Luxembourg Sees Islamic Finance a Tonic After LuxLeaks

(Bloomberg) — Islamic finance offers a path toward greater transparency for Luxembourg after confidence in the country’s tax regime was undermined last year, according to Finance Minister Pierre Gramegna.
The reliance on asset-backed deals in Shariah-compliant finance fits the approach now being considered by the Grand Duchy, he said in an interview in Dubai on Tuesday. As part of this, Luxembourg has vowed to rein in sweetheart tax deals.

“The safety that collateral gives is one way of having a financial system that’s built on confidence and transparency,” Gramegna said. “It really fits that strategy.”

Thousands of leaked documents at the end of last year, the so-called LuxLeaks revelations, showed some international companies effectively lowered their tax burden to less than 1 percent of profit in Luxembourg through so-called tax rulings. The country, one of the smallest economies in the 28-member European Union, also introduced new tax measures this year.

“LuxLeaks has shown that there is a need to adjust tax systems worldwide,” Gramegna said.

Second Sukuk

The country also plans to sell its second sukuk, which adheres to Islam’s ban on interest, in the first half of next year, he said. The nation of about half a million people raised 200 million euros ($223 million) of five-year Islamic bonds in September.

The yield on its debt due 2019 has fallen 17 basis points since it began trading in October to 0.27 percent at 4:13 p.m. in Dubai. That compares with a eight basis point decline in the average yield on global sukuk to 2.87 percent, according to a Deutsche Bank AG index.

Luxembourg’s second Shariah-compliant bond offering will probably be structured through property-related investment vehicles, Gramegna said.

“It’s part of the strategy of our international financial center,” he said. “It’s not only diversifying our way of financing, our budget, but it’s also a way to diversify the products that you offer in the financial center. Obviously I think sukuk has put us on the map.”

Not Immune

Luxembourg is rated AAA at Moody’s Investors Service and Standard & Poor’s, the highest investment-grade ranking. Landlocked between Germany and France, the country has reinvented itself as a business and finance hub, softening the blow as traditional industries, such as steel, decline.

Still, not all Islamic finance products are immune to risks, according to Rizwan Kanji, a Dubai-based partner at law firm King & Spalding LLP, which helps structure Shariah-compliant deals.

“Not every Islamic finance structure has a collateral,” Kanji said by telephone. “Ninety percent of the world’s sukuk issuances are asset-based, and there’s no recourse to the collateral or the underlying asset.”

Asset-backed sukuk typically transfer ownership of underlying assets if the borrower is unable to repay, while holders of asset-based sukuk have no claim to the assets used to structure the debt.

For Gramegna, Islamic finance is part of the approach to strengthen the system and address wider concerns about the risks of conventional finance.

Increasing interest in Islamic finance “comes when the markets are demanding more security,” Gramegna said. “Complicated products proved to be quite dangerous in the past. Islamic products are very much down to earth.”