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in which the financier enters into an Istisna’a contract and pays progress payments to the construction contractor for each milestone. When the project is completed, the project company enters into a credit sale contract with the financier to make payments on an instalments basis. There is also the option of an integrated solution. The structure consist- ing of Istisna’a and Ijarah is more appropriate when sponsors or the project company want to construct the plant based on an EPC contract, EPC lump sum contract or an EPC lump sum turnkey contract. The main similarity between all these contracts is that all engineering, pro- curement and construction will be rendered by one contractor in order to ensure integrity between all the stages. In such a case, Ujrah or Ju’alah is not needed for the engineering stage, nor is Murabaha and Muajjal required for the procurement stage. The financier can put the engineering, procurement and con- struction stages into one integrated order, to be constructed by one general contractor based on Istisna’a. Immediately after the construction of the plant, it will be delivered to the project company based on Ijarah (lease purchase contract). It doesn’t matter whether both the Istisna’a and Ijarah are concluded simultaneously or whether a Memorandum of Understanding (MOU) is firstly signed be- tween project company and financier, with Istisna’a concluded between financier and general contractor. Such a MOU simply repre- sents the true intention of each party to con- clude the Ijarah contract whenever the plant is completed. If the Istisna’a and Ijarah are concluded coincidentally, the Ijarah shall be considered as Ijarah Fi-Themmah or a forward lease purchase contract. This implies that an asset is not available now but is under con- struction and therefore will be handed over to the project company as lessee whenever the construction is completed. In both cases, the financier shall be considered as the purchas- er based on the Istisna’a contract and also as a lessor under the Ijarah contract.
Another instrument which can be applied to Shariah-compliant project financing is Mush- arakah. Musharakah is a kind of partnership based on which partners join together with different contributions: work, capital, serv- ice and so on. Although both Shirkat-ul-Milk (joint ownership) and Shirkat-ul-Agh (joint venture) could be used in project finance, only Shirkat-ul-Agd is appropriate to the integrated module. Shirkat-ul-Milk could be suitable for major equipments at the procurement stage. The financier under the Musharakah contract shall be considered as the equity holder of the project company. However, in most cases the financier is reluctant to be the owner of the project during its life. Such an issue could be resolved by Diminishing Musharakah, in which the financier and the sponsors form a Special Purpose Vehicle as a joint venture. The financier undertakes to rent out their share in the SPV and the sponsors promise to purchase the financier’s share gradually.
16 GlobalIslamic Finance June 2010
In extreme cases, should the financiers not be ready to bear the ownership risks of the SPV, it is possible to combine Musharakah with Murabaha, which involves the sale of the financier’s share to the sponsor on an instal- ments basis. There are some controversial issues with respect to the suitability of Dimin- ishing Musharakah and the combination of Musharakah and Murabaha in project financ- ing. One such issue is the timing of the sale of the financier’s share to sponsors. This is- sue relates to the execution of the Murabaha leg of the transaction. Some scholars do not approve of the selling of the financier’s share until the construction of the project has been commercially completed. Other scholars be- lieve that the sale of the share could be done upon the completion of each milestone. An- other issue relates to the conclusion time of the sale of the share. On this matter, there are two different jurisprudential standpoints; one approves the conclusion of such a contract at the beginning of Musharakah and the other approves it only upon some physical progress. A third issue relates to the way through which the financier’s share should be evaluated; should it be based on market value or Net As- set Value of SPV?
We should add that some above-mentioned financing structures, such as parallel Istisna’a, are based on three entities: the fin- ancier, the project company and the contrac- tor. According to some jurisprudent points of view, it’s permissible to arrange a financing plan comprising only the financier and the project company. For example, the industrial plant could be built based on an EPC LSTK contract using Istisna’a and Ijarah Fi-Them- mah. In this situation, Istisna’a and Ijarah Fi- Themmah contracts are signed between the financier and the project company. Based on Istisna’a, the project company, as pro- curer or seller, undertakes to construct an industrial plant .. Concurrently, under Ijarah Fi-Themmah, as lessee, commits to lease it with a purchase option. On the other hand, the financier shall be considered as the pur-
9
Investors
1 8 3 2 6
Special Purpose Vehicle
7
Investment Bank
5 4
Producing
Diagram 1: Procedures of Issuing Ijarah Sukuk
Sponsors Trustee or
chaser under the Istisna’a contract and as a lessor based on the Ijarah Fi-Themmah con- tract. Since the project company isn’t a con- struction contractor and it has to subcon- tract the project, some jurists critique this structure by reasoning that it is a notional transaction that can be interpreted as Riba Evasions (usury).
The role of Sukuk in Shariah-com-
pliant project financing
In Shariah-compliant project financing, it’s also possible to securitize some of the above-mentioned structures in order to in- volve a wide range of investors, such as institutional and retail. As a result, Ju’alah Sukuk, Murabaha Sukuk, Muajjal Sukuk, Ijarah Sukuk and Istisna’a Sukuk should be considered as Shariah-compliant securities that facilitate project financing via domes- tic and international capital markets. It’s necessary, however, to mention that in con- ventional project finance, usually just 10% of project costs can be financed through is- suing bonds. It is maybe because at least a few years of profitability are required to issue public bonds in capital markets. Therefore, issuing Sukuk has a less important role in Shariah-compliant project financing in re- gards to the contribution of Islamic and con- ventional financial institutions. Diagram 1 illustrates the structure of Ijarah Al-eiqtina’a Sukuk, which could be issued for the pro- curement stage in project financing.
In this part of the article we have looked at the different features of project finance, the significance of Shariah-compliant project fi- nancing, the models and instruments used in Shariah-compliant financing, and we have begun looking at the role of sukuk in Shariah-compliant financing. In part 2 of this article will take a more in-depth look at su- kuk in Shariah project financing, as well as examine two case studies of Shariah project financing in action.
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