UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance

Archive for Muqaradah Bonds

Project Finance and Raising Equity Capital in Islamic Finance: Al-Muqaradah Bonds

Is Islamic finance debt slavery in another form?  I would have to argue that Islamic finance in its true form does not constitute debt slavery, however, if instruments and products are developed in a manner which are not in conformity with the Sharia’h, then we may witness the emergence of a morphed version of Islamic finance based on misinterpretation of Islamic principles, which if left unregulated, may continue to cement us in a form of debt slavery whereby the powerful continue to enslave the masses in invisible chains of debt incarceration.  It’s time to break free from prison.  The answer lies in developing the Islamic finance industry in the correct manner with the proper regulation and dispute resolution mechanisms.  Otherwise, Islamic finance will be unknowingly harnessed by the powerful elite which currently oppress the masses and mold the world economy to fit their own needs through the Bretton-Woods institutions and system and this elite class will then distort and misuse Islamic finance to continue their same agenda under an ethical guise.  Who or what is protecting the Islamic finance industry from this clandestine project?

A Muqaradah bond is an Islamic bond in which no interest is earned but whose market value varies with expected profits.  (A) The term is based on the conclusion of lawful Muqaradah with capital on one hand and labor on the other.  The shares of profit are mutually determined by the parties beforehand by a definite proportion of the total.  (B, 72)  It is called a bond because it is terminal in nature…its maturity is determined by the tenure or project completion date.  (A)

In essence, the Muqaradah bond is a financial instrument with the purpose of raising equity capital to finance a project or business.  The unit price is determined by dividing the Muqaradah capital by the number of units issued.  It is registered under the bondholder’s name (recorded bonds) all of which represent the common asset in the Muqaradah capital.  (B, 73)

Mudharabah is another name for the Muqaradah Bonds.  (B, 74) The Mudharabah concept involves a process whereby the financiers purchase raw materials and equipment from the supplier.  The goods are then sold to the customers at a mark-up price.  In fact, the Muqaradah certificate is an investment instrument arising from a valid Mudharabah contract that evidences the rights and ownership of the Rah al-mal (owner of the capital) over the capital invested in the project.  (B, 74)

Muqaradah Sukuk Bonds (MSB)

A Muqaradah Sukuk Bond (MSB) represents common ownership and entitles the bondholders shares in the specific project in which the bonds have been issued for.  The duration of this ownership is limited to the duration of the specific project or business on which the Muqaradah is based.  On the ownership of the Muqaradah bond, a bondholder is entitled to all the rights as specified in the Sharia’h in the matter of sale, gift, mortgage, succession, and other matters.  (A)

The contract (‘aqd) in Muqaradah Sukuk Bond is based on the official notice of bonds sale, mainly the Prospectus.  Subscription of the bonds is considered the ‘offer’ from the investor and the approval of the issuer is regarded as the ‘acceptance’ in the formation of the Muqaradah contract.  The official notice of sale must contain the conditions which are required by Sharia’h in Muqaradah (Mudharaba) ‘aqd’ contracts as well as clear information concerning the capital and the proportion and distribution of profits between the investors and the issuer in accordance with Sharia’h rules.  (A) The issuer and the investors of the Muqaradah bond are bound by the Sharia’h.

Upon the expiry of the specified time period of the MSB, the bondholder has the right to transfer the ownership of the bond by sale or trade in the securities market as long as this has been agreed by the issuer or mudarib and is specified in the contract.

Disposal or Sale

  1. After the subscription period is over and before the operation of the specific project, if the Muqaradah capital is still in the form of money, the trading of bonds would be based on the exchange of money for money and therefore must satisfy the rules of sarf. http://wiki.islamicfinance.de/index.php/Sarf
  2. If the Muqaradah capital is still in the form of debt, the trading of bonds must be based on the principle of Islamic debt trading or exchange: debt for debt.
  3. If the Muqaradah capital is in the form of money, debt, assets and benefits, the trading of bonds must be based on the market price evolved by mutual consent.  (A)

Distribution of Profits

The profits realized from such investment should be distributed between the investors and the issuer according to the Muqaradah agreement.  (B, 74)  In the distribution of profits, factors need to be taken into account such as the ratio of the  issuer’s share with the investor’s share together with the ratio of the investors’ and  issuer’s ownership of the assets in accordance with his or her participation to the total value of the company or project assets.

In the Muqaradah Sukuk Bond instrument, it is not permissible to guarantee the investor a fixed lump- sum profit amount.  (B, 73) However, there are scholars who purport that it is permissible to provide, for example, that for the first RM1 million (Malaysian currency), the sum can be allocated in preference to one party and the balance to the other party.

