Selection of publications 2

FORUM FRANCOPHONE DES AFFAIRES COMITE NATIONAL LIBANAIS

Le Liban et l’Espace Economique Francophone

Publication éditée par le FFA à l’occasion des Assises de la Francophonie Economique

Beyrouth, octobre 2002

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Securitisation: Breaching the Sovereign Ceiling By Iad Boustany, BSEC December 17, 2002

When dealing in emerging markets, one of the main advantages of securitisation/structured finance is the ability to breach the sovereign ceiling and hence provide cheaper funding. In order to better understand this we will focus on (A) the rating approach for securitisation, (B) the theory of sovereign ceiling, (C) structuring techniques to breach the sovereign ceiling. (A) The rating approach for securitisation In measuring corporate risk, rating is a fact of life. The to-be-rated company cannot influence or modify its previous performance, nor can it enhance its present strategic positioning or improve its key success factors. Rating is hence viewed as an indicator of the ability and willingness to generate cash flow and make timely payments in the future given past performance and present strategic positioning. Rating standard corporate unsecured unsubordinated bonds is a ‘predetermined’ process. In structured finance rating is more of an objective. Theoretically nothing can impede any Originator from reaching a AAA rating on its borrowing to the extent that it is willing to pay the price of that AAA in terms of credit enhancement. Practically, the cost of the credit enhancements might outweigh the benefits from the AAA rating. The structuring bank’s role would be to determine the optimal enhancement levels given (i) the Originator’s cost of funding, (ii) the market conditions and (iii) the sovereign ceiling. The process begins with the Originator determining the cost of funding that would render the structured finance deal interesting given his cost of capital. Once the cost of money determined, a rough equivalent in risk is identified and a rating objective determined. The Investment Bank is mandated and instructed to design a structure that meets the designated targets. The investment bankers/structurers will make the best use of legislations throughout different countries and different enhancement techniques to set the structure which meet : (i) legal perfected interest, (ii) fiscal efficiency, (iii) credit worthiness, (iv) accounting ‘de-linkage’. Legal perfected interest in the underlying assets is a must. The securitisation aims, among other things, at ensuring that the transferred assets are not affected by any claims against the Originator. In other words, the assets transferred to the SPV are remote from any claims from any other creditors. Hence the transaction must meet the below stated requirements: (a) Perfection of legal interest in the purchased assets assuring that the Originator’s eventual liquidators do not have any rights over the transferred assets. (b) No prior claim over the assets. By prior claim is meant claims by the Obligor himself (e.g. set off), claims by a third party (rights created in favor of other creditors), and claims by preferred creditors, workers, etc. (c) No consolidation of the SPV with the Originator. Consolidation, or lifting the legal veil, refers to the


right of the judicial authorities in disregarding the veil of separate legal entities that dissociate the Originator from the SPV. Fiscal efficiency is reached when (i) exemption from stamp duty tax on the numerous agreements to be executed is ensured, (ii) exemption from withholding tax on interest payment to be made from the obligors to the SPV and from the SPV to the Investors is ensured, (iii) exemption from property transfer tax on transferred assets is ensured, and (iv) income tax and other double taxation are avoided. Creditworthiness is reached through credit enhancement techniques. Those techniques are numerous but can be summed up under three main themes: (a) internal credit enhancement like subordination or sequentiality between the issued note or the insertion of triggers that would modify rights over the cash flows, (b) external credit enhancement using swaps and insurances and (c) over-collateralization. Accounting ‘de-linkage’ is only reached when the transaction is eligible for ‘sale treatment’ . Under IAS 39, derecognition of assets is governed by the ‘substance over form’ principle. Only when the assets have been sold ‘in substance’ can they be derecognized from the balance sheet. But what is a sale ‘in substance’ ? A sale ‘in substance’ in not limited to a ‘legal sale of assets’ , it is rather the full relinquishment of control over the assets as well as a substantial relinquishment of risk and rewards form the sold assets. This ‘in substance sale’ is better known as True Sale. Once True Sale is achieved, the bankers/structurers must make sure that the SPV is not reconsolidated under another IAS rule which is SIC 12. (B) The theory of sovereign ceiling The cost of funding for healthy companies in emerging markets and more specifically poorly rated countries is an issue. The rating agencies have developed the theory whereby no company would be allowed a higher rating than that of the country in which it is operating. The concept better known as the sovereign ceiling is based on the underlying assumption that a sovereign default will force all domestic issuers or obligors to default as the sovereign will necessarily impose restrictive measures impeding access to hard currency necessary to service their obligations. This indicator is very hard to measure in absence of conclusive experience and comprehensive intellectual framework. And in absence of comparative methodology this concept (sovereign ceiling) remains impossible to synthesize and express using rating symbols. Traditionally, a sovereign’ s rating on its foreign currency has been viewed as the cap on rating for every private issuer domiciled in that country. Sovereign rating is the ability and the willingness of the sovereign to make timely payment of principal and interest. Furthermore sovereign rating has also been viewed as the best proxy for the sovereign ceiling. But sometimes, sovereign rating is not the best proxy for sovereign ceiling. Sometime the likelihood of default is a much bigger risk than forced default and government interference in private sector hard currency debt repayments. A first example is given


by Panama or the EU members. In such countries, exchange controls are difficult to implement. By joining the single currency and the ‘pacte de stabilité’ , the EU members have relinquished monetary and foreign exchange policy to the independent European Central Bank. A second example is given by rating agencies who do not view local currency guidelines or local currency rating as a ceiling. In such cases they will consider any corporate or structured deal on a ‘stand-alone’ basis by focusing on the transaction’ s own merits ‘absent country risk’ . The sovereign ceiling theory has no scientific grounding or justification known to us nor has it been demonstrated via a ‘debat contradictoire’ . It seems that this theory is more of a dogmatic approach that provides an intellectual comfort for rating agencies with limited time and resources to dealing with a variety of cultural models in business. This theory also neglects any other corporate organization than the one based on the written contract. It totally neglects the binding effects of know how, notoriety, pledge, and other social or cultural constraints characterizing none western societies. Such cultural issues are also found in some industries in Europe like the diamond market in Anvers. One might refer here to the works of David Freidman as detailed in his reference book ‘Law’ s order’ . One can also point out that the sovereign ceiling theory has been put aside by its own genitors for specific political reasons. Some countries have earned investment grade rating while lacking the basics of any investment grade requirement. Countries like Japan and Korea officially objected the rating agencies discriminatory practices. (C) Structuring techniques to breach the sovereign ceiling. Several techniques allow breaching the ceiling. But before describing such structured finance techniques, one must begin by determining the risks. Traditionally emerging market risks include: Convertibility, transfer, devaluation, expropriation, political violence, freeze on deposits, legal risk and economic environment risk. The aforementioned list is not exhaustive. It is nevertheless considered that the main emerging market risk is the Transfer/convertibility risk. Addressing the other risks is out of the scope of the present document. The first set of structuring techniques used by investment bankers and securitisation specialists in their effort to address sovereign risk issues is based on the ability to capture hard currency outside the scope of government intervention and beyond government’ s reach. These techniques are referred to as ‘bypassing the exchange controls’ . The first technique is Future Flows: Many securitisations emanating form Turkey, Brazil, Egypt and Mexico have achieved BBB (AAA where a monoline insurance wrap has been obtained) by capturing hard currency cash flows in bank accounts located off-shore. The Originator, typically an exporter, assigns the receivables and instructs its clients to settle their due in an off-shore account administered by a Trust. The only way a government can affect such a structure is if consolidating the SPV with the Originator and then considering any payments to SPV as part of his scope of intervention. It is worth noting that sophisticated structuring techniques can address such issue and avoid SPV consolidation. The structure is not


totally immune from country risks because it will always be limited to the Originators capacity to continue generating the needed receivables. Another technology often used in future flow deals is the Supply Bonds. An insurer will cover supply risk by paying the trustee if the Originator fails to deliver the goods. Another technology used to bypassing the exchange controls and country risks is the swaps and guarantees that can be locked into a structure and triggered in the event of forced default or lack of access to foreign currency. In this case the guarantor or the swap counterparty will make hard currency payments to the SPV and will be entitled to whatever fund available in local currency or on-shore accounts. Currency swaps are used to address the devaluation issues as well as transfer risk and convertibility risk. A swap trigger promising to pay abroad if sufficient local currency funds are collected domestically will allow the cash flow to bypass government controls. Apart form the commercial insurers, two main agencies underwrite emerging market risks: OPIC (Overseas Private Investment Corporation) a US government agency and MIGA (Multilateral Investment Guarantee Agency) the World Bank subsidiary. Rating agencies awarded insured transactions with above sovereign rating (MSF deal in Brazil). It is worth noting that the deal will only reach a stand-alone rating level. Should the structure collapse or the obligors default OPIC and MIGA will not be obligated to make payments. Alternative structuring technology like the Bonex structures exist and can lift a deal above sovereign. The Investment banker can structure a deal in a way to outlast the exchange controls. It consists at providing access to foreign currency for the expected duration of the exchange controls. Two techniques are here available. The first is to fund an off-shore account with enough cash to outlast the exchange control period. The funds should be applied on satisfaction of interest due to investors. It is unclear whether rating agencies would require providing for principal payments. But how to determine the time frame for exchange controls? This period as set by rating agencies was of 12 to 18 months before the Argentine crisis. It is now of 24 months. This technique has become a very expensive mitigation tool. The second option available to structuring banks is the risk triggers who’ s role is to legally increase the weighted average life of the notes in order for them to outlast the control period. During the periods of exchange controls, all money is captured in a Guaranteed Investment Contract (GIC Account). The amounts are in hard or local currency and used to pay the notholders once the controls are lifted. Some bankers/structures prefer using exemption form control technologies in order to reach above sovereign ceilings. Such techniques are most effective in emerging economies characterized by an overwhelming industry sector or company exempt from controls due to its strategic importance. Usually such players enjoy prior access to foreign exchange and history of exemption form the measures impeding foreign debt service. Multi-lateral B-loan is the second technique that can be designed to achieve better than sovereign rating using exemption of controls technologies. Here a multi-lateral organization funds an emerging market borrower, sub-participates the loan to an SPV which issues bond to investors. The multi-lateral agency lends to the structure its ‘preferred creditor status’ . The assumption is that countries in financial distress need urgent backing form multi-lateral agencies. Hence they will not risk


compromising the relationship by defaulting on any payment due to any such entity. The structure relies on the incentive for government not to impose controls and historical evidence indicates that any transfer ban would not apply to a particular creditor in a specific deal. Securitisation deals structured in dollarised economies, with structural linkage to hard currencies can benefit from an above sovereign rating. This is not a structured finance technique but more a sovereign strategic move to increase Direct Foreign Investments and capital drain. It is the sovereign’ s self limitation of control power that provides bankers and rating agencies with the firm belief that private entities are not capped anymore. This is the case in Europe where Greek transactions can reach a AAA rating although the sovereign in 5 notches below. It is also the case in Bahrain or Bermuda or Panama. A very poor intellectual framework and evident lack of convincing scientific evidence are the main characteristics of this specific exemption from sovereign ceiling theory. This issue seems more motivated by some geo-political considerations. Under investment bankers pressure and evermore innovative structures, rating agencies have loosened their requirements and somewhat undertaken a shift in their policy proposing and accepting solutions for breaching the sovereign ceiling. In June 2001 Moody’ s has announced that the debt of emerging markets may not be constrained to the country ceiling where (a) the creditworthiness of the borrower is judged to be sufficiently high and (b) the likelihood of a general moratorium in the event of a government default is sufficiently low and (c) where the Obligor has special access to foreign exchange. They have not yet dared questioning the mainstream theory they have so much contributed in putting in place.

