Shariah Issues of Islamic Leasing: Perspective of the Lessor I. Introductory Remarks This essay is presented in basically two parts, one of which provides an exposition of the fiqh rules pertaining to ijarah, and the other addresses market developments and Shariah related issues in ijarah bonds. The essay thus begins with a review of the basic concept and definition of ijarah as well as its conditions of validity according to the leading schools of fiqh. This is followed by a brief discussion of the two forms of ijarah, namely operational lease and financial lease, drawing attention to the fact that financial leasing and securitisation of ijarah do not find a precedent in the works of fiqh. Two other sections that follow also expound the fiqh rules pertaining to insertion of stipulations in, and the relevance of options (khiyarat) to, ijarah, issues pertaining to liability for loss and imposition of penalty for default, and termination of ijarah. The second part on developments in the Sukuk market briefly discusses the Sukuk in general and then turns to ijarah bonds. The reader will note in this part a degree of emphasis on the potential benefits of Islamic bonds in reference to the mobilisation of funds and its potential to stimulate to economic development. This discussion also refers to the relevance of Islamic bonds to the Shariah principle of maslahah (public interest). Developments in Islamic banking and finance in general, and Islamic bonds in particular, are dominated by the concerns of authenticity and Shariah compliance on the one hand, and the desire to open all legitimate avenues that bring prosperity and economic development on the other. Being at its early stages of development, Islamic finance demands an unusual degree of Shariah-informed technical competence and originality as well as vision and perspective that reflect on issues of poverty and the dire need for resource development in the much large part of the Muslim world. This is by no means a facile combination and call for concerted efforts of all concerned. Yet we also note that Islamic finance will no doubt benefit by the positive effects of that successful experience and signs are that the Islamic capital market will also prove its credibility and resilience in the years to come. The last section of this essay briefly addresses the development of hybrid assets in Sukuk that combine a number of different contracts into a single marketable formula and product. II. The Contract of Ijarah Ijarah derives from the root word ajara – to recompense, compensate or give a consideration and return. Ajr refers to a worker’s wage, and ujrah to rental payment. In its juristic usage, ijarah primarily refers to both a rental as well as a hire contract that engages the services of persons. In its current usage ijarah also occurs in two types, namely operational lease and financial lease, the latter is known as ijarah wa iqtina. Ijarah is validated by the Quran, Sunnah, and general consensus (ijmac). Several passages are found in the Quran (al-Kahf, 77: al-Qasas, 26: al-Talaq, 65-6) on the worker’s entitlement to a wage where reference are also made, to the practices of previous Prophets on ijarah thus indicating that ijarah represents an instance of continuity in the Quran of the laws of previous nations. References also occur in hadith to ijarah and the employer-employee relations, including, for example, the instruction, in symbolic terms, to the employer to “pay the employee his wages before the sweat of his brow dries up”. The companions of the Prophet practiced ijarah, in the sense of employment as well as rental of real property. The validity of ijarah is thus upheld by conclusive ijma of the companions, as well as general custom (urf) among Muslims that prevails to this day. The fiqh texts provide elaborate details on ijarah which stop short nevertheless of offering a blueprint for the modern applications of this contract, especially as a mode of contemporary finance. This essay explores the relevant aspect of fiqh on ijarah that are of relevance also to contemporary applications of this contract. Scholars of the four schools of Islamic law have differed somewhat on the precise definition of ijarah. All the madhahib are in agreement however, that ijarah is a contract of the sale of known and specified benefits or services in return for a compensation. Minor variations that occur in the definition of ijarah may be summarised as follows: Whereas the Maliki and Hanbali definitions of ijarah qualify benefits and services into lawful benefits and services (manfaah mubaÍah) that would preclude unlawful objects and activities, other schools subsume this qualification under the conditions and requirements of ijarah. Another stipulation of the Hanbali definition is that the benefit or service materialises in the future. For if it existed at the time of contract, it would resemble sale, whereas ijarah only yields its benefits over a specified period in the future. The Maliki definition further stipulates