Reviewing the existing literature on Islamic project finance and major Islamic modes of financing, particularly sukuk, the author examines such regulatory issues as the role of shari’a supervisory boards and the process of dispute resolution. She presents a case study of the East Cameron sukuk to highlight various structural and regulatory issues.
The author focuses on various modes of Islamic project finance and singles out sukuk as the most popular Islamic financial instrument. She points out irregularities in the legal framework governing Islamic sukuk issuances that hinder investor confidence and highlights the difference between asset-based and asset-backed sukuk, establishing that only the latter are truly in the spirit of shari’a and provide adequate protection to sukuk holders in case of default or bankruptcy of the issuing entity.
The East Cameron sukuk is presented as an example of a truly asset-backed sukuk structure, and the author uses the case to highlight issues related to structure and legal documentation as well as judicial proceedings in the case of bankruptcy.
How Is This Research Useful to Practitioners?
The author mainly focuses on regulatory issues and the legal framework of sukuk issuances. She highlights the need for a pan-Islamic financial supervisory body, the need for harmonization between various Islamic jurisdictions, and the importance of having a cross-examination of new projects by independent shari’a advisers, rather than just the company’s in-house advisers, before issuing fatwas, or judgments, validating a particular transaction. All of these steps will enhance the acceptance of Islamic issuances by investors and increase the scope of Islamic project finance.
The governing law and the jurisdiction must be explicitly stated while contracts are being drawn up for any Islamic transaction, and the two must be synchronized. The author cites the Nakheel sukuk bankruptcy as an example where even though the governing law was that of England, the jurisdiction where the contracts were to be enforced was Dubai, United Arab Emirates. Dubai courts, however, were not obliged to enforce English law, which presented immense difficulties in terms of investor protection against the loss from Nakheel’s bankruptcy.
The author draws on previous literature to highlight the importance of niyah, or true intentions, when entering into contracts that form part of an Islamic finance transaction. She highlights two cases—the Investment Dar Company and the East Cameron sukuk—whereby after default, the issuers demonstrated that their true intentions were not to transfer ownership of assets to the sukuk investors. Both argued in court that the sukuk was nothing more than a secured loan, which contradicts the spirit of the structure.
The East Cameron project is one of the rare cases of bankruptcy whereby the US court ruled in favor of the sukuk holders because the agreements had been drawn under Louisiana state law and explicitly transferred ownership rights to the sukuk holders. Even though the case was then resolved through settlement rather than judicial verdict, the East Cameron project set an important precedent for future Islamic instruments issued in Western jurisdictions. It established that a Western court is able to accommodate and apply shari’a principles to a project while simultaneously adhering to the state law; hence, it is possible to protect the rights of sukuk holders even in non-Islamic jurisdictions.
The case also highlights the importance of drawing up legal contracts so that it is possible to establish, without ambiguity, whether a true transfer of ownership has taken place in issuing a sukuk (and thus whether the structure is truly shari’a compliant).
How Did the Author Conduct This Research?
The author relies on published literature to draw inferences about the shortcomings of Islamic project finance and makes use of secondary research on the East Cameron sukuk case study. She selects the East Cameron sukuk because it was the first sukuk offering in the United States. It also has the distinction of being the first sukuk to be regulated under SEC Rule 144A and to be rated by Standard & Poor’s. Because of its pioneering nature—that is, its securitization of oil and gas overriding royalty interests (ORRI), which are recognized as tangible assets in Louisiana—the East Cameron sukuk earned various accolades at renowned financial platforms.
The 13-year, $165.7 million sukuk was issued by East Cameron Partners, an oil and gas exploration and production company; it sold the rights to the future production of oil and gas from the area under exploration. The sukuk made use of two special purpose vehicles and was based on a two-tiered musharaka structure. The sukuk holders owned the rights to the ORRI and agreed to share any profits and any failures. The company eventually filed for bankruptcy because of the global financial crisis and natural disasters. The bankruptcy case was brought to court in Louisiana, where the judge ruled in favor of the ownership rights of the sukuk holders. The case was eventually resolved out of court, and the parties managed to resolve it in a way beneficial to both the sukuk holders and East Cameron.
The author highlights the difficulties in obtaining primary data in the Islamic finance sector and proposes areas that need further research—for example, the analysis of differences between asset-based and asset-backed structures and the role of the shari’a boards.
This research brings to light important issues regarding the regulatory and legal framework of Islamic financial transactions. I agree with the author’s call for harmonization of Islamic jurisdictions. But I would like to add that such contradiction is only present between the jurisdictions of Malaysia and the Gulf Cooperation Council. I also agree with the author’s suggestion of independent validation of transactions before approval of new products by shari’a boards, but the monetary and efficiency costs involved in independent ratification of fatwas before the offering of each and every new product need to be considered. I believe that development of standardized contracts governing common Islamic structures approved by major, supranational Islamic standard-setting bodies will simplify the issuance process of sukuk and other financial instruments and go a long way in boosting investor confidence in all jurisdictions.