An introduction to Sukuk:(Islamic bonds)

David Simpson, 3VB

An introduction to Sukuk:(Islamic collective investment schemes)

David Simpson, 3VB

An introduction to Sukuk:(collective investment schemes)

David Simpson, 3VB

An introduction to Sukuk:?

David Simpson, 3VB

Definition of sukuk

Definition of sukuk

• Conventional bond

– a pure debt obligation

– tradeable

– no ownership interest

Definition of sukuk

• Non-Shariah compliant

– interest-bearing (riba)

– no underlying assets

Definition of sukuk

Islamic Jurisprudence Council, February 1988: “any combination of assets (or the usufruct of such assets) can be represented in the form of written financial instruments which can be sold at a market price provided that the composition of the group of assets represented by the sukuk consist of a majority of tangible assets.”

Definition of sukuk

Islamic Jurisprudence Council, February 1988: “any combination of assets (or the usufruct of such assets) can be represented in the form of written financial instruments which can be sold at a market price provided that the composition of the group of assets represented by the sukuk consist of a majority of tangible assets.”

Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), May 2003:“Investment Sukuk are certificates of equal value representing undivided shares in ownership of tangible assets, usufruct and services or (in the ownership of) the assets of particular projects or special investment activity”

Sukuk al-Ijara

Originator

SPV incorporated SPV issues sukuk Investors subscribe for sukuk and pay proceeds to SPV Originator sells certain assets to SPV SPV leases assets back to Originator Originator makes rental payments to SPV SPV issues Periodic Distribution Amount to Investors On default:

SPV exercises option to sell assets back to Originator at “Exercise Price” SPV pays Dissolution Amount to Investors

Sukuk al-Ijara

SPVOriginator

SPV incorporated SPV issues sukuk Investors subscribe for sukuk and pay proceeds to SPV Originator sells certain assets to SPV SPV leases assets back to Originator Originator makes rental payments to SPV SPV issues Periodic Distribution Amount to Investors On default:

SPV exercises option to sell assets back to Originator at “Exercise Price” SPV pays Dissolution Amount to Investors

Sukuk al-Ijara

SPVOriginator Investor

SPV incorporated SPV issues sukuk Investors subscribe for sukuk and pay proceeds to SPV Originator sells certain assets to SPV SPV leases assets back to Originator Originator makes rental payments to SPV SPV issues Periodic Distribution Amount to Investors On default:

SPV exercises option to sell assets back to Originator at “Exercise Price” SPV pays Dissolution Amount to Investors

Sukuk al-Ijara

SPVOriginator Investor

SPV incorporated SPV issues sukuk Investors subscribe for sukuk and pay proceeds to SPV Originator sells certain assets to SPV SPV leases assets back to Originator Originator makes rental payments to SPV SPV issues Periodic Distribution Amount to Investors On default:

SPV exercises option to sell assets back to Originator at “Exercise Price” SPV pays Dissolution Amount to Investors

Sukuk al-Ijara

SPVOriginator Investor

SPV incorporated SPV issues sukuk Investors subscribe for sukuk and pay proceeds to SPV Originator sells certain assets to SPV SPV leases assets back to Originator Originator makes rental payments to SPV SPV issues Periodic Distribution Amount to Investors On default:

SPV exercises option to sell assets back to Originator at “Exercise Price” SPV pays Dissolution Amount to Investors

Sukuk al-Ijara

SPVOriginator Investor

SPV incorporated SPV issues sukuk Investors subscribe for sukuk and pay proceeds to SPV Originator sells certain assets to SPV SPV leases assets back to Originator Originator makes rental payments to SPV SPV issues Periodic Distribution Amount to Investors On default:

SPV exercises option to sell assets back to Originator at “Exercise Price” SPV pays Dissolution Amount to Investors

Sukuk al-Ijara

SPVOriginator Investor

SPV incorporated SPV issues sukuk Investors subscribe for sukuk and pay proceeds to SPV Originator sells certain assets to SPV SPV leases assets back to Originator Originator makes rental payments to SPV SPV issues Periodic Distribution Amount to Investors On default:

SPV exercises option to sell assets back to Originator at “Exercise Price” SPV pays Dissolution Amount to Investors