that the consideration (iwaÌ) in ijarah does not emanate from the usufruct thereof. This is deemed necessary in order to differentiate ijarah from agricultural cropsharing contracts and orchard farming wherein the iwaÌ is given out of the benefits (manfaah) that obtain in them. To say that ijarah is the sale of benefits differentiates it from sale, gift and charity (bay, hibbah, Iadaqah) which consist of the transfer of the capital asset as a whole and not only of its benefits. Ijarah is thus a sale of benefits, or usufruct, usually of durable goods. Reference is also make in the precise determination of what may or may not be suitable for ijarah to the prevailing custom, which is also applicable to the mode of payment, whether of wages or rental, as to how they are paid. Consideration in ijarah is normally payable toward the end of a specified period, be it a week, month or year, as the benefit of ijarah usually materialises over a period of time. Yet Custom may change this and determine that the benefit of ijarah be paid in advance. Custom also determines the manner how the usufruct is derived in ijarah. A tenant is thus expected to live in the rented place and use it for familiar purposes of living and not outside the customary expectations of proper usage for that purpose. Since ijarah is a variety of sale, it is lawful in everything that can lawfully be bought and sold, and the rules of Shariah pertaining to sale are also generally applicable to ijarah. The fuqaha’ have, however, singled out basically two things namely the human being, and the waqf property which cannot be sold but can be made the valid subject matter of ijarah. Furthermore, since ijarah is a variety of sale, anything that can be paid as a price (thaman) in sale can also be given as consideration in ijarah. Most of the rules relating to the contract of sale, such as those pertaining to sanity, adolescence and consent of the contracting parties without which no contract can come into existence also apply to ijarah. Other rules of sale that apply to ijarah include options (khiyarat) such as khiyar al-ru’yah (option of viewing), khiyar al-ayb and khiyar al-shart (option of defect, and option of condition), revocation (faskh), and iqÉlah (termination by mutual agreement), but not pre-emption (shuf ca). The Shafi’s also disallow khiyar al-shart in ijarah. In a defective ijarah (ijarah fasidah) the fair rent or wage (ajr al-mithl) but not the one specified in contract would be applicable. Since ijarah transfers the ownership of usufruct from the lessor to the lessee, the former must not only own the assets involved but also be able to transfer the ownership of its benefits to the lessee. It is also a requirement of a valid ijarah that the capital asset survives and does not perish with the ijarah. This would preclude items such as food, fuel and money which cannot be used unless they are consumed altogether. Other conditions required in a valid ijarah are that the two sides of the exchange must both be known and specified in such a way that eliminates the possibility of disagreement and dispute; that the usufruct in question has a financial or market value; and also that it does not involve indulgence in haram activities and substances. Objects such as a dead carcass, pork, wine, and prohibited activities such as usury, prostitution and gambling may not be the subject either of sale or ijarah. Moreover, ijarah like sale involves exchange of values on both sides. The usufruct in ijarah may thus be sold for money, another object of value, or indeed another usufruct such as rental of a house in exchange for the rental of another house. This is the majority position although the Hanafis have held that the countervalues of ijarah should not be of the same genus. The reason given that the benefits of ijarah are non-existent on both sides at the time of contract, and since ijarah is a form of sale, if both the countervalues are of the same genus, it would resemble deferred sale (bay bi’l-nasi’ah) on both sides, which is not permissible. Deferment is allowed according to the majority of jurists of one of the countervalues in sale, such as in salam or bayc bi-thaman Ajil (BBA) but not of both sides of the bargain. Leasing is used as a mode of financing by Islamic financial institutions with the purpose of enabling customers to use durable goods and equipment such as ships, aircrafts, heavy machines and plants in productive enterprises without having to buy them. In a simple ijarah that does not involve securitisation of the ijarah receivables, the customer or the lessee, pays a certain amount in cash as rental of the leased asset over a period of time. Since the Islamic bank or financial institution acquires the desired asset only when a client requests it and commits himself to enter into a lease contract with the bank, the bank can make a profit by setting the rent at a level that covers, over the lease period, the purchase price as well as a return in line with the current rate of mark-up