How To Understand A Hybrid Sukuk

Transcription

1 SLAMIC INANCE HYBRID SUKUK: AN OVERVIEW INTRODUCTION DR. HAFAS FURQANI* Hybrid sukuk is among the favorable emerging type of sukuk in the Islamic capital market worldwide. It is viewed as one of the innovative products in the Islamic capital market compared to the plain vanilla sukuk structures that were basic and standard, which didn t add value such as option to exchange or convert into equity at a specified time. The term hybrid itself usually refers to something that is composed of two or more widely differing elements. Hybrid sukuk, in this regard, can be defined as a kind of security that:» combines some elements of equity and debt;» the underlying assets consists of tangible assets ( ayn) and intangible assets (dayn);» combines Shari ah contracts in the structuring process. Nevertheless, in the modern financial terms, hybrid instrument usually refers to a security containing two elements, i.e. equity and debt, which could be described as either a bond with equity features or a share with debt characteristics. Hence, a hybrid instrument can be converted or exchanged into equity. TYPES OF HYBRID SUKUK Based on that perspective, it can be understood that a hybrid sukuk is a sukuk that as the features of having beneficial ownership of the, and also, equity features while using Shari ah contracts. This gives the sukuk holders the right to receive periodic distribution of income and have the right to convert or exchange the sukuk into equity at some future date and under prescribed conditions. issuer s sukuk (usually a subsidiary or a company that the issuer own shares). This is done at a specified rate of conversion and under prescribed conditions. In other word, exchangeable sukuk is convertible to third party s shares.» Perpetual sukuk: this is a type of sukuk that incorporates the characteristics of equity with regular return. This is done with no predetermined maturity date and with a call option at the discretion of the issuer. DESCRIPTION OF HYBRID SUKUK The distinct feature of a hybrid instrument is its combination features of debt and equity. Unlike the standard sukuk, a hybrid sukuk gives their holders the right, but not the obligation, at a future date to subscribe for equity. Similar to a standard feature of traditional sukuk, in a hybrid sukuk it is required that the underlying sukuk assets should be subjected to one of the Shari ah compliant principles, such as musharakah, mudarabah, ijarah, etc. Unlike the standard sukuk, a hybrid sukuk is structured with both debt and equity-linked features in the contracts that would grant the holder the right to convert the sukuk certificates to shares or equity ownership from the issuer (or the obligor), following the conversion of the sukuk. The right to convert will be exercised based on a specified conversion date or during a conversion period, at any time between two specified dates or at any time from the issue date of the sukuk up to its maturity as can be seen in Figure 1: Sukuk Issued Call period starts Final matuarity In this regard, hybrid sukuk can be classified into three types, namely: CALL PERIOD TIME» Convertible sukuk: this is a type of sukuk that gives the holder the right at a future date to convert their sukuk into new equity shares of the sukuk issuer. This is done at a specified rate of conversion and under prescribed conditions. Hence, in other word, a convertible sukuk is convertible to issuer s shares.» Exchangeable sukuk: this is a type of sukuk that gives the holder the right at a future date to exchange their sukuk for existing equity shares of a company apart from the Issuer exercises call option (at any time in call period) Sukuks not converted are redeemed Figure 1 Hybrid Sukuk Conversion and Redemption Source Coyle, B. (2002: 19). Hybrid Financial Instruments. United Kingdom: Financial World Publishing. * Dr. Hafas Furqani, Researcher at International Shariah Research Academy (ISRA), He can be contacted at hafas@isra.my. /////////////////////////////////////////////////////////////////////////////////////////////////// 1

2 In practice, the decision whether or not to convert sukuk into equities on the conversion date depends on whether the current share price is higher than the conversion price and also the time remaining between the period between the issue date and the conversion date. If the current market price of the share is less than the conversion price, it is not worthwhile for sukuk holders to convert their sukuk into equity. It would be cheaper to buy shares from the market rather than converting the sukuk into equity. The sukuk holder, in this case, will observe if there is still opportunity to convert or waiting another subsequent date that will occur. If the price is still below the conversion price, the sukuk holders might hold sukuk until the redemption date. The probability of converting the sukuk depends on whether it is issued with a put option and, if so, the redemption price available for the