CIS region sukuk first analysed

Author: Ashley Lee | Published: 16 Aug 2012
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The Development Bank of Kazakhstan’s (DBK) sukuk offering marks the first such issuance out of the former Soviet Union. But compliance with local laws proved considerable challenging for deal counsel.

The landmark MYR 240 million ($75.5 million) 5-year sukuk al-murabahah offering by the Development Bank of Kazakhstan, a wholly-owned subsidiary of the government of Kazakhstan, to Malaysian and Kazakh investors signals the opening of former Soviet countries to Islamic finance. In an unusual feature for Malaysian ringgit-denominated sukuk, it is listed on the Kazakhstan Stock Exchange (KASE).

Deal counsel told IFLR that much of their time went towards educating the Kazakh institutions involved regarding Islamic instruments, especially the murabahah structure. Both Kazakh regulators and the Kazakh government were eager to see the transaction go ahead, however.


Nonetheless Mark Lim, a partner at Baker & McKenzie firm Wong & Partners, who acted as Malaysian law counsel for joint lead managers Royal Bank of Scotland and HSBC Amanah Malaysia, said that most complexities of the deal involved ensuring compliance with the laws of both countries.

Malaysia-specific issues

Malaysia’s profile is steadily rising as an international centre for Islamic finance. But deal counsel warned that lawyers must be aware of its idiosyncratic rules in terms of its diligence and disclosure requirements.

Malaysian currency controls presented a particularly unexpected challenge for deal counsel. Kazakh law requires a minimum 20 percent simultaneous offer to investors in Kazakhstan if companies invest abroad, which was handled by Kazakh investment bank Halyk Finance.

But foreign currency and exchange controls in Malaysia meant that Kazakh investors could not receive payment in ringgit. To apply with the controls, a process agent was appointed to not only settle securities but also convert ringgit to US dollars to be paid as profit to investors in Kazakhstan. The costs of this process were borne by investors.

Another issue involved ensuring that use of the sukuk’s proceeds complied with both Malaysian law and the DBK’s charter. While the DBK has a set of requirements for proceeds set out in its charter, counsel were especially careful with how the proceeds would be used, taking into account religious restrictions.

Norton Rose Dubai of counsel Alex Roussos, who represented DBK, said obviously the proceeds couldn’t be used for anything that washaraam, or legally prohibited under Islamic law. To ensure compliance, he worked closely with Malaysian joint lead managers HSBC and RBS on shariah issues.

Dispute resolution in Kazakhstan

Furthermore, as courts in Kazakhstan do not have a history of recognising foreign judgments, deal counsel had to structure new means of dispute resolution too. Azizul Azmi Adnan, partner at Wong & Partners who was also involved in the deal, said that transaction documents related to sukuk issuances out of Malaysia were usually governed under Malaysian law and specify Malaysian courts as having jurisdiction.

But because of the difficulty of enforcement of foreign judgments, especially considering DBK’s quasi-sovereign status, deal counsel had to disclose the legal and practical difficulties of actually enforcing a judgment obtained in the Malaysian courts against the issuer in Kazakhstan in the offering document.

However, as a safeguard, arbitration could be an option for dispute resolution. Roussos explained that disputes in relation to the sukukcould be resolved by arbitration held at the Kuala Lumpur Regional Centre for Arbitration. He said that since Malaysia and Kazakhstan were both signatories to the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards, an arbitration award should be recognized and be enforceable in Kazakhstan provided the conditions set out in the Convention are met.

Kazakhstan: a future Islamic finance centre in the CIS region?

Aside from cross-border issues, deal counsel found that the Kazakh regulators were eager to facilitate Islamic finance transactions. Lim said that the Kazakh central bank was very supportive of the sukuk issuance, and helped alleviate the regulatory complexities that a bank fundraising via sukuk issuances would otherwise encounter.

Roussos agreed. He noted that Kazakhstan had recently passed legislation that specifically accommodated sukuk. Though it did not mention murabahah, which was utilised in the DBK deal, it included provisions for ijarah, mudarabah and musharakah.

Kazakhstan has so far taken the lead regarding Islamic finance in the CIS region as the first to pass laws creating a framework for Islamic finance and granting the necessary exemptions, especially regarding matters of taxation, for the issuance of sukuk.

Roussos said that the murabahah sukuk deal will have a significant impact on Kazakhastan’s ambitions to become a leading centre for Islamic finance in the CIS region, and will pave the way for more sukuk issuances by sovereigns, financial institutions and corporates in the region.

But Roussous added that he expected other CIS countries, especially those with a Muslim majority, to enter the Islamic finance market. “They may or may not follow DBK into Malaysia, but they will also consider global offerings,” he said. “It makes sense because of the current liquidity in global markets in respect to sukuk.”