Islamic Infrastructure Project Finance

Islamic
Islamic Infrastructure
Infrastructure Project
Project Finance
Finance
Plasma university
Lecturer/ustad Mohamed omar
AGENDA
Islamic Infrastructure Project Finance
INTRODUCTION TO ISLAMIC
ISLAMIC BANKING INFRASTRUCTURE
PROJECT FINANCE
• GROWTH & • PROJECT FINANCE
POTENTIAL OF • MODE OF ISLAMIC
GLOBAL/ LOCAL PROJECT FINANCE
ISLAMIC BANKING • RISK & MITIGATES
• CONCEPT OF ISLAMIC • CONSTRAIN &
BANKING CHALLENGES
• ISLAMIC MODE OF
FINANCING
GLOBAL ISLAMIC BANKING

EMERGENCE OF ISLAMIC FINANCIAL
Islamic INDUSTRY
Infrastructure Project Finance
• First Islamic Bank setup in Egypt
• Dubai Islamic Bank (first Islamic private commercial bank, 1975), the Faisal Islamic bank of Sudan (1977) and the Bahrain
1963-75 Islamic bank (1979).
• Iran fully converted its banking and economic system to an Islamic one
1983-84
• The High Council of OIC (Organization of Islamic Conference) declared Takaful /Islamic insurance as Sharia'h compliant (1985)
• Amana Income Fund, the world’s first Islamic Mutual Fund was created in Indiana (1986)
• Sudan introduced Islamic Banking (1989)
1985-90 • Islamic bond market emerged when the first tradable Sukuk were issued by Shell MDS in Malaysia (1990)
• Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) was established to advise on Islamic finance
standards all over the world (1991)
• Islamic Financial Services Board (IFSB) setup in Malaysia to establish standards (2002)
1991-2005 • Islamic Bank of Britain became the first Islamic commercial bank established outside the Muslim world (2004)
• Islamic Finance posting 15-20% growth globally

• Operating in about 75 Muslim & non-Muslim countries
• 275 Islamic Financial Institutions globally
1991-2005 • The total Islamic banking assets raise to USD 1.3 trillions
GLOBAL SCENARIO – GROWTH & POTENTIAL
 Islamic banking assets with commercial banks globally grew to $1.3 trillion in 2011,
suggesting an average annual growth of 19% over past four years (2011: 24%).
 The top four markets account for 84% of industry assets.
 13 Islamic banks have an equity base of more than US$ 1 billion.
 Islamic banking assets are forecast to grow beyond the milestone of $2 trillion by 2014.
 The industry’s average ROE was 12% in 2011.
 The severity of performance challenge has prompted several institutions to initiate wide-
ranging transformation programs, called the new 3 R’s for the industry:
• Regulatory transformation – involving compliance risk, capital optimization, integrated
balance sheet management and liquidity management
• Risk transformation – around Shari’a governance, single data management framework,
segment / product specific risk models
• Retail banking transformation – strengthening customer centric operating model,
channel integration and technology enablement.
One potential scenario shows global Islamic banking assets with commercial banks
to reach $1.8 trillion in 2013 (2011: $1.3 trillion), representing average annual
growth of 17%
Islamic Banking Asset Growth (US$b)

Islamic banking growth outlook continues to be positive, growing 50% faster than
overall banking sector in several core markets. In Saudi Arabia, market share of
Islamic banking assets is now over 50%.
Banking asset penetration (% of Nominal GDP) and Islamic
banking market share of total assets (%) in 2011
Top 20 Islamic banks make up 55% of the total Islamic banking assets and are concentrated in
7 countries, include: Saudi Arabia, Kuwait, UAE, Bahrain, Qatar, Malaysia and Turkey
 Top three markets for Islamic Banking Assets (2011)
• Saudi Arabia (US$207 billion)

• Malaysia (US$ 106 billion)
• UAE (US$75 billion)
 New markets embracing Islamic Financial Industry are
• Egypt (Issuing sovereign Sukuks & developing new regulatory framework for Islamic
Banks)
• Iraq (contemplating Islamic Banking legislation)
• Libya (implementing its Islamic Banking framework)
• Indonesia (Bank Indonesia projects that in 2013, growth of Islamic banking assets will
be in the range of 36% to 58%)
LOCAL ISLAMIC BANKING

LOCAL SCENARIO – GROWTH & POTENTIAL
 Islamic banking was formally launched in Pakistan in March 2002 when the first Islamic
Banking license was awarded to Meezan Bank Limited.
 There are currently 5 full fledge Islamic banks and 13 conventional banks having Islamic
banking branches with a network of 1024 branches across Pakistan.
 The industry has been maintaining strong growth momentum with over 50 percent
average annual growth since inception; this growth trend is likely to gather further
momentum with increasing awareness level and expansion of Islamic banking network in
second and third tier cities.
 In terms of total assets, Islamic Banking is 8.9% of the total banking industry.
 Keeping in view the fact that approx 96% of the population of Pakistan is Muslim, Islamic
Banking has the potential to grow to that level.
 There are currently 5 full fledge Islamic
banks with a network of 657 branches
and 13 conventional banks having 367
Islamic banking branches
 The Islamic banks also has 73 sub-
branches
No. of Islamic Banking Branches
CAGR = 37.73%
1024
886
751
651
515
289
150
2006 2007 2008 2009 2010 2011 2012

Growth of Market Share for Islamic banks

Deposit Growth of Islamic Banking
CAGR = 34.21%
Asset Growth of Islamic Banking
1000 CAGR = 32.36%

837
800
641
PKR in billion
600 477
366
400 276
206
200
0
2007 2008 2009 2010 2011 2012
CONCEPT OF ISLAMIC
BANKING
IDEOLOGY OF ISLAMIC ECONOMICS
Islam as a “complete code of life” encompasses every aspect of human life. It provides
directives as to how economic and financial activities should operate based on moral and
just economic system. The source of Islamic morality stems from Shariah.
Two sources of law in Islam

