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Corporate Sukuk in EuropeAlternative financing forinvestment projects

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Content

Foreword

Executive summary

Tax, regulatory and policy environment I. Cross-country experiences II. Economic and regulatory review

Survey insights: Hallmarks of optimism I. Tax and regulationII. Financing requirementsIII. Investment strategiesIV. Risk management

Project-oriented case scenarios Case scenario 1: Manufacturing industry–TurkeyCase scenario 2: Automotive industry–Germany Case scenario 3: Renewable energy–GermanyCase scenario 4: Real estate–TurkeyCase scenario 5: Pharmaceutical industry–GermanyCase scenario 6: Infrastructure industry–UKCase scenario 7: Agriculture industry–France

Industry thought leaders’ perspective

Looking forward: Harnessing the potential of Sukuk market

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Dear colleagues,

We are pleased to present Deloitte’s Islamic Financethought leadership report, now in its 5th edition, our latest industry study of the Islamic capital marketlandscape. The study adopts an innovative, newapproach to Islamic financial research which involvedextensive outreach and dialogue with the industry leaders’ community, academia and prominent Islamicfinance thought leaders.

The dialogue included numerous interviews andinteractive industry sessions to discuss the insights andopportunities for corporate Sukuk in European markets.Sincere thanks are extended to the industry experts andthought leaders who contributed their unique insightsto this report. In particular, the members of the researchteam and industry experts who generously providedsupport and played an invaluable role in shaping ameaningful discussion about the case for corporateSukuk in Europe markets and its potential integration to the world’s debt capital market.

The global financial crisis was marked by marketvolatility, a lack of liquidity in many capital markets, and heightened the debate–among industrystakeholders–of the need for alternative financing asset classes which will have balanced risk and returncharacteristics that enhance regulatory capital andequity buffers in the financial industry.

Responding to several global forces, financial servicesinstitutions are now required to comply withfundamental regulatory capital changes. The Basel IIIrequirement emphasized on capital quality and the needfor improvement of common equity. Basel IV emergedto supplement these requirements and addresses theimportance of capital instruments and debt exposuresnot only in the banking institutions but also in thecorporate world. It further proposes the revision forcredit risk, emphasizing on exposures to banks, assetquality and risk weighting methodology, and greatertransparency among many other transactional practices.

While progress has been made on the regulatory front,the Islamic capital market introduced innovative equityand debt instruments which are seen to havestrengthened the capitalization and liquidity positions ofInstitutions offering Islamic Financial Services (IIFS). Thedevelopment of High Quality Liquidity Asset (HQLA)Sukuk, Hybrid and Perpetual Sukuk is a case in point.

On the corporate debt front, different project financingstructures were introduced and used by governmentand private sectors. Key markets that used these typesof structures include the GCC, Malaysia, Turkey,Pakistan, Indonesia and Europe.

Deloitte’s report provides a portrait of the developmentin Islamic capital market instruments and highlightspotential growth markets for the Sukuk in Europeanmarkets and sectors that could benefit from thesearguably socially responsible investment asset classes. To this end, the report discusses these industry trendsand proposes that the growth of the Sukuk market inEurope and elsewhere in the world could bridge the gap in infrastructure funding/financing, particularly withrespect to real economy projects and public-privatepartnerships (PPPs).

We hope this report provides you with usefulinformation on how Islamic capital market instrumentssuch as the Sukuk could be used as an alternativefinancing tool to bridge the gap of European and globalcapital requirements to finance projects. It is indeed ourprofound hope that this report encourages a dialoguethat can help grow Islamic capital market offerings.

Foreword

Dr. Hatim El-Tahir,FCIB, FCISILeader, the Deloitte MEIslamic Finance Knowledge Center(IFKC)

Al Zamil Tower. GovernmentAvenue, Manama, Kingdom of BahrainPhone +973 1 721 4490 Ext 310Fax +973 1 721 4550


Industry policy-makers and regulators continue to keeppace with global regulatory and financial marketsdevelopments providing the required support for theindustry’s sustainable growth. The Islamic capital marketis uniquely advantaged in the current climate to createinnovative Sharia’-compliant debt and equityinstruments that will address the increased demand forfunding infrastructure projects in both developing andmaturing economies. Currently, developing countriesspend about US$1 trillion a year on infrastructure andan additional US$1-1.5 trillion will be needed through2020 in areas such as water, power and transportationprojects, according to the World Bank.

This industry study assesses the demand and supply in European markets for an alternative financinginstrument that will stimulate economic growth andcross-border investment. There is arguably a reciprocalneed from European corporates to finance infrastructureand investment projects, caused by scarce debt financefor long-term infrastructure projects that generallyrequire a high level of upfront capital. At the same time, there is a need from Middle Easterners and Asianinvestors for Sharia’-compliant assets in maturingeconomies that are often in time not economicallycorrelated e.g. Europe.

The study provides empirical analysis of matching thesetwo needs among historically interdependent trade andinvestment economies–the Middle East and Asia (MEA)and Europe.

Three trends emerging:• Governments in several European jurisdictions areattempting to provide level playing fields for Islamicfinance practice. Some have gone a long way such asthe UK, Luxembourg, and Ireland. Others are strivingto match the regulatory developments in thesecountries and have provided good breakthroughs inchanging national regulatory frameworks to host theindustry, in particular, Turkey, Germany, Italy andpossibly Spain, and to some degree France.

• Constrained professional and industry dialoguebetween corporate professionals and investmentbankers, widening knowledge and awareness gaps of Islamic Finance amongst the market players.

• The observational analysis enforces good marketsentiment amongst practitioners and market players.The general perception is optimism for great growthin this market in the next few years, depending on the improvement of global market conditions.

The survey’s key findings reveal that:• 91% of respondents have considered ethicalinvestments in Sukuk.

• 73% of respondents would consider Sukuk andanother 25% might consider the instrumentdepending on its merits if the transaction entailed any tax benefits.

• The majority of respondents prefer equity followed by Sukuk over all other proposed asset categories.

• Stakeholders are more likely to dedicate a smallerpercentage bracket of their Capex to Sukuk.

• 81% of participants prefer to invest in USD-denominated Sukuk.

• 75% of respondents would still consider investing inSukuk even with lower/similar yields than other bonds.

• 55% of respondents would definitely consider Sukukas a tool to reduce risk and diversify their portfolio,with another 34% speculative.

Executive summary

91% of respondents have consideredethical investments in Sukuk


Cross-country experiences: France, Germany,United Kingdom, and TurkeyThe participation of each industry stakeholder plays acrucial role in developing an ecosystem required to buildconfidence in both potential Sukuk issuers and investors.This study found that the United Kingdom is leading inthe implementation of initiatives to encourage thegrowth of Islamic Finance and the issuance of Sukuk inthe country.

The study assesses various indicators, such as socialdynamics, an economic and regulatory review, and aparticipating stakeholder’s review to gauge the currentclimate and potential in moving forward.

Social dynamicsThe social fabric of different societies are gradually re-sewn with globalization and the migration of peopleseeking better job prospects in developed nations. WhileMuslims constitute a minority group in France, Germany,and the United Kingdom, there is growing demand forSharia’-compliant goods and financial services.

TurkeyWith the majority of the population being Muslim, itwas expected that the development of Islamic Financein Turkey would be largely driven by local demand.However, this was not the case given the sensitivities ofdeveloping the industry in the secular republic prior to2012. The tide changed after 2012, when the Turkishgovernment introduced Islamic Finance, through theissue of Turkey’s first sovereign Sukuk.

France, Germany, and the United KingdomThere are approximately four to five million Muslimsresiding in each of the three countries. This creates areasonable mass for Islamic Finance in areas of retail,corporate and the SME landscape, all of which couldhelp grow corporate Sukuk issues in these countries.

