Islamic Finance

Investment Banking 95

to the lessee, the rent is increased by an equivalent amount. The

reimbursement obligation is set off against the additional rent so that there

is no flow of funds, resulting in the lessee (originator) bearing these costs.

The rent is usually divided into fixed rent (being the amount of the initial

purchase price) and variable rent (which will be fixed by reference to the

aggregate fixed rent that has yet to be paid using a conventional interest

rate as a benchmark for the calculation of the variable rent).^1

In many of thesesukuk, the originator has given an undertaking to

purchase back the assets if there is an event of default for the balance of all

fixed rent that has not yet been paid together with all other amounts that

may be owing under theijara.

Sukuk al-musharaka

This structure can be asharikat al-aqt(partnership or joint-venture) or a

sharikat ul-melk(co-ownership). With a sharikat al-aqt, the originator

introduces assets as its share of the partnership orjoint venture capital.

The proceeds of thesukukissue will represent the investors’ capital in the

joint venture or partnership.

The originator would normally be appointed as the manager (mudarib)of

thepartnershiporjointventureandwouldundertakeactivitiesinaccordance

with a business plan that would be part of the partnership or joint venture

agreement. Profits would be payable to the two partners, although the

manager would usually be paid an incentive fee (in effect to reduce the profit

entitlement to the investors so that they would receive what would be, in

effect, a fixed income return). There would also be a purchase undertaking

from the originator to purchase the investors’ share if there were an event

of default or at the end of the specified period of thesukuk. Depending on

the jurisdiction, the transfer of assets into and out of the partnership or joint

venture can lead to difficult tax and value added tax issues.

Sukuk al-mudaraba

This structure is of interest to originators who do not have assets that they

can easily make available for a sukuk al ijaraor sukuk al-musharaka,but

which needs finance for additional business investments or activities. A

mudarabainvolves investors (calledrabb al maal) providing funds to a

(^1) The variable rent will be calculated usually by reference to a conventional interest rate such as LIBOR.
The arguments that are currently put forward to support this practice are usually twofold: The first is a
very technical argument which is that it is possible to use any benchmark as part of a mathematical
calculation to produce the return on an Islamically compliant product. The position taken by most Shari’a
Supervisory Boards is that, provided the relevant clause is carefully drafted to provide that a return is
calculated by reference to a formula that includes an interest rate benchmark but does not say that the
return is interest, such an approach is Shari’a compliant. The better position is that the reference to an
interest rate is acceptable based on the Shari’a grounds of necessity or public need because, at present,
there is no viable Shari’a compliant alternative.