 Shariah—Revealed knowledge
• Quran –Recited
• Hadith/Sunnah—Un-recited
 Fiqh– Derived knowledge through ijtihad (exertion)
• Ijma (consensus)
• Al-Qiyas (analogy)
Islamic laws can be broadly classified into two types

 Ibadat (devotional acts) – Any worship which is not legalized by Shariah is void
 Muamalat (dealings or transactions)—Transactions are permitted unless prohibited by

Islamic law (principle of permissibility)
In muamalat, new transactions can be accommodated through ijtihad as long as they

do not contain the prohibited (riba and gharar)
Finance/ Banking in Islam (Matter of Muamalat)

 Laws governing economic/financial activities
• Principle of permissibility: All transactions are permitted except
those explicitly prohibited by Islamic law
• Prohibitions are riba and gharar, fraud, hoarding, exploitation of
need, gambling, etc.
• Obligations & Recommended (charity, honesty, interest-free
loans, risk sharing, etc.)
RIBA
What is Riba?
The word “Riba” means excess, increase or addition. According to Shariah

terminology, implies any excess compensation without due consideration.
EQUATION OF RIBA
Extra Guarantee RIBA

PROHIBITION OF RIBA
Prohibition of Riba in Quran:
“Those who devour Riba shall rise up before Allah like men whom Shaitan has
demented by his touch; for they claim that trading is like Riba. But Allah has
permitted trading and forbidden Riba. He that receives an admonition from his
Rabb and mends his ways may keep what he has already earned; his faith is in
the hand of Allah. But he that pays no heed shall be among the people of fire
and shall remain in it forever.”
(Al Baqarah 275)
“O you who believe, Fear Allah and give up what remains of your demand for
Interest, if you are indeed a believer. If you do not, then you are warned of the
declaration of war from Allah and His Messenger; But if you turn back you shall
have your principal: Deal not unjustly and you shall not be dealt with unjustly.”
(Al Baqarah 278 – 279)
PROHIBITION OF RIBA
Prohibition of Riba in Ahadith:

Narrated by Jabir (RAA): The Prophet (SAW) cursed the receiver and payer of
interest, the one who records it and the two witnesses to the transaction and
said, “They are all alike [in guilt].”
(Muslim)
Narrated by Abu Hurayrah (RAA): The Prophet (SAW) said, “There will certainly
come a time for mankind when everyone will take Riba and if he does not do so,
its dust will reach him.”
(Abu Dawood)
Narrated by Abu Hurayrah (RAA): The Prophet (SAW) said, “On the night of
Ascension I came upon people whose stomachs were like houses with snakes
visible from outside. I asked Jibrael who they were, He replied that they were
people who had received interest.”
(Ibn-e-Majah)
TYPES OF RIBA
 First Type : Riba al Nasiah:

• Root word nasaa meaning to postpone - refers to the delayed payment Riba.
When there is exchange of the same specie over a period of time, the
amount exchanged has to be the same (qard hasan).
• If an excess is paid over the amount this will lead to riba al nasiah.
 Riba Al-Nasiah… Riba in loan contracts:

• Give out loan (principal sum)
• Repayment include additional amount because of delay in payment This is
the riba prohibited in Al-Qur’an A.k.a. Riba al-Duyun, Riba Al-Jahiliyyah
 Implication in Financing Transactions:

• financing using loan contracts.
• No extra is allowed
TYPES OF RIBA
 Second Type: Riba al Fadl:

• If there is exchange among the same specie of the ribawi goods, it has to be
done on spot and should be of equal amounts.
• If the amounts exchanged are different then it will be riba al fadl.
• saying of the Prophet: “Gold for gold, silver for silver, wheat for wheat, barley
for barley, dates for dates and salt for salt – like for like, equal for equal and
hand to hand. If the commodities differ, then you may sell as you wish,
provided that the exchange is hand to hand” (Muslim, Kitab al-Musaqat)
• The six commodities listed in the above Ahadith could be divided into two
categories:
1. Currency – gold and silver
2. Staple food – wheat, barley, dates, salt
TYPES OF RIBA
SUMMARY OF RIBA AL-FADL
 Implication in Financing Transactions:

• Currency exchange – must be spot transaction
• No forward currency transactions
DIFFERENCE BETWEEN TRADE & USURY
 Does similarity in risk and pricing profile make Islamic products doubtful in the eyes of
Shariah?
• Suppose cash sale price is $10, deferred sale price payable in one month is $12. Now,
the buyer requests for one month extension and seller increases the price to $14.
• Prophet (pbuh) allowed $2 profit for the deferred sale but prohibited $2 for the
extension of time (riba al-jahiliyyah)
• The non-believers “used to say that it is same as we increase the price in the beginning
of the sale, or we increase it at the time of maturity”.
But
Quran says: “Trade is like usury, but God hath permitted trade and forbidden usury”(2:275)
“The Holy Quran could have mentioned the difference between interest and profit in pure
logical manner, and could have explained how the profit in a sale is justified while the
interest is not. The Holy Quran could have also spelled out the evil consequences of riba on
the economy. But this line of argument was intentionally avoided….once a particular
transaction is held by Allah to be haraam, there is no room for disputing it on the basis of
pure rational argumentation because Allah’s knowledge and wisdom encompasses all those
points which are not accessible to ordinary reason.” (Mufti Taqi Usmani )
ISLAMIC VS CONVENTIONAL BANKING
Conventional Banking
Money
Bank Client
Money + Money (interest)
Every Debt that pulls any kind of gain is Riba