Sukuk al-Ijara

2006

Sukuk al-Ijara

2006

Sukuk al-Ijara

2006

Sukuk al-Ijara

2006

Sukuk al-Ijara

2006

Sukuk al-Ijara

2006

Sukuk al-Ijara

2006

Sukuk al-Ijara

2006

Sukuk al-Ijara

2006

Sukuk al-Ijara

2006

Sukuk al-Ijara

2006

Sukuk al-Ijara

2006

Sukuk al-Mudaraba

Originator

SPV incorporated SPV issues sukuk Investors subscribe for sukuk and pay proceeds to SPV SPV and Originator enter into Mudaraba Agreement: Mudaraba enterprise

SPV contributes principal amount Originator contribute expertise and management skills Agreed profit-sharing ratio

SPV uses profits to pay periodic returns to investors On maturity:

Mudaraba enterprise dissolved SPV calls on Originator to buy back Mudaraba interest at (market) value

Sukuk al-Mudaraba

SPVOriginator

SPV incorporated SPV issues sukuk Investors subscribe for sukuk and pay proceeds to SPV SPV and Originator enter into Mudaraba Agreement: Mudaraba enterprise

SPV contributes principal amount Originator contribute expertise and management skills Agreed profit-sharing ratio

SPV uses profits to pay periodic returns to investors On maturity:

Mudaraba enterprise dissolved SPV calls on Originator to buy back Mudaraba interest at (market) value

Sukuk al-Mudaraba

SPVOriginator Investor

SPV incorporated SPV issues sukuk Investors subscribe for sukuk and pay proceeds to SPV SPV and Originator enter into Mudaraba Agreement: Mudaraba enterprise

SPV contributes principal amount Originator contribute expertise and management skills Agreed profit-sharing ratio

SPV uses profits to pay periodic returns to investors On maturity:

Mudaraba enterprise dissolved SPV calls on Originator to buy back Mudaraba interest at (market) value

Sukuk al-Mudaraba

SPVOriginator Investor

SPV incorporated SPV issues sukuk Investors subscribe for sukuk and pay proceeds to SPV SPV and Originator enter into Mudaraba Agreement: Mudaraba enterprise

SPV contributes principal amount Originator contribute expertise and management skills Agreed profit-sharing ratio

SPV uses profits to pay periodic returns to investors On maturity:

Mudaraba enterprise dissolved SPV calls on Originator to buy back Mudaraba interest at (market) value

Sukuk al-Mudaraba

SPVOriginator Investor

SPV incorporated SPV issues sukuk Investors subscribe for sukuk and pay proceeds to SPV SPV and Originator enter into Mudaraba Agreement: Mudaraba enterprise

SPV contributes principal amount Originator contribute expertise and management skills Agreed profit-sharing ratio

SPV uses profits to pay periodic returns to investors On maturity:

Mudaraba enterprise dissolved SPV calls on Originator to buy back Mudaraba interest at (market) value

Sukuk al-Mudaraba

SPVOriginator Investor

SPV incorporated SPV issues sukuk Investors subscribe for sukuk and pay proceeds to SPV SPV and Originator enter into Mudaraba Agreement: Mudaraba enterprise

SPV contributes principal amount Originator contribute expertise and management skills Agreed profit-sharing ratio

SPV uses profits to pay periodic returns to investors On maturity:

Mudaraba enterprise dissolved SPV calls on Originator to buy back Mudaraba interest at (market) value

Sukuk al-Mudaraba

SPVOriginator Investor

SPV incorporated SPV issues sukuk Investors subscribe for sukuk and pay proceeds to SPV SPV and Originator enter into Mudaraba Agreement: Mudaraba enterprise

SPV contributes principal amount Originator contribute expertise and management skills Agreed profit-sharing ratio

SPV uses profits to pay periodic returns to investors On maturity:

Mudaraba enterprise dissolved SPV calls on Originator to buy back Mudaraba interest at (market) value

Sukuk al-Mudaraba

2007

Sukuk al-Mudaraba

2007

Sukuk al-Mudaraba

2007

Sukuk al-Mudaraba

2007

Sukuk al-Mudaraba

2007

Sukuk al-Mudaraba

2007

AAOIFI Statement, February 2008

AAOIFI Statement, February 2008• It is not permissible for the Manager of Sukuk to undertake to

offer loans to Sukuk holders, when actual earnings fall short of expected earnings.

