Sukuk Issuance by Public Sector – A Case Study on WAPDA GoP (Government of Pakistan) Ijarah Sukuk Submitted By Mohsin Ali 1100345 Submitted To Dr. Mohd Pisal Zainal Date of Submission: November 20th, 2011 Semester: September – December 2011 Islamic Financial Institutions & Markets IB 1004 Contents 1.0 Introduction 2.0 What Sukuk are? 2.1 Sukuk al-Ijarah 3.0 Sukuk Overview – International 4.0 Sukuk Overview – Pakistan 5.0 WAPDA GoP (Government of Pakistan) Ijarah Sukuk 5.1 The Company 5.2 Ownership and Management 5.3 Power Generation by WAPDA: 5.4 Transaction Background 5.5 Pronouncement 5.6 Key Terms & Conditions 5.7 Structure of Transaction: 5.8 Critical Success Factors 5.9 Financial Analysis 5.10 Risk Analysis 6.0 Conclusion 7.0 Refrences Sukuk Issuance by Public Sector – A Case Study on WAPDA GoP (Government of Pakistan) Ijarah Sukuk 1.0 Introduction The growth of Islamic banking and finance has gained momentum during the last decade, particularly in the areas of Sukuk and securitization. In addition to a large number of products for retail banking and investment instruments, securitization in the framework of the Islamic finance industry has developed a lot of momentum. While Shirkah-based instruments of investment like Mudarabah certificates and participation term certificates (PTCs) have been in use since the early 1980s, local currency instruments/Sukuk based on modes other than Shirkah have been issued since 1992. The first issue of dollar-denominated Sukuk of $600 million was offered in Malaysia in 2002. This was followed by the launching of $400 million Solidarity Trust Sukuk of the Islamic Development Bank in September 2003. Since then, about forty sovereign and corporate Sukuk issues have been offered in Bahrain, Malaysia, Saudi Arabia, Qatar, UAE, the UK, Germany, Pakistan, Indonesia, The Philippines and a number of other countries. Prominent Sukuk issues include PCFC’s’s Sukuk of USD 3.5 billion to help fund DP World’s acquisition of the UK’s P&O, $3.52 billion Sukuk offered by Nakheel, the property arm of Dubai’s DP World, and Pakistan’s sovereign Sukuk of $600 million. Sukuk are gaining popularity as an alternative source of funding, particularly for sovereigns and corporate bodies. Their growth has been fuelled by strong demand in the global capital market for Shariah-compliant instruments. Sukuk have taken a crucial position among the instruments of Islamic capital markets by providing an alternative to conventional fixed income securities issued for funding large developmental and capital expenditures of the big entities and facilitating IFIs and investors in managing liquidity with profitability. That is why the governments of Muslim countries tend to finance large projects through Sukuk, same is the case of Pakistan. GoP (Government of Pakistan) has issued many successful Sukuks since 2005 to finance large developmental projects including construction of Highway by NHA, construction of Mangla Dam and hydel power projects by WAPDA, National Industrial Parks Development and Management Company sukuk, Karachi Shipyard & Engineering Works Limited Sukuk etc. Here in this case study I will discuss Sukuk issued for hydel power projects by WAPDA (Water and Power Development Authority), starting from defining Sukuk. 2.0 What SUKUK are? Sukuk are called Investment sukuk and defined as“certificates of equal value representing undivided shares in ownership of tangible assets, usufruct and services or ( in the ownership of ) the assets of particular projects or special investment activity, however, this is true after receipt of the value of the sukuk , the closing of subscription and the employment of funds received for the purpose for which the sukuk were issued” Shari’a Standards, 1424-5H/2003-4 Accounting and Auditing Organization for Islamic Financial Institutions, p298. The standard mentions that the sukuk have been designated as Investment sukuk in order to delineate them from shares and bonds. In simple terms, sukuk are entitlement scrips with each suk representing a fractional ownership in a an underlying asset or project, which may be an investment project like a motorway project, or a property development project or a collection of underlying assets (e.g. real assets like a factory’s inventory or vehicles held under Ijara’h scheme of financial institutions). Sukuks can be issued with different underlying contracts including Musharakah, Mudarabah, Istisna, Salam, Ijarah etc. But here as my focus is on WAPDA GoP Ijarah Sukuk, so I will only discuss Ijarah Sukuk. 