Tax, regulatory and policy environment

France Turkey Germany UK

Social dynamics

Legal framework

Tax neutrality

Indirect policies

Business support

Participants

Summary of findings

Conducive ecosystem rating

Very conducive Conducive Improvement required


8%

5%

99%

4%

Percentage of Muslims

The study assesses various indicators,such as social dynamics, an economicand regulatory review, and aparticipating stakeholder’s review togauge the current climate and potentialin moving forward

Key findings:While demography may determine the acceptance of Islamic Finance withinthe country, it will not be the core determinant of interest from foreigninvestors in these countries. Luxembourg and Ireland are examples of Europeancountries with similar demographics to France, Germany, and the UnitedKingdom, and these two countries have made progressive developments in theindustry with favorable banking regulations and government initiated policies.

Germany

France


Economic and regulatory reviewLegal frameworkEstablishing a comprehensive and effective legalframework secures the enforceability of Islamic Financecontracts and ensures that there is an effective legalprocess for dispute resolution. Precedent Sukuk defaultcases have highlighted disputes across differentjurisdictions on the rights given to investors of specialpurpose vehicles (SPVs), a structure heavily utilized inIslamic Finance contracts.

• Supervisory body: Autorité des marchés financiers - France (AMF).

• Legal framework was modified in 2009 to allow banks and private issuers to sell Sukuk.

• Clear guidelines for Sukuk issuance, drafting Sukukprospectus, and obtaining approval for listing onFrench regulated market.

• Provision of advice to Sukuk issuers throughout the listing process to ensure compliance with EUProspectus Directive.

• Established cooperation with Accounting & AuditingOrganization for Islamic Financial Institutions (AAOIFI)to develop amendments to French law toaccommodate Islamic Finance.

• Supervisory body: The Capital Markets Board of Turkey(CMB).

• Legal framework was modified in 2013 to permit theuse of diversified Islamic financial instruments inTurkey, enabling Sukuk that are structured using

Istisna’, Murabaha, Mudaraba, Musharaka, and Wakala.

• Issued clear guidelines, principles, and legalframework for lease certificates (Ijarah), specialpurpose vehicles, and Sukuk Ijarah.

• Supervisory body: The Federal Financial Supervisory Authority (BaFin).

• There are clear guidelines on bank licenserequirements for Islamic financial instituitions underthe German Banking Act.

• Issued a banking license to a foreign bank (Kuveyt TürkBeteiligungsbank) to conduct limited Islamic bankingoperations in Germany.

• Actively held conferences on Islamic Finance since2009.

• Supervisory body: The Financial Conduct Authority(FCA), the Prudential Regulation Authority (FRA), the Bank of England, and the government (i.e. HMTreasury).

• Legislative measures introduced to establish a levelplaying field for Islamic and conventional instrumentsand to enable UK companies to issue a range ofIslamic financial products. Any inequality is swiftlyremediated through revisions in the legislation andregulations.

Turkey

UK


Comparison with other European countries with established Sharia’ practices

Ireland Luxembourg

Supervisory body–Central Bank• Established a Sharia’ Funds Specialist Unit to ensureregulatory applications involving Sharia’ funds.

• Sharia’ element is viewed as a “socially responsible”investment element.

Supervisory body–Commission de Surveillance du Secteur Financier (CSSF)• Regulation issued in 2011 to clarify the tax rules andlisting requirements for Islamic financial instruments.

• There are no specific legal requirements concerningSharia’ investment funds set up under the Luxembourg law.

Tax neutrality Amendments to tax laws, in order to establish taxneutrality for Islamic Finance transactions andinstruments, create a level playing field betweenconventional and Islamic financial products. Inequality of tax treatment arises in Islamic Finance transactionsdue to a sale or exchange of the underlying asset to the SPVs, triggering capital gains, stamp duty, andwithholding income taxes depending on where theasset owner is located in a foreign jurisdiction. Providingtax incentives could reduce the hidden costs of issuingSukuk and encourage more enterprises to issue or investin them.

Key findings:Having the first mover advantage into theEuropean Sukuk market, the Saxony Anhalt(Germany) state’s Sukuk issue in 2004 did notautomatically translate into Germany becomingleaders in the European Sukuk market. With notax neutrality or favorable government policiessubsequent to the maiden Sukuk issue,corporate Sukuk issuance has been moreconcentrated on foreign companies that arekeen on tapping into the deep liquidity in theGerman financial markets, rather than from localmedium-size companies.

Developments appear more promising in France,the United Kingdom, and Turkey, where thereare regulations and infrastructures in place topromote the issuance of Sukuk. However,guidance provided in Turkey is limited to Sukukbased on Ijarah (lease certificates). Despite thelimitations, the Turkish government’s opensupport to develop the country’s Islamic Financesector and sovereign Sukuk issuance serves as apromising factor.

Tax neutrality

Analyzed countries

France Yes

Turkey Yes

Germany No

UK Yes

Comparison with other established financialmarkets

Ireland Yes

Luxembourg Yes



Ireland Luxembourg

Sharia’-compliant funds domiciled in Ireland • Accommodated within the existing tax framework.• Entitled to the same favorable tax treatment offered toconventional funds (ie. zero tax on fund’s income orgains, net assets, no stamp duty, and zero withholdingtax on distributions to non-Irish residents).

• Enjoy equal tax treatment for Islamic financialinstruments and similar reporting obligations withconventional funds.

• Treatment of Sukuk and remuneration of Sukuk is similar to conventional debt and interest.

• Payments on Sukuk are not subject to withholding tax. • The direct and indirect tax authorities have also issuedclarifications on the major principles of IslamicFinance, direct tax treatment, and indirect taxtreatment of Murabaha and Ijarah contracts.

Other participating stakeholders review Indirect policies Implementation of policies to encourage thedevelopment of identified industry sectors, growth oflocal companies, or socially responsible investments canbe strategic for the development of Islamic Finance. The governments of France, the United Kingdom, andTurkey have implemented several schemes which havesynergies with the development of corporate Sukuk.Socially Responsible Investment (SRI) Scheme:• The French government’s active support for initiativesthat develop social and environmental transparency of business.

• Requirement for compulsory annual non-financialreporting on social, environmental and societal criteriafor businesses whose shares are traded on a regulatedmarket.

Exploring the potential of the French sociallyResponsible Investment Scheme:Factors of Socially Responsible Investments (SRI):

Given the parallels that can be drawn between SRI andSharia’-compliant products, France’s emphasis on theSRI culture is strategic for potential growth of the Sukukmarket in France.

Ethicalfactors

Socialfactors

Environmentalfactors

Nogambling

No financingof weapons

No excessiverisks/speculations

Given the parallels that can be drawnbetween SRI and Sharia’-compliantproducts, France’s emphasis on the SRIculture is strategic for potential growthof the Sukuk market in France


Examples of socially responsible investments includegreen bonds, which are debt instruments issued to raisefinancing for projects that generate direct environmentalbenefits (renewable energy, social housing, educationetc).

Green tax systems • France, Germany and the United Kingdom have inplace green tax systems to encourage greeninnovation and achieve energy efficiency. Theincentives to develop green innovation come invarious forms such as: - Tax incentives, subsidies on research, and lowinterest loan programs for energy-efficientconstruction and retrofitting in Germany.

- Discounts on the climate change levy and capitalallowances on equipment to improve energyefficiency in the United Kingdom.- Exemption from local property taxes for up to fiveyears on green buildings in France. The developmentof green property is strategic for the development ofIslamic Finance as the underlying investments arealso Sharia’-compliant.

France, Germany and the UnitedKingdom have in place green tax systemsto encourage green innovation andachieve energy efficiency


Ireland Luxembourg

Ireland is home to two industries that are Sharia’-compliant and have the potential to boost the Sukukliquidity pool.• Renewables and clean tech industry- Identified by the government as a key industry for development - Incentives for companies to realize inherent valuefrom “carbon offset” qualifying assets

• Aircraft leasing industry- One of the oldest and longest establishedinternational financial services industries in Ireland

Luxembourg has marketed itself not just as a primelocation for setting up and servicing conventional funds,but also Islamic funds.