murabahah. That presumes that the lease is for a time long enough to cover the life of the asset. The banks are usually not interested in the asset itself and the contract generally provides for sale or gift of the asset to the lessee at the end of the contract period. This is known as ijarah-wa-iqtina’, or a lease ending up with the lessee owning the asset. This form of ijarah is widely practiced as it is akin to murabahah and suits the banks’ role as financial intermediaries. The Syariah Advisory Council (SAC) of the Securities Commission of Malaysia has noted that financial leasing is not a new contract but an extension of the contract of ijarah and a mechanism that develops the same concept into a mode of financing. Moreover, the sale of usufruct which is a feature of financial lease is lawful and Islamic jurisprudence recognises it as mÉl. The SAC thus noted that ‘financial lease without a penalty clause does not contradict Syariah. The SAC further noted that in their calculation of the lease rental, the (operational lease and financial) leasing companies take a similar approach, which is based on the value of the asset, rate of charge or return, and the period of financing, The main difference being that an operational lease does not offer an option to the lessee to buy the leased asset. Notwithstanding its general acceptance in Islamic banks, some aspects of financial leasing practices are not fully Shariah compliant and need to be reviewed and rectified. One of these in concerned with assignment of lease without transfer of ownership. The lessor can sell the leased property to a third party in which case the relation of lessor and lessee shall be established between the new owner and the lessee. However, assignment of the lease itself for a monetary consideration without assigning ownership of the leased asset is not valid. The difference between the two situations is that in the latter case the ownership of the asset is not transferred to the assignee, but he becomes entitled to receive rent of the asset only. This kind of assignment is acceptable in Shariah only where no monetary consideration is involved. For example, a lessor can assign his right to claim rent from the lessee to his brother or friend in the form of a gift. Similarly, he can assign this right to any one of his creditors to set off his debt out of the rent receivables. But if the lessor wishes to sell this right for a price, he would be indulging in the sale of money (the amount of rentals) for money which would be tantamount to a riba. Unlike sale which under the scholastic fiqh cannot be effected for a future date, ijarah for a future date is permissible. The lease period, and also the lessor’s entitlement to rent, however, commence form the date on which the leased asset has been delivered to the lessee, regardless as to whether the lessee has started using it or not. This enables both the lessor and lessee to make preparation plans ahead over a longer period of time. The rent or any part thereof may be payable in advance before delivery of the asset to the lessee, but the amount so collected by the lessor remains with him as payment on account that is adjustable against the actual rent. Jointly owned property by two or more persons can be leased out and the rent is distributed among them in proportion with their respective share in the property. A joint owner of a property may also lease out his part to his partner but not to an outsider without a settlement with his partner/s first. The lessee may not use the leased asset for purposes other than those specified in the lease agreement. If no such purpose has been specified in the lease agreement, the asset may be used for any purpose that is deemed customary and normal. III. Two Modes of Lease Financing The fiqh discourse does not envisage ijarah as a mode of financing, but a transaction for the transfer of usufruct from person to person for an agreed consideration and period. Yet as earlier noted, in financial leasing, ijarah is basically used as a substitute to long term lending on the basis of interest. The lessee thus acquires the equipment he needs without borrowing on interest but resorts to leasing as an alternative. Leasing companies and Islamic banks often lease objects such as plants and machinery to business firms and entrepreneurs who may be unable to buy them for their production purposes. The lessee accordingly acquires ownership of the leased asset as per contract stipulation which turns the simple ijarah to ijarah wa iqtina’ (also known as ijarah muntahiya bitamlik). As already noted, in a financial lease, Islamic banks and institutions are usually not interested in the asset itself. Yet the option remains open for them to retain ownership of the item, sell or lease it to another client for a sum usually less than that agreed for the first contract. Financial leasing has also become popular due to a tax advantages as the rental can be offset against corporate tax by the lessee, including zakah. Since the client