SUKUK CONFERENCE PROVIDES NEW INSIGHTS TO STAKEHOLDERS

On 23rd November,i participated in a Sukuk Conference organised by reputable law firm, Coulson Harney Advocates here in Nairobi at Sankara Hotel. The conference attracted participants across wide spectrum of stakeholders such as Capital Market Authority, Nairobi Security Exchange, National Treasury, Nasdaq Dubai, Islamic Corporation for Development of Private Sector, Commercial Banks, Investment banks, Islamic Finance Counsulting firms, Financial and Tax Consulting firm, Legal firms among others.

Mr. Paul Muthaura, Acting CEO of Capital Markets Authority while delivering key note address titled "Where are the regulators heading?" informed participants that the CMA is positive towards creating enabling environment by designing regulatory, legal and supervisory framework that shall involve all stakeholders. In order to ensure work is done within the timeframe, CMA has established Project Management Office (PMO) which shall start its function 1st December 2015, to design the framework and advise CMA on required reforms in order for the government and corporate entities issue Sukuk in the next financial year 2016/2017.

The conference discussed important issues around Sukuk such as structuring Sukuk transactions, Tax implications of a Sukuk transactions, Process of issuing Sukuk and listing a Sukuk. Key questions were asked and responded by panelists. Some of these questions and answers are:

1. Are Sukuk qualify as Collective Investment Scheme or conventional bond? Ryona Byrne from Clifford Chance responded that what they have seen is that the issue is country specific not generic, in some jurisdictions like South Africa it was perceived to be so and exceptions were necessary to enable South Africa issue its USD 500 million Sukuk. However, in United Kingdom is of the view that provided Sukuk behaves and bear similar characteristics with a conventional bond, then it is not a collective investment scheme. Mr. Rogito Nyangeri of Nairobi Securities Exchanges was of the view that Kenya shares the same view with UK.

2. Are the underlying assets move from the obligor/issuer to Sukuk holders? The answer is no, however, sukuk holders have economic rights on the underlying assets and Sukuk documents are the one that creates such right to the assets. But at no time, the assets will be fully owned by the certificate holders since that is not the motive of parties, hence most of Sukuk we have seen are asset backed rather than asset based.

3. What is the timeline it takes to structure a Sukuk transaction? What has been observed is that it takes about 10 to 12 weeks to finalise Sukuk transaction. But the situations depend from one transaction to another.

4. What are the factors affecting Sukuk pricing? Numerous factors wer highlighted such as who is the obligor, credit rating of the obligor, collateral, currency, credit enhancement, jurisdiction, maturity and amount among others.

5. What are the additional costs in issuing Sukuk? Apart from normal costs associated with bond issuance at international market, Sukuk attracts additional costs for hiring Shari'ah scholars, specialist legal and tax advisors.

6. What are the parties involved in Sukuk Ijarah structure? Numerous parties are involved such as arrangers/managers, obligor, issuer SPV, delegate-to enforce payments on default, paying agents, transfer agents, registrar, stock exchanges/ financial regulator, clearing systems and Shari'ah advisors. However, parties may change depending on the specific situation.

7. What is the tax implication in a case of Sukuk Ijara if it were to be issued in Kenya today? Mick Murphy from Viva Africa Consulting, presented different scenarios on transfer of assets to SPV, if it involves legal transfer or transfer of interest only it will attract different tax on each scenario. On Income of the Sukuk, again there are several scenario to look at whether SPV is Kenyan or offshore, each case attract different taxes. On a final note, it was observed that Kenya tax legislation in particular VAT and Income tax are prohibitive for issuing Sukuk and needs to be reviewed to achieve tax neutrality. This requires treatment of Sukuk like conventional bond for tax purposed.

8. Is it worthy for a Kenya to issue Sukuk in the face of some challenges? Each panelist responded in positive, presenting arguments from social and moral perspective, economic perspective and political perspective. On economic perspective it was argued that Sukuk opens the country to a wide range of investors across the globe, complement financial inclusion, go hand in hand with ambitions of making Kenya 'Financial Service Center' as well as support existing Islamic financial institutions in the market to better manage liquidity. On the political side, it was argued that country like South Africa had no need to issue Sukuk as it could have raised the money via vonventional bond, but by issuing Sukuk the political message that goes with it is that South Africa is prepared for all business models or situations and focused to attract investors across the world without regional or religious bias.

