Dubai World, Saad Group

The Dubai World debt negotiations hit another potential snag with the repayment of the Nakheel sukuk maturing in May becoming more likely even without a restructuring deal. This compounds the issues caused by the offer of a 1% interest rate for banks who are owed money by Dubai World at the same time that trade creditors are offered 40% cash payment with the remaining 60% paid through a sukuk yielding 10%. A top official at Al Ghurair, which is described as a 'key trade creditor' by Emirates Business 24/7, said the 10% profit was "very generous".

I have previously questioned whether the restructuring would incorporate Shari'ah-complaince and there still has not been a complete reporting of this aspect of the restructuring. However, the use of a sukuk to repay trade creditors indicates that Dubai World remains interested in Islamic finance. The big potential problem is the differential treatment of different creditors, most of which are unsecured creditors. Banks are offered 1%, trade creditors offered 10% on a portion with the remaining being repaid while sukuk holders of the sukuk maturing next month receive full repayment. This differential treatment does no favors to Islamic finance because it reinforces the uncertainty about the rights of creditors in one of the largest geographical concentrations of sukuk issuers. This will make it more difficult for issuers to bring new sukuk to market because although the problems are largely Dubai-related, the uncertainty is generalized to the UAE, if not the GCC. Although the debt holders would suffer delays and would probably come out worse for it, for the Islamic finance industry, it may have been preferable for the whole Dubai World mess to end up in the tribunal in front of internationally recognized judges under DIFC law, which closely resembles English law.

Sukuk holders of the Saad Group have agreed to dissolve the sukuk trust. According to a Reuters factbox, the Saad Group sukuk was an asset-based sukuk, which would mean that the dissolution of the sukuk trust does not provide investors with an avenue to recover their money except through a bankruptcy proceeding as unsecured creditors of Saad Group, where they would be treated equally (pari passu) with other unsecured debt holders and subordinated to any secured creditors.

Khalil Jarrar has an interesting column in the latest Opalesque Islamic Finance Intelligence.

My latest article on the East Cameron sukuk was published by Islamic Business & Finance in the latest issue.

Other News

• The World Bank and the International Finance Corporation will be in Malaysia to discuss a Shari'ah-compliant fund for green technology investments.
  
• The relative strengths and weaknesses of using equity vs. debt in Islamic finance acording to an executive at Elaf Bank in Bahrain.
  
• Arcapita is planning to build a fund management business to reduce the cyclicality of revenues in the private equity business. I believe this is something that more Islamic investment banks and private equity houses will undertake to smooth their revenues and reduce the prospects of being severely harmed in future downturns and this is good for the industry as a whole.
  
• The Abu Dhabi Stock Exchange may begin to indicate which investments are Shari'ah-compliant and which are not.
  
• The CEO of a Malaysian invesmtent bank, Alliance Investment Bank, says that sukuk have a promising future.
  
• Kencana Petroleum Bhd, a Malaysian oil and gas services company, is planning to issue $78 million (MYR250 million) in sukuk sales. Cagamas issued $156 million (MYR500 million) in 5 year sukuk that were rated AAA by MARC because Cagamas is state-owned.
  
• Indonesia issued $22 million in sukuk, about 20% of its planned offering. Demand was limited, according to reports, because of limited liquidity in the sukuk.
  
• KPMG in India has expressed support for the development of guidance from the central bank for Islamic financial institutions in the country which have been slow to develop.
  
• The latest monthly commentary abou the performance of the Dow Jones Islamic Market Indexes for April is now available.
  
• Dundee University in Scotland will offer a postgraduate degree in Islamic finance.
  
• AsiaOne has a summary of Islamic finance structures that are commonly used.
  
• The company offering Salaam Halal, Principle Insurance Holdings, has been sold to a Kuwaiti buyer who was one of the largest shareholders.
  
• AAOIFI will hold its annual meeting at the end of May.
  
• The new Christian ETFs will not be a competition to Islamic financial products, but will encourage greater uptake of ethical products, according to an article in the Malaysian Insider.
  

Should issuers disclose the use of sukuk proceeds

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.