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National Islamic Finance Committee
Funding Infrastructure Development through Islamic Finance: Issues and Challenges
National Islamic Finance Committee 1
Ronald Rulindo, Ph.D. (Director of Islamic Finance Product Innovation, Financial Market Deepening and Infrastructure Development of KNKS)
Delivered on BI-ADFIMI-KNKS joint CEO seminar on “Islamic Structured Finance: Cases of Infrastructure Project Finance in IsDB Member Countries”
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National Islamic Finance Committee is established to enhance the impact of Islamic finance on national economic development
EXECUTIVE MANAGEMENT
STEERING BOARD
CHAIRMAN
VICE CHAIRMANCatalyst of
Islamic economic
development in Indonesia
Functions
Coordinate the
Stakeholders
Create Policy and Strategy
Recommendations
Monitor and Evaluate
Provide Solutions
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01 The need for infrastructure development
02 Islamic Finance and Infrastructure Financing
03 Funding Infrastructure through Islamic Finance: Case of Indonesia
01The need for infrastructure development
Agenda
Komite Nasional Keuangan Syariah
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Global infrastructure spending trends shows continuous improvement in terms of budget allocation across countries, dominated by electricity and road sectors
Source: Oxford Economics
Billion US$, based on 2015 prices and exchange rates
Global infrastructure spending, 2007-2040 Average annual investment by sector, 2007-2015
35%
29%
12%
12%
8%
2% 2%
INVESTMENT BY SECTOR
Electricity
Road
Telecoms
Rail
Water
Port
Airport
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How can the world bridge its infrastructure gap other than government spending?
Source: McKinsey Global Institute
The world invests $2.5 trillion annually in transport, power, water, and telecom as of today
The world needs to invest $3.3 trillion annually just to meet growth forecast by 2030Find a way to attract
more alternative financing sources
$120 trillion fundsunder management of
Banks
Investment Companies
Insurance
Public & private pension
Sovereign wealth funds
Endowment &
Foundations
Infrastructure & private
equity funds
Unlock flow of finance
To Improve Productivity
of Infrastructure
Investment
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The State of Infrastructure Investment in OIC Member Countries varied from one to another
Source: https://infracompass.gihub.org/compare_countries. COMCEC OIC
9.8%
13.9%
14.7%
14.8%
17.8%
19.3%
20.7%
21.0%
23.8%
26.4%
37.1%
46.0%
0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0% 45.0% 50.0%
Total Infrastructure Investments Contribution towards GDP(Total Infrastructure Investment - %GDP)
MOROCCO SENEGAL GUINEA NIGERIA
INDONESIA BENIN SAUDI ARABIA MALAYSIA
COTE D'IVOIRE EGYPT TURKEY TUNISIA
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Infrastructure spending needs and the funding gaps in several OIC Countries years ahead demonstrated the demands for more investments
Source: GIH and Oxford Economics (2018), Global Infrastructure Outlook, Infrastructure investment needs 50 countries, 7 sectors to 2040. COMCEC OIC
80
81
100
246
292
460
480
608
613
675
878
975
1712
61
63
92
210
208
383
355
417
499
445
657
569
1642
0 200 400 600 800 1000 1200 1400 1600 1800
SENEGAL
JORDAN
AZERBAIJAN
MOROCCO
KAZAKHSTAN
MALAYSIA
PAKISTAN
BANGLADESH
TURKEY
EGYPT
NIGERIA
SAUDI ARABIA
INDONESIA
Infrastructure Spending Needs 2016-2040 Cumulative in Selected OIC Countries (USD billion, 2015 prices and exchange rates)
2016 - 2040 Current Trend 2016 - 2040 Investment Need
818 19
36
70 77 84
114125
191
221 230
406
Infrastructure Gap in Selected OIC Countries 2016-2040 (USD billion 2015 prices and exchange rates)
Gap Amount
Total Investment Needs till 2040:
US$ 7,200
Total Infrastructure Gap
till 2040: US$ 1,599
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Islamic Finance sector size and investment allocation in infrastructure sector
Source: ICD – IsDB, Thomson Reuters (2017)
1,589.0
42.5124.4
344.8
91.2
US$ (2016)
Global Islamic Financial Sectors Size (USD billion & Percentage)
Islamic Banking Takaful Other IFIs Sukuk Islamic Funds
Total Value of Islamic Financial Industry: US$ 2,438 billion
72.6%
1.9%
5.7% 15.7%
4.1%
SectorsTotal assets
(USD billions)
Percentage going to
Infrastructure
Infrastructure Investments by
Islamic Finance (USD Billion)
Islamic Banking
1,598.90 4.74% 75.8
Takaful 42.5 2.00% 0.9
Sukuk 344.8 11.57% 39.9
IDB Project Financing
3.12
Total 119.7
Total Islamic Finance Investments in Infrastructure Sector (2017-2018, USD Billion)
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01 The need for infrastructure development
02 Islamic Finance and Infrastructure Financing
03 Funding Infrastructure through Islamic Finance: Case of Indonesia
02Islamic Finance and Infrastructure Financing
Agenda
Komite Nasional Keuangan Syariah
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Islamic finance befitting for Infrastructure Project
Source: World Bank, IsDB
Returns should be linked to the profit/earnings and derived from commercial risk taken by financier
Islamic financiers become partners in the project
Transactions should be free from speculation or gambling (maysir)
Existence of uncertainty in a contract is prohibited
Investment relating to prohibited goods and activities are not permitted
Infrastructure projects allow risk to be shared among the parties involved in the project, including financiers (in PPP)
Infrastructure projects allow Islamic financiers to become a party to the project, not only as a lender
Infrastructure projects, by nature, should be free from speculation or gambling
Project contracts are generally well defined with certainty
Infrastructure projects mainly exclude the areas of the prohibited goods
Principles of Islamic Finance Infrastructure Project
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Islamic finance contracts vis-à-vis conventional for infrastructure financing
Conventional and Islamic Finance Contracts for Infrastructure Financing
Contract Categories
Conventional Finance Islamic Finance
Equity
Equity provided by sponsors (ownership shares in the SPV)
Equity provided by sponsors (ownership shares in the SPV) —can take the form of musharakah or mudarabah
Infrastructure Equity fundsInfrastructure equity funds—the fund manager works as an agent (wakil) to manage the funds
DebtLoans with interest Sale-based instruments (murabahah
and istisna)Interest-based bonds
Hybrid
Various structures such as convertible bonds, preferred shares, mezzanine financing, etc.