Perspectives de la Titrisation au Liban

Intervention de Iyad Boustany au CEDROMA, Université Saint Joseph, le 26 mars 2003

Excellences, Chers amis, La place prépondérante de la technologie dans notre quotidien nous pousse à une erreur de perspective associant automatiquement le neuf au meilleur. La technologie est le domaine par excellence ou, effectivement, le neuf est synonyme de meilleur. Mais ce qui s’applique à la technologie ne s’applique pas forcément à la finance et au droit,…..Une idée, une pratique n’est pas meilleure qu’une autre tout simplement par ce qu’elle lui succède dans le temps. Dire que la titrisation est une innovation ne nous informe pas sur l’apport de cette innovation et son éventuelle supériorité sur les autres modes de financement ? Et si tel était le cas dans quel cadre peut elle se développer ? Notre intervention portera dans un premier temps sur (i) ce que la titrisation apporte de plus au Liban et dans un deuxième temps sur (ii) le cadre nécessaire à son bon développement. I- Qu’est ce que la titrisation apporte de plus La titrisation se résume dans sa substance dans la transformation des caractéristiques d’un actif. Cette transformation altère toutes les composantes de l’actif : son immobilité devient mobilité, son indivisibilité devient divisibilité, sa sous performance devient sur performance. Certains ont été jusqu’à dire que la titrisation transforme le plomb en or. Ce passage se fait par l’intervention, on est tenté de dire l’alchimie du TRUST, cette entité centrale au cœur de la titrisation et qui permet cette modification des caractéristiques. Ainsi, un actif se transforme en un autre actif via le Trust. La définition évacuée, voyons ce que la titrisation apporte réellement de plus aux entreprises et aux investisseurs. I-(i) Ce que la titrisation apporte aux entreprises Pour les entreprises traditionnellement condamnées au financement bancaire, les banques d’affaires semblaient apporter du nouveau. Mais leurs premières expériences des banques d’affaires sont loin d’être concluantes puisque ces dernières se sont attelées à travailler le passif de leurs clients. Or le passif des bilans des entreprises libanaises est étriqué et déséquilibré. Il est le fruit d’un double et fragile équilibre : d’abord l’équilibre entre dette et capital et ensuite l’équilibre au sein même de la structure capitalistique. L’actif des entreprises, par contre, y offre un espace de travail conséquent et dispose d’une taille plutôt respectable pour développer les métiers de la banque d’affaire. L’actif du bilan de ces entreprises se distingue par son caractère risqué pour l’entreprise (risque commercial), coûteux pour elle (car ne générant aucun revenu et ne portant pas d’intérêts), lourd en conséquences sur sa gestion (car nécessitant des équipes de gestion, de recouvrement, etc.) et pesant pour son bilan (car dégradant les ratios financiers). Le traitement de cet actif est, non seulement possible, mais souhaitable pour l’entreprise. C’est là ou la titrisation apporte un plus, en effet :

♦ La titrisation dé-comptabilise l’actif du bilan ; ♦ La titrisation ne pèse pas sur la structure du capital des

entreprises : les luttes de pouvoir induites par les opérations sur le capital sont ainsi évitées ;

♦ La titrisation ne modifie pas la structure d’endettement de l’entreprise : il s’agit d’un off balance sheet financing qui n’augmente pas la dette et son corollaire en termes de publicité à la centrale des risques ;

♦ La titrisation améliore les ratios bilanciels de rentabilité et de liquidités ;

♦ La titrisation donne lieu à des retombées image et marketing très favorables ;

♦ La titrisation préserve les lignes bancaires pour des opérations stratégiques de haut de bilan.

I-(ii) Ce que la titrisation apporte aux investisseurs On a vu que la titrisation est donc intéressante pour les entreprises. Mais qu’en est il des investisseurs ? En effet, les diverses opérations de titrisation, en décloisonnant les marchés du crédit et/ou de ceux du risque, sont taillées sur mesure pour répondre à l’attente des investisseurs en termes de rémunération, de risque et de maturité. En transformant, par exemple, un crédit hypothécaire (mortgage loan) ou un crédit inter-entreprise (trade credit) en un titre négociable, un crédit long terme en investissement court terme, un non-performing loan en un titre « AAA » la titrisation contribue à l’optimisation des modes d’allocation du capital, à la multiplication des opportunités d’investissement tout en favorisant une vérité des prix. Elle joue donc un rôle charnière dans le financement des entreprises et, pour les investisseurs, un rôle dans la double augmentation d’abord des opportunités d’investissement et ensuite de la rentabilité par investissement. La titrisation opère un lien entre les différents marchés spécifiques et cloisonnés du crédit et celui organisé et standard de la bourse. La motivation pour les autres intervenants et qui se trouve derrière l’utilisation de la titrisation est l’arbitrage. Ce terme est utilisé pour qualifier un état ou, toute chose égale par ailleurs, le cédant diminue son coût du crédit et l’investisseur augmente sa rentabilité. L’imagination fertile des financiers est tendue vers un but : la capture du plus de valeur possible. II- Dans quel cadre s’épanouit la titrisation Si nous convenons de l’utilité et même de la nécessité de la titrisation comme mode de financement dans le paysage financier libanais il reste donc à savoir quels sont les efforts à consentir, les reformes à entreprendre pour y arriver. La titrisation, pour réussir, requiert (i) des ajustements que je qualifierais de spécifiques ou techniques propres à la bonne structuration d’une opération et (ii) des ajustements environnementaux dans lesquels s’insère l’opération de structuration.

II-(i) Les reformes techniques La titrisation relève autant de la finance d’entreprise que de la finance de marché. Or les marchés des capitaux sont le maillon faible de la place financière de Beyrouth. Et qui dit marché dit offre et demande, liquidité , prix, des indicateurs tous basés sur des instruments acceptés et fiables de mesure du couple risque/rentabilité. Je me bornerai donc à proposer ici les reformes qui auraient du avoir lieu il y a dix ans sur la place de Beyrouth. J’évoquerai uniquement les points essentiels (a) l’infrastructure de quantification de la rentabilité, (b) la superstructure de mesure du risque, (c) les outils de contournement du risque. (a) L’infrastructure de quantification de la rentabilité n’est qu’une des applications d’un concept beaucoup plus large qui est celui de la transparence. L’infrastructure appelée de nos vœux n’est rien d’autre qu’un institut public ou privé chargé de collecter, traiter et diffuser les informations financières (faut il préciser que ce n’est pas le cas au Liban aujourd’hui) au triple niveau micro, meso et macro-économique. Une simple modification du Code de Commerce rendant obligatoires les dépôts des comptes suffit. Fama et Von Hayeck, concepteurs et architectes du monde de l’information disaient il y a vingt ans déjà que ‘l’information est la matière première des économies de marché’. La communauté européenne a entendu cet appel et compris le message en consacrant deux directives à l’information (la 4eme et la 13eme) dans le cadre de la construction de l’Europe. (b) Quant à la superstructure de mesure du risque, elle consiste en la mise en place d’un organisme de notation des crédits sur la base de ‘National Scale Rating’. Cette institution jouerait un double rôle d’abord (I) permettre au marché une rationalisation des coûts du risque sur la base de la vérité des prix et ensuite (ii) créer le climat de confiance suffisant pour casser le tabou idéologique autour du dépôt bancaire permettant au déposant de faire le choix de la désintermédiation et transformer son dépôt improductif en investissement direct. Cet organisme devrait être géré par l’une des agences internationales de notation. (c) Enfin, concernant les outils de contournement du risque, il est possible de mettre en place un organisme chargé de pallier aux faiblesses inhérentes à la structure économique, juridique et politique libanaise en garantissant contre ces risques. Dans les pays démocratiques, le pouvoir est extrêmement sensibilisé aux besoins de ses concitoyens et soucieux de préserver leurs outils d’ascension sociale qu’est l’entreprise. Par là, et dans le but de permettre un maintien de la compétitivité des entreprises les gouvernements encouragent ces types d’assurances permettant l’accès aux marchés des capitaux avec du papier AAA. Il s’agit des Monolines ou encore des assureurs d’opérations financières. Les gouvernants libanais ont évidemment d’autres soucis que ceux de leur pairs dans les pays démocratiques. Nous ne pouvons qu’appeler à la mise en place, en Europe mais pour le compte exclusif du Liban, de cette institution qui permettra aux entreprises libanaises d’accéder à du financement à des coûts compétitifs.

II-(ii) Les réformes environnementales Le développement des marchés des capitaux n’est que le reflet du développement d’un pays. La bourse n’est en fin de compte qu’un baromètre de cette croissance. La léthargie actuelle de la Bourse de Beyrouth ne reflète que l’état de l’économie du pays. Développer les marchés des capitaux exige, présuppose et accompagne le développement économique global. Or le développement est en substance faire le choix de la Liberté. Je bornerais ici à citer quelques conclusions d’éminents économistes, je vous les livre tels quels:

♦ Le prix Nobel d’économie, conseiller du Président de la Banque Mondiale, Amartya Sen résume dans sa thèse que le développement économique ne peut se faire sans liberté. Sa thèse est d’ailleurs intitulée :’Development as Freedom’. Sa notion de la liberté ne se limite pas à la liberté politique, le mot doit aussi être compris comme ‘émancipation’ (taharror) de la religion, de la pauvreté, des castes ou classes sociales, des clans ou tribus….. ;

♦ Alain Peyrefitte penseur du développement insiste que ‘le développement économique avant d’être un taux de croissance, est un choix de valeurs’. Ethos de comportement compétitif, fois dans un ordre juridique impartial et juste ;

♦ Jean de Witt place la liberté religieuse et juridique comme facteurs présupposant tout développement économique ;

♦ Spinoza et Locke tout deux refusent de proposer une réflexion sur les fondements éthologiques de la modernité et du développement hors du cadre de la liberté ;

♦ Hegel en parlant des phéniciens affirme que leur développement est du à une société qui vit ‘en confiance’ confiée à elle même. Hegel parle d’hommes audacieux, libres et responsables ;

♦ Bastiat, Shumpeter et Von Hayeck professent que l’autorité politique, religieuse, sociale, centralisée ou autoritaire étouffe et la liberté et le développement ;

♦ Robert Lucas, l’un des maîtres de l’école de Chicago insiste que la combinaison du capital et du travail ne suffit pas à expliquer le développement. Il propose d’insérer dans ses équations mathématiques un tiers facteur immatériel ;

♦ Francis Fukuyama, malgré les critiques que nous pouvons lui faire est allé jusqu’à intituler son livre dédié au rapport entre démocratie et développement : ‘trust’.

Liberté comme tolérance, liberté comme confiance, liberté comme esprit critique, liberté comme responsabilité individuelle et collective, liberté comme émancipation, liberté comme principe de subsidiarité… telle est la condition sine qua non au développement de l’économie et des marchés financiers. Chacun des théoriciens de la modernité et du développement à contribuer à mettre à nu un de ses multiples aspects. La synthèse, elle, est venue à la fois du Pape Jean Paul II dans son encyclique Centesimus Annus (1991) et du

prix Nobel d’économie Kenneth Arrow qui affirment ensemble: L’activité économique n’est jamais que l’épanouissement d’une exigence de liberté. En conclusion En guise de conclusion un dernier mot sur la titrisation de gouvernement, sujet particulièrement à la mode au Liban. Je me permets de reprendre à mon compte Locke, le grand philosophe Anglais du XVIIe, qui est, sans doute, à l’origine de la première opération de titrisation décrite en 1666 dans ses ‘essais sur la tolérance’ ; je cite: ‘ce qui scelle le passage de l’état de nature à la société moderne c’est le TRUST. Ainsi Locke semble confirmer le contenu de mon introduction ou, je vous le répète, la titrisation est la transformation via Trust d’un ‘état’ vers un autre ‘état’. Locke continue pour dire: Cette structure juridique correspond à une responsabilité confiée en dépôt ; Rois, Ministres, Assemblées ne sont que des dépositaires de la confiance. Excellences, chers amis, je vous l’affirme : c’est là la vraie titrisation de gouvernement.

June 2003 Page 1 of 4

Bankruptcy Rem oteness June 2 0 0 3

This docum ent issued by Bemo Securit isat ion SAL is for discussion purposes only. The informat ion contained in this docum ent has been com piled in good faith, but no representat ion or warranty is m ade as to it s accuracy or com pleteness. This docum ent is confident ial and m ust not be dist r ibuted to any person not involved in the t ransact ion without the consent of Bem o Securit isat ion SAL. The Notes are only suitable for sophist icated investors who are capable of understanding and evaluat ing the r isks involved in invest ing in the Notes. This st ructure is the intellectual co- property of Bem o Securit isat ion SAL. All or part of the st ructure ( ‘Fiduciary Securit isat ion Fram ework’© ) contemplated and envisaged in this Term Sheet is or m ight be regist ered under Lebanese law, Statute 75 of April 13 t h 1999. Thus it is fully protected against any type of total or part ial im itat ion, copy, reproduct ion, etc. Any at tem pt to replicate such a st ructure without the prior writ ten consent of it s owners will give rise to legal act ion. © All r ights reserved; no part of this docum ent m ay be reproduced, stored in a ret r ieval system, or t ransm it ted in any way or form or by any m eans, elect ronic, m echanical, photocopying, recording, or otherwise without the prior writ ten permission of Bem o Securit isat ion SAL. This docum ent may not be lent , hired out or otherwise disposed of in any form of binding or cover other than that in which it is published w ithout the prior consent of Bem o Securit isat ion SAL.

I n a securit isat ion t ransact ion, the legal st ructure should ensure that (a) a bankruptcy of t he or iginator does not lead to any im pact on the assets of the SPV, (bankruptcy rem ot e feature ) and (b) that the SPV does not file for voluntary bankruptcy, or t here is no involuntary bankruptcy act ion taken against the SPV (bankruptcy proof feature) . I -Bankruptcy rem oteness feature One of t he basic aim s in secur it isat ion is to ensure that the assets t ransferred to the SPV are not affected by any claim s against the or iginator. I n other words, t he assets t ransferred to the SPV are param ount property of t he SPV with no claim s of any other creditors. From this viewpoint , t here are 4 basic steps to be taken: (1) Perfect ion of legal interest in the SPV, (2) No prior claim s of any person, (3) No consolidat ion of t he SPV with t he or iginator , (4) No claw back 1 ) Perfect ion of legal interest : 4 potent ial t hreats to r ights of SPV/ investors

a) Transfer of interest by originator was not legally perfect , or was not a "t rue sale" .

b) Transfer of interest was t rue sale, but is subject to over- r iding, prior claim s that get t ransm it ted to t he SPV.

c) Transfer of interest was a t rue sale, but the SPV holding such interest is t reated as substant ively a sub-set of t he or iginator, clubbing the assets and obligat ions of t he two.

d) The t ransfer was a t ransfer in ant icipat ion of or iginator bankruptcy, and hence, is voided by Court .