renting the equipment is not its owner, any wealth assessment for zakah will not include the item in question. Financial leasing has once again been criticised for what it basically boils down to a form of disguised security agreement since it transfers to the lessee all the risks associated with ownership. The long-term and non-cancellable nature of financial lease add to the weight of that problem. Even when the leased object is eventually made into a free gift or given at a nominal price, it does not address the issue that the residual value is predetermined and built into the lease payments which may prove to be unjust. For the lessee loses the asset as will as the extra payments he may have made in the event he dies or is unable to continue the lease payments. To address this problem, it is suggested that the lease agreement should not bind the lessee to acquire ownership of the asset nor should it contain a condition of gift or sale at the end of the lease period, as this would tie up one agreement with another and make the one a pre-condition of the other. However, the lessor is at liberty to sign another contract with the lessee at the end of the lease period, just as he may also make a unilateral promise to sell the leased asset to the lessee at the end of the lease period. In this way the lessee would still have the option whether or not he wishes to acquire ownership of the leased asset. In some cases the lease commences on the very day the lessee receives the price irrespective of whether he has taken delivery of the asset. The lessee’s liability for rent thus begins prior to taking delivery of the leased asset. This contravenes one of requirements of ijarah as it amounts to charging rent on the money given to the customer, and it is tantamount to interest. If the supplier has delayed delivery after receiving the price, the lessee should not be liable for the rent of the period of delay. Furthermore, when the lessee himself has been entrusted with the purchase of the leased asset, two separate relations come into play between the institution and the client one after the other. In the first instance, the client is an agent (wakil) of the institution to purchase the asset on the latter’s behalf. The lessor-lessee relationship has not yet come into operation at this stage. The second stage begins from the date when the client takes delivery from the supplier. It is only then that the lessor-lessee relation begins within the context of ijarah. During the first stage, the client cannot be held liable for the obligations of the lessee as he only acts as a trustee and agent. But when he takes delivery of the assets, he also acquires the role of the lessee. IV Liability for Loss Since the lessor, in a financial lease bears ownership responsibilities, in the event the asset is destroyed during the lease period, he alone stands to suffer the loss. Similarly if the leased asset loses its utility and function without the lessee’s fault or negligence, the lessor's entitlement to rent discontinues. This may also be said to be one of the differences between ijarah and conventional leasing, as the latter entitles the lessor to receive rent even if the lessee could not obtain any benefit from the leased asset. Long term leases with fixed rent may be liable to market fluctuations of rent and inflation which may present loss-incurring factors for the lessor. To prevent excessive uncertainty in this regard, the lessor may insert a condition in the lease that the rent may be reviewed or made renewable on new terms after a specified period of times. This would be what is now known a floating ijarah, as opposed to a fixed rate ijarah. If the lessee contravenes any of the terms of the agreement, he may be held liable for compensation of the loss caused, but he cannot be compelled to pay the rent of the remaining period. The lease asset normally reverts to the lessor when the lease is terminated. Should there be no contravention on the part of the lessee, the lease cannot be terminated without mutual consent. Hence any stipulation which gives the lessor unrestricted power to terminate the lease would be contrary to the Shariah. In a similar vein, any clause which obligates the lessee to payment of rent for the remaining of the lease period would be ultra vires the Shariah. If the leased asset has totally lost its utility and function, accidentally destroyed or its usufruct value substantially reduced and no restoration or repair is feasible, the lease terminates as of the day of the loss of utility and usufruct. However, in modern practice, the leased assets are usually insured against such contingencies, in which case, it may be unnecessary to insert advance stipulations in the lease contract. The lessee's control over the leased article and its beneficial use is in the nature of a trust (amanah) which means he is not liable for loss and damage that occurs through normal use of the leased object. But he is liable to pay compensation when he violates the terms of the