Wednesday, October 31, 2012

IFSB considering changes to capital adequacy requirements, ADIB may issue a sukuk which qualifies

The IFSB is considering which sukuk will qualify as capital under the more stringent Basel III requirements, and "'For issuing sukuk as part of bank capital we have proposed different types of sukuk,' [IFSB Spokeswoman Rose] Halim said, adding that sharia advisors where still discussing details."  Meanwhile the article mentions a proposed sukuk issuance from Abu Dhabi Islamic Bank which would be a hybrid Tier 1 perpetual USD mudaraba sukuk.  

Comments from Arqaam Capital available here suggest that the sukuk will likely be a mudaraba structure, with non-cumulative divedends that are fully discretionary and "We think it probably will qualify as Tier-1 under Basel 3 provided it is classified under equity."  This will be a relatively complicated structure to fit within the Basel capital rules, but from a cash flow perspective, it may be relatively more simple with the mudaraba funds combined with the bank's funds, and applied towards the Islamic banking business, with a share of the profits from the mudaraba used to pay the coupons ("Non-cumulative dividends, fully discretionary = Fixed 6 year rate (MS + initial margin), afterwards MS will be reset, not the margin (no step-ups) = No principal loss absorption or non viability absorption (no conversion into shares or write-down of principal).").

This would be different from some of the recent mudaraba sukuk because it would not subject the investor to principal loss based on the bank's capital level, but would probably have excess returns paid into a reserve account that could be used to make up for shortfall in profits below the anticipated coupon.  However, in contrast with other mudaraba sukuk, it would not reduce the principal amount if there were a shortfall in profits; the holders of the sukuk would just see a reduced coupon payment.  

The exact structure is of course unknown until it is released, but it sounds, from the description by Arqaam Capital, that it will be an innovative mudaraba structure that maintains some simplicity in the relationship between risk and reward, without relying (apart from any call features) on a fixed price purchase undertaking, which featured prominently in some of the pre-AAOIFI ruling sukuk that were deemed to have crossed a line.  

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