Funding Infrastructure Development through Islamic Finance: Issues - - PowerPoint PPT Presentation

National Islamic Finance Committee

Funding Infrastructure Development through Islamic Finance: Issues and Challenges

National Islamic Finance Committee

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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”

National Islamic Finance Committee

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National Islamic Finance Committee is established to enhance the impact of Islamic fjnance on national economic development

EXECUTIVE MANAGEMENT EXECUTIVE MANAGEMENT STEERING BOARD CHAIRMA N VICE CHAIRMAN

Catalyst of Islamic economic developmen t in Indonesia

Functions

Coordinat e the Stakehold ers Create Policy and Strategy Recommenda tions Monitor and Evaluate Provide Solutio ns

National Islamic Finance Committee

01The need for infrastructure development 02Islamic Finance and Infrastructure Financing 03Funding Infrastructure through Islamic Finance: Case of Indonesia

01 The need for infrastructure development

Agenda

Komite Nasional Keuangan Syariah 3

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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

bal infrastructure spending, 2007-2040 Average annual investment by sector , 2007-2015

35% 29% 12% 12% 8% 3%3%

investment by sector

Electricity Road T elecoms 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 2030 Find a way to attract more alternative fjnancing sources $120 trillion funds under management of

Banks Investment Companies Insurance Public & private pension Sovereign wealth funds Endowmen t & Foundation s Infrastruct ure & private equity funds Unlock fmow

• f fjnance

T

• Improve

Productivit y of Infrastructu re 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 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0% 45.0% 50.0%

9.8% 13.9% 14.7% 14.8% 17.8% 19.3% 20.7% 21.0% 23.8% 26.4% 37.1% 46.0%

T

• tal Infrastructure Investments Contribution towards GDP

(T

• tal Infrastructure Investment - %GDP)

TUNISIA TURKEY EGYPT COTE D'IVOIRE MALAYSIA SAUDI AR ABIA BENIN INDONESIA NIGERIA GUINEA SENEGAL MOROCCO

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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

SENEGAL JORDAN AZERBAIJAN MOROCCO KAZAKHSTAN MALAYSIA PAKISTAN BANGLADESH TURKEY EGYPT NIGERIA SAUDI ARABIA INDONESIA

200 400 600 800 1000 1200 1400 1600 1800

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

Infrastructure Spending Needs 2016-2040 Cumulative in Selected OIC Countries (USD billion, 2015 prices and exchange rates)

2016 - 2040 Investment Need 2016 - 2040 Current T rend 8 18 19 36 70 77 84 114 125 191 221 230 406

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 Infrastructur e 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)

US$ (2016) 1,589.0

42.5 124.4 344.8 91.2

Global Islamic Financial Sectors Size (USD billion & Percentage)

Islamic Banking T akaful 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%

Sectors Total assets (USD billions) Percentag e going to Infrastruct ure 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)

National Islamic Finance Committee

01The need for infrastructure development 02Islamic Finance and Infrastructure Financing 03Funding Infrastructure through Islamic Finance: Case of Indonesia

02 Islamic Finance and Infrastructure Financing

Agenda

Komite Nasional Keuangan Syariah 9

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Islamic fjnance befjtting for Infrastructure Project

Source: World Bank, IsDB

Returns should be linked to the profjt/earnings and derived from commercial risk taken by fjnancier Islamic fjnanciers 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 fjnanciers (in PPP) Infrastructure projects allow Islamic fjnanciers 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 defjned with certainty Infrastructure projects mainly exclude the areas

• f the prohibited goods

Principles of Islamic Finance Infrastructure Project

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Islamic fjnance contracts vis-à-vis conventional for infrastructure fjnancing

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 funds Infrastructure equity funds— the fund manager works as an agent (wakil) to manage the funds Debt Loans with interest Sale-based instruments (murabahah and istisna) Interest-based bonds Hybrid Various structures such as convertible bonds, preferred shares, mezzanine fjnancing, 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 fjnancing method in which all parties

jointly contribute and bear losses Musharakah

• Profjt and loss sharing-contract based

Mudarabah

• Manufacture or build assets based on terms

specifjed by the buyer, at agreed price, within a certain time Istisna

• A lease for a specifjc rent for a specifjc 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 fjnancing and implementation of Islamic fjnance 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 fjnance instruments

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Possible challenges of Islamic project fjnancing implementation in infrastructure projects

Source: Rarasati et.all (2019), EDP Sciences.

01

Understanding

• f

Islamic fjnancial transactions (contracts, shariah structure & compliance)

02

Financial institution capability in conducting project fjnance

03

Investor behavior and characteristics (risk and return appetite)

04

Government policies and regulations

06

Mismatch in the duration between Islamic fjnance transaction maturity and infrastructure project fjnancing need

07

Project preparation and readiness (Feasibility studies)

08

Financing scheme and process

09

Understanding of infrastructure project fjnancing

05

Government support, guarantee and commitment (incl. incentives and level playing fjeld for Islamic fjnance-related projects)

10

Cost of Islamic fjnance fund (source of fund)

National Islamic Finance Committee

01The need for infrastructure development 02Islamic Finance and Infrastructure Financing 03Funding Infrastructure through Islamic Finance: Case of Indonesia

03 Funding Infrastructure through Islamic Finance: Case of Indonesia

Agenda

Komite Nasional Keuangan Syariah 1 4

National Islamic Finance Committee

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Demand of infrastructure fjnancing in Indonesia

Private Sector 270700% 42% State-Owned Enterprises 135300% 21% Government Budget 37%

Investment target 2020-2024 Rp6.445 trillion (trillion Rp)

Lack of managerial skills of project

• wner

Insuffjcient state and regional budget Increasing level of government debt Increasing debt to equity ratio

• f the

industry

ISSUES

Source: National Development Planning Agency

Source

• f

Fund?

