We are on the subject of Sukuk default scenarios and I am explaining all possible events which can be envisaged in the run-up to the Sukuk maturity date and where the originator or obligor may not be able to walk the tightrope and resultantly may put the transaction in jeopardy.

I concluded the last article on the most important aspect of the Sukuk transaction which is the originator’s responsibility to pay the periodic profit or partial redemption (if that was agreed at the outset) or both on time and the risk of its failure to comply with it.

Actually, the list of mishaps drawn up to be made part of the events of default schedule in the financing documentation is largely based on the items found in a conventional bond transaction. Therefore, it is required for the legal counsel drafting any Shariah transaction documents to be mindful of areas not condoned by the Islamic financing principles.

Hence, due consideration should be accorded by the drafters to the red flags raised by the Shariah people be they the staff of the Shariah department of an Islamic financial institution, the Shariah advisors appointed to oversee the transaction or the members of the Shariah board themselves.

In my own experience, I had seen some transaction lawyers taking such Shariah comments as uncalled for or unnecessary and an obstacle in the swift completion of the transaction, necessitating long one-to-one meetings or conference calls to explain each point and the lawyers agreeing to almost all issues and amending the documents accordingly albeit at the cost of precious time.

It will be of interest to readers if I narrate what happened in a large Sukuk transaction I was engaged with from the Shariah side. There was a deadlock on a long list of Shariah issues found in the set of Sukuk documents and it was agreed to call for a meeting with the respected late Dr Hussain Hamed Hassan, the head of the Shariah board, who was himself a JD (juris doctor) from a renowned US university, in addition to having obtained a Master’s degree in Islamic Shariah from Al Azhar University — the best learning seat in the Islamic world. By the way, he had also done a Master’s program in economics from Cairo University.

The meeting was attended by both sets of transaction lawyers, ie the ones representing the investors and the originator. Also, the mandated lead banks, the investing banks and the rating agency personnel were invited. During the course of the marathon meeting, Dr Hussain asked all the attendees to explain their respective position and what is their ultimate demand on the Shariah points they have received.

Dr Hussain patiently heard the lawyers, bankers and rating agency officials and provided a very interesting assessment remark. He said that at the outset, all the parties knew that this will be an Islamic financing Sukuk transaction and not a conventional bond deal.

They all were appointed knowing fully well that they are required to work on it and with the clear understanding that the Sukuk transaction shall require the Shariah board’s approval as a prerequisite. He quipped that both sets of legal counsels have requested for exemption from a good number of issues; on the other hand, the rating agency officials have cited their own reasons for seeking exemption to be able to grant the desirable rating to the transaction and lastly, the investors need exemption from a few but critical Shariah parameters in order to condense the level of investment risk to an acceptable threshold.
By drawing a circle on the paper, Dr Hussain illustrated that the Sukuk transaction commenced with a full circle but a major chunk was removed by giving exemptions to both legal counsels so that they can provide an acceptable legal opinion, another chunk was taken out as the exemption to the rating agency to enable it to grant the investment grade rating and the investor banks too were obliged. All of such accommodation left a very small amount of Shariah element in the circle. He remarked that how will each party justify it to be a different transaction than a conventional bond?

Dr Hussain concluded with the example that if you play football where it is not allowed to touch the ball by hand and try to bring in the laws of cricket where the ball is constantly in the hands of players, it will not be condoned by anyone. Similarly, if the parties are trying to conclude a Sukuk transaction, they should be ready and willing to apply the Shariah principles, rather than the bond strictures.

It was agreed by all participants to accommodate almost all Shariah comments and observations barring a few which were found to be more on the commercial side. The meeting took place at the beginning of the rise of Sukuk and the subsequent transactions saw marked improvement in the documentation to the satisfaction of Shariah scholars. The Sukuk documentation has since reached the status of being a ‘semi-template’ and does not need more than a few weeks for a Sukuk transaction to be rolled out provided all the other aspects are taken care of.

I thought it was important to recount the incident which in fact had set the tone right for the growth of the Islamic capital market with all participants working cohesively and respecting each other’s limitations.

The purpose of this educative series and the article is not to hurt any religious or commercial sentiments either consciously or even unwittingly.

Sohail Zubairi is an Islamic finance specialist and AAOIFI-certified Shariah advisor and auditor. He can be contacted at [email protected]

Next week: Discussion on the events of default in a Sukuk transaction shall continue.