UK sukuk first explained

Author: Gemma Varriale | Published: 2 Jul 2014
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The sukuk could be a game-changer for London’s bid to become an Islamic finance hub
The UK's trailblazing sukuk developed an innovative structure, setting a benchmark that is hoped will inspire the country's corporates to tap the lucrative shariah market.

Issued on June 25,  the £200 million ($343 million) bond attracted orders of more than £2 billion.

The transaction is the first sukuk to be issued by a non-Muslim country. It has been hailed as a landmark in the UK's strategy to bolster its appeal as a global hub for shariah-compliant finance. 

But leading lawyers believe the onus is now on the industry to take the lead and make Islamic finance a viable option in the competitive UK market.

"Delivering on past expectations, this sukuk is a significant statement of support by the government for the UK as the most important centre for Islamic finance outside the Muslim world," said Neil Miller, Linklaters' global head of Islamic finance who led the team advising the government on the deal.

"The government has proven that the concept works, now the industry needs to work out how it can now bring this type of financing into the UK," he continued, saying that it's a two-way street.

"You've got to find corporates that are interested, but the industry has also got to compete with all of the other avenues of financing that are available to western corporates."

The structure

The deal is a sukuk al-ijara, a shariah-compliant leasing structure, which allows the rental income of three central UK government offices to underpin the transaction.

Miller said there were three reasons for choosing the sukuk al-ijara structure. Primarily, it is what's known in the industry as a vanilla structure.

"It's one of the simpler Islamic finance structures that's easier to understand," he said. "It was important that we could structure an instrument that wasn't going to be overly complicated as the first issuance by the government."

Ijara is also the favoured form of sukuk used for other government issuances in the Muslim world.

UK tax rules were another reason driving the structuring decisions. Since 2003, the framework has been subject to a series of revisions aimed at creating a level playing field for Islamic finance in the UK. "We wanted to make sure that we fitted within the tax regime that has been set up for precisely this sort of structure," said Miller.

But Norton Rose Fulbright's Farmida Bi believes that ultimately the UK's nascent shariah finance market will need to issue more diverse structures that combine physical assets with investment assets.

"We will need more hybrid structures where, for example, you have a partial ijara with a partial wakala," she said. "It's not always easy to find unencumbered assets to put into ijara structures."

"Some of the hybrid structures that are being used in other jurisdictions are likely to be attractive in the future," Bi continued. "There's nothing in the regulatory framework that would stop those being used by UK entities."


KEY TAKEAWAYS

  • The UK has become the first non-Muslim country to issue a sovereign sukuk;
  • The benchmark deal was issued on the basis of a sukuk al-ijara structure;
  • The documentation included innovative features to ensurethe UK Treasury achieved its objective of issuing a gilt-like instrument;
  • The Islamic finance industry now needs to work out how it can now bring this type of financing into the UK, a leading lawyer has said.

A gilt-like sukuk

The sukuk documentation included a number of innovative features to ensure that the Treasury achieved its objective of issuing a gilt-like instrument, while remaining shariah-compliant and falling within the UK's alternative finance arrangements legislation.

In the Treasury's last bond which was issued more than ten years ago, the noteholders were represented by a trustee, or a representative acting in a fiduciary capacity on behalf of holders.

However, there is no such entity in a gilt.

"There has, to our knowledge, never been an international sukuk adopting an analogous approach to a UK gilt whereby there is no fiduciary acting on behalf of the holders," said Richard O'Callaghan, a capital markets partner with Linklaters. "For the first time ever in the international sukuk context, we have stripped out the delegate."

He continued: "This means that we have directly enforceable rights against the Treasury under the procurement undertaking in circumstances analogous to those under the gilt and different to those under the last eurobond that the UK government issued."

Islamic finance in the UK
  • In 2008, the UK government announced it would issue a shariah-compliant sukuk. This was postponed on the onset of the global financial crisis.
  • The UK has five domestically regulated Islamic investment banks and one retail bank. Islamic banks have also set up businesses in the UK, such as Qatar Islamic Bank’s QIB (UK), Kuwait Securities House’s Gatehouse Bank and Boubyan Bank’s BLME.
  • In recent years, both shariah-compliant and conventional investors from the Gulf have been active in the UK. Investment in London from Qatar, Malaysia, Brunei and Kuwait shows that Islamic finance could be a key driver for investment.
  • Qatar's investments in UK infrastructure, real estate, and financial institutions have topped $16 billion.

Further reading

Dubai's new sukuk standards explained

In search of a global Islamic finance hub

An IFLR guide to the evolution of global sukuk structures