Jump to Content Jump to Main Navigation
Signed in as:

11 Islamic Project Finance

John Dewar, Munib Hussain

From: International Project Finance (3rd Edition)

Edited By: John Dewar

From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: null; date: 07 June 2023

Islamic financial services — Capital markets

(p. 285) 11  Islamic Project Finance


11.01  Islamic finance is concerned with the conduct of commercial and financial activities in accordance with Islamic law. With approximately 1.8 billion adherents, the global population of Muslims equates to over 24 per cent of the world’s population.1 This, in conjunction with:

  1. (1)  the rapid growth in the wealth of many Middle Eastern and Asian countries;

  2. (2)  the trend for a significant number of governments, financial institutions, and individual Muslims of investing in a manner which is consistent with Islam; and

  3. (3)  the shortage of conventional sources of debt as a result of tightening conventional bank lending (particularly in the project finance market where commercial banks are having to grapple with a combination of lower margins and longer tenors in the context of the bank capital adequacy rules implemented under Basel III), means Islamic finance is a rapidly growing segment of the global finance industry.

11.02  In the Middle East and parts of Asia and Africa, a growing proportion of the financing for projects is sourced in accordance with Islamic finance principles. With traditional project finance structures being rooted in conventional interest-based systems, the manner in (p. 286) which risks are allocated and transaction structures are implemented needs to be reassessed, as the investment of the Islamic-compliant participant will, no doubt, be conditional on compliance with Islamic finance principles. Structuring the investment of such capital therefore requires a comprehensive understanding of Islamic finance principles, knowledge of international and domestic laws, and documenting such arrangements in a manner that satisfies the priorities of all the project participants, including those not necessarily constrained by Islamic finance principles.

11.03  This chapter analyses how these priorities are accommodated and how Islamic finance techniques are applied in project financings. Context is paramount to achieve this aim, and so by way of introduction, the sources of Islamic finance are discussed, followed by a brief analysis of the principles and financing techniques that underpin Islamic finance. For those unfamiliar with Islamic finance principles, this will enable a better understanding of the ensuing discussion of the issues that commonly arise in a project financing that is entirely or in part financed with Islamic-compliant funding. Then, the focus is turned to assess how Islamic project finance techniques are utilized in practice, including how such arrangements are documented.

Sources of Islamic Finance

11.04  Islamic finance is concerned with the conduct of commercial and financial activities in accordance with Islamic law. Islamic law is a manifestation of the divine will of Allah (SWT) and finds its expression in the Qur’an (Book of Allah (SWT)) and Sunnah (words or acts) of the Prophet (PBUH).2 The Qur’an is the most sacred canonical text in Islam and perceived by Muslims as the word of Allah (SWT) for which reason it is a primary reference for Muslims and is inviolable.3 The Sunnah is comprised of all the sayings, acts, and approvals (tacit or otherwise) of the Prophet (PBUH)4 as compiled by the Sahabah (closest companions of the Prophet (PBUH)).5 The law contained in both of these primary sources is known as sharia’a which means ‘the road to the watering place [and] the clear path to be followed’. Reflecting the Qur’an and Sunnah, sharia’a is therefore a compilation of the values, norms, and rules which govern all aspects of a Muslim’s life (such as family life and economic activities). Sharia’a is pervasive in that a Muslim is obliged to comply with sharia’a at all times and in all respects:

(p. 287)

Then We placed you on the right road [sharia’a] of Our Command, so follow it. Do not follow the whims and desires of those who do not know. (Qur’an, Surah Al-Jathiyah 45:18)

11.05  Notwithstanding its breadth (as exemplified in Figure 11.1), sharia’a is not amply codified to rule on every matter that may arise in contemporary scenarios, since the Qur’an and Sunnah were settled over one thousand four hundred years ago. Sharia’a has, however, remained relevant and addresses the myriad of original situations through the use of secondary sources that are based on ijtihad,6 namely:

  1. (1)  ijma: consensus of the independent jurists qualified to exercise ijtihad (a mujtahid) on a particular interpretation of sharia’a; and

Figure 11.1  Islamic construct

  1. (2)  qiyas: interpretation by analogical reasoning where one situation is measured against another by the mujtahids, in each case subject to and in accordance with the Qur’an, Sunnah, and ijma.

The principles derived from the application of ijma and qiyas to sharia’a form the body of jurisprudence known as fiqh (understanding and knowledge applied to any branch of knowledge). The body of rules that underpin the derivation of fiqh is referred to as usul al fiqh.7

11.06  Certain sharia’a principles may be ambiguous not least because of the numerous tafasir of the Qur’an and the voluminous ahadith as well as the mujtahids involved in the practice of ijtihad, interpreting sharia’a in different yet equally permissible ways because of the interpretation methodologies they may apply. This means that often there can be different legal opinions (fatwa) on the same aspect of sharia’a. This difference of methodology for interpreting sharia’a and the body of fatwa derived thereby is one reason why there have (p. 288) developed several schools of thought/fiqh (madhabs) to which a mujtahid would ordinarily be aligned. The renowned madhabs are:

  1. (1)  Hanafi, founded in Kufa, Iraq by Imam Abu Hanifa Nu’man Ibn Thabit (RA)8 and based largely on logical deduction by the mujtahids;

  2. (2)  Maliki, founded in Medina, Saudi Arabia by Imam Malik ibn Anas (RA);9

  3. (3)  Shaf’i, founded by Imam ash-Shaf’i (RA);10 and

  4. (4)  Hanbli, founded by Imam Ahmed Bin Hanbal (RA),11 which is predominant in the Arabian peninsula and is perceived as the more doctrinal of the madhabs.

As fiqh is law derived by mujtahids interpreting sharia’a in accordance with the methodology ascribed by a madhab, differences on a matter relating to fiqh are inevitable but there can be no difference on sharia’a itself, as this is law derived from the Qur’an and Sunnah.

11.07  With respect to these differences, the Prophet (PBUH) was reported to have said, ‘My community’s differences of opinion (ikhtilaf) are a blessing,’12 and evidently this process has derived a comprehensive corpus juris providing guidance on almost every facet of a Muslim’s life (see Figure 11.1). For commercial organizations, however, the various methodologies of interpreting sharia’a and the different fatwa derived as a result, mean that in order for them to determine the legitimacy of a particular commercial activity with sharia’a, they may need to seek expert guidance.

The role of sharia’a scholars and regulators

11.08  This has led to the role of specialist sharia’a scholars and sharia’a advisory firms rising to prominence. Most banks, sponsors, and sharia’a-compliant funds retain independent sharia’a scholars (who are usually renowned in the relevant domestic market) and who sit as a sharia’a supervisory board to issue fatwa certifying the compliance of a transaction structure or a financial product, for example, with the Qur’an, Sunnah, and typically a specific madhab.13 The typical duties of a sharia’a supervisory board include:

  1. (1)  assisting in the development of products and structuring transactions;

  2. (2)  issuing fatwa relating to certain activities, products, or transactions having reviewed their legitimacy from a sharia’a perspective;

  3. (3)  day-to-day oversight of the operations of the institution to ensure sharia’a compliance; and

  4. (p. 289) (4)  providing a letter on an annual basis to indicate sharia’a compliance by the institution for inclusion in its annual report.

11.09  This approach of retaining independent sharia’a scholars became the subject of some criticism, since it appeared to result in a lack of harmonization and hampered the development of common principles across international and even domestic financial markets. This had the ancillary effect of undermining regulatory confidence in Islamic finance. In order to mitigate this, bodies of interpretation such as the Sharia’a Supervisory Board and the Islamic Fiqh Academy endeavour to issue fatwa to deal with contemporary issues that may arise in the Islamic finance context. And in order to systematize and regulate Islamic finance with the intention one day to have globally accepted sharia’a standards for Islamic finance transactions, the Accounting and Auditing Organization for Islamic Financial Institutions, the International Islamic Financial Market, and the Islamic Financial Services Board are playing a prominent role. Their issuance of practice directions and standards for accounting have gone some way towards becoming global standards and thereby instilling investors with the confidence to invest in sharia’a-compliant products. This chapter will consider Islamic project finance structures that are consistent with the core consensus of Islamic scholars and these leading regulators.

Islamic Finance Principles

11.10  Akin to Western legal systems, in Islam there is a presumption that everything is permissible (halal) unless there is an express law which rebuts that presumption by declaring it as forbidden (haram). Financiers are therefore expected to carry out their activities subject to, and in accordance with, sharia’a principles. The pertinent sharia’a principles that relate to Islamic finance are that the following are avoided in any transaction: (i) riba (excess or increase); (ii) gharar (uncertainty); (iii) maisir (speculation); and (iv) qimar (gambling). Two other relevant sharia’a principles are the prohibition on investing in, or being involved with, haram products and activities (such as alcohol and gambling establishments) and the prohibition of becoming unjustly enriched.14

11.11  Riba has been declared haram on several occasions in the Qur’an15 and Sunnah.16 Riba means any excess paid or received on the principal or an additional return received on the principal derived by the mere passage of time.17 There are two types of riba: riba al-naseeyah (a pre-determined premium on the principal received by a lender solely due to the passage of time), and riba al-fadl (excess compensation received by one party from an exchange or sale of goods without adequate consideration). Interest paid on a conventional loan is a form of riba al-naseeyah and certain exchange of commodities contracts may contain riba al-fadl if on an exchange of commodities of similar value, one party pays excessive (p. 290) compensation to the other party. The philosophy behind the absolute prohibition of riba (which has the effect of rendering any contract harbouring riba as being void), is that sharia’a regards money as having no intrinsic value in itself (unlike commodities such as gold, silver, dates, and wheat) and is merely a means of exchange to procure goods and services. Money cannot therefore derive a profit either from the exchange of money of the same denomination or due to the passage of time, as is the case with interest.

11.12  Sharia’a by no means prohibits the making of profit, but it does scrutinize the basis upon which profit is made, as, for example, charging interest could exploit the client in a time of hardship whilst the financier’s wealth is increased by no effort of its own. Islam instead empowers the financier to derive a profit by investing its money or other consideration directly (or indirectly through a joint venture arrangement, for example) in real assets using one or more of the Islamic finance techniques discussed here.18 The financier will then generate a profit and recoup the principal sum invested in the asset by exercising its rights as an owner—using, leasing, or selling the asset. Here, unlike conventional finance, the money itself has not yielded the profit; instead, the assumption of the risks and responsibilities as owner of the asset, or as a partner in the venture, has yielded the profit made by the financier. This highlights the preference of Islamic finance for equity over debt and seeking to deal in tangible assets. This also explains why Islamic finance can be used as a form of both asset-backed financing and asset-based financing. Therefore, in facilitating financing arrangements, if the client requires money for a profit-seeking venture, the client and the financier enter into an equity-sharing arrangement and if the client requires money for an asset, rather than simply loaning the money, the financier purchases the asset outright from the supplier and then sells it on to the client for a profit.

