Islamic Finance in Oman - New Horizons for Growth

Islamic banking and finance emerged as one of the fastest growing segments within the financial services industry in Oman in 2012.  Eighteen months after Oman’s head of state Sultan Qaboos bin Said Al Said, issued a decree authorising the establishment of Islamic banking, in December 2012 the Central Bank of Oman issued the Islamic Banking Regulatory Framework (IBRF).  This detailed 500-page document which sets out the regulations that will govern Oman’s financial sector opens new horizons for both conventional and Islamic banks to market sharia-compliant products. 
 
Two new dedicated Islamic banks, Bank Nizwa and Alizz Islamic Bank, and Islamic banking windows in seven conventional lenders have already started or are poised to start operations.  High public demand for Sharia-compliant products has resulted in an enthusiastic market response to the introduction of Islamic banking and a rush among customers opening new accounts.  Market analysts expect Islamic banking institutions to capture a 5-7.5 per cent market share of Oman’s OMR16 billion total banking deposits by the end of 2013 and an asset base of OMR3-4 billion in the next three to four years.  The challenge for institutions awash with depositors’ funds and high levels of capitalisation (under the IBRF the minimum capital requirement is OMR100 million for Islamic banks and OMR10 million for Islamic windows) will be to find a home for excess liquidity in Sharia-compliant vehicles.
 
One Islamic capital market instrument that has proven successful in other jurisdictions in soaking up liquidity from Islamic banking sectors is sukuk, commonly referred to as Islamic bonds.  Sukuk are different from bonds, however, in a number of important ways.  First, the assets on which sukuk are based must be Sharia-compliant unlike the underlying assets of a bond issue.  Second, sukuk give the sukuk holder partial ownership in the underlying asset whereas a bond is a debt obligation of the issuer to the bond holder.  Third, the value of sukuk is based on the market value of the underlying asset rather than on the issuer’s credit worthiness as reflected in the rating of bonds.  Fourth, sukuk holders receive a share of the profits (and must share in any losses) that the underlying assets in contrast to regular interest payments and the principal when the bond matures.  Fifth, an obligor’s payments to sukuk holders depend on the profits and losses that the underlying assets generate.  A bond issuer’s payments to bond holders are not tied to the performance of the underlying assets. 
 
Being asset-backed or asset-based, sukuk are secured and provide a much better risk than unsecured conventional bonds or similar instruments.  Oman is likely to witness a growth of sukuk issues alongside Islamic funds in the coming years channelling funds into infrastructure development, manufacturing industries and small and medium enterprises (SMEs) and boosting growth in the economy.  The drawback for the market at present is the absence of any regulatory framework governing sukuk.  Oman’s capital market regulator, the Capital Markets Authority (CMA) has issued draft regulations (Regulations) which are still in the consultative stage, the main features of which are outlined below.
 
The Regulations define sukuk as “negotiable capital market instruments (such as notes or certificates) that represent or evidence a proportionate interest in underlying assets and revenues, and have been structured according to Sharia precepts.”  Sukuk holders pay capital in cash (not in kind) to an issuer in return for which the issuer holds certain assets or classes of assets in trust on behalf of the sukuk holders for the purpose of generating income or gains for a specified period of time.  Funds raised under a sukuk instrument benefit a specified person called the obligor.  The obligor must repay the capital of the sukuk holders and may make additional payments to the sukuk holders in accordance with the terms of the sukuk instrument.  Such payments may be paid out in instalments or a lump sum.
 
The Regulations provide for two types of corporate entities to issue sukuk:  (a) a joint stock company incorporated in Oman or (b) a limited liability company incorporated in Oman for the special purpose of issuing sukuk (SPV).  SPVs may acquire, hold and dispose of tangible or intangible assets (including receivables or shares in a company) for the purpose of conducting a Sharia-compliant transaction only.  SPVs may obtain financing, grant security interests over assets, indemnify shareholders or agents or enter into hedging arrangements in connection with a Sharia-compliant transaction.  SPVs may finance an obligor or another SPV or act as a trustee or agent for a participant in a Sharia-compliant transaction.  SPVs are allowed to enter into a partnership or other Sharia-compliant structure in connection with a Sharia-compliant transaction.  SPV may enter into activities that are ancillary to the core activities as well as other activities with the written approval of the CMA.
 
One innovative concept in the Regulations is that of the creation of a trust in the context of sukuk.  The creation of trusts is not otherwise recognised under Omani laws. The Regulations permit an SPV to create a trust where the SPV acts as a trustee and the sukuk holders or their nominees are beneficiaries.  A shareholder of an SPV may also create a trust in which the shareholder’s shares in the SPV are the trust property and the beneficiaries are either a charity or other beneficiaries approved by the CMA.  The trust instrument or the declaration of trust must be filed with the CMA. 
 
The implementation of the Regulations will first require an amendment of the Capital Markets Law enabling the CMA to regulate the sukuk market. No timeframe for has yet been announced for either the amendment or the adoption of the Regulations despite pressure from several leading corporates seeking authorisation for sukuk issues to finance major retail developments. Also, the Islamic banking industry is pressing forSharia-compliant protocols to govern the tax returns they are required to file by the end of 2013.  Without an amendment to the Oman Corporate Tax Law, SPVs will be required to pay tax at a 12% flat tax on the SPV’s annual profits in excess of RO 30,000.  The consultation process has highlighted a number of inconsistencies in the Regulations that need to be resolved before the framework is finally adopted.
 
Market commentators are optimistic however that the regulators will be able to finalise the sector’s legal framework before the end of 2013.  Government and quasi-government institutions are expected to take the lead on sukukissues.  Record government spending on major infrastructure and services projects under the country’s eighth five-year development plan 2011-15 and an expansionary budget for 2013 which saw government expenditure rise by 29% to OMR12.9billion ($33.5 billion) has created unfulfilled demand for project finance.  This demand coincides with the retreat from the region of major US and European banks in the face of the euro zone crisis, internal liquidity issues and a depressed global economy.  Oman’s new Sharia-compliant banking and finance sector is predicted to play a key role in meeting this critical funding shortfall.  The emergence of the Islamic banking and finance industry in Oman could not have come at a more propitious time.

 
Tony Watson is a senior associate and head of AMJ’s Commercial Law Team with over 13 years’ experience in commercial and corporate law in various jurisdictions in the Middle East with a special focus on Islamic finance, real estate and intellectual property.  As A US-qualified lawyer he has built a niche practice in Oman advising on FDI advising American companies on setting up business under the Oman-USA Free Trade Agreement.  Tony holds a post-graduate diploma in Islamic Banking and Insurance and was an adjunct professor of Islamic history at the University of South Florida.
 
Tony can be contacted via email at: anthony.watson@amjoman.com
  
AMJ is a leading, globally-ranked, corporate/commercial legal practice providing clients with first-class advisory and legal services across a broad range of practice areas and industry sectors in Oman.  AMJ has expanded over the past decade to become the largest law firm in Oman with seven teams of multi-lingual, international and Omani lawyers providing fast, focused, legal advice and practical insights on a broad range of commercial transactions, agreements, laws and the developing regulatory framework in water and power, oil and gas and infrastructure sectors, privatisation, banking and capital markets, mergers and acquisitions and telecommunications.  We combine cross-border expertise with in-depth knowledge of Omani law and practice gained from more than 33 years at the heart of Muscat’s banking and business district.
 
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