdaus Kadir is Researcher of Shariah Management at Maybank Islamic Berhad, Malaysia. He can

be contacted at affirdaus.k@maybank.com.my. ****

Nur Hidayah Salim is Manager of Corporate Investment Banking at Maybank Islamic Berhad, Malaysia.

She can be contacted at hidayah.s@maybank.com.my.

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2.0 OVERVIEW OF PERPETUAL SUKUK

Perpetual Sukuk are commonly defined as hybrid Sukuk which have features of both debt

and equity capital.1 Perpetual Sukuk have the features of “permanence” and “loss absorption”

which means the Sukuk carry a perpetual legal tenure and subordinated to debt and other

liabilities of the issuer of such Perpetual Sukuk. Perpetual Sukuk are innovative form of debt

instruments (from a legal standpoint) with equity-like features that typically ranks senior only

to common equity.2

Key strategic benefits and flexibility of Perpetual Sukuk include:

Perpetual Sukuk serve as a unique balance sheet management tool which is cost effective

as they are priced as a subordinated debt yet deemed as equity for accounting purposes

Non-dilutive way of shoring up capital i.e. no adverse effect of shareholder dilution

Longer term funding compared to straight or “plain vanilla” Sukuk.

Help to enhance issuer’s credit profile due to increased financial flexibility and efficient

capital management.

From an investor’s point of view, Perpetual Sukuk offer attractive risk and return profile

compared to senior Sukuk.

3.0 SALIENT FEATURES OF PERPETUAL SUKUK

In this section, the paper will explain salient features of perpetual Sukuk for a better

understanding. In this manner, the features of perpetual Sukuk are distinguished between

issuance by the corporate entity or Islamic financial institutions which will carry different

features respectively as the following;

3.1 Common Salient Features of Perpetual Sukuk Issued By Corporate Issuers:3

(a) Ranking – subordination:

Perpetual Sukuk are contractually subordinated to the claims of external creditors. Upon

liquidation of the issuer, the outstanding amount of the Perpetual Sukuk would rank as

1 Thesis titled “A Valuation Framework for Pricing Hybrid Bonds” University of St. Gallen (HSG) Graduate School

of Business, Economics, Law and Social Sciences dated 31 December 2010 http://www.unisg.ch/~/~/media/7187EDAFFDF54BDEB7463364E6AA9800.ashx 2 Ibid.

3 Ibid.

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junior to a straight debt obligation but senior to the issuer’s ordinary shares and typically

preference shares too.

(b) Permanence – Perpetual:

Perpetual tenure is required for accounting equity treatment.

(c) Call Option:

In order to preserve the equity-like characteristics of a hybrid instrument, the issuer has a

call option, but not the investor. Perpetual Sukuk carry right or option, but not obligation,

of the issuer to redeem the perpetual Sukuk after the expiration of an initial non-call

protection period (i.e. first call date). Rating agencies’ typically require the call date of

Perpetual Sukuk to be no shorter than 5 years from the issue date of the Perpetual Sukuk.

(d) Step up Profit:

Similar to straight Sukuk, Perpetual Sukuk initially pay a fixed profit rate, however after

the first call date Perpetual Sukuk commonly include a step-up profit feature where the

prevailing profit rate will be revised to include a post-call spread in order to incentivize

the issuer to exercise the Call Option at the first call date. In addition, some Perpetual

Sukuk also contain provisions on change of control to ensure continuity of the controlling

shareholders or leverage event whereby in the event of change of ownership of the Issuer

or change of leverage ratio, a profit step-up shall apply.

(e) Profit Deferral:

The issuer must have the ability to defer profit without being in default for the Perpetual

Sukuk to be recognised as equity under accounting standards. In this manner, the

Perpetual Sukuk carry similar characteristic like equity where it absorb loses before other

creditors when issuer’s financial condition deteriorates.

Different variations of the right to profit deferral can be distinguished: optional vs.

mandatory deferral and also cumulative (i.e. deferred profit accrues) vs. non-cumulative

(i.e. missed profit payments are forgone).

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(f) Capitalisation of Deferred Profit:

Some Perpetual Sukuk also pay additional profit on the outstanding deferred profit. Each

amount of the deferred profit shall itself be entitled to profit as if it constituted the

nominal value of the Perpetual Sukuk at the prevailing profit rate, as long as such amount

of deferred profit remains outstanding.

(g) Dividend & Capital Stopper:

As protection to investors of the Perpetual Sukuk, should the Issuer opt to defer

distribution of profit of the Perpetual Sukuk, the issuer is not permitted to distribute

dividends or capital distributions to its shareholders.

(h) Loss Absorbing:

The Perpetual Sukuk are intended to provide protection for senior and other creditors and

to provide a capital cushion to absorb unexpected potential losses arising from the

Issuer’s operations.

(i) Replacement Capital Covenant:

The issuer may be required by rating agencies to commit to issuance of replacement

securities of equivalent or lower ranking in order to redeem the Perpetual Sukuk to

maintain an appropriate level of permanency on its balance sheet. The replacement capital

covenant clause is included in some Perpetual Sukuk where the issuer can only redeem

using proceeds from issuance of another hybrid or more subordinated instrument.

3.2 Common Salient Features of Perpetual Sukuk Issued By Islamic Banks:4

Perpetual Sukuk are issued by Islamic banks to shore up Tier-1 capital. An instrument shall

qualify as an Additional Tier 1 capital instrument of an Islamic bank in Malaysia if it meets

all the following criteria as set out in the Capital Adequacy Framework for Islamic Banks

issued by Bank Negara Malaysia (“CAFIB”):

(a) the instrument is issued and paid-up;

(b) the instrument is subordinated to depositors, general creditors and other holders of

subordinated debt of the financial institution;

4http://www.bnm.gov.my/guidelines/01_banking/01_capital_adequacy/gl_12_capital_adequacy_framework_i

slamic_capital_components.pdf

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(c) the instrument is neither secured nor covered by a guarantee of the financial institution or

an affiliated entity or other arrangement that legally or economically enhances the

seniority of the claim vis-à-vis depositors, general creditors and other holders of

subordinated debt of the financial institution;

(d) the instrument is perpetual, and shall therefore not have a maturity date, step-up features

or other incentives for the financial institution to redeem the instrument;

(e) the instrument may be callable at the initiative of the financial institution only after a

minimum of five years, subject to amongst others, exercise of a call option must receive

written approval of Bank Negara Malaysia

(f) any repayment of principal, other than through the exercise of a call option, (e.g. through

repurchase) must be with the prior written approval of Bank Negara Malaysia and the

financial institution shall not assume or create market expectations that approval will be

given;

(g) dividends/coupons must be paid out of distributable items, and such distributions must

meet certain condition including distributions/payments shall be at the full discretion of

the financial institution at all times and cancellation of discretionary payments must not

constitute an event of default;

(h) the instrument cannot have a credit sensitive dividend feature, that is a dividend/coupon

that is reset periodically based in whole or in part on the credit standing of the financial

institution or any of its affiliated entities;

(i) the instrument cannot contribute to liabilities exceeding assets if such a balance sheet test

forms part of national insolvency law governing the provisions of the instrument;

(j) the provisions governing the instrument require the instrument to be written-off, or the

instrument to be converted into ordinary shares, if the consolidated or entity level CET1

Capital Ratio of the financial institution falls below a pre-specified level

(k) the instrument cannot have any features that hinder recapitalisation, such as provisions

that require the financial institution to compensate investors if a new instrument is issued

at a lower price during a specified time frame;

(l) if the instrument is issued out of a special purpose vehicle (SPV), proceeds must be

immediately available without limitation to the financial institution in a form which meets

or exceeds all of the other criteria for inclusion in Additional Tier 1 Capital;

(m) the provisions governing the issuance of the capital instrument require the instrument to

be written-off, or the instrument to be converted into ordinary shares upon the occurrence

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of a trigger event, which shall be determined by the requirements detailed out in the

CAFIB;

(n) the purchase of the instruments is not directly or indirectly funded by the financial

institution;

(o) the instrument is not purchased by the financial institution or its affiliated party over

which it exercises control or significant influence; and

(p) the instrument issued shall be structured using unrestricted non-exchange-based contracts

(e.g. Musharakah, Mudarabah, or Wakalah), in addition to meeting other Shariah

requirements.

