Sukuk Contracts: The Evolution

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1 JUNE 2013 S p e c i a l E d i t i o n f o r t h e 4 th A n n u a l W o r l d I s l a m i c B a n k i n g C o n f e r e n c e A s i a S i n g a p o r e... Sukuk Contracts: The Evolution in this issue Islamic Contracts: Debt vs Partnership in this issue RAM RATINGS ACCOLADES What s Next for the Sukuk Market? Best Islamic Rating Agency 2012 Awarded by Global Islamic Finance Awards, RAM RATINGS London ACCOLADES Most Outstanding Rating Agency for Best Islamic Sukuk Rating 2011 Agency Awarded by Kuala 2012 Lumpur International Awarded Islamic by Finance Global Forum, Islamic Kuala Finance Lumpur Awards, London Best Research in Islamic Finance 2011 Awarded Most Outstanding by CPI Financials, Rating Dubai Agency for Sukuk 2011 Best Awarded Islamic by Rating Kuala Lumpur Agency 2011 Awarded International by Red Islamic Money Finance Group, Forum, Kuala Lumpur Kuala Lumpur Best Research in Islamic Finance 2011 Awarded by CPI Financials, Dubai Best Islamic Rating Agency 2011 Awarded by Red Money Group, Kuala Lumpur

2 Publisher s Note Analytical Contacts: Islamic Ratings Mohamed Zakariya Othman Head (603) zakariya@ram.com.my Amir Shazlan Kamarudzaman Analyst (603) shazlan@ram.com.my Islamic contracts utilised by issuers have been evolving in tandem with the development of the sukuk market. Overall, RAM has rated around 160 sukuk issuers, to the tune of RM309 billion in total. Through the years, RAM has rated numerous Islamic papers based on various types of contracts - from the earliest form of debt-based sukuk (Murabahah and Bai Bithaman Ajil or BBA), to partnership-based contracts (dominated by Musharakah). The latter, in particular, has racked up a substantial share of the RAM-rated sukuk market since inception, i.e. 45.5% as at end-december 2012 in stark contrast to the 11.2% in 2004, when the Islamic contract made its debut. In this edition of Sukuk Focus, attention will be centred on the evolution and trends of the Islamic contracts within RAM s rated portfolio. In the process, a clearer picture will emerge on the shift of debt-based to partnership-based contracts, along with the developments that had accompanied and spurred the transformation. Sukuk Focus Special Edition 1

3 Islamic Contracts: Debt vs Partnership Introduction T he RAM-rated sukuk market had earlier experienced an influx of debt-based sukuk such as Murabahah and BBA. At the time, underlying sukuk contracts followed a linear, straightforward approach; sukuk had been raised pursuant to a contract of sale, with the most common based on the principles of Murabahah and BBA the earliest form of sukuk contract and structuring. The origination of debt-based sukuk was underpinned by the BBA concept, whereby the sale contract between the issuer and the seller consequently results in an obligation from the issuer. On the other hand, Islamic partnership contracts are best represented by equitybased principles, i.e. Mudharabah and Musharakah, which are simply - Shariahcompliant modes of pooling capital. Partnership-based sukuk departs from a typical debt-based arrangement to a profit- and loss-sharing agreement that seeks to provide a pay-off to the sukuk investors. This is based on the performance of the underlying business in which the sukuk investors have undivided proportionate interest in the partnership venture. Murabahah and BBA had been followed by other principles such as Mudharabah and Musharakah, which proved sustainable in the market, particularly in RAM s rating history. This article will focus on the trend of debt- and equity-based contracts, as well as the dominant underlying Shariah principle in RAM s portfolio. Composition of Islamic contracts the evolution The composition of Islamic contracts has undergone significant evolution, with debtbased structures having dominated the scene until Sukuk issues based on the debt contract come up to RM64.2 billion to date. In the first decade of RAM s presence in the sukuk market, Murabahah and BBA had formed the underlying principles that had facilitated sukuk issuance (refer to Charts 1 and 2). The transition of Shariah contracts had also been in tandem with the market s understanding of sukuk. Between 1990 and 2000, the Malaysian sukuk market had been in its nascent stage. Much attention had been focused on the introduction of the market, the players, and the concept as well as the mechanism of sukuk - a phase when awareness by the stakeholders (including potential investors and issuers) had been key to the growth of sukuk structures. The origination of debt-based sukuk was underpinned by the BBA concept, whereby the sale contract between the issuer and the seller consequently results in an obligation from the issuer Sukuk Focus Special Edition 2

