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Dubai Saturday Update

2009-12-05T09:15:00.000-08:00

The jockeying between Dubai World, Nakheel and the sukuk certificateholders has begun in earnest, following a meeting of the certificateholders amongst themselves on Friday. According to the Financial Times

"Lawyers representing holders of sukuk bonds from Nakheel, the real estate unit of Dubai World, are expected to reject any attempt by the government-owned holding company to call a standstill on its debts."
[...]
"One bondholder said: "We are not going to give the government the luxury of a standstill that avoids default. We expect full repayment, so we are keeping the pressure as high as possible."
[...]
"The move was made as Dubai World seeks to encourage holders of the sukuk to negotiate, placing repayment within a broader restructuring of the conglomerate and its real estate units, Nakheel and Limitless

"As the government pushes for a wholesale restructuring of Dubai World, it may inject cash into these flagging property companies if creditors are willing to compromise, according to a person close to the situation.

"Nakheel groaning under $8bn in debt, is seeking ways to recapitalise its balance sheet to match its short-term liabilities with long-term real estate development plans. The company has had to put on indefinite hold many projects as cash flow and financing dried up.

"Options could include paying out the sukuk at a certain percentage on the dollar, as well as rolling over the sukuk into new debt or possibly granting equity.

"Dubai World did not call a meeting of bondholders 21 days in advance of the December 14 maturity date, a step necessary to approve any standstill request. That raises the prospect of a default if the company does not pay the bonds before the two-week period of grace expires on December 28.

"The government is thought to believe enforcement remains a poor option for bondholders, as Nakheel's assets are located almost entirely in Dubai."

Dubai World has until December 28 to make full repayment on the sukuk to avoid a default, which would then shift the attention onto the ability of the courts in Dubai to judge any claims brought there. These courts would also likely be called upon to enforce any judgments the certificateholders receive in English (or other) courts.

This would be a large challenge to the legal system in Dubai, which is lacking in precedent for anything like the resolution of a default by a government-related entity on its debts and could be further complicated by the complex structure used to ensure the sukuk was Shari'ah-compliance. At this point, the certificateholders could be applying pressure on Dubai World in the hopes of getting better terms from Dubai World and may not necessarily be signaling that they will unequivocally reject either a standstill agreement or a haircut on their debts. However, this will not be settled probably until near the end of the grace period (December 28).

In positive news for Dubai, the FT reports that "On Friday the Dubai government confirmed that it would step in to avoid any default on bonds issued by Dubai Electricity and Water Authority, guaranteed by the government." Unlike the Nakheel sukuk, any default by DEWA would be a sovereign default because of the irrevocable guarantee of the debts, including the Thor Asset Purchase (Cayman) Ltd. notes, that has been accelerated to December 14, 2009 and downgraded to junk (BB- from A-).

What can we learn from sukuk defaults?

2009-12-03T16:13:00.001-08:00

Although Nakheel is still technically not in default for its ‘09 sukuk and may repay the full amount due, it is a good time to consider what works and what doesn’t in the world of sukuk. I have alluded to some of what I am thinking in other blog posts, as have others, but I think it should be made explicit what worked and what didn’t. It may still be early for introspection on the future of sukuk and the conclusions may change as defaults are resolved, and with those caveats, I am going to take a stab at it.

What went wrong (Reuters Timeline)

(Musharaka sukuk) East Cameron Partners $165.67 million, 11.25%. Issued in 2006, due 2019. Company entered Chapter 11 bankruptcy in October 2009
(Musharaka sukuk) The Investment Dar $100 million, LIBOR + 2%. Issued in 2006, due 2011. Company missed regular payment in May 2009.
(Manfa’a sukuk) Saad Group (Golden Belt 1 Sukuk), $650 million, LIBOR+0.85%. Issued in 2007, due 2012. Company missed periodic payment in November 2009 after questions arose in June 2009.
(Ijara sukuk) Nakheel, $3.52 billion, 6.345%. Issued in 2006 due December 14, 2009. Company may be judged in default based on request for standstill agreement.

The list above describes some of the sukuk that have run into trouble during the past 13 months. They include companies in Saudi Arabia, Kuwait, the UAE and the US with several different structures for the sukuk they issued. However, there are some differences between the sukuk that I think presents an instructive case for how sukuk could be structured in the future to provide the investors with more protection than they have now, or at least to give guidance on the yield investors will demand for different structures.

The main thing that I think is instructive is the divide between the East Cameron on the one hand and the other three on the other. The East Cameron—the first to run into trouble—was structured as a musharaka where the investors through an SPV entered into a joint venture with East Cameron and the contribution from East Cameron was an overriding royalty interest in 2 leased properties off the coast of Louisiana (which is considered real property under Louisiana law). The ORRI gave the investors the right to a certain quantity of gas over the life of the sukuk. When there was a shortfall in the amount of production and the issuer filed for bankruptcy, sukuk certificate holders filed claim in the bankruptcy case.

The certificateholders claimed that the terms of the sukuk gave them legal claim on the ORRI because it was sold to the SPV as a part of the transaction. The company asserted that it had not in fact been a ‘true sale’ because it was done to create a financing transaction, and was not a ‘true sale’. The company remains in bankruptcy still, but the judge ruled that the sale of the ORRI to the SPV was in fact a ‘true sale’ (there was a legal opinion denoting it as such in the original documentation. This means that the sukuk was in fact asset-backed. For the specific transaction, the property needs to remain registered as being leased by a U.S. Minerals Management Service authorized lessee. As a part of the bankruptcy process, the sukuk certificateholders have extended DIP financing that keeps the lease and finances production.

In contrast to the East Cameron sukuk, the other 3 were all in one form or another asset-based sukuk. That is, they did not give the investors legal claim on any assets. The one partial exception is the Nakheel sukuk, which did provide investors with a share pledge of 18.89% of Nakheel as well as two fully-perfected mortgages over the underlying properties DWF South and Crescent Lands. However, as a Reuters article today describes, the legal environment in Dubai and the UAE is, to put it mildly, not as predictable as in the U.S. where the East Cameron bankruptcy proceedings were held.

” Creditors, including the likes of Standard Chartered, HSBC and Lloyds, have chosen lawyers and auditors to represent them and have yet to respond to the request for restructuring.

Rejection would tip the Islamic bond, or sukuk, into default, opening the door for legal proceedings.

Creditors could sue in English courts as well as in the United Arab Emirates, a seven-member federation that includes Dubai.

But even if they win and a court orders assets to be seized, the sukuk agreement and the UAE's foreign ownership laws cast doubt on whether such a verdict could be enforced, lawyers say.”

The point with this is that the Nakheel, Investment Dar and Saad Group (Golden Belt) sukuk are all in essence asset-based sukuk and therefore investors’ claims are backed only by the full faith and credit of the issuers, not the assets on which the sukuk are based. This is convenient for the issuers and comfortable for the bankers that structured the products, but hardly do much for the investors who may have (wrongly) believed that they had recourse to an underlying asset.

However, that argument should not be construed as an attempt to discredit the use of asset-based sukuk. They are—like conventional unsecured bonds—a useful way for companies to raise financing that may be more attractive than secured debt or equity for the issuers. However, it should be more clear now that an asset-based sukuk is equivalent for investors if there is a default to an unsecured bond. No recourse can be expected against any of the assets used in the sukuk. This may make asset-based sukuk more expensive, but that is how it should be.

On the other hand, asset-backed sukuk may become more widely used if investors are concerned about the ability of an issuer to pay periodic payments and the final redemption amount. If that happens, they will have the ability (in theory at least) to take possession of the asset backing the sukuk and will be more likely to have a higher recovery value than investors in asset-based sukuk. Of course, if anything can be learned from the Nakheel sukuk debacle, it is that there is a wide gap between having a mortgage over property and being able to legally enforce the claim to an asset and take possession. However, it should still be seen as more secure than an asset-based sukuk.

Finally, there should be new recognition that sukuk based on or backed by tangible assets has some limitations in the diversification that investors can create across regions and industries. Many people complain that the replication of conventional finance is the cause of the problem and, while I don’t agree with that perspective, there was an overconcentration in some sectors like property and energy by sukuk investors and when those sectors ran into hard times, there was a general panic about the whole Islamic financial industry.

New forms or applications of sukuk that go beyond the most common forms like ijara could provide financing for a broader scope of projects and industries, which would provide diversification. This diversification, as well as more awareness of the difference between asset-based and asset-backed sukuk can provide for new growth in Islamic finance as well as hopefully some additional stability.

The land backing the Nakheel sukuk

2009-12-02T21:44:00.001-08:00

The FT has a great article on the Dubai Waterfront (the site of the collateral for the Nakheel sukuk and the overlapping nature of English and UAE laws and the impact of the Shari'ah-compliant structure of the sukuk. The land backing the Nakheel sukuk is subject to a 50-year lease holding that was transferred to the SPV and is supposed to be repurchased by Nakheel to redeem the sukuk. The investors were granted a fully-perfected mortgage over the land, but the ability to enforce this mortgage under UAE law is uncertain.

Sakoui, Anousha and Robin Wigglesworth. "Sukuk restructuring crunch-point looms" Financial Times, December 3, 2009.

The open desert near Dubai’s Jebel Ali industrial area was supposed to be the site of Nakheel’s grandest vision – the Dubai Waterfront.

Here, the property developer wanted to build a city twice the size of the Hong Kong island, with skyscrapers for 1.5m residents, all ringed by a 75km canal.

But Dubai and Nakheel’s financial crisis has stalled the project, perhaps permanently, making it another multi-billion dollar casualty of the emirate’s crisis.

Unfortunately for Nakheel’s many creditors, the barren, dusty land of the proposed Dubai Waterfront is also the security behind the developer’s $3.52bn (£2.1bn, €2.3bn) Islamic bond, which is due in less than two weeks.
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One of the uncertainties is that many of these financings have been structured to comply with Islamic law, but created under English law. Bondholders in one of the Nakheel bonds, which needs to be repaid with about $4bn on December 14, have the benefit of a guarantee from Dubai World which some investors believe would be enforceable under English law.

Some bondholders are currently in the process of forming a group that would represent in excess of 25 per cent of the outstanding issue, which under English law would be enough to block a restructuring.

Dubai: news & thoughts about the crisis

2009-12-02T14:29:00.000-08:00

The National Day in the UAE has quieted the flow of news on the Dubai World debt crisis, which is on its way to becoming more of a Nakheel debt crisis (although there are certainly other companies within Dubai World like Limitless with debt issues). A press statement (pdf) released by Dubai World on December 1 clarified what will and will not be included in the restructuring:

”The proposed restructuring process will only relate to Dubai World and certain of its subsidiaries including; Nakheel World and Limitless World. The process will not include Infinity World Holding, Istithmar World and Ports & Free Zone World (which includes DP World, Economic Zones World, P&O Ferries and Jebel Ali Free Zone), all of which are on a stable financial footing. The total value of debt carried by the companies subject to the restructuring process amounts to approximately US$26 billion, of which approximately US$6 billion relates to the Nakheel sukuk.”