The Association of the Luxembourg Fund Industry andLuxembourg for Finance has put together brochures toprovide comprehensive information on the legalframework and tax treatment for a range of commonlyused Islamic Finance structures, as well as best practiceguidances for investors.


Key findings:

Country 1. Stock exchanges 2. Support frominternational andlocal organizations

3. Educationalinstitutions

4. Sukuk issuers 5. Sukuk investors Ecosystem

France NYSE Euronext Paris• Platform to issueSukuk

• Does not have ratingrequirements

Paris Euro Place• Teamed up withAAOIFI

• Developed tax lawguidebook to assistSukuk issuers underdifferent laws

• Several educationalinstitutions offeringspecialized courses in Islamic Finance

• No sovereign Sukuk issue

• 2 corporate Sukukissues in 2012

• Private PlacementFunds

• Investors from theMiddle East

In placeMore conducive forprivate placement

Germany Frankfurt StockExchange• Sukuk and bondissues have the samelisting requirements

• One of the two mostpopular stockexchanges in Europefor Sukuk listing

• Turkey, being one ofGermany’s mostimportant tradingpartners

• Bank license grantedto a Turkish bank toconduct limitedIslamic bankingoperations


• First Sukuk issue inEurope (State ofSaxony Anhalt) in2004

• 13 foreign companies(Middle East &Malaysia) withoverseas operationshave listed corporateSukuk on theFrankfurt StockExchange

• 1 corporate Sukukissued via privateplacement in 2013

• Internationalinvestors

In placeMore conducive for bigcorporations due tocost of issuance

United Kingdom

London Stock Exchangeand AlternativeInvestment Market • No annual listing fees• One of the two mostpopular stockexchanges in Europefor Sukuk listing

• The Middle East,being one of theUnited Kingdom’smost importanttrading partners

• Strong governmentsupport through theestablishment of theIslamic Finance taskforce

• Renownededucationalinstitutions offeringspecialized courses in Islamic Finance

• First sovereign Sukukissue in 2014

• 49 corporate Sukuklisted on LSE to dateby foreign companies(Middle East &Malaysia) withoverseas operations


In placeConducive for localmedium-sizeenterprises. However,credit ratings of Sukukissued may deterpopularity amonginvestors

Turkey Borsa Istanbul• No Sukuk listing• All bonds listed are by Turkish companiesdenominated inTurkish Lira

World Bank• Established the WorldBank Global IslamicFinance DevelopmentCenter in Turkey

• Provided US$250million loan toimprove Islamicfinancing to SMEs


• First sovereign Sukukissue in 2014

• 1 potential corporateSukuk issue receivedregulatory approval in2014


In placeMore publicity requiredto assure issuers onpricing

• France has in place a conducive ecosystem toencourage medium-size enterprises to issue Sukuk.Given the number of Muslims residing in the country,there are a number of enterprises offering Sharia’-compliant products and services (ie. restaurants/supermarkets selling halal food). The increasingdifficulty in obtaining long-term corporate loans fromconventional banks and the lack of Islamic banks tooffer financing solutions makes Sukuk issuance apotentially attractive financing option for medium-sizeFrench enterprises. This is supported by the positiveregulation and tax reforms in place for Islamicfinancing products which have been implementedsince 2007.

• Furthermore, the French government’s focus onpromoting enterprises to include socially responsibleinvestments (e.g. Green bonds and environmentally-friendly developments) as part of the enterprise’sstrategy creates a potential demand from Frenchenterprises to invest in Sukuk, given the parallels thatcan be drawn between the two types of instruments.

• The key challenge that remains is the current politicalclimate which has discouraged both medium-sizeenterprises and even large corporations from publicissuance of Sukuk, despite having the platforms andresources to generate a demand and supply forcorporate Sukuk.

• Turkey, being the only emerging market analyzed, has received a high level of support from the WorldBank Group to develop its Islamic Finance sector. Thegovernment has also been taking proactive stepstowards developing the national bond and Sukukmarkets for more effective channeling of capital intoeconomic development.

• Given that non-bank financial institutions (NBFIs) havebeen playing a limited role in Turkish financial marketsin the past, the market is not saturated and there isplenty of room for development moving forward.These factors give a clear indication that there areopportunities being created to develop the Sukukmarket.

• The key challenge, however, is the macroeconomicinstability in the country which has threatened toreverse the growth in Turkey’s economy. Improvingregulations to allow for more effective and efficientissues of the additional Sukuk before redemption ofthe first Sukuk in circulation, or creating an effectivemechanism to handle creditors’ rights and bankruptcyproceedings could encourage NBFIs to turn to theSukuk markets to raise capital or invest in Sukuk. Themost encouraging intitiative is for the government toimplement incentives to reduce the cost and makeIslamic financial instruments more attractive thanconventional instruments. This was successfullyimplemented in Malaysia, however the politicalclimate might be challenging for this initiative to be implemented.

• Germany has the third largest trading exchange andliquid market in the world and this reputation hasattracted international companies from the MiddleEast and also Malaysia to list Sukuk on the exchange.The number of Muslims residing in the country andstrong trade relations with Turkey are indicators thatthe demand for Sharia’-compliant goods and servicesis expected to increase. The providers of these goodsand services are likely to be keen to seek Sharia’-compliant financing to expand their operations.

• Given that there is currently a Turkish participationbank in Germany offering limited Sharia’-compliantfinancing options, Sukuk issuance will have to provethat it is more cost effective and attractive comparedto the Sharia’ financing options offered by the Turkishparticipation bank.


Creating a corporate Sukuk market in Europe

Germany

France

Turkey


• The key challenge that remains for Germany is largelydue to taxes. While there are no withholding taxes oninterest or payments under a loan, there is a 26%withholding tax slapped on bonds/Sukuk resulting inhigh costs involved for Sukuk issuance. Furthermore,creating tax neutrality for Sharia’-compliant financingstructures could be implemented to encouragemedium-size enterprises to consider Sukuk issuance.

• The United Kingdom houses the London StockExchange (LSE), which is one of the largest tradingexchanges and liquid markets in the world. The LSE’sstellar reputation and low cost of listing has attractednot just international companies to list Sukuk on theexchange, but also medium-size enterprises to list onthe Alternative Investment Market (AIM), which is partof the LSE but caters for smaller growing companies.The British government has maintained extremelycordial relationships with the Middle East and hasbeen extremely proactive, voicing support for thedevelopment of Islamic finance in the country.

• Furthermore, London is known to be one of the bestcities for foreign property investment opportunitiesand this has attracted investors from Asia, the MiddleEast, and Europe. Specifically investors from theMiddle East have been increasing their demand forSharia’-compliant investments originating fromLondon. This serves as a motivating factor formedium-size enterprises to consider bond issuance.

• The key challenge for the United Kingdom is tointroduce measures to make Sukuk issuances moreattractive than the other conventional and Islamicfinancing options currently available on the market.The United Kingdom boasts the highest number ofIslamic banks in Europe which provide medium-sizeenterprises with sufficient supply of Sharia’-compliantfinancing options for enterprises. These options offermore confidentiality than a public issue of Sukuk on an exchange.

UK


This section quantifies the results gathered through the‘online survey questionnaire’ in order to increase ourunderstading of the key determinants of an efficientSukuk market in Europe.

Global responses were received, with approximately halfbeing from the Middle East and a third from Europe. Asexpected, this reflected the study’s main objective ofbringing together highly liquid Middle Eastern and Asian(MEA) investors with scarce European corporate debtmarkets.

Regulatory and TaxKey messages:• The UK pioneered regulatory development byremoving the double charge through the Stamp Duty Land Tax in 2003, in support of the Ijarah Sukuk.