That is the last and not the least. It was great half a day! Thank you Coulson Harney Advocates for organising it, keep the Sukuk ball rolling and for bringing new insights to stakeholders.

Ivory Coast launches sovereign Sukuk to capture Gulf Wealth

Ivory Coast – one of the most advanced economies of the West African region – is hoping to attract Gulf wealth with the launch of its inaugural sovereign Sukuk as the country positions itself to broaden its funding pool by joining its peers in the Islamic finance space.

Heavily dependent on agriculture, the Republic whose economy was significantly affected by decade-long civil unrest is seeing an emergence of its former glory days under the presidency of Alassane Ouattara, who was recently re-elected for a second term and has vowed to boost financial inclusion.

Launched yesterday by Nialé Kaba, Ivory Coast’s minister of economy and finance, the CFA150 billion (US$243.15 million) five-year Sukuk facility is part of a program arranged by the Islamic Corporation for the Development of the Private Sector and comprises two equal tranches which will be issued over the 2015-20 period. Proceeds will be channeled toward the country’s robust investment project pipeline.

Regional appeal was an apparent theme in the structuring of the deal which is to be issued in the West African CFA franc at a yearly 5.75% profit rate and has been marketed to Gulf investors. Kaba in her speech indicated that the latest upgrade of the Republic’s sovereign rating to ‘Ba3’ from ‘B1’ by Moody’s was a major selling point during the Sukuk roadshow in Saudi Arabia.

With deep infrastructure needs, Africa has been looking toward the Middle East for financing needs; likewise, Gulf and global investors are increasingly parking their investments in the resource-rich region. Nations such as Senegal, South Africa and Gambia have issued Sukuk in the hopes of making headway in the Islamic financing space and capturing the Shariah dollar.

Source: IFN Daily Alert.

The IFSB and IAIS Release Joint Paper on Issues in Regulation and Supervision of Microtakaful (Islamic Microinsurance) Sector.

The Islamic Financial Services Board (IFSB) and International Association of Insurance Supervisors (IAIS) today announced the issuance of a Joint Paper on Issues in Regulation and Supervision of Microtakaful (Islamic Microinsurance).

Microtakaful is an important mechanism that provides Shariah-compliant protection to low-income and under-privileged segments of society under the principles of Tabarru' (donation), Ta'awun (mutual assistance) and prohibition of Riba (interest). Due to its nascent stage, regulators and supervisors have relatively little experience or empirical data to support their role in creating an environment conducive to the promotion of affordable Takaful services to low income and under-privileged segments. Therefore, the main objective of this paper is to highlight and identify regulatory issues prevailing in the Microtakaful sector and outline the role this sector can play in enhancing financial inclusion. In particular, the issued Paper:

· Identifies current practices and models for offering Microtakaful products, and the challenges and potential issues in offering them to target customers.

· Reviews the current regulatory framework for the Microtakaful sector in various jurisdictions and suggest initiatives to strengthen it and thus enhance financial inclusion through the Takaful sector.

· Provides guidance to the regulatory and supervisory authorities in implementing an enabling environment for the development and growth of the Microtakaful sector.

The Issued Paper highlights distinguishing features of various models used for offering Microtakaful products which, despite having many common features with Takaful products, pose various unique supervisory challenges. Backed by a survey from Microtakaful operators as well as regulatory and supervisory authorities, the Issued Paper delineates the distinguishing features of Microtakaful such as types of participants, product features, participants' contribution and distribution channels.

The paper also sheds light on corporate governance aspects of the Microtakaful sector, including the role of boards of directors and Shariah Boards in providing policy direction and ensuring the effectiveness of the Shariah governance framework.

This Issued Paper also delves into critical issues that require the attention of regulatory and supervisory authorities of Microtakaful sector. These areas pertain to the requirement of the separation of funds, solvency and capital adequacy framework, investment policies and Shariah compliance requirements. Other key aspects covered include customer education and awareness, consumer protection, licensing requirements and supervisory review processes. Finally, the Issues Paper illustrates the relevance of the IAIS' Insurance Core Principles in the practice of Microtakaful.

The Secretary-General of the IFSB said, "Following the global financial crisis, the G20 and international standard-setters have stressed the importance of supporting initiatives to widen access to finance, as a means to promote greater financial and social stability". He further noted that, "This joint Issued Paper with the IAIS continues the IFSB's work in clarifying the appropriate regulatory issues that can, in appropriate manner, extend and widen the reach of Islamic finance to the poorest and least-served segments of society".