The restructuring process is described in several phases:

”It is envisaged the restructuring process will be carried out in an equitable way for the overall benefit of all stakeholders and will comprise several phases including: long term plans and commitment of stakeholders; determination of maintainable profit and cash generation; assessment of deleveraging options, including asset sales; assessment of funding requirements and the formulation of restructuring proposals to financial creditors and their implementation.”

In short, this sounds like they are going to assess the willingness of creditors to delay repayment for quite a while, then determine whether the businesses have a chance of being profitable and capable of making a profit over that period of time. From there, they will dispose of whatever assets fall outside the profitable parts of the businesses to reduce the debt load on the companies.

While that sounds like a good idea (find out how you can make a profit to pay debtholders), I think it comes down to finding out whether there is any way that the businesses included in the restructuring can repay the debts either through asset sales or through future profitability and then adjust the expectations of the creditors with that reality, which will likely lead to a sharp haircut. The terms of the restructuring that will happen will probably be somewhat negotiated through the media if the investors think they are getting a bad deal. The negotiations are just getting under way

The other event that happened today is a general revaluation of the risks of the other Dubai-linked companies. S&P downgraded six GREs (DIFC Investments, DP World, Dubai Holding Commercial Operations Group, Dubai Multi Commodities Centre Authority, Emaar Properties and Jebel Ali Free Zone to high-yield from investment grade (with the exception of DMCCA which was previously rated BB). In their note, they state that under their ratings criteria “a standstill is a default”. Additionally, “Standard & Poor’s is of the opinion that, as evidenced in the case of Dubai World and Nakheel, the Dubai government is either unable or unwilling, or both, to provide extraordinary government support”.

This last note is the reason for the downgrade and for a lot of the frustration by investors who believed that the government would support the government-related entities, even though they were not legally obliged too. Reuters has a good description:

“‘Companies such as Dubai World can no longer be seen as having the protection of their respective governments. This is true all over the region and not just in Dubai," said Anshuman Jaswal, an analyst with Celent, a Boston-based financial research and consulting firm.

Foreign banks had lent to Dubai government-linked firms on the implicit understanding that they were backed by the UAE -- the world's third largest oil exporter flush with cash from a six-year boom in oil prices.

‘Something that has irritated international investors is that the government distanced itself from Dubai World, which legally speaking is true, but morally speaking, they had gone out of their way before to make that tie,’ one investor said.”

In contrast to that view, Prince Alwaleed says that investors made poor assumptions about the government backing for the GREs, “These banks are very mature banks, and they have to differentiate between a corporate loan and a sovereign loan”.

The Dubai crisis still has a way to go before it is resolved and the impact of the restructuring (of Nakheel more than any other sukuk) will see a return of the uncertainty that plagued the sukuk markets after the AAOIFI ruling and the Saad & Algosaibi, East Cameron Partners and The Investment Dar sukuk defaults. The sukuk market was just returning to a ‘new normal’ with slower growth and smaller sukuk from higher quality issuers than before the crisis, but there were sovereign sukuk from the Islamic Development Bank, Dubai, Indonesia and quasi-sovereign sukuk from the World Bank’s IFC and high-grade sukuk issued by Petronas and GE Capital. This will continue although there will probably be higher yields on non-sovereign government-related corporate to compensate for the “Dubai World” risk that the government might step away in a default.

The Dubai crisis has done one thing; it has empowered the critics of the Islamic finance industry. In the cases where the suggestions are positive this is a great thing. The industry has not done everything perfectly and still has many gaps where a second-best alternative has been adopted (e.g. commodity murabaha/tawarruq for liquidity management). There are also some over-engineered products that do not serve the benefit of anyone but the people who put them together. Critiques of these areas is justified, particularly when sukuk like the Nakheel sukuk which is in essence a relatively simple, uncontroversial structure (with a couple bells & whistles like the pre-IPO rights feature), can lead to such great confusion on the part of investors.

However, other critics argue that Islamic finance should have emerged unscathed from the credit crisis had it not created financial products that mimicked those used in conventional finance. This is false and the longer the recession has continued, the more apparent this has become. Islamic finance is no panacea. It is vulnerable to the economy’s booms and busts and we are definitely facing the latter on a worldwide scale. To deny that an industry that bills itself as being more connected to the real economy than conventional finance could be susceptible to a recession in the real economy, especially this deep into the recession, seems to me to be denying reality.

It has been clear to me that the credit crisis would have an impact on the Islamic finance industry, although not by the same transmission mechanisms as conventional finance. The impact would be secondary. As I wrote in February 2008, “In my opinion, however, the credit crisis does not pose much of a threat to the industry; not because it is fundamentally insulated from the conventional financial industry but because oil prices are still high. The stability of the Islamic financial industry will face its greatest test if oil prices drop significantly, something not particularly likely unless the credit crunch produces a significant fall in demand across the world.”

I underestimated the impact of the credit crisis at that point, but as the recession deepened and oil prices began to fell, I reevauated the impact of the recession on Islamic finance. In October 2008, I focused on the impact of the property bubble that was starting to burst: “Islamic financial institutions are realizing that they're exposed to the credit crisis through their investments in the GCC real estate market which has begun to slow.” Now, the property market collapse in Dubai is spreading into the sukuk market. Fortunately, the UAE Central Bank has stepped in to minimize any transmission from the sukuk markets to the banking institutions, including Islamic banks. If the systemic risk from the Nakheel sukuk is limited, then—amid the writedowns by investors—the Islamic finance industry will have passed another test and should come out stronger on the other side.

What can Nakheel sukuk holders expect in a default?

2009-11-30T18:54:00.000-08:00

The Nakheel sukuk is perhaps the nearest test of the impact of the standstill agreement will play out in Dubai that we have. The sukuk is a complicated financial product and the laws in Dubai do not provide a clear precedent for how the investors in the sukuk will be treated and what recourse they will have provided by the sukuk.

First, a quick look at the structure (excluding the pre-IPO part of the sukuk which is a moot point now). The sukuk was set up as an ijara sukuk based on two properties (and any buildings on the land), which was initially valued at $4.22 billion based on the developments that were to be constructed on it. The two plots were DWF South and Crescent Lands, both in the Dubai Waterfront development. Long leases on these properties were sold to the SPV set up that issued the sukuk. The plots were then leased back to Nakheel for the length of the sukuk for the $3.52 billion amount raised and during the term of the sukuk, Nakheel pays lease payments corresponding to the periodic payment amounts on the sukuk. Half of the lease amount was paid to sukuk holders through the SPV and half was deferred until maturity. At the maturity or in cases of default, the long lease would be repurchased by Nakheel and the deferred lease payments would be made. In the situation that has occurred where there was no public offering, Nakheel was obligated to pay an additional amount to the investors through the SPV.

The sukuk was backed by a few additional guarantees that may provide sukuk investors with some recourse, but this is subject to the ability of investors to receive claim over assets largely located in the UAE, which has no established legal precedent for anything like what has occurred.

The repurchase of the asset (the long-term lease) is guaranteed by Nakheel's parent company Dubai World, which is in no better situation to repay the sukuk than Nakheel. Dubai World is also just a holding company for a number of other companies including DP World, Limitless, the Jebel Ali Free Zone). However, these companies all have their own creditors and their own debts to service and the important thing for Nakheel sukuk holders is that the creditors of Dubai World through the guarantee are subordinated to the creditors of the subsidiaries of Dubai World. The prospectus is pretty clear here:

"Dubai World is a holding company. As such, Dubai World is dependent on the operations of and cash flows generated by its subsidiaries. Therefore any claim that may be made by a creditor on Dubai World will effectively be structurally subordinate to any claims made by creditors directly on Dubai World’s subsidiaries.

As has been mentioned elsewhere, there is no guarantee from the government of Dubai in effect, although there was a general sentiment that Dubai would bail out Dubai World if it ran into trouble, with help from Abu Dhabi if necessary. Now this is shown to be a poor assumption, much as it was by the holders of equity in Fannie Mae and Freddie Mac in the U.S. (although not those companies creditors).

In addition to the guarantee by Dubai World, Nakheel sukuk holders were granted a share pledge of 18.89% of the outstanding equity in Nakheel at the time the sukuk was originated. This is probably worthless if Nakheel cannot restructure or repay the outstanding sukuk due December 14th (and the Nakheel 2 and 3 sukuk that come due in December 2010 and January 2011 for another $2 billion). Sukuk holders were, however, also granted a mortgage over the two properties which formed the basis for the sukuk through a Security Agent. Their recourse is limited by a general lack of precedent in how the laws will be applied. For one, they will need to provide details to the Attorney General of Dubai and enter settlement negotions for two months as described in the prospectus:

"However, the rights of the Trustee and the Security Agent to bring proceedings against Dubai World or the Co-Obligors may be delayed pursuant to Law 10 of 2005, which provides that proceedings may be brought against the Government of Dubai and government entities (which may include Dubai World and the Co-Obligors) before the courts of Dubai provided that the relevant claimant has first given details of such claim to the Attorney General of Dubai and has entered into settlement negotiations for a period of two months. If the parties are unable to reach a mutually acceptable settlement at the end of the two months, the claimant shall be entitled to commence proceedings against the Government of Dubai or the government entity.

Even if they are able to move through this level there are two problems investors may encounter. The first is that they are not able to touch the assets of the government:

"In addition, Law No. 10 of 2005 amending Government Lawsuit Code No. (3) of 1996 (as amended by Law No. 4 of 1997) provides that an establishment of the Government may be sued, but that no debt or obligation of such establishment may be recovered by way of an attachment on its properties or assets.

There is also an issue with the entire structure that could limit investors' ability to enforce the mortgages. The concepts of trust and beneficial interest, on which the entire sukuk is structured (under English law), are not recognized in Dubai. To provide investors, especially foreign financial institutions, with some recourse based on the mortgages used as security, the sukuk used a Security Agent as a domestic agent for investors to enforce the mortgage:

"There is an absence of precedent or authority as how a court would construe Law No. 3 of 2006 and, accordingly, there can be no assurance in respect of Dubai World's or the Co-Obligors' entitlement to immunity in any attachment or enforcement action, whether relating to the Mortgages, the Share Pledge or otherwise. The Dubai Lands Department (the Governmental of Dubai's property registration authority) will register mortgages in favour of UAE licensed banks or persons. Further, the Dubai Lands Department will not register a mortgage, inter alia, if a bank mortgagee is not licensed to operate in the UAE The Security Agent is licensed to operate in the UAE. However, in the absence of clear judicial or legislative guidance or clarification on the arrangement contemplated by the Security Agency Agreement there can be no assurance of the enforceability of the Mortgages by the Security Agent in the manner contemplated by the Security Agency Agreement or any enforcement process or procedure."

