Covered sukuk may meet demand for asset-backed structures in GCC

Providing recourse to a pool of assets if the originator becomes insolvent, covered bonds found a new lease of life in Europe and the United States during the global financial crisis as investors sought liquid and safe investments.

The structure could now play a role in Islamic finance, if tax and pricing issues can be resolved to the satisfaction of investors. It was used for the first time by London-based Gatehouse Bank, a subsidiary of Kuwaiti firm Securities House, through a private placement in December.

A five-year, £6.9 million ($ 10.4 million) sukuk, backed by a property in Basingstoke which the bank acquired in July 2011, proved the structure’s viability and its ability to obtain necessary tax treatment under British rules. In a conventional covered bond, investors are entitled to claims not only on the issuer but also on assets backing the structure, giving them two layers of security.

The Gatehouse sukuk works in a similar way; it incorporates a purchase undertaking by the bank that gives primary security to noteholders, while in case of default they have secondary security on the property, according to Farmida Bi, London-based partner at Norton Rose, who worked on the deal. The Gatehouse sukuk is based on an ijara (lease) contract, which is commonly used in Islamic finance, but which in most cases doesn’t give investors 
recourse to underlying assets.

Plain vanilla ijara structures are asset-based because they do not involve a full transfer of underlying assets to the investor. By adding the second layer of security, the Gatehouse sukuk effectively became asset-backed, said Bi.

Some scholars have called for Islamic finance to move from asset-based structures towards asset-backed ones, which they see as closer to the risk-sharing principles of Shariah law.

“The structure answers the question of whether sukuk are asset-based or asset-backed,” Bi said.