ICIEC’s Sukuk Policy Contents

• The Market • Definition Of Sukuk • Sukuk Types • Sovereign Ijara Sukuk • Sukuk Insurance Policy

THE MARKET Sukuk Issuance in USD billion

90 85

80

70

60 49 45 50

40 30 26 30 19 20 12 8 10 6 1 1

0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Sukuk Issuance by Markets (During last 10 years)

Amount in US million % of total value Number of Issues % of total number UAE 25,050 52.3% 30 18.2% Bahrain 5,633 11.8% 90 54.5% Malaysia 5,496 11.5% 12 7.3% Saudi Arabia 5,440 11.4% 9 5.5% Qatar 2,020 4.2% 4 2.4% Kuwait 1,575 3.3% 9 5.5% Indonesia 650 1.4% 1 0.6% Pakistan 600 1.3% 1 0.6% USA 600 1.3% 2 1.2% UK 271 0.6% 2 1.2% Brunei Darussalam 200 0.4% 2 1.2% Sudan 130 0.3% 1 0.6% Japan 100 0.2% 1 0.6% Turkey 100 0.2% 1 0.6% Total 47,865 100.0% 165 100.0%

DEFINITION OF SUKUK Definition by AAOIFI (1) (The Accounting & Auditing Organization for Islamic Financial Institutions)

“Sukuk are defined as Certificates of equal value representing undivided shares in the ownership of tangible assets, usufructs* and services or (in the ownership of) the assets of particular projects or special investment activities”

* Use of benefit of an asset

Definition (2) (In more simple terms)

“Sukuk are defined as undivided shares in the ownership of underlying assets (tangible or intangible) relating to a particular project or investment activity” Sukuk vs. Bonds

Sukuk Bonds – Investment certificate – Contractual Debt obligation – Ownership in a real or financial assets – The issuer is obliged to pay regular – Right to share in the revenues & on specific dates realized proceeds of Sukuk assets – The amount of interest is – The underlying business arrangement determined as % of capital must be Shariah compliant – The Principal is guaranteed at – Expected earnings should not be maturity guaranteed by the issuer – Don’t give voting rights in the – The issuer shall not undertake to company, repurchase the assets for its nominal – Give right to interest before value (except in Ijara Sukuk) distribution of profits to – Sukuk holders can’t extend financing shareholders to issuer in order to enable repurchase of assets.

SUKUK TYPES

Structure Originator Market (Jurisdiction)

• Murabahah • Sovereign • Domestic • Mudarabah • Sub-Sovereign • Global • Musharakah • Corporate • • Salam • Istisnaa • Wakala • Hybrid

* There are 14 Sukuk Types identified by AAOIFI NB: In 2012, 61% of Sukuk are of MURABAHAH Structure

SOVEREIGN IJARA SUKUK What is Ijara?

In the Islamic finance industry, the term “ijara” is broadly understood to mean the ‘transfer of the usufruct of an asset to another person in exchange for a rent claimed from him’ or, more literally, a “lease”. Definition of Sukuk Al-Ijara

Sukuk Al-Ijarah refers to the buying and leasing back of assets by the investors to the issuer and such Sukuk shall represent the undivided beneficial rights/ownership/interest in the asset held by the trustee on behalf of the investors Stage 1 (initiation)

Originator 1) Sells Assets SPV 2) Issues Sukuk Investors (Lessee) (Issuer, Trustee, (Sukukholders) Member Country Lessor) 4) Transfers Purchase 3) Invests in Sukuk Price Of Assets Assets

The Originator Sells assets to a Special Purpose Vehicle (“ SPV”) which is set up as a trustee for the sukuk holders and then leases them back from the SPV. The SPV pays the purchase price to the Originator as consideration for its purchase of the Assets in an amount equal to the Principal Amount. The SPV leases the Assets back to Originator under a lease arrangement (Ijara) for a term that reflects the maturity of the Sukuk. Stage 2 (Ongoing)

5) Leases Assets Back Originator 7) Transfers periodic Investors distributions (Lessee) SPV (Sukukholders) Member Country 6) Makes periodic payments

The Originator (as Lessee) makes Rental payments at regular intervals to the SPV/Trustee (as Lessor). The amount of each Rental is equal to the Periodic Distribution Amount payable under the sukuk at that time. Stage 3 (Redemption)

9) Transfers redemption Originator 8) Pays Asset’s Purchase Price value Investors (Obligor) SPV (Sukukholders) Member Country 11) Transfers Sukuk assets 10) Redeems Sukuk Certificates

The assets are transferred back to the Originator, who makes the final payments to the SPV. The SPV makes final distribution to the Sukuk holders as the full redemption of their investment in Sukuk. Main Parties…