This is a new legal concept without precedent so there is great uncertainty about the ability of the Security Agent structure to withstand legal challenge, also described in the prospectus:

"A mortgage granted over real property must be perfected by entering into a mortgage agreement, completing an application form and registering the mortgage agreement in the lands register at the Lands Department. Only the interests of a lender licensed by the central bank may be registered. As such, a non-licensed lender will be prohibited from taking the steps necessary to perfect certain security interests in real property (where registration is required). A possible (but as yet untested before the UAE Courts) way of non-UAE licensed banks or persons deriving the benefit of such mortgage could be to appoint a UAE licensed bank to act as a security agent who would act for all lenders on any enforcement of the security in the UAE."

As one can see, there are a tremendous number of uncertainties about the procedure for investors to enforce upon the various guarantees and collateral provided in the sukuk structures that would appear to give investors a claim on more than just the unsecured pledge of Nakheel and Dubai World, but in all cases, there is a lot of doubt about whether they will end up being legally enforceable.

These factors probably point towards some type of restructuring of the sukuk, rather than an outright default and legal challenge by investors. There would be severe ramifications for Dubai were it to just step back and let the sukuk go into default (not to mention years of embarrassing litigation). Both sides now have an incentive to negotiate some type of settlement (or Abu Dhabi could ride to the rescue as many still seem to believe will be the case). Any restructuring would probably avoid a large mess, but would do nothing to clarify how the legal system would react in a similar situation in the future, which would be unfortunate, but would probably still be preferable to the turmoil that would follow a default.

Dubai Monday Update

2009-11-30T16:36:00.001-08:00

The fallout from the Dubai debt problems continues with the stock markets in the region falling 7% (Dubai) and 8% (Abu Dhabi). There remains little clarity on what will eventually happen, although it is becoming increasingly clear that the companies within Dubai World (with the possible exception of DP World and Jebel Ali Free Zone) will not receive a bailout financed by Abu Dhabi, at least not without some continued pain for Dubai. The Nakheel sukuk—following the request for the sukuk to have trading suspended on the NASDAQ Dubai—is not likely to be resolved neatly, because Nakheel is not believed to have the money available (nor does Dubai World) to repay the over-$4 billion due on December 14 (although it would not technically be in default until December 28).

The Jebel Ali Free Zone, which issued a sukuk of its own a few years back, did make a periodic payment today on its sukuk of between AED 125m to 135m ($34-37m). Following this, Dubai World changed tone slightly and has announced that it is negotiating a restructuring of $26 billion in debt, including $6 billion in sukuk.

It remains a question whether there will be terms agreeable to both Dubai World and the banks to which it owes debt (including reportedly a large chunk to British banks including Standard Chartered and HSBC). Tomorrow will likely not treat the regional markets any kinder than today, although it looks like the moves by the UAE central bank have limited the carnage to the stock markets and there have not yet been any reports of any runs on the banks.

Sunday Dubai Update

2009-11-29T10:57:00.000-08:00

A number of articles have discussed various aspects of the troubles facing Dubai when the markets reopen on Monday after the Thanksgiving and Eid holidays. The overarching theme is that Dubai has borrowed far in excess of its means to repay and it is becoming increasingly clear that the expected support from Abu Dhabi will not be entirely forthcoming. There appears to be a consensus view that Abu Dhabi will pick and choose between which Dubai entities to support, and it is unlikely that this will include Nakheel, the property company owned by Dubai World which has a $3.5 billion sukuk maturing on December 14th. The articles below provide a fairly good summation of the reporting on Dubai in the last day or two.

Financial Times, "Dubai plans appeal to bondholders", 11/29/09

"Dubai's government is preparing a campaign to persuade the holders of a bond due for repayment next month to agree to a delay even if that sparks claims that the emirate has defaulted on the debts of a government-backed company.

"Pushing aside concerns about potential legal action, the department of finance is preparing to communicate with the public and with the bondholders of an upcoming $4bn sukuk, or Islamic bond, issued by Nakheel, a major real estate developer, via the new chief restructuring officer of Dubai World, Nakheel's parent.

"It needs to gain the agreement of the holders of three-quarters of the bond's value. It will also start a press campaign headed by senior members of the supreme fiscal committee and department of finance.

Reuters, "Dubai house prices seen extending falls on debt crisis" 11/29/09

"Dubai's property market is likely to face further price falls and increased concerns over the availability of finance after the emirate said it would delay debt payment issued by two of its flagship firms, analysts said."

Associated Press, "Report: Indebted Dubai World rejected asset sale", 11/29/09

"Dubai World "totally rejected the idea of selling some of its good investment and real estate assets at low prices," a company official was quoted as saying by Al-Itihad newspaper on Sunday.

"The official said that any asset sale needed to be in a "commercially fair manner in order to achieve (Dubai World's) long-term strategic objectives, away from ... economic pressures."

AFP, "Dubai faces first test as finance hub", 11/28/09

"'What happens next and, more pertinently, how critical decisions are disclosed will cement its continuing credibility and its place as a financial centre,' said Cubillas Ding, senior analyst at Celent research and consultancy group.

'Dubai's untested financial legal system is now facing its first real test in relation to how it deals with the international community. No one wants to play in a playground where the rules are unclear,' he said.

The Sunday Telegraph, Abu Dhabi will not race to Dubai's rescue", 11/29/09

"In particular, advisers have suggested ring-fencing the problem debts, particularly from Nakheel, the Dubai World subsidiary, and putting them into a separate run-off.

"The model could resemble the “good-bank/bad-bank” structure imposed on Northern Rock – whereby the toxic assets were separated off, leaving the rest of the bank to recover normally.

The Sunday Telegraph, "Emirates Group boss says Dubai business world 'in shock'", 11/29/09

"The British boss of Dubai's flagship airline told The Sunday Telegraph: "We are all a bit shocked by what's happened and the global fall-out of the past 48 hours. But Dubai will navigate itself out of this, as will we. I am confident that the airline will not be affected by this."

The Sunday Telegraph, "Dubai: an emirate in crisis", 11/29/09. This is a long, detailed overview of the entire situation facing Dubai and Abu Dhabi.

"Dubai is in trouble. We already knew that, long before the announcement last week that it wanted to delay payments on billions of dollars of debts owed by its Dubai World (DW) state holding company. But the trouble caused by a collapse in the property market put the city on a par with other states around the globe. This announcement was of a different order. It damaged the credibility of the city's government and, by extension, the United Arab Emirates (UAE) as a whole.

Bloomberg, "Dubai World May Pay Nakheel Sukuk by Deadline, National Says", 11/28/09

"Nakheel PJSC, the Dubai-owned developer whose parent is seeking to delay debt payments, may still meet the Dec. 14 deadline to pay a 14.7 billion United Arab Emirates dirham ($4 billion) Islamic bond, The National said, without citing anyone.

Reuters, "Abu Dhabi to aid Dubai 'case by case' - official", 11/28/09

"Abu Dhabi, capital of the United Arab Emirates and one of the world's top oil exporters, will 'pick and choose' how to assist its debt-laden neighbour Dubai, a senior Abu Dhabi official said on Saturday.

"'We will look at Dubai's commitments and approach them on a case-by-case basis. It does not mean that Abu Dhabi will underwrite all of their debts,"'the official in the government of the emirate of Abu Dhabi told Reuters by phone.

Khaleej Times, "Restructuring 'A Sensible Business Decision'", 11/28/09

"The Dubai government sought to reassure financial markets about its plans to seek a six-month delay in debt payments for its flagship Dubai World conglomerate, saying the restructuring plan was 'a sensible business decision' that aims to ensure the group’s long-term success.

"In a statement issued late on Thursday night, Shaikh Ahmad bin Saeed Al Maktoum, Chairman of the Dubai Supreme Fiscal Committee, said that the government understood the concerns of creditors and had anticipated the market reaction to its unexpected request.

The Telegraph, "Rothschild appointed to help sell Dubai World assets", 11/28/09

"Paul Reynolds, head of Rothschild's advisory operations in the Middle East, was this week asked to work for the Dubai government's chief restructuring officer alongside Aidan Birkett of Deloitte, who was appointed on Wednesday.

"The team is tasked with assessing the group's assets, which is likely to result in a large scale sell-off of assets as varied as the QE2 cruise liner; Turnberry, the golf course that hosted this year's Open Championship; and a raft of properties.

"A spokesman for the Dubai department of finance confirmed that all options and asset sales would be considered, except for the DP World subsidiary that bought P&O, the British ports company.

The Canadian Press, "Official: Dubai World's debt delay request made with 'full knowledge' of market reaction", 11/27/09

"A top Dubai finance official said the emirate fully expected fallout from its debt problems and assured foreign creditors that Dubai World's request to postpone payment on some of its $60 billion in debt was 'carefully planned.'

"The comments by Sheik Ahmed bin Saeed Al-Maktoum, the chairman of Dubai's Supreme Fiscal Committee, came as world markets reacted in shock to what some analysts indicated amounted to a default Dubai World, the city-state's key engine of growth with interests ranging from ports to real estate.

"Ahmed said the emirate's leadership thought long and hard, weighing creditors' interests, before announcing they were seeking a 'standstill' on Dubai World's debt until at least May.

The Independent, "Dubai expansion fuelled by years of cheap money", 11/27/09

"Worries over Dubai's ability to pay its debts come after years of expansion fuelled by cheap money - bringing a huge potential headache for UK banks.

FT Alphaville, "UAE vs NewsCorp", 11/29/09

"The leaders of the United Arab Emirates don’t take too kindly to criticism, according to a report by Zawya Dow Jones: 'The Sunday London Times newspaper was removed by authorities from shelves in the United Arab Emirates on Sunday amid intensive reporting of Dubai’s debt problems, an executive at the paper said.'

Nakheel may repay sukuk on time

2009-11-28T12:35:00.000-08:00

Very interesting report from The National on the future for Nakheel certificateholders:

Dubai World could still meet the December 14 deadline on the US$4 billion (Dh14.69bn) payment of a sukuk from Nakheel under one option being considered by advisers to the conglomerate.

Repayment on schedule is one of four alternatives being considered by Dubai World, which announced on Wednesday it would seek a freeze on billions of dollars in debt repayments to bondholders and creditors.

The options are still being pondered by Aidan Birkett of Deloitte, the new chief restructuring officer of Dubai World. He was appointed to oversee its reorganisation, along with the investment bank Rothschild and the US corporate specialists AlixPartners.

If Dubai World pays back the sukuk, it would solve a problem for the company and its bondholders, and leave open the option of rescheduling bank debt and other liabilities, including bills owed to international contractors.

Other options being considered include a scheme to offer bondholders 80 per cent redemption of the value of their holdings, with a similar offer made to bankers.

Alternatively, Dubai World may move forward with the plan to seek a general “debt holiday” under the terms of last week’s standstill proposal, by which payments would be frozen until May 30 next year with a view to negotiating a rescheduling of all its debts.

In the most drastic scenario, Dubai World might embark on a general liquidation of assets in response to legal action by creditors. But this is thought to be a remote possibility, as it is likely to impair the value of Dubai World assets, leaving everyone worse off.

