Sukuk structured using sharecropping participation contracts generally result in a debt. For that reason, the majority of Shariah scholars impose strong limitations on their trading.

Their concern relates to the neglect of important procedural steps during the structuring stage, the consequence being that investors purchase a discounted debt instead of an asset. Murabahah, Istisna and Tawarruq Sukuk are generally considered to be debt-based.

Murabahah has been the workhorse of Islamic finance and its applications of Murabahah have been very distinct between Malaysia and the GCC, with four major approaches to the concept being applied:
• Business, consumer and trade
finance by installment sales
• Metals and commodities buying
and selling
• Working capital by Bai al Inah
• Working capital by Tawarruq

All of these methods result in a debt, which is generally not viewed as tradable. Nonetheless, the approach in Malaysia has been to build the Islamic financial system in an evolutionary manner since the Islamic Banking Act of 1983 came into force.
The application of Bai al Dayn, or the selling of debts, as approved by Malaysian scholars means that the tools used have allowed for a strong similarity to traditional banking practices. Although challenged by Shariah scholars elsewhere, the approach has been thoroughly researched by the Malaysian ulama. More critically, many of the other approaches pursued in Malaysia have either set the global standard or are similar to AAOIFI (Accounting and Auditing Organization for Islamic Financial Institutions) standards.

Bai al Dayn is defined as the sale of a debt arising from trade and services transactions in the form of a deferred payment sale. The Malaysian Shariah analysis of debt results in a hybridized understanding of debt as something akin to both a true asset-backed security and a traditional bond.

Eligibility in Bai al Dayn programs requires the debt to come from a permissible Islamic contract as defined by the Shariah Advisory Council of the Securities Commission Malaysia (SC).

This contract must represent the transacting of a permissible property being sold or used or constructed. The target contract and debt result in a crystallized debt once the initiation and completion of the contract have taken place, that is, the deal is closed, the object transferred and money is due.

From the Malaysian perspective, Bai al Dayn generates an Islamic promissory note, which is an affirmation of debt and tradable instrument. The note is negotiable and when traded is understood to carry the underlying contract, and may be sold at either a discount or premium to par. They do not bear a coupon although there are profits paid in installments.

In contrast, a majority of opinions elsewhere views that a negotiable instrument must attach to the ownership of real assets based upon an underlying Shariah-permissible contract. Therefore, the difference of Shariah analysis turns on the view of what may be traded: the asset or its related obligations.

According to the Shape Financial Report The Sukuk Market, 1Q 2008, Bai Bithaman Ajil (BBA), which is a debt or Dayn instrument, was the most popular Malaysian Sukuk issued until 2007. Other than BBA, there have been other debt instruments applied in the Malaysian market. These include government investment issue (GII), Islamic accepted bills or green bankers acceptances, sale and buy-back agreement based on Bai al-Inah structure, negotiable Islamic debt certificate (NIDC), Murabahah notes issuance facility and Cagamas Mudarabah and Musharakah bonds.

Nonetheless, the Malaysian market has pioneered a number of alternative instruments including Ijarah Sukuk, Istisna Sukuk, Mudarabah Sukuk and Musharakah Sukuk. When one considers some of these products, it is worth comparing them to the AAOIFI investment Sukuk standards (Table 1). It is worth mentioning that two key debt tools traded in the domestic market are Murabahah and Istisna or debts arising from them, amidst the rapid evolution of the Malaysian system to introduce new non-debt instruments.

Murabahah Sukuk
Murabahah certificates are of equal value, issued for the purpose of financing the purchase of goods through Murabahah so that the certificate holders become the owners of the Murabahah commodity. Murabahah Sukuk refers to a securities issuance where the underlying transaction between the issuer and the obligor is a sale then purchase of an asset at a mark-up.

In Malaysia, the Islamic commercial paper and medium-term note program are usually structured under Murabahah notes issuance facilities (MuNIF), while the longer tenured programs are usually structured under Bai Bithaman Ajil with Islamic debt securities (BaIDS).

