In Abu Dhabi and generally across the GCC, a company is not allowed to take in debt in excess of its share capital and if an entity is issuing a multi-billion dollar sukuk, it is inevitable that its debt raising will exceed its share capital. According to a GCC-based banker, the way to structure around the excess – conventionally and in Islamic finance – is to set up an offshore vehicle.
The offshore vehicle issues the debt and it is guaranteed by the entity, which will eventually benefit from the debt. It is, however, slightly different in the case of an Islamic Ijarah structure because essentially, there has to be a relationship between the parties.
Recent examples of offshore-based issuances are the Tourism Development and Investment Company (TDIC) Sukuk issued by the government of Abu Dhabi and the General Electric Sukuk. In terms of structure, the Abu Dhabi-based issuers set up TDIC Sukuk Limited, a special purpose vehicle (SPV) based in the Cayman Islands.
“Basically, what happened was that it took a plot of land on the island and granted the right to develop and use that land to an offshore company based in the Cayman Islands. That entity then entered into the Ijarah deal with TDIC and will receive profits on a quarterly basis,” a lawyer close to the deal explained.
The SPV, however, the lawyer explained, was set up to be an orphan entity: “Notwithstanding the SPV is called TDIC Sukuk Limited, legally speaking and from an accounting perspective, it is an independent company.” Had the deal been done onshore, it would have been perceived as synthetic, said the lawyer.
In the case of GE, the deal’s arrangers and lawyers had chosen to issue offshore with Bermuda as the preferred jurisdiction as it is most commonly used for aviation structures. “It is one of those jurisdictions that crop up from time to time from an aircraft perspective because Bermuda has aircraft registers and is typically used for aviation deals in the US,” said Paul McViety, senior associate at law firm Clifford Chance.
“The US tax side of things was considered in great detail and most certainly in terms of the timing. Taking a step back and looking at the structuring, the sukuk issuance needed to be very carefully structured to not trigger any tax concerns because of course, if an aircraft lands in a particular state or jurisdiction, the transfer of interest in that aircraft – or in this case, beneficial interest in that aircraft – gives rise to additional tax concerns.”
Obviously, on GE’s side, it was quite careful in structuring a financial instrument that gave it the optimal tax position, he added.
Global offshore wealth fell to US$6.7 trillion in 2008, down from US$7.3 trillion in 2007, with Switzerland maintaining its lead as the largest offshore centre, accounting for US$1.8 trillion or 28% of offshore wealth last year.
Increased regulatory scrutiny is changing the landscape of cross-border wealth management, with pressure mounting on offshore centres that have based their edge primarily on tax avoidance. However, due to this, offshore centres risk losing their appeal quickly once their tax and legal advantages are overtaken by onshore jurisdictions.
On the Islamic front, the most popular offshore centres encompass Labuan, Jersey, Bermuda and Luxembourg while Singapore and Hong Kong are touted to be the next big thing in this realm. Offshore centres such as Luxembourg have a long-standing history in terms of Islamic finance, having been chosen to domicile the first Shariah-compliant insurance company in Europe in 1983.
The Luxembourg Stock Exchange was also the first European stock exchange to enter the sukuk market, having listed sukuk since 2002. As at the end of 2009, 15 sukuk have been listed and traded on the Luxembourg Stock Exchange and 39 Shariah-compliant investment funds and sub-funds have been established in the jurisdiction.
Recently, the Labuan Financial Services Authority introduced a new regulatory framework for captive insurance, trusts, foundations as well as Islamic financial services and products. Director-general Azizan Abdul Rahman is confident that these new laws will boost business in the jurisdiction by 20% this year. Four new laws were enacted and comprehensive amendments were made to four existing ones.
For as long onshore jurisdictions still keep a strict leash on tax allowances for Islamic finance, offshore issuances will still remain the issuers’ mode of choice.
This article first appeared in Islamic Finance Asia (Pg 28, March 2010 issue). For more details, please visit www.IslamicFinanceAsia.com.