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.
Popular writings have also been
describing things like “sukuk sale” or “sukuk in Islamic debt market” or any
other expressions that are nonetheless confusing. In the context of Mudarabah
specifically, it is normal to see inaccurate phrases like “One billion dollar
worth of Mudarabah sukuk have been to sold to international investors” or
“pricing for the Mudarabah sukuk” or “Mudarabah sukuk sold in Islamic capital
market” because all these imply that there are sale contracts (between the
issuer and the investors) involved in the issuance of the sukuk. The truth is
Mudarabah is neither loan nor a sale contract. It is by contrast a sort of
“partnership” arrangement founded upon agency (wakalah) as previously stated.
This happens when the Mudarib is in fact appointed as a trading agent/project
manager for the capital provider and he is to be compensated with a certain
percentage of profit if any, while capital loss if not due to the mudarib’s
fault or wrongdoings is to be incurred by the capital provider. However there
are views by some jurists that Mudarabah is a special form hiring
contract (ijarah al-ashkhas)
permitted by the Sunnah whereby the mudarib is hired by the capital provider
based on contingency fees in the form of profit sharing to run the mudarabah
business. Apart from not being a sale contract what is important to state is
that Mudarabah is not a lending contract either, hence the mudarib cannot be
considered indebted to the capital provider. However as we used to mention in
several of our previous postings, market players whether due to
misunderstanding or willful efforts by
issuers in collaboration with
other connected parties involved in the issuance process, tend to project
Mudarabah sukuk as secured investment. Sukuk subscribers normally are enticed
or persuaded to invest if given strong assurance (false or otherwise) not only
as to prospect of guaranteed profit but most importantly of capital protection.
However, they can arguably be blamed for not making due Shariah diligence as to
the true nature of Mudarabah as a structure for the sukuk where neither capital
nor profit can be fully guaranteed or secured.
REGULATING
THE FUNCTIONS OR ROLES OF A MUDARIB IS THE KEY FOR RISK MANAGEMENT
Given the nature of Mudarabah as
wakalah-based arrangement according to which the Mudarib acts as an agent for
the capital provider in running the business/project as entrusted, one key
element in risk management of this type of investment is related to the need for
the capital provider to be reasonably prudent in selecting the Mudarib as
investment agent. There needs to be sufficient degree of due diligence done to
ensure risks can be mitigated right before the Mudarib is appointed. In the
context of Mudarabah sukuk, relevant information must be sufficiently obtained
from various sources as to the status and track records of the prospective
issuer. It is not enough to rely just on information as contained in the
relevant prospectus. Although regulatory authorities may require certain
information be provided in the document, investors however must exercise
independent search of their own to be on the save side.
In order to protect the interest of
the capital provider, Muslim jurists have elaborated on certain fundamental
rules governing the conduct of a Mudarib as agent for the investor. As
principal, the capital provider apart from being prudent in selecting and
appointing the Mudarib can minimize his exposure or risk by exercising his
rights as a Muwakkil (principal) as per wakalah contract. In the context of
Mudarabah, there are several situations that may happen in a particular case.
Sometimes these aspects are discussed by the Muslim jurists in connection with
what are known as Mudarabah Mutalqah (unrestricted) and Mudarabah Muqayyadah
(restricted) where the actions of the Mudarib can be controlled.
Generally there are actions that a
Mudarib can take by default as a mudarbah contract is understood to come
with certain basic implied terms to be read into such a contract itself.
In this situation, even though not expressly provided for in the agreement, the
Mudarib can perform such actions as a matter of right as Mudarib. However there
are actions that a Mudarib can only perform with expressed provision in the contracts.
In this kind of situation, the capital provider can specifically authorize the
Mudarib to undertake certain actions that are outside the scope of the implied
terms of the Mudarbah. Furthermore there are actions that a Mudarib can take
when full discretion is given to him by the capital provider. A Mudarib can
also be expressly prohibited by the capital provider in performing
certain acts in which case these need to be avoided at all costs. Muslim
jurists nevertheless are not in agreement about the status of some of the
relevant actions as to which category they should
belong.. to be continued in Part 2.