The market utilizes MuNIF for short-term maturities, while it uses BaIDS for long-term issues. This is, however, a market convention and not required under the Shariah.

Murabahah Sukuk was popular when the Sukuk market in Malaysia began developing in the early 2000s. Since 2006, rapid changes in the structures applied saw the phasing-out of Murabahah-based Sukuk and its replacement by alternative methods such as ijarah, Mudarabah and Musharakah. Interestingly, Tawarruq-based Sukuk are applied outside Malaysia. Nonetheless, these Sukuk represent a large universe of currently outstanding Sukuk, and we will now review the three main applications of Murabahah Sukuk.

Model I: Murabahah Sukuk for asset acquisition
Assuming a steel manufacturer would like to buy iron in bulk from a supplier to fulfill pending sales orders, as the purchase involves a large amount of cash, the company would like to tap into the capital markets instead of bank financing.

This may enable the company to secure a longer payment period or to lock in terms and conditions in a manner that may not be possible with a bank syndicate. Figure 1 depicts the structure of Murabahah Sukuk.

When the SPV (special purpose vehicle) has sold the asset to the company, the Sukuk represents a receivable of the selling price. A receivable is viewed by a majority of Shariah scholars as a claim on money. Thus, from the AAOIFI perspective, Murabahah Sukuk should not be traded freely in the secondary market as the exchange of receivables (money) with payment from another party (same type of money) could be done only at par value.

The Malaysian scholars, however, adopt a different view of debt trading. This concept is based on Bai al Dayn, in which receivables are a distinct asset category eligible for trading at a discount. This approach has enabled secondary trading of Murabahah Sukuk in the Malaysian domestic market.

Model II: Two-party Murabahah Sukuk
In the second method, instead of buying an asset from a third party (supplier/dealer), the SPV buys an asset from the company itself at the time of issuance. The SPV then sells the same asset back to the company at a higher deferred price. This structure, known as Bai al Inah, is practiced in Malaysia.

Model III: Murabahah Sukuk – Tawarruq
As the Bai al Inah structure is not accepted outside Malaysia, bankers in the Gulf countries have applied Tawarruq, calling it Murabahah Sukuk. In Tawarruq, instead of buying and selling between two parties, the arranger acts as a wakeel or purchasing and selling agent to trade commodities on behalf of the issuer. The steps are:
1. The issuer appoints the arranger as its wakeel to trade commodities.
2. The issuer undertakes to buy from the wakeel whatever the wakeel buys as agent of the issuer.
3. The wakeel, buys a commodity on behalf of the issuer from a broker on a spot basis. The issuer is now obliged to pay for it, and does so on a deferred basis at a marked-up price – the Murabahah transaction.
4. The wakeel then sells the commodity to another broker. This generates cash proceeds which are paid to the issuer for the sale of the issuer’s commodity.

In the mid-2000s, several Sukuk were issued in the GCC on this basis, whereby the wakeel was an SPV operating on behalf of the investors to buy and sell commodities with the obligor. As such a method results in a debt and the Sukuk are not tradable, the approach has fallen out of favor. Therefore, most Tawarruq transactions are syndicated.

Conclusion
In summary, Murabahah Sukuk may be structured to facilitate a true asset acquisition transaction for companies. In such a case, the company is truly interested to own the asset which is the object of the sale. Yet, most Murabahah Sukuk are simply a means to provide the cash to a company or sovereign.

The second approach is achieved either via Bai al Inah (in Malaysia) or Tawarruq (in the Middle East). Nonetheless, in all the structures, the Sukuk ultimately represents a receivable arising from a permissible sales transaction under the relevant Shariah jurisdiction.

Thus, Murabahah Sukuk are generally not tradable in the secondary market, except in Malaysia.

The article is an excerpt of Sukuk, which is the first volume in the Islamic Capital Market Series by the Securities Commission Malaysia, now available in the market.