At the end of last year, General Electric broke convention and issued a whopper of a deal with its US$500 million Sukuk issuance — the first to originate from the US since the now defunct East Cameron Gas Sukuk in 2006 and the first American corporate to issue an Islamic paper.

General Electric Company (GE) is a diversified technology, media and financial services company with products and services ranging from aircraft engines, power generation, water processing, security technology and medical imaging to business and consumer financing, media content and industrial products. As at the 31st December 2008, GE operated in five segments — energy infrastructure, technology infrastructure, NBC Universal, capital finance and consumer and industrial.

GE also acquired Interbanca — an Italian corporate bank — as well as Whatman, Vital Signs, Merrill Lynch Capital and Citi Capital. With relatively healthy financials despite the global recession, and a string of successful acquisitions over the past two years, why then would GE need to break from its conventional financing methods and explore Islamic options?

Market debut
The GE Sukuk was based on an Ijarah structure with aircraft assets as its underlier, and also involved some aspects of commodity Murabahah. The deal was lead managed by Bank Islam Brunei Darussalam and co-managed by Standard Chartered Bank, while Citi and Goldman Sachs acted as the deal’s global coordinators and joint bookrunners alongside Liquidity House and the National Bank of Abu Dhabi.

The purpose of the issuance, according to the deal’s lawyers at Allen & Overy, was to solidify GE Capital’s fast growing presence across the Middle East and Asia and to establish a new investor base, as well as affirm the company’s commitment to its investors in this relatively unchartered territory.

The Sukuk holds a five-year maturity and guarantees fixed periodic distributions of 3.875% a year. It also holds the same ratings as its issuer GE Capital at AA2 by Moody’s and AA+ by Standard & Poor’s.

According to Roger Wedderburn-Day, the Islamic finance partner at Allen & Overy, GE Capital had achieved its intended target to diversify its investor base with the Sukuk issuance: “We understand the investor base included a broad mix of asset managers, investment and conventional banks as well as central banks and other government related entities across the target regions. GE has been very successful in achieving its objectives in this regard.”

Structurally sound…
Paul McViety, senior associate at Clifford Chance was quick to explain that the structure, despite its commodity Murabahah element, is best described as Sukuk Ijarah — a straightforward leasing structure incorporated under a special purpose vehicle in Bermuda.

“The coupon and diverse certificates rely upon underlying leases to service period distributions. There is also the component of commodity Murabahah to ensure that if there are amounts that are in excess notionally in the ledger, they can be invested Islamically to generate additional returns.”

Wedderburn-Day of Allen & Overy went on to describe the breakdown of the components within the two Islamic structures, elucidating that 10% of the issue’s proceeds are held in a reserve account and invested via ongoing commodity Murabahah arrangements. “Provision is also made for similar commodity Murabahah arrangements as a temporary measure in certain limited circumstances.

“These include, for example, an aircraft loss event, in which case the proceeds of the relevant aircraft assets may be used in commodity Murabahah transactions until replacement aircraft assets can be identified. This is subject to at least 51% of the Sukuk assets consisting of aircraft assets at all times,” he added.

Taxing issues
Perhaps the most prevalent issue throughout the structuring of the deal — which has also served to discourage most potential US-based issuers — are tax matters surrounding deals which originate from that part of the world. It is a well-known fact that the US has not made any provisions for Islamic finance issuances in the past in terms of tax, unlike the more active markets such as Malaysia and Indonesia.

In order to minimize tax burdens, the deal’s arrangers and lawyers had chosen to issue offshore, with Bermuda as the preferred jurisdiction. McViety of Clifford Chance revealed: “Bermuda was chosen as the main jurisdiction for the issuer and trustee because it is a jurisdiction most commonly used for aviation structures.

It is one of those jurisdictions that crop up from time to time from an aircraft perspective, because Bermuda has aircraft registers and is typically used particularly for aviation deals in the US.

“The US tax side of things was considered in great detail, and most certainly in terms of the timing. Taking a step back and looking at the structuring, the Sukuk issuance needed to be very carefully structured to not trigger any tax concerns, because of course, if an aircraft lands in a particular state or jurisdiction; the transfer of interest in that aircraft — or in this case, beneficial interest in that aircraft — gives rise to additional tax concerns.

Obviously on GE’s side, it was quite careful in structuring a financial instrument that gave it the optimal tax position,” he added.

GE had obtained separate tax advice from Clearys & Gottelieb, while law firms Allen & Overy advised on the issuance itself and Clifford Chance was responsible for ensuring that the deal’s structuring and documentation accorded with analysis that was undertaken. Wedderburn-Day also revealed that there were a number of complications that had to be addressed in the structuring of this transaction, both from US tax and Shariah perspectives, in order to ensure that the transaction received the same US tax treatment as a conventional issue.

“This was in addition to the significant complications involved in addressing the usual aviation finance considerations in a Shariah context,” he affirmed, without going into further detail.

What the future holds
It would be a shame to see GE issue the first and last US-based corporate Sukuk, especially after its success in tapping into previously alien markets. However, should tax structures continue to work against Islamic issuers in the US, more prudent measures would have to be taken to avoid triggering huge concerns.

“It is not uncommon for Sukuk issuances to involve offshore special purpose vehicles,” revealed McViety. However, he added that the additional analysis that has to be done vis a vis leasing arrangements and the careful delegation of roles that other parties play in the transaction, alongside a careful choice of jurisdiction and the state in which the deal originates — such as Delaware, in this case — need to be taken into account.

“Although it is not straightforward in terms of getting around the tax issues with an issuance like this, it is certainly not an insurmountable feat.

You just have to ascertain that what you package together works from a Shariah perspective and a commercial perspective, taking into consideration the tax implications of the various roles and responsibilities,” McViety
concluded.