• Many other markets have reacted similarly, resulting in better regulation across Europe.

• 70.4% of respondents confirm that the market theyoperate in facilitates Islamic finance transactions.

• 81.4% of respondents are aware of readily availablesupport from professional service providers.

• 73% of respondents would consider Sukuk andanother 25% might consider it if a tax benefit isperceived.

• 56.8% of respondents would consider Islamic financetransactions if financial reporting is aligned withconventional counterparts.

The practitioners’ perspectiveHallmarks of optimisim

Participants by region

49.3%4.3%

11.6%5.8%

29.0%

Middle East Asia USA OtherEurope

Does the regulatory system in which your company residesfacilitate Islamic Finance transactions? (e.g. Investing/Issuing Sukuk)

14.3%

15.3%

Yes No Some progress in place

70.4%

Do other professional services providers (such as lawyers, consultants and rating agencies in the country in which your… facilitate Islamic finance transactions? (e.g. Investing/Issuing Sukuk)

11.6%

7.0%

81.4%

Yes No Some progress in place


Financing requirements Key messages:• Sukuk ranked second highest asset class followed byequity

• Majority of participants are likely to allocate 10%-30%of their Capex allocation.

• 38% of the participants would consider Sukuk as afund raising mechanism whilst 33% are not sure.

Rank asset classes as per your asset allocation strategy for the next 3-5 years. (Rank 1 - High; Rank 5 - Low)

Sukuk(Islamic bonds)

Asset backedsecurities (ABS)

Derivatives

Cash

Alternatives

Property

Bonds

Equity

0 5 10 15 20

5 4 3 2 1

Compared to conventional counterparts (bonds), would you consider Sukuk (Islamic bonds) if there were any tax benefit(s)(tax neutrality, incentives, deductions, and exemptions) associated with the development and use of Sukuk in your country? Frequency

25.0%

2.3%

Yes i would No i wouldn’t

I might consider Sukuk after considering all the merits of the product

72.7%

Would you consider an Islamic Finance transaction if financial reporting is aligned with the treatment of conventional counterparts? (i.e. IFRS/GAAP)

4.5%

38.6%

Yes No

Yes, but need more informaion on the merits of the model

56.8%

38% of the participants would considerSukuk as a fund raising mechanism whilst 33% are not sure


Behavioral financeKey messages:• Evenly distributed responses were given in relation to using Sukuk as a method of raising funds.

• A lack of awareness around the Sukuk instruments’may have attributed to limited use within Europeancorporates.

• The UK has set up an Islamic Finance Secretariat(UKIFS), aiming to educate and promote Islamicfinance instruments.

Please state the reasons: (select all that apply) Frequency

Lack of awarenessof its benefits

Applicable laws andregulations do not

support Sukuk

Lack of efficientsecondary market

tradabilityHigher issuance cost

Other

Is your company likely to consider issuing Sukuk (Sharia’-compliant bonds) for raising funds? Frequency

32.7%

29.1%

Yes No Don’t know

38.2%

What percentage of your total Capex will be allocated to Sukuk? Frequency

19.0%

23.8%

10-30% 31-50% More than 50%

57.1%


Investment strategies Key messages: • Most respondents agree about the similarity betweenethical investments and Sharia’-compliant investments.

• 91% of respondents have considered ethicalinvestments and Islamic finance instruments.

• Yield to maturity was ranked as the highest concern in investing in Sukuk.

• 75% of respondents would still consider investing inSukuk even with lower/similar yields than other bonds.

Have you considered ethical investments / Islamic Finance products like Sukuk? Frequency

8.5%

Yes No

91.5%

Please give the relative rank of the following factors/concerns that matter most in investing in Sukuk. (1 being the most important and 6 being the least)

Soun

d re

gula

tory

disc

losu

re

6

Yiel

d to

mat

urity

Qua

lity

of u

nder

lying

ass

ets

Liqui

dity

and

trad

abilit

y

of th

e se

curit

y Tax

ince

ntive

sRa

ting,

and

list

ing

of th

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curit

y

45%

40%

35%

30%

25%

20%

15%

10%

5%

0%

5 4 3 2 1

Will you still consider investing in Sukuk if it provides the same/lower yield than bonds with the same characteristics? Frequency

25.0%

Yes No

75.0%

A lack of awareness around the Sukukinstruments’ may have attributed tolimited use within European corporates


Would you consider alternative financing e.g. (Islamic Finance), in an attempt to diversify your investment portfolio and reduce risk?

11.4%

34.1%

Yes Yes, but would need more information on the merits of the model

54.5%

No

Risk management Key messages:• 52% of respondents would definitely consider Sukukas participatory equity-based financing, with another43% speculative.

• The US dollar is the preferred currency with 81% ofparticipants preferring to invest in US$ denominatedSukuk.

• 55% of respondents would definitely consider Sukukas a tool to reduce risk and diversify their portfolio,with another 34% speculative.

• More than half of respondents would use alternativefinancing to diversify and manage the risk of theirportfolios.

Would you consider alternative financing e.g. (Islamic finance), which offers a participatory equity-based financing where both parties share the profit and loss in the business?

4.5%

43.2%

Yes Yes, but would need more information on the merits of the model

No

52.3%

What is the most preferred currency of Sukuk to invest in?

8.3%

8.3%

2.1%

USD EUR GBP Other

81.3%

The US dollar is the preferred currencywith 81% of participants preferring toinvest in US$ denominated Sukuk


Project-oriented Sukuk financing structuresPublic issuance of sukuk

Stock Exchange: NYSE Euronext 1) Issuers can opt for issuing different products • Retail bonds• European private placement• Green bonds

2) Key requirements • Prospectus, appointment of a listing agent responsiblefor filing the admission application (Europeanfinancing institution)

• Admission request filed with Euronext • Choice of market segment

A listing timetable jointly agreed with Euronext Paris.

Stock Exchange: Borsa Istanbul1) Listing on Borsa Istanbul (Istanbul Stock

Exchange). However, bonds must bedenominated in Turkish lira (Regulatory approvalrequired)

2) Listing on stock exchanges in France/Germany/UKallows for the flexibility of issuing Sukukdenominated in euros.

Stock Exchange: Frankfurt Stock Exchange Key admission conditions:• Securities prospectus• Brief company profile and information on thecorporate bonds

• A calendar of company events• Audited annual financial statement and a groupmanagement report

• Up-to-date issuer or bond rating by one of DeutscheBörse’s accredited credit rating agencies

• Defined company key figures on debt servicecoverage, debts and capital structure

Stock Exchange: London Stock Exchange

1) Eligibility requirements for the main market &Professional Securities Market • Minimum value of issue of £200,000 • Free transferability of debt securities • All securities of same class to be listed

2) Issuers can contact the UK Listing Authority to discuss proposed transaction timetables or technical matters.

3) Listing agent is not required

France

Turkey

Germany

UK


Civil, common law and Sharia’ lawThe conflict between common law and Sharia’ leads tosome gray areas. As in any particular jurisdiction, clashesmay occur due to dual system governance of financialtransactions. For example, in cases where the verdictdecided upon was based on sale contract law, while thesubstance of the contract was actually a conventionaldebt contract. Therefore, confusion emerges as to thelegal basis of the verdict.

• True sale executionThe execution of a true sale is an important element ina Sukuk transaction, as it constitutes a real transfer ofownership from the originator to the Sukuk holdersvia the SPV. Subject to jurists’ interpretations, in orderfor a transaction to be deemed a “true sale,” it mustmeet the four key criteria articulated through theSharia’ perspective. Re-characterization of the transferby court or other bodies may not be permitted, thetransferred asset themselves must be bankruptcyremote from the originator, the transfer must then beperfectible at the election of the issuer, and finally alloverriding liens must be cleared off of the sale (IFSB,2009, p.9).

Nevertheless, some Sukuk issuances do not execute atrue sale, as with asset-based Sukuk issuance, due tothe absence of property and bankruptcy acts undercivil law origin.

