SUKUK MURABAHAH & MUDHARABAH

Background information
y Originator y Issuer y Purpose of financing y Reason to select Murabahah/Mudharabah Sukuk y Main features of the sukuk

Originator KNM Group

y Established manufacturer of process equipment for the global oil & gas,

petrochemicals and minerals processing industries

y Direct subsidiaries:
y y y y y y y

KNM Process Systems Sdn. Bhd. KNM International Sdn. Bhd. KNM Capital Sdn. Bhd. KNM Management Services Sdn. Bhd. KNM Renewable Energy Sdn. Bhd. KNM Capital Labuan Limited KNM Services (Singapore) Pte. Ltd.

y Listed on Bursa Malaysia Securities Berhad in August 2003 and transferred to

the Main Board in September 2005 y 90% of its revenues are realized from the export markets continuously strengthen its position overseas through expansion and strategic acquisitions

Issuer KNM Capital Sdn Bhd

y A private limited company under the Companies Act

1965 y Established on 24th April 2006. y A wholly owned subsidiary of KNMB y Involved in the provision of funding and treasury services and all related treasury functions for the KNM Group.

Purpose of financing
y Refinance KNMB s existing outstanding MUNIF

under the MUNIF/IMTN program y KNM Group s expansion plans in China y Future investments, capital expenditure requirements and working capital purposes.

Cuttings from KNMB Annual Report 2008

Reason to select murabahah / mudarabah sukuk structure

y ICP/IMTN Guarantee access to a wider investor base.

Reason to select murabahah / mudarabah sukuk structure

y Provides maximum flexibility to KNMC in managing

its funding requirement for its expansion plan and investments overseas. y Facilitates KNM Group s centralization of all its funding and treasury functions through the setting up of KNMC y Address the issue of riba arising from the transaction through hybrid sukuk

Structure of the sukuk

Country Sukuk Name Name of Issuer Principal activities of issuer Name of Originator/Obligor Principal activities of Originator / Obligor Date of Issue Issue size Tenor (years) Issue Price Listing Status Shariah Principle Used sukuk issuance Rating Profit/Coupon Profit / Frequency Coupon Payment

Malaysia ICP/IMTN KNM Capital Sdn Bhd Involved in the provision of funding and treasury services and all related treasury functions for the KNM group of companies KNM Group Berhad Engaged in the designing and manufacturing of process equipment for the oil and gas, petrochemicals, minerals processing, desalination, renewable energy, environmental and power industries. 18 October 2006 RM300 million 7 years

Not listed Hybrid Mudharabah and Murabahah Short-term rating of 1ID and long-term rating of A+ID by MARC

Underlying/ Identified assets Purpose of Issue / Utilization of sukuk proceeds

Land / building (factory) owned by KNM Process Systems Sdn Bhd and Perwira Awan Sdn Bhd yRefinance KNMBs existing outstanding MUNIF under the MUNIF/IMTN program yFinance KNM Groups expansion plans in China yFinancing future investments, capital expenditure requirements and working capital purposes.

Links
y Issuances of sukuk in tranches.
http://www.bondinfo.bnm.gov.my/portal/server.pt/gateway/PTARGS_0_22874_1632_313_0_43/http%3B/hqblkhub.w2 k.bnm.gov.my%3B7070/BondInfoHub/InvestorTools/BondSearch/bondSearch,$TablePages.linkPage.sdirect?sp=AInve storTools%2FBondSearch%2FbondSearch%2CresultTab

y Newspaper article
http://www.bernama.com/bernama/v5/newsbusiness.php?id=537676

KNM uses hybrid Islamic instruments (Murabahah and

Mudharabah schemes) to make its ICP/IMTN transaction Shariah compliant. Purchase and selling price:
investors purchase an identified asset in cash at a discount

from the issuer. Investors, then immediately sell the said identified assets back to the issuer the issuer will pay the investors the purchase price and the profit (selling Price) at the maturity date

MECHANISM AND VALUATION OF TRANSFER OF ASSET

y Selling price is determined at the transaction date, but

settled on deferred basis. y In the second tier, the issuer will advance the proceeds to the KNM Group and its subsidiaries using Mudharabah contract (Mudharabah Muqayyadah).
y Issuer-capital provider y KNM-Mudharib y Profit sharing ratio of 1:99 y concept of waiver (Tanazul) is exercised

Transfer of assets upon Maturity

y Upon maturity, it is the issuers obligation to pay the

selling price under the ICP/IMTN programme.

y The redemption takes place as follows:
y in relation to ICP, the face value of the notes. There will

not be profits payable on the ICP in view that they are issued at a discount;

Transfer of assetsfollows: Maturity y The redemption takes place as upon

y in relation to the IMTN,
y y

the face value of the primary notes, representing the face value, and the secondary notes, representing the profits.

y Profit payment basis is actual/actual days basis.

