Understanding Islamic Finance - Doha Academy of Tertiary Studies

392 Understanding Islamic Financewhich refers to the process in which ownership of the underlying assets is transferred to alarge number of investors in the form of instruments, presently termed Sukuk (the plural ofthe word Sak, or Sanadat, meaning certificate of investment or simply certificates).The ownership of the securitized assets is transferred to a special purpose vehicle (SPV) orspecial purpose Mudarabah (SPM) that is set up for the dual purpose of managing the assetson behalf of the Sukuk holders and for the issuance of the investment certificates. The SPVthat serves as Mudarib manages both the liabilities and assets of the issues. The contractualrights attached to Sukuk determine the mutual ownership and benefits of the securitizedassets for the individual investors who subscribe to the Sukuk. The Sukuk holders earn anyrevenue generated by the project and/or capital appreciation of the assets involved.The AAOIFI has defined investment Sukuk as certificates of equal value representingundivided shares in the ownership of tangible assets, usufruct and services or (in the ownershipof) assets of the particular projects or any specified investment activity. 3 InvestmentSukuk should be distinguished from common shares and bonds. While shares representthe ownership of a company as a whole and are for an indefinite period, Sukuk representspecified assets and are for a given period of time (so far issued for periods ranging fromthree months to ten years). Sukuk, unlike bonds, carry returns based on cash flow originatingfrom the assets on the basis of which they are issued.Islamic financing being asset-backed by nature, provides ample opportunities for issuanceof Sukuk on the basis of assets already booked by IFIs or by purchasing the assets withproceeds of a variety of Sukuk created on the principle of Shirkah. The process and theprocedures applied for Sukuk issue are almost same as those used for securitization in theconventional set-up, with the exception of avoiding Riba, Gharar and the activities prohibitedby the Sharī´ah.Securitization involves evaluating, isolating and efficiently allocating specific risks, evaluatingthe taxation, accounting and legal implications, designing appropriate credit enhancementstructures 4 and pricing the (residual) risk for pricing the units of the securitized assetsor pools. Securitization provides a premium over equivalent related plain securities andbetter stability than vanilla papers. Other benefits of securitization for investors include:focused risks associated with securities, portfolio diversification, tailored cash flow structuresbacked by the securitized assets, a flexible range of maturities and experienced riskassessment.Securitization is also beneficial for the originator, as it provides incentives for developinga transparent fund approval process, efficient collection procedures, and a well-built mechanismto control this process. Public availability of information about pool performance addsto confidence in securitized papers. New forms of securities in the form of Sukuk assist thedevelopment of capital markets, attract conservative buyers, draw international capital andfacilitate the efficient sharing of risks.Securitized papers are generally traded at a premium over vanilla corporate papers ofsimilar rating and tenor. The premium depends on the liquidity/active secondary market forthe securitized paper, the complexity of the transaction structure, investors’ comfort withthe underlying collateral and investors’ demand at the time of issuance. It makes them3 AAOIFI, 2004–5a, Standard on Investment Sukuk, p. 298.4 Credit enhancements in respect of Sukuk could be internal and/or external collateral aspects, in addition to the underlyingassets, to reduce the risk to investors and to enhance the rating of the issue. Some examples are: cash reserves, Takaful cover,overcollateralization, early warning triggers performance guarantee by originators of facilities and third party guarantee, if possible.