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© Allen & Overy 2013 1 Roger Wedderburn-Day Debt Financing and Sukuk LSE Islamic Finance Seminar Series 30 October 2013
© Allen & Overy 2013 2 Introduction –What is debt financing? –How do bond issues work? –Why is there a bond market? –How is this relevant to sukuk? –How do sukuk work? –What are sukuk? –Interesting features of sukuk –What is the future for sukuk?
© Allen & Overy 2013 3 What is debt financing? –Bank loan –Corporate financing options –Equity –Bank debt –Securities
© Allen & Overy 2013 4 How do bond issues work? –What is a bond? –Significant differences from loans: –Multiple creditors –Diversity in creditors –Tradable
© Allen & Overy 2013 5 Why is there a bond market? –Why issue securities? –Different source of funding (issuer) –More flexible (bank lender) –Hedging (non-bank lenders)
© Allen & Overy 2013 6 How is this relevant to sukuk? –Same reasons: –Alternative source of funding (issuer) –More flexible (bank lender) –Hedging (non-bank lenders)
© Allen & Overy 2013 7 How do sukuk work? –Islamic bonds, but…..
© Allen & Overy 2013 8 How do sukuk work? PAKISTAN INVESTORS US$50 million US$500 million Islamic Republic of Pakistan – Conventional Bond Issuance (2004) Bond
© Allen & Overy 2013 9 How do sukuk work? ISSUER INVESTORS Sukuk US$500 million US$50 million STEP 1 Investors purchase sukuk from Issuer. STEP 2 Issuer purchases Land from Highway Authority for Purchase Price, declares trust and issues sukuk. STEP 3 Issuer leases Land to Pakistan for rental fee. Issuer pays Investors periodic distributions. STEP 4 Pakistan purchases land for Exercise Price. Issuer pays Investors final distribution. Rental (50m) Ijara (Lease) PAKISTAN Exercise Price (500m) Land NATIONAL HIGHWAY AUTHORITY Purchase Price (500m) Land Islamic Republic of Pakistan – Sukuk Al Ijara (2005) US$500 million
© Allen & Overy 2013 10 What are Sukuk? –Trust certificates –Do not pay interest –Returns mimic conventional fixed-income debt securities –Carry a Fatwa signed by Shari’a scholars –Governed by English law not Shari’a
© Allen & Overy 2013 11 What are sukuk? Sharia Scholars –Limited number –Relied on by Sharia institutions –Scholars provide a fatwa –Wide range of views Enforceability –Being bound by Sharia is essentially elective –With exceptions, Sharia is not national law. –Shamil case
© Allen & Overy 2013 12 Sukuk – Interesting features Principal documents SukukConventional bondSubscription AgreementAgency Agreement Sale Agreement Lease Agreement Service Agency Agreement Purchase Undertaking
© Allen & Overy 2013 13 Sukuk – Interesting features –Role of the Trustee –What happens on default?
© Allen & Overy 2013 14 What is the future for sukuk?
© Allen & Overy 2013 15 What is the future for sukuk?
© Allen & Overy 2013 16 What is the future for sukuk? –Islamic issuer or issuer based in Middle East / Asia –To build a new investor base –To benefit from future liquidity as market develops –To complement commitment to Middle East / Asia –Political reasons
© Allen & Overy 2013 17 What is the future for sukuk? –Sovereign sukuk –Middle East credit issues –Sukuk defaults and restructurings –Sharia compliance –Need greater predictability and consistency –Secondary market liquidity –GE sukuk –First sukuk by western multinational –Will others follow? 17
© Allen & Overy 2013 18 Any questions? 18
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