Perfect ion of legal interest im plies t he creat ion of legal r ights in t he assets in favor of the SPV. However, t here is a lurk ing fear of a Court regarding the substance of a t ransact ion as financing. Besides, in several count r ies, there is a possibilit y of lack of clear law inhibit ing secur it izat ions. I f the secur it isat ion t ransact ion has passed on legal interest in t he assets to the SPV, t he liquidator of t he or iginator in bankruptcy does not have any r ight against the assets. This would be t rue even if the or iginator is assigned the role of collect ion. As collect ion or serv icing agent , the or iginator has no bet ter r ights than those of a postm an. Hence, t he


liquidator ’s r ights will be lim ited to only such r ights as the or iginator him self had.

2 ) Prior ity of claim s: By priorit y is m eant the suprem e legal r ights of the SPV on the assigned/ sold assets. There are two inherent thoughts here - (a) there should not be any exist ing claim s against the assigned/ sold assets, eit her, of t he obligor him self (such as claim for set -off, waiver, or cross-default ) or of any other part y (such as r ights created in favor of other creditors already) ; and (b) t here should not be any subsequent claim s of any third party such as claim s of workers of the or iginator , preferred creditors, etc. As far as pre-exist ing pr ior claim s are concerned, t he law provides that the t ransferor of any assets t ransfers them with the sam e features and disabilit ies that existed at t he t im e of t ransfer . So any pr ior claim s set -off or other r ights that existed at t he t im e of assignm ent would const rain t he r ights of t he SPV. I f any prior r ights existed at the t im e of assignm ent , t hose would also affect the predom inant r ights of t he SPV. For exam ple, if any tax claim or claim of a creditor , or a secur ity interest in a specif ic asset , exists at the t im e of assignm ent , t he SPV would acquire t he sam e subject to such pre-exist ing r ight . A usual sit uat ion is where the originator has outstanding loans where the lenders have secur it y interest in all present and future assets of the or iginator. I n law, a general security interest such as charge over all present and future assets is a float ing charge, and a float ing charge is vacated when the asset is sold off. However, if the lender ’s interest was a fixed charge, the SPV would be affected by such charge.

Next , com es the quest ion of subsequent prior claim s on the assets of the or iginator. There are usual statutory preferent ial claim s in winding up. These are either dues to t he state, or dues of workers etc which are t reated as preferred claim s, and they take priorit y over claim s of all secured creditors. However, none of t hese r ights to preferent ial paym ents shall affect the SPV holding legal r ights in assets, as the assets already stand t ransferred to t he SPV and have since becom e the property of t he SPV.

3 ) Protect ing against consolidat ion:

Consolidat ion or lift ing or piercing the corporate veil refers to t he r ight of j udicial or other author it ies in disregarding the veil of separate legal ent it ies that dissociates the or iginator from the SPV, and t reat ing the two as one. I n other words, the aggregat ion of the assets of the SPV with those of the originator. This is possible if the j udicial author ity com es to reckoning that t he creat ion of a separate legal ent it y in form of the SPV was m erely an arrangem ent or colorable device, that the SPV is only an alter-ego for the originator and that the whole schem e is not t o be given any legal effect .

One of the biggest threats to securit isat ion st ructure is the possibilit y t hat a Court , tax author ity or other agency would t reat the SPV and the originator as one. The very essence of securit isat ion, it m ay be noted, is to decom pose the com pany and break and take away it s assets into a separate ent it y which has legal r ights of it s own over t he propert ies t ransferred to it . I f consolidat ion of t he assets of t he SPV is done with those of the originator , it would am ount to a nullif icat ion of the process of securit isat ion.


4 ) Protect ing against claw back:

Claw back refers to the legal provisions which ent it le an author ity, norm ally in case dealing with bankruptcy, to t reat any t ransfer of assets, even though legally m ade, as void, and therefore, claw back or reclaim the assets already t ransferred. Such claw-back provisions are norm ally applicable to a com pany that goes into bankruptcy.

This bankruptcy rule is called a rule to avoid t ransfers in contem plat ion of bankruptcy. The under ly ing rat ionale of the rule is that certain t ransfers if m ade im m ediately before bankruptcy of an ent it y will be regarded as t ransfers m ade in contem plat ion of bankruptcy, as a fraudulent preference, and will be avoided, that is, held illegal. Except ion is m ade for " t ransfers in good fait h and for valuable considerat ion" . Since the effect of the above provision is not to m andatory avoid t ransfers m ade som et im e pr ior t o bankruptcy, and m ore so, t ransfers m ade in "good fait h" are protected, secur it isat ion deals would not k illed even if the or iginator f iles for bankruptcy soon after the assignm ent . But t hen, good fait h, lies in the eyes of t he beholder - therefore, one m ust be part icularly careful for secur it izat ions m ade by dist ressed of potent ially dist ressed com panies. I I -Bankruptcy proof features While the first feature is sat isfied by an irrevocable legal t ransfer of the assets from the or iginator to t he SPV, if any act ion in bankruptcy is init iated, the ent ire purpose of the st ructure m ay be foiled. The fear is that aft er t ransferr ing the assets, the originator him self m ay play gam es and init iate a voluntary bankruptcy act ion if t he SPV is essent ially under the cont rol of t he or iginator. I n the case of a corporate SPV, where the SPV is owned by the originator of the secur it ized assets, rat ing agencies require t hat an SPV have at least one, and som et im es m ore than one, independent director on it s board of directors, that is, som eone who is not also on the board of the parent com pany. The SPV’s organizat ional docum ents would then require t he vote of greater t han a sim ple m ajor ity of t he directors, including in t hat vote the independent directors, for the board to approve a voluntary bankruptcy filing. The requirem ent of an independent t rustee is relevant in case of t rust form also.

1 ) I nvoluntary Bankruptcies An involuntary bankruptcy case can be com m enced by any person who has an am ount t o receive from the SPV - the creditors of t he SPV. Norm ally, t he SPV will not be allowed to engage any em ployee, but it m ight have to incur expenses for fees, account ing serv ices, etc. To reduce the r isk of an involuntary filing against an SPV, t hird-party credit ors of the ent it y ( typically , professionals, including at torneys and accountants, and financial inst itut ions providing funding or serv ices) are asked to execute an agreem ent that t hey will not f ile an involuntary pet it ion against the SPV unt il m ore than one year has passed after the asset -backed secur it ies have been repaid.

2 ) Lim itat ions on purpose and business: The const itut ional docum ent should define the purpose of t he SPV: m erely to hold the assets, collect them , pass them on, reinvest them ( if a pay through or bond st ructure) etc. The SPV would be given no other power to carry on any other act ivit y.


3 ) Lim itat ion on life: The SPV would stand dissolved on sat isfact ion of the securit isat ion t ransact ion. I f any steps are to be taken to dissolve it , t he sam e should be out lined.

4 ) Lim itat ions on Debt Obligat ions: Generally , the indebtedness of an SPV m ust be lim ited to (a) the asset backed secur it ies; and (b) indebtedness to credit enhancers ( if any) and other liabilit ies incurred in t he ordinary course of business relat ing to the ownership and operat ion of the secur it ized assets. Under certain circum stances, subordinated debt m ay also be perm it ted.

5 ) Liens and Security I nterests: Typically the secur it ized assets can be subject to no voluntary liens or security interests other t han liens in favor of the holders of t he asset -backed securit ies. Except ions can be m ade to the extent assets m ay be used to secure liabilit ies to let ter of credit issuers or to provide liquidity support .

A EUROMONEY PUBLICATION

2 0 0 3 / 2 0 0 4

Global Securitisation Review

Market review for the MENA/GCC regionby Iad H. Georges Boustany, BSEC, Bemo Securitisation S.A.L

The MENA market is witnessing increased activity on the securitisation front,ranging from regulatory developments to the completion of an importantnumber of transactions, notably in Egypt, Lebanon and the GCC, and theevolution of Islamic financial structuring.This article will focus first on theimportance of securitisation for emerging economies, with an assessment ofthe proposed opportunities. Secondly, it will review the hurdles that facestructuring from regulatory, financial, accounting, tax, capital markets andrating perspectives. Finally, it will examine the new opportunities in thismarket, essentially through the emergence of Islamic finance.

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Why securitisation helps companiesin Emerging Markets (EM)The last two years have witnessed a regainedinterest in investment banking activities in emergingmarkets, after a tough period of stagnation anddownsizing.The market has become more mature,modest and realistic.Traditionally, emerging markets’investment banks offered the same product range asin developed markets, mainly standard debt andequity solutions, such as bonds issuance, mergers orIPOs.This product range proved to be totallyinadequate and reflected a deep misunderstanding ofthe nature of the market.The investment banks’activities were constantly and inexorably directedtowards corporate finance and capital markets.Theinvestment banks’ miscalculation and permanentaccounting losses contributed to promoting the ideathat no investment banking activity was possible inemerging markets, while investment bankers ignoredopportunities offered by the customers’ growingassets.The main reasons that both corporate financeand capital market activities did not appeal to

customers are:• the family nature of business;• the absence of growth perspectives;• under capitalisation of organisations;• a massive usage of short-term funding; and• lack of strategic vision.

Figure 1 highlights the fundamental weaknesses oftraditional investment banking offerings (bonds,IPOs, mergers, etc.) to emerging market companies.

On the other hand, it seems that thedevelopment of investment banking activities inemerging markets could be achieved through thedevelopment of structured finance. In fact, the assetside of the balance sheet offers many interestingfeatures to develop high added-value financialservices.

The reasons the EM companies are appealing forstructured finance activities, particularlysecuritisation, are:(1) the current assets represent 30% to 40% of the

total assets;(2) these assets can, to an acceptable extent, be

Figure 1: Fundamental weaknesses of traditional investment banking offerings

Corporate finance Capital markets

Capital Small size transactions Totally illiquid

Ego problems One way market

Will for autonomy Lack of serious transparency

No perspectives for growth No culture for dividends’ distribution

No perspectives for growth

Information shortage

Debt The debt market is well Small size for investment served by local banks bank operations

The size of bond issuance is Lack of information and related to equity which risk benchmarkis generally weak

laws. In the absence of such laws, setting up an SPVthat meets the required standards of flexibility andbankruptcy remoteness becomes an issue.

The first solution that comes to mind in suchmarkets is the usage of an offshore vehicle. In fact,offshore vehicles are, to a large extent, tolerated byMENA legislation. But in the case of Saudi Arabiaand other emerging markets, sale of (some) assetsto non-citizens is strictly prohibited! A way aroundthis second hurdle is to set up a two-tier structure:an “Owner SPV” and an “Issuer SPV.” In the absenceof trust laws and securitisation laws, the Owner SPVwill have to be a limited liability company.This raisesother hurdles, especially in light of Saudi legislationwith respect to losses. In case losses exceed three-quarters of capital (and not shareholders equity!),the shareholders will face a risk of removal of thelimitation of the liability. In fact, the losses musteither be absorbed by an immediate capital increaseor initiate immediate liquidation of the company.Failing to do so, the partners will become jointly andseverally liable for the debt of the company. It istherefore easy to understand why setting up trustservices, under such circumstances, continues to bevery difficult.

Of course, the Arranger can always establish theOwner SPV as a subsidiary of the Originator.Thissolution exposes the Owner SPV to two risks: (i)consolidation risk, which in itself contradicts thepurpose of the transaction, and (ii) control over theassets, especially in a situation where conflict ofinterest occurs; the Originator being usually theholder of a junior tranche. It seems clear that havingthe Owner SPV as a subsidiary of the Originator isnot satisfactory in the absence of autopilot schemes(pre-determined management powers) and/orspecific legislation. Specific structuring techniques canaddress the Owner SPV bankruptcy remotenessissues to an acceptable extent.Yet, this requires skill,imagination and flexibility from all parties to the deal.Accounting standardsThe accounting standards are not standardisedthroughout the MENA region. Some countries haveshifted to International Accounting Standards (IAS),others have implemented a mixture of FinancialAccounting Standard Board (FASB) and IAS, andfinally some countries have kept their own nationalstandards. In Lebanon for example, IAS applyaccording to the financial ministerial order N.6258/1introduced in August 21, 1996 and improved on June14, 2001, according to N. 673/1. De-recognition, saleaccounting, consolidation and claw back are thenfavourable to securitisation transaction.

In the case of GCC, and more specifically theSaudi Arabian market, accounting standards have

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transferred;(3) such transactions have no impact on the capital

structure of the customer;(4) off-balance-sheet financing does not increase

debt;(5) positive impact on the balance sheet, improving

return and liquidity ratios;(6) lower cost of funding than the traditional bank

loans;(7) positive marketing impact; and(8) the bank lines are saved for strategic

investments.Securitisation seems to be the appropriate tool

to satisfy the financing requirements of emergingmarket companies.Yet many legal and culturalhurdles impede the full development of thesecuritisation activity in these markets.

