News Column

Gateway Sukuk

May 18, 2014

Hong Kong is joining the likes of Singapore and, more recently, the UK by becoming the latest non Muslim domicile to issue Sukuk. A bill which paves the way for the administrative region to issue a debut $500 million Sukuk, was, Reuters reported, passed in March. Marketed as an 'inaugural' Sukuk, it may be the first of many to be issued from the world's third most important leading international financial centre.

The bill acknowledges Islamic finance as being "among the fastest growing segments in the international financial system," and Sukuk as "among the most prominent instruments used in Islamic finance." However, up until recently, Hong Kong's regulatory landscape made it difficult to issue Sukuk that represented value for money.

"Sukuk have more complex product structures than their conventional bond counterparts," the bill said. "They are usually structured with special purpose vehicles and multiple asset transfers, which may attract additional profits or property tax exposures, or stamp duty charges when compared with conventional bonds. This has put Sukuk in a disadvantaged position from a commercial viability perspective."


In an attempt to remedy this, The Inland Revenue and Stamp Duty Legislation amended the Inland Revenue Ordinance and the Stamp Duty Ordinance to provide for comparable treatment for some common types of Sukuk vis-À-vis conventional bonds in terms of profits tax, property tax and stamp duty liabilities, thus removing a major impediment to the development of a Sukuk market in Hong Kong.

the prevailing context of LO," the Legislative Council said. "It was therefore necessary to amend LO to encompass such a situation, in which the Government is to be regarded as 'borrowing' money from the SPV set up to effect Sukuk issuance."

The Legislative Council explained that the Alternative Bond Scheme Ordinance was amended to cover Sukuk schemes. The new Bill broadens the meaning of the word "borrow" and introduces the concept of a "specified alternative bond scheme" in LO to cover a situation where the Government raises funds by way of Sukuk issuance. This will enable the funds so raised to be credited to a bond fund (BF).


As issuance of Sukuk under GBPs may have implications on other types of bonds issued under a GBP and the local bond market, the Bills Committee enquired about the Administration's considerations in launching Sukuk under a GBP, the target investors and offering mechanism involved, as well as the management of Sukuk proceeds.

In respect of the considerations for issuance of Sukuk, the Administration advised that the timing and actual issuance size will be determined with regard to the prevailing market conditions and needs. The preliminary thinking for the inaugural Sukuk issuance under a GBP might be in the size equivalent to around $500 million or more. "While conventional bonds issued under GBP were denominated in Hong Kong dollar, the Administration will make reference to international practice in deciding whether the inaugural Sukuk issuance should be denominated in Hong Kong dollar or US dollar," the Legislative Council said.

Regarding the target investors of Sukuk, the Administration pointed out that institutional investors are the major players in the global Sukuk market. It is envisaged that the investors of the inaugural Sukuk issuance under GBPs would be institutional investors, noted the Legislative Council. Depending on market interest and developments, consideration may be given to whether retail investors should be included in Sukuk issuances under GBPs in future. "As far as the offering mechanism is concerned, the Administration may engage financial institutions and legal advisers in arranging the deal through a SPV, although conventional institutional GBs are issued by the Government by way of tender," it said.

On the management of Sukuk proceeds, the Administration said that under the existing framework of GBPs, proceeds from bond issuances under GBPs will be placed with the Exchange Fund (EF) for investment by the Hong Kong Monetary Authority (HKMA). Investment return for BFs is calculated based on the average annual rate of return of EF's investment portfolio over the past six years or the average annual yield of three-year Exchange Fund Notes for the previous year, whichever is the higher.


According to the Legislative Council, while Hong Kong sees the value of issuing Sukuk it realises it faces stiff competition from more established centres. "While recognising the benefits for Hong Kong in developing a Sukuk market and Islamic finance, which include diversification in financial products and services available to Hong Kong financial markets and reinforcing Hong Kong's status as a major international financial centre and asset management centre, the Bills Committee has expressed concern about the competitiveness of Hong Kong's Sukuk platform vis- À-vis those of other jurisdictions in attracting international Sukuk issuers and investors, it said. "In particular, it is observed that major Islamic financial centres, such as Malaysia, have well-developed Sukuk markets, and Hong Kong lacks ties with Islamic communities."

To give the region more of an edge, the Administration advised the ABS Ordinance to provide a comparable taxation framework for some common types of Sukuk vis- À-vis conventional bonds. "Coupled with the core strengths of Hong Kong financial markets, including a transparent regulatory framework, a low and simple tax regime, the strong presence of international financial intermediaries and the well- established market infrastructure, Hong Kong is now on a better footing to promote Islamic finance through encouraging issuers to raise funds by issuing Sukuk," the Legislative Council said. "Moreover, given Hong Kong's role as Mainland China's gateway to the global financial market, Hong Kong has the advantage of matching the needs of fund raisers and the investment demand of investors between Mainland China and the Middle East."

According to Legislative Council, Hong Kong hopes that its Government Sukuk will pave the way for further issuances. "The Administration envisages that Sukuk issuance under GBPs will signal to the markets that Hong Kong's legal, regulatory and taxation frameworks are well-established to accommodate Sukuk issuances, thereby giving further impetus to other potential Sukuk issuers from the public or private sector, both local and international, to raise funds in Hong Kong," it said. "Furthermore, given the shortage of highly-rated Sukuk in the international capital markets, an inaugural Sukuk issuance originated by the Hong Kong Government, with an excellent credit rating of AAA, will draw attention and interest in the global market and attract a new group of investors from the Middle East and other parts of the world to Hong Kong's financial platform who look for opportunities to diversify their investment portfolios into highly- rated Sukuk products."