The following qualifying criteria for inclusion in Additional Tier 1 capital of an Islamic bank

under Basel-III requirement differentiate an additional Tier 1 capital instrument to Perpetual

Sukuk issued by other corporate issuers:5

(a) No Step-up Profit

Additional Tier-I instruments must not have step-ups or other incentives to redeem. Other

incentives to redeem include a call option combined with a requirement or an investor

option to convert the instrument into shares if the call is not exercised.

(b) Redemption subject to regulatory approvals

Any payment of principal, either through repurchase or redemption or exercise of call

option, must be with prior regulatory/supervisory approval and Islamic banks should not

assume or create market expectations that regulatory/supervisory approval will be given.

(c) Write-off or conversion mechanisms for achieving principal loss absorption and/or loss

absorbency at the point of non-viability

Principal loss absorption and/or loss absorbency through either (i) conversion to common

shares or (ii) a write-off mechanism which allocates losses to the instrument, subject to

the regulatory/supervisory requirements.

5 Basel III: A global regulatory framework for more resilient banks and banking systems (revised June 2011),

developed by the Basel Committee on Banking Supervision of the Bank for International Settlements (BIS) http://www.bis.org/publ/bcbs189.pdf

7

(d) Non-payment of profit

Distributions/payments shall be at the full discretion of the financial institution at all

times and as such any waived distributions/payments are non-cumulative i.e. are not

required to, and must not, be made up by the financial institution at a later date.

4.0 EXAMPLES OF SOME LANDMARK ISSUANCES

In this section, the paper will illustrate three (3) structures of perpetual Sukuk issued locally

and globally in which two of the perpetual Sukuk were issued in Malaysia, namely Malaysia

Airline System Berhad (MAS)’s Perpetual Junior Sukuk (2012) and Malaysia Airports

Holdings Berhad’ (MAHB)’s Perpetual Subordinated Sukuk (2014) and an Additional Tier 1

Capital Perpetual Sukuk issued by Abu Dhabi Islamic Bank (ADIB) which was issued in

2012. MAHB and MAS Perpetual Sukuk are based on Musharakah whilst ADIB Perpetual

Sukuk is based on Mudarabah. Though MAHB and MAS Perpetual Sukuk are based on

Musharakah, there are few differences between these two structures. The key difference is on

deferral of profit or Periodic Distribution where as in the MAHB, the deferred profit will be

capitalised and for MAS, the deferred profit will not be capitalised. ADIB Perpetual Sukuk,

on the other hand, is claimed to be the first Basel 3 compliant in the world. The detailed

structures are as follow:

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4.1 STRUCTURE 1

Malaysia Airline System Berhad (“MAS”) Perpetual Junior Sukuk (“Perpetual Sukuk”) under

a Perpetual Junior Sukuk Programme of up to Malaysian ringgit 2,500.0 million in nominal

value.6

Musharakah Transaction

1 (a) MAS will identify its Shariah compliant Business which will be used as the

underlying asset for that particular Musharakah transaction.

1 (b)-(d)In respect of the issuance of the Perpetual Sukuk, the Sukukholders shall from time

to time, via the Trustee, form a Musharakah partnership with MAS to invest directly

into the Business (“Musharakah Venture”) identified for that particular tranche.

The Sukukholder(s) shall subscribe to Perpetual Sukuk issued by MAS where each

Perpetual Sukuk shall represent the respective Sukukholder’s undivided

proportionate interest in the relevant Musharakah Venture. The contribution of the

Sukukholder(s) to the Musharakah Venture is the proceeds raised from each tranche

of the Perpetual Sukuk (“Musharakah Capital”) while MAS will contribute the

Business into the Musharakah Venture. Simultaneously, MAS shall make a

declaration that it holds on trust a percentage of the interest in the Business for the

benefit of the Sukukholder(s) pursuant to the Musharakah Venture.

2 The Sukukholder(s) shall appoint MAS as the Manager to manage the Musharakah

Venture.

3 Pursuant to the Musharakah Sale Undertaking declared and issued by the Trustee

for and on behalf of the Sukukholder(s) to MAS, the Trustee (for and on behalf of

the Sukukholder(s)) undertakes to sell the Sukukholder(s)’s interest in the

Musharakah Venture to MAS at the relevant Exercise Price upon any redemption of

6 Source: Extracted from principal, term and conditions.

http://issuance.sc.com.my/uploads_issuance/MAS%20-%20PTC.pdf

Musharakah

Venture

Trustee

1a. Identifies Business

1c. Issues Sukuk

1b. Sukuk Proceeds/

Musharakah Capital

1d. Invests in Musharakah Venture

4. Musharakah Distribution Amount

3. Declares Musharakah Sale Undertaking

2. Appoints as Manager

MAS

(Issuer/ Manager)

Sukukholder(s)

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the Perpetual Sukuk or any dissolution or winding up of the Issuer in accordance

with the terms set out herein.

4 The income from the relevant Musharakah Venture of up to the Musharakah

Distribution Amount shall be distributed semi-annually to the Sukukholder(s) of

that particular tranche of Perpetual Sukuk on each Periodic Distribution Date. Any

shortfall between the Musharakah Distribution Amount and the actual income

generated from the Musharakah Venture shall be paid by MAS as Advance Part

Payment. For avoidance of doubt, the Advance Part Payment will be set-off against

the relevant Exercise Price pursuant to the Musharakah Sale Undertaking.

Musharakah Distribution Amount channelled to purchase Commodities via

Musawamah Transaction

The Issuer may give, not less than five (5) business days before the relevant Periodic

Distribution Date, a notice in writing (“Musawamah Investment Notice”) to the

Trustee that part or all of the Musharakah Distribution Amount on such Periodic

Distribution Date will be invested in Commodities (“Musawamah Investment

Amount”) via a Musawamah Transaction.

4.2 STRUCTURE 2

Malaysia Airports Holdings Berhad (“MAHB”) Perpetual Subordinated Sukuk (“Sukuk

Musharakah”) pursuant to a Perpetual Subordinated Sukuk Programme (“Sukuk

Programme”) of up to RM2.5 Billion in Nominal Value.7

7 Source: Extracted from principal, term and conditions.

http://issuance.sc.com.my/MemberAccessIssuance/documents/download/1178/PTC

MusharakahVenture

Sukukholders

(represented by the Sukuk Trustee)

Purchase Undertaking

Identify Business

Proceeds (Musharakah Capital)

Issue Sukuk

2

4a

2

1

MAHB

(Issuer/ Managing Partner / Obligor)

4b Sale Undertaking

Income from Musharakah Venture 3

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1. The Sukuk Trustee (on behalf of all the Sukukholders) and MAHB will enter into a

Master Musharakah Agreement under which, the parties as Musharakah partners may,

from time to time, enter into musharakah agreements (each a “Musharakah

Agreement”) for the purposes of undertaking the “Musharakah Venture” consisting of

Shariah-compliant investments in the airport operations business of the Issuer and/or its

subsidiaries which entails the collection of passenger service charge, landing and parking

fees, and other ancillary charges to airlines or part thereof identified and held on trust by

MAHB on behalf of the Sukukholders (“Business”). The Sukukholders (through the

Sukuk Trustee) shall appoint MAHB as the “Managing Partner” of each Musharakah

Venture.