put. However, this will affect sukuk holders that will prefer early redemption at a premium rather than conversion into equity. NOTABLE HYBRID SUKUK ISSUANCE Hybrid sukuk in the form of exchangeable, convertible and perpetual sukuk have been used to raise funds with additional objective of offering sukuk holders the option to exchange or convert their sukuk into company s shares. The non-dilutive nature of hybrid, and the ongoing capital markets uncertainty, will continue intrigue companies to look at hybrid structures as part of their infrastructure funding options. There is an increasing trend among issuing companies for hybrid sukuk issuance in the market. Some of the notable hybrid sukuk issuances are as in Table 1: Date Jan Sept Sept Jul Jun Mac Nov 2013 Issuer PCFC Development FZCO (SPV) Rafflesia Capital Ltd Sabana Treasury Tamweel PJSC Malay-sian Airline System (MAS) DIB Tier 1 Sukuk Ltd GEMS MEA Sukuk Limited Obligor & Partner PCFC Ports, Customs & Free Zone Khazanah Nasional Bhd Sabana REIT Tamweel Funding Limited Malaysian Airline System (MAS) Dubai Islamic Bank PJSC GEMS Type Islamic Principle Amt (USD Mln) Tenure (Years) Country Bloomberg Code Convertible Sukuk Musharakah 3,500 2 yrs UAE EF Exchangable Sukuk into ordinary shares of Telekom Malaysia Berhad Convertible Sukuk into units of a Reit Convertible Sukuk into ordinary Shares of Tamweel Perpetual Sukuk Mudarabah Perpetual TIER 1 Capital Certificates Subordinated Perpetual Certificates Table 1 Some of notable hybrid Sukuk Issuance Source collected from various sources including each sukuk prospectus. musharakah yrs Malaysia EF musharakah, Ijarah & Wakalah Wakalah and Istisna Musharakah and Musawamah yrs Singapore EJ yrs UAE EI Perpetual Malaysia EJ Mudarabah 1000 Perpetual UAE EJ Mudarabah 200 Perpetual UAE EJ /////////////////////////////////////////////////////////////////////////////////////////////////// 2

3 HYBRID SUKUK STRUCTURE: KHAZANAH EXCHANGEABLE SUKUK (2006) On 27 September 2006, Khazanah Nasional Berhad, via a special purpose company, and Rafflesia Capital Limited (the Issuer ) launched and priced an Exchangeable Sukuk. The offering comprised of US$750 million 5-year certificates due 2011, and is exchangeable into ordinary shares of Telekom Malaysia Berhad ( TM ) at RM1.00 each held by Khazanah. The Exchangeable Sukuk were priced at 100% of the principal amount with yield to maturity of 5.07% and will carry an annual periodic payment of 1.25% and exchange premium of 19% over the 1-day volume weighted average price of TM shares on 27 September The structure of Khazanah exchangeable sukuk is as shown in Exhibit 1: KHAZANAHNASIONAL (Obligor) 2a Transfer Exchange Property 3b Pays USD750m ORCHID CAPITAL LTD (SPV) 4 Undertakes to buy the Exchange Property for 121.4% of face value at maturity 2b Transfer Exchange Property RAFFLESIA CAPITAL LTD (SPC) - Issuer 3a Pays USD750m 1b Issue Proceeds USD750m INVESTORS TM SHARES 1a Issues ExchangableTrust Certs SUKUK Exhibit 1 Khazanah Exchangeable Sukuk Structure Source Securities Commission Malaysia. (2009). The Islamic Securities (sukuk) Market. Kuala Lumpur: SC. Rafflesia Capital Limited, a company based in Labuan, issued the exchangeable trust certificates (sukuk) to the investors; in consideration of which, the investors paid the issue proceeds worth USD 750 million. Khazanah National Berhad (Khazanah) as the obligor that is responsible for the sukuk issuance, sold and transferred the exchange property consisting of Telekom Malaysia (TM) shares to its wholly owned SPV, Orchid Capital Limited, at the equivalence of USD 750 million. Orchid then sold and transferred the exchange property to Rafflesia. The issue proceeds were used by Raflessia to pay Orchid the consideration for the purchase of exchange property. Orchid then paid the issue proceeds to Khazanah. After five years, Khazanah is made responsible to purchase back the exchange property at % of the face value upon the maturity of the sukuk. However, the issuer was given the call option to exercise the purchase undertaking after three years at 130% of the face value. When the sukuk matured, the purchase undertaking by Khazanah would be exercised. Thus, Khazanah would purchase the exchange property (TM shares) at the agreed price. The payment would be used by Rafflesia to pay the sukuk holders their scheduled dissolution amount as initially agreed. The sukuk holders could also opt to exchange their sukuk with TM shares, especially when the shares were showing good performance. The sukuk were exchangeable at any time, on or after the 40 th day after the closing date of issuance, until the close of business on the 10 th business days prior to the scheduled dissolution date. However, Khazanah reserved the right to a final decision on whether the exchanges should be given by TM shares or to settle via cash. /////////////////////////////////////////////////////////////////////////////////////////////////// 3