trust and uses the leased article contrary to what is normal and customary, or when proved deliberately negligent and abusive. Financial lease agreements often stipulate a penalty for the lessee in the event of late payment. Uthmani observed that a penalty of this kind is not valid in an Islamic lease. The reason given is that the rent after it becomes due is a debt payable by the lessee and a monetary charge on it is tantamount to riba. A stipulation may, however, be inserted in the ijarah agreement making late payment by the lessee over a period of time liable to a certain amount of charity. This may provide a deterrent to late payment even though it does not compensate the lessor for his opportunity cost over the period of default. The SAC of the Securities Commission of Malaysia, has held that late payment in an operating or a financial lease may be subjected to a one per cent penalty, which may not, however, be compounded. In holding this position the SAC actually followed an earlier resolution of its sister organisation, namely the Shariah Advisory Council of the Central Bank (Bank Negara) of Malaysia, which had also approved imposition of a flat one per cent penalty per annum. In a subsequent resolution of the SAC (8 November 2000) the issue of default was addressed more widely, that is, with reference to all Islamic financing transactions, under the rubric of compensation (tawil). Thus it was held that imposing tawil is permissible 1) for arrears of due payments, 2) for failure to pay after the due date, 3) for early settlement before due date in Islamic financing products that are based on contracts of exchange (cuqËd mucawÉÌÉt) including Islamic debt securities. Tawil can be imposed after it is found that deliberate delay in payment (mumÉÏalah) is present on the part of the payee to settle the payment of principal or profit. The rate of tacwÊÌ on late payment of profit is one per cent per annum of the arrears which may not be compounded. Where the tacwÊÌ rate on payment of the principal is based on the prevailing market rate in the Islamic interbank money market; it too may not be compounded. The SAC resolution added that “the imposition of tacwÊÌ, or syarÏ jazÉ’i” is penalty agreed upon by the caqd parties as compensation that can rightfully be claimed by the creditor, when the debtor fails or is late in meeting his obligation to pay back the loan. Payment by way of tacwÊÌ may not in any case exceed the total amount of the outstanding balance. The SharÊcah evidence cited for this resolution refers to two hadiths, and a ruling of qiyÉs as follows: Delay in repayment by the affluent is injustice (maÏl al-ghaniy Ðulmun). Harm may neither be inflicted nor reciprocated (lÉ Ìarar wa la ÌirÉra fi’l-Islam). This last hadith is moreover supported by the legal maxim that "harm must be eliminated (al-Ìararu yuzÉl).” Qiyas: delay in due payment is seen to be analogous to ghaÎb (usurpation) and the usurper may, in the Shafici and Hanbali schools, be held liable to compensate the owner for his loss. The cillah or effective cause that is in common between ghaÎb and mumaÏalah is “obstructing the use of property and exploiting it in a tyrannical way.” The Fiqh Academy of the Organisation of Islamic Conference, in its resolution 66 (1992) authorised imposition of liquidated damages and penalty in istisnÉc (manufacturing contract) on the basis of a prior agreement between the contracting parties. This is when the parties agree and stipulate in their contract as to what sum shall be payable in the event one party fails to complete or delay his contractual obligation. The evidence quoted in support of this ruling is the Bukhari hadith narrated by Ibn SÊrÊn that a man said to the owner of animals for hire: “prepare one of your animals for travel; should I not hire it on such and such a date, I shall pay you 100 dirhams,” and he did not go on that day. Judge ShurayÍ Ibn ×Érith ruled in this case and is quoted to have said “whoever imposes a condition upon himself voluntarily, he must abide by it.” One other renowned hadith quoted in support declares that “Muslims are bound by their stipulations unless it be a condition that renders a Íaram into Íalal and vice versa – al-Muslimuna calÉ shurËÏihim…).” MuÎtafÉ al-ZargÉ is also quoted to have drawn the conclusion concerning compensation (tacwÊÌ) to the effect that it is payable for losses borne by the parties involved in a business transaction as a result of waste and disruption of business. It was further suggested that due to change of circumstances people may need to insert a condition on tacwÊÌ in their contracts to secure their economic interests in which case they are bound by their stipulations. The present writer concurs with this conclusion. V. Options and Stipulations (KhiyÉrÉt) Each of the parties in an operational lease has the right to insert an option in the contract such as the option of condition (khiyÉr al-sharÏ) according to which the option stipulator can duly exercise it and dissolve the lease. This