1
PERPETUAL SUKUK: A PRELIMINARY SHARIAH ASSESMENT
BY
MUHD RAMADHAN FITRI ELLIAS* MUHAMAD NASIR HARON
**
AHMAD FIRDAUS KADIR***
NUR HIDAYAH SALIM****
1.0 INTRODUCTION
Perpetual sukuk (“Perpetual Sukuk”) is among the latest innovative structures in the market.
The development of this instrument has been driven by its commercial advantages as well as
new regulatory requirements particularly in the financial sector. It is called Perpetual Sukuk
because of its distinctive features compared to normal sukuk where as it carries no maturity
date and treated as equity (from an accounting standpoint) rather than debt. While this
innovation is commendable, it deserves Shariah observation on some of structural and
operational issues of the Sukuk. This brief paper would attempt to analyse such issues and
highlight justifications provided by the respective Shariah advisers in approving the Sukuk
structure. The paper begins with an overview of perpetual Sukuk, its common features and
basic requirements and in respect of additional tier 1 capital instruments by financial
institutions, specific requirements according to Basel III. Subsequently, the study will
illustrate several current structures of perpetual Sukuk issued in Malaysia, namely Malaysia
Airline System Berhad’s Perpetual Junior Sukuk (2012) and Malaysia Airports Holdings
Berhad’s Perpetual Subordinated Sukuk (2014) and global, namely Abu Dhabi Islamic Bank
PJSC’s Additional Tier 1 Capital Securities (2012). Finally, the paper will highlight on
potential Shariah issues that might arise and discuss it from Shariah perspective. The
discussion and analyses of most of the issues in this paper, however, are neither conclusive
nor exhaustive.
This paper is presented for the Shariah Forum, Kuala Lumpur Islamic Finance Forum (KLIFF), 3 December
2015, The Royal Chulan Hotel, Kuala Lumpur. Views expressed in this paper do not necessarily represent
the views of the respective organisations of the authors.
* Muhd Ramadhan Fitri Ellias is Executive Vice President & Head of Shariah Management at Maybank
Islamic Berhad, Malaysia. He can be contacted at [email protected]. **
Muhamad Nasir Haron is Researcher of Shariah Management at Maybank Islamic Berhad, Malaysia. He
can be contacted at [email protected]. ***
Ahmad Firdaus Kadir is Researcher of Shariah Management at Maybank Islamic Berhad, Malaysia. He can
be contacted at [email protected]. ****
Nur Hidayah Salim is Manager of Corporate Investment Banking at Maybank Islamic Berhad, Malaysia.
She can be contacted at [email protected].
2
2.0 OVERVIEW OF PERPETUAL SUKUK
Perpetual Sukuk are commonly defined as hybrid Sukuk which have features of both debt
and equity capital.1 Perpetual Sukuk have the features of “permanence” and “loss absorption”
which means the Sukuk carry a perpetual legal tenure and subordinated to debt and other
liabilities of the issuer of such Perpetual Sukuk. Perpetual Sukuk are innovative form of debt
instruments (from a legal standpoint) with equity-like features that typically ranks senior only
to common equity.2
Key strategic benefits and flexibility of Perpetual Sukuk include:
Perpetual Sukuk serve as a unique balance sheet management tool which is cost effective
as they are priced as a subordinated debt yet deemed as equity for accounting purposes
Non-dilutive way of shoring up capital i.e. no adverse effect of shareholder dilution
Longer term funding compared to straight or “plain vanilla” Sukuk.
Help to enhance issuer’s credit profile due to increased financial flexibility and efficient
capital management.
From an investor’s point of view, Perpetual Sukuk offer attractive risk and return profile
compared to senior Sukuk.
3.0 SALIENT FEATURES OF PERPETUAL SUKUK
In this section, the paper will explain salient features of perpetual Sukuk for a better
understanding. In this manner, the features of perpetual Sukuk are distinguished between
issuance by the corporate entity or Islamic financial institutions which will carry different
features respectively as the following;
3.1 Common Salient Features of Perpetual Sukuk Issued By Corporate Issuers:3
(a) Ranking – subordination:
Perpetual Sukuk are contractually subordinated to the claims of external creditors. Upon
liquidation of the issuer, the outstanding amount of the Perpetual Sukuk would rank as
1 Thesis titled “A Valuation Framework for Pricing Hybrid Bonds” University of St. Gallen (HSG) Graduate School
of Business, Economics, Law and Social Sciences dated 31 December 2010 http://www.unisg.ch/~/~/media/7187EDAFFDF54BDEB7463364E6AA9800.ashx 2 Ibid.
3 Ibid.
3
junior to a straight debt obligation but senior to the issuer’s ordinary shares and typically
preference shares too.
(b) Permanence – Perpetual:
Perpetual tenure is required for accounting equity treatment.
(c) Call Option:
In order to preserve the equity-like characteristics of a hybrid instrument, the issuer has a
call option, but not the investor. Perpetual Sukuk carry right or option, but not obligation,
of the issuer to redeem the perpetual Sukuk after the expiration of an initial non-call
protection period (i.e. first call date). Rating agencies’ typically require the call date of
Perpetual Sukuk to be no shorter than 5 years from the issue date of the Perpetual Sukuk.
(d) Step up Profit:
Similar to straight Sukuk, Perpetual Sukuk initially pay a fixed profit rate, however after
the first call date Perpetual Sukuk commonly include a step-up profit feature where the
prevailing profit rate will be revised to include a post-call spread in order to incentivize
the issuer to exercise the Call Option at the first call date. In addition, some Perpetual
Sukuk also contain provisions on change of control to ensure continuity of the controlling
shareholders or leverage event whereby in the event of change of ownership of the Issuer
or change of leverage ratio, a profit step-up shall apply.
(e) Profit Deferral:
The issuer must have the ability to defer profit without being in default for the Perpetual
Sukuk to be recognised as equity under accounting standards. In this manner, the
Perpetual Sukuk carry similar characteristic like equity where it absorb loses before other
creditors when issuer’s financial condition deteriorates.
Different variations of the right to profit deferral can be distinguished: optional vs.
mandatory deferral and also cumulative (i.e. deferred profit accrues) vs. non-cumulative
(i.e. missed profit payments are forgone).
4
(f) Capitalisation of Deferred Profit:
Some Perpetual Sukuk also pay additional profit on the outstanding deferred profit. Each
amount of the deferred profit shall itself be entitled to profit as if it constituted the
nominal value of the Perpetual Sukuk at the prevailing profit rate, as long as such amount
of deferred profit remains outstanding.
(g) Dividend & Capital Stopper:
As protection to investors of the Perpetual Sukuk, should the Issuer opt to defer
distribution of profit of the Perpetual Sukuk, the issuer is not permitted to distribute
dividends or capital distributions to its shareholders.
(h) Loss Absorbing:
The Perpetual Sukuk are intended to provide protection for senior and other creditors and
to provide a capital cushion to absorb unexpected potential losses arising from the
Issuer’s operations.
(i) Replacement Capital Covenant:
The issuer may be required by rating agencies to commit to issuance of replacement
securities of equivalent or lower ranking in order to redeem the Perpetual Sukuk to
maintain an appropriate level of permanency on its balance sheet. The replacement capital
covenant clause is included in some Perpetual Sukuk where the issuer can only redeem
using proceeds from issuance of another hybrid or more subordinated instrument.