2. The Sukukholders shall provide capital contribution to the Musharakah Venture through

subscription of the Sukuk Musharakah which will be issued by the Issuer and constituted

by the Trust Deed. MAHB shall contribute the Business, as a capital contribution in-kind

to the Musharakah Venture. Upon issuance of the Sukuk Musharakah, the Musharakah

Capital from the Sukukholders shall be invested with MAHB (in its capacity as

Managing Partner) for the purposes of undertaking the Musharakah Venture. The Sukuk

Musharakah comprise certificates representing the Sukukholders’ undivided beneficial

interest in the Musharakah Venture and any funds held by the Managing Partner on

account of the holders of the Sukuk Musharakah.

3. Income from the Musharakah Venture shall be distributed to each partner based on a

profit sharing ratio which will be determined prior to the issuance of the Sukuk

Musharakah. Any losses incurred in the Musharakah Venture shall be borne by each

partner in proportion to each partner’s respective capital contribution in the Musharakah

Venture. Each Musharakah Agreement will contain terms for the target periodic

distributions from that Musharakah Venture for each Distribution Period. Such target

periodic distribution shall be based on the Periodic Distribution Rate and shall be

referred to as the “Periodic Distribution Amount”.

As agreed by the Sukukholders, MAHB may at its sole discretion (unless a Compulsory

Periodic Distribution Payment Event has occurred) elect to make payment of all or some

of a Periodic Distribution Amount on the Periodic Distribution Date or elect to defer

such payment by giving notice (“Optional Deferral Notice”) to the Sukukholders at

least three (3) (but not more than fifteen (15)) Business Days prior to a Periodic

Distribution Date.

(A) Non Deferral

In the event that MAHB does not defer distributions of the Periodic Distribution

Amount:

(a) Venture Profits Equal to /in Excess of Periodic Distribution Amount

If the profits generated from the Musharakah Venture (“Profits”) are equal to or in

excess of the Periodic Distribution Amount, (i) Profits up to the Periodic

Distribution Amount will be distributed to the Sukukholders; and (ii) any excess

Profit thereafter will be retained by the Managing Partner in the “Reserve Account”

on behalf of the Sukukholders on a custody basis. If, on the dissolution of the

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Musharakah Venture, there are any positive balances in the Reserve Account, the net

excess amount will be paid to the Managing Partner as an incentive payment.

(b) Venture Profits Less than Periodic Distribution Amount

If the Profits are insufficient to pay the Periodic Distribution Amount the Managing

Partner (i) shall utilise any amount available in the Reserve Account to cover the

shortfall between such Periodic Distribution Amount and the Profits and (ii) may at

its sole discretion provide a Shariah-compliant liquidity facility whereby it shall

advance to the Sukuk Trustee (on behalf of the Sukukholders) an amount sufficient

to make up the shortfall between the Periodic Distribution Amount and the Profits

(adjusted accordingly pursuant to any utilisation of the Reserve Account as referred

to in (i) above, if applicable), in order to enable MAHB as the Issuer to make

payment of the said Periodic Distribution Amount. The Managing Partner shall be

entitled to deduct from the Reserve Account any amount advanced under such

liquidity facility at a later date. Alternatively, such amounts advanced by the

Managing Partner will be repaid to the Managing Partner upon redemption of the

Sukuk Musharakah in full.

(B) Deferral

In the event that MAHB intends to defer distribution of any part or all of the Periodic

Distribution Amount, and provided the Issuer has given notice of such deferment:

(a) Venture Profits Equal to /in Excess of Periodic Distribution Amount

If there has been sufficient Profits in the Musharakah Venture to satisfy the payment

of such part or all of the relevant Periodic Distribution Amount which would

otherwise become due and payable under the Sukuk Musharakah, under the Master

Musharakah Agreement, the Sukukholders irrevocably authorize the Managing

Partner to, in its sole discretion, reinvest all the Profits up to the value of such or all

Periodic Distribution Amount) being deferred into the Musharakah Venture as

additional capital from the Sukukholders (“Additional Capital”). Any excess of the

Profits above the Periodic Distribution Amount shall be retained by the Managing

Partner in the Reserve Account on behalf of the Sukukholders on a custody basis.

Any payment of such Additional Capital at a later date shall constitute payment of

Musharakah Capital to the Sukukholders (“Capital Payment”). Any Capital

Payment made by the Issuer shall be shared by the Sukukholders of all outstanding

Sukuk Musharakah on a pro-rata basis and the respective Sukukholders’ Musharakah

Capital shall be adjusted accordingly.

(b) Venture Profits Less than Periodic Distribution Amount

If the Profits are insufficient to pay any Periodic Distribution Amount or such part

thereof which has not been deferred and is therefore due and payable, the Managing

Partner (i) shall utilise any amount available in the Reserve Account to cover the

shortfall between such Periodic Distribution Amount which has not been deferred

and is therefore due and payable and the Profits and (ii) may at its sole discretion

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provide a Shariah-compliant liquidity facility whereby it shall advance to the Sukuk

Trustee (on behalf of the Sukukholders) an amount sufficient to make up the

shortfall between any Periodic Distribution Amount which has not been deferred and

the Profits (adjusted accordingly pursuant to any utilisation of the Reserve Account

as referred to in (i) above, if applicable), in order to enable MAHB as the Issuer to

make payment of the said Periodic Distribution Amount which has not been

deferred. The Managing Partner shall be entitled to deduct from the Reserve

Account any amount advanced under such liquidity facility at a later date.

Alternatively, the Net Liquidity Facility will be repaid to the Managing Partner upon

redemption of the Sukuk Musharakah in full.

In the event the Profits are lower than the Periodic Distribution Amount deferred, the

Musharakah Venture shall be dissolved through an exercise of the Purchase

Undertaking (as described below), and the Exercise Price shall be applied towards

investment in a new Musharakah Venture. The accounting entries associated with

the dissolution of the Musharakah Venture and reinvestment into a new Musharakah

Venture shall be made in the books of the Managing Partner. For the avoidance of

doubt, a dissolution of the Musharakah Venture in this manner will not result in

redemption of the Sukuk Musharakah.

4a MAHB (in its capacity as the Obligor) will provide a Master Purchase Undertaking,

pursuant to which, on each dissolution date of a Musharakah Venture set out below, it

shall execute a transfer/sale agreement (“Transfer/Sale Agreement”) for the purchase of

the Sukukholders’ undivided beneficial interest in the Musharakah Venture at the

relevant Exercise Price.

MAHB will execute a power of attorney in favour of the Sukuk Trustee pursuant to

which the Sukuk Trustee is granted the authority to execute the Transfer/Sale Agreement

in the event of failure/refusal of MAHB to execute the Transfer/Sale Agreement pursuant

to the exercise of the Master Purchase Undertaking.

The purchase of the Sukukholders’ undivided beneficial interest in the Musharakah

Venture would dissolve the then outstanding Musharakah Venture.

The dissolution dates applicable to the Purchase Undertaking include:

(a) the date of Winding-up of MAHB; and

(b) the Periodic Distribution Date in respect of which MAHB has elected to defer

payment of all or part of the Periodic Distribution Amount payable on such

Periodic Distribution Date, where there is a shortfall of Profits (as defined in the

PTC).

4

b

.

The Sukuk Trustee (on behalf of the Sukukholders) will provide a Master Sale

Undertaking, pursuant to which the Issuer shall have the right to early redeem the Sukuk

Musharakah under:

(i) Redemption at the option of the Issuer;

(ii) Redemption for tax reasons;

(iii) Redemption upon a rating event;

(iv) Redemption for accounting reasons;

(v) Redemption for tax deductibility;

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(vi) Redemption in the case of Minimal Outstanding Amount;

(vii) Redemption upon a Change of Control; and

(viii) Redemption upon a Revocation of License.

