Showing posts with label Tie Your Camel First. Show all posts
Showing posts with label Tie Your Camel First. Show all posts

Thursday 11 July 2019

Analysis of DG Restructured Sukuk Terms -- Lessons for Other Investors

"دخول الحمام ليس مثل خروجه"

In this post we’ll take a detailed look at DG’s restructured sukuk (the “Nile Delta Sukuk”).
Our primary text is the listing particulars for Nile Delta published on the Irish Stock Exchange last August.   For those who want comparatives, here’s equivalent information for “Dana Gas Sukuk” the previous incarnation.
The DG restructuring saga provided investors some important lessons.  Not only the hapless group that invested in Dubious Gas, but also those considering other “Islamic” investments or doing business in the UAE.
Analytical comments (appearing below in italicized bold face) will be both descriptive and prescriptive.
Descriptive for those who’ve already entered the hammam (investors in the sukuk).  Other than a secondary sale they are “in” for what appears to be a prolonged bath.  As an aside, AA sincerely hopes he is wrong.
Prescriptive for those lucky investors who haven’t yet entered but may be considering so-called “Islamic” investments or dealing with obligors in Sharjah.  AA undertakes this task knowing full well that while repetition is said to be effective in teaching donkeys, history shows that teaching investors is a more difficult task.
Shari’ah Compliance
The self-averred devoutly scrupulous members of DG’s Board and management were mightily troubled that the previous sukuk was no longer Shari’ah compliant due to a change in scholarly interpretation on al-mudarabah transactions.  So much that they felt compelled to reject their contractual obligations.  As part of the proposed restructuring, they offered sukuk holders an opportunity to right that wrong with a Shari’ah compliant instrument.
What was the outcome?
As the Listing Particulars succinctly state on p 48:  “No assurance can be given as to Shari’ah rules.”
While the Shari’ah Advisory Board of Dar Al-Shari'ah has opined that the sukuk is Shari’ah compliant, the LP notes that there are no assurances that it will be deemed so by other Shari’ah scholars and boards.
You may also recall, and if you don’t, AA will remind you that DAS opined that the previous sukuk was Shari’ah compliant.  That’s not to cast aspersions on DAS scholarship or diligence.
It’s a simple fact that there is no central body that gives a definitive pronouncement on Shari’ah compliance.
As well a subsequent change in interpretation decided such transactions were not Shari’ah compliant. Whether this was intended to be retroactive or not was not explicitly stated.
This by itself should give pause to investors contemplating Shari’ah transactions for two reasons.  For the faithful -- compliance with religion.  For those prudent in conducting financial transactions  -- enforcement of issuer obligations.
Simply put if you’re looking for Shari’ah compliant investment opportunities, your best bet is equity.
Legal Enforceability
But there is more here that should increase anxiety.  Prudent investors usually craft legal agreements to protect their rights to enforce the issuer’s obligations in this world.
The learned courts of Sharjah accepted the argument that while Dana Gas Sukuk was Shari’ah compliant at inception a subsequent changed interpretation about the compliance (or in this case non-compliance) of mudarabah transactions made it non-compliant.  No grandfathering was granted to transactions began prior to the change in interpretation.
As the LP wryly notes on page 45:  Investors may have difficulties in enforcing any English court judgments or arbitral awards, which do not satisfy the requirements of UAE laws, against Dana Gas in the courts of Sharjah.”
The history of the Dana Gas sukuk restructuring suggests that “may have” above is more appropriately written as “almost certainly”.   While there is no doctrine of case precedent in the UAE, prudent investors probably would want to avoid these courts.
Investors should pay particular attention to the courts whose acquiescence is required for enforcement.  The LP disclose the various shortcomings in key GCC/MENA legal systems not only regarding enforcement of foreign court judgements but also creation and enforcement of security rights.
But there are more than legal warnings in offering memoranda.  By creating the DIFC, the Ruler of Dubai made an unequivocally unfavorable statement about Dubai and UAE courts.  The DIFC is a partial answer.  But as events in Asia suggest, one would be well advised not to “bank” on “one country two systems”.
Reliance on Complex Structuring
These transactions involve elaborate structuring.
First, to attempt to create the “Islamic” equivalent of a bond.  Much of this involves the use of Abu-Yusuf-y transactions.   Often poorly or incompletely executed in light of legal requirements.
Second, to attempt to mitigate the legal risks of local jurisdictions.  Key transaction documents are made subject to the laws of what are perceived to be more investor friendly jurisdictions.  But as several cases, including DG, have shown ultimately this does not work unless the key local jurisdiction where enforcement will take place plays along.
The result is many “moving parts” which affords desperate issuers opportunities to seek to undermine the structure.
Before we turn to Nile Delta, let’s look at the case of Golden Belt Sukuk discussed in an earlier post on this site.
Investors wanted a bond-like structure with a fixed interest rate.  So clever lawyers created a transaction in which the Trustee on behalf of the investors would lease Maan’s properties in KSA back to him at a fixed rental.  However, for probably imagined to be very good reasons, the transaction did not require that he actually sell and re-register the properties in Trustee’s name.
