SUKUK. Sovereign issuers are anticipated to lead the sukuk market in 2010 to finance higher fiscal deficits as well as support economic growth.

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1 SUKUK Back on Track The market topped the USD100bln mark in 2009, underpinned by an increase in the global demand for Shariahcompliant funds for investments across a wide range of sectors and industries. In 1H10, sukuk issuance amounted to USD16.6bln and is set to reach a prosperous USD35bln by year end. Malaysia was the largest issuer with 56.6% of all issuance. Sovereign issuers are anticipated to lead the sukuk market in 2010 to finance higher fiscal deficits as well as support economic growth. KFH Research Ltd KDN PP15024/03/2010 (023669) 20 July 2010

2 Contents : Back on Track 1.0 Defined Generic Structures of Asset-Based vs. Asset-Backed AAOIFI s View on Structures Overview of Market Impact of Financial Crisis by Sector The Real Estate Sector The Power and Utilities Sector The Transport Sector The Construction Sector The Oil & Gas Sector The Financial Services Sector Other Sectors Outlook Announced in the Pipeline (as at end June 2010) 57

3 : Back on Track Over the last decade, the Islamic finance industry has evolved to become a major part of the international financial system. According to the Islamic Financial Services Board, the global Islamic finance assets are set to reach USD1.6tln by 2012 from only around USD150bln in the mid-1990s. The remarkable growth has been mainly driven by ample liquidity flows from the recycling of petrodollars, encouraging demographics, as well as the active role played by some jurisdictions around the world to promote the development of Islamic financial markets in their respective countries. or Islamic bonds have emerged as one of the main components of the Islamic finance industry. It forms a significant component of the Islamic capital markets, perhaps second only to equity. Over the years, the sukuk market has grown to reach approximately USD100bln to contribute around 12% of the total global Islamic finance assets in The sukuk market faced trying times during the financial meltdown, as reflected in the reduction of sukuk issuance over the last few years, dropping by 54.9% in 2008 to USD15.5bln compared to USD34.3bln issued in But with the sukuk market coming out of the worst of the financial crisis, prospects remain high. The sukuk market is anticipated to brush off the scars of 2008 and to grow throughout 2010 with USD30bln new sukuk issuances vs. USD24.6bln in With the flourishing of the sukuk market, various sectors around the world have and will continue to benefit from the unique characteristics and diverse range of sukuk structures in raising funds for a range of different purposes. In 2009, more than 50% of sukuk issuers have been sovereign, quasi-sovereign and multilateral agencies. Power & utilities and financial services issuers accounted for 11% and 10%, respectively, of the sukuk primary market during the year, followed by transport (8%) and oil & gas (6%). On instrument type, Ijarah is the most popular structure, accounting for 41.9% of total sukuk issuances in 2009, probably a direct consequence of the recent debate regarding the Shariah compliance of some other structures. This year, we expect governments or sovereigns to continue to drive the sukuk issuances as many corporate issuers are still deterred by challenging market conditions. More sovereign issuers are anticipated in 2010, which include Japan, Thailand, Turkey, UK and Russia to finance higher fiscal deficits as well as support economic growth. Sovereign sukuk issuances are also expected to help to revive the global sukuk market as they provide the necessary benchmark pricing for the private sector to gauge investor appetite this year. Risks to sukuk growth this year include deteriorating economic and financial conditions which may shake investors confidence. Nevertheless, we believe that growth will continue to be supported by increasing popularity of Shariah-compliant products, governments support for Islamic finance, huge investment and financing requirement in the GCC and Asia regions, as well as issuers desire to tap investor from the Middle East and Muslim Asia. Global Issued by Sector (2009) Oil & gas 6% Transport 8% Leisure & tourism 4% Financial services 10% Power & utilities 11% Agriculture 3% Source: Zawya, S&P, IFIS, Bloomberg, KFHR Real estate 2% Others 2% Sovereigns 54% 3

4 1.0 Defined are defined by the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) as certificates of ownership in a pool of underlying assets, in which the certificates are of equal value. Initially, Islamic securities (sukuk) were introduced as an Islamic alternative to the conventional bonds which function more as fixed-income instruments. However, as the Islamic securities (sukuk) market develops, it becomes increasingly distinct from conventional bond instruments. are issued with the aim of using the mobilised funds for establishing a new project, developing an existing project, or financing a business activity as per the respective shares. To investors, sukuk provide the opportunity to invest in a new asset class, create an avenue for a more efficient and effective allocation of capital, and facilitate the channelling of surplus savings into ethical investments. Concurrently, the issuer is able to widen and diversify its investor base which could lead to a competitive and sometimes lower pricing. Below are the characteristics of an investment sukuk as stated by the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI): Investment sukuk are certificates of equal value issued in the name of the owner or bearer in order to establish the claim of the certificate owner over the financial rights and obligations represented by the certificate. Investment sukuk represent the common share in the ownership of the assets made available for investment, whether these are non-monetary assets, usufructs, services or a mixture of all of these plus intangible rights, debts and monetary assets. These sukuk do not represent a debt owed to the issuer by the certificate holder. Investment sukuk are issued on the basis of a Shariah nominated contract in accordance with the rules of Shariah that govern their issuance and trading. The trading of investment sukuk is subject to the terms that govern the trading of the rights they represent. The owners of these certificates share the return as stated in the subscription prospectus and bear the losses in proportion to the certificates owned (held) by them. are now being issued in many regions of the world which sometimes have very different legal systems. The growth in demand over recent years raises challenges to the sukuk market which has lead to slight differences in certain aspects of sukuk issuance among the range of jurisdictions. A prime example of this could be allowable underlying assets in a sukuk transaction. Missing from the AAOIFI standards are financial assets and debts as possible underlying assets. However, under the Malaysian jurisdiction, debt receivables are considered a permissible asset class for securitisation according to the Shariah Advisory Council (SAC) of Securities Commission (SC) Malaysia. This means jurisdictions adopting the AAOIFI standards will inevitably be utilising different sukuk structures and thus different methods of raising investor s funds, than jurisdictions which rely on local law, as will be seen in the relevant sections. Under the mechanics of sukuk, returns to investors or sukukholders represent rights to receive payments from a trade transaction, ownership of a particular asset, or a business venture. In contrast, the returns to conventional bondholders represent the right to receive indebtedness for borrowed money. In addition, a sukuk does not pay interest but generates a return through actual economic transactions in the form of sharing or leasing assets. This means that sukuk are different from conventional bonds by nature in a range of areas which will be summarised in the following table: 4

5 vs. Conventional Bond Parameter Conventional bond Issuer A sukuk issuer shall be engaged in An issuer of conventional bonds is Shariah-compliant business activity not limited in its business activities Investor base Enjoys a wider investor base from Conventional bonds can only tap both Islamic and conventional the conventional investors investors Ownership Investors take direct ownership of an A conventional bond is purely the underlying asset or pool of assets financial debt of the issuer Administrative cost Additional fees in terms of legal and Shariah advisory fee Financing cost A larger pool of sukuk investors creates more demand, hence may be able to achieve slightly more competitive pricing Source: KFHR 2.0 Generic Structures of No additional administrative costs associated with conventional bond issues A comparatively smaller pool of conventional bond investors suggests that there is less demand for the paper Generic structures of sukuk include Ijarah, Musharakah, Mudharabah, Istisna, Wakalah, Al- Istithmar and Salam. Ijarah sukuk. Ijarah sukuk is commonly used for project financing. It is a leasing structure coupled with a right available to the lessee to purchase the asset at the end of the lease period (finance lease). The rental rates of return on the sukuk can be either fixed or floating, depending on the agreement. Structure of a Generic Ijarah Investors proceeds Periodic rentals and capital amount distributions Obligor as seller Title to assets proceeds Issuer/ Lessor (Special Purpose Company to hold the assets in Trust for the sukuk holders) Periodic rentals and capital amount payments Lease agreement for a fixed period of time Obligor leases back assets as lessee Source: Islamic Finance Advisory Board 5

6 Musharakah sukuk. Under the Musharakah partnership structure, pricing could be linked to performance of the underlying assets, rather than benchmark rates, on a profit-and-loss-sharing basis. Investors could receive profits in excess of their actual investment contribution based on a pre-agreed ratio but any loss will be shared on the basis of the equity participation. Structure of a Generic Musharakah 4. Undertakes to buy the Musharakah shares of the SPC on a periodic basis 1. Land or physical asset contribution 2b. proceeds Corporate Musharakah SPC Periodic profit (20%) + incentive fee (as agent) Periodic profit (80%) 3. Issues sukuk Musharakah 2a. proceeds Investors Note: Corporate and the Special Purpose Company (SPC) enter into a Musharakah arrangement for a period of say, five years. Profit-sharing ratio between the SPC and the Corporate is 80:20 Source: BNM Mudharabah sukuk. Mudharabah-based sukuk is another partnership structure with profit sharing but in this instance, there is no sharing of losses. The return to the investors from Mudharabah sukuk would be higher than that under the Musharakah structure as the risk is higher. The return profile would also be smoother as the profitsharing pay-outs would be adjusted in highly profitable years to maintain pay-outs in less profitable or loss-making years. Structure of a Generic Mudharabah Upon completion, SPV hands over project to owner Project Mudharib collects regular profit payments and final capital proceeds from project activity for onward distribution to investors Project owner SPV (Mudharib) Investors SPV enters into an agreement with project owner for construction of project SPV issues sukuk to raise funds Source: Islamic Finance Advisory Board 6

7 Istisna sukuk. This type of sukuk is used for financing of greenfield infrastructure projects, given that for such projects the underlying assets do not yet exist. Under the principle of Istisna, the issuer will sell to the financier the identified assets which have yet to be constructed. The financier will then immediately sell back the assets to the issuer based on deferred payment terms. Structure of a Generic Istisna Investors 1. Issues sukuk 2a. proceeds Contractor 3. Sells assets to SPV SPV 4a. Transfer title to assets End buyer 2b. proceeds are used to pay the contractor under the Istisna contract to build and deliver the future project 4b. Pay monthly instalments to SPV Source: KFHR Note: Completed property/ project is leased or sold to the end buyer. The end buyer pays monthly instalments to the SPV. The returns are distributed among the sukuk holders. Source: MIFC Al-Istithmar sukuk. This type of structure is used for direct investments in a bundle of assets which make it hybrid in nature. The underlying assets will combine both financial assets such as Murabahah receivables with tangible assets such as Ijarah lease rentals in a ratio of 70:30 respectively. They are asset-based sukuk and are usually traded in the secondary market. Structure of a Generic Al-Istithmar Custodian Issuer Issuer issues holders pay Issue Proceeds Issuer manages the Assets for the holders 2. Issuer undertakes to buy at maturity 5. Distribution of Income generated from Assets holders Trading Secondary Market Source: KFHR Note: Some jurisdictions impose certain limits on a portfolio for the certificates to be tradable whereby the proportion of the tangible assets has to be more than the receivables. Some Shariah scholars require the majority portion to be at least 51%, and others insist that it should be at least 2/3 of the portfolio. 7

8 Wakalah sukuk. AAOIFI defined it as certificates which represent a project or a particular activity carried out according to the Wakalah principle, where a wakil or a representative is appointed, to manage the project on behalf of the sukuk holder. As wakil, the issuer is entitled to receive a management fee. In order to generate income, the issuer enters into other contracts, such as Mudharabah and Ijarah, with other parties. Proceeds from the sukuk issuance will be used by the issuer for investments in particular project based on Shariah principles. Structure of a Generic Wakalah 1. Enters into a wakalah contract. The wakalah contract is based on the relationship between the investor and the issuer 3. Issues sukuk Investor (muwakkil) Issuer (wakil) 4. proceeds 2. Enters into other contracts such as Mudharabah/ Ijarah/ etc. in order to generate income Other Parties Source: Securities Commission Malaysia, KFHR Salam sukuk. Salam refers to a sale in which payment is made in advance by the buyer, and the delivery of the asset is deferred by the seller. Salam structures are more popular for short-term financing. Structure of a Generic Salam Payment against future delivery of assets Reimbursement of cash plus a mark-up on maturity Cash Issuer SPV Investors Certificate of participation Delivery of asset at maturity Surrender of certificate at maturity Source: Durham University, KFHR 8

9 3.0 Asset-Based vs. Asset-Backed The asset-based structure is normally financial activity such as sale and purchase agreements which result in debt creation. The debt that is created represents the receivables which will be distributed to the entitled parties. In sukuk structures, the debt represents the coupon plus principle investment via a right in the obligor s cash flow. This is common in most structures utilised in the global market whereby the sukukholder s rights to receive will be embedded in a debt receivable. Asset-backed sukuk (ABS) are different of that with asset-based mainly through way of a true sale transaction. The investors / sukukholders are actually buying undivided shares of the underlying asset which will be represented by way of transfer of legal title. In this scenario the sukukholders (as owners) have the full ownership rights over the asset and thus are entitled to revenue generated from it. It should be noted that ABS also share the risks that come with ownership such as loss or damage to the underlying asset. The main differences between the two types can be summarised as follows: Asset-Based Revenue / income from sukuk assets does not necessarily form the source of payment for the sukukholders Tthe source of payment usually comes from issuer / obligor s cash flow Normally structured as ON balance sheet Source: Securities Commission Malaysia Asset-Backed (ABS) Refers to securities / sukuk backed by assets that had been sold / transferred by an originator to a buyer / issuer (usually an SPV) Main source of payment is the revenue from the underlying assets Can either be ON or OFF-balance sheet Asset-backed sukuk / securities give a number of benefits to both originators and investors which are namely: Originator Investors Additional source of funding that is normally Portfolio diversification cheaper due to additional structural High quality asset (credit enhancement) protections (credit enhancements) and better ratings Reduce asset and liability mismatch not to be exposed to bankruptcy risk of the originator Potentially higher rate of return than other monetise illiquid assets Locking in profits fixed return investments Transfer risk Off-balance sheet Source: Securities Commission Malaysia 9