The New Normal in Dubai, Fallout from the Standstill Agreement

2009-11-27T11:38:00.000-08:00

The recent news that Dubai World has asked for a standstill agreement with its debtholders, including the holders of the Nakheel sukuk which matures on December 14th, is undoubtedly bad news for those issuers. However, it is not necessarily the end of the world for the Dubai, Inc. entities or for their sukuk. The announcement about the standstill agreement has not yet been fully described, so it is unclear whether it will constitute a technical default on the debt of the Nakheel sukuk.

It has been clear for quite a while that Dubai's government related entities (GREs) like Nakheel have had more debt than they will be able to service out of the revenue they can generate with property prices down more than 50% since their peak. The Dubai World companies are legally distinct from the government of Dubai, one of the seven Emirates within the UAE. This has led to considerable uncertainty about what the eventual outcome of the debt when it matures. There was optimism in early November when Dubai's Department of Finance repaid the Dubai Civil Aviation Authority sukuk of $1 billion following the issuance of $1.93 billion in sukuk at the end of August.

Optimism was the first reaction a couple days ago when Dubai raised an additional $5 billion in debt from two government-owned banks, National Bank of Abu Dhabi and Al Hilal Islamic bank, in Abu Dhabi. The optimism soon turned to pessimism after Dubai World, the ultimate guarantor of the sukuk, said they would need a 6 month standstill agreement from creditors, including the Nakheel sukuk. The result was a fall in the price of Nakheel's sukuk (story includes graphic of the price chart for the sukuk) from 110 prior to the announcement to close to 50. At the same time, the credit default swaps on Dubai's debt (the cost of insurance) rose from around 300 basis points to 541.2 basis points on Friday. ThomsonReuters had a chart showing the increase (not including the rise on Friday):

This summary of the latest events seems to confirm the negativity surrounding the Nakheel sukuk and the other debts owed by Dubai World and its related companies. However, it could be the start of a much needed restructuring and a realization that things have changed, the much mentioned "New Normal" (originally coined, I believe, by PIMCO's Mohamed El-Erian).

The new normal for Dubai is a recognition that it cannot continue the breakneck speed of development that it had embarked upon, fuelled in large part by debts like that of Nakheel. It has recognized that the world today is a more risk averse, less leveraged place. In order for Dubai to realign itself within the New Normal will probably include some form of bail-out from its wealthy neighbor of Abu Dhabi, which has far more oil revenue that continues to flow in, as well as the sovereign wealth fund, Abu Dhabi Investment Authority, which has assets estimated at $627 billion.

This will be a profoundly humbling experience for Dubai, which has been able to raise debt on its own and on behalf of the companies located there. However, with a much longer timetable for the development of sufficient resources to repay the bonds and sukuk issued, it may be the best alternative, especially prepared to a straight default by Nakheel or Dubai World. The announcement that a chief restructuring officer has been appointed to work with the Dubai Financial Support Fund which is managing the so-far-raised $15 billion may signal that the Emirate has started on the road to the New Normal. Only time will tell whether a default (which would likely be followed by others) can be avoided.

The turmoil created by the Nakheel sukuk being the first shoe to drop, however, may have spillover effects in the Islamic finance indsutry, particularly the sukuk markets. Until this point in what had been a recovery in the sukuk markets, only high-grade corporate and sovereign issuers had tapped the markets. Dubai's Department of Finance was one of these issuers and it will be telling how the prices of these new issues fares in the market with the developments in the Nakheel sukuk resolution. The spillover will probably be mitigated the better the resolution goes, but there will still be fallout. Investors bid up the Nakheel sukuk from the low 60s earlier to 110 and they have seen the value of these sukuk fall precipitously. This could make investors hesitant in the future to invest in sukuk. We shall see.

Dubai World asks for standstill agreement, including Nakheel sukuk

2009-11-25T18:47:00.000-08:00

The big news of the day was the $5 billion that the Dubai Department of Finance raised from two government-owned banks in Abu Dhabi that will be managed by the Dubai Financial Support Fund. Following this announcement, Dubai World saw a chief restructuring officer appointed to manage the sizable debts of the government-related entity. Dubai World, which guarantees the $3.52 billion sukuk issued by Nakheel which matures on December 14th, has asked debtors for a standstill agreement for six months. This would delay repayment of both the Nakheel sukuk as well a sukuk maturing in March from Limitless , another property company. [UPDATE 11/27: The maturing debt from Limitless is not a sukuk, it is a $1.2 billion, 2-year syndicated loan from 18 mostly GCC-based financial institutions. It was priced at LIBOR+125 basis points.]

The move was rather shocking, especially since the market price of the Nakheel sukuk was reflecting a full repayment of the principal and deferred lease payments, plus an additional amount due because no qualified public offering was issued during the sukuk term. The price of the sukuk fell from around 110 to 86 following the announcement and many ratings agencies cut the ratings on other Government Related Entities. If the standstill agreement is not voluntary, it could be a default event, which is reflected in the dramatic rise in the price of insuring Dubai's debt against default, although Dubai World is not formally part of the government and the Dubai World debt is not guaranteed by the government.

UK and Malaysian Islamic banks launched a standardized wakala agreement for inter-bank depositss. The contract is designed to reduce the reliance on commodity murabaha, which has attracted criticism.

The Saudi Arabian Monetary Authority governor Dr. Muhammad Al Jasser discussed the systemic concerns that regulators need to focus on when regulating Islamic financial institutions, especially those that operate across multiple countries. Dr. Zeti Akhtar Aziz, the governor of Bank Negara, also spoke recently on the regulatory focus for Islamic financial institutions being the liquidity management of Islamic financial institutions. The IFSB has established a liquidity management task force earlier this year.

Other News

KFH-Turkey received an Islamic banking license from the Dubai International Financial Center.
The Islamic Financial Services Board launched a new guideline for takaful institutions.
Middle East & Asia Capital Partners will launch a Shari'ah-compliant fund to finance renewable energy next year.
Tamweel continues to prepare for the merger with Amlak, which is expected to be put before shareholders as early as January.
Deutshe Bank converted $30 million of its $100 million convertible murabaha from Gulf Finance House.
Reuters describes a Shari'ah-compliant microfinance effort in Helmand province, Afghanistan. The program is very basic providing goods in kind and charging an 'administration fee' of 2%, presumably to recover costs associated with servicing the loans.
Islamic banks in Lebanon are small, but have been successful so far.
Tamweel, the troubled Dubai mortgage lender has refused to take delivery of 200 units due to the lack of completed infrastructure according to Emirates Business 24-7.
Deloitte appointed Daud Vicary Abdullah to head its Islamic Finance Industry group.
The deputy finance minister of Malaysia, Awang Adek Hussin confirmed that two foreign banks' Islamic banking license applications have been shortlisted by Bank Negara.

How Islamic Banks Can Reduce Risk Exposure (Guest Post)

2009-11-24T09:45:00.000-08:00

This is a guest post from Siddhartha Herdegen. Siddhartha Herdegen is an economist and consultant studying Islamic finance in Bahrain. He received a master's degree in Global Leadership from the University of San Diego in 2008.

As a classically trained economist familiar with conventional finance I was intrigued by the promise of Islamic finance. It was a different form of financing based on community oriented Shariah law. It avoided the pitfalls of interest based debt financing and easy credit which have plagued the west in recent years and it purported to share risk rather than transfer it.

I have been disappointed however in the realization of that promise as more often than not Shariah compliant Islamic banks and financial institutions focus on recreating the mistakes of conventional institutions rather than developing a true asset-based, shared risk alternative.

Intention of Shariah

The unifying concept behind Shariah is the benefit of society and every law is designed with the community’s welfare in mind. Shariah recognizes that in order to advance economically societies must take risks. Therefore Islamic banks should strive to understand the socially beneficial types of risk.

Islamic banks do not profit from money lent on credit because the interest earned would be riba which is impermissible under Shariah. Even though there are risks associated with lending on credit—most prominently default risk—these risks are not risks which are socially beneficial.

Shariah considers these profits a drain on future productivity and forbids interest lending. Other risks however are beneficial to society such as entrepreneurial risk. When an entrepreneur creates a new product or service, or purchases inventory for resale, they are taking a risk that society may not value their product or service.

This is the risk entrepreneurs throughout history have taken; some have been successful, others have failed. Those that succeeded have benefited society through improved technology and efficiency. The profits earned by such successful entrepreneurs are permissible under Shariah because they are derived from benefiting society.

Principle of Shared Risk

One of the bedrock principles of Islamic finance is this idea of shared risk. The Shariah approved products for business partnerships and so called Islamic bonds reflect this risk sharing aspect.

Mudarabah profit and loss sharing (PLS) arrangements for example, allow the Mudarib to profit from business gains but also stipulates he should lose money in the event of a business loss. A Musharakah contract likewise, shares business losses between participating parties.

Of the Shariah approved business arrangements, Sukuk is probably the most secure investment as it is generally backed by real property which is then leased back to the originator. Still, in a Sukuk the participants should recognize they are involved in a business venture and loss is a possibility. If the possibility of loss is not there, the intention of Shariah is distorted.

Risk in Islamic Banking Operations

As previously stated, risk justifies economic gain under Shariah but not all risk. Risk which is not socially beneficial such as gambling is not allowed as the transaction serves no socially useful purpose. Risk of inflation or the time value of money is compensated for by paying less for forward sales such as Salam or Istisna and more for financed sales in Murabaha.

Profits from guaranteed interest however are risk free and are therefore considered a drain on society’s resources. These profits are risk free because a loss occurs only when individuals act in an unethical way. When profits are guaranteed they become risk free and such profits are contrary to Shariah.

In business ventures there are no guarantees of return because the business may not be profitable even when everyone is acting ethically. Consumers will only purchase the offered product or service if they perceive it as being beneficial to themselves. There is nothing immoral about using resources in the most efficient manner.

The path toward technological improvement and economic efficiency is full of experimentation and mistakes. It is inevitable many businesses will fail while attempting to create better products and services. While money is a means of easing transactions it is also a means of storing labor. Excess productivity can be stored in the form of money until it is needed. In an economy without banks this excess wealth or stored labor could be put to use by personally investing in a business venture.

The difficulty of bringing together individuals with excess wealth and those with promising business ideas is a drag on the economy as it is haltingly inefficient. One of the roles of banks then is to bring together those with capital and those with ideas, to facilitate the transaction by providing expert analysis and to spread the risk of failure over a pool of investors.

Shariah recognizes the benefits of this arrangement and allows for the operation of banks with the stipulation they operate as socially beneficial institutions rather than simply a conduit for wealthy people to increase their wealth through obtaining risk free rents.

Using Conventional Banking Model Increases Risk

The development of conventional banks in western economies led to a system of finance which was incompatible with Islamic thinking. As Islamic institutions have gained a foothold in the financial marketplace they have done so primarily by mimicking the success of conventional financial institutions and copying their products.

Murabaha sales for example are very similar to conventional loans with the profit rate being equivalent to interest charged by conventional banks. Likewise, Musharakah mutanaqisah for real estate has an appearance similar to conventional loans on property.

