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Boarding Complete: An Islamic Rendering

Part II of II

In our previous issue, we discussed the Shariah principles
of ijara, simple ijara, ijara wa iqtina, ijara mawsufa fi al
dimmah, istisna’a, and how ijara and mawsufa fi al dimmah work.
Our attorney’s had detailed the different types of leasing
provided by Shariah law. But there is more yet to come. This Part
II of the article gives a detailed description of sukuk, murabaha,
mudarabah, and how financial leasing applies to the leasing of

What may be surprising from a Western perspective is the
ingenuity and reliance on Islamic principles such as those detailed
previously and below regarding financial leasing. The ban of
levying interest is an intricate art of financing which questions
the very business nature of forward-thinking financial institutes
and other entities dealing with financial matters. So, continue
reading to understand further the principles ascribed by Shariah
law and their implementation.


Sukuk is a form of an asset-backed trust certificate
(bond) which is issued to the investor as evidence of ownership of
an asset or part ownership or its usufruct (earnings) based on the
principles of Shariah. Sukuk differs from conventional
bonds regarding asset ownership, investment criteria, issue price
and unit, investment rewards and risks, and effects and cost.
Unlike conventional bonds which can be issued without underlying
assets, Sukuk is always issued upon underlying tangible asset
either in ownership or an underlying master lease agreement, Sukuk
Al-ijara. Accordingly, the Sukuk represents a share in an
underlying asset whereas an ordinary bond accounts for a share of
the debt. The conventional bondholder may get a principal amount
upon bond maturity or coupon payment while Sukuk investors acquire
shares of profits from an underlying asset. The Sukuk can be
tradable or nontradable. The types of Sukuk certificates are based
on al salam, murabaha, muskarakah, mudarabah, and ijarah.

Typically Sukuk Al-ijara is commonly used for
aircraft financing. In this type of transaction, a special purpose
vehicle (SPV) will purchase the asset and lease it ultimately to
end-user who wanted to use the asset under structured arrangements.
An SPV will issue Sukuk certificate under note issuance facility to
entitle the holder of Sukuk an ownership and right to receive a
proportion of rental payment. The particular transaction is
provided below under the heading ‘how does Islamic financial
leasing work for aircraft leasing.


The Murabaha is simple but extensively used as a buy and sell
technique also known as cost-plus financing. In a Murabaha
transaction, the client seeks to finance from a financial
institution. The seller in this transaction is obligated to
disclose to the buyer or the client the cost price of the asset.
Typically, the client approaches the financier for funding the
purchase of the asset; the financier will purchase the asset and
take the necessary title either directly or through an agent and
may use it’s own fund or fund invested by investors. The
financier discloses cost as well as the profit margin for financing
to its client. The financier then sells such asset to a client with
a cost and a profit margin disclosed. The client can make deferred
payment terms. Some schools questions this type of transaction, but
it remains acceptable by most schools because by purchasing the
asset the financier assumes the risk attached to the asset and
therefore such a risk entitles the financier to profit while
selling. As a fixed price is typically set at the start of the
transaction the client has no influences as to variations in the
base lending rate and the transaction is not affected by

The following example will make clear the process of such a
transaction. The financier and bank enter into a Murabaha agreement
with the client, later the client is appointed as an agent to
purchase goods on the financier’s behalf, and the financier
will disburse such money to the client for the purchase of goods.
The client takes possession in the name of the financier.
Therefore, transfer of the risk to the financier as an owner takes
place. Upon purchase, the client will offer to purchase and upon
acceptance of such offer the sale concludes with a transfer of


It is a profit sharing and trust financing technique wherein
many investors pool their funds together and become shareholders in
major financial projects. This transaction is a form of partnership
by an equity type investment wherein one partner provides capital
(rabb ul amal), one that is commonly the beneficial owner,
the other party manages the investment and is responsible for
operations and the management of the business (Mudarib).
The financier acts as Mudarib and finances large projects
on behalf of investors. The financier may put its funds or act on
behalf of depositors with the financier serving as a trustee for
the investors and thereby assumes fiduciary responsibilities.
Alternatively, the financier can provide funds to the client who
acts as Mudarib. The partners acting as investors and the
one managing the business must distribute the profits by a fixed
and pre-determined ratio. In case a financier acts on behalf of
depositor-investors, the fixed financier’s share is from the
revenue generated who in turn pays its depositors all the profits
received after deducting its fees.