2.1 Sukuk Al Ijara’h are Investment sukuk in which the underlying asset contracts are based on the principle of Ijara’h. More specifically, they are investment certificates representing ownership in leased assets or ownership rights in lease rentals. In the words of The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) “Certificates of ownership in leased assets” are, “… certificates of equal value issued either by the owner of a leased asset or a tangible asset to be leased by promise, or they are issued by a financial intermediary acting on behalf of the owner with the aim of selling the assets and recovering its value through subscription so that the holders of the certificates becomes owners of the assets.” Another type of Sukuk Al-Ijara’h is described as “Certificates of ownership of usufruct of existing assets”. It represents an existing owner of assets’ issuance of rights (lease certificates) to lease (let) the assets. Hence the usufruct rights of the underlying assets gets transferred to the holders of the certificates, who can then sub-let them in return for Ijara’h rent. Hence the owners of the certificates (Sukuk Al-Ijara’h) become the owners of the usufruct of the assets, of the duration of the sukuk issue. They are issued for the sake of leasing out tangible future assets and rental collection from the subscription revenue. Another type, described as certificates of ownership of services of a specified party can also be issued in this category of Sukuk Al- Ijarah. 3.0 Sukuk Overview – International Today, the global Sukuk issuance, denominated in international currencies, is estimated to be $48 billion. If domestic sukuk issuance is included, it has now exceeded $149 billion. Although the size of the market may seem modest by global standards, the sukuk market has been registering an average growth of 30% per annum. High levels of surplus savings and reserves in Asia and Gulf region has further boosted demand for Sukuks. Asia has a savings rate which is higher than any other region in the world and is expected to remain between 30 and 40 per cent of GDP for many years to come. The Middle East and in Asia, two of the fastest growing regions in the global economy are expected to spend $500 billion and $1 trillion respectively on infrastructure over the next five years — Islamic capital market, in particular the sukuk market, will serve as an important avenue to meet these funding requirements. 4.0 Sukuk Overview – Pakistan In Pakistan, the first Islamic Sukuk was issued in 2002 when Sitara Chemicals Industries issued its MTFC. However, the market really started in FY 2005 and since then Sukuks worth at least Rs. 300 billion has been issued or are in the process of issuance. Market is growing at a very healthy rate as large corporates and conglomerates such as WAPDA, Engro Chemicals, PEL, EDEN Developers, Maple Leaf Cement, etc are using Sukuk to fund their requirements. In Pakistan Islamic banks IBs, like their conventional rivals, have also been investing heavily in the government papers, avoiding taking risks involved in advancing credit to the private sector. Investment of IBs continued to rise during this quarter and reached to Rs. 231 billion registering a growth of 19 percent. This rise in investment is lead by rise in investment in federal government securities mainly due to availability of GoP Ijara Sukuk; government issued more than 45 billion Sukuk during the quarter under review. With the issuance of Sukuk of Rs. 45 billion during the quarter, all six tranches of GOP Ijara Sukuk based on Jinnah Terminal Karachi (the underlying asset) were completed whereby GOP raised more than Rs. 190 billion from Islamic banks during last nine months. The next few quarters may however witness some slow down as the identification of new assets, their valuation and documentation etc may take some time before the government could announce the issuance of further Sukuk. This also signifies the need for developing diversified investment avenues for efficient liquidity management of Islamic banks. As far as, Pakistan’s place in Sukuk issuing countries is concerned, according to IIFM bulletin Pakistan is on 7th position in terms of issuance of sukuk. 