Parties Role Originator : Seller, Lessee, Obligor, Servicing Agent SPV : (Special Purpose Vehicle) Issuer of the Sukuk, Lessor & Trustee SPV issues Sukuk. Right against SPV to payment of the Periodic Distribution Amount and the Dissolution Amount. Investors : Sukukholders assume investment risks, which would include non-payment by the obligor (originator) (MLA) : Mandated Lead Arranger Advisor, Principal Paying Agent, Book runner Servicing : Commercial banks providing various services e.g. Sukuk Banks issuance, collection and transfer of subscription monies Sukuk Issue : Investment banks, institutional investors participating Underwriters in the Sukuk underwriting syndication ICIEC’S SUKUK INSURANCE POLICY AAOIFI Standard No.17 (year 2003) “It is permissible for the issuer or the certificate holders to adopt permissible methods of managing risk, of mitigating fluctuations of distributable profits (profit equalization reserves), such as establishing an Islamic insurance fund with contributions of certificate holders, or by participating in insurance () by payment of premiums from the income of the shares of Sukuk holders or through donations (tabarru’at) made by the Sukuk holders.”

AAOIFI Resolution (year 2007)

“The Shariah Council of the Accounting and Auditing Organization for Islamic Financial Institutions (“AAIOFI”) issued a resolution prohibiting originators, issuers and managers from guaranteeing Sukuk or specifically providing loans to Sukukholders when actual earnings fall short of expected earnings but it allowed third party guarantee”

Fiqh Academy Resolution

The Figh Academy of the Organization of the Islamic Cooperation, issued a resolution at its 20th meeting held in Algeria last September 2012, permitting the protection of Sukukholders by Islamic insurance instruments.

Shariah Clearance

The wording of ICIEC Insurance Policy was cleared by the Shariah Committee of IDB Group In its meeting held in KL in September 24th 2012 The first insurance policy to cover Sukuk in the market Sukuk Policy Profile-1

Rationale :  Gaps in the Islamic capital markets in terms of supporting Sukuk issuance owing to lack of 3rd party guarantees  Member countries’ need to mobilize resources from the Capital markets  Development of Islamic Financial Services Industry

Objective : ICIEC’s position as the world’s only Shariah compliant credit & political risk insurer makes it the prime party to issue 3rd party guarantees in the form of Takaful Key Benefits :  Credit enhancement of the Sukuk Structure  Better rating  Better pricing  Improve risk management.  Increase financing facilities  Help in structuring Shariah compliant financial facilities Sukuk Policy Profile-2

Risks Covered : Political risks & Non-payment risks  Insolvency of the originator  Failure or refusal of the originator to pay on due date  Currency inconvertibility and transfer restrictions imposed by the obligor’s country  Expropriation, confiscation or government intervention in the business of the obligor  War or civil disturbance in the originator’s country Eligibility : Originator from a Member Country (Sovereign or Sub-Sovereign or Corporates). Ijarah Sukuk only. Asset backed structure. Tenor : Up to 15 years

Cover % : 95% Stage 1 (Policy Issuance)

Originator 5) Transfers assets 9) Issues Sukuk Investors SPV (Member Country) (Sukukholders)

1) Applies for Cover 3) Issues offer 4) Accept Policy 7) Issues policy 8) Pays premium

2) ICIEC works closely 2) ICIEC works closely MLA with the MLA with the Reinsurers Reinsurers (Adviser/Arranger) 6) ICIEC signs a reinsurance agreement Stage 2 (Policy Management)

ICIEC coverage remains in the ongoing until closing stage, the policyholder will report to ICIEC all periodic distributions.

10) Leases Assets Back 12) Transfers periodic Originator policyholder distributions and notifies Investors ICIEC (Member Country) (SPV) (Sukukholders)

11) Makes periodic distributions Stage 3 (Closing)

Policyholder informs ICIEC when Sukuk certificates are redeemed and are transferred to the Originator. The policy officially closes.

13) Completes 14) Transfers Originator repayments Policyholder redemption value Investors (Member Country) (SPV) (Sukukholders)

16) Transfers Sukuk 15) Redeems Sukuk assets Certificates Stage 4 (In case of Claim)

17) Delay/nonpayment 19) loss minimization Originator Policyholder effort Investors (Member Country) (SPV) (Sukukholders)

18) NPL/Claim 21) Claim paid Submitted

22) ICIEC recovers from originator Reinsurers

23) Reinsurers pay share of claims Underwriting Approach

• History: what is the originator, asset class and underlying obligor payment history, what is their business history?

• Security: is the underlying asset sufficient to secure payment in the event of problems or default?

• Strength of the issuer’s balance sheet? Does the issuer have cash, reserves, standby access to ensure timely payment? what is the nature, history and consistency of the issuers cash flow? What coverage does this provide for the future?

• Servicing: will the originator service collections related to the underlying Asset ? Is the originator skilled and competent to perform this?

• Country & Sector Risks: Country rating, W&CD, Expropriation, transfer and convertibility, sector analysis. Thank you