What are the challenges?Absence of regulationAlthough some assert that a securitisation law mustbe enacted prior to conducting securitisationactivities, experience shows that securitisation canoccur in the absence of any specific legislation. InLebanon for instance, the transfer of assets can bedone according to article 280 of “Code ofObligations and Contracts,” or based on thefiduciary Trust law N.520 of June 6, 1996 that dealswith “Financial Markets Development and FiduciaryContracts.”

The Special Purpose Vehicle (SPV) could be eithera company with a variable capital regulated by theCommerce Code, a community according to “Codeof Obligations and Contracts” or a Fiduciaryregulated by Central Bank Directive N. 6601 of May23, 1997.This transfer can be done on a true salebasis. Marketable securities are regulated by article252 of Code of Commerce, and their trading on theBeirut Stock Exchange has been easier since theintroduction of a new section in Decree N.7667 ofDecember 16, 2000, which encourages innovationand allows “all other securities or financial negotiablevalues”.

What seems easy and straightforward in Lebanonappears more complicated in other jurisdictionssuch as Saudi Arabia,Turkey or Egypt. In Saudi Arabiafor instance, sale of assets and receivables is ofcourse possible, but restrictions on the nature of thepurchaser make the task sometimes impossible. Inthis Islamic-Shariah based legal system, form can betotally disregarded by the court that can focusexclusively on substance, and hence pierce any typeof legal or corporate veil.True sale can be re-qualified. Except for Lebanon, most of the MENAmarkets have not enacted trust or securitisation

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been raised up to international standards by a blendof IAS and Saudi GAAP (based on FASB).Theexisting standards are FASB inspired, but otheraccounting issues (not explicitly addressed) are to beconstrued in line with IAS.The usage of such arobust accounting base makes the sale of assetseasier, but at the same time brings confusion as towhich benchmark to take.With respect to the truesale issue, it is unclear whether the de-recognition offinancial assets is risk/reward or control-based?Needless to say that IAS internal contradiction (IAS39 and SIC 12) has not been tested yet and the waythey will interact with FASB is still unknown.Unstable tax environmentAnother issue to address is tax related. In theabsence of adequate legislation, tax issues can erodethe economics of any securitisation transaction. In atwo-tier structure where the Owner SPV will haveto route funds to an offshore Issuer SPV, such fundswill be subject to withholding tax. Such tax cansometimes be circumvented through structuringtechniques involving the Luxemburg Fiduciary Trustor a Jersey-based specific vehicle.

Another issue is when, having enacted suchsecuritisation or fiduciary or trust laws, thegovernment fails to understand or to grasp thesubstance of such concepts, and due to temporarycash shortage (which is common in emergingmarkets), modifies such laws in a way to levy taxeson such vehicles.

Tax legislation is one of the most unstable areasin the MENA region. Lebanon gives a good exampleof such risks, as it has witnessed throughout the lastdecade a swing in income tax, the introduction ofthe VAT (without lowering the customs duties), andthe enactment of a tax-neutral fiduciary trust law in1996, which was later subjected to double taxationin 2003.Absence of capital marketsSecuritisation is not only about corporate finance,but also about capital markets.The absence of capitalmarkets is yet another hurdle to overcome in theMENA region. Much has been written on emergingmarkets’ inability to develop capital markets.According to experts, the most important reasonsfor this failure are the lack of infrastructure of thereturn measurement, and the lack of superstructureof risk measurement.The infrastructure of thereturn measurement is an application of thetransparency concept. It boils down to setting up apublic or a private institute dealing with collection,processing and dissemination of legal, financial andindustry information on micro, meso and macroeconomical levels.This critical breakthrough requiresonly a slight modification in the existing laws and a

minimal capital allocation. It is a path that emergingmarkets have not yet decided to take, especially dueto the role of transparency in uncoveringcorruption.

Fana and Von Hayeck, the “architects” of theinformation age, confirmed 20 years ago thatinformation is the raw material of marketeconomies.Accordingly,The European Communityallocated two directives (the 4th and the 13thdirectives) to upgrade and harmonise information,disclosure and transparency throughout Europe inconjunction with the construction of the EuropeanUnion. No similar measure was ever attempted inMENA.

In markets poorly covered and barely understoodby Rating Agencies, and in the absence oftransparent reliable affordable data, heavy investmentis required to establish independent and objectiverisk measurement. Rating agencies have refused tomake such investment, arguing that the return onsuch investment is more than hypothetical.Thesolution to this seems to be another governmentalaction setting up a “National Scale Rating.” This willallow for rationalisation of risk costs and for buildingtrusted relationships between the investor and themarkets, allowing bank depositors to dis-intermediate and convert unproductive deposits intodirect investments.

Capital markets cannot flourish without anindependent and scientific measurement of both riskand return. Until then, banks will remain thepredominant structured paper investors in theMENA region. Having banks as end-buyers ofstructured paper distorts the disintermediationprocess and dramatically narrows the spreadsavailable for both investors and originators.Thisfactor diminishes the attractiveness of EMsecuritisation and seems to be a key factor inunderstanding the shy move towards securitisationin the MENA at times when the industry iswitnessing continuous stunning growth throughoutthe world.Sovereign ceilingWhen dealing in emerging markets, one of the mainadvantages of securitisation/structured finance is theability to breach the sovereign ceiling and henceprovide lower funding costs.

The cost of funds for healthy companies inemerging markets, and more specifically, poorly ratedcountries, is an issue.The rating agencies havedeveloped the theory whereby no company wouldbe allowed a higher rating than that of the countryin which it is operating.The concept, better knownas the sovereign ceiling, is based on the underlyingassumption that a sovereign default will force all

techniques allow breaching the ceiling and mitigatingemerging markets risks2.The techniques can begrouped under three main headings:3 (1) bypassingtechniques, (2) outlasting techniques and (3)exemption techniques.

The bypassing techniques used by investmentbankers and securitisation specialists in their effortto address sovereign risk issues are based on theability to capture hard currency outside the scope ofgovernment intervention and beyond government’sreach.These techniques are referred to as “bypassingthe exchange controls”.The first technique is FutureFlows. Many securitisations emanating from Turkey,Brazil, Egypt and Mexico have achieved BBB (AAAwhere a monoline insurance wrap has beenobtained), by capturing hard currency cash flows inbank accounts located offshore.The Originator,typically an exporter, assigns the receivables andinstructs its clients to settle their due in an offshoreaccount administered by a Trust.The only way agovernment can affect such a structure isconsolidating the SPV with the Originator and thenconsidering any payments to the SPV as part of hisscope of intervention. It is worth noting thatsophisticated structuring techniques can addresssuch issues and avoid SPV consolidation.Thestructure is not totally immune from country risks,because it will always be limited to the Originators’capacity to continue generating the neededreceivables.

Another technology often used in Future Flowdeals is the Supply Bonds.An insurer will coversupply risk by paying the trustee if the Originatorfails to deliver the goods.Another technology usedin bypassing the exchange controls and country risksis the swaps and guarantees that can be locked intoa structure and triggered in the event of forceddefault or lack of access to foreign currency. In thiscase the guarantor or the swap counterparty willmake hard currency payments to the SPV and willbe entitled to whatever funds are available in localcurrency or onshore accounts. Currency swaps areused to address the devaluation issues, as well astransfer risk convertibility risks.A swap triggerpromising to pay abroad if sufficient local currencyfunds are collected domestically will allow the cashflow to bypass government controls.

Apart from the commercial insurers, two mainagencies underwrite emerging market risks: OPIC(Overseas Private Investment Corporation), a USgovernment agency and MIGA (MultilateralInvestment Guarantee Agency), the World Banksubsidiary. Rating agencies awarded insuredtransactions with above sovereign rating (the MSFdeal in Brazil). It is worth noting that the deal will

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domestic issuers or obligors to default, as thesovereign will necessarily impose restrictivemeasures impeding access to hard currencynecessary to service their obligations.This indicatoris very hard to measure in the absence of acomprehensive intellectual framework or anyconclusive experience.This concept cannot besynthesised and expressed using rating symbols dueto the lack of comparative methodology andbenchmarks. The sovereign ceiling theory has noscientific grounding or justification known to us, norhas it been demonstrated via a “débat contradictoire.”It seems that this theory is more of a dogmaticapproach that provides an intellectual comfort forrating agencies with limited time and resources todeal with a variety of cultural models in business.This theory also neglects any other trade modelthan the one based on the written contract. It totallyneglects the binding effects of know-how, notoriety,pledge and other social or cultural constraintscharacterising non-western societies.

Such cultural issues are also found in someindustries in Europe, such as the diamond market inAnvers. One might refer here to the works of DavidFreidman, as detailed in his reference book Law’sorder. One can also point out that the sovereignceiling theory has been put aside by its own genitorsfor specific political reasons. Some countries haveearned investment-grade rating while lacking thebasics of any investment-grade requirement. Othercountries like Japan and Korea, and lately evenGermany, officially objected the rating agencies’discriminatory practices. In order to make up for theabove weaknesses, sovereign rating has beenpromoted as the best proxy for the sovereign ceiling.

When dealing in emerging markets, one of themain advantages of securitisation/structured financeis the ability to breach the sovereign ceiling andhence provide a lower cost of funding. Several

Figure 2: Sovereign ratings for some MENAcountries1

Country Moody’s Fitch Standard Ratings & Poor’s

Bahrain Baa3 A- A-

Egypt Ba1 BB+ BB+

Israel A2 A- A-

Jordan Ba3 NA BB

Kuwait A2 AA- A+

Lebanon B2 B- B-

Oman Baa2 NA BBB

Qatar A3 NA A+

Saudi Arabia Baa3 NA A

UAE A2 NA NA

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only reach a stand-alone rating level. Should thestructure collapse or the obligors default, OPIC andMIGA will not be obligated to make payments.Alternative structuring technology like the Bonexstructure existed and was able to lift a deal abovethe Sovereign ceiling levels.

The investment banker can structure a deal in away to outlast the exchange controls. It consists ofproviding access to foreign currency for theexpected duration of the exchange controls.Twotechniques are available here.The first is to fund anoffshore account with enough cash to outlast theexchange control period.The funds should beapplied to satisfy the interest due to investors. Buthow to determine the time frame for exchangecontrols? This period, as set by rating agencies was12 to 18 months before the Argentine crisis. It isnow 24 months.This technique has become a veryexpensive mitigation tool.

The second option available to structuring banksis the risk triggers, whose role is to legally increasethe weighted average life of the notes in order forthem to outlast the control period. During theperiods of exchange controls, all money is capturedin a GIC Account.The amounts are in hard or localcurrency, and used to pay the Noteholders once thecontrols are lifted. Combining both techniques (theoffshore accounts and the risk triggers) usuallyproves quite efficient.

The exemption techniques refer to thosetechniques involving players more powerful than theSovereign.The first most obvious one is thestructuring technique based on Preferred Creditor.The underlying assumption being that thegovernment will default on all creditors except themultilateral agencies (like the World Bank and itssubsidiaries).A transaction where the lender insubstance or even the Lender of record is amultilateral agency can achieve above sovereign.Experience proved that it is not systematically thecase and government seems to be able to defaulteven on those prominent players.Anotherexemption technique involves a company within acountry with extensive powers due to historical orindustrial reasons.These companies have unlimitedaccess to hard currencies or are perceived by theSovereign as vital players, drivers of economicalgrowth. It is the case with PDVSA in Venezuela or toa lesser extent with Solidere in Lebanon. Hence, it isnot in the best interest of the Sovereign to forcethese companies to default even if the Sovereign isitself in urgent need for hard currencies.Theforegoing is true, subject to local politics andEmerging Markets Sovereigns sometimes do shootthemselves in the foot.

Under pressure from investment bankers andever more innovative structures, rating agencies haveloosened their requirements and somewhatundertaken a shift in their policy of proposing andaccepting solutions for breaching the sovereignceiling. In June 2001 Moody’s announced thatemerging market debt may not be constrained tothe country ceiling where (a) the creditworthinessof the borrower is judged to be sufficiently high; and(b) the likelihood of a general moratorium in theevent of a government default is sufficiently low; and(c) where the Obligor has special access to foreignexchange. Rating agencies have not yet daredquestion the mainstream theory they havecontributed to putting in place.

What are the new opportunities?Islamic financeOne of the main developments in emerging marketsis Islamic finance. Like all conventional banks, Islamicbanks are in the business of financing and assetmanagement. Some have indeed participated insecuritisation transactions.The definition of anIslamic bank as provided by the Organization ofIslamic Conference (OIC) is as follows4:“A financialinstitution whose status, rules and proceduresexpressly state its commitment to the principle ofShariah and to the banning of the receipt andpayment of interest on any of its operations”(Shariah being the economic, political, religious andsocial order of Islam). Islamic banks startedoperating in the early eighties at the national level inPakistan, followed by Iran and Sudan.To date, thereare more than 2675 Islamic financial institutions,banks, insurance and reinsurance companiesoperating in different countries, mainly in the GCC6

region.Nonetheless, conventional banks of Western and

European countries (including Lebanon) startedtaking advantage of Islamic banking techniques dueto the success of Islamic banking operations,particularly using the fund in a profitable waythrough asset finance or joint ventures. Moreover,Islamic finance tends to relate finance to assetswhich makes securitisation the perfect match forIslamic institutions. Similarly, securitisation seems tobe an interesting opportunity for Islamic financialinstitutions, due to the fact that it opens new liquidmarkets, new classes of investors, a balance sheetclean-up technology and fee-income earnings.