option is limited to three days according to the majority view. The ShÉficis validate insertion of the option of condition in sale but not in ijarah. The option of condition relates contractual relations, such as aspects of a mutual agreement and terms of relations between the contracting parties. The parties to an operational lease or a financial lease and their representatives may thus according to the majority choose to insert conditions that reflect the market situation or timing of fulfillment of their contractual obligations. Both the lessor and lessee, or their agents, have the right to stipulate the option of viewing, (khiyÉr al-ru’yah) which would entitle them to dissolve their contract after seeing the hired object, if they have not seen it at the time of contract. Under the option of defect (khiyÉr al-cayb), if the lessee finds any defect in the leased object, he is entitled to dissolve the contract provided the defect in question is such as to obstruct normal enjoyment of the leased article. The lessee himself or anyone else with his permission may utilise the leased article with or without payment. If the leased asset is differently used by different users, the lessee may not sub-lease the leased asset without the permission of lessor. If the sub-lease rental is equal or less than the original rent, and the asset is used for similar purposes, all the leading madhÉhib agree on the permissibility of sub-leasing. However, opinions vary in the event where the sub-lease rental is higher than the original rent. Whereas the ShÉfici and Hanbali schools allow this, Imam Abu Hanifah has held that the surplus should be given in charity, but allows it if the sub-lessee has enhanced the assets in some way. Notwithstanding the pious calibre of Abu Hanifah's view, the ShÉfici and Hanbali view would appear to be closer to present market reality and custom and may therefore be followed. V. Revocation of Ijarah Since the principal purpose of ijarah is to enable the lessee to enjoy the usufruct of the leased object, the majority of schools, excepting the Hanafis, allow revocation (faskh) of ijarah in basically one situation only, which is when the leased article loses its utility and benefit. The majority consequently do not allow revocation of ijarah on grounds of any personal disability that befalls the lessor or the lessee. Hence a lease contract may not be revoked on any other ground. The Hanafis also permit revocation of ijarah on ground of disabilities affecting the parties even when the leased item remains intact. Revocation is thus allowed of the lease, for example, of a shop if prior to taking occupancy, the lessee loses all his merchandise. Similarly, when someone hires a chef for an event which is, however, unexpectedly postponed or cancelled, the hire contract may be revoked. Disagreement among the schools has also arisen over the dissolution of ijarah in the event of death of one of the contracting parties. The majority of schools maintain that ijarah remains intact even after the death of one of the contracting parties and hold that their legal heirs would inherit the contract. The latter would consequently step into the shoes of their deceased relative and would consequently be bound to honour the contract. The Hanafis maintain on the other hand that the contract is dissolved upon the death of one of the contracting parties. This is because usufruct according to the Hanafis is a manfacah (benefit) which is not mÉl and therefore not inheritable. Transfer of ownership by way of sale, gift and inheritance also does not vitiate the ijarah, which according to the majority including the Hanafis survives the transfer and the new owner must observe it until the end of its period. Ijarah basically expires when its period of validity comes to an end unless it be for a reason that necessitates its extension beyond the due date. Thus when the hire period of an animal or a vehicle comes to end during the continuation of a journey they have been hired for, the ijarah continues until the time the carrier reaches destination. As already noted ijarah that is subject to option of condition, option of defect or option of viewing comes to an end with the due exercise of these options. VII. Islamic Bonds or Sukuk Sakk (p1. sukuk, also sakÉik) in Arabic lexicology derives from the idea of striking one’s seal on a document signifying a covenant or conveyance of rights and obligations. The word is also used for minting coins. In its present usage, Sukuk refer to certificates or financial securities that represent a proportional or undivided interest in an asset or pool of assets, and the claim embodied in Sukuk is not simply claim to a cash flow but an ownership claim. This also differentiates Sukuk from conventional bonds as the latter proceed over interest bearing securities, whereas Sukuk are basically investment certificates consisting of ownership claims in a pool of assets. The aim is to sell the assets and recover its value from subscription, in which case the holders