The Sukuk Trustee (on behalf of the Sukukholders) is required to execute the

Transfer/Sale Agreement for the sale to MAHB of the Sukukholders’ undivided

beneficial interest in the Musharakah Venture at the applicable Exercise Price.

MAHB will execute a power of attorney in favour of the Sukuk Trustee pursuant to

which the Sukuk Trustee is granted the authority to execute the Transfer/Sale Agreement

in the event of failure/refusal of MAHB to execute the Transfer/Sale Agreement pursuant

to the exercise of the Master Sale Undertaking.

4.3 STRUCTURE 3

Abu Dhabi Islamic Bank PJSC (‘‘ADIB’’) U.S.$1,000,000,000 Additional Tier 1

Capital Certificates issued by ADIB Capital Invest 1 Ltd.8

Payments by the Certificateholders and the Issuer

On Issue Date, the Certificateholders will pay the issue price in respect of the Certificates to

the Issuer. Pursuant to the Declaration of Trust, the Issuer, in its capacity as the Trustee, will

declare a trust, in favour of the Certificateholders, over the proceeds of the issuance of the

Certificates, any and all of its rights, title, benefits and interests under the Transaction

Documents and any and all amounts standing to the credit of the Transaction Account from

8Source: Extracted from Prospectus dated 14 November 2012.

http://www.londonstockexchange.com/specialist-issuers/islamic/4402r-2012-11-19.pdf

14

time to time. The Trustee will apply the proceeds of the issuance of the Certificates towards

the capital of the Mudaraba (the “Mudaraba Capital”) pursuant to the Mudaraba

Agreement. ADIB (as Mudareb) will invest the Mudaraba Capital in the business activities of

ADIB in accordance with an agreed Investment Plan prepared by the Mudareb.

Periodic payments by the Trustee

Unless a Non-Payment Event or a Non-Payment election has occurred, prior to each Periodic

Distribution Date, the Mudareb shall distribute the profit generated by the Mudaraba to both

the Issuer and the Mudareb in accordance with an agreed percentage split (90 percent to the

Issuer (as Rab-al-Maal) and 10 percent to the Mudareb). The Issuer shall apply its share of

the profit (if any) generated by the Mudaraba on each Periodic Distribution Date to pay the

Periodic Distribution Amount due to the Certificateholders on such date.

Payments of Mudaraba Profit by ADIB (as Mudareb) are at the sole discretion of ADIB (as

Mudareb) and may only be made in circumstances where ADIB will not be in breach of

certain conditions as a result of making such payment. The Mudareb shall not have any

obligation to make any subsequent payment in respect of such unpaid profit (whether from its

own cash resources, from the Mudaraba Reserve or otherwise).

Under the terms of the Mudaraba Agreement, the Mudareb shall be expressly entitled to

comingle its assets with the Mudaraba Assets.

Dissolution payments, redemption and variation by the Issuer and the Mudareb

The Certificates are the perpetual securities in respect of which there is no fixed redemption

date. Accordingly, the Mudaraba is a perpetual arrangement with no fixed end date.

Subject to certain conditions set out in Clause 7 of the Mudaraba Agreement, ADIB (as

Mudareb) may at its option liquidate the Mudaraba in whole, but not in part, on the basis of

an actual liquidation of the Mudaraba in the following circumstances:

(i) on the First Call Date or any Periodic Distribution Date after the First Call Date, by

giving not less than 30 nor more than 60 days’ prior notice to the Trustee; or

(ii) on any date on or after the Issue Date (whether or not a Periodic Distribution Date), by

giving not less than 30 nor more than 60 days’ prior notice to the Trustee:

(a) upon the occurrence of a Tax Event; or

(b) upon the occurrence of a capital Event.

The Trustee (but only upon the instructions of ADIB (acting in its sole discretion)) shall,

upon receipt of notice in accordance with paragraph (i) above redeem the Certificates, and

upon receipt of notice in accordance with paragraph (ii) above redeem all of, and not only

some of, the Certificates or vary the terms thereof, in each case by giving not less than 30 nor

more than 60 days’ prior notice to the Certificateholders, all as more particularly described in

the Conditions.

ADIB (as Mudareb) and the Trustee undertake in the Mudaraba Agreement, in circumstances

where the Certificates are required by ADIB to be varied upon occurrence of a Tax Event or a

Capital Event, to make such variations as necessary to ensure that the Certificates become or,

as appropriate, remain Qualifying Tier 1 instruments.

15

Extract of Condition 8 (Periodic Distribution Restrictions)9

“8.1 Non-Payment Event

Notwithstanding Condition 7.4 (Periodic Distributions), if any of the following events occurs

(each, a “Non Payment Event”), ADIB (as Mudareb) shall not pay Mudaraba Profit or Final

Mudaraba Profit on any Mudaraba Profit Distribution Date or Mudaraba End Date (as the

case may be), and as a result thereof the Trustee shall not pay Periodic Distribution Amounts

on the corresponding Periodic Distribution Date:…”

“8.2 Non-Payment Election

ADIB may in its sole discretion elect that Mudaraba Profit will not be paid to the Trustee( in

its capacity as Rab-al-Maal) on any Mudaraba Profit Distribution Date or that Final

Mudaraba Profit will not be paid to the Trustee (in its capacity as Rab-al-Maal) on any

Mudaraba End Date, and ADIB shall, in each case, instruct the Trustee not to make payment

of a Periodic Distribution Amount to Certificateholders on such Periodic Distribution Date

(as the case may be) not to make payment of any Outstanding Payments otherwise payable on

redemption or repayment of the Certificates (each a “ Non-Payment Election”)”

“8.3 Effect of Non-Payment Event or Non-Payment Election

If ADIB makes a Non-Payment Election or a Non-Payment Event

occurs,…Certificateholders shall have no claim in respect of any Periodic Distribution

Amount not paid as a result of either a Non-Payment Election or a Non-Payment Event and

any non-payment of Mudaraba Profit, Final Mudaraba Profit or a Periodic Distribution

Amount in such circumstance shall not constitute a Dissolution Event. ADIB shall not have

any obligation to make any subsequent payment in respect of any such unpaid profit…and the

Trustee shall not have any obligations to make any subsequent payment in respect of any

such Periodic Distribution Amounts.”

9 Ibid.

16

5.0 POTENTIAL SHARIAH ISSUES IN PERPETUAL SUKUK

In this section, the paper will elaborate several potential Shariah issues attached to Perpetual

Sukuk structures which require further Shariah deliberations. Since all Perpetual Sukuk that

have been issued in the market are based on equity-based contracts i.e., Mudarabah and

Musharakah, the discussion will be only confined to potential Shariah issues arising from

these contracts. This paper has identified several Shariah issues relating to Perpetual Sukuk

which are issue of non-maturity date, deferral of periodic distribution amount, capitalisation

of deferred periodic distribution amount, non-payment of profit, step-up and top-up rate,

conversion into shares in the case of non-viability and redemption of perpetual Sukuk.

Together with the issues, this section also highlights Shariah justifications offered by

respective Shariah advisers in endorsing the structure.

5.1 Perpetuity - No Maturity Date

Among the distinct criteria to ensure its accounting equity treatment, Perpetual Sukuk shall

have no maturity date and it may only be callable at the option of the issuer after a minimum

of say, five years. Hence, the study would be taking through several structures of Perpetual

Sukuk which have been issued by the ADIB, MAS and MAHB as reference

a) Requirement of Maturity Period for Mudarabah Contract

The scholars have a diverse opinions whether determining a specific period for Mudarabah

contract is a requirement from Shariah perspective.

