The kingdom of Saudi Arabia has issued Islamic bonds (Sukuk) worth $9 billion within six months after the world's biggest oil exporting country tapped global debt markets for the first time by selling $17.5 billion in conventional bonds.
Half of the new Islamic bonds will be repaid in five years, while the remainder will mature in 10 years.
The effort to raise funds from global investors follows a crash in oil prices that turned the kingdom's massive budget surplus into a gaping hole. Just five years ago it was unthinkable that oil-rich Saudi Arabia would need to borrow money from abroad.
Saudi Arabia said in December 2016 that its budget deficit for this year will reach 198 billion riyals ($53 billion), or 7.7% of its GDP. It planned to narrow the gap by issuing debt and tapping its foreign reserves.
The government had received bids worth $33 billion for the new debt. The bonds, known as "sukuk," comply with Shariah or Islamic principles which doesn't allow the payment of interest."The bond will help alleviate pressure on foreign reserves and deepen the bond issuance program of Saudi Arabia."
Last year, the Saudi government revealed a plan, called Vision 2030, to diversify its economy. It also announced a fiscal balance program set to be carried out over three years. The government warned of dire consequences if it did not press on with dramatic austerity measures, including cutting more gas subsides and increasing taxes.
The dollar sukuk, with a coupon of 2.894 percent for the five-year paper and 3.628 percent for the 10-year tranche, is the largest-ever Islamic bond and the largest emerging markets debt sale this year, beating Kuwait's $8 billion conventional bond in March 2017.
The Sukuk is based on hybrid structure, which replicates the riyal-denominated sukuk offer launched by oil giant Saudi Aramco earlier this month. This is common in the Saudi local currency debt market. A different lease-based (ijara) sukuk structure has been the most commonly used by countries raising money via international debt issuances.
A hybrid structure might be too complex for some international investors to the point of possibly testing their appetite for the deal, bankers told Reuters last week. An amount equal to 51 percent of the bond proceeds will be used in a mudaraba agreement, a form of Islamic investment management partnership. The remaining 49 percent of the proceeds will be used under a murabaha facility by the trustee, a Cayman Islands-incorporated company called KSA Sukuk Limited, to purchase sharia-compliant commodities, the prospectus says.
In designing hybrid structure it needs to be ensured that more than 51% of its portion must come from non debt based financiang i.e Musharakah, Mudarbah or Ijarah. Remaining 49% can be brought from debt based financing i.e Muhabah, Salam, Istisna. This combination makes the Sukuk tradable.
In an ijarah financing system, which can be used to issue a sukuk-al-ijarah to investors, the SPV (lessor) leases to a particular company (lessee) and this company utilizes the assets in its production The lessor SPV receives a periodic payment by the lessee company and the lessor provides a portion of the payment to the suppliers. The certificate holders also receive a portion of the proceeds as a predetermined return on investment. The sum of the periodic rental payments from which the return is secured is agreed between both parties, which are the lessor SPV and the lessee company; this is why the certificate is capable of giving its holder a predetermined rate on investment. However, the return on investment is low, because the sukuk al-ijarah fund is a low risk fund with a minimum risk of capital loss.
Musharakah Sukuk are issued in the market for the mobilization of funds, so as to facilitate the establishment of new projects, make improvements in existing projects and finance the activities of business (with certificate holders as owners). These are documents with equal value, which are considered to be negotiable instruments that can be traded in secondary markets. Under this mechanism, the originator and SPV participate to form an agreement which is based on a specific period (5 to 7 years) and a pre-defined profit-sharing ratio. Musharakah shares are purchased by the corporation at regular intervals from the SPV. The corporation contributes its assets to the agreement and sukuk proceeds are contributed by the SPV. The corporation acts as the key agent for the development of land with the funds available from the musharakah, so as to sell them on obtaining fixed amount of fees and a variable incentive fee. Profits obtained from this mechanism are disseminated among the sukuk holders. In a musharakah, by the end of the specified period, there are no shares with SPV.
Mudarabah Sukuk as described by the AAOIFI refers to a certificate issued in the holder's name and represents the units owned by the holder in the mudarabah equity. The holders of the certificate are known as Rabbul Maal and the returns of shares in the mudarabah equity depend upon the ownership of shares. A formal conclusion of a legally created mudarabah contract forms the basis of the mudarabah sukuk. It includes the labor and capital provided by both parties, while the division of profit between the parties is predefined. The mudarabah sukuk enable their holder to obtain his capital, as and when the sukuk are submitted, and also to collect a fixed proportion of profits declared in the issuance publication. The prime purpose of issuing sukuk is to provide monetary support to a finance-generating project or any activity distinct from the general business activities. The profit generated from these separate business activities is distributed according to the agreed percentage. The contract may specify the proportion of the company's earnings that are to be given to the sukuk holders in order to return their investments in installments.
Trading of sukuk involving the transfer of mudarabah capital in terms of money should be in accordance with the rules of exchange of money (Sarf). If the mudarabah capital is in the form of debt, the transfer should be in accordance with the principles of Islamic debt trading. If the mudarabah capital is in the form of money, debt, benefits or assets, trade should be conducted according to the market price determined by mutual consent.
Murabaha Sukuk is circulated in the market for the mobilization of funds, so as to facilitate the trading of products (with certificate holders as owners). These are certificates with equal value, whose issuer is a supplier to the murabaha community. The key subscribers are the purchasers of the offered financial product. The sukuk holders possess the right to the selling price of the murabaha commodity. A non-negotiable monetary debt receivable symbolizes the murabaha sukuk, which has to be obtained from the client at the murabaha price. The SPV and borrower enter into a contract on mutual agreement. Sukuk are issued by the SPV to investors on receiving the proceeds. The SPV purchases a murabaha commodity from the supplier on the basis of the options available on the spot. The SPV sells the commodity to the purchaser for the spot price and a profit margin, which can be paid in the form of instalments. Investors obtain profits by recovering the selling price.