Whereas Allah has permitted trading and forbidden Riba
Islamic Banking
Goods &
Services
Bank Client
Money
Islamic banking Conventional banking

• Transactions are • Transactions are money lending
asset-based/backed and Riba based
• It is socially-responsible banking • Involve in many impermissible
because it operates under Shariah transactions like Short selling, Sale
restrictions of Debt, Speculation, artificial
financial transactions, no sanctity
for Islamic law of contract.
• Does not permit financing of
prohibited goods / Industries • Permit financing of prohibited
goods / Industries like alcohol,
casinos etc.
• Ethics and moral values play a • A matter of choice
major role in investment decisions.
Not a choice but a must
From the previous slide, we find the differences are on three levels:
i. Conceptual & socio-religious level:
 Not lending money.
 Cannot deal with interest & non permissible commodities/businesses.
ii. Business model & governing framework:
 Actively participates in trade and production process.
 Governing framework as directed by Shariah Advisors and Shariah Board.
iii. Product level implementation:
 Usually asset backed & involve trading/renting of asset.
 Implementation is not just a mere change of paper work and terms but it
involves the right intention, the correct sequence of steps and timing of
execution.
ISLAMIC MODES OF FINANCING
 Murabaha
 Salam
 Istisna
 Ijarah
 Mudaraba
 Musharaka
 Diminishing Musharaka
Murabaha:
 A sale of goods in which seller discloses profit to the purchaser.
 The bank buys and then sells the good to the client at a pre-agreed price.
 Price paid at a later date.
 The bank must own and posses the good.
 The profit rate and other terms should be clearly specified in the contract.
 The bank can ask for guarantees or collateral.
 Murabaha bills of trade cannot be traded (at discount)
Salam:
 A pre-production sale of goods - selling goods in advance.
 Can be used for homogenous goods.
 Used to finance the agricultural sector.
 The price has to be fixed and paid when the contract is concluded.
 Goods delivered at a later date.
 The delivery time should be fixed.
 Parallel salam.
Istisna:
 A pre-production sale is used when an item/asset needs to be
manufactured/constructed.
 The price of the good should be known and time of payment can be
negotiated among the parties.
 The seller of the good can either manufacture it or sub-contract it (Parallel
Istisna).
 Once delivered, the bank will sell the goods either directly or through agent.
Ijarah:
 A leasing contract involves sale of usufructs of durable assets/goods.
 Ownership in the asset is retained by the lessor. The asset can be transferred
to a third party or the lessee at the end of the tenor
 The lease payments are calculated by aggregating;
• Fixed element (equivalent to principal on the conventional facilities).
• Variable element, generally on the basis of a reference such as K plus a
fixed margin
• Service amount usually equal to the amount paid to the company/
customer (in its capacity as service agent under the service agency
agreement).
 Cost of total damage of asset is borne by owner.
 Lessee can sub-lease the asset to third party unless explicitly prohibited in the
Ijarah contract.
Mudaraba:
 A form of partnership – one party supplies the capital (Rab-ul- Maal) other
manages (Mudarib)
 Profit shared among parties at a pre-agreed ratio.
 Loss borne by financier (Rab-ul-Maal) only.
 Financier cannot ask for a guarantee of capital or return.
 Mudaraba can be restricted or unrestricted.
Musharaka (Shirka-tul-Aqd):
 A partnership contract in which all partners contribute capital and labor.
 One partner can be the managing partner
 Profit is shared among the partners at a pre-agreed ratio.
 In case of loss, sharing on the basis of share in capital.
 One partner can not guarantee the return or capital of other partner.
Diminishing Musharaka (Shirka-tul-Milk):

 Joint ownership contract between bank and customer to jointly own the Asset.
 Contract of lease between the bank (as lessor) and customer (as Lessee) whereby
lessor leases its undivided ownership in the Asset to lessee.
 The maintenance cost can be paid by the lessee if included in the contract, but costs of
total damage of asset is borne by lessor to the extent of its ownership.
 From time to time customer purchases ownership share in Asset from the bank to
increase its ownership.
 Upon maturity, the customer acquires 100% ownership in the Asset.
Bank
PROJECT FINANCE
PROJECT FINANCE – AN OVERVIEW
Defined by International Project Finance Association (IFPA):
“The financing of long-term infrastructure, industrial projects and public

services based upon a non-recourse or limited recourse financial structure
where project debt and equity used to finance the project are paid back from
the cash-flow generated by the project.”
Non-recourse financing refers to the fact that the sponsor’s liability is restricted
to the amount of capital invested. Certain projects are structured with limited
recourse, which means that the sponsors are liable for any additional capital
infusions the project may require due to cost overruns or shortfalls in cash flow
in the initial phase of the project (i.e. the construction phase).
 Often referred to as a new financing technique, project finance is actually

centuries old and predates corporate finance.
 The earliest example of project financing dates back to 1299 when the
English Crown negotiated a loan from the Frescobaldi, a leading Italian
merchant bank of that period, to develop the Devon silver mines.
 “Project finance” is not the same thing as “financing projects” because

projects may be financed in many different ways. For instance, large-scale
public sector projects can be financed by the public sector’s issuance of
debt, whereas private sector projects are funded by large companies raising
corporate loans against their balance sheets (a full recourse finance) for eg.
Financing for capacity enhancement.
Main Features Of Project Finance

 A project is established as a separate company, which operates under a
concession obtained from the host government.
 The project manager provides a major portion of the project’s equity, thereby
tying the provision of finance to the management of the project.
 The project company operates with a high ratio of debt to equity, with lenders
having only limited recourse to the government or to the equity holders in the
event of default. This limited recourse is vital as it lowers the risk of sponsors
or equity providers becoming liable for injecting additional equity to meet debt
obligations.
 The long-term financiers of the projects have recourse only on project cash
flows.
 Sponsors or creditors are repaid or earn a return solely from the revenue that
is generated by sale of the project’s output.
Main Features Of Project Finance