4 RM Million Chart 1: RAM-rated sukuk issued: Type of Islamic contract - by value ( ) Combination Wakalah Musharakah Murabahah Mudharabah Istisna Ijarah BBA Bai Inah Chart 2: RAM-rated sukuk issued: Type of Islamic contract by percentage ( ) % Combination Wakalah Musharakah Murabahah Mudharabah Istisna Ijarah BBA Bai Inah Sukuk Focus Special Edition 3

5 With the release of the Securities Commission s ( SC ) Islamic Securities ( IS ) Guidelines in 2004, the market started to realise that sukuk also represented the securitisation of tangible assets under lease, implying that the definition is not strictly limited to a pure debt facility. This had led to an exploratory phase for the Malaysian sukuk market, during which it had ushered in a new breed of sukuk using equity or partnership contracts. The IS Guidelines allowed the development of more diversified and innovative sukuk structures that applied participatory or equity contracts, with no direct creation of debt obligations evidenced by the sukuk. Notably, the ability to structure sukuk without resorting to primary debt creation helps to dispel Shariah concerns on Bai Inah and Bai Al Dayn. Sukuk rating for RAM kicked off with the debt-based RM300 million Murabahah sukuk issued by Petronas Dagangan Berhad in It had also been the first Islamic instrument to be listed on the Kuala Lumpur Stock Exchange (now Bursa Malaysia). At that time, and as with markets in their early developmental stages, the number or choice of structures had been limited - confined to only debtbased sukuk. Equity contracts, particularly Musharakah (Esso Malaysia Berhad s Islamic commercial paper 1 was the first RAM-rated Musharakah issue in 2004), experienced a boom in 2006, mainly attributable to a shift in mindset that had resulted in significant issues from Rantau Abang Capital Berhad 2 and Projek Lebuhraya Utara-Selatan Berhad 3. The partnership-based contract would later be a prominent feature in the sukuk market, with issuers steadily embracing the idea of moving towards risk-sharing contracts in the Malaysian sukuk market. Last year, however, marked a significant return to debt-based contracts; Murabahah recaptured the market, largely due to the increasing use of the concept of commodity Murabahah via Tawarruq (refer to Charts 3 and 4 for the trend of debtversus partnership-based contracts). The spike in the use of the Murabahah contract had been driven by the ongoing innovations in Malaysia and the push for liquidity. One such initiative is to set up the world s first Shariah-compliant commoditytrading platform that offers an infrastructure for Islamic liquidity and promotes cross-border transactions. In Malaysia, the Commodity Murabahah Programme ( CMP ) had been designed as the pioneer commodity-based transaction, where the underlying assets are contracts based on crude palm oil. Commodity Murabahah transactions formed the bulk of RAM-rated issues in 2012, valued at RM23.3 billion and constituting 63.8% of all RAM-rated sukuk issues for the year 4. The increased use of commodity Murabahah had boosted debt-based sukuk which became the preferred type of Islamic contract in Nonetheless, we believe that Musharakah will maintain a strong presence in the near to medium term given the market s increased familiarity with it and the structure s element of fairness based on the concept of risk-reward sharing. 1 Islamic Commercial Papers ( CP ) Issuance Facility Programme, valued at RM300 million. 2 i) Islamic Medium-Term Notes ( MTN ) Programme, valued at RM7 billion. ii) Islamic CP/MTN Programme, valued at RM3 billion. 3 i) Sukuk Musharakah MTN Programme, valued at RM4.5 billion. ii) Sukuk Musharakah Series 1, valued at RM2.3 billion. iii) Sukuk Musharakah Series 2, valued at RM2.4 billion. 4 For a list of RAM-rated commodity Murabahah via Tawarruq structures, refer to the December 2012 issue of Sukuk Focus, i.e. Malaysia: Islamic Finance Haven. Sukuk Focus Special Edition 4

