Islamic Finance in Commercial Aircraft Leasing

Islamic finance is a leading and rapidly emerging industries in the international finance industry. Islamic finance is well adapted to asset finance and has suited to offer a substitute to conventional financing structures, developing on the religious and legal principles which are at its foundations.

Islamic finance refers to how businesses and individuals raise capital in accordance with Shariah, or Islamic law. It also refers to the types of investments that are permissible under this form of law. Islamic finance can be seen as a unique form of socially responsible investment and an alternative approach that is based strongly around morals and religious belief.

Islamic Finance in Aviation

Most Shariah compliant aircraft finance transactions are organised using an Ijarah. This is a type of lease according to which the owner of the aircraft carries the legal right to use and gain profit from the aircraft to another individual for a decided period and decided rent. An Ijarah can be integrated with sale and purchase undertakings between lessor to lessee to produce a product similar to a finance lease (Ijarah wa iqtina – – – lease and ownership).

However, in some situations Shariah principles can seem to differ with traditional ideas of risk allocation between a financier or lessor and a lessee, it is essential that Shariah compliant transaction documentation does indicate commercial reality. For instance, it would be exceptional that a lessor had adequate maintenance and insurance competency to assist the commercial functioning of an aircraft. Techniques have hence advanced to make sure that, although the documentation adapts to the principles of Shariah, it acknowledges that the airline will keep up and insure the aircraft in drills.

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Sukuk is a type of an asset-backed trust certificate (bond) which is released to the investor as a proof of ownership of an asset or part ownership or its usufruct (earnings) depending on the principles of Shariah. Sukuk varies from traditional bonds concerning asset ownership, investment criteria, issue price and unit, investment rewards and threats, and impacts and prices.

Usually, Sukuk Al-Ijarah is generally employed for aircraft financing. In this kind of transaction, a special purpose vehicle (SPV) will buy the asset and finally lease it to end-user who wished to use the asset under structured arrangements.

Main Characteristics

Variation of Funding Sources

As of the time, Islamic Financing has not been reviewed as a commercial option over traditional finance. Combined with traditional-style documentation, bankable governing law, the potential to integrate with traditional funding sources and a paved way for a fresh market.

Sukuk Holders are Investors

The relationship of Sukuk holders to issuer is that of investor and not a creditor. The Sukuk holders are joint owners of trust assets, being aircraft (subject to leases), the lease revenues and lease rights. They practise their rights as owners via a Sukuk agent, who has the authority to impose lease rights, and can be obliged to do so by pertinent proportion of Sukuk holders.

The Sukuk Holders’ Rights

The Sukuk holders’ rights against the issuer are confined in recourse to the trust assets usually being the aircraft itself. The intricacy of each transaction is determined by the investor/rating needs.

Islamic Financing Arrangements

Under Islamic Financing arrangements, the conventional elements comprise of Aircraft Management and Remarketing Agreements, elimination of the lessor from other transactions for bankruptcy remoteness and determination of the lessor in a tax-friendly jurisdiction.

Aircraft lessors’ need for Islamic Funding bids fair to exceed traditional funding sources accessible owing to massive aircraft orders and requirement for an expert yearning for regional risk. The current run of advanced Islamic aircraft financings has aided in building Islamic aircraft financing technology, while non-airline sukuks and airline bonds have identified investor appetite for this asset class.

Risk Mitigation

To safeguard the Islamic financier from the essential risks which come with ownership of a financed asset, a Special Purpose Vehicle (SPV) can hold the aircraft subject to a Mudarabah (an investment management agreement) and the SPV becomes the Mudarib (the investment manager) and the financier becomes the Rabb-ul-maal.

Under the Mudarabah financing prototype, the investors pass their funds to the Mudarib for it to employ following with the investment plan. The Mudarib should have a share of profits (which can be small) and will not be held accountable for losses unless lead by its negligence or default. While the legal nature of a Mudarabah should be tested under local law, interposing the Mudarib as the lessor and legal owner of the aircraft can create some distance between the Islamic financiers and ownership threats.

Labuan Leasing License

Labuan Leasing signifies the business of letting or sub-letting property-on-hire for the intents of the use of such property by the hirer/lessee, irrespective of whether the lease/let is with or without a choice to buy the property.

A Labuan Leasing Company is authorised to cater to both international and local Malaysian entities meanwhile you can enjoy 100% ownership and a low tax rate of 3% on net audited profits. Foreigners and Malaysians are encouraged to initiate their leasing business in Labuan that provides many favourable tax incentives and regulatory structure where innovative leasing frameworks have been put in place by the Labuan FSA to aid businesses in minimising their operational prices essentially.

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