Shariah Compliant Securitisation
Presentation to Derivatives and Structured Products
Working Group
Jonathan Lawrence (London) and Remsen Kinne (San Francisco)
Thursday 4 February 2010
What is Shariah?
 “O you who believe! Stand out firmly for Allah, as
witness to fair dealing, and let not the hatred of
others to you make you swerve towards inequality
and depart from justice.”
Qur’an 5:8
 In the business context, Shariah is a means of
conducting business through a distinct set of rules
designed to facilitate fairness.
 High correlation between Shariah compliant
investing and socially responsible investing
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Where are Shariah rules codified?
 Interpretations of the Qur’an from various Islamic
schools of thought
 Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI)
 The fact remains: Shariah mandates are not always
consistently applied from Scholar to Scholar.
Information is asymmetric, and Shariah Advisers
and lawyers skilled in the area become useful to
work through the counter-intuitive results
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Shariah terms
Halal – that which is permitted or compliant
Haram – that which is not permitted
Riba – charging of interest or unjustified increase
Gharar – the taking of unreasonable risk; preventable
uncertainty
 Maisir – betting; gambling; reliance on chance or
speculation, rather than effort
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Industry prohibitions
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Gambling
Pork production or consumption
Adult Entertainment
Banking and finance
Alcohol production or consumption
Weapons production
Tobacco production or use
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Riba
 The charging of sums for borrowed money (i.e.
interest) is forbidden
 But the pledging of Halal assets, the guarantying of
obligations and the leasing of property under what
we might consider a finance lease (or ijara) is
permissible
 Murabaha is the selling of a commodity at an
agreed upon mark-up, and is used in Shariah as a
fixed income investment substitute.
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Shariah Finance Themes
 Connection to underlying assets
 Commercial risk taking and sharing by all parties
(including financier)
 Entrepreneurship
 Returns linked to actual investment outcomes
 Sharing profit and loss
 Specific credit particpation in identified business
risks
 Satisfaction of commercial and Islamic law
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Islamic securitisation
 Transforms bilateral risk sharing between borrowers
and lenders into market-based refinancing of one or
more underlying Islamic finance transactions
 Scholar verification process: (i) type of assets; and
(ii) transaction structure including credit
enhancement and ownership conveyance
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Conditions
 Real purpose behind fund raising; type of asset
identified and not consumable
 Investor pay-off from profitable ventures only
 Collateral assets must not be debt, cash or haram
 No interest generation
 Investors hold unconditional, unsecured payment
obligation (no guaranteed promissory note)
 Ownership element
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Conditions (continued)
 Investor contribution proceeds not invested in short
term cash instruments or interest bearing debt
 Underlying assets not used for speculative
purposes and low turnover
 Takaful insurance
 Credit enhancement and/or liquidity support in
permissible form
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Sukuk
 Most popular ABS structure within Islamic finance,
legitimised in February 1988
 Financial instruments / trust certificates representing
undivided ownership share in underlying asset or
interest held by issuer
 Most sponsored by sovereign and quasi-sovereign
issuers in Islamic countries
 Right to share in profits and asset realisations
 Bought and sold in secondary market and used in
conjunction with other structures
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Sukuk al Ijara
CERTIFICATE HOLDERS
Issue
proceeds
Return
Sells assets
SELLER
Issues
Sukuk
Leases assets
SPV ISSUER
Purchase price
(issue
proceeds)
LESSEE
Rent
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Sukuk al Musharaka
CERTIFICATE HOLDERS
Issue
proceeds
Return
Issues
Sukuk
ORIGINATOR
SPV ISSUER
Cash
contribution
Share in
profits
and
losses
Share in
profit
and
losses
Contribution in kind (at
least 30%)
VENTURE
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Credit enhancement
 Permitted, providing underlying assets not
recharacterised
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First-loss accounts
Non-interest bearing liquidity facilities
Over-collateralisation
Tranching
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Rating Criteria and Risk
 Same criteria as conventional product
 Lack of same historical data
 Concerns over legal regimes / lack of rules in
jurisdictions in which underlying assets located
 Thinner secondary trading market
 Regulatory risk on failure of Shariah compliance
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Challenges
 Limited enabling legislation
 Restrictions on foreign ownership of assets and
enterprises
 Limited enabling infrastructure e.g. SPVs, trusts