Among others are the opinion of Al-Sharbini which has been mentioned in his book of

Mughni Al-Muhtaj as the following;

سكت أم الشراء فإن القراض المؤقت ال يصح سواء أمنع المالك العامل التصرف أم البيع كما مر أم

Indeed, the contract of Qiradh/Mudarabah which its specific period has been determined is

considered void (batil) even if the rabbul mal (investor) allowing the mudarib (entreprenuer)

to utilize the capital after the end of the period, or the investor allowing the mudarib to sell

the capital as per mentioned earlier or he (investor) just remain silent or allowing the

mudarib to buy something from the capital.10

According to Hanbalites School of law, the stipulation of specific period for Mudarabah

contract would lead the contract becomes null and void. It is because such determination of

10

Al-Sharbini, Muhammad Ibn Al-Khatib, Mughni Al-Muhtaj, (1997) Lubnan, Dar al-Ma`refah, Vol. 2, p. 402.

17

mudarabah period will violate nature of Mudarabah which is non-binding. This opinion has

been mentioned by Ibnu Qudamah as the following:

وال يصح ان يشترط ما ينافي مقتضى العقد نحو أن يشترط لزوم المضاربة أو ال يعزله مدة بعينها ...

Mudarabah contract is considered void if there is any imposition of specific conditions that

may violate the purpose of contract (muqtadha al-aqd) such as stipulation of condition that

made the contract binding or stipulation of condition of non-withdrawal of any contracting

parties from the venture within a specific period.11

On the other hand, according to the Hanafites jurists, it is permissible for any contracting

parties to specify a certain period for Mudarabah contract and the mudarabah venture will

automatically dissolved after the expiry of the term. The following is the opinion of the

Hanafites jurist;

وإن وقت لها وقتا بطلت بمضيه

And if the contract is specified for a certain period, the Mudarabah will be dissolved after the

end of the term.12

According to AAOIFI, the contracting parties of Mudarabah may agree to specify a maturity

period for Mudarabah venture. This practice will be resulting the bindingness of mudarabah

contract until the expiry date of mudarabah. The AAOIFI has resolved this issue as the

following;

“The general principle is that a Mudarabah contract is not binding, i.e. each of the

contracting parties may terminate it unilaterally except in two cases:

a) When the Mudarib has already commenced the business, in which case of

Mudarabah contract becomes binding up to the date of actual (تنضيض حقيقي ) or

constructive liquidation (تنضيض حكمي)

b) When the contracting parties agree to determine a duration for which the contract

will remain in operation. In this case, the contract cannot be terminated prior to the

end of the designated duration, except by mutual agreement of the contracting

parties.”13

Based on abovementioned AAOIFI Standard, it is understood that the maturity period is not

regarded as Shariah requirement for a Mudarabah contract. However, if such maturity period

11

Ibn Qudamah, Muwaffiq Addin Abdullah, Al-Kafi, (1994) Lubnan, Dar Al-Kutub Al-Ilmiyyah, Vol. 2, p. 153. 12

Al-Musili, Abdullah Ibn Muhammad Ibn Mudud, Al-Ikhtiyar Li Ta’lil Al-Mukhtar, Dar Al-Fikr Al-Arabi,

Vol. 3, p.25. 13

AAOFI Shariah Standards, p.235.

18

was stipulated in Mudarabah agreement, thus the nature of the mudarabah contract will be

binding.

Requirement of Maturity Period for Musharakah Contract

Similar to Mudarabah contract, the jurists are also of the view that the maturity period is not

regarded as a requirement for Musharakah contract. This can be supported by several

classical views and contemporary resolutions to support that argument as the following

stated.

Imam Al-Nawawi of the Shafiites mentioned the following opinion in his book of Minhaj At-

Tolibin:

ولكل فسخه متى شاء وينعزالن عن التصرف بفسخهما

Each parties in the Musharakah contract may withdraw from the musharakah venture at any

time, and both contracting parties shall stop from utilizing the musharakah venture should

they opt to withdraw from such contract.14

According to Hanbalites jurist, Ibnu Qudamah has also elaborated that the contract of

Musharakah is non-binding in nature, thus the maturity period is not considered as a

requirement. He mentions n the book of Al-Kafi as the following:

جوازها و انفساخها حكم الوكالة لتضمنها للوكالة فإن عزل أحدهما صاحبه قبل ان ينض المال فذكر القاضي وحكمها في

: أن ظاهر كالم أحمد رضي هللا عنه أنه ال ينعزل حتى ينض

The ruling of non-bindingness of musharakah and right to dissolve of musharakah contract

are similar to the ruling of Wakalah.. If one of the contracting parties exit from the contract

prior to profit computation; according to Al-Qadi: Clearly, based on the Imam Ahmad’s

opinion is that the contracting parties shall not exit from the contract until the profit had

been computed.15

With regards to this matter, AAOIFI in its Shariah Standard also does not stipulate that the

requirement of a Musharakah contract to have a maturity period.Nevertheless, the

contracting party may enter into a binding promise where the duration of Musharakah

contract may be specified for a certain period of time. The AAOIFI in its Shariah Standard

No. 12, clause (3/1/6/1) state as the following;

“Each partner is entitled to terminate the Sharika (i.e. to withdraw from the partnership)

after giving partner/s due notice to this effect , in which case he shall be entitled to his share

14

An-Nawawi, Yahya Ibn Syarf, Minhaj At-Tolibin (2005) Lubnan, Dar Al-Minhaj, P. 271 15

Ibn Qudamah, Muwaffiq Addin Abdullah, Al-Kafi, (1994) Lubnan, Dar Al-Kutub Al-Ilmiyyah, Vol. 2, P. 147

19

in the partnership, and this withdrawal would not necessitate the termination of the

partnership of the remaining partners. It is permissible for the partners to enter into a

binding promise for the continuity of the partnership for a period of time. In this case, it is

permissible for the parties to agree to terminate the partnership before such a fixed period. In

all these cases, the obligations and actions that took place before termination will remain

unaffected and they will continue to exist. This rule applies to non-stock companies as

well.”16

From above mentioned arguments, it is to note that there are no Shariah requirement for both

Mudarabah and Musharakah contract to specify a maturity date. Thus, both suit well with the

key feature of Perpetual Sukuk i.e. perpetuity.

5.2 Deferral of Periodic Distribution Amount

This is among the main features of the perpetual Sukuk as to allow it to be treated like equity

structure from accounting perspective. As for the perpetual Sukuk to obtain an “equity credit”

feature is the deferment of periodic distribution to the investors. In this arrangement, the

issuer may at its sole discretion elect to make payment of all or some of a periodic

distribution on the periodic distribute date or elect to defer such payment by giving prior

notice to the Sukukholders. The deferral on Periodic Distribution Date shall not triggers a

dissolution event of the musharakah venture or the mudarabah venture..

Pursuant to practice of Sukuk Perpetual based on musharakah basically the issuer hold the

sole discretion whether to distribute the profit payment at the periodic distribution date or to

defer the distribution of realized profit payment to a later date as determined by the issuer. In

this kind of arrangement, there is arising Shariah issue as to whether this practice of deferring

the payment of realized profit in musharakah is permissible for Shariah stand point. One may

assume that this practice seemly prevents the right of the Sukukholders to claim for their

profit at the periodical distribution date, thus lead to violation of main objective of the

partnership contract (muqtadha aqd).

From the Shariah perspective, all the partners have the right to receive the realised profit at

the profit distribution date. The proportion of profit to be distributed amongst the partners

must be stated specifically and agreed upon at the time of the contract, otherwise the contract

is not valid under Shariah. Thus, once the profits in partnership are realized, then the

distribution must be made to all partners based on ratio as agreed.

