sukuk and securitization

Sukuk and Securitization: Vital Issues in Islamic CapitalMarkets

Sigit S.Wibowo

November 24th, 2008

Sigit S.Wibowo () Prog. Ekstensi Manajemen-FEUI November 24th , 2008 1 / 24

Contents

1 Introduction2 The Capital Market in an Islamic Framework3 Securitization and Sukuk


Introduction

The growth of Islamic banking and �nance has gained momentumduring the last decade, particularly in the areas of Sukuk andsecuritization

Sukuk are gaining popularity as an alternative source of funding,particularly for sovereigns and corporate bodies

The major requirement for making an investment certi�cateShar¬�ah-compliant is that it should not represent interest-bearingdebt as dominant part of the underlying assets

Like the two categories of modes in Islamic �nance, i.e. participatoryand �xedreturn/debt-creating, Sukuk or investment instruments canalso be variable-return Sukuk (VRS) and �xed-return Sukuk (FRS)


Introduction

MUI Fatwa


The Capital Market in an Islamic Framework

The salient features of the capital market comprises debt, equity andthe Sukuk markets

An equity market, commonly known as a stock market, is the tradingplace for the stocks of joint stock companiesA debt market, which deals in debentures and bonds, normally involvesRiba and Gharar and, therefore, is not an active part of Islamic�nancial markets, except for debts that can only be assigned to otherson a par value without transferring the risk of default

Key components of an Islamic capital market are Shar¬�ah-compliantstocks, Islamic funds and Sukuk/Islamic investment certi�cates

An Islamic capital market can be developed by developing Sukuk,introducing Islamic depository receipts (IDRs) at a mass level,replacing debt �nancing with Shirkah-based indirect and direct�nancing, securitization and fund management


Advantages of IDRs

For the originators

expansion of investor baselow cost of funds in highly liquid marketsbetter image of securities by trading in more organized markets

For the investors

diversi�cation of portfolio in other marketsIFIs to have Shar¬�ah-compliant stockshigher returns for IFIs than conventional placements in Murabaha;liquidity management facility for IFIs.

Institutions supporting IDR development include

Islamic Development Bank (IDB)International Islamic Financial Market (IIFM)rating agenciesInternational Financial Services Board (IFSB)local regulatory bodiesIslamic �nancial institutions


Securitization and Sukuk

Today, �nancial institutions increasingly resort to securitization, whichis a process of pooling/repackaging the nonmarketable and illiquidassets into tradable certi�cates of investment

Securitization transforms the originator�s role from being anaccumulator to that of a distributor


Securitization and Sukuk (cont�d)

The ownership of the securitized assets is transferred to a specialpurpose vehicle (SPV) or special purpose Mudarabah (SPM) that isset up for the dual purpose of managing the assets on behalf of theSukuk holders and for the issuance of the investment certi�cates

Islamic �nancing being asset-backed by nature, provides ampleopportunities for issuance of Sukuk on the basis of assets alreadybooked by IFIs or by purchasing the assets with proceeds of a varietyof Sukuk created on the principle of Shirkah

Securitization involves evaluating, isolating and e¢ ciently allocatingspeci�c risks, evaluating the taxation, accounting and legalimplications, designing appropriate credit enhancement structures andpricing the (residual) risk for pricing the units of the securitized assetsor pools


Parties to Sukuk Issue/Securitization

Key players in various issues of Sukuk are:

The originator or the issuer of Sukuk, who sells its assets to the SPVand uses the realized fundsThe SPV �an entity set up speci�cally for the securitization processand managing the issueInvestment banks �as issue agents for underwriting, lead managingand book-making services for Sukuk against any agreed-upon fee orcommissionSubscribers of Sukuk �mostly central banks, Islamic banks and NBFIsand individuals who subscribe to securities issued by the SPV


Parties to Sukuk Issue/Securitization (cont�d)

Other parties to the general securitization process may include

the obligorthe lead managerthe servicerthe cash administrator or receiving and paying agentthe credit enhancement providerthe legal and tax counselthe auditorthe custodian/R&T agents


Classes of Securitized Papers

asset-backed securitization (ABS)

pool-based securitization:

mortgage-backed securitizationCDO/CLO: collateralized debt/loan obligations (notShar¬�ah-compliant unless subjected to the rules of Hawalah)lease rentals securitization (for Shar¬�ah-compliance of Ijarah Sukuk,ownership of the assets must also be transferred to the Sukuk holders)

future �ow securitization (FFS):

securitization of receivables to be generated in futureroad toll securitization (transfer of pro rata ownership to Sukuk holdersnecessary for Shar¬�ah compliance)telecom receivable securitizationcredit card receivable securitization (not Shar¬�ah-compliant unlesssubjected to the rules of Hawalah)


Flow Diagram of the Securitization Process

A �ow diagram of the typical securitization process


Special Purpose Vehicle (SPV)

SPVs are formed as separate legal entities for the speci�ed purpose ofmanaging the securities issues pool-based securitization

The legal structure of an SPV depends upon the regulatory and legalenvironment in which it has to work

Once the ownership has been transferred to the SPV, the discretionof the original owner in respect of the asset comes to an end, and itcannot be reversed in the case of insolvency of the original owner orotherwise

Alternative payment structures adopted by SPVs include

the �pass-through structure��the SPV remits any funds collectedcompletely and immediately to the investorsthe �pay-through structures��desynchronization of servicing of thesecurities from the underlying cash �ows


Securitization Mitigates the Risks

Originator�s perspective:

mitigates liquidity risk of an illiquid assetreduced cost of fundingtakes assets o¤ balance sheet, without loss of usereduced cost of �nance if SPV is serving as multiple originators bypooling assets