 The project company enters into comprehensive contractual arrangements
with suppliers and customers.
 The contractual arrangements are designed to allocate each major risk in a

project to the party that is best able to appraise and control that risk. For
example, the main contractor is obviously best suited to ensure that
construction is completed within the budget and on schedule. He therefore
enters into a turnkey contract that specifies a fixed price and penalties for
delays, and is usually required to post a performance bond. A turnkey contract
refers to a business arrangement where the project or asset being constructed
is delivered in a complete state.
Characteristics of Infrastructure Finance

 Investment:
• Capital intensive (i.e. investment amount are usually lumpy, large and
incurred during the initial stages of the project).
• Enjoy economies of scale.
 Maturity:
• Long operational lives and requires long tenure financing.
• Maturity can vary from 5 to 20 years.
 Costs and Returns:
• Stable rates of return linked with the cash flows of the project.
• Cost of credit usually high due to high risk involved.
• Uncertainty in the longer-run and higher cost of funds can make some
viable projects unprofitable.
Source of financing can be either from public or private institutions or

combination of both.
Public source:
• Budgets allocation from government;
• Specialized public bodies and development banks; and
• Sovereign Wealth Funds
• Sovereign Guarantees
Private source:
• Syndicated financing by banks/financial institutions;
• Infrastructure funds;
• Private equity funds; and
• Issuance of capital market instruments (i.e. bonds and Sukuk)
PROJECT FINANCE – MAJOR PARTICIPANTS
1. Government: The project company usually needs to obtain a concession from the
host government to undertake the project. The government may also establish a
new regulatory framework, guarantee currency convertibility, and provide
environmental permits.
2. Project sponsors or owners: A separate company is established to undertake the

project. Sponsors are generally the project owners with equity stake and will
generally be involved in project construction and management.
3. Project company: The project company is a single purpose entity created to execute
the project. Controlled by the sponsors, it is the project’s hub through its contractual
arrangements with operators, contractors, suppliers and customers.
4. Contractor: The contractor is responsible for constructing the project according to

the specifications outlined in its contract. Primary contractors will then subcontract
with local firms for different components of the construction.
5. Operator: Operators are responsible for maintaining the quality of the project’s
assets and ensuring maximal operational efficiency.
PROJECT FINANCE – MAJOR PARTICIPANTS
6. Suppliers and customers: The supplier provides the critical input, like fuel for a
power plant project. The customer is the party willing to purchase the project’s
output.
7. Lenders: Infrastructure projects involve substantial funding, raised as debt from

a syndicate of lenders such as banks and specialized lending institutions.
8. Multilateral agencies: The World Bank, IFC and regional development banks are
often lenders or co–financiers of infrastructure projects in developing countries.
9. Export credit agency (ECA): Because infrastructure projects in developing

countries often require imported equipment from developed countries, ECAs
are routinely approached by contractors to support these Projects.
10.Other important parties include: Insurers, legal and financial advisors (assemble
the transaction given the number of important contracts and help structure the
financing for the project) and the trustee (responsible for monitoring the
project’s progress).
PROJECT FINANCE – MAJOR AGREEMENTS
Project Documents:
• EPC/ ECC
• O&M contract
• Input /Fuel Supply Agreement
• Off-Take Agreement e.g. PPA
Sponsor Documents
• Project Funds Agreement
• Shareholders Agreements
In case of Islamic Facility
• Investment Agency Agreement
• Declaration of Trust
• Musharaka Agreement
• Management Agreement
• Payment/ Ijara Agreement
• Purchase Undertaking
• Sale Undertaking
Security Documents
• Hypo/ mortgage
• Share Pledge Agreement
• Direct Agreements
• Guarantee
Other Documents
• Common Terms Agreement
PROJECT FINANCE – GLOBAL POTENTIAL
Estimate of Global Infrastructure Financing Needs:
 The Organisation of Economic Cooperation and Development (OECD) estimates

that approximately USD71 trillion would be needed globally by 2030 for
investment in road, rail, telecoms, electricity and water infrastructure.
 Emerging markets would require a total of USD21 trillion for infrastructure

investments in the next decade.
 The GCC region would require approximately about USD2 trillion by 2020 for
infrastructure investment.
ISLAMIC PROJECT FINANCE

ISLAMIC PROJECT FINANCE
“The way to understand Islamic finance is to replace the word

‘Islamic’ with the word ‘Structured.’ Like any structured finance deal,
you have constaints that must be overcome with creativity and
innovation. Here, the principles are based on the principles of Shari’a.
The question is how to structure the deal given these constraints.”
ISLAMIC PROJECT FINANCE – PRODUCT STRUCTURES
 A scheme to finance the cost of construction whereby the mode and the
purpose of financing are Shariah compliant.
Categories Mode of Financing

Asset based Ijarah (on existing/ future assets i.e. forward lease), Ijarah in
tranches, DM
Debt Based Istisna (manufacturing/ commissioning), Murabaha (cost plus

profit)
Equity Based Mudaraba, Musharaka
Agency Based Wakala

Combination Istisna cum ijarah, wakala cum ijaraha
 Mode of financing can be either by way of obtaining direct financing from

financier or by way of issuing Islamic securities.
ISLAMIC PROJECT FINANCE – ISTISNA CUM IJARAH


Company Sui Southern Gas Company Limited (“SSGC”)
Purpose To finance construction of 18” Dia X 53 pipeline from Dhader

to Abbe-e-Gham
Facility Amount PKR 1,000 million.
Tenor 3 years.
Grace 15 months.
Payment of periodic lease rentals after construction and advance
5 lease rentals during construction
4 Right to use Financiers’ Share in Asset on Ijarah.
Provide Funds & appoint