10 4.0 AAOIFI s View on Structures Following from the AAOIFI fatwa in Feb 2008, it is increasingly important to distinguish between asset-based sukuk and asset-backed as it may make a huge difference to those involved. Many people often confuse the two and cannot differentiate between the features of the different types of sukuk. Furthermore, this may have an impact on how the structure is viewed under different jurisdictions whether it is deemed Shariah compliant or not. As we note from AAOIFI s fatwa, there are a number of areas addressed which affect both types of sukuk structures. The main feature which distinguishes them from each other is a true sale of an asset. However, in some asset-backed securities (ABS), the transfer of ownership in a sale/purchase agreement between the issuer and the originator would be only beneficial ownership and not the full legal title. AAOIFI s ruling abrogates this practice which is acceptable to English law and rules that any transaction doing so would be Shariah non-compliant. In many cases of sukuk structures, the transfer of ownership is beneficial only thus not representing a true sale (by way of title and beneficial ownership transfer). This is evidenced in the treatment of the underlying assets in the relevant sukuk structures whereby originators keep the asset on balance sheet. In a true sale scenario such assets would be taken off-balance sheet representing the transfer of title ownership. Such a scenario poses many risks to the originators as the true transfer of ownership would give the new owners full rights of disposal over the assets and therefore no way of recourse to the assets for the originator. This can cause much confusion among investors who may think they are buying an asset-backed security whereas in reality it is asset-based. 5.0 Overview of Market Since 2001, the world has seen steady growth of the sukuk market until recent years where there has been greater interest from the international community and the spread of sukuk issuance around the world. The method of raising investor s funds through Islamic sukuk structures has become an integral part of Islamic finance and a pivotal pillar of its continuous growth. In 2009 we saw the remarkable point in which global sukuk outstanding reached the USD100bln-mark making its presence known within the international finance scene. The main factors that contributed to the rapid growth of sukuk over the years include the following: Growing preference for Shariah-compliant products. The Islamic finance industry first commenced with the establishment of the Islamic banking system, and has since witnessed the development of Islamic capital markets, on the back of sustained economic growth and large investment projects, namely in Malaysia and the GCC. As appetite among businesses and individuals to conduct their finances in a Shariahcompliant manner increased, the demand for a product that performs a similar function to a bond leapt. As the sukuk market developed, the industry witnessed a wide range of products being engineered to meet the requirements of investors and borrowers. Growing wealth within the Islamic world. Demand for sukuk from investors has also surged on the back of growing wealth within the Islamic world, further enhanced by greater understanding of sukuk instruments and clarity of documentation, as well as credit ratings from international agencies. 10

11 Massive liquidity looking for Shariah-compliant debt. The demand for sukuk is driven by high levels of surplus savings and reserves in Asia and the GCC looking for Shariah-compliant instruments. The savings rate in Asia is higher than any other region in the world and is expected to remain between 30% and 40% of GDP for many years to come. Government policies. Muslim countries as well as non-muslim countries such as the UK, Hong Kong and Singapore have introduced relevant legislations in their respective country to enable sukuk issuance. Economic diversification away from oil and gas. Continuous efforts on economic reforms and diversification have seen non-oil economic sectors contributing to GCC s growth momentum. Services sub-sectors include financial/ banking, tourism, information, ICT, ports/ shipping, aviation, healthcare and education. Large surpluses have also been channelled into the real estate/ property, construction and infrastructure/ utilities sectors, leading to increased sukuk issuances. Infrastructure development. Infrastructure spending in Asia and the Middle East has helped to push the demand for sukuk, given the growing preference for sukuk as a source of cash flow and financing for companies. In the GCC, a large number of infrastructure development projects throughout the region have been financed by sukuk, given the drive to tap the deep pool of Islamic liquidity in the region. Global Outstanding ( F) USD bln F Source: S&P, KFHR Global Issuance (1H09 1H10) USDmln H2009 1H2010 Source: IFIS, KFHR 11

12 For full year 2009, total global sukuk issued amounted to USD24.56bln, 58.8% y-o-y higher than the USD15.46bln raised in Notable developments in 2009 were: Cumulative global sukuk outstanding topped the symbolic bar of USD100bln as at end Malaysia became the number one issuing country (by a bigger margin) accounted for 54.2% of the value of sukuk issued. The US dollar made a partial comeback but local currencies were the denomination of choice for sukuk issuance. Big new players tapped the market such as General Electric Capital Corp and International Finance Corporation. Two sukuk defaulted (Investment Dar and Golden Belt) while one other (Nakheel) avoided default with a last-minute support package and repayment. Entering the first half of 2010, we see the growth of sukuk issuance continuing on a global scale rising to USD16.6bln compared to USD10.2bln in the same period 2009, representing a 62.7% increase. Total Global Issued ( ) USD mln Mena Other Source: Zawya, S&P, IFIS, Bloomberg, KFHR In the primary sukuk market, Malaysia dominated in terms of volume and value of sukuk deals originated globally in 2009, totalling USD13.3bln or 54.2% of new sukuk issues. This was followed by the UAE at 13.6% (USD3.3bln) and Saudi Arabia at 12.7% (USD3.1bln). Of the USD24.56bln sukuk issued, 48.1% were denominated in the Malaysian Ringgit, trailed closely by the USD at 28.5%. Malaysia and GCC (in particular the UAE) are expected to continue to dominate the primary sukuk market in the next few years, driven by their authorities support for the development of Islamic finance and the UAE s status as a regional gateway to global investors. The sukuk market had also witnessed continued geographic diversification in 2009, with new issuers such as Singapore and the US joining the sukuk bandwagon, and this trend is set to continue. Also, more sovereign issuers are expected to tap the sukuk market in line with the needs to finance their budget deficits. Entities in more than 20 countries, predominantly non-muslim countries, have also expressed their intention to tap the sukuk market. 12

13 Global Issued by Country (2009) Bahrain US 2.4% Brunei 1.6% Pakistan 1.5% Gambia 0.1% Singapore 6.4% 0.4% Indonesia 7.1% Saudi Arabia 12.7% Malaysia 54.2% Source: Zawya, KFHR UAE 13.6% Global Issues (Domestic & International) by Country (USD mln equivalent) Country 1Q Malaysia 2,473 13, , ,412.9 UAE - 3, , ,807.5 Saudi Arabia 450 3, , ,716.3 Bahrain 175 1, ,065.0 Indonesia 1,565 1, Pakistan Qatar Kuwait Brunei Pakistan Singapore Gambia Grand Total 4,668 24,555 15,464 34,300 Source: Zawya, KFHR 6.0 Impact of Financial Crisis The sukuk market was not spared from the effects of the global financial crisis. After expanding robustly in 2006 and 2007 (total value of sukuk issued increased by 122.1% y-o-y and 28.0% y-o-y respectively), the sukuk market experienced a marked slowdown in 2008 and New issuances were either delayed or priced slightly higher to reflect rising global financial markets volatility as well as a slight drop in investors demand for sukuk. Similarly in the sukuk market, the HSBC-DIFX index, a measure of sukuk average spreads over Libor, rose from 58.6bps in early-2007 to 174.4bps by end-2007, an increase of 115.8bps over a year, reflecting heightened subprime concerns. Subsequently, the index climbed higher, rising 999.5bps in 2008 to end the year at 1,173.9bps, reflecting market volatility post the Lehman Brothers collapse in Sep 08. The sukuk index peaked at 1,234.4bps on 11 Feb 2009, trending downward for the remaining of 2009 to end the year at 466.6bps, as fiscal and monetary policies worldwide worked to counter the fallout of the crisis, risk aversion eased and investors confidence slowly returned, as reflected by the gradual rebound in global financial markets. During this period, sukuk spreads in general widened more compared to conventional bonds in the same rating category. During 2010 the spread has hovered between a high of 526bps on 15 Feb and a low of 369bps on 15 Apr. As of 28 Jun 10 the spread lies at 432.5bps over Libor indicating a stabilisation still higher than

14 HSBC-DIFX Index of Spreads over Libor ( Jun 2010) Source: DIFX-HSBC, KFHR It is important to note that spreads are not only a measure of credit and systemic risks but also of liquidity risk. When liquidity dried up during the subprime crisis, investors retreated into safer and highly liquid asset classes such as US Treasury. The sukuk market is rather an illiquid market and therefore it has been penalised because of this lack of liquidity. US Treasury Yield Trends, as of 11 Jun % :J A J O 08:J A J O 09:J A J O 10:J A 2 Year 5 Year 10 Year Source: Bloomberg, KFHR The chain of unfavourable global events since 2008 continued to negatively impact the primary sukuk market in 1H09. In 1H09, total global sukuk issued amounted to USD7.6bln, 31.4% lower than the USD11.1bln raised in 1H08, mainly due to the following reasons: Investors were extremely cautious amidst the on-going challenging market conditions and adopted a wait-and-see approach. Risk aversion resulted in a switch in preference for sovereign or near-sovereign and high quality (AAA-rated) classes of investment assets. Wide credit spreads and shortages of USD funding in issuing countries. The challenging economic environment in the GCC countries, particularly in the UAE, saw many infrastructure projects being shelved. Nevertheless, as the overall market conditions improved, the primary sukuk market rebounded in 2H09, with total sukuk issued amounted to USD16.9bln, an increase of 292.1% y-o-y and more than doubled the USD7.6bln issued in 1H09. Nonetheless, the amount of sukuk issued in 4Q09 was lower than that recorded in 3Q09 by 8.6%, mainly attributed to credit concerns and lingering issues with respect to troubled sukuk (Golden Belt, Investment Dar, Maple Leaf and East Cameron ). In addition, there were uncertainties associated with Nakheel s ability to repay USD3.52bln of sukuk due in Dec However, this was eventually paid on time, provided a huge relief to the global sukuk market and the general investing community. 14

15 Global Issued, Quarterly Basis ( ) USD mln Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 MENA Other Source: Zawya, S&P, IFIS, Bloomberg, KFHR The sukuk market was not spared from the event of defaults. In the US, the country s first sukuk (East Cameron ) defaulted in Oct Elsewhere in the GCC, Kuwait s Investment Dar was the first to default on its USD100mln sukuk in May 2009, followed by the recent default of International Investment Group s USD200mln sukuk in Apr It is important to note that the sukuk defaults were not caused by faulty structures, but mainly due to the deteriorating credit positions of the issuers. Country Default in H10 US In Oct 2008, the first US sukuk, East Cameron Gas Company's (ECG) USD165.7mln issuance, defaulted. The ECG sukuk, at issuance, were rated at a low CC by S&P. The company filed for bankruptcy protection after its offshore Louisiana oil and gas wells failed to yield the expected returns, partly because of hurricane damage. Pakistan JCR-VIS Credit Ratings in Jan 2009 assigned the sukuk of New Allied Electronics Industries (Pvt.) Limited (NAEIL) a D rating on account of overdue payments on its debt instruments and for breach of bond covenants. Kuwait In May 2009, Kuwait s Investment Dar (not rated) announced that it had defaulted on the payment of the periodic distribution to holders of its USD100mln Bahrain-registered sukuk, maturing in The default comes as the company works to restructure its entire debt, not just its sukuk. The company had USD3.7bln of total debt outstanding as of Sep 08. On 13 Apr 2010, International Investment Group (IIG) announced that it was unable to pay the coupon of a USD200mln sukuk (not rated), an amount of USD3.35mln due on 12 Apr The sukuk issued by IIG matures on 10 Jul Saudi Arabia Saad Group, the Saudi conglomerate which, along with Ahmad Hamad al Gosaibi and Bros, is in the midst of Saudi Arabia's biggest financial scandal, had issued a USD650mln Golden Belt sukuk (not rated). The company is now in default on its other debts and its Cayman Islands assets have been frozen. Malaysia The Malaysian Rating Corporation (MARC) estimated 4.8% of Malaysian bonds, conventional and Islamic, to have defaulted in 2009, whereas Rating Agency Malaysia (RAM) predicted a 1.8% default. However, given that the Malaysian market is more mature and has more experience with default than the GCC, the sukuk industry is expected to come out of this storm damaged but still viable. Source: IFIS, RAM, MARC, KFHR 15

16 Despite the tough market conditions, sukuk defaults are insignificant as compared to that of conventional bonds. According to an article published by S&P (dated 4 Oct 2009), global corporate defaults totalled 215 issuers in the first nine months of 2009, nearly four times the 59 defaults recorded in the same corresponding period in By country, there were 155 issuers from the US that defaulted during the year, 13 in Europe, 34 in emerging markets and 13 in other developed region (Australia, Canada, Japan and New Zealand). At the same time, bankruptcy filings have also surged to 54 issuers in the first nine months of 2009, which surpasses the full year 2008 of 49 bankruptcy related defaults. 7.0 by Sector Over the last decade with the flourishing of the sukuk market, different sectors around the world are benefitting from the unique characteristics of Islamic securities. The ability to raise funds for oil and gas projects like East Cameron in the US and real estate projects in Abu Dhabi such as the Sorouh Real Estate, explains why the demand is rapidly increasing for Islamic securities. Here we will see the different sukuk structures and the utilisation of funds for various sector developments during the last few years. More than 50% of 2009 s fund-raisers have been sovereign, quasi-sovereign and multilateral agencies, in line with the general interest of investors which saw a shift in preference to safe havens and high quality issues. In the GCC, the sukuk market was revived in Jun 2009 with an issuance of a USD750mln sukuk by the Government of Bahrain. Other notable sovereign sukuk issuances were Government of Indonesia USD650mln, Ras Al Khaimah USD400mln and Islamic Development Bank USD850mln. Power and utilities and financial services issuers accounted for 11% and 10% respectively of the sukuk primary market in 2009, driven by recovery in commodity prices and fund raising activities by financial institutions worldwide. Global Issued by Sector (2009) Oil & gas 6% Transport 8% Leisure & tourism 4% Financial services 10% Power & utilities 11% Agriculture 3% Source: Zawya, S&P, IFIS, Bloomberg, KFHR Real estate 2% Others 2% Sovereigns 54% On instrument type, Ijarah is the most popular structure, accounting for 41.9% of total sukuk issuances in 2009, probably a direct consequence of the recent debate regarding the Shariah compliance of some other structures. Prior to 2005, the first few sukuk issued in the global market had all been Ijarah-based. In 2005, the first Musharakah-based sukuk was issued by DMCC Gold. Subsequently and prior to 14 Feb 2008, other sukuk structures of Musharakah, Mudharabah and Exchangeable trusts picked up pace quickly. 16

