Luxembourg first country to issue sovereign Sukuk in the Eurozone

On 9 July 2014, Luxembourg Parliament voted a law aimed at allowing the issuance of the first Luxembourg sovereign Sukuk in response to the recent surge in investor demand for Sharia-compliant instruments. In a nutshell, the law authorizes a sale and buy-back transaction of real estate assets to a Special Purpose Vehicle (“SPV”) owned by the Luxembourg state for the purpose of issuing sovereign Sukuk with a value of EUR 200 million. Issuing Sukuk would help Luxembourg to diversify its status as a financial centre and develop new skills to help it stand out from other European hubs. In 2002 Luxembourg’s stock exchange was already the first in Europe to list a Sukuk.

Sharia compliant bond

One of the characteristics of Islamic banking is that each certificate has to represent real physical assets, which causes conventional bonds to be prohibited by the Sharia. Sukuk, often referred to as Islamic bonds, are the Islamic answer to conventional bonds that do not fit with the Sharia prohibition on taking interest (“Riba”). In accordance with Sharia principles, Sukuk are set up in such a way that their holders receive part of the profit generated by the underlying assets (e.g. real estate, vehicles, airports …) instead of interest payments.

Sukuk are similar to conventional bonds in the sense that they generate periodic payments to their holders, given that the underlying assets mostly generate periodic payments, such as rent. However, the word bond is misleading, since Sukuk, in contrast with bonds, are always asset-backed and holders have to bear a share of any loss and also share the costs related to maintaining the assets. While traditional bonds are seen as relatively safe investments, these features can potentially make Sukuk a low-return investment.

Sukuk can also be issued by governments, listed on stock markets and rated by international rating agencies.

Luxembourg sovereign Sukuk

Luxembourg will be the first jurisdiction in the Eurozone to securitise three government properties, i.e. the two towers of the Gate of Europe in Kirchberg and the Gutenberg building in Strassen, to back Sukuk worth EUR 200 million. Luxembourg sovereign Sukuk are set up according to the Al-Ijara structure, the most common structure for sovereign Sukuk with rental payments on property providing income for the investors.

First the above-mentioned buildings will be sold by the Luxembourg Government to an SPV having the legal form of a public limited liability company (“société anonyme”), which on the date of this note has not yet been created. The share capital of this vehicle will be guaranteed by the Luxembourg Government, who will be the sole shareholder.

At the same time, the SPV will issue Sukuk with a limited term of five years for a value equal to the purchase price of these buildings (fixed at EUR 200 million). Sukuk represent a right against the SPV to the payment of a periodic distribution amount. HSBC and BNP Paribas have been appointed as co-lead arrangers of this first issue of Luxembourg sovereign Sukuk.

Secondly the SPV acting as a trustee on behalf of the Sukuk holders will let these buildings to the Luxembourg Government, who will then sublet them to the sitting tenants. Part of the rent paid will flow back to the holders of the Sukuk, causing them to receive a return generated by the performance of the underlying assets. This is in compliance with Sharia principles. Another part of the rent will be applied to pay for the costs related to the set-up and maintenance of the structure.

At maturity date, holders will recover the invested principal by reselling their Sukuk to the issuer, who will finance this transaction through the sale of the underlying assets. This means that after five years, the SPV will transfer the ownership of the underlying assets to the Luxembourg Government. This five-year period starts running at the date of the acquisition of the buildings by the SPV.

Analogous cases

The United Kingdom was the first country outside the Islamic world to issue sovereign Sukuk. These Sukuk were also set up according to theAl-Ijara structure. Rental payments of three central government properties provide the income for Sukuk holders. The order book created to sell these Sukuk was opened at 8.30 am on 25 June 25 2014 and was closed at 10.45 am on the same day with seventy-five orders totalling around GBP 2.3 billion. By issuing sovereign Sukuk the United Kingdom Government has demonstrated that it is possible to create a successful base for Islamic finance outside the Islamic world.

The first to issue sovereign Sukuk was Sachsen-Anhalt, a federal state in Germany. In 2004 the Sachsen-Anhalt Government issued sovereign Sukuk worth €100 million which were listed in Luxembourg and backed by Ministry of Finance buildings.

Further development

In the near future the above-mentioned Luxembourg SPV will be created in the legal form of a public limited liability company (“société anonyme”). The Luxembourg Finance ministry has also confirmed that the Luxembourg state will organise a roadshow for investors at the end of September. Representatives will visit London, Saudi Arabia, the United Arab Emirates, Malaysia and Qatar.