legal guide09.indd - Islamic Finance News

Convertible Sukuk in Kuwait: A Legal
Framework
By Hossam Abdullah
Given the current turmoil of the international
financial sector, convertible Sukuk becomes one of
the most attractive corporate finance instruments to
both issuers and investors. Convertible Sukuk grants
the Sukuk holders the option to convert the Sukuk
for a pre-agreed number of listed and traded shares
in the issuing entity or the obligor.
As such, convertible Sukuk are considered hybrid
instruments with both beneficial ownership of the
Sukuk assets that have underlying Shariah compliant
transactions such as Ijarah, Musharakah or
Mudarabah that generate a profit return and equity
features. A common misunderstanding is that Sukuk
are bonds or debts but from a Shariah standpoint,
Sukuk should represent ownership of underlying
assets or transaction which determine whether or
not they can be traded in the secondary market.
Companies would typically consider the factors
stated below before proceeding to issue Sukuk:
• conversion price — the nominal price per share
at which conversion would take place
• conversion ratio — the number of shares each
convertible Sukuk converts into which may
be expressed on a number of Sukuk or as a
percentage
• conversion value — the result of multiplying the
conversion price by the conversion ratio
• conversion premium — the divergence of the
market value of the Sukuk compared to that of
the conversion value
Issuers may also prefer to have an early redemption
call feature to induce investors to exercise the
conversion option at the right timing.
The main benefit for a corporate entity to issue
convertible Sukuk is to reduce the cash profit
payment it makes to Sukuk holders as compared
to a standard Sukuk. In exchange for this benefit,
the value of shareholders’ equity is reduced due to
the equity dilution if the Sukuk holders convert the
convertible Sukuk into new shares. From investors’
prospective, despite the low profit rate of return,
convertible Sukuk carry an additional value through
the option to participate in the company’s equity as
they benefit from the potential rise in the price of
the underlying stock. If the stock does not perform
well there would be no conversion and Sukuk
holders would hold on to the Sukuk until maturity
with a lower return as compared to the return of
non-convertible Sukuk.
The shares or the equity to be delivered against the
redemption of the convertible Sukuk do not need to
exist at the time of issue of the convertibles. Often,
such shares or equity are issued in the future by the
issuer or the obligor upon exercise of the conversion
option by the Sukuk holders.
In addition to cost, timing, Shariah and tax issues
applicable to Sukuk generally, among the most
important issues lawyers will need due diligence
before recommending issuance of convertible Sukuk,
are the level of support the legal framework can
afford for a smooth issue and conversion of Sukuk.
These include the recognition of Sukuk issue in the
target jurisdiction, structure of the Sukuk to be a
bankruptcy remote from the issuer and the obligor,
whether the company which will issue the equity
part upon conversion is allowed to have authorized
capital to ease the conversion process, and any
restriction on the maximum face value of Sukuk a
company can issue.
Kuwaiti convertibles — issues
Unlike some of the GCC jurisdictions, there has been
no specific provision in Kuwait for the issuance of
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