3.2 Common Salient Features of Perpetual Sukuk Issued By Islamic Banks:4
Perpetual Sukuk are issued by Islamic banks to shore up Tier-1 capital. An instrument shall
qualify as an Additional Tier 1 capital instrument of an Islamic bank in Malaysia if it meets
all the following criteria as set out in the Capital Adequacy Framework for Islamic Banks
issued by Bank Negara Malaysia (“CAFIB”):
(a) the instrument is issued and paid-up;
(b) the instrument is subordinated to depositors, general creditors and other holders of
subordinated debt of the financial institution;
4http://www.bnm.gov.my/guidelines/01_banking/01_capital_adequacy/gl_12_capital_adequacy_framework_i
slamic_capital_components.pdf
5
(c) the instrument is neither secured nor covered by a guarantee of the financial institution or
an affiliated entity or other arrangement that legally or economically enhances the
seniority of the claim vis-à-vis depositors, general creditors and other holders of
subordinated debt of the financial institution;
(d) the instrument is perpetual, and shall therefore not have a maturity date, step-up features
or other incentives for the financial institution to redeem the instrument;
(e) the instrument may be callable at the initiative of the financial institution only after a
minimum of five years, subject to amongst others, exercise of a call option must receive
written approval of Bank Negara Malaysia
(f) any repayment of principal, other than through the exercise of a call option, (e.g. through
repurchase) must be with the prior written approval of Bank Negara Malaysia and the
financial institution shall not assume or create market expectations that approval will be
given;
(g) dividends/coupons must be paid out of distributable items, and such distributions must
meet certain condition including distributions/payments shall be at the full discretion of
the financial institution at all times and cancellation of discretionary payments must not
constitute an event of default;
(h) the instrument cannot have a credit sensitive dividend feature, that is a dividend/coupon
that is reset periodically based in whole or in part on the credit standing of the financial
institution or any of its affiliated entities;
(i) the instrument cannot contribute to liabilities exceeding assets if such a balance sheet test
forms part of national insolvency law governing the provisions of the instrument;
(j) the provisions governing the instrument require the instrument to be written-off, or the
instrument to be converted into ordinary shares, if the consolidated or entity level CET1
Capital Ratio of the financial institution falls below a pre-specified level
(k) the instrument cannot have any features that hinder recapitalisation, such as provisions
that require the financial institution to compensate investors if a new instrument is issued
at a lower price during a specified time frame;
(l) if the instrument is issued out of a special purpose vehicle (SPV), proceeds must be
immediately available without limitation to the financial institution in a form which meets
or exceeds all of the other criteria for inclusion in Additional Tier 1 Capital;
(m) the provisions governing the issuance of the capital instrument require the instrument to
be written-off, or the instrument to be converted into ordinary shares upon the occurrence
6
of a trigger event, which shall be determined by the requirements detailed out in the
CAFIB;
(n) the purchase of the instruments is not directly or indirectly funded by the financial
institution;
(o) the instrument is not purchased by the financial institution or its affiliated party over
which it exercises control or significant influence; and
(p) the instrument issued shall be structured using unrestricted non-exchange-based contracts
(e.g. Musharakah, Mudarabah, or Wakalah), in addition to meeting other Shariah
requirements.
The following qualifying criteria for inclusion in Additional Tier 1 capital of an Islamic bank
under Basel-III requirement differentiate an additional Tier 1 capital instrument to Perpetual
Sukuk issued by other corporate issuers:5
(a) No Step-up Profit
Additional Tier-I instruments must not have step-ups or other incentives to redeem. Other
incentives to redeem include a call option combined with a requirement or an investor
option to convert the instrument into shares if the call is not exercised.
(b) Redemption subject to regulatory approvals
Any payment of principal, either through repurchase or redemption or exercise of call
option, must be with prior regulatory/supervisory approval and Islamic banks should not
assume or create market expectations that regulatory/supervisory approval will be given.
(c) Write-off or conversion mechanisms for achieving principal loss absorption and/or loss
absorbency at the point of non-viability
Principal loss absorption and/or loss absorbency through either (i) conversion to common
shares or (ii) a write-off mechanism which allocates losses to the instrument, subject to
the regulatory/supervisory requirements.
5 Basel III: A global regulatory framework for more resilient banks and banking systems (revised June 2011),
developed by the Basel Committee on Banking Supervision of the Bank for International Settlements (BIS) http://www.bis.org/publ/bcbs189.pdf
7
(d) Non-payment of profit
Distributions/payments shall be at the full discretion of the financial institution at all
times and as such any waived distributions/payments are non-cumulative i.e. are not
required to, and must not, be made up by the financial institution at a later date.
4.0 EXAMPLES OF SOME LANDMARK ISSUANCES
In this section, the paper will illustrate three (3) structures of perpetual Sukuk issued locally
and globally in which two of the perpetual Sukuk were issued in Malaysia, namely Malaysia
Airline System Berhad (MAS)’s Perpetual Junior Sukuk (2012) and Malaysia Airports
Holdings Berhad’ (MAHB)’s Perpetual Subordinated Sukuk (2014) and an Additional Tier 1
Capital Perpetual Sukuk issued by Abu Dhabi Islamic Bank (ADIB) which was issued in
2012. MAHB and MAS Perpetual Sukuk are based on Musharakah whilst ADIB Perpetual
Sukuk is based on Mudarabah. Though MAHB and MAS Perpetual Sukuk are based on
Musharakah, there are few differences between these two structures. The key difference is on
deferral of profit or Periodic Distribution where as in the MAHB, the deferred profit will be
capitalised and for MAS, the deferred profit will not be capitalised. ADIB Perpetual Sukuk,
on the other hand, is claimed to be the first Basel 3 compliant in the world. The detailed
structures are as follow:
8
4.1 STRUCTURE 1
Malaysia Airline System Berhad (“MAS”) Perpetual Junior Sukuk (“Perpetual Sukuk”) under
a Perpetual Junior Sukuk Programme of up to Malaysian ringgit 2,500.0 million in nominal
value.6
Musharakah Transaction
1 (a) MAS will identify its Shariah compliant Business which will be used as the
underlying asset for that particular Musharakah transaction.
1 (b)-(d)In respect of the issuance of the Perpetual Sukuk, the Sukukholders shall from time
to time, via the Trustee, form a Musharakah partnership with MAS to invest directly
into the Business (“Musharakah Venture”) identified for that particular tranche.
The Sukukholder(s) shall subscribe to Perpetual Sukuk issued by MAS where each
Perpetual Sukuk shall represent the respective Sukukholder’s undivided
proportionate interest in the relevant Musharakah Venture. The contribution of the
Sukukholder(s) to the Musharakah Venture is the proceeds raised from each tranche
of the Perpetual Sukuk (“Musharakah Capital”) while MAS will contribute the
Business into the Musharakah Venture. Simultaneously, MAS shall make a
declaration that it holds on trust a percentage of the interest in the Business for the
benefit of the Sukukholder(s) pursuant to the Musharakah Venture.
2 The Sukukholder(s) shall appoint MAS as the Manager to manage the Musharakah
Venture.
3 Pursuant to the Musharakah Sale Undertaking declared and issued by the Trustee
for and on behalf of the Sukukholder(s) to MAS, the Trustee (for and on behalf of
the Sukukholder(s)) undertakes to sell the Sukukholder(s)’s interest in the
Musharakah Venture to MAS at the relevant Exercise Price upon any redemption of
6 Source: Extracted from principal, term and conditions.
http://issuance.sc.com.my/uploads_issuance/MAS%20-%20PTC.pdf
Musharakah
Venture
Trustee
1a. Identifies Business
1c. Issues Sukuk
1b. Sukuk Proceeds/
Musharakah Capital
1d. Invests in Musharakah Venture
4. Musharakah Distribution Amount
3. Declares Musharakah Sale Undertaking
2. Appoints as Manager
MAS
(Issuer/ Manager)
Sukukholder(s)
9
the Perpetual Sukuk or any dissolution or winding up of the Issuer in accordance
with the terms set out herein.
4 The income from the relevant Musharakah Venture of up to the Musharakah
Distribution Amount shall be distributed semi-annually to the Sukukholder(s) of
that particular tranche of Perpetual Sukuk on each Periodic Distribution Date. Any
shortfall between the Musharakah Distribution Amount and the actual income
generated from the Musharakah Venture shall be paid by MAS as Advance Part
Payment. For avoidance of doubt, the Advance Part Payment will be set-off against
the relevant Exercise Price pursuant to the Musharakah Sale Undertaking.
