One of the privileges of practising law in an area of finance that is still emerging is the opportunity to work on new and often very novel transactions. Our appointment to advise the government of the Sultanate of Oman on the country’s inaugural sovereign Sukuk was an opportunity the capital markets team in Linklaters’s Dubai office were delighted to accept. This role followed on from our earlier work advising Her Majesty’s Treasury in the UK on the first sovereign Sukuk to be issued by the government of a non-Muslim majority country. In this article, NEIL D MILLER and JONATHAN FRIED discuss several aspects of the Omani sovereign Sukuk transaction, with a view to drawing some lessons that may help other countries contemplating a similar journey.
As many readers will appreciate, Oman was the last of the GCC countries to formally permit financial institutions to offer Islamic financial and banking services in its jurisdiction when in May 2011 Sultan Qaboos permitted the establishment of standalone Islamic banks and ‘Islamic windows’ of conventional banks. The Central Bank of Oman followed up by releasing the comprehensive Islamic Banking and Regulatory Framework in December 2012 and before the end of 2013, two fully-fledged Islamic banks – Bank Nizwa and Alizz – had commenced operations.
2013 continued to be a busy year as several of the Omani conventional banks launched their Islamic windows, the Muscat Securities Market launched a Shariah compliant Index, Takaful Oman Insurance completed its OMR23 million (US$59.54 million) IPO and Tilal Development Company issued the first corporate Sukuk Ijarah, among various other developments.
The Oman government quickly concluded that the momentum of growth in the nascent Omani Islamic financial services industry would be supported by the issue of a sovereign Sukuk and the plan to do so was announced in 2014.
The procurement process for appointing a legal counsel began in December 2014 and Linklaters was approached to offer proposals for advising the government of Oman or the issue manager and principal financial advisors (IMFA) respectively. The final selection decision and our appointment as the international legal counsel to the government was confirmed on the 15th January 2015 and we would work alongside the local counsel Trowers & Hamlins. The IMFA team would be represented by Allen & Overy and Al Busaidy, Mansoor Jamal & Co.
Although there was a desire to expedite the issuance, the Sukuk eventually came to market on the 3rd November 2015. The path from inception to launch was an interesting one for all of the participants involved in the process. In certain respects, it operated as a case study in how to achieve this type of product innovation in a country just starting its voyage into the Islamic financial services industry.
Sukuk are complex financial instruments that sit at the top of the pyramid of Islamic financial products. Every Sukuk facility involves two intimately connected elements and this means they are really ‘two deals in one’. The first element goes to the heart of the Shariah credibility of the arrangement and concerns the assets which need to be identified to underpin and support the issuance. The second element concerns the offering to investors, when a prospectus is issued to qualified investors. As sophisticated securities instruments, the basis on which Sukuk can be issued is a matter for oversight by the authorities responsible for regulating the capital markets, so clear regulation and a good working relationship with the regulator is important to enable this type of transaction.
Asset considerations
The vast majority of sovereign Sukuk (especially inaugural issuances) adopt the Sukuk Ijarah form. The main reasons for this include: ease of comprehension; clarity around the Shariah compliant character of the asset (which often comprises real estate) and the (relative) simplicity in documenting a sale and leaseback transaction. In this respect, the Oman Sukuk was no different. The government identified a parcel of land in the Duqm region and what made this transaction slightly more challenging was that the government needed the flexibility to be able to deal with the land as the Duqm region is developed. As a result, instead of identifying a portion of land that was to be immutable during the tenor of the Sukuk, a co-ownership interest of 24.22% was granted in a larger parcel of land. This means that as the government’s plans for the land evolve, it has been able to retain the flexibility to allocate specific areas of the land to projects without encumbering the rights of certificate holders under the Sukuk.
SPV
Virtually all Sukuk require the establishment of a legal entity that will operate as the issuer. In Sukuk Ijarah, the SPV receives Sukuk proceeds from the certificate holders and uses the money to acquire the assets which it then leases to the obligor, generating a rental stream. In many Sukuk, the SPV will be an offshore entity domiciled in a jurisdiction such as the Cayman Islands. In most sovereign transactions, the government will have political, strategic and security concerns about using an offshore entity and will usually require that a 100% wholly-owned domestic entity holds the assets. This is fine in those jurisdictions where the existing legal regime provides for SPVs to be established quickly, efficiently and at minimal cost.
In the case of Oman, the only legal form available was to establish the issuer as a limited liability company under applicable regulations. Unfortunately, the process involved in doing that was lengthy and probably contributed most toward the longer-than-planned period before issuance. It illustrates an area where jurisdictions wishing to use Sukuk should consider creating legislation and the enabling administrative procedures that facilitate the prompt and competitive establishment of the legal vehicles needed.