11.13  Gharar can be defined as the sale of probable items whose existence or characteristics are uncertain or speculative (maisir), the risk of which makes it akin to gambling (qimar).19 The rationale for prohibiting gharar and maisir stems from the belief that bargains should be based upon contractual certainties as far as possible in order to bring about transparency and avoid conflict over key terms of a contract such as the object, the quality of goods, the time for delivery, and the amount payable. Contemporary examples of gharar include: the sale of an object prior to it coming into existence, which, subject to certain exceptions,20 would render the contract as void; where the object is unknown; where the specifications of the object are unknown; and where the price or rent cannot be ascertained with certainty.

Islamic Finance Techniques

11.14  Profit and loss sharing forms the bedrock of Islamic finance, since Islam perceives that the ideal relationship between contract parties should be that of equals where profit and losses are shared. Mudarabah (investment fund arrangement) and musharaka (joint venture arrangement) are two finance techniques which facilitate this priority. With the need for (p. 291) diversity in risk/return profiles and conventional lender reluctance to enter into a profit and loss arrangement, where the lender would otherwise expect the client to remain liable for the principal and interest regardless of how the venture performs, certain traditional Islamic trading techniques have been adapted which, to an extent, are sharia’a-compliant versions of conventional finance products. These include murabaha (cost plus financing), istisna’a (commissioned manufacture of a specified asset), and ijarah (lease purchase finance). Finally, a key source of sharia’a-compliant financing is the sukuk (trust certificates), which have similarities to conventional bonds. The focus of this chapter will be on the istisna’a and the ijarah structures, as these techniques form the building blocks of most single facility and multi-sourced sharia’a-compliant transactions. There has also been a recent trend towards incorporating project sukuk into multi-sourced financings and, so, the typical structure of a project sukuk is also analysed.


11.15  A mudarabah is an investment fund arrangement under which the financiers act as the capital providers (rab al-mal) and the client acts as the mudareb (akin to an investment agent) to invest the capital provided by the rab al-mal and manage the partnership. The profit of the venture, which is based on the amount yielded by the fund that exceeds the rab al-mal’s capital investment, can be distributed between the parties at a pre-determined ratio but with any loss (subject to whether the loss is caused by the mudareb’s negligence) being borne by the rab al-mal. The fund is controlled by the mudareb, with the rab al-mal as a silent partner. In practice, however, conventional investment agency arrangements may be used instead of the mudarabah, enabling the rab al-mal to exercise further control over the fund and potentially limiting the discretion of the mudareb when it comes to investing the capital.21


11.16  A musharaka is similar to a mudarabah except that the losses are borne in proportion to the capital invested by both the client and the financier. Each party to a musharaka has the right to participate in the affairs of the enterprise, but each can also choose to waive that right and instead be a silent partner as in a mudarabah.22 However, the silent partner will then only be entitled to profits in proportion to its capital investment and not more. Under a ‘continuous musharaka’, each partner retains its share of the capital until the end of the project or, in the case of a ‘diminishing musharaka’ (musharaka muntahiya bittamleek), it is agreed at the outset that one of the partners will purchase units in the musharaka from the other partner at a pre-agreed unit price.

11.17  Both the musharaka and the mudarabah arrangements have been utilized in the context of sukuk, where the investors disburse proceeds to the musharaka or the mudarabah in return for sukuk certificates (the certificates). The issuance proceeds are then used by the musharaka or the mudarabah (by the rab al-maal who will likely be the originator of the sukuk) to invest in a particular business or to purchase certain assets. The returns generated by that investment are then paid by the musharaka or the mudarabah to the investors on each periodic distribution date.

(p. 292) Murabaha

11.18  A simple murabaha transaction involves the purchase of an asset by the financier (on behalf of the client) who then sells the asset to the client for the cost of the asset plus a pre-stated margin on a deferred payment basis, which may be pegged to a benchmark such as LIBOR.23 The profit margin earned by the financier is considered to be legitimate profit and not interest because the financier acquires ownership of the asset (and therefore the risk associated with ownership of the asset) before on-selling it to the client. The client is also not bound to accept delivery of the asset, although in practice, the financier will mitigate this risk by seeking a letter of credit, a good faith down payment (such as arbun),24 or a unilateral purchase undertaking from the client. This transaction is effected through a murabaha contract, which reflects a conventional sale and purchase agreement. Upon acquiring ownership of the asset, the client may go a step further and sell the asset to a third party for cost price so that the client now has the money it may have always wanted (rather than the asset), whilst it remains liable to the financier to pay the cost price of the asset plus a pre-stated margin on a deferred payment basis. In this case, the underlying asset could be a base metal such as copper, but not commodities which were originally used as a means of exchange or money such as gold, silver, and wheat. For larger transactions, it may not be possible to purchase the required amount of commodity on, for example, the London Metals Exchange and so an alternative is to acquire shares in a publicly trading company since shares represent an ownership interest in the relevant company. This variation of the simple murabaha is commonly referred to as the ‘Commodity murabaha’.25 In the project financing context, there has been a recent trend to utilize the Commodity murabaha to provide both working capital funds required by a project company and equity contributions that a sponsor is obliged to make to a project in a sharia’a-compliant manner.26


11.19  An istisna’a is a construction and procurement contract for the commissioned manufacture of a specified asset and can be used during the construction phase of a project financing. Here, following a request from the client, the financier procures the contractor to manufacture an asset which meets the specifications of the client for delivery by a specified date. The financier will, in practice, appoint the client as its wakil (agent) (which can be facilitated pursuant to a wakala agreement) to enter into the engineering, procurement, and (p. 293) construction (EPC) contract with the contractor. Sharia’a requires that the price payable for the asset is fixed at the outset (but not necessarily paid in full at this point) and only altered if the specification of the asset is amended by the client. The proportion of the price payable, and the date on which it is payable will usually be the same as the milestone payments due under the EPC contract. Although the client will contract under the EPC contract as a wakil, there will not be privity of contract between the client and the contractor once the asset has been constructed, so the warranties given by the contractor to the financier in respect of the asset in respect of defects to the assets, for example, will be assigned to the client. The manufactured asset must be accepted by the client if it meets the given specifications. Once the asset has been constructed, title to the asset must be transferred by the contractor to the financier, who will then either sell the asset to the client outright or alternatively lease the asset to the client pursuant to an ijarah.


11.20  The ijarah is a form of lease financing pursuant to which the usage (usufruct) of an asset or the services of a person are leased by the lessor to the lessee for rental consideration.27 The nature of the asset or service must be precisely defined in the lease. Under the ijarah, the lessor (the financier) will purchase the asset from the supplier and then transfer possession to the lessee (the client) with the profit margin built into each lease payment over the term of the lease. The lessee may act as the lessor’s agent to purchase the assets from the supplier. It is also possible for the lessee to own the asset which it sells to the lessor who, in turn, will lease it back to the lessee. The lease can take effect as an operating lease, with the asset returning to the lessor at the end of the lease term, or akin to a finance lease, with title to the asset being transferred to the lessee at the end of the lease term or ownership units being transferred to the lessee during the term of the lease (an ijarah-wa-iqtina’a). The lease will commence immediately upon execution of the ijarah if the assets have sufficient economic value and substance so that it can and is used for the purpose intended. If the assets do not have sufficient economic value at the time the lease is executed, then the rent will only become payable when such value and substance does exist. In any event, although sharia’a does not permit a forward sale, the ijarah can become effective at a future date provided the rent is only payable after the leased asset is delivered to the lessee.28 This type of forward lease is called an ijarah mawsufa fi al-dhimma and is most prevalent in the project financing context.

11.21  As will be explored further here, it is useful to note that the ijarah has become the mechanism by which the principal and the profit margin are returned to the financier during the post-construction period of a project financing as rental consideration comprising the purchase price of the asset as well as a fixed and/or floating profit margin calculated by reference to LIBOR.

11.22  Although the lessor can claim compensation from the lessee for misuse of the leased assets, akin to an operating lease, the lessor remains responsible for all maintenance and repair incidental to ownership, including structural maintenance of the leased assets.29 (p. 294) In practice, the lessee will be appointed as an agent of the lessor to ensure adequate insurance is in place for the leased assets through the service agency agreement (see paragraph 11.61). The lessee is only liable to pay the rent so long as the asset exists, so if the asset is destroyed and therefore cannot be used by the lessee, the lessee can then terminate the lease without further liability and the lessor’s only recourse will be to pursue a claim under the insurances.


11.23  Although sukuk (plural of sakk) are often referred to as ‘Islamic bonds’, they are more akin to Islamic trust certificates representing an undivided beneficial ownership interest in an underlying asset where the return is based on the performance of that underlying asset. The key attributes of sukuk are that they are generally asset-based securities (although sukuk can also be asset backed akin to a conventional securitized bond), and any profit or benefit derived from the sukuk must be linked to the performance of a real asset and the risks associated with ownership of that asset. Sukuk are, therefore, distinguishable from conventional bonds, which are bearer negotiable debt securities that pay the holder fixed or floating interest on a periodic basis during the term of the bond. Sukuk do share certain features with conventional bonds, such as being in certificated form, being freely transferrable on the secondary market if the sukuk is listed, paying a regular return, and being redeemable at maturity, but conventional bonds are also tradable debt which sharia’a prohibits. Therefore, sukuk have to be linked to an underlying asset using, for example, an ijarah, musharaka, or mudarabah arrangement to generate revenues that mirror the coupon payments received under a conventional bond. The return generated is justified, as the sukuk holder has a beneficial ownership interest in the underlying asset as represented by the sukuk and is, therefore, assuming ownership risks.

