Egypt's first sukuk law: A legal overview

The passing of Egypt's first sukuk law in May 2013 marks a major milestone in the development of the Islamic finance industry at the national and regional levels. However, the actual value that may result from passing the sukuk law will depend on the adequacy of the regulatory framework in which it will be implemented. The first piece of this important framework is the Executive Regulations of the law, which the government plans to issue in the next few weeks.

The law's drafting and passing were met with several political hurdles. It has been argued by the opposition's figures that the mere fact of passing of such law by a Shura Council, dominated by Islamic parties, particularly the Freedom and Justice Party, is a testament to the Islamic parties' reliance on funding sources from the GCC countries, where Shariah-compliant financial instruments are more popular and developed than they are in Egypt.

Such reliance is seen by part of the opposition as opening the door to political influence from the Gulf. It could be argued that the reason for such unpopularity of Shariah-compliant instruments in Egypt is the suppression of Shariah-compliant finance under the regime of Hosni Mubarak, which contributed in part to the creation of a negative attitude towards Islamic finance.

Some of the critical aspects of the new Egyptian sukuk law are: a) the law's drafting process; b) sukuk issuance under the law and its limits; and c) key provisions regarding Shariah supervision over sukuk issuance and settlement of sukuk disputes.

Drafting the law

The initial draft of the law in March 2013 encountered significant resistance from the Salafist Al-Nour party, which demanded the law be approved by Al Azhar, which is the supreme Islamic authority in Egypt. Al-Nour's objections largely centered on nationalist fears that the law would enable foreigners to own Egyptian public property through issuance of sukuk granting its owners portion of ownership of public assets.

Potentially setting a precedent for review of future legislation by religious entities, President Morsi was forced to refer the law back to Al-Azhar for review. The law was ultimately passed after incorporating Al-Azhar's amendments, and now awaits the issuance of its executive regulation, which is due to be completed in the coming months.

In addition to Al-Azhar's comments, other parties contributed to the drafting of the law, such as representatives and experts of the Islamic finance industry, including the Egyptian Islamic Finance Association (EIFA).

EIFA's efforts and discussions with the Shura Council resulted in the broadening of the scope of law to include both corporate and sovereign sukuk rather than exclusively sovereign. The law allows for both asset-based and asset-backed structures despite EIFA's recommendation to restrict asset-backed sukuk, which has been subject to criticism by various Shariah boards and organizations.

In addition, asset-backed sukuk structures could provide a different cost of financing to issuing parties, as the profit rate would be based on the underlying credit quality as well as the expected performance of the sukuk assets.

Geographic scope

Although sukuk issuance can occur within Egypt and internationally through offshore special purpose vehicles (SPVs), the law stipulates that sukuk assets be located within Egypt, which is likely to limit the size and liquidity of the country's sukuk.

However, given the probable need for financing within the Egyptian market, these limits are not likely to be a problem within the next decade. Indeed, the law is expressly written to discourage capital outflows from Egypt and encourage capital inflows.

Shariah supervision and dispute settlement

A central Shariah board established at the cabinet level shall oversee compliance. Corporate issuers will have their own Shariah boards, but the transaction will also be subject to the central Shariah board's approval. The prime minister will appoint the board's members based on nominations from the finance ministry. To be considered for the central board membership, a candidate must have a Ph.D. in in Shariah and to have participated in at least three sukuk issues.

Although the Egyptian Economic Courts have a general jurisdiction over all sukuk disputes, the law allows the transaction parties to agree on arbitration as a dispute resolution mechanism. The law also leaves the door open to interpretations allowing settlement by foreign arbitration tribunals for offshore sukuk.

Conclusion

The new sukuk law constitutes a bold step towards the development of a Shariah-compliant finance industry in Egypt, and may prove to be a viable resource that could be used to address the current gap in the public funding needs.

Dr. Walid Hegazy has more than 15 years of legal experience with a focus on Islamic banking and finance, project financing, corporate restructuring and corporate governance. Before launching Hegazy & Associates, Dr. Hegazy was heading the Islamic Finance Practice Group at the international law firm of Freshfields Bruckhaus Deringer.

(Zawya / 05 June 2013)

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