Islamic Finance and Sukuk in Nigeria: A Paradigm Shift In Nigeria’s Infrastructure Financing

By Feyisikemi Adeagbo

Introduction

Infrastructure is a key determinant of the growth potential of an economy. In many cases, and especially for emerging
market countries like Nigeria, the utilisation of capital is important to creating needed infrastructure which encourages the inflow of FDI necessary to drive economic growth. Accessing the capital necessary for infrastructure projects can take various forms. Traditionally, banks have been the providers of infrastructure loans such as syndicated loans. However, this has over time changed as alternative options like the issuance of sovereign bonds have begun to play a more significant role in replacing syndicated loans in financing infrastructure projects. In this evolving landscape, Islamic finance has also become a relatively new centre of attraction in the global financing market and is increasingly being adopted by African countries. For a country that homes over 90 million Muslims, Nigeria may need to utilise
more of the potential that lies in Islamic finance in narrowing its infrastructure deficit.

This article gives an overview of the legal framework of Sukuk in Nigeria, how it has been adopted and the future of this financing mechanism in Nigeria.

Islamic Finance and Sukuk

Islamic finance, relatively new and dating back to the 1970s, is a financial system that complies with the principles of Sharia (Islamic law). It is equity-based, ethical, sustainable, and a risk-sharing type of financing. Just like the conventional financial system, Islamic finance involves the raising of capital by corporations, investments, and other
compositions of conventional financing, however with adherence to the financial principles contained in the Quran.
Chief among these principles is the prohibition of interest payment and dealing in businesses contrary to the principles of Shariah as contained in the Quran.

Over the past decade, Islamic finance has gained more attraction in the world, including among non-Muslim countries such as Hong Kong, UK and South Africa. It has emerged as an effective tool for financing development worldwide through Islamic Banking, Islamic bonds (Sukuk), Islamic Insurance (Takaful), Islamic Funds and Other Islamic Financial Institutions (OIFIs). Sukuk, the most common tool of Islamic Finance, are certificates of equal value representing undivided shares in the ownership of tangible assets, usufruct and services or (in the ownership of) the assets of particular projects or special investment activity. Like conventional bonds, Sukuk have fixed term maturity and are tradeable at normal yield price. However, while in the case of a conventional bond, the certificate represents a pure debt obligation, Sukuk represents the ownership interest in the underlying asset which can either be asset based or asset backed. In the former, certificate holders have beneficial ownership of the underlying asset while the legal title resides with the obligor. As such, no true sale has occurred, and the holders solely depend on the creditworthiness of the originator. Asset-backed Sukuk on the other hand involves the true sale of the underlying asset. Certificate holders rely solely on the revenue the asset generates and have no recourse against the originator.

The Legal Regime of Sukuk in Nigeria

Sukuk bonds are legally regulated in Nigeria through the SEC Rules and Regulations, 2013 (the SEC Rules), the NSE Rules on Sukuk Listing and Similar Debt Securities, 2018 (the Rules) and other relevant State and Federal laws
enacted on the issuance of sukuk bond. Rule 572 of the SEC Rules defines sukuk as investment certificates or notes of equal value which evidences undivided interest of tangible assets, usufructs and services or investment in the assets of particular projects or special investment activity using shariah principles and concepts approved by the Securities and Exchange Commission (SEC). The SEC Rules also provides that only public companies (including SPVs), state
government, local government and government agencies can offer sukuk upon SEC’s approval.

The structures of sukuk have been derived from the different types of Islamic contracts. The SEC Rules recognises four ways by which a sukuk can be structured. This is in addition to any other form approved by SEC.

Sukuk Ijarah: this is structured as a lease contract arrangement. Here, proceeds realised from issuance of bond
certificate is used to purchase an asset. After which the asset will be leased to a third-party lessee. The rent paid on this asset is the source of returns to the certificate holders and the certificate issued to the investors represents security over the leased asset. It is regarded as the classical Sukuk as it has become the most used structure.

Sukuk Musharakah: this structure is a partnership arrangement that shares similarities with an equity investment.
Certificate holders as well as other parties such as a company or contractor finance a business venture and become co-owners. Parties then share profit based on a pre-agreed profit-sharing ratio and share loss on the basis of capital contribution to the venture.

