$US 1 billion Dubai Global Sukuk

This case describes the basic structure of the Dubai Sukuk It is intended to be used as the

basis for class discussion. Answers are not provided. It is expected that the course leader will

guide participants accordingly.

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Case Abstract

A sukuk has economic characteristics similar to those of a conventional bond, but is structured

so as to be compliant with Sharia law enabling them to be sold to Islamic investors who are

prohibited by Sharia law from investing in conventional debt securities. The sukuk issued by

the Government of Dubai in October 2004 had the typical structure of a sukuk al ijara, that is a

sukuk combined with the sale and leaseback of the assets being financed. In the transaction,

the assets in question were land and buildings at Dubai International Airport (the Sukuk Assets)

which were owned by the Department of Civil Aviation of the Government of Dubai (the

Government).

Those who take riba (usury or interest) will not stand but as stands the

one whom the demon has driven crazy by his touch.

Quran Sura 2:275-280

Islamic bonds a fast-growing market

Islamic bonds (sukuk) are rapidly gaining in popularity.The first international sukuk was issued

by the Government of Malaysia in August 2002. In 2003 global sukuk issuance totalled

approximately $1.9bn and this increased to approximately $6.7bn in 2004.

The Sharia

A suk (the singular of sukuk) has economic characteristics similar to those of a conventional

bond, but is structured so as to be compliant with Sharia law and can be sold to Islamic

investors who are prohibited by Sharia law from investing in conventional debt securities. The

Sharia is a body of Islamic law drawn from various sources including the Quran which includes

a number of principles relating to financial transactions. The Sharia is not a codified body of

law and is subject to development and sometimes conflicting interpretation. However, the

major Islamic financial institutions have a Sharia Supervisory Board on which Islamic scholars

sit, and in practice these Boards determine whether a proposed transaction being arranged by

the institution is compliant with the Sharia.

The most well-known principle of Sharia law is the prohibition on riba, which is generally

described as being a prohibition on usury or the earning of interest by lending money. Any

return which is based solely on the time value of money (as opposed to the use of an actual

asset) is susceptible to being caught by the prohibition on riba however it is described. If

however an Islamic financier has an ownership interest in the financial asset then it is allowed

to benefit from the return generated by that asset.

The nature of sukuk

Sukuk are structured to comply with these principles. In a traditional bond issue, the investor

holds a certificate of debt under which the issuer typically agrees to make payments of interest

and principal. With sukuk, by comparison, the investor holds a certificate which represents a

beneficial ownership interest in an underlying asset. The yield is linked to a return on that

asset, most typically generated by the rentals under a Sharia compliant lease (ijara) of the

asset.

The Government of Dubai sukuk

The sukuk issued by the Government of Dubai in October 2004 had the typical structure of a

sukuk al ijara, that is a sukuk combined with the sale and leaseback of the assets being

financed. In the transaction, the assets in question were land and buildings at Dubai

International Airport (the Sukuk Assets) which were owned by the Department of Civil Aviation

of the Government of Dubai (the Government).

The key elements are:

A special purpose vehicle, Dubai Global Sukuk FZCO (the Issuer), was incorporated in

Dubai Airport Free Zone.

The Government conveyed title to the Sukuk Assets to the Issuer pursuant to a purchase

agreement.

The Issuer issued trust certificates (the equivalent of the bonds in a normal bond issue) to

the investors (the Certificate holders). Each trust certificate (Certificate) represented a

share in the beneficial ownership of the Sukuk Assets. The proceeds of the issue of the

Certificates were used by the issuer to pay the purchase price of the Sukuk Assets to the

Government.

The Certificates were held in the European clearing systems of Euroclear and Clearstream

and were listed on the Luxembourg Stock Exchange and the Dubai Financial Market.

The Sukuk Assets were leased back to the Government by the Issuer. This was structured

as an agreement to enter into 10 consecutive leases each of six months under a Master

lease agreement in order to allow payments of rental to be calculated by reference to

LIBOR for each period.

The rental payments paid by the Government to the Issuer for the use of the Sukuk Assets

are to be used to make periodic distributions to the Certificate holders (the equivalent of

interest paid under a conventional bond).

The Government entered into a purchase undertaking whereby it agreed to repurchase the

Sukuk Assets at the scheduled redemption date of the Certificates or in a default situation.