The losses and profits under Mudarabah are born due to
an investor (rabb ul-amal). Accordingly, the loss is
carried by investor unless negligence, misconduct can be attributed
to, or any terms of the contract that are breached by, the
Mudarib. Any assets acquired by Mudarib are in
possession of investor and managed by Mudarib on behalf of
investor’s. Financiers utilize the Mudarabah funds for
further Islamic transactions such as Murabaha,
ijara’a, or Istisna’a, etc.

How does Islamic financial leasing work for aircraft

After the global financial crisis in 2007 – 08 the use of
Sukuk as alternate funding source was used by aviation
sector. UAE was the largest Sukuk market in the middle
east in 2011 with 69% of Sukuk issuance in logistics and
real estate market which was overtaken by Kingdom of Saudi Arabia
(KSA) in 2012 according to Zawya reports. However, the
International AirFinance Corp’s launch of a US Dollars 5
billion Shariah-compliant aircraft leasing fund represented the
first time exclusive utilization of an Islamic finance structure
for their aircraft financial leasing operations. Further, Dubai
Islamic Bank (DIB) and Air Arabia announced the signing of an
aircraft financing deal in November 2014 to facilitate the delivery
of six new Airbus A320 aircraft’s in 2015. Increasingly, the
Islamic aircraft lease financing is in use by international
airlines including, Etihad Airlines, Saudi Arabian Airlines, Air
Arabia, Emirates, Malaysian Airlines, Turkish Airlines and by some
of the world’s largest aircraft leasing companies. Air Arabia
has received a total of 29 of the 44 A320 aircraft’s it ordered
from Airbus in 2007 though the use of Islamic financing arrangement
with DIB.

We will now consider the Islamic structure of ijara
being used in practice. The Sukuk al-ijara is most
commonly used technique for aircraft leasing. In this transaction,
the owner (lessor) assigns the right to use aircraft to an airline
company (lessee) for a pre-determined monthly rental payment. The
operation is not simple as it seems by the statement above hence it
will be explained with the examples as employed below:

I. The airline company wishes to purchase an aircraft and plans
to raise finance through the issuance of Sukuk.
Identification of the seller or supplier of the aircraft occurs,
and negotiations are entered into and finalized between the seller
and airline company. Next, an SPV is created by the airline company
as a separate company or such structure as deemed fit, which is 100
%, i.e., entirely owned by the airline company. (The rationale
behind creating an SPV to purchase the asset is that airline
companies often prefer to keep their fleet new and cannot afford to
continue the purchase of new aircraft as per the changes in new
technologies that are entering the market due to innovations of
leading aircraft manufacturers.) The SPV will then issue
Sukuk certificates and receive the proceeds which are used
to purchase new aircraft from the manufacturer or seller. Now the
SPV will hold the aircraft as a trustee for the investors and will
lease the aircraft to the airline company under the ijara
arrangement. Later as per the ijara arrangement between
the airline’s company and SPV, the airline’s company will
pay rentals to SPV for tenure and amount matching the
Sukuk coupon’s amount and tenure. The SPV will then
pay investors through a semi-annual coupon distribution of value.
Airline companies may grant irrevocable purchase undertakings to
buy the aircraft on the maturity of Sukuk. Upon maturity,
the SPV redeems the trust certificate for investors at the
dissolution of the SPV. The SPV will receive the purchase price
from the airline company at dissolution. The purchase price given
by the airline company will be the initial purchase price of
aircraft plus service or managing fees. The aircraft is transferred
to the airline company upon payment to SPV/Sukuk

II. The other option that can be used by airline companies is
that they may purchase the aircraft and sell it to SPV which will
lease it back to the airline company. This transaction is called
sale and leaseback. In any of the above scenarios, the SPV will act
as a trustee for Sukuk holder after issuing Sukuk
certificates. SPV will hold the aircraft as an asset in its balance
sheet or place the asset in trust. Again the same process of
receiving proceeds from investors and paying investors proceeds
from lease amount proportional to their share and ownership in the
asset will follow.