of the certificates become owners of the assets. The primary condition of Sukuk is the existence of assets on the balance sheet of the government, the monetary authority, corporate body or bank which wants to mobilise its financial resources. SharÊcah considerations dictate that the pool of assets should not solely comprise debts from Islamic financial contracts such as murÉbaÍah and istisnac but have a dominantly asset backed component such as ijarah, mudarabah and salam. The Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) released in November 2002 a document on SharÊcah standards concerning Sukuk. The document provides that “Investment Sukuk are certificates of equal value representing, after closing subscription, receipt of the value of the certificates and putting them to use as planned, common title to shares and rights to tangible assets, usufructs and services, or equity of a given project of a special investment activity.” Zero-coupon Sukuk, as they are known, are debt financing but non-tradable Sukuk which are created where the assets to be mobilised do not exist yet. The purpose would be to create more assets on the balance sheet of company. However, certificates of this nature would not readily be tradable because of SharÊcah restrictions on sale of debts (except for Malaysia and Indonesia). The primary asset pools to be generated would partake of istisnÉc and instalment purchase/sale contracts that create debt obligations. The certificates on these debt arrangements are known as fixed rate zero coupon Sukuk and they are generally deemed to be SharÊcah compliant. Sukuk may be divided into two types: Sukuk that yield pre-determined returns, and Sukuk based on profit and loss sharing. Sukuk al-ijarah are a prime example of certificates that yield pre-determined returns. So far Sukuk al-ijarah has been the dominant type of Sukuk issued, although Salam sukuk has also been used for similar purposes and it is being actively promoted by the government of Bahrain. Part of the motivation to promote these new tools has been to replace the commodity murÉbaÍah transactions so commonly used by Islamic banks to generate liquidity. Ijarah bonds are “securities of equal denomination for each issue, representing physical durable assets that are tied to an ijarah contract as defined by SharÊcah.” Ijarah bonds represent leased assets without actually relating the bond holders to any corporate body or institution. For instance, an aircraft leased to an airline can be represented in bonds and owned by a thousand different bond holders, each of them individually and independently collecting their periodic rent from the airline company without having to associate with other bondholders. They are, in other word, not owners of a share in a company that owns the leased airline, but simply a sharing owner of one thousandth of the aircraft itself. The bondholders receive steady income that is even more risk averse than common stock, due to the fixed and predetermined nature of their rental cash flow. Ijarah bonds are nevertheless exposed to risks arising from general market conditions, price movements of real assets, the ability of the lessee to pay the rental instalments, maintenance and insurance costs. This might mean that the expected return on some forms of ijarah bonds may not be precisely predetermined and fixed. The fixed rental may thus represent a maximum that is subject to certain deductions. Pure ijarah sukuk are usually issued on the basis of stand-alone assets identified on the balance sheet. The assets can be parcels of land to be leased, equipment such as aircraft and ships. The rental rates on these Sukuk can be both fixed and floating depending on the particular originator and contract. There is scope, of course for introducing mudarabah and musharakah bonds although these are more likely to be designated as notes since the returns will be variable rather than fixed - unlike the ijarah and salam certificates which are pre-determined. Mudarabah and musharakah bonds have, in fact, been introduced by many countries as well as the IDB. Securitisation is commonly used as a risk management tool as well as an instrument of monetisation of illiquid and untapped assets. It helps to decrease funding risks by diversifying the sources of funds. Securitisation can generate gains for both financial institutions and investors. The investors are enabled to make their investment decisions almost independently of the creditstanding of the originator and focus instead on the degree of protection provided by the SPV to meet the investment target. Ijarah-based securitisation starts with the identification of a suitable underlying asset, which must be capable of both sale and leasing. The process normally starts with the lessor/originator selling the leased asset to a special purpose vehicle (SPV). The latter then enters into a lease contract with the originator. The lease contract creates income in the form of rental payments in favour of the SPV. The SPV then issues