The Luxembourg Sovereign Sukuk - A Milestone In Islamic Finance

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1. ISLAMIC INVESTMENT THE GRAND DUCHY SYMPHONY THE LUXEMBOURG SOVEREIGN SUKUK , A MILESTONE IN ISLAMIC FINANCE 26 businessislamica.com
2. By : Julien Dif About Julien Dif Julien Dif is a partner in the Geneva and Dubai offices of Bonnard Lawson and heads the firm’s Luxembourg office, which he founded in 2008. He is admitted to the Bar in Geneva and Luxembourg and registered as a foreign lawyer with the Government of Dubai Legal Affairs Department. Specialized in investment funds law, Julien Dif advises wealthy families, banking institutions and asset managers in relation to the creation of their investment vehicles in Luxembourg. Such advice also covers all aspects relating to the distribution and placement of such foreign collective investment schemes in Switzerland as well as in the United Arab Emirates. Julien Dif is a member of the Society of Trust and Estate Practitioners (STEP). He regularly advises his private clients on estate planning issues through the use of well-established vehicles such as, among others, trusts and foundations. He also acts for large banking institutions and trust companies on a variety of Swiss private international and tax law issues. THE LUXEMBOURG SOVEREIGN SUKUK IN QUESTION Last September, Luxembourg has Julien Dif issued Sukuk bonds worth EUR 200 million, representing the first Euro-denominated Islamic financial instrument issued by an EU Member State. Investors of various kinds (central banks, commercial banks and asset managers) from various places (Middle East, North Africa, Europe and Asia) put in orders twice the size of the bonds. Yet this success may seem surprising at first glance for the bonds were denominated in a currency that was losing momentum back then, and the profit rate was not as attractive as some of their counterparts. In the view of subscribers, Luxembourg had as a matter of fact strong arguments to put forward. THE GRAND DUCHY ON THE MAP Luxembourg is only about 60 percent the size of Dubai, bordering France, Germany and Belgium. It hardly hosts 500,000 people and yet it holds several assets that larger countries do not, such as state-of-the-art IT infrastructure or international financial centre. Those resulted in the development of a dynamic financial technology sector. In terms of investment fund centre, Luxembourg ranks second only to the United States worldwide and third with respect to domicile for Islamic investment funds, after Malaysia and SaudiArabia. More than 100 Islamic investment funds have been established there to date. In addition, its regulatory framework covers Shariacompliant structures (e.g. UCITS) and local institutions provide training in Islamic finance. GROWING RANGE OF ISLAMIC FINANCIAL SERVICES There may be a number of reasons for the success of the Luxembourg sovereign Sukuk bonds, not the least of which is that Luxembourg’s involvement in Islamic finance has been actually going on for some time. The first significant step has taken place as soon as in 1978 with the establishment of an Islamic financial institution for the first time in Europe. From this time on, the Grand Duchy kept on strengthening and diversifying ties with Islamic finance. This has been followed by the establishment of the first Sharia compliant insurance company in 1983. Later on, the first corporate Sukuk bonds listed in Europe were listed on the Luxembourg Stock Exchange (2002). Then the Central Bank took it to another level in 2010 by joining the Islamic Financial Services Board, meaning that it now participates in general meetings and other bodies of a major institution that issues standards and guiding principles for the industry. Other Luxembourg entities such as the agency responsible for the financial regulation (CSSF) and the representative body of the investment fund community (ALFI) publish information and guidelines on Islamic finance on a regular basis. In consideration of the above, the issuance of the Sukuk bonds and the success it has achieved were no coincidence. VOL 9 - June 2015 27
