Issuance Process of Sukuk, Initial Public Offering and Private Equity

 

INTRODUCTION

The Islamic private equity (IPE) market has grown dramatically over the last few years. There are some similarities between venture capital (VC) and some traditional methods in Islamic financing. In medieval Islamic societies it is hard to pinpoint the starting of IPE but there were partnership arrangements like those practiced in conventional private equity (PE). Despite the financial subprime crisis and the lack of liquidity in financial markets, PE still plays an important role in financing growing unlisted firms all over the world. However, conventional PE and Islamic PE display different features. First, Islamic PE funds have less investment opportunities and cannot diversify their projects across activities and sectors mainly because of the Shari’ah compliance criterion. For instance, the PE fund is composed of the managers team, the Shari’ah supervision board SSB and the supervision compliance officer SCO. Second, the choice of PE partnerships depends on the target’s performance, the Islamic scholars’ school, and the religiosity degree of the country where they operate, and the SSB policy. Third, they bear varied and different risks from their conventional counterparts. Therefore, Islamic PE financing is expensive and still not very competitive. Fourth, to overcome and mitigate risks, conventional PE funds can issue convertible securities and abandon prematurely bad quality projects. In contrast, Islamic PE funds are actively involved in the project only in specific cases and cannot prematurely exit the target but can gradually sell their stocks to cover their equity. Finally, financial modes vary according to the degree of involvement of the PE fund in the project and the pre-agreed arrangements between the entrepreneur and the PE fund.

1. Sukuk

Sukuk, or Islamic bond, represents an important avenue for international fundraising and investment activities generating significant cross-border flows globally, and is the most popular financial instrument in the ICM. The Sukuk market has evolved as a major contributing factor driving the internationalization of Islamic finance, which has been facilitated by further developments of the international Islamic financial infrastructure, prompting Islamic financial institutions to venture beyond their domestic borders. Islamic funds have also grown in numbers providing an avenue for Muslim investors as well as other investors seeking alternative assets to invest in.

Key Differences between Sukuk and Conventional Bonds

The key differences between Sukuk and conventional bonds could be summarized as follows:

• Sukuk are asset-based (but not necessarily asset-backed).

• Sukuk represent undivided proportionate ownership interest in the underlying asset in the Sharī`ah-compliant investment scheme.

• Attached to this ownership interest is the corresponding right to income streams from that asset.

• Sukuk cannot be based on a transaction of debit and credit on a future basis (unlike conventional bonds).

Sukuk Al-Ijarah

A Sukuk al-Ijarah is based on an Ijarah, which refers to a lease or rental or hire contract whereby the lessor leases out goods, services, assets, real property or equipment to a lessee at an agreed rental fee for a predetermined lease period. The characteristics of an Ijarah are:

• Lessor holds title to Ijarah property and bears responsibility for its upkeep.

• Rentals derived under the Ijarah agreement are equivalent to the coupon payable under Sukuk.

• Assets sold by SPV issuer to asset originator is pre-agreed and includes:

• Face amount of the outstanding Sukuk; and

• All other amounts due and owing by asset originator (as lessee) to SPV issuer (as lessor) under the Ijarah agreement.

Figure 1: Cash flows in Sukuk al-Ijarah – At Inception

Figure 2:  Cash flows in Sukuk al-Ijarah – Periodic Payment

 Figure 3:  Cash flows in Sukuk al-Ijarah – At Maturity/Dissolution

Graphically, the key steps and cash flows of Sukuk al-Ijarah are presented below in three phases:

• At inception

•  Periodic payments during the life of the instrument; and 

• At maturity or dissolution

2. Initial Public Offering (IPO)

The IPO, or initial public offering, is a well-known fact in the stock market when it comes to new companies, underwriters, and investors. Initial Public Offerings (IPOs) provide a vehicle for potential investors to receive higher returns. Numerous studies have been conducted on the performance of initial public offerings in a variety of markets (Bajo et al., 2014). The attention may be linked to the usefulness of IPOs for economic growth and recruitment, but more often than not, it is focused on the considerable profit gains that they suggest to investors, according to Bessler and Thies (2007). In many markets, initial public offerings (IPOs) underpricing, or a new stock's positive gain on the listing day compared to its IPO offer price, is a typical occurrence. Various models and hypotheses have been offered in the finance literature to explain the so-called underpricing issue. In most countries, IPOs are quite essential, especially in growing countries like Malaysia. To establish whether the financial market is efficient, researchers should track IPO pricing and performance. To become publicly traded in Malaysia, IPO businesses must be listed on the Kuala Lumpur Stock Exchange (KLSE), presently known as Bursa Malaysia.