4 SELECTED SHARI AH ISSUES IN HYBRID SUKUK STRUCTURE The features of hybrid sukuk have attracted the attention of both issuers and investors. There is a growing interest among issuing companies and investors in the global market for these types of debt and equity-linked sukuk as they provide companies with a means of raising capital at a reasonable cost, which allows for a more flexible and greater mobilization of funds. At the same time, it provides investors with an attractive method of investment as an alternative or supplement to the debt and equity products in their investment portfolio. Nevertheless, the structuring of hybrid sukuk poses greater challenges due to their complexity. Hence, the number of sukuk issuance using hybrid structure is not as extensive as straight/plain sukuk in the Islamic capital market. This could be due to the difficulties in obtaining Shari ah approvals for these types of sukuk. It could also be due to some issues in certain country s regulation, such as foreigners ownership of shares, taxes and others. Some notable Shari ah issues in hybrid sukuk structure are as follows: Conversion Mechanism In hybrid sukuk, the sukuk holders are given right to exchange or convert their sukuk into equity. To facilitate that purpose, in the sukuk structure, there are some other elements such as conversion price, conversion ratio, conversion value, conversion premium and conversion mechanism, all of which are important for investors decision on whether to convert/exchange or not to convert/exchange. Shari ah requires that all the information and process of conversion should be transparent, fair and free from ambiguities and uncertainties (gharar). The issue of gharar (uncertainty) emerges when those elements are unknown, inexistence, incapable to be delivered or are made contingent upon something that trigger uncertainty to both the issuer and investors. Likewise, gharar might also happen if the characteristics of the shares of company to be converted or exchanged are unknown, which might invalidate the contract. Underlying Assets Hybrid sukuk, similar to the standard type of sukuk, requires certain underlying assets. The underlying assets can be in the form of tangible (i.e. cash), intangible (i.e. fixed assets) or receivables (which are mustaqir, established and certain); while its use must comply with the requirements of Shari ah. In other word, the nature of a hybrid sukuk s underlying assets in the asset securitisation process and the utilization of the proceeds generated from selling the assets must be Shari ah compliant. The mixture of tangible and financial assets in the pool of investment assets is possible in hybrid sukuk provided the tangible asset dominates the intangible asset. This is based on the Islamic legal maxim lil akthar hukm al-kulli which means the majority portion dictates the rule of the whole combination. In addition, AAOIFI, in their Sukuk Pronouncement (2008), placed guidelines that sukuk must truly represent ownership in real or physical assets, which may also include services or usufruct. Therefore, the originator/obligor must be able to prove the transfer of the title in its records. Return on Investment Hybrid sukuk structure that uses musharakah, mudarabah or wakalah bi al-istithmar as its underlying principle, the following requirements must be followed:» The profit rate should be determined by the parties involved in the contract based on the capital contribution.» The profit should neither be fixed in exact amount nor guaranteed. Instead, it should be determined by the success of the project and hence, the contracting parties would get more or less amount in profit distribution in accordance with the agreed rate.» The lose should be part of the risk that the investors should bear, except in the case of negligence, misconduct or breaching by the entrepreneur, agent or partner of the terms and conditions. Purchase Undertaking The obligor shall execute a purchase undertaking to dissolve the sukuk contract. Therefore, the sukuk issuers shall buy back the entire sukuk from the investor and the investor will recover his principal investment by attaining cash. Unlike other standard sukuk whereby a purchase undertaking typically uses cash to settle the exercise price payable in respect of the sukuk assets, the exercise price in a purchase undertaking of a convertible or exchangeable sukuk is of a different mechanism. In a convertible or exchangeable sukuk the exercise price can be converted into a certain number of shares of the obligor (for a convertible sukuk) or of another entity (for an exchangeable sukuk). The number of shares to be delivered will be calculated in accordance to the value of the assets on the maturity date. If the convertible/exchangeable sukuk uses mudarabah, musharakah or wakalah bi al-istithmar as its underlying Shari ah contracts, one of the requirement is that the exercise price should be based on the net value of the assets, its market value, fair value or a price to be agreed at the time of their actual purchase. /////////////////////////////////////////////////////////////////////////////////////////////////// 4