Musharakah Distribution Amount channelled to purchase Commodities via
Musawamah Transaction
The Issuer may give, not less than five (5) business days before the relevant Periodic
Distribution Date, a notice in writing (“Musawamah Investment Notice”) to the
Trustee that part or all of the Musharakah Distribution Amount on such Periodic
Distribution Date will be invested in Commodities (“Musawamah Investment
Amount”) via a Musawamah Transaction.
4.2 STRUCTURE 2
Malaysia Airports Holdings Berhad (“MAHB”) Perpetual Subordinated Sukuk (“Sukuk
Musharakah”) pursuant to a Perpetual Subordinated Sukuk Programme (“Sukuk
Programme”) of up to RM2.5 Billion in Nominal Value.7
7 Source: Extracted from principal, term and conditions.
http://issuance.sc.com.my/MemberAccessIssuance/documents/download/1178/PTC
MusharakahVenture
Sukukholders
(represented by the Sukuk Trustee)
Purchase Undertaking
Identify Business
Proceeds (Musharakah Capital)
Issue Sukuk
2
4a
2
1
MAHB
(Issuer/ Managing Partner / Obligor)
4b Sale Undertaking
Income from Musharakah Venture 3
10
1. The Sukuk Trustee (on behalf of all the Sukukholders) and MAHB will enter into a
Master Musharakah Agreement under which, the parties as Musharakah partners may,
from time to time, enter into musharakah agreements (each a “Musharakah
Agreement”) for the purposes of undertaking the “Musharakah Venture” consisting of
Shariah-compliant investments in the airport operations business of the Issuer and/or its
subsidiaries which entails the collection of passenger service charge, landing and parking
fees, and other ancillary charges to airlines or part thereof identified and held on trust by
MAHB on behalf of the Sukukholders (“Business”). The Sukukholders (through the
Sukuk Trustee) shall appoint MAHB as the “Managing Partner” of each Musharakah
Venture.
2. The Sukukholders shall provide capital contribution to the Musharakah Venture through
subscription of the Sukuk Musharakah which will be issued by the Issuer and constituted
by the Trust Deed. MAHB shall contribute the Business, as a capital contribution in-kind
to the Musharakah Venture. Upon issuance of the Sukuk Musharakah, the Musharakah
Capital from the Sukukholders shall be invested with MAHB (in its capacity as
Managing Partner) for the purposes of undertaking the Musharakah Venture. The Sukuk
Musharakah comprise certificates representing the Sukukholders’ undivided beneficial
interest in the Musharakah Venture and any funds held by the Managing Partner on
account of the holders of the Sukuk Musharakah.
3. Income from the Musharakah Venture shall be distributed to each partner based on a
profit sharing ratio which will be determined prior to the issuance of the Sukuk
Musharakah. Any losses incurred in the Musharakah Venture shall be borne by each
partner in proportion to each partner’s respective capital contribution in the Musharakah
Venture. Each Musharakah Agreement will contain terms for the target periodic
distributions from that Musharakah Venture for each Distribution Period. Such target
periodic distribution shall be based on the Periodic Distribution Rate and shall be
referred to as the “Periodic Distribution Amount”.
As agreed by the Sukukholders, MAHB may at its sole discretion (unless a Compulsory
Periodic Distribution Payment Event has occurred) elect to make payment of all or some
of a Periodic Distribution Amount on the Periodic Distribution Date or elect to defer
such payment by giving notice (“Optional Deferral Notice”) to the Sukukholders at
least three (3) (but not more than fifteen (15)) Business Days prior to a Periodic
Distribution Date.
(A) Non Deferral
In the event that MAHB does not defer distributions of the Periodic Distribution
Amount:
(a) Venture Profits Equal to /in Excess of Periodic Distribution Amount
If the profits generated from the Musharakah Venture (“Profits”) are equal to or in
excess of the Periodic Distribution Amount, (i) Profits up to the Periodic
Distribution Amount will be distributed to the Sukukholders; and (ii) any excess
Profit thereafter will be retained by the Managing Partner in the “Reserve Account”
on behalf of the Sukukholders on a custody basis. If, on the dissolution of the
11
Musharakah Venture, there are any positive balances in the Reserve Account, the net
excess amount will be paid to the Managing Partner as an incentive payment.
(b) Venture Profits Less than Periodic Distribution Amount
If the Profits are insufficient to pay the Periodic Distribution Amount the Managing
Partner (i) shall utilise any amount available in the Reserve Account to cover the
shortfall between such Periodic Distribution Amount and the Profits and (ii) may at
its sole discretion provide a Shariah-compliant liquidity facility whereby it shall
advance to the Sukuk Trustee (on behalf of the Sukukholders) an amount sufficient
to make up the shortfall between the Periodic Distribution Amount and the Profits
(adjusted accordingly pursuant to any utilisation of the Reserve Account as referred
to in (i) above, if applicable), in order to enable MAHB as the Issuer to make
payment of the said Periodic Distribution Amount. The Managing Partner shall be
entitled to deduct from the Reserve Account any amount advanced under such
liquidity facility at a later date. Alternatively, such amounts advanced by the
Managing Partner will be repaid to the Managing Partner upon redemption of the
Sukuk Musharakah in full.
(B) Deferral
In the event that MAHB intends to defer distribution of any part or all of the Periodic
Distribution Amount, and provided the Issuer has given notice of such deferment:
(a) Venture Profits Equal to /in Excess of Periodic Distribution Amount
If there has been sufficient Profits in the Musharakah Venture to satisfy the payment
of such part or all of the relevant Periodic Distribution Amount which would
otherwise become due and payable under the Sukuk Musharakah, under the Master
Musharakah Agreement, the Sukukholders irrevocably authorize the Managing
Partner to, in its sole discretion, reinvest all the Profits up to the value of such or all
Periodic Distribution Amount) being deferred into the Musharakah Venture as
additional capital from the Sukukholders (“Additional Capital”). Any excess of the
Profits above the Periodic Distribution Amount shall be retained by the Managing
Partner in the Reserve Account on behalf of the Sukukholders on a custody basis.
Any payment of such Additional Capital at a later date shall constitute payment of
Musharakah Capital to the Sukukholders (“Capital Payment”). Any Capital
Payment made by the Issuer shall be shared by the Sukukholders of all outstanding
Sukuk Musharakah on a pro-rata basis and the respective Sukukholders’ Musharakah
Capital shall be adjusted accordingly.
(b) Venture Profits Less than Periodic Distribution Amount
If the Profits are insufficient to pay any Periodic Distribution Amount or such part
thereof which has not been deferred and is therefore due and payable, the Managing
Partner (i) shall utilise any amount available in the Reserve Account to cover the
shortfall between such Periodic Distribution Amount which has not been deferred
and is therefore due and payable and the Profits and (ii) may at its sole discretion
12
provide a Shariah-compliant liquidity facility whereby it shall advance to the Sukuk
Trustee (on behalf of the Sukukholders) an amount sufficient to make up the
shortfall between any Periodic Distribution Amount which has not been deferred and
the Profits (adjusted accordingly pursuant to any utilisation of the Reserve Account
as referred to in (i) above, if applicable), in order to enable MAHB as the Issuer to
make payment of the said Periodic Distribution Amount which has not been
deferred. The Managing Partner shall be entitled to deduct from the Reserve
Account any amount advanced under such liquidity facility at a later date.
Alternatively, the Net Liquidity Facility will be repaid to the Managing Partner upon
redemption of the Sukuk Musharakah in full.
In the event the Profits are lower than the Periodic Distribution Amount deferred, the
Musharakah Venture shall be dissolved through an exercise of the Purchase
Undertaking (as described below), and the Exercise Price shall be applied towards
investment in a new Musharakah Venture. The accounting entries associated with
the dissolution of the Musharakah Venture and reinvestment into a new Musharakah
Venture shall be made in the books of the Managing Partner. For the avoidance of
doubt, a dissolution of the Musharakah Venture in this manner will not result in
redemption of the Sukuk Musharakah.
