ISLAMIC private debt securities (IPDS) have been playing a key role in the Malaysian capital market since the last decade.
Billions of ringgit have since been raised for companies and agencies, both public and private.
The essence of IPDS is that they come out of a chain of transactions that create the underlying debt which is the
subject matter of the process.In the conventional mode what is securitised is debt owned by an issuing company. This debt normally generates
interest given the very nature of conventional lending.
In Islamic finance, however, any income generated through interest payment via lending or credit activities is not
recognised as it is pure riba’ (usury).
So, when IPDS were first created, a condition was made that before a debt can be sold or negotiated, there must be an underlying contract of sale and purchase involving real tangible assets at the beginning of the process.This transaction normally contains a delayed payment element in it so that a debt is created.
This is the debt that will later become the focus of the intended securitisation. It is more likely that another concept, bai’ al-inah, is also used in creating IPDS.Bai’ al-inah allows sale and buy-back transactions so that an earlier sale of assets would produce a cheaper price
compared to the price tag for the subsequent sale. As a result the first buyer, normally a financier, would pay in cash the purchase price of the asset, say RM100mil, and immediately sell the same asset to the first party, normally a customer, for RM210mil payable in instalments for five years.The whole process involves a number of inter-related transactions:1) Normal sale and purchase contract (al-bai’), when the customer sold his assets to the financier in the first transaction the sale price was RM100mil.
2) Buy-back transaction that occurred immediately after the first transaction, which cost RM210mil. The buy-back and normal sale areknown together as Bai’ al-inah.
3) The payment for the buy-back transaction is delayed through the instalment mechanism known in Islam as bithaman ajil or deferred payment.
4) The debt as oed by the customer as a result of the buy-back transaction will then be sold as securities accompanied by a certificate or note.
5) When this debt is sold as securities another concept is used – bai’ al-dayn or sale of debt.
As seen from the above, there is a fine distinction between a conventional bond and an Islamic security.
In the conventional sense, a bond is a debt instrument whereby the issuer will pay a certain percentage of interest to the buyer of the issued bond, or if it is a zero coupon bond, it will be issued at discount and repaid in full at maturity.Bond holders will receive the proceeds in the form of interest.
In contrast, the debt created in the IPDS transaction is an unpaid purchase price owed by the customer to the financer.
Such a debt is not a result of a money-lending process as there was no such activity.Moneylending is known in Islamic finance as al-Qard.
In the final analysis, the customer owes no more than the amount of money payable in the future, which in the example given is five years.
To international Muslim jurists, particularly those in the Middle East, given the fact that what is owed is actually sums of money, this debt is subject to rules applicable to sale and purchase of money in Islamic commercial law, one of which says that money can only be exchanged at par if they are of a similar type (for example, ringgit to ringgit).
They said even if the underlying debt (which was later securitised) was not the result of a moneylending transaction (qard), the question of riba’ arises if it was sold not at par value, for example a debt of RM100mil was sold at a discount for RM90mil or at a premium for RM120mil.
In the capital market, practically no one will buy a debt instrument at par.
Hence, according to the jurists, although Islamic debt securities were created out of the buying and selling of tangible assets, their sale in the capital market is not free from riba’ because they are sold not at par value as required by Islamic law.
This is the essence of the difference in opinion between them and Malaysian syariah advisers, who sanction IPDS based on the bai’ al-dayn principle.To Malaysian advisers, a debt created out of the actual sale and purchase of tangible assets will automatically transform into an asset of a special category, for example, financial asset (a term normally used in the conventional sense by financial institutions to mean an interest-paying debt owned by them) and thus allowed to be sold and bought at whatever price it might fetch since it is already an asset.To the international Muslim jurists such an asset is more of a future monetary claim.So, the law that governs it is similar to the rules that govern the exchange of money of similar type.
Their objection here is in addition to another reservation they have on the validity of bai’ al-inah as employed by Malaysian instruments.
The ongoing doubt about the legality of our IPDS, at least in the scrutiny of international investors, has somehow hampered our penetration into the international Islamic capital market which is a bit conservative in the approach to the permissibility of Islamic instruments.
This became very clear when Malaysia successfully marketed its global sovereign Islamic bond in US dollars.
The Malaysian Global Sukuk, although containing an element of floating rate, thanks to not being a debt-based security, was oversubscribed.
It used ijarah (leasing of physical assets) as an underlying transaction.
So the key to our future success in the Islamic capital market sector lies in our ability to create more non-debt Islamic securities that will satisfy our international investors.
The review of legal and tax regulatory aspects should come hand in hand with continuous research and development in the product development.