SSGC as Saani to construct
1 Financiers
assets
2
Construct assets either by
itself or through agent
3
SSGC deliver the asset to the financiers
Project Asset
Process Flow:
1. Financiers provide funds to SSGC for construction of project assets as Saani.
2. SSGC can either construct asset by itself or appoint a construction contractor (ECC) for the
same by the completion date in accordance with the Specifications and cost agreed. The
Istisna price will be paid to the Manufacturer by the Musharaka in advance.
3. On completion date, SSGC will deliver the project assets to financiers.
4. During the construction period, Ijarah rentals will not be recognized as income and will
appear as liability under Advance Rentals.
5. Financiers will lease the Asset under Ijarah to SSGC as lessee whereby SSGC will have an
exclusive right to use Financiers’ share in the Asset in consideration for Ijarah Rentals
comprising of principal plus profit both.
6. The project assets will transfer to SSGC at the end of the tenor.
7. SSGC will undertake to purchase the assets in the event of default.
Agreements Parties Description
Agency Agreement Investment Agent & Financiers appoint Investment Agent.

Financiers
Procurement Investment Agent and SSGC Parties appoint SSGC as manufacturer

Agreement (as Saani ) (Saani) for construction of Project Asset.
Management SSGC and Investment Agent To appoint SSGC as Managing Co-owner for
Agreement structural maintenance, insurance and
security of Project Asset once completed.
Ijarah Agreement Investment Agent (Lessor) & To take on lease the Project Asset.
SSGC (Lessee)
Purchase Undertaking By SSGC to Investment Agent To undertake purchase of the Project Asset
at EOD.
Sale Undertaking By Investment Agent to SSGC To undertake Sale of the Project Asset to
Investment Agent SSGC at the end of tenor.
ISLAMIC PROJECT FINANCE – TRANSACTION DETAILS
ISLAMIC PROJECT FINANCE – STRUCTURE (ISTISNA &
Islamic IJARAH) Project
Infrastructure Finance
ISLAMIC PROJECT FINANCE – TRANSACTION DETAILS
ISLAMIC PROJECT FINANCE – STRUCTURE (ISTISNA &
Islamic IJARAH) Project
ISLAMIC PROJECT FINANCE – WAKALA CUM IJARAH


Company Foundation Wind Energy (“FWE”)
Purpose To set up Wind Power Generation Complex.
Project Cost USD 134 million
Facility Amount PKR 10,000 million.
Tenor 12 years.
Grace 2 years.
Project Construction of 50 MW wind power project, situated at Kutti

Kun, District Thatta, Sindh.
3 Construction and Management
FWE Project
(Project Company) Assets
5 Right to use the
assets
Periodic lease rentals
construct the assets

Appoint as Agent to
Funds
1 2
6 Deliver the Project
4 Assets on
Financiers completion
Process Flow:
1. Financier will appoint FWE as their Wakil (Agent) to construct the Project Assets on behalf
of the financier.
2. FWE (as Agent) will enter into the arrangement with Nordex to manufacture and supply
the wind turbine and construct a wind-based power generation complex for the
financiers.
3. Financiers will inject the funds in the project company as and when required by FWE.
4. FWE will be deemed to commence usage of financiers’ share in asset as it completes and
will take the asset on lease, after completion, through the lease commencement notice
signed by both the parties.
5. FWE will make periodic payments of lease rental comprising of principal and profit both
for using the Project Assets.
6. Financiers undertake to transfer the Project Assets at the end of the Tenor.
7. FWE undertakes to purchase the Project Assets in the event of default.
Investment Agency Investment Agent & Financiers appoint Investment Agent.

Agreement Financiers
Procurement Investment Agent and FWE Parties appoint FWE as manufacturer

Agreement (asWakil) (Wakil) for construction of Project Asset.
Management FWE and Investment Agent To appoint FWE as agent for structural
Agreement maintenance, insurance and security of
Project Asset once completed.
FWE (Lessee)
Purchase Undertaking By FWE to Investment Agent To undertake purchase of the Project Asset
at EOD.
Sale Undertaking By Investment Agent to FWE To undertake Sale of the Project Asset to
Investment Agent FWE at the end of tenor.
Equipment Procurement & FWE & Contractors Contractors take the responsibility for
Construction Contracts construction and completion of the Project
Operation and Maintenance FWE & O&M Contractor To operate and maintain the Project.
(O&M) Contract
Power Purchase Agreement FEW & NTDC To purchase the electricity from FEW.
GOP Guarantee By Govt. of Pakistan to To guarantee the obligations of FWE.

Financiers
Implementation Agreement Relevant Govt. Authority Government support for the Project.
and FWE.
Security Documents By FWE to Investment To create security in favour of Investment

Agent Agent.
Common Terms Agreement FWE, Investment Agent To agree on general terms used under
and Financiers. facility agreements, security document etc.
ISLAMIC PROJECT FINANCE – TRANCHES IJARAH


Company Pakistan International Bulk Terminal (“PIBT”)
Purpose To finance Company’s capex plan.
Project Cost USD 184 million.
Local Facility PKR 4,100 million.