4a MAHB (in its capacity as the Obligor) will provide a Master Purchase Undertaking,
pursuant to which, on each dissolution date of a Musharakah Venture set out below, it
shall execute a transfer/sale agreement (“Transfer/Sale Agreement”) for the purchase of
the Sukukholders’ undivided beneficial interest in the Musharakah Venture at the
relevant Exercise Price.
MAHB will execute a power of attorney in favour of the Sukuk Trustee pursuant to
which the Sukuk Trustee is granted the authority to execute the Transfer/Sale Agreement
in the event of failure/refusal of MAHB to execute the Transfer/Sale Agreement pursuant
to the exercise of the Master Purchase Undertaking.
The purchase of the Sukukholders’ undivided beneficial interest in the Musharakah
Venture would dissolve the then outstanding Musharakah Venture.
The dissolution dates applicable to the Purchase Undertaking include:
(a) the date of Winding-up of MAHB; and
(b) the Periodic Distribution Date in respect of which MAHB has elected to defer
payment of all or part of the Periodic Distribution Amount payable on such
Periodic Distribution Date, where there is a shortfall of Profits (as defined in the
PTC).
4
b
.
The Sukuk Trustee (on behalf of the Sukukholders) will provide a Master Sale
Undertaking, pursuant to which the Issuer shall have the right to early redeem the Sukuk
Musharakah under:
(i) Redemption at the option of the Issuer;
(ii) Redemption for tax reasons;
(iii) Redemption upon a rating event;
(iv) Redemption for accounting reasons;
(v) Redemption for tax deductibility;
13
(vi) Redemption in the case of Minimal Outstanding Amount;
(vii) Redemption upon a Change of Control; and
(viii) Redemption upon a Revocation of License.
The Sukuk Trustee (on behalf of the Sukukholders) is required to execute the
Transfer/Sale Agreement for the sale to MAHB of the Sukukholders’ undivided
beneficial interest in the Musharakah Venture at the applicable Exercise Price.
MAHB will execute a power of attorney in favour of the Sukuk Trustee pursuant to
which the Sukuk Trustee is granted the authority to execute the Transfer/Sale Agreement
in the event of failure/refusal of MAHB to execute the Transfer/Sale Agreement pursuant
to the exercise of the Master Sale Undertaking.
4.3 STRUCTURE 3
Abu Dhabi Islamic Bank PJSC (‘‘ADIB’’) U.S.$1,000,000,000 Additional Tier 1
Capital Certificates issued by ADIB Capital Invest 1 Ltd.8
Payments by the Certificateholders and the Issuer
On Issue Date, the Certificateholders will pay the issue price in respect of the Certificates to
the Issuer. Pursuant to the Declaration of Trust, the Issuer, in its capacity as the Trustee, will
declare a trust, in favour of the Certificateholders, over the proceeds of the issuance of the
Certificates, any and all of its rights, title, benefits and interests under the Transaction
Documents and any and all amounts standing to the credit of the Transaction Account from
8Source: Extracted from Prospectus dated 14 November 2012.
http://www.londonstockexchange.com/specialist-issuers/islamic/4402r-2012-11-19.pdf
14
time to time. The Trustee will apply the proceeds of the issuance of the Certificates towards
the capital of the Mudaraba (the “Mudaraba Capital”) pursuant to the Mudaraba
Agreement. ADIB (as Mudareb) will invest the Mudaraba Capital in the business activities of
ADIB in accordance with an agreed Investment Plan prepared by the Mudareb.
Periodic payments by the Trustee
Unless a Non-Payment Event or a Non-Payment election has occurred, prior to each Periodic
Distribution Date, the Mudareb shall distribute the profit generated by the Mudaraba to both
the Issuer and the Mudareb in accordance with an agreed percentage split (90 percent to the
Issuer (as Rab-al-Maal) and 10 percent to the Mudareb). The Issuer shall apply its share of
the profit (if any) generated by the Mudaraba on each Periodic Distribution Date to pay the
Periodic Distribution Amount due to the Certificateholders on such date.
Payments of Mudaraba Profit by ADIB (as Mudareb) are at the sole discretion of ADIB (as
Mudareb) and may only be made in circumstances where ADIB will not be in breach of
certain conditions as a result of making such payment. The Mudareb shall not have any
obligation to make any subsequent payment in respect of such unpaid profit (whether from its
own cash resources, from the Mudaraba Reserve or otherwise).
Under the terms of the Mudaraba Agreement, the Mudareb shall be expressly entitled to
comingle its assets with the Mudaraba Assets.
Dissolution payments, redemption and variation by the Issuer and the Mudareb
The Certificates are the perpetual securities in respect of which there is no fixed redemption
date. Accordingly, the Mudaraba is a perpetual arrangement with no fixed end date.
Subject to certain conditions set out in Clause 7 of the Mudaraba Agreement, ADIB (as
Mudareb) may at its option liquidate the Mudaraba in whole, but not in part, on the basis of
an actual liquidation of the Mudaraba in the following circumstances:
(i) on the First Call Date or any Periodic Distribution Date after the First Call Date, by
giving not less than 30 nor more than 60 days’ prior notice to the Trustee; or
(ii) on any date on or after the Issue Date (whether or not a Periodic Distribution Date), by
giving not less than 30 nor more than 60 days’ prior notice to the Trustee:
(a) upon the occurrence of a Tax Event; or
(b) upon the occurrence of a capital Event.
The Trustee (but only upon the instructions of ADIB (acting in its sole discretion)) shall,
upon receipt of notice in accordance with paragraph (i) above redeem the Certificates, and
upon receipt of notice in accordance with paragraph (ii) above redeem all of, and not only
some of, the Certificates or vary the terms thereof, in each case by giving not less than 30 nor
more than 60 days’ prior notice to the Certificateholders, all as more particularly described in
the Conditions.
ADIB (as Mudareb) and the Trustee undertake in the Mudaraba Agreement, in circumstances
where the Certificates are required by ADIB to be varied upon occurrence of a Tax Event or a
Capital Event, to make such variations as necessary to ensure that the Certificates become or,
as appropriate, remain Qualifying Tier 1 instruments.
15
Extract of Condition 8 (Periodic Distribution Restrictions)9
“8.1 Non-Payment Event
Notwithstanding Condition 7.4 (Periodic Distributions), if any of the following events occurs
(each, a “Non Payment Event”), ADIB (as Mudareb) shall not pay Mudaraba Profit or Final
Mudaraba Profit on any Mudaraba Profit Distribution Date or Mudaraba End Date (as the
case may be), and as a result thereof the Trustee shall not pay Periodic Distribution Amounts
on the corresponding Periodic Distribution Date:…”
“8.2 Non-Payment Election
ADIB may in its sole discretion elect that Mudaraba Profit will not be paid to the Trustee( in
its capacity as Rab-al-Maal) on any Mudaraba Profit Distribution Date or that Final
Mudaraba Profit will not be paid to the Trustee (in its capacity as Rab-al-Maal) on any
Mudaraba End Date, and ADIB shall, in each case, instruct the Trustee not to make payment
of a Periodic Distribution Amount to Certificateholders on such Periodic Distribution Date
(as the case may be) not to make payment of any Outstanding Payments otherwise payable on
redemption or repayment of the Certificates (each a “ Non-Payment Election”)”
“8.3 Effect of Non-Payment Event or Non-Payment Election
If ADIB makes a Non-Payment Election or a Non-Payment Event
occurs,…Certificateholders shall have no claim in respect of any Periodic Distribution
Amount not paid as a result of either a Non-Payment Election or a Non-Payment Event and
any non-payment of Mudaraba Profit, Final Mudaraba Profit or a Periodic Distribution
Amount in such circumstance shall not constitute a Dissolution Event. ADIB shall not have
any obligation to make any subsequent payment in respect of any such unpaid profit…and the
Trustee shall not have any obligations to make any subsequent payment in respect of any
such Periodic Distribution Amounts.”
