Sukuk

1. Islamic Aircraft Financing
Structures
Robert Fugard
Linklaters
Partner, Asset Finance Group

2. 2
the current environment
• reappraisal by banks of approach to aircraft finance
- exit of some traditional lenders
- restriction of categories of airline credits considered
• difficulties in sourcing equity prepared to invest in the industry
- as a reaction to uncertainty in the industry
- as a result of changes to tax rules
• restriction of tax-based leasing
- loss of traditional tax products: US, Germany and Japan
• curtailing of Export Credit Agency support
- abolition of LASU fixed rate option
- increases in premia and reduction in advance rates

3. 3
the Islamic finance market
• Islamic funds estimated at over $200 billion
• growing market
- return of Islamic funds to region
- opportunity to tap into the significant funds of Islamic investors
seeking Shari’a compliant investments
- establishment of regional secondary market infrastructure in Dubai
(DIFC), Bahrain, Saudi Arabia
• over 250 Islamic Finance Institutions worldwide
- Western institutions most active in this market are HSBC Bank plc
(through HSBC Amanah Finance) and Citigroup
- Local financial institutions include Arab Banking Corporation,
Dubai Islamic Bank,Abu Dhabi Islamic Bank, Kuwait Finance
House, First Islamic Investment Bank, as well as Islamic Development
Bank

4. 4
what Islamic finance offers
• diversification of funding sources
• investor’s regional understanding of risk
• conventional-style documentation
• bankable governing law
• ability to combine with conventional funding sources

5. ‘basic’ Islamic leasing structure
5
Islamic investors
Modareb
Islamic Lessor
(Cayman SPV)
Airline
Sale of
aircraft
Declaration of trust
Islamic lease
(Ijara)
investment
(85%)
investment (85%)
Equity
contribution
(initial rental)
(15%)
Investment (Modaraba)
agreement
Vendor
Insurance &
Maintenanc
e Services

6. 6
airline sukuk structure
• sukuk defined by AAOFI’S Shari’a standards as
“Certificates of equal value representing undivided shares in
ownership of tangible assets, usufruct and services or (in the
ownership of) the assets of particular projects or special
investment activity”
• can provide greater diversification of funding sources than ‘basic’
Islamic leasing structure
• access to larger volumes of capital
• potential to provide liquid investments for Islamic investors

7. 7
airline sukuk structure
• sukuk gives investors share in profits generated by investment in
asset
– ijara - based cash flows most appropriate for sukuks
– real estate ijara - based sukuks
Malaysia $600m issue (June 2002)
IDB $400m issue (July 2003)
Qatar $700m issue (September 2003)
Bahrain $250m issue (June 2004)
Saxony € 100m issue (August 2004)
Dubai DCA $750m issue (proposed)
• problems with morabaha - based sukuks and tradeability
– sale of debt (bay al - dayn) prohibition
• aircraft ijara - based sukuk would fuse aircraft ijara technology and
conventional EETC technology

8. 8
airline sukuk features
• relationship of sukuk holders to issuer is that of investor, not
creditor
• sukuk holders are joint owners of trust assets, being
– aircraft (subject to leases)
– lease revenues
– lease rights
• sukuk holders exercise rights as owners through sukuk agent, who
is empowered to enforce lease rights against airline, and can be
compelled to do so by relevant proportion of sukuk holders
• sukuk holders rights against Issuer are limited recourse to the trust
assets

9. 9
airline sukuk features
• complexity dictated by investor/rating requirements
– rating agencies (eg Standard - Poor’s, Moody’s, Fitch) apply
conventional rating criteria - Shari’a compliance not relevant - so need
to minimise reliance on performance of ijara
• likely rating agency focus on
– level of over - collateralisation
– bankruptcy protection
– quality of assets
– liquidity facility
• possibility of credit enhancement
– asset value guarantee
– investment - grade put option

10. airline sukuk features
• investor loan to value ratio enhancements restricted by “one class
only” certificates
– possible solution: morabaha - based subordinated tranche (on limited
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recourse basis)
• level of bankruptcy protection depends on jurisdiction of airline
– relative under-development of regional bankruptcy laws (compared to
s1110 US Bankruptcy Code)
– repossession and deregistration risk mitigated by international route
network and external flagging
• liquidity facility - classic US EETC 18 month requirement versus 42
month “Iberbond” liquidity line
– conventional interest - bearing liquidity line not possible
– possible solution: morabaha - based secured liquidity facility

11. 11
airline sukuk features
• ‘standard’ ingredients will include
– aircraft management and remarketing agreements
– lessor ‘ring fenced’ from other transactions for bankruptcy remoteness
– lessor established in tax neutral jurisdiction
• listing issues - eg: Luxembourg/London/DIFC
• Shari’a board approval
– structural and documentation review
– written opinion in prospectus
– composition of Shari’a board

12. 12
airline sukuk structure
Sukuk Holders
investment
(85%) Declaration of Trust
Issuer
Head Lease
(Ijara)
SPV Lessor
Airline
Airline
Sub Lease
(Ijara)
Up-front purchase price (85%)
Sale of aircraft
(Morabaha)
Deferred purchase price (15%)
Liquidity
Provider
Mortgage
Liquidity
Facility
Asset
Value
Guarantee
Asset Value
Support Provider
Sub Lease
(Ijara)
Sub Lease
(Ijara)
Airline Airline

13. 13
market outlook
• regional inflow of Islamic funds increasingly matched by greater
sophistication of regional financial intermediaries and investors
• airlines’ requirement for funding seems likely to outstrip
conventional funding sources available to region due to
– huge aircraft orders
– need for specialised appetite for regional risk
• run of innovative Islamic aircraft financings (eg. by Emirates) have
helped develop ‘downstream’ Islamic aircraft financing technology,
while non-airline sukuks and airline bonds (eg. Emirates’ $500
million eurobond issue) have established investor appetite for this
asset class

14. 14
Any Questions?