Case Study: Jordans Sovereign Sukuk: A Dual Solution to Both Liquidity Management and Financing

Sari et al., 2017

INTRODUCTION

On October 17, 2016, Jordan issued its first sovereign local currency Sukuk (Islamic Bond). This Sukuk was a remarkable success because it was oversubscribed by three times and priced within the countrys conventional bond price at 3.01%, thus providing a cheaper source of funding for the Government of Jordan. This Sukuk killed two birds with one stone by firstly solving the long persistent challenge of liquidity management faced by Islamic banks in Jordan (lack of Shariah compliant liquidity management tools) and secondly providing a source of funding for the Government of Jordan to finance its developmental activities.

The Sukuk transaction brought about a unique synergistic partnership between two globally

renowned development organisations, which are the Islamic Corporation for the Development of the Private Sector (ICD) and the Japan International Cooperation Agency (JICA). ICD the private sector arm of the Islamic Development Bank Group acted as the Transaction Technical Advisor providing know-how as a guide throughout the issuance process. JICA served as the Technical Assistance Provider to Jordan to fund all expenses related to the issuance such as legal firm expenses and training expenses.

The partnership began in October 2014 when JICA entered into a Memorandum of Understanding (MoU) with ICD to cooperate in supporting the development of the Islamic money market and International Capital Market for the countries of common interest. This partnership also marked the Japanese entitys entry into the Islamic Finance Industry.

GLOBAL ISLAMIC FINANCE INDUSTRY

The growth of the global Islamic Finance Industry is staggeringly unprecedented. It has expanded dramatically to the extent that it has become part of G20 agenda. The Industrys global assets have grown at an average annual rate of 17.6% between 2009 and 2013 as estimated by Ernst & Young. This is more than eight times the growth of global financial assets (according to McKinsey, the growth of global financial assets was just under 2 percent per annum since 2007). Thus, the Islamic Finance Industry has caught the attention of the world. Today, the Global Islamic Finance Industry is worth more than US$ 2 trillion and is projected to reach US$ 3.5 trillion by 2021.

The Global Islamic Finance Industry is based on the principles of Islamic Commercial

Jurisprudence which advocates justice and fairness through equitable sharing of risks and returns while prohibiting dealings in harmful, unethical activities such as interest (riba), gambling/speculation (gharar), arms and pornography. The goal of Islamic Finance is to bring about overall economic development by serving the real economy (real economic activities with underlying asset-backed transactions) as opposed to conventional financing of speculative activities like dealing in zero-sum game derivatives

JORDAN SOVEREIGN SUKUK ISSUANCE CHALLENGES

Every success story has its share of challenges, and so did the Jordan Sukuk. The major challenge faced by most Sukuk issuances is the length of time it takes to issue Sukuk. This delay is usually caused by a myriad of factors ranging from Shariah opinion, understanding of the Sukuk product structure especially to first timers and similar factors. In the case of Jordan the length of time from executed mandate for issuance to actual issuance took eighteen (18) months. The major reasons are discussed below:

First Time Issuer: As this was the first Sovereign issuance for the Government of Jordan there were delays as expected on the part of the government officials and agencies involved as this was their first time dealing with such a financial instrument. This required ICD to demystify issues all the way to provide guidance and build capacity of the Jordanian officials involved. This will go a long way to make future issuances faster and more efficient.

Pricing the Sukuk: By the recommendation of the local Jordanian scholars, the profit rate should be determined according to the Jordanian real estate market value (and not according to the creditworthiness of the issuer as was usually the case in practice). This methodology requested by the scholars was not common practice. To satisfy the requirement of the Sharia Scholars, ICD led the efforts and established an Expert Advisory Committees (EAC). Its members were drawn from real estate estimators and economists. Their mandate was to conduct a study on the underlying asset (building under construction) to be used for the issuance and then advise on the range of the rental payment.

After conducting the necessary studies and taking several considerations regarding the circumstances of the property, the EAC recommended the rate to be 2.9273% per annum (margin of error +/- 3% from the arithmetic mean). Implementing the new pricing methodology involved a new method of subscription. The subscribing Banks would subscribe based on an expected yield (and not a finalised one). After the closing of the transaction, investors will negotiate with Government of Jordan on the final yield. To cover the operational expenses incurred by the Special Purpose Vehicle (SPV), a deduction (0.251% per annum) from the periodic payments will take place. The deduction is subject to a ceiling. The offering circular contained clauses on how the Sukuk investors, within the Sukuk Committee, will vote on the final yield. ICD played a major role in bridging the gap and at the same time finding an acceptable solution between the local Sharia Scholars and the investors. Many meetings took place with investors to raise awareness for the newly introduced subscription mechanism on which the final profit rate agreed was 3.01%.

Sharia opinion on use of building under construction as underlying asset: ICD had to develop a Sukuk structure that revolves on the use of the MoFs partially completed building. The Sharia reservation, by the Jordanian scholars, was about questioning the economic benefit of leasing an asset that has not been fully completed. Having sought Shariah guidance from the Industry revered Islamic Development Bank (IDB) Group Sharia Board Committee, ICD was able to convince the Jordanian Scholars on its permissibility as the use of such uncompleted asset will lead to raising finance that will be used for the completion of the construction and hence achieving economic benefit.

DEVELOPMENT IMPACT OF THE JORDAN SOVEREIGN SUKUK

This transaction brought about a strong collaboration of two global development bodies ICD and JICA for the good of tangible developmental outcomes. After decades of being unable to invest excess liquidity, the four Islamic banks were able for the first time to find a Sharia compliant instrument that met their regulatory requirements (these banks are not allowed to invest in interest-bearing instruments). Furthermore, a Palestinian Islamic Bank (Al Safa Bank), through its parent conventional bank based in Jordan (Cairo Amman bank) had subscribed to the Sukuk, hence accessing a liquidity management tool that was not available in the Palestinian domestic market. Not only does the use of this instrument place the Islamic banks on par with the conventional banks in the same environment (for liquidity management purposes), but also allowed the creation of an Alternative Islamic Capital Markets in par with the already existed Conventional one. This has brought about financial inclusion of a previously excluded class of investors.

This transaction has also enabled GoJ to use Sukuk in complete autonomy via the created SPV Structure to finance their future infrastructure projects after having acquired the need technical knowledge and practical experience for future issuances. This has paved the way for the private sector to follow the governments footstep by issuing corporate Sukuk using the Sovereign issuance as a benchmark. GoJ is currently reviewing a proposal to make Sukuk available at the retail level. This move will deepen the market and increase demand further for other sovereign issuances.

Noteworthy is the fact that this Jordan Sukuk transaction recently won the most prestigious Global Islamic Finance Community Award; that is the 2016 Islamic Finance News (IFN) Award for the Sovereign Deal of the Year 2016. IFN hailed the developmental impact of the deal and its expected ripple effects on the industry, because it bears a number of unique features that may influence the evolution of the Islamic Capital Markets.

CONCLUSION

Undoubtedly the Jordan Sukuk is an innovative Islamic Financial Instrument permitting multiple benefits. The future for the Jordanian Islamic Finance Industry looks bright as it has surmounted all challenges of a first time Sukuk issuer coming out stronger and victorious. This will pave the way for future issuance of an International Currency Sovereign Sukuk and raising larger infrastructure funding. Also, it provides Jordan the opportunity to lead as a mentor for reverse linkages with other countries aspiring to issue their maiden Sovereign

question

1. What were the key stakeholders during the Jordan Sukuk issuance process? (350 words) please paraphrase and respect the word count