In the event of default y KNM opened and maintains two Shariah compliant
accounts called finance service accounts (FSA).
y First account (FSA1) deals with the Islamic Commercial

Papers (ICP) payments.

y The second account (FSA2) deals with the Islamic Medium

Term Notes (IMTN) payments.

In the event of default

y Funds from these accounts are allocated to repay the

ICP/IMTN that were issued in the amount tabulated in the annual reduction schedule.
y duty of the issuer to make sure that 100% of the amount needed is

deposited into these two accounts one month before the payment is due.

In the event of default

y When it is considered as default?
y if failure to meet such payment is not remedied within (14

days) from the expected deposit date.

y Upon declaration of event of default:

y no further ICP/IMTN issuance may be made.

y The whole of the principal sums outstanding payable

shall become immediately due and payable.

ICP/IMTN v.s AAOIFI Requirements

y First, sukuk, to be tradable, must be owned by sukuk

holders, with all rights and obligations of ownership, in real assets, whether tangible, usufructs or services, capable of being owned and sold legally as well as in accordance with the rules of Shariah.

y The notes are:

y represented by global certificates y deposited with Bank Negara Malaysia (BNM) y traded in RENTAS (Real Time Electronic Transfer of Funds

and Securities). y May not be offered/sold/delivered directly or indirectly

ICP/IMTN vs AAOIFI Requirements

AAOFI defines Murabaha certificates..
y

The issuer is seller of the assets.

y y y

The investors are buyers of that asets Realized funds are the purchasing cost of the assets. The certificate holders own the murabahah assets and are entitled to its sale price

ICP/IMTN vs AAOIFI Requirements

y When the SPV has sold the asset to the company, the

Sukuk represents a receivable of the selling price. y Thus, from the AAOIFI perspective, Murabahah Sukuk should not be traded freely in the secondary market
y Because the exchange of receivables (money) with payment

from another party (same type of money) could be done only at par value.

y Therefore, the AAIOFI Requirement 2008 is met.

ICP/IMTN v.s AAOIFI Requirements y Second, Sukuk, to be tradable, must not represent receivables or
debts, except in the case of trading or financial entity selling all its assets, or a portfolio with a standing financial obligation, in which some debts, incidental physical assets or usufruct, were included unintentionally.

y In KNMs case, the assets are purchased and sold-back to the

issuer expecting to get their selling price which is considered receivables.

y However, KNM notes are not traded in the secondary market. y Therefore, the second requirement in the AAOIFI February 2008

sukuk pronouncement were met.

ICP/IMTN v.s AAOIFI Requirements

y Third, it is not permissible for the manager of sukuk, to undertake

to offer loans to sukuk holders, when actual earnings fall short of expected earnings. It is permissible, however, to establish a reserve account for the purpose of coverings such short falls to the extent possible, provided the same is mentioned in the prospectus.

y KNM does not offer loans in the event when earnings fall

under the expected earnings since there is NO profit under ICP. y In the case of IMTNs profits, the company established (FSA1 & 2) to meet the due payment of profits of IMN and the selling prices of the ICP/IMTN programme. y Hence, the company meets the AAOIFI February 2008 sukuk pronouncements.

y Fourth, it

is not permissible AAOIFI Requirements ICP/IMTN vsfor the Mudarib (Investment manager), to undertake {now} to repurchase the assets from sukuk holders or from one who holds them, for its nominal value, when sukuk are extinguished, at the end of its maturity. It is, however, permissible to undertake the purchase on the basis of the net value of the assets, its market value, fair value or a price to be agreed, at the time of their actual purchase.

y In the case of KNM, the purchase and the sell-back contracts take place at the time

of contract, a price in which the payment will be deferred, is agreed.

y Therefore, this transaction meets the AAOIFI February 2008 sukuk pronouncements.

ICP/IMTN v.s AAOIFI Requirements

y Fifth, it

is permissible for a lessee in sukuk alijarah to undertake to purchase the leased assets when the sukuk are extinguished for its nominal value, provided he {lessee} is not also a partner, Mudarib, or investment agent.

y As this transaction (ICP/IMTN) is not related to sukuk

ijarah, this requirement is not applicable to the AAOIFI 2008 pronouncement at the moment.

ICP/IMTN Supervisory Boards should not limit y Six, Shariah vs AAOIFI Requirements
their role to the issuance of fatwa on the permissibility of the structure of Sukuk. All must carefully reviewed {by them}, and then they should oversee the actual means of implementation, and then make sure that the operation complies, at every stage, with Shariah guidelines and requirements as specified in the Shariah Standards.

ICP/IMTN vs AAOIFI Requirements

y Evidence that the SC approval of ICP/IMTN has been

obtained.
y Receipt of endorsement from the Shariah adviser in

respect of the ICP/IMTN Programme.

y Blanket consent of the identified assets for the sale

and purchase transaction in accordance with shariah principle of murabahah.