3. ISLAMIC INVESTMENT SHORTAGE OF TOP-RATED SECURITIES The pool of Islamic investments has been rising lately and is forecast to continue growing . It is however facing a critical shortage of top-rated securities. One of the reasons is that, as demonstrated in recent defaults from corporate issuers of Sukuk bonds, Islamic finance is not immune to credit crunch. Further, the new Basel III banking rules have set higher standards and, as a result of the lack of foreign currency Islamic securities, Islamic banks struggle to comply with liquidity requirements. Lately Luxembourg took a major step in issuing sovereign Sukuk bonds that received positive responses from investors. Many countries have issued or plan to issue similar Islamic financial instruments to that of Luxembourg: Great Britain launched a few months prior to the Luxembourg issuance its own sovereign Sukuk bonds worth GBP 200 million (although being a EU Member State, Great Britain is not part of the Eurozone); Hong Kong joined the drive and raised about USD 1 billion in local currency. Nevertheless, Great Britain and Hong Kong do not fully match Luxembourg's top credit rating with the “Big Three” agencies. 28 businessislamica.com SUKUK BONDS UNDER SCRUTINY What exactly are those securities that generate increasing attention from investors? “Sukuk” is the Arabic word for “certificates”. This is why it is often used in English as plural. They are Sharia-compliant bonds, i.e. complying with Islamic ethics, which prohibit the charging or paying of interest on money. Islamic finance developed a means of generating revenue through an instrument that is backed by tangible assets, and that shares risks and rewards between investors and financial institutions. The mechanism is the following: the issuer sells assets the ownership of which is divided between the subscribers, then leases the underlying assets back and effects periodic payments to the subscribers. When the Sukuk have matured, the issuer redeems the assets to the subscribers for the purchase value. Regarding the Luxembourg sovereign Sukuk bonds, a bill was adopted prior to their issuance so as to authorise the Government to sell three buildings located in the Country to a State-owned enterprise the sole purpose of which is the lease, sub-lease and buyback thereof at the end of the 5-year term. The Al-Ijara structure (i.e. asset-backed) used here is the most common for Sukuk bonds, although structures based on other Sharia-compliant modes of financing may also be used. The term “bond” may be misleading in that such financial instrument does not fully correspond to the bond mechanism, i.e. a debt obligation where the issuer in most cases has to pay the holders coupons and repay the principal at the maturity date. Sukuk bonds differ from conventional bonds in a number of respects including absence of debt obligation and Sharia-compliant underlying assets only. It is referred to as bonds to the extent only that it is an equivalent thereto. FROM THE SOVEREIGN SUKUK BONDS UNTIL NOW Non content with having successfully issued the sovereign Sukuk bonds, the Grand Duchy has been continuing its way so far. Only a month later, Luxembourg’s Prime Minister, Xavier Bettel, and Finance Minister, Pierre Gramegna, visited the United Arab Emirates. In Abu Dhabi, Pierre Gramegna and his Emirati counterpart, Obaid Humaid Al Tayer, signed a protocol on double taxation and a Memorandum of Understanding on cooperation in the field of Islamic finance as well. During his visit, the Finance Minister also attended the inauguration of the first Luxembourg bank to establish a branch in Dubai (BIL). Later on in Dubai, the Prime Minister gave a keynote speech at the World Islamic Economic Forum. In March 2015, Luxembourg's hereditary couple, Grand Duke Guillaume and Grand Duchess Stephanie, along with a financial delegation led by Finance Minister participated in Dubai and Doha in seminars covering topics such as private banking, investment funds, financial technology and Islamic finance. This clearly demonstrates Luxembourg's commitment to be on the map for Islamic finance in Europe. The Grand Duchy of Luxembourg is now a key player in the field of Islamic finance. WHAT'S NEXT? In summary, Luxembourg was already an ideal domicile for Islamic investment funds. The sovereign Sukuk bonds have provided an unprecedented sovereign Islamic security denominated in Euro with outstanding security, which further strengthens Luxembourg's credentials as global hub for Islamic Finance outside the Islamic world. The next step in this field is expected to be the collaboration with the Abu Dhabi Global Market, a recently established financial free zone that is purported to provide a global platform on investment flows.