LEGAL ALERT LUXEMBOURG SOVEREIGN SUKUK 18 JULY 2014
I. INTRODUCTION Islamic finance refers to transactions which are designed for the purpose to respect Islamic values. In a nutshell, the objective of Islamic Finance is therefore to ensure that risks and rewards pertaining to a financial transaction are shared between the party that contributes capital and the party that uses it. In this respect, the return received by investors in a transaction which is compliant with the principles of Islamic Finance must be based on real physical assets and cannot be derived from cash made available by the bank to the borrower against periodic interest payments. To foster Luxembourg's position as one of the leading Islamic Finance centers in the Eurozone, the Luxembourg Parliament has enacted on 9 July 2014 a law for the purpose to issue the first sovereign Sharia compliant bond (the Sovereign Sukuk) in the Eurozone (the Sukuk Law). The initiative of the Luxembourg legislator purports to induce and encourage a diversification of the Luxembourg financial center towards the promising market of Islamic Finance based on the existing framework for Islamic Finance in Luxembourg 1. As the Luxembourg Parliament s finance and budget commission in relation to the Sukuk Law (the Commission ) stressed, Luxembourg should gain and enjoy a first-mover advantage in this field, being the first non-islamic State to issue Euro-denominated Sukuks in the Eurozone. II. PRINCIPAL FEATURES OF SUKUKS Sukuks are Sharia compliant financial instruments, which are issued in order to raise finance in a Sharia compliant manner and, like conventional financial instruments, can be listed on a stock exchange. By subscribing a Sukuk, its holder will receive a beneficial ownership in the underlying assets, which are acquired with the issue proceeds. Typically, the underlying assets produce periodic payments, such as rental or lease installments, to be paid to the issuer of the Sukuk, which will use the cash-flows to make periodic payments to the investors. These periodic payments do not, from an Islamic Finance perspective, qualify as interest but represent a return which is generated by the performance of the underlying assets. At maturity, the issuer will redeem the Sukuk and pay to the investors the principal owed under the Sukuk through the sale of the underlying assets. III. PRINCIPAL FEATURES OF THE SOVEREIGN SUKUK The Commission has defined the Sovereign Sukuk as a fixed-term financial instrument backed by a tangible asset. The issue of the Sovereign Sukuk will provide for three key elements reflecting, in principle, the same economic rationale applying to fund raising by the Luxembourg State in respect of the issue of a conventional sovereign bond: - the Luxembourg State will create a special purpose vehicle (SPV) having the legal form of a public limited liability company (société anonyme), which will issue the EUR200,000,000 Sovereign Sukuk and purchase with the issue proceeds three buildings in Luxembourg-City for EUR200,000,000; - for a term of five years, the SPV will lease the buildings to the Luxembourg State, which will sublease them. The rental payments received by the SPV will be used to make periodic payments under the Sovereign Sukuk to investors and to pay the costs incurred by the Luxembourg State in relation to the set-up and maintaining of the structure; - at maturity of the Sovereign Sukuk, the Luxembourg State will compulsorily buy-back the buildings for EUR200,000,000, which amount will be paid to the investors when the SPV will redeem the Sovereign Sukuk. 1 http://www.cssf.lu/en/finance-islamique/ 2
IV. CLARIFICATIONS MADE BY THE COMMISSION The Commission clarified that: - the incorporation of the SPV will not require any contribution in kind but only the minimum cash contribution necessary in connection with the establishment of a public limited liability company (société anonyme); - the placement of the Sovereign Sukuk to investors is similar to a traditional bond placement; - the State will bear the risks pertaining to the buildings as if it had retained their property, so that the issue of the Sovereign Sukuk will, from this perspective, be economically transparent. The Commission clarified that the guarantee to be granted by the Luxembourg State over the sale of the buildings (garantie de bonne fin) will only cover a five years period, and will not place the investors in a better position than under a traditional bond issue; - the tax treatment of the Sovereign Sukuk must be individually assessed by each investor and is not addressed by the Sukuk Law 2 ; - despite concerns voiced by the Conseil d Etat regarding the costs to be incurred in connection with the issue of the Sovereign Sukuk, such measure is necessary to tap the targeted source of financing. From an economic policy perspective any potential additional costs should be largely outpassed by the overall profit expected for Luxembourg from the diversification of its financial industry. V. DISCLOSURE AND INVESTOR PROTECTION The issue of the Sovereign Sukuk will advertise the attractiveness of Luxembourg as location for the issue of private Sukuks. In this respect, attention must however be paid to the applicable disclosure and investor protection rules. Depending on whether a private Sukuk will be marketed to investors by an offer including a listing on the regulated market or the Euro MTF market of the Luxembourg Stock Exchange or by way of private placement, the disclosure in the offer documents in relation to the issuer and the underlying assets may need to comply with the provisions of the Luxembourg Prospectus Law 3, the Prospectus Regulation 4 or the rules and regulations of the Luxembourg Stock Exchange. Further, a Sukuk could qualify as asset backed security or, subject to certain conditions, as guaranteed debt security for the purpose of the Prospectus Regulation, which will trigger different disclosure regimes. Further, a Sukuk may, under certain circumstances, also qualify as a structured finance instrument within the meaning of the CRR 5 triggering further disclosure requirements in accordance with CRA 3 6. 2 See Circular of the Luxembourg Tax Director L.G.-A nr 55 of 12 January 2010, at p.5, n 3.2 for the position of Luxembourg tax authorities in relation to Sukuks 3 Luxembourg law of 10 July 2005 on prospectuses for securities, as amended 4 Commission Regulation (EC) No 809/2004 of 29 April 2004 implementing Directive 2003/71/EC of the European Parliament and of the Council as regards information contained in prospectuses as well as the format, incorporation by reference and publication of such prospectuses and dissemination of advertisements, as amended, inter alia by the Commission Delegated Regulation (EU) No 486/2012 of 30 March 2012 amending Regulation (EC) No 809/2004 as regards the format and the content of the prospectus, the base prospectus, the summary and the final terms and as regards the disclosure requirements 5 Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 6 Regulation (EU) No 462/2013 of the European Parliament and of the Council of 21 May 2013 amending Regulation (EC) No 1060/2009 on credit rating agencies 3
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