5 CONCLUSION Since the first hybrid sukuk issued in 2006, quiet a high proportion of sukuk issuances have been in the form of convertible and exchangeable sukuk. There has been a growing interest among issuers and investors for hybrid sukuk due to it being equity-linked. This is because such sukuk structuring is viewed as among the innovative products in the Islamic capital market compared to the standard type of sukuk structure, which were structured in its basic and standard form and to the dominant debt based feature in the sukuk structure. It is expected that more hybrid sukuk will be issued in the market. In order to assist the development of hybrid sukuk, the regulatory environment within which the convertible, exchangeable and perpetual sukuk are issued must be supportive enough to encourage its growth and pave the way for its enhancement and innovative offerings. APPENDIX Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI): Sharia Standard No. (25) Combination of Contract 3 Shari`a Status of Contracts Combining» It is permissible in Shari`a to combine more than one contract in one set, without imposing one contract as a condition in the other, and provided that each contract is permissible on its own. Combining contracts in this manner is acceptable unless it encounters a Shari`a restriction that entails its prohibition on exceptional basis. 4 Shari`a Controls on Contracts Combining» Contracts combining should not include the cases that are explicitly banned by Shari`a like combing sale and lending in one contract.» it should not be used as a trick for committing riba such as agreement between two parties to practice Bai`ul Eina or riba Alfadhl» It should not be used as an excuse for practicing riba. The two parties could misuse, for instance, contracts combining when they conclude a lending contract that, at the same time, facilitates some other compensatory gains to them. For example, they could stipulate in the contract that the borrower should offer accommodation. In his house to the lender, or should grant him a present. Contracts combining could also be misused by imposing excess repayment in terms of quantity or quality on the borrower. (See Shari`a Standard No. 14 on Loan item (1/4).» Combined contracts should not reveal disparity or contradiction with regard to their underlying rulings and ultimate goals. Examples of contradictory contracts include granting an asset to somebody as a gift and selling/leasing it to him simultaneously, or combining mudaraba with lending the mudaraba capital to the mudarib, or currency enchange wuth Jua`la } or Salam with Jua`la for the same contract value, or leasing with selling (i.e. hire-purchase in its traditional form) 5 Shari`a Concessions for contracts combining» In principle, the Shari`a concessions that can be granted to implicit and subsidiary contracts at the time of combining contracts cannot be granted to the same contracts when concluded independently. Here, implicit and subsidiary contracts refer to contractual commitments that are not explicitly embodied in the deal agreement or those which succeed the original commitments of the transaction. The concessions to be granted in this case should be judged in the light of traditions, practice and professional experience, and subjected to clearance by the Shari`a supervisory board of the institution.» Concessions granted to implicit and subsidiary contracts comprise relief from the following Shari`a-banned acts: a. Gharar, which affects financial contract, may be overlooked in implicit and subsidiary contracts. b. Jahala, which also affects financial contracts, may be ignored with regard to the object of a subsidiary contract. c. Sale-based riba and violation of currency exchange rules (as when spot delivery is ignored in a contract that combines currency exchange with money transfer) are also forgivable in subsidiary and implicit contracts. d. Selling of a debt for another debt may be ignored when it comes in the context of a subsidiary contract. A fitting example here is purchasing (on debt) the shares of an indebted company. e. Subsidiary and implicit contracts may also relieved from some prerequisites that underline the validity of contracts (such as offer and acceptance) when such relief is dictated by need or desire to achieve a Shari a-permitted interest. Source AAIOFI Sharia Standard 2010 LEARN MORE For more information please nimap@bloomberg.net. To learn more about Islamic markets on the Bloomberg Professional service, go to ISLM <GO> or ISRA <GO>. The views expressed in this bulletin does not necessarily reflect those of International Shariah Research Academy for Islamic Finance (ISRA) and Bloomberg or its editors. Bloomberg and International Shariah Research Academy for Islamic Finance (ISRA) are not liable for errors or any consequences arising from the use of information contained in this bulletin. 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