Sukuk Al Ijarah In sukuk ijarah, unlike sale contracts that the transfer of ownership happens instantly.

Ijarah contracts do not transfer ownership on its own. It istransfer of the usufruct of an asset to another person in exchange for a rent claimed from him or, more literally, a lease. The most common structure of sukukijarah applied in the market is a sale and leaseback structure. Thus, an issuer that wants to raise sukuk would have to identify assets to sell and leaseback. For example, in case of Malaysia Global Sukuk, sale of beneficial title transfer to sukuk holder and SPV (Federal Land Commision ) holds the legal title in order to ensure benefit of the investors. In order to generate returns for investors,sukuk structures rely upon either the performance of an underlying asset or a contractual arrangement with respect to that asset. The ijara is particularly useful in this respect as it can be used in a manner that provides for regular payments throughout the life of a financing arrangement, together with the flexibility to tailor the payment profile - and method of calculation - in order to generate a profit. In addition, the use of a purchase undertaking is widely accepted in the context of sukuk al-ijara without Sharia objections. These characteristics make ijara relatively straightforward to adapt for use in the underlying structure for a sukuk issuance. Overview of Structure: Issuer SPV issues sukuk, which represent an undivided ownership interest in an underlying asset or transaction. They also represent a right against Issuer SPV to payment of the Periodic Distribution Amount and the Dissolution Amount.

The Investors subscribe for sukuk and pay the proceeds to Issuer SPV (the Principal Amount). Issuer SPV declares a trust over the proceeds (and any assets acquired using the proceeds) and thereby acts as Trustee on behalf of the Investors. Originator enters into a sale and purchase arrangement with Trustee, pursuant to which Originator agrees to sell, and Trustee agrees to purchase, certain assets (the Assets) from Originator. Trustee pays the purchase price to Originator as consideration for its purchase of the Assets in an amount equal to the Principal Amount. Trustee leases the Assets back to Originator under a lease arrangement (ijara) for a term that reflects the maturity of the sukuk. Originator (as Lessee) makes Rental payments at regular intervals to Trustee (as Lessor). The amount of each Rental is equal to the Periodic Distribution Amount payable under the sukuk at that time. This amount may be calculated by reference to a fixed rate or variable rate (e.g. LIBOR or EIBOR) depending on the denomination of sukuk issued and subject to mutual agreement of the parties in advance. Usually issuer SPV pays each Periodic Distribution Amount to the Investors using the Rental it has received from Originator. Upon an event of default or at maturity (at the option of Trustee under the Purchase Undertaking); or the exercise of an optional call (if applicable to the sukuk) or the occurrence of a tax event (both at the option of Originator under the Sale Undertaking), Trustee will sell, and Originator will buy-back, the Assets at the applicable Exercise Price, which will be equal to the Principal Amount plus any accrued but unpaid Periodic Distribution Amounts owing to the Investors. Payment of Exercise Price by Originator (as Obligor).

Issuer SPV pays the Dissolution Amount to the Investors using the exercise price it has received from Originator.Trustee and Originator will enter into a service agency agreement whereby Trustee will appoint Originator as its servicing agent to carry out certain of its obligations under the lease arrangement, namely the obligation to undertake any major maintenance, insurance (or takaful) and payment of taxes in connection with the Assets. To the extent that Originator (as Servicing Agent) claims any costs and expenses for performing these obligations (the Servicing Costs) the Rental for the subsequent lease period under the lease arrangement will be increased by an equivalent amount (a Supplemental Rental). This Supplemental Rental due from Originator (as Lessee) will be set off against the obligation of Trustee to pay the Servicing Costs. Key Features of the Underlying Structure: The consideration (Rentals) must be at an agreed rate and for an agreed period; the subject of the ijara must have a valuable use (i.e. things without a usufruct cannot be leased) The ownership of the asset(s) must remain with the Trustee and only the usufruct right may be transferred to the originator (therefore anything which can be consumed cannot be leased by way of an ijara). As ownership of the asset(s) must remain with the Trustee, the liabilities arising from the ownership must also rest with the Trustee (as owner) - an asset remains the risk of the Trustee throughout the lease period (in the sense that any harm or loss caused by the factors beyond the control of the Originator is borne by the Trustee). Any liabilities relating to the use of the asset(s), however, rest with the Originator (as lessee). The Originator (as lessee) cannot use an asset for any purpose other than the purpose specified in the ijara (or lease) agreement (if no purpose is specified, the Originator can use

