Partnership Sukuk

Fareiny Morni

 

 

Partnership sukuk are sukuk structures that are based on the two partnership contracts; mudharabah (profit-sharing) and Musharakah (profit-and-loss sharing). These two sukuk structures were designed in a similar manner to the business contracts that was widely practiced during the time of the Prophet Muhammad p.b.u.h. It was narrated that Prophet Muhammad p.b.u.h. himself had ventured into a mudharabah partnership with Sayyidatina Khadijah a.s. before his prophethood.

Essentially, three elements must be in existence for a partnership contract to be valid. These elements are: (1) Partners; (2) Capital Contribution along with Profit and Loss Sharing Ratio; and (3) Offer and Acceptance. Table 1 depicts a comparison between mudharabah and Musharakah partnership.

 

Table 1A Comparison between Mudharabah and Musharakah Partnership

 

 

Musharakah

Mudharabah

Role of Partners

Partners equally contribute capital and effort/ work into the enterprise.

One party provides capital while the other party contributes the effort/ work into the enterprise.

Capital Contribution

All partners are required to contribute capital into the enterprise. Capital can be in monetary terms or in kind.

Only one party i.e. the capital provider or rabbul-mal, contributes capital into the enterprise.

Work Contribution

All partners may contribute their efforts/ work into the enterprise together, or one partner may be appointed as the agent to the other partners.

Only one party i.e. the entrepreneur or mudharib, contributes effort/ work into the enterprise.

Profit Dissemination

Profit-sharing ratio need not be based on capital contribution and must be agreed upon at the beginning of the contract.

Profit-sharing ratio is pre-determined, at the commencement of the contract.

Loss Sharing

Loss is distributed based on capital contribution.

Loss is borne by the capital provider. The entrepreneur’s loss is considered to be due to fruitless efforts.

 

As a sukuk instrument, a partnership sukuk is usually designed in two ways: (1) Sukuk investors become a partner with the sukuk issuer; or (2) Sukuk investors form a partnership among each other and appoint the sukuk issuer as their agent/ representative to oversee the underlying project which the sukuk is created for. Mudharabah or Musharakah partnership can be utilized in both circumstances.

 

An Examination of the Mudharabah and Musharakah Sukuk Structure

In a mudharabah sukuk, most often sukuk investors become the capital provider while the sukuk issuer is the entrepreneur. The sukuk issuer utilizes the funds which were contributed by sukuk investors into various projects which are outlined in the sukuk prospectus. Profits are distributed accordingly between sukuk investors and issuer – in most mudharabah sukuk it is usually 1:99 where the sukuk issuer agrees to 1 per cent of the share of profits and sukuk investors are allocated the remaining 99 per cent of the profits. To ensure an uninterrupted stream of profits from the sukuk, it is permitted for the sukuk issuer to create two reserve accounts – one is to meet the profit distribution schedule while the other is to meet capital repayment at the end of the sukuk period.

 

Meanwhile for Musharakah sukuk, in majority of the issuances, sukuk investors form a partnership among themselves and appoint the sukuk issuer to conduct/ manage the enterprise on their behalf. Hence profit is only shared among the sukuk investors (the profit-sharing ratio is undisclosed in the sukuk documents but it can be presumed that profit is distributed based on the percentage of capital contribution). Losses are deducted from the pool of capital and is shared based on a percentage of capital contribution. The sukuk issuer is paid a fee for their services.

Sukuk documents also reveal that there are several elements in the design of partnership sukuk to be similar to conventional bonds. Among them are:

(1) majority of the partnership sukuk profits are disseminated semi-annually, similar to the disbursement of coupon payments by conventional bonds;

(2) a number of sukuk documents have disclosed expected profit rates which the sukuk investors will receive and included a clause that any return above the expected profit rates are to be returned to the sukuk issuer;

(3) sukuk capital is repaid based on face value i.e. at the end of the partnership, the partners’ capital will be returned as according to the contribution that they had made;

(4) sukuk is rated in a similar manner to bond rating; and

(5) the sukuk structure provides for several reserve accounts to ensure that the profit/ income stream and capital repayment received by sukuk investors are regular.

This practice is similar to income smoothing in Islamic financial institutions (IFIs) where reserve accounts are set up to ensure that the IFIs are able to meet their obligations when it becomes due.

 

Moving Forward

For now, the interest in partnership sukuk has been limited, and this could be attributed to the instrument being perceived as higher risk compared to other sukuk structures. Recently, the introduction of hybrid partnership structures has renewed the interest in partnership sukuk.These hybrid structures are essentially partnership sukuk combined with another financial contract such as ijarah, murabahah, musawamah and many others. The development in hybrid sukuk shows the versatility of the sukuk market and adaptability of the partnership contract as a flexible financial instrument which can be designed to suit the needs of the sukuk investor. In recent years, there have been more partnership sukuk that are issued based on the hybrid structure compared to the traditional mudharabah or Musharakah structure.

In conclusion, there is a need for the instrument to be improved. Sukuk issuers should explore other avenues that can enhance performance of partnership sukuk and reduce its overall risk compared to other sukuk structures but also distinguish the instrument against other sukuk contracts.

* A study based on the Malaysian experience. For instance Sukuk capital repayment is based on face value in the case of Malaysia as permitted by the Securities Commission, but not as per AAOIFI standards.

 

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