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MENAFN - Arab News - 13/06/2011

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(MENAFN - Arab News) Any euphoria about Egypt becoming the latest haven for sukuk origination should be immediately tempered with the reality that Egypt is a country in transition with elections - both parliamentary and presidential - due later this year and that the process of adopting sukuk and tax neutrality legislation will be a drawn out process in a country that hitherto was notorious for its lethargic top down bureaucracy.

This euphoria has perceivedly come because of the initial approval last week by the board of directors of the Egyptian Financial Supervisory Authority (EFSA) of a proposal to amend the Executive Regulation of Capital Market Law No. 95 of 1992 regarding the rules governing issuing and trading in sukuk.

The proposal which deals with "completing the legal framework governing issuing and using sukuk as well as expanding the scope of activities in which sukuk can finance", will be sent out for consultation with the relevant authorities, professional bodies and market players.

The final draft of the legal framework will then be submitted to the board of directors of the EFSA for final approval before being submitted to the government for parliamentary debate, adoption and ratification.

Egyptian legal sources stress that nothing substantial is likely to happen this side of the general election which is scheduled for September 2011.

Other international experts on sukuk were more to the point. "I must admit I was not sure exactly what the document (announcement) represented. It appears to be an 'in principle' approval that indicated a desire to introduce legal and regulatory changes to implement sukuk in Egypt. It also suggests that some sort of consultation process will take place and this is to be commended as the input of market practitioners is needed to make sure that all relevant aspects are addressed," stressed one such expert.

The EFSA announcement, issued on 6 June 2011, though lacking clarity in translation, interestingly does stress the importance of transparency and the level of various disclosures in the sukuk structure and documentation.

According to the EFSA, "the amendments state that the issuance of sukuk shall include all the data of the activity, project or the field which use the revenue of IPO in sukuk as well as all the information related to the mechanism of using the revenue of sukuk and the contracts signed between the issuer and other parties related to issuance process. It shall include all the rights and obligations as well as value of the fees agreed upon. In addition to this, the amendments obliged the issuer or the party managing IPO's revenues to keep independent accounts for the project."

Furthermore, "the IPO of sukuk shall include - in addition to the data stated currently in the Executive Regulation of Capital Market Law No. 95 of 1992 - the date of the decision issued by the company's general assembly to approve the issuance of the securities, the type of security and its revenue, number and date of EFSA's license to offer security in public subscription, conditions for issuing securities, guarantees, net assets of the company, summary of cash flow sources as well as liquidity and profitability ratios."

Neil Miller, Global Head of Islamic Finance at KPMG, the global auditing and advisory firm, is encouraged that the financial regulator in Egypt is contemplating amendments to the legal system that will permit the issuance of sukuk in Egypt.

"An Egyptian sovereign sukuk will be a catalyst to attract capital from other parts of the Muslim ummah into Egypt when most traditional sources of finance are temporarily scarce," he said.

But as a seasoned lawyer for many years previously with Norton Rose, the City-based international law firm, he has structured tens of Islamic financial transactions including several sukuk originations.

In making these changes, he advises, the Egyptian authorities need to ensure that the Shariah, legal, regulatory and tax treatment of the Sukuk are understood and clearly ascertainable by both arrangers, issuers and investors.

One of the lessons to be learnt from experiences in other jurisdictions, he maintains, is that investors require clarity and certainty especially as investors remain very cautious of the risks involved.

As a minimum, maintains Neil Miller, sukuk as currently conducted around the world generally require several legal/regulatory elements to be re-examined and/or put in place.

These include the tax treatment of the underlying Shariah instruments that will be used to generate the cashflow to the Issuer.

This needs to be clarified to avoid duplication. Tax impact on transfers, income and capital gains etc all need to be considered.

Another requirement is the ability to create legal entities to hold sukuk assets.

These are usually special purpose vehicles (SPVs) and it is not clear whether or not this is feasible under the prevailing legal framework in Egypt.

Similarly, the common law trust has tended to be a crucial component of every sukuk deal completed to date. The lack of an onshore trust law is not necessarily insoluble but the ability (or not) of enforcing the rights of the beneficiaries under the trust onshore will need to be assessed.

At the same time, the announcement does seem to focus on the issue of disclosure and transparency in terms of what the 'IPO' (probably a reference to or the Offering Memorandum or PPM etc) should disclose about the underlying business proposition and cashflows. Clearly, the regulatory treatment of these instruments will be important. It may also be desirable for Egyptian Sukuk to be listed to improve marketability and this may also impact the regulatory treatment. This could be done either on the local stock exchange or an international or regional stock exchange such as London Stock Exchange, Luxembourg Stock Exchange or Nasdaq Dubai.

"Egypt is a beacon in the Arab world and can be an engine for the growth of the sukuk market in North Africa. There remains an acute shortage of government issued sukuk paper; so it is likely that the market will respond very favorably to any such issue," says Miller.

While sukuk is seen by a growing number of officials, bankers and corporates as an alternative way of raising government and corporate financing to fund budget activity, expansion, projects and balance sheet activities, including refinancing often more expensive conventional debt, there remains an in-built cynicism about Islamic finance amongst many Egyptian officials and bankers, who were nurtured on the interest (riba) ethic.

Many Egyptian officials and bankers still today scoff at Islamic finance and dismiss it as a ruse masquerading as ethical finance in which interest is disguised as profit.

Many also see no difference between fixed rate interest-based bonds and sukuk.

Such attitudes are not unique to Egypt but are prevalent even amongst many Saudi, Kuwaiti, UAE, Qatari, Bahraini, Pakistani and other bankers.

It reflects the failure of the Islamic banking movement to engage meaningfully with a wider constituency than its narrow parochial comfort zone.

There is no doubt that Egypt is in dire need of inward foreign investment to finance projects and economic development which would start to address some of the issues so often expressed by the demonstrators in Tahrir Square which precipitated the momentum for the so-called Arab Spring.

Sukuk may well be one of many other vehicles to help attract some of much-needed investment.

But the government will have to realize that investors are not simply going to come because they are beguiled by the idealism of the Arab Spring but because there is a business and investment case to investment in Egypt through sukuk.

This would warrant the adoption of a robust requisite legal and regulatory infrastructure for sukuk issuance.


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