17 Global Issued by Instrument (2009) Al Istithmar 7.6% Musharakah 10.0% Ijarah - Musharakah Al Wakalah 3.3% 3.5% Al Salam 0.9% Mudharabah 0.8% Istisna 0.1% Ijarah 41.9% Murabahah 32.0% Source: Zawya, IFIS, KFHR The Malaysian sukuk market has been one of the most dominant throughout the globe over recent times which have seen the development of various sukuk structures utilising a wide range of concepts. In 2008, five Shariah principles were utilised for raising funds which might be considered more diverse than other regions. However, 2009 saw the reliance on the Musharakah, Murabahah and Ijarah principles which have an ease and conformity to them when structuring sukuk issuances. Malaysia has depended on these three principles as they serve the needs of local investors with an ability to generate income from the underlying assets and cash flows. Domestic Issuance in 2009 Approved by Securities Commission Malaysia Issuer Shariah Principle Size of Issues (RM mln) Q4 1 Pengurusan Air SPV Berhad Ijarah, Musharakah 20, Q3 1 Sime Darby Berhad Musharakah 4, Q2 1 CIMB Islamic Bank Bhd Musharakah 2, CIMB Bank Bhd Musharakah 5,000.00* 3 Jati Cakerawala Sdn Bhd Musharakah UMW Holdings Bhd Musharakah United Growth Bhd Musharakah 2, * Combined issue size limit of RM5.0bln (or its equivalent in foreign currency) with Multi Currency Subordinated Debts Programme approved in March 2009 Q1 1 Unique Wealth Management Sdn Bhd Musharakah 1, Pinnacle Tower Sdn Bhd Musharakah Telepal SPV Sdn Bhd Murabahah ABS Passage Bhd Musharakah 2, Source: Securities Commission Malaysia, KFHR 17

18 Malaysian Issued by Instrument (2008) Malaysian Issued by Instrument (2009) Ijarah 29.1% Musharakah 34.2% Ijarah 31.7% Musharakah 33.3% Istisna 5.6% Istisna 1.0% Mudharabah 8.9% Murabahah 22.2% Murabahah 34.6% Source: Zawya, Securities Commission Malaysia Comparing to some of the GCC countries, Malaysia utilises a range of different structures whereas the UAE and Saudi, for example, stick to a handful of structures as shown in the following diagram. This is due to the independent evaluation of acceptable sukuk structures in accordance with Shariah law. Notably missing from the concepts used are Murabahah and Musharakah since they are normally constructed with features not acceptable according to Middle Eastern interpretations. AAOIFI hold a similar stance on certain structures such as in Bai Murabahah where the sale and buy back feature (Bai al- Inah) is commonly incorporated. The Shariah Advisory Council of Bank Negara Malaysia and the Securities Commission Malaysia, on the other hand, have permitted such transactions and structures according to their understanding of the application of Shariah law. Another area of difference among the jurisdictions is the matter of being tradable in a secondary market. In Malaysia, the Islamic Capital Market is considered relatively active as trading sukuk is deemed permissible under that jurisdiction. However in the GCC region, trading of sukuk is only permissible if traded at face value since any debt represents actual money and trading of monies would lead directly to riba. This subtle difference means that sukuk issued in GCC countries are normally structured for shorter tenures than in Malaysia since sukukholders are more likely to hold the certificates until maturity. It is important to note that both sides have relevant evidences to support their views and with the differences aside, sukuk continues to grow in both jurisdictions. However, many of the modern international institutions such as AAOIFI and the OIC Fiqh Academy are striving for the unification of the application of Islamic law (Shariah) in Islamic finance in order to allow universal application and cross-border development of the Islamic Capital Markets. Saudi Arabia by Instrument ( ) Al-Wakalah Bel-Istithmar 17% Ijarah 4% UAE by Instrument ( ) Mudharabah 27% Istisna 4% Mudharabah 13% Source: Zawya, KFHR Al-Istithmar 66% Ijarah 69% 18

19 7.1 The Real Estate Sector The US housing weakness may extend well into its fifth year as rising foreclosures return more properties to the market and demand stays depressed. As long as home prices are falling, the financial system and the economy will continue to unravel. The drop in home values is contributing to the decline in spending because home equity was a major source of cash for purchases of expensive items such as autos during the housing and credit booms. Being the original cause of the subprime crisis, the housing sector remains a key source of weakness for the US economy. With foreclosure filing at a record high, household income is under pressure and with tighter bank lending, indications are for house prices to decline further in 2010, albeit at a slower pace. In 1Q10, prospects seem to be improving in the real estate market outside the US as a revival of demand in Bahrain, Kuwait and Oman emerged as well as an increase in expatriate and local populations in Saudi Arabia and Qatar. Furthermore, since a drop in lending rates in the GCC region, credit disbursements to the construction and real estate markets have increased marginally. In UAE, prospects remain fragile as the Dubai World crisis and the outflow of expatriates has caused the reduction in demand and rental prices have dropped by 10-15% since Dec With the GCC countries now focusing on diversifying their economies towards non-oil sectors, a number of development projects have arose in the hospitality area. The region has seen hotel projects reaching past USD7bln worth currently in the pipeline. In 2008, the real estate market saw the introduction of a range of sukuk from different countries around the Asian-Pacific and GCC regions. This was mainly due to the announcement of many development projects such as the Sorouh Real Estate by Sun Financing Ltd which was designed to finance the development of Al Reem Island in Abu Dhabi, holding one hundred thousand residents in twenty two thousand residential homes as well as 100 skyscrapers for commercial businesses. The Sorouh Real Estate made up for 43% in USD amount of global sukuk issued 2008 in the real estate sector. Total Number of Global Issued Amount of Global Issued (USDmln) Source: Zawya, KFHR Following 2008, the year 2009 turned out to be a much less productive year with sukuk issuance in real estate dropping by USD2,146.5mln or 84.3% from further saw major players such as the UAE drop out due to the real estate crisis, crippling global sukuk issuance in the sector. Dubai was a prime example whereby not only did an oversupply of housing projects emerge but also state-owned property developers Nakheel deferred payment of the coupon to the sukukholders in Dec However, 2009 saw Singapore and Saudi Arabia issuing sukuk in the sector which accounted for 75% of all sukuk issued in

20 The City Developments is the first corporate sukuk Ijarah to be issued in Singapore as the country looks to become a major player in Islamic finance. The sukuk from the country s second largest property developer will likely encourage other corporates wishing to raise Shariah compliant funds. Real Estate Issued by Country (2008) Real Estate Issued by Country (2009) Indonesia 8% Malaysia Kuwait 25% 8% Singapore 50% Malaysia 25% Pakistan 17% Qatar 8% Saudi Arabia 25% UAE 34% Source: Zawya, KFHR Comparing the above to the global sukuk issuance in all sectors, real estate dropped from 18.2% in 2008 to just 2.1% in Most of this could be attributed to the financial crisis which slowed development, especially in GCC countries. Notably, the large amounts of debt created by the boom in real estate in caused more set-backs for the sector when developers were unable to meet their financing obligations. There are a number of regulatory changes which are expected to have an impact on future real estate developments. First of all Saudi Arabia expects the much-awaited mortgage law to be implemented later this year. In the UAE, changes in inheritance laws are expected to enable non-resident UAE citizens to own houses which will inevitably increase demand. After coming to a halt in 2009, sukuk issuance for the Malaysian real estate sector is expected to pick up as the economy is expected to show strong signs of recovery in Furthermore, 2010 is expected to see a burst of development projects which have been held back since the global financial crisis, however with a good number of high-end condominiums and shopping complexes nearing completion, concerns of an oversupply might stem further future developments in the real estate market. 20

21 Musharakah Structure Malaysia s largest sukuk issuance between 2008 and 2009 was the Putrajaya Holdings sukuk worth USD92.1mln utilising the Musharakah principle. Putrajaya Holdings Musharakah Source: IFIS, KFHR Salient features of the transaction are as follows: The Investors ( holders ) form a partnership based on the underlying Shariah contract of Musharakah to invest in the Trust Asset (the Venture ). On that basis, the holders (Musharakah Partners) shall from time to time, subscribe to the relevant issued by the Issuer. The shall represent their proportionate undivided interest in the Venture. The Venture involves investment in the Trust Asset held on trust by the Issuer. The holders shall be entitled to benefits and returns generated from the Trust Asset and also from the disposal of the. Any income above the expected return shall be treated as incentive fee to the Manager, PjH. The Issuer shall make good any shortfall with an amount which will be deducted from the Issuer s obligation pursuant to a purchase undertaking whereby the Issuer shall acquire the upon dissolution/maturity date at an exercise price to be determined. The sukuk issuer, Putrajaya Holdings Sdn Bhd, is majorly owned by Petroliam Nasional Berhad (PETRONAS) and is involved in many real estate projects in Malaysia. The proceeds of this issuance, which will be the capital contributions collected by the issuer from the Musharakah partners (sukukholders), will be used to pay existing contracts in a real estate development located in Putrajaya and for working capital on new real estate projects. This particular structure is an asset-based sukuk whereby the venture which the Musharakah partners invest in is a financial asset (i.e. payment from the government from the sub-lease). This means that the investors have a right upon the issuer (Putrajaya Holdings Sdn Bhd) for the principle amount plus any expected returns. In this structure the underlying asset ( Trust Asset ) is the rights, entitlements and benefits of a sub-lease agreement with FLC, an agent for the Government. It should be noted that the investors do not have ownership in any tangible assets. In the case of shortcomings in returns to investors, the issuer has agreed to top-up to the amount of expected return which will be deducted from the obligation (purchase agreement) to acquire the sukuk upon maturity. Therefore this structure becomes similar to a fixed rate return sukuk, although if a shortcoming in returns occurs, sukukholders would face a deduction in their principle amount upon maturity to substitute the fixed return. 21

22 The details of the sukuk can be summarised as below: Name of Shariah Principle Amount of Issuance Type of Collateral Rating Use of Proceeds Regulatory Authority Tenure Limit of Issuance Return Source: IFIS, KFHR Putrajaya Holdings Musharakah USD92.1mln Asset-based IMTN Programme None AAA (Indicative) by MARC Working Capital and payment of real estate development contracts Securities Commission Malaysia 1-24 Years Up to RYM1.5bln (USD460mln) Based on sub-lease of asset to GoM, divided among holders at the pre-agreed ratio. Any excess of profit above an Expected Return will be paid by the sukukholders to the manager as an incentive fee. When analysing this sukuk and the structure being utilised, the issuance may face some scrutiny when comparing it to international standards. For example, in AAOIFI s fatwa in early 2008, the issue of valuing the underlying asset at the end of the tenure was addressed whereby the purchase undertaking in a Musharakah sukuk can only be the market value, net asset value, cash equivalent value or any price agreed upon at the time of purchase of the asset. This rules out the face value of the sukuk also known as exercise price as it removes some of the risks faced by the sukukholders. This issue is not addressed in most jurisdictions as most governments incorporate English or similar laws to deal with financial transactions. Therefore we see some instances where the need to refer to Shariah law to find the correct way to transact in Islamic finance arises. To deal with some of the credit worries arising from the financial meltdown, Malaysia have made ratings mandatory for all sukuk issuance within the jurisdiction while others such as GCC countries do not. This is likely to be addressed in the near future as the financial meltdown has indicated the need for rating agencies to give independent judgements upon the sukuk issuances to ensure that all risks have been truly identified to protect investors. Murabahah / Ijarah Structure In the GCC region the only sukuk to be issued in real estate during 2009 was the DAAR II which was issued by Dar Al-Arkan Real Estate Development Company. Dar Al- Arkan has been responsible for major real estate developments in Saudi Arabia over the last few years, earning them USD2.5bln in revenues. 22

23 Dar Al-Arkan Murabahah / Ijarah Dar Al-Arkan Real Estate Development Company (as Guarantor) Proceeds holders Periodic Distribution Amounts Dissolution Distribution Amount Guarantee Distribution Shortfall Amount Value Restoration Amount Investment management Agreement Dar Al-Arkan International Company II (as Issuer and Trustee) Periodic Distribution Amounts Dissolution Distribution Amount Ijarah/Murabahah Counterparties Ijarah/Murabahah Counterparties Proceeds to be invested in Ijarah and Murabahah agreements with } restricted subsidiaries Profit Collections Proceeds Al-Arkan Company (as Investment Manager) Source: IFIS, KFHR Salient features of the transaction are as follows: Dar Al-Arkan International Company II signs Investment Management Agreement with Al-Arkan Company to properly utilise the Proceeds to generate return. The holders subscribe to the five year program giving them their proportionate undivided interest in the Trust Assets. The Trust Assets involve investment of proceeds in real estate development projects utilising Ijarah and Murabahah Shari ah contracts which will be held on trust by the Issuer. The holders shall be entitled to benefits and returns generated from the Trust Asset and also from the disposal of the. Dar Al-Arkan Real Estate Development Company will provide, as guarantor, the remaining amount in case of any shortfall in return or at the event of dissolution. In this issuance the parent company will be providing the guarantee for any shortfall in returns making it a fixed rate sukuk structure. The investment of proceeds collected by the issuer will be used for Ijarah and Murabahah agreements with restricted subsidiaries of the organisation. This inevitably creates a structure which allows returns to be generated directly from the cash-flows of the organisation. The sukukholders have only a right to the revenue generated from the leasing agreements between bodies of the whole organisation hence making it an asset-based sukuk. In the case of default, the sukukholders would have no rights in any tangible assets. In this sukuk there is the extra security of a guarantor which increases investor protection but may reduce returns slightly. 23

24 The details of the sukuk can be summarised as below: Name of Shariah Principle Amount of Issuance Type of Guarantor Rating Use of Proceeds Regulatory Authority Tenure Limit of Issuance Return Source: IFIS, KFHR DAAR II Ijarah USD200mln Asset-based Dar Al-Arkan. Guarantee of shortfall in distribution of return and shortfall in principle upon maturity. Ba2 Moody s and BB Standard & Poor s Real Estate development projects in Saudi Arabia Capital Market Authority Saudi Arabia 5 Years Up to USD400mln 5.375% * Face Value of Certificates / Aggregate Value of 7.2 The Power and Utilities Sector In terms of electricity use, the Energy Information Administration projects that global electricity consumption is expected to grow by 85% from 2004 to 2030 or by 2.4% per annum. Over the next 25 years, global electricity generation is projected to increase from 16,424 kilowatthours in 2004 to kilowatt-hours in 2030, driven by non-oecd countries. Non-OECD s electricity demand growth is expected at 3.5% per annum, higher than OECD s 1.3%, driven by robust GDP growth, rising population and higher standards of living in Asia and GCC regions. By 2030, total electricity generation in the non-oecd region is expected to outpace electricity generation in the OECD by 30%. 20,000.0 World Electricity Generation by Region, F Bln kilowatthours 15, , , OECD Non-OECD Source: EIA, KFHR According to the 10th Malaysia Plan, energy consumption in Malaysia is expected to grow an average 6.7% between 2011 and 2015, higher than the anticipated GDP growth (5.5%). Tenaga Nasional Berhad is planning to build two dams in Peninsular Malaysia due for commissioning in which will further boost the electricity sector in the country. According to market observers, an estimated 4,000MW of power is needed for Peninsular Malaysia alone. 24