• It is not permissible for the Mudarib to re-purchase the assets from Sukuk holders or from one who holds them, for its nominal value, when the Sukuk are extinguished, at the end of its maturity.

• Shari'ah Supervisory Boards should not limit their role to the issuance of fatwa on the permissibility of the structure of Sukuk.

Regulation of Sukuk

• Bond?• Collective investment scheme?• Other?

Regulation of Sukuk

• Definition of collective investment scheme– Arrangements with respect to property– Sharing of profits or income arising from the acquisition, holding,

management or disposal of the property or sums paid out of such profits or income

– Surrender of day-to-day control– Pooling of contributions and/or management as a whole

• UK: FSMA s.235• QFC: Financial Services Regulations, para 6 of Part 3 of Sch 3• DIFC: Collective Investment Law, Article 15

Regulation of Sukuk

• QREIC Sukuk 2006, QFCRA Waiver

– deleted and replaced every chapter of INAP, PRIN, GENE, COND, INDI, ISFI, AMLR, CTRL, ASET and PIIB

– 9.4.1: “... as far as reasonably practical, ensure that all offer documents or listing documents contain sufficient information as is necessary to enable the prospective investors in the Transaction to make a reasonable evaluation of the offer...”

Regulation of Sukuk

• Collective Investment Rules 2.3.9– Arrangements do not, for the purposes of Article 15 of the Law, amount to a

Collective Investment Fund if the arrangements are arrangements under which the rights or interests of the participants are evidenced by sukuk certificates where the holders of the certificates are entitled to rely on the credit worthiness of:(a) the issuer of the sukuk certificates; or(b) any other Person who has assumed obligations under the sukuk certificates,for obtaining their rights and benefits arising under the certificates.

• DFSA Offered Securities Rules• DIFX Listing Rules (Nasdaq Dubai)

Regulation of Sukuk

• “Alternative Debentures” – s77A, SI 2001/544 (see PERG 2.6.11CG)

The arrangements which grant rights under an alternative debenture arise where:(1) the arrangements provide for a person ('the bond-holder') to pay a sum of money ('the capital') to another

('the bond-issuer');(2) the arrangements identify assets, or a class of assets, which the bond-issuer will acquire for the purpose of

generating income or gains directly or indirectly ('the bond assets');(3) the arrangements specify a period at the end of which they cease to have effect ('the bond term');(4) the bond-issuer undertakes under the arrangements:

(a) to make a repayment of the capital ('the redemption payment') to the bond-holder during or at the end of the bond term (whether or not in instalments); and

(b) to pay to the bond-holder other payments on one or more occasions during or at the end of the bond term (the 'additional payments');

(5) the amount of the additional payments does not exceed an amount which would, at the time at which the bond is issued, be a reasonable commercial return on a loan of capital; and

(6) the arrangements are a security admitted to:(a) an official list; or(b) trading on a regulated market or on a recognised investment exchange.

Further perimeter issues

• The Investment Dar Company KSCC v Blom Developments Bank Sal [2009] EWHC 3545 (Ch)

– Article (5) of TID’s memorandum of association:• The objectives for which the company is established

shall be Sharia compliant. None of the objectives shall be construed and interpreted as permitting the company to practice directly or indirectly any usury or non-Sharia compliant activities.”

Further perimeter issues

• The Investment Dar Company KSCC v Blom Developments Bank Sal [2009] EWHC 3545 (Ch)

– “where one finds, as one does in this master wakala contract, a device to enable what would at least to some eyes appear to be the payment of interest under another guise, that is at least an indirect practice of a non-Sharia compliant activity. I do not think it appropriate for me to go through the expert evidence in detail because I am satisfied that I cannot resolve which expert is correct on this application.” [para 17]

The future of sukuk

• Lessons learnt from early structures• Increased standardisation• Greater use of Al-Ijara

The future of sukuk

The future of sukuk

The future of sukuk

The future of sukuk

Thank You

David Simpson, 3VB