SECURITIZATION

By Dr. Muhammad Imran

Usmani

PresenPresentation Outline

• Introduction

• Shari’a Perspective on Securitization

• Types of Sukuk

• Securitization of Musharakah

• Securitization of Murabaha

• Securitization of Ijarah

PresenIntroduction

• In normal conventional market, security is a document, representing receivable amounts owed by the issuer in favor of the holder.

• Normally the amounts secured by a security are interests bearing loans.

Different kinds of securities

Bonds issued by a companyBonds issued by a governmentDebenturesCertificatesNotesTreasury Bills

PresenShari’a Perspective

• Securities representing a loan or debt (such as bonds) cannot be sold or purchased.

• If they are sold at a price higher or lower than their face value, it is considered as “Riba”

• If they are purchased at their face value (Bai al Dayn), this involves “Gharar” and hence prohibited.

• However, securities may be assigned to a third party at par value.The difference between sale and assignment (HAWALA) is that transfer in HAWALA is with recourse while transfer in Sales in without recourse.

PresenSecuritization

Definition

“Issuing certificates of ownership, against an asset, investment pool or business enterprise.”

• If the securities represent the proportionate ownership of the holder in illiquid or tradable assets, the trade of such securities is permissible.

• The sale of such security will be tantamount to the sale of holder’s proportionate share in the assets.

PresenTypes of Sukuk

Ijara Sukuk

Sukuk of ownership in leased assetsIssued with the aim of selling the asset so that holders of Sukuk become owners of the assets.

Sukuk of ownership of usufructs of assetsIssued with the aim of leasing the asset so that holders of Sukuk become owners of the usufruct of the assets.

Sukuk of ownership of servicesIssued for the purpose of providing services through a specified provider so that Sukuk holders become owners of these services.

PresenTypes of Sukuk

Musharaka SukukIssued with the aim of using the mobilized funds for establishing a new project, developing an existing project or financing a business activity on the basis of any of partnership contracts.

Participation certificates – represent projects or activities managed on the basis of Musharaka.

Mudaraba Sukuk – represent projects or activities managed on the basis of Mudaraba.

Investment Agency Sukuk – represent projects or activities managed on the basis of an investment agency by appointing an agent to manage the operation.

PresenTypes of Sukuk

Murabaha SukukIssued for the purpose of financing the purchase of goods through Murabaha so that Sukuk holders become the owners of Murabaha Commodity

Salam SukukIssued for the purpose of mobilizing funds so that the goods to be delivered on the basis of salam come to be owned by the Sukuk holders

Istisna’ SukukIssued for the purpose of mobilizing funds to be employed for the production of goods so that the goods produced come to be owned by the Sukuk holders

PresenTypes of Sukuk

Muzara’a (sharecropping) / Musaqa (irrigation) Sukuk

Issued for the purpose of using the mobilized funds for financing a project so that Sukuk holders become entitled to a share in the crop as per the agreement.

Mugharasa (agricultural) SukukIssued for the purpose of mobilizing funds so that Sukuk holders become entitled to a share in the land and plantation.

Securitization of Musharakah

PresenMusharakah Securitization

• Musharakah is a mode of financing which can be securitized easily.

• Especially in case of big projects where huge amounts are required.

• Every subscriber can be given a Musharakah certificate, which represents his proportionate ownership in the assets of the Musharakah.

• After the project is started, these Musharakah certificates can be treated as negotiable instruments. Certificates can be bought and sold in the secondary market.

PresenMusharakah Securitization

Essential Conditions

• Profit earned by the Musharakah is shared according to an agreed ratio.

• Loss is shared on pro rata basis.

• All the assets of the Musharakah should not be in liquid form. Portfolio of Musharakah should consist of non-liquid assets valuing more than 33% of its total worth.

PresenMusharakah Securitization

Essential Conditions

• However, if Hanafi view is adopted, trading will be allowed even if the non-liquid assets are less than 33% but the size of the non-liquid assets should not be negligible.

• Whenever there is a combination of liquid and non-liquid assets, it can be sold and purchased for an amount greater than the amount of liquid assets in combination.

PresenDifference

Musharakah Certificates

• Represents the direct pro rata ownership of the holder in the assets of the project.

• If all the assets of the joint project are in liquid form, the certificate will represent a certain proportion of money owned by the project.

Conventional Bond

• Has nothing to do with the actual business undertaken with the borrowed money.

• The bond stands for a loan repayable to the holder in any case, and mostly with interest.

PresenMusharakah Securitization

Securitization of Musharakah can be used for:

• Construction of Projects and factories

• Expansion Projects

• Working Capital Finance

Securitization of Murabaha

PresenSecuritization of Murabaha

• Murabaha is a transaction, which cannot be securitized for creating a negotiable instrument to be sold and purchased in secondary market.

• However, if the Murabaha paper is transferred, it must be at par value; not more, not less.

• A mixed portfolio consisting of a number of transactions including Murabaha, may issue negotiable certificates subject to certain conditions.

PresenConditions

• In Murabaha Securitization, pool of asset should consist of Ijarah valuing more than 33% of its total worth.

• However, as described earlier if Hanafi view is adopted, trading will be allowed even if the non-liquid assets are more than 10% of its total worth.

• Investors will have a Mudaraba relationship with the Manager of the Pool.

PresenConditions

• Investors in the pool will have Musharakah relationship and each one will be proportionate owner of the pool.

• Profit will be shared according to an agreed ratio between the Pool and the Manager.

• Share of the pool will be further divided among the investors according to the rules of Musharakah.

Securitization of Ijarah

PresenSecuritization of Ijarah

• It is possible to create a secondary market instrument for the financiers on the basis of Ijarah.

• The lessor (owner) can sell the leased asset wholly or partly either to one party or to a number of individuals to recover his cost of purchase of the asset with a profit thereon.

• This purchase of a proportion of the asset by each individual may be evidenced by a certificate, which may be called 'Ijarah certificate’.

PresenSecuritization of Ijarah

• Ijarah certificate represents the holder's proportionate ownership in the leased asset.

• The holder will assume the rights and obligations of the owner/lessor to the extent of his ownership.

• The holder will have the right to enjoy a part of the rent according to his proportion of ownership in the asset.

PresenSecuritization of Ijarah

• In the case of total destruction of the asset, he will suffer the loss to the extent of his ownership.

• These certificates can be negotiated and traded freely in the market and can serve as an instrument easily convertible into cash.

• Essential Condition

“It’s essential that the Ijarah certificates are designed to represent real ownership of the leased assets, and not only a right to receive rent.”

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