In areas where real assets and durable goods are being purchased it is appropriate that Islamic institutions give consumers the ability to purchase expensive goods over time. In other areas though such mimicry leads to products which are contrary to the intention of Shariah.

Let’s look again at the principle of shared risk. Ostensibly, Islamic banks which are set up as Mudarabah companies do this by paying depositors a portion of their profit as compensation for the risk of operating a business.

Traditionally such contracts stipulate the Mudarib (in this case the depositor) is eligible to receive a portion of the profit but also must bear the risk of losing money if the venture is unprofitable. This risk of loss in failure justifies the profit earned on success.

Such an arrangement makes bank depositors who are used to receiving risk free rent nervous, and Islamic banks have catered to this concern by guaranteeing returns. Still others have gone as far as guaranteeing a certain minimum rate of return. These stipulations place the burden of failure on the bank rather than the investor and reveal the Mudarabah to be a façade.

Islamic banking is still in its infancy and this creates some hardships in terms of liquidity. Immature financial markets make it difficult for banks and other financial institutions to operate in a purely Shariah compliant way. Banks often rely heavily on Sukuk offerings to guarantee stable return rates.

These Sukuk however can increase banks’ risks if they have not been structured properly. Some institutions issuing Sukuk do not supply sufficient asset backing or do not fully transfer the asset to the special purpose vehicle (SPV) set up to facilitate the Sukuk offering. In such cases banks leave themselves exposed to increased risk if the Sukuk issuer runs into financial difficulty. These Sukuk offerings are Shariah compliant in name only.

As we have seen lately conventional banks compound their risk by leveraging their funds through fractional reserve banking; essentially borrowing money on credit and lending or investing it. By not lending borrowed money Islamic financial institutions should be more insulated from this compounding of risk.

Unfortunately, following the uninspired banking practices of conventional banks, Islamic banks often use Tawarruq or “commodity Murabaha” to provide liquid funds for bank operations; by doing so they make themselves susceptible to compound failures.

In an ideal world, Islamic financial institutions would make more effort to comply with the intention of Shariah than to conform to conventional banking standards. Banks established as a PLS entity should actually share the risk of the business with their depositors by allowing them to incur losses as well as reap rewards.

The Dilemma of Asymmetric Information

One of the problems in banking is the fact that depositors are at the mercy of the bank executives when it comes to information about the institution. They must rely on proper reporting and ethical business practices for their income.

One reason depositors are reluctant to take on the risk of bank losses is they are afraid in bad years the bank would pass on their losses but in good years banks would hide gains through unethical accounting tactics. This asymmetry of information creates an economic barrier banks must work hard to overcome in order to have truly Shariah compliant business structures.

Because bank executives are often not at as much risk as depositors under a truly Shariah compliant scheme there is a potential for moral hazard in that poor business practices, while they affect the institution, do not typically affect the executives directly. Therefore they have little incentive to be diligent in their research or prudent in their investments.

Recommendations

To reduce the risk Islamic financial institutions are exposed to they need only fully adopt Shariah standards. In order for them to accomplish this however, they must cede some control by making their books more transparent and acting in more ethical ways. When depositors know bank executives are making decisions with their own wealth at stake they will feel more comfortable with the outcome, whether good or bad.

It is perhaps not insignificant that such changes would bring Islamic banks closer to the ideal of community based, asset-backed, full-reserve banks envisioned by Islamic financial theory. In so doing they would be offering Muslims a real alternative to conventional banking and creating a model of banking which would be significantly more resistant to speculative forces. Banks built on Shariah ideals would also be more resistant to economic downturns and inflationary pressures.

Criticism of tawarruq, GE Capital sukuk

2009-11-21T11:33:00.000-08:00

According to the Secretary General of the OIC Fiqh Academy, Abdul Salam Al-Abadi, some GCC-based banks have reduced their use of organized tawarruq following the OIC Fiqh Academy's criticism of the practice as not Shari'ah-compliant. None of the banks were identifies, but if it is the case that the OIC Fiqh Academy ruling had an effect, it increases the uncertainty in Islamic finance about which products are Shari'ah-compliant and also the Shari'ah risk associated with changing and differing views over time about whether a given product will remain accepted as Shari'ah-compliant. The Secretary General of the General Council for Islamic Banks and Financial Institutions (CIBAFI), Ezzadine Khoja, also criticized tawarruq. His criticism was that "The goods are just virtual, there is no real movement of the goods [...] All things are done by the bank, the bank at the end gives money and takes more. There is no effect on the economy".

The GE Capital sukuk for $500 million was priced at 175 basis points over Treasuries, which compares to 155 basis points over Treasuries for recently issued conventional debt. The difference of 20 basis points can be viewed as a 'sukuk premium'. It is unclear what this premium reflects, but it could be due to the relative lack of clarity about how sukuk function either in restructuring or default. The sukuk issuance comes 4 months after GE Capital ended its issuance of debt with a government backstop that began during the credit crisis. While GE Capital was a part of the Temporary Liquidity Guarantee Program, it issued $51 billion in long-term debt and $17 billion in commercial paper.

Other News

Russia could be a promising market for Islamic finance according to Lahem al Nasser writing in Asharq Alawsat.
The Islamic Bank of Britain is hoping to expand the number of Islamic mortgages it offers by expanding its distribution to other mortgage brokers.
Siddhartha Herdegen gave a talk about Islamic finance at the University of Utah.
An event by Credit Suisse focused on how Gibraltar could attract Islamic finance.
The Tamweel and Amlak merger is on track to be completed in the first quarter of 2010 as the default rate has declined from a high of 3%.
An article by the Secretary General of Islamic Economics Forum for Indonesian Development (ISEFID) describes the potential for Islamic finance in Indonesia.
The UAE has taken steps to have its companies and governments become more transparent following the economic and financial crisis.

Should issuers disclose the use of sukuk proceeds

2009-11-20T18:49:00.000-08:00

The way sukuk are structured involves setting up an external company to separate the assets of the sukuk from the company's assets and other business. Are some sukuk structured that way to issue sukuk to finance businesses that would not be halal investments in the underlying company?

The recent International Finance Corporation sukuk is an unremarkable sukuk apart from the identity of its issuer, but as I read through the prospectus, the use of an SPV as the issuer led me to consider whether the structure used by many sukuk could be a way for non-Shari'ah-compliant companies to raise funds using sukuk based on Shari'ah-compliant assets without investors necessarily knowing whether the proceeds would be used for a Shari'ah-compliant purpose.

The IFC sukuk was issued by a Cayman Islands-domiciled SPV, the Hilal Sukuk Company, and is similar to sukuk issued by the Islamic Development Bank. The SPV issues sukuk and then uses the proceeds to buy ijara contracts from the IFC, which acts as manager and collects the lease payments and distributes them to the holders of the sukuk.

The payments are smoothed over the maturity using a reserve account that accumulates excess profits and uses it to cover any shortfalls. Any balance in the reserve account at maturity is paid to the IFC as an incentive fee. At maturity (or in the case of default), the SPV has the right only to sell the assets back to the IFC at a pre-determined exercise price. Any shortfalls not covered by the reserve account are advanced by the IFC and then repaid from future lease payments or the sale of the assets at maturity, but beyond that, there is no recourse to other assets of the IFC (it is an unsecured debt).

However, the issue that arose in my mind was that the IFC is generally a conventional financial institution that issues debt to finance its lending (with interest). As such, were the IFC itself being considered as an investment by investors concerned about Shari'ah-compliance, it would probably not be judged to be a halal investment. However, it is able to issue sukuk because a portion of its lending is done in a Shari'ah-compliant manner through ijara (the assets for the IFC sukuk are ijara financing of medical equipment).

The way the sukuk prospectus describes it, the investors are buying investments from the SPV and those monies will be used solely for buying Shari'ah-compliant ijara assets from the IFC. The structure ensures that the relevant scope of Shari'ah review is on the structure of the sukuk certificates, the assets being used and the mechanism for lease payments to flow to sukuk certificateholders. There is not explicit mention in the prospectus to what the IFC will use the proceeds of the sukuk for.

They may use it to extend more financing using Shari'ah-compliant ijara contracts (or murabaha or other contracts). However, because money is fungible, it is impossible to tell whether the funds will be used eventually to support interest-bearing loans that make up a bulk of the IFCs assets. While the transaction itself is Shari'ah-compliant according to the scholars who reviewed it, it is not clear whether the use of the proceeds will be in halal areas.

Without the disclosure, there is a gap in some sukuk structures about whether they follow the spirit of the law and not just the letter. Could, for example, a large conventional bank that also offers a few Shari'ah-compliant mortgages use those assets to issue a sukuk to fund the rest of its balance sheet? At what point would the underlying issuer's business be raised with respects to the Shari'ah-compliance of the sukuk it issues. At this point it is not clear, but it is an important thing to consider as a growing number of issuers look to Islamic finance as a way to raise financing.

Islamic banks v. conventional banks, Islamic finance & SRI, GE Capital sukuk

2009-11-18T22:00:00.000-08:00

A study by two professors at Ajman University of Science and Technology found that Islamic banks outdid conventional banks. However, the study, as reported, only looked at four years of data for three Islamic and three conventional banks. Although it is useful to know that Islamic banks have outperformed conventional banks in the past four years (at least among a 6 bank sample), it is not really a useful finding for the industry as a whole.

The dangers of extrapolating using data on just a few institutions over a few years are well known, there is an additional hiccup that could reduce the value of the findings further. The sample period, 2006-2009, was one in which the conventional financial industry saw the most challenging events worldwide as global credit markets froze up and economic growth slowed. And this period was also accompanied by the impacts of these events on Islamic banks (I have long argued that they were susceptible to the financial crisis and economic downturn). However, the financial complexity of conventional banks versus Islamic banks is divergent and not just because of the requirements for Shari'ah-compliance.

Islamic banks are generally operating using primarily basic contracts like murabaha and ijara and have very little use of mudaraba and musharaka. They also have nearly no exposure to any derivatives products which have been particularly volatile. This volatility extends beyond the so-called toxic derivatives. For example, the volatility index, which is based on options on index components of the Standard & Poor's 500 Index, reached record highs in 2008 and have been elevated for much of 2008 and 2009.

Islamic banks, therefore, are involved in lower risk investments compared to their conventional competitors. They also do not have significant exposure to the products which are widely held up as the 'preferred' Islamic products with profit-and-loss sharing. I offer this criticism only to put what I am reading about the study in context of where there might be questions remaining that cannot be answered based on the current experience in Islamic banking. I also should note that I have not read the study. I would appreciate if it were emailed to me so that I could give a more complete analysis.

An article about sustainable finance which criticizes the 'value-neutral' approach to finance points to Islamic finance as potentially providing an example and starting point for a sustainable financial industry that incorporates social welfare in the financial industry. While it acknowledges the limitations of Islamic finance as it currently is practiced (particularly the focus on negative screens and an absence of positive screens), it does demonstrate the benefits of Islamic finance as one method of implementing social responsibility in finance. In a related development, Islamic investment bank First Energy Bank is investing $1 billion in a Saudi solar plant.

