Stricter rules could impede sukuk market

Fitch Ratings says further tightening of the guidelines issued by scholars on Islamic securities issuance may negatively affect the development of a liquid and efficient asset-backed sukuk market.

While Fitch is indifferent about the choice by originators of an Islamic versus a conventional ABS structure, it warns imposing excessively strict guidelines will result in structures that are both cumbersome and highly singular, potentially restricting the scope of this market.

"In the context of the Mena region, a liquid, transparent and efficient ABS sukuk market is of paramount importance as countries including Saudi Arabia and the UAE face substantial infrastructure investments for their development programmes," said Jaime Sanz, senior director in Fitch's Emerging Markets Structured Finance team.

Fitch noted the current debate whether guidelines should be tightened or loosened has led to some confusion as to what will be acceptable under future Shariah-compliant ABS issuance. In Fitch's view, a clear and widely accepted set of rules would facilitate investors' understanding of asset-backed securities in an Islamic context.

The agency has found the following four key areas of uncertainty when presented with Islamic structures by emerging market originators and arrangers. First, there remains considerable uncertainty as to the Islamic treatment of securitisations of future receivables.

While informally the guideline has been that no less than one-third of a securitisation's assets must be Ijara (real existing) assets, there is no formal clarity as to whether future receivable structures (which are detached from real assets) could become Shariah-compliant under certain conditions.

Second, tranching is problematic for ABS structures that seek to be Shariah-compliant, as the uneven sharing of risk and reward among investors is considered unIslamic, even if subordinated investors accept their junior position in the waterfall. Third, hedging mechanisms within ABS structures are again viewed as unIslamic, since accepting a possible future loss is considered tantamount to speculation. As a result, Fitch has not been presented with any Islamic ABS structure including a fully-compliant hedge solution.

Last, an originator's undertaking to purchase a sukuk's principal at face value at maturity again creates problems in Islamic finance. This is because the fair market value of that principal may have diverged from its nominal value at issuance, again creating a conceptual problem of speculative investing under Shariah guidelines.

Whether a transaction is Shariah-compliant or not typically does not affect enforceability upon an event of default before maturity. However, if a transaction's structural or legal aspects are modified substantially to achieve Shariah-compliance, Fitch and its legal counsel will examine the impact of such modifications on enforceability.

Ultimately, Fitch relies on the judgment of a transaction's scholars as to Shariah compliance, and on the fact that once a fatwa has been issued for a specific transaction, the decision is unequivocal and cannot be challenged or revoked.