The Background and the Rationale Behind Islamic Finance

Despite the existence of general conventional financing methods, Islamic finance techniques have recently become quite popular among the Muslim countries due to the growing population and the wealth especially in the Middle East and certain other Far Eastern countries. Consequently, significant number of financial institutions and individual Muslims tend to utilize new financing techniques, complying with Islamic law, and thus the concept of Islamic finance relating to the conduct of financial and commercial transactions in accordance with Islamic law1 came into scene.

Conventional financing tools are mostly based on interest systems as opposed to Islamic finance techniques which must comply with Sharia Rules banning interest charging. Principles of Islamic finance are similar to the ones used in Western legal system. Nevertheless, it is based on the understanding that everything is permissible (halal), unless there is a legal code which refutes that presumption by declaring it as forbidden (haram). The activities of financiers must comply with Sharia rules. Such rules relating to Islamic finance provide that the business transactions cannot involve Riba (excess or increase, interest), Gharar (uncertainty), Maisir (speculation) and Qimar (gambling). Needless to say, investing in or being involved with haram products and activities, such as gambling activities, alcohol, and becoming unjustly enriched are prohibited by Sharia'a principles. Generally speaking, Riba means any excess payment or additional return deriving from the principal amount of a debt. In the modern financial system, this may stand for any charged interest on the principal amount lent. Both Quran and Sunnah provide for the prohibition of Riba on several occasions. This, in fact, does not mean that Sharia prohibits making profits, but that it scrutinizes the basis on which, the profit is made, because charging interest would be harmful for the borrower while financiers would enjoy profits without spending any effort of their own. These barriers led Islamic institutions and scholars to establish sharia compliant finance techniques such as different types of Sukuk. Variety of sukuk types stem from the need for different financial structures for different purposes. Ijarah, Shirkah, Salam and Istisna, Mudaraba, Musharaka are some of the mostly utilized ones of Sukuk types.2

The structure of Sukuk Al-ijarah and what puts it on the map

As stated above, there are different types of Sukuk depending on the financial structure that is desired to achieve. Sukuk al-Ijarah is the most preferred sukuk type in aircraft financing because it is quite similar to financial lease. In case of sukuk al-ijarah, the lessor, in other words the owner, transfers the right of use on the aircraft to an airline company in order to receive a predetermined monthly rental payment amount from the lessee (e.g the airline company). An aircraft, subject to a sukuk al-ijarah contract, has to be in valuable use. In this scenario, the operating risk of the aircraft, which is subject to ijarah is transferred from lessor to the Airline Company (lessee). This is how the structure is seen from the outside. The relationship behind this scene is a little bit more complex.

The rationale of Sukuk Al-ijara is that when a company needs an asset but cannot afford to purchase it directly3, a Special Purpose Vehicle ("SPV") comes to the scene. The SPV purchases the asset and then leases it to the company for a fixed period of time. Obviously, SPV is established with the finds of the purchasing company. Another reason to opt for Sukuk Al-ijara is that although the company can afford to purchase the asset, it may need to maintain its cash, and thus, the company may first purchase the asset and then sell it to the SPV and the SPV leases it back to the company (sale and lease back). Either way SPV, which may be some form of a partnership or a trust company, acts as the sukuk issuer. SPV holds these assets in its balance sheet or alternatively places them in a different trust. In both ways, based on those assets, certificates may be issued by an authorized entity, mostly an investment bank, to sell to the investors in exchange for receipt of cash funds. The investors, namely sukuk al-ijarah holders become the owners of the asset and are entitled to receive a return when that asset is leased. The SPV receives the sukuk proceeds from the investors; in return, each investor gets a portion of ownership in the asset to be leased.

What about Turkey?

As of February 2015, in Turkey, there has not been any transaction regarding aircraft financing which could be defined as Sukuk Al Ijarah implementation. However, it is not difficult to predict that aircraft financing through Islamic Finance tools will open up more opportunities for airline companies, institutional and individual investors in Turkey in the near future. Last but not least, further good news on the Aircraft financing, which this time directly involves Turkey, is that Turkey is included in to the list of states as defined under the Sector Understanding on Export Credits for Civil Aircraft (ASU List), which stands for the states qualifying for the reduction of the minimum premium rates and consequently whose airline companies are able to enjoy the Cape Town Treaty discount since October 20, 2014. All these progresses give solid ideas on the positive future of Turkey's civil aviation sector.

Footnotes

1. The Qur'an is the primary source, which is accompanied and interpreted by the Sunna. In addition to the primary sources, Ijma, Qiyas and Ijtihad represent the secondary sources.

2 In total there are fourteen sukuks identified by AAOIFI. For further detail see http://www.aaoifi.com/.

3 This is very common for airline companies due to the expensive financing costs of aircraft. On the other hand, in order to keep their fleet young and be competitive with other airline companies, the fleet must be renewed. As a result, getting an aircraft with a leasing agreement (sukuk al ijarah) is more reasonable than buying it because each year a new design, well equipped aircraft are being produced by the leading manufacturers.

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.