Other scholars purport that where the investors agree that if the profit is over a particular ceiling, then one of the parties may take the additional profit.  Several scholars also advocate that if the profit is below or equal to the amount of the ceiling, then the distribution of profit may be in accordance with a pre-determined ratio as specified in the transaction agreement.

It is important to note that Muqaradah bond ratings represent the probability of realizing expected returns rather than the ability to meet scheduled payments as there is no predetermined profit to be paid at agreed intervals.  (B, 74)

 

The Mudarib

 

The issuer in a Muqaradah bond is regarded as the depository of the common fund and the project assets are entrusted to him or her to administer similar to the common law concept of a trustee. (mudarib)  In Muqaradah, the mudarib is held to similar standards of a trustee in the common law.  For example, any act of negligence or dishonesty committed by the mudarib shall render him or her liable for losses.  The issuer has the right to purchase bonds offered for sale by other according to the prices declared from time to time by the issuer similar to the common law concept of a right of first redemption.  (B,73)

  1. The mudarib realizes profit from his or her investment in Muqaradah bonds according to a pre-determined ratio with the investors according to the agreement.
  2. Mudaribs share with the investors the ownership of the project assets in a ratio according to his or her participation to the total value of the company/project assets.
  3. It is not permissible to guarantee a fixed lump sum amount of profits.
  4. The mudarib has the right to purchase bonds offered for sale by others according to the prices declared from time to time by the mudarib.
  5. The mudarib is considered as the depositary of the common fund and the project assets entrusted to him or her.  If he or she is negligent or has committed dishonesty leading to losses, he or she shall be liable for the losses.  (A)

Guarantee of Muqaradah Bonds

 

A third party guarantor may guarantee to compensate any losses sustained in the project.   However, such guarantee must be concluded in a separate contract from the main contract.  The issuer is not permitted to guarantee the capital of the Muqaradah itself as this would amount to a situation where the investor would not bear any loss in the value of the bonds.  Furthermore in this structure, the issuer cannot guarantee the investor a fixed amount paid as profit.  On the other hand, it is permissible for both the issuer and the investor to agree to put aside a pre-agreed portion of the profits as reserves in order to provide protection or to meet any losses which may arise during the project.  (B, 74)

  1. It is permissible for a third party to promise to compensate any losses sustained in the project.  However, this guarantee should be concluded in a separate contract and not included in the main contract of the Muqaradah bond between the issuer and the investor.
  2. It is not permissible for the issuer to guarantee the capital of the Muqaradah (the investor would not bear any loss in the value of the bonds) or to guarantee the investor a fixed amount paid as profit.
  3. It is permissible for the issuer and the investor to agree to put aside a specific or certain portion of the profit as reserves in order to provide for protection or to meet any losses arising during the implementation of the project. (A)

Muqaradah bonds do not need any form of securitization since the Muqaradah bond is a genuine asset.  The sale of Muqaradah bonds to the investors is also free from any discounting mechanism as the need for discounting no longer exists as the value of the bond depends on company performance rather than movement in interest rates.  Thus, when investors wish to dispose the Muqaradah bonds before maturity, the investors may do so on the basis of project performance which implies that the bonds can be sold at below or above face value. (A)

Muqaradah bonds provide an alternative to interest-bearing financial instrument.  There are many Islamic finance instruments in existence today which may allow interest in other forms or do not comply with Sharia’h rulings.  Unfortunately, the proliferation of such instruments is jeopardizing the success of the Islamic finance industry.  (A)  A pure Islamic financial system would contain a set of rules and regulations governed strictly by Sharia’h principles which would not give an opportunity for usurious financial instruments such as debt related bonds to evolve.  (B, 72)  What is it about the current Islamic finance industry which is allowing this virus to infect the industry?  A closer examination may be needed in order to detect the problem and the solution.

If the Islamic finance industry is to evolve in its true form, practitioners must develop financial instruments which adhere to Sharia’h rules such as the Muqaradah bond and expel all usurious financial instruments currently in use today.  (A)  Furthermore, solid and reliable regulation and dispute resolution mechanisms must be put in place in order to secure the future evolution of the Islamic finance industry in its pure form.

Al-Muqaradah Bonds as the Basis of Profit-Sharing by Walid Khayrullah

http://www.irti.org/irj/go/km/docs/documents/IDBDevelopments/Internet/English/IRTI/CM/downloads/IES_Articles/Vol%201-2..Walid%20Khayrullah..AL-Muqaradah%20Bonds..dp.pdf

End Notes:

A. International Journal of Islamic Financial Services Vol. 1 and No. 2. (1992)

B. Law and Practice of Islamic Banking and Finance by Dr. Nik Norzrul Thani; Mohamed Ridza Mohamed Abdullah; and Megat Hizaini Hassan. (2003)

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