9 Ibid.
16
5.0 POTENTIAL SHARIAH ISSUES IN PERPETUAL SUKUK
In this section, the paper will elaborate several potential Shariah issues attached to Perpetual
Sukuk structures which require further Shariah deliberations. Since all Perpetual Sukuk that
have been issued in the market are based on equity-based contracts i.e., Mudarabah and
Musharakah, the discussion will be only confined to potential Shariah issues arising from
these contracts. This paper has identified several Shariah issues relating to Perpetual Sukuk
which are issue of non-maturity date, deferral of periodic distribution amount, capitalisation
of deferred periodic distribution amount, non-payment of profit, step-up and top-up rate,
conversion into shares in the case of non-viability and redemption of perpetual Sukuk.
Together with the issues, this section also highlights Shariah justifications offered by
respective Shariah advisers in endorsing the structure.
5.1 Perpetuity - No Maturity Date
Among the distinct criteria to ensure its accounting equity treatment, Perpetual Sukuk shall
have no maturity date and it may only be callable at the option of the issuer after a minimum
of say, five years. Hence, the study would be taking through several structures of Perpetual
Sukuk which have been issued by the ADIB, MAS and MAHB as reference
a) Requirement of Maturity Period for Mudarabah Contract
The scholars have a diverse opinions whether determining a specific period for Mudarabah
contract is a requirement from Shariah perspective.
Among others are the opinion of Al-Sharbini which has been mentioned in his book of
Mughni Al-Muhtaj as the following;
سكت أم الشراء فإن القراض المؤقت ال يصح سواء أمنع المالك العامل التصرف أم البيع كما مر أم
Indeed, the contract of Qiradh/Mudarabah which its specific period has been determined is
considered void (batil) even if the rabbul mal (investor) allowing the mudarib (entreprenuer)
to utilize the capital after the end of the period, or the investor allowing the mudarib to sell
the capital as per mentioned earlier or he (investor) just remain silent or allowing the
mudarib to buy something from the capital.10
According to Hanbalites School of law, the stipulation of specific period for Mudarabah
contract would lead the contract becomes null and void. It is because such determination of
10
Al-Sharbini, Muhammad Ibn Al-Khatib, Mughni Al-Muhtaj, (1997) Lubnan, Dar al-Ma`refah, Vol. 2, p. 402.
17
mudarabah period will violate nature of Mudarabah which is non-binding. This opinion has
been mentioned by Ibnu Qudamah as the following:
وال يصح ان يشترط ما ينافي مقتضى العقد نحو أن يشترط لزوم المضاربة أو ال يعزله مدة بعينها ...
Mudarabah contract is considered void if there is any imposition of specific conditions that
may violate the purpose of contract (muqtadha al-aqd) such as stipulation of condition that
made the contract binding or stipulation of condition of non-withdrawal of any contracting
parties from the venture within a specific period.11
On the other hand, according to the Hanafites jurists, it is permissible for any contracting
parties to specify a certain period for Mudarabah contract and the mudarabah venture will
automatically dissolved after the expiry of the term. The following is the opinion of the
Hanafites jurist;
وإن وقت لها وقتا بطلت بمضيه
And if the contract is specified for a certain period, the Mudarabah will be dissolved after the
end of the term.12
According to AAOIFI, the contracting parties of Mudarabah may agree to specify a maturity
period for Mudarabah venture. This practice will be resulting the bindingness of mudarabah
contract until the expiry date of mudarabah. The AAOIFI has resolved this issue as the
following;
“The general principle is that a Mudarabah contract is not binding, i.e. each of the
contracting parties may terminate it unilaterally except in two cases:
a) When the Mudarib has already commenced the business, in which case of
Mudarabah contract becomes binding up to the date of actual (تنضيض حقيقي ) or
constructive liquidation (تنضيض حكمي)
b) When the contracting parties agree to determine a duration for which the contract
will remain in operation. In this case, the contract cannot be terminated prior to the
end of the designated duration, except by mutual agreement of the contracting
parties.”13
Based on abovementioned AAOIFI Standard, it is understood that the maturity period is not
regarded as Shariah requirement for a Mudarabah contract. However, if such maturity period
11
Ibn Qudamah, Muwaffiq Addin Abdullah, Al-Kafi, (1994) Lubnan, Dar Al-Kutub Al-Ilmiyyah, Vol. 2, p. 153. 12
Al-Musili, Abdullah Ibn Muhammad Ibn Mudud, Al-Ikhtiyar Li Ta’lil Al-Mukhtar, Dar Al-Fikr Al-Arabi,
Vol. 3, p.25. 13
AAOFI Shariah Standards, p.235.
18
was stipulated in Mudarabah agreement, thus the nature of the mudarabah contract will be
binding.
Requirement of Maturity Period for Musharakah Contract
Similar to Mudarabah contract, the jurists are also of the view that the maturity period is not
regarded as a requirement for Musharakah contract. This can be supported by several
classical views and contemporary resolutions to support that argument as the following
stated.
Imam Al-Nawawi of the Shafiites mentioned the following opinion in his book of Minhaj At-
Tolibin:
ولكل فسخه متى شاء وينعزالن عن التصرف بفسخهما
Each parties in the Musharakah contract may withdraw from the musharakah venture at any
time, and both contracting parties shall stop from utilizing the musharakah venture should
they opt to withdraw from such contract.14
According to Hanbalites jurist, Ibnu Qudamah has also elaborated that the contract of
Musharakah is non-binding in nature, thus the maturity period is not considered as a
requirement. He mentions n the book of Al-Kafi as the following:
جوازها و انفساخها حكم الوكالة لتضمنها للوكالة فإن عزل أحدهما صاحبه قبل ان ينض المال فذكر القاضي وحكمها في
: أن ظاهر كالم أحمد رضي هللا عنه أنه ال ينعزل حتى ينض
The ruling of non-bindingness of musharakah and right to dissolve of musharakah contract
are similar to the ruling of Wakalah.. If one of the contracting parties exit from the contract
prior to profit computation; according to Al-Qadi: Clearly, based on the Imam Ahmad’s
opinion is that the contracting parties shall not exit from the contract until the profit had
been computed.15
With regards to this matter, AAOIFI in its Shariah Standard also does not stipulate that the
requirement of a Musharakah contract to have a maturity period.Nevertheless, the
contracting party may enter into a binding promise where the duration of Musharakah
contract may be specified for a certain period of time. The AAOIFI in its Shariah Standard
No. 12, clause (3/1/6/1) state as the following;
“Each partner is entitled to terminate the Sharika (i.e. to withdraw from the partnership)
after giving partner/s due notice to this effect , in which case he shall be entitled to his share
14
An-Nawawi, Yahya Ibn Syarf, Minhaj At-Tolibin (2005) Lubnan, Dar Al-Minhaj, P. 271 15
Ibn Qudamah, Muwaffiq Addin Abdullah, Al-Kafi, (1994) Lubnan, Dar Al-Kutub Al-Ilmiyyah, Vol. 2, P. 147
19
in the partnership, and this withdrawal would not necessitate the termination of the
partnership of the remaining partners. It is permissible for the partners to enter into a
binding promise for the continuity of the partnership for a period of time. In this case, it is
permissible for the parties to agree to terminate the partnership before such a fixed period. In
all these cases, the obligations and actions that took place before termination will remain
unaffected and they will continue to exist. This rule applies to non-stock companies as
well.”16
From above mentioned arguments, it is to note that there are no Shariah requirement for both
Mudarabah and Musharakah contract to specify a maturity date. Thus, both suit well with the
key feature of Perpetual Sukuk i.e. perpetuity.
5.2 Deferral of Periodic Distribution Amount
This is among the main features of the perpetual Sukuk as to allow it to be treated like equity
structure from accounting perspective. As for the perpetual Sukuk to obtain an “equity credit”
feature is the deferment of periodic distribution to the investors. In this arrangement, the
issuer may at its sole discretion elect to make payment of all or some of a periodic
distribution on the periodic distribute date or elect to defer such payment by giving prior
notice to the Sukukholders. The deferral on Periodic Distribution Date shall not triggers a
dissolution event of the musharakah venture or the mudarabah venture..
