Asset Securitization in the UAE
(Part II of II)
In part one of our series on Asset Securitization, we defined asset securitization, reinforced its importance and illustrated the ways in which it useful for financing purposes. In fact, asset securitization transactions had evolved centuries back and were also, incredibly pervasive during the late seventeenth and the early eighteenth centuries.
Anyone from the Republic of India would easily be able to recognize the name 'East India Company.' This company, a mercantilist corporation of Britain, and South Sea Company, jointly held nearly eighty percent (80%) of the British Crown's national debt by 1729 through the process of asset securitization. They essentially became 'Special Purpose Vehicles' (the SPV) for the British Treasury. Clearly, this process has been pervasive and prevalent for much longer. This part two explores and discusses the concept of securitization within the UAE Regulatory Framework and further highlights the manner of enforcement of security created to secure the rights of creditors.
Regulatory Framework in the United Arab Emirates
The securitization market in the United Arab Emirates (the UAE) is at a nascent stage. Hence there is no proper law from which securitization could derive its regulatory framework. However, since its emergence as a leading financial center, the Dubai International Financial Centre (the DIFC ) has been a robust platform for undertaking asset securitization in the country. DIFC has a sound legal structure to facilitate securitization transactions in the country, within conventional and Islamic structures alike. Moreover, in 2008, the DIFC passed the DIFC Special Purpose Company Regulations, which eased the securitization framework within the DIFC for foreign investors and the local businesses. DIFC legal framework comprises of the Law of Security, the Real Property Law, and also the DIFC Security Regulations, which categorically safeguard security created over assets within the DIFC, and by entities based and operating from within the DIFC. Notably, there are several free zones in the UAE, and each such free zone has its regulations for creating security interests by entities licensed within that zone and over assets located therein.
Any financial transaction is effected and perfected by executing documentation governing the terms of understanding and intent of parties. These documents include the financing documents, which cover the terms and structure of proposed transaction, including security documents, and creating a right over assets of the obligor for its creditors. These documents are a mechanism which ensures a lender's ability to enforce their rights, including taking possession of the property/assets secured, selling it and appropriating the proceeds to repay their debt, in the event obligor, fails to perform. Importantly, the laws applicable to documenting, registering and enforcing security interest created (either in the form of a mortgage or pledge) over assets in the financial transaction are governed by the UAE Commercial Transaction Law (the Commercial Code) and the UAE Civil Transactions Law (the Civil Code).
In the absence of a separate legal framework for securitization of assets under Dubai law (or; UAE law), the agreements executed between the parties evidencing an Islamic securitization shall be Sharia compliant and adhere to the terms of Civil Code and Commercial Code, both.
Article 1399 of the Civil Code defines a mortgage contract to mean "a contract by which a creditor acquires, over an immovable property allocated for the payment of his debt, a real right by which he obtains preference over creditors and creditors following him in rank, for the repayment of his claim out of the price of such property, no matter into whose hands it has passed."
Article 101 of the Civil Code defines Immovable Property (Real Property) as "anything of permanently fixed nature which cannot separate without damaging or altering its surrounding."
The Civil Code and Commercial Code (read with Law number 14 of 2008, in cases where the real property located within the Emirate of Dubai) cover the mortgage of 'real-estate' upon terms that are recorded by way of a mortgage deed, by and between the parties. The only way to create a valid and enforceable mortgage is to register the mortgage deed with the appropriate authority (where the immovable property locates). For instance, a mortgage deed gets recorded with the Dubai Land Department and the local Municipality in the Emirate of Abu Dhabi is responsible for registration of mortgages.
We now examine mortgages created over a 'Musataha' right. Musataha is a form of long-term lease which allows the holder (the Musatahee) the right to use and exploit (including development) the land belong to the land owner for a term of fifty (50) years. The lease is renewable by mutual consent (or; as agreed contractually) for a further period of up to fifty (50) years. Once vested with musataha rights, the musatahee may dispose of such rights in any manner he deems fit. For musataha rights to become active, the musataha agreement granting those rights must be registered either with the Land Department or, the Municipality, as the case may be.
Similarly, the usufruct is also a form of long-term lease for ninety-nine (99) years. However, usufruct form of 'lease-contract' varies from 'Musataha' as it does not entitle the leaseholder to develop the property.
It is essential to highlight here that both - Musataha and usufruct can potentially apply to underlying assets for ijara based Sukuk (the Sukuk Al Ijara).