11.24  Sukuk are regularly issued by sovereigns, corporates, Islamic financial institutions (referred to herein as the IFIs), and other financial institutions as a means of sourcing additional sharia’a-compliant financing. The main reasons for the significant growth of the sukuk market, include:

  1. (1)  relative to an Islamic bank financing, sukuk attract a wider investor base whilst also attracting interest from conventional bond investors (there is nothing inherent in a sukuk structure that limits its application to predominantly Muslim countries or investors; sukuk can be issued by issuers located anywhere and be held by certificate holders located in any jurisdiction (subject to regulatory requirements));

  2. (2)  there is considerable Islamic-sourced liquidity with many of the investors in sukuk being well-capitalized banks in the Gulf Cooperation Council (GCC) region, a number of which can only invest in financial instruments that comply with Islamic finance principles; and

  3. (3)  there may also be a strategic policy desire in a particular jurisdiction to promote the use of sharia’a-compliant products and to enhance that jurisdiction’s reputation as a platform for sukuk issuances.30

(p. 295) Islamic Project Finance Techniques

11.25  As mentioned previously, a reassessment of how risks associated with the construction, operation, ownership, and financing of a project are allocated, and how transaction structures are implemented, will need to be undertaken in order to contemplate the priorities of all the project participants in the most commercially acceptable manner. Conventional project finance structures have evolved to take into account these risks by apportioning risks to the participants according to their role and who is best able to assume a particular risk. Such structures have, however, been developed in Western riba-based financial systems and, as a result, have not contemplated certain additional priorities that an Islamic participant has, most notably, compliance with the principles of sharia’a. These priorities have been accommodated in two types of sharia’a-compliant project finance transactions: a single facility transaction comprising only sharia’a-compliant funding with no conventional riba-based financing; and a multi-sourced transaction where conventional and sharia’a-compliant sources of funding are integrated into a single financing. The former type of transaction is not common, especially in large project financings, since the liquidity of Islamic banks and the capitalization requirements of such banks means that, at least for now, they cannot alone finance such projects. What follows, therefore, is a brief discussion of conventional project finance structures in order to appreciate how such structures need to be adapted to a sharia’a-compliant model. Then there follows an analysis of how the multi-sourced project finance transaction is facilitated in practice, including how such arrangements are documented.

Conventional Project Finance Structures

11.26  In a conventional project financing, the sponsors will, generally, incorporate a single purpose project company to build and operate a particular project. A syndicate of banks and other financial institutions (such as ECAs and the development banks) will finance the construction of the project pursuant to one or more interest-bearing facility agreements. There will be a common terms agreement (the CTA) to govern the rights between the lenders and the project company, and an intercreditor agreement or coordination deed to govern the rights, obligations, and priorities of the lenders as between themselves. During the construction phase, the project company will ordinarily be obliged to pay interest on the loan (which will typically be based on an interbank lending rate (such as LIBOR)) plus a specified margin. The interest payable during the construction phase is capitalized (i.e. added to the principal amount of the loans). During the operating phase, the project company will then begin to repay the borrowed principal (plus the capitalized interest) according to a repayment schedule, as well as interest on a current basis.

11.27  The project company will enter into a series of project contracts, including the construction contract between the project company and the contractor to construct the project and deliver ownership of the same to the project company upon completion. In return, the project company will make stage payments to the contractor upon achieving certain milestones.31

(p. 296) Multi-sourced Sharia’a-compliant Financings

11.28  Most projects source the monies required to construct and operate that project from multiple sources, for reasons that include accessing a broader pool of funding and using local banks or international financial institutions for geopolitical reasons. Apart from the commercial lenders, who provide a riba-based loan facility to the project company, one or more financing facilities can be provided by other financial institutions, such as ECAs, development banks, and the IFIs. Each facility may serve a different purpose in the financing. An ECA, for example, may have a separate facility agreement from the commercial lenders stating that its facility is to be used for the acquisition of certain equipment or services provided to the project by a company of the same national origin as that ECA. Likewise, because the priority of an IFI is to invest in accordance with sharia’a, such IFIs will expect their investment to be made in the project in accordance with Islamic finance principles. The IFIs cannot lend, akin to the conventional lenders, directly to the project company, as one of the many sharia’a issues that would arise is that the return on the investment would be deemed to be riba. Therefore, as is the case with the requirements of the ECAs, the priorities of the IFIs are accommodated by adapting the structure of the project, as manifested through separate documentation, comprising the Islamic facility.

11.29  In practice, there have been several instances where a project financing has featured more than one Islamic facility.32 The reason for this may, perhaps in part, be due to irreconcilable differences between the investment criteria of certain IFIs which arise because:

  1. (1)  the participation criteria of the IFIs may be based on a specific madhab, and so may mean one IFI accepts a particular Islamic finance technique, but another IFI does not;

  2. (2)  a Qur’anic ruling is interpreted differently;

  3. (3)  an IFI may not accept a particular hadith or does not assign it particular credence because the conditions applied to collate that hadith were contrary to the methodology applied by a particular madhab; or

  4. (4)  the fatwa of a mujtahid or sharia’a scholar authorizing a particular Islamic financial technique is not accepted.

Such marked differences generally arise in cross-border financings, where an IFI is based in a jurisdiction where it aligns itself with the more doctrinal Hanbli madhab, and so has a more stringent participation criteria than an IFI based in another jurisdiction which abides by the more liberal Hanafi madhab. Assuming the project company continues to require access to funds from these IFIs with different participation criteria, then generally separate documentation for each Islamic facility will need to be entered into with the IFIs to suit their respective sharia’a requirements. Regardless of the number of Islamic facilities and the structures adopted, the practical effect of these structures will, for the most part, be the same, although their manifestation in the documentation may well differ.

11.30  The Islamic financing strategies adopted in recent project financings are now explored to discuss: (i) the structural considerations and documentation involved in projects with one (p. 297) or more Islamic facilities; and (ii) the issues that arise when integrating the conventional facilities and the Islamic facilities in a multi-sourced project financing.

Islamic facilities

11.31  Recent Islamic project financings have included two Islamic facilities, namely, a wakala–ijarah facility and an istisna’a–ijarah facility, which are two of the most prevalent, commercially accepted, and sharia’a-compliant structures for an Islamic facility in a multi-sourced project financing.33 As part of a growing trend, project sukuk facilities (using a sukuk-al-musharaka) have also been utilized in the context of multi-sourced project financings.34 The typical structure used for a project sukuk is analysed further later in this chapter.

Wakala–ijarah facility and istisna’a–ijarah facility—overview

11.32  The structure and documentation adopted to implement a wakala–ijarah facility is depicted in Figure 11.2. The structure for an istisna’a–ijarah facility is largely consistent with the wakala–ijarah structure save for certain discreet exceptions, which are analysed further here.

(p. 298) 11.33  During the construction phase, the wakala agreement under the wakala–ijarah facility, and the istisna’a agreement under the istisna’a–ijarah facility, provide the construction financing for certain assets (referred to as the Islamic assets), isolated from the overall project, up to the value of the financing to be provided under the relevant Islamic facility. The remainder of the project assets are financed using advances from the conventional facilities. Upon a phase payment request from the project company (for an amount equivalent to the EPC milestone payments payable by the project company to the EPC contractor pursuant to an EPC contract), the IFIs provide the required funding to the Islamic facility agent who disburses the same to the project company. During the construction period, the project company makes advanced rental payments to an agent for the IFIs, which mirrors the interest payable by the project company to the financiers under the conventional facility. Upon construction of the Islamic assets, on or before the scheduled commercial operation date, the operations phase begins and the ijarah mawsufa fi al-dhimma becomes effective to lease the usage of the Islamic assets to the project company. The project company pays lease payments during the course of the lease and, at the end of the lease (as is the case in the wakala–ijarah facility), ownership of the Islamic assets is transferred to the project company. An alternative is that units of the IFIs’ ownership interest in the Islamic assets are transferred to the project company during the course of the lease, as is the case in the istisna’a–ijarah structure.35

Figure 11.2  Wakala-ijarah facility

11.34  Prior to embarking on a discussion of the Islamic facility documents used in recent financings, it is useful to note that the Islamic facility agent (or the Investment Agent) acts as agent for the IFIs. The Islamic facility agent is appointed for the wakala–ijarah facility pursuant to the terms of an asset agency agreement and the investment agent is appointed for the istisna’a–ijarah facility pursuant to the terms of an investment agency agreement. The advantage of appointing an agent is that: (i) the agent acts as a liaison between the project company and the IFIs during the course of the project; (ii) the agent can, if required, sign the Islamic facility documents on behalf of all the IFIs; and (iii) the agent would also be involved in receiving and disbursing monies received from the IFIs and the project company in accordance with the finance documents. The agent may also receive from the EPC contractor, title to the Islamic assets upon their construction. It is usual, in practice, to appoint an IFI who is participating in the Islamic facilities and, therefore, familiar with the transaction, as the agent.

Wakala–ijarah facility and istisna’a–ijarah facility—construction phase

Wakala agreement (wakala–ijarah facility)

11.35  Under the wakala agreement, the IFIs appoint the project company to act as their wakil in respect of the procurement of the Islamic assets from an EPC contractor pursuant to an EPC contract, but subject always to the terms of the wakala agreement. The EPC contract effects the istisna’a arrangement (commissioned manufacture of the Islamic assets) between the IFIs and the EPC contractor. The parties to the wakala agreement will be the project company (as the wakil) and the Islamic facility agent (acting on behalf of the IFIs).

11.36  A wakala is an agency contract that has been applied in many project financings. It is preferred by IFIs, as the wakil assumes the responsibilities for project execution and (p. 299) completion and supervision of the construction of the Islamic assets. The wakil will also be responsible for negotiating the terms of the EPC contract, based upon the specifications required by it, as the eventual lessor of the Islamic assets; this is a key requirement of sharia’a. The wakil usually also indemnifies the IFIs and the Islamic facility agent against all claims, losses, and liabilities incurred by them as a result of the negligence or wilful misconduct of the wakil. From the perspective of the project company, the wakala arrangement does not adversely impact on its management of the project, since it can continue to deal with the EPC contractor with limited involvement from the IFIs, so long as it acts in accordance with the terms of the wakala agreement.

11.37  The Islamic assets, together with their cost, are specifically identified in a schedule to the wakala agreement in order to avoid gharar. During the construction period, as is depicted in Figure 11.2, upon a drawdown request from the wakil for an amount equal to an EPC milestone payment under the EPC contract, the IFIs pay the equivalent amount as a phase payment under the wakala agreement to the Islamic facility agent for onward disbursement to the wakil. A key requirement of istisna’a is that the asset price is fixed at the outset and, therefore, such contracts are either fixed price or capped. A schedule to the wakala agreement specifies the date and the amount of the phase payments in order to, inter alia, avoid gharar as to when payments are made. There is flexibility as to amending the phase payment schedule, if required. The maximum amount of the total phase payments is expressed in the agreement as being the cost of constructing the Islamic assets, which is the total facility amount to be contributed by the IFIs. In some financings, on or before each phase payment date, the wakil is obliged to deliver a promissory note up to the value of the phase payment to the IFIs. The wakil is also entitled to a one-off wakil fee payable by the Islamic facility agent, which is usually set off against the monies owed by the wakil as lessee under the ijarah.