6 RM Million Chart 3: RAM-rated sukuk issued: debt versus partnership - by value ( ) Combination Partnership-Based Debt-Based Chart 4: RAM-rated sukuk issued: debt versus partnership by percentage ( ) % Combination Partnership-Based Debt-Based The partnership-based contract would later be a prominent feature in the sukuk market, with issuers steadily embracing the idea of moving towards risk-sharing contracts in the Malaysian sukuk market Sukuk Focus Special Edition 5

7 The other equity-based contract - Mudharabah - made its debut in 2005 (PG Municipal Assets Berhad s RM80 million Mudharabah bonds programme). Although Mudharabah entered the market during this period, the utilisation of the profitsharing contract did not reach the heights achieved by its partnership-based counterpart, with the largest only coming up to 7.7% in As the sukuk market develops in terms of issuance, each new issue represents a step up the ladder of sophistication. Sukuk issues have begun moving away from plain vanilla debtbased contracts to partnership-based ones that focus on the specific underlying Shariah-compliant business venture to generate income for investors. Since their inception up to 2012, the top 3 types of contracts or Shariah principles utilised have been Musharakah (43.3%), Murabahah (18.7%) and BBA (12.1%). Notably, Musharakah commanded the lion s share of the pie in 2007, mainly driven by the bumper issuance that year, when Cagamas Berhad ( Cagamas ) 5, Binariang GSM Sdn Berhad 6 ( Binariang ) and Malakoff Corporation Berhad 7 accounted for a collective RM62.1 billion of the RM65.9 billion of Musharakah-based issues. Cagamas sukuk was a landmark at the time; it was the largest funding programme (RM60 billion Conventional and Islamic CP and MTN) in South-East Asia, and also the first of its kind with an unusually long tenure (40 years) in the region. In December 2007, the SC approved an application from Maxis Communications Berhad - the provider of mobile telecommunication services in Malaysia - 5 i) Islamic MTN Programme, valued at RM20 billion. ii) Islamic CP Programme, valued at RM10 billion. 6 i) Islamic MTN Programme, valued at RM19 billion. ii) USD900 million Cumulative Non-Convertible Islamic Junior Sukuk, valued at RM3.2 billion. iii) Islamic CP Programme, valued RM2 billion. 7 i) Islamic MTN Programme, valued RM5.6 billion. ii) Cumulative Non-Convertible Islamic Junior Sukuk, valued at RM1.7 billion. iii) Islamic CP/MTN, valued at RM600 million. through its special-purpose company, i.e. Binariang, to issue a substantial sukuk. A total of RM15.4 billion of sukuk Musharakah - comprising RM12.1 billion nominal value of Islamic MTN, RM300 million nominal value of Islamic CP and RM3.0 billion nominal value Cumulative Non-Convertible Islamic Junior Sukuk had been issued to both domestic and offshore investors. The sukuk issue had been oversubscribed 2 times. Chart 5: RAM-rated sukuk (by type of Islamic contract), Wakalah 2.6% Combination 9.3% Musharakah 43.3% Bai Inah 0.3% BBA 12.1% Ijarah 7.0% Istisna 5.1% Murabahah 18.7% Considering the form of contract The evolution of sukuk contracts and the development of their transaction structures have been essentially shaped and influenced by 2 main factors: a) Market and commercial considerations b) Shariah-compliance Both the abovementioned factors are closely inter-linked and cannot be exclusive of each other. The market and commercial factors determine the market demand for and viability of sukuk instruments while Shariah-compliance determines the validity and recognition of Mudharabah 1.5% Sukuk Focus Special Edition 6