GE Capital is planning its first sukuk, which is expected to be a 5-year sukuk of more than $500 million.

The Atlanta-based unit of Arcapita, the Bahraini private equity group is profiled in an Atlanta business newspaper, including a description of the group's investment strategy which differs from the stereotypical idea of private equity, "Arcapita, unlike some private equity firms, doesn’t have an exit requirement for its investments. Still, 'we don’t hold anything forever'" according to Charles Ogburn, the executive director and head of corporate investment.

Other News

Saad Trading, Contracting & Financial Services announced that the Golden Belt 1 Sukuk Company, the issuer SPV for Saad's $650 million sukuk due in 2012, would be unable to make a periodic payment because the company's assets were frozen.
The Investment Dar is planning to present its $3.5 billion restructuring plan to creditors soon.
Gulf Finance House received a $100 million convertible murabaha facility from Deutsche Bank, which follows its $100 million convertible murabaha from Macquarie Bank. This is a part of the firm's efforts to "redesign" their business model.
Luxembourg would 'welcome' the establishment of an Islamic bank. The President of the Central Bank, Yves Mersch, says that "We had Islamic banking institutions in the seventies which discontinued its services and as for now there is no Islamic bank that operates in Luxembourg, but there is no prohibition to have a setup of such an institution".
Sarasin, the Swiss firm offering a Shari'ah-compliant wealth management offering will start with the Gulf but also include Southeast Asia next.
Malaysia continues to see growth in its domestic Islamic finance industry.
The Islamic Development Bank is going to offer financing of $1 billion to agricultural projects with the UN Food and Agriculture Organization (FAO).

Islamic and ethical finance, Nakheel sukuk, sukuk markets

2009-11-15T00:03:00.000-08:00

The CEO of Noor Islamic Bank highlighted the opportunity for Islamic banking to compete with conventional banking in the wake of the financial crisis. He suggested that the financial crisis has created additional demand for ethical and more risk averse financial services, which would benefit Islamic finance. I think that Hussain Al Qemzi, the CEO, is making an important point for the Islamic finance industry by recognizing the two selling points for Islamic finance, especially if it is going to be able to attract non-Muslim customers, is the ethical framework (which has many similarities to the ethical/sustainability-focused mindset that goes beyond just Muslims) and the relatively more risk averse structure of Islamic finance. A focus on these areas could assist Islamic financial institutions in expanding outside of the main areas where Islamic finance exists.

The Nakheel sukuk is now trading above the redemption value on maturity, reflecting the additional premium payable to sukuk holders if there is no qualified public offering before the sukuk matures. This also reflects confidence that the sukuk will be redeemed in full upon maturity, which has been a longstanding concern given the property market collapse in Dubai since the sukuk was issued. Nakheel is currently in talks with Dubai World, which has guaranteed the sukuk that mature in December. Bloomberg also has an article on the subject.

The sukuk market has rebounded by about 40% compared to the first ten months of 2008. However, the issuance has been mostly by sovereign or government-related entities (GREs). This means that the credit quality of new issues has improved, which Moody's believes is a positive because it will help develop a "more detailed yield curve" which will benefit corporate issuers in the future. However, the lack of many corporate issuers, besides the most highly rated issuers like Saudi Electric Company (which was forced to pay far more than their sukuk of 2007) is potentially problematic for the market. Without a variety of issuers across the credit ratings scale, there will be few opportunities for companies to enter the market and the continued growth in the market will be limited. Only time will tell whether this persists, but the first signs of a rebound in the corporate sukuk area should come from the secondary markets. If trading of listed corporate sukuk becomes more liquid, it may begin to entice new issuers into the market.

Islamic Finance Resources, another blog, has some great material posted up and one of the recent is a collection of webcasts and podcasts on Islamic finance. This site is definitely recommended as a source of invaluable resources on Islamic finance.

Other News

Sukuk could be the new alternative investment in the wake of the financial crisis which saw risky investments take large hits because of its more conservative structure.
Indonesia will not pay higher yields on sukuk than conventional bonds. This comes following investor demand for higher yields on several recent sukuk auctions.
SWIFT is working with Path Solutions on a financial messaging system for the Islamic banking industry.
Swiss company Sarasin is launching an Islamic wealth management unit.
QInvest and Fortis Bank are launching a Shari'ah-compliant ship financing fund.
Indonesian company Mitra is issuing a 200 billion rupiah ($21.4 million) sukuk along with a conventional bond.
Pakistan is considering issuing a sovereign sukuk.
Bank Negara Malaysia governor Dr. Zeti Akhtar Aziz gave a speech highlighting the prospects of Islamic finance integrating into the international financial system. She also highlighted in another speech the ability of Islamic finance to deal with the risks to the Islamic financial system.
UBS is planning to expand to offer Islamic derivatives to help clients hedge risks, reports Reuters.
DIFC and bankers in London are discussing partnerships and new opportunities. A conference held by UK Trade & Investment will discuss the effects of the credit crisis on Islamic finance.
France may also look to Malaysia for guidance on developing its Islamic financial industry. Australia may also become a source of sukuk based on its natural resource wealth, according to the deputy governor of the Malaysian central bank.
Hong Kong continues to move forward on its plans to attract Islamic finance with proposed tax changes to level the playing field for sukuk.
The FT discusses the attention paid to Islamic finance following the financial crisis.

Tuesday news bullets

2009-11-10T15:30:00.000-08:00

Dubai repays the $1 billion Dubai Civil Aviation Authority sukuk that matured on November 4th with proceeds from the $1.93 billion sukuk issued last week.
A report from Moody's says that sukuk issuance in the first 10 months of 2009 exceeded the same period in 2008 by 40%, although the sukuk market is dominated by government-related entities.
The Investment Dar's Bahrain unit extended its standstill agreement according to a statement by the Investment Dar Sukuk Co on the Bahrain stock exchange. It is unclear whether the Investment Dar's standstill agreement was also extended.
Al Baraka Bank Syria's IPO was heavily oversubscribed
Two applications from foreign banks to receive Islamic banking licenses in Malaysia are being processed according to the Deputy Finance Minister. It is part of a liberalization planned that will expand the opportunities for foreign investors in Islamic financial institutions.
Malaysia's Securities Commission signed an agreement about cooperation with the regulators in Hong Kong and Singapore.
A conference in New Jersey focused on how corporate America can market to the Muslim market in the country.
Uganda's regulators are learning more about Islamic finance in preparation of a review of the country's laws and how Islamic finance could fit into them.
In the wake of a successful $2 billion sukuk issuance, the 'shut-up' heard round the world. The Emirate's leader Sheikh Mohammed Bin Rashid Al-Maktoum expects the second tranche of $10 billion in bonds to be 'well received' and dismissed critics who wonder whether Dubai will be supported by the rest of the UAE, and particularly Abu Dhabi.

Sukuk: debt vs. equity, Islamic finance assets grew 2008 to 2009

2009-11-07T19:18:00.001-08:00

Reuters has a good article on the debate around sukuk and whether they should be more akin to equity or debt. The article includes an update on the progress of the East Cameron bankruptcy. Sukuk holders may propose a reorganization that would give them an equity interest in the underlying company and their counsel expects that East Cameron will emerge from Chapter 11 bankruptcy early next year. The debate over sukuk is one that has been particularly in the forefront over the past two years following the AAOIFI ruling that prohibited mudaraba and musharaka sukuk from including repurchase agreements to redeem them, as well as by several high profile sukuk defaults.

The debate will continue, but the likely end result will probably be a compromise between the sukuk being debt or equity. They will likely continue to be arranged with fixed or variable payments based on an underlying interest rate, making them more like debt. However, they will also probably include more equity-like features that have been included in some recent sukuk. They will also probably move away from the asset-based structure that transform them into unsecured obligations of the issuer. This means that the asset used in the structuring is transferred to the SPV issuing sukuk with a purchase obligation clause at the maturity or in cases of default that gives investors no claim to the asset, only a claim on the issuer.

In contrast to asset-based sukuk, asset-backed sukuk effect a transfer of the asset to the SPV that gives the sukuk holders legal claim to the asset if there is a bankruptcy of the issuer or default on the sukuk. This was the structure of the East Cameron sukuk and one of the issues tackled by the bankruptcy court was whether the sale of the overriding royalty interest to the SPV was a 'true sale' or whether it was only done to create a financing transaction. The court documents suggest that it is the former, which if finalized would create a significant precedent for future sukuk issues in the U.S. A Reuters Q&A provides a similar overview of sukuk and the East Cameron sukuk in particular. A Factbox shows a few examples of asset-based and asset-backed sukuk. Reuters also provides a brief timeline of developments in the sukuk market.

Reuters also presents the views of two experts, an Islamic finance lawyer Megat Hizaini Hassan and the CEO of a Malaysian ratings firm.

A report by The Banker magazine finds that there are assets of $822 billion in Islamic banks and Islamic windows at conventional banks, up 28.6% from the $639 billion estimated as of 2008. The industry, however, continues to miss growth opportunities because Shari'ah-compliant products are more expensive. At a conference in France, the CEO of Renault Nissan Carlos Ghosn said that company would raise money from Islamic investments if it were more cost competitive.

Other News

The IFC sukuk could prove to be a significant issue despite its small size because it was listed exclusively in the Gulf and the arranging syndicate included mostly Gulf-based firms.
Thailand continues to consider a sovereign sukuk, although it remains at least two years out because of a lack of regulatory changes needed to facilitate the issue.
The Wall Street Journal wrote an article about the need for more trained professionals in Islamic finance and the growth in the number of business schools which offer programs in Islamic finance.
The Irish newspaper The Independent has two articles about Islamic finance including one about how Ireland is considering changes to laws to attract Islamic finance.

Regulation in Islamic finance, Questions remain about Dubai GREs

2009-11-04T22:00:00.000-08:00

Malaysia's prime minister Najib Razak said that the Islamic financial industry needs strong regulation to ensure it avoids future crises. This has been an area where the industry has been slow to recognize its susceptibility to a similar financial crisis that occurred beginning in 2007 in the conventional financial industry. For too long, there were many articles talking about how the Islamic financial industry was 'immune' to crisis because of the way it operated. I have been pointing out that there are some aspects of the Islamic financial system (including lack of deposit insurance and a true 'lender of last resort') that could even make Islamic finance more vulnerable to a crisis if there was a serious loss of confidence in one or a few large Islamic banks. It is good to see that there is a greater recognition of the need for regulation to prevent either poor risk management or damaging innovation from creating a situation where there could be a crisis. Now, all that needs to happen is for these regulations to be adopted. That could take a while, although the Islamic FInancial Standards Board has begun discussing liquidity standards that would address one potential area of systemic risks in Islamic finance caused by the difficulties of Islamic banks in managing liquidity and asset and liability maturity mismatches.

