Academic journal article International Review of Management and Business Research

Risk in Funding Infrastructure Projects through Sukuk or Islamic Bonds

Academic journal article International Review of Management and Business Research

Risk in Funding Infrastructure Projects through Sukuk or Islamic Bonds

Article excerpt

Introduction

The stakehoders of a project involve its' owners or joint venture partner, any consultant, the client and the financier of projects have to mitigate the risk to ensure project is implemented successfully. There are numerous studies on risk management of infrastructure projects (Gilmour, et al., 2010; Fitcher et al., 2010) and risk management of ICM (Gazi & Syed, 2101). However, there are limited studies, which analyze the funding of infrastructure projects through the Islamic Capital Market (ICM). This paper provides an overview of risk of issuance of Sukuk to fund infrastructure projects. This type of funding has developed in capital markets over the last 10 years and has become increasingly popular.

Project Financing

Raising funds should be considered as one of the most crucial activities for the development of an infrastructure project. This is especially true at the planning stage. Project owners need to decide which method of financing is to be adopted in order to best suite project requirements. Selecting and subsequently managing the funds appropriately will be a key factor to ensure that the project will be successfully implemented. Conversely, mis-management could expose the project owners and stakeholders to both financial and legal consequences. A proper and comprehensive project funding structure is prerequisite to ensure its successful implementation so as avoid any unnecessary time and cost overruns (Abdul Maulud, 2005). Thus a smooth implementation would provide financial stability in order to ensure expected profitability and returns on investment.

Historically, the preferred form of financing large scale infrastructure projects worldwide is through project financing. Project finance is the long term financing of infrastructure and industrial projects based upon the projected cash flows of the project rather than the balance sheets of the project sponsors (Marco, 2004). Several studies were conducted by researchers, which have proven that project financing is critically important especially for emerging economies. As such there is linkage between infrastructure investment and economic growth (Marco, 2004).

Project financing techniques have become a primary means for financing a broad range of economic units globally. Only recently there are some project financing principles have been applied such as Public-Private Partnerships (PPP) and Private Finance Initiatives (PFI) ( Project finance: meaning, 2011). The application of these techniques has been refined in most industrial categories and with respect to most types of assets. However, project financing is more often than not is more complicated than alternative or conventional financing methods.

Project Financing: Islamic Capital Market (ICM)

Project finance is the most commonly used for funding large scale infrastructure project. Most of these infrastructure projects are financed non-recourse to the sponsoring companies (Camacho, 2005). There are many projects that are financed with a debt to value ratio of as high as 80% and with a project duration as long as 20 to 30 years (Camacho, 2005). The main purpose of engaging in project financing is to transfer and allocate the risk to the several of parties based on the expertise (Camacho, 2005). However, there are differences between the conventional project financing and Islamic financing, primarily from the shari'ah compliance aspect.

The emergence and application of Islamic financing in project funding has emerged as the only alternative to the conventional financing. The main difference between Islamic financing and conventional financing is the way the funds are used in order to finance the project. The sources of fund must comply with the shari'ah guidelines.

Islamic finance is defined as "any finance that is compliant with the principles of Islamic Law ( Shari'ah)" (ACCA, 2010). It is based on two major guidance for muslims, the Holy Quran and the sunnah of Prophet Muhammad (s. …

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