SMEs/SMIs Financing via Shari'ah Compliant Instrument C A S A B L A N C A S T O C K E X C H A N G E M O R O C C O MAY 20 TH, 2014 BY D R. N I D A L A L S A Y Y E D, CEO W W W. I N A Y A H. O R G A M M A N, J O R D A N Prepared by inayah CEO: NIDAL ALSAYYED ( Email: nidal@inayah.org ) www.inayah.org
Introduction About INAYAH.org &Dr. Nidal Alsayyed Background Contribution to Islamic Finance Strengths and Focus areas Industry recognition 2
Brief Introduction on the Topic 3 INAYAH RESEARCH & CONSULTING www.inayah.org May, 2014
Socio-Economic ventures المحاور الداعمة لتمويل الشركات الصغيرة WAQF MICRO FINANCE SME
مباحث التمويل الصغير واألصغر من منظور شرعي ان فهىو وان ظرة ان ؤسساتيت. ) شأة ويرادم وي هجياث وتجارب( والع انت ىيم انصغير في ان غرب وتجارب ي ك انمياس عهيها. يمترح ص ذوق ألغادير وي هجيت انتذىل. يتطهباث ويفاتيخ انذراست: يستىي دخم األفراد تذذيذ االدتياجاث. انبرايج اإل ائيت نأليى ان تذذة في انبهذا ان ختهفت. ان راكز وانص اديك انذونيت نألبذاث..يثم: ICARDA WWW.INAYAH.ORG
Why SME s? Policymakers and bankers worldwide are increasingly focusing on micro-, small and medium-sized enterprises. (IDB) is making important efforts to nurture the microenterprise and SME sector and its export activities. Three important subsidiaries serving the sector: the International Islamic Trade Finance Corporation (ITFC), Islamic Corporation for the Development of the Private Sector (ICD) and the Islamic Corporation for Insurance of Investments and Export Credit (ICIEC). Each of the IDB WWW.INAYAH.ORG
تحديات التمويل الصغير في المغرب )الصورة العامة ) The brief survey of possible funding gaps affecting smaller enterprises suggested that SMEs in the developed world could generally expect to receive funding if they have a commercially viable proposition. The banks are the principal source of funding and a lack of collateral might result in credit ه ا يأتي دول انت ىيم اإلساليي cases. rationing in some
Islamic Banking for SME الصيرفة اإلسالمية في الشركات الصغيرة Wide range of Islamic financial instruments, each with a specific purpose: ensure that the instrument used is suitable for the economic purpose that a company seeks to achieve. There are two main categories of transaction types: Profit- and loss-sharing partnership equity investments; and Transactions with a predictable or fixed return structure.
SME s in Morocco SMEs is a natural niche for Islamic banking as it deals directly with the real economy, creates employment, involves the productive use of resources, especially capital and finance, and contributes to the alleviation of poverty. Ethical and moral values. Islamic banking also advocates entrepreneurship and risk sharing. In the profit-sharing concept of a financed project, the financier and the beneficiary share the actual or net profit/loss, rather than leaving the risk burden to the entrepreneur. The principle of fairness and justice requires that the actual output of such a project be fairly distributed between the two parties. For micro-enterprises and SMEs looking for financing, Islamic banking can help promote entrepreneurial development WWW.INAYAH.ORG
What are Sukuk 10 AAOIFI: Investment Sukuk are certificates of equal value representing undivided shares in ownership of tangible assets, usufruct and services or (in the ownership of) the assets of particular projects or special investment activity, however, this is true after the receipt of the value of Sukuk, the closing of subscription and the employment of funds received for the purpose of which the Sukuk were issued (standard no. 17, clause 2) Further reading: AAOIFI Sharia Standard No. 17 DAY ONE : SESSION I BRIEF INTRODUCTION ON THE TOPIC
