UK: A growing market for corporate sukuk?

Arab News : The publication at end June 2008 of a detailed "Impact Assessment of Sukuk (Islamic Bonds) Legislation" in the UK and the confirmation by Kitty Ussher, the economic secretary to the Treasury and City minister, that she was hopeful that it would be possible to issue a debut UK sovereign sukuk sometime during 2009, and that the Treasury's Debt Management Office was working toward this possibility, has raised expectations that the UK might well be a growing market for corporate Sukuk originations over the next few years.

The impact assessment follows a market consultation exercise on the possibility of the UK issuing a debut sovereign sukuk in the wholesale sterling market, and provides a valuable insight into how the UK Treasury and HM Revenue & Customs (HMRC) view alternative financial products, in this case Islamic finance. In fact, HMRC has further published a consultation document on "Stamp Duty Land Tax: Commercial Sukuk".

The conclusions in both documents suggest that if the UK opted not to introduce sukuk legislation "would mean missing opportunities to develop Islamic finance in the UK, including addressing stamp duty land tax (SDLT) barriers to business and would allow tax inequality of alternative finance products to continue. The clarification of tax rules will encouragement the development of the alternative finance industry. A competitive market in these products could substantially benefit London as a global financial player, generating further investment."

In early June 2008, following a meeting of the Treasury's Islamic Finance Experts Group (IFEG), Ussher announced that the UK government favored a "bill-like" Sukuk program which could be fully integrated with the conventional Treasury bill program. Subject to some remaining barriers to be overcome, a rolling program of up to 2 billion pounds of "bill-like" sukuk issuance would be achievable over time.

Bankers such as David Testa, CEO of Gatehouse Bank, stress that it is not cost efficient to issue a corporate sukuk out of the UK because of the current SDLT regime. As such, he advises any UK corporate wishing to issue a sukuk to do so offshore.

SDLT, according to HMRC, is a charge on the acquisition of a chargeable interest whether or not evidenced in writing. Issuing a conventional bond secured on a building does not cause any SDLT to arise.

In a sukuk structure, however, according to HMRC, the originator (the financial institution) in order to be Shariah-compliant must transfer an asset to a special purpose vehicle (SPV) so that the investors can own part of the underlying asset. SDLT will therefore be charged if a chargeable interest such as a building is transferred to an SPV that issues a sukuk, and is charged again when the originator buys back the building when the sukuk is wound up.

If there is no change in the legislation, then any sukuk issuance in the UK will be subject to the following potential three SDLT charges:

i) SDLT Charge I - SPV purchasing asset from originator. At this point, the purchaser (the SPV) will be liable for a chargeable consideration for the transaction at a rate of 4 percent (assuming the asset is valued more than 0.5 million pounds)

ii) SDLT Charge II - Originator purchasing asset from SPV. On the winding up of the Sukuk, the originator will purchase the asset back from the SPV, at the point the purchaser (this time the originator) will be liable for a chargeable consideration for the transaction at a rate of 4 per cent (assuming the asset is valued more than 0.5 million pounds).These extra charges puts the structure at a considerable disadvantage relative to conventional securitizations.

iii) SDLT Charge III - There is also some uncertainty as to whether sukuk certificate holders would be liable to SDLT, as the certificate will evidence their interest in an underlying chargeable asset.

In the case of SDLT, stressed HMRC in the impact assessment, it is desirable that no SDLT is charged when land is sold to the issuer of sukuk; no SDLT is charged on the leaseback of the building to the vendor; and that no SDLT arises on the issue of the sukuk certificate.

The cost benefit analysis reveal that one-off and annual costs by main affected groups (the UK Treasury, HMRC, issuers, investors) for the introduction of the sukuk legislative framework are minimal. The assumptions are that the total costs would depend on the cost of sukuk issuance and the likely number of issuances. The issuance of commercial sukuk is voluntary so the benefits will necessarily outweigh the costs. The exchequer costs are likely to be minimal, subject to precise details of implementation.

Should the sukuk legislation go ahead, the HMRC will enforce the policy; the annual cost of enforcement would be minimal to the exchequer; enforcement would comply with the Hampton Principles; and the policy will not have a significant impact on competition.

The impact assessment however warns that "continued difficulties with the development of Shariah-compliant products gives the potential to cause difficulty and frustration for the financial institutions offering such products and within the UK Muslim community."

However, it adds that "there are clear social and equality benefits in the wide availability of well-defined, well-regulated financial products for all sections of the community. It is reasonable to expect that the development of a regulated Islamic financial sector in the UK would bring into the regulated environment financial transactions that may currently be taking place without any significant regulation or consumer protection."

HMRC will also conduct a post-implementation review of any sukuk legislation to establish actual costs and benefits and the achievement of desired policy effects within 1-3 years of the introduction of any legislation.