MIAN

1
IN THE NAME OF ALLAH THE BENEFICIENT THE
MERCIFUL
WEL COME
2
Sukuk and its Legal and Regulatory Framework in
Pakistan

• By
• SIBGHATULLAH AHSAN
• Partner
• MIAN SIBGHAT
• Advocates Legal Consultants
• Islamabad.

3
ISLAMIC FINANCIAL SYSTEM- AN INTRODUCTION

• Based on QURAN and SUNNAH
• Demands socio economic justice
• Prohibits all kinds of RIBA
• Prohibits all forms of exploitation
• Provides equal opportunities to all
• Condemns accumulation of wealth in few hands
• Encourages acts of benevolence

4
PRINCIPLES OF ISLAMIC FINANCE

• Prohibition of RIBA
• Alkharajo bil dhaman (entitlement to profit is
  associated with corresponding risk)
• Prohibition of sale of goods before acquiring
  ownership
• Prohibition of sale of food stuff before
  possession
• Prohibition of debt for debt
• Avoidance of Gharar (uncertainty)

5
PROHIBITION OF RIBA

• QURAN
• ALLAH has permitted BAI (sale) and prohibited
  RIBA (Al Baqarah 275)
• O you believers, fear ALLAH and give up whatever
  is left in lieu of RIBA if you are indeed
  believer, Watch out! If you do not obey this
  order (and give up all outstanding RIBA), then
  there is a declaration of war against you from
  ALLAH and HIS PROPHET. However, if you repent
  you have entitlement only to your principals.
  Neither you inflict zulm on others, nor the
  others should do zulm on you. (Al Baqarah 278-9)

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PROHIBITION OF RIBA

• SUNNAH
• Obadah ibn Samit directly reports from the
  Prophet as saying Buy and sell gold for gold,
  silver for silver, dates for dates, wheat for
  wheat, salt for salt, and barley for barley on
  the like for like basis. Whosoever gave more or
  took more, verily he made a RIBA deal. However,
  trade gold for silver as you wish subject to the
  condition that the exchange be hand to hand
  (spot). Trade wheat for dates or barley for dates
  also likewise.

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EXCHANGE OF HOMOGENEOUS COMMODITIES OR CURRENCIES
DELIVERY Must be simultaneous / spot
Commodity A
Commodity B
MEASURMENT Must be same in amount / weight /
count
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EXCHANGE OF HETEROGENEOUS COMMODITIES OR
CURRENCIES
DELIVERY Must be simultaneous / spot
Commodity B
Commodity A
MEASUREMENT May be different
9
EXCHANGE INVOLVING RIBA IN HOMOGENEOUS
COMMODITIES OR CURRENCIES
DELIVERY Any one of the counter values is delayed
Commodity A
Commodity B
MEASURMENT Counter values are not equal
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EXCHANGE INVOLVING RIBA IN HETEROGENEOUS
COMMODITIES OR CURRENCIES
DELIVERY Delay in any of the counter values
would amount to RIBA (Delivery must be
simultaneous / spot
Commodity B
Commodity A
MEASUREMENT May be different
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Some principles derived from the Hadith

• General principles
• In a contract of sale counter values must be
  exchanged simultaneously
• Quantity /number/measure etc. should be same
• Exceptions
• Credit Sale
• Salam
• Qard-e-Hasanah

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WHAT IS RIBA

• Simple definition
• Any delay or discrimination (regarding weight,
  measure or count) in any of the counter values in
  a contract of exchange is riba
• Any addition without a counter value is RIBA
• Every loan entailing an increase is RIBA

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ISLAMIC CONTRACTS FOR COMMERCIAL TRANSACTIONS

• Musharaka (Profit and Loss sharing)
• Modaraba (Profit sharing)
• Musawamah (Bargaining sale)
• Ijarah (Leasing)
• Salam (Advance payment sale)
• Istisna (Contract of manufacturing)
• Murabaha (Cost plus margin sale)

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MUSHARAKA

• Characteristics
• All parties share in the capital
• All parties share profits as well as losses
• Profits are distributed as per agreed ratio
• Loss is borne by the parties as per capital ratio
• Every partner is agent of other

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MUSHARAKA
May be in any agreed ratio
PROFIT Rs. 100
Rs. 40
Rs. 60
PARTNER A
PARTNER B
VENTURE
Rs.1000
Rs.1000
Rs. 50
Rs. 50
LOSS Rs.100
Must be according to capital ratio
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MUSHARAKA
May be in any agreed ratio
PROFIT Rs. 100
Rs. 50
Rs. 50
PARTNER A
PARTNER B
VENTURE
Rs.2000
Rs.3000
Rs. 40
Rs. 60
LOSS Rs.100
Must be according to capital ratio
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MUDARABA

