Sukuk: debt vs. equity, Islamic finance assets grew 2008 to 2009

Reuters has a good article on the debate around sukuk and whether they should be more akin to equity or debt. The article includes an update on the progress of the East Cameron bankruptcy. Sukuk holders may propose a reorganization that would give them an equity interest in the underlying company and their counsel expects that East Cameron will emerge from Chapter 11 bankruptcy early next year. The debate over sukuk is one that has been particularly in the forefront over the past two years following the AAOIFI ruling that prohibited mudaraba and musharaka sukuk from including repurchase agreements to redeem them, as well as by several high profile sukuk defaults.

The debate will continue, but the likely end result will probably be a compromise between the sukuk being debt or equity. They will likely continue to be arranged with fixed or variable payments based on an underlying interest rate, making them more like debt. However, they will also probably include more equity-like features that have been included in some recent sukuk. They will also probably move away from the asset-based structure that transform them into unsecured obligations of the issuer. This means that the asset used in the structuring is transferred to the SPV issuing sukuk with a purchase obligation clause at the maturity or in cases of default that gives investors no claim to the asset, only a claim on the issuer.

In contrast to asset-based sukuk, asset-backed sukuk effect a transfer of the asset to the SPV that gives the sukuk holders legal claim to the asset if there is a bankruptcy of the issuer or default on the sukuk. This was the structure of the East Cameron sukuk and one of the issues tackled by the bankruptcy court was whether the sale of the overriding royalty interest to the SPV was a 'true sale' or whether it was only done to create a financing transaction. The court documents suggest that it is the former, which if finalized would create a significant precedent for future sukuk issues in the U.S. A Reuters Q&A provides a similar overview of sukuk and the East Cameron sukuk in particular. A Factbox shows a few examples of asset-based and asset-backed sukuk. Reuters also provides a brief timeline of developments in the sukuk market.

Reuters also presents the views of two experts, an Islamic finance lawyer Megat Hizaini Hassan and the CEO of a Malaysian ratings firm.

A report by The Banker magazine finds that there are assets of $822 billion in Islamic banks and Islamic windows at conventional banks, up 28.6% from the $639 billion estimated as of 2008. The industry, however, continues to miss growth opportunities because Shari'ah-compliant products are more expensive. At a conference in France, the CEO of Renault Nissan Carlos Ghosn said that company would raise money from Islamic investments if it were more cost competitive.

Other News

• The IFC sukuk could prove to be a significant issue despite its small size because it was listed exclusively in the Gulf and the arranging syndicate included mostly Gulf-based firms.
  
• Thailand continues to consider a sovereign sukuk, although it remains at least two years out because of a lack of regulatory changes needed to facilitate the issue.
  
• The Wall Street Journal wrote an article about the need for more trained professionals in Islamic finance and the growth in the number of business schools which offer programs in Islamic finance.
  
• The Irish newspaper The Independent has two articles about Islamic finance including one about how Ireland is considering changes to laws to attract Islamic finance.