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Sukuk to finance investment and government projects

الصكوك - sukuk

Sukuk are securities issued by companies or governments to raise funds from investors in order for financing specific projects. Sukuk are been issued according to a contract between issuer and investors. Sukuk are securities that carry a specified financial value and maturity period. Sukuk are characterized by their ability to achieve predetermined financial returns for a specific period, as well as the legal protection provided by the Egyptian legislature for investors’ rights in this regard.

In Egyptian law, Sukuk are been included among the commercial securities that can be freely traded and can be held by banks, companies, and individuals alike. Sukuk can be used to fund various projects, such as infrastructure projects, real estate projects, small and medium-sized enterprises, as well as government projects, through providing an alternative source of financing rather than the traditional loans.

The types of Sukuk are vary according to the agreed terms and conditions between the issuer and the investors, we will discuss main principles of Sukuk.

What is the term of Sukuk?

The term sukuk means equal value securities, issued for a specified period not exceeding thirty years, each representing a common share in ownership, assets, benefits, specific projects, or cash flows, as determined by the Issuance Contract.

What is the process of Securitization?

Securitization is a process through-which the ownership of assets, benefits, or project rights of the financing institution are acquired in exchange for issuance of Sukuk in return. Such process shall be executed according to issuance contract in-which contain the basis of Sukuk issuance in accordance with the provisions of this law.

The contract regulates the relationship between the issuer, the beneficiaries, the issuer’s regulator, and Sukuk holders, regarding the mechanism of how to invest the returns of Sukuk, the duration of this investment, the expected returns, the method of distribution, and the obligations of those parties.

The securitization process can be done either through a Sukuk issuance company or by beneficiary institution issuing Sukuk by itself according to the rules governing this matter.

The legal framework for Sukuk Issuance

Law No. 17 of 2018, has been issued to amend some provisions of Capital Market Law No. 95 of 1992, Such law regulates the legal framework for Sukuk issuance, including the contract format for Sukuk issuance, their trading as one of the types of securities that can be offered and traded.

The role of parties involved in the securitization process, the conditions for the beneficiaries of Sukuk issuance, continuous disclosure requirements after Sukuk issuance and until redemption, accounting standards that the beneficiary institution and the Sukuk issuance company shall comply with, as well as the auditing standards that auditors shall comply with.

Furthermore, the Prime Minister issued Decree No. 2479 of 2018, amending the Executive Regulations, which includes the provisions for Sukuk offering and procedures, the information included in the prospectus for Sukuk issuance, disclosure requirements during the term of Sukuk, and the rules for forming a Sukuk holders’ group.

Parties of Sukuk Issuance process

  • Sukuk Company:

The entity that issues Sukuk and holds the assets, benefits, rights or projects being financed on behalf of the Sukuk holders. It also transfers the funds collected to the beneficiary and acts as an agent for the Sukuk holders, ensuring the periodic payment of returns and the redemption value at the Sukuk maturity date.

  • Beneficiary:

Legal entity that benefits from the financing revenues resulting from the Sukuk issuance and holds the assets, benefits, rights, projects or other rights.

The Egyptian Capital Market Law allows certain entities, companies, authorities, and international or regional organizations to benefit from financing through issuing their own Sukuk.

  • Issuance Arranger:

A bank or a financial securities company established in accordance with concerned laws or any other licensed institution authorized by FRA to manage and organize the issuance of Sukuk on behalf of the beneficiary and issuer.

  • Paying Agent:

A licensed bank by the Central Bank of Egypt to act as an agent for the issuer in coordinating the payment of Sukuk and the redemption of their value at the end of the period to the Sukuk holders or one of the licensed companies engaged in the activity of issuance and central registration.

  • Credit Rating Agency:

A licensed company by FRA to study the credit worthiness of the Sukuk issuer and to issue a report indicating its ability to fulfill its obligations towards the Sukuk holders or not

  • Custodian:

A licensed company by FRA to provide financial and legal record-keeping services for Sukuk, and to perform clearance and settlement for the emerging financial positions resulting from Sukuk trading operations and registration of mortgage rights on them. The custodian also monitors the entitlements of the Sukuk holders and provides periodic reports to either the Sukuk issuer or the beneficiary as the case may be, according to contracts, or Sukuk agreements.