25 Throughout 2008, sukuk issuance in the power and utility sector totalled only two sukuk with a combined amount coming to USD521.4mln. These issuances were located in Pakistan and UAE with the larger of the two being issued by Tabreed 08 Financing Corporation coming to USD462.8mln (89% of sukuk issued in 2008). Total Number of Global Issued Amount of Global Issued (USD mln) Source: Zawya, KFHR In 2009, there was a large increase in sukuk being issued in the power and utilities sector led by large demand from Saudi Arabia. In Jul 2009, Saudi Electrical Company began issuance of sukuk al-istithmar amounting to USD1.86bln. Power & Utility by Country (2008) Pakistan 4.2% Power & Utility by Country (2009) Malaysia 29.83% UAE 95.8% Saudi Arabia 67.19% Indonesia 2.99% Source: Zawya, IFIS, KFHR Ijarah Structure In the Asian-Pacific region, Pengurusan Air SPV Berhad issued in 2009 an amount of sukuk totalling over USD800mln utilising both Ijarah and Musharakah structures. This made up for 30% of sukuk issuance in the sector during Pengurusan Air SPV Berhad is an entity under Pengurusan Aset Air Berhad (PAAB), a water asset management company wholly owned under the Ministry of Finance Malaysia, which was created for the purpose of issuing sukuk. The 2009 issuance was utilising the following structures: 25

26 Pengurusan Air SPV Berhad Ijarah Exercise Purchase Undertaking Lease Assets PAAB (Obligor/Originator Asset Proceeds SPV (Issuer) Proceeds holders Ijarah Rentals Periodic Rental Distribution Source: Zawya, IFIS, KFHR Salient features of the transaction are as follows: The holders will acquire certain existing leasable assets (Ijarah Assets) from PAAB, by way of transfer of the beneficial ownership, of the Ijarah Assets after the Asset Purchase Agreement. The Issuer (on behalf of the holders, as Lessor) shall then lease the Ijarah Assets to PAAB (Lessee) for a pre-determined Rentals and tenure (Ijarah Lease Term) after the Ijarah Agreement. The Issuer will declare a Trust over the Ijarah Assets, its present and future rights and interest in the Ijarah Agreement, the Purchase Undertaking and the proceeds in favour of the holders, and shall issue the to the holders to represent the holders undivided beneficial ownership in the Trust Assets. The proceeds will be utilised by the Issuer to pay the Asset Purchase Price to PAAB under the relevant Asset Purchase Agreement. Upon receipt by the Lessor from the Lessee of Rentals on the relevant Distribution Dates, the Issuer will use the amounts to make payments to the distributions due under the to the holders. Following the Purchase Undertaking, PAAB shall acquire the Ijarah Assets, by way of transfer of beneficial ownership, upon the Scheduled Distribution Date and upon declaration of a Dissolution Event at the Exercise Price. Name of Shariah Principle Amount of Issuance Type of Guarantor Rating Use of Proceeds Regulatory Authority Tenure Limit of Issuance Source: IFIS, KFHR Pengurusan Aset Air Ijarah USD828mln Asset-based IMTN/ICP Programme N/A Short Term P1 Long Term AAA RAM Ratings Acquisition of Water Rights and Refinancing Securities Commission Malaysia 7-30 Years Up to RM20bln (USD6.2bln) This sukuk issuance is designed to raise funds for (PAAB) to be able to refinance principle amounts of any existing banking facilities, to finance the acquisition of existing water assets, rights, liabilities and land from privatised water concessionaries, and to finance capital expenditure. The above sukuk utilises a simple Ijarah structure which generates return from the rental payments paid under the Ijarah contract between PAAB and the sukukholders. In this transaction the sukukholders are entitled to the rental payment because they are 26

27 beneficial owners according to the law of the land. However, beneficial ownership does not mean full ownership and so the sukukholders have no recourse to the asset in case of failure to pay the Ijarah rentals. Instead the sukukholders only have the right to the rental payments under the Ijarah agreement. This is the case with most structures which are not asset-backed (ABS via a true sale) as will be seen in the coming structures. PAAB is utilising a Musharakah version of the sukuk in tandem with the Ijarah structure as part of the ICP/IMTN programme spanning between one to ten years. The Musharakah structure is as follows: Musharakah Structure (i) Pengurusan Musharakah This structure is based on the Shariah principle of Musharakah to raise funds for the parent company (PAAB) as mentioned above. Pengurusan Air SPV Berhad Musharakah Source: Zawya, IFIS, KFHR Salient features of the transaction are as follows: Investors will form a Musharakah amongst themselves and subscribe to the issued by the Issuer which represents their proportionate and undivided interest in the pool of Musharakah Assets to be managed by PAAB. The Issuer will appoint PAAB as the Manager on behalf of the holders who will manage the proceeds paid by the holders for the purpose of purchase existing assets of PAAB, funding and acquisition of assets under construction of PAAB and funding of assets to be acquired by PAAB. The Musharakah Assets will form part of the Musharakah Venture. Prior to acquisition of assets, the Musharakah Capital will be invested in Shariah compliant instruments. The Issuer (as Lessor) will lease the existing assets in the Musharakah Venture to PAAB for the pre-determined Rentals and tenure following the Ijarah Agreement. The Issuer will declare Trust over the Musharakah Assets, its present and future rights and interest in the Ijarah Agreement, the Purchase Undertaking and the proceeds in favour of the holders. The Musharakah shall represent the holder s undivided beneficial ownership in the Musharakah Trust Assets. holders will share any returns from the Musharakah Venture (i.e. rentals from the Ijarah Agreement between the SPV and PAAB and any income derived from investment of the Musharakah Capital). Losses will be borne according to the respective capital contribution of the Musharakah Venture. The returns to investors will be limited to an amount known as Expected Return and any surplus shall be paid by the holders to the Manager as an incentive fee. 27

28 Following the Purchase Agreement, PAAB will acquire the Musharakah Assets by transfer of beneficial ownership at the scheduled distribution date and upon declaration of a Dissolution Event at the Exercise Price. In this structure there is no guarantee that the investors/sukukholders will receive their principle amount since in the Musharakah Shariah principle there can be no guarantee. Therefore the investors will risk their capital for a greater return. (ii) Nucleus Avenue Serial Musharakah Nucleus Avenue Berhad (NAB) is a wholly owned subsidiary of MMC Corporation, a conglomerate responsible for a magnitude of projects involving natural gas supplies, operating container terminals and multi-purpose ports, power producing and supplying treated water to name a few. In the first half of 2010, NAB issued a USD156.66mln sukuk for the purpose of acquiring Malakoff, (Malaysia s largest independent power producer). The sukuk structure is as follows: Nucleus Avenue (M) Berhad Serial Musharakah 6 Undertaking to Purchase the relevant portion of the Trust Assets upon the Dissolution Date at the Exercise Price Musyarakah 1 Distribution to Senior 1 Senior Investor Senior Investor Invest Senior Difference of the expected periodic distribution 4 3 Distribution Musyarakah 2 Junior Investor Junior Investor Distribution to Junior Difference of the Invest expected periodic Junior distribution 2 5 Incentive fee to NAB NAB Trust Assets 6 Source: Zawya, IFIS, KFHR Undertaking to Purchase the relevant portion of the Trust Assets in 50 years or upon occurrence of certain events at the Redemption Amount Salient features of the transaction are as follows: The investors will form a Musharakah among themselves to invest in the Musharakah Venture comprising of trust certificates issued by NAB. NAB will issue trust certificates representing a proportionate undivided ownership of the Trust Assets to the respective Senior or Junior investors for a consideration. Income generated from the Trust Assets shall be distributed to the Senior holders and Junior holders based on the agreed ratio. Any difference between the expected periodic distribution and the distribution from the Trust Assets distributed to the Senior holders, NAB will make good the difference with an amount that will be set-off against NAB s obligation following the Purchase Undertaking. The same case applies to Junior holders with the exception that the Manager will decide at discretion to distribute or not. 28

29 In this structure the underlying assets are a pool of Shariah compliant assets including all the shares to be acquired from Malakoff Berhad. The Issuer retains the right to exchange these assets with other suitable assets and to purchase the trust assets on a deferred payment basis. If the Musharakah venture generates more than the expected return then the sukukholders will pay the surplus to the manager as an incentive fee. Upon maturity the Issuer is obliged to purchase the trust assets from the sukukholders returning them their principle investment. The returns generated from the Musharakah venture will be distributed according to the preagreed ratio 70:30 between the senior and junior sukukholders respectively. 7.3 The Transport Sector The global economic crisis and collapse of world trade in 2009 had a major impact on the transport sector according to the International Transport Forum (ITF) at OECD. World container travel fell by 26% in 2009 while air freight dropped 10%. Data also indicated a 23% reduction in rail ton-km and a reduction of just over 21% in road ton-km in the EU. Rail freight in the US and Russia shows decline of 14% and 12% respectively during the same period. Nevertheless, the transport sector showed signs of a recovery in the later part of 2009 with 2010 expected to push the sector back to levels seen pre-economic crisis. Growing population, increasing urbanisation and higher incomes are expected to boost demand for transport and put great pressure on transport systems around the globe. In Malaysia, investments approved in the transport sub-sector in 2009 exceeded the investments in 2008 which amounted to RM1.4bln (19 projects). The investments approved in 2009 were mainly in the aviation sub-sector with 16 projects valued at RM7.6bln. Nine projects were approved in the maritime sub-sector with investments amounting to RM66.5mln while one project was approved for highway construction and maintenance (RM2.1mln). In the GCC region, Saudi Arabia plans to be the leader in aviation by 2035 with large development plans underway (such as the King Abdul-Aziz International Airport) to overhaul their aviation sector. This is in line with the growing number of pilgrims and visitors entering the country each year. In 2009, Medina Airport saw a 20% increase in passengers from the previous year. Elsewhere in Kuwait, with high levels of growth in passenger traffic and cargo movement, the country is undertaking a number of projects to upgrade and expand its airport facilities. Today, over 50 international airlines operate scheduled flights in and out of Kuwait International Airport (KIA), a figure that is set to increase through the continued adoption of open-skies agreements, which the Kuwaiti government began undertaking in The global transport sector proved to be one of the main drivers of sukuk in the previous two years constituting 16.7% of sukuk issuance in 2008 and 10.2% of sukuk issuance in In spite of the number of sukuk issues in the sector decreasing by 35% between 2008 and 2009, the amount issued in USD has remained almost unchanged with a drop of just 3%. Total Number of Global Issued 17 Amount of Global Issued (USDmln) Source: Zawya, IFIS, KFHR 29

30 As has been the case over the previous decade, Malaysia has dominated the transport sector with the majority of sukuk being issued there. This is mainly due to the large amount of infrastructure development in the country such as the recent plans to build a Mass Rapid Transit System (MRT) as part of the 10th Malaysian Plan. The MRT system is expected to be worth RM36bln (USD11.2bln). Malaysia also plans to expand its airport facilities as the government expects airline passenger arrivals to grow to 62 million in 2015 from 47 million in Transport Issued by Country (2008) Transport Issued by Country (2009) Indonesia 0.8% Pakistan 0.1% Indonesia 0.47% Malaysia 99.1% Malaysia 99.53% Source: Zawya, IFIS, KFHR Pakistan and Indonesia combined only made up less than 1% of sukuk issued in 2008 with the rest being issued in Malaysia. Such was the same case in 2009 with only one sukuk issuance outside of Malaysia. Ijarah Structure Borcos Shipping Sdn Bhd is a Malaysian shipping company set up in the early 80s which specialises in the provision of marine transportation and support services for the offshore oil and gas industry. Borcos Shipping IMTN Ijarah Shipbuilders(s) (1b) Borcos will order the Shipbuilder(s) to construct and deliver under the respective Shipbuilding contract(s) Assets (5) Call and Put Option (2) Enters into Ijarah Agreement Borcos (3) Issue Investors Facility Agent (1a) Issuer agrees to construct and deliver Identified Assets under Istisna Purchase Agreement via Facility Agent Source: Zawya, Bloomberg, KFHR 30

31 Salient features of the transaction are as follows: The Investors will lease the Ijarah Assets to the Issuer/Lessee under the Ijarah Agreement for the Ijarah tenure and Ijarah Payments. During construction of the vessels, the Issuer will enter into a forward lease arrangement on the investors share of the vessel (yet to be completed) for advance rental payment with the provision that if any vessels could not be delivered, all advance payments would be refunded back to the Issuer/Lessee. Once the vessels have been delivered the forward part of the contract will fall and the requirements of a normal Ijarah will be in force. The Issuer will issue sukuk Ijarah to the investors. The Issuer will then declare trust in the Ijarah Assets in favour of the investors evidencing their undivided beneficial ownership in the Ijarah Assets and receivables. During the tenure the Issuer will distribute Ijarah Payments to the investors in proportion to the Ijarah holdings. The investors will grant the Asset Call Option to the Issuer under which the Issuer would be entitled to call on the investors to sell the Ijarah Assets to the Issuer at the maturity date at an exercise price. The Issuer will grant the Asset Put Option to the investors under which the investors would be entitled to sell the Ijarah Assets at an exercise price. BAIS Structure Borcos Shipping Sdn Bhd utilised two principles as part of its IMTN programme namely Ijarah and Bai Bithaman Ajil (BBA). The proceeds of the two will be utilised by Borcos Shipping Sdn Bhd to refinance existing banking facilities, to finance the construction of new vessels and for working capital purposes. Borcos Shipping IMTN Bai Bithaman Ajil First Sale and Purchase from Borcos to Investors Borcos (3) Investors pay the Purchase Price Investors (1) Borcos identifies the Assets Assets (2) Investors purchase Assets from Borcos at Purchase Price Second Sale and Purchase from Investors to Borcos Borcos (1) Resale of Assets at Selling Price Investors (2) Borcos issues notes evidencing debt arising from the second sale Assets Source: Zawya, IFIS, Bloomberg, KFHR 31