sukuk al-ijarah that is supposed to represent an undivided proportionate ownership in favour of its holders over the leased asset. At the end of the lease period, which also signifies maturity of the Sukuk the issuer will redeem the Sukuk from the holders, effectively by buying back the underlying asset. Securitisation of ijarah gained momentum in the last few years with the issuance initially of the Malaysian Global Sukuk of USD600 million in June 2002. This was followed with the USD700 million State of Qatar Islamic Sukuk in 2003, and the USD250 million Bahrain Monetary Agency's International Sukuk Company's Ijarah Sukuk in early 2004. Saudi Arabia, Pakistan and the IDB have added to the list. In June 2004 the Department of Civil Aviation of UAE mandated the Dubai Islamic Bank to issue USD750 million Sukuk al-ijarah to raise funding for the expansion of Dubai International Airport. Indonesia is reported to be issuing “part of its planned USD2 billion in overseas bonds in 2005 in the Islamic format.” All the issues introduced so far were highly successful and well received in the Middle East, Europe and beyond. Yet the relatively low number of issues have been a restrictive factor on overall liquidity in the markets, and the situation is not helped by the fact that investors were inclined to hold on to their investments. The successful reception of ijarah bonds and its world-wide SharÊcah compliance endorsement is partly due to the fact that they avoid the somewhat controversial bayc al-dayn mode of asset securitisation. A distinction of note to be drawn is between lease-based securitisation, and debt-based securitisation, which makes the former acceptable generally whereas reservations tend to persist in the Middle East and Gulf regions over the acceptance in SharÊcah of the latter, although it is accepted in Southeast Asian countries that adhere to the ShÉfici madhhab. In a 2004 Euromoney Islamic banking and finance summit held in Kuala Lumpur, commentators confirmed that murÉbaÍah and bayc bi-thamam Éjil continued to be in focus but that Sukuk, although limited in supply and institution bound, is the most sought after product. The overall size of Islamic finance worldwide was estimated at USD250 billion and according to a subsequent Asian Wall Street Journal estimate, 270 billion comprising murÉbaÍah transactions in short-term market operations, equity-based real estate and hedge funds, retail finance products like mortgages, car financing etc, but that Islamic bonds were yet to be fully developed. It was further noted that only 20 per cent of Muslim population in GCC countries buy Islamic products. The focus in the future should be on real estate investment trust and real estate investment funds which have wider retail appeal and distribution. In her keynote address, Dr. Zeti Aziz, Governor of Central Bank Malaysia called for exploring the prospects of “creation of an Islamic Universal Bond. Interested countries and selected institutions could sell their assets to a special purpose vehicle, which, in turn, would lease back the assets to the countries. Proceeds could then be transferred to the participating countries for the general purposes of socio-economic development. In February 1988, the Fiqh Academy of the Organisation of Islamic Conference considered, at the request of delegates from Jordan, Pakistan and Malaysia, the question of Islamic investment certificates at their fourth annual plenary session held in Jeddah. The Academy held that the SharÊcah encourages documentation of contracts as stipulated in sura 2:282 of the Qur’Én: When you deal with each other in transactions involving future obligations in a fixed period of time, reduce them to writing... It is more just in the sight of God, more suitable as evidence and more convenient to prevent doubts among yourselves. The Fiqh Academy thus held in its decision number (5), 1988: Any collection of assets can be represented in a written note or bond, and the bond or note can be sold at the market price provided that the composition of the group of assets, represented by the security, consists of a majority of physical assets and financial rights, with only a minority being cash and interpersonal debts. Some of the salient features, and maslahah-oriented benefits, of ijarah and ijarah bonds may be summarised as follows: a) As already noted, ijarah bonds do not represent debt; they represent undivided ownership on the leased asset. They are as such participatory trust certificates that resemble equities. Since the Sukuk are neither debt nor monetary instruments, Islamic legal difficulties that accrue the sale of debts or money do not arise in this case. The Sukuk would, however, lose their SharÊcah compliance without a share in ownership of the asset. b) The determining factor of the cost of ijarah financing is the benchmark rate used by the lessor to assess his required return. The market reference used is the London Inter-Bank Offer Rate (LIBOR) over which a competitive premium is added. | 
