Deemed loan relationships: alternative finance: investment bond arrangements: conditions: payments to bond-holders
Additional payments and redemption payments
‘Additional payments’ are those payments to bond-holders that fulfil the function of interest on a conventional bond - they represent the return on money invested. But there is an important difference. If a conventional bond specifies that it pays interest at a particular rate, the investor has a contractual entitlement to that interest. On the other hand, while the periodic distribution amounts payable to a sukuk holder may be benchmarked to an interest rate - for example, the issue terms may specify an expected return of 7% per annum - the investor does not have a legal right to that amount. If the bond assets do not generate sufficient income to pay 7% per annum, the investor will receive less.
CTA09/S507(2) allows for this. It specifies that the amount of the additional payments may be fixed at the beginning of the bond term, wholly or partly determined by reference to the value of bond assets or the income they generate, or determined in some other way. Although this provides considerable flexibility in the quantum of ‘additional payments’, the return from the sukuk must nevertheless not exceed a reasonable commercial return (CFM44200).
Sukuk arrangements generally provide for the underlying assets to be sold when the certificates mature, the trust to be dissolved, and a final ‘dissolution payment’ to be made to sukuk holders. Sukuk differ from conventional securities in that the holder has no contractual right to repayment of the amount subscribed. Nevertheless, the arrangements will normally be structured so that the risk run by certificate holders resembles normal credit risk - there may be guarantees or similar arrangements to protect investors from losing their capital. Similarly, investors will not normally profit from any increase in the value of the bond assets.
Sukuk with a 5-year term are issued for a total of £1 million, which the issuing company uses to acquire income-generating assets from a connected company. The return from the sukuk is benchmarked to 7% per annum, so that over the 5 years a total of £350,000 is distributed to holders. But the income generated from the assets in fact amounts to £500,000 over the period. The surplus £150,000 is accumulated in a distribution account.
At the start of the arrangements, the issuing company agrees to sell the assets back to their original owner after 5 years. But the sale price may be expressed as a formula, so that - in this case - the assets are sold for £850,000. This, together with the £150,000 in the distribution account, allows the issuer to make a dissolution distribution of £1 million, so that in effect the certificates are redeemed at par.
It is nonetheless possible that, because of a shortfall in the disposal proceeds of the bond assets or in the income previously generated, the capital distributed to holders at the end of the bond term is less than the amount subscribed. S507(2)(h) makes it clear that provision for such a reduction does not disqualify arrangements from coming within the legislation.
Most alternative finance investment bonds - like their conventional equivalents - are repaid in a single lump sum at the end. But the legislation also allows the redemption payment to be made in instalments.