Sukuk under Turkish Law

Islamic finance is growing in popularity and becoming a major financial instrument-setter in the world of finance. Innovative structures created one after another have triggered the ever-increasing trend towards Islamic finance.

Among these innovations is sukuk (sukuk is the plural form of “sak”), basically a trust certificate and commonly referred to as the general name for Islamic bonds that first appeared in Malaysia in 2002. Sukuk has not only been attracting the attention of Muslim investors trying to avoid interest gains but has also become a profitable investment tool for investors from Europe, North America and the Far East looking to diversify their portfolios and get a higher return and/or yield on their investments.

First of all, a sukuk transaction may be structured like a bond issue or a securitization scheme. Bond-like sukuk issues have been criticized by distinguished scholars as these structures may not fall into the permissible area drawn by the Quran: sunna (dictum/practice and decisions of the Prophet), ijma (consensus of the community of scholars) and qiyas (analogical deductions and reasoning). However, securitization, a structured finance technique born in the US in the early ‘70s that became a trillion dollar industry in less than 40 years, perfectly fits the needs of investors who want to comply with the rules of Islamic law while investing in a relatively safe instrument.

The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) defined sukuk as certificates of equal value put to use as common shares and rights in tangible assets, usufructs and services or as equity in a project or investment activity. Sukuk are not debts of the issuer, they are fractional or proportional interests in underlying assets, usufructs, services, projects or investment activities. Furthermore, the underlying business or activity, and the underlying transactional structures (such as the underlying leases), must be Shariah-compliant (for instance, the business or activity cannot engage in prohibited business activities).

According to AAOIFI standards, sukuk must demonstrate:

* that any income arising must derive from the underlying activities for which the funding has been used, and not simply comprise interest;

* sukuk must be backed by real underlying assets and these assets must be Shariah-compliant in nature and be being utilized as part of a Shariah-compliant activity; and

* there must be full transparency as to the rights and obligations of all parties.

Sukuk structures are mainly built on traditional Islamic contract types such as ijara (lease), murabaha (cost-plus financing), mudaraba (where one party injects capital while the other puts in sweat equity), musharaka (where both parties contribute capital), istisna (where a manufacturer undertakes to manufacture a specific asset for a client), and so on. The most common Islamic contract type used for sukuk transactions is ijara.

An ijara sukuk structure basically works as follows: A single or a group of assets that are admissible for ijara contracts are selected. The originator creates a Special Purpose Vehicle (SPV) with a separate independent legal entity to whom it sells the asset(s) with the understanding that the originator will lease back the asset(s) from the SPV. Rent is negotiated and a term-specific lease contract is signed. The SPV then securitizes its assets by issuing ijara sukuk for sale to investors. The sukuk sale proceeds to provide funds to the SPV to pay for the asset(s) purchased from the originator. A rent-pass-through structure is adopted by the SPV to pass on the rents collected from the lessee to sukuk holders. At the expiry (or termination) of the lease deed the flow of rents would stop and ownership of the asset pool would be with the sukuk holders as a group. The sukuk contract embeds a put option to the sukuk holders that the originator is ready to buy the sukuk at their face value on maturity or the date of dissolution.

Next week, I will be giving details on Turkish sukuk law, which is a new chapter in the Turkish Capital Markets Law.

Berk Cektir http://www.berkcektir.av.tr/ The information provided here is intended to give basic legal information. You should get legal assistance from a licensed attorney at law while conducting legal transactions and not just rely on the information in this corner. http://www.todayszaman.com info@berkcektirlaw. Photo by photoexpress.com.