32 Salient features of the transaction are as follows: Bai Bithaman Ajil is the contract of sale and purchase on a deferred payment basis with a pre-agreed payment period. Sale price includes profit margin. The investors will first purchase the BBA Assets from the Issuer following the BBA Purchase Agreement. The investors will then sell the BBA Assets to the Issuer following the BBA Sale Agreement. The Sale Price will include the original Purchase Price plus a profit margin agreed by the Issuer and investors. Payment will be on a deferred instalment basis. The evidence of the Issuer s obligations to pay the Sale Price will be seen in the notes issued to the sukukholders which the Issuer will redeem upon maturity. Most structures utilising the BBA principle are listed under Murabahah since there is the element of Murabahah present. However, the use of a deferred payment scheme, which will normally be long term, forces the name to change to Bai Bithaman Ajil (sale with deferred payment). There are really two types of BBA in the global sphere which we should differentiate in order to recognize which one is being applied. The normal or globally accepted model is a simple Murabahah structure between the three parties. The asset in the transaction will pass from the supplier to the seller then to the buyer with an added profit margin declared to the parties. The other BBA which is acceptable only in the Asian-Pacific region is a model which includes sale with buy back (Bai Al- Inah). This is when two parties sell and then purchase the same asset between each other twice in order to create a debt with the asset returning to the original owner. The difference between the two transactions is the profit margin. Without going into the details of the different rulings on such a transaction, it is important to know that a structure as above would not be permissible to other regions of the world such as the GCC region since it involves a transaction which to them is deemed impermissible in Islamic law. Therefore this sukuk would only attract investors following the Asia-Pacific region s interpretations. Musharakah Structure PLUS Expressways Berhad is the largest toll expressway company in South East Asia and is responsible for 62% of all inter-urban toll expressways in Peninsular Malaysia. PLUS SPV Berhad Musharakah holders Proceeds Sale of Beneficial Ownership SPV 2 SPV 1 Sale Price Sale Undertaking Deed Purchase Undertaking Deed Sale Price Sale of Beneficial Ownership Obligor (PEB) PEB Source: IFIS, Zawya, Bloomberg, KFHR 32

33 Salient features of the transaction are as follows: PLUS Expressways Berhad (PEB) declares trust on the Portfolio for the benefit of the holders of units in the Portfolio. For each issuance, PEB sells the Portfolio to SPV 1 who in turn sells to SPV 2 (the Issuer). The Issuer declares trust over the Portfolio and any other assets that will be specified as Trust Assets. The Issuer then issues Trust Certificates ( Musharakah) which evidence the interest of holders of the Musharakah in the Trust Assets (which includes the Portfolio). The investors will form a partnership amongst themselves to invest in the Trust Assets. The Issuer will be the Manager of the Trust Assets on behalf of the holders. PEB will then enter into a Purchase Agreement with the Issuer on behalf of the holders whereby PEB will purchase the Trust Assets from the Issuer at the exercise price. Periodic payments will be distributed to the holders from the income generated from the Trust Assets. Any returns above the expected return will be treated as receivables for PEB. Any shortfall in periodic distributions to the holders will be made good by PEB which will set-off the difference against PEB s obligation following the Purchase Agreement. PLUS Expressways Berhad as the Obligor and Trustee will use the proceeds gathered from the sukukholders to refinance the existing banking facility which was to acquire Expressway Lingkaran Tengah Sdn Bhd, Linkedua (Malaysia) Berhad and Konsortium Lebuhraya Butterworth-Kulim (KLBK) Sdn Bhd, three toll companies for different regions around Malaysia. 7.4 The Construction Sector Overall, world construction spending reached USD4.8tln in 2008, but growth slowed to less than 1%. This was the lowest rate of growth since 2002, and a marked slowdown from the intervening years when world construction spending was growing between 3% and 6% p.a. In 2009, emerging markets put on a strong performance in the construction industry with China and India growing 8% and 9% respectively. The emerging markets are rapidly expanding due to the developments of rural areas and large amounts of resources and exports. On the other hand, the western developed countries show a lacklustre year with many contracting construction markets due to the credit crunch and lack of willing investors. Global Construction Spending Growth : % Change Korea China Japan Mexico Australia India Other Countries USA 0.1 Italy Germany France UK Brazil Spain Source: Davis Langdon & Seah International: World Construction

34 Malaysia is expected to flourish in the construction industry over the next five years with a number of projects just unveiled in the new 10th Malaysian Plan. The Prime Minister has announced that 52 high-impact projects worth RM63bln (USD11.2bln) are to be implemented under the Public-Private Partnership, which ensure equitable sharing of risks and returns and is expected to drive the economic transformation agenda of the government. In the GCC region, the construction market showed signs of resilience against the financial crisis as over USD1tln worth of projects have been announced or are underway. Most of these are situated in UAE which, despite the real estate crisis, accounts for more than 61% of the region. GCC Construction Projects Market * USDbln Bahrain 41 Kuwait 57 Oman 42 Qatar 58 Saudi Arabia 274 UAE 457 *only includes projects underway or planned (as at 17 Jun 10) Source: MEED Projects Although prospects remain good for the construction sector, after the Dubai real estate debacle the sukuk issuance hit a low in From a high of almost USD1.5bln in 2008 the sukuk issuance fell to just USD124mln with the majority being issued in the Asia- Pacific region. The oil rich countries do not participate in issuing sukuk for the construction sector as much compared to the Asian-Pacific region as regulation and local laws are not comprehensively enacted yet to support the role of sukuk. Moreover, the governments will use the revenue from oil production to fund the projects rather than issuing sukuk. Total Number of Global Issued 10 Amount of Global Issued (USDmln) Source: Zawya, IFIS, KFHR Between 2008 and 2009, Purple Island Corporation of Saudi Arabia issued the second largest sukuk for the sector with a total issuances amounting to USD266.6mln. However the largest sukuk was issued by Lingkaran Trans Kota Holdings (LITRAK), a highway maintenance company in Malaysia, totalling USD350mln. 34

35 Construction Issued by Country (2008) Saudi Arabia 18.2% Construction Issued by Country (2009) Indonesia 13.24% Pakistan 6.4% Malaysia 75.3% Malaysia 86.76% Source: Zawya, IFIS, KFHR Malaysia has dominated this sector of sukuk issuance since the start of the millennium and is likely to continue over the next two years. Malaysia is still considered a developing country and therefore requires higher levels of funding to finance its infrastructure projects. Compared to the oil rich countries which have most of their infrastructure built, Malaysia still requires additional infrastructure to become a fully developed country. Moreover, Malaysian regulators have played a development role promoting the issuance of sukuk through legislation and attracting foreign investors. China is a leading economy in the 21st century and is a major player in the construction field with huge infrastructure developments underway. Statistics show that since the beginning of 2010, the prosperity indexes in many sub-industries of the construction industry show rising momentum. As far as the cement industry is concerned, in Mar 2009, the national cement output was mln tons, up 10.1% y-o-y; and the cement sales volume of national key cement enterprises is 49.85mln tons, up 8% y-o-y and 128% m-o-m. According to another statistics, in 1Q09, the national cement output was mln tons, up 12.9% y-o-y. Elsewhere in India, opportunities remain in abundance with the region being characterised by an acute power shortage, a weak transport network, poor water, sanitation and waste management systems as well as ports and airports that cannot keep up with demand. With the economy registering high growth rates above 8.5% over the last four years, it is expected to be a key area for investment in the future. The Indian government has targeted the sector as a priority area that is crucial to attract foreign direct investments. Musharakah Structure (i) Gamuda Musharakah Gamuda Berhad is Malaysia s leading construction group responsible for a number of large infrastructure projects in the Asia-Pacific and GCC regions. Among them is the Kaohsiung Mass Rapid Transit System in Kaohsiung, Taiwan, the airfield and road tunnel works for the New Doha International Airport (NDIA) in Qatar and the Sitra Causeway Bridges in Bahrain. Gamuda Berhad s subsidiaries are principally involved in civil engineering and construction, township development, proprietor and operator of clubhouse, property maintenance services, township and golf club management, operation and maintenance of water treatment plants, information technology services, trading, landscaping, insurance agency, hire and rental of plant and machinery, manufacturing, supply and laying of road surfacing materials, quarrying and investment holding. 35

36 This particular issue was for the refinancing of its existing credit facilities and to finance its future investment for the group s business. Gamuda Berhad also used the Shariah principle of Bai Murabahah as part of the Islamic Commercial Papers/Islamic Medium Term Notes (ICP/IMTN) programme which will be displayed below. Gamuda Berhad Musharakah Musharakah Venture Portfolio Units holder holder holder Issuer $ Initial Owner of Portfolio Units (Gamuda) Trustee Sale Undertaking Purchase Undertaking The Obligor (Gamuda) Source: Bloomberg, Zawya, IFIS, KFHR Salient features of the transaction are as follows: The Investors form a Musharakah Partnership amongst themselves to invest fractions of undivided beneficial ownership in the Portfolio to be provided by Gamuda as the Initial owner of the Portfolio Units. Musharakah Partners will contribute capital ( Proceeds) following their subscription for the purpose of investment in the Portfolio (Musharakah Venture). Gamuda as Obligor will undertake to purchase the respective Portfolio Units from the Issuer (on behalf of the holders) upon maturity via the Purchase Undertaking. The Trustee will give a Sale Undertaking to the Obligor that the Trustee will sell the Portfolio Units to the Obligor upon maturity to ensure the Portfolio Units are not sold to any other third party. Note that the use of a purchase undertaking is common in most sukuk structures around the world. This is to ensure that the investors/sukukholders are guaranteed to get back their principle amount upon maturity. This is founded on the principle that a unilateral promise to purchase an asset is binding on the party and thus enforceable by law. Without this the investors would most likely not invest as there is no guarantee of getting back the principle sum and would be forced to find an interested party to sell their invested interests to. In some jurisdictions such as France, a promise (i.e. purchase undertaking) is non-binding and so would not be present in the sukuk structures issued from that jurisdiction unless there was a change in the application of the law. 36

37 (ii) Offshoreworks Musharakah Offshoreworks Capital Sdn Bhd is an SPV created for the sole purpose to facilitate the issuance of sukuk on behalf of the parent company Offshoreworks Group. The organisation is involved in a range of different projects which include engineering and construction of offshore work barges and platforms. The objective of this sukuk is to raise funds for the refinancing of existing commitments and to finance the acquisition of vessels and/or barges and survey, geotechnical, seismic, diving and other related equipments. Offshoreworks Capital MCP/MMTN Musharakah (3) Appoint Project managers OSS and OGS (2a) Issue (5) Purchase Undertaking OHSB/Obligor (2b) Proceeds OWC/Issuer (1) Identify Musharakah Assets (2b) Proceeds Musharakah Venture Trustee (2c) Invest in venture (2b) proceeds holders (4) Distributions Source: Zawya, Bloomberg, IFIS, KFHR Salient features of the transaction are as follows: The Issuer (OWC) will identify the assets (Musharakah Assets) which it wishes to venture and invite for investments with other investors. The Issuer and the Trustee (acting on behalf of the investors) will form a Musharakah amongst themselves to invest in the Musharakah Assets via subscription to the issued by OWC (Issuer). The Issuer will declare trust with the Trustee on the Assets for the benefit of investors and itself. The Issuer and holders will contribute their portion of capital for the purpose of the Musharakah Venture. The Proceeds will flow through the Trustee and Issuer to end with the Obligor (OHSB). The subscription of the would then represent the holder s undivided ownership/interest in the Musharakah venture. Offshore Stephaniturm (OSS), Offshore Discovery (OGS) and the Obligor (OHSB) will be appointed as Project Managers for the Musharakah Venture. Any profit generated from the Musharakah Venture will be distributed by the Issuer to the holders on a pre-agreed ratio. Any loss made will be borne by both parties (Musharakah Partners) by their respective capital participation in the Musharakah Venture. The holders are entitled to their expected profit but if any excess profit is generated it will be given to the Project managers as an incentive fee. Any shortfall in expected profit will be made good by the Obligor (OHSB) which would be set-off against the Obligor s obligation under the Purchase Undertaking. The Obligor will give a Purchase Undertaking to the Trustee (on behalf of the holders) to purchase the Musharakah Assets at an exercise price upon maturity. 37

38 Mudharabah Structure Manfaat Tetap Sdn Bhd is a SPV setup for the purpose of issuing sukuk for its parent company Sistem Lingkaran-Lebuhraya Kajang Sdn Bhd (SILK). SILK is a private listed company in Malaysia where it focuses its major resources to implement and complete construction of its maiden privatised highway, Kajang Traffic Dispersal Ring Road (KRR). The proceeds raised from the sukuk will be used for the settlement of the existing Bai Bithaman Ajil Islamic Debt Securities (BAIDS) holders. Manfaat Tetap Sdn Bhd Mudharabah Profit Sharing Based on Pre-Agreed Ratio Profit Sharing Based on Pre-Agreed Ratio Mudharabah 2 Investment Investors Mudharabah Investment Issue Mudharabah Issuer Purchase Consideration Purchase of Beneficial Rights of SILK Highway (Ijarah Assets) (Asset Purchase Agreement) Issuer Lease the Ijarah Assets (Ijarah Agreement) SILK SILK pays Ijarah Rentals Existing BAIDS Holders SILK Makes Full and Final Settlement of the Existing BAIDS Holders Source: Bloomberg, Zawya, IFIS, KFHR Salient features of the transaction are as follows: The Investors shall contribute capital to the Issuer as the Rab-ul-Mal as part of a Mudharabah venture. The Issuer will issue Mudharabah to investors as evidence of their investment. Upon receiving the capital from the holders the Issuer will enter into an Asset Purchase Agreement with SILK to buy the Ijarah Assets at an agreed Purchase Price. The Issuer will enter into an Ijarah Agreement with SILK to lease the Ijarah Assets for an agreed Ijarah Rental payment. The Issuer will concurrently enter into a Mudharabah Venture with SILK utilising part of the proceeds from the Mudharabah Venture with the holders, to invest in the business of SILK. The profit derived from the business will be shared in a pre-agreed ration between the Issuer (as Rab-ul-Mal) and SILK (as Mudharib). Proceeds received by SILK from the Mudharabah Venture will be utilised as full and final settlement to the existing BAIDS holders. 38