Listing Platform in Bursa Malaysia

Today, Bursa Malaysia offers three listing platforms, namely the Main Market, ACE Market and LEAP Market, to suit the differing needs of companies of all sizes and at different stages of their business cycle. With more than 900 companies across various economic sectors, Bursa Malaysia hosts the highest number of public listed companies in the ASEAN region.

Steps in the Initial Public Offering process

Main And ACE Market

Stage 1: Pre-Submission

1) Appointment of the advisers

2) Structuring of the IPO

3) Due diligence & internal control review

4) Preparing the documents required for submission

5) Pre-Submission Consultation with the regulators and key stakeholders 

Stage 2: Post-Submission for Approval

         1) Public exposure of the prospectus

    2) Queries from the regulators and visits by the regulators to the company's key                           business premises

 

Stage 3: Post-Approval

1) Appointment of an investor relations (IR) company

2) Execution of underwriting agreement (if required)

3) Registration and lodgment of the prospectus

4) Commencement of pre-marketing

 

Stage 4: Listing

1) Launch of Prospectus

2) Roadshows and book building exercise

3) Allocation of shares

4) Listing on the Main or ACE Market of Bursa Securities (Commencement of trading)

LEAP Market

Stage 1: Pre-Submission

1) Appointment of the advisers

2) Structuring of the IPO

3) Due diligence & internal control review

4) Deposit/lodgment of information memorandum

 

Stage 2: Post-Submission for Approval

1) Review by of the authorities of following 3 focus areas:

a. Corporate Governance

b. Conflict of Interest

c. Public Interest

Stage 3: Listing

1) Placement of Shares

2) Listing on the ACE Market of Bursa Securities (Commencement of trading)

3. Private Equity

An IPE fund, according to Sheikh Taqi Usmani, is made up of high-net-worth people (such as retired executives), business families, corporations, and institutions. Their goal is to increase capital and diversify their portfolios in exchange for excellent returns. The establishment of these funds results in a significant concentration of capital. In fact, hundreds of millions of Muslims, such as farmers and artisans, have savings that they never deposit in banks. These funds are capturing a large portion of these savings, which are growing rapidly. An IPE fund can finance a wider range of investments than a single investor could. Of course, when these investors work together, the dangers are reduced. In contrast with conventional PE funds, IPE funds must invest in companies that are Shari’ah compliant to make a halal profit.

Organization of a PE fund

PE firms are structured as partnerships with two key components:

• The General Partners (GP); the management team responsible for the selection and management of the target company and, ultimately, the exit strategy.

• The Limited Partners (LP); the providers of the capital. They provide funding and allow the GP to draw down funds as required for investments that meet an agreed profile.

At this point, IPE appears more restrictive than conventional PE. In fact, there are many investments which are not in accordance with Shari’ah principles (haram investments) including no investment in interest-bearing instruments.

Figure 4: An overview on the structure of PE funds

In contrast with conventional PE funds, in addition to the LP and GP, the IPE fund must ask for the approval of Islamic authorities before making any investment decision (see Figures 4). In fact, they operate in the following way:

1. The Shari’ah committee also called the Shari’ah Advisory Council (SAC) sets the Shari’ah policy of the fund. It recruits a Shari’ah Adviser (SA) to supervise target companies.

2. Investors raise funds for a fixed period of time to finance the selected IPE fund (IPEF).

3. The management team (MT) of the selected fund invests only in the more profitable target companies.

4. The SAC checks whether the project is Shari’ah compliant or not and that it is in accordance with their policy.

5. MT and SA control target firms and report irregularities to the SAC.

6. MT must disclose information about the progress of target companies to investors.

7. The IPE fund exits the target company at a fixed date and shares the losses and profits with the entrepreneur.

The Role of the Shari’ah Advisory Council (SAC)

The fund's executive committee selects the fund's target firms. To protect their interests, the LP delegates this role to this committee. They frequently lack commercial experience. In Islamic finance, the Shari'ah committee, in addition to the standard executive committee, must approve the executive committee's actions; they retain and pick only Shari'ah compliance enterprises. Figures 2 set out the principles of Islamic Private Equity.

Figure 5: The Principles of Islamic Private Equity

The Shari’ah Board is an independent committee and contains at least three scholars who specialize in Islamic jurisprudence (Fiqh al Muamalat) as well as experts not only in the Islamic religion and its applications but also in financial law. This committee must:

• Check whether the selected projects are in accordance with the principles of Shari’ah or not. Some scholars argue that the Shari’ah and executive committee should be independent to avoid conflicts of interest.