The amount paid by the Government to repurchase the Sukuk Assets is to be used by the

Issuer to repay the principal amount of the Certificates to the Certificate holders.

Upon a total loss of the Sukuk Assets the Issuer will have recourse to the proceeds of the

insurance policies. If these are not sufficient to allow the Certificates to be redeemed in full

the Government will be obliged to make up the shortfall.

Under Sharia law the Issuer is required to retain responsibility for major maintenance and

structural insurance of the Sukuk Assets. However, under a servicing agency agreement

the Issuer appointed the Government as its agent to carry out these activities.

The description above is only a basic summary of the structure of the Government of Dubai

transaction. As the sukuk is a relatively new product, each transaction is likely to raise

interesting problems for the bankers and lawyers involved.

The following are the key parties in the Dubai Global Sukuk:

Issuer - Ownership of the Issuer

The authorised and issued share capital of the Issuer is

AED1,000,000 consisting of ten shares with a nominal

value of AED100,000 each. Nine of the Issuers shares

are owned by the Government (acting by its Finance

Department) and the remaining one share in the Issuer is

owned by Dubai Islamic Bank PJSC.

Seller The Government will convey to the Issuer (as trustee and

agent for and on behalf of Certificate holders) title to the

Sukuk Assets.

Lessee The Government will enter into ten consecutive Leases of

the Sukuk Assets with the Issuer pursuant to the Master

Lease Agreement during the period of five years

commencing.

Obligor The Government will enter into the Purchase Undertaking,

pursuant to which the Government will undertake to

purchase the Sukuk Assets from the Issuer at the

Exercise Price (as defined below) either on the Scheduled

Dissolution Date or on the date specified by the Trustee to

Certificate holders.

The following are the key elements of the Sukuk Certificates:

Form and Delivery of the Certificates The Certificates will be issued in registered global form

only without coupons attached.The Certificates will be represented by interests in the

Global Certificate deposited with a common depository for

Euroclear and Clearstream, Luxembourg.

Clearance and Settlement Holders of the Certificates may elect to hold their interest

in the Global Certificate in book-entry form through each

of Euroclear or Clearstream, Luxembourg.

Denominations The Certificates will be issued in minimum denominations

of US$10,000 and integral multiples of US$1,000 in

excess thereof.

The Trust Assets The Trust is the trust constituted by the Issuer under the

Declaration of Trust. The Trust Assets are the Sukuk Assets, all of the Issuers

rights, title, interest and benefit, present and future.

Purchase Agreement Pursuant to the Purchase Agreement, the Seller will sell to

the Issuer the Sukuk Assets. The proceeds received by

the Issuer from the issuance and sale of the Certificates will be used to pay the aggregate purchase price payable by the Issuer to the Seller for the Sukuk Assets.

Sukuk Assets Certain land, buildings and other property at Dubai

International Airport.

Master Lease Agreement Under the terms of a Master Lease Agreement between

the Issuer as lessor and the Government, acting as

lessee, the Government agrees to enter into ten

consecutive leases of the Sukuk Assets (each, a Lease)

during the period.

Use of Proceeds The proceeds of the issue of the Certificates will be used

by the Issuer to purchase the Sukuk Assets from the

Government, as Seller, pursuant to the Purchase

Agreement.

Listing Application has been made to list the Certificates on the

Luxembourg Stock Exchange and the Dubai Financial

Market.

Governing Law and jurisdiction The Declaration of Trust and the Agency Agreement and

the Certificates will be governed by English law and

subject to the non-exclusive jurisdiction of the English

Courts.

The Purchase Agreement, the Master Lease Agreement,

each Lease, the Servicing Agency Agreement, the

Purchase Undertaking, the Agency Declaration, the Share

Agency Declaration, the Certificate Purchase Agreement

and the Costs Undertaking will be governed by the laws of

the UAE as applied in Dubai. The courts of Dubai have

non-exclusive jurisdiction to hear all disputes relating to

them.

Dubai Global Sukuk: Case Study Questions

Answer the following questions:

• What Sharia Board requirements should be put in place?
• What was innovative about this issue?
• How was the issue rated and by whom?
• What risks for investors are associated with investing in sukuk?
• Was the issue a success?