Legal Issues Relating to Secondary Bond Issues under Islamic Law

Andrew Haynes

Law Department - College of Social Sciences - University of Wolverhampton - UK

Abstract

Secondary securitisation is one of the largest areas in the raising of finance by larger companies and enables them to access the international lending markets. It is the process whereby the company wishing to raise funds issues bonds to the market from a separate company created for the sole purpose of so doing (an SPV). For reasons we will discuss, this enables the bonds to be issued at a lower rate of interest or return. Developments in technology mean that it may well develop further as banks, due to their cost overheads, become an expensive source of finance in comparison. For all schools of Islamic law this creates problems arising from: - the fact that interest rates cannot be charged under Sharia’h law - the fact that the purchasers of bonds need to be exposed to the underling risks of the originator’s company which would require a dividend and an asset based rather than an asset backed approach (this is developed further below); - the underlying assets must be Sharia’h compliant - the transfer of money between the originating company an the SPV must be Sharia’h complaint and satisfying this can become complex; - the limitations on purchasing debt at other than its face value have an impact on the capacity of Sharia’h compliant bonds to develop a secondary market. - The need to hedge a currency risk where the buyers need bonds denominated in a currency other than that of the originator’s business raises problems. The ISDA/IIFM Master Agreement may help provide a Sharia’h compliant derivative contract but this may not be recognised by all schools of Islamic law. Notwithstanding the similarities many Islamic bonds differ from conventional asset backed securities. They are not viewed as contractual debt obligations of an issuer obliged to pay holders interest and principal on specified dates, rather they are claims to an undivided beneficial ownership in the underlying assets. Thus, the sukuk holders are entitled to share in the cashflow generated by the underlying assets in addition to being entitled to share in the proceeds of the realisation of the underlying assets. This complicates matters. It will be seen that secondary securitisation can work in varying degrees according to the school of Islamic Law concerned in the country of the originator. I would thus propose to examine secondary securitisation and how it needs to be adjusted according the Islamic School involved.

Keywords

"Secondary bond issues", "Islamic law", "exposure to risk", "money transfer", "debt sale", "derivatives"