5.0 WAPDA GoP (Government of Pakistan) Ijarah Sukuk 5.1 The Company WAPDA, the Pakistan Water and Power Development Authority, was created in 1958 as a Semi-Autonomous Body for the purpose of coordinating and giving a unified direction to the development of schemes in Water and Power Sectors, which were previously being dealt with, by the respective Electricity and Irrigation Department of the Provinces. Since October 2007, WAPDA has been bifurcated into two distinct entities i.e. WAPDA and Pakistan Electric Power Company (PEPCO). WAPDA is responsible for water and hydropower development whereas PEPCO is vested with the responsibility of thermal power generation, transmission, distribution and billing. There is an independent Chairman and MD (PEPCO) replacing Chairman WAPDA and Member (Power) who were previously holding the additional charges of these posts. WAPDA is now fully responsible for the development of Hydel Power and Water Sector Projects. PEPCO has been fully empowered and is responsible for the management of all the affairs of corporatized nine Distribution Companies (DISCOs), four Generation Companies (GENCOs) and a National Transmission Dispatch Company (NTDC). These companies are working under independent Board of Directors (Chairman and some Directors are from Private Sectors). 5.2 Ownership and Management WAPDA is 100% owned by the Government of Pakistan and operates under the WAPDA Act, 1958, passed by the National Assembly in 1958. WAPDA is a separate legal entity operating under the ambit of the Ministry of Water and Power (“MoW&P”). WAPDA’s present management comprises of a Chairman and three Members working through a Secretary. 5.3 Power Generation by WAPDA: Pakistan is currently facing a crisis in the power sector. The energy crisis has its roots in a number of issues including lack of integrated energy planning and demand forecasting; imbalance in energy mix with a heavy reliance on oil and costly imported fuel; non-utilization of vast indigenous resources e.g. coal and hydel energy; lack of effective planning, structuring, and implementation of identified and viable projects. The total installed power generation capacity of WAPDA as of December 31, 2010 stood at 11,363 MW, of which 6,463 MW is sourced from hydel assets and the balance of 4,900 MW is from thermal assets. Which is 4,000 MW less than the actual required. For which WAPDA started many Small Scale Hydro Electric Power Projects. WAPDA has various projects in the pipeline, whereby the Authority seeks to expand its hydro electric power generation capacity through the setting up of new plants and the capacity expansion of existing facilities. The funds raised through the Sukuk Issue will be utilized by WAPDA to finance the various hydropower generation projects already underway or currently in the development pipeline, as it looks to attend to the projected power deficit. Below is a snapshot of the existing/proposed hydropower projects. Following is a table detailing the hydel projects which were in the development pipeline with WAPDA markets at the issuance of Sukuk under discussion. 5.4 Transaction Background The Pakistan Water and Power Development Authority (“WAPDA”), established under the WAPDA acted as an autonomous body for the development and use of the water and power resources of Pakistan on a unified, multi-purpose basis WAPDA’s financing requirement: PKR 8,000 million to (partially) fund the ongoing hydropower generation projects already underway or currently in the development pipeline (as mentioned in the last table) Key objectives for WAPDA were: • To raise financing in a cost efficient manner • Strengthen its presence in the local financial markets • Diversify and cultivate WAPDA’s investor base • Undertake a landmark transaction which will catalyze the promotion of Islamic Financial instruments and lead the way for other public sector entities Keeping in view WAPDA’s requirements and objectives, National Bank of Pakistan proposed the Sukuk mode of Islamic financing to WAPDA, WAPDA mandated National Bank of Pakistan to act Joint Lead Manager for a domestic Sukuk Al-Ijara issue. 5.5 Pronouncement Initially the pronouncement issued on behalf of the respective Shariah boards of the State Bank of Pakistan (“SBP”), Standard Chartered Bank and Dubai Islamic Bank confirmed that, in their view, the proposed issue of the Certificates and the related structure and mechanism described in the Transaction Documents were in compliance with Shariah principles. And all other Certificate holders consulted their own Shariah advisers as to whether the proposed Issue described in the pronouncement referred to above was in compliance with Shariah principles. 