Investors ignored (but the Offering Circular did not!) that a local KSA court was likely to compare the rental charge due under the sukuk to market rentals for similar properties.  And, if the sukuk rentals were above market rental rates, adjust the sukuk rentals according.  And, for some reason the local law requirement for a “wet” signature to make a document legally binding was missed.  But why quibble? What could possibly go wrong? Quite a great deal.
Back to DG on page 51 (the Nile Delta) Listing Particulars makes the following points about the transfer of the Trust Assets.
  1. While the Purchase Agreement for the Trust Assets is governed by English Law, substantially all of the initial Ijara Assets are located in the Emirate of Sharjah.  
  2. To the extent that the laws of the Emirate of Sharjah and, to the extent applicable in Sharjah, the federal laws of the UAE are applied in relation to any dispute relating to the Purchase Agreement or the transfer of the Ijara Assets, there are doubts whether an ownership interest in certain Ijara Assets can be effectively transferred without registration of the transfer with appropriate authorities. 
  3. Accordingly, no assurance is given that any ownership interest in the Ijara Assets will be effectively transferred to the Trustee.  
  4. Oops – not really a sale and transfer.  
  5. Also note the bit about applicability of UAE federal laws in Sharjah.  One might be advised not to “bank” on UAE federal laws saving one in this transaction, if indeed one imagined they might. And perhaps in other transactions in other Emirates.
But the LP goes on to note potential remedies. 
  1. Dana Gas has agreed in the Purchase Undertaking to indemnify the Issuer for the purposes of redemption in full of the outstanding Certificates in the event that any transfer of the Ijara Assets is found to be ineffective. 
  2. Given the issuer’s past behavior, no doubt a source of great comfort to some investors.
  3. In the event that the Trust Assets are not purchased by Dana Gas for any reason, the Delegate will seek to enforce the above provisions of the Purchase Undertaking.   Seek? Indeed! Achieve? Well, that did not seem to work out so well with the previous incarnation.
  4. It is likely that, in any action heard by them, the courts of Sharjah would review the transaction as a whole and seek to uphold the intention of the parties to treat the arrangements as a financing transaction on the terms agreed, provided that the transaction is not recharacterised as a sale and purchase of assets as described below.   As they did with the previous sukuk?
  5. A Sharjah court may characterise the transactions contemplated by the Transaction Documents as a sale and purchase of assets that is void as a result of the failure to register the transfer of the Ijara Assets as described above and may therefore refuse to enforce the indemnity in the Purchase Undertaking. 
  6. Accordingly, Dana Gas would be required to return the purchase price it received for those assets to investors less any amounts already paid to investors in respect of those assets (i.e. Periodic Distribution Amounts paid under the Certificates). As a result, in this particular situation, investors in the Certificates may not receive back the full amount of their investment. 
  7. This is a familiar argument.  Where have I heard it before? (Purely rhetorical question.) Positioning for October 2020 and another convenient attack of conscience?
  8. Prospective investors should note that, to Dana Gas’ knowledge, this matter has not been considered by the courts of Sharjah, therefore there can be no assurance as to the approach that would be taken by the courts of Sharjah in such circumstances.  Since the legal concept of case precedents does not exist in Sharjah, does it matter whether or not they have?
In summary a highly structured instrument composed of several transactions subject to the laws of more than one jurisdiction with enforcement dependent on the jurisdiction—which just happens to be the one with the least reliable legal system—about whose validity as Shari’ah compliant there is no assurance.
A transaction that is therefore highly fragile.
Providing a borrower in distress the opportunity to seek to undermine the entire structure.
If you’re already in the hammam, you don’t have many options.  Striking when the iron is cold isn’t going to get you much.
If you’re thinking about investing, (فكر في الخروج قبل الدخول ).
It’s very simple.
  1. Do not deal with people you do not trust.
  2. Make sure the contract between you and your counterparty is specific – amounts, dates, rights and responsibilities—and contains a realistic path to enforce your rights.
  3. Never rely on your contract to correct deficiencies in (a) your counterparty’s character and (b) local law. 
  4. No matter how much some clever lawyer tries to persuade you he has "fixed" problems with his brilliant structuring. Be suspicious of transactions that have complex structures.  They often fall apart in times of distress.
  5. Make sure, as much as you can, that if you have to enforce your rights under a contract, you will get a fair shake in the legal system and in certain jurisdictions a fair shaykh. Or in other words, that the law is fair and reasonably predictable.
  6. If any of these elements are missing, take your money and business somewhere else.


Monday 28 December 2009

Follow-Up on Earlier Tie Your Camel Post - The Trusting Lawyer

Here's the latest news on an earlier post.

