Explanation of the Sukuk program

I had concluded the last article by commenting that whether it is a bond or a Sukuk facility, the capital market system, infrastructure and the process flow for the issuance are neutral, barring minimal variances.

Nevertheless, the paramount difference you need to know between bonds and Sukuk is the way they are structured and documented. While a bond is interest-based clean lending by subscribers, a Sukuk facility is a quasi-equity vehicle where the investors do not lend money on interest but become the pro-rata undivided owners of the underlying asset or investment and derive benefits from the return produced by it.

At this explanatory stage, I do not want to go into the debate of why Sukuk are internationally classified as debt capital market (DCM) instruments, to which I personally do not agree, but I will cover it later on.

Let me explain the neutrality in simple terms and without going into technical jargon through the next step in the issuance of Sukuk. The originator of Sukuk makes a decision at the outset whether it would like to issue a single one-off Sukuk facility, or has the intention to return to the market frequently in future, owing to its expanding business needs.

If the originator intends to return to the market repeatedly, it would opt for a Sukuk program in which it declares the total amount needed by it over a period of time, within which it would be expected to make a series of Sukuk issuances. The aggregate amount of all issuances must not exceed the originally declared program amount, save if the program amount has subsequently been reduced or increased. This equally applies to the issuance of a bond program.

Again, the market practice for a bond or a Sukuk program is neutral in that the program is launched through a base prospectus — also known as the offering circular.

In some jurisdictions, the state puts a limit to the maximum amount an entity is allowed to raise through the program and the time frame within which the program must be exhausted. For example, in Malaysia, the Securities Commission has set a maximum period of seven years for a Sukuk program within which it must be consumed.

It means within this period, the originator must complete the issuance of the last Sukuk under the program. It does not mean that the maturity of all Sukuk issued under the program must end by the 7th year from the launch date of the program. What it means is that if the maturity of the last Sukuk is five years, it can still be issued in the 7th year, ie within the validity of the program. If the originator fails to fully capitalize the program amount within the validity period, the program shall elapse.

Once the originator has finalized the appointment of the bank(s) and signed the mandate letter, the selection of a legal counsel as the transaction lawyer is carried out. This process is undertaken by the mandated bank or by the originator itself through a bidding process or direct selection based on the past satisfactory experience by the originator, or the bank. This step is also common in the Sukuk and bond issuance process.

It is possible that there are two law firms appointed for the same transaction, one representing the originator and the other to safeguard investors’ interest. Or, one law firm is considered sufficient to look after both sides.

Here, it is important to understand that for a Sukuk transaction, one law firm should ideally be considered enough to protect the interest of investors as well as the originator due to the nature of the Islamic principles found in the Shariah nominate contract selected for the Sukuk issuance.
As I have explained in this series from time to time, the Shariah strictures in the sale and investment contracts have remained unchanged since 7th century AD. These contracts distribute the odds fairly between the two parties, such that even slightly tilting the balance toward one party shall render the transaction void and the Shariah board will not be able to approve the Sukuk issuance.

I had personally observed in many transactions that the solicitors drafting the Sukuk documentation try to borrow the approach applied in the documentation of a bond and introduce provisions alien to Shariah moralities. Perhaps, the need for such efforts arises due to a good number of subscribers to a Sukuk transaction are conventional institutional investors, such as pension funds, hedge funds, conventional banks and others, which are comfortable with conventionally drawn provisions aimed at eliminating investment risks.

A close scrutiny of the Sukuk documentation may thwart any attempt to dilute the glorious Shariah principles. In fact, I had personally collected a good number of the conventional provision samples while reviewing Sukuk and Islamic syndication documents, and was able to either provide alternate Shariah compliant wording or get them removed under the watchful eyes of Shariah board scholars.

Interestingly, I had also used the collection of such provisions to develop an advanced level training course for the legal fraternity where each such provision was discussed as to why it is Shariah repugnant and the alternate wording explained. The course, delivered through IFN’s platform in various jurisdictions, had proved highly beneficial to the corporate lawyers since it helped to remove many misperceptions and enabled them to prepare the Sukuk and Islamic syndication documents with low/no Shariah issues.

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.