CA-8.2.1

From a capital adequacy perspective, the parties in a securitisation structure include the originator, the issuer and the investors, in addition to which the following may be involved: an institution that acts as manager of the issuance, a servicer to service the underlying assets,³⁹ one or more credit rating agencies to rate the Sukuk, an investment banker to act as an adviser or to place the securities with investors, and (in some Sukuk securitisations) an institution that acts as a provider of credit enhancement.⁴⁰

³⁹ Depending on the structure of the Sukuk securitisation, a servicer may perform different functions for management of the underlying assets in the Sukuk — for example, to collect payment, handle related taxes, manage escrow accounts and/or remit payments.

⁴⁰ See Paragraphs CA-8.2.22 to 27 for details.

CA-8.2.2

An Islamic bank licensee may act as originator of Sukuk issues where the ownership of assets held by the Islamic bank licensee is transferred to holders of Sukuk by means of a securitisation. Such a securitisation may offer the Islamic bank licensee one or more of the following benefits:

CA-8.2.3

The achievement of the second of these benefits will depend on the way in which the securitisation is structured. For this, the Islamic bank licensee must be able to derecognise all or most of the exposures relating to the assets from its balance sheet, according to the criteria for de-recognition set out in Paragraphs CA-8.2.20 to 22.

CA-8.2.4

An Islamic bank licensee may act as sponsor of a Sukuk issuance or similar programme involving assets of a customer in which the Islamic bank licensee manages or acts as adviser to the programme, places the Sukuk into the market, or provides liquidity and/or credit enhancements. In this case, the benefit to the Islamic bank licensee would be the earning of fees for the services provided, but the Islamic bank licensee will incur capital charges if it offers credit enhancement (as outlined in Section CA-8.4).

CA-8.2.5

Consideration of the collateral security structure⁴¹ is a critical factor; it needs to be the subject of legal opinions and is subject to Shari'a permissibility (in the case of perfectibility⁴²). Those security interests must be the first priority (there can be no prior or subsequent claims) and be perfected (or perfectible).

⁴¹ Collateral security structure is mainly used in Sukuk based on Shari'a-compliant project financing.

⁴² In legal terminology, perfection relates to the additional steps required to be taken in relation to a security interest in order to make it effective against third parties and/or to retain its effectiveness in the event of default by the grantor of the security interest.

CA-8.2.6

The legal opinions must address the nature of the security interest, the enforceability of the security interest against third parties, and perfection requirements (such as notices and registration). The effects of bankruptcy (see also Paragraph CA-8.3.22) on perfection must also be considered and opined upon. Major issues related to Sukuk based on collateral security interest and related perfection include the following:

CA-8.2.8

Sukuk are issued based on securitisation of assets where the originator "transfers" the assets via an SPV to Sukuk investors and the latter have a legally recognised asset ownership interest. For such transfer of assets to hold legally, there must be an agreement that is evidence of a binding sale transaction from the originator to the Sukuk investors; that is, such a contract must be valid, binding and legally enforceable on all parties involved. With this sale transaction, the investors will become legal owner of the assets underlying the Sukuk transaction, with all of the rights and obligations that accompany actual ownership. The SPV must be "bankruptcy remote" from the originator. Thus, upon the insolvency of a Sukuk originator, the underlying assets cannot be clawed back into the bankruptcy estate of the originator. In such Sukuk, Sukuk holders have no recourse to the originator; their only recourse is to the underlying assets.

CA-8.2.9

There are four key criteria for a transaction to be considered as a "true sale" that transfers legal title to the SPV for the benefit of the Sukuk investors:

