Islamic Project Finance and Infrastructure Funding in Thailand Key Concepts and Structures Stephen Jaggs 23 November 2012 Allen & Overy 2012 BN:1932301.1 1
Religious Principles and Background Body of Islamic law is known as Shari'a. Shari'a principles have shaped the way in which Islamic finance has evolved. Shari'a is derived from a number of sources including the Quran (which is the primary source), the sayings (hadith) and teachings (sunnah). Shari'a is not a codified body of law and is capable of development and interpretation new issues usually resolved by a legal opinion (fatwa) from a religious scholar opinion of Islamic scholars on different issues may vary (depending on which of the Islamic schools of thought they belong to) Allen & Overy 2012 2
Key Principles and Prohibitions The charging of interest (riba) for the use of money is prohibited interest is interpreted as any return which is predetermined, guaranteed or calculated other than by reference to profits actually generated wealth should be invested in a productive enterprise so that the owner earns a return by sharing profits and assuming the risk of any losses Shari'a prohibits uncertainty (gharar) in contracts sale of items whose existence or characteristics are not certain is not permitted this means that a contract containing obligations to insure or indemnify another person or to grant an option to purchase an asset may be unacceptable Speculation or gambling (mayseer) is prohibited contracts to insure for a profit are not permitted the same may apply to dealings in futures and options to the extent that these are speculative Shari'a prohibits Muslims from using or dealing in certain commodities which are forbidden (haram, i.e., not halal) Allen & Overy 2012 3
Shari a Scholars Islam is not strictly an organised religion and therefore does not have a specific church with a unified set of views. Various scholars (based in Arabian Gulf, Pakistan or Malaysia) specialising in the application of Islamic principles to finance have developed reputations in this area. Islamic banks and institutions place reliance on their opinions in determining whether transactions are in compliance with Shari'a. Typically commercially astute and have exposure to issues through acting on several Shari'a boards for various banks (usually with education background in economics / finance). Weight is given to the identity of the scholars. They will provide a fatwa (opinion) that a transaction adheres to Islamic principles. Disclosure of proclamation or fatwa and identity of scholars issuing the fatwa are key to attracting potential Islamic investors. Can be employed on a transaction by transaction basis or through the establishment of a board. Allen & Overy 2012 4
Project Financing Structures Wakala (agency) Ijara (leasing) Wakala Ijara Istisna'a (custom manufacturing) Istisna a-ljara Musharaka (partnership) Tawarruq (commodity murabaha) (cost-plus financing) Allen & Overy 2012 5
Wakala (agency) TRANSACTION a contract of agency in which one person (or persons) (muwakkil) appoint(s) someone else as its agent (wakil) to perform a certain task on its (or their) behalf WAKIL person seeking finance may contribute its own capital (as muwakkil) may receive a fixed remuneration MUWAKKIL financier contributes capital wakil invests capital, on behalf of muwakkil, in Shari'a compliant transactions PROFITS profits can be shared in any agreed ratio ownership of the invested assets remains with muwakkil at all times wakil may receive an incentive fee LOSSES losses are shared according to the share of contribution by each muwakkil muwakkils' loss is limited to its share wakil does not bear any of the loss attributable to invested capital Allen & Overy 2012 6
Ijara (leasing) TRANSACTION a known benefit arising from the use, possession and/or occupation of a specified asset is made available in return for a payment ASSETS lessor must have full possession and legal ownership of assets prior to lease the conditions of usage of the leased items must be stated (lease period, existence of asset, lessor s responsibility for maintenance and insurance, servicing) RENTAL the amount and timing of the lease payments should be agreed in advance can be fixed or by reference to a market rate Option to purchase or acquire leased asset : sale undertaking (call option) provides lessee with the option to purchase the leased asset at a pre-agreed residual value (ijara wa iqtina); or structures under which the leased asset is transferred to the lessee at the end of the lease (ijara muntahia bittamleek) Allen & Overy 2012 7
Ijara (leasing) continued LESSOR STEP 2 Lessor leases assets to Lessee for $[(x + y)/n] Assets LESSEE STEP 1 Lessor buys assets from Seller for $x Assets Price $x Rental $[(x+y)/n] SELLER Allen & Overy 2012 8
Wakala - Ijara Combines a wakala (agency) structure with an ijara (leasing) structure Usually used in project financings for certain banks that prefer not to use an Istisna'a-Ijara structure (especially in Saudi Arabia) The banks appoint the project company as their wakil (agent) to construct project assets on their behalf and make payments through the project company for those assets The banks then lease the assets back to the project company using an ijara structure for rental income Allen & Overy 2012 9
