ISLAMIC PROJECT FINANCING

1. ISLAMIC PROJECT FINANCING Assoc Prof Dr Engku Rabiah Adawiah Engku Ali Ahmad Ibrahim Kulliyyah of Laws International Islamic University Malaysia rabiah@iiu.edu.my eradawiah@yahoo.com

2. Agenda • Project Financing: An Overview • Shari`ah Perspective on Project Financing • Islamic Project Financing – Instruments & Contracts • Track-record of Islamic Project Financing • Transaction Structures of Islamic Project Financing with Case Studies • Some Examples of Contemporary Islamic Project Financing • The Way Forward

3. Project Financing: An Overview • Definition: “The financing of an economic unit (i.e. project) in which the lenders look initially to the cash flows & other assets comprising the economic unit as collateral for the loan” • Project financing – focus on the financing of projects in which the financiers look to the cash flows of the project for the repayment of the financing amount • Project financing techniques – primary means for financing broad range of economic units world-wide, e.g.: power generation, oil & gas industries, mining, various infrastructure projects, manufacturing, etc.

4. Shari`ah Perspective on Project Financing • Purpose should be for Shari`ah compliant projects/ activities – Islamic project financing • Techniques & instruments – Shari`ah compliant • Conceptually • Structurally • Documentation • Modus operandi – execution & implementation • Recovery mechanisms • Cannot be a mere “debt-leverage” exercise like conventional project financing due to the Shari`ah prohibition of payment & receipt of interest (riba)

5. Syndication if needed) Bridging financing Main financing Tranches Securitization – Islamic securities BBA / Murabahah Istisna` Bay` al `inah / Tawarruq Ijarah / ijarah muntahiyah bit tamlik Ijarah mawsufah fi dhimmah Musharakah / musharakah mutanaqisah Mudarabah Islamic Project Financing – Instruments & Contracts Multi-level financing: Underlying Contracts:

6. Track-record of Islamic Project Financing • Started with only one / two instruments, e.g.: BBA & murabahah • Developed further with various other instruments, e.g.: Ijarah, istisna`, mudarabah, musharakah etc. • Latest trend: more complex, liquid & competitively priced instruments through securitization – Islamic securities • Continuous potentials for new instruments / financing structures to be developed

7. ISLAMIC FINANCING: TRANSACTION STRUCTURES

8. Basic Transaction Structure for Project Financing: Parallel Istisna` Financier Company Istisna’ 1 – deferred payment (price = cost + profit) Istisna’ 2 – progressive payment (price = cost) Note: Both istisna’ are to construct the same “project” (e.g. real estate, airport etc.) Contractor

9. Basic Transaction Structure: Istisna` Sukuk 1st Istisna’ contract (Construction Cost + Profit Margin) for deferred payment Issuer Financier Issues Istisna’ Sukuk 2nd Istisna’ contract (Construction Cost) Creates SPV Project Company (SPV)

10. Case Study: Islamic Project Financing (SKS Tanjung Bin Istisna` MTN) STEP 1:Issuer and Financier will execute an Istisna’ Purchase Agreement, under which Issuer will agree to construct and deliver & sell to the Financier a specific asset (The Asset). FINANCIER (On Behalf of Investors) STEP 2:The Istisna’ Purchase Price will be RMXXX Million and will be disbursed in one lump sum STEP 3:The Financier and Issuer will execute an Istisna’ Sale Agreement, under which the Financier will agree to construct and deliver to Issuer the asset. Delivery to Issuer will take place upon the Financier taking delivery of the Asset under the Istisna’ Purchase Agreement. 4 3 1 2 ISSUER STEP 4:The Istisna’ Sale Price will be equivalent to the aggregate of the Istisna’ Purchase Price and profit thereto. The Sale Price will be payable according to an agreed payment schedule. STEP 5:The Issuer issues the Istisna’ Bonds to evidence the future payment of the Istisna’ Sale Price • The RM5.6b SKS Power Istisna` MTN Transaction Structure

11. Lease-based Project Financing: Basic Transaction Structure Utilised to finance project costs 1 Sale of asset to financier for cash payment Company undertakes to redeem asset at the end of lease period Financier/Bank Company Financier leases back asset to company in return of rental streams (inclusive of profits) 2

12. Project Financing: Basic Transaction Structure of Sukuk Al Ijarah Company as Lessee 6. Payment of rentals 2. Lease of asset Exercise price at dissolution Sale at dissolution Dissolution Amount Periodic rental payments 3. Sukuk issuance 1. Sale & Transfer of asset Sukuk Holders (Investors) SPV Company as Owner of asset 5. Proceeds 4. Payment of Proceeds from sale of sukuk To finance projects

13. Case Study: Sukuk al Intifa` 1 Land Owner Ijarah Contract On Use of Land Developer Evidenced by Sukuk Certificates 4 Payment For Lease of Land (SAR/US$) 5 Payments For Lease Rental (SAR/US$) 3 Lease of Rights of Future Use of Units On Chosen Time Slots 2 Proceeds from Sukuk Sales SUKUK AL INTIFA’ Development Costs (SAR/US$) 6 Commercial and Hotel Complex Sukuk Investors 4 “Time Use” By Sukuk Holders 7