• Interpret the Qur’an, the Sunnah and the Hadith which are the source of Islamic law, and Ijma’, Qiyas and Ijtihad which are used to provide interpretation and thereby facilitate future development and implementation of the Islamic judicial system.

• Review all the stages of the investments to ensure that they are Shari’ah compliant. At the end of the year, this committee will control the financed enterprises and check whether they are Shari’ah compliant. Some projects can become ineligible when new elements occur such as research and development activities that can be useful to the weapons industry. Malaysia recommends the appointment of a SCO who will do the following tasks daily:

• Check that all aspects of the business are in accordance with the Shari’ah (portfolio management, trading practices, operational matters etc).

• Report any non-compliance to the Shari’ah Board.

• Provide Shari’ah expertise on documentation, structuring, investment instruments and ensure compliance with the general Shari’ah principles and the standards, regulations and resolutions of the regulator.

COMPARISON BETWEEN SUKUK, INITIAL PUBLIC OFFERING (IPO) AND PRIVATE EQUITY

ITEM	SUKUK	INITIAL PUBLIC OFFERING	PRIVATE EQUITY
Definition	According to the Securities Commission Malaysia (SC) Sukuk as certificates of equal value which evidence undivided ownership or investment in the asset using shariah principle and concept endorsed by the SAC.	The process of offering shares of a private corporation to the public in a new stock issuance. An IPO allows a company to raise capital from public investors.	Investing in unlisted companies or businesses or turning public companies private , thus creating value in the enterprise by improving its operation.
Objective	Creating returns similar to those of conventional fixed-income instruments like bonds	To raise capital for a business	To increase capital and diversify their portfolios in exchange for excellent returns.
Risk	sukuk is low risk means lower risk in portfolio which are less volatile than other asset such as equities	IPO are quite risky for individual investors because they do not have enough previous data to make evaluations.	Private equity is higher risk because it will give impact investment directly. For The investor with risk tolerance, it can be a profitable investment for them.
Trading platform	Issued and traded either exchange (Bursa Malaysia) or over-the-counter (OTC) via an appointed bank.	Companies must meet the standard of the exchange (bursa Malaysia) and the securities  and exchange commission to hold an IPO.	The capital is not listed on a public exchange.
Issuance process	The issuer sells certificates to investors The issuer uses the proceeds from the certificates to purchase the asset Investors receive partial ownership of the asset	Select an investment bank Due diligence and regulatory filings Pricing Stabilization Transition to Market Competition	Fundraising Deal generation Initial screening Due diligence and evaluation Structuring Post-investment monitoring Exit
Regulators	Malaysian regulatory structure contains core legislations that govern Sukuk issuance, for instance, Capital Market Services Act 2007 (CMSA) (amendment 2012); Securities Commission Act 1993 (SCA)	The main requirements for listing on the Main Market are found in the Capital Markets and Services Act 2007 ("CMSA") and the Main Market Listing Requirements. The Securities Commission ("SC") and Bursa Malaysia are the regulatory bodies for companies wishing to list on the Main Market.	Private equity corporations  are required to have anti-corruption policies and procedures in place, as part of the Securities Commission Malaysia’s measures to strengthen anti- corruption measures for the capital market, and pursuant to the enactment of the corporate liability provision under section 17A of the Malaysian Anti-Corruption Commission Act 2009 effective 1 June 2020.
Guideline	Guidelines on Sukuk set out the main terms and conditions related to the issuance of, buying or sale of Sukuk which need approval from SC(ISRA, 2015).	The SC Guidelines provide that an applicant submitting a proposal to SC is expected to have good corporate governance practices. In considering a proposal, the SC would take into account the applicant's corporate governance record, including any previous actions taken against the applicant for any breach of relevant laws, guidelines or rules issued by the SC and Bursa Malaysia.	These Guidelines on the Registration of Private Equity Corporations and Management Corporations (Guidelines) are issued by the Securities Commission Malaysia (SC) under section 377 of the Capital Markets and Services Act 2007 (CMSA) read together with section 76 of the CMSA.

CONCLUSION

In conclusion, there are a few differences between sukuk, initial public offering and private equity.  Sukuk are investments that are tradable. Sukuk has become a very successful islamic finance product. Sukuk need to fulfill several requirements in order to be shariah compliant.  Private equity constitutes an important role in the financial system as it provides financing and advisory services to companies that might otherwise encounter difficulty in attracting capital. Beside that, private equity also brings financial knowledge,expanded business network , strategic input, an institutional framework and corporate governance mechanisms in order to build more sustainable business for the investor.

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