• One partner (Rab al Mal) contributes capital and
  the other (Mudarib) contributes his skills or
  services to the venture
• Venture may for a fixed period or purpose
• Both share profit in pre-agreed ratio
• Loss is borne by Rab al Mal only, Mudarib loses
  his services

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MUDARABA
PROFIT
50
50
VENTURE
SERVICES
CAPITAL
RABBUL MAL
MUDARIB
ALL MONETORY LOSS
LOSS OF SERVICES
LOSS
19
MUDARABA
PROFIT
40
60
VENTURE
SERVICES
CAPITAL
RABBUL MAL
MUDARIB
ALL MONETORY LOSS
LOSS OF SERVICES
LOSS
20
IJARAH

• Usufruct of an asset is passed to other party
  against a periodic rent payment
• The asset must have corpus (body) and be in
  existence
• The asset must not be consumable in nature
  (should not vanish if used)
• Ownership will remain with the lessor and he will
  bear all the risks related to ownership

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IJARAH
Use/ usufruct Only
LESSOR
LESSEE
Ownership
Asset
Usufruct
Usufruct
Periodical payments/Rent
22
SALAM (Advance payment)

• It is an exception to the general principle of
  instant exchange of counter values in a contract
  of sale

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SALAM (Advance payment)

• Full payment of purchase price, No deferment or
  installment in advance money allowed
• No loan adjustment is allowed
• Quality and quantity must be specified
• Date of delivery must be specified

24
MURABAHA

• Murabaha is sale of a commodity at cost plus
  margin it must fulfill all the conditions of a
  valid sale
• It may be spot sale or a deferred/credit sale
• Deferred sale Murabaha is used as financing mode
  by Islamic Banks
• Deferred price becomes a debt and shall be dealt
  with as a loan transaction
• Price once settled at the time of sale can not be
  changed due to default of creditor, any thing
  above sale price would be RIBA

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Conditions for Murabaha

• Since it is a sale contract it must fulfill all
  the conditions of a valid sale
• The Bank should purchase the asset from a third
  party and not from the customer himself
• The Bank must own the asset before it sells to
  the customer
• The Bank must have possession (physical or
  constructive) i.e. it must come to its risk
• The seller must know and disclose the cost
  including freight, insurance and taxes etc.
• Profit may be fixed in lump sum or through agreed
  ratio to be charged over the cost

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MURABAHA
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CLASSICAL MURABAHA
COST MARGIN
PRICE
IMMIDIATE DELIVERY
SELLER
BUYER
GOOD
IMMIDIATE DELIVERY
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BAI MUJJAL (deferred sale)
PRICE
DEFERRED PAYMENT
SELLER
BUYER
GOODS
IMMIDIATE DELIVERY
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MURABAHA WITH
DEFERRED PAYMENT
COST MARGIN
PRICE
DELAYED PAYMENT
SELLER
BUYER
GOOD
IMMIDIATE DELIVERY
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What is Sukuk?

• The word Sukuk plural of word Suk which means
  _______________
• The Accounting and Auditing Organization for
  Islamic Financial Institutions defines Sukuk as
• Certificates of equal value representing
  undivided shares in ownership of tangible
  assets, usufruct and services or (in the
  ownership of ) the assets of particular projects
  or special investments activity

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Legal Definition of Sukuk

• Pakistani Law does not define the word Sukuk
• There is no particular legislation in Pakistan
  that governs a Sukuk by a company
• Then how to define a Sukuk and how to regulate a
  Sukuk issue in Pakistan
• Section 120 of the Companies Ordinance
• 120. Issue of securities and redeemable capital
  not based on interest.
• (1) A company may by public offer or, upon
  terms and conditions contained in an agreement in
  writing, issue to one or more scheduled banks,
  financial institutions or such other persons as
  are specified for the purpose by the Federal
  Government by notification in the official
  Gazette, either severally, jointly or through
  their syndicate, any instrument in the nature of
  redeemable capital in any or several forms in
  consideration of any funds, moneys or
  accommodations received or to be received by the
  company, whether in cash or in specie or against
  any promise, guarantee, undertaking or indemnity
  issued to or in favour of or for the benefit of
  the company

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DIFFERENT KINDS OF SUKUK

• Sukuk representing ownership in tangible assets
  (mostly based on Sale and Lease back or direct
  lease).
• Sukuk representing Usufructs or Services (based
  on sublease or sale of services).
• Sukuk representing equity share in a particular
  business or investment portfolio (based on
  Musharakah/ Mudarabah).
• Sukuk representing receivable or future goods
  (based on Murabaha or Salam or Istisna).

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BASIC SHARIAH RULES

• All the rules of original contract on the basis
  of which Sukuk are created should be applied.
• The issuer cannot guarantee the face value of the
  certificate for the holder except in case of
  negligence/misconduct.
• In Sukuk based on sale and lease back, the issuer
  can unilaterally undertake that he will purchase
  the asset after one year for a certain price.

