legal guide09.indd - Islamic Finance News

Securitization and Shariah Law
By John H Vogel
Following the dramatic growth of securitized
financings during the past 15 years, the global
economic collapse of 2008-2009 brought an abrupt
end to these types of transactions, both in the
Middle East and North Africa (MENA) region and
the West. For the first time, there are defaults in the
Islamic Sukuk market — most notably East Cameron
Bay Partners and Investment Dar Company.
As recovery is seen in the economies of the Middle
East, as well as those of the West, there is likely to
be a substantial increase in governmental regulation
of the financial sector, including a greater level of
standardization, harmonization and transparency.
Moreover, liquidity is much reduced throughout the
MENA region as a result of the worldwide economic
crisis, as well as a “freeze” by central banking
authorities in the Middle East on banking accounts
of some developers. As a result, it is likely that there
will be a renewed effort to encourage securitization
in the MENA region of qualifying assets. Saudi Arabia
has said it will institute a “Fannie Mae”-like structure
for housing, and the UAE is likely to do the same.
In addition, MENA countries are increasingly permitting
the foreign ownership of real estate, a condition
for successful securitization. For MENA countries, asset
securitization would help in the creation of new
markets, reduce financial institutions’ capital adequacy
requirements and sector concentration risk,
and expand corporations’ access to new sources of
finance on favorable terms.
The challenge, looking forward, is the harmonization
and standardization of Shariah-compliant financial
products, allowing their transformation into marketable
financial instruments.
Many MENA countries are undertaking large-scale
infrastructure projects requiring long-term finance,
including roads, bridges, power and water facilities,
oil and gas facilities and telecommunications. These
Securitization 101
To refresh the reader’s memory, a securitization
is a transaction whereby an asset (including payment
streams from assets) is separated from the
owner or originator of such an asset and independently
financed, based upon its characteristics.
To accomplish this, a single purpose entity
(SPE) is created that purchases the asset from
the owner/originator. The SPE obtains the funds
for the purchase by issuing securities that represent,
depending on the overall kind of transaction
and legal regime, either ownership or some
other obligation encumbering the asset at issue.
The sale and the securities issuance are consummated
concurrently, so that the main risks the
purchasers of the securities face are risks related
to the asset itself and not the credit risk of the
owner/originator. The SPE has restrictions on
its ability to incur debt, make other financial arrangements,
declare bankruptcy or insolvency
and operate the asset.
For a securitization structure to comply with Shariah,
the assets being securitized must be consistent
with the principles of Shariah (the securitization
of pools of interest-bearing loans would
not be appropriate, for example) and should be
a tangible asset.
The relationship between the underlying obligor
and the originator should also fall within one of
the accepted Islamic finance schemes. Because
the main principle underlying any Islamic finance
operation requires that the operation be assetbacked
in the context of a Shariah compliant securitization
structure, it must then translate into
some degree of ownership. Another major principle
is equitable risk-sharing as to the underlying
assets by the parties to the transaction.
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