Sukuk return/pricing and payment Fixed Return Vs. Variable return: Choosing the right underlying structure; Mapping cash flows to the transaction, Sukuk is not an interest paying instruments, therefore a clear link must be established between the return and the underlying transaction; Documentation perspective Commercial consideration matching requirement with limitations Assessing the role of security / Collaterals 11 DAY ONE : SESSION IV EXAMINING RETURN OR PRICING IN SUKUK AND SECURITIZATION TRANSACTIONS
Structuring an SME Sukuk Transaction 12 Availability of Asset Nature of the Asset Risk assessment Jurisdiction and Regulations Selecting a right jurisdiction for tax efficiency and other purposes Tenure Fixed Vs Variable Maturity terms Investor considerations Asset Type Return DAY ONE : SESSION III SUKUK STRUCTURING AND DOCUMENTATION: A STEP BY STEP GUIDE
Asset Backed vs. Asset Based Sukuk Asset Backed Sukuk (ABS) = Securitization + Certificates Backed by Assets + SPV (independent) (So the recourse to the Assets due to True Sale) Asset Based Sukuk (AbS) = Securitization + Certificates Backed by Collaterals+ SPV (credit interlinked) (So the recourse to the Originator)
www.inayah.org Comparative Table
Securitization Typical Sukuk Structure 15 Investment Return on Investment Investment (Sharia compliant transaction) Proceeds Issuer/Trustee SPV Distribution Distribution [ ] (As Obligor/Undertaking) Proceeds Shari'ah compliant Contract Declaration Of Trust Sukuk Holders Distribution Underlying Transaction: Any Sharia compliant contractual relationship between the Issuer representing Sukuk Holders and the Obligor
الصكوك وأدوات االستثمار األخرى Sukuk Vs. Other Investments Characteristics Sukuk Equity Bonds Ownership of Assets Performance linked return Underlying transaction 16 X X Securitizat ion X/ X Equity Risk X Covered Bonds X/ X X/ X/ Fixed Returns X Risk Mitigation X
Shari'ah Compliant for SMEs/SMIs 17 Based on approved Shari'ah compliant structures/contracts/instruments Mimic the commercial aspects of the conventional instruments, however structurally and documentation wise significantly different Meet the short & long term liquidity and investment needs of the SME project Fund generation for various stakeholders in a Shari'ah compliant way Essential component for Society overall Economics growth DAY ONE : SESSION I BRIEF INTRODUCTION ON THE TOPIC
Fundamental Shariah requirements for SMEs Sukuk issuances 18
A. Structuring a Sukuk? Outline B. Various parties and their role. C. What corporate structure is required? D. What assets are required? A distinction between asset based and asset backed Sukuk E. Securitization vs. Sukuk differences and similarities F. Innovation and the factors driving innovation 19 DAY ONE : SESSION II FUNDAMENTAL SHARIA REQUIREMENTS FOR THE ISSUANCE OF SUKUK
How Sukuk transaction is structured? Basic requirement to decide the structure of the Sukuk include the following: Asset: Availability/non availability, nature and type, Return: Fixed, floating,. Risk Appetite: Jurisdiction / Regulatory framework: Nature of Obligor/Issuer : Utilization of proceeds: Convertibility, multiple issuances, and other special features: Redemption: Enforcement: Other considerations for Morocco? 20 DAY ONE : SESSION II FUNDAMENTAL SHARIAH REQUIREMENTS FOR THE ISSUANCE OF SUKUK
