Wednesday, January 09, 2013

Egypt finishes draft sukuk laws

The Egyptian Ministry of Finance and Financial Supervisory Authority have finalized laws governing sovereign and corporate sukuk, respectively, although they have not yet been released, and will have to be combined into one law, according to the Daily News Egypt newspaper.

While it would appear at first glance that the Egyptian government, with a large (and growing) budget deficit, would be the sector most in need of the sukuk law, I would argue that it is the corporate sector that needs the law more.  As a result, it will be interesting to see whether the regulations of each will have to remain tied together, as the article suggests, at the risk of delaying both if there are objections to either one. 

With the caveaet that I am not an expert on the current situation in Egypt, I would offer the following thoughts.  First, while the idea of a sovereign sukuk sounds like a good way to finance the budget deficit, it may add costly delay to the financing of the deficit, and as the EGP depreciates and foreign exchange reserves move closer towards exhaustion, the cost of issuing a sukuk in several months versus a conventional bond (or finalizing the agreement with the IMF that would provide much needed funds) may be dramatically higher if investors lose confidence in the government's finances. 

Put another way, assume there is a 20bps discount (purely hypothetical) for Egypt to issue a sukuk, but where they could issue a bond today, it will take 3 months to pass the law and arrange the sukuk (it may take longer than that).  Days ago, Qatar doubled the deposits it holds with the Egyptian Central Bank to $4 billion and provided an extra $500 million as a grant to provide additional foreign exchange reserves while the IMF loan is negotiated, and the central bank is rationing the supply of dollars as the foreign exchange reserves have already fallen by $20 billion.  Even if the cost of a conventional bond today is higher than a hypothetical sukuk, there may be a far greater cost if there is a full blown currency crisis, which would dramatically increase the cost of both bonds and sukuk by the time the government is ready to issue a sukuk. 

Meanwhile, opening the way for corporate sukuk would probably yield few new issues given the turmoil with the currency (by either raising dramatically the cost of local currency issuance to foreign investors, or raising the probability of default for domestically focused companies that issue non-local-currency denominated sukuk).  However, with the prospects for an agreement between the government and the IMF that would (hopefully) bring some stability in the exchange rate, it would behoove the government to get the regulations passed and implemented as soon as possible for corporate sukuk.  When greater stability comes, the companies will then have more options for financing to bridge working capital shortfalls or to expand their businesses, which will increase employment.

Returning to the article, the final section (which relates also to the discussion above of potential delays caused by political argument around the sovereign sukuk that has the potential to delay the corporate sukuk regulations) describes:  
"The jurisprudential studies committee in the Islamic studies congregation affiliated to Al-Azhar has twice opposed a law drafted by the Ministry Of Finance on sovereign sukuk compliant with Islamic Shari’a because it was deemed harmful to the economy and the country’s national security. It was also considered detrimental to the rights of future generations as it would allow the ownership of sukuk by foreigners and would open the door for the manipulation of fixed assets without real regulation."
This is a unique argument that I have not heard before, but Abdel Monem Said, the director of the Cairo-based Al-Ahram Center for Political and Strategic Studies, writing in Asharq Alawsat, explains that it may be based more on an objection to potential foreign ownership of sukuk: 
"Al-Azhar’s objection came in an unexpected way, for it was based on two Islamic rules: firstly, that it is not permitted, according to authorized Islamic schools of thought, to sell public Islamic assets in the form of bonds; and secondly, that foreigners might be able to buy public Egyptian assets of extreme strategic importance, such as the Suez Canal, for which generations of Egyptians sacrificed their lives."
Meanwhile, another writer described the objection as: 
"The [Islamic Research Academy at Al Azhar] mostly objected to the bill based on the potential loss of sovereignty for Egypt. It allows foreigners to own Egyptian land based on the fact that non-Egyptians will be able to purchase government sukuk. Therefore, they will have partial ownership in Egyptian state projects and properties."
From my perspective, these fears are remote since the sovereign sukuk could be structured to be equivalent to an unsecured bond, which would remove any claim from the sukuk holders on the underlying asset.  The typical way this is done would be to use sovereign assets (buildings, land, etc.) as the underlying asset.  These would be sold to an SPV that would pay for the asset using the proceeds of the sukuk sale.  The government would grant a purchase undertaking committing to buy back the assets at maturity or in the case of default.  The SPV would lease back the assets to the government and the lease payments would be passed along to sukuk holders.  At maturity, the government would buy back the asset for its face value (this is, at least for now, still permitted where it is not in mudaraba or musharaka).

This structure replicates an unsecured bond, because it would likely only transfer beneficial ownership (the right to enjoy the economic benefits of the asset), not full legal title to the SPV.  I am not a lawyer, of course, and nor am I an Egyptian (to whom in the end it is up to to decide how to manage the government's assets).  But the argument that the government would be putting the country's sovereign assets at risk doesn't sound like it holds true.  At worst, it would end up functioning too much like a conventional bond where the government is forced to repurchase the sovereign assets at face value even if their value has depreciated. 

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