39 Murabahah Structure This structure is the Murabahah version used in Gamuda Berhad s ICP/IMTN sukuk programme. Gamuda Berhad Murabahah Source: Zawya, Bloomberg, IFIS, KFHR Salient features of the transaction are as follows: The Issuer and the Trustee (on behalf of the holders) execute an Asset Purchase Agreement under which the Issuer will sell the Assets to the Trustee. The Asset Purchase Price will be the amount to be disbursed. The Trustee will then sell the Assets back to the Issuer. The Asset Sale Price will represent the Asset Purchase Price and the Murabahah Profit portion which will be equivalent to the yield to maturity under the Murabahah Notes. The obligation to pay the Asset Sale Price is evidenced by the Notes. 7.5 The Oil & Gas Sector Demand for oil and gas is expected to remain strong mainly due to the lack of a substitute for oil as fuel in the transportation sector. In addition, the expected global economic recovery would increase economic and manufacturing activities, thus leading to an increase in demand for oil and oil-related products such as industrial gas, plastic resin as well as fertiliser. OPEC anticipates world oil demand to grow by 0.95 million barrels per day (mbpd) in According to OPEC, recent data indicates that demand growth has been slightly higher than estimated in the first half of the year. However, an expected moderation in the pace of the economic recovery is likely to impact demand growth forecasts for the second half. OPEC expects supply of oil from the non-opec countries to increase in 2010 by 0.64 mbpd from an estimated 0.74 mbpd in In May, OPEC crude oil production averaged mbpd, translating to an increase of 0.14 mbpd over the previous month. 39

40 Global Oil Demand and Supply (1995 Jun 2010) USD pb Jan -05 Apr-05 Jul -05 Oct-05 Jan -06 Apr-06 Jul -06 Oct-06 Jan -07 Apr-07 Jul -07 Oct-07 Jan -08 Apr-08 Jul -08 Oct-08 Jan -09 Apr-09 Jul -09 Oct-09 Jan -10 Apr-10 Source: Bloomberg, KFHR Demand Supply The oil and gas sector has played a big part in sukuk issuance during 2008 by making up 11% of the market. The largest issuer in the year was by Saudi Basic Industries Corporation (SABIC) amounting to USD1.3bln saw only one sukuk issuance in the sector by PETRONAS Global totalling USD1.5bln which made up 7.4% of total global sukuk issues for the year. Total Number of Global Issued Amount of Global Issued (USDmln) Source: Zawya, IFIS, KFHR The market also saw a range of structures being utilised between 2008 and 2009 represented in the following chart. Al-Istithmar structure is mainly used in Saudi Arabia and has not been practiced in the Asia-Pacific region mainly because the need does not arise. In Malaysia, Ijarah, Musharakah and Murabahah are the main structures utilised and generally allow many possibilities. Musharakah 1% Murabahah - Istisna 1% Ijarah 52% Al-Istithmar 46% Source: Zawya, IFIS, KFHR 40

41 The marked falls in engineering, procurement and construction (EPC) costs over the course of 2009 have encouraged governments to press ahead with new projects. It is estimated that construction costs in Oct 09 had fallen by 45%. Gulf governments also benefitted from a 60% reduction in piping and equipment costs over the same period. Istisna Structure Tanjung Offshore Berhad and its subsidiaries are involved in the provision of integrated services to both upstream and downstream activities in the oil and gas industry. In the following structure we see the use of the Istisna contract in order to finance the acquisition and construction of offshore vessels, production platforms, lift barges and oil rigs. This sukuk issuance is designed to raise funds for the construction of two offshore support vessels which will be utilised by Tanjung Offshore Berhad for its future business activities. Istisna Transactions Construction Contract 3 rd Party Contractor Tanjung Offshore Istisna 3 rd party Contractor will deliver the completed Asset to TOB Subsidiary TOB Subsidiary orders the construction of the asset utilising the proceeds of the advanced by TOB Tanjung (Issuer) Advances by Issuer to TOB Subsidiary TOB Subsidiary (5) Hibah of completed Asset to the Issuer (6) TOB will re-hibah back the Asset to TOB Subsidiary (2) Issuer agrees to construct and deliver Asset under Istisna Purchase Agreement (3) Investors pay issuance proceeds (Istisna Purchase Price) Facility Agent (4) Issuer settles the Istisna Sale Price on deferred payment basis (1) Investors agree to construct and deliver Asset under Istisna Sale Agreement Investors Source: Zawya, IFIS, Bloomberg, KFHR Salient features of the transaction are as follows: The Issuer will enter into an Istisna Sale Agreement with the investors via the Facility Agent whereby the investors agree to construct and deliver the Identified Assets to the Issuer for a consideration of the Istisna Sale price. The Istisna Sale Price will be the Istisna Purchase Price plus profit, payable on a deferred basis. Thereafter the Issuer will enter into an Istisna Purchase Agreement with the investors via the Facility Agent whereby the Issuer will agree to construct and deliver the Identified Assets to the investors for a consideration of the Istisna Purchase Price, payable in an immediate lump sum. Delivery of the Identified Assets to the Issuer under the Istisna Sale Agreement will take place upon the investors taking delivery of the same under the Istisna Purchase Agreement. The Istisna is evidence of the Istisna Sale Price payable by the Issuer to the investors (holders) under the Istisna Sale Agreement. 41

42 The Issuer s Subsidiary will construct the Identified Assets with a 3rd Party Contractor and make a gift (Hibah) of the completed Identified Assets to the Issuer. Upon completion of the Istisna transactions, the Issuer will make a gift (Hibah) back to its subsidiary. Notable in the above structure the sale and buy back feature is present (bai al- inah) with the exception that the asset is not in existence yet. This feature is used in order to create the debt and obligation to repay the debt for the sukuk to be issued. The Istisna principle only exists within the construction contract whereby the 3rd party will construct the asset for an agreed consideration price (sukuk proceeds). Ijarah Structure Petroliam Nasional Berhad (PETRONAS) is the national oil company of Malaysia and one of the largest contributors to the country s revenue. PETRONAS is engulfed in many areas of the oil and gas industry from exploration and discovery to logistics and maritime. The PETRONAS Global was one of the largest issues in the sukuk market during It was also the only sukuk to be issued in the sector during 2009 and is larger than the four sukuk issues during 2008 combined standing at USD1.5bln. Petronas Global Ijarah Sellers Petroliam Nasional Berhad (Lessee / Servicing Agent) Petroliam Nasional Berhad (as Obligor) Petroliam Nasional Berhad and the Sellers Purchase Agreements Rental Lease Agreement / Service Agency Agreement Purchase Undertaking Exercise Price Sale Undertaking Exercise Price / Payment in Kind Asset Purchase Price for Assets PETRONAS Global Ltd. (as Issuer) Declaration of Trust Proceeds Periodic Distribution and Redemption Amount holders Source: Bloomberg, Zawya, IFIS, KFHR Salient features of the transaction are as follows: The Issue, once proceeds have been paid by the holders, will purchase the Assets from the Sellers at an agreed Purchase Price. The Assets will comprise of the Seller s beneficial ownership of the Group Properties. Upon acquisition of the Assets by the Issuer, they will subsequently lease the Assets to the Lessee for ten consecutive Lease Periods at an agreed Rental payment. Concurrently, the Lessee will enter into a Service Agency Agreement with the Issuer whereby the Lessee/Service Agent will be responsible for all maintenance, insurance, structural repair, taxes, etc. Upon maturity the Trustee will exercise its right to oblige the Obligor to purchase all of the Assets for an exercise price in accordance with the Purchase Undertaking. 42

43 Under the Sale Undertaking and in occurrence of a tax event, PETRONAS may exercise its option whereby the Trustee will sell the Assets to PETRONAS at an exercise price. 7.6 The Financial Services Sector 2009 turned out to be a difficult year for the financial sector in the GCC region. In the banking sector the average dividend yield for GCC banks dropped 36% y-o-y to 3.3% for 2009, down from 5.4% in Among the worst hit were those listed on Kuwait Stock Exchange losing 62%. Elsewhere in Asia, Malaysian banks recorded a net earnings growth for a third consecutive quarter with a 47.7% y-o-y jump for 1Q10. This is mainly due to a 29.6% y-o-y expansion of non-interest income. The financial services sector contributed over 21% of all sukuk issuance during the year 2008 and 11.7% during 2009 making it one of the largest sectors in terms of amount issued. Although the number of sukuk issued between 2008 and 2009 dropped by 60%, the amount issued in USD remained quite substantial. This was mainly due to larger sukuk issuances than the previous year such as the USD850mln Islamic Development Bank or the USD500mln GE Capital. Total Number of Global Issued 15 Amount of Global Issued (USD mln) Source: Zawya, IFIS, KFHR The financial services sector represents the global input to the sukuk market with a range of countries participating in sukuk issuance. We see in 2009 the sector symbolises the three parts of the world, the east, the middle and the west. However, the dominant force in the sector has been Malaysia over the last number of years. Financial Services by Country (2008) Financial Services by Country (2009) UAE 22.2% Pakistan 0.7% Indonesia 1.3% United States 21% Malaysia 35% Saudi Arabia 10.1% Source: Zawya, IFIS, KFHR Malaysia 65.7% Saudi Arabia 44% 43

44 Musharakah Structure Cagamas Berhad is the national mortgage company and leading securitisation house in Malaysia. It issues debt securities to finance the purchase of housing loans and other consumer receivables from financial institutions and non-financial institutions. Cagamas has been responsible in the past for issuing a large number of sukuk in the financial services sector. Cagamas has contributed 20% of all sukuk issued in the sector between 2008 and 2009 in USD amount. This sukuk issue is for the purpose of working capital and general corporate purposes. As part of their Islamic Commercial Papers and Islamic Medium Term Notes (ICP/IMTN) programme, Cagamas will be utilising five Shariah principles namely: Murabahah, Ijarah, Mudharabah, Istisna and Musharakah. Cagamas Musharakah Source: Zawya, Bloomberg, IFIS, KFHR Salient features of the transaction are as follows: The investors form a Musharakah amongst themselves and will invest in the Assets of Cagamas through a Trustee. Cagamas will be appointed as the Manager over the Musharakah Venture and will be paid an incentive fee. Cagamas will issue the certificates to the investors as evidence of their interests in the Trust Assets. The profit derived from the Venture will be distributed between the investors according to their respective holdings in the investment or by any particular pre-agreed ratio between investors prior to the investment. The losses will be borne according to the respective investments. Return from the Venture will be distributed by Cagamas to the holders. Any excess in profit generated from the Musharakah Venture above the expected return will be paid to the Manager as an incentive fee. Any shortfall in expected return will be made good by Cagamas which will be set-off against its obligation following the Purchase Undertaking. Upon maturity, Cagamas will purchase the Assets from the Trustee (on behalf of the holders / investors) at an exercise price. The Cagamas sukuk Musharakah is very generic and simple with only a few points to highlight. Like most other sukuk structures, there exists a debt creation mechanism which in this case is done via the purchase undertaking which makes it obligatory for Cagamas to purchase the assets after a period of time. When the investors as Musharakah partners invest in the underlying assets (known as the Musharakah Venture), the transfer of ownership is only beneficial ownership and not a true sale. Therefore the sukukholders have the right over the return which Cagamas has agreed to distribute with absolutely no recourse to the underlying assets in the case of non-payment. Investors would have to analyse the credit worthiness of Cagamas rather than the investment portfolio or the return to be generated from the underlying Musharakah venture. 44

45 Ijarah Structure Cagamas Ijarah Source: Bloomberg, Zawya, IFIS, KFHR Salient features of the transaction are as follows: The Trustee (on behalf of the Investors) shall purchase a leasable Asset from Cagamas (the Issuer) for a Purchase Price. The Trustee will lease the Asset to the Issuer over a given tenure for the Ijarah Rental payments. The Issuer will issue the Trust Certificates () to the Investors as evidence of their interests in the Asset and the Issuer s obligation under the transaction documents. Upon maturity, the Issuer will purchase the Asset from the Trustee (on behalf of the holders) for a consideration of a Sale Price. In the above simple Ijarah structure the investors would require some form of purchase undertaking from the issuer Cagamas to ensure that upon maturity they will receive their principle amount. Name of Shariah Principle Amount of Issuance Type of Rating Use of Proceeds Regulatory Authority Tenure Source: IFIS, Bloomberg, KFHR Cagamas Ijarah Up to RM20bln (USD6.2bln) Asset-based AAA MARC & RAM Working Capital and General Corporate Purposes Securities Commission Malaysia 7-40 Years Istisna / Ijarah Structure Tamweel Limited is one of the largest real estate financiers in the GCC region. The sukuk below is worth USD300mln and was issued with the intention to support its business activities and capital expenditure. 45

46 Tamweel Istisna / Ijarah Source: Bloomberg, Zawya, IFIS, KFHR Salient features of the transaction are as follows: Upon subscription by the investors and payment of Proceeds, the Issuer (as Trustee) will purchase Tamweel s rights, title and interest in the Original Leased Assets and Original Istisna Assets (combined Portfolio Assets). Tamweel as Service Agent will provide services with respect to the Portfolio Assets and will distribute the Portfolio Profits to the Trustee. The Issuer will declare a trust over the Portfolio Assets for the benefit of the holders. Any surplus in the Portfolio Profit greater than the Distribution Amounts will be put into a Reserve Account and will be used to fund future distributions to the holders. However, any surplus upon maturity will be given to the Service agent as an incentive fee. If there is a shortfall in distribution amounts to holders which cannot be covered by the Reserve Account will be made good by the Service Agent through a financing agreement or loan to the Issuer. Tamweel as Obligor will have the right via Purchase Undertaking to purchase all of the Trustee s rights, title and interest in the Portfolio Assets upon maturity at an exercise price intended to fund the Redemption Amount payable by the Issuer to the holders. 7.7 Other Sectors The remaining sukuk issuance for the period span across a number of sectors which include Telecommunication, Consumer Goods, Agriculture, Conglomerate, Industrial Manufacturing, Mining & Metals, Food & Beverage, Retail, Services and Leisure & Tourism. Combined they make up less than 10% of sukuk issuance between 2008 and 2009 with a total amount coming to USD3.1bln of the USD33bln total issued. The amount issued overall increased by almost 100% y-o-y in