Tenor 12years.
Grace 3 years.
Project To set up a dedicated Cement, Coal and Clinker Terminal at
Port Qasim with a handling capacity of 11 million tones per
annum.
3 Construction and Management
PIBT Project
(Project Company) Assets
5 Right to use the
individual Project
Assets
Periodic lease rentals
Manage construction as
Funds to construct the
Project Assets
Agent (Wakil)
1 2
6 Deliver the
4 individual assets
Financiers (part of project
asset) as and
when completed.
Process Flow:
1. PIBT (as Agent) will construct a dirty cargo handling terminal at Port Qasim.
2. Financiers will inject funds as and when required by PIBT.
3. PIBT as agent, will construct the Project Asset and will also enter into supply, construction
and other contracts on behalf of the Musharaka.
4. PIBT will be deemed to commence usage assets as soon as each asset/section are come
into the usable condition and will take such asset/section on lease thereby making rental
payments to its financiers’ for using each individual assets.
5. Financiers undertake to transfer the Project Assets at the end of the Tenor.
6. PIBT undertakes to purchase the Project Assets in the event of default.
Benefit:
It helps the Islamic financiers to recognize the Advance Lease Rental as soon as any
individual asset, part of the project asset, is completed and in usable condition.
Agency Agreement Investment Agent & Financiers appoint Investment Agent.

Financiers
Procurement Investment Agent and PIBT Parties appoint PIBT as agent to construct
Agreement (Agent) the Project Asset.
Management PIBT and Investment Agent To appoint PIBT as agent for structural
Agreement maintenance, insurance and security of
PIBT (Lessee)
Purchase Undertaking By PIBT to Investment Agent To undertake purchase of the Project Asset
at EOD.
Sale Undertaking By Investment Agent to PIBT To undertake Sale of the Project Asset to
Investment Agent PIBT at the End of Tenor.
Equipment Procurement PIBT and Contractors Contractors take the responsibility for
and Construction construction and completion of the Project.
Contracts
Implementation Relevant Govt. Authority and Government support for the Project.
Agreement PIBT.
Project Funds PIBT, Sponsors & Investment To undertake contribution from Sponsors of
Agreement Agent the Project.
Security Documents By PIBT to Investment Agent To create security in favour of Investment
Agent.
Common Terms PIBT, Investment Agent and To agree on general terms used under
Agreement Financiers. Islamic facility agreements, security
document etc.
ISLAMIC PROJECT FINANCE – COMBINATION WITH
Islamic InfrastructureDM Project Finance
Category Ijarah Diminishing Musharaka
Construction of By project company as Saani/ Same
Project Asset Wakil/ Managing Co-owner
Delivery of Project On completion Same
Asset
Ownership Financier will own 100% Financier and sponsor will jointly
own the Project Assets, normally in
80:20 ratio.
Periodic Payment Lease Rental comprising of Lease Rental comprising of profit
principal and profit only. Principal will be repaid
periodically through purchase of
financier’s share in Musharaka
Assets under purchase undertaking.
At Maturity Project Assets will be The project company periodically

transferred to sponsor either purchases the financier’s
through sale at a nominal Musharaka Share and subsequently
amount or by way of gift project assets are gradually
transferred.
ISLAMIC PROJECT FINANCE – SUKUK


Company Liberty Power Tech Limited(“LPTL”)
Purpose To setup a new project under the name of LPTL.
Project Cost USD 241 million.
Issue Size PKR 15,000 million.

Tenor 12 years.
Grace 2 years.
Project To setup a 200 MW power plant on the BOO (Build Operate
Own) concept, based on Residual Furnace Oil (RFO) in
Faisalabad.
ISLAMIC PROJECT FINANCE – SUKUK (SHIRKAT-UL-
Islamic MILK) Project
LPTL Cash & other 2 Sukuk

Musharaka
(as Partner) 1a assets (Land) in Sukuk Holders
tranches LPTL as Trustee &
Issuer
Cash in tranches 1b
to purchase the
undivided
Cash & other assets in ownership in
LPTL tranches 3
project land.
(as Manager)
Construction & delivery
4 of Power Plant
Rental Payments
Renting of Sukuk Holders

LPTL undivided share in Power Plant 5 Musharaka
(as User) LPTL= Trustee &
7 Sukuk Holders
Issuer
6 Rental Payments Periodic
Distributions
Process Flow:
1. LPTL and Sukuk Holders enter into a Musharaka to construct and then own undivided
share in the Power Plant. Sukuk will be issued by LPTL, as Issuer, to the Sukuk Holders
against the cash contribution towards Musharaka.
2. The Sukuk Holders will purchase the undivided ownership in the land while the Project
Company contribute its share in kind (the remaining portion of undivided ownership in
land). This will enable the financiers to charge rental as income from the very day
musharaka is created.
3. LPTL (as managing co-owner) will get the Power Plant constructed as per specification at
an agreed cost.
4. Sukuk Holders’ undivided share in Musharaka Assets (Power Plant) will be rented to LPTL
on completion of the construction in consideration of Periodic Rentals which include Base
Rental (Principal) and Variable Rental (Profit).
5. LPTL undertakes to purchase the Sukuk Holders’ Musharaka share on maturity or in the
event of default.
Agency Agreement IA& Financiers Financiers appoint Investment Agent.
Procurement Agreement Investment Agent and LPTL Parties appoint LPTL as agent to construct the
(Agent) Project Asset.
Management Agreement LPTL and Investment Agent To appoint LPTL as Managing Co-owner for
structural maintenance, insurance and security of
Ijarah Agreement Investment Agent (Lessor) To take on lease, Investment Agent’s share in the
& LPTL (Lessee) Project Asset.
Purchase Undertaking By LPTL to Investment To undertake purchase of Investment Agent’s

Agent share in the Project Asset at EOD.
Sale Undertaking By Investment Agent to To undertake Sale of Investment Agent’s share in

LPTL Investment Agent the Project Asset to LPTL at the End of Tenor.
Declaration of Trust LPTL, Investment Agent & For the purpose of declaration of trust and
Financiers issuance of Sukuk to investors.
Equipment Procurement and LPTL and Contractors Contractors take the responsibility for
Construction Contracts construction and completion of the Project
Operation and Maintenance LPTL and O&M Contractor To operate and maintain the Project.
(O&M) Contract
Fuel Supply Agreement LPTL & Supplier To guarantee fuel supply from the supplier for
operations of the Project.
Power Purchase Agreement LPTL & Purchaser To guarantee purchase of Power from the
Project.
Project Funds Agreement LPTL, Sponsors & To undertake contribution from Sponsors of
Investment Agent the Project.
Security Documents By LPTL to Investment To create security in favour of Investment