5.6 Key Terms & Conditions 5.7 Structure of Transaction: WAPDA Company Limited (“WAPDA SPV”), a wholly owned subsidiary of Pakistan Water and Power Development Authority (“WAPDA”), raised upto PKR 10,000 million (inclusive of a green-shoe option of upto PKR 2,000 million) through the issue of long-term Sukuk. The WAPDA SPV was formed for the sole purpose of carrying out the transaction contemplated below, and the parent, WAPDA, utilized the funds thus generated to partially finance the small-scale hydro electric power projects planned by the Authority. At Inception: Under the envisaged structure, in the first step WAPDA SPV issued Certificates or Sukuk to Investors worth upto PKR 10,000 million, which were received by WAPDA SPV in the second step as mentioned in the figure below. The Sukuk holders can trade these sukuks in secondary market. WAPDA SPV utilized these proceeds to purchase identified Hydel Power Generation Turbines (which are already mentioned in the previous section) from WAPDA. The assets thus acquired remained in Trust by the WAPDA SPV, for the benefit of the Certificate-holders, till such time that the Trust is dissolved. Subsequent to this purchase, WAPDA SPV and WAPDA entered into an Ijara Agreement, whereby WAPDA SPV leased these Turbines to WAPDA in the last step. Periodic Distribution: During the leased period WAPDA SPV received KIBOR benchmarked lease rentals on a six-monthly basis. These lease rentals are also comprised of a fixed element representing equal amortization of the Issued Amount, first of such amortization payment to become payable after four (4) years from the Issue Date. The Sukuk investors are earning Periodic Distribution Amounts, on their Certificate holdings, being equal to the lease rentals received by the WAPDA SPV. At Maturity or Dissolution: WAPDA also gave a Purchase Undertaking to WAPDA SPV, under which it was obligated to purchase the Hydel Power Generation Turbines in case of a Dissolution Event at the Exercise Price, occurring prior to the end of the Lease Term (as the term is still on) on the date notified to Certificate-holders by the Trustee. The Exercise Price would equal fixed rentals that would have been payable under the Ijara Agreement, plus accrued Variable Rental plus all taxes and expenses of the WAPDA SPV. Then WAPDA SPV will pay the principal to Sukuk holders to redeem the capital after which the Sukuk certificates would be redeemed. At last WAPDA SPV would sell the turbines to WAPDA so, the complete process would complete successfully. Cash flow of complete transaction starting from the purchase of Sukuks till the final payment by WAPDA to WAPDA SPV for the purchase of turbines is summarized in the figure: 5.8 Critical Success Factors • 100% owned by the Government of Pakistan • Fully responsible for the development of Hydel Power and Water Sector Projects. • Responsible for planning and executing schemes for Generation, Transmission and Distribution of Power 5.9 Risk Analysis Shariah Compliant: Shariah compliance from relevant authorities enabled investors with Shariah compliant investment mandates to participate in this Issue. Restricted availability of Shariah compliant securities in Pakistan market significantly enhanced the Issue’s attractiveness. Floating Rate Instrument: Given that the Certificate is a floating rate instrument, investors are protected against the interest rates risk, in that the market value of their investment would not be adversely affected, by an increase in the market rate of return. Reinvestment Risk: Tenor of certificate mitigates reinvestment risk as Compared to investment in T-Bills. Due to their shorter tenor, funds invested in Treasury Bills were managed and re-deployed, whereas funds placed in the Issue are invested for the full 10- year tenor. 6.0 Conclusion Sukuk provide a tremendous potential for growth in the global Islamic capital market that is critical for the sustained development of the Islamic finance industry. Their emergence has attracted a large number of investors across the world. Sukuk create a framework for participation of a large number of people/ institutions in financing projects in the public and private sectors, including those of infrastructure, such as roads, bridges, ports, airports, dams etc. WAPDA GoP Ijarah Sukuk is also one of them, wherein Sukuk were issued in 2007 for hydel power projects having maturity time of 10 years. Different Financial institutions took part in it. Uptill now the Sukuk is working fine and after this Government of Pakistan has issued number of Sukuk on the same terms. 7.0 References • Ayub, Muhammad, 2007, Understanding Islamic Finance. John, Wiley & Sons Ltd. • Jabeen, Zohra and Javed, M. Tariq, “Sukuk-structures - an analysis of risk-reward sharing and wealth circulation” • Sukuk Report, 1st Edition, International Islamic Financial Market, • Islamic Banking Bulletin, June 2011, State Bank of Pakistan • Faisal, Muhammad, September 2007, Presentation on Islamic Sukuk Concept & Applications • Rasool, Hammad, October 21, 2008, Presentation on Sukuk (Islamic Bond) • wapda.gov.pk, Accessed: November 18, 2011 • nepra.org.pk, Accessed: November 18, 2011 • secp.gov.pk, Accessed: November 18, 2011
Posted on: Fri, 13 Sep 2013 01:14:34 +0000
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