CA-8.2.10

According to Shari'a rules, it is not permissible for the Mudarib (investment manager), Sharik (partner) or Wakil (agent) to undertake in advance to repurchase the assets at maturity from Sukuk holders or from one who holds them, for their nominal or par value. It is, however, permissible for a third party credit enhancement provider to undertake the purchase on the basis of the net value of assets, their market value, fair value or a price to be agreed at the time of purchase. In such cases, the risks of the assets are retained and are subject to the requirements of section CA-8.4. In the event of negligence or misconduct by the Sukuk manager (i.e. Mudarib, Sharik or Wakil), it is required that the Sukuk manager be liable to guarantee the payment of capital to Sukuk holders, at the nominal or par value (again subject to the requirements of CA-8.4). It is also permissible for a lessee (i.e. the originator) in an Ijara Sukuk to undertake to purchase the leased assets at maturity for their nominal value, provided the lessee is not also a Sharik, Mudarib or Wakil. If the lessee is an Islamic bank licensee, such an undertaking would be treated as a 'clean-up call' (see CA-8.2.21) if it satisfies certain conditions or it is subject to section CA-8.4 if it is of a more general nature.

CA-8.2.11

The SPV must be formed as a company or trust or other legal entity having no other business. In a Sukuk securitisation, the SPV must be organised, for example, as a Musharakah, Mudarabah or Wakalah, where the requirement of SPV having no other business applies. In the case of a Musharakah, there is a partnership contract with financial participation by the Sukuk investors. In the case of a Mudarabah structure, only the Sukuk investors participate with money as Rabb al-Mal, while the other party (i.e. the SPV) acts as the manager (as Mudarib) of the securitised assets. In the case of Wakalah, the SPV as an agent (Wakil) acts as the manager of assets on behalf of the Sukuk investors.

CA-8.2.12

Islamic bank licensees must not use a general-purpose or operating company (as opposed to an SPV) for holding the securitised assets, as such a company might have other assets and other liabilities, each of which would be likely to interfere with the exclusivity of the Sukuk investors' rights over the securitised assets. By its very nature, it is a legal shell with only the specific assets transferred by the originator, and those assets are effectively owned by the Sukuk investors, legally or via a trust, there being nothing else in the vehicle in which any other party could have an interest. Such an SPV cannot be consolidated with the originator for tax, accounting or legal purposes, as that would affect its bankruptcy-remote position.

CA-8.2.13

Sukuk can be "credit enhanced" to raise their credit quality above that of the underlying asset pool. Credit enhancement is therefore intended to reduce the credit risk to the Sukuk investors and reduce the funding cost of the originator. It also results in the Sukuk having an enhanced credit rating by ECAIs recognised by the CBB in section 4.6 of this Module. Subject to Shari'a permissibility, the mechanisms used in credit enhancement may include, inter alia, those discussed in Paragraphs CA-8.2.14 to CA-8.2.17.

CA-8.2.14

Subject to Shari'a approval of the structure, an originator may retain a small equity share in a pool of securitised assets in order to provide over-collateralisation. For example, the originator of a securitisation of a pool of Ijara lease assets might securitise 90% of the pool and retain 10% as an equity position (first loss position) — that is, a residual claim. The Sukuk holders would be entitled to income based on 90%, and the originator, based on the remaining 10%, of the rental income from the pool. The treatment of retained holdings is outlined in Section CA-8.3.

CA-8.2.16

Excess spread is the difference between (a) the expected periodic net income from the securitised assets (i.e. the income after expenses such as servicing fees and operating fees have been paid) and (b) the periodic amounts payable to the Sukuk investors. Subject to Shari'a approval, excess spread may be built into a Sukuk structure such that the issuer/SPV retains a certain percentage of the periodic net income if this is in excess of the target level of the periodic payments to the Sukuk holders, and holds this amount in an excess spread reserve. If the net income falls below the level required to meet the target level of the payments to the Sukuk holders, the issuer/SPV may release an amount from the excess spread reserve in order to make good the shortfall in whole or in part.⁴³

⁴³ This mechanism is comparable to the "profit equalisation reserve" commonly used by a bank to "smooth" the profit payouts to investment account holders.

CA-8.2.17

Cash collateral is a segregated trust account, funded at the time when a new series of Sukuk is issued, that can be used to cover shortfalls in payment of coupons, principal or servicing expenses if the excess spread falls below zero. The account can be funded by the issuer, but is most often generated by a Qard from the originator or another third party. Commonly, the pooling and servicing agreements dictate the amount of the cash collateral, which is typically based on a specified percentage of the Sukuk issued. The amount in the cash collateral account is subject to risk-weighting as outlined in this Module, depending upon the use of funds.