11.38  Upon construction of the Islamic assets, the wakil agrees to accept delivery of the Islamic assets from the EPC contractor, whilst acknowledging that title to the Islamic assets will pass automatically to the Islamic facility agent. It is critical that ownership is transferred directly from the EPC contractor to the Islamic facility agent as depicted in Figure 11.2, as certain sharia’a scholars do not favour ownership of the Islamic assets being transferred via the wakil, prior to being transferred to the Islamic facility agent and then being leased back to the project company pursuant to the lease agreement.36 Although uncommon in project financings, as an alternative to leasing the Islamic assets to generate a return, the Islamic facility agent may instead sell the Islamic assets by way of a parallel istisna’a that is entered into at the time of the original istisna’a for the construction of the Islamic assets. The sale of assets not in existence or owned by the seller at the time the contract is entered into, is ordinarily prohibited by sharia’a, but the istisna’a is an exception to this prohibition. This does not, however, permit the Islamic facility agent to sell the Islamic assets to the project company, as sharia’a prohibits a sale and buyback. The sale could, however, be to a special purpose vehicle owned by a corporate service provider, which is not related to the project company, or to a third party on an arm’s-length basis. Upon delivery of the Islamic assets, (p. 300) the wakil will also be responsible for ensuring that all licences and permits are in place and all filings have been made to protect the ownership interest of the Islamic facility agent.

11.39  The wakala agreement terminates in accordance with its terms on the date on which title to all the relevant Islamic assets is received by the Islamic facility agent from the EPC contractor. Upon the occurrence of an event of default under the wakala agreement, the lease agreement, and/or the finance documents, the Islamic facility agent may be entitled to terminate the wakala agreement subject always to the terms of the intercreditor agreement. Upon termination, the wakil will be liable for all losses, liabilities, and damages resulting from such termination, which will be equal to the aggregate of the phase payments disbursed by the IFIs.37

11.40  When structuring an Islamic project financing, a pertinent consideration that needs to be settled at the outset is the governing law that applies to the Islamic facility documents and the forum for settling any disputes arising thereunder. Although the principal determinant as to the validity of the Islamic facility documents will be based on compliance with sharia’a, there are no internationally recognized sharia’a courts applying universally settled principles of fiqh that have developed with respect to issues, such as insolvency, that arise in the context of complex cross-border project financing. Project participants will require a level of certainty as to interpretation of law and the remedies available to be able to anticipate how courts may deal with project-related issues so that, inter alia, the finance parties can determine whether to provide funding to the project and so that risks can be apportioned appropriately amongst the participants. For these reasons, the finance parties will insist on specifying a governing law which is accessible, has a developed jurisprudence covering issues that arise in a complex cross-border financing, and which has a consistent law which is not subject to different interpretation methodologies, as is the case between the madhabs.38 English law is often chosen as the governing law in many complex cross-border financings because of its globally renowned creditor-friendly approach, established system of precedent, and the willingness of the English courts to accept jurisdiction to hear disputes governed by English law even when there is little nexus to the jurisdiction other than the election of the parties.

11.41  Using English law as the governing law raises several conflict of laws issues because the law of the jurisdiction in which the project is located may have automatic jurisdiction as a result of the lex situs doctrine, or the agreement may not be enforceable in the jurisdiction in which the project is located as the agreement may be inconsistent with its laws. Another issue, which sharia’a scholars are more concerned with, is whether English law or sharia’a takes precedence in the event of a conflict between the two sets of legal principles. From this flow the related issues of whether the judiciary in England are qualified to adjudicate on a dispute relating to an Islamic finance agreement, whether sharia’a or English law will be applied, and if sharia’a, then which particular madhab will be applied. The approach of the English courts, in the main, has been to distinguish between sharia’a and (p. 301) the contractual governing law of an Islamic agreement by ruling that sharia’a issues are not justiciable in the English courts. That element of the agreement is deemed as forming part of the commercial agreement (which English courts will rarely interfere with) and not the legal agreement. Instead, the dispute will be dealt with by applying the ordinary principles of English law and an English court will avoid ruling or commenting on the compliance of the agreement with sharia’a.39

11.42  In a recent US bankruptcy court case, In re Arcapita Bank, B.S.C.(c), et al.,40 a creditor objected to the debtors’ motion to approve the debtor in possession and exit financings, asserting, among other things, that the financing was not sharia’a compliant. In statements made on the record, the court noted that the financing agreement was governed by English law and expressly provided that no obligor was permitted to bring a claim based on sharia’a compliance of the finance documents. The court then appeared to adopt the English courts’ approach of avoiding ruling or commenting on compliance of an agreement with sharia’a, citing the English court case, which found that, irrespective of sharia’a compliance, sharia’a was not relevant in determining the enforceability of a financing agreement governed by English law, and that sharia’a principles are far from settled and subject to considerable disagreement among clerics and scholars.41

11.43  In practical terms, the parties to the Islamic facility documents must satisfy themselves as to their validity and compliance, with the fatwa giving legitimacy to those documents, as being in accordance with sharia’a, prior to entering into these documents. The Islamic facility documents will usually contain a provision where each party acknowledges that it is satisfied with the legitimacy of the fatwa and the compliance of the Islamic facility documents with sharia’a.42

11.44  However, for a number of reasons, which may include the participation of domestic lenders, a legal necessity of the jurisdiction in which the project is based or where there is no real choice of law as a result of the applicable principles of conflict of laws such as the doctrine of lex situs,43 there is a trend for Islamic facility documents to be governed by the relevant local law and subject to the jurisdiction of the local courts, especially where the project is based in the Middle East. Sharia’a scholars in a number of Saudi project financings have (p. 302) required that the governing law of the Islamic facility documents be Saudi Arabian law (which has a sharia’a legal system) instead of English law, and that the parties submit to the jurisdiction of the Saudi Arabian courts or a special committee established to deal with banking disputes. This is to ensure that any dispute is settled before a Saudi judicial forum that applies sharia’a. This may mean that the Islamic facility documents, when construed in their totality, or individually, may cause a court in a jurisdiction, such as Saudi Arabia, to reach the conclusion that the features thereof, which purport to make them consistent with sharia’a principles applicable to a financing transaction, should be disregarded and that accordingly, the transaction should be re-characterized as a conventional financing transaction (that is, one which is not in compliance with sharia’a principles). One element which might lead such a court to consider a payment obligation to be a payment of riba or an amount in the nature of riba could be the use of LIBOR as a reference rate in the calculation of that payment or amount.

Istisna’a agreement (istisna’a–ijarah facility)

11.45  As an alternative to the structure documented in the wakala agreement, under an istisna’a–ijarah facility, the IFIs will appoint the project company to procure the Islamic assets on the terms of the istisna’a agreement. The project company (as Procurer) then takes the necessary steps to construct the Islamic assets, including contracting with the EPC contractor by entering into the EPC contract. In return, the IFIs agree to purchase the Islamic assets and pay the agreed amount to the project company in order to fund the construction of the Islamic assets in phase payments. The main difference between the istisna’a agreement and the wakala agreement is that there is no agency arrangement between the IFIs and the Procurer to procure the Islamic assets; the Procurer is simply contracted to procure the construction of the Islamic assets and the IFIs act as purchasers of those Islamic assets. This may be preferred by the IFIs, since the project company at all times remains responsible for procuring the Islamic assets and so, for example, the IFIs will not be liable for any delays in the construction of the Islamic assets. In other respects, the istisna’a agreement operates in much the same way as the wakala agreement, with the Procurer making requests to the Investment Agent for phase payments reflecting the EPC milestone payments under the EPC contract. It is to be noted that although the project company is not appointed as a wakil, similar obligations are imposed on the project company in respect of entering into the EPC contract with the EPC contractor and maintaining the licences and permits for the Islamic assets upon their delivery.

11.46  The parties to the istisna’a agreement are the project company (as Procurer) and the Investment Agent (acting on behalf of the IFIs). In certain projects where an istisna’a agreement has been entered into, instead of the Investment Agent contracting with the Procurer, the IFIs have incorporated a special purpose vehicle company (SPV Co) owned by the IFIs in proportion to their respective investments. The SPV Co acts as purchaser of the Islamic assets from the project company, which in turn procures the construction of the Islamic assets from the EPC contractor pursuant to an EPC contract. An advantage of this SPV Co structure is that the IFIs’ interest in the Islamic assets becomes insolvency remote and asset risk remote. Certain sharia’a scholars have, however, not favoured the Islamic assets being held by an SPV Co, preferring the Islamic facility agent, who is usually a reputable IFI in the jurisdiction where the project is situated, to hold title to the Islamic assets for and on behalf of the IFIs. The rationale for such an approach is that the IFIs should be seen to take risk on the assets and not be shielded from liability by the SPV Co.

(p. 303) Asset participation agreement (wakala–ijarah facility)

11.47  The asset participation agreement is an agreement between the IFIs to participate in financing the acquisition of, and ownership of, the Islamic assets in pre-agreed proportions. Each IFI will be obliged to pay its participation upon the project company serving a drawdown notice to the Islamic facility agent pursuant to the wakala agreement as depicted in Figure 11.2. The asset participation agreement will also contain provisions in relation to an IFI transferring its participation to another IFI.

Asset agency agreement (wakala–ijarah facility)

11.48  The asset agency agreement documents the terms upon which the IFIs appoint the Islamic facility agent as their agent in connection with the project. The Islamic facility agent is authorized to enter into the finance documents on behalf of the IFIs as well as to hold title to the Islamic assets if this has been agreed. Aside to this, the obligations of the Islamic facility agent do not differ markedly from that of a facility agent to the conventional lenders.

Investment agency agreement (istisna’a–ijarah facility)

11.49  The investment agency agreement, generally, contemplates the same terms as the asset participation agreement and the asset agency agreement under the wakala–ijarah facility. Pursuant to this agreement, the IFIs agree to participate in the financing of the acquisition of the Islamic assets and the Investment Agent is appointed to hold title to the same. This agreement also documents the decision-making procedure between the IFIs, conduct of business between the IFIs, the payment mechanics for the IFIs pursuant to the terms of the finance documents, and the treatment of any late payment fees levied on the project company.

Wakala–ijarah facility and istisna’a–ijarah facility—operations phase

Lease agreement (ijarah mawsufa fi al-dhimma)

11.50  Once constructed, the IFIs lease the usage of the Islamic assets to the project company by way of an ijarah pursuant to the lease agreement. The ijarah, in practice, has become the mechanism by which the principal and the profit margin are returned to the IFIs during the post-construction period of a project financing, as rental consideration. Rental consideration comprises the purchase price of the Islamic assets as well as a fixed and/or floating profit margin which, in a conventional project financing, would be equivalent to the debt service payable by the project company. The profit margin can be structured as variable rentals, adjusted according to agreed terms so that the rate of return can be benchmarked against LIBOR, for example, but in each case, the basis for determination and adjustment must be disclosed to the lessee prior to the execution of the lease agreement. Benchmarking the variable rental against LIBOR has the advantage that the ijarah tenor can be longer, as the rate of return takes into account market conditions which a fixed return may not necessarily contemplate. Most sharia’a scholars agree that benchmarking against LIBOR is acceptable, since although typically LIBOR is used to calculate interest, in this context, LIBOR is solely being used as a benchmark; no riba is present in the lease agreement itself, as the lessor is taking risk in the ownership of the asset and, therefore, is entitled to receive profit amounts. Certain scholars have held that benchmarking the variable rental against LIBOR can impute gharar, since any fluctuations in LIBOR are not foreseeable and, therefore, an element of the rental payable is not foreseeable. Gharar can be resolved here by (p. 304) renewing the lease agreement each time LIBOR is revised, or providing that the variable rental amount can only be up to a certain percentage above or below LIBOR.44

11.51  Although the lease agreement will be executed at the same time as the other finance documents, the rental consideration will only be payable once the Islamic assets have sufficient economic value and substance that they can be used for the intended purpose. This will be the scheduled date on which the operations phase of the project begins, as will have been forecasted by the technical adviser for the project. This scheduled date will be expressed in the lease agreement in order to avoid gharar as to when the rental consideration becomes payable.45 Whilst the lease period only commences from this date, the forward lease has an essential use for the IFIs during the construction phase by obliging the project company to pay advance rentals during the construction phase (equivalent to the debt service amount that a lender would receive during the construction phase under a conventional financing). The lease agreement will contain a schedule of dates on which advance rental payments are to be made.

11.52  There has been debate as to whether accepting advance rentals is permitted by sharia’a, since the IFIs are generating a return from the Islamic assets prior to their construction and, therefore, prior to the same being available to the IFIs to lease to the project company. Such a return has been perceived by certain sharia’a scholars as riba; the IFIs making a return on monies they disburse to the project company (as wakil under the wakala agreement or as Purchaser under the istisna’a agreement) for the construction of the Islamic assets, rather than the return being generated by the project company making use of the Islamic assets. This has been resolved by providing for the deduction of the aggregate amount of the advance rentals paid during the construction phase from the first rental payment that is due once the operation phase has begun, or on a pro rata basis during the term of the ijarah. The lease agreement usually contains a gross-up clause whereby the project company will pay a supplemental rent reflecting the advance rentals deducted during the operations phase, as otherwise, the rationale for the IFIs obtaining a return during the construction phase would be thwarted. However, if during the construction phase an event of default results in the termination of the wakala agreement or the istisna’a agreement (as the case may be), the IFIs will be obliged to refund the aggregate of all the advance rentals already paid by the project company. An amount equal to the refunded amount would then be incorporated within the termination sum payable by the project company under the wakala agreement or the istisna’a agreement.

11.53  With respect to events of default, the project financing will need to be structured so that any Islamic facility event of default under the lease agreement (and the other Islamic facility documents) constitutes an individual event of default under the CTA so that the IFIs can take enforcement action in respect thereof. This can be achieved by including an event of default in the CTA to the effect that any default under the Islamic facility documents (i.e. an individual facility event of default) will constitute a CTA event of default. Conversely, (p. 305) sharia’a scholars look unfavourably on treating a CTA event of default as an Islamic facility event of default. This is because cross-referring to the conventional finance documents in this manner may taint the Islamic facility, especially since the rationale for having separate documentation for the Islamic facility is to keep it distinct from the conventional facilities to the extent possible. Several techniques have developed to keep the Islamic facility separate from the conventional facilities. These include the use of an Islamic common terms agreement which mirrors the terms of the conventional CTA.46 An alternative approach, which has grown in prevalence because of its simplicity and inexpensive nature, is for the Islamic facility agent (acting on behalf of the IFIs) to be a party to the relevant finance documents, including the CTA and the intercreditor agreement. These approaches ensure that, to the extent possible, the Islamic facility is kept distinct, whilst with respect to events of default, the exercise of remedies, and the project’s revenue and enforcement cash waterfalls, there is coordination between all the facilities and a pari passu relationship (where this has been agreed) between the conventional senior lenders and the IFIs.

11.54  It is useful specifically to outline some of the pertinent features of a lease agreement which enable the ijarah to be used as an effective Islamic finance technique pursuant to which the principal and the profit margin are returned to the IFIs during the post-construction phase of a project financing.

Voluntary prepayment

11.55  Under a conventional financing, the project company has a right to make voluntary prepayments of the facility on terms specified in the facility agreement. Likewise, the project company can, subject to the terms of the CTA and the intercreditor agreement, make voluntary prepayments of the Islamic facility either by the exercise of a call option (referred to as a sales undertaking), as is the case in an istisna’a–ijarah facility, or by making early rental payments pursuant to the lease agreement, as is the case in a wakala–ijarah facility.

11.56  The sales undertaking, which is documented separately, is a unilateral promise (wa’d) granted by the IFIs to the project company to sell all or some of the Islamic assets at their outstanding value on specified lease payment dates (to avoid break costs) during the term of the lease. Exercising the sales undertaking in respect of all the Islamic assets is akin to voluntarily prepaying the entire conventional facility and exercising the sales undertaking in respect of certain Islamic assets is akin to making a partial voluntary prepayment of the conventional facility. Where several Islamic assets have been leased, the sales undertaking will be exercisable (by the service of an exercise notice) against specific Islamic assets, and go towards satisfying the total outstanding value of such Islamic assets. The sales undertaking may provide that the prepayment applies to all the Islamic assets on a pro rata basis so that the project company purchases an interest in all the Islamic assets in accordance with their value. This will result in the project company owning a beneficial interest in the Islamic assets in accordance with the proportion of interest in the Islamic assets it has acquired, with the remainder of the beneficial interest remaining with the IFIs. Although the beneficial interest will not entitle the project company to an equivalent proportion of future rentals payable under the lease agreement, the return of the IFIs will decrease, as their (p. 306) ownership interest in the Islamic assets will have been reduced. At the end of the lease term, the IFIs will, pursuant to the sales undertaking and a sales agreement (a form of which will be appended to the sales undertaking), transfer their legal interest in the Islamic assets to the project company for a nominal amount, or on a cashless basis, since at the end of the lease agreement term, the IFIs have recovered the cost of acquiring the Islamic assets and their profit margin thereon.47

11.57  The alternative, as is the case in a wakala–ijarah facility, is for the project company to make early rental payments (on specified payment dates in order to avoid break costs) which are applied pro rata to reduce all the remaining rental payments due under the lease agreement. If the project company wishes to acquire all of the Islamic assets prior to the expiry of the lease agreement term, then it will need to pay the termination sum, which is the aggregate of the outstanding principal amount that the IFIs paid to acquire the Islamic assets and any rental consideration due but unpaid. At the end of the lease term, the IFIs will transfer the ownership of the Islamic assets to the project company (pursuant to a transfer of ownership instrument) for a nominal amount or on a cashless basis.

Termination and mandatory prepayment

11.58  Upon the occurrence of an event of default and the issuance of an enforcement notice, the conventional lenders and the IFIs will accelerate the monies paid under the various facilities. Under the conventional facility, the lenders would call in the loan in accordance with the terms of the facility agreement and the intercreditor agreement. Under an Islamic facility, the IFIs may accelerate by requiring the project company to pay a termination sum by exercising a put option (referred to as a purchase undertaking) as is the case in an istisna’a–ijarah facility, or obliging the lessee to pay the termination sum pursuant to the lease agreement as is the case in an wakala–ijarah facility.

11.59  The purchase undertaking is a wa’d granted by the project company to the IFIs to purchase all the Islamic assets upon the issuance of an enforcement notice subsequent to an event of default. Following payment of the termination sum, ownership in the Islamic assets is transferred to the project company pursuant to a sale agreement, a form of which will be appended to the purchase undertaking. The alternative, as is the case in a wakala–ijarah facility, is that upon the issuance of an enforcement notice subsequent to an event of default, the project company will be obliged to pay the termination sum following which the IFIs will assign the ownership of the Islamic assets to the project company. If the lessee fails to pay the termination sum, then the lessor will have the right to take possession and sell the Islamic assets.

11.60  It should be noted that the purchase undertaking will also cover mandatory prepayment events or ‘early settlement events’, as is the case where there has been a change of law which adversely affects the economics or legality of the project, as a consequence of which the conventional lenders and/or the IFIs may desire, or be required by law, to cease their participation in the project. In such circumstances, upon the IFIs serving an exercise notice upon the project company pursuant to the purchase undertaking, the project company (p. 307) will generally be obliged to prepay the outstanding amount contributed by the relevant IFI affected by the mandatory prepayment event, by acquiring that IFI’s beneficial interest in specific Islamic assets. The lease agreement in a wakala–ijarah facility also contains similar provisions, but rather than acquiring a beneficial interest in specific Islamic assets, the rental amounts thereunder are reduced pro rata in proportion to the interest of the relevant IFI that has been prepaid.

Total loss of the Islamic assets

11.61  If an event causes a total or partial destruction of the Islamic assets as a consequence of which the Islamic assets cannot be used by the lessee to generate a return, the IFIs will not have a right to receive further rental payments from the project company, with the IFIs’ only recourse being to the insurances they are obliged to maintain as owners in respect of the Islamic assets. As owners, the IFIs will be assuming the risk of a total loss of the Islamic assets as well as risks associated with renewal payments under the policies, together with any delay in the processing and payment of claims under the insurance policies. Where the loss or damage to the Islamic assets arises from the wilful misconduct or gross negligence of the lessee, then the lessee will continue to remain liable for the rental consideration in addition to reinstating the Islamic assets. In practice, the IFIs will appoint the project company as the service agent pursuant to the terms of the service agency agreement to, inter alia, maintain the appropriate levels of insurance. Should the service agent not maintain the appropriate levels of insurance, the service agent will be obliged to indemnify the IFIs to cover the outstanding amounts under the ijarah not covered by the insurance proceeds. Where a total loss of the Islamic assets is not a CTA event of default, but only an Islamic facility event of default, the conventional lenders may decide against accelerating the financing, and so the service agent will ordinarily be required to replace the Islamic assets with other assets that are designated as Islamic assets, and then lease the same to the project company pursuant to a new or replacement lease agreement. This ensures that the pari passu treatment of the conventional and Islamic facilities is maintained.

Late payment fees

11.62  Under a conventional financing, where the project company fails to comply with its payment obligations under a facility agreement, default interest is levied on the unpaid sum. Lenders justify this additional rate as compensation for the increased risk of lending to the defaulting project company so long as the rate of default interest is reasonable as a matter of English law, i.e. the default interest is not deemed a penalty offending the rules laid down in Dunlop Pneumatic Tyre Co Ltd v New Garages & Motor Co Ltd;48 sharia’a, however, regards such additional compensation, which adds to the income of an IFI after a debt has become payable, as riba. Therefore, under the lease agreement, the lessor cannot charge the lessee a late payment fee for payment of the rent consideration after the due date where such a fee, once paid, would form part of the income of the lessor. In order to avoid a situation where the lessee takes advantage of this prohibition, the lease agreement will stipulate that the lessee pay the late payment fees directly (or through the lessor for onward payment) to a registered charity or charitable fund maintained by the lessor. As a consequence, the late payment fees do not form part of the income of the lessor whilst the lessee is deterred from delaying rental payments under the lease agreement. As is the case in an istisna’a–ijarah facility, certain scholars also permit a deduction from the late (p. 308) payment fee of any actual costs (excluding opportunity costs and funding costs) incurred by the IFIs due to the lessee making a late payment. The remainder of the late payment fee is then paid to charity.49

Service agency agreement

11.63  As outlined earlier, the IFIs as owner of the Islamic assets remain responsible for insurance, structural maintenance, settlement of ownership taxes, and maintenance of consents in respect of the Islamic assets. The project company will be appointed as the IFIs’ service agent pursuant to the service agency agreement, since it is best placed to undertake these obligations. The project company, in turn, passes through some of these obligations and associated costs, to the operation and maintenance (O&M) contractor pursuant to an O&M agreement. The IFIs will remain responsible for each of these obligations and will indemnify the service agent for the costs incurred by the service agent in undertaking its obligations under the service agency agreement. The IFIs will, however, usually be counter-indemnified by the project company (as lessee under the lease agreement) for such costs by way of supplemental rent. In addition, as discussed earlier, where there is a total loss of the Islamic assets and the service agent has failed to maintain adequate insurance cover in respect of the same, the service agent will be required to indemnify the IFIs for any shortfall between the amount of the insurance proceeds and the aggregate amount of the remaining rental consideration due under the lease agreement. The IFIs will pay the service agent a service agency fee which will usually be netted off against the amounts the project company owes to the IFIs.

Project sukuk

11.64  Sukuk are well suited for use in a project financing context particularly given that there should be little difficulty in identifying a real asset for use as part of the sukuk structure, the performance of which can yield a return for the certificate holders. In addition, the use of project sukuk illustrates a significant step towards developing alternative funding sources in light of tightening bank lending (particularly in the project finance context where commercial banks are likely to be less able to offer longer tenors in the context of the bank capital adequacy rules being implemented under Basel III); a step which has certainly been welcomed by the sponsor and lending communities alike, who are now beginning to see capital market issuances (both Islamic and conventional) as a key financing source to plug the funding gaps in the project finance market.

Sukuk al-ijarah

11.65  A commonly used sukuk structure in the context of both asset-backed and asset-based sukuk, is the sukuk al–ijarah structure (as illustrated in Figure 11.3). This structure involves the acquisition by a special purpose vehicle (the SPV Issuer), as agent and trustee for the certificate holders, of assets from the seller using proceeds generated from the issuance of the sukuk to the certificate holders. Each certificate holder will have a joint and undivided property interest, together with the other certificate holders, in the Islamic assets. The SPV Issuer then leases the Islamic assets to the lessee in return for the rent which equates to the purchase price of the Islamic assets plus a fixed and/or variable (p. 309) margin, which may, akin to the margin payable under a lease agreement entered into by Islamic banks, be benchmarked against LIBOR. Using the rental proceeds, a return is then paid to the certificate holders, in proportion to their investment, periodically or as may otherwise have been agreed between the certificate holders and the SPV Issuer. At the end of the term of the sukuk, the SPV Issuer will exercise a purchase undertaking requiring the lessee to acquire the Islamic assets; the price payable under the purchase undertaking will be the balance of the fixed rent that has not yet been paid and all other rental amounts that are then outstanding under the lease. The proceeds of the sale will then be distributed to the certificate holders in repayment of the capital contributed by the certificate holders.

Figure 11.3  Sukuk al-ijarah

Sukuk al-musharaka

11.66  Traditionally, asset-backed sukuk have not been favoured in the context of multi-sourced project financings for two main reasons:

  1. (1)  Upon acceleration of the certificates, the certificate holders would have recourse to the underlying Islamic assets (which are also project assets forming part of the project) and this could adversely affect the operation of the project if those Islamic assets were integral to the operation of a project. As a result, the ability of the project company to generate revenue to make debt service payments to the other senior creditors is also likely to be impacted. Thus, granting the certificate holders recourse to the Islamic assets is likely to be unacceptable to the other senior creditors unless any such recourse is on pari passu terms with the other senior facilities.

  2. (2)  Granting the IFIs, but not the other creditors, recourse to the Islamic assets, contradicts the general principle in a project financing that all financiers should rank pari passu, and thus operate on a level playing field, including in relation to project cashflow and security. Thus, the security taken over the Islamic assets will, if and to the extent realized following enforcement against the project, need to be shared amongst all of the senior creditors.

11.67  As a consequence, project sukuk, in the context of multi-sourced project financings, have been structured as asset-based financings, giving the SPV Issuer (acting on behalf of the certificate holders) a right (as a senior creditor) to proceeds from, inter alia, the sale of project assets following an intercreditor vote to enforce and sell the same. This means that whilst the certificate holders’ return is based on the performance of a real asset, upon an acceleration by only the certificate holders of the face amount of the certificates, the certificate holders may only enforce the rights of the SPV Issuer as against the project (p. 310) company for amounts due and payable to the SPV Issuer under the finance documents; the certificate holders will not have the right to appropriate the Islamic assets and sell them to repay amounts owed to them under the certificates. However, where there is a general acceleration of all the senior facilities following an intercreditor vote of the relevant senior creditors, then the senior creditors (including the SPV Issuer acting on behalf of the certificate holders) will have recourse to all of the secured project assets (including the Islamic assets) on a pari passu basis.

11.68  The structure of a typical project sukuk is illustrated in Figure 11.4 and utilizes:

  1. (1)  a diminishing musharaka arrangement between the project company (as originator) and an SPV Issuer (which holds the certificate holders’ interest in the musharaka);

  2. (2)  an istisna’a arrangement pursuant to which the musharaka procures the construction of the Islamic assets by the project company (as Procurer); and

  3. (3)  an ijarah arrangement pursuant to which the Islamic assets are then leased by or on behalf of the musharaka (as lessor) to the project company (as lessee).

Figure 11.4  Sukuk al-musharaka

The steps involved are:

  1. (a)  The certificate holders contribute the issuance proceeds to the SPV Issuer in exchange for the certificates. In accordance with a declaration of trust, the SPV Issuer then declares a trust over the proceeds and any assets or rights acquired with the same.

  2. (b)  To consummate the musharaka, the SPV Issuer (as a senior creditor and a partner to the musharaka) contributes the proceeds of the sukuk issuance to the musharaka and (p. 311) the project company (as a partner in the musharaka) contributes its rights in an asset (such as its rights under a land lease), in each case, in accordance with a musharaka agreement. In return, the SPV Issuer and the project company receive units in the musharaka.

  3. (c)  The project company (as managing partner) then applies these contributions for the purposes of the musharaka, namely, to construct and develop certain project assets pursuant to a procurement (istisna’a) agreement. In certain complex industrial projects (such as in the petrochemicals sector) the completion risk in respect of the Islamic assets may be mitigated, with the certificate holders (alongside the other senior creditors) benefiting from completion support (usually in the form of completion guarantees from the sponsors assuming they are of at least an investment grade rating) during the pre-completion period of the project. The existence of completion support and/or robust EPC arrangements with creditworthy EPC contractors, is, generally, considered important to the successful marketing of a project sukuk because of the unwillingness of certain investors to assume the construction risk in respect of a project, particularly if the project is highly complex.

  4. (d)  Upon construction, the Islamic assets are then leased to the project company by (or on behalf of) the musharaka under a forward lease agreement. Rental payments are then (usually on a semi-annual or quarterly basis) paid by the project company to the musharaka, which then pays a corresponding amount to the SPV Issuer (as a senior creditor) for payment to the certificate holders in accordance with the terms of the certificates. In practice, the rental payments are likely to be paid directly by the project company to the paying agent for the account of the SPV Issuer. These proceeds from the sukuk assets (which mainly comprise the SPV Issuer’s contractual rights as a senior creditor under the finance documents, and which are, therefore, distinct from the underlying Islamic assets of the project company) are the sole source of payments on the certificates. The certificate holders’ recourse is limited to the contractual assets of the SPV Issuer and therefore takes the form of an asset-based financing (i.e. on a default, the certificate holders would only be able to enforce their contractual rights under the sukuk documents as against the SPV Issuer and direct the SPV Issuer to enforce its contractual rights against the project company). The certificate holders are unable to compel either the SPV Issuer or the project company to sell specific Islamic assets unless there is a general intercreditor vote of the senior creditors to do so.

  5. (e)  The musharaka partners share in any profits generated by the musharaka in accordance with agreed proportions (which do not necessarily have to correlate with the initial contributions of the partners) which, for the SPV Issuer, are sized to be sufficient to meet the relevant periodic distributions payable by the SPV Issuer to the certificate holders. Any losses of the musharaka are shared in proportion to the initial amounts contributed by the partners.

  6. (f)  In a diminishing musharaka arrangement, ownership units in the musharaka are transferred by the partners to the project company upon each periodic distribution payment being made, such that on the final maturity of the certificates, the project company will own all of the rights to Islamic assets and the musharaka will then be dissolved.

Status of the project sukuk

11.69  A key commercial consideration to be settled at the outset, is whether the project sukuk is to be treated as pari passu with the other senior facilities, not only with respect to sharing the security granted by the project company and the payment (p. 312) of periodic distribution amounts at the same level in the cashflow waterfall, but also with respect to intercreditor voting rights.

11.70  In this regard, the certificate holders may benefit from similar rights received by bondholders in most conventional project bond issuances made pursuant to Rule 144A and/or Regulation S of the US Securities Act 1933, particularly with respect to the intercreditor arrangements (including the ability to vote on specified waivers and the ability to initiate and then vote to take enforcement action in respect of particular events of default) and receiving the benefit of incurrence covenants only.50

11.71  As is the case with conventional project bonds, other senior creditors may have a concern that the project’s decision-making process could be adversely affected due to the inherent difficulties of obtaining decisions from certificate holders. This concern can be mitigated by incorporating a general ‘snooze you lose’ provision (which has the effect of disregarding the facility of a creditor which fails to respond within the requisite timeframe, which gives some certainty to the project company and the other creditors that a decision will be reached by the end of the specified period. Other potential mitigants include:

  1. (1)  to the extent permitted by applicable regulations and assuming that the certificates are held in a clearing system (such as Clearstream or Euroclear), providing that the certificate holders vote through clearing systems rather than at an actual meeting;

  2. (2)  where the project sukuk is rated, then no decision would be required of the certificate holders to the extent there is a re-affirmation of the project sukuk’s rating by the relevant rating agencies after taking into account the relevant waiver or amendment that the certificate holders would otherwise be asked to vote upon; and

  3. (3)  for technical matters, deferring the relevant decision to a technical adviser who would confirm whether the decision requested from the certificate holders would have an adverse impact on the project. The interest of ensuring the project sukuk is marketable has to be balanced with the overarching aim of ensuring that the decision-making process for the project financing as a whole continues to function in an effective and efficient manner.

Other matters to consider when structuring and issuing a project sukuk

11.72  In addition, the following matters (most of which equally apply to the structuring and issuance of conventional bond issuances) should also be considered when structuring and issuing a project sukuk:

  1. (1)  The jurisdiction in which the SPV Issuer is incorporated should be selected in contemplation of the tax treatment of periodic distributions by the SPV Issuer to the certificate holders. In some jurisdictions, prevailing tax treatment may make sukuk less (p. 313) tax-efficient for the SPV Issuer than conventional bonds. This is because the periodic distributions under a sukuk may be treated as non-deductible distributions, whereas interest payments are generally deductible for tax purposes. A number of countries, such as the UK and Luxembourg, have addressed this imbalance by introducing legislation neutralizing such negative tax impacts.51

  2. (2)  To mitigate currency risk, it may be necessary to match the currency in which the sukuk is denominated, to the currency in which the project company generates most of its revenues. In certain jurisdictions, there may be regulations dictating the currency in which a sukuk can be denominated.

  3. (3)  Careful consideration should be given to what the minimum denominations and minimum hold requirements of the certificates should be. If the denominations and minimum hold requirements are high, then this will likely mean that financial institutions, pension funds, and insurers will take larger participations and ‘buy and hold’ certificates until maturity. This may also assist in streamlining the decision-making process within the sukuk facility in comparison to a sukuk in which ownership is more disbursed.

  4. (4)  Sukuk are subject to the same securities regulations that apply to conventional capital market instruments, hence, the SPV Issuer and the project company (as the originator) will need to comply with the relevant regulations, including the issuance of a prospectus that generally follows the form of a conventional bond prospectus except that a sukuk prospectus is likely also to include the fatwa issued by the sharia’a supervisory board of the SPV Issuer, the project company, and/or the joint lead managers of the sukuk.

  5. (5)  In order to broaden the investor base, the project company will need to give consideration as to whether the sukuk will be listed on a well-established bond market such as London, Dublin, Luxembourg, or Dubai. As a consequence of the nature of the investors in sukuk (i.e. IFIs, pension funds, and insurers who, because of the relative lack of depth of the sukuk market, will generally ‘buy and hold’ certificates until their scheduled maturity), the secondary market for trading sukuk is in its nascent stage.

  6. (6)  Consideration should be given to whether the project sukuk is issued before, concurrently, or after the other senior financing has been procured, taking into account the project company’s priority to ensure it has sufficient committed funds in place to complete the project at the outset and possibly needing to place the issuance proceeds on deposit if the project sukuk is issued at the outset, but the funds are not required until a later date (this financial inefficiency is known as ‘negative carry’).

  7. (p. 314) (7)  Measures should be taken to safeguard against claims of non-compliance of sukuk, and Islamic finance instruments generally, with sharia’a. In Dana Gas PJSC v Dana Gas Sukuk Ltd and others,52 a purchase undertaking agreement governed by English law was found to be valid and enforceable even though it was claimed that the mudarabah agreement on which it was based, governed by UAE law, was contrary to sharia’a. Because the parties had contractual provisions dealing with the risk of illegality under sharia’a, the claimant’s argument that the purchase undertaking agreement was void for mistake due to developments in sharia’a law was dismissed. Furthermore, because payments under the purchase undertaking agreement were made to a bank in London, performance was deemed to be taking place in England and not the UAE; as such, UAE law and sharia’a were held to be irrelevant in determining the enforceability of the purchase undertaking agreement. This case highlights the importance of contractual safeguards, including representations and warranties providing for the compliance with sharia’a and performance of payment obligations in non-sharia’a-governed jurisdictions.

Other techniques utilized in a multi-sourced project financing

Commodity murabaha

11.73  As outlined earlier in this chapter, recently there has been an increasing use of the commodity murabaha to provide both the working capital funds required by a project company, as well as to fund the equity contributions that a sponsor is obliged to make to a project, in accordance with sharia’a. As illustrated in Figure 11.5, the project company (as the Purchaser) requests the Investment Agent (appointed pursuant to a separate murabaha facilities investment agency agreement) to purchase certain commodities from a supplier for the cost price with funds made available by the IFIs. The Investment Agent then sells (p. 315) the purchased commodities to the Purchaser for the relevant deferred price (which includes the cost price of the commodities plus a pre-stated margin) on deferred payment terms. The Purchaser then sells these commodities to a third party for the cost price so that at the end of this process, the Purchaser (as the project company) receives an amount equivalent to the equity contributions of the sponsors. The obligation of the Purchaser to repay the deferred price to the IFIs is set forth in the equity subscription agreement.


11.74  During the construction phase of a project, an alternative to the wakala and istisna’a is the diminishing musharaka, as documented in a musharaka agreement.53 Although the musharaka is not often applied in project financings, it is a useful mechanism by which the IFIs and the project company can agree to procure and enjoy joint ownership of the Islamic assets with the profits being shared in pre-agreed proportions, and losses being borne according to the capital contributions made to the venture. The Islamic facility agent enters into a separate istisna’a agreement with the project company to procure the Islamic assets, which it does by entering into an EPC contract with the EPC contractor. Title to the assets will, however, first be transferred to the project company by the EPC contractor, following which the project company transfers the IFIs’ proportion of the Islamic assets to the Islamic facility agent pursuant to the musharaka agreement. The IFIs generate a return during the operating phase by leasing their ownership interest to the project company pursuant to an ijarah and receiving the principal amount they invested in the musharaka. The IFIs transfer a portion of the Islamic assets to the project company by selling ownership units in the Islamic assets on each principal payment date.

Figure 11.5  Commodity murabaha

Integrating the Conventional and Islamic Facilities

11.75  It is essential that the issues and tensions that arise when integrating the conventional facilities and each Islamic facility in a single project financing are resolved (or at least mitigated) at the outset. Most of these matters have been discussed earlier in this chapter, and it will have become apparent that the most pertinent issues to resolve relate to the complex intercreditor arrangements between the conventional lenders and the IFIs. It is paramount that the events of default and the exercise of remedies in a default scenario between the conventional facilities and the Islamic facilities are harmonized. This is because the project is an indivisible whole and, as an intercreditor matter, it would not be acceptable for one facility to be accelerated as a result of an event of default, whilst others are unable to because there is no corresponding event of default in the documents relating to that facility.

11.76  Furthermore, conventional banks and IFIs need to be paid from the project’s cash waterfall on a pari passu basis. So there is a need to ensure that scheduled payments, as well as mandatory or voluntary prepayments, are coordinated in a commercially acceptable manner. Usually, prepayments are distributed pro rata to both the senior conventional lenders and the IFIs in the pre-enforcement payment waterfall pursuant to the intercreditor agreement. Issues may arise, however, if the sharia’a scholars do not permit proceeds from the sale of the Islamic assets or early lease payments to be distributed to the conventional lenders. It is (p. 316) for this reason that the IFIs and the senior conventional lenders will need to agree: (i) when the IFIs will jointly make decisions with the conventional lenders under the CTA and the intercreditor agreement; (ii) whether acceleration under an Islamic facility can be undertaken without consulting the senior conventional lenders so that accelerating the Islamic facility does not necessarily mean the other facilities also have to be accelerated; and (iii) what voting threshold applies if a process of consultation does need to take place, noting that if the threshold is high, it will be unlikely the IFIs will obtain the requisite consent for the prepayment to proceed, since the Islamic facilities have traditionally been smaller in proportion to the aggregate amount of the conventional facilities.

11.77  Although project security is covered in detail elsewhere in this book,54 an important issue to consider when structuring an Islamic project financing is whether the security granted by the project company will be in respect of the project company’s obligations under just the conventional facilities, or will also directly cover any Islamic facility. Furthermore, as the proposed security package would usually cover the project as a whole, the impact on the Islamic assets will need to be considered as well as the extent to which security will be shared with the conventional lenders.


1  Why Muslims are the World’s Fastest-Growing Religious Group, April 2017. Pew Research Center.

2  Throughout this chapter, the term ‘SWT’ follows the name of Allah (SWT) (which means ‘praise and exaltation’) and the term ‘PBUH’ (which means ‘Peace be upon Him and His Family’) follows the name of the Prophet Muhammad (PBUH). Also, following the names of other venerable Muslims, the term ‘RA’ (which means ‘May Allah (SWT) be pleased with him’) is used. These are terms used by Muslims as a mark of veneration and respect.

3  The Qur’an must be interpreted in light of the exegesis (tafsir and plural tafasir) of the Qur’an, the most notable being Imam as-Suyuti’s (RA) Tafsir, Ad-Durr al-Manthur Fi’t-Tafsir Bi’l Ma’thur.

4  Each saying, act, or approval of the Prophet (PBUH) is called a Hadith (singular of Ahadith) and these have been collated according to stringent rules most of which are documented in the six canonical collections (as-Sihah as-Sittah), which include Sahih Bukhari, Sahih Muslim, Sunan al-Sughra, Sunan Abu Dawood, Sunan al-Tirmidhi, and Sunan Ibn Majah.

5  Of the Sahabah, Imam Ali ibn Abi Talib (AS) has contributed significantly to the development of the tafasir of the Qur’an, fiqh, usul al fiqh, and the Islamic normative sciences. The contributions of Imam Ali (AS) have been such that the Prophet (PBUH) was reported to have said in the hadith narrated by Ibn Abbas (RA) as is documented in Al-Mustadrak alaa al-Sahihain Hakim, ‘I am the city of knowledge and Ali is its gate.’

6  Ijtihad means the individual interpretation of sharia’a principles by mujtahids to infer expert legal rulings from foundational proofs within or without a particular madhab.

7  For a general discussion on usul al fiqh, see Prof Ahmad Hasan, The Principles of Islamic Jurisprudence, the Command of the Sharia’ah and Juridical Norm (Adam Publishers and Distributors, 2005).

8  (80–150 ah/699–767 ce). Imam Abu Hanifa (RA) is known in the Islamic world as ‘The Greatest Imam’ (al-imâm al-a`zam) and his school has assisted with the development of the principles of Islamic finance not least because of its application of qiyas.

9  (93–179 ah/712–795 ce).

10  (150–204 ah/767–820 ce).

11  (164–241 ah/780–855 ce).

12  Al-Jami as-asghir, Jalal ad-Din as Suyuti.

13  In England, there is no express requirement for regulatory approval of a sharia’a supervisory board; however, in an application to the Financial Conduct Authority or the Prudential Regulation Authority to become authorized as a bank, the relevant bank would need to indicate whether the members of the sharia’a supervisory board would perform an executive or an advisory role. To the extent an advisory role is to be performed, the bank would not need to apply for each member to be an ‘approved person’. The competence of the members of the sharia’a supervisory board would still be relevant to determine whether the bank is fit and proper to be authorized. To the extent that the sharia’a supervisory board would perform an executive role, then the bank would need to apply and meet the requirements of the Financial Conduct Authority for each member to be an approved person, including the requirement as to competence and capability.

14  For example, if a financier charges a late payment fee when their client is in default, this is not typically retained by the financier and is instead donated to charity.

15  Qur’an, Surah Al Baqara 2:275, Qur’an, Surah Al Baqara 2:276-280, Qur’an, Surah Al-Imran 3-130, Qur’an, Surah An-Nisa 4:161, and Qur’an, Surah Ar-Rum 30:39.

16  Majma al-Zawa’id, Ali ibn Abu Bakr al-Haythami (vol. 4, 117).

17  For a detailed study of riba and a discussion of the related fatwa of the various madhabs, see Wahbah Al-Zuhayli, Financial Transactions in Islamic Jurisprudence (tr. Mahmoud A. El-Gamal; rev. Muhammad S. Eissa) (Dar Al-Fikr, 2003), Vol. 1, chapter 10 (‘Al-Zuhayli’).

19  For a detailed discussion of gharar, see Al-Zuhayli 82–7.

20  Examples of Islamic forward contracts include bai salam and istisna’a. On the other hand, conventional forward contracts and futures are not permitted, as the object of the sale may not exist at the time the trade is to be executed and are therefore also considered akin to qimar.

21  For a detailed discussion of mudarabah, see Al-Zuhayli, chapter 28.

22  For a detailed discussion of musharaka, see Al-Zuhayli, chapter 21.

23  Where the financier does not disclose the cost of the asset and the value of the margin charged, such a transaction is called a musawama. The musawama has recently been adopted in the context of sharia’a-compliant hedging.

24  Note, however, that the majority of the mujtahids have ruled that an arbun is a forbidden type of sale for contradicting the Sunnah, and containing gharar as the buyer of the asset may or may not purchase the asset at a future date (see Al-Zuhayli, 99–100). Recently, arbun has been used to mirror conventional covered call options giving the holder the right to buy a fixed quantity of an underlying asset on or before a specified date in the future.

25  A variation of Commodity murabaha, which is referred to as tawarruq, is where the intention of the client is not to own the commodity but to sell it instantaneously and obtain the required funds using one single transaction where the bank buys from, and sells the commodity back to, the broker as the client’s agent. Tawarruq is considered to be a makruh (reprehensible) sale in the opinion of Imam Malik (RA); however, it has been accepted as a financing technique by contemporary sharia’a scholars in the absence of a viable alternative.

26  See para. 11.73.

27  For a detailed discussion of ijarah see Al-Zuhayli, chapter 13.

28  This is subject to the payment of advance rentals: see paras 11.51 and 11.52.

29  The lessee will remain responsible for any routine maintenance and repair of the Islamic assets.

30  The use of sukuk in the context of a multi-sourced project financing is discussed further at para. 11.64 et seq.

31  For further details in relation to the conventional project finance structures, see Chapter 2.

32  For example, the Sadara Integrated Chemical Project, located in Saudi Arabia (June 2013), which featured a wakala–ijarah facility, an istisna’a–ijarah facility, and a sukuk facility.

33  The wakala–ijarah facility structure was introduced in the Shuaibah IWPP located in Saudi Arabia (December 2005) and subsequently also applied in the Marafiq IWPP located in Jubail, Saudi Arabia (May 2007), the Al Dur IWPP located in Bahrain (June 2009), and the PP11 IPP (June 2010). An istisna’a–ijarah structure was applied in the Qatargas 2 LNG project located in Qatar (December 2004), in the Rabigh refinery located in Saudi Arabia (March 2006), and also in the PP11 IPP.

34  For example, the Sadara Integrated Chemical Project located in Saudi Arabia (June 2013) and the SATORP Jubail Export Refinery Project located in Saudi Arabia (June 2010).

35  See also para. 11.20.

36  Some sharia’a scholars have not favoured a mechanism where the project company would hold title to the assets on behalf of the IFIs, as one effect of this is that the IFIs become insulated from ownership risks in respect of the Islamic assets.

37  On a termination of the istisna’a, the IFIs will be responsible for repayment of any advance rentals received from the project company as further discussed later in the chapter.

38  The Convention on the Law Applicable to Contractual Obligations 1980 (the ‘Rome Convention’) also requires that a governing law of an agreement must belong to a country, and sharia’a does not belong to a particular country, although it has been adopted by countries such as Saudi Arabia.

39  See Shamil Bank of Bahrain v Beximco Pharmaceuticals Ltd [2003] 2 All ER (Comm) 849. This approach was reaffirmed in a recent English High Court case, Dana Gas PJSC v Dana Gas Sukuk Ltd and others [2017] EWHC 2928. Dana Gas (an issuer based in the UAE) attempted to render its mudarabah sukuk unenforceable on a number of grounds, one of which was that the sukuk were not sharia’a-compliant. Although Dana Gas had sought to bring proceedings to adjudicate on this matter in the Sharjah Federal Court of First Instance, a number of the sukuk documents were governed by English law, and so Dana Gas had also sought and obtained an interim injunction in the English High Courts preventing the sukuk holders from declaring an event of default or dissolution event in relation to the sukuk. In its injunction claim, Dana Gas referred to the Ralli Bros principle, which provides that an English law contract that requires performance of an act that is unlawful in the place of its performance will not be enforced by an English court. On 17 November 2017, the English High Court ruled against Dana Gas on all grounds.

40  Case No. 12-11076 (SHL) (Bankr. S.D.N.Y.).

41  However, the precedential value of the Arcapita bankruptcy court’s refusal to consider whether the financing was sharia’a-compliant may be limited given that the district court dismissed the objector’s appeal of the bankruptcy court’s approval of the financing (along with an appeal asserted by the objector of confirmation of the debtors’ chapter 11 plan of reorganization) as equitably moot.

42  A similar disclaimer is also included in any prospectus issued by an issuer of a sukuk.

43  The rule that the law applicable to proprietary aspects of an asset is the law of the jurisdiction where the asset is located.

44  This approach has been supported by Mufti Taqi Usmani in, An Introduction to Islamic Finance (Maktaba Ma’ariful Quran, 2007) 168–71.

45  The lease agreement may contain a mechanism to adjust the first rental payment date if the scheduled operation date is postponed for certain reasons up to a long stop date. An alternative is for the lessor and lessee to enter into an ‘Agreement to Lease’ which operates during the construction phase and obliges the lessor and lessee to enter into the lease agreement once the operations phase actually begins.

46  The definitions used in the Islamic common terms agreement will be revised so that ‘interest’ is replaced with ‘commission’ or ‘profit return’, for example. The parties to this agreement will also only include the IFIs and the Islamic facility agent.

47  The Sales Undertaking will also cover the circumstance where the project company elects to replace or repay a single IFI in specified circumstances, such as where the relevant IFI requires the project company to increase the rental consideration payable to take account of a tax deduction payable in respect of that payment by the project company.

48  [1915] AC 79.

49  For a critique of the reasons given by such scholars, see Mufti Taqi Usmani, An Introduction to Islamic Finance (Maktaba Ma’ariful Quran 2007) 131–40.

50  However, perhaps as an exception to this general approach, in the project sukuk issued as part of the Sadara Integrated Chemicals Project and the SATORP Jubail Export Refinery Project, each located in Saudi Arabia, to ensure the project sukuk could be marketed successfully to the discreet class of investors in Saudi Arabia who purchase securities of this type on a ‘buy and hold’ basis, the sukuk was largely afforded pari passu status with the other senior debt, which meant that the certificate holders (through the SPV Issuer): (i) benefit from the maintenance covenants (as well as the incurrence covenants) that bondholders would not normally benefit from in a typical Rule 144A or Regulation S issuance; (ii) have the right to early redemption of the certificates upon a mandatory redemption of any of the senior facilities; and (iii) share in the project financing security on a pari passu basis with the other senior creditors.

51  In the UK, this imbalance has been addressed by legislation relating to ‘Alternative Finance Arrangements’ which is contained in Chapter 6 of Part 6 of the Corporation Tax Act 2009 (CTA) for companies within the charge to UK corporation tax and in Part 10A of the Income Tax Act 2007 (ITA) for individuals and others within the charge to UK income tax. Under this legislation (see sections 507, 509, 510, and 513 of CTA 2009 and sections 564G, 564L, and 564M of ITA 2007, in particular), where the arrangements meet certain conditions (including that they are listed on a recognized stock exchange or admitted to trading on a multilateral trading facility operated by an EEA-regulated, recognized stock exchange), amounts paid by issuers to certificate holders (other than those representing the principal amount originally paid by the certificate holders to the issuer) are generally deductible by the issuer under the loan relationships regime, and taxable in the hands of the certificate holders as interest (if the relevant certificate holder is subject to UK income tax) and as interest under a loan relationship (if the relevant certificate holder is subject to UK corporation tax).

52  [2017] EWHC 2928 (Comm).

53  The musharaka–ijarah structure was adopted in the Al Waha project located in Saudi Arabia (December 2006).

54  See para. 12.47 et seq.