Sukuk parties Discuss Role of each of the parties: Investors Obligor / Issuer Lead Manager (Investment Bank) Regulators / Relevant Authorities Sharia Board / Sharia Consultants Legal Counsel (for each party/transaction) Service Providers (as required) Auditors/clearing stream Others specific for any particular Sukuk issue 21 DAY ONE : SESSION II FUNDAMENTAL SHARIA REQUIREMENTS FOR THE ISSUANCE OF SUKUK
What assets are required? Asset based Vs Asset backed 22 What is meant by Asset Based / Asset Backed Based on availability of Asset Sale of Asset? Lease of Asset? Other Investments (Musharakah, Mudarabah, Wakalah) Regulatory requirement Issues with fees and taxes for Asset transfer Based on the underlying transaction type Discuss the requirement based on transaction type: Ijara, Mudarabah, Wakalah, Salam etc (more details and discussions will follow when we deal with the transaction type) DAY ONE : SESSION II FUNDAMENTAL SHARIA REQUIREMENTS FOR THE ISSUANCE OF SUKUK
Islamic Securitization vs. Sukuk: Differences & Similarities Sukuk is in essence securitization of the underlying transaction; However there exists a very important difference between a simple Islamic Securitization and Sukuk; Recourse to the Asset: In securitization the recourse of the investors is only to the asset securitized 23 Whereas in a Sukuk the recourse for the investors is both to the Obligor and the underlying assets/receivables DAY ONE : SESSION II FUNDAMENTAL SHARIA REQUIREMENTS FOR THE ISSUANCE OF SUKUK
SMEs Sukuk Challenges Market operational and Regulatory framework. Fixed Income mentality! Debt based Sukuk Training. Restructuring of Defaulted Sukuk.
Innovations in Islamic Finance 25 11/05/2014
Innovation in Islamic Finance Questions for Discussion Why is there a need for innovation - Are the basic structures in Islamic Finance able to address the commercial requirements? Is replicating conventional structures actually innovation? What is the scope for innovation in Islamic Finance and what are the parameters and rules for such innovation? 26 DAY ONE : SESSION II FUNDAMENTAL SHARIA REQUIREMENTS FOR THE ISSUANCE OF SUKUK INNOVATION
Innovation and the factors driving innovation Need for continuous innovation Major hindrances to adaptability Challenges and Solutions Regulations and legal framework Conventional approach of the market players Risk mitigation techniques External Vs Internal Factors External environment Internal Islamic financial institutions readiness 27 DAY ONE : SESSION II FUNDAMENTAL SHARIA REQUIREMENTS FOR THE ISSUANCE OF SUKUK INNOVATION
Factors Driving Innovation Innovation under Islamic Finance Need for Innovation Commercial considerations Specific requirements of the Parties. Commercial viability. Legal considerations Local law restrictions. Enforcement issues. Taxation issues Limitations of the various basic Sharia structures 28 DAY ONE : SESSION II FUNDAMENTAL SHARIA REQUIREMENTS FOR THE ISSUANCE OF SUKUK INNOVATION
Sukuk based on Sale Third Party (Seller) 29 Purchase Price Assets / Property Issuer/Trustee Pursuant to Declaration of Trust Sale Agreement Deferred Sale Price Assets / Property Company (As Purchaser ) Cash Proceeds Declaration of Trust Distribution Sukuk Holder DAY ONE : SESSION III SUKUK STRUCTURING AND DOCUMENTATION: A STEP BY STEP GUIDE 11/05/2014
التمويل الصغير بصكوك اإلجارة Company (As Seller) 30 Purchase Undertaking Company (وعد ملزم من طرف ثالث) رأس المال والممتلكات ثمن الشراء اتفاقية تأجير عوائد اإليجارات شركة ذات غرض خاص SME s SPV SME s Company ) المستأجر (As Lessee توزيع األرباح اتفاقية قانونية مساهمات نقدية وعينية Public Sukuk Holders DAY ONE : SESSION III SUKUK STRUCTURING AND DOCUMENTATION: A STEP BY STEP GUIDE