16

AAOIFI Shariah Standards,p.209.

20

In this case, the author views that the practice of deferment of realized profit to other partners

is in line with Shariah requirement as it does not violates the muqtadha aqd of musharakah.

This is because basically in perpetual Sukuk, the Sukukholders agreed upon the establishment

of the partnership to grant authority to the issuer at its sole discretion to make payment of all

or some of a (profit) Periodic Distribution Amount on the Periodic Distribute Date or elect to

defer such payment by giving sufficient notice to the Sukukholders. Thus, there is no Shariah

issue as the profit of the musharakah venture are realized but only the distribution of such

realized profit is being deferred to a determined later date by the issuer. Furthermore, this

arrangement has been agreed and made known to the Sukukholders prior to subscription of

the perpetual Sukuk. This practice is acceptable from Shariah perspective as long as the

consent of all contracting parties are obtained in all circumstances. The permissibility of

practice of deferring the profit payment in partnership contract by the consent of other

partners are also mentioned by the AAOIFI in its Shariah Standard as the following;17

3/1/5/14 It is permissible, based on the articles of association or a decision of the

partners, not to distribute the profits of the company. It is also permitted to set aside

periodically a certain ratio of profit as a solvency reserve or as a reserve for meeting

losses of capital (investment risk reserve) or as a profit equalization reserve.

Their view is based on the following evidences;

a) Hadith:

المسلمون على شروطهم

“All the conditions agreed upon by the Muslim are upheld”18

In this hadith, the contracting parties may stipulate any conditions as long as the conditions

does not contravene with the Shariah requirement. In the case of perpetual Sukuk, the

deferral terms are stipulated in the terms and conditions and the relevant documentationhat

the issuer has the discretion whether to distribute or defer the realized profit payment.

b) Islamic legal maxim;

ما التزماه بالتعاقدأألصل في العقد رضى المتعاقدين ، ونتيحته هي 19

17

AAOIFI Shariah Standards, p.208. 18

Narrated by At-Tirmidzi, Source: At-Tirmidzi, ´Abu ÑIsÉ MuÍammad bin ÑIsÉ bin Saurah. (2000). Sunan At-Tirmidzi. (Beyrut: Dar al-Kutub Al-ÑIlmiyyah). Ch. 17, Hadith 1352, Vol. 2, 343. Abu Isa said this Hadith is in category of Hassan Sahih, while al-Albani validated this chain of hadith. 19

Muhammad Al-Zarqa, Sharh al-Qawaid al-Fiqhiyyah. Damsyik: Dar al Qalam, p.482.

21

“The original ruling of contract is mutual understanding by contracting parties, and

its consequences (obligation & rights) as per agreed in the contract”

The above legal maxim indicates that the mutual consent and agreement of the

contracting parties as the key element of the respective contract.

c) Quranic verse;

أيها ٱلذين ءامنوا أوفوا بٱلعقود ـ ي

“O ye who believe! Fulfill your undertakings”.20

Apart from above issue of deferral of profit under perpetual Sukuk, there are several

different circumstances on the application of deferral of profit that require further Shariah

assessment on its mechanism as provided below. The examples of application of deferral

profit distribution can be seen in MAS and MAHB Perpetual Sukuk which are based on

musharakah contract.

Notwithstanding the above, the paper wishes to highlight a pertinent issue with regards to to

deferral of profit/periodic distribution as follow:

Deferral of Unrealized Return (In case where the venture profits in shortfall of Periodic

Distribution Amount)

If there has been any shortfall of Profits rendering the same insufficient to satisfy the

payment of all or such part of the relevant Periodic Distribution Amount which would

otherwise become due and payable under the Sukuk Musharakah, or loss in the Musharakah

Venture, the Musharakah Venture shall be dissolved through an exercise of the Purchase

Undertaking, and the Exercise Price shall be applied towards investment in a new

Musharakah Venture. The accounting entries associated with the dissolution of the

Musharakah Venture and reinvestment into a new Musharakah Venture shall be made in the

books of the Managing Partner. The requirement to have accounting entries is to evidence the

constructive payment of the Exercise Price pursuant to the dissolution of the Musharakah

Venture and reinvestment of the capital into a new Musharakah Venture.

Shariah highlight:

20

Surah al Maidah: verse 1

22

If the profit is unrealized and the expected profit is not achieved, the sukukholders, pursuant

to up-front purchase undertaking, may exercise their rights under the undertaking to require

the issuer to purchase the sukukholders’ interest in the musharakah venture at agreed an

exercise price and subsequently dissolve the musharakah venture. Subsequently, the Exercise

Price shall be applied towards investment in a new Musharakah Venture.

Upon exercise of the undertaking, the Musharakah venture is technically dissolved and the

partners re-enter into a new Musharakah venture where the capital contributed by the Issuer is

amounting to the previous Musharakah capital amount plus the deferred expected profit. In

this case, since the issuer purchases the sukukholders’ interest in the initial Musharakah

venture, the payment must be in form of cash or in-kind and cannot be in form of debt. It is

because the debt does not qualify to be capital for Musharakah investment. Thus, in justifying

this practice to ensure the new capital is on cash basis, the issuer is required to reflect the

constructive payment of the Exercise Price pursuant to the dissolution of the Musharakah

Venture and reinvestment in managing its accounting records.

The sequence of events, i.e., dissolution of initial Musharakah and re-establishment of a new

Musharakah with/without additional capital (equivalent to deferred profit), to the Shariah

advisers of the respective sukuk, is sufficient to eliminate the riba issue.

5.3 Capitalisation of the Deferred Periodic Distribution Amount

In Perpetual Sukuk, the issuer has a sole right to distribute the profit payment immediately at

the time of periodic distribution date or to defer the payment to a later date. In case of

deferring the profit payment, the deferred profit amount will remain the same until the issuer

pays to the Sukukholder at the next periodic date as determined by the issuer. This may apply

to the case of Perpetual Sukuk of MAS where it is cumulative but non-capitalisation of

deferred profit. There is also situation where the deferred amount of profit will be capitalized

and the subsequent periodic distribution will be higher as a result of the capitalization. This

issue relevant to the Perpetual Sukuk of MAHB where it categorized as cumulative and

capitalisation of deferred profit amount. Pursuant to this practice, one may ask whether such

capitalization which gives rise to a higher profit/periodic distribution is tantamount to riba

nasiah since the subsequent profit becomes higher due to deferral of preceding profit. In

addition, another Shariah concern whether this is another manifestation of qalb al dayn

which is contentious from the Shariah perspective.

Shariah highlight:

23

In this case, the deferred amount of profit is capitalised whereby the Sukuk shall carry a

higher expected return until the issuer satisfies the amount of deferred profit to the

sukukholders at a later date. Such practise of capitalising the deferred amount is implemented

by the MAHB Perpetual Sukuk Musharakah as the following stated in its PTC;

Venture Profits Equal to /in Excess of Periodic Distribution Amount

If there has been sufficient Profits in the Musharakah Venture to satisfy the payment of

such part or all of the relevant Periodic Distribution Amount which would otherwise

become due and payable under the Sukuk Musharakah, under the Master Musharakah

Agreement, the Sukukholders irrevocably authorize the Managing Partner to, in its sole

discretion, reinvest all the Profits up to the value of such or all Periodic Distribution

Amount) being deferred into the Musharakah Venture as additional capital from the

Sukukholders (“Additional Capital”). Any excess of the Profits above the Periodic

Distribution Amount shall be retained by the Managing Partner in the Reserve Account

on behalf of the Sukukholders on a custody basis. Any payment of such Additional

Capital at a later date shall constitute payment of Musharakah Capital to the

Sukukholders (“Capital Payment”). Any Capital Payment made by the Issuer shall be

shared by the Sukukholders of all outstanding Sukuk Musharakah on a pro-rata basis and

the respective Sukukholders’ Musharakah Capital shall be adjusted accordingly.21

Based on above circumstance, the capitalisation of deferred profit amount is resulted from the

reinvestment activity as regarded as additional capital of the Sukukholders. The evidence

signifies the deferred profit amount utilized as an additional capital for the Sukukholders is

via the accounting entries, in which in the case of any shortfall of the relevant Periodic

Distribution Amount which would otherwise become payable, or loss in the Musharakah

Venture, the Musharakah Venture shall be dissolved through an exercise of the Purchase

Undertaking, and the Exercise Price shall be applied towards investment in a new

Musharakah Venture. The accounting entries associated with the dissolution of the

Musharakah Venture and reinvestment into a new Musharakah Venture shall be made in the

books of the Managing Partner. The requirement to have accounting entries is to evidence the

constructive payment of the Exercise Price pursuant to the dissolution of the Musharakah

Venture and reinvestment of the capital into a new Musharakah Venture.

