Debashis Dey, Partner, Clifford Chance LLP. Sukuk Structures, Default and Assets

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1 Debashis Dey, Partner, Clifford Chance LLP Sukuk Structures, Default and Assets

2 Overview Treatment of Assets transferred and Balance Sheet of Obligor Differences from Conventional Bond Structures Role of the Delegate on enforcement Regulatory Reaction to Regional default issues Future Structures res

3 Do Sukuk assets come off the balance sheet of the Obligor? Under IFRS or local GAAP, sukuk assets are not removed from the balance sheet for most international corporates However, for certain financial institutions governed by AAOIFI, sukuk assets may be removed from the balance sheet More applicable to partnership structures (e.g. musharaka) Generally, sukuk is asset-based but not asset-backed, therefore: no true-sale (compare a securitisation) no ring-fencing of the asset from the insolvency estate of the original owner true-sale structures require a transfer of the asset that cannot be unwound by an insolvency proceeding But note, even asset-backed transactions (e.g. securitisations) rarely allow the original owner to remove the asset entirely from its balance sheet

4 What is the accounting treatment for an Obligor for sukuk? SPV issuers are orphan special purpose vehicles Obligors do not typically y consolidate the orphan SPV issuer on their balance sheet in respect of sukuk However, in for example, a sukuk-al-ijara transaction, Obligors will account for their contingent liabilities under the relevant undertaking (in particular, the Purchase Undertaking) and their liability to make payments of Rental on each Periodic Distribution tion Date up to and including the maturity date

5 Trust Structure A. Conventional Bond B. Sukuk (Ijara) Issuer Covenant to Pay (in Trust Deed) Trustee Obligor Transfer Lease (Sukuk) Trustee Powers of attorney are granted to Delegate Delegate Purchase undertaking Promise to Pay (in the Bond) Bondholders Covenant to Pay is held on trust for the Bondholders ode (in Trust Deed) Islamic Asset Certificateholders Lease and purchase undertaking are held on trust for the Bondholders (in Declaration of Trust)

6 Enforcement A. Conventional Bond B. Sukuk (Ijara) Trustee can sue Issuer for unpaid amounts under Bonds Delegate can sue obligor in the name of the Trustee for unpaid amounts under Purchase Undertaking Issuer Trustee Obligor Trustee Delegate Bondholders cannot sue unless the Trustee (i) is bound to act and (ii) fails to do so Bondholders Islamic Asset Certificateholders cannot sue unless the Delegate (i) is bound to act and (ii) fails to do so Certificateholders

7 Islamic Securitisation Shari a principles require a transfer of ownership and risk (as well as reward) of an asset for investors Conventional asset-backed securitisation requires the separation of an asset from the insolvent estate of the originator In true sale structures, the sale needs to be legally perfected in order to achieve the desired credit rating Recourse of investors is to the assets and to the extent that the assets do not perform, investors take the risk of not being repaid Securitisation is therefore seen to be harmonious with the principles of Shari a

8 Powers vested in the Delegate Power to convene Meetings Determine whether any Dissolution Event or Potential Dissolution Event has occurred Amendments Waiver, Authorisation and Determination Power to "flip" the Agency roles Appointment of new Trustees

9 Delegation of authority to the Delegate Trustee irrevocably appoints the Delegate to be its attorney Upon the occurrence of a Dissolution Event or Potential Dissolution Event, to perform tasks the Delegate considers necessary to exercise the Trustee's rights under the Purchase Undertaking and Guarantee Subject to the Delegate being indemnified/secured/prefunded to its satisfaction

10 Impact on the Certificateholders No action Recourse typically y limited to credit of Obligor and only through action of Delegate Non-petition Unless a Secured Sukuk, no assets are available or ring-fenced Local law could have an effect on enforcement rights (Saudi) Banking Regulations also would apply if an FI Perfection of Asset transfer an issue in analysis Dubai-1-# v1

11 Regulatory Reaction to Regional default issues Future Structures February 2010