MUDARABAH RISK MANAGEMENT

SHARIAH-BASED RISK MANAGEMENT IN MUDARABAH SUKUK-PART 1

          Modern day sukuks are generally structured based on conventional bond models where capital protection and profit guarantee are normally provided with the provision of security or collateral terms: as if the structures are based on debt transactions where creditors are fully protected as part of the so called credit enhancement process involving a lot of provisions under positive covenants and negative pledges normally used in credit/loan/bond documentation. Mudarabah sukuk on the contrary are not supposed to be debt-based instruments: rather they are based on agency in the context of the management company being the investment or business agent of the capital provider or investors. There is no creditor-debtor relationship here that warrants the above-mentioned credit enhancements normally employed in conventional lending contracts for debt securities. Since Mudarabah sukuk do not involve any debt contract between the issuer and investor, the kind of protection available to the investors here is not on the basis that the capital provider is a creditor or lender but rather a principal (muwakkil) in an agency contract. Hence different approaches are needed to protect the interest of such a principal in the context of the mudarabah investment contracts.

MUDARABAH SUKUK CERTIFICATES: WHY DOES IT MATTER?

The topic may looks irrelevant when one recognises the fact that sukuk are no longer novelties like what they used to be around 20 years ago. Since then billion dollars of sukuk have been issued, both as public and private securities not to mention also, in not small number of reading materials, sukuk have been referred to as debt securities. In fact many so-called Islamic finance writers generally put sukuk within the framework of the so called Islamic debt market or sometimes Islamic fixed income instruments. However from a number of court cases so far adjudicated, it is clear that the true nature of sukuk certificates is still far from proper understanding. This is so partly because sukuk have been issued using various underlying contracts not similar to conventional bonds of various types where the main contract used in the structures are no other than debt contracts i.e lending/borrowing contracts.

The above issue leads us to answering the question posed in the heading: why the nature of certificates issued in connection with sukuk needs to be fully explained. As mentioned, this matter is closely related to the contracts used in the relevant structures as there is no single character that can be attributed to such certificates without full understanding of the underlying contracts employed. For example in Dana Gas sukuk case, the issue about whether the sukuk were truly of mudarabah type where profit could not be fully guaranteed remains relevant as ever although the parties had come to mutual  settlement of their disputes.

MUDARABAH SUKUK: ARE THEY REALLY RISKY?

MUDARABAH SUKUKS: ARE THEY REALLY RISKY?

Mudarabah sukuk (sukuk is plural form of sakk- commercial certificate/document, nevertheless here the term is used as a singular word as generally treated) came to the forefront when Dana Gas case was at its highest point in 2017/2018. Then everyone was discussing Dana Gas in the context of the so-called impending default when the company declared that its Mudarabah sukuk was no longer Shariah compliant and thus illegal and unenforceable under UAE law. The issue then was about profit payment by Dana Gas to holders of the sukuk: what are the rights of the sukuk holders when the so-called profit was not going to be paid as expected and as to whether that would trigger a default. Basically there are many questions that have been raised in this Mudarabah sukuk, among others are the followings:

·        Whether non-payment of profit by the Mudarib (Dana Gas) constitutes a default?

·        What are actually profits in the context of Mudarbah?

·        Whether the purchase undertaking provided in the agreement was valid and enforceable in law?

·        What are the rights of Mudarabah sukuk holders when the sukuk was declared as not valid or not Shariah compliant?

·        What laws are to be used the settling the dispute between the sukuk issuer and its sukuk holders?

·        What was actually the nature of a Mudarabah contract entered into by the parties: whether it is truly a Mudarabah of something else?

As it turned out later, the parties to the debacle had managed to resolved their dispute seemingly through an amicable settlement toward the end of 2018, and that development was indeed something that was commendable given the fact that settlement of disputes through compromise (sulh) leading to final resolution is in fact the best Islamic option among several other options in dispute settlement. Notwithstanding the positive development and the terms used by the parties in their settlement agreements, many relevant questions about Mudarabah and Sukuk Mudarabah are far from being clearly addressed in actual practices.