8 the sukuk products as true Islamic financial instruments. The market and commercial considerations provide the context in which sukuk can be issued and transacted, based on the economic needs of issuers in raising and mobilising capital that can meet investor demand in the market. More specifically, these factors entail the following: Shariah-compliance requirements. Since partnership-based sukuk is equity-like in nature, involving the sharing of profit and loss, there should be no guarantee on capital and profit. Despite this, the structure itself is still evolving, with ongoing resolutions to improve the Shariah-compliance aspect. For example, Legal and regulatory framework - Debt versus equity sukuk understood as debt/fixed-income instrument - Tax issues Commercial competitiveness - Sukuk vis-à-vis conventional bonds Issuer s concerns - Cost efficiency - Timeliness of transaction - Understanding and familiarity Investors protection - For example, equitybased sukuk with purchase undertaking - Other form of credit enhancements Investor - Market understanding and familiarity - Risk and return considerations The market looks at sukuk as the Islamic and Shariah-compliant alternative to fixedincome securities. Market participants or stakeholders would expect sukuk to behave like conventional bonds in terms of capital preservation, frequency of periodic distributions, rate of return, and other additional investor-protection mechanisms. The early use of debt-based structures commensurates with the fact it is not difficult to meet the fixed-income characterisation. the Accounting and Auditing Organisation for Islamic Financial Institutions (or AAOIFI) made a pronouncement in February 2008 that restricted the use of certain credit enhancements in Musharakah, Mudharabah and Wakalah sukuk. Following that, the popularity of Musharakah sukuk in some regions had waned, although this had also been influenced by the overall decline in sukuk issuance amid the global credit crunch towards the end of 2007 through to When the market started to adopt partnership-based contracts, such fixedincome characteristic had created some contradictions in terms of meeting The domination of Musharakah is a testament for issuers attempting to uphold the principles and spirit of Islamic finance, i.e. to adopt a risk-sharing approach. In an Sukuk Focus Special Edition 7

9 effort to preserve the purity of the structure, Musharakah sukuk are moving away from guarantee mechanisms. Instead, the purchase-undertaking clause is incorporated to mitigate the risky nature of the principle, to facilitate the stable income that can match that of other fixedincome instruments. Conclusion The type of contracts utilised by RAM-rated sukuk issues has undergone a noticeable transition, from pure debt-based sukuk (largely dominating a full decade from the early 1990s) to partnership-based sukuk (which surfaced in 2004). Musharakah started gaining traction in 2006, albeit still lacking market share. As a form of equity financing, various foreign Musharakah entities is considered looking to utilise closer to the the commodity Shariah s aim Murabahah of ensuring via gains Tawarruq and losses contract are (refer shared to Table equitably. 1). The Musharakah increase contracts usage of accounted the contract for almost also signals half of the all RAM-rated gradual convergence sukuk cumulatively of opinions as at for end- the 2012, contracts although available the market in the has Malaysian witnessed the sukuk increasing market. popularity of commodity Murabahah structures, most notably in This development was spurred by the increase of cross-border flows from As a form of equity financing, various foreign entities looking to utilise the commodity Murabahah via Tawarruq Musharakah is considered contract (refer to Table 1). The increase closer to the Shariah s aim of usage of the contract also signals the ensuring gains and losses are gradual convergence of opinions for the shared equitably contracts available in the Malaysian sukuk market. Table 1: RAM-rated issuers with commodity Murabahah structures Issuer Rating (Malaysian National Scale) Date of issuance Taqa AA 1 5 Mar 2012 Type of sukuk Sukuk Murabahah Programme Programme Value Amount RM3.5 billion Obligor s country UAE Bahrain Mumtalakat Holding Company BSC Development Bank of Kazakhstan AA 2 AA 2 10 Apr Aug 2012 Sukuk Murabahah Programme Sukuk Murabahah Programme RM3 billion RM1.5 billion Bahrain Kazakhstan Noble Group Limited AA 2 16 Oct 2012 Multi-Currency Sukuk Murabahah Programme RM3 billion Hong Kong Golden Assets International Finance Limited AA 2(s) 19 Nov 2012 IMTN Programme RM5 billion Indonesia financing, The evolution Musharakah in Islamic contracts is considered follows a closer similar to trend the Shariah s for various aim sectors of ensuring within gains RAM s and portfolio losses are where shared debt-based equitably. Musharakah structures dominated contracts proceedings accounted and for almost gradually half shifted of all to RAM-rated partnership-based sukuk cumulatively contracts. For as at example, end-2012, although for the the infrastructure market has sector, witnessed Musharakah the increasing gained popularity prominence in of 2006 commodity constituting Murabahah 76.1% of structures, the total market most share. notably While in Musharakah This development proved to be was a retainable spurred structure, by the increase Murabahah of and cross-border Ijarah regained flows from a foothold in 2012 (refer to Chart 6). Sukuk Focus Special Edition 8