• BankruptcyBankruptcy law is crucial for facilitating true saletransactions in which investors are protected and willreceive payment on asset-backed Sukuk, even in casesof the originator’s bankruptcy.

• Special Purpose Vehicle An SPV is a remote firm, which is independent fromthe obligor. The SPV is established based on trust lawin which the Sukuk’s originator transfers the assets tothe Sukuk holders via the SPV as a trustee with goodfaith. Therefore, trust law plays an important role ingoverning the SPV’s establishment. Trust law has beenwell incorporated into both common and civil lawjurisdictions. This trust law recognizes the equity forremedies and rights in which beneficiaries areprovided with equitable treatment remedies againstunfaithful acts. Within common law treatment, thelegal rights of the trustee are bound by the legal rightsof beneficiaries.

In contrast, under civil law treatment, the beneficiarieshave no rights or control towards the assets managedby the trustee. Hence, civil law treatment entails aproblem for Sukuk issuance that originates from civillaw jurisdiction countries. In those cases, in the eventof default, the Sukuk holders do not have recourse tothe asset due to civil law restrictions, and thereforethose Sukuk are characterized as asset-based Sukuk.However, for Mudarabah and Musharakah Sukuk, thetrust elements are embedded in those underlyingcontracts.

Bankruptcy law is crucial for facilitatingtrue sale transactions in which investorsare protected and will receive paymenton asset-backed Sukuk, even in cases ofthe originator’s bankruptcy


Murabaha

Rene

wab

le E

nerg

y/Ph

arm

aceu

tical

/ M

anuf

actu

ring

Cost plus financing arrangement: Financing the purchase of commodities used in the production of renewable energy, pharmaceutical medical drugs and textiles.

Key Sukuk financing structures and sectors

Sale where goods are purchased in advance for delivery on an agreed future date: Financing the purchase of commodities used in the production of renewable energy, pharmaceutical medical drugs and textiles.

Construction project to be delivered on a future date for a fixed, agreed-upon price and with specific product specifications: Financing the construction of production plants/facilities in overseas territories and locally.

Leasing arrangement: Finance or Operating lease of equipment used in the production of renewable energy, pharmaceutical medical drugs and textiles.

Salam

Murabaha

Real

Est

ate

Construction project to be delivered on a future date for a fixed, agreed-upon price and with specific product specifications: Financing the development of real estate properties.

Istisna’

Ijarah

Construction project to be delivered on a future date for a fixed, agreed-upon price and with specific product specifications: Financing the construction of production plants/facilities in overseas territories and locally.

Leasing arrangement: Finance or Operating lease of equipment used in the production of renewable energy, pharmaceutical medical drugs and textiles.

Istisna’

Ijarah

Expansion of operations in international

markets

Expansion of operations in local

markets

Investing in new business streams

Using Sukuk to diversify capital

sources


The opportunity: Manufacturing industry inTurkey• The manufacturing industry is one of the main driversof the Turkish economy, accounting for 24.2% of total GDP.

• Turkey’s 2023 goals include reaching certainbenchmarks for exports in various sub-sectors.

The proposed issuer: ABC manufacturingcompany (Turkey). • One of the largest companies in Turkey with threemanufacturing facilities in Turkey.

• Exports largely to Europe and the United States of America.

• Listed on the Istanbul stock exchange.• Debt securities used in the industry:- Turkish currency commercial paper - Turkish currency of bonds qualified investors withmaturity of 5 years. - Turkish currency of bonds used via public offeringwith maturity of 5 years.

The challenge:The ABC manufacturing industry in Turkey typicallyobtains financing through bank loans and in some cases corporate bonds.

Business issues:• The export-oriented nature of the Turkish ABCmanufacturing business puts the industry in avulnerable position when there is a slowdown in the global economy.

• Domestic political uncertainty could make the countryunstable affecting the operations of companies (i.e.foreign investors selling off their stake in Turkish assetsamid the political uncertainty).

• Resources required for constant innovation, in order to achieve operational and cost efficiency as well ascreate new innovative products.

Financing issues:• Inability for special purpose vehicles (SPVs) in Turkey to issue second Sukuk before the redemption of theSukuk in circulation.

• Small- and medium-size enterprises tend to experienceproblems in obtaining sufficient working capital for

their day-to-day operations after the banks increasedinterest rates and lowered the amount of loansavailable to the private sector.

• Attractiveness of bonds issued by Turkish company to international investors, given that there is nogovernment backing and higher country risk in view of the political uncertainty in the country.

The case for Sukuk issue:The key possible transactional features andconsiderations which set a Sukuk issuance apart are therequirements for Sharia’-compliant assets and utilizationof proceeds.

Case scenario 1: Manufacturing industry(Turkey)

Transactional features

Issue price US$100 million

Tenure 2-year tenure

Coupon rate 6-month coupon rate

Payments Settlement options

Currency US Dollar

Underlying asset New machinery acquired to produce new ranges of textile products

Governing law English law

Listing As required

Regulatory approval As required

Regulations As required

Table 1: Transaction summary - issuance, terms and regulatory and legal aspects

The proposed structure type - IjarahSale-based contract: Ijarah

SPV purchasesmachinery

Supplier1

3

2

4

Customer

Bank transfers usufruct to ABC manufacturing company

“The purchaseprice”

Periodicrentals

Potential transfer of rights over the machinery at end of agreement but this cannot be a condition for the Ijarah initial contract

SPV (Sukuk issuer)


The opportunity: Automotive industry inGermanyBoasting the largest concentration of OriginalEquipment Manufacturer (OEM) plants in Europe, with21 of the world’s 100 top automotive suppliers beingGerman companies, Germany is Europe’s number oneautomotive market in production and sales.

The proposed issuer: ABC automotive company(Germany) • A leading German automotive manufacturingcompany, top 5 automotive supplier in the world and industrial partner to key industries

• Listed on the Frankfurt Stock Exchange • Debt Securities used:- Euro Corporate bonds with maturity of 5 years- Euro Corporate bonds with maturity of 7 years

The challenge:Given the capital-intensive nature of the automotivemanufacturing industry, it is no surprise that the bondmarket in Frankfurt Germany has been dominated byissuance from large corporations.

Business issues: • Effective product technology and constant innovationis required to survive in the current competitive marketplace.

• Sustainable long-term business strategies are requiredto address high labor costs which threaten Germany’sautomotive industry in view of stiff competition fromCentral Europe, China and Latin America.

Financing issues:• Being a capital-intensive industry, it is crucial forautomotive manufacturers to get the right financialleverage and the most cost-effective financingsolutions for their operational and productioninnovation needs.

The case for Sukuk issue:The key possible transactional features andconsiderations which set a Sukuk issuance apart are the requirements for Sharia’-compliant assets andutilization of proceeds.

Case scenario 2: Automotive industry(Germany)






Currency US Dollar

Underlying asset

Machinery acquired to produce automotive parts

Governing law German law

Listing As required

Regulatoryapproval

As required


Table 1: Transaction summary - issuance, terms andregulatory and legal aspects

The proposed structure type - MurabahaSale-based contract: Murabaha

Bank purchasesthe good

Supplier1

3

2

4

CustomerBank sells the machinery to ABC automotive company


“The scale price”=

Originalpurchase price

+Agreed profit

Possession

Other

Payment canbe deferred:installments orlump sum paidon a specifiedfuture date

Islamic Bank


Case scenario 3: Renewable energy(Germany)

The opportunity: Renewable energy industry inGermany• The completion of new offshore windfarms inNorthern Germany has increased wind energyproduction in the country.

• Renewable energy sources (solar, wind, hydropower,biomass) make up 34% of Germany’s public netpower supply in 2015, with the government targetingan 80% share in electricity generation by 2050.