  • Independent Party:

This is a legally independent person from the beneficiary and the parties involved in the Sukuk process. They are appointed with the approval of FRA to represent the Sukuk holders and protect their rights, and act as a delegate for the issuance in cases where the Capital Market Law permits the beneficiary to issue their own Sukuk by it selves.

Sukuk Types

1- Mudaraba Sukuk:

These are issued based on a Mudaraba contract between the Sukuk holders and the issuer, and the proceeds from the issuance shall be used to finance an economic activity or a specific project managed by the issuer.

Sukuk represents a common share in the ownership of the main assets, Sukuk proceeds are distributed from the profits generated by the activity or the project according to the ratio specified in the contract. The face value of the Sukuk is repaid at the end of its term from the activity or the project.

2- Murabaha Sukuk:

These are issued based on a Murabaha contract or issued to finance the purchase of a Murabaha commodity to be sold to the buyer after the issuer acquires and receives it.

Sukuk represents a common share in the ownership of the commodity after its purchase and before its sale and Sukuk proceeds will be the price difference after its sale to the buyer who promised to buy it.

3- Musharaka Sukuk:

These are issued based on a Musharaka contract, and the proceeds from the issuance are used to finance the establishment of a project, the development of an existing project or to finance an activity based on partnership.

Sukuk represents a common share in the ownership of the Musharaka assets, and Sukuk holders are entitled to a share of the profits generated by the partnership according to the proportion of their Sukuk ownership. 

4- Ijarah Sukuk:

These are issued based on an ijarah contract for assets or services, and the proceeds from the issuance are used to finance the purchase of the assets or services to be resold to the recipient of these assets or services.

Sukuk represents a common share in the ownership of the assets or services. Sukuk proceeds are the price difference between the purchase price of the assets or services and their sale price.

5- Shariah Sukuk:

The Capital Market Law sets conditions for Sukuk issuances to comply with the provisions of Islamic law, known as Shariah Sukuk or Islamic Sukuk.

Which can be referred to in any of its contracts, prospectuses, documents, promotional materials, or advertisements, according to the following conditions:

  1. A Shariah Supervisory Committee shall be formed for the issuance at FRA in accordance with the regulations issued by a decision of the board of FRA regarding the requirements for forming Shariah Supervisory Committees and the conditions for their membership.
  2. The project to be securitized shall be approved by the Shariah Supervisory Committee, indicating its compliance with the provisions of Islamic law.
  3. The request for listing and trading Sukuk issuance on any stock exchange shall be approved by the Shariah Supervisory Committee. Such Committee shall be committed to verifying the continuation of the sukuk’s compliance with the provisions of Islamic Sharia.
  4. The Board of Directors of FRA issued Decision No. 42 of 2019 regarding the formation and membership requirements of Sharia Supervisory Committees for Sukuk issuances that are compatible with the provisions of Islamic Sharia.

What is the difference between stocks and bonds?

Sukuk, bonds and stocks are financial instruments that are dealt in the financial markets and we need to differentiate between them; In order to understand the nature of these tools and their distinctive characteristics.

  • Sukuk are similar to stocks in that both represent ownership of a return-producing asset, or participation in the capital of a profitable project.
  • The sukuk is not interest arranged on the nominal value, but rather it is a profit originating from the activity in which the sukuk holders’ funds were used. or the revenue generated from the assets they own under the sukuk.
  • The structure of the issuance of sukuk makes the return on it and its price in the market less volatile, and therefore more predictable.
  • Sukuk are not permanent for the issuing company, as is the case with shares. Rather, they have a term in which they are liquidated in the ways stipulated in the prospectus.
  • The holder of the share has, upon liquidation, his share of the company’s assets when it is liquidated and debts are paid off. As for the sukuk, they are designed to enable its holders to recover their capital or close to it at the end of its term, regardless of the value of the issuer’s assets for the sukuk or his ability to pay his debts to others.
  • The sukuk’s nominal value is not guaranteed by the issuer, and therefore it is not a debt owed by the issuer, unlike bonds.
  • The sukuk has an expected return linked to that nominal value.
  • And that the issuance structure includes arrangements that reduce the risks of fluctuations in the price of the sukuk and lead to the stability of the amount that the sukuk holder can recover at the end of its term.