Wouldn't you expect an investor, particularly a lawyer, to check the Commercial Registry to learn a bit about the company before plunking down BD50,000?  In Bahrain the MOIC CR is just a mouse click away.

Thursday 17 December 2009

Tie Your Camel First, Then Trust in God Part VI - The Implicit Guarantee Defense - Turnaround is Fair Play

According to the Financial Times, in deciding to make its investment in Citigroup the Emirate of Abu Dhabi "assumed the US government would make any investor in Citi whole".  They also apparently believed that "Citi is America" as the sophisticated head of another unnamed sovereign fund in the region so carefully summed up the matter.

The article also notes that ADIA plunked down US$7.5 billion after "only three days of due dilgence".

Seems it's not only sophisticated and sober investors and bankers from the West who believe in the implicit guarantee and apparently as well the Great Magic Pumpkin, though it may be lonely in the pumpkin patch at times.

Some hopefully helpful hints:
  1. "Too big to fail" does not mean too big to have one's share price go down, way down.  
  2. There appears to be a real unmet need in the region, particularly the UAE,  for courses in convertible bond/security basics and structuring. And thus a significant  business opportunity to be seized.
Earlier posts here and here.

Tuesday 8 December 2009

Tie Your Camel First, Then Trust in God - Part V Maintenance Fees

I thought every developer and property owner knew that maintenance was one of those really important things.  
  1. Be sure that you understand the costs of maintenance, and
  2. Make sure you make provisions for the payment of the same.
Especially if you live in a part of the world where the climate was particularly harsh on buildings.

I wonder if there's implicit maintenance.

Sort of like the famous implicit guarantee.   The Rene Descartes philosophy of maintenance: "I think the property is being maintained, therefore it is".

Or then again maybe Shaykh Khalifa is supposed to take care of this.  This is another thing I don't think he said he'd never do. 

Tuesday 24 November 2009

Tie Your Camel First, Then Trust in God - Success - Part III

Tamweel has refused to take delivery of villas in AlMazaya Development due to lack of infrastructure.

There's nothing like a recession to spark a bit of common sense in business.

Previous posts here and here.

Friday 20 November 2009

Tie Your Camel First, Then Trust in God - Part II

In this article the tie your camel injunction (make sure there are utilities) applies not only to builders but also to buyers.

Previous "tie your camel" post.

Monday 2 November 2009

The One Billion Dirham "Camel"

"Tie your camel first, then trust in God."
SRA
(Jami'y al-Tirmidhi)

Given the anniversary, a belated postmortem of the AED 1.5 billion convertible bond deal beween Dubai Banking Group ("DBG") and Shuaa Capital ("SC") and DBG's resulting AED 1.016 billion (US$277 million) loss - slightly more than the cost of the average camel.

On 31 October 2007, DBG and SC sign an agreement for a one-year convertible bond.  The bond has a quarterly 6% coupon and is convertible into 250 million SC shares.  The stated conversion price is AED 6.000 per share.  However, since as part of the deal DBG advanced SC another AED 176 million (so SC could terminate its stock option program), the effective strike price per share is AED 6.704 - approximately SC's market price at signing.

Fast forward to the maturity date one year later.  SC shares are trading at AED 2.71.

Not surprisingly, DBG has no interest in converting.  To do so would result in an immediate loss of AED 998.50 (US$272 million) - roughly 60% of the initial investment.

However, SC issues a conversion notice, advising DBG that the bond has been converted to shares.

What?  How could that happen?

Clause 6 in the Note Certificate allows both parties - SC and DBG - the right to force conversion.

DBG refuses, threatens litigation to force repayment.  The parties embark on a very public drawn out dispute.

On 25 June 2009 they announce a settlement:  the bond will be converted into 515 million SC shares.  The resulting strike price is billed at AED 2.91 per share - though when the extra AED 176 million is factored in, the strike price is actually AED 3.25 per share.  At this point SC's shares are trading at AED 1.28.

Using market value, DBG has just paid AED 1.676 billion for AED 659 million in shares - a loss of AED 1.017 billion (US$277 million) - 60% of its initial investment.   One heck of a "control" premium.  DBG's one consolation is that it owns a lot more of SC than it would have under the original conversion terms.  Somehow I'm suspecting that may be cold comfort.

Of course, markets move.  Anyone with a stock portfolio in October 2007 has seen some wide and painful movements.

But the whole point of a convertible bond is the structure is designed to give downside protection.   To combine the "safety" of a bond with an option to capture  potential price appreciation.   One only converts if the stock price is favorable.  If not, one cashes in the bond.

But for this to work,  one can't give the issuer of the bond the right to convert because as shown by the above example, the issuer has an incentive to convert when the market price of its stock is below the strike price. 

I'm at a loss to explain this transaction from any banking or finance principle I know.

If anyone out there can, please post.

To rephrase the hadith quote above:  "First, tie down you deal terms firmly, then trust in God".

For those interested in more background, additional documents and information can be found here as part of shareholder information for SC's March 2009 EGM.