Sukuk Istinah: this is structured like a project financing. It often involves the construction of capital-intensive assets like a gas processing plant. To finance the construction of the asset, funds are mobilised by issuing certificates to investors. This certificate represents ownership of the asset and upon construction, the asset can either be sold or leased. It is similar to a fixed price turnkey contract and also referred to as the ‘Islamic project bond’.

Sukuk Murabahah: this is structured as contract of sales arrangement. It involves purchasing commodities with the
proceeds from the sukuk bond and the transfer of ownership of the commodities to the certificate holders. The commodity is thereafter sold at the purchase price plus profit margin.

The Rules, in addition to the listing requirements for conventional bonds, put in place some requirements for issuing Sukuk. Top of these additional requirements is the appointment of a Shariah adviser by the issuer whose major responsibility is to ensure the Sukuk complies with Shariah principles.

Sukuk and Infrastructure Financing in Nigeria

Nigeria, despite its wealth of natural resources, has been unable to sustain the requisite level of economic growth and
infrastructure development. Several attempts, such as the adoption of the public private partnership, have been made to narrow the country’s infrastructure deficit. Recently, the Federal Government of Nigeria (FGN) has opened up to issuing sovereign Sukuk to finance some key infrastructures such as road networks within the country. Before this, the Osun state government was the pioneer of Sukuk in Nigeria. In 2013, the state government issued a N10 billion Sukuk
to finance the construction of ten schools in the state. It was structured as a Sukuk Ijarah, whereby certificate holders
became co-owners of the schools and thereafter leased the schools to the Osun state government for the payment of
rent.

The FGN followed suit in 2017, 2018 and 2020 when it issued N100 billion, N100 billion and N162 billion sovereign
Sukuk (Ijarah) respectively in those years to finance the rehabilitation of key roads across Nigeria. Since the inception of issuing the sovereign Sukuk in 2017, the FGN has raised N362.57 billion for the rehabilitation and construction of roads in the country. The third sovereign Sukuk of N162 billion in 2020, which was oversubscribed to the tune of N669.124 billion, was issued to finance 44 economic road projects in Nigeria. Structured as an Ijarah, the ownership of the roads upon completion will be transferred to a trustee, usually an SPV, to hold on behalf of the certificate holders. The SPV-trustee will thereafter lease the roads to the FGN in return for rents which will be the income for the certificate holders. Upon maturity date, the FGN will purchase the roads.

While the sovereign Sukuk issued by the FGN is structured as an Ijarah, the arrangement in essence combines Sukuk Istinah and Sukuk Ijarah. The Istinah element is the capital-intensive project, such as the roads, to be delivered in the future and the Ijarah element is the advance rental paid prior to delivery and actual sale proceeds following delivery of the project. This is a fair representation of the structure adopted by the FGN in the issuance of its sovereign Sukuk
Ijarah for the construction and rehabilitation of roads.

The current arrangement may be challenging since it usually involves projects that do not directly generate revenue for the FGN. For example, most current road projects by the FGN do not have tolls, from which revenue may be
generated. As such, the FGN, the Originator of the Sukuk, solely bears responsibility for paying rental proceeds to investors. This serves as a pointer to the challenges faced in Nigeria’s approach to debt financing for projects as most projects financed may not be fiscally sustainable. Part of the recommended solution to this involves the FGN creating revenue policies such as tolls, infrastructure tax, among others.

Conclusion

The FGN appears to have prioritised investing the proceeds of Sukuk in the rehabilitation of roads in Nigeria, which is arguably an important physical asset for economic development. Following the oversubscription of the third sovereign Sukuk to the level of 446%, the Debt Management Office (DMO) mentioned, in a press release, its plan to issue the fourth sovereign Sukuk of N200 billion to N250 billion to finance critical roads across the country. This trend can be interpreted to mean that not only will the FGN finance infrastructure projects, but also create an avenue for more people to participate in investments into government-issued bonds thus deepening financial inclusion.

On a final note, in addition to making policies that allow infrastructure projects financed by Sukuk to generate revenue, there is a need to create a Shariah framework for Sukuk Bond issuance in Nigeria. The existing Sukuk framework in Nigeria is modelled after the conventional bond system, which is not optimally designed based on Shariah principles.
Sukuk has shown its massive potential in the global finance market and as Nigeria opens up to its possibilities, there is a growing need to improve on the existing framework in order to access the untapped benefits for infrastructure development in Nigeria.

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