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Tuesday, 7 July 2009

Markets seek common sukuk forms as debt sale divides

The sale of debt to third parties, especially through multiple securitisations, has been blamed for fueling the worst global financial crisis in generations. But some banking experts say the sale of debt is key to developing a liquid secondary Islamic bond market and a deeper, more sophisticated sharia banking system.
The global total of asset-backed securities issued and sold to investors fell by 79 percent to $441 billion in 2008, as overleveraged borrowers, banks and investors exited the market, according to think-tank International Financial Services London.
1. How does Islam view the sale of debt?
2. Does Islam allow the sale of debt between creditor and debtor and why?
3. Does Islam allow the sale of debt to a third party and why?
4. Does a prohibition on the sale of debt obstruct the development of the Islamic finance industry? If yes, how? Are there other ways in which such sales could be structured?
Megat Hizaini Hassan is an Islamic finance lawyer and heads the sharia banking practice of law firm Zaid Ibrahim & Co.
The views expressed in this article are those of the author and should not be seen as representing the views of Reuters News.

By Megat Hizaini Hassan
KUALA LUMPUR, June 24 - A sale of debt (bai' dayn) is permitted under Islamic law only under certain circumstances as outlined by jurists (Fuqaha') of various schools of thought (Mazahib) in Islam.
In general, the sale of the debt is permitted if the debt is sold by the creditor to the debtor itself, but the jurists' views differ on whether such debt can be sold by the creditor to a third party.
Jurists from the Hanafi school of thought prohibit such debt sale to third parties, while jurists from the Maliki and Shafi'i schools of thought permit it only subject to certain conditions.
Differences in the jurists' views on the sale of debt to third parties arise from certain Shariah issues relating to such debt sale, among them being the problem of delivery of the debt/sold item to the third party, or that the debt sale price may be different from the debt amount thus involving usury (riba), which is prohibited, or if payment of the debt sale price is deferred, thus involving a sale of debt for a debt (bai' al-kali bil-kali) which is also prohibited.
In this regard, the Council of the Islamic Fiqh Academy, an organ of the Organisation of Islamic Conference (OIC) and a very influential sharia standard setting institution, in 1998 issued a resolution prohibiting the sale of deferred debt to a third party, on the basis that this would involve elements relating to usury or sale of debt for a debt.
Nevertheless, in the Malaysian Islamic capital market the concept of sale of debt has in the past been used in issuing sharia compliant debt instruments.
The debt sale has been permitted by the regulator sharia board, i.e. the Securities Commission of Malaysia's (SC) Sharia Advisory Council, which accepted such sale of debt based on views of jurists in Maliki and Shafi'i schools of thought allowing for sale of debt to third parties, and because the position of the buyer/third party in such debt sale would be safeguarded by regulation and surveillance by the SC and the central bank.
Despite the use of the debt sale concept in Malaysia in the past, attempts have been made in recent years to employ universally accepted structures, especially by financial institutions seeking to raise funds via sukuk structures in which sharia compliant financing portfolios are underlying assets.
This is evident for example in the Malayan Banking subordinated bond issuance in 2006, involving the use of the bank's ijara thumma al-bai' financing portfolio as the underlying assets, as well as the Islamic Development Bank's (IDB) tadamun trust certificate issuance in 2008, which similarly involves the use of IDB's ijara and murabaha financing portfolios -- a form of securitised assets -- as underlying assets.
These recent issuances in Malaysia are by no means unique - the use of financing portfolios in sukuk issuances has basis in the earlier sukuk istithmar issuance by IDB which involved IDB's ijara, murabaha and istisna financing portfolios as the underlying assets.
The IDB sukuk istithmar structure was accepted as being sharia compliant universally in the Middle East.
In all these cases, the use of a financing portfolio in a sukuk structure is considered permissible from the sharia perspective, so long as the bulk of the financing portfolios are in the form of ijara (under which the bank owns assets and leases it to the customers) - as such, an ijara financing portfolio is not considered a debt from the sharia perspective and such sale of an ijara financing portfolio would not attract the sharia rules relating to a debt sale.
Such an approach exemplifies the uniqueness of Islamic finance, whereby a transaction that may be considered as a debt sale from the perspective of conventional finance would in certain circumstances be viewed differently from the Shariah perspective, in the light of the inherently different nature of Islamic financing structures compared to conventional loans.
In my view, such a prohibition is not really an obstruction to the development of Islamic finance, but rather a challenge that needs to be addressed by the industry.
The examples mentioned earlier on the sale of Shariah compliant financing portfolios (i.e. the IDB sukuk istithmar, Maybank and Tadamanun issuances) indeed represent the manner that the industry has in fact rose to the challenge, by way of innovative structures that would be considered as a sale of debt from the perspective of conventional finance. But from the Shariah perspective these examples nevertheless would be viewed as a sale of assets which is in line with Shariah requirements. (Editing by Kim Coghill)


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