However, it should be noted that although some of these instruments have been generally accepted as being in compliance with Islamic principles so that, they can be traded in the secondary market, the negotiability of certain others is still a point of debate and controversy due to their legal acceptablity or compliance with Shari‘ah.
Therefore, some of these bonds can be traded in the secondary market while the trade of others is limited to the primary market because they can be exchanged only at face value.
In Malaysia for instance, almost all of the domestic Islamic debt papers issued so far have been based on the principles of murabahah, bay‘ bi al-thaman al- ajil, bay’ al-’inah and bay’ al-dayn, despite the controversy surrounding the issuance of tradable bonds in the secondary market based on the above two contracts. At the same time, there is a perceptible increase in the willingness amongst Malaysian issuers of bonds to explore other Islamic principles of financing, namely the profit-oriented based musharakah as well as the asset-backed mode of ijarah. Hopefully, the future issuance of Islamic bonds will focus on the widely accepted bonds such as musharakah bonds, mudarabah bonds and ijarah bonds.
However, the problem with Malaysian Islamic bonds has been the application of bay’ al-’ina and bay’ al-dayn, which is not well accepted by the Middle eastern investors. The contract of bay’ al-’ina and bay’ al-dayn is seen as something similar to riba based financing. This will certainly pose a great challenge to the Malaysian companies seeking Islamic funds in the Middle-east via bond issues.
3 Principal Steps Involved in the Issuance of Sukuk:
i. Securitization
Asset securitization is the essence of Islamic bond issues, as a bond must assume the role of al-mal or property to qualify as an object of sale. An object of sale in the Islamic law of contract must be a property of value. When a bond certificate is supported by an asset as evidence via the securitization process, it is transformed into an object of value and therefore qualifies to become an object of trade whereby it can be purchased and sold in both the primary and secondary market. Investors then will have to the right to sell (haqq al- mali) these bonds. In the bay` al-‘ina asset securitization, the financier purchases an asset from the issuer and sells it back to the same party at a credit price. This buy-back agreement will ensure that the issuer will receive the money in cash while financier will be paid a prefixed or contracted amount in a future date. Debt payments will be made by installment through bond issues.
The difference between cash and mark-up price will represent the profit due to the financier. The underlying asset is therefore crucial in determining the Islamicity of these bonds. In the Malaysian experience these assets include factories, equipment, stock and inventory and even intangible asset such as a list including building and properties.
ii. Sukuk Issuance
Issuance of Islamic Debt Certificate ( Shahdah al-Dayn), which usually takes place in the primary market where in settling its debt, the issuing company will sell debt certificates or bonds to investors. As mention above, debt certificates issues are valid only when it is supported by an asset. In other words, the bonds must be securitized.
Here the underlying security is the BBA or al-murabahah asset. The underlying asset need not be BBA or al-murabahah alone. If the 1st stage involves a contract of Ijarah, then the debt certificate is called Sukuk al-Ijarah. If an Istisna’ contract is used, we can called it Sukuk al-istisna.
Islamic bond can be categorized into two, namely bonds issues with coupons and those with none. The former is known as the Islamic coupon bond while the latter Islamic zero coupon bond.
iii. Trading of Debt Certificate (Discounted Bay' al-Dayn)
For liquidity purposes, bond trading in the secondary market is crucial. However, almost all Islamic bonds today were bought for long-term investments. The lack of secondary market however should not imply that trading issues is no longer significant. This requires an illustration on the Islamic view of bond trading in the secondary market.
As mentioned earlier when a debt certificate is securitized, it now becomes property(al-mal), which is also an article of trade. As an article of trade, the bonds can be sold by investors to the issuer or the third party if a secondary market for Islamic bonds exists. The trading or sale and purchase of the debt certificates is called bay’ al-dayn.
In Malaysia, the contract is bay’ al dayn at a discount is acceptable while Middle-east 'Ulama’ consider it invalid even though the debt is supported by underlying assets.