The proposed issuer: ABC renewable energycompany (Germany) • A major player in the offshore wind industry.• Installation of wind turbines largely in Germany andFrance and provision of offshore installation, service,and maintenance of wind turbines.

• No bonds have been issued by the company and it is not listed on any stock exchange.

The challenge:Provision of renewable energy is capital intensive duringthe construction stage of the windmills.

Business issues: • The European Union scaled down governmentsubsidies for renewable energy sources (i.e. wind,solar) given the high costs of renewable energyaffecting businesses forced to utilize renewableenergy.

• Challenge to ensure that costs for renewable energieswill be reduced through research and development,more prevalent usage to bring about economies ofscale.

• New technology with high operating risks, smallerproject sizes.

• Capital cost-intensive structure and high operating and maintenance costs.

• Renewable energy developers and sponsors have been classified as high risk.

• Long time horizons resulting in long exposure periodto risk (long to extra-long maturities and interest ratesat the low range).

Financing Issues: • Difficulties in mobilizing financing given the high up-front costs and perceived commercial risks. Highcollateral is required in the renewable energy business.




Tenure 3 years tenure



Currency US Dollar

Underlying asset Windmill

Governing law German law

Listing As required




The proposed structure type - Istisna’Sale-based contract: Istisna’

Title to asset oncompletion


ManufacturerCustomer

Sale or lease contract (Ijarah & Istisna’)

e.g. Advance rental payments during construction

Advance paymentof purchaseprice (instalments)

Purchase contract (Istisna’)

Payment

Today Future

Delivery

Bank


Case scenario 4: Real estate (Turkey)

The opportunity: Real estate (construction)industry in Turkey Leveraging strong government support and goodinternational relations, Turkish construction companieshave ventured into more high risk regions such asCentral Asia, the Russian Federation and the MiddleEast. Securing numerous projects over the past fewdecades, the construction industry now accounts foralmost 5.9% of Turkey’s gross domestic product andemploys more than 1.8 million people. Based on arecent Engineering News Report survey, Turkey is nowranked second in the world for having top internationalcontractors.

The proposed issuer: ABC Real Estate company(Turkey)• A conglomerate specialized in construction, realestate, investment, energy production, health andeducation sectors.

• Portfolio of projects across 11 countries includingTurkey, the Middle East, Central Asia and Russia.

• Issued bonds and listed on Istanbul Stock Exchangeand under private placement for the purpose offinancing construction projects in Turkey and in Russia.

The challenges:Construction companies require significant financingthroughout the project term to facilitate the completionof the construction. Securing long-term financing fromfinancial institutions and understanding the new marketmay be challenging for companies entering new foreignmarkets. One strategy to facilitate the process is bypartnering up with a local firm with a good credithistory and reputation.

Business issues: • Gaining a competitive advantage (i.e. throughresearch & development) in view of strong local and international competition.

• Political uncertainty in both Turkey and countrieswhere Turkish companies undertake internationalprojects could affect the operations of companies (i.e. foreign investors selling off their stake in Turkishassets amid the political uncertainty).

Financing issues:• Inability for special purpose vehicles (SPVs) in Turkey to issue second Sukuk before the redemption of theSukuk in circulation.

• Difficulties in managing cash flows, in view of delayedprogress payments by payee, cost overruns and designchanges requested during the execution of theproject. Should companies fail to secure adequatefinancing during the time span of the constructionproject, it can result in the construction being delayedindefinitely and bankruptcy.










Payment

Today Future

Delivery

Bank



Tenure Dependent on the project duration



Currency US Dollar

Underlying asset Construction of buildings (project completion)

Governing law English or French

Listing As required

Regulatoryapproval

As required




Case scenario 5: Pharmaceuticalindustry (Germany)




Supplier1

3

2

4

Customer

Bank transfers usufruct to ABCcompany


Periodicrentals


SPV (Sukuk issuer)

The opportunity: Pharmaceutical/chemicalmanufacturing industry in GermanyBeing one of Europe’s key assets and top performinghigh technology sector, pharmaceutical companies in Germany have adopted a consistent approach of investing in capital expenditure. As at 2013, the German pharmaceutical market stood as the fourthlargest pharmaceutical market globally, and secondlargest pharmaceutical production market in Europe.

Target company: ABC pharmaceutical company(Germany) • Independent, family-owned, international research-based pharmaceutical company headquartered inGermany.

• Production plants and affiliates in Latin America and Europe.

• Partnership with affiliates for the exclusive productionrights of patented medical drugs.

• No debt securities issued. Loans taken from financialinstitutions or shareholders.

The challenge:The pharmaceutical industry invests a percentage of itsearnings in research and innovation, a key componentfor generating potential new patents and medication for the industry. However, unlike other industries (i.e.automotive and energy), where industry heavyweightshave taken to the bond markets to raise financing, thetraditional sources of financing for the pharmaceuticalindustry continue to be private and public equity. Debtfinancing is only feasible for large pharmaceuticalcompanies with stable cash flows.

Business issues: • A complex licensing and approval process, as well as price controls implemented by the governmentrequiring drug manufacturers to prove the additionalbenefits of new medicines and then negotiate thereimbursement price with authorities, serves toimpede innovation and discourage investment inresearch to develop more medical patents.

• Retail pharmacy is subject to entry and priceregulations that impede competition in both retail and manufacturer level prices.

• Tax issues for German bond issuers entail withholdingtaxes of 26.35%.

• The pharmaceutical drug approval process can oftentake more than a decade, requiring long-termfinancing.

• Expansion and construction of production facilities inforeign markets require significant financing duringthe construction stage.




Tenure 10 years tenure



Currency US Dollar

Underlying assetMachinery for the production of newly patented medical drugs

in new markets

Governing law German or English law

Listing As required



The opportunity: Infrastructure industry in UnitedKingdom• In 2014, the performance of UK infrastructure wasranked 10th in terms of infrastructure quality ascompared to France at 8th and Germany at 7th.

• According to the 2014 Infrastructure pipeline, 69% of planned infrastructure investment will be privatelyfunded, 19% will be publicly funded, and 12% will be financed by a mixture of public and privateinvestment.

The proposed issuer: ABC infrastructure group (UK)• ABC group finance, develop, build, and maintaincomplex infrastructure such as transportation, powerand utility systems, and social and commercialbuildings.

• Debt Securities used:- Guaranteed Convertible Bonds- ABC group aims to improve its range of debt fundingsources and liquidity through issue of convertiblebonds

The challenges:Private investment in infrastructure has always been an integral part of the UK’s financial framework,accordingly private infrastructure investment has begunto flourish in the market to support the gap in publicinfrastructure investments.

As reported by Nesta in 2014, alternative finance in the UK is expected to grow to £1.74 billion. Alternativefinance covers a variety of new financing models thathave emerged outside of the traditional financial system.

Business issues: • The Infrastructure sector in UK has suffered fromunder-investment in the public infrastructureinvestments.

Financing issues:• The need of government support in financinginfrastructure projects in the UK as the banks alonecannot meet the future financing requirements of theinfrastructure sector. To combat this, new innovativefinancing structures and avenues of raising capitalshould arise.

• Annual infrastructure spending will be more thandouble by 2020. This will create an opportunity foralternative financing to bridge gaps in financing.

The case for Sukuk issue:The key possible transactional features andconsiderations which set a Sukuk issuance apart are the requirements for Sharia’-compliant assets and utilization of proceeds.




Tenure Dependent on the project duration



Currency US Dollar

Underlying asset Construction of buildings ( project completion)

Governing law English or French

Listing As required

Regulatoryapproval

As required










Payment

Today Future

Delivery

Bank

Case scenario 6: Infrastructure industry(UK)



Case scenario 7: Agriculture industry(France)

The opportunity: Agriculture industry in FranceWith more than 950 thousand people working in theagriculture sector, the industry constitutes one of themost important industrial sectors in France. As one ofthe leading agricultural producers in Europe, the Frenchgovernment continues to support the industry throughpledging aid to help companies invest in modernizingproduction over the next three years.