Some of the proceeds from the recent Dubai sukuk, which raised $1.93 billion, will be used to pay the maturing $1 billion sukuk from the Dubai Civil Aviation Authority, which matured today. The UAE said that the timing of the issue of a $10 billion bond planned by Dubai that may be used to redeem the Nakheel sukuk maturing next month will "depend on the needs at the time" according to the Minister of Economy. In a contrary development, ratings agency Moody's Investor Service downgraded five government related entities (GREs) because the government after the Dubai finance department relinquished its obligations to cover the entities' debts. Although the GREs are not part of the government and do not have a government guarantee, they are closely tied to the government and any defaults would likely have repercussions on the Emirate's perceived creditworthiness.

Other News

Amlak and Tamweel, the two large Dubai-based Islamic mortgage firms will be merged beginning in January with their investors owning one-third of the resulting bank.
Gulf Finance House is planning on converting into a commercial bank from an investment bank and will issue $100 million in a convertible Islamic instrument. GFH issued Macquarie Bank with a $100 million convertible murabaha earlier this year.
The ISDA-IIFM template for Shari'ah-compliant derivatives will be released either this year or early next year.
The IFC listed its $100 million sukuk on the Bahrain Stock Exchange and NASDAQ Dubai.
The U.S. is selling the building in which its embassy has resided in London to Qatari Diar, which recently began the process of issuing sukuk to fund its European acquisitions. Al Salam Europe, the European unit of the Bahraini firm is also planning on expanding its investments in Europe with real estate and private equity investments planned by January.
Islamic finance could continue its rapid growth and see total assets of $4 trillion in 8-10 years according to the CEO of Doha Bank in a speech recently.

A scholar raises issues of copy-cat products, IFC sukuk, South Korea considers sovereign sukuk

2009-11-02T20:35:00.000-08:00

Shari'ah scholar Dr. Hatem El-Karanshawy, a former director of the Central Bank of Egypt, cautions the Islamic finance industry on 'Islamizing' products that do not inherently fit with Islamic principles. He says that venture capital can fit in well with few modifications. The growth in Islamic finance has been accompanied by 'copy-cat' versions of conventional financial products using contracts that allow Shari'ah scholars to approve them. In many cases, these products do provide value, but as I mentioned in a blog post two months ago, there is a need to keep in mind whether new innovation is beneficial in Islamic finance just as in the conventional financial industry.

The International Finance Corporation's $100 million sukuk is receiving favorable coverage from Arab News, which points out that many Arab countries have not yet stepped into the Islamic capital markets to raise funds. In addition to the most recent sukuk (and a Ringgit-denominated one it issued in 2004), the IFC has been involved in several other Islamic finance transactions over the past few years.

South Korea appears to be the latest non-Muslim majority country to work to attract Gulf money by passing laws that put Islamic finance including sukuk on equal regulatory and tax footing to conventional bonds. The country recently announced a list of state-owned companies that the government is looking to privatize and which it seeks Gulf investment. In addition, the government is considering an $80 billion initiative for environmentally-sustainable areas of growth. The government is also on a roadshow to gauge interest in a $500 million - $1 billion sovereign sukuk.

Other News

HSBC is considering subscribing to the second $10 billion tranche of bonds issued by Dubai. The first tranche was purchased by the UAE central bank.
Islamic banks' assets grew by 66% between the end of 2007 and the end of 2008 according to the Union of Arab Banks.
The NY Times published an article on the growth of Islamic finance in universities' curricula.
According to Standard & Poor's, the performance of Shari'ah-compliant equities lagged in the third quarter, a period when a lot of the leading stocks were financials.
Bahrain-based Al Baraka plans on spending $30-$50 million on a bank acquisition in Indonesia. The bank also says that the IPO of its Syrian unit is oversubscribed.

Why are sukuk in the GCC issued with short maturities?

2009-10-30T21:47:00.000-07:00

Mubadala, the Abu Dhabi sovereign wealth fund says that there needs to be a better developed secondary bond market for longer-term bonds to come to market. It also pointed to the need for a 'strong local bid'. Given that the GCC is the source of a large share of the sukuk issuance, and most sukuk outside of Malaysia are of maturities of 5 years or less, this poses a question of whether the Islamic financial industry can step in to fill the gap.

The sukuk secondary markets are notoriously illiquid, although there has been an improvement in this area as the number of new issues has declined in the past year or two. With a shortage of new issues, there has been an uptick in the trading of outstanding sukuk in the secondary markets. There has also been the nascent steps towards provide more opportunities for secondary market trading with the launch of bond and sukuk trading on the Saudi exachange Tadawul. However, even with these steps, there are few listed sukuk, with most trading on either NASDAQ Dubai (formerly the Dubai International Financial Exchange) or the Bahrain Stock Exchange.

As I have described before, the secondary market for sukuk has been caught in a chicken-or-egg problem (which came first?). During the boom times, there were a number of new issues, most of which were heavily oversubscribed. A decent proportion of these sukuk were listed on secondary markets theoretically giving investors who were not able to subscribe in the offering the chance to pick them up in the secondary markets. However, there wasn't much activity in the secondary markets.

This can be ascribed to two things. First, the secondary markets weren't active because the secondary markets weren't active. Although a tautological argument, it was true. If you subscribe to a sukuk and receive an allocation, then sell it on the secondary market, you would generally hope to be able to take the proceeds and purchase a new sukuk to replace it. In an illiquid secondary market, for one you could probably not receive what you perceive to be the fair value, but also, you would likely have to overpay for a replacement. Without the benefit of a market maker in the sukuk, the gap between bids and offers in the market perpetuated the illiquidity.

Second, the continuing stream of new issues made it less beneficial to chase the offer in the secondary market if there was a chance of getting in on a newly issued sukuk. Why pay up if there is a chance that another similar sukuk might come along that you might be able to receive an allocation at par?

However, this equation changed after the financial crisis when credit was generally scarce and expensive and there were few companies willing to issue new sukuk. In addition, the outstanding issuers were affected by the growing economic crisis so that their ability to repay came into question (in some cases, they defaulted on their sukuk). The investors in these sukuk, either through concern over the sukuk or their own need for cash, became more willing to participate in the secondary markets.

This created some market turmoil, with many sukuk trading far below par and yielding higher than may have been justified by the fundamentals of the companies and sukuk. However, it also created an opportunity for a few sukuk funds which launched over the past year to step in on the buy side of the market and create additional liquidity by narrowing the spread between the bid and ask of listed sukuk.

No sukuk exemplifies this transformation perhaps more than the Nakheel sukuk which matures in December. In an illiquid market, with concerns about Nakheel's ability to repay, the bond traded down to nearly 60% of its par value even though the payment on maturity, if made, would be nearly 115% of par. Since reaching this point, the sukuk has become more actively traded and has rebounded in the trading price to greater than par. Some of this rebound was due to the fundamental ability of Nakheel to pay, albeit with support from the Dubai government, but some could be chalked up to the greater liquidity and the entrance of bidders for the sukuk.

To be clear, the sukuk market remains illiquid in many listed sukuk names, but there has been a greater level of activity in secondary markets as of late. Returning to the initial point of what is needed for longer-term maturities, it is generally the case (even in US Treasuries, some of the most liquid bonds in the world) that longer maturity products are less liquid and more volatile in price than shorter-dated bonds. Without a liquid secondary market for shorter maturity bonds and sukuk, it is unlikely that investors would purchase longer-dated sukuk.

Mubadala's point is well taken and the sukuk market, largely as a result of external events, has begun to liquify. This is a necessary, but probably not sufficient, precondition for the introduction of longer maturity sukuk. The resolution of sukuk through cases of default will also go a long way towards reassuring investors that they will not be trappen in a 10-year or longer sukuk regardless of what happens. To see a possible future, the experience of Malaysia is instructive. The Malaysian secondary markets are active and there have been numerous resolutions of sukuk defaults. Consequently, there have been several longer-dated sukuk--for example, the Cagamas residential mortgage-backed securities which have maturity dates of over 10-years, something that has not happened in the GCC...yet.

Other News

The performance of the Dow Jones Islamic Market Indexes for October are now available.
The IFC sukuk was priced at 25 basis points over mid-swaps, which is the tightest pricing yet for a sukuk, although the sukuk received a higher pricing (by 10 basis points) over what conventional debt issued by the IFC would be priced at.
Germany's financial regulator jumps into the mix of European countries wanting to attract Islamic finance shortly after France passed laws defining the rules for Islamic financial products, but far behind the U.K., which has so far led the EU in its accommodation of Islamic finance.

Dubai issues $1.93 billion in sukuk

2009-10-28T22:30:00.000-07:00

Dubai announced the results of its 5-year sukuk issuance today. There were two tranches, one for $1.25 million of USD-denominated sukuk and the other was $680 million in AED denominated sukuk. The sukuk were priced at 375 basis points over mid-swaps. Bloomberg reports that the USD sukuk were priced to yield 6.39%. The AED tranche are floating-rate notes based on a spread over EIBOR, priced to yield 5.65% according to the same Bloomberg article.

The nearly $2 billion issuance is the first issuance of bonds by Dubai since April 2008, before the real estate markets in Dubai began to tumble in the wake of the global credit crisis. There are a number of maturing debt issues--some $6.8 billion in the fourth quarter of 2009--none more crucial to Dubai's reputation than the $3.52 billion Nakheel sukuk. The Nakheel sukuk is not officially sovereign debt, but it is a government-related entity guaranteed by Dubai World, the government-linked holding company.

Nakheel, the developer of the palm-shaped islands off the coast of the Emirate, has run into severe difficulty following the property crash in Dubai, and has confirmed it has received money from Dubai's Financial Support Fund, although the amount has not been disclosed. Although the funds raised in this sukuk issuance will go to the government, in part to pay maturing sovereign sukuk, there will soon be another $10 billion bond issuance, a part of the $20 billion bond program that was started with a $10 billion bond issued to the UAE central bank.

Nakheel has been reported to be in restructuring talks over the $3.52 billion sukuk, which could include a tender offer involving equity. However, a number of investors have publicly criticized the possibility of recieving equity for their investment. Due to the deferred lease payments throughout the sukuk, the total amount payable on maturity is around $4 billion. Were the Nakheel sukuk to not be fully redeemed upon maturity, it would send a bad signal to the bond markets about the credit-worthiness of other highly-indebted government-related entities and could affect the Dubai government's ability to raise future debt.

However, the ability of Dubai to access the international capital markets, as well as the support from the UAE central bank through the earlier bond, sends a positive signal that Dubai will not allow Nakheel to default on its debt. The outcome is still uncertain, although the secondary market trading in Nakheel suggests that there will be a favorable outcome. The latest pricing is 107 - 108.5 as of October 28th. The final maturity value of the Nakheel sukuk is near 115.

Other News

Indonesia plans its next sukuk in mid-November. The first two auctions have seen investors demanding higher yields. The first auction had all bids rejected and the second auction saw less than 5% of the total bids accepted.
Jordan continues to consider issuing a sukuk, although the discussions are in an early stage.
Next year may see $20 billion in sukuk issuance according to a poll. The issuance was $9.3 billion in the first seven months of 2009. The total sukuk issuance this year could be around $15-17 billion. However, with a pipeline estimated at $45 billion, this would be less than some expect.

