1. Sau Ngan Wong, Senior Counsel, Finance and Markets Global Practice
Legal, institutional & policy Foundations for sukuk market Abu dhabi, UAE 19 April 2015
Sau Ngan Wong, Senior Counsel,
Finance and Markets Global Practice
The World Bank Group

2. Agenda - Legal considerations - Shariah considerations - Policy considerations - Institutional considerations - Structuring considerations - Tax considerations - Preconditions to market & industry readiness

3. Legal considerations
Risks of uncertainty in enforcement of Sukuk agreements
Example in UK court decision of Beximco ruled that clause in Sukuk documentation providing for the governing law in Murahabah agreements to be Shariah is not binding as the governing law is UK law
This is because England is a party to Rome Convention which provides for the choice of law of a country but not the choice of law of a non-national system of law, such as Shariah law
Tamweel PJSC case where ‘asset-based” and “asset-backed” Sukuk were issued
For asset-backed Sukuk, freehold titles to properties were transferred to Sukuk holders along with ijarah cash flows with legal title vesting in names of investors
Upon insolvency of Tamweek, only holders of these Sukuk continue to receive payment as compared
PARTIES WHO WISH TO APPLY SHARIAH LAW TO CONTRACTS MUST CHOOSE A JURISDICTION THAT WILL APPLY SUCH LAW

4. Legal considerations contd.
Most Sukuk transactions issued to date while deemed to be Shariah-compliant are more similar to conventional unsecured bond
Risks that Sukuk that do not conform to AAOIFI criteria can undermine Sukuk holders’ interests in event of default
Example of East Cameron Partners (ECP) Sukuk default where Sukuk holders argue in the court that they own a portion of the ECP’s oil assets. ECP argued that there was no real transfer of ownership of royalties into the Special Purpose Vehicle. US Bankruptcy court upheld terms of Sukuk based on investors’ reliance on characterization of “transfer of royalty interests”

5. Legal considerations contd.
AAOIFI recommendations for Sukuk may not be easy to put into effect due to legal restrictions that may be imposed in some jurisdictions
Some investors may not wish to undertake true asset risk with ownership transfer if AAOIFI criteria are met for Sukuk structures
E.g. Restrictions governing the transfer of state assets to third parties in Indonesia –
State assets for government operational activities cannot be transferred to third parties and certain state assets may not be transferred to third parties without the prior approval of the Indonesian Legislature and sale of state assets may only be done through public auction
No concept of beneficiary ownership
Indonesia introduced the State Sukuk Law which allows for the transfer of rights attached to certain assets without having to transfer the legal title of the assets.

6. Legal considerations contd.
Company laws
Usually provide definitions of shares, stock and bonds and some regulate offerings of shares and bonds
Securities laws
How does the law treat Sukuk product? Is it a security, bond or collective investment scheme?
Registration and filing
Is there a distinction between public offering and private placement or concept of exempt market for purposes of compliance with registration and filing?
Other considerations: civil and commercial laws
Legal and Regulatory Treatment
Status of new Sukuk law?
Can we adopt the existing laws in place to issue an Islamic version of sovereign or corporate bonds?

7. Shariah considerations contd.
AAOIFI gives 6 recommendations on proper Sukuk structures:
Must be owned by Sukuk holders together with rights & obligations & ownership of assets must be transferred to Sukuk holders
Must not represent receivables or debt
Manager of Sukuk must not offer loans to Sukuk holders when actual earnings fall short of expected earnings
No prior agreement to repurchase assets from Sukuk holders at nominal value when Sukuk are extinguished
Lessee in Ijarah transaction may purchase leased assets at nominal value when Sukuk are extinguished

8. Shariah considerations contd.
The laws of many jurisdictions are unclear and untested on the regulatory treatment of Shariah compliant structures -
Most Islamic markets are not governed by Shariah, but are subject to a local version of civil code not particularly supportive of capital markets, especially in the areas of trust law and SPV structures
Hence, specific amendments in most markets still need to be made to local civil code, trust law, banking or securities regulations