Target company: Agriculture Limited • French group specializing in plant, animal and human nutrition (fertilizers).

• 77 production units, employing more than 7000employees across 46 countries.

• Strong emphasis on research, development andinnovation.

• No debt securities issued.

The challenge:Despite the resilience of the French agricultural industry,the bankruptcy rate for the sector has increased since2010. Firm productivity has thus become an importantdeterminant of the survival of the company.

Business issues: • High overheads, operational inefficiency, the end ofEuropean subsidies, as well as embargoes placed byRussia on European imports have made Frenchcompanies vulnerable to price competition from theirEuropean neighbors. It is crucial for French companiesto invest in technology to reduce operational costsand compete effectively.

Financing issues:• In order to invest in technology to compete moreeffectively, French companies require adequatefinancing to acquire the technology, know-how andequipment. Given that bank loans account for themajority of financing for the agricultural industry,companies will need to fulfill the requirements of high collaterals necessary to obtain bank financing.







Currency EUR

Underlying asset Machinery for the production of fertilizers

Governing law French law

Listing As required






Supplier1

3

2

4

Customer

Bank transfers usufruct to Agriculture Limited


Periodicrentals


SPV (Sukuk issuer)


Industry thought leaders’ perspectives

The challenges facing the Sukuk market for Europeanindustry are likely just a precursor to common challengesmany experts have anticipated in the following section.We set out to address three key strategic practice areasof regulation and tax, market structure and practices,and talent and skills development. The following are the points of views of industry thought leaders whogenerously contributed to this debate.

Regulatory and TaxAt the top of the agenda is the tax issue. “Tax treatmentis one of the key challenges as there is a tax break onthe interest payment for bonds while Sukuk profitpayments might fall into the category of dividendswhich are taxed, and certain tax exemptions such asdouble taxation on sale of asset need to be addressed,”said Ijlal Alvi, CEO, IIFM.

On the legal front, “some continental Europeanjurisdictions do not recognize the legal concept of trust,and an alternative therefore needs to be found to thecommon Sukuk concept of an SPV held by trustees.Such alternatives do exist, but where this is an issuesome thought may need to be given to the Sukukstructure, or it may need to be established under thelaw of a different jurisdiction,” remarked Peter Casey,Advisor, Board Advisory Member, IFSB.

Generally, there is a lack of a European Union-wideregulatory regime despite the single market. However,"the favorable tax jurisdictions such as Dublin andLuxembourg may be best for Sukuk. Other factorsinclude the currency issue which needs addressing.When should Sukuk be euro, sterling or dollardenominated?” commented Emeritus Professor Rodney Wilson.

“It is clear that existing and established internationalmarket regulations can encompass Sharia’-compliant as well as conventional financial practice. Similarly legalinfrastructure can also accommodate (although perhapsmore readily where English common law prevails) ifthere is a top down approach to determining whether it is appropriate to enable the requisite revision to suchlegislation where issues have become apparent,” saidStella Cox, Managing Director, DDGI Limited.

“One of the key challenges is identification of assets on the corporate balance sheet. I also suggest thatEuropean corporate issuers may consider issuing Sukukbased on the covered bonds model. From the BaselCommittee perspective it is important that Europeanregulators should recognize Sukuk from a capitaladequacy point of view,” observed Ijlal Alvi. Equallyimportant the need to create “Enabling regulatory andsupervisory framework for asset-based and equity-financing. This includes securitized assets, participatoryfinancing, and equity financing,” said Dr. Zamir Iqbal,Director, World Bank Global Centre for Islamic Finance.

Creating an efficient Sukuk market“Sukuk could be used to finance long-terminfrastructure investments in the context of public-private partnerships. How attractive are suchpartnerships for investors concerned with Sharia’compliance? There are many choices in how Sukuk canbe structured. Most European Sukuk have been basedon Ijara contracts, but is there scope for Musharakah or Mudarabah Sukuk? Convertible Sukuk may also beattractive to some investors, especially if there isoptimism about the longer term stock market outlook.Offering a variety of structures to serve different types of clients may be preferable than standardizing andpromoting a single structure,” explained EmeritusProfessor Rodney Wilson.

“However, the ability to enable and, if needed, enforce‘true sale’ of the assets, should in most circumstanceslimit the downside risk faced by an investor and as sucheffecting a real asset-backed transaction should havemarket appeal. Sukuk are suited to all sectors of theeconomy and a regulatory push could come into playthrough accurate risk charges for capital requirements,reflecting the limited potential for ultimate loss, whichshould result in a preferential risk weight allocation to atrue sale transaction” emphasized Sabeen Saleem, CEO,the Islamic International Rating Agency (IIRA).

The world’s capital markets are seeing their center ofgravity shift toward new types of investment assetclasses such as green bonds and Sukuk. Investors areevidently interested in these new assets looking forhigher returns. “At present, Sukuk tend to have higheryields than comparable bonds (possibly because there is an illiquidity premium),” asserted Peter Casey.


“UK practitioners are very aware that British and otherEuropean corporates have been accessing forms ofIslamic finance for many years, however theoverwhelming majority have done so through privatemarket arrangements which have included bi-lateral,club and syndicated facilities. In the UK there arenumerous examples even now. It might be suggestedthat there is a degree of standardization and familiarityin those structural arrangements that provides comfortto the beneficiary in terms of comparability of offeringsfrom other financial sectors (especially with regard tolevels of dependable commitment, pricing, governinglaw and legal precedent, tax treatment etc),” stressedStella Cox.

There are also a number of operating issues likely tohave impact on the way the Sukuk market evolves inEurope. For instance, the “establishment of a secondarytrading platform for Sukuk in an international Europeancenter, such as London, would boost the liquidity andtradability of Sukuk, thereby improving investmentdemand for Sukuk. In addition, such a secondarytrading platform for Sukuk could provide a usefulmechanism where issuers gain more understanding of the importance (particularly for investors) ofconsistent practices, allowing investors to evaluateSukuk investments more easily,” argued Sohail Jaffer,Deputy CEO, FWU Group.

However, Islamic banks appear to be “much more activein cross-border syndications, driven by an opportunisticapproach, particularly in emerging countries. Thisrequires specific strategies for European corporates totap into this niche market and benefit from the Sukuk’sattractive yield,” asserts Abdelilah Belatik, SecretaryGeneral, CIBAFI.

Moving towards the total standardization of practiceswould be difficult in the Sukuk market, “where eachSukuk issuance involves a unique set of underlyingassets. However, a certain degree of consistenttreatment of principles common to most Sukuktransactions would help facilitate a smooth, fasterissuance process–that would ultimately lead to morecorporates considering Sukuk as a viable means ofraising funding for their business and assist investorsduring their evaluation of Sukuk investments,” saidSohail Jaffer.

In addition to the tax obstacle, “Sukuk need to be givenequal treatment with conventional bonds including, inparticular, avoiding property transfer taxes when assetsare transferred into an SPV at the beginning of theperiod and out again at the end. From a regulatorypoint of view, thought needs to be given to thedisclosures that are made in the offering document, inparticular about the structure of the Sukuk, the Sharia’opinions obtained, and the Sharia’ compliance of theunderlying business. Subsequent disclosures, forexample annual financial statements, need to be thoseof the ultimate obligor rather than merely the SPV(which technically will be the issuer). Ideally thesedisclosure issues would be addressed through Sukuk-specific regulation, but within Europe it is likely thatcapital market regulators will be able, where necessary,to use general provisions to require the necessarydisclosures,” reiterated Peter Casey.

“So the challenge is potentially one for practitioners.How do we convince our corporate clients of the valueproposition of Islamic finance? Conversely, how do we identify the domestic market opportunities foroverseas investors that will support further broadeningof their own investment perspectives and, perhaps,diversification into assets that may not be their usualpreference, but that are better suited to support theorigination of wholesale capital market issues from the UK or other European market platforms?” said Stella Cox.

