Difference between the originator and issuer of Sukuk

We are on the subject of the processes and documentation for the issuance of Sukuk and in the last article I had explained the neutrality of most of the processes in issuing bonds or Sukuk. The issuance of Sukuk has to follow the beaten track of bonds simply because bonds have been there for donkey’s years whereas Sukuk are still a baby of the global capital market.

I am going to skip the mundane steps which are more or less implied such as verifying the originator’s legal capacity to seek funding through the issuance of Sukuk, the resolution of the board of directors, the ability to provide securities and collaterals, or signing a negative pledge or deciding the form of security to be definitive or global, or deciding on the jurisdiction of the issuer entity, the listing bourse or bourses in the case of dual listing, etc.

At this juncture, it is important to clarify that the originator and the issuer are two different entities. It is incorrect to call the originator as the issuer of the Sukuk. The originator is the entity needing funds, which is also called the borrower in the case of bond issuance but for Sukuk, an alternate term ‘obligor’ is used since there is no lending or borrowing of money in Sukuk, whereas the ‘issuer’ is the special purpose and bankruptcy-remote shell company (SPC) which issues the Sukuk to investors and represents them in dealing with the originator/obligor.

Again, the SPC is stereotyped from bond issuance and is adopted, by default, for Sukuk issuance too. Let me clarify that it is not a must from a Shariah standpoint to use an SPC for Sukuk, since the originator/obligor can directly sell the certificates to investors against cash payment.
However, given that a considerable number of buyers of Sukuk are still the conventional institutional investors, the SPC route is embraced for their satisfaction and comfort.

The bankruptcy remoteness of the SPC is defined from the fact that this entity is brought to life only for one transaction and has neither entered into any other transaction in the past nor is authorized to do so in future and that it will be put to rest upon completion of the transaction with the redemption of the Sukuk amount with profit (or loss) to investors.

Hence, there is no question of the SPC to be sued or to apply for liquidation. Also, the use of an SPC from one of the established offshore jurisdictions such as Jersey, British Virgin Islands, Cayman Islands, Malta, etc, for a Sukuk or bond issuance provides a tax shield depending on the relevant regulations.

The concept of bankruptcy is analogous to an ongoing concern which may have a number of creditors and debtors and the other assets and liabilities, and remains exposed to be sued for the failure to pay or meet any other commitment as a result of anything adverse from mismanagement or embezzlement to adverse market conditions (such as related to the current coronavirus pandemic), or to apply for relief from creditors by declaring bankruptcy as per the laws of the land it operates in.

Let me now come to the documentation. The first thing that needs to be cleared is the Shariah structure memorandum for the Sukuk. Normally, I have seen the appointed lawyer preparing the structure memorandum but in my opinion, it should ideally be developed by the Shariah advisor under the overall guidance of the Shariah scholars overseeing the Sukuk transaction.

Once, a lawyer tried to explain to me that the reason that the Shariah structure memorandum is prepared by lawyers is because it goes into the prospectus which is widely circulated to the market and hence it is important that the legal jargon is used in this document for the sake of consistency. This is fine so long as the document is reviewed by the Shariah scholars and approved with or without seeking changes.
Now that hundreds of Sukuk have come into the market covering all types of structures, be they single or hybrid, the Shariah structure memorandums have also assumed the status of boilerplate or template documents, simply needing to ‘fill in the blanks’.

It is a similar case with the full set of financial, capital market and listing documentation. This has certainly brought the lawyer fee considerably down from the initial days of Sukuk issuance.

Next is the preparation of the prospectus, also called the offering circular. This is another commonality between bonds and Sukuk. A renowned Shariah scholar had termed the Sukuk prospectus as the ‘invitation to invest’ based on facts narrated in it.

This is true, given the magnitude of information a prospectus contains. I will leave the explanation on the contents of a Sukuk prospectus until the next article.

The purpose of this educative series and the article is not to hurt any religious or commercial sentiments either consciously or even unwittingly.

Sohail Zubairi is an Islamic finance specialist and AAOIFI-certified Shariah advisor and auditor. He can be contacted at [email protected]

Next week: Discussion on the process for issuance of Sukuk shall continue.