Pursuant to practice of Sukuk Perpetual based on musharakah basically the issuer hold the
sole discretion whether to distribute the profit payment at the periodic distribution date or to
defer the distribution of realized profit payment to a later date as determined by the issuer. In
this kind of arrangement, there is arising Shariah issue as to whether this practice of deferring
the payment of realized profit in musharakah is permissible for Shariah stand point. One may
assume that this practice seemly prevents the right of the Sukukholders to claim for their
profit at the periodical distribution date, thus lead to violation of main objective of the
partnership contract (muqtadha aqd).
From the Shariah perspective, all the partners have the right to receive the realised profit at
the profit distribution date. The proportion of profit to be distributed amongst the partners
must be stated specifically and agreed upon at the time of the contract, otherwise the contract
is not valid under Shariah. Thus, once the profits in partnership are realized, then the
distribution must be made to all partners based on ratio as agreed.
16
AAOIFI Shariah Standards,p.209.
20
In this case, the author views that the practice of deferment of realized profit to other partners
is in line with Shariah requirement as it does not violates the muqtadha aqd of musharakah.
This is because basically in perpetual Sukuk, the Sukukholders agreed upon the establishment
of the partnership to grant authority to the issuer at its sole discretion to make payment of all
or some of a (profit) Periodic Distribution Amount on the Periodic Distribute Date or elect to
defer such payment by giving sufficient notice to the Sukukholders. Thus, there is no Shariah
issue as the profit of the musharakah venture are realized but only the distribution of such
realized profit is being deferred to a determined later date by the issuer. Furthermore, this
arrangement has been agreed and made known to the Sukukholders prior to subscription of
the perpetual Sukuk. This practice is acceptable from Shariah perspective as long as the
consent of all contracting parties are obtained in all circumstances. The permissibility of
practice of deferring the profit payment in partnership contract by the consent of other
partners are also mentioned by the AAOIFI in its Shariah Standard as the following;17
3/1/5/14 It is permissible, based on the articles of association or a decision of the
partners, not to distribute the profits of the company. It is also permitted to set aside
periodically a certain ratio of profit as a solvency reserve or as a reserve for meeting
losses of capital (investment risk reserve) or as a profit equalization reserve.
Their view is based on the following evidences;
a) Hadith:
المسلمون على شروطهم
“All the conditions agreed upon by the Muslim are upheld”18
In this hadith, the contracting parties may stipulate any conditions as long as the conditions
does not contravene with the Shariah requirement. In the case of perpetual Sukuk, the
deferral terms are stipulated in the terms and conditions and the relevant documentationhat
the issuer has the discretion whether to distribute or defer the realized profit payment.
b) Islamic legal maxim;
ما التزماه بالتعاقدأألصل في العقد رضى المتعاقدين ، ونتيحته هي 19
17
AAOIFI Shariah Standards, p.208. 18
Narrated by At-Tirmidzi, Source: At-Tirmidzi, ´Abu ÑIsÉ MuÍammad bin ÑIsÉ bin Saurah. (2000). Sunan At-Tirmidzi. (Beyrut: Dar al-Kutub Al-ÑIlmiyyah). Ch. 17, Hadith 1352, Vol. 2, 343. Abu Isa said this Hadith is in category of Hassan Sahih, while al-Albani validated this chain of hadith. 19
Muhammad Al-Zarqa, Sharh al-Qawaid al-Fiqhiyyah. Damsyik: Dar al Qalam, p.482.
21
“The original ruling of contract is mutual understanding by contracting parties, and
its consequences (obligation & rights) as per agreed in the contract”
The above legal maxim indicates that the mutual consent and agreement of the
contracting parties as the key element of the respective contract.
c) Quranic verse;
أيها ٱلذين ءامنوا أوفوا بٱلعقود ـ ي
“O ye who believe! Fulfill your undertakings”.20
Apart from above issue of deferral of profit under perpetual Sukuk, there are several
different circumstances on the application of deferral of profit that require further Shariah
assessment on its mechanism as provided below. The examples of application of deferral
profit distribution can be seen in MAS and MAHB Perpetual Sukuk which are based on
musharakah contract.
Notwithstanding the above, the paper wishes to highlight a pertinent issue with regards to to
deferral of profit/periodic distribution as follow:
Deferral of Unrealized Return (In case where the venture profits in shortfall of Periodic
Distribution Amount)
If there has been any shortfall of Profits rendering the same insufficient to satisfy the
payment of all or such part of the relevant Periodic Distribution Amount which would
otherwise become due and payable under the Sukuk Musharakah, or loss in the Musharakah
Venture, the Musharakah Venture shall be dissolved through an exercise of the Purchase
Undertaking, and the Exercise Price shall be applied towards investment in a new
Musharakah Venture. The accounting entries associated with the dissolution of the
Musharakah Venture and reinvestment into a new Musharakah Venture shall be made in the
books of the Managing Partner. The requirement to have accounting entries is to evidence the
constructive payment of the Exercise Price pursuant to the dissolution of the Musharakah
Venture and reinvestment of the capital into a new Musharakah Venture.
Shariah highlight:
20
Surah al Maidah: verse 1
22
If the profit is unrealized and the expected profit is not achieved, the sukukholders, pursuant
to up-front purchase undertaking, may exercise their rights under the undertaking to require
the issuer to purchase the sukukholders’ interest in the musharakah venture at agreed an
exercise price and subsequently dissolve the musharakah venture. Subsequently, the Exercise
Price shall be applied towards investment in a new Musharakah Venture.
Upon exercise of the undertaking, the Musharakah venture is technically dissolved and the
partners re-enter into a new Musharakah venture where the capital contributed by the Issuer is
amounting to the previous Musharakah capital amount plus the deferred expected profit. In
this case, since the issuer purchases the sukukholders’ interest in the initial Musharakah
venture, the payment must be in form of cash or in-kind and cannot be in form of debt. It is
because the debt does not qualify to be capital for Musharakah investment. Thus, in justifying
this practice to ensure the new capital is on cash basis, the issuer is required to reflect the
constructive payment of the Exercise Price pursuant to the dissolution of the Musharakah
Venture and reinvestment in managing its accounting records.
The sequence of events, i.e., dissolution of initial Musharakah and re-establishment of a new
Musharakah with/without additional capital (equivalent to deferred profit), to the Shariah
advisers of the respective sukuk, is sufficient to eliminate the riba issue.
5.3 Capitalisation of the Deferred Periodic Distribution Amount
In Perpetual Sukuk, the issuer has a sole right to distribute the profit payment immediately at
the time of periodic distribution date or to defer the payment to a later date. In case of
deferring the profit payment, the deferred profit amount will remain the same until the issuer
pays to the Sukukholder at the next periodic date as determined by the issuer. This may apply
to the case of Perpetual Sukuk of MAS where it is cumulative but non-capitalisation of
deferred profit. There is also situation where the deferred amount of profit will be capitalized
and the subsequent periodic distribution will be higher as a result of the capitalization. This
issue relevant to the Perpetual Sukuk of MAHB where it categorized as cumulative and
capitalisation of deferred profit amount. Pursuant to this practice, one may ask whether such
capitalization which gives rise to a higher profit/periodic distribution is tantamount to riba
nasiah since the subsequent profit becomes higher due to deferral of preceding profit. In
addition, another Shariah concern whether this is another manifestation of qalb al dayn
which is contentious from the Shariah perspective.
