Tuesday, October 02, 2012

Observations on the possible structure of the QIB mudaraba sukuk

The brief description from Fitch's rating announcement of the yet-to-be-launched $1.5 billion sukuk contains an interesting few points (this post is not a recommendation to buy or sell anything; see full disclaimer on the right side of the screen):
1) QIB's obligations under the documentation rank pari passu with QIB's other unsecured obligations; 
2) QIB's undertaking to purchase the relevant Sukuk assets on the scheduled or any earlier dissolution dates from QIBSL and to liquidate the relevant mudaraba assets; and 
3) On any periodic distribution date, if the returns generated from the Sukuk assets are insufficient to cover the periodic distribution payments due, QIB may pay further amounts to the SPV to remedy such shortfall via a liquidity facility. Fitch views the provision of a liquidity facility as an obligation of QIB as failure to provide liquidity if required would lead to payment default under the certificates and in the agency's view this would also constitute an event of default for QIB.
Without having read a copy of the offering documents, it is impossible to understand exactly the structure being used, but it is interesting that a sukuk of such large size is being issued as a mudaraba, given the questions raised by AAOIFI in their ruling from 2008 (specifically relating to the redemption of the sukuk and liquidity facilities provided by the originator (QIB) to the issuer (the SPV issuing the sukuk).

Initially, it was unclear whether the liquidity facilities would be provided in a way that fits within the AAOIFI guidance, since Fitch would view the "provision of a liquidity facility as an obligation of QIB" and failure to make the liquidity available would constitute a payment default according to Fitch.  AAOIFI restricted the use of liquidity facilities to cover shortfall between the actual return and the anticipated return (based on LIBOR) which the mudaraba sukuk will expect. 

However, paying the fixed return of 'anticipated' profits plus redemption of the principal is not the requirement; it is the provision of liquidity.  This reminds me of the structure used by Saudi Hollandi Bank for its post-AAOIFI ruling mudaraba, which also contained a liquidity facility to meet profit shortfalls (as well as a reserve account that would collect profits in excess of the periodic distribution amounts). 

The way the liquidity and redemption are set up to be both likely to be attractive to investors who are looking more for regular income and redemption at par, as well as within the bounds reaffirmed by AAOIFI worked like this:
  • Each period (semi-annually, for example), the profit accruing to the SPV on the basis of its investments in the originator would have a portion set aside for the periodic distribution (based on a spread over LIBOR).  
  • Any excess would be put into a reserve account; any shortfall would be covered through a qard loan from the originator
  • At the redemption date, the originator would buy the assets back (with no guarantee that this would be at par).  The redemption amount would be first used to repay any qard loans for periodic payment shortfalls.  The remainder would be distributed to investors to redeem the sukuk. 
Although I have not seen the QIB sukuk offering documents, I would expect that it would use a similar mechanism that both makes the likelihood of redemption at par and full payment of the periodic distributions high and includes enough loss-sharing (at least in theory) to fit within the AAOIFI guidelines.  

No comments: