Return on Musharaka? Don't bank on it

In the last article we compared the terms of the conventional five year syndicated loan facility of $6.5 billion with the PCFC Sukuk of $3.5 billion launched early this year.

It was noted that due to such an overwhelming response by the conventional banks more than $14 billion was pledged against the required $6.5 billion PCFC finds itself in a strong position to negotiate the price of the syndicated loan facility from an indicative 125 basis points over LIBOR to 100 basis points or may be even lower.

Compare it to the PCFC Sukuk launched early this year, it becomes evident that the Sukuk investors have been much better off at an anticipated return ranging between 7.125 per cent and 10.125 per cent a year.

If the initial public offering (IPO) of any of PCFC-owned company or companies takes place during the Sukuk, or up to one year after its redemption, the investors will be entitled to have up to 30 per cent of the redemption in shape of IPO shares which in other words mean substantial upside to their overall return from investing in the Sukuk.

You may be wondering as to how the PCFC Sukuk carries a pre-determined profit rate whereas the Islamic Sharia is averse to the idea of fixing a return on an investment from the outset.

To clarify, it is a projected return based on a business plan prepared and submitted by PCFC to the investors.

The following is from an article in the Musharaka agreement entered into between PCFC and the Special Purpose Company (SPC) representing the Sukuk investors.

"PCFC acknowledges that it has prepared the business plan based on which the Musharaka is expected to yield a minimum profit of (say 15 per cent) per annum on its total equity. The Musharaka profit will be distributed between PCFC and the investors at the ratio of 30:70 respectively.

However, in the case of the occurrence of any public offering of any of its businesses by PCFC (part of which will be diverted to the investors for Sukuk redemption), the profit distribution ratio between the partners will be in equal proportions (i.e. 50:50)."

The reduction in the profit distribution ratio for the investors in case of a public offering is based on the understanding that the investors would gain substantial upside on their overall return by disposing off the shares, received by them as part of the Sukuk redemption, at the market price.

Another clause in the Musharaka agreement states that the investors have entered into the Musharaka in reliance on the business plan which is expected to provide the investors with a minimum return of [say 10.125] per cent per annum on their contribution to the Musharaka equity.

Here, I would also like to quote the following from the offering circular to the investors which clearly states that the return is anticipated and not absolute.

"The objectives of the Musharaka shall be to earn profit from the application of the capital contributions by investing the capital in PCFC's group businesses in a Sharia compliant manner which will yield desirable return for the Musharaka partners in accordance with the Musharaka business plan appended to the Musharaka agreement."

All the above is clearly explained in the offering circular and by subscribing to the Sukuk, the investors have accepted and relied on PCFC's business plan and the mechanism for distribution of the Musharaka profit.

Another provision in the Mush-araka agreement which makes the transaction fully Sharia-compliant and radically different than the conventional term loan facility is the sharing of any genuine Musharaka losses by the Sukuk holders and PCFC in accordance with their respective equity contribution ratio. What does Sharia mean by "genuine losses"? This will be explained in the next article.

The writer is Vice-President and Head of Sharia Structuring, Documentation and Product Development, Dubai Islamic Bank.