CASE ANALYSIS: EQUATE PETROCHEMICAL COMPANY Presented By: Mahadzir Ahmad - G0439291 Uda Iskandar Sidek - G0412896

PRESENTATION OUTLINE The Equate Project Financing The Equate Project The Islamic Tranche – USD200m Ijara Facility Shariah Issues Islamic Project Financing Conclusion

The Equate Project – Ownership and Production Flow KPC BOUBYAN (10%) UCC (45%) PIC (45%) Ethane Plant Ethylene Plant Ethylene Glycol Plant Polyethylene Plant

Financing The Equate Project

Structuring the Islamic Tranche KFH had 3 options: - Istisna’ – would expose Equate to refinancing risk after construction Murabaha – low profit rate for a long time for KFH Ijarah – long term financing at variable rate

The Islamic Tranche – USD200 Million Ijara Facility The salient features of the Ijara facility provided by KFH are: Equate to sell some assets of the project to the Islamic banks Equate to lease back the assets (the Leased Assets) based on Ijara from the Islamic banks Equate to pay rental computed using London Interbank Offered Rate (LIBOR) as benchmark Equate to pay rental semi-annually during the lease period

Shariah Issues The use of LIBOR is deemed as a mechanism to compute rent payable and does not amount to riba’. Delayed rental payment by Equate would be subjected to a revision of the rental facility and higher rental rates may be imposed by KFH for subsequent payments. However, the quantum of the revised rental rates is not contractual. Rental payments may be varied at the semi-annual intervals, and the actual amount payable shall depend on the prevailing LIBOR. (The rental rate was initially priced at 1.75% over LIBOR but reduced to 0.80% over LIBOR in 1997.)

Taqi Usmani’s view “The basic difference between an interest-based financing and a valid lease does not lie in the amount to be paid to the financier or the lessor.” Gharar is not applicable when “both parties have agreed with mutual consent upon a well defined benchmark that will serve as a criterion for determining the rent, and whatever amount is determined, based on this benchmark, will be acceptable to both parties. Therefore, there is no question of any dispute between them.”

Shariah Issues In case of total loss of the Leased Assets, Equate is not obliged to make any more rental payment or to repurchase the assets. Compensation to the Islamic banks would come from the insurance companies. KFH is allowed to take insurance coverage from conventional insurance companies. Participating Islamic banks are allowed to assign their rights and obligations as the facility is backed by the Leased Assets. (KFH was the Arranger and other Islamic banks participated by providing some of the funds to make up the US$200 million facility).

Shariah Issues No commitment fee may be levied but Equate shall pay a lump sum management fee for the Arranger role played by KFH. (Commitment fee is fee paid to banks based on the unutilised portion of the facility being provided.) The sale of the assets by Equate to form part of the Leased Assets may be done gradually and each payment by KFH shall be either less than or equal to the book value of the assets being sold. (The maximum that Equate can sell under this Ijara facility is US$200 million, of course.) The assets being sold to KFH to form part of the Leased Assets may include work-in-progress assets. The Leased Assets may be transferred to Equate at the end of the lease period by way of gift.

Briefs on Project Finance & Islamic Project Finance Financing of long-term infrastructure, industrial projects and public services Based on a non-recourse or limited recourse financial structure Project debt and equity used to finance the project are paid back from the cash flow generated by the project Islamic Project Finance Same commercial objectives with conventional project finance Undertaken via Shariah compliant scheme i.e. Mudharabah or Musharakah Murabahah, Istisna’ and Ijarah are common contracts / facilities used subsequent to the Profit-Loss and Risk sharing scheme

Islamic Project Financing If the partnership between the capital providers had been undertaken via Musyarakah, the International banks would have to contribute their share of the new capital injection and lessen the burden of the sponsors, and when the crude oil prices were to rise again (as it did in year 2000), the International banks would reap more benefits from the profits of the project. Unfortunately, this is not the case for Equate Petrochemical Company.

Conclusion The USD200 million Ijara facility provided by KFH and TII, being in full compliant with Shariah, sets the standard for other Islamic banks in structuring Ijara facilities in the future. In this respect, the outstanding efforts by KFH, TII and the Shariah scholars are well recognised. However, upon closer scrutiny, we are of the view that, qualitatively, the Equate project does not match the criteria of being a Mudharabah or Musyarakah. To agree that Equate was financed Islamically would be blurring the Profit-Loss and Risk sharing ideals behind Mudharabah and Musyarakah when parties undertake a project jointly. Thus, Equate cannot be deemed as an Islamic Project Finance.