Misperceptions On Costs And Complexity Of Sovereign Sukuk: Economics And Legal Perspective Moinuddin Ul Islam Farhanah Mohd Mokhtar MSc In Islamic Banking and Finance IIUM Institute of Islamic Banking and Finance

The Islamic Bond: Sukuk Bond is a debt instrument which allows investors to lend money to corporation or government entity for a certain period of time at a fixed interest rate (premium). The capital will be returned at maturity date. Sukuk is financial certificate of equal value representing undivided ownership of tangible asset, usufruct and business activity. It is an ownership claim of an asset but not a financial claim to cash flow.

Sukuk AAOIFI Governance SC of Malaysia Types of Sukuk Asset-Based Asset-Backed Unsecured Contracts Secured Covered Sale-Based Lease-Based Murabahah Partnership-Based Salam Ijarah Istisna Musharakah Mudarabah

Sovereign Sukuk Meaning Sukuk issued internationally by government of issuer’s country Meaning Asset-based sukuk Common Structure Ijarah Contract Common Contract To have access over huge and growing Islamic funds Common Interest Expected to $30billion by end of the year (Moody’s, 2014) Size

Issues On Issuance Of Sovereign Sukuk Identification of Underlying Assets (Othman and Kamarudzaman, 2012) Right To Leasehold Under Sukuk Ijarah Structure (Zakaria, 2012) Slow Development of Sovereign Sukuk: Lack in Demand (Jobst, 2008)

Issues On Issuance Of Sovereign Sukuk Untested Instruments and Lack of Ratings (Hassan, 2012) Limited Diversity and Illiquid Secondary Market (Jobst, 2008) Parity Between Taxation On Sukuk And Conventional Bond (Jobst, 2008)

Findings: The Misperceptions (1) The Underlying Asset Importance of presence of underlying asset Asset Backed Sukuk Asset Based Sukuk Most of the sovereign sukuk issued are asset-based sukuk The issuer only passes beneficial ownership of asset to sukuk holders, while still keeps its legal ownership

Findings: The Misperceptions (2) Right To Leasehold Asset International sukuk holders are assumed to be entitled to right to leasehold the property Viewed as property owners in the country However, through purchase undertaking agreement, the government repurchases the sukuk-underlying assets at a predetermined price Malaysia: treated as unsecured securities

Findings: The Misperceptions (3) Lack in demand Commonly issued at premium Asset-based sukuk dependent on ratings Almost all first time sovereign sukuk issuance of 16 countries are oversubscribed

Findings: The Misperceptions (4) Summary Lack Of Availability Of Shari’ah Compliant Asset Issues for non-Muslim countries on searching for Shari’ah compliant asset: no prohibited items or interest bearing assets Options: Setting up Islamic financial institution Put a portion of earning from underlying asset in Islamic financial institutions in another country

Findings: The Misperceptions (5) Illiquid Secondary Market Ijarah structure does not allow the sukuk holders to trade the sukuk: no secondary market Malaysia: Introduction to Sukuk Wakalah Current development: Perpetual sukuk To attain requirement of Basel III

Findings: The Misperceptions (6) Taxation Malaysian Legal Framework: Section 2(7) and 2(8) of Income Tax Act (ITA) All underlying sales and purchase of assets required under Shari’ah law will be disregarded for tax purposes. Tax exemption of 100% from Year of Assessment 2007 to 2016 for Islamic banks and Islamic banking units on income derived from Islamic banking business conducted in international currencies. Tax deduction on expenses incurred on the issuance of Islamic securities based on principles of Mudarabah, Musharakah, Ijarah, Istisna’ and other Islamic securities approved by SC Extension of stamp duty exemption of 20% on instruments of Islamic financing products approved by the SAC or BNM or SC up to Dec 31st 2015

Conclusion The Underlying Asset Malaysia is one of the pioneers in issuance of sukuk. From the introduction first sovereign sukuk to most advanced perpetual sukuk, the country has benefitted from both economics and legal changes that it had gone through. Although there is substantial development of sukuk market, some issues still remains which needs to be clearly identified. The Underlying Asset Right To Leasehold Asset Lack in demand Lack Of Availability Of Shari’ah Compliant Asset Illiquid Secondary Market Taxation

Thank You SIFEC2014 Misperceptions On Costs And Complexity Of Sovereign Sukuk: Economics And Legal Perspective