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.