Monday, May 4, 2020


          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.

          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.