CA-8.2.18

The credit enhancement in a Sukuk structure can be provided by an "internal" mechanism such as by the issuer of the Sukuk structure or by an "external" arrangement such as a third-party guarantee. These credit enhancement structures are explained in the following:

CA-8.2.19

The assets in a Sukuk securitisation have to be in compliance with Shari'a rules and principles.

CA-8.2.20

In order to comply with Shari'a rules and principles, the structure must transfer all ownership rights in the assets from the originator via the issuer to the investors. Depending on the applicable legal system, these ownership rights do not necessarily include registered title. The transfer could be a simple collection of ownership attributes that allow the investor (a) to assume the role of the originator and (b) to perform (sometimes via a servicer) duties related to ownership. The transfer could also include rights granting access to the assets, subject to notice, and, in the case of default, the right to take possession of the assets.

CA-8.2.21

An originating Islamic bank licensee may exclude securitised exposures from the calculation of its assets for capital adequacy purposes only if all of the following conditions have been met. Islamic bank licensees meeting these conditions must still hold regulatory capital against any exposures that they retain in respect of the securitisation (such as credit enhancements — see Section CA-8.4).

⁴⁴ A clean-up call is an option that permits the securitisation exposures to be called before all of the underlying exposures or securitisation exposures have been repaid. It is generally accomplished by repurchasing the remaining securitisation exposures once the pool balance or outstanding securities have fallen below some specified level.

CA-8.2.22

The conditions for bankruptcy remoteness include the following:

CA-8.2.23

Islamic bank licensees must carry out the credit analysis of their securitisation exposure based on the following criteria, in order to be allowed to use the risk weights in Section CA-8.3. If an Islamic bank licensee is unable to perform the due diligence and maintain the information specified in this paragraph, it will be required to risk weight the securitisation exposure at 1,250%. The criteria are applicable to securitisation exposures of Islamic bank licensees both in the banking and trading book:

CA-8.2.24

The capital treatment of a securitisation exposure must be determined on the basis of the economic substance rather than the legal form of the securitisation structure. Islamic bank licensees must consult with the CBB when there is uncertainty about whether a given transaction should be considered a securitisation.

CA-8.3.5

The credit risk in Salam Sukuk is similar to that of the underlying Salam contract, where the credit risk exists upon the subscription of the Sukuk until the delivery and sale of the subject matter. The RW is based on the counterparty (Salam supplier) unless the Salam capital is guaranteed by a third party, in which case the RW is that of the guarantor if lower than that of the supplier.

CA-8.3.6

The market risk in Salam Sukuk (in the absence of a parallel Salam contract or other hedge) is likewise the same as that of the underlying contract, namely a long position in the underlying commodity. This risk can be measured according to either the maturity ladder approach or the simplified approach as set out in Section CA-5.6 (commodities and inventory risk).

CA-8.3.7

A Salam Sukuk issuance which is structured with an undertaking from the issuer that the underlying commodity will be sold to a third party at a specified selling price (by means of a parallel Salam contract) must carry the RW of the buyer of that underlying commodity in the parallel Salam contract.

CA-8.3.8

For the type of Salam Sukuk described in Paragraph CA-8.3.7, there is no capital charge for market risk that consists of basis and forward gap risks (namely, the risk that the hedge may be impaired because the underlying commodity delivered may be of inferior quality or may be delivered later than the contractual date) as the underlying commodity is normally traded on an exchange that eliminates the risk of late/non-delivery or delivery of a commodity of inferior quality.

CA-8.3.9

The asset may be constructed on behalf of an ultimate customer or off-taker with whom the Islamic bank licensee enters into a parallel Istisna contract. In this case, there is a credit risk exposure to the ultimate customer for the payment due under the parallel contract. This credit risk occurs upon commencement of the construction work by construction firm, until the whole amount or all the instalments (progress billings) are paid by the ultimate customer. The RW for this credit exposure is that of the ultimate customer, unless there is a guarantee, in which case the RW is that of the guarantor if lower.