For safeguarding the interest of the party in whose favor the security creation take place, it is vital to execute and register the security document in the jurisdiction where the property locates, even if the laws of another jurisdiction apply to the financing document.
- Movable Assets
Article 1448 of the Civil Code defines pledge to mean "a contract giving rise to a right to retain a property in the hands of an obligee, or a stakeholder by way of security for a right which may be required, in whole or in part, giving such obligee priority over other obligees.
The Civil Code further provides that it is essential that a pledge must be capable of delivery and auctioned. A 'pledge' must be provided in consideration of an ascertained debt specified at the time of creation of a pledge and created over the movable property. An essential requisite of a perfect pledge is that the creditor must take possession of the movable asset. The asset to be pledged must be in existence at th time of creation of pledge.
The parties must also record the terms and conditions of the pledge by way of an agreement, which must either be in Arabic or have Arabic translation. There is no formal registration process for pledges created in the UAE and therefor as a prudent step, the document should be executed before the Notary Public to create a record of such security creation, and registered with the local traffic police with a notation of charge on the vehicle's title.
Creating a pledge on shares involves a written agreement in which all the details of the pledge are set out. Such particulars include the amount, period, event of default, and the terms and conditions pertaining the share pledge.
Pledging of Shares in joint stock companies and Free Zone companies can effect by delivering the share certificates to the pledgee (mortgagee) as provided for under the UAE Commercial Companies Law (Federal Law Number 2 of 2015, as amended). To effect a valid and enforceable pledge, the 'pledger' should undertake to request the company to register the pledge in the register of shares of the company to secure the full payment of the facility or loan. The pledger shall have the right to receive the dividends and utilize the rights related to the shares unless otherwise agreed in the pledge agreement.
The Council of Ministers' Decision Number 12 of 2000, shares of a public joint stock company, subject to certain exceptions, must be listed on one of the stock exchanges in the UAE. A pledge over the shares of a listed company is recorded in the share register maintained by the relevant stock exchange where such shares pledged are listed.
In light of recently amended position about the pledge of shares of a limited liability company (the LLC), Article 79 of the UAE Commercial Companies Law permits shareholders in LLCs to pledge their shares. Any such pledge must be per the company's memorandum and articles of association, under and agreement notarized before the notary public and entered into the Commercial Register maintained by the Department of Economic Development in the relevant Emirate.
Article 81 of the UAE Commercial Companies Law further provides for a mechanism of enforcement against a defaulting shareholder or partner's pledged shares in the LLC. The creditor enforcing his rights over the shares may agree with the shareholder or the partner and the LLC on the method and terms of sale, by way of private arrangement. Otherwise, the pledged shares shall be offered for sale at court controlled public auction. The shareholder or partner will have the right to buy back the shares from the winning bidder in the auction within fifteen (15) days of such 'auction' on the same terms and conditions.
For the purpose of enforcement of security, the UAE courts have a vital role in enforcing any security upon a claim being filed by security holder for the realization of debt for the security created. The asset so created shall be realized upon an order passed to that effect. However, since there are no blanket regulations for the enforcement of securities and each case gets decided at the sole discretion of the court, it may sometimes raise uncertainty in the minds of parties.
An essential factor where UAE scores over other financial markets undertaking securitization transactions are the zero tax regime and non-payment of any stamp duty. The UAE Ministry of Economic Development does not prescribe payment of any amount of stamp duty on any securitization transaction, which otherwise is quite high in other countries, including India. However, withholding tax may have to be paid on remittance of receivables from an entity in the UAE to another outside the UAE.
UAE Economy is still emerging in the field of securitization but it has to act swiftly in order to reap the benefits of risk management and liquidity associated with securitiation activity. Though Islamic securitization like conventional structured finance purports to generate equal financial opportunities for the originating entity, each transaction of Islamic securitization may invite different interpretations of Sharia law. This may adversely affect the growth of this activity in comparison to conventional securitization. At the same time, the DIFC legislative framework has extended a great support to the UAE economy to jump start financial activities, including Islamic finance. DIFC has set regulations in place to streamline Sharia compliant financial frameworks. It is extremely promising that DIFC has already become the largest global platform for the Sukuk market. Additionally, with the emergence of the Abu Dhabi Global Markets (the ADGM) in the Emirate of Abu Dhabi, there is a scope for infrastructural development in the country which may make securitization a viable source of financing. There is enough scope for development of the securitization on a viable source of financing. There is enough scope for development of the securitization market in the UAE. It is imperative, however, for the Government to push the envelope and develop laws and regulations to facilitiate securitization activity with ease.