10 Chart 6: RAM-rated infrastructure sukuk issued: Type of Islamic contract - by percentage ( ) % Musharakah Murabahah Mudharabah Istisna Ijarah/Musharakah Ijarah BBA Bai Inah We expect the Malaysian sukuk landscape to continually evolve, with a balance between partnership- and debt-oriented structures in the medium term. For partnership-based contracts, in particular Musharakah, the regular use of the structure is largely due to its familiarity and attractiveness vis-à-vis preserving the true spirit of the Shariah. In terms of debtbased structures, the establishment of the commodity Murabahah platform and the straightforward approach of debt-based instruments as well as its close resemblance to products with debt characteristics will help maintain its presence in the sukuk market. For partnership-based contracts, in particular Musharakah, the regular use of the structure is largely due to its familiarity and attractiveness vis-à-vis preserving the true spirit of the Shariah Sukuk Focus Special Edition 9

11 Malaysian sukuk market (rated sukuk) Malaysian Rated Corporate Sukuk Market League Table of Lead Managers* as at 31 December 2012 by Programme Value RM Million % CIMB Investment Bank Berhad 33, % Maybank Investment Bank Berhad 8, % Standard Chartered Bank Malaysia Berhad 8, % HSBC Amanah Malaysia Berhad 4, % RHB Investment Bank Berhad 4, % OSK Investment Bank Berhad 3, % AmInvestment Bank Berhad 3, % HSBC Bank Malaysia Berhad 2, % Hong Leong Investment Bank Berhad 1, % Bank Muamalat Malaysia Berhad 1, % Affin Investment Bank Berhad % The Royal Bank of Scotland Berhad % OCBC Bank (Malaysia) Berhad % Kenanga Investment Bank Berhad % Deutsche Bank (Malaysia) Berhad % Hong Leong Islamic Bank Berhad % 74, % The value of consortium issues have been equally divided by the number of lead managers of a consortium. *In deriving the league table, RAM will only take into consideration the lead managers that are specifically identified in the principal terms & conditions in the case of sukuk not rated by us. Source : RAM Sukuk Focus Special Edition 10

12 Malaysian sukuk market (rated sukuk) Infrastructure & utilities 25% Corporate Sukuk Market Issued & Rated by Economic Sector as at Dec 2012 (by number of issues) Asset-backed securities 11% Trading & services Transportation 6% 2% Public Diversified Finance holdings 1% 4% Property & real estate 15% Financial services 7% Mining & petroleum 2% Plantation & agriculture 9% Consumer products 1% Industrial products 13% Construction & engineering 4% Trading & services 4% Transportation 1% Corporate Sukuk Market Issued & Rated by Economic Sector as at Dec 2012 (by value) Property & real estate 11% Construction & engineering 2% Infrastructure & utilities 49% Industrial products 3% Plantation & agriculture 3% Consumer products 0% Assetbacked securities 3% Diversified holdings 9% Financial services 14% Public Finance 0% Mining & petroleum 1% Corporate Sukuk Market Issued & Rated by Financing Contract as at Dec 2012 (by number of issues) Corporate Sukuk Market Issued & Rated by Financing Contract as at Dec 2012 (by value) Others 1% Bai Al-Dayn 0% Musharakah 15% Mudharabah 4% BBA 25% Murabahah 33% Ijarah 19% Istisna 3% Musharakah 41% Mudharabah 1% Bai Al-Dayn 1% Others 2% Ijarah 10% BBA 15% Istisna 4% Murabahah 26% Sukuk Focus Special Edition 11

13 Sukuk rated by RAM BBB 5.4% -Rated Sukuk (long-term) as at Dec 2012 (by number of issues) BB 1.4% B 1.7% C 0.9% AAA 24.1% -Rated Sukuk (long-term) as at Dec 2012 (by value) A 9.7% BBB 0.6% BB B 0.7% C 0.2% 0.4% AAA 34.8% A 27.6% AA 38.9% AA 53.6% Total number of issues = 352 Total value = RM359billion -Rated Sukuk (short-term) as at Dec 2012 (by number of issues) -Rated Sukuk (short-term) as at Dec 2012 (by value) P3 6.5% NP 12.9% P2 7.2% P3 0.4% NP 1.8% P1 51.6% P2 29.0% P1 90.5% Total number of issues = 31 Total value = RM19 billion Sukuk Focus Special Edition 12