Shariah highlight:
23
In this case, the deferred amount of profit is capitalised whereby the Sukuk shall carry a
higher expected return until the issuer satisfies the amount of deferred profit to the
sukukholders at a later date. Such practise of capitalising the deferred amount is implemented
by the MAHB Perpetual Sukuk Musharakah as the following stated in its PTC;
Venture Profits Equal to /in Excess of Periodic Distribution Amount
If there has been sufficient Profits in the Musharakah Venture to satisfy the payment of
such part or all of the relevant Periodic Distribution Amount which would otherwise
become due and payable under the Sukuk Musharakah, under the Master Musharakah
Agreement, the Sukukholders irrevocably authorize the Managing Partner to, in its sole
discretion, reinvest all the Profits up to the value of such or all Periodic Distribution
Amount) being deferred into the Musharakah Venture as additional capital from the
Sukukholders (“Additional Capital”). Any excess of the Profits above the Periodic
Distribution Amount shall be retained by the Managing Partner in the Reserve Account
on behalf of the Sukukholders on a custody basis. Any payment of such Additional
Capital at a later date shall constitute payment of Musharakah Capital to the
Sukukholders (“Capital Payment”). Any Capital Payment made by the Issuer shall be
shared by the Sukukholders of all outstanding Sukuk Musharakah on a pro-rata basis and
the respective Sukukholders’ Musharakah Capital shall be adjusted accordingly.21
Based on above circumstance, the capitalisation of deferred profit amount is resulted from the
reinvestment activity as regarded as additional capital of the Sukukholders. The evidence
signifies the deferred profit amount utilized as an additional capital for the Sukukholders is
via the accounting entries, in which in the case of any shortfall of the relevant Periodic
Distribution Amount which would otherwise become payable, or loss in the Musharakah
Venture, the Musharakah Venture shall be dissolved through an exercise of the Purchase
Undertaking, and the Exercise Price shall be applied towards investment in a new
Musharakah Venture. The accounting entries associated with the dissolution of the
Musharakah Venture and reinvestment into a new Musharakah Venture shall be made in the
books of the Managing Partner. The requirement to have accounting entries is to evidence the
constructive payment of the Exercise Price pursuant to the dissolution of the Musharakah
Venture and reinvestment of the capital into a new Musharakah Venture.
The Shariah advisers of the respective Sukuk opine that this practice is acceptable in Shariah
and there is no issue of riba nasiah and qalb al-dayn from Shariah perspective as the
capitalization of deferred profit amount as the Sukukholder is materialized through a
21
Source: Extracted from principal, term and conditions. http://issuance.sc.com.my/MemberAccessIssuance/documents/download/1178/PTC
24
dissolution and formation of a new Musharakah venture. Furthermore, the payment of the
exercise price pursuant to the Purchase Undertaking and the re-injection of the new capital
are evidenced by an accounting entry.
5.4 Non-Payment of Profit
Drawing reference to ADIB’s Additional tier-1 Sukuk which based on mudarabah principle,
there is an issue of non-payment of profit that may lead to Shariah concern to be addressed.
In the event of non-payment of profit, generally the Sukukholders not having a claim in
respect of any periodic distribution amount not paid as a result of non- payment of periodic
distribution amount and the consequential of non-payment of any periodic distribution
amount in such circumstance shall not constitute an Event of Default. In this case also, the
issuer (mudarib) shall not have any obligation to make any subsequent payment in respect of
any such unpaid profit (whether from its own cash resources, from the Mudarabah reserve or
otherwise). This is different from the deferral of periodic distribution where the Sukukholders
still have right to claim is respect of periodic distribution amount which has been deferred by
the issuer.
Shariah highlight
With regards to the issue of non-payment of profit, there will be two scenarios that can be
highlighted which are non-profit payment in the case of non- realized Profit distribution
Amount and non-profit payment in the case of realized Profit distribution amount. If the non-
profit payment occurs in the event of non-realised of profit from the mudarabah venture, thus
there will be no Shariah issues in such practice. However, in second circumstance if there is
any realised profits accrued from the mudarabah venture and the mudarib elect to make non-
payment of profits to the rabb al-mal (investors), then there will be Shariah issues arises.
In this case, this practice might trigger Shariah issues as it may affect the muqtadha aqd of
mudarabah which is profit sharing where the Sukukholders in its capacity as rabb al mal
have no right to claim such profits. The issuer as mudarib hold the right to make or not to
make profit distribution payment based on its discretion. Although the profit sharing ratio of
mudarabah is determined earlier between the contracting parties but the payment of profits
still lies at the discretion of the issuer (mudarib).
This issue is the most contentious issue in Additional Tier 1 Capital Perpetual Sukuk. Though
some might argue that up front tanazul can be the solution, few issue new to be considered as
per below:
25
1. Can the tanazul be granted up-front where the subject of waiver have yet to be
materialized?
2. The non-payment of realized profit is considered a violation to muqtadha al ‘aqd of
Mudarabah/Musharakah. Can Tanazul be applied to justify the non-payment?
All in all, the above Tanazul issue is not exclusive to this sukuk structure and this issue
remains as unresolved issue.
5.5 Step Up Rate and Top-Up Mechanism
Similar to common Sukuk, Perpetual Sukuk initially pay the profit in accordance with the
agreed indicative rate until the first call date. After suchperiod, commonly it will have step-up
profit feature where the prevailing profit rate will be revised to include a post-call spread in
order to incentivize the issuer to exercise the Call Option at the first call date. Currently, a
step-up of 100 bps is the norm for most corporate hybrid issuers. The step-up rate might be
also been triggered upon certain time intervals.
In the same way, the periodic distribution amount may also consist the feature of top-up
where in certain provisions like change of control, change of ownership and change of
leverage ratio, wherein such periodic distribution will be revised to include an incremental
spread above the current agreed indicative rate.
Basically, there is no Shariah issue for the contracting parties in Mudarabah and Musharakah
contracts to mutually revise the profit sharing ratio as this practice has no prohibition and still
under the consent (Taradhi) of both parties. The most important requirement for the profit
sharing in Mudarabah and Musharakah contracts is that a party or some parties in the
contracts shall not been guaranteed for profit in whatever situation of the venture.
With regards of this, AAOIFI in its Standard No. 12 for contract of Sharika, clause 3/1/5/5
stated:
“It is permissible that one of the partners to agree on the adoption of any method of
allocation of profit, either permanent or variable, for example, by agreeing that the
percentages (rate) of profit shares in the first period are one set of percentages and in the
second period are another set of percentages depending on the disparity of the two periods or
the magnitude of the realised profit. This is allowed provided that using such method does
not lead to the likelihood of a partner being precluded from participation in profit.”22
Alike the previous for Musharakah contract, AAOIFI also allowed the same for Mudarabah.
In Shariah Standard No. 13 of Mudarabah, it is mentioned in clause (8/3)
22
AAOIFI Shariah Standards, p.207.
26
“The parties shall agree on the ratio of profit distribution when the contract is concluded. It
is also permissible for the parties to change the ratio of distribution of profit at any time and
to define the duration for which the agreement will remain valid”. 23
5.6 Event of Non Viability
Under Basel III capital requirement, all capital instruments issued by a financial institution
must have a loss-absorption term linked to a non-viability event. All capital instruments are
required to absorb losses at the point of non-viability (PONV) by being written off or
converted into shares.
To be more specific, BNM CAFIB defines the criteria of Additional Tier 1, which includes
among others;24
15.1(m) the provisions governing the issuance of the capital instrument require the instrument
to be written-off, or the instrument to be converted into ordinary shares, upon the
occurrence of a trigger event, which shall be determined by the requirements set out
in paragraphs 32.1 to 32.3. The amount to be written-off or converted into ordinary
shares must be the full principal value of the instrument;
15.1 (p) the instrument issued shall be structured using unrestricted non exchange
based contracts (e.g. Musharakah, Mudarabah or Wakalah), in addition to meeting
other Shariah requirements.