Wakala Ijara - continued Project Company (as Lessee) Specified Lease #Agreement Rental #payments #EPC Contractor #Phase payments Project Company (as Wakil) Wakala #Agreement #Phase payments Islamic Facility #Agent Rental #payments #Phase payments #Agency Agreement Participating #Banks K e y Transfer of title upon construction Project Co (as Service Agent) Service Agency #Agreement Cashflow Finance Document Transfer of Asset Allen & Overy 2012 10
Istisna'a (custom manufacturing) TRANSACTION contract of exchange with deferred delivery, applied to specified made-to-order items the contract is irrevocable after the commencement of manufacture, except where delivered goods do not meet the contracted terms ASSETS the nature and quality of the item to be delivered must be specified the manufacturer must make a commitment to produce the item as described manufacturer must procure his own raw materials PAYMENTS payments can be made in one lump sum or in instalments instalments usually timed to match actual progress in achieving certain milestones in the manufacturing process Allen & Overy 2012 11
Istisna'a (custom manufacturing) continued Buyer agrees to make payments to Seller (instalments or lump sum) BUYER Assets (custom) Price (negotiable) SELLER Seller constructs and delivers custom assets for the Buyer. Allen & Overy 2012 12
Istisna'a - Ijara Combines an istisna a (custom manufacturing) structure with an ijara (leasing) structure Usually used in project financings Under an istisna a agreement the banks require the project company to procure certain project assets and sell these to the banks for an agreed price The banks then lease the assets back to the project company using an ijara structure for rental income Allen & Overy 2012 13
Istisna'a Ijara - continued EPC Contractor Project Company (as Lessee) Transfer of title upon construction Phase payments Sale Undertaking Forward Lease Agreement Rental payments Purchase Undertaking Project Company (as Procurer) Procurement Agreement Phase payments Transfer of title upon construction Special Purpose Vehicle Rental payments Investment Agency Agt Islamic Facility Agent Participating Banks Phase payments Key Cashflow Finance Document Service Agency Agreement Project Co (as Service Agent) Transfer of Asset Allen & Overy 2012 14
Musharaka (partnership) TRANSACTION sharing of ownership in a property or sharing by contract in a specific endeavour CAPITAL CONTRIBUTION all partners contribute capital partners have management rights, but are not obligated to exercise them partners must receive accounting and other information on business activity PROFITS contributions are subject to profit sharing in an agreed ratio between the partners profits may not be an agreed fixed amount determined at the outset LOSSES losses are shared according to the financing share of each partner losses may not be limited to a partner's capital contribution Diminishing musharaka can be used to structure a financing transaction where the client buys back the financier's share in the musharaka at periodic intervals for a pre-determined price. Allen & Overy 2012 15
Musharaka (partnership) continued PARTNER A (Investors) PARTNER B (Client) CAPITAL CAPITAL 60% 40% PROJECT 30% PROFIT 70% 60% 40% LOSS Allen & Overy 2012 16
Murabaha (cost-plus financing) TRANSACTION buyer purchases items from a seller at a specified profit margin payable to the seller typically used to facilitate short-term trade transactions ASSETS the assets must be in existence and under the ownership and in the physical or constructive possession of the seller at the time of contracting the financier maintains ownership of the purchased items until delivery and bears all the costs and risks of ownership until delivery in the event of default, the financier only has recourse to the assets financed and no further mark-up or penalty may be applied to the sum outstanding PROFITS profit margin may be agreed as a percentage of cost or as a fixed amount the end user and financier must pre-agree and specify the mark-up profit margin can not be a reward for the use of the financier's money if the financier avoids taking any risk and does not perform any service other than providing money for the transaction, deal becomes akin to charging interest Allen & Overy 2012 17
Tawarruq (Commodity Murabaha) 2. Financier sells goods to Buyer for deferred price of $(x+ y) 1. Financier buys commodities from Broker for price of $x FINANCIER Commodities Price $x BROKER 1 Goods Deferred Price $(x+y) 3. Buyer settles deferred price in instalments over an agreed period 4. Buyer appoints Financier as agent to sell commodities on spot basis BUYER (Client) Commodities Commodities Financier as agent BROKER 2 Spot Price 6. Financier remits sale proceeds of spot sale 5. Commodities sold on spot basis Allen & Overy 2012 18
Questions? These are presentation slides only. The information within these slides does not constitute definitive advice and should not be used as the basis for giving definitive advice without checking the primary sources. Allen & Overy means Allen & Overy LLP and/or its affiliated undertakings. The term partner is used to refer to a member of Allen & Overy LLP or an employee or consultant with equivalent standing and qualifications or an individual with equivalent status in one of Allen & Overy LLP's affiliated undertakings. DB:4901771 Allen & Overy 2012 19 BN-#1932301-v1-