CA-8.3.10

The RW for Istisna Sukuk where there is no parallel Istisna is based on that of the issuer, unless a third party provides a guarantee, in which case the third party's RW (if lower than that of the issuer) will be applicable. In addition, a RW of 20% will be added to cater for the price risk to which the underlying Istisna is exposed.

CA-8.3.11

In the event the returns to the Sukuk holder are from the cash flow of the underlying assets, which fall under the category of "Exposure to Assets" Istisna, the RW must be based on the "supervisory slotting criteria" approach which carries RW of 70–250%.

CA-8.3.12

Refer to Section CA-3.4 on Istisna for detailed treatment.

CA-8.3.13

The RW for IMB rentals is based on the lessee's counterparty credit risk, since the bearer of the residual value risk of the underlying asset is not borne by the Sukuk holders. Refer to Section CA-3.5 on Ijara and IMB for detailed treatment.

CA-8.3.14

The capital treatment of Musharakah Sukuk is based on the intent of the underlying investments in Musharakah that can be categorised as follows:

CA-8.3.15

Refer to Section CA-3.6 on Musharakah for detailed treatment.

CA-8.3.16

The treatment of Mudarabah Sukuk is based on the intent of the underlying investments in Mudarabah, as follows:

CA-8.3.17

Refer to Section CA-3.7 on Mudarabah for detailed treatment.

CA-8.3.18

The treatment of Wakalah Sukuk is based on the intent of the underlying investments in Wakalah, which can be categorised as follows:

CA-8.3.19

Refer to Section CA-3.10 on Wakalah for detailed treatment.

CA-8.3.20

The applicable RW must be based on the standing of the obligor or issuer as shown in the table in CA-8.4.3. If the Sukuk structure involves funding of an asset purchase in foreign currency, the relevant exposure must be calculated based on measures of foreign exchange risk described in Section CA-5.5 (foreign exchange risk).

CA-8.3.21

Refer to Section CA-3.2 on Murabahah for detailed treatment.

CA-8.3.22

For all those Sukuk structures where legal transfer of assets has not taken place due to the reasons outlined in Section CA-8.2, the applicable RW must be the credit RW as shown in table CA-8.4.3, subject to any Shari'a-compliant credit enhancement by the issuer (see Paragraphs CA-8.4.23 and CA-8.4.24). In some cases, a number of originators may form a pool to contribute assets in an asset-based structure (e.g. multiple sovereigns). In such cases, the rating of the Sukuk is that of the pool, subject to any Shari'a-compliant credit enhancement.

CA-8.3.23

For Sukuk with credit enhancement provided by the issuer or the originator, the RW is based on the credit rating of the credit enhancer (see table in CA-8.3.24 below). See Section CA-8.2 for details of various types of credit enhancements.

CA-8.3.24

Exposures in a Shari'a-compliant credit enhancement structure (described in section CA-8.2) must be risk-weighted as shown in the following table.

CA-8.3.25

The treatment in Paragraphs CA-8.3.26 to CA-8.2.30 applies to an Islamic bank licensee that has obtained a credit risk mitigant to a securitisation exposure. Credit risk mitigants include guarantees, collateral and on-balance sheet netting or any other Shari'a-compliant credit risk mitigation as recognised in Paragraph CA-4.7.21. Collateral in this context is that used to mitigate the credit risk of a securitisation exposure, rather than the underlying exposures of the securitisation transaction, subject to fulfilling criteria in Paragraphs CA-8.2.5 and CA-8.2.6.

CA-8.3.26

Eligible collateral is limited to that recognised under Section CA-4.7. Collateral pledged by SPVs may be recognised.

CA-8.3.27

Credit protection provided by the entities listed in Paragraph CA-4.7.21 may be recognised. SPVs cannot be recognised as eligible guarantors. An Islamic bank licensee must not recognise any support provided by itself.

CA-8.3.28

Where guarantees fulfil the minimum operational conditions as specified in Paragraph CA-4.7.12, Islamic bank licensees can take account of such credit protection in calculating capital requirements for securitisation exposures.

CA-8.3.29

Capital requirements for the guaranteed/protected portion is calculated according to CRM as specified in Paragraphs CA-4.7.24 to CA-4.7.31.

