D o w J o N E s I s L A M I C M A R K E T I N D E x E s N E w s L E T T E R
1 The United states is not normally considered among the most
signiicant Islamic inance markets, and so the recently proposed sukuk legislation in the New York state senate came as a welcome surprise to many. Efforts vis-à-vis Islamic inance in the United states have not been as conspicuous as in other western nations, but, if passed, this legislation would, in our view, actually stand in a line of important governmental and regulatory efforts to welcome and integrate Islamic inance into the prevailing U.s. legal framework.1
The Proposed Legislation
on February 1, 2011, New York state senator Kevin Parker introduced legislation to the New York state senate allowing for the creation of an investment vehicle termed an “alternative inance investment bond,” or “AFIB.” The senator’s proposed legislation deines an AFIB as “a certiicate of equal value representing undivided shares of ownership of tangible assets, usufructs and services or (in the ownership of) the assets of particular projects or special investment activity.”2 As such, the AFIB appears to track the
concept of a sukuk and the shari'ah’s requirement that entitlement to proit be coupled with a market or asset risk by specifying the AFIB-holder’s ownership in the underlying asset.
A supporting memorandum included along with the legislation states:
“[In] the past decade, nations from the Persian Gulf, southeast Asia, and other emerging markets have experienced tremendous
Umar F. Moghul
A New York Sukuk?
Umar F.
Moghul
Murtha Cullina LLP
growth. Investors from these countries are seeking investment opportunities abroad that comport with their religious beliefs as Muslims, namely a prohibition on interest… In addition to the potential for job growth and development, permitting the state and private entities to issue alternative inance investment bonds would permit communities that do not engage in interest-based transactions, the opportunity to beneit from capital inancing facilitated by the state for the construction of education and health care facilities as well as increase the market for those who wish to purchase the state’s debt instruments.”3
Further, senator Parker, in proposing this legislation, comments, “This legislation reverses an historic inequity where far too many New Yorkers have been unable to beneit from public-private partnerships with the state.”4 senator Parker also mentions that
such “investment vehicles might be used in economic development generally, and speciically in distressed census tracts.”5 At the
time of writing this article, the outcome of this precedent-setting proposed legislation was not known and will likely not be known for some time.
senator Parker’s proposed legislation contemplates a inancing instrument whereby a “bond issuer undertakes (A) to make a repayment of the capital (‘the redemption payment’) to the bond [i.e., AFIB] holder during or at the end of the bond term (whether or not in installments), and (B) to pay to the bond holder other payments on one or more occasions during or at the end of the bond term (‘additional payments’).” An “alternative inance investment bond agreement” is to set forth the sum paid by “bond holder[s]” to the “bond issuer,” identify the assets “which the bond issuer will acquire,” and specify a “bond term.” Interestingly, this agreement is also to specify that “the amount of the additional payments does not exceed an amount which would be a reasonable commercial return on a loan of the capital.” “Additional payments” thus appear to be intended as an interest equivalent for New York law purposes. Lastly, the proposed legislation calls for the AFIB to be “regulated in a manner consistent with traditional bonds and other debt instruments.” Certain of these requirements seem to implicate some of the shari'ah-based criticisms leveled against sukuk, including guaranteeing the return of principal and pricing the return with interest-rate benchmarks,6 and also raise the
D o w J o N E s I s L A M I C M A R K E T I N D E x E s N E w s L E T T E R
2 Potential Markets
An important question this legislation raises is: what is its contemplated set of issuers and target investors? The proposed legislation appears to target issuances by the state as well as municipal entities. with regard to potential investors, the legislation explicitly discusses making AFIBs available to American Muslims for purchase. To our knowledge, this is an untapped market but one that probably would have to irst be educated and organized. Non-U.s. investors may very well seize upon Non-U.s. sukuk offerings, though a tax-exempt issuance may be unattractive if they are untaxed in their home jurisdictions (since they usually carry a lower return).