such asset for the purpose it would be used for in the normal course of its business). The asset(s) must be clearly identified in the ijara (and identifiable in practice). Rental must be determined at the time of contract for the whole period of the ijara. Although it is possible to split the term of the ijara into smaller rental periods where different amounts of rent may be calculated for each such rental period, the amount of rental must be fixed at the start of each such rental period and Sharia will consider each rental period as a separate lease. If an asset has totally lost the function for which it was leased, and no repair is possible, the ijara shall terminate on the day on which such loss (a Total Loss) has been caused. If there has been a total loss, the trustee may have the right/ability to substitute or replace the affected asset - although, in reality, it would only look to do so if the Originator (as service agent) is able to use the insurance (or takaful) or any other total loss proceeds to procure substitute or replacement assets. If a total loss is caused by the misuse or negligence of the Originator, the Originator will be liable to compensate the trustee for depreciation in the value of the affected asset, as it was immediately before such total loss, and In the event that an asset has only suffered partial loss or damage, the ijara will continue to survive with respect to that asset.The above requirements are based on the principles set out in Accounting and Auditing Organization for Islamic Financial Institutions (the AAOIFI) ShariaStandard No. 9 (Ijarah and IjarahMuntahiaBittamleek) and other established principles relating to Ijara.

Sukuk al-Istisna: Istisna is a contractual agreement for manufacturing goods and commodities, fallowing cash payment in advance and future delivery or a future payment and future delivery. A manufacturer or builder agrees to produce or build a well described good or building at a given price on a given date in the future. Price can be paid in installments, step by step as agreed between the parties. Istisna can be used for providing the facility of financing the manufacture or construction of houses, plants, projects, and building of bridges, roads and highways (Shaukat, 2010). In addition, Istisna sukuk are certificates that carry equal value and are issued with the aim of mobilizing the funds required for producing products that are owned by the certificate holders. The issuer of these certificates is the manufacturer (supplier/seller), the subscribers are the buyers of the intended product, while the funds realized from subscription are the cost of the product. The certificate holders own the product and are entitled to the sale price of the certificates or the sale price of the product sold on the basis of a parallel Istisna, if any. Istisna Sukuk is quite useful for financing large infrastructure projects (Nisar, 2005). Istisna' sukuk for the finance of their development projects and this could be executed in two forms: Parallel Istisna

Originator establishes an intermediary (SPV) and transfers the functions of finance and executing the project via an Istisna contract then pays the price of the contract by Istisna sukuk with certain maturity dates. Issuer of securities also, according to a different Istisna contract orders those particular projects to the contractor and undertakes to pay for the price of the contract in due course. SPV also sells the Istisna sukuk to the investors via an investment bank and pays its debt to the contractor. Istisna and Ijarah Al-muntahi Bi-ttamlik

In this model, originator establishes an intermediary firm (SPV) and undertakes to receive a particular commodity or project supplied by this firm in form of Ijarah Al-muntahi Bittamlik. The SPV also orders the commodity or project to a contractor to be manufactured according to an Istisna contract and undertakes to pay the price in due course, then offers the Istisna sukuk to the public via an investment bank and collects the funds and pays for its debts to the contractor. The SPV receives the commodity or project from the contractor and gives it to the originator in form of Ijarah Al-muntahi Bi-ttamlik on behalf of the owners of securities. The secondary market for Istisna sukuk and Ijarah sukuk will be on the basis of trading a title deed of a physical asset and there is no legal and jurisprudential problem (Musavian& Zehtabian, 2009). Istisna Sukuk in Practice Tabreeds five-year global corporate Sukuk (on behalf of the National Central Cooling Company, UAE) provided a fixed coupon of 5.50%. It is a combination of Ijara Istisna and Ijara Mawsufah fi al dhimmah (or forward leasing contracts). The issue was launched to raise funds to retire some existing debt, which totals around US$136 million, as well as to finance expansion. The Durrat Sukuk will finance the reclamation and infrastructure for the initial stage of a broader US$ 1 billion world class residential and leisure destination known as 'Durrat Al Bahrain', currently the Kingdom of Bahrain's largest residential development project. The return on the Sukuk is 125 basis points over 3 months LIBOR payable quarterly, with the Sukuk having an overall tenor of 5 years and an option for early redemption. The proceeds of the issue (cash) will be used by the Issuer to finance the reclamation of the land and the development of Base Infrastructure through multiple project finance (Istisna) agreements. As