CA-8.3.30

For the purpose of setting regulatory capital against a maturity mismatch, the capital requirement is determined in accordance with Paragraphs CA-4.7.27 to CA-4.7.28. When the exposures being hedged have different maturities, the longest maturity must be used.

CA-8.4.1

An Islamic bank licensee taking the role of an originator is required to hold regulatory capital against all of its retained securitisation exposures. Repurchased securitisation exposures must be treated as retained securitisation exposures.

CA-8.4.2

The risk-weighted asset amount of a retained securitisation exposure is computed by multiplying the amount of the exposure by the appropriate risk weight in accordance with the table in CA-8.4.3.

CA-8.4.3

The following credit risk weights are applied for retained securitisation exposures where the Islamic bank licensee is the originator.

⁴⁵ The rating designations used in the following tables are for illustrative purposes only and do not indicate any preference for, or endorsement of, any particular external assessment system.

CA-8.4.3A

When the Islamic bank licensee provides credit protection to a securitisation exposure, it must calculate a capital requirement on the covered exposure as if it were an investor in that securitisation. If the Islamic bank licensee provides protection to a Sukuk issuance, it must treat the credit protection provided based on the risk of the underlying assets of the Sukuk as shown in Paragraph CA-8.4.3. If the Islamic bank licensee provides protection to a Sukuk issuance that has no legal transfer of assets, it must treat the credit protection provided based on the ECAI rating of the originator (as shown in the table in Paragraph CA-8.4.3).

CA-8.4.4

For off-balance sheet exposures arising from the provision of a liquidity facility, Islamic bank licensees must apply a 100% credit conversion factor (CCF) and then risk-weight the resultant credit-equivalent amount as shown in table CA-8.4.3. For risk-based capital purposes, Islamic bank licensees must determine whether, subject to the criteria in Paragraph CA-8.4.4A, an off-balance sheet securitisation exposure qualifies as an 'eligible liquidity facility' or an 'eligible servicer cash advance facility', in which case a lower CCF may apply (see CA-8.4.4B and CA-8.4.5).

CA-8.4.4A

Islamic bank licensees are permitted to treat off-balance sheet securitisation exposures as 'eligible liquidity facilities' if the following minimum requirements are satisfied:

CA-8.4.4B

Where the conditions in Paragraph CA8.4.4A are met, the Islamic bank licensee may apply a 50% CCF to the eligible facility regardless of the maturity of the facility. However, if an external rating of the facility itself is used for risk-weighting the facility, a 100% CCF must be applied.

CA-8.4.4C

Liquidity facilities in certain types of Sukuk structures are commitments from the facility provider to provide liquid funds if these are needed to meet contractual payments to Sukuk holders and there is a delay between the date of their collection and the date on which the payment to the Sukuk holders is due. The need for such facilities may result from a timing mismatch between cash collections from the underlying Sukuk assets (such as Ijara rentals) and the scheduled payments due under the programme to the Sukuk holders.

CA-8.4.5

An eligible servicer cash advance facility, based on Qard, is an advance granted by the servicer to the SPV to ensure timely payment to the investors⁴⁶ — for instance, in cases of timing differences between collection and payments. However, it is a Shari'a requirement that such facilities remain essentially separate from the Sukuk undertaking and that this separation be properly documented. In the case of servicer cash advances, a risk weight of 50% is applied to such facilities.

⁴⁶ It is, however, not permissible for the manager of Sukuk, whether the manager acts as Mudarib (investment manager), or Shank (partner) or Wakil (agent) for investment, to undertake to offer loans to Sukuk holders when actual earnings fall short of expected earnings. It is permissible, however, to establish a reserve account for the purpose of covering such shortfalls to the extent possible, provided the same is mentioned in the prospectus. It is not objectionable to distribute expected earnings, on account, or to obtain project financing on account of the Sukuk holders.

CA-8.4.6

A Qard made to enhance earnings raises issues of Shari'a compliance and must be distinguished from credit enhancement by means of "excess spread", as described in Paragraph CA-8.2.24 and must be treated as under Paragraph CA-8.4.3A.