Salam Sukuks are circulated in the market for the mobilization of funds, so as to deliver the goods (with certificate holders as owners). These are certificates with equal value, whose issuer is the supplier of goods (covered under salam). Key subscribers are purchasers of the offered goods. The funds gained from the subscribed contribution of goods are recognized as its cost (salam capital). The certificate holders possess the right to the selling price of the salam goods. Despite this, it is non-tradable and is recognized as a receivable. Shariah obligations of salam such as quality, quantity, place of asset deliverance are applicable to salam sukuk. Prior to maturity, the purchased goods are not sold off again. These transactions have a relative magnitude that is equal to exchange of debt, which makes them less appealing to investors. Therefore, they are purchased by an investor in the case where the estimated price of a commodity is expected to reach a higher level by the time of maturity. In order to source the purchases and commodity, the SPV guarantees the agreement with an originator. On the part of the sukuk holders, the originator purchases the commodity and resells it in order to make a profit from the investment. SPV obtains the proceeds of the sukuk and provides them to the investors. The proceeds are handed over to the originator, who is responsible for selling the commodity by using a forward contract. The commodities are received by the SPV from the originator. The originator resells the commodities in order to make a profit. The sales proceeds from the commodity are received by the sukuk holders.
Istisna Sukuk is circulated in the market for the mobilization of funds, so as to produce products (with certificate holders as owners). These are certificates with equal value, whose issuer is the supplier. The key subscribers are the purchasers of the offered financial product, and the funds gained from the subscribed contribution are recognized as its cost. The certificate holders possess the right to the selling price of the Istisna certificates. It is an important financial tool for managing the financing arrangements of large infrastructure projects. It facilitates financial intermediation on the basis of giving permission to the contractor for participation in another Istisna contract. Therefore, financial institutions can opt for guaranteeing a contract on a deferred price by subcontracting the authentic structure to a specified firm.
To combine non-debt based financing and debt based financing hybrid sukuk or mixed-assets sukuk have been introduced in the market. The inherent combination of assets considered in the hybrid sukuk can include receivables based on murabaha, ijarah and istisna financing options. Hybrid sukuk are comprised of a set of assets taken from different categories, which should include at least 51% of the tradable assets. The first hybrid sukuk were issued by the Islamic Development Bank (IDB) in 2009, and were comprised of a set of assets (Ijarah contracts 65.8%, Murabaha receivables 30.73%, and Istisna 3.4%).
In Saudi Arabai sukuk market is new and immature; the first issuance of sukuk was in 2004 on behalf of HANCO Rent-A-Car. The product was named the Caravan sukuk, and structured on an ijarah basis for three years. The researcher believes that this delay in the issuance of sukuk in the KSA was due to the lack of an independent body governing the issuance of securities.
In 2003, the Saudi government established the Capital Market Authority (CMA) as a separate regulatory body under Article 4 of the CML in accordance with Royal Decree No. (M/30) dated 2 July 2003 to regulate and develop capital market activities in Saudi Arabia. Although there is no specific framework for the issuance of sukuk in Saudi Arabia, the CMA regulates and monitors the issuance of sukuk side-by-side with the issuance of shares and debt instruments under the CMA Listing Rules and the CMA Offer of Securities Regulations. Therefore, the Listing Rules and the Offer of Securities Regulations are the regulatory measures that control the issuance of sukuk in Saudi Arabia. The researchers find that all Saudi securities laws and regulations, such as the CML, Listing Rules and the Offer of Securities Regulations do not mention Islamic law (Shariah) or Islamic bonds (sukuk) in their articles even though Article 1 of the Basic Law of Governance in Saudi Arabia stipulates that the Constitution of the Kingdom of Saudi Arabia is the Holy Quran and the Sunnah.
Despite 15 sukuk issuances from 2000 to 2008 and huge Islamic mutual funds in Saudi Arabia, there is no single piece of legislation specifically regulating the implementation of Islamic sukuk in the KSA. Therefore, there remain some regulatory difficulties between the CMA and the Ministry of Commerce and Industry concerning the issuance of sukuk. This is due to the fact that the Offers of Securities Regulations do not refer specifically to sukuk, and therefore they must be defined as debt instruments even though Shariah compliant sukuk do not create a debt obligation on the issuer.
It is clear that the issuance of sukuk in Saudi Arabia is suffering from heavy regulation and supervision drawbacks, which need to be identified in order to resolve the problems of regulation and insufficiency of supervision. It can be concluded that the issuance of Sukuk in Saudi Arabia is not being regulated, issued or operationalised from within a framework that takes account of the nature of sukuk as distinct from conventional debt instruments, which means that sukuk in Saudi Arabia are issued as debt instruments.
Mufti Taqi Usmani has argued that most of the sukuk, especially those with a musharaka or mudaraba structure, are not lawful from a Shariah perspective because the assets in the sukuk may be shares of companies that do not confer true ownership but which merely offer sukuk holders a right to returns.
Currently, there is no independent central Shariah board to regulate and supervise Islamic banking activities and also to appoint a Shariah Committee like the Shariah Advisory Boards in other countries. This absence of a central Shariah supervisory board raises the probability of conflict in opinions (fatwas) between Islamic scholars about the issuance of sukuk in Saudi Arabia. These differing opinions between Islamic scholars may result in significant damage to the issuer of sukuk in addition to a loss of confidence among investors.