Applied to securitisation, the Shariah conceptslead to certain differences between conventional andIslamic transactions. For a securitisation to beIslamic, it must ensure a two-level compliance: (i) theunderlying asset and (ii) the structure. Islamic

do allow for the capital owner to contribute capitalin kind (i.e. merchandise) provided that value ismutually agreed at the time of the contract.Theagreed value becomes the capital of the Mudaraba.Most of the Scholars who allow in kindcontributions, however, require the business of theMudaraba be the sale and purchase of the relevantmerchandise.

Musharaka is another (similar9) mode of Islamicfinance, which is represented by two or morefinancers who want to establish or participate in anew project and are entitled to share the profits ofthis project according to an agreed ratio.The lossesare shared in proportion to the capital contribution.One influential Scholar within the Hanbali School(the author of Al-Mughni, which is one of mostinfluential texts used in the Kingdom of SaudiArabia) considered that “if someone allows anotherperson to work his mule and receives a portion ofthe profits arising from the mule, this would not bea partnership and would not be a Mudaraba butwould be a structure close to the Muzaraa or theMusacat.” Muzaraa and Musacat (or sharecropping)are generally arrangements pursuant to which aperson allows another to plant his land or exploithis farm and would receive a portion of the profitsarising from the land or the farm.Al-Mughnidefended this structure as a means of exploitation ofan asset and sharing of the profits produced.

In this context, a similar structure seems to havebeen recently approved by the Fatwa Committee ofthe Jordanian Islamic Bank. In effect, the ShariahCommittee of the Bank allowed (i) the purchase bythe Bank of refrigerated trucks for operation by theBank’s customer and (ii) the distribution of theprofits arising from the trucks’ operation (after thepayment of the capital to the Bank in full) inaccordance with a pre-agreed percentage.

Equipment securitisation (using leases or leased-back underlying assets) is possible under the schemeknown as Ijara. Shariah compliant structures providefor both Ijara (operating lease) and Ijara wa Iqtina(financial lease)10. Unlike conventional operatinglease, Ijara does not restrict the lessee’s right topurchase the assets at anytime during or after thelease term11,Also there are no restrictions as to theterm of the Ijarra agreement.An Ijara agreement canrange from hours to years.The Iajara wa Iqtina hascertain advantages over other forms of directparticipation (Musharaka) mainly because of theadequate protection of the investment and of thetax advantages attached. It is yet unclear whether amismatching between the term of the Ijara and theamortising life of the leased assets would lead to re-qualifying the Ijara or the Ijara wa Iqtina.

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institutions are concerned with the Islamicacceptability of the asset classes; they tend to ensurethat the underlying assets are “Halal”.Alcohol,tobacco or gambling, and other related assets areprohibited, and will not be eligible underlying assetsin a Shariah compliant securitisation because theygenerate non-Halal revenues. Mortgage-BackedSecurities are also not to be considered since theyare pools of interest-bearing assets.

For a securitisation transaction to be eligible,having a Halal underlying asset is not enough.Thescheme linking the parties must in itself comply withcertain accepted principles.The parties’ relationshipsmust be governed by agreement which in substancedo not contradict the Shariah principles.This doesnot imply that a Shariah compliant securitisation cantake only one form.Arrangers are not limited to onerigid scheme that ties the Obligors, the Creditorsand the Assets. Nevertheless, the underlying“scheme” should in substance match with one of theaccepted financing schemes.These are mainlyMurabaha, Mudaraba, Mucharaka and Ijara.

In inventory and trade finance securitisationtransactions, the underlying structure should beconstrued in substance as a Murabaha contract, i.e. asale on a profit mark-up.The SPV would bepurchasing goods and selling them to clients at apre-agreed profit margin, rather than having a poolof interest-bearing loans.To be in consonance withthe principles of Islamic finance governing exchangetransactions every Murabaha transaction must meetthe main following condition: Murabaha transactionsmay be undertaken only where the client of a bank,or financial institution, wants to purchase acommodity.This type of transaction cannot beeffected in cases where the client wants to get fundsfor a purpose other than purchasing a commodity,like payment of salaries, settlement of bills or otherliabilities7.

Another permissible scheme underlying an Islamicsecuritisation transaction is the Mudaraba whichcombines financial experience with businessexperience, and where one party provides capitaland the other labour (the Mudareb is sometimesreferred to as the Trustee8). Banks will then providecapital and clients provide the expertise, and theprofit will be shared according to an agreed ratio.Under a Mudaraba scheme, the SPV would be thecapital owner and contribute the capital whereas theOriginator/Servicer would be the Mudarib andwould provide its experience and services.Themajority of the Islamic Scholars require that in aMudaraba the capital owner contribute the capital incash. Certain Scholars, including certain Scholarswithin the Hanbali School of Islamic Jurisprudence,

76

An issue still unresolved (one of many) is the onerelated to options.We choose to address this specifictopic because of its fundamental role in emergingmarkets securitisation. EM assets are usually localcurrency denominated whereas issued paper appealsto investors only if in hard currency.This inherentmismatch requires embedding currency options,forwards12 or swaps within a structure.Techniquesmight be implemented using other acceptedconcepts. Salam, for instance, is a sale transaction thatconsists of the sale of a deferred commodity againsta present price. In other words, it is a Forward TradeTransaction, which can be suitable for agricultureoperations. Istisna is another kind of sale where acommodity is transacted before its existence; thiskind of transaction can be used to facilitate financingin sectors like house financing, technology, aircraftand ship building industries. It is unclear whetherthese concepts might be applicable for currencies,stocks and other marketable securities.Yet accordingto a large majority of scholars13, this is notpermissible on various grounds, the most importantbeing the element of risk and uncertainty (gharar)and the possibility of speculation of a kind which isnot permissible. However, another ground forrejecting such contracts may be riba prohibition. BaiSalam in currencies with fluctuating exchange ratescan not be used to earn riba because of the presenceof currency risk. It is possible to demonstrate thatcurrency risk can be hedged or reduced to zero withanother forward contract transacted simultaneously.And once risk is eliminated, the gain clearly would beriba.This is a substance modification of the riskpatterns of the underlying assets which seems notacceptable under Shariah.

Finally, from a risk/return perspective, theinvestors in Islamic transactions are remunerated ona profit and loss sharing basis, while a conventionalstructure allows a debt issue with fixed return, withor without a right of recourse to the issuer.However, the successful application of securitisationrequires available credit and financial data on theunderlying asset, appropriate accounting standardsand the possibility of a rating process; theseconditions are not well satisfied in various Islamiccountries. Moreover, it is yet unclear to whichextent modification of risk/return patterns isacceptable under Shariah.This puts a question markover all credit enhancement techniques usuallyembedded in a securitisation deal, and morespecifically the tranching techniques.

The size of the Islamic market is said to beUS$100bn growing at a 17% rate per annum. GCCbanks (the GCC is where the main Islamic bankingactivity is) dominate with a 71.44% of total capitalfor top 100 MENA banks. Saudi banks have thebiggest share, followed by the UAE and Bahrain.Among the non-GCC, Egypt leads withUS$4,201bn.14

Government securitisation andprivatisationAnother new area of activity is Governmentsecuritisation and privatisation. Lebanon was thefirst MENA country to enact a GovernmentSecuritisation law.The 2002 enacted law N.430allows the Central Bank of Lebanon to hold anaccount for the management, servicing andreduction of public debt.That way, it will receive theproceeds of the country’s privatisation programmeover the next 20 years.

The Ministry of Finance is also authorised toentrust the Central Bank with the structuring ofsecuritisation transactions; SPVs could then beestablished by the Ministry of Finance and receivethe privatisation proceeds on a true sale basis, suchtransfer being expressly immune against any freezeorder or set-off risk.We foresee a growth ingovernment securitisation transactions in the MENAregion, as more governments reform theireconomies and look for efficient means to privatiseor securitise segments of their economies.

Notes:1 Official web site of each Rating Agency as of

August 2003.2 Emerging Market risks include: convertibility,

transfer, devaluation, expropriation, politicalviolence, freezes on deposits, as well as legal,economic and environmental risks.Theaforementioned list is not exhaustive. It is

Figure 3: Geographical distribution per capital

GCC countries US$m

Bahrain 6,378

Kuwait 4,836

Oman 892

Qatar 1,750

Saudi Arabia 12,797

United Arab Emirates 7,396

Non-GCC countries US$m

Algeria 829

Egypt 4,201

Jordan 2,552

Lebanon 1,863

Libya 714

Morocco 1,871

Syria 730

Tunisia 851

deferred to a future date and hence, are similarto futures in this sense.The latter however, arestandardised contacts and are traded on anorganised Futures Exchange while the former arespecific to the requirements of the buyer andseller.

13 Mohammed Obaidullah, Financial Contracting inCurrency Markets:An Islamic Evaluation,International Journal of Islamic Financial Services,Volume 3, Number 3.

14 Arab Banking and Finance, 19th Edition, 2003-2004,p. 25.

Author:Iad H. Georges Boustany, General Manager

BSEC, Bemo Securitisation S.A.L7th Floor

BEMO BuildingSassine Square

AchrafiehBeirut

LebanonTel: +961 1 200609Fax: +961 1 200647

Email: [email protected]

77

nevertheless considered that the main emergingmarket risk is the transfer/convertibility risk.Addressing the other risks is out of the scope ofthis article

3 See FitchRating research on Sovereign Rating andCeiling.

4 Nassiruddin Ahmed, Islamic Banking and its Modeof Investments, Anthology of Islamic Banking, p. 307.

5 Nassiruddin Ahmed, Islamic Banking and its Modeof Investments, op.cit. p. 308.

6 GCC, Gulf Cooperation Council, includes 6countries: Bahrain, Kuwait, Oman, Qatar, SaudiArabia and United Arab Emirates.

7 Al Rajhi Bank: an in-depth insight in IslamicBanking, http://www.alrajhibank.com.sa/instru-murabaha.htm

8 Afzal Elahi, Leasing in Islam, op.cit. p. 315.9 Farid Scoon, Musharakah and Mudarabah -

Towards Rationalisation, op.cit. p. 356.10 Derek Weist, Issues in Islamic Leasing, op.cit. p.318.11 Afzal Elahi, Leasing in Islam, op.cit. p.316.12 Some Islamic scholars use the term forward to

connote a salam sale. However MohammedObaidullah uses this term in the conventionalsense where the obligations of both parties are

MENA – GCC Securitisation market review

Dr. Nasri Antoine Diab law firm

BSEC Bemo Securitisation SAL

This article first appeared in Global Securitisation and Structured Finance 2004,published by Globe White Page Ltd, www.globalsecuritisation.com.

For the last couple of years, the MENA markets have been pushing for more

diversity in their financial activities. In that respect, securitisation has been a

significant agent and is experiencing notable growth that has already

materialised in markets like Egypt, Lebanon, the GCC countries and, very recently,

Saudi Arabia. We will, throughout this overview, focus on the opportunities

offered by this new approach for emerging economies, taking into account the

specificities of the targeted markets.Therefore, we will analyse the characteristics

of the relevant markets from an economic and regulatory stand. We will then

show how some other relevant factors have placed hurdles to the development

of those markets. Lastly, we will examine how securitisation can complement

Islamic Finance and the trends of government securitisation.

From an economic perspective

Investment banks, whether international or regional, have constantly tried to

offer the same range of products they offer in developed countries to

companies in the MENA – GCC regions. This global but also simplified

approach to corporate finance has yet to succeed. In our opinion, the main

reason for such failure is that this approach ignores the opportunities offered

by the status of a typical regional company’s balance sheet. Therefore, the

size, the customers’ growing assets and the structure (family owned) of a

majority of those companies were not in most cases taken into account in

order to offer tailored products that would reasonably match the needs of

these companies and compete with services offered by the banking sector.

The investment banking community has never taken the time and allocated

the resources required to understand the needs and specificities of emerging

markets. This lack of interest can be explained and better understood if one

was to look at the numbers: the cost of required resources far outweighs

expected returns. Investment banks have therefore offered equity and debt

products where asset based solutions were needed.

MENA – GCC Securitisation market review

Dr Nasri Antoine Diab – Dr. Nasri Antoine Diab law firm

Iad Georges Boustany, Elias Sayegh – BSEC Bemo Securitisation SAL.

© N.A. Diab and BSEC Bemo

Securitisation SAL 2004

N.A. Diab and BSEC Bemo Securitisation SAL 1

2 N.A. Diab and BSEC Bemo Securitisation SAL

MENA – GCC Securitisation market review I N.A. Diab and BSEC Bemo Securitisation SAL

Regulatory framework

The evolution of securitisation has already showed that it

is possible to structure such operations in markets where

no specific regulations exist Although a defined legal

framework would aid better understanding of the concept

and avoid the risks associated with legal uncertainties,

most of the countries in the MENA – GCC regions have

still to enact such regulations. For the purpose of better

addressing this issue, we will first address the countries

that have enacted such regulation or are on the verge of

doing so. We will then analyse how securitisation would

apply in some countries of the MENA – GCC region that

have not yet envisaged such a possibility and the main

hurdles for the use of such financial structure.