While certain features such as convertibility of debt to equity are allowed, other structures such as preferred shares are not permissible.
Structures combining various contracts such as istisna-ijarah, wakala-ijarah, etc.
Islamic Finance Contracts for Project Financing
• Partnership financing method in which all parties jointly contribute and bear losses
Musharakah
• Profit and loss sharing-contract based
Mudarabah
• Manufacture or build assets based on terms specified by the buyer, at agreed price, within a certain time
Istisna
• A lease for a specific rent for a specific period
Ijara
• Agency contract whereby a principal appoints an agent to perform an act on its behalf
Wakala
Source: COMCEC OIC, Chu and Muneeza (2019)
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Project financing and implementation of Islamic finance contracts for Infrastructure PPP Projects
Source: World Bank, IsDB
Note: EPC = engineering, procurement, and construction; SPV = special purpose vehicle; O&M = operations and maintenance
Islamic finance
instruments
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Possible challenges of Islamic project financing implementation in infrastructure projects
Source: Rarasati et.all (2019), EDP Sciences.
01Understanding of Islamic financial transactions
(contracts, shariah structure & compliance)
02Financial institution capability in conducting project
finance
03Investor behavior and characteristics (risk and return
appetite)
04 Government policies and regulations
06Mismatch in the duration between Islamic finance
transaction maturity and infrastructure project
financing need
07 Project preparation and readiness (Feasibility studies)
08 Financing scheme and process
09 Understanding of infrastructure project financing
05
Government support, guarantee and commitment
(incl. incentives and level playing field for Islamic
finance-related projects)
10 Cost of Islamic finance fund (source of fund)
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01 The need for infrastructure development02 Islamic Finance and Infrastructure Financing03 Funding Infrastructure through Islamic Finance: Case of Indonesia
03Funding Infrastructure through Islamic Finance: Case of Indonesia
Agenda
Komite Nasional Keuangan Syariah
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Demand of infrastructure financing in Indonesia
Private Sector2,707
42%
State-Owned Enterprises
1,353
21%
Government Budget2,385
37%
INVESTMENT TARGET 2020-2024 Rp6.445 trillion
(trillion Rp)
Lack of managerial skills of project owner
Insufficient state and regional budget
Increasing level of government debt
Increasing debt to equity ratio of
the industry
ISSUES
Source: National Development Planning Agency
Source of Fund?
Current issue in
State-owned Companies
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Infrastructure financing from Islamic financial intitutions
Source: OJK and Ministry of Finance, 2019
Infrastructure financing from Islamic banking and capital market is increasing.However, the size of infrastructure financing from Islamic bank in Indonesia is lower than Islamic capital market (Sukuk).
46.25
91.89 91.80 104.51
148.25
-
20.00
40.00
60.00
80.00
100.00
120.00
140.00
160.00
2015 2016 2017 2018 Oct-19
Surat Berharga Syariah Negara (SBSN) Project Based Sukuk Issuance
(trillion Rp)
11.19
14.44
22.2024.65
28.53
0.00
5.00
10.00
15.00
20.00
25.00
30.00
2015 2016 2017 2018 Jun-19
Financing to Construction Sector by Indonesia’s Islamic Banking Industry
(trillion Rp)
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Advantages of using Islamic financial products/schemes for corporations
Public demand for sharia compliant transaction is increasing
Uniqueness of sharia compliant products that could address specific financial requirements and financing diversification
Several support and incentives from the government have been given to the Islamic finance industry
Investor diversification from local and international
Source: PT Bank Permata Tbk, with adjustments
• Anti Riba Movements• Critics on Debt
• Partnership• Sale and Lease Back• True Sale• Blended Finance
• Tax incentives on murabahah financing transactions
• Lower cap of sukuk issuance fee
• Listed in sharia index stocks• Wider access to Middle-Eastern/Islamic
investors• Wider access to green/impact investors
ADVANTAGES SUPPORTING FACTS
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Implication of Islamic financing schemes on Public Private Partnership
Unlike in conventional system where the price of lending money is interest rate, in Islamic financial system, money is not treated as a priced commodity. Every transaction should have real underlying assets and the contracts/’aqad used are specialized based on the transaction characteristics.