The Issues Paper is available for download from the IFSB and IAIS websites at www.ifsb.org and www.iaisweb.org.

KENYA'S EUROBOND 2014/2015 AND DEBUT SUKUK 2015/2016

June 2014, Kenya plans to sell USD 1.5 billion Eurobond to American and European investors to fund infrastructure projects including rail and roads as part of the program to transform the country into middle income country by 20130 became a reality.

The issuance of the Eurobond by International Finance Corporation (IFC) was initially expected to be in January 2014 or several years back as Mohammed Wahliye writes "The Eurobond issuance in Kenya had been in the pipeline for the last seven years. However, everything was just ink and paper until last week (June 2014) when the Government received $2 billion (Sh175.1 billion) in its account with the Central Bank of Kenya (CBK) after it completed the issuance of a 10-year $1.5 billion (Sh131.3 billion) and a five-year $500 million (Sh43.8 billion) Eurobonds on the Irish Stock Exchange market." (The Standard, July 1st 2014).

According to some media reports, Kenyan government received Shs 250 billion from Eurobond loan, a total of Shs 196.9 billion transferred to Exchequer account and Shs 53 billion used to repay syndicated loan.

The 10-year and five-year bonds, carried a coupon of 6.875 per cent and 5.875 per cent, respectively, recorded a large order book, with a total subscription exceeding $8 billion (Sh700.2 billion), much more over and above what Kenya sought to raise in the global capital markets.

What is Eurobond?

A Eurobond is a bond that is issued in a currency other than the currency of the country where it is issued. According to Mohammed Wahliye "The currency in which Eurobonds are issued also determines their name, like Eurodollar, which is issued in US dollars, or Euroyen, which is issued in Japanese yen. So Kenya's is a Eurodollar bond. Through these two bonds, the Government essentially asked investors to lend $2 billion on the promise that it will pay it back in five and 10 years with interest. The Government, through CBK, gave these private investors a piece of paper known as a bond, and in return CBK collected on the Government's behalf $2 billion cash in the form of a loan. The buyers or investors of these Eurobonds, who are generally large companies, banks or financial institutions and governments, will be paid interest on an annual basis and the principle amounts at maturity. Eurobonds are free of withholding tax and are traded electronically in the secondary markets across international financial centres."

Expectations versus reality.

1. Kenyan's expected Eurobond to go towards financing huge infrastructure projects such as roads, railways, ports, water and energy to ensure steady economic growth. Mohamed writes "So proceeds from the Eurobond will accelerate economic growth, poverty reduction and would be helpful for the country's economy if the borrowed funds are spent on infrastructure projects that offer a greater scope for augmenting revenue earnings and creating employment opportunities." However,accroding to Business Daily of 6th November 2015, it is unclear what happened to all that money. Media reports that Treasury Cabinet Secretary (CS) Henry Rotich 'has been at pains to explain which infrastructure projects were funded by the Shs 196.9 billion.'

Though Mr.Rotich gave a statement to media on how government shared billions among ministries to fund infrastructure projects, 'the CS has, however, been unable to list the specific projects the money was used to fund fuelling speculation that the funds could have been used to pay salaries and other recurrent projects or that they could have been stolen.' Mohamed Wahliye sadly states that "It is extremely disappointing that we can't put a finger on any meaningful asset the bond has helped finance."

2. Eurobond expected to ease interest rates.'The current high domestic borrowing by fiscal authorities to finance the Budget deficit increases the competition for funds and drives up interest rates.' Wahliye writes. He further said that 'With Treasury Cabinet Secretary Henry Rotich now planning to borrow less from domestic markets because of this new money from the bond proceeds, there will be pressure on banks to lend the excess liquidity elsewhere. The extra supply of cash will, therefore, hopefully help to bring down bank lending rates to the productive sectors of the economy.'

Contrary to expactions, June 9th 2015, CBK raised the benchmark interest rate to 10 per cent from 8.5 per cent, setting the stage for a rise in the cost of loans in the coming months. And on October 22, 91-days treasury bills peaked at 22.5 per cent while interbank lending rate reached 25.84 per cent. According to Business Daily of October 24th 2015, banks started to advise their customers on the interest rates changes which according to some banks have gone high up to 27% and likely to take effect before end of November.