 Reference assets meeting Shariah criteria
 Historically no strong funding / balance sheet
rationale
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East Cameron Gas Sukuk case
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East Cameron Partners (“Originator”)
Musharaka sukuk
July 2006
Fund Originator’s purchase of lender’s net profits
interest in and further development of Louisiana
offshore natural gas properties
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Issuer:
Amount:
Expected return:
Maturity:
Rating:
Distribution:
Listing:
Governing law:
East Cameron Gas Co.(Cayman)
$165.67 million
11.25%
13 years
CCC+
Regulation S/Regulation D
N/A
U.S./Louisiana
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 Securitized asset: Right to oil and gas overriding
royalty interest (“ORRI”)
 Repayment: From proceeds of Originator’s sales to
offtakers (quarterly)
 Offtake split: ~11% Originator/~90% Purchaser
(Issuer’s Louisiana SPV subsidiary)
 Closing reserves: ~$53 million aggregate to Issuer
and Originator reserve accounts
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 True sale of ORRI (RE under Louisiana law) to
Purchaser by Originator
 Over-collateral/projected pre-maturity full payout
from ORRI funding to Purchaser
 Gas offtake contract price collar
 Sukuk secured by assets of Issuer (ORRI and
secured accounts)
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 Key Shariah compliance features
 Lawful underlying asset – oil and gas
 Acquisition of physical asset by Purchaser -- RE
 Risk sharing -- through Issuer/Purchaser funding
agreement
 True commercial value of collar – customary, wellestablished pricing mechanisms
 Fatwa by Shariah advisors
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 Reserve shortfall enforcement event (rating
downgrade to CC)
 Originator filed Chapter 11 October 2008
 U.S. Bankruptcy Court W. D. Louisiana
 True sale ruling
 DIP financing by Sukuk investors
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GE Capital Sukuk case
Sukuk Aircraft Leasing, Inc. (“Servicing Agent”)
Ijara sukuk variation
December 2009
Fund purchase price for Issuer’s purchase of
portfolios of aircraft leases and beneficial ownership
interests in leased aircraft from LLCs wholly-owned
by Servicing Agent (“Originators”)
 Servicing Agent is wholly-owned by General Electric
Capital Corporation (“GE Capital”)
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Issuer:
Amount:
Return:
Maturity:
Rating:
Distribution:
Listing:
GE Capital Sukuk Ltd (Bermuda)
$500 million
3.875%
5 years
AARegulation S
LSE, NASDAQ Dubai, Bursa
Malaysia
 Governing law: England and Wales (except
Guarantee governed by New York
law)
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 Securitized asset: Aircraft leases and beneficial
ownership interests in leased
aircraft
 Repayment 1:
From Sharia compliant lease
payments (semi-annually to
maturity)
 Repayment 2:
Proceeds of Originators’
repurchase of aircraft and leases
(at maturity)
 Closing reserves: $50 million to Issuer reserve
account for maturity/early
termination
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 GE Capital unsecured Guarantee
 Insurance undertaking (Servicing Agent)
 Reserve accounts reverse commodity murabaha
transactions (Issuer/Servicing Agent)
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 Key Shariah compliance features
 Strip non-compliant portion of lease payments –
donate to charity
 No Sukuk holder interest in non-compliant insurance
proceeds – Servicing Agent loss payee
 Risk sharing – Issuer formed as trust, Sukuk
certificates evidence holders trust interests
 Risk sharing – unsecured payments to Sukuk holders
and unsecured guarantee
 No Issuer rights to receive interest – judgment
interest waiver
 Review by Shariah advisors (Citi Islamic Investment
Bank, Goldman Sachs International)
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 “We intend to be regular issuers in the sukuk market
and are heartened by the support we have seen in
this first transaction.”
 quote attributed to GE senior vice president and
treasurer
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Shariah finance challenges
 Scholars and schools of thought
 Lack of standardisation / certainty
 Often unrated, rating agencies require government
guarantees
 Transaction costs
 Asset ownership by financier involves potential
liability e.g. environmental, warranty claims
 Insurance / takaful
 Tax treatment
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Islamic securitisation
 Conclusion
 Any questions?
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Further resources
 www.aaoifi.com Accounting and Auditing Organization
for Islamic Financial Institutions
 www.islamic-finance.com
 www.securities.com/ifis Islamic Financial Information
Services (subscription required)
 www.shariahcap.com Shariah Capital
 www.sii.org.uk/web5/infopool.nsf/html/qintifq Securities
& Investment Institute: Islamic Finance Qualification
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Disclaimer
This webinar and these slides are for informational
purposes only and do not contain or convey legal
advice. The information herein should not be used
or relied upon in regard to any particular facts or
circumstances without first consulting with a lawyer.
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