Status of securitisations regulations in the region

Several countries have addressed the securitisation

issue in a formal way. In this respect, Turkey has already

issued a regulation as early as in year 1992 treating

the subject from the sole aspect of asset-backed

securitisation. Other types of securitisations (eg

mortgage-backed securitisation) are not specifically

addressed by this regulation although the evolution of the

legal framework and its flexibility permit securitisation to

be a very popular product in the Turkish economy and to

be broadly used by banks to reshape their balance sheets.

Tunisia has done the same by including the concept of

securitisation in its plan to reshape the banking sector. The

trend was also confirmed with the adoption of Law N.

2001-83 dated July 24, 2001, addressing many of the

issues related to funds but also creating a new entity in the

Tunisian legal framework, the ‘fonds commun de créances’.

This structure mirrors the legal situation of securitisation in

France and is an adaptable structure for such transactions.

As for Lebanon, the government has been studying

comprehensive draft law for more than two years now.

Nevertheless, Lebanon offers an adequate framework for

structured finance operations: It has already enacted a

Fiduciary Trust Law N. 520 dated June 6, 1996, dealing

with “Financial Markets Development and Fiduciary

Contracts”. In addition, the Lebanese legal framework

offers flexible opportunities for the transfer of assets or

receivables pursuant to Article 280 of ‘Code des

Obligations et des Contrats’. This article states clearly that

assignability of assets is the rule and restriction is the

exception. The setting up of an SPV is made relatively easy

with the possibility of choosing between a company with

variable capital, a community, or a fiduciary.

Egypt, which has been reserved in addressing the

subject, has included a securitisation provision in regulation

dealing with real estate. Egypt still has to enact a broader

and more comprehensive law addressing the issue,

although some transactions have already closed

(securitisation of credit card receivables for example). It is

also interesting to mention that the absence of such a

precise and predetermined setting for securitisation has not

been a hurdle for securitisation transactions, a number of

which has already closed in some MENA – GCC countries.

Shariaa based systems

Taking Saudi Arabia and all other Shariaa based systems as

an example, experience has shown some stringent

restrictions and uncertainties at many levels. Although

transfer of assets or receivables is allowed, some

restrictions apply as to the nature of the purchaser. Also,

courts apply Shariaa in their decision-making process.

Shariaa is itself divided in different schools. Although the

Hanbali school is dominant in Saudi Arabia, the judge can

decide to choose another school and to focus exclusively

on substance, ignoring what was created in form (a

necessity in structured finance). This brings great

uncertainty to the cornerstone of a securitisation

transaction: the concept of true sale. The possibility of

requalifying a true sale and of piercing the legal and

corporate veil makes any investor very wary before taking

such a risk. Another problem faced in Saudi Arabia and in

some other countries in the area are the very strict laws on

foreign ownership. Those handicaps bring us to the

conclusion that one of the best ways to structure a

securitisation transaction in such an environment would

be through a two-tier structure with both an SPV in the

country of origination (the owner SPV), and one in a

foreign country, (issuer SPV), with adaptable legislation

(Jersey, Luxembourg). It is necessary to mention that it is

not possible to create an SPV as a subsidiary of the

originator since it would expose the owner SPV (the local

one) to consolidation risk and would remain under the

control of the originating entity. Those two risks defy the

very essence of a securitisation transaction.

Other relevant factors

In addition to those mentioned above, there are a number

of other factors to be considered in any market for

securitisation. In the MENA – GCC region these factors are

also hurdles at this very early stage of the evolution of

regional structured finance


N.A. Diab and BSEC Bemo Securitisation SAL I MENA – GCC Securitisation market review

Absence of capital markets and

lack of experience of main players

Capital market efficiency is measured by many

parameters. The regional markets lack some basic

parameters. Thus, there is both a lack of infrastructure for

accurate return and, a lack of superstructure of risk

measurement. Simply stated, and in a market ignored by

the Rating agencies, there is a real problem with

information collection, transparency, processing,

disseminating and analysis. This is a direct result of poor

harmonisation of the available data, not only on a regional

level but also within the same country where the reporting

requirements and levels of disclosure are rarely to be

counted on. This is a major handicap when we know the

importance of information and its analysis. In building the

financial markets of the European Union, commissions

have understood very early how important that issue is

and have consequently addressed it at the highest levels in

the 4th and the 13th Directives.

In the rare cases where the above handicaps can be

overcome, some additional factors come into play. First, on

the investors’ level, there is real hesitation to engage in

what still seems to be an exotic financial instrument. This

is a result of the lack of experience but also in the case of

banks, of the fear of competition. With the boundaries of

commercial banking and investment banking yet to be

defined and, more importantly, to be clearly understood by

the players in the region, the market will experience

disruptions that will impede its natural evolution.

Secondly, the stagnation of financial activities has

affected the private sector and companies that would be

viewed as potential clients for a securitisation transaction

in that it has made them so dependent on traditional

banking and on their relation with those banks that they

would not jeopardise it for a financing alternative that

they are still not familiar enough with, even if it would

offer a better cost of funds.

The choice of securitisation often comes at a moment

where a company has exhausted other alternatives. This is

obviously not the best time for a securitisation transaction

to be structured. On the other hand, once the

securitisation structure is in place, the trustees probably

have the most important role in making sure that the

mechanism created by the structure is working well.

Therefore, their role is a prominent one and cannot be

ignored. In order to accomplish the tasks delegated to

them, these firms, or in some cases these individuals, must

understand and exercise their role to the fullest extent.

This requires experience and investments. The shortage of

such experience in the region can however be addressed

by delegating these specific tasks to foreign trustees and

leaving very little to the discretion of locals (although

some tasks have to be accomplished by locals as required

by law).

Even if all those issues are addressed, the absence of

rating agencies intervention and of understandable and

regular data remains a hurdle in developing the markets.

Last but not least, it is crucial to mention that in developed

markets, private players interact with regulatory bodies

that play a pivotal role in defining tasks, requirements,

flow of information, quality of investors and other crucial

duties. In order to accomplish the above mentioned duties,

these regulatory bodies must be at least as competent as

the most sophisticated players. The learning process is a

self-feeding one where new initiatives build knowledge for

all interacting parties. The scarcity of such initiatives and

transactions in the MENA – GCC region dilutes the

knowledge base of the regional public and private players

Accounting

Beyond the absence of harmonisation of the standards

used throughout the region, which already makes

the data eventually available hard to understand, the

implementation of International Accounting Standards

(IAS) raises another problem. These standards (IAS or

other) are the result of a lengthy nurture process

stemming from back and forth trial and error actions in

very sophisticated markets. Standards have been put to

the test and improved on numerous occasions. They grew

in sophistication along with the markets. This is a major

difference with MENA – GCC where these standards have

been imported in their most refined/sophisticated version.

Thus, instead of starting to evolve in a rather flexible

market, regional markets have to evolve with complicated

accounting standards that developed markets did not

experience while growing their business. This creates an

additional hurdle for innovative financial instruments.

MENA hot topics

Government use of securitisation

As a result of the growth of securitisation in the developed

markets, regional governments have considered using this

financial tool as a means to boost their economies.

Therefore, some of the countries have looked at

securitisation as a method that would help reduce public

debt. Lebanon is one of these countries and the first in the


MENA – GCC Securitisation market review I N.A. Diab and BSEC Bemo Securitisation SAL

MENA – GCC to have enacted a government securitisation

legislation (Law N.430 of year 2002). It has planned for the

Lebanese government to receive the proceeds of

privatisation programs that will eventually take place over

the next 20 years. But although securitisation is a

considerably important tool to use in governments’

economic policy, it is a tool to use very carefully.

The downside of the use of securitisation transactions

in government operations is that some strict requirements

have to be met in order not to put at risk the very

qualification of the transaction. Therefore, and in reference

to the standards set by the European System of Accounts

(ESA 95), there is a risk that a securitisation transaction be

treated as a government borrowing. This would happen in

cases where a government is securitising future flows. The

very purpose of securitisation would be jeopardised in that

a government borrowing would have embedded in it risks

that are different from those of the securitised assets, and

the investors would want to be aware of those risks. Also,

guarantees given by the government jeopardise the

qualification of securitisation since it could be deemed

that no complete transfer of risks and rewards has been

operated by the government which would have to support

the structure in case of failure. Thus, this scheme is also

considered as government borrowing. Finally, there is a

number of guidelines that a government will need to

follow in order to make sure the transaction will not be

requalified. Thus, securitisation is not the easy and simple

solution to governments’ economic problems as some

have tried to represent.

Islamic finance

Islamic finance materialises in the perusal of the teaching

and orientation of Shariaa principles in the finance industry

and more specifically, for the scope of our analysis, for

securitisation purposes. The major aspect of Islamic finance

is the adherence to Halal activities meaning activities that

are allowed under the Shariaa. It is usually a Shariaa board

or in some cases a single recognised scholar that issues a

Fatwa confirming the compliance of a securitisation

transaction with the guidelines.

Shariaa has traditionally linked finance to assets per se

and to the risks inherent to those assets.Thus, knowing the

importance of this very similar approach for a

securitisation transaction as well, a very quick link was

made in order to help develop both markets in parallel.

This evolution is yet to be experienced since most

securitisation operations are now being done in markets

where Islamic finance has not yet reached full potential,

while most the of Islamic banking community and

activities are taking place in the Muslim world. There is

some level of mismatching in the products offered and the

needs of the markets. European and US investment banks

are trying to address this new market by creating a new

approach to regional needs that would be in line with

Islamic finance principles; this mismatching could ideally

be addressed by developing regional know-how in

securitisation structuring.

Compliance of a securitisation transaction with the

Shariaa has to be verified on two levels. First, the assets to

be securitised must be assets that are eligible. Therefore,

revenues deriving from any activities related to gambling,

alcohol, or any non permitted activities are not eligible to

be securitised under Islamic Shariaa. On a second level, the

securitisation structure has to be declared compliant with

Islamic principles. This can fall under the ethical

investment asset class.

The ultimate result of a transaction that would be

declared Shariaa compliant could be the issuance of Sukuk,

which is the Islamic name given to hybrid bonds. Within a

securitisation transaction and as a result of the linkage

with the ownership of assets, an important distinction

could be made for instance between Ijara Sukuk and

Investment Sukuk. This example would help understand

how some ownership elements would affect a

contemplated transaction under Shariaa principles. As an

example of Ijara, we can mention financial and operational

leases. Although financial leasing operations per se are

allowed by Shariaa, securitisation of a pool of financial

leases would not obtain Shariaa approval because

investors would not be considered as taking the risks and

rewards of the physical assets. Thus, such a transaction

would not be permitted, unless the asset being leased is

acquired or the usufruct of this asset is transferred. This

brings us to the definition of the investment Sukuk as it is

given by the Accounting and Auditing Organization for

Islamic Financial Institution, Shariaa Standard No.17:

“Investment sukuk are certificates of equal value

representing undivided shares in ownership of tangible

assets, usufruct and services or (in the ownership of) the

assets of particular projects or special investment activity,

however, this is true after receipt of the value of the sukuk,

the closing of subscription and the employment of funds

received for the purpose for which the sukuk were issued”.

This is a broader aspect of Sukuk and allows for easier

application of securitisation. The definition of Investment


N.A. Diab and BSEC Bemo Securitisation SAL I MENA – GCC Securitisation market review

Sukuk has elements of the definition of ownership

embedded in it. Therefore, it allows for dismemberment

of ownership and would for example allow for a

securitisation resulting in a usufruct right over the

securitised assets. The creation of such a right would only

materialise after Sukuk issuance and subscription.


Contributor profiles I N.A. Diab and BSEC Bemo Securitisation SAL

Dr. Nasri Antoine Diab law firmBeirut, Lebanon

Tel +961 1 901 316 or 961 1 901 317

Dr. Nasri Antoine Diab

Email [email protected]

Dr. Nasri Antoine Diab graduated with an LLM from

Georgetown University and has also obtained a Post-

Graduate in Business Administration (Solvay – Brussels)

and a PhD. Law from the University of Paris 2. He is a

Law Professor at the Faculty of Law and Political Sciences

at Saint-Joseph University (Beirut); lawyer at the Beirut

Bar; member of the Ministry of Justice’s Committee of

Legislative Modernization; member of the Lebanese Banks

Association’s Legal Committee as well as a member of

the Energy Institute (London). He is also the author

of four books including ‘La Tritrisation des Actifs’

published in 2003 at LGDJ-Bruylant (Paris-Brussels)

with I. Boustany.