In addition to the tax obstacle, “Sukukneed to be given equal treatment withconventional bonds including, inparticular, avoiding property transfertaxes when assets are transferred into an SPV at the beginning of the periodand out again at the end


Managing brains Attracting skilled talent remains an exceptional challengefor the IIFS in all sectors and markets. This is especiallythe case for the Islamic capital market. “This is the mostimportant area that needs thought, engagement andaction by all stakeholders. Industry, academia andstudents need to bond together to deliver an effectiveoutcome. One of the best ways of doing this is throughprofessional accreditation, similar to that employed bythe accounting profession. In such a scenario, therelevant industry professional body sets the standardsfor competency and qualification, as well as ongoingprofessional development. Those standards areindependently accredited by the likes of the FAA.Universities and educational establishments as well as their programs are then accredited against thosestandards. This will ensure a common benchmark forglobal use and the inter-operability of human capitalacross geographies,” explained Daud Vicary Abdullah,President and CEO, The Global University of IslamicFinance (INCEIF).

“Leading investment banks and commercial law firms employ staff with experience of structuring and issuance. How can their knowledge be bestdisseminated? Are there proprietary issues to beaddressed impeding the free flow of information?” said Rodney Wilson.

“Stress on complete education in terms of economics,finance and accounting, in addition to completeknowledge of Islamic Fiqh simultaneously, is required to lead the development of the industry from this pointonwards. We need to turn increasingly to those whohave comprehensive knowledge in multiple fields ortowards multi-specialists,” reflected Sabeen Saleem.

“The Islamic financial sector has evolved and grownfrom a banking footprint in the emerging markets. Our ethical investment counterparts have come,predominantly, from the international markets but do not have a similar form of dedicated bankinginfrastructure to support them,” notes Stella Cox. “Work currently underway to research and explorepotential for collaboration and co-operation betweenthe two may provide further opportunities for bothfinancial market subsets to expand. Although it has long been acknowledged that the socially responsibleinvestment community may have interesting investmentopportunities for our market, from personal experience,there is a great deal of potential for socially responsibleinvestors to utilize and benefit from the Islamic capitalmarkets infrastructure available in the UK and elsewherein Europe (as well as the other core hubs of the industry)if the usual issues of knowledge, transparency andmutual understanding can start to be addressed,” she added.

Bank of England data show debt issuance by UKbusinesses running at twice the levels seen before the crisis. “Many corporates have restructured theirbalance sheets, repaying bank borrowing and financingthemselves with cheaper, long paid corporate debt. Inthis respect the UK corporate sector, which has longbeen largely dependent on banks for finance, isbecoming more like its US counterpart, where corporatebonds play a bigger role,” said Ian Stewart, Partner andChief Economist, Deloitte UK.

The establishment of a Center of Excellence by variousmarket participants and institutions will build capabilitiesand the skill sets required, according to Sohil Jaffer, with the following suggested three key benefits:• Act as a catalyst for driving the European Sukukmarket forward by championing consistent bestpractice.

• Provide a center that offers corporates/SMEs, investorsand other interested professionals guidance andeducation on the nuances related to the Sukukmarket.

• Encourage the development of skills relevant to theSukuk market (structuring, issuance, evaluation, etc.)by providing a body of knowledge established bymarket participants.

Attracting skilled talent remains anexceptional challenge for the IIFS in allsectors and markets. This is especially the case for the Islamic capital market.


Looking forwardHarnessing the potential of Sukuk market

Three main drivers familiar to capital market leadershave likely intensified the need for seeking alternativefinancing instruments: the growth imperative, scarceclassic bank lending, and regulatory change. These threeinterrelated topical issues were reflected in much of theanalysis in this report.

The results of this Deloitte study indicate that theprospects of a European Sukuk market are dependenton balancing the debate on two strategic fronts–thebusiness and financial benefits of issuing Sukuk asopposed to issuing conventional corporate bonds on the one hand, and on the other, the dialogue withregulatory and policy-makers aimed at supporting the industry to devise enabling regulatory and taxlegislations that help create interest from medium and large European corporates.

Overall, the study results reveal that several market andbusiness environment policies–in many Europeanjurisdictions–are changing for the good of industrygrowth. We expect continued development of Sukukstructuring and origination in light of the current global‘scarce debt’, which was further exacerbated by the fallin prices of oil and commodities. Given these dynamicchanges, the Islamic capital market’s business modelshould be reengineered to leverage this emerging needfor fundraising in Europe and elsewhere in the world.Arguably, in the Middle East and Asia (MEA), investorsaspire to diversify their investment portfolio with qualityassets in Europe which conform to the Sharia’ principles.In Europe, blue-chip firms and quasi-sovereignenterprises are keen to diversify their debt financingmethods and evidently search for cost effectivefinancing. These two markets can possibly make theSukuk a viable asset class in Europe.

Ian Stewart, Chief Economist, Deloitte UK asserts that“as banks have retrenched, alternative lenders, includingprivate equity firms and asset managers, have moved inas providers of debt finance to medium and largerbusinesses. Mid-cap private businesses, which do nothave access to equity funding, are increasingly turningto alternative lenders to diversify their sources offinance. Deloitte's Alternative Finance Deal Trackershows a 67% rise in the number of deals involvingalternative lenders in the UK and Europe over the lasttwelve months.” This supports our view that the Sukukmakes a potentially attractive asset class for large andmid-cap enterprises to finance investment projects,infrastructural development and PPPs.

Perhaps the challenge remains now in the“demonstration effect,” which is important forshowcasing the benefits of Sukuk. Two or three anchorSukuk issuances will help create the interest and forgedeals from both markets mentioned above.


Khaled HilmiPartner FSI Consulting Leader Tel +971 4 376 [email protected]

Aly El AzharyAudit Partner Tel +966 2 657 [email protected]

Joe El FadlPartnerRegional FSI Leader Tel +961 1 364 [email protected]

Nauman AhmedPartner ME Tax Leader Tel +966 1 3 887 [email protected]

James BabbPartner Clients & IndustriesLeaderTel +971 4 376 [email protected]

Dr. Hatim El TahirDeloitte IFKC ME Leader Tel +973 17 [email protected]

Aejaz AhmedERS Partner Tel +966 1 282 [email protected]

Research project team

Ying Ying Wong

Sajida Mohammed Business AnalystTel +973 17 [email protected]

Key contacts

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Deloitte provides audit, tax, consulting, and financial advisory services to public and private clients spanning multipleindustries. With a globally connected network of member firms in more than 150 countries, Deloitte brings world-class capabilities and high-quality service to clients, delivering the insights they need to address their most complexbusiness challenges. Deloitte has in the region of 200,000 professionals, all committed to becoming the standard ofexcellence.

Deloitte's professionals are unified by a collaborative culture that fosters integrity, outstanding value to markets andclients, commitment to each other, and strength from cultural diversity. They enjoy an environment of continuouslearning, challenging experiences, and enriching career opportunities. Deloitte's professionals are dedicated tostrengthening corporate responsibility, building public trust, and making a positive impact in their communities.

About Deloitte & Touche (M.E.)Deloitte & Touche (M.E.) is a member firm of Deloitte Touche Tohmatsu Limited (DTTL) and is the first Arabprofessional services firm established in the Middle East region with uninterrupted presence since 1926. Deloitte is among the region’s leading professional services firms, providing audit, tax, consulting, and financial advisoryservices through 26 offices in 15 countries with around 3,000 partners, directors and staff. It is a Tier 1 Tax advisorin the GCC region since 2010 (according to the International Tax Review World Tax Rankings). It has receivednumerous awards in the last few years which include Best Employer in the Middle East, best consulting firm, and the Middle East Training & Development Excellence Award by the Institute of Chartered Accountants in England and Wales (ICAEW).

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