Sukuk are instruments or certificates which represent an underlying ownership interest in an asset. While a number of mechanisms can be employed to structure a Sukuk transaction from a Shariah perspective, a Sukuk structure typically involves the acquisition of assets from the entity seeking to raise financing (the originator) by a limited recourse, bankruptcy-remote, SPV established in a tax neutral off shore jurisdiction. The SPV will fund itself by the issue of Sukuk instruments and then use the proceeds raised to pay the originator for those assets with investors receiving an undivided interest in the underlying pool of assets. The Cayman Islands are, unquestionably, the off shore jurisdiction of choice for SPVs on Sukuk structures originating in the Middle East and CIARAN BOHNACKER finds out why.

The prevalence of Cayman SPVs in Sukuk structures stems from a number of factors:

  • Trust regime in the Cayman Islands

Where an SPV is used, the originator will generally not wish to include the SPV as an asset on their balance sheet and, in the multitude of techniques employed to structure a Sukuk, Shariah scholars typically require the originator and the SPV to deal at arm's length. This separation is achieved by having the shares in the SPV wholly-owned by an off shore trust.

The Cayman Islands recognize the concept of a trust and has a robust trust legislation. It also has a wealth of quality and experienced professional service providers who are able to act as independent share trustees and provide independent directors to the SPV to facilitate an 'off balance sheet' orphan structure. Stringent legal requirements are imposed on trust companies which off er trust services, both in terms of their obtaining the necessary license to do so and in terms of ongoing monitoring. Accordingly, those involved in establishing Cayman trust structures can expect that the trustee will properly carry out its role and that, in the unlikely event any issues arise with the trust company itself, there will be an appropriate regulatory framework in place to deal with this.

Furthermore, the SPV will typically also declare a trust over the funds raised through a Sukuk issuance and the underlying assets transferred to the SPV by the originator. The SPV consequently holds such assets on trust, and begins acting as trustee for the investors as the holders of the Sukuk instruments.

The Cayman Islands have been at the forefront of developments in off shore trust legislation to encourage the Islamic finance industry to transact business there and have specifically amended its trust regime to ensure that the SPV (as trustee) on Sukuk transactions is not considered to be conducting 'trust business' and therefore exempt from any onerous trust license requirements, increased regulation, administration and costs. Additionally, in circumstances where the Sukuk instruments are redeemable at the option of the investors, it was arguable that the issuer could be considered a mutual fund and be regulated as such under the Mutual Funds Law (as amended) of the Cayman Islands. Again, sensitive to the growth of the Sukuk market and the commercial reality of Sukuk structures, Cayman legislative amendments now mean that the issuance of Sukuk instruments that comply with the definition of 'alternative financial instruments' falls outside the scope of the Mutual Funds Law (as amended) of the Cayman Islands.

  • Absence of tax

The Cayman Islands are tax neutral. There are no income, capital gains, corporation or withholding taxes. It is also possible for Cayman SPVs to register with and apply to the government of the Cayman Islands for a written undertaking that they will remain tax-free for a minimum 20-year period, thereby providing holders of Sukuk instruments with additional comfort.

  • Ease, speed and cost of incorporation

A Cayman SPV can be formed on the day of filing and there are no lengthy regulation or fi ling procedures. Accordingly, from a Cayman perspective, Sukuk transactions can be structured and brought to market very quickly. The cost of forming and maintaining a Cayman SPV is competitive and minimal in the context of Sukuk transactions.

  • Sophisticated off shore center for financial services

The Cayman Islands are widely recognized as one of the most sophisticated off shore centers for financial services in the world resulting in the Cayman Islands enjoying an 'Aa3' sovereign risk rating.

  • Reliable legal system

As a British Overseas Territory, the Cayman Islands have a strong relationship with the UK. The Cayman Islands have its own independent legal system based on English common law. The final appeal from the Cayman Courts is the English Privy Council. Since English law is generally the law of choice for Sukuk transactions, it provides all parties with additional comfort that the Cayman element to the transaction is based on English law.

  • Use of Arabic names

Recognizing the growing importance of the Islamic finance industry and as an indication of the Cayman Islands' commitment thereto, the Cayman Islands Government General Registry has introduced an Arabic language facility to enable companies to register and issue certificates in both English and Arabic.

Originally published in Islamic Finance News

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