Current issue in State-

• wned

Companie s

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Infrastructure fjnancing from Islamic fjnancial intitutions

Source: OJK and Ministry of Finance, 2019

ture fjnancing from Islamic banking and capital market is increasing. e size of infrastructure fjnancing from Islamic bank in Indonesia is lower than Islamic capital ma

2015 2016 2017 2018 43739

• 20.00

40.00 60.00 80.00 100.00 120.00 140.00 160.00 46.25 91.89 91.80 104.51

148.25

Surat Berharga Syariah Negara (SBSN) Project Based Sukuk Issuance (trillion Rp)

2015 2016 2017 2018 43617 0.00 5.00 10.00 15.00 20.00 25.00 30.00 11.19 14.44 22.20 24.65

28.53

Financing to Construction Sector by Indonesia’s Islamic Banking Industry (trillion Rp)

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Advantages of using Islamic fjnancial products/schemes for corporations

Public demand for sharia compliant transaction is increasing Uniqueness of sharia compliant products that could address specifjc fjnancial requirements and fjnancing diversifjcation Several support and incentives from the government have been given to the Islamic fjnance industry Investor diversifjcation 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 fjnancing 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

ADVANTAGE S SUPPORTING FACTS

National Islamic Finance Committee Komite Nasional Keuangan Syariah

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Implication of Islamic fjnancing schemes on Public Private Partnership

Unlike in conventional system where the price of lending money is interest rate, in Islamic fjnancial 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.

Convention al Loan Murabahah and Istishna fjnancing (Sales contract) Mudharabah and Musyarakah fjnancing (Partnership contract) Ijarah fjnancing (Leasing contract) Busines s model Loan/credit Bank/fjnancier builds the asset (eg. housing, infrastructure projects) before transfering the

• wnership to the

government/private sector entity. After the construction, the asset could be refjnanced through KIK EBA Bank/fjnancier and the private sector entity will establish a partnership to build the asset. Leasing of assets with purchase options (eg. housing, infrastructure projects) Account ing treatme nt Bank records interest income and asset Customer records interest expense and liability Bank/fjnancier 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 Asset during construction will be booked as inventory by the bank. After the construction, the asset could be refjnanced through KIK EBA so Badan Usaha do not need to book as liability Assets are booked by lessor (bank/fjnancier). Lessee (government/private sector entity) records rental expense in income statement, not booked as a liability

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Sukuk Musharakah – IMFD (ofg-balance sheet) for alternative infrastructure project fjnancing scheme

Source: KNKS

State-owned Company

Subsidiary Islamic SPC

1 1 3

Third Party

4 5 6 6

Infrastructu re Project

4

Investor

2

• te: 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 T emporary 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-fjnancial 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-

• wned Company.

5. The Islamic SPC disbursed the profjt to the investors. 6. At the maturity, the Islamic SPC execute purchase undertaking of the investor’s

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Islamic Close-ended Funds as an alternative source of infrastructure project fjnancing (for State-owned Companies)

Source: KNKS

Supporting agents: 1. Arranger 2. Legal Counsel 3. Tax & Financial Counsel 4. Rating Agency 5. Auditor 6. Islamic fjnance experts Infrastructur e Projects

State-owned Company

1

Investors

Islamic Close- ended Funds (SPV) 2 2 3 a 3b 3 b 6 4

Custodian & T rustee

5 7

1 : Project indetifjcation 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 (specifjed 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 & T rustee. 5 : the Custodian & T rustee 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 Profjt-Sharing Investment Account (PSIA) Underlying Asset SRIA (Specifjc Financing) Investment Account SRIA Other Assets Equity T

• tal Asset

T

• tal Liabilities and Equity

Islamic Banks

Islamic Bank’s balance sheet illustration when implementing SRIA for Islamic PPP

Islamic Public Private Partnership Global Investors Government Guarantee PT Penjaminan Infrastruktur Indonesia The Islamic Corporation for the Insurance of Investment and Export Credit Islamic PPP Guarantee Facilitator

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Conclusion Islamic fjnancial industry is relatively new and still facing various challenges Islamic fjnancial industry is relatively new and still facing various challenges However, it has a huge potential in contributing to Indonesia’s infrastructure development However, it has a huge potential in contributing to Indonesia’s infrastructure development Government

• f Indonesia

continues to encourage Islamic fjnancial industry’s contribution to infrastructure development Government

• f Indonesia

continues to encourage Islamic fjnancial 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 fjnance

National Islamic Finance Committee

Thank You

National Islamic Finance Committee

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