Summary of terms and conditions |
|
Issuer |
|
Obligor |
|
Size of issue |
OMR250 million (US$647.1 million) |
Mode of issue |
Sukuk certificates of OMR100 (US$258.84) each |
Purpose |
Raising of general capital for the government for its projects |
Tenor |
Five years |
Profit rate |
3.5% |
Payment |
Biannual |
Currency |
Omani riyal |
Maturity date |
3rd November 2020 |
Lead managers and principal advisors |
• Meethaq Islamic Banking and Standard • Chartered Bank ( as joint finance advisors and joint lead managers) |
Bookrunner |
|
Governing law |
Oman |
Legal advisors |
Allen & Overy and Al Busaidy, Mansoor Jamal (for the issue manager and the joint lead managers) Linklaters and Trowers & Hamlins (for the issuer and the Omani government) |
Listing |
|
Underlying assets |
Land |
Rating |
‘A1’ (Moody’s) |
Shariah advisors |
Shariah Supervisory Boards of Meethaq Islamic Banking Group and Standard Chartered |
Structure |
|
Tradability |
Tradable on third market of the Muscat Securities Market |
Investor breakdown |
Regional GCC investors only |
Face value/minimum investment |
Each certificate has a face value of OMR100 and minimum investment is OMR500,000 (US$1.29 million) |
Trust versus agency
As Sukuk have evolved, the most common method whereby a sufficient (ie from a Shariah perspective) proprietary interest in the underlying assets is vested in the certificate holders has been to use the English legal tool of a common law trust (under which the trustee holds the assets for the benefit of the certificate holders). In those Muslim jurisdictions that have tended to adopt a civil code approach when creating secular laws, the trust does not exist as it is not an instrument generally recognized in civil legal systems. At first blush, this seems to constitute an insurmountable problem and is one that several Muslim countries have resolved in different ways. Some jurisdictions have introduced the concept of financial trusts by passing trust regulations.
In other jurisdictions, agency-based arrangements have been used instead (eg Saudi Arabia). The latter approach was adopted in Oman whereby the issuer was constituted the agent of the certificate holders and instead of a declaration of trust being a key constitutive document of the Sukuk, a declaration of agency was used in the alternative. As a matter of English law, it may be arguable that a trust-based approach offers a slightly more robust approach and therefore better protection to investors; however, in jurisdictions where trusts are not recognized, the issuer is an onshore vehicle and the transaction is largely domestic or intra-regional (as was the case with the Oman sovereign Sukuk), there is little to be gained by seeking to impose a trust–based arrangement. In any future international offerings, it may be necessary for the local counsel in Oman to consider a trust-based structure.
Securities regulations
One of the most interesting, and at times challenging, aspects of the transaction concerned the regulatory environment under which the deal was executed. The Capital Market Authority (CMA) is responsible for the regulation of the capital markets in Oman. A Capital Market Law exists in Oman but the law does not deal with Sukuk and arguably is more focused on equity capital markets than debt capital markets. Also in existence during the period prior to the issuance of the Sukuk was a draft Sukuk Regulation (the Sukuk Regulation). The Sukuk Regulation was not brought into force by the time of issuance and has not yet come into force, although it is expected that it may do so at some point in the near future.
The government’s legal advisors and the legal advisors to the IMFA worked closely with the CMA throughout the Sukuk process and the relationship was always cordial and constructive. However, there was an unavoidable state of uncertainty about precisely what regulatory requirements had to be observed and while the advisors were directed by the CMA toward the Sukuk Regulation for guidance, the fact it remained in a draft form made the task of the local counsel difficult. The issue of whether the issuer should be constituted as a trustee or an agent (discussed previously) was an example of one area where the draft Sukuk Regulation could not be observed. The Sukuk Regulation contains provisions that, if and when they do come into full legal effect, may remedy some of the uncertainties encountered during the transaction. For example:
- SPVs: Part III of the Sukuk Regulation comprises several chapters that describe an arrangement for establishing an SPV to perform the role of issuer under Sukuk. It is to be hoped that a specific regime managed under the licencing auspices of the CMA will enable SPVs to be established quickly and efficiently in the case of future Sukuk.
- Financial trusts: Part IV of the Sukuk Regulation comprises several chapters that set out a regime for the creation and management of financial trusts for the benefit of certificate holders. Among other things, it provides that a financial trust will only come into force when it has been registered on the ‘Register of Financial Trusts’ to be maintained by the CMA.
It is to be hoped that the draft Sukuk Regulation will be further reviewed in light of the knowledge gained from the experience of undertaking the first sovereign issue and in due course will provide a clear regulatory framework for future Sukuk issuances in Oman whether sovereign or corporate.
One of the fascinating takeaways from this transaction was that even when no specific regulations for Sukuk issuance are in force, if there is the necessary political will and a willingness on the part of the relevant regulatory authorities and other stakeholders in the transaction to cooperate, it is still possible to make an issue happen. However, in the medium term, and particularly if international investors are to be attracted to future issuances in Oman, it will be necessary to have more certainty around procedures and regulation so the promulgation of legislation is to be encouraged.
Neil D Miller is the global head of Islamic finance and Jonathan Fried is a partner in capital markets at Linklaters. They can be reached at [email protected] and [email protected] respectively.