Islamic Bond @ Sukuk in Practicality

INTRODUCTION

The 1970s saw a global movement towards commercialization of the Islamic banking system, spanning countries from the Middle East to South Asia. But growth over the next 10 years was at a snail’s pace given the lack of proponents, and competition with the fast-paced conventional banking system. But today, Islamic financing service (IFS) products had achieving it upward turn in global market, where demand for financial products that comply with Sharia law is growing fast, not just among the world’s 1.2 billion but also among non-Muslim.

Islamic bond is one of the well established Islamic financial products that had been given high rank to compete with conventional bond, as German state of Saxony-Anhalt has just sold Europe’s debut Islamic bond to fulfill current market demand. In this paper report, Malaysian Islamic bond will be use as the focus example to be discuss on, to make it easier to understand and to give more clear view regarding Islamic bond issues.

In fact, Malaysian Islamic financing and banking system is one of the best in the world as compared other Muslim countries systems and Malaysia had proposed giving the fledgling market another helping hand by floating the idea of an Islamic universal bond. In order to give general knowledge and to provide guideline will see first some of the important elements that are applied by the system as the fulfillment of Shariah command.

Implementation of Islamic Shariah in Islamic Bond

In Islamic finance, any income generated through interest payment via lending or credit activities is not recognised as it is pure riba' (usury). At the beginning of the system, a condition was made that before a debt can be sold or negotiated, there must be an underlying contract of sale and purchase involving real tangible assets at the beginning of the process. This transaction normally contains a delayed payment element in it so that a debt is created.

This is the debt that will later become the focus of the intended securitisation. It is more likely that another concept, bai’ al-inah, is also used in creating debt security. Bai’ al-inah allows sale and buy-back transactions so that an earlier sale of assets would produce a cheaper price compared to the price tag for the subsequent sale.

For example, as a result the first buyer, normally a financier, would pay in cash the purchase price of the asset, say RM100mil, and immediately sell the same asset to the first party, normally a customer, for RM210mil payable in installments for five years.

The whole process involves a number of inter-related transactions:

Normal sale and purchase contract (al-bai’), when the customer sold his assets to the financier in the first transaction the sale price was RM100mil.
Buy-back transaction that occurred immediately after the first transaction, which cost RM210mil.
The buy-back and normal sale areknown together as Bai’ al-inah.
The payment for the buy-back transaction is delayed through the instalment mechanism known in Islam as bithaman ajil or deferred payment.
The debt as owed by the customer as a result of the buy-back transaction will then be sold as securities accompanied by a certificate or note.
When this debt is sold as securities another concept is used – bai’ al-dayn or sale of debt.
As seen from the above, there is a fine distinction between a conventional bond and an Islamic security. In the conventional sense, a bond is a debt instrument whereby the issuer will pay a certain percentage of interest to the buyer of the issued bond, or if it is a zero coupon bond, it will be issued at discount and repaid in full at maturity. Bond holders will receive the proceeds in the form of interest. In contrast, the debt created in the Islamic transaction is an unpaid purchase price owed by the customer to the financer. Such a debt is not a result of a money-lending process as there was no such activity. Moneylending is known in Islamic finance as al-Qard. The Malaysian Global Sukuk, although containing an element of floating rate, it is not being a debt-based security. It used ijarah (leasing of physical assets) as an underlying transaction.

Some other key elements that exist are:

Al-Bai Bithaman Ajil - Financing with deferred repayments over a specific period of time.
Al-Mudharabah - An agreement to provide the capital by one party and management expertise by the other party. Any losses suffered in the venture will be born by the provider of the capital.
Al-Murabahah - Financing with a repayment agreed by both parties that include the profit mark up.
Al-Qardhul Hassan - Benevolent loan, where the provider of capital is guaranteed at least the principal portion.
These are only some of the elements that would be able to discuses here. Basically, the elements that had been given are the key terms that should generally known by commoners. The review of legal and tax regulatory aspects should come hand in hand with continuous research and development in the product development.

Islamic Bond in Real Market

Globally, there are some 260 Islamic institutions, mainly banks, in 76 countries and they handled close to US$200 billion in the system, with the market growing by 12% to 15% annually. With the infrastructure for internationally thriving sector in place, cross border financial activities are taking place in offshore centers like Bahrain and Labuan, with countries like Malaysia and Qatar offering Sukuk (sovereign Islamic bonds). Inter-governmental organizations like Islamic development Bank have also issued Sukuk.

In the United Kingdom, the laws have been charged so that those offering Islamic mortgage finance do not pay double stamp duty. The system may open up into Europe, where there are large Muslim populations in countries like France - or even China.

Reflective of the global aspirations and standing of Malaysia, the Islamic Financial Services Board (IFSB) was established in Kuala Lumpur in March 2003 to develop more suitable regulatory and prudential supervisory standards for the IFS globally.

In Malaysia, there is up to RM77.4 billion Islamic corporate and bond had been issued and rated by financing concept as at December 2003 in the domestic market. Finance under Bai Bithaman Ajil concept contributed the largest portion of transaction with 58% from total value, followed by Murabahah, 25%.

Issues Rise

Crisis of Islamic Bond System

Muslims have different understanding of Islamic law and regulation that would be practice in many fields including financial systems or specifically Islamic Bond System. Because of this reason, there is no such real worldwide established Islamic Bond that could fix all Muslims’ belief ness even the one that just issued by Malaysian financial system; world best financial system builder. Not all Muslims’ countries given their full support to these new Islamic products, compared to conventional bonds that had been widely supported all over the world including among Muslims. Islamic bonds somehow, got a small portion of international market with a minor injection by western countries, like England, Germany and America. Muslims’ countries did not put much effort on building its united and strong Islamic financial products which should be at least dominating Muslims market.

Disqualified Company to Invest

With better systems that keep on develop by Muslims’ economists; Islamic bonds might be able to attract buyers to inject big amount or major amount of money capital worldwide. But there are doubts about the suitable track to flow the money on companies with good track records that will lead the economic growth of each industry and on those that will be able to sustain high earnings growth. In addition, there are also difficulties to find well performed companies with cleans from interest base systems nowadays.

Conclusion

As senior fellow with the Institute of Islamic Understanding Malaysia (IKIM), Mazilan Musa, said “The differences are a minor disagreement and not a fundamental one. Malaysia has taken the path that Islamic banking products are permissible if there is no evidence to suggest otherwise”

As such, harmonizing Shariah opinions is not only a great challenge, but is necessary for the global IFS to reach a higher plain. Observers say Malaysia is already seen as a leader in the in the IfS globally, and the country, as the new head of the Organization of Islamic Conference, could try to utilize the goodwill at the political level to push the IFS forward.