9. Policy considerations
An acceptable and a successfully placed Shariah-compliant structure needs to have the following elements:
Legal Validity - most transactions documents are governed by English law except for documents that deal with local assets as a form of security or in sale and leaseback (Ijara) arrangements
Wide Shariah acceptance – however, lack of uniformity of views between Shariah scholars means that it may not be possible to replicate a Shariah structure everywhere

10. Policy considerations contd.
Accounting treatment – IFRS debt-like treatment have been achieved for Shariah-compliant financing instruments
Relationship with Conventional Financing
Inter-creditor and priority issues
Security structures (what happens if underlying security structure not recognized by Shariah, e.g. a floating charge)
Sharing of enforcement proceeds (particularly, treatment of interest recovered)

11. Policy considerations contd.
Assets
Nature of the available assets - are they a pool of assets, secured by fixed or floating charges etc.?
Can Governments use assets such as land, banks, schools, hospitals for the Sukuk ?
Will there be a true sale of the assets?
Corporate Vehicle
What local company structures are available? Will these company vehicles be suitable for the issuance of a Sukuk?
Is the issuer of the Sukuk able to utilize offshore ‘Special Purpose Vehicles’ for the Sukuk structure?
Are there any foreign ownership restrictions?

12. Policy considerations contd.
Choice of Listing Venue and Credit Rating
Is the stock market capable of listing a Sukuk?
Is dual listing considered (e.g. LSE or Nasdaq Dubai)?
Effect of credit rating on the Sukuk
Use of Proceeds for sovereign Sukuk
Is the Sukuk aimed as being used for a specific purpose/project or for general budgetary purposes?
Need to develop the project if the Sukuk is for a specific project. What happens in the event that the project does not complete?
Is credit enforcement in the form of government guarantee contemplated?

13. Institutional considerations
Secondary market
Is a secondary market for trading of the Sukuk certificates ? In certain developing markets, Sukuk holders may be unable to trade the Sukuk certificates.
Absence of a secondary market means that an investor must be prepared to hold onto the Sukuk certificates for an indefinite period of time or until maturity
The government will need to develop (or support the use of an) infrastructure required for the secondary market including developing payment and settlement procedure systems for investors to use
Which exchange could the source be listed on as this would impact on marketing the Sukuk and on secondary trading taking place?

14. Structuring considerations
Sovereign Assets
Does the Government have sufficient tangible assets to support the issuance of a Sukuk?
Nature of assets: land banks, educational institutions, hospitals and commodities
Any security over those assets?
True Sale?
Corporate Vehicle
Availability of suitable corporate vehicles for the issuance of Sukuk?
Can offshore ‘Special Purpose Vehicles’ be used?
Any foreign ownership restrictions?
Listing and Credit Rating
Is listing required/expected?
Which exchanges can/should be used?
Effect of credit rating on the Sukuk
Use of Proceeds?
Credit Enhancement?

15. Structuring considerations contd.
Sources of Capital
Local, regional or international investors?
Will funding be available from international markets?
Composition of Shariah Board and responsibility for appointment - may need to have mechanisms to ensure quality of Shariah advice?
Availability of secondary market trading and impact on pricing

16. Structuring considerations: Timeline for Sukuk issuance

17. Tax considerations Accounting and Tax treatment
Will there be “double taxation”?
What is the tax treatment regime for Sukuk (if any)?
Any exemptions/special consents?
Tax treatment
Withholding, capital gains/sales tax and stamp duties
There are moves in some non-Islamic countries (most notably in the UK) to give Shariah-compliant structures equivalent tax treatment
e.g. the UK has abolished double stamp duties for Shariah- compliant mortgages and companies can obtain tax breaks for profit payments under Sukuk in the same way as coupon payments under conventional bonds

18. Need for market readiness ...

19. Need for industry readiness …

20. THANK YOU