47 Number of Issued ( ) Amount Issued (USD mln) Source: Zawya, Bloomberg, KFHR 2009 saw the largest issue in the Leisure & Tourism sector by TDIC Limited with a size of USD1bln being issued in the UAE. Malaysia s Sime Darby contributed a further USD520mln for the agriculture sector contributing over half of sukuk issuance for the two year period. Amount Issued per Sector (USD mln) Telecommunication 22.4% Leisure & Tourism 31.7% Source: Zawya, KFHR Services 0.4% Mining & Metals 0.3% Conglomerate 5.2% Retail 0.4% Food & Beverage 0.8% Industrial Manufacturing 6.0% Agriculture 27.0% Consumer Goods 5.6% Malaysia was the largest contributor with over 60% of sukuk issuance during in the category of others. Following behind was Indonesia with 21.6%, Pakistan with 14% then Qatar and UAE with just 2% each. In USD amount Malaysia stood at the top with 56% and UAE behind with 32%. The rest had 5% or less. Musharakah Structure (i) Pinnacle Tower Musharakah Pinnacle Tower Sdn Bhd is an entity with the purpose of becoming the Special Purpose Vehicle (SPV) for the IMTN sukuk programme. SACOFA Sdn Bhd is responsible for telecommunication projects and infrastructure across Sarawak, East Malaysia. The proceeds, which may reach up to RM450mln (USD138mln), are to be used by SACOFA Sdn Bhd for working capital and capital expenditure purposes. This structure includes the Shariah concept of Ijarah as part of the ICP/IMTN programme as shown further below. 47

48 Pinnacle Tower IMTN Musharakah Source: Zawya, Bloomberg, IFIS, KFHR Salient features of the transaction are as follows: The Issuer and Sacofa Sdn Bhd will enter into a Musharakah Agreement as partners for the purpose of undertaking a Musharakah Venture. Each partner contributes capital to the Venture based on an agree ratio. The Issuer will issue to investors to finance the investment into the Musharakah Venture which forms the Issuer s capital contribution. The will represent an undivided ownership of the holders in the Musharakah Venture. Simultaneously, the Issuer will make a declaration of trust over all of its interests in the Musharakah Venture for the benefit of the holders. Sacofa will contribute capital in the form of cash or kind and will represent their stake in the Musharakah Venture. Sacofa will be appointed the Manger for the Venture following a Management Agreement. Any profit derived from the Musharakah Venture will be distributed according to the pre-agreed ratio. Any losses will be borne by the respective parties according to their capital contribution. The expected return to the holders will be from the namely derived from Ijarah Rentals up until the date of maturity. (ii) Dawama Musharakah Dawama Sdn Bhd is engaged in pre-press, design, typesetting, printing, distribution and marketing of textbooks and other publications from Dewan Bahasa dan Pustaka. Dawama Sdn Bhd issued the sukuk for the purpose of meeting working capital requirements. 48

49 Dawama Musharakah (4a) Remittance of Income Received DBP (Awarder) Designated Accounts (4b) Payment of Transaction Expenses Dawama (Obligor / Agent / Issuer (3b) Investment Delivery of Contract Commitment Contract (5) Payment of Periodic Distributions (1a) Musharakah Agreement Musharakah Venture (1b) Provide Capital in kind (3a) Proceeds holders (2) Issue Musharakah Trustee Services Trustee Source: Bloomberg, IFIS, Zawya, KFHR Salient features of the transaction are as follows: Dawama will enter into a Musharakah Agreement with the investors (holders) for the purpose of undertaking a Musharakah Venture. The holders will provide the capital contribution for the Musharakah Venture. The interest of the holders will be represented by Dawama as Agent (Wakil) and initial Trustee for the holders. The Musharakah Venture will be the business of Dawama in the execution of the contract to distribute school textbooks to DBP. Dawama will issue the to the investors which represent their undivided interest in the Musharakah Venture. The Issuer will declare trust over the Musharakah Venture for the benefit of the holders and itself. The holders will appoint the Trustee to hold and administer the Assets. Dawama will be appointed as the Project Manager to execute the contract and will procure the payments of all income generated from the Musharakah Venture. The profit generated from the Musharakah Venture will be distributed between Dawama and the holders in a pre-agreed ratio limited to the amount of expected profit. Any excess in profit derived from the Musharakah Venture above the expected profit will be paid to the Issuer as an incentive fee. Losses will be borne by the parties according to their respective capital contribution. Any shortfall in expected profit shall be made good by the Issuer and will be set-off against the Issuers obligation following the Purchase Undertaking. Upon maturity the Issuer will purchase the assets from the holders for an exercise price. 49

50 (iii) Sime Darby Musharakah Sime Darby Berhad is the Malaysian arm of the Sime Darby organisation and is involved in many different fields among which are plantations, energy and utilities, property developments and automobiles. The utilisation of the proceeds includes working capital, financing of future investments and capital expenditure. Sime Darby Musharakah Source: Zawya, Bloomberg, IFIS, KFHR Salient features of the transaction are as follows: The investors and the Issuer will enter into a Musharakah Agreement as partners for the purpose of undertaking a venture to invest in the business of the Issuer. The Issuer will issue the to the investors as evidence of their undivided interest in the Musharakah Venture. Proceeds raised form the issuance will be the capital contribution of the holders in the Musharakah Venture. The Issuer will declare a trust over all the business for the benefit of the holders and itself. The Issuer will contribute its capital into the Musharakah Venture. The issuer will be appointed as Manager over the Musharakah Venture. The return on the will be the yield of expected profit up until maturity whereby the profit derived from the Musharakah Venture will be divided between the partners according to a pre-agreed ratio. Losses will be borne by the respective parties according to each capital contribution. Any shortfall in returns lower than the expected profit will be made good by the Issuer as an advance part payment of the exercise price. Any excess above the expected profit will be paid to the Issuer as an incentive fee. Upon maturity the Issuer will purchase the holders interests in the Musharakah Venture for an exercise price. 50

51 Ijarah Structure (i) Pinnacle Tower Ijarah Pinnacle Tower IMTN Ijarah Source: Bloomberg, IFIS, KFHR Salient features of the transaction are as follows: The Issuer will enter into a lease agreement whereby the Issuer will lease to Sacofa its portion of the Musharakah Assets for a period which corresponds to the tenure of the Musharakah Venture. The Musharakah Assets form the underlying assets for the Ijarah Agreement which will earn the Ijarah Rentals payable to the Issuer concurrently with the distribution of profits in the Musharakah Venture. Upon termination of the Ijarah Agreement the Musharakah Venture will be dissolved with the Musharakah Assets being transferred to Sacofa by way of Hibah (gift). Both Musharakah Partners will have no further rights in the Musharakah venture. (ii) Menara ABS Ijarah The following sukuk structure is one of only a few asset-backed sukuk issuances which currently exist. This structure is utilising the principle of Ijarah (leasing) with a true sale between sukukholders and originator. In this case the originator is Telecom Malaysia, a government controlled company which is responsible for most of the country s telecommunication infrastructure. TM will utilise the proceeds from the sukuk for working capital, capital management and investments. 51

52 Menara ABS Berhad Ijarah Source: Bloomberg, IFIS, Zawya, KFHR Salient features of the transaction are as follows: Menara ABS buys the properties from TM at an aggregate appraised fair market value. Menara ABS Berhad creates a trust in favour of the holders (Tranche A, B and C). Menara ABS Berhad will enter into a Master Ijarah Agreement with TM whereby they will immediately lease the properties back to TM (Lessee) for a fifteen year period under the Ijarah contract for a consideration of lease rentals paid by TM to Menara ABS Berhad (as Lessor). At the end of the twelfth year, Menara ABS will offer TM the right to renew the lease over all the properties (Lease Option). Menara ABS may offer (at its discretion) TM the right to purchase all or any of the properties within the period of thirty three months before expiration of the lease at the then fair market value (Purchase Option). If this right is not exercised then Menara ABS Berhad will have the right to sell such properties to interested third parties. To fund the purchase of the acquisition of the properties by Menara ABS Berhad from TM, Menara ABS Berhad will issue to investors. The Issuer (Menara ABS Berhad) will use the Ijarah Rentals to pay the coupon to the holders. The above structure incorporates a true sale between investors and TM which gives the investors full ownership rights over the sold assets. In the case of TM not executing their option to purchase back the asset before maturity, the investors/sukukholders would have the right to sell the properties to any other interested 3rd party as rightful owners. This brings many benefits to investors such as a security by way of the underlying asset. In case of default where TM could no longer pay the Ijarah lease rentals, the investors could dispose of the assets to regain their principle investment. (iii) TSH Ijarah TSH Resources Berhad is a Malaysian company which specialises in the resources field. They are particularly involved in palm and wood. The following sukuk is issued for the general purpose of working capital for its business activities and to finance TSH s existing obligations. 52

53 TSH Ijarah Purchase Undertaking (1) Enter into Ijarah Agreement Trust Assets TSH Resources Berhad/Lessee (3) Proceeds from Ijarah Payment TSH Resources and Subsidiaries (1) Sale of Identified Assets (2) Sale Consideration of the Identified Assets Issuer/Lessor (2) Issues Ijarah (2) Proceeds holders (3) Ijarah Payments Power of Attorney Source: IFIS, Bloomberg, Zawya, KFHR Salient features of the transaction are as follows: The Issuer will acquire beneficial title, interests and rights in the Identified Assets from the Seller via a Sale and Purchase Agreement. The Identified Assets will be safeguarded by an irrevocable Purchase Agreement which will be granted by the Seller to the Issuer. Following the Sale and Purchase Agreement, the Issuer will lease back the Assets to the Seller (now Lessee) via an Ijarah Agreement for a consideration. The Issuer will then issue the Ijarah to fund the acquisition of the Identified Assets from the Seller. The Lessee will pay the Ijarah Payment over the tenure which will coincide with the Issuers obligation to pay the holders of the Ijarah their return. The Issuer will declare a trust over the Trust Assets (beneficial title, interests and rights of the Identified Assets) on behalf of the holders. The holders will have undivided ownership over the Trust Assets. Murabahah Structure (i) DHTI Murabahah DHTI Capital Sdn Bhd (D Cap) performs fund raising activities to finance construction, maintenance and acquisition of telecommunication infrastructures in the State of Johor, Malaysia on behalf of the Holding Company, D Harmoni Sdn Bhd. The following sukuk proceeds are utilised for the purpose of acquiring telecommunication towers and financing telecommunications on existing towers. 53

54 DHTI Capital Murabahah Source: Zawya, IFIS, Bloomberg, KFHR Salient features of the transaction are as follows: The identified assets to be utilised are owned by DHTI and shall be free from encumbrances with consent from any chargee (if required) obtained. DHTI will enter a Letter of Gift in favour of the Issuer before entering any sale or purchase agreements. The investors will purchase the identified assets from the Issuer at the Purchase Price. The investors will subsequently sell the assets to the Issuer which will be equivalent to the Purchase Price plus the profit margin. It will be known as the Selling price with the settlement being made at the point of sale. The Issuer will issue the to evidence its obligation to pay the Selling Price on a deferment basis. Upon maturity the Issuer will enter into a Letter of Gift in favour of DHTI. This structure includes the sale and buy back (bai al- inah) feature like most of the sukuk Murabahah issued in Malaysia. A gift is given by the parent company DHTI to DHTI Capital in order to facilitate the sukuk issuance since the issuer is only a fund raising subsidiary. Once the sukuk has matured the asset will be gifted back to the parent company. (ii) TH Plantation Murabahah TH Plantations Berhad is responsible for the cultivation of oil palms, processing of fresh fruit bunches and marketing of crude palm oil in Malaysia. The proceeds raised from the sukukholders will be used to finance subsidiaries capital, development expenditure requirements and acquisition of future plantation estates. TH Plantation Murabahah Source: Bloomberg, Zawya, IFIS, KFHR 54

55 Salient features of the transaction are as follows: The Issuer will identify the assets to be utilised for the transactions. The Facility agent (on behalf of the Sole Subscriber) will enter into a Purchase Agreement with the Issuer to purchase the MMTN Assets for the nominal value of the MMTN to be issued. Payment will be on a spot basis The Facility agent (on behalf of the Sole Subscriber) will immediately sell the MMTN Assets to the Issuer via a Sale Agreement at an agreed Selling Price. The Selling Price will be equivalent to the nominal value plus profit of the MMTN to be issued. The Selling Price will be on a deferred basis. The obligation of the Issuer to pay the Selling Price will be evidenced by the issuance of the MMTN ( Murabahah) which will be discharged upon maturity. Name of TH Plantations Shariah Principle Murabahah Amount of Issuance Up to RM200mln (USD61.52mln) Type of Asset-based MMTN Programme Guarantor N/A Use of Proceeds Acquisition of Plantation Estates and Finance Subsidiaries Capital Regulatory Authority Securities Commission Malaysia Tenure 10 Years Collateral None Source: IFIS, Bloomberg, KFHR 8.0 Outlook Global sukuk sales rose 58% to USD24.6bln in 2009, from USD15.5bln the previous year. In 1H10, sukuk issuance amounted to USD16.6bln and is set to reach a prosperous USD35bln by year end. Gulf issuers raised USD2.3bln from sukuk sales so far this year, about 19% less than the amount they borrowed during the same period of Local-currency sukuk sales in Malaysia have dropped 47% to RM8.8bln (USD2.7bln) as fewer infrastructure projects were started in the first part of the year. Nevertheless, the medium-term prospects for sukuk issuances in Malaysia remain bright. The world s largest sukuk market has announced in its five-year plan that annual development spending will rise 23% to RM142.4bln (USD44bln) in 2015, from an estimated RM115.5bln in We are also positive on the medium-term prospects for sukuk issuances in the GCC, given that the region is growing out of its downturn at a good speed. There are several factors moulding the shape of the region s recovery. First, higher commodity prices and external demand are boosting production and exports in many economies in the region. Second, government spending programmes are playing a key role in fostering the recovery. Middle East demand for infrastructure investments is also strengthening after the global financial crisis battered property markets in the region. Saudi Arabia, the world s biggest oil supplier, plans to spend USD400bln in the five years through 2013 on infrastructure projects such as roads, airports and water projects. Saudi Arabia has allocated almost USD70bln to development projects this year, 16% more than in Saudi Arabian Oil, the world s largest state-owned oil company, and French producer Total SA said in March they plan to raise USD8bln in debt financing that will likely include sukuk for a joint refinery and petrochemical project. 55