Investors�perspective:

foreign exchange risk is reduced if underlying asset is denominated inmultiple currenciespooling of diversi�ed assets with heterogeneous risk mitigates earningsriskundivided ownership of the asset is an added protection


Shar¬�ah Bases of Sukuk Issue

Types of investment certi�cates or Sukuk: the AAOIFI, Shar¬ahStandard for Investment Sukuk):

Sukuk of ownership in leased assets: further divided into Sukuk ofownership of usufruct of existing assets, Sukuk of ownership ofdescribed future assets, Sukuk of ownership of services of a speci�edparty and Sukuk of ownership of described future servicesSalam SukukIstisna�a SukukMurabaha SukukMusharakah Sukuk: further divided into participation certi�cates,Mudarabah Sukuk and investment agency SukukMuzara�ah (share-cropping) SukukMusaqah (projects involving irrigation of fruit-bearing trees) SukukMugharasah (projects involving plantation of gardens) Sukuk


Shar¬�ah Bases of Sukuk Issue (cont�d)

Most of the Sukuk issues so far are based on the concept of Ijarah,while a few Sukuk are based on Shirkah, Salam or pooled assets

A number of Sukuk issues are subject to severe criticism due to theinvolvement of Bai�al �Inah, Bai�al Dayn and other non-Shar¬�ahcompliant traits that make the Sukuk as good or as bad asinterest-based bonds

Sukuk issues of Malaysia are mostly based on the concepts of Bai�al�Inah of underlying assets and the concept of Tabarru�(donation tothe investor irrespective of the cash �ow of the project underlying theSukuk or certi�cates), while their trading in the secondary markettakes place through Bai�al Dayn. (Lately, they have also been issuingIjarah Sukuk, which is a healthy development.)


Tradability of Sukuk in the Secondary Market

Mudarabah/Musharakah certi�cates or Sukuk

Tradable at market price after the commencement of the activity forwhich the funds were raised

Ijarah Sukuk based on freehold existing assets

Tradable at market price

Ijarah Sukuk of existing assets subject to head lease

Tradable at market price or at a rate agreed upon at the date ofredemption

Ijarah Sukuk based on future tangible assets

Tradable at market price only after the asset is ascertained and leased


Tradability of Sukuk in the Secondary Market (cont�d)

Sukuk based on existing speci�ed servicesTradable prior to sub-leasing of such services

Sukuk based on described future servicesTradable at market price only after the source of the service isascertained

Salam SukukNot tradable except at the face value

Istisna�a SukukTradable if funds converted into assets and before sale to the orderer

Sukuk issued on Mudarabah basis for Murabaha sales �MurabahaSukuk

Tradable before sale of the goods to the end-buyer or if receivables (ifinventory is maintained) are less than 50 %; after sale of the goods andwithout inventory of more than 50%, tradable only at face value withrecourse


Issues in Terms and Structures of Sukuk

Issues concerning for more vigorous and sustained support for theemerging �nancial system

Pre�xed rates of return in almost all Sukuk, in some cases evenwithout any provision for third party guaranteeA number of contracts are combined in one arrangement of Sukukissue in such a way that they are interdependent on one another, whichmake Shar¬�ah-compliance at stakeMost of the issues lack transparency in respect of documentation andrights and liabilities of various parties to the issue


Sekuritisasi Aset Bagi Bank Umum

Mekanisme sekuritisasi aset bagi bank umum (konvensional)

PENYEDIAJASA

KREDITURASAL

(BANK)

PENERBIT EFEKBERAGUN ASET EFEK BERAGUN

ASET

RATING AGENCY

DEBITURTata usaha asetuntuk kepentinganPenerbit EBA

Pembelian kembaliDana Tunai/EBA 4

1 Asset keuangan

KREDIT PENDUKUNG

FASILITAS LIKUIDITAS

INVESTOR

Meningkatkan kualitasasset keuangan

Mengatasi mistmatchkewajiban pembayaran kepadapemodal

2

3

Rating EBA



Aset keuangan yang dialihkan dalam rangka Sekuritisasi

Aset wajib berupa aset keuangan yang terdiri dari kredit, tagihan yangtimbul dari surat berharga, tagihan yang timbul di kemudian hari(future receivables) dan aset keuangan lain yang setara

Aset keuangan yang dialihkan wajib memenuhi kriteria sebagai berikut

memiliki arus kas (cash �ows)dimiliki dan dalam pengendalian Kreditur Asaldapat dipindahtangankan dengan bebas kepada Penerbit



Fungsi Bank dalam Sekuritisasi

Kreditur AsalPenyedia Kredit PendukungPenyedia Fasilitas LikuiditasPenyedia JasaBank KustodianPemodal

Persyaratan

tidak menyebabkan rasio KPMM Bank lebih rendah dari ketentuanyang berlakusesuai dengan PBI No. 7/4/PBI/2005 dan SE No. 7/51/DPNP danprinsip kehati-hatianuntuk KPR, Peraturan Presiden RI No. 19 Tahun 2005 tentangPembiayaan Sekunder Perumahan


Artikel

Bisnis Indonesia

KOMPAS, Selasa, 09 Mei 2006, Depkeu Kurang Dukung SPV NPL:Sekuritisasi Bisa Tingkatkan "Recovery Rate"


Reference

Muhammad Ayub (2007), Understanding Islamic Finance. WestSussex, U.K.: John Wiley & Sons Ltd. (Chapter 15)


sukuk and securitization

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