Those who live off the interest on loans will never stand up, except in the way those whom Satan knocks down with a fit rise up again. That is because they say: "Trading is just like taking interest." Yet God has permitted trading and forbidden taking interest (qurantoday.com, 2011). The German state Saxony- Anhalt, in July 2004, took the unprecedented step to benefit from this Islamic rule and raised debt in a new way. By issuing a “sukuk” debt instrument, conforming to Islamic principles, the Bundesland located in East Germany and by West German standards considered as under-developed was the first one among the OECD countries to enter a new path of raising public funds (rundschau-online.de, 2009). While there are until today no genuine Islamic banks in Germany - unlike the situation in Great Britain -, the ministry of finance of the state was convinced of the opportunities linked to such a financial structuring, aiming to raise €100m͘
This report analyzes the given German sukuk issuance and compares and contrasts it to conventional products. For this, I will first give a general overview of the chosen product, describing the rationale behind the instrument, and then explain in detail the specific features relating it to Islamic finance. I will then discuss key differences and similarities of the financial instrument vis-à-vis regular products, including demand and supply considerations, before concluding by giving a view on the overall situation of Islamic finance in Germany.
Overview of the Saxony-Anhalt Sukuk
In mid-July 2004, a roadshow for the first Islamic Eurobond began, following the confirmation by the central German state of Saxony-Anhalt on July 14 that it intended to issue the first European-based and backed Islamic bond (sukuk) at the end of the month. It had a face value of €100m and the fact that this was the first issuance of this kind in the Western world deserves some more explanation about the background. Basically, the decision for the sukuk was based on three main factors:
First, the state had accumulated on a per-capita basis more debt than any other federal state of Germany, totaling 18.3 billion Euros (derfreitag, 2004). Hence, a broadening of the investor basis made sense in order to circumvent already saturated traditional capital markets. The mandate of Saxony- nhalt’s funding policies already gives an idea of the innovative tools that had been used before͘ The State is using a much higher proportion of bonds than the average of the German Federal States. Thus, it has been able to build-up an internationally diversified investor base, also supported by the fact that it has issued U.S. Dollar denominated commercial paper and Japanese Yen denominated medium-term notes before. Consistent with its strategy, the State has raised more than two-thirds of its outstanding public debt in the international capital markets (Saxony-Anhalt, 2011). The clear objective is to reduce financing costs and to attract investors with a long-term view͘ s the Finance minister stated: “Each euro we save as interest directly saves taxpayers’ money͘ On the rab capital markets, lower yields are common, and consequently we were able to raise debt at favorable conditions” (bfinance.de, 2004). Furthermore the state was looking for investors and entrepreneurs interested in going into Germany and to choose Saxony-Anhalt as their new location. Hereby, the government was especially targeting the fight against the image of having people with a “brown” neo-Nazi character, which was thought to deter foreign investors. The German Sukuk was to demonstrate their open-mindedness and interest in Muslim investors worldwide, well aware of the fact that this was the first Islamic bond from a European issuer.
A message which was widely heard, since afterwards the state was among the top places in a ranking for Middle East investors about “sleeper investment opportunities” (rundschau-online.de, 2009).
Lastly, the particular focus on Muslim investors stemmed from the personal relationship the permanent secretary of the Finance ministry, Mr. Gühl, had with the Middle East. Before that position he was treasurer of the “ rab-German co-operation for trade and industry”, where he built up close ties with wealthy and conservative Muslims (derfreitag, 2004). Indeed, the Ministry of Finance of Saxony-Anhalt had been working on this issue for three years, following a visit to Bahrain in 2001, where officials met both conventional and Islamic bankers. The Ministry of Finance of Saxony-Anhalt initially planned to issue the sukuk in 2003. However, after the September 11 attacks, initial political opposition to issuing an Islamic bond gained ground again for a while. The sukuk structure itself posed no problem from a legal and regulatory point of view (arabnews, 2004).
The “Saxony-Anhalt Sukuk”, as it was named, was structured as a Sukuk Al Ijara. As described in the introduction, interest payments are forbidden under the Shari´ah (Islamic law). On the other hand, returns based upon and generated by the ownership of assets and income from genuine trading transactions are permitted, and indeed transactions of this nature are actively encouraged (arabnews, 2004). An Ijara is essentially a lease contract whereby assets are leased out, with the lessor retaining all the rights and responsibilities that go with ownership. As an Ijara Sukuk represents ownership in well defined securities, it can also be freely traded in the secondary market at the specific current market price.
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Following this type of structuring, the transaction was essentially a sale (to a special purpose vehicle) and leaseback (to Saxony-Anhalt) of certain previously state-owned real estate assets and is illustrated in the graph (see also Appendix a) (sukuk.me, 2008). In detail, the underlying Structure of the Saxony-Anhalt Sukuk. Graph adapted from class material. transactions consisted of a certain number of specified buildings owned by the Ministry of Finance, which was sold through a master lease contract for 100 years to a special purpose vehicle (step nr. 1). This entity was incorporated in the Netherlands for tax reasons, as German law was not yet fully developed regarding securitization, especially from a tax perspective. By choosing the Dutch “Stichting Sachsen Anhalt Trust” foundation, the Sukuk remained competitive with regards to municipality tax, which would not apply for a conventional bond (zawya.com, 2011).. The finance minister admitted openly that this was a sort of tax evasion done by the state government for avoiding a higher tax burden (Freitag.de, 2004).