Welcome change for sukuks

Ministerial Order 388 of 2007 amended Executive Regulation 113 of 1992, (executive bylaw of the Decree Law 31 of 1990 for the Regulation of Securities and Foundation of Investment Funds as amended ( the Executive Regulation), and became the first rules promulgated in Kuwait with respect to the issuance of sukuks. Prior to the amendment of the Executive Regulation, Islamic finance companies located in Kuwait needed to go offshore (for example to Bahrain or the Cayman Islands) in order to issue sukuks. Ministerial Order 388 has finally brought sukuks within the ambit of the Executive Regulation.

Article one of the amended Executive Regulation provides the first definition of a sukuk under Kuwaiti regulations. Sukuks are defined as: "the instruments that have equal value issued by companies under certain types of contracts which comply with the Islamic shariah such as musharaka, mudharaba, ijarah or an investment agency in certain investment project or activity, subject to the provisions of the relevant laws". The Executive Regulation further provides that the recognised features of sukuks in Kuwait are:

• They are instruments issued in the name of the sukuk holder in equal denomination amounts to prove the right of the holder in the underlying assets, benefits and services.
• They represent a common share of the ownership of real assets, benefits or services available at the disposal of the issuer company or the real assets, benefits or services to be made available. However, they do not represent indebtedness by the issuer thereof to the owners of sukuks.
• They are issued under a legal contract subject to shariah rules regulating the relation between the respective parties, their issue and trading mechanism as well as their return.
• Sukuks shall be traded according to the shariah conditions and rules stipulated for the trading of the underlying assets, benefits and services.

The amendment to the Executive Regulation should have the effect of enhancing the local sukuk market in Kuwait by allowing Kuwaiti companies to issue sukuks in Kuwait. The amended regulations should also enable Kuwait to participate in the growth of the sukuk market worldwide, which is expected to reach $100 billion over the next five years. Because sukuks can now be issued in Kuwait, the expectation is that small and medium-sized businesses in Kuwait that otherwise would not have been able to enter into the sukuk market will be able to do so under the new regulations.

However, even though the amendment to the regulations opens the door for sukuks to be issued in Kuwait, not one application to issue a sukuk has been filed with the Kuwait Ministry of Commerce and Industry (MOCI) to date. Even though Kuwaiti companies have been strong participants in the sukuk market – recently, for example a Kuwait company issued the first ever exchangeable sukuk out of Jersey, and the National Industries Group issued a $1.5 billion sukuk through a Cayman Islands special purpose vehicle. Some changes will likely need to occur in the sukuk market and regulatory environment in Kuwait for it to reach its full potential with respect to Islamic bond issuances.

Despite the recent amendment to the Executive Regulations, and even though Kuwait exceeds Bahrain in the number of Islamic investment institutions 31 to 23, Bahrain enjoys the international reputation for being the financial center for sukuk issuance in the Middle East. Bahrain's reputation may be aided by some of its business-friendly regulations of which Kuwaiti regulators should take note. For example, SPVs for sukuk issuances can be formed with paid-up capital of BD1000 ($2,700), and documentation can be filed in the English language. However, the effects of Ministerial Order 388 of 2007 may start to bridge that gap in perception by making Kuwait a more active player in the international sukuk market.

Even though the legislation is welcome, it could go further. Some of the more popular types of sukuk (for example ijarah) require the use of an SPV. Since the new legislation does not allow for the incorporation of SPVs either as the issuer or as part of the structure, an SPV will still need to be formed, which can take up to two months and require investment of substantial capital (exceptions to this include if a corporate entity already exists to be used instead of a newly formed SPV, or a new entity is incorporated offshore). Therefore, without additional changes to the law in Kuwait, the structure of sukuks issued in Kuwait may be limited.

What also compounds difficulties for setting up sukuks in Kuwait are that sukuks are currently subject to the same rules as bonds regarding maximum issuance amounts. Viewing sukuks just as debt and not as a right in the underlying assets (as per the express terms of Ministerial Order 388 of 2007) creates an injustice and a contradiction. Because of this view, Kuwaiti issuers will not be able to issue sukuks above their paid-up capital (as with conventional bonds in Kuwait) which will relegate the local market to small and medium-sized sukuk issuances, while the billion dollar sukuk issuances will still go offshore. Future companion legislation concerning sukuk capital requirements will need to be enacted before Kuwait can establish a more prominent profile when it comes to larger Middle East sukuk issuances.

The legal and business communities in Kuwait have urged the MOCI to allow foreign-issued sukuks to be marketed in Kuwait. Sukuks which are issued in foreign markets face restrictions that are generally applicable to the marketing and sale of any type of securities in Kuwait. The marketing, offer and sale of any securities in Kuwait require the approval of the MOCI and the Central Bank of Kuwait (CBK), regardless of whether the security in question is a private placement or public offering. Furthermore, under Kuwait securities law a licence or approval to market, sell and offer any foreign securities in Kuwait cannot be issued directly to a foreign entity. Such a license or approval will only be issued by the MOCI to a Kuwaiti joint stock company (typically a Kuwaiti bank or Kuwaiti investment company), the objects of which provide for the investment of funds for their own account or on the behalf of third parties. Therefore, foreign-issued sukuks, even if permitted by the MOCI for marketing, offer and sale in Kuwait will ultimately need to be negotiated through a Kuwaiti entity.

In addition to the above, procedural arrangements and implementing legislation will need to be discussed and enacted by the MOCI and the CBK. The first sukuk filing under the new Executive Regulation will compel the CBK and MOCI to agree on procedure and logistics for future sukuk issuances. Such rules may take significant time to develop before the market in Kuwait becomes a viable option for Kuwaiti companies wishing to issue sukuks locally.

The amendment to the Executive Regulation is a welcome change; however, Kuwaiti law must be refined and amended in order for Kuwait to take its place as a complete player in the international Islamic finance market. The mindset of the market in Kuwait has yet to adjust to the new legislation, as so far there have been no applications filed to issue a sukuk according to the new regulations. Some future legislative change will be necessary before Kuwaiti Investment companies will be able to freely and easily issue and market sukuks without recourse to markets outside of Kuwait. The legal and investment communities alike look forward to the future developments in the evolving sukuk market place in Kuwait.