Conventional Loan
Murabahah and Istishna financing(Sales contract)
Mudharabah and Musyarakahfinancing
(Partnership contract)
Ijarah financing(Leasing contract)
Businessmodel
Loan/credit Bank/financier builds the asset (eg. housing, infrastructure projects) before transfering the ownership to the government/private sector entity.
After the construction, the asset could be refinanced through KIK EBA
Bank/financier and the private sector entity will establish a partnership to build the asset.
Leasing of assets with purchase options (eg. housing, infrastructure projects)
Accounting treatment
Bank records interest income and asset
Customer records interest expense and liability
Bank/financier book the asset as inventory (including during construction) before selling it to government/private sector entity.
Customer do not need to book the asset before the purchase and after the purchase it could be securitized (off balance sheet)
Asset during construction will bebooked as inventory by the bank.
After the construction, the asset could be refinanced through KIK EBA so Badan Usaha do not need to book as liability
Assets are booked by lessor (bank/financier).
Lessee (government/private sector entity) records rental expense in income statement, not booked as a liability
Taxation Refer to accounting treatment
No VAT charged in asset ownership transfer in murabahah financing
Income tax for investors of profit and loss sharing product is lower than income tax for deposit investors
No VAT charged in rental payments and sale of assets at the end of leasing period
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Sukuk Musharakah – IMFD (off-balance sheet) for alternative infrastructure project financing scheme
Source: KNKS
State-owned Company
Subsidiary
Islamic SPC
1
1
3
Third Party
4
5
6
6
Infrastructure Project
4Investor
2
Note: SPC = Special Purpose Company
1. Establishment of an Islamic Special Purpose Company
(SPC).
2. The Islamic SPC issue Sukuk Musharakah to the
investors, the proceeds recorded as the Temporary
Shirkah Funds at the Islamic SPC.
3. The State-owned Company orders the project to the
Islamic SPC with Ijarah Maushufah Fi Dzimmah –
upfront leasing (in Ijarah Muntahiyyah Bi Tamlik-
financial lease) and pay the rent.
4. The Islamic SPC orders the construction of the project
to the third party with Istishna’, and then the SPC
delivers to the The State-owned Company.
5. The Islamic SPC disbursed the profit to the investors.
6. At the maturity, the Islamic SPC execute purchase
undertaking of the investor’s portion (the principal).
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Islamic Close-ended Funds as an alternative source of infrastructure project financing (for State-owned Companies)
Source: KNKS
Supporting agents:1. Arranger2. Legal Counsel3. Tax & Financial
Counsel4. Rating Agency5. Auditor6. Islamic finance
experts
Infrastructure Projects
State-owned Company 1
Investors
Islamic Close-ended Funds (SPV)
2
2
3a
3b
3b
6
4
Custodian & Trustee
5
7
1 : Project indetification by the state-owned company
(originator) as the underlying for the issuance of Islamic close-
ended funds
2 : Appoint Asset Manager to create Islamic close-ended funds
(specified for infrastructure; based on the underlying project;
inviting investor’s participation,
3a : The funds disbursed the collected proceeds to the the
state-owned companies .
3b : The state-owned company or their subsidiary issue
common shares to the funds.
4 : Paying out dividen to the Custodian & Trustee.
5 : the Custodian & Trustee deliver dividen to the funds.
6 : The funds disbursed to the investors.
7 : At the time of funds dissolvent, the originator undertake
shares’ buyback at par.
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Assets Liabilities
Cash Deposits
Financing Profit-Sharing Investment Account (PSIA)
Underlying Asset SRIA (Specific Financing) Investment Account SRIA
Other Assets Equity
Total Asset Total Liabilities and Equity
Islamic Banks
Islamic Bank’s balance sheet illustration when implementing SRIA for Islamic PPP
Islamic Public Private Partnership
Global Investors
Government GuaranteePT Penjaminan
Infrastruktur Indonesia
The Islamic Corporation for the Insurance of Investment
and Export Credit
Islamic PPP Guarantee Facilitator
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Conclusion
Islamic financial industry is
relatively new and still facing various
challenges
However, it has a huge potential in contributing to
Indonesia’s infrastructure development
Government of Indonesia
continues to encourage Islamic financial industry’s
contribution to infrastructure development
We are open to collaborate with various stakeholders with relevant expertise and interest in supporting infrastructure development through Islamic finance
National Islamic Finance Committee
Thank You
National Islamic Finance Committee 23