BSEC – Bemo Securitisation SAL7th floor, BEMO building, Sassine Square,

Ashrafieh, Beirut, Lebanon

Tel +961 1 200609 Fax +961 1 200647

Web www.bemosecuritisation.com

Iad H. Georges Boustany

General Manager, Executive VP - Structured Finance


Iad Boustany is the General Manager at BSEC - Bemo

Securitisation SAL, and the Executive VP of the

Structured Finance desk. He has extensive experience in

the structured finance/securitisation arena spread over a

variety of jurisdictions such as France, Luxemburg,

Lebanon, Jersey and Saudi Arabia. Among the more

noteworthy ‘firsts’ he has been responsible for are (i) the

first Shariaa compliant securitisation (Saudi Arabia); (ii)

the first Saudi Arabian true sale securitisation; (iii) the

first inventory securitisation on vehicle fleet; (iv) the first

term securitisation in Lebanon; (v) the first SIV in

Lebanon; (vi) credit scoring models for corporate and

consumer credit in non-transparent economies. He holds

a Masters degree in Structured Finance (ESCP - Ecole

Supérieure de Commerce de Paris), a BA in Applied

Mathematics (Université Paris X). He is a lecturer at

Saint-Joseph University, School of Management

(Undergraduate and Graduate programs) and lecturer in

the MBA delivered by Université Paris IX Dauphine

(France) with Saint-Joseph University (Lebanon) He is the

author of ‘La Titrisation des Actifs’, LGDJ/Bruylant, Paris

and Brussels, 2003 (with N. Diab), the first securitisation

book focusing on emerging markets’ securitisation.

Elias Sayegh

Associate – Structured Finance


Elias Sayegh is an associate at Bemo Securitisation. He

graduated with a LLB in French and Lebanese Law and a

B.A in Political Science from St. Joseph University, Beirut,

Lebanon. He also holds an LLM in Banking and Financial

Law from Boston University School of Law. He worked for

a leading local law firm before joining the BSEC team.

Dr. Nasri Antoine Diab law firm

Beirut, LebanonTel +961 1 901 316 or 961 1 901 317

BSEC – Bemo Securitisation SALwww.bemosecuritisation.com

7th floor, BEMO building, Sassine Square, Ashrafieh, Beirut, LebanonTel +961 1 200609 Fax +961 1 200647

2 0 0 4 / 2 0 0 5

Global Securitisation Review

Contents

Structured finance in the emerging markets 1

International Finance Corporation (IFC),The World Bank Group

European Securitisation Forum plays pivotal role in explosive growth of securitisation 9

European Securitisation Forum

An overview of securitisation in Asia 15

Asian Securitization Forum

Australian securitisation update and outlook 18

Australian Securitisation Forum

Trustees and administrative service providers: adding value to the structured finance markets 24

Deutsche Bank,Trust & Securities Services

Coming to terms with extendible notes 28

Global Securitization Services, LLC

Are there potential housing bubbles and will they burst? 33

Bear, Stearns International Ltd.

What to look for in CDO analytical tools 42

Wall Street Analytics

Recent changes in securitisation surveillance data and technology 47

Lewtan Technologies

Islamic and conventional securitisation: challenges and opportunities for SMEs 53

BSEC- Bemo Securitisation SAL

IAS 39: Understanding your market for securitisation better 59

KPMG LLP

A review of the European CMBS Market 63

Eurohypo Investment Banking

Securitisation in Europe: a director’s perspective 70

SPV Management Limited

The role of the credit enhancer in Europe 74

MBIA

Securitisation activities in the Nordic countries 79

Nordea

Conduit facilities: warehousing a new role for European conduits? 83

Danske Bank

The European RMBS safe haven 90

Deutsche Bank

Role of the search consultant: stability returns to the market 97

RJF Global Search

The review of the European ABCP market: the growth of a rising star or Icarus flight? 102

BNP Paribas

The UK covered bond is off to a flying start - but will its wings be clipped? 108

Clifford Chance LLP

Securitisation - the Scottish perspective 111

Tods Murray LLP

Overview of the French securitisation market: review of the current changes in the legal

and regulatory framework 114

Orrick, Herrington & Sutcliffe

Italian SME transactions 119

Euro Capital Structures - Unicredit Banca Mobiliare

New opportunities offered by the Italian corporate law reform for securitisation transactions 122

Gianni, Origoni, Grippo & Partners

Contents

Contents

Securitisation in Switzerland 127

Walder Wyss & Partners

Recent trends in the Spanish securitisation field 132

Gómez-Acebo & Pombo Abogados

New trends in the Portuguese securitisation market 137

Macedo Vitorino e Associados

The Austrian securitisation market and its legal framework 143

Cerha Hempel Spiegelfeld Hlawati

A legal perspective of securitisation in the Czech Republic 147

Glatzova & Co.

Cross-border securitisation in Luxembourg 152

Arendt & Medernach

Securitisation accounting - an evolution of industry practice and accounting complexity 156

KPMG LLP

The US ABCP market - extendible CP, an engine for growth 160

Dewey Ballantine LLP

A sizzling CDO market 166

Credit Suisse First Boston

Foresight, commitment and quality-ABS comes of age 177

MBNA

Recent developments in the North American CMBS market – a legal perspective 181

Cadwalader,Wickersham & Taft LLP

A review of the origination and underwriting of US ABCP conduits, 2004 187

Calyon Corporate and Investment Bank

Evolution and performance of LATAM structured finance 192

Fitch Ratings

Editor: Jennifer Gibb

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Although every effort has been made to ensure the accuracy of the information contained in this bookthe publishers can accept no liability for inaccuracies that may appear.© Copyright rests with the publishers, Euromoney Institutional Investor PLC, England. ISBN 184374 109 1

Commercial space securitisation in Latin America 197

Baker & McKenzie

The role of SHF in the development of the Mexican housing finance market 203

Sociedad Hipotecaria Federal

Securitisation in Asia - accounting and taxation 210

Deloitte Touche Tohmatsu

Developments in the Asian securitisation market from a trustee perspective 219

The Bank of New York

CDOs in Asia: 2004 coming of age 225

Lehman Brothers

Recent trends in Japanese real estate securitisation market: development securitisation and

real estate funds 232

Mori Hamada & Matsumoto

Directory 239

Co-publishers 260

Advertisers index 264

Islamic and conventional securitisation:challenges and opportunities for SMEsby Iad Georges Boustany,Abdallah Nassif and Elias Sayegh, BSEC – Bemo Securitisation SAL

Securitisation targeting SMEs is an innovative growing market. Concurrently,Shariaa compliant Sukuk issuance is growing as an indicator of the Islamicbanking markets. Originating securitisation transactions from SMEs andsubsequently structuring and issuing Sukuk is a challenging opportunity.

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Challenges of conventionalsecuritisation for SME’sGeneral securitisation challengesSecuritisation of assets originating from SMEs faceschallenges of multiple natures. First, SMEs must addressthe typical securitisation issues usually faced by theirlarger siblings.These issues are known throughout theindustry and can be summarised as follows: a) Transferof interest by originator was not legally perfected, orwas not a “true sale”, b) Transfer of interest was truesale, but is subject to over-riding, prior claims that gettransmitted to the SPV, c) Transfer of interest was atrue sale, but the SPV holding such interest is treatedas substantively a sub-set of the originator, clubbing theassets and obligations of the two, d) The transfer was atransfer in anticipation of originator bankruptcy, andhence, is voided by Court .

Bankruptcy proof feature is another commonchallenge which is mitigated by addressinginvoluntary bankruptcy, limitations on purpose andbusiness, limitation on life, limitations on debtobligations, liens and security interests.Specific SME challengesMoreover, SMEs face specific hurdles that render theoutcome of an SME securitisation much morevolatile.These specific hurdles are related to thevery nature of the originator and its level of“institutionalisation”. BSEC’s experience in SMEssecuritisation in Saudi Arabia, Europe and the USallows it to draw some general conclusions and tohighlight some characteristics.Balance sheet issues and corporateproblemsOne of the main traditional arguments forsecuritisation is the “true sale” and its impact on thebalance sheet, raising the level of liquidity, redeemingdebt, balancing the accounts and enhancing theratios.This is valid for both large blue chips andSMEs.Yet, experience showed that unlike large bluechips, SMEs balance sheet problems tend to be morethan just a financial issue. Highlighted financialproblems are merely a symptom for a much deepercorporate ailment. Hence, limiting the

Structurer/Arranger approach to “financial advisory”will prove counterproductive.The client ishighlighting his symptom whereas he needs a curefor a deeper corporate problem. Structuring teamsmust be as knowledgeable in corporate finance andmanagement as they are in securitisation.

The finance teams of small and midsized SMEscould be unequipped to carryout extensive balancesheet analysis. Moreover they are often unable totake a “Helicopter View” of the company’s financesand are more involved in day to day financialoperations.The need for a specific securitisation isusually urgent, however the client is best served by asolution that solves his ailment which is traditionallyan under capitalisation problem or an inadequatedebt structure.When performing an SMEsecuritisation, an analysis of the client’s (originator)balance sheet from a pure corporate finance angleshould be undertaken to determine the ultimatesource of the problem. In structuring SMEstransactions, Structurer/Arranger should solve notonly the client’s short term cash requirement butalso his long term structural imbalance.Thisapproach led in some instances to successfullyraising of fresh equity in conjunction with asecuritisation transaction.Sensitivity to market conditionSMEs are very sensitive to market or industryconditions. Unlike blue chips, their financial structureis exposed to volatile cycles. Even in the absence ofany material change in their corporate structure orclient base, weaker SMEs remain greatly exposed toliquidity squeeze resulting from any adverse changein general economic or industry conditions. Suddengrowth in working capital fuelled by an upwardindustry trend or a favourable general economiccondition usually puts pressure on the SME’s cashposition. Cash crisis driving the need forsecuritisation highlight an acute under capitalisationproblem.The same can take place in a much lessfavourable environment when a client starts delayingor defaulting on payments.

SMEs usually lack the necessary bargaining power

the economy enters recession and when it comesout of it. General and regional problems ply withtheir entire weight on the economical environmentrendering any forecast hazardous and predictionsalmost impossible to assess.The latter rendersfinancial manager’s tasks much more difficult at leastwith respect to the forward looking assumptionsunderpinning any CFO planning.This inability toperform strategic financial planning exposes SMEs toadverse economic conditions.Fraud without villainsPoor understanding of the corporate entity itselftends to be the general pattern in MENA/GCCmarkets. Disregarding corporate structures iswidespread and derives form the combination ofmultiple factors that all contribute to weakening theacknowledgment and understanding of thecorporations as a stand alone entity. First, the factthat businesses tend to be small in emergingmarkets and hence highly identified to their owner.Second, businesses tend to be family owned andhence move from one generation to the otherwithin the family.Third, some schools of thoughtwithin Shariaa-based legal systems negate the rightof a corporation to independent existence. Shariaacourt tend to disregard any corporate entity,constantly piercing the corporate veil and treatingthe corporation as mere screen which sole purposeis to organise the owner’s business.

The above stated factors are deeply rooted inthe peoples’ beliefs and result in dangerouscommingling of the corporate assets (mainly cash)with the owner’s assets. It is common for companiesto advance funds to their shareholders adding yetanother layer of complexity to an SME’ssecuritisation scheme.Environmental challengesThe MENA/GCC is a very challenging market whenit comes to structured finance.This is mainly due to(i) poor sovereign rating, (ii) to legal systems thatcannot support a structured finance transactioneven when the sovereign rating is investment grade,and/or (iii) underlying political factors. Nonetheless,this environment has not impeded thematerialisation of some, local or cross-border,securitisation deals in several countries like Lebanon,Egypt and Saudi Arabia. One common characteristicof these deals is the cumbersome and lengthystructuring process (most of the successful dealstook more than a year of structuring and in somecases transactions failed to close after two years ofwork!).These deals, in particular the ones that BSECwas involved with, were difficult to originate, tostructure and to place.

Origination is difficult in this region mainly

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to (i) impose stringent payment discipline to theirclients and (ii) pass the delay to their suppliers(usually large and powerful companies). Hence SMEsare in the middle of the food chain, highly exposedto a liquidity crisis in sluggish economicalenvironment. In France, one bankruptcy out of five isdirectly due to a client’s default. Even sound SMEswill find little help from their bankers in adverseeconomical situations.The new environment thatBasel II will impose on commercial banks will onlymake it more difficult for SMEs to finance theiroperations.These SMEs will look for alternativemeans to acquire financing. Securitisation boutiquesthat offer an efficient and effective turnkey solutionwill find a growing demand for their services.Corporate finance or capital markets?Securitisation for larger groups requires deep andconstant monitoring of the capital markets. Largergroups are interested in securitisation to the extentit delivers high investment grade cost of funds.Thistight spread (spread between cost of bank financingand cost of securitisation) renders the process verysensitive to market movements and credit spreads.Securitisation for larger companies, that aretransparent, well structured, already known to therating agencies and usually listed, is a “capital marketsgame”. On the other hand, SMEs are usually notlisted, less transparent and unknown to the ratingagencies.They target lower rating for theirsecuritisations and tend to be less demanding whenit comes to cost of funds. Responding to the SMEsneeds would require more expertise in corporateand managerial finance rather than in bond trading.SME securitisation keeps the securitisation practicein close encounters with the corporate financearena.To rate or not to rate? That is thequestion A blue chip originator would not close an unratedsecuritisation transaction, not because of prestige orany other management or governance issue, butrather because of pure cost. Unrated paper willentail high cost even for a poorly rated institution.Choosing not to rate a securitisation deal beats thepurpose of the deal itself, at least from a largecorporation point of view. Once again, SMEs tend tohave a totally different view on the subject.The initialmotivation is rarely cost of funds. SMEs tend to givemore weight to liquidity and off balance sheettreatment. Hence rating a deal is not as vital as itwould be for large blue chips.SMEs in the MENA/GCC: more challengesEconomical cycles are much blurred in emergingmarkets. Unlike Europe or the US, MENA/GCCmarkets lack the indicators that clearly signal when

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because of the lack of knowledge and theunfamiliarity of the decision makers of SMEs (thatare predominantly family owned) with the relativelysophisticated/complex funding solutions offered bysecuritisation deals in contrast with traditional bankloans. SMEs (i) often want money urgently, (ii) rarelyhave qualified resources at the decision making levels(to interact with the Structurer/Arrangers), (iii)resist (for cultural reasons) required changes incorporate governance that are sometimes crucial toa transaction and, in some cases, (iv) are offered veryinteresting “relationship motivated” rates from liquidregional commercial banks.