The Administration also pointed out that a number of overseas jurisdictions, such as Malaysia, Indonesia, Qatar, Dubai, Bahrain and Turkey have issued sovereign Sukuk to develop their Islamic financial markets. The UK and Egypt are also contemplating issuing sovereign Sukuk. "Hong Kong should make reference to the experience of these jurisdictions and use GBPs as a window to promote the local Sukuk market," said the Legislative Council.


In view of increasing competition from other financial centres in developing the Sukuk market and Islamic finance, the Bills Committee stressed the need for the Administration to make concerted efforts with relevant parties in promoting Hong Kong's Sukuk platform.

The Administration said that the strengths of Hong Kong's bond market, including the Sukuk market and the listing platform, have been one of the key features in the promotional work targeting international investors in recent years in promoting the opportunities and advantages presented by Hong Kong as an international financial centre.

The Administration said that the Bills Committee will take every possible opportunity to promote Hong

Kong's bond market, including the Sukuk platform, when meeting with institutional investors, issuers and asset managers. The Administration has been collaborating with relevant parties such as Hong Kong Economic and Trade Offices and the market in promoting Hong Kong's Sukuk platform overseas and keeping a close contact with the industry to encourage them to issue Sukuk in Hong Kong. "The inaugural Sukuk issuance under the GBP will be useful in building interest and momentum in Islamic finance activities in Hong Kong," said the Legislative Council.

Given that Sukuk are innovative financing instruments and have more complex structures than conventional bonds, the Bills Committee expressed concern about protection for Sukuk investors, and stressed the importance for the Administration to ensure a robust regulatory regime over Sukuk issuers.

The Administration has explained that, similar to other financial products, Sukuk are subject to the prevailing regulatory regime in respect of product offering, marketing, disclosure, and intermediaries requirements in accordance with the relevant provisions of the Securities and Futures Ordinance (SFO) and the Companies Ordinance. For instance, issuers are required under SFO to seek authorisation from the Securities and Futures Commission (SFC) on the issuance of any advertisement, invitation or document, which is or contains an invitation to the public to enter into or offer to enter into an agreement to acquire the relevant Sukuk products, unless an exemption applies. As institutional investors will be the target investors of Sukuk issued under a GBP, certain exemptions under SFO will apply, said the Legislative Council.

As regards international co-operation in the regulation of Islamic financial products, the Bills

Committee notes that the SFC and the Securities Commission Malaysia (SCM) signed a Declaration of Mutual Cooperation on Development of Islamic Capital Market and Islamic Collective Investment Schemes in November 2009 which provides the framework for SFC's and SCM's mutual recognition of Islamic collective investment schemes offered to the public. SFC has so far authorised one Malaysia-based Islamic equity fund under the mutual recognition framework. SFC and SCM will continue to maintain dialogue on the regulation of Islamic funds.


The Bills Committee has urged the Administration to increase exchanges with other financial centres in fostering co-operation and keeping abreast of the latest developments in the global Sukuk market. An adequate supply of professionals and market practitioners with expertise in Sukuk issuance and Islamic finance is vital to the development of the Sukuk market and Islamic finance in Hong Kong, noted the Legislative Council.

On the promotion of market awareness and knowledge of Islamic finance, the Administration said that HKMA has been in close collaboration with overseas central banks (such as Bank Negara Malaysia (BNM)), international organisations (such as the Islamic Financial Services Board and the International Centre for Education in Islamic Finance) and local industry bodies (such as the Treasury Markets Association) to offer training for market practitioners. Over the past few years, HKMA has organised a series of Islamic finance seminars and workshops covering a wide range of topics (e.g. Islamic capital markets, Islamic money markets, Islamic equity funds and indices, Islamic banking, etc.).

To continue the efforts, the Bills Committee notes that HKMA is planning to organise an Islamic finance conference jointly with BNM in Hong Kong. This will provide a good opportunity for Hong Kong market practitioners to interact with their Malaysian counterparts to exchange views on issues concerning structuring Sukuk and for Hong Kong corporates to understand more about the potential of Sukuk issuance as a viable funding option.

As regards cooperation with key Islamic financial markets, such as Malaysia and Dubai, the Administration has informed the Bills Committee that HKMA has been maintaining a close partnership with these markets. For instance, HKMA and BNM set up a private sector-led Joint Forum on Islamic finance in 2013 which aims to promote closer collaboration between the private sector in Hong Kong and Malaysia by offering a platform for market players in both places to discuss practical and pertinent issues in the area of Islamic finance.

SFC has also been working closely with its counterparts from major Islamic markets. For example, in April 2008, SFC signed a Memorandum of Understanding with the Dubai Financial Services Authority for mutual co-operation on capacity building and human capital development in Islamic finance, as well as the promotion and development of the Islamic capital market.

Hong Kong's regulatory landscape made it difficult to issue Sukuk that represented value for money

Major Islamic financial centres, such as Malaysia, have well-developed Sukuk markets, and Hong Kong lacks ties with Islamic communities

The Bills Committee expressed concern about protection for Sukuk investors

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Source: Islamic Business & Finance

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