A Musharaka sukuk is a certificate representing a share in a joint venture between holders and an originator, each contributing capital to a project or asset, with profits shared under an agreed ratio and losses borne in proportion to capital.
A joint venture housed in a special purpose vehicle
Holders pay their funds into a special purpose vehicle that enters a Musharaka with the originator. The originator often contributes land, a factory or an operating right, holders contribute cash, and together these form a common asset held in co-ownership.
What is the originator's in-kind contribution worth?
An existing asset must be valued at market value by an expert on the day the venture is formed. If the originator brings land valued at 100 million and holders bring 300 million, their respective shares are set at 25 and 75 percent.
Negotiated profit ratio, losses by capital
Profit is shared according to the contract ratio, which may reward the originator for managing the project, whereas losses strictly follow capital shares. A clause placing all losses on a single party is void.
Managing agent and incentive fee
The originator is usually appointed manager of the project. It may receive a fixed fee and, if profit exceeds an expected level, keep the surplus as an incentive fee. This brings the return close to a target rate without legally guaranteeing it.
Gradual buy-out of the units
In the diminishing version, the originator periodically buys units from holders, raising its ownership to 100 percent at maturity. It often also leases its share from holders, combining Musharaka and Ijara to stabilise distributions.
The 2008 debate on buy-back at face value
In 2008 the AAOIFI Sharia board stated that a partner cannot promise to buy units back at their original value, since that guarantees capital. The buy-back must be at market value or at a price agreed at the time of sale.
Net asset value or market value at buy-back
In practice the value may come from an independent valuation or from the project's revalued net assets. If the project has lost value, holders recover less than they invested, which is the normal consequence of a genuine partnership.
Why some issues aged badly
Before 2008, several Gulf Musharaka sukuk included a buy-back at par that made them close to bonds. Difficulties faced by some issuers during the property downturn showed investors behaving as creditors rather than partners.
What banking supervisors look at
The IFSB distinguishes the prudential treatment of profit-sharing sukuk from that of debt-based sukuk. For a holding bank the risk is closer to an equity stake, which may increase the capital requirement depending on the local regime.
Information to holders during the life of the issue
Because returns depend on project results, documentation requires periodic accounts, an auditor and sometimes a Sharia board report. Holders should be able to follow revenue, costs and the valuation of the common asset.
How it compares with a project bond
A conventional project bond pays a coupon due regardless of results and remains senior debt. A Musharaka sukuk only obliges the issuer to distribute a share of actual profit; in return its holders own part of the financed asset.
Projects and sectors where it appears
It is used in commercial real estate, energy, telecoms and to raise capital for Islamic banks. It needs a project generating measurable profit; infrastructure without its own revenue is better suited to Ijara.
Specialist external source
IFSB standards cover capital adequacy, risk management and disclosure requirements that apply to sukuk held or issued by Islamic financial institutions.