Musharakah Sukuk: Asset Pool, Guarantee and Tradability
A power company plans a Rs 10 billion Musharakah Sukuk to part-finance a 200 MW plant. The SPV would contribute three assets: land valued at Rs 4 billion; a receivable of Rs 3 billion due from a state-owned power purchaser; and construction work in progress of Rs 3 billion. The term sheet says the originator guarantees a 12% annual return to Sukuk holders and will repurchase the Musharakah units at face value at maturity. The lead arranger calls the guarantee 'liquidity support' and says the structure is standard. The Sukuk is intended to be listed and traded on the Pakistan Stock Exchange. The Shariah Advisor must opine before the offering. The originator's finance director argues that without the guarantee the Sukuk will not be rated investment grade and will not sell.
1. Identify the Shariah issues in the proposed asset pool and the guarantee/repurchase arrangement.
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Asset pool.
- Land: tangible and generally acceptable.
- Receivable from the power purchaser: this is a debt. Debt may be sold at face value but cannot be traded at a premium or discount. A pool containing debt is not fully tradable; the debt portion must be limited and handled separately.
- Construction work in progress: this is not an existing tangible asset. Sukuk holders cannot own something that does not yet exist in the required form. Istisna or a forward construction structure may be needed.
Guarantee of 12%. A guarantee by the originator of a fixed annual return shifts the investment risk back to the originator and converts the return into a predetermined payment. That is the substance of Riba. Calling it liquidity support does not change the analysis; the guarantee covers the return, not merely temporary cash timing.
Repurchase at face value. A purchase undertaking can be used to return capital, but a fixed face-value repurchase that effectively guarantees principal and profit is contested. It must not be used to guarantee a profit; pricing should be at market value or a defined formula, and the Shariah Advisor must review it.
Conclusion. The structure as term-sheeted is not Shariah-compliant.
2. Propose a compliant structure and the conditions under which the Sukuk could be traded.
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Structure.
- True sale. The originator sells identified, existing tangible assets (land and, once completed, the plant) to the SPV. The sale must be genuine, with ownership risk passing to the SPV.
- Musharakah or Ijarah. Sukuk holders own the assets through the SPV and lease them to the originator or share in the project's profit and loss. Returns must be contingent on performance.
- Construction phase. Use Istisna or a combined Istisna-Ijarah structure so that construction is funded and the asset comes into existence before it is leased. Do not sell work in progress as if it were a finished asset.
- Receivables. Keep the debt portion ring-fenced and non-tradable, or hold it to maturity. Do not include it in a tradable pool beyond the permitted limit.
- No fixed guarantee. Replace the 12% guarantee with a market-based return. Any liquidity support must be limited to temporary cash advances and must not guarantee profit.
- Purchase undertaking. Price it at market value or a formula tied to the asset value, not at face value plus accrued profit.
Tradability. The Sukuk can be listed and traded only if the underlying pool is predominantly tangible assets or usufruct. If the pool is debt-heavy, it must be held to maturity.
Judgement. The structure can be made compliant, but it will not offer a guaranteed 12% return.
3. What should the Shariah Advisor's opinion and the regulatory approval process look like?
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Shariah Advisor's opinion. The opinion should:
- Identify each asset and state whether it is tangible, usufruct or debt.
- Confirm the true sale and the transfer of ownership risk.
- Reject the fixed 12% guarantee and the face-value repurchase as drafted.
- Approve the revised structure, with conditions on the debt portion, the construction phase and the purchase undertaking.
- Require ongoing Shariah audit and annual certification.
Regulatory process. The Sukuk will require approval from the securities regulator, and the bank or institutions distributing it will need their own Shariah governance approvals. The offering document must disclose the structure, the assets, the risks and the Shariah approvals. Marketing must not describe the Sukuk as a guaranteed fixed-return investment.
Handling the finance director. The Shariah Advisor should explain that a credit rating can be supported by the originator's obligations as lessee or purchaser at market value, by escrow arrangements and by the quality of the assets, but not by a guarantee of profit. If the issue cannot sell without a guarantee, the product is not a Sukuk; it is a conventional bond with Islamic labels.
Judgement. The Advisor should not approve the term sheet. Approving it would compromise the certification and mislead investors.