Despite the growth of the Sukuk market, AYMAN H A KHALEQ and BARRY COSGRAVE believe that more creativity around asset classes in terms of soft ware and intellectual property rights is needed to encourage the introduction of Sukuk instruments as a viable option in western and emerging markets.
To many Islamic finance practitioners, the growth in the size of the Sukuk market has not necessarily been accompanied by a deeper level of geographical or asset class diversification. The over-reliance on real estate assets or, for that matter, governmental or quasi-governmental credit enhancements is as prevalent today as it was during the pre-credit crunch era.
This phenomenon can be attributed to a number of factors some of which are driven by the dearth of Islamic finance human resources at top investment banks, investment companies and multinational corporations. In addition, the ease and straightforwardness of seeking to deploy conventional lines of credit or, in some instances, bonds, rendered Islamic finance instruments less relevant in the context of funding projects and businesses in non-Islamic jurisdictions.
However, there have been a number of eff orts, successful and otherwise, to deploy Sukuk in the context of investment in or funding of global businesses. Such efforts include the East Cameron Sukuk in 2006 which were backed overriding royalty interests in two Gulf of Mexico off shore oil concessions, and the sovereign Sukuk issuance by the state of Saxony-Anhalt in 2005 which, whilst utilizing federal land and buildings as the asset under an Ijarah-based Sukuk, was nonetheless a pioneering issuance by a non-Islamic sovereign state. Other notable eff orts include the issuance of Sukuk by GE Capital, the International Finance Corporation and, more recently, Goldman Sachs.
Needless to say, the jury is still out as to whether such efforts have been truly successful or not. One reason behind such uncertainty stems from contrasting views adopted by practitioners in connection with setting the criteria for measuring success. Some take the view that success should be measured by the extent to which the underlying structure complies with Shariah; although such approach is hindered by the fact that Shariah is interpreted diff erently by scholars.
Another is the ability of a structure to withstand default and other types of risks. Yet another approach is to assess whether the structure achieved a high level of acceptance from non-Islamic investors. Of course, many of us adopt the view that success should factor in all of the above criteria, and that ultimately the end result should be our ability, as practitioners, to bring into play a suite of Shariah compliant funding instruments that can be utilized by Islamic and non- Islamic investors regardless of the locale of the relevant asset.
One such example of a Sukuk offering that catered for Islamic and non-Islamic investor while capitalizing on an asset base that has not been utilized in the past to back Sukuk offerings, is the issuance by a German financial services company of Sukuk, through a special purpose issuer vehicle incorporated in Luxembourg using a Dutch Stichting (foundation) structure — a structure first used in the Saxony-Anhalt Sukuk mentioned above. The Stichting structure enabled the issuer to put in place a limited recourse 'orphan' structure which replicates the English law trust concept that is more commonly used with Cayman Islands-based issuers.
The Sukuk were issued in the amount of US$55 million under an Ijarah- based structure involving proprietary soft ware and associated intellectual property rights, developed by the financial services company for use by its institutional Takaful and banking clients. The proceeds of the offering will be utilized to fund commissions factoring — a financing tool used by financial services companies in order to manage income streams — and such financing will be aimed at Shariah compliant factoring wherever possible.
What was interesting about the choice of asset in this particular case is that it is an asset that has not been considered before. Through transparency on the part of the financial services company and flexibility on the part of the Shariah scholars underpinned by independent valuation reports from highly reputable firms to support the issue size of the Sukuk, a successful and ground-breaking transaction was concluded.
More importantly, and as we have seen in the various Sukuk restructurings that the industry witnessed in recent years, the issue of transferring legal title over the underlying assets is of utmost significance. This has led to a certain amount of scepticism from investors who are understandably concerned that where land was the underlying asset of an Ijarah-based structure, the transfer of that land was invalid owing to the fact that such transfer was never registered. The soft ware and associated intellectual property rights used for the Sukuk referenced above was easily transferrable by way of contract and delivery in accordance with industry practice. This is an example of a growth in creativity around asset classes as soft ware falls within the description of so-called 'intangible assets'.
However, such assets are nevertheless certain and income-generating and as such are assets that may be used to underpin other Sukuk structures going forward. The Sukuk industry is still Ijarah-focused but Ijarah has usually only been used for land, buildings and machinery. This new asset class may also help to breathe life into the industry and inspire new entrants to the market.
The Islamic banking industry still has a long way before it achieves the type of global acceptance that better established means of financing have achieved. That said, we have come a long way and recent events, including the Arab Spring, are likely to give more impetus to eff orts by governments and the private sector alike to introduce a new funding stream.
Whilst we are likely to witness most of such efforts in Islamic markets that have not traditionally been active in Islamic banking, such as Egypt, Turkey, Tunisia, Libya and Oman (and the growth in the Sukuk market in Indonesia is testament to the potential that such markets present), more needs to be done to introduce Sukuk instruments as a viable options in western markets (including the US and the European Union) as well as some emerging markets like Brazil, India and Russia.
Recent issuances, including the one by the German financial services company, strike the right chord in that they are Shariah compliant, but address the type of structural issues that a conventional bond issuance by a European corporate would be expected to tackle including as they relate to title, security, tax, accounting and regulatory matters.
What such a transaction also proves, is that the Shariah is flexible and can adapt to a complex proprietary soft ware system as it would to real estate, commodities or other asset classes.
First published in Islamic Finance news Volume 9 Issue 47, November 28, 2012
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