Agent Agent.
Common Terms Agreement LPTL, Investment Agent and To agree on general terms used under Islamic
Financiers. facility agreements, security document etc.
ISLAMIC PROJECT FINANCE – PROFIT SHARING

STRUCTURES
ISLAMIC PROJECT FINANCE – MUDARBA
Provide periodic lease rentals (Adv. Or

7
actual)
3 Give funds as
1
Appoint SPV as
agent to construct Mudarib
the assets
Project
SPV Financiers
Company Provide Funds as
6
Lease the assets 2 Rabul Mal
back
8 Share the agreed profit percentage with

Financiers
5 Project Co. will deliver the

assets
4 Project
Company
ISLAMIC PROJECT FINANCE – MUSHARAKA
6 Provide periodic lease rentals (Adv. Or Sponsors

actual)
(As Musharaka
Partner)
1
2 Give funds as Both Musharaka Partner provide
agent to construct funds towards Musharaka (create
the assets musharaka)
Project
Musharaka
Company
Lease the assets
5 back
Financiers
(As Musharaka
Partner)
Sponsors
3 4 Project Co. will deliver the (As Musharaka
assets
8 Partner)
Project Sharing of profit at
agreed ratio
Company
Financiers
Musharaka (As Musharaka
Partner)
PROJECT FINANCE – RISKS & MITIGATES

PROJECT FINANCE – RISK & MITIGATES
Construction Risk:
 Construction is the most risky phase in infrastructure project. During construction phase, we may
face the risk of cost overrun, missed deadlines, defaults/ delays in construction of the facility,
design or its non-conformity to the desired specifications etc. These risks often come from the
following different factors:
• Any modifications or changes in the characteristics of the facility, during the construction phase.
• Poor estimates of cost or construction delays or cost over run.
• Technical or financial failure of the constructors.
Mitigates:
 Different operators are outsourcing these risks through turnkey construction contracts, with fixed
price and a fixed date of delivery. Generally, manufacturers bear risks associated with construction.
Indeed, sponsors of the project company seek to transfer to contractors and incorporate clauses for
liquidity damages.
 As lenders, they can allocate a portion of the risks related to the construction jointly with the
sponsors by establishing a line of credit with major additional funding to cover the additional costs
or delays encountered during the construction phase.
Lease Default Risk:
 If the Project Assets are not delivered to the Investment Agent, the Investment Agent
cannot lease the same to the Lessee under the Forward Lease arrangement. Under
Shariah, the Forward Lease Agreement has to be terminated and the financiers has to
return the Advance Lease Rentals already paid by the Lessee.
Mitigates:
 In this case, since the Lessee or its appointed contractor is also the Wakil/ Saani, the
financier normally include arrangement of liquidity damages to set-off the obligation to
return the Advance Lease Rentals.
Operating-related risks:
 Risk of insufficient revenue and/ or income, arises from an incorrect estimation of
project revenues, of the factors used to calculate the costs of management,
maintenance or renewal and major repairs.
Mitigates:
 Financiers normally include arrangement of third party undertaking like Govt. guarantee,
minimum off take guarantee, minimum toll guarantee etc.
Political/ Policy Risk:
 In addition to the above, political stability and economic environment of the
host state of the project are important for assessing the conditions of the
project's success.
 These risks might be caused by political decisions taken against the project
directly such as changing tax regimes, nationalization, expropriation,
confiscation, not obtaining permits or imposing other regulatory constraints
directly affecting the profitability of the project.
Mitigates:
 Political risks cannot be controlled by private partners in case of Public Private
Partnership projects. These are usually borne by the government or govt.
agencies.
 Another way to minimize such risk is to involve some large multilateral agencies
like world bank, IFC, ADB, IDB etc.. Involvement of such agencies will restrict
government for making unfavorable amendments.
ISLAMIC PROJECT FINANCE – CONSTRAINS &