The Shariah advisers of the respective Sukuk opine that this practice is acceptable in Shariah

and there is no issue of riba nasiah and qalb al-dayn from Shariah perspective as the

capitalization of deferred profit amount as the Sukukholder is materialized through a

21

Source: Extracted from principal, term and conditions. http://issuance.sc.com.my/MemberAccessIssuance/documents/download/1178/PTC

24

dissolution and formation of a new Musharakah venture. Furthermore, the payment of the

exercise price pursuant to the Purchase Undertaking and the re-injection of the new capital

are evidenced by an accounting entry.

5.4 Non-Payment of Profit

Drawing reference to ADIB’s Additional tier-1 Sukuk which based on mudarabah principle,

there is an issue of non-payment of profit that may lead to Shariah concern to be addressed.

In the event of non-payment of profit, generally the Sukukholders not having a claim in

respect of any periodic distribution amount not paid as a result of non- payment of periodic

distribution amount and the consequential of non-payment of any periodic distribution

amount in such circumstance shall not constitute an Event of Default. In this case also, the

issuer (mudarib) shall not have any obligation to make any subsequent payment in respect of

any such unpaid profit (whether from its own cash resources, from the Mudarabah reserve or

otherwise). This is different from the deferral of periodic distribution where the Sukukholders

still have right to claim is respect of periodic distribution amount which has been deferred by

the issuer.

Shariah highlight

With regards to the issue of non-payment of profit, there will be two scenarios that can be

highlighted which are non-profit payment in the case of non- realized Profit distribution

Amount and non-profit payment in the case of realized Profit distribution amount. If the non-

profit payment occurs in the event of non-realised of profit from the mudarabah venture, thus

there will be no Shariah issues in such practice. However, in second circumstance if there is

any realised profits accrued from the mudarabah venture and the mudarib elect to make non-

payment of profits to the rabb al-mal (investors), then there will be Shariah issues arises.

In this case, this practice might trigger Shariah issues as it may affect the muqtadha aqd of

mudarabah which is profit sharing where the Sukukholders in its capacity as rabb al mal

have no right to claim such profits. The issuer as mudarib hold the right to make or not to

make profit distribution payment based on its discretion. Although the profit sharing ratio of

mudarabah is determined earlier between the contracting parties but the payment of profits

still lies at the discretion of the issuer (mudarib).

This issue is the most contentious issue in Additional Tier 1 Capital Perpetual Sukuk. Though

some might argue that up front tanazul can be the solution, few issue new to be considered as

per below:

25

1. Can the tanazul be granted up-front where the subject of waiver have yet to be

materialized?

2. The non-payment of realized profit is considered a violation to muqtadha al ‘aqd of

Mudarabah/Musharakah. Can Tanazul be applied to justify the non-payment?

All in all, the above Tanazul issue is not exclusive to this sukuk structure and this issue

remains as unresolved issue.

5.5 Step Up Rate and Top-Up Mechanism

Similar to common Sukuk, Perpetual Sukuk initially pay the profit in accordance with the

agreed indicative rate until the first call date. After suchperiod, commonly it will have step-up

profit feature where the prevailing profit rate will be revised to include a post-call spread in

order to incentivize the issuer to exercise the Call Option at the first call date. Currently, a

step-up of 100 bps is the norm for most corporate hybrid issuers. The step-up rate might be

also been triggered upon certain time intervals.

In the same way, the periodic distribution amount may also consist the feature of top-up

where in certain provisions like change of control, change of ownership and change of

leverage ratio, wherein such periodic distribution will be revised to include an incremental

spread above the current agreed indicative rate.

Basically, there is no Shariah issue for the contracting parties in Mudarabah and Musharakah

contracts to mutually revise the profit sharing ratio as this practice has no prohibition and still

under the consent (Taradhi) of both parties. The most important requirement for the profit

sharing in Mudarabah and Musharakah contracts is that a party or some parties in the

contracts shall not been guaranteed for profit in whatever situation of the venture.

With regards of this, AAOIFI in its Standard No. 12 for contract of Sharika, clause 3/1/5/5

stated:

“It is permissible that one of the partners to agree on the adoption of any method of

allocation of profit, either permanent or variable, for example, by agreeing that the

percentages (rate) of profit shares in the first period are one set of percentages and in the

second period are another set of percentages depending on the disparity of the two periods or

the magnitude of the realised profit. This is allowed provided that using such method does

not lead to the likelihood of a partner being precluded from participation in profit.”22

Alike the previous for Musharakah contract, AAOIFI also allowed the same for Mudarabah.

In Shariah Standard No. 13 of Mudarabah, it is mentioned in clause (8/3)

22

AAOIFI Shariah Standards, p.207.

26

“The parties shall agree on the ratio of profit distribution when the contract is concluded. It

is also permissible for the parties to change the ratio of distribution of profit at any time and

to define the duration for which the agreement will remain valid”. 23

5.6 Event of Non Viability

Under Basel III capital requirement, all capital instruments issued by a financial institution

must have a loss-absorption term linked to a non-viability event. All capital instruments are

required to absorb losses at the point of non-viability (PONV) by being written off or

converted into shares.

To be more specific, BNM CAFIB defines the criteria of Additional Tier 1, which includes

among others;24

15.1(m) the provisions governing the issuance of the capital instrument require the instrument

to be written-off, or the instrument to be converted into ordinary shares, upon the

occurrence of a trigger event, which shall be determined by the requirements set out

in paragraphs 32.1 to 32.3. The amount to be written-off or converted into ordinary

shares must be the full principal value of the instrument;

15.1 (p) the instrument issued shall be structured using unrestricted non exchange

based contracts (e.g. Musharakah, Mudarabah or Wakalah), in addition to meeting

other Shariah requirements.

