Infrastructure Financing through Islamic
Finance in the Islamic Countries
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makes the latter responsible for procuring or manufacturing the project assets. The underlying
EPC contracts are used in implementing the project instead of signing detailed
procurement/construction contracts to avoid contractual complications. The financiers
provide the funding for the development of the project by effecting drawdowns at difference
stages of the construction. Under this structure, the project company becomes responsible for
delivering the project assets and undertakes all the construction and procurement risks. The
contract would also identify the remedies for the financiers in cases where the project
company fails to deliver the project assets on time or at all (Clifford Chance 2013).
The financiers would typically use the ijarah contract to lease the assets to the project
company and earn rental income. However, Islamic financiers would expect returns during the
construction period as is the case in conventional finance. This is enabled by the payment of
advance rentals by the project company by using the concept of a forward lease arrangement
( ijarah mawsufah fil dhimah) before the project is completed. The condition imposed by
Shariah scholars for using advance rentals is that if the project asset is not delivered due to
some reason, then all the rental payments have to be returned to the project company. Once
the project is completed and the asset is transferred to the financiers, the actual rental
payments are made by the project company for the use of the assets.
The financiers, being owners of the project assets, become responsible for its associated rights
and obligations such as risks of loss, environmental liability, etc. To avoid these risks, the
financiers appoints the project company an agent through a service contract under which the
latter deals with ownership related tasks such as carrying out major maintenance and taking
out insurance. Although takaful can be used in some jurisdictions to insure the assets, they
tend to be restrictive and expensive. In some cases, the Shariah scholars have allowed the use
of conventional insurance to protect infrastructure assets.
Most projects using Islamic financing would have purchase and sale undertakings that are
employed in cases such as default to identify termination rights. In case of a default by the
lessee, the financiers would exercise the purchase undertaking that would require the project
company to purchase the assets at a price reflecting the total outstanding amount of the
Islamic tranche. The sale of the assets to the project company through the purchase
undertaking creates a debt in favour of the financiers (Clifford Chance 2013).
If there is a total loss of the asset due to some reason, the lease contract terminates according
to Shariah principles and as a result the purchase undertaking does not have any effect. This
risk is mitigated by the service contract which requires the project company to provide the
financiers with the insurance proceeds that cover the actual value of the assets. The project
company would be liable to pay the financiers any shortfall in the insurance proceeds since it
is required to comply with strict insurance obligations as a service agent.
3.3.4. Islamic Syndication and Co-financing
Since project finance involves large amounts of investments and Islamic financial institutions
are relatively small, Islamic tranches will be a part of multi-sourced financing arrangements
which in many cases will have conventional components. For example, Islamic financial
institutions may be involved in financing the project with other financial institutions such as
conventional banks and multi-lateral development institutions (Clifford Chance 2013; GIFR