Tax-Exempt Sukuk
A tax-exempt AFIB offering—apparently contemplated by this legislation—would certainly be an exciting and challenging undertaking. In the United states, there are multiple layers of regulation complicating the issuance of governmental bonds in general and tax-exempt governmental bonds in particular.7 These
impact any sukuk offering in the United states and create challenges with the shariah’s requirements regarding asset-backed inancing.
First, in order for governmental bond interest to be exempt from federal taxation, the bond issue must comply with a number of complex rules including the requirement that only governments, governmental authorities, nonproit organizations, and a very limited range of speciic for-proit projects are eligible for tax-exempt bond inancings. In all of these cases, the bond must be issued by a government or a governmental authority either for its own account or as a conduit issuer for the beneit of some eligible project or nonproit organization. The sharing of title to property owned by a governmental entity or a nonproit corporation with a private citizen as a for-proit entity may be prohibited under some U.s. laws (depending on the jurisdiction) and may cause the loss of the interest tax exemption (which presumably would apply to the sukuk return). This of course could have a signiicant adverse impact
upon the sale of a sukuk. The sale or sharing of title to government assets, as we have seen from recent events, may also have political ramiications that must be accorded due weight.
second, governmental bonds have a speciic and beneicial exemption from the registration requirements of the securities Act of 1933, as amended (the “1933 Act”).8 Under most state securities
laws, which remain applicable to a limited extent, tax-exempt governmental bonds also receive exemptions from registration. If a sukuk failed to meet the governmental bond exemptions from registration under the 1933 Act, it would either have to be registered or its sale limited by the rules of private placement exemptions.
Third, every governmental authority must issue bonds in accordance with its authorizing legislation and its state’s laws, both of which may vary widely. Among such variances may be concepts of, and rules relating to, permitted borrowers, permitted projects, permitted structures, ownership and control of the underlying project, the ability to create afiliates, and authorization procedures.9 The issue
of ownership makes certain economic development and housing inancings viable in the Islamic context because they typically involve private ownership, and tax exemption is not always expected or is statutorily authorized in spite of private ownership. similarly, certain small-issue industrial development bonds are tax exempt despite private ownership. If a sukuk offering were undertaken to beneit a 501(c)(3) organization, the Islamic ownership requirements might also impact rules relating to private use of and private beneit from property. If these rules were violated, the 501(c)(3) entity could lose its tax-exempt status and/or be subject to other sanctions.
Umar F. Moghul is an international inance attorney and partner at Murtha Cullina LLP
in the United States, where he practices in Islamic inance and investments, real estate,
and private equity. Mr. Moghul is also a lecturer in law at the University of Connecticut
School of Law, where he teaches Islamic law and jurisprudence, and a trustee of the
Hartford Seminary.
1 These regulatory successes include the New York state Banking Department’s approval of Islamic residential mortgage inancing structures, the Board of Governors of the Federal
Reserve’s decision to allow U.s. inancial institutions to engage in Islamic transactions in countries, and New York tax authorities' issuing of rulings eliminating the additional tax that might otherwise result from a murabaha-based home inancing structure. see e.g., Umar Moghul, Regulating Islamic Finance in the U.s., Global Islamic Finance Report (forthcoming).
2 sen. Kevin Parker, Legislative Bill Drafting Commission 08345-02-1, section 2(1) (on ile with the author).
3 sen. Kevin Parker, New York state senate Introduces Memorandum in support, submitted in accordance with senate Rule VI, section 1, Page 2 (on ile with the author). 4 Press release, available at: http://www.longislandexchange.com/press/2011/01/31/senator-parker-creates-new-opportunities-for-investment/ (accessed February 9, 2011). 5 Id. at p. 4.
6 see e.g., Taqi Usmani, sukuk and Their Contemporary Applications (translator Yusuf DeLorenzo) (discussing the author’s views on certain sukuk from an Islamic perspective). 7 Tax-exempt governmental bonds provide returns exempt from federal income taxation, and in many cases, state income taxes as well.
8 see section 3(a)(2) of the securities Act of 1933 (48 stat. 74, 15 U.s.C. 77a-77mm). It should also be noted that the exemption for a bond under the 1933 Act may or may not
exempt any other related rights or property interests that may be deemed to be securities for purposes of the 1933 Act.