the works carried out under each Istisna are completed by the Contractor and delivered to the Issuer, the Issuer will give notice to the Project Company under the Master Ijara Agreement and will lease such Base Infrastructure on the basis of a lease to own transaction (Nisar, 2005). General step involved in the structure. 1. SPV issues Sukuk certificates to raise funds for the project. 2. Sukuk issue proceeds are used to pay the contractor/builder to build and deliver the future project. 3. Title to assets is transferred to the SPV. 4. Property/project is leased or sold to the end buyer. The end buyer pays monthly

installments to the SPV. 5. The returns are distributed among the Sukuk holders

Figure: 1 Structure of Sukuk Istisna

Key Features of the this Structure Set out below is a summary of the basic requirements that should be considered when using a combination of Istisna and forward leasing as the underlying structure for the issuance of sukuk: The price and specifications for the good or asset need to be specified at the outset; It is quite common for the purchaser to split the purchase price (paid in advance) into staged payments that correspond to certain milestones that are agreed upfront with the contractor; Although it is not necessary to fix the time of delivery under the Istisna, the purchaser may elect to fix a maximum time for delivery - this essentially means that, if the contractor delays delivery after the scheduled completion date, the purchaser will not be bound to accept the goods and to pay the price;

 Liquidated damages provisions may be included in order to incentivize the contractor to deliver on schedule (and to mitigate late delivery risk); Although not universally accepted, the majority of Shariah scholars consider forward leasing permissible on the understanding that: advance rentals are taken into account (as rental which has been paid) and have to be refunded in full if the assets are never actually delivered for leasing. Such matters have to be carefully addressed in the documentation in order to ensure that the commercial deal is not disturbed: for example, by careful calculation of any termination payments that are triggered if a termination occurs pre-delivery (DIFC, 2009).

Case study of zamzam sukuk: Zamzam Tower is one of first Munshaats projectcs and one of the largest real estate projects in the region. It is one of the biggest towers in the project of Abraj Al-Bait, within the endowments of King Abdullaziz , assigned for serving the Two Holy Mosques Ajyad Castle. The project is established on a plot owned by the endowments of King Abdullaziz, assigned the Two Holy Mosques. It is the first of its kind in Makkah Al-Mukarramah based on the (B.O.T) system. The usufruct is for 25-Hijri years. The leased part of the tower is 33 floors, which includes 1315 residentials units. The tower is highly characterized by its architectural design that matches the atmostphere of Makkah Al-Mukurramah, and the direct

view of the Holy Mosque. It is also only 150 metres away from King Abdulazizs gate. Zamzam Tower is supported by 36 elevators to work according to smart advanced systems. The background of the Special Purpose Vehicles: Munshaat Real Estate projects Co. (K.S.C.C) Munshaat Real Estate projects Co. (K.S.C.C) was established on the 8th of April 2003, with a current paid up capital of KD 32.2 Million, divided into 322 Million shares, by its main founders AREF investment Group and The International Leasing and investment Company (ILIC). The business of Munshaat mainly focus on the local and international Real Estate industry through the professional development and management of real estate products, managed in a professional and specialized manner targeting lucrative and nontraditional markets and employing the best investment tools which comply with the Islamic essential, in addition contributing in the investment projects through B.O.T basis. Why did the issuer decide to select a forward Ijarah contract? In the case of sukuk zamzam tower, munshat company has issued sukuk forward Ijarah and the proceeds will be used to fund infrastructure projects on land neighboring to the Holy Mosque in Makah. This strcture according to time-sharing financing and its future-use was the first in the Kingdom and the region. This project gained the support of the Saudi Council of Ministers and the Shoura Council. . All contracts and agreements come under Saudi law and have been scrutinized by both Saudi and international law firms. The law of Saudi Arabia does not allow for foreigner to own land or property that is located on the holy city Makah. This was the main obstacle and challenge facing munshat company to start their project under this law hence the foreigner investors cannot invest in this project under the popular transaction on that time which it depend on assets-backed. Because of this issue munshat

company start looking for another alternative that can underling this project can be complied with shariah law and in the same time Saudi Arabia law. One of the unique contracts on the Islamic law of contract is forward Ijarah, this contract is combined from two transactions one is Istisna and the other is Ijarah. Using this transaction was the solution of the issue of ownership to enable the foreigner investor to invest and enjoy the stay at the holy city for all Muslim around the world. Under this transaction munshat company has issued sukuk al_intifa which enable the local and foreigner investors to hold this sukuk which give them beneficial ownership and not real ownership of the estate. Issues and the opinion of scholars regarding to Forward Ijarah Zukuk:
The forward Ijarah contract is similar to Istisna contract in terms of conditions but the only difference with this contract is the subject matter not real estate but only usufruct.