Sukuk markets recovering, IFC sukuk listed in Dubai and London, Islamic asset management faces a 'chicken-or-egg' problem

2009-10-26T22:35:00.000-07:00

The sukuk market is expected to recover following signs that Nakheel will avoid default and GE Capital Corporation, which has a joint venture with Abu Dhabi-based Mubadala, was reported to be considering issuing a sukuk. The recovery in Nakheel's sukuk have come following the $10 billion in bonds issued by Dubai and the prospect for the Emirate to issue $6.5 billion in bonds and sukuk. The sukuk-reported to be $2.5 billion of this amount-are reported to be priced near 6%. The funds from the bond and sukuk issuance are expected to be administered by the Dubai Financial Support fund, which has provided some assistance to Nakheel.

With the listing of the World Bank Group's IFC sukuk, NASDAQ Dubai expects the sukuk and bond markets to pick up before the IPO market. The sukuk will be listed on both NASDAQ Dubai and the London Stock Exchange and is rated Aaa by Moody's.

The Islamic asset management industry faces a 'chicken-or-egg' problem as the industry has a shortage of investments to choose from, particularly in the fixed income area, while there are few investments available because of questions about the strength of demand. The increasing involvement by governments is a double-edged sword, notes an article from Reuters. Governments can provide a source of issuers willing and able to issue sukuk, but could crowd out other issuers, particularly lower-rated issuers. So far this year, roughly 80% of sukuk have come from government issuers and many of the others were issued by high-grade corporate issuers.

Emirates Business 24/7 has an interesting article about the debate over standardization in Islamic finance. There are many views on how standardization should happen, whether it should be a goal at all and what aspects of the industry should be standardized.

Other News

The International Swaps and Derivatives Association (ISDA) is expected to release guidelines on Islamic derivatives, and these could come by December. The standardized agreement, being jointly developed by the ISDA and the International Islamic Finance Market (IIFM), would provide a standardized contract for Shari'ah-compliant hedging products.
The opening of the country's first Islamic bank led German paper Das Spiegel to write a good article that provides an overview of the industry's development.
Tamweel, the troubled Dubai-based Islamic mortgage company, made a periodic payment on its sukuk due in 2013.
The Irish Revenue Service has clarified its rules on the taxation of Islamic finance products and a summary is available from Arab News.
The CIO of CIMB-Principal Islamic Asset Management Dr. Zeid Ayer believes that Brunei should open its sukuk up to international investors to broaden the base of investors. The sultanate issues sukuk despite large oil reserves and little need to raise financing as a way to promote the growth of its Islamic finance industry.
The results of an Islamic Finance Perceptions survey are summarized in an article.
As Malaysia issues RM3 billion ($888 million) in sukuk, it has also extended the tax exemption on Islamic financial products to 2015 that have helped the industry grow rapidly in the country.

Dubai wades back into international capital markets, sukuk coming back or are defaults too strong a headwind for the next year

2009-10-20T21:51:00.000-07:00

Dubai Civil Aviation may issue sukuk and conventional bonds to refinance $1 billion in debt maturing in November, in signs that Dubai may be re-approaching the sukuk and bond markets despite uncertainty about the level of debt in government-related entities like Dubai World and Nakheel, which has a $3.52 billion sukuk maturing in December. The ability of Dubai to tap capital markets has been buoyed by the return of risk appetite among investors as well as the repayment a month early by Nakheel of over $1 billion in bank debt extended earlier this year. However, there is still skepticism about Dubai's ability to restructure its debt and government-related entities.

A senior executive at Nomura believes that there will be a further uptick in the issuance of new sukuk by corporate and sovereign issuers in the next 18 months. The issuance through the end of September was $13.5 billion, primarily out of Saudi Arabia, which accounted for 44% of issuance and included sukuk from Saudi Electric Company and the Islamic Development Bank. Other more recent data shows that $18 billion in sukuk have been issued so far this year.

The sukuk market remains in a state of flux because of the unresolved issues about asset-based and asset-backed sukuk, which is discussed in an article in the Financial Times. The important point brought up in the FT article is that not all sukuk transfer ownership of the underlying asset to the investors. In many cases of asset-based sukuk, the asset is transferred to the SPV that issued the sukuk but with a repurchase agreement that requires the issuer to repurchase the asset in the case of default. This means that the asset ownership transfers back to the company and the sukuk holders are given essentially an IOU that the company will redeem the principal of the sukuk in a default. This is different from an asset-backed sukuk where ownership is transferred to the sukuk holders, who then have legal right to the asset. This was the case in the East Cameron sukuk, which was based on an overriding royalty interest that entitles the sukuk holders to a share of production in the underlying lease. Other sukuk transfer ownership of a tangible asset (the ORRI is legally recognized as real property in Louisiana, but is not a transfer of the underlying properties being drilled, which are leased from the US government).

Other News

The World Bank's IFC sukuk price guidance is 35-40 basis points over 5-year US Treasuries.
Jordan is considering offering sukuk to cover its growing budget deficit.
A columnist in the Guardian discusses the role of regulation and religion in finance.
Emirates Development Bank, the government funded bank that is anticipated to take over Islamic mortgage lenders Amlak and Tamweel is one step closer to launch, although the fate of Amlak and Tamweel remains uncertain.
Saudi Electric may tap sukuk markets again to finance a new contract the firm signed.
There is a nice article is in a Minnesota paper about local organization African Development Center, which offers Shari'ah-compliant home and business financing.
An English paper has a good article about the growth of Islamic finance.
Korea needs incentives for investments in sukuk, according to the head of Doha Bank's representative office in the country.
Islamic Finance Resources links to a recent paper on the history of Islamic finance in France, a relevant article given the recent French law about Islamic finance that was struck down by the constitutional court on procedural grounds.
Ithmaar is offering a rights issue as well as a 5-year mandatory convertible sukuk.
Gatehouse Bank, based in the UK, joined Paris Europlace, a Paris-based organization that promotes the French financial industry and established an Islamic Finance Commission in December 2007.

FSA rules on Islamic finance, France law struck down, 10-20% growth in 3 years in Islamic finance, other news

2009-10-15T21:43:00.000-07:00

The Financial Services Authority has released the suggestions received on its regulatory proposal for sukuk (Alternative Finance Investment Bonds) that was initially released late last year. The comments are incorporated into a revised proposed law that is open for comment until November 6, 2009.

France's new law on Islamic finance was struck down by the country's high court on procedural grounds although the opposition Socialists who asked for the review by the Constitutional Council who oppose it as a violation of the secular principles of France.

A study by BDO based on a poll of 173 financial services executives involved in Islamic finance puts the growth prospects for the industry at 10-20% over the next 3 years. A substantial percentage, 23%, said the industry could grow quicker and an equal percentage believed there would be little growth, between 0% and 10%, in the next 3 years. The industry continues to enjoy unsaturated markets and growing recognition by companies not necessarily considering Islamic finance based on a need for Shari'ah-compliant funding sources. However, there has been a severe economic downturn that has hurt the industry, a shortage of experienced practitioners and there are a number of issues remaining to be resolved, particularly how sukuk are treated if the issuer defaults on periodic payments. This is not necessarily going to be a quick process and it could be one of the reasons for the large percentage of sukuk this year coming from high-grade companies and sovereign issuers where the probability of default is far lower than some of the issuers in previous years.

The World Bank's International Finance Corporation is planning a $100 million sukuk to show its commitment to the Middle East and Islamic finance. The Reuters article notes that "they [the IFC] have only a few ijara contracts, that's really the limiting factor". This suggests that the structure they are considering would be similar to the Islamic Development Bank sukuk, which is based on a pool of financing provided to other parties by the Bank which can include murabaha and istisna'a, but must have at least 51% in ijara because they represent an underlying asset and not just a debt receivable.

Indonesia rejected all of the bids in its first monthly sukuk auction because investors were asking for higher yields than the Ministry of Finance was willing to accept. The decision is not seemed to be a significant setback because there is an expectation that the Indonesian central bank may raise interest rates. If the Ministry of Finance accepted higher yielding bids from investors in sukuk, it could increase the cost of raising conventional debt.

Investors in the Golden Belt 1 sukuk issued by the Saad Group do not know whether the next periodic payment will be made according to Citigroup, the sukuk trustee.

There is continues to be controversy about whether there need to be more safeguards for borrowers in Malaysia who default on bai' bithaman ajil (BBA) sales contracts. In some cases, a defaulting borrower can end up owing more than the amount of the financing originally taken. There has been controversy before around the BBA contract. A lower court said that the sale was not genuine and there was no difference between the profit charged and interest, although this was reversed by a higher court.

Other News

The Dubai Financial Services Authority (DFSA) issued proposals for changes to how it regulates Islamic financial services.
Shariah Capital, based in the US, is considering offering a Shari'ah-compliant ETF in the US and the UK, although no timeline for its launch is provided.
Etisalat plans a bond and sukuk raise that would begin with a $500 million tranche.
Bursa Suq Al-Sila', the Malaysian-based commodity murabaha exchange is expanding into the GCC.
The CIMA Certificate in Islamic Finance was launched recently. SHAPE Financial has launched its own certified Islamic financial analyst program.
Despite a downgrade to the Originator, a Tamweel Residential ABS sukuk did not have its rating changed by Moody's.
Sorooh is planning a Shari'ah-compliant fund to invest in European commercial property. ING is planning its own Shari'ah-compliant real estate fund with Amiri Capital that will invest in UK commercial property.
An opthamologist in Dubai proposes an Islamic economic system that I cannot even comprehend, but there is a $1 million reward to anyone who can prove that it wouldn't work.

Islamic securitization, other news

2009-10-10T14:38:00.000-07:00

A lawyer from Patton Boggs has an article in Islamic Finance News about the requirements for Shari'ah-compliant securitization to develop in the Middle East. Securitization markets across the world have been restricted following the credit crisis, but the securitization if done in a Shari'ah-compliant way would allow Islamic banks to increase the diversification of their assets and would free up capital for additional financing.

Other News

The Islamic Development Bank's $1.5 billion sukuk program and the first issue of $850 million in sukuk received a AAA rating from Fitch's and Standard & Poor's and a Aaa rating from Moody's Investor Services.
Malaysian ports operator Pelabuhan Tanjung Pelepaas plans to raise MYR1.5 billion ($441 million) from sukuk issues with a maturity of up to 10 years.
Standard & Poor's will be responsible for maintaining and calculating the National Bank of Abu Dhabi's NBAD UAE Listed Islamic Index.
The fate of Islamic mortgage firms Amlak and Tamweel continues to be discussed as a UAE state panel oversees their restructuring.
Swiss Re received approval to launch a retakaful unit in Malaysia. The takaful industry has been growing, but there is a shortage of retakaful firms forcing many takaful providers to use conventional reinsurance.
France sees Islamic finance as a potential way to deal with the credit crunch, although Islamic finance is not immune from similar crises that began in the U.S. in 2007.