Structuring, as aforementioned, is a very complexand lengthy process.This is due mainly to (i) the legalsystems that are not structured finance andsecuritisation friendly (ii) volatile fiscal environmentand, (iii) to the regional culture and way ofconducting the businesses. Overcoming thesehurdles requires significant innovation andimagination; in other words, time, patience,endurance and resource investment.To circumventcertain legal deficiencies the arranger must put inplace intricate multi-tier structures to assure (i)security interest transfer to investors (ii) securityinterest enforcement, (iii) true sale and, (iv)

bankruptcy remoteness which are the corner stonesof any securitisation deal.While structuring the dealthe arranger also faces many issues that must beresolved between the originator and his creditorsand/or suppliers whether regarding pledges (andsometimes title!) over the assets to securitize; ornegative covenants in their agreements, that couldprevent the materialisation of deals. It is alsopossible in the course of the due diligence process,to find that several court judgments were notsatisfied by the originator.Closing SME dealsPlacing a structured deal is not an easy process either.Regional investors, both high net worth individualsand institutional investors, are not familiar with theasset-backed securities class.They find it difficult tounderstand that the risk underlying a securitisationtransaction is not the credit risk of the originator,who sold the assets, but another type of credit riskthat was mitigated with several credit enhancementfeatures. An additional hurdle is that most “true sale”deals cannot be rated, or when rated are capped tothe “structured finance sovereign ceiling” that can belower than sovereign ceiling.Post closing issuesDifficulties continue even after closing deals.Arrangers

Figure 1: Schematic of an SME securitisation

Power ofAttorney to

Sell Assets

Powers to direct Agent and instruct to sell Assets

Powers to manage SPCaccounts

Sukuk

Payment

Assignment

Funding

Sale of Assets

Cash

ISSUER(SPV)

Security Trust

Administrator

Obligors

HANCO

BackupServicer

Manager

KSA JERSEY

SAKK HOLDERS

Servicing

Purchaser (SPC)

CollectionsAccounts

SPV CashAccount

SPC LockboxAccount

SPC ExcessSpread Account

1. Lockbox, 2.Excess Spread, 3.SPV Cash,4.Order Note, 5.Rights under Funding

AGENT

approach for a securitisation transaction, aconnection can be made in order to help developboth markets in parallel.This development hasseveral advantages for SMEs. In addition to analysisof the Islamic Bond Market today (the Sukukmarket), we will further explore the opportunitythat a Shariaa compliant instrument offers to thesetypes of companies (SMEs).

For the past few years, there has been a relativelyshy movement in the marketplace as certain newinstruments have found their way amongst the vastrange of instruments already offered.At theforefront of these instruments, Sukuk haveundeniably been one of the most successfulinnovations, or rather additions to the currentfinancial framework.Although it still constitutes asmall portion of the market share (approximatelyUS$2bn to US$3bn of issuance worldwide in 2004),this type of instrument has experienced notablegrowth, setting the pace for a considerable increasein the near future.

Traditionally, the main markets for suchinstruments on both the origination and selling sidewere the different parts of the world with adominant Islamic population: mainly the area coveringWest Africa to the Far East and the South East.Today,this reality is changing as Islamic Sukuk becomes aglobal instrument.Also, the main banks interested inIslamic products were exclusively Islamic Banks.Thisreality has also drastically changed.

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often have to monitor the performance of thetransaction on regular basis to make sure thateverything is going according to the transactiondocuments (i.e. the servicer has implemented requiredbusiness procedures, cash generated is comparable towhat was projected, etc) and to help transactionparties come up with solutions to unforeseenproblems arising from the local systems (like trying tocircumvent periodic cash transfer delays by local banksto lockbox accounts in foreign jurisdictions, etc) oreven helping the trustees/administrators to betterunderstand their “complicated” duties resulting fromthe complexity of the structure.

Structured Finance in the MENA/GCC ischallenging, but not impossible so long as arrangerscan control their costs.Transaction Cycle time isparticularly long, which is why mostly regionalarrangers (which are more cost efficient than themajor players) will be able to tap this market in theforeseeable future.This cost efficiency will over timegive experienced arrangers operating out of thismarket an edge, and lead them to target SMEs inNorth America and Europe where legal systems aresecuritisation friendly.

Islamic securitisation for SMEsGeneral overviewShariaa has traditionally linked finance to assets andto the risks inherent to those assets.Thus,acknowledging the importance of this very similar

Managers league table for Islamic bonds

Islamic Bonds as of July, 2004 provided by IFIS

Pos. Manager or Group Amt US$m Iss. %Share

1 Dubai Islamic Bank 750.00 1 28.78

2 AmMerchant Bank Berhad 438.69 2 16.84

3 Citigroup 373.00 2 14.31

4 Aseambankers Malaysia Bhd 184.21 1 7.07

5 HSBC 140.79 2 5.40

6 Commerce International Merchant Bankers Berhad 138.16 2 5.30

7 Amanah Short Deposits Bhd 128.95 4 4.95

8 Credit Suisse First Boston 100.00 1 3.84

9 RHB Sakura Merchant Bankers Bhd 78.95 1 3.03

10 Abrar Discounts Bhd 65.79 1 2.52

11 KAF Discounts Bhd 63.16 2 2.42

12 Bank Islam Malaysia Bhd 39.47 1 1.51

13 Alliance Merchant Bank Bhd 26.32 1 1.01

14 OSK Securities Bhd 26.32 1 1.01

16 BSEC – Bemo Securitisation SAL* 26.13 1 1.00

17 PT Bank Mandiri 25.81 2 0.99

Total of issues used in the table 2,605.74 25 100.00

Source: Dealogic, Securities Commission – Malaysia

Euromoney Institutional Investor PLC.

*BSEC ranking 4th in MENA/GCC and 16th globally

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Following their emergence in the early 70s,Islamic Banks underwent a period of steady butrelatively slow growth.This activity started pickingup in the mid-nineties and has really accelerated atpresent with the evolution of the concept of Islamicbanking and the needs and requirements of Islamicinvestors.These two factors have helped theindustry reach a level of complexity and prospectivegrowth that had never been in anyone’sexpectations. Nevertheless, the growth of such aninstrument has still to be reflected on the financialmarkets through an active trading of the Sukuk. Upuntil now, Sukuk are and remain an instrument withno secondary market.This is in part linked to themarkets where the underlying asset and the sale ofthose securities have traditionally been taking place.Those markets do not benefit from the appropriatecomplexity to back up such a trading.Again, with theglobalisation of this instrument and Islamic finance ingeneral, there is no doubt that this reality is about tochange in the coming years.Sukuk for SMEsAmong the variety of Shariaa compliant instruments,we will focus on the Sukuk. Sukuk are the equivalent ofIslamic bonds.They are based on a MudarabahContract (profit sharing agreement).They are most ofthe time issued through Special Purpose Vehicles (SPV).

The Issuance of Sukuk presents an opportunityfor SMEs.As it was mentioned earlier, and from theexperience BSEC has had with investors in the Sukukmarket, the demand for such an instrument faroutweighs the current supply.The scarcity of such aninstrument and the mismatching of the offer and thedemand, linked to the difficulties mentioned in thefirst part of this article pertaining to the hurdles thatSMEs encounter in issuing and selling their paper,leads us to conclude that until the market adapts tothe Sukuk demand, this instrument can be a goldenopportunity for SMEs to add some value to theirpaper and make sure they will find some investors tobuy it.This window will probably close when and if,the global players of structured finance start lookingcloser at this developing market and begin offeringIslamic compliant instrument to their large clients.Sukuk getting globalAs we previously mentioned, the Sukuk market isevolving globally.This evolution is taking place onboth sides of securitisation transaction, meaning thatthe assets being originated for a securitisationtransaction are not necessarily located in thetraditional Islamic finance countries (i.e. the Muslimworld as described above).As an example of thischange in the approach to the Sukuk, we canmention the eastern German state of Saxony-Anhaltthat has successfully launched Europe’s first Islamic

bond issue.Although not a securitisation, thisUS$120m bond can definitely be considered as asign to the financial market but also can beassimilated to a strategic and political decision forrespect of diversity and religion.

The evolution has also affected the “end side” ofthe transaction, at the time the Sukuk have to beunderwritten.Western/conventional banks arecontinuously looking at new, diversified andcompetitive products.Well structured securitisationtransactions can offer Sukuk which would fit whatthese banks are looking for.As an example of thegrowing interest that conventional banks have in thismarket it is worth noting that internationalconventional banks underwrote over 40% ofQuatar’s recent sovereign Sukuk.HurdlesAlthough Islamic finance in general and Sukuk inparticular present a great opportunity at this stage oftheir evolution, there are still some concerns relatingto their marketability.Therefore, the process by whichan instrument is declared Islamic compliant starts withthe choice of the scholar(s) that will look at thecontemplated transaction.Then, if the transaction isapproved by such scholar(s), the next step would beto obtain a Fatwa certification from a Shariaa advisor(scholar) or a board of Shariaa advisors. Most financialinstitutions that are looking at the Islamic financebusiness have established such boards.The compliancehas to be verified on two main levels: the assetssecuritised have to be Shariaa compliant (i.e. excludingalcohol, tobacco, pork, or any other form of prohibitedactivities) and the structure contemplated also has tobe in line with Islamic principles mainly prohibitinginterest based earnings. On both levels, problems arisefrom the roots of the concept itself: the interpretationof the Koran. Islam has many schools of thought, andwhere a school of thought can approve of aninstrument as being Shariaa compliant another mightdisapprove of it. Even within schools of thought thereis significant leeway for personal interpretation,especially in the complicated structured financetransactions.That leads to some disturbance in thismarket where Shariaa compliance is based rather onpersonal understanding of the Shariaa than onempirical facts.This reality is to be very carefullyconsidered in conjunction with any prospectiveinvestors (if known) as some of them haverequirements as to the scholar they would like to seegiving the approval to a contemplated transaction.Outlook for SukukSome institutions have started to look for ways tobetter harmonise the industry.As an example wemention the International Islamic Financial Market(IIFM).The purpose of such an institution is to

mention what is called “ethical funds”.These types offunds are restricted by their policy on investments thatethically suit the investor base of those funds.As anexample of such ethical funds, we can mention someenvironmentally friendly investment funds; others canbe animal friendly or even humanist funds.This varietyof funds that are conscious oriented and tailor made tosuit a specific category of people could be an idealframework within which the Islamic instruments canevolve and find the necessary funds to back up Shariaacompliant issuances.What is becoming a deep andliquid market is also turning out to become a veryattractive means to financing SMEs globally.

Authors:Iad Georges Boustany

Abdallah NassifElias Sayegh

7th Floor, Bemo BuildingSassine Square

AchracfichBeirut

LebanonTel: +961 1 200 609Fax: +961 1 200 647

Email: [email protected]@bemosecuritisation.com

[email protected]: www.bemosecuritisation.com

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promote trading of Islamic compliant instrument.Theservices it offers come at a late stage in a transaction,where the transaction would have obtained a Shariaacompliant “stamp”.Then the IIFM would provide foran endorsment.The aim of such endorsement is tobridge the debatable issues that separate scholars. Bycertifying or endorsing a transaction, the IIFM willprovide for an easier trading of the instruments in themarkets of its member countries (a number ofconsiderable Islamic markets).This initiative is coupledwith some others, of which we can mention thetentative harmonisation of the Shariaa Standards froman accounting and auditing angle.This was done by theAccounting and Auditing Organization for IslamicFinancial Institutions (AAOIFI).

In order for the Islamic finance instrument todevelop to their fullest extent, there has to be aninvestor base that is aware of the existence of suchan instrument and understands the opportunitiesoffered by it.This investor base has to go beyond theinstitutional investors that have so far bought suchinstruments and in many instances held themwithout active trading.A considerable addition wouldbe the creation and/or the activation of the existingfunds oriented towards this type of investment.

Nowadays, investors are increasingly interested notonly in the return their investment is providing them,but also, in the type of products their money isinvested in.As an example of such interest, we can

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