CHALLENGES
Islamic CHALLENGES
Sharia’ah Issues
 Islamic financial transactions appear to be more complex than their conventional
counterparts.
 Difference of opinions among Shari’ah scholars, not only in different countries,
but even within a single jurisdictions.
• Sharia principles are often expressed in general terms, allowing for
considerable discretion on how to apply these principles. Because there are
different schools of Islamic jurisprudence, they may construe certain precepts
differently. Within each school there are also majority and minority views on
various issues, either of which may be applied in any particular case. Therefore,
a document or structure may be accepted by one Sharia committee of a bank
but rejected by a different Sharia committee.
 Controversies in certain financing instruments among Shari’ah scholars:
• Organised tawarruq (i.e. has been declared unlawful by the Islamic Fiqh
Academy).
• Murabaha Based sukuk structures are permitted in some jurisdictions.
Islamic CHALLENGES
 Issue of accruing income on forward lease contracts. During the construction
period Advance Rental is a liability .
 Islamic debt-based instruments have inherent problems of tradability and
liquidity. In order to make instrument tradable in light of Shariah the instrument
should by back by at least 20% ownership in the tangible assets.
 Delay in payments is another concern. Conventional lenders can charge interest/
penalty while Islamic Financiers cannot.
 In case of Total Loss or destruction securities like cash collateral and receivables
cannot be enforced (major risk).
 Under the Shariah laws unilateral promises are enforceable and therefore they
perform a very important roles is Islamic agreements like in case of forward
Ijarah/ DM where customer; (i) promises to take assets on lease once completed,
and (ii) gives a purchase undertaking to purchase back assets in case of EoD or at
maturity. These promises are not yet challenged in court of law and pose the risk
that the customer may dishonor his commitments.
 Takaful coverage is not available for such large projects.
Islamic CHALLENGES
Legal & Contractual issues
 Problems may arise in settling disputes involving Islamic contracts in jurisdictions that do
not have supporting Islamic laws, thereby creating uncertainty about Islamic financial
transactions. These structures had never been tested in a major litigation and it was
unclear whether a court might pierce the corporate veil and assert liability on Islamic
investors. Even in case of default, it is unclear whether Islamic law or English law would
prevail.
 Integrating Islamic financing with conventional financing in a single deal, raises further
complications regarding inter-creditor arrangements. In case of default, Islamic investors
who own specific assets in the project could claim those assets. Although this structurally
puts an Islamic investor in a better position than a conventional lender, who is usually
only a beneficiary of security but this would violate the pari passu treatment of most inter-
creditor arrangements. Pari Passu treatment refers to the fact that all creditors holding
the same securities should have equal claim on project assets. The standard solution,
opted in most of the project finance deals, is for Islamic investors to forgo their rights in
case of liquidation or default.
Islamic CHALLENGES
 Shariah advisors and legal professionals face the challenge of structuring the transaction that satisfies
both Shariah principles and legal/regulatory requirements of the host country. Particularly the
governing laws is one of the important legal issues to be solved. Most large project financings involve
multiple and diverse parties and jurisdictions. The choice of law is rather ambiguous, to say the least,
and raises a whole set of questions. One is whether and to what extent the parties can validly agree on
Islamic law as a governing law of a financial transaction.
Issues Related to Market Participants
 Limited number of sources in providing long-term Islamic funds for infrastructure project as Islamic
financial sector is still developing.
 Islamic financial principles and the legal implications of Islamic instruments are not clearly understood
by many market participants.
Leveling Playing Field/Standardization:
 The Islamic structures set out above can potentially trigger multiple tax duties (for example, stamp
duties) on the sale and transfer of assets. It is very important for the Islamic finance that the
governments should provide tax neutrality.
 Need laws and regulations that able to reduce legal and regulatory disparities between Islamic and
conventional finance.
 Need for risk mitigation organizations and instruments that can be used to support infrastructure
financing (e.g. takaful companies).
THANK YOU
DEBT FOR A REASONABLE NEED
IMPACT OF DEBT CULTURE ON SOCIETIES
IMPACT OF DEBT CULTURE ON SOCIETIES
THE DEBT TRAP CYCLE

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Islamic

GLOBAL ISLAMIC BANKING

• Islamic Finance posting 15-20% growth globally

Islamic Banking Asset Growth (US$b)

 Top three markets for Islamic Banking Assets (2011)

• Saudi Arabia (US$207 billion)

 New markets embracing Islamic Financial Industry are

LOCAL ISLAMIC BANKING

No. of Islamic Banking Branches

2006 2007 2008 2009 2010 2011 2012

Growth of Market Share for Islamic banks

Deposit Growth of Islamic Banking

Asset Growth of Islamic Banking

1000 CAGR = 32.36%

Two sources of law in Islam

Islamic laws can be broadly classified into two types

 Muamalat (dealings or transactions)—Transactions are permitted unless prohibited by

In muamalat, new transactions can be accommodated through ijtihad as long as they

Finance/ Banking in Islam (Matter of Muamalat)

The word “Riba” means excess, increase or addition. According to Shariah

Extra Guarantee RIBA

Prohibition of Riba in Quran:

Prohibition of Riba in Ahadith:

 First Type : Riba al Nasiah:

 Riba Al-Nasiah… Riba in loan contracts:

 Implication in Financing Transactions:

 Second Type: Riba al Fadl:

SUMMARY OF RIBA AL-FADL

 Implication in Financing Transactions:

Every Debt that pulls any kind of gain is Riba

Whereas Allah has permitted trading and forbidden Riba

Islamic banking Conventional banking

Diminishing Musharaka (Shirka-tul-Milk):

Defined by International Project Finance Association (IFPA):

“The financing of long-term infrastructure, industrial projects and public

 Often referred to as a new financing technique, project finance is actually

 “Project finance” is not the same thing as “financing projects” because

Main Features Of Project Finance

Main Features Of Project Finance

 The contractual arrangements are designed to allocate each major risk in a

Characteristics of Infrastructure Finance

Source of financing can be either from public or private institutions or

2. Project sponsors or owners: A separate company is established to undertake the

4. Contractor: The contractor is responsible for constructing the project according to

7. Lenders: Infrastructure projects involve substantial funding, raised as debt from

9. Export credit agency (ECA): Because infrastructure projects in developing

Estimate of Global Infrastructure Financing Needs:

 The Organisation of Economic Cooperation and Development (OECD) estimates

 Emerging markets would require a total of USD21 trillion for infrastructure

ISLAMIC PROJECT FINANCE

“The way to understand Islamic finance is to replace the word

Categories Mode of Financing

Debt Based Istisna (manufacturing/ commissioning), Murabaha (cost plus

Equity Based Mudaraba, Musharaka

Agency Based Wakala

 Mode of financing can be either by way of obtaining direct financing from

ISLAMIC PROJECT FINANCE – ISTISNA CUM IJARAH

Categories Mode of Financing

Purpose To finance construction of 18” Dia X 53 pipeline from Dhader

Facility Amount PKR 1,000 million.

4 Right to use Financiers’ Share in Asset on Ijarah.

Provide Funds & appoint

Agency Agreement Investment Agent & Financiers appoint Investment Agent.

Procurement Investment Agent and SSGC Parties appoint SSGC as manufacturer