Any profit created from the sale and purchase of a debt is riba as enshrined in the holy Qur'an:
"And whatever riba you give so that it may increase in the wealth of the people, it does not increase with Allah." [al-Rum 30:39].
Prophet Muhammad (S.A.W) said:
“That every loan entailing benefit is usury”.
The Nature of Bay' al-Dayn
The issue of bay’ al-dayn arises when the bonds are traded in the secondary market at a discount. We have to note that buyers in the secondary market are usually speculators, that those who do not intend to keep the bond for long-term investment purposes.
Their main objective is to make quick capital gains on the basis of market liquidity and interest rate movement. However, there is no indication that controversies exist in the bay’ al-dayn where bonds are sold or redeemed at par value. We may now discuss bay’ al-dayn to show its nature according to Islamic view.
According to al-Majallah, Dayn defines as the thing due i.e the amount of money owed by a certain debtor. So also a sum of money not existing is considered a debt, as also a certain sum of money from things which exist or are present, or from a heap of wheat which is present before it is separated from the mass. Al-Dayn can be either monetary, or a commodity, like, food or metal. Based on the aforementioned of al-Dayn, and the literal meaning of Bay’ al-Dayn we can define it as the sale of payable right either to the debtor himself, or to any third party. This type of sale is usually for immediate payment or for deferred payment (al-Nasi’ah).
Sale of Bay' al-Dayn to a 3rd Party
According to most of Hanafis, Hanbalis and Shafis jurists , it is not allowed to sell al Dayn to non-debtor or a third party at all. Such opinions are based on the forbidden sale of al Kali Bil al Kali, sale of a Gharar, sale which the seller does not possess.
Conditions:
As an exception Malikis, Hanafis and some Shafi’s jurists allowed selling al-Dayn to a third party. Since the creditor has the right to sell it to the debtor, as well as he has the right to sell it to a third party provided the following rules must be observed:
a) The Dayn must be Mustaqir (confirmed debt) and the contract must be performed on the spot, not deferred in order to avoid any relationship with the sale of a debt for a debt which is prohibited by Islamic law.
b) The debtor must be a financially capable, must accept and recognize the sale, in order that he will not deny the sale. This condition aims to avoid any dispute between the parties, and the debtor must be easily accessible so that the creditor knows whether he has the capacity to pay his debt or not.
c) The sale should not be based on selling gold with silver or opposite, because, any exchanges between these items necessitates the immediate possession, and if the debt is money, its price in another debt should be equal in terms of amount of quantity.
Furthermore, the selling of al-dayn must avoid the occurrence of Riba between the two debts, and must also avoid any kinds of Gharar which may be raised at the level of inability of the buyer from possessing what he bought, as it is not permitted that the buyer sells before actual receipt of the purchased item.
It is important to note that Muslim scholars have unanimously prohibited the trading of debt (bay` al-dayn) at anything other than face value. Where the price paid for a debt is not the same as the face value of that debt, the transaction would be tantamount to riba al-Nasi’ah and is therefore prohibited. It is noteworthy that trading in bonds is a subject of dispute on two counts:
First, the bonds are normally sold at less then their nominal values. Second, the state or the issuer would use the mode of Bay` al-` inah and Bay` al-Dayn and these both sales transactions are regarded as riba by the majority of Muslim scholars. This is the very reason for the controversy about the legitimacy of Malaysian Islamic bonds which renders it to be unacceptable by individual Islamic jurists and institutions outside Malaysia and the Middle-Eastern countries. Islam does not allow the legal devices to be treated as a justification for transactions, which Islam regards unjust and against Islamic belief.
The bonds would have been acceptable from an Islamic point of view if the application of the mode of financing would be based on the legal maxim of al-Ghunmu bil ghurmi meaning that no person is allowed to invest in a way that generates profit without exposing himself to the risk of loss. It would expose both parties to the outcome of their deal, be it a profit or a loss, and thus avoid of usury as as matter of Islamic principle.