14. The project manager i.e. Munshaat Real Estate Projects Co. has been awarded to construct one of the six towers on waqf land adjacent to the Grand Mosque of Mecca. Issues for preliminary deliberation Financing cost of construction. Restriction on ownership of non-Saudi of real property in Mecca/Medina. As for cost of financing, the contract of forward lease (al-Ijarah al-Mawsufah fi al-Dhimmah) was adopted. To avoid the issue of non-Saudis owning the property in Mecca, the concept of time-sharing is promoted. Zam Zam Tower Sukuk Al-Intifa’

15. Basic Transaction Structure: Mudarabah Project Financing Contract of Mudarabah Profit Sharing ratio – X:Y Financier (Rabb al Mal) Company (Amil / Mudarib) Y% to rabb al mal CAPITAL Profit shared in accordance to pre-agreed proportions (X:Y) X% to mudarib Project Revenue Invests in project (e.g. real estate) Loss borne Totally by rabb al mal

16. Basic Transaction Structure: Mudarabah Sukuk Issues Mudarabah Sukuk Issues Mudarabah Sukuk Investors (Rabb al Mal) Issuer (Amil / Mudarib) Contract of Mudarabah Contract of Mudarabah Y% to rabb al mal Profit shared in accordance to pre-agreed proportions (X:Y) CAPITAL X% to mudarib Outcome of project Invests in project (real estate) Loss borne Totally by rabb al mal

17. Case Study: PG Municipal MudarabahSukuk Security Trustee Rabb al Mal 1 Sukuk Holders Profit sharing 1st Mudarabah - Invest Capital (Sukuk Proceeds) Issue Mudarabah Sukuk (rated/unrated) SPV X% Investors Y% PG Municipal (SPV) Mudarib 1 & Rabb al Mal 2 Profit 2nd Mudarabah PG Local Authority (Administrator) Profit sharing Administrator X% Investors Y% Mudarib 2 Profit from Tax Collection Manage and Administer Tax Collections

18. Basic Transaction Structure: Musharakah Project Financing Contract of Musharakah Capital contribution – X:Y Financier / Bank Company • Profit: shared according to agreed ratio or according to ratio of capital contribution • Loss shared according to ratio of capital contribution Capital X% Y% Project Revenue Invests in project (e.g. real estate)

19. Basic Transaction Structure: Musharakah Sukuk Issues Musharakah Sukuk Investors Issuer Contract of Musharakah Capital contribution – X:Y • Profit: shared according to agreed ratio or according to ratio of capital contribution • Loss shared according to ratio of capital contribution Capital X% Y% Revenue of Project Invests in Project (real estate)

20. Case Study: Assar Senari RM150m Musharakah Sukuk Company Sukuk Holders (Investors) Issue Sukuk Musyarakah 1 Invest Capital (87%) Invest Capital (13%) 1 5 Musyarakah Venture Lease completed IOT User Agreements (RMXXX Million) Owned by 2 Profit sharing (Starts 2nd Year) Trustee Company X% Investors Y% Project Manager (As Agent of Trustee) Completed IOT Construct & Lease IOT Oil Companies 3 4 Construction period 12 – 18 Months

21. Case Study: Wings FZCO Emirates as obligor Emirates as lessee Emirates as lessee Lease of New Emirates Group Headquarters Lease of New Engineering Centre Rental Rental MUSHARAKAH Exercise Price Sale of units Wings FZCO as partner Emirates as partner Land parcels valued at USD100m Proceeds: USD550m Wings FZCO Emirates • Issues Sukuk – evidence proportionate share in Musharakah d c b a • Proceeds – USD550m: used for construction of Group Headquarters & Engineering Centre Investors • Periodic Distribution Amount • Dissolution Distribution Amount

22. Case Study: Vastalux Musharakah Sukuk Active Partner Sukuk Holders (Investors) Company Musharakah Mutanaqisah 2 1 1 2 agency agency Invest Capital (90%) Invest Capital (10%) Issue Sukuk 3 2 SPV Service Contract (RMXXX Million) Profit sharing 7 Company X% Investors Y% 4 Assignment Musyarakah Venture Musyarakah Revenue (RMXXX Million) 5 4 6 Servicing Oil Companies Oil Companies • Case study of RM200m Vastalux Musyarakah Sukuk

23. SOME EXAMPLES OF CONTEMPORARY ISLAMIC PROJECT FINANCING Islamic Project Financing through Securitization Islamic Project Financing: Istisna’ Bonds Islamic Project Financing: Musharakah Sukuk Islamic Project Financing: Sukuk al Intifa’

24. Recent Islamic Project Financing viaIslamic Securities Issuances (Malaysian)

25. Recent Islamic Project Financing via Islamic Securities Issuances (Global)

26. The Way Forward… • Better, competitive & more efficient Islamic project financing instruments • Truly Syariah compliant • Transparent deals – disclosure, accounting & auditing • Global acceptance & recognition

27. Thank You Wassalamualaikum wrt wbt