14 Total outstanding sukuk (RM million) as at 31 December 2012 Government, 150,000 Quasi-Govt, 88,655 BNM, 61,500 ABS, 4,815 Corp, 145,728 Financial, 10,635 Corp(BG), 16,700 Source: Bond Pricing Agency Malaysia ( BPAM ) Top 10 sukuk facilities in 2012 Facility Code Facility Name Instrument SUKUK PERUMAHAN KERAJAAN MTN 12/31/ ,999,999, PLUS BERHAD RM23.35 BILLION SUKUK PROGRAMME MTN 1/12/ ,350,000, PLUS BERHAD RM11.0 BILLION GUARANTEED SUKUK PROGRAMME MTN 1/12/ ,000,000, DANAINFRA RM8.0 BILLION GUARANTEED ICP/IMTN PROGRAMME CP/MTN 7/20/2062 8,000,000, IDB TRUST USD6.5B TRUST CERTIFICATE ISSUANCE PROGRAMME Undisclosed 10/27/2110 6,500,000, TPSB RM5.311B SUKUK PROGRAMME MTN 11/19/2032 5,311,000, GOLDEN ASSET RM5.0 BILLION SUKUK MURABAHAH PROGRAMME MTN 11/19/2027 5,000,000, CTX RM5 BILLION SUKUK PROGRAMME MTN 8/27/2027 5,000,000, TANJUNG BP RM4.5 BILLION SUKUK IJARAH MTN 8/16/2029 4,500,000, TBEI RM4500 MILLION SUKUK MURABAHAH UNDER TAWARRUQ (COMMODITIES MURABAHAH) PRINCIPLE MTN 3/16/2032 4,500,000, Source: BPAM Maturity Date Facility Limit Sukuk Focus Special Edition 13

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16 Malaysian Sukuk Market Handbook Your Guide to the Malaysian Islamic Capital Market ISBN: Published by RAM Rating Services Berhad As a pioneer in the Islamic finance industry, Malaysia has been setting benchmarks while assuming a pivotal role on the sukuk pitch. The nation s Islamic capital market has been experiencing exponential growth, and we are well poised as the world s most competitive and attractive sukuk market, underscoring Malaysia s significance as the largest and most innovative global sukuk marketplace. The Malaysian Sukuk Market Handbook, published by RAM Rating Services Berhad ( RAM Ratings ), is a comprehensive guide that serves as a practical tome for institutions and professionals keen on unlocking maximum value from the domestic Islamic capital market. The contributors to this handbook are eminent personalities from various backgrounds, well known in their respective fields of expertise. This handbook the first of its kind - also strives to broaden the sukuk investor and issuer bases, and covers inter alia the applicable Shariah principles, the Malaysian regulatory framework, the role of Shariah advisers, legal and tax considerations, rating approaches, market infrastructure and details of hallmark sukuk transactions., a leading credit-rating agency in Asia, was incorporated in 1990 as the pioneer of the Malaysian capital market in this sphere. In sukuk transactions, our task involves both quantitative and qualitative analysis vis-à-vis evaluating the financial strength of obligor institutions with such underlying structures, as approved by Shariah scholars. portfolio encompasses a vast range of local and foreign corporates, multinationals, Islamic and conventional banks, Takaful and insurance companies, government-linked and other public-financed entities, myriad complex investment vehicles and the ringgit-denominated securities they issue, structured-finance transactions backed by receivables or other financial assets, and sukuk. As one of the region s most experienced rating agencies, is a leader in the provision of crucial and independent credit opinions that are sought after by market participants as regards their investment and financial decisions. For further enquiries about the Malaysian Sukuk Market Handbook, kindly contact our publication team at

17 Information contained in this publication is obtained from sources believed to be reliable and correct at the point of writing; however, its accuracy or completeness cannot be guaranteed. No statement in this publication is to be construed as a recommendation to buy, sell or hold securities, or as investment advice, as it does not comment on the security's market price or suitability for any particular investor. Published by RAM Rating Services Berhad Reproduction or transmission in any form is prohibited except by permission from. Copyright 2013 by RAM Rating Services Berhad