Categories of Sukuk:
Sukuk al-Ijarah
Ijarah is a contract according to which a party purchases and leases out equipment required by the client for a rental fee. The duration of the rental and the fee are agreed in advance and ownership of the asset remains with the lessor. Hence, the relationship between the parties differs from that of a debtor-creditor relationship since it is based on buyer-seller of an asset. Ijarah bonds, on the other hand are securities of equal denomination of each issue, representing physical durable assets that are tied to an ijarah contract as defined by Shari‘ah.
Sukuk al-Istisna'
Istisna‘ is a contract to sell a manufacturable good with an undertaking by the seller to present it manufactured from his own material, according to specified description and at a determined price.The suitability of istisna‘ for financial intermediation is based on the permissibility for the contractor in istisna‘ to enter into a parallel istisna‘ contract with a subcontractor. Thus, a financial institution may undertake the construction of a facility for a deferred price, and sub contract the actual construction to a specialized firm.
Sukuk al-Musharakah
Musharakah bonds based on the musharakah contract are relatively similar to muqaradah bonds. The only major difference is that the intermediary will be a partner of the group of subscribers represented by a body of musharakah bondholders in a way similar to a joint stock company while in mudarabah the capital is only from one party. It should be noted that almost all the criteria applied to mudarabah bonds are also applicable to the circulation of musharakah bonds.
Musharakah Certificate vs Conventional Bond
A Musharakah Certificate represents direct ownership of the holder in the assets of the project. If all the assets of the joint project are in liquid form, the certificate will represent a certain proportion of money owned by the project.
A Conventional Bond on the other hand, Has nothing to do with the actual business undertaken with the borrowed money.The bond stands for a loan repayable to the holder in any case, and mostly with interest.
Sukuk al-Muqaradhah is an alternative to Islamic Debt Certificate
The Islamic financial system is a set of rules and regulation that govern the flows of funds from the surplus-spending unit to the deficit-spending unit. These rules and regulations are strictly governed by Shari’ah principles where there is neither a possibility nor a need to apply usurious financial instruments such as the debt related bonds.
Hence, the solution for Islamic financial system dilemma lies in the development of financial instruments in which the Shari’ah rulings are not violated. One such instrument is the Muqaradah bond. A Muqarada bond is an Islamic bond in which no interest is earned, but whose market value varies with the anticipated or expected profits. It is the product of Muslim scholars and thinkers who developed and designed the financial instrument where interest or similar forms of returns which Islam has unequivocally prohibited are excluded.
The Council of the Islamic Fiqh Academy of Organization of Islamic Countries (OIC) during its fourth conference in Jeddah, Saudi Arabia from 18 to 23 Jamadul Akhir 1406H/6 to 11 February 1988, approved the mode of Muqarada by issuing Fatwa after having reviewed various studies on Muqarada bonds.
The meaning of Muqarada bonds and its salient features is given in the following: Muqarada bonds, as the term denotes, are based on the conclusion of lawful “Muqarada” (the mudaraba) with capital on one hand and labor on the other, and the shares of profit are determined (securitized) beforehand by a definite proportion of the total. It is called a bond because it is terminal in nature that its maturity is determined by the tenure or project completion date.
Final Remarks
Indeed, the conventional bond market comprises of primary market and secondary market. The primary bond market is where the bonds are initially issued, while the secondary market where the bonds are resold to other investors. Islamic bonds are also having primary and secondary markets. The main difference, however, is the way the bonds are issued and traded afterwards. In the process of Islamic bond issuance bay’ al-‘Inah is used to securitize the instrument in the primary market, while in the secondary market, bay’ al-Dain is used in order to legalize reselling of the bonds. Such process is mostly used in the Malaysian market, while most of the Middle-Eastern countries do not accept it. The proposed alternative is Islamic bonds based on Muqaradah.
It is thus, concluded here that, an effective issuance & appreciation of Sukuk may discover a potential way out of global debt-pro crisis by enjoying the following achievements:
(i) raising the required capital. (ii) development of expected projects. (iii) settlement of outstanding debts. (iv) maximize the soci-economic achievement both in public & corporate sectors. (v) nation with future prosperity.
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