56 In Qatar, the government and state-owned companies plan to spend as much as USD100bln in the next four years on projects including roads, sewage treatment, water treatment, ports and airports. The UAE, which is among the four biggest oil producers in the Organisation of Petroleum Exporting Countries, is investing in nuclear power and railways to revive economic growth in 2010 and In Dec 09, UAE awarded a AED75bln (USD20.4bln) contract to a group led by Korea Electric Power Corp to build nuclear power plants. Kuwait is undertaking a number of projects to upgrade and expand its airport facilities to provide for the increasing passenger traffic and cargo movement. Both state-run Kuwait Airways and Wataniya Airways have aggressive expansion plans, and both have indicated to that they intend to open new routes and acquire new planes on a continual basis. Bahrain is investing heavily in infrastructure as a means of providing economic stimulus in the short term and to lay the foundations for economic growth in the future. The 2010 state budget allocated the Ministry of Works with a record USD570mln for infrastructure development, with the ministry also being tasked with carrying out projects worth a further USD343mln on behalf of other state agencies. Of these funds, some USD400mln is being invested in road construction and maintenance, with additional funds spent on other transport and communications infrastructure. 20 GCC Real GDP Rates % Bahrain Kuwait Qatar Saudi Arabia UAE F Source: IMF, KFHR sales are also projected to grow throughout 2H10 and 2011 as governments utilise sukuk to raise funds for infrastructure projects and to help manage deficit spending and support economic growth. Other countries have already announced their intention to issue sukuk such as the government of Iran, Sudan and the UK. The upcoming sovereign sukuk issuances are expected to help the sukuk market grow to new highs during 2011 as they help to gauge investor appetite and act as a benchmark for the private sector. Nevertheless, major hurdles still remain for the sukuk market to develop a larger market share. This includes: Staggered economic and financial recovery is making placement of sukuk difficult, given that the buyers of sukuk are also the buyers of conventional bonds. Lack of standardisation, notably when it comes to Shariah interpretations. Bad publicity given to sukuk defaults is creating hesitancy among investors. Lack of adoptability in some jurisdictions due to the existing laws contradicting the Shariah. 56

57 A shortage in sukuk features with heavy dependence on debt receivables is raising concerns among industry experts. Notwithstanding this, the long term prospects for the sukuk market are expected to remain strong given the increasing popularity of Shariah-compliant products, governments support for Islamic finance, huge investment and financing requirement in the GCC and Asia regions, and issuers desire to tap investors from the Middle East and Muslim Asia. With a healthy array of sukuk in the pipeline, the market is attracting interest from an increasing number of issuers in Muslim and non-muslim countries alike. Islamic Assets Trend USDbln F Source: Various, KFHR estimates Banking Funds Takaful 9.0 Announced in the Pipeline (as at end June 2010) Issuer Name Structure Country Currency Sub Date Ahmed Salem Bugshan (ASB) Lafarge Malayan Cement PT Bakrieland Development Tsk (ELTY) PT Semen Gresik Projeck Lintasan Kota (Prolintas) Ahmad Salem Bugshan Lafarge Malayan Cement Issue Size (USDmln) Tenor (Years) Sector Ijarah Saudi Arabia Conglomerate Unknown Malaysia MYR Construction Bakrieland II Unknown Indonesia IDR Construction Semen Gresik Prolintas Junior Ijarah Indonesia Construction Musharakah Malaysia MYR Construction UEM Land (UEML) UEM World Murabahah Malaysia MYR Construction IJM Corporation IJM Ijarah Malaysia MYR Construction PT Adhi Karya (Persero) TBK Projek Lintasan Kota (Prolintas) MOCCIS Trading Adhi Karya II Mudharabah Indonesia IDR Construction Prolintas Senior MOCCIS Second Ijarah Malaysia MYR Construction Ijarah Malaysia MYR Consumer Goods MOCCIS Trading MOCCIS Murabahah Malaysia MYR Consumer Goods Khazanah Nasional Berhad Khazanah Singapore Unknown Singapore SGD Jun Financial Services 57

58 Issuer Name Structure Country Currency Sub Date Cagamas Berhad First Investment Company Cagamas 2010 First Investment Company Issue Size (USDmln) Tenor (Years) Sector Unknown Malaysia MYR Jun Financial Services Unknown Kuwait KWD Financial Services Qatar Islamic Bank QIB Unknown Qatar USD Financial Services CJ Capital CJ Capital Murabahah Malaysia MYR Financial Services Kuveyt Turk Katilim Bankasi AS Kuveyt Turk Katilim Bankasi Unknown Turkey Financial Services Islamic Bank of Thailand Development Bank of Kazakhstan (DBK) Ithmaar Bank HBME Company Ltd Unicorn Capital Saudi Arabia Dar Al Dhabi Holding Company Ekttitab Holding Company Islamic Bank of Thailand Domestic Development Bank of Kazakhstan Ithmaar Mandatory Convertible Unknown Thailand THB Financial Services Unknown Kazakhstan Financial Services Unknown Bahrain USD Financial Services HBME Unknown Region-wide USD Financial Services Unicorn Capital Saudi Arabia Unknown Saudi Arabia Financial Services Dar Al Dhabi Unknown Kuwait KWD Financial Services VTB Bank VTB Bank Unknown DB Company (DBSC) Ekttitab Unknown Kuwait Financial Services Dubai Bank (Tranche 1) Russian Federation Financial Services Ijarah UAE USD Financial Services Doha Bank Doha Bank Ijarah Qatar USD Financial Services Bahrain Islamic Bank Khazanah Nasional Berhad UMW Holdings Berhad First Fidelity Leasing Mudharabah (FLM) Bahrain Islamic Bank Khazanah Nasional Exchangeable IV UMW Holdings ICP Ijarah Bahrain BHD Financial Services Unknown Malaysia USD Financial Services Unknown Malaysia MYR Financial Services First Fidelity Musharakah Pakistan PKR Financial Services GE Capital GE Capital II Unknown Al Salam Bank - Bahrain The Export Import Bank of Korea (Eximbank) Bank Syariah Mega Indonesia (BSMI) Bank Mega Al Salaam Bank - Bahrain United States Financial Services Manfa'a Bahrain BHD Financial Services Eximbank Unknown South Korea Financial Services Bank Syariah Mega Bank Mega Syariah Unknown Indonesia IDR Financial Services Ijarah Indonesia IDR Financial Services Abu Dhabi Islamic Bank ADIB Tier 1 Ijarah UAE AED Financial Services 58

59 Issuer Name Structure Country Currency Sub Date WOM Finance United Growth Islamic Development Bank WOM Finance United Growth Islamic Development Bank 2010 Issue Size (USDmln) Tenor (Years) Sector Ijarah Indonesia IDR Financial Services Musharakah Malaysia MYR Financial Services Unknown Saudi Arabia Financial Services Telepal SPV Sdn Bhd Telepal Murabahah Malaysia MYR Financial Services Unique Wealth Management PT Bank Syariah Muamalat Indonesia Al Sawfa Group Holding Company Government of Pakistan Government of Yemen Government of Sudan Unique Wealth Musharakah Management Malaysia MYR Financial Services Bank Muamalat 2011 Unknown Malaysia USD Financial Services Al Sawfa group Ijarah Kuwait USD Food & Beverage Pakistan Domestic Unknown Pakistan PKR Jun Government Issue Yemen Sovereign Unknown Yemen YER Government Issue Sudan Sovereign Unknown Sudan Government Issue Government of Iran Iran Unknown Iran EUR Government Issue Government of Dubai Dubai Unknown UAE USD Government Issue Bank Negara Malaysia Government of Hong Kong UK Sovereign Japan Bank for International Cooperation Government of Indonesia Bank Negara Indonesia (BNI) Government of Luxembourg Airport Authority Kong Kong Malacca Historic City Council (MBMB) Singapore Government of Jordan Bank Negara IPM Murabahah Malaysia MYR Government Issue Hong Kong Ijarah Hong Kong Government Issue UK Sovereign Japan Bank for International Cooperation Indonesia Global Bank Negara Indonesia Luxembourg Sovereign Airport Authority Hong Kong Ijarah United Kingdom GBP Government Issue Murabahah Japan USD Government Issue Unknown Indonesia USD Oct Government Issue Ijarah Indonesia USD Government Issue Unknown Luxembourg Government Issue Ijarah Hong Kong Government Issue Malacca Mudharabah Malaysia MYR Government Issue Singapore Sovereign Jordan Sovereign Ijarah Singapore USD Government Issue Unknown Jordan Government Issue Government of Kerala Kerala Unknown India Government Issue Martin Dow Pharmaceuticals (Pakistan) Limited Martin Dow Pharmaceuticals Unknown Pakistan PKR Healthcare 59

60 Issuer Name Structure Country Currency Sub Date Unknown A UK Hospital Ijarah United Kingdom Issue Size (USDmln) Tenor (Years) Sector GBP Healthcare Octagon Octagon Ijarah Malaysia MYR Haisan Resources Berhad (HRB) Bear Mountain Resort Megan media Holdings PT Multi Nitrotama Kimia (MNK) PT Multi Nitrotama Kimia (MNK) PT Perdana Karya Perkasa FACB Industries Incorporated Saudi Aramco Total Refining and Petrochemical Company PT Java Energi Semesta (JES) Esso Malaysia Kencana Petroleum Perisai Petroleum Teknologi (PPTB) Perusahaan Listrik Negara (PLN) Haisan Ijarah Malaysia MYR Bear Mountain Resort Megan Media Multi Nitrotama Kimia (Series A) Multi Nitrotama Kimia (Series B) Perdana Karya Perkasa FACB Industries Jubail Refining and Petrochemical Company Java Energi Semesta Esso Malaysia Kencana Petroleum Perisai Petroleum Teknologi Industrial Manufacturing Industrial Manufacturing Unknown Canada USD Leisure & Tourism Ijarah Malaysia MYR Media Ijarah Indonesia IDR Mining & Metals Ijarah Indonesia IDR Mining & Metals Ijarah Indonesia IDR Mining & Metals Murabahah Malaysia MYR Mining & Metals Unknown Saudi Arabia SAR Oil & Gas Unknown Indonesia Oil & Gas Ijarah Malaysia MYR Oil & Gas Unknown Malaysia MYR Oil & Gas Murabahah Malaysia MYR Oil & Gas PLN V Ijarah Indonesia IDR Jul Power & Utilities Agni Inc. Agni Inc. Ijarah Singapore MYR Power & Utilities Liberty Power PT Mitra Abadi Rahardja (MAR) Abu Dhabi Energy Company Liberty Power Tech Mitra Abadi Rahardja Taqa Malaysian Musharakah Pakistan PKR Power & Utilities Unknown Indonesia Power & Utilities Unknown UAE MYR Power & Utilities Agni Inc. Agni Inc. II Ijarah Singapore MYR Power & Utilities Syarikat SESCO SESCO Mudharabah Malaysia MYR Power & Utilities Jati Cakerawala Syarikat Bekalan Air Selangor (Syabas) National Central Cooling Company Saudi Electricity Company Jati Cakerawala Musharakah Malaysia MYR Power & Utilities Syabas Ijarah Malaysia MYR Power & Utilities Tabreed 2010 Saudi Electricity IV Unknown UAE Power & Utilities Unknown Saudi Arabia USD Power & Utilities 60

61 Issuer Name Structure Country Currency Sub Date Issue Size (USDmln) Tenor (Years) Sector Nakheel Nakheel 4 Unknown UAE - Jul-10-5 Real Estate Al Aqeeq Real Estate Development Company Al Aqeeq Unknown Saudi Arabia SAR Real Estate PACE (Pakistan) Ltd PACE Musharakah Pakistan PKR Real Estate Jabal Omar Development Company Eden Housing Ltd (EHL) Al Oula Real Estate Development Company Eden Builders Limited (EBL) Anwar Global Properties Inc. Emaar Limited Al Mazaya Holding Company Jabal Omar Unknown Saudi Arabia Real Estate Eden Housing III Ijarah Pakistan PKR Real Estate Al Oula Ijarah Saudi Arabia SAR Real Estate Eden Builders Canadian Ameen Emaar Limited Al Mazaya Holding Musharakah Pakistan PKR Real Estate Ijarah Canada CAD Real Estate Ijarah UAE USD Real Estate Unknown Kuwait Real Estate Axiata Group Axiata Group Murabahah Malaysia MYR Jul Telecommunication PT Indonesia Comnets Plus Indonesia Comnets Murabahah Indonesia IDR Telecommunication Maxis Communications Maxis Unknown Malaysia MYR Telecommunication Malaysia Airports Holdings Berhad (MAHB) Syarikat Prasarana Negara Berhad (SPNB) Syarikat Borcos Shipping Malaysian Airline System Pelabuhan Tanjung Pelepas (PTP) Source: Zawya, KFHR Malaysia Airports Syarikat Prasarana Negara 2010 Borcos Shipping IMTN (Tranche 2) Malaysian Airline System Unknown Malaysia MYR Jun Transport Unknown Malaysia MYR Transport Ijarah Malaysia MYR Transport Unknown Malaysia Transport PTP Unknown Malaysia MYR Transport 61

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64 Disclaimer & Disclosure By accepting this publication you agree to be bound by the foregoing terms and conditions. KFH Research Limited ( KFHR ) has prepared this publication for general information purposes only and this does not constitute a prospectus, offering document or circular or offer, invitation or solicitation to purchase, subscribe for or sell any security, financial product or other investment instrument ( Investments ), or to engage in, lead into, conclude or refrain from engaging in any transaction. In preparing this publication, KFHR did not take into account the investment objectives, financial situation and particular needs of the recipient. Before making an investment decision on the basis of this publication, the recipient needs to make its own independent decision, preferably, with the assistance of a financial adviser, in evaluating the Investment in light of its particular investment needs, objectives and financial circumstances. 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