IN THE NAME OF ALLAH
THE BENEFICIENT
THE MERCIFUL
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August 27,2008
Sukuk and its Legal and
Regulatory Framework in
Pakistan
By
SIBGHATULLAH AHSAN
Partner
MIAN & SIBGHAT
Advocates & Legal Consultants
Islamabad.
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August 27, 2008
ISLAMIC FINANCIAL SYSTEMAN 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

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August 27,2008
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)
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August 27,2008
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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August 27,2008
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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August 27,2008
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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August 27,2008
EXCHANGE OF HETEROGENEOUS
COMMODITIES OR CURRENCIES
DELIVERY: Must be
simultaneous / spot
Commodity B
Commodity A
MEASUREMENT: May be
different
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August 27,2008
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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August 27,2008
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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August 27,2008
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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August 27,2008
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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August 27,2008
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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August 27,2008
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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August 27,2008
MUSHARAKA
PROFIT
Rs. 100
Rs. 60
Rs.1000
PARTNER A
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Rs. 40
Rs.1000
VENTURE
Rs. 50
Must be according to
MIAN
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capital
ratio
May be in any
agreed ratio
PARTNER B
Rs. 50
LOSS
Rs.100
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August 27,2008
MUSHARAKA
PROFIT
Rs. 100
Rs. 50
Rs.2000
PARTNER A
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Rs. 50
Rs.3000
VENTURE
Rs. 40
Must be according to
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capital
ratio
May be in any
agreed ratio
PARTNER B
Rs. 60
LOSS
Rs.100
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August 27,2008
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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August 27,2008
MUDARABA
PROFIT
50 %
50 %
SERVICES
RABBUL MAL
CAPITAL
VENTURE
ALL MONETORY LOSS
MUDARIB
LOSS OF SERVICES
LOSS
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August 27,2008
MUDARABA
PROFIT
60 %
40 %
SERVICES
RABBUL MAL
CAPITAL
VENTURE
ALL MONETORY LOSS
MUDARIB
LOSS OF SERVICES
LOSS
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August 27,2008
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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August 27,2008
IJARAH
Use/ usufruct Only
Ownership
LESSOR
Asset
LESSEE
Usufruct
Usufruct
Periodical payments/Rent
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August 27,2008
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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August 27,2008
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

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August 27,2008
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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August 27,2008
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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August 27,2008
MURABAHA
MURABAHA
CLASSICAL / SPOT
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DEFERRED
with LUMP SUM
PAYMENT
DEFERRED
with INSTALLMENT
PAYMENT
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August 27,2008
CLASSICAL MURABAHA
COST +MARGIN
IMMIDIATE DELIVERY
PRICE
SELLER
BUYER
GOOD
IMMIDIATE DELIVERY
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August 27,2008
BAI’ MU’JJAL (deferred sale)
DEFERRED PAYMENT
PRICE
SELLER
BUYER
GOODS
IMMIDIATE DELIVERY
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August 27,2008
MURABAHA WITH
DEFERRED PAYMENT
COST + MARGIN
DELAYED PAYMENT
PRICE
SELLER
BUYER
GOOD
IMMIDIATE DELIVERY
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August 27,2008
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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August 27,2008
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
31
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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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August 27,2008
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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August 27,2008
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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August 27,2008
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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August 27,2008
Legal Nature of Sukuk




Is it a debenture? or
It’s 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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August 27,2008
Asset Backed Securitization Rules

These Rules provide mechanism for securitization and
define securitization as:
"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

The Sukuk does not fall in the definition of actionable
claim or receivables therefore Sukuk can not be issued
under these Rules
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August 27,2008
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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August 27,2008
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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August 27,2008
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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August 27,2008
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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August 27,2008
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) Auditor’s certificates as to profit and loss and
dividend or returns on securities issued in previous 5
years
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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. 92-51-2802542
Email.
[email protected]
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August 27,2008