Sukuk al-ijarah Company (As Seller) 31 Purchase Undertaking Company (As Obligor) Purchase Price Assets / Property Issuer/Trustee Pursuant to Declaration of Trust Lease Agreement Lease Rentals SME Company (As Lessee) Cash Proceeds Declaration of Trust Distribution Sukuk Holder DAY ONE : SESSION III SUKUK STRUCTURING AND DOCUMENTATION: A STEP BY STEP GUIDE
Sukuk al-mudarabah Common 32 Investment Pool Return on 6 Investment (& Joint Cap) 5 Investment 2 Mudaraba Agreement 8 Second Distribution (Mudaraba Agreement) [ ] (As Mudarib) Issuer/Trustee Mudaraba Contribution Joint Capital 7 First Distribution First Distribution 7 (Pro-rata) 4 (Pro-rata) (Tacit Musharaka) 3 Mudarib Contribution Purchase Undertaking [ ] (As Obligor) 1 Rab Al Maal Contribution (As Rab Al Maal) Declaration Of Trust 9 Second Distribution (Mudaraba Agreement) ((Rab Al Maal Share) (Capital at Marturity) Sale Undertaking Sukuk Holders (As Rab Al Maal) DAY ONE : SESSION III SUKUK STRUCTURING AND DOCUMENTATION: A STEP BY STEP GUIDE
Sukuk al-musharakah Investments 33 as per Musharaka Business Plan Return on Investment Musharaka Entity Management Agreement Managing Partner (Company) Distribution Distribution Issuer/Trustee Pursuant to Declaration of Trust Contribution in-cash Musharaka Agreement Contribution in-kind/cash Company Cash Proceeds Declaration of Trust Distribution Purchase Undertaking Sukuk Holder DAY ONE : SESSION III SUKUK STRUCTURING AND DOCUMENTATION: A STEP BY STEP GUIDE
Sukuk Wakala 34 Sukuk Holders $ Investments $ Returns Funding Declaration of Trust Issuer SPV Trustee & Muwakkil (Principal) Master SU Financing Returns S/A; On Maturity or Exercise of the relevant PU or SU Investments Payments by the Sukuk Holders & pursuant to Wakala Agreement through Trustee investment into Wakala Assets PU Purchase Undertaking SU Sale Undertaking Portfolio of Wakala Assets Master Wakala Agreement Master PU Company Wakil (Agent) & Obligor DAY ONE : SESSION III SUKUK STRUCTURING AND DOCUMENTATION: A STEP BY STEP GUIDE 11/05/2014
Distinction between various Sukuk structures Pricing/Return/Risk 35 Fixed Return Variable Return Valuation Risk Musharaka Yes* Yes Underlying Assets High risk Mudaraba Yes* Yes Wakala Yes* Yes Underlying Assets Underlying Assets High risk High risk Istisna Yes No Receivable Low Risk Salam Yes No Receivable Low Risk Murabaha Yes No Receivable Low Risk Ijara Yes Yes Underlying Assets / Receivables Moderate Risk DAY ONE : SESSION IV EXAMINING RETURN OR PRICING IN SUKUK AND SECURITIZATION TRANSACTIONS
Shariah position on shortfall, default and documentation requirements Remedies available to investors: AAOIFI guidelines and Sharia position Discuss concept of return based on underlying transaction Events of Default: Shariah position and limitations Triggering the Event of Default Establishing default of the obligor under various underlying transaction types: Ijara, Musharaka, Mudaraba, etc Mitigation of risk return shortfall and default Additional documents? 36 DAY ONE : SESSION IV EXAMINING RETURN OR PRICING IN SUKUK AND SECURITIZATION TRANSACTIONS
Discussions A. What aspects need to be taken into account in relation to financing SMEs via Sukuk/Securitization? (Do we need specific authorization)? If yes, what type of authorization?) B. Balancing the Shariah, legal and regulatory requirements in issuances. 37 C. Effects of absence of or non-compliance with the legal and regulatory requirements (example, if any) DAY ONE : SESSION V LEGAL & REGULATORY ISSUES CONCERNING ISSUANCE OF SUKUK & SECURITIZATION
Thank you Dr. Nidal Alsayyed, PhD CEO Inayah Research and Consulting Jordan, UK, and Qatar nsayed70@gmail.com Tel. 0096279 782 0837