Non viability event will be declared by the Central Bank25
upon existence any of the
following circumstances: 26
a. the Islamic financial institution fails to follow any directive of compliance issued by
the Bank, which is necessary to preserve or restore its or the financial group’s
financial soundness;
b. the Islamic financial institution fails to meet all or any of its financial obligations as
they fall due, that may significantly impair its ability to meet regulatory capital
requirements on a continuing basis;
c. the capital of the Islamic financial institution or financial group has reached a level or
is eroding in a manner that may detrimentally affect its depositors, creditors or the
public, and the Islamic financial institution or financial group is unable to recapitalise
on its own;
d. the Islamic financial institution’s assets are insufficient to provide protection to
depositors and creditors; or
23
AAOIFI Shariah Standards p. 237. 24
BNM, Capital Adequacy Framework for Islamic Banks (Capital Components), p. 13 25
PIDM will also be the authority to declare non viability if the institution is a member of PIDM’s insurance scheme. 26
Ibid pp. 27-28
27
e. any other state of affairs exist in respect of the Islamic financial institution or
financial group that would put the interest of depositors or creditors at risk, including
the loss of confidence of depositors and the public
It this further stated in item 33.3 of BNM CAFIB that in applying the requirements in
paragraphs 15.1(j), 15.1(m) and 16.1(j):27
a. for capital instruments structured using unrestricted non-exchange based contracts
(e.g. Musharakah, Mudarabah or Wakalah), only conversion into ordinary shares is
allowed;. (b)
b. for capital instruments structured using exchange-based contracts (e.g. Murabahah,
Tawarruq or Ijarah), a write-off or conversion into ordinary shares is allowed; and
Based on the above requirements, it is noted that the write-off option is not relevant in the case
of perpetual Sukuk in the current practise, at least from the Shariah perspective. This is due to
the fact that the exchange contracts such as Murabahah or tawarruq are not compatible with the
very basic nature of perpetual sukuk, i.e., perpetuity and under non-exchange contracts such as
Musharakah and Mudarabah, thus only conversion to ordinary shares is allowed. An Islamic
financial institution may however consider the application of Ijarah contract to include a write-
off mechanism at the PONV.
From observation of the author, the conversions from Mudarabah or Musharakah Sukuk to
ordinary shares are acceptable to Shariah as both instruments are equity in nature. As for the
conversion of Musharakah Sukuk to ordinary shares is rather quite straight forward from the
Shariah perspective. The Issuer convert the Sukuk to ordinary shares and the underlying
Shariah contract which is Musharakah remains intact. In fact, this conversion would be a matter
of complying with Basel-III requirement as it would not affect the Shariah ruling applicable to
the instruments.28
For Mudarabah Sukuk, it is also acceptable to be converted to ordinary shares. Since the
Mudarabah Sukuk represents the Sukukholders’ (as rabbul mal) ownership in the Mudarabah
asset and rights to receive the agreed profit and also to bear losses, the conversion means the
Mudarabah asset owned by the sukukholders is converted to Musharakah venture as
Musharakah capital and the capital is evidenced by the ordinary shares. Consequently, that the
earlier mudarabah is dissolved. It is worth noting that the conversion event has been agreed up-
front by the Issuer and the Sukukholders at point of subscription of Mudarabah Sukuk.
27
Ibid p. 29 28
ISRA Research Paper no 52/2013, p. 36
28
5.7 Redemption of Perpetual Sukuk
In terms of redemption, there are various events that may lead to redemption of the perpetual
Sukuk. It is allowable for the Issuer to redeem the Sukuk after certain specified period e.g.,
non-call protection period of 5 years. Under the current perpetual sukuk structures, the
redemption is done via exercising the Sale Undertaking and Purchase Undertaking. The Sale
Undertaking is granted by the Sukukholders and the Purchase Undertaking is granted by the
Issuer.
For example, in the PTC of MAHB Sukuk Musharakah, the Sukuk Trustee (on behalf of the
Sukukholders) will provide a Master Sale Undertaking, pursuant to which the Issuer shall
have the right to early redeem the Sukuk Musharakah under:29
i. Redemption at the option of the Issuer;
ii. Redemption for tax reasons;
iii. Redemption upon a rating event;
iv. Redemption for accounting reasons;
v. Redemption for tax deductibility;
vi. Redemption in the case of Minimal Outstanding Amount;
vii. Redemption upon a Change of Control; and
viii. Redemption upon a Revocation of License.
On the other hand, the dissolution of MAHB Sukuk Musharakah pursuant to the Purchase
Undertaking include the following events:
i. the date of Winding-up of MAHB; and
ii. the Periodic Distribution Date in respect of which MAHB has elected to defer payment
of all or part of the Periodic Distribution Amount due on such Periodic Distribution
Date, where there is a shortfall of Profits described above.
However, under Basel-III requirement, redemption of Additional Tier 1 capital instruments
inclusive of perpetual Sukuk cannot be redeemed except with prior approval from the
regulator.30
In addition, the Issuer shall not give any impression to the market that they will
redeem the sukuk.31
With regards to Purchase Undertaking and Sale Undertaking, upon invocation of the
undertakings, the Issuer and the Sukukholders will execute sale and purchase contract for
purchase of the Sukukholders’ interest in the musharakah venture at a purchase price which is
29
MAHB PTC, p.9 30
Ibid, p. 16, IFSB, p. 8 31
IFSB, p 8
29
known as exercise price. The Purchase Undertaking and Sale Undertaking are considered two
separate unilateral promises (wa’dan) instead of being deemed as bilateral promise
(muwa’adah). Each undertaking is not inter-related and its application relates to two different
conditions which consequently lead to two different effects. While muwa’adah is not
accepted by international Shariah boards such as AAOIFI Shariah Council and the
International Fiqh Academy, wa’dan has been widely practised in global Sukuk market and it
is allowed by many Shariah boards.
The undertakings to acquire or purchase the interests or ownership of other parties are not
violating the tenets of Mudarabah and Musharakah. With regards to Mudarabah contract,
AAOIFI Shariah Standard No. 13 (4/4/3) stipulates the following:
“The general principle is that a Mudharabah contract is not binding, i.e. each of the
contracting parties may terminate it unilaterally except in two cases:
a. When the Mudarib has already commenced the business, in which case of Mudarabah
contract becomes binding up to the date of actual) تنضيض حقيقي ) or constructive
liquidation (تنضيض حكمي)
b. When the contracting parties agree to determine a duration for which the contract
will remain in operation. In this case, the contract cannot be terminated prior to the
end of the designated duration, except by mutual agreement of the contracting
parties.”
Similarly under Musharakah, the Musharakah venture may be dissolved based on agreement
by the transacting parties. BNM Musharakah Standard stipulates in item 24.1 that “a
musyarakah contract is dissolved under the following circumstances:32
a. mutual agreement to terminate;
b. contract expires upon the maturity date agreed by the partners;
c. demise or dissolution of partners;
d. loss of legal capacity;
e. the total acquisition by one partner of the other partners’ share of musyarakah; or
f. Invalidity of musyarakah”.
For avoidance of doubt, the issue of pre-determined formula pursuant to Sale Undertaking or
Purchase Undertaking remains as a contentious issue.
5.8 Other Related Issues
Apart from abovementioned issues related to Perpetual Sukuk, it is worth noting that the
Perpetual Sukuk also inherited some general Shariah concerns relating to a straight Sukuk
32
BNM Musyarakah Standard, p 20
30
structure amongst others issue on subordination, beneficial ownership, recourse to the
underlying assets in Sukuk, purchase undertaking (wa`d), rebate (ibra’) in sale-based sukuk,
liquidity facility, tradability of sale based Sukuk and portfolio of assets as underlying assets
in Sukuk. These issues are not been discussed in this paper and still remained important
issues to be addressed by other studies. Owing to that, due to uniqueness of the Perpetual
Sukuk compared to other Sukuk this paper rather serve to discuss on some of the pertinent
Shariah issues of Perpetual Sukuk that do not arise in common Sukuk structures.
6.0 CONCLUSION
As the Perpetual Sukuk are recognised as one of the new landmark in Sukuk headway, there
is room of discussion need to be galvanised in order to ensure the conformity of the practices
with Shariah requirements. This is also rooted from the given distinct requirements outlined
by the Basel-III for the Additional Tier-1 Capital instruments which been the underlying
foundation for the Perpetual Sukuk for financial institutions. This paper has highlighted
some of the pertinent issues to be urgently addressed to ensure the practices of perpetual
Sukuk is in line with Shariah principles. To achieve this goal, the involvement and
commitment of all stakeholders including the Shariah experts, regulators, industry players
and investors are required.
Top Related