However, according to media reports that CBK has intervened and directed banks to freeze all planned interest rates increases and instead reduce their market rates on loans in line with the current market conditions. Lenders were however quick to dig in with their lobby group (KBA) indicating that the industry might ignore the directive and the rates high. (Daily Nation, November 13). Currently, only Standard Chartered Bank and Barclays bank informed their customers that they had shelved their plans to increase rates. Equity Bank followed suit with the cancellation of notices sent out last month that had informed borrowers of the bank’s intention to increase rates by upto six %age points with effect from November 19. This move by banks triggered by a steep fall in Treasury Bill and bond yields from 22.5% on October 21 to 9.7% last week (Business Daily, November 17).

3. Eurobond expected to reduce domestic borrowing by the government as it were before. Wahliye writes that 'at the moment, the domestic markets have been the biggest source of Government borrowing...With Treasury Cabinet Secretary Henry Rotich now planning to borrow less from domestic markets because of this new money from the bond proceeds, there will be pressure on banks to lend the excess liquidity elsewhere.'

With the current cash crunch facing the government due to KRA below expected average collections, 'The government is seeking to borrow a staggering Sh78.8 billion in syndicated loans from local banks to plug a gaping Sh600 billion hole in the budget, which has been made worse by low tax collection and wastage.' (Daily Nation, October 14, 2015). Daily Nation October 14 reported that ' government has borrowed Shs 100 billion from the local market since july and all the money used to settle local and foreign debt."

By November 4, Treasury was looking for Shs 80 billion but managed to borrow Shs 60 billion commercial loan from Citi bank, Standard Bank and Standard Chartered Bank as the first tranche. The rest will be secured from 'other sources' according to Treasury Principal Secretary Mr. Kamau Thugge. Again, the treasury says the money will go to infrastructure projects!

“With respect to interest rates, the intended reduction in the borrowing rates has not been felt. The 91-day Treasury Bill rate reduced slightly in August 2014 after the bond was issued in June 2014 and stabilised until May 2015 when an upward trajectory was witnessed. This indicates that the sovereign bond did not have a huge impact on the domestic borrowing by the government,” the Budget Office said in a brief prepared for PAC.

Currently, the public debt stands at Shs 2.6 trillion, equivalent to 46.8% of GDP (Daily Nation, November 4). The opposition has become vocal and accussed the government of 'over-borrowing, over spending and over stealing.' (The standard Nov 2). The government says any debt below 50% of the GDP is sustainable and rejected the wrong doing.

4. The flotation of the bond expected to be a step in the right direction for easing pressure on foreign exchange reserves. It would enable the Government maintain a stable exchange rate. It is expected that the dollar proceeds from the bond, Kenyan shilling is expected to receive a cushion.

Despite proceeds being received, Kenya shilling against dollar reached an all time high of 106.15 in September of 2015. According to exchangerate.org.uk, by June 2014 Kenya shilling exchanged with dollar at 87.88. A year after the bond, the rate reached 102.30 and now after ups and downs it has reached at 102.35 per dollar. The Parliamentary Budget Office said the Eurobond had had no impact in stabilising the exchange rate.

Now Uhuru government is "facing criticism over the current economic uncertainty facing the country, which have been characterized by a serious cash crunch, sliding value of currency, high interest rates and sky rocketing public debt." Jeffrey Gettlemen writes on Business Daily of Nov 6, 'Kenya is going deeper and deeper into debt'

DEBUT SUKUK (ISLAMIC BOND).

Mr. Henry Rotich speaking after a successful debut $2 billion Eurobond in 2014 said that Kenya plans to issue another international bond in fiscal 2015/16 and may consider a Sukuk. The Star newspaper reported that "The National Treasury is also working on an Islamic bond, popularly known as Sukuk, to draw foreign investments from oil-rich Gulf and Middle East regions whose participation in the hugely successful $2 billion (Sh177.60 billion) debut Eurobond last June was religiously prohibitive."

With the current political climate, outcry on mismanagement of the Eurobond proceeds, mismatch between expectations and reality coupled wiht serious corruption allegations where it is reported that 'the publication of an official audit found just one percent of Kenya government spending and a quarter of the entire $16 billion (15 billion euro) budget was properly accounted for.' (Daily Nation, July 31st 2015), "...the money from the Eurobond was deposited in an offshore account over which she had no power,” " Agnes Odhiambo (controller of budget)also disclosed money from the Sh175.6 billion ($17billion) Eurobond has been received and approved for spending, but Treasury has not been clear on what the money has been used for,” (Daily Nation of October 22, 2015) makes one wonder if the country is ready and prepared to issue Sukuk.