III. Usually, in the above scenarios, the lessor, i.e., SPV
under such Islamic transaction being the owner of the aircraft
remains liable for ownership taxes, if any, major maintenance and
hull and equipment insurance. However, in practice should neither
the lessor nor airline company wish such responsibilities to be
taken upon by the lessor. Therefore, the lessor will appoint the
airline company as service agent and thereby repay the service
agent (airline company) these costs. Ordinarily, these repayment
obligations endured by the lessor will be paid pack to the lessor
by the airline company in the form of extra rent to set off.
Therefore, the liability passes to the lessee but in Shariah
compliant ways.

IV. In case, the financier such as a bank or financial institute
is financing the aircraft they would prefer acting as an investor
(rabb ul amal) and enter into mudarabah with the
SPV (mudarib) who will be an investment manager. Under
this mudarabah, the financier will pass their funds to
mudarib for its use in agreement with the investment
strategy. The mudarib (SPV in this case) will hold a small
proportional interest in profits and will not be responsible for
any losses except such losses which are caused by its negligence,
misconduct or fault.

The Airfinance Journal examines the financial structures of
global airlines and rewards the best financing structures in
different categories. The case study of some award winning deals
will make clear to the readers the practical implementation of
Islamic financial leasing transactions.

In 2008, the transaction between Etihad and Al Hilal Bank, Abu
Dhabi (the Bank) won Airfinance’s
Award for Journal Middle East Deal of the Year in 2008 for
financing structure of an Airbus A340-600 for Etihad. The
transaction documents involved were ijara and
mudarabah. The Islamic financier appointed a Bank as an
investment agent by entering into Investment Agency Agreement. The
Bank as an investment agent entered into a mudarabah
agreement with the SPV. This SPV was a Cayman Islands company. The
Bank was acting as an investor (on behalf of Islamic financier as
investment agent) hence it was rabb ul-amal, and SPV was
mudarib. Under this investment strategy, the SPV acquired
the Airbus and then leased it to Etihad by use of the funds given
by the Bank as an investor. The Bank as an investment agent entered
into an administrative agency agreement with the SPV and SPV
appointed the Bank as an agent of mudarib for performing
certain actions. The proceeds received by SPV, as the
mudarib, with a small deduction in a percentage of profits
were payable to the Investment Agent i.e. the Bank under the
mudaraba agreement. Distribution of the profits received
by the Bank to the Islamic financiers will take place under the
Investment Agency Agreement.

The SPV also entered into ijara with Etihad and
appointed Etihad as its service agent. The lease payable by Etihad
included fixed rents, variable rent and an extra sum to set off the
reimbursements obligations owned by SPV as lessor, to Etihad as the
service agent.

Another recent example of exceptionally innovative financing
structure was carried out by Emirates known as Emirates ECA Sukuk.
This is first ever Export Credit Agency (ECA) backed Sukuk
transaction. In this deal, the Khadrawy Limited (Cayman Islands)
incorporated SPV issued certificates, which comprised US Dollars
913 million Sukuk due in 2025. The Sukuk has
ten-year tenor and were listed on London Stock Exchange and NASDAQ
Dubai. The proceeds of this Sukuk have used for
pre-funding the aircraft financing of four Airbus A380-800
aircraft. The pre-funding issues were managed by an innovative
combination of ijara and manfa’a (sale of the
right to use the asset for a pre-determined period) wherein the
tangibility of aircraft during the pre-funding period was overcome
by usufruct represented by tone kilometers.


The deals in Islamic financial structures have not only garnered
the attention of Muslim states but have also earned appreciation
from Western countries, countries in Europe, Asia and other parts
of the world, who are actively exploring the Shariah ways of
investments and financing. The appreciation of Shariah principles
has explored further ways of addressing the concerns of the
conventional financing industry and sponsors. Our GCC based firms
will be happy to structure and assist you with your ventures for
explorations into Islamic financing transactions.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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