DUBAI: A master agreement for asset-backed Islamic bonds will help spur demand for securitized paper in the fast-growing industry, bankers and lawyers said. Islamic finance industry body IIFM is looking to develop a template in 12 to 18 months that will help mitigate some of the legal and operational complexities surrounding asset-backed Islamic bonds, or sukuk, said its chief executive Ijlal Alvi. At present, issuers offer instruments that provide no recourse in the event of a default, bankers and lawyers said. Asset-backed sukuk are seen closer to the spirit of Islamic law as they involve a transfer of tangible assets — investors become the legal owners of these in the case of default. Sukuk structure came under scrutiny after some high-profile defaults and near-defaults in the global financial crisis. Investors were taken aback as they realized the majority of sukuk were asset-based and that these could not be accessed directly by sukuk holders following a default. "People didn't really talk about asset-backed sukuk until the stress tests were applied," said Tim Ross, partner at Latham & Watkins in Dubai. "Some investors were caught off guard — they had an unsecured payment claim." As investors cried foul, market watchers saw the industry shifting towards a securitized model. Yet some 90 percent of transactions are still structured as asset-based sukuk. "While asset-backed transactions, conventional and Islamic, have been done in the Gulf, they are more difficult and costly for companies to undertake," said Gregory Man, senior associate at Clifford Chance in Dubai. He added such transactions usually face tougher legal and analytical requirements imposed by rating agencies and many companies in the region lack sufficiently robust internal systems to service and report on the assets to investors and agencies. IIFM's Alvi added there are legal challenges in some jurisdictions that make transferring the titles of assets much more expensive and time-consuming. A master agreement would aim to provide a standardized base from which issuers could structure the sukuk in line with their own jurisdictions and increase awareness about the product. "In this credit environment, creditors would prefer direct recourse to the assets," Alvi said. "Although asset-based is a valid structure as well, I think it is preferable to encourage increase in asset-backed sukuk over the medium to long-term." Despite the challenges, companies would look to issue more asset-backed sukuk if investors demanded it, bankers said. "Among investors, there is still no real drive to do it," said one Gulf-based Islamic banker. "Much of the corporate world comes from a conventional background so asset-based sukuk is closer to the debt model they are used to working with. "Most investors simply don't care enough, despite all the frenzy following defaults."