Unless situation changes, Sukuk is likely to be shelved for more years due to political climate but more importantly, to prevent religious motivated investors from facing high Shari'ah non-compliance risk due to negative Eurobond precedent.

Normally, Sukuk proceeds are expected to be channelled to specific projects or specifically used in Shari'ah compliant manner. With many questions sorrounding Eurobond and its aftermaths, extra efforts will be required from the government, Shari'ah scholars (who will approve the structure) and other stakeholders to assure investors that the funds won't end up in servicing any existing government interest loans or invested in conventional banks to earn interest (Some reports shows that Eurobond earned Shs 14 million interest from offshore banks), or ending up in corruption scandals.

NEW BOOK REVIEW: Between Debt and the Devil: Money, Credit, and Fixing Global Finance.

By Brenda Jubin of Reading The Markets.

Adair Turner, the former chairman of Britain’s Financial Services Authority and described by The Economist as a man for all policy crises, upends financial orthodoxy in Between Debt and the Devil: Money, Credit, and Fixing Global Finance (Princeton University Press, 2015). He argues that nothing regulators have done thus far has addressed the fundamental underlying cause of financial instability: that “modern financial systems left to themselves inevitably create debt in excessive quantities and in particular debt that does not fund new capital investment but rather the purchase of already existing assets, above all real estate. It is that debt creation which drives booms and financial busts: and it is the debt overhang left over by the boom that explains why recovery from the 2007-2008 financial crisis has been so anemic.” (pp. 3-4)

For 50 years private-sector leverage increased as “credit grew faster than nominal GDP. In the two decades before 2008 the typical picture in most advanced economies was that credit grew at about 10-15% per year versus 5% annual growth in nominal national income. And it seemed at the time that such credit growth was required to ensure adequate economic growth.” (p. 7) If that theory is in fact correct, we’re condemned to financial instability and crisis. But, Turner argues, we can develop a less credit-intensive growth model if we address the three drivers of credit intensity: (1) the increasing importance of real estate in modern economies, (2) increasing inequality, and (3) global current-account imbalances unrelated to long-term investment flows and useful capital investment.

One policy initiative we should be willing to use in moderation, although Turner admits it will horrify central bankers, is fiat money creation, “using central bank-printed money either to finance increased public deficits or to write off existing public debt.” (p. 12) This action, though reminiscent of a cautionary tale in Goethe’s Faust in which Mephistopheles tempts the emperor to print and distribute paper money, is necessary to escape the debt overhang.

Demonstrating the increasing complexity in the financial system, Turner points to the shift in typical bank balance sheets. In the U.K. in 1964, more than 90% of aggregate bank balance sheets were made up of loans to the real economy plus government bonds and reserves at the Bank of England. By 2008 “much more than half the balance sheets of many of the biggest banks in the world … were accounted for by contractual links, whether in loan/deposit or in financial derivative form, between these and other banks, or between them and other financial institutions, such as money market funds, institutional investors, or hedge funds.” This shift, he notes, reflected in part the dramatic rise in trading activity. “The value of oil futures trading has gone from less than 10% of physical oil production and consumption in 1984 to more than 10 times that of production and consumption now. Global foreign exchange trading is now around 73 times global trade in goods and services. Trading in derivatives … now dwarfs the size of the real economy; … the total notional value of outstanding interest rate derivative contracts had soared by 2007 to more than $400 trillion, about nine times the value of global GDP.” (p. 25)

I could go on and on (and in fact I have pages of notes), but there is no space here. Turner’s book is tightly argued and is packed with insights about the financial markets as well as the real economy. For example, he lists five factors that explain why market bubbles and subsequent crashes are inevitable and five features of debt contracts that make them potentially dangerous. He explains why fixing the banks will not fix the economy. He argues that, if it is to succeed, the eurozone must become a complete currency union and hence a political union and that if this cannot be done, “eurozone breakup is likely to be inevitable and is preferable to sustained stagnation.” (p. 159) He explains in what sense less liquid and less complete markets can be good. And these examples represent but a tiny fraction of the issues Turner tackles in his book.

We know that we still have a long way to go to recover from the financial crisis and that we’re slipping back into some of the practices that gave rise to it in the first place. Turner’s book is both a critique of the status quo and a set of suggestions for getting out of the morass without precipitating yet another crisis. It will, and should, be controversial, but Turner is a worthy adversary.