The opinion of shriah scholars on the validity of forward Ijarah:

Hanafi: They did not accept this type of contract, because firstly, they do not consider ad

recognize USUFRUCT as a subject matter. The usufruct is not in existence The subject matter in not exist in time of the contract. Based on this opinion, who considered this type contract might fall into the debt that cannot be tradable and negotiable.
The rest of schools of thought in consensus of opinion that they approve this contract some of them differ in the matter of payment, they emphasize on the immediate payment because they are

justifying the impact of deferred payment may lead to sale debt for debt, which is not allowed in islam, while other allowed deferred payment based on basis of analogy of Istisna contract. In the other hand some scholars claiming that this Sukuk is only money and still not backed by asset, so it is still jus tradt money as a result cannot be tradable that comes within prohibitation riba. This Sukuk cannot be tradable until the project is completed.

First issue is that the lessor have to ensure that scholars are consensus of opinion that, if the lessor failed to facilitate the benefit of lease meaning benefit of enjoying his right, lessor has

to pay compensation. In this case, we see the exercise of this ruling when munshaat failed to complete the project within two years as mentioned in the contract, they extend the period for two more years.
Second issue that enabling the Lessee to benefit from the usufruct enjoyment on the agreed time is considered as one of the main condition of the validity of this contract and any break or delay on enabling the lessee to use that assets the lessor will be obligated to compensate the lessee.

The Main Features of Zamzam Tower Sukuk: Country Sukuk Name Name of Issuer Name of Originator/Obligor Date of Issue Issue size Tenor (years) Listing Status USD 390 millions 24 years Registered Listing in the Stock Exchange Makkah, Saudi Arabia Zamzam Tower Sukuk Munshaat Real Estate projects Co. Binladin Group

Shariah Principle Used sukuk Forward Ijarah Sukuk issuance Profit/Coupon Underlying/ Identified assets 26 percent per annum The King Abdul Aziz Waqf

Structure of Zamzam Tower Sukuk:

Step 1: The Binladin Group signs Ijarah contract with The King Abdul Aziz Waqf on the basis of Build-Operate-Transfer agreement for 28 years. Under this agreement, the Binladin group will build a shopping complex, four towers and a hotel. Step 2: The Binladin Group appoints Munshaat Real Estate Projects KSC as Special Purpose Vehicles (SPV) to finance the construction and operate the project and then transfer it to the Waqf at the end of the 28-years lease period. Step 3: The Binladin Group signs Forward Ijarah contract with Munshaat Real Estate Projects KSC to construct the required asset for its customer.

Step

4:

Munshaat

Real

Estate

Projects

KSC

packages

the

Forward

Ijarahs

Asset into the Sukuk Unit for issuance to potential investors. Step 5: Munshaat Real Estate Projects KSC issues the Sukuk Certificates to investors at fixed profit rates Step 6: Investors subscribe to Sukuk for future benefits Step 7: Sukuk subscription generates required cash proceeds valued USD 390 Millions Step 8: Munshaat Real Estate Projects KSC disburses progress payments to Contractor and Consultants Step 9: Contractor delivers completed asset to Munshaat Real Estate Projects KSC on behalf of the investors on the agreed date Step 10: Investors have the right to use the property or sell this right to the third party

References:

1. Adam, Nathif. (2005). Sukuk: A Panacea for Convergence and Capital Market. Development in The OIC countries. Conference paper. Indonesia. 2. Dubai International Financial Centre Sukuk Guidebook. 2009. UAE. 3. Jhordy Kashoogie Nazar. 2010. Regulatory and Financial Implications of Sukuks Legal Challenges for Sustainable Sukuk Development in Islamic Capital Market. 8th International Conference on Islamic Economics and Finance 4. Mughees Shaukat. 2005. COMMON STRUCTURES OF SUKUK, Published in the GLOBAL ISLAMIC FINANCE MAGAZINE-United Kingdom, DECEMBER 2010 issue- Also available at http://instituteofhalalinvesting.org/Articles/MugheesShaukat.htm 5. Musavian S. Abbas and Mostafa Zehtabian. 2009, Operational Models for Ijarah, Istisna and Murabahah Sukuk from Islamic point of view, Working Paper.

6. Shariq Nisar. 2005. Islamic Bonds (sukuk): Its Introduction and Application. 7. Dr. Aznan Hasan 2010, Ahmad Ibrahim Kulliyyah of Laws,International Islamic University Malaysia. 8. Arab News, 16 February 2004, Zam Zam Tower and Timeshare Bond Mushtak Parker, London. http://archive.arabnews.com/?page=6&section=0&article=39601&d=16&m=2&y=20 04 LONDON, 16 February 2004