Non viability event will be declared by the Central Bank25

upon existence any of the

following circumstances: 26

a. the Islamic financial institution fails to follow any directive of compliance issued by

the Bank, which is necessary to preserve or restore its or the financial group’s

financial soundness;

b. the Islamic financial institution fails to meet all or any of its financial obligations as

they fall due, that may significantly impair its ability to meet regulatory capital

requirements on a continuing basis;

c. the capital of the Islamic financial institution or financial group has reached a level or

is eroding in a manner that may detrimentally affect its depositors, creditors or the

public, and the Islamic financial institution or financial group is unable to recapitalise

on its own;

d. the Islamic financial institution’s assets are insufficient to provide protection to

depositors and creditors; or

23

AAOIFI Shariah Standards p. 237. 24

BNM, Capital Adequacy Framework for Islamic Banks (Capital Components), p. 13 25

PIDM will also be the authority to declare non viability if the institution is a member of PIDM’s insurance scheme. 26

Ibid pp. 27-28

27

e. any other state of affairs exist in respect of the Islamic financial institution or

financial group that would put the interest of depositors or creditors at risk, including

the loss of confidence of depositors and the public

It this further stated in item 33.3 of BNM CAFIB that in applying the requirements in

paragraphs 15.1(j), 15.1(m) and 16.1(j):27

a. for capital instruments structured using unrestricted non-exchange based contracts

(e.g. Musharakah, Mudarabah or Wakalah), only conversion into ordinary shares is

allowed;. (b)

b. for capital instruments structured using exchange-based contracts (e.g. Murabahah,

Tawarruq or Ijarah), a write-off or conversion into ordinary shares is allowed; and

Based on the above requirements, it is noted that the write-off option is not relevant in the case

of perpetual Sukuk in the current practise, at least from the Shariah perspective. This is due to

the fact that the exchange contracts such as Murabahah or tawarruq are not compatible with the

very basic nature of perpetual sukuk, i.e., perpetuity and under non-exchange contracts such as

Musharakah and Mudarabah, thus only conversion to ordinary shares is allowed. An Islamic

financial institution may however consider the application of Ijarah contract to include a write-

off mechanism at the PONV.

From observation of the author, the conversions from Mudarabah or Musharakah Sukuk to

ordinary shares are acceptable to Shariah as both instruments are equity in nature. As for the

conversion of Musharakah Sukuk to ordinary shares is rather quite straight forward from the

Shariah perspective. The Issuer convert the Sukuk to ordinary shares and the underlying

Shariah contract which is Musharakah remains intact. In fact, this conversion would be a matter

of complying with Basel-III requirement as it would not affect the Shariah ruling applicable to

the instruments.28

For Mudarabah Sukuk, it is also acceptable to be converted to ordinary shares. Since the

Mudarabah Sukuk represents the Sukukholders’ (as rabbul mal) ownership in the Mudarabah

asset and rights to receive the agreed profit and also to bear losses, the conversion means the

Mudarabah asset owned by the sukukholders is converted to Musharakah venture as

Musharakah capital and the capital is evidenced by the ordinary shares. Consequently, that the

earlier mudarabah is dissolved. It is worth noting that the conversion event has been agreed up-

front by the Issuer and the Sukukholders at point of subscription of Mudarabah Sukuk.

27

Ibid p. 29 28

ISRA Research Paper no 52/2013, p. 36

28

5.7 Redemption of Perpetual Sukuk

In terms of redemption, there are various events that may lead to redemption of the perpetual

Sukuk. It is allowable for the Issuer to redeem the Sukuk after certain specified period e.g.,

non-call protection period of 5 years. Under the current perpetual sukuk structures, the

redemption is done via exercising the Sale Undertaking and Purchase Undertaking. The Sale

Undertaking is granted by the Sukukholders and the Purchase Undertaking is granted by the

Issuer.

For example, in the PTC of MAHB Sukuk Musharakah, the Sukuk Trustee (on behalf of the

Sukukholders) will provide a Master Sale Undertaking, pursuant to which the Issuer shall

have the right to early redeem the Sukuk Musharakah under:29

i. Redemption at the option of the Issuer;

ii. Redemption for tax reasons;

iii. Redemption upon a rating event;

iv. Redemption for accounting reasons;

v. Redemption for tax deductibility;

vi. Redemption in the case of Minimal Outstanding Amount;

vii. Redemption upon a Change of Control; and

viii. Redemption upon a Revocation of License.

On the other hand, the dissolution of MAHB Sukuk Musharakah pursuant to the Purchase

Undertaking include the following events:

i. the date of Winding-up of MAHB; and

ii. the Periodic Distribution Date in respect of which MAHB has elected to defer payment

of all or part of the Periodic Distribution Amount due on such Periodic Distribution

Date, where there is a shortfall of Profits described above.

However, under Basel-III requirement, redemption of Additional Tier 1 capital instruments

inclusive of perpetual Sukuk cannot be redeemed except with prior approval from the

regulator.30

In addition, the Issuer shall not give any impression to the market that they will

redeem the sukuk.31

With regards to Purchase Undertaking and Sale Undertaking, upon invocation of the

undertakings, the Issuer and the Sukukholders will execute sale and purchase contract for

purchase of the Sukukholders’ interest in the musharakah venture at a purchase price which is

29

MAHB PTC, p.9 30

Ibid, p. 16, IFSB, p. 8 31

IFSB, p 8

29

known as exercise price. The Purchase Undertaking and Sale Undertaking are considered two

separate unilateral promises (wa’dan) instead of being deemed as bilateral promise

(muwa’adah). Each undertaking is not inter-related and its application relates to two different

conditions which consequently lead to two different effects. While muwa’adah is not

accepted by international Shariah boards such as AAOIFI Shariah Council and the

International Fiqh Academy, wa’dan has been widely practised in global Sukuk market and it

is allowed by many Shariah boards.

The undertakings to acquire or purchase the interests or ownership of other parties are not

violating the tenets of Mudarabah and Musharakah. With regards to Mudarabah contract,

AAOIFI Shariah Standard No. 13 (4/4/3) stipulates the following:

“The general principle is that a Mudharabah contract is not binding, i.e. each of the

contracting parties may terminate it unilaterally except in two cases:

a. When the Mudarib has already commenced the business, in which case of Mudarabah

contract becomes binding up to the date of actual) تنضيض حقيقي ) or constructive

liquidation (تنضيض حكمي)

b. When the contracting parties agree to determine a duration for which the contract

will remain in operation. In this case, the contract cannot be terminated prior to the

end of the designated duration, except by mutual agreement of the contracting

parties.”

Similarly under Musharakah, the Musharakah venture may be dissolved based on agreement

by the transacting parties. BNM Musharakah Standard stipulates in item 24.1 that “a

musyarakah contract is dissolved under the following circumstances:32

a. mutual agreement to terminate;

b. contract expires upon the maturity date agreed by the partners;

c. demise or dissolution of partners;

d. loss of legal capacity;

e. the total acquisition by one partner of the other partners’ share of musyarakah; or

f. Invalidity of musyarakah”.

For avoidance of doubt, the issue of pre-determined formula pursuant to Sale Undertaking or

Purchase Undertaking remains as a contentious issue.

5.8 Other Related Issues

Apart from abovementioned issues related to Perpetual Sukuk, it is worth noting that the

Perpetual Sukuk also inherited some general Shariah concerns relating to a straight Sukuk

32

BNM Musyarakah Standard, p 20

30

structure amongst others issue on subordination, beneficial ownership, recourse to the

underlying assets in Sukuk, purchase undertaking (wa`d), rebate (ibra’) in sale-based sukuk,

liquidity facility, tradability of sale based Sukuk and portfolio of assets as underlying assets

in Sukuk. These issues are not been discussed in this paper and still remained important

issues to be addressed by other studies. Owing to that, due to uniqueness of the Perpetual

Sukuk compared to other Sukuk this paper rather serve to discuss on some of the pertinent

Shariah issues of Perpetual Sukuk that do not arise in common Sukuk structures.

6.0 CONCLUSION

As the Perpetual Sukuk are recognised as one of the new landmark in Sukuk headway, there

is room of discussion need to be galvanised in order to ensure the conformity of the practices

with Shariah requirements. This is also rooted from the given distinct requirements outlined

by the Basel-III for the Additional Tier-1 Capital instruments which been the underlying

foundation for the Perpetual Sukuk for financial institutions. This paper has highlighted

some of the pertinent issues to be urgently addressed to ensure the practices of perpetual

Sukuk is in line with Shariah principles. To achieve this goal, the involvement and

commitment of all stakeholders including the Shariah experts, regulators, industry players

and investors are required.