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BASIC SHARIAH RULES (CONT..)

• Different types of reserves (e.g. profit
  equalization reserve) or takaful pool can be
  created.
• Only those Sukuk can be traded that represent
  proportionate ownership of tangible assets,
  usufructs or services.
• Trading or redemption of Sukuk is allowed after
  closing subscription, allotment of Sukuk and
  commencement of activity.
• Sukuk of usufructs can be traded before the
  assets are sub-leased.
• Sukuk of services can be traded prior to passing
  the services to the user.
• In Sukuk of Musharakah/Mudarabah, the issuer can
  redeem the certificates on the market price or
  the mutually agreed price.

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TRADABILITY OF SUKUK

• Tradable Sukuk
• Sukuk representing tangible assets or
  proportionate ownership of a business or
  investment portfolio are tradable. For e.g. Sukuk
  of Ijarah or Musharakah / Mudarabah
• Non-Tradable Sukuk
• Sukuk representing receivables of cash or goods
  are nontradable. For e.g. Sukuk of Salam or
  Murabaha

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Legal Nature of Sukuk

• Is it a debenture? or
• Its a stock/share? or something else?
• to ascertain we need to know what is debenture
  and what is stock/share.
• Debenture is not defined as a word in the
  Companies Ordinance or any other law but as per
  company law it includes debenture stock, bonds,
  term finance certificate and any other
  securities, other than a share, of a company,
  whether constituting a charge of the assets of
  the company or not
• share means a share in the share capital of a
  company (S.2 (1) 35 of the Companies Ordinance)
• Sukuk is neither equity nor debenture or bond or
  a debt instrument

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Asset Backed Securitization Rules

• These Rules provide mechanism for securitization
  and define securitization as
• The Sukuk does not fall in the definition of
  actionable claim or receivables therefore Sukuk
  can not be issued under these Rules

"Securitization" means a process whereby any
Special Purpose Vehicle raises funds by issue of
Term Finance Certificates or any other
instruments with the approval of the Commission,
for such purpose and uses such funds by making
payment to the Originator and through such
process acquires the title, property or right in
the receivables or other assets in the form of
actionable claims
38
Nature of Sukuk

• As discussed Sukuk is a security of its own kind,
  not provided by any law in Pakistan.
• We may classify it as redeemable capital

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How to Issue Sukuk

• Presently most of the Sukuk are issued under
  private placement which does not require any
  regulatory compliance
• Companies are issuing privately placed Sukuk when
  they get syndicate financing from financial
  institutions to meet their financing requirements
• Most of the Sukuk are based on Ijarah
• These Sukuk are being issued under S. 120 of the
  Companies Ordinance through an agreement between
  the issuer and the financial institutions

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How to Issue Sukuk to Public?

• There is no specific provision in Pakistani law
  for Sukuk therefore we will resort to some
  provisions of the Companies Ordinance that govern
  issue of securities, debentures and redeemable
  capital
• Again the Sukuk will be issued under S. 120 of
  the Companies Ordinance.
• However, for guidance on public issue we will
  look at the guide lines issued for Term Finance
  Certificates (TFCs)

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PUBLIC ISSUE OF SUKUK

• Once we consider that Sukuk is a security in the
  form of redeemable capital then we can issue
  Sukuk public through circulating and publishing
  prospectus under section 57 of the Companies
  Ordinance,1984
• An independent trustee shall be appointed and the
  assets will be transferred in the name of the
  trustee who will hold the same for the benefit of
  the investors/Sukuk holders
• For issuing Sukuk general public a company will
  file an application to SECP

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Approval from SECP

• i) In case of a new project, Expansion or
  Balancing, Modernization Replacement (BMR), a
  feasibility study should be conducted and a
  report should be prepared.
• ii) Pre-IPO placement of should be finalized.
• iii) Underwriting arrangements, if any, should be
  completed.
• iv) Credit rating of the entity as well as the
  instrument from any rating agency should be
  carried out.
• v) Trustee, Bankers to the Issue, Balloters,
  Registrar (Transfer Agent) and Legal Adviser to
  the Issue should be appointed.
• vi) Clearance of the prospectus from the
  concerned stock exchange(s) should be obtained.
• vii) Auditors certificates as to profit and loss
  and dividend or returns on securities issued in
  previous 5 years

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JAZAKUMULLAH KHAIR AND THANK YOU
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Contact

• Sibghatullah Ahsan
• Advocate High Court
• MIAN SIBGHAT Advocates Legal Consultants
• Off. 102-A, 1st Floor, Azeem Mansion,
• Block 87-E, Fazal-e-Haq Road, Blue Area
• Islamabad.
• Ph. 92-51-4309208, 4319884
• Fax. [phone]
• Email. mslaw.pk_at_gmail.com