Unintentional Investment Advice from the Chairwoman of the Federal Reserve

A Case of Goldilocks' Fever?

Earlier this week the Chairwoman of the US Federal Reserve System spoke at The British Academy President's lecture.

She was asked about the possibility of a new financial crisis, according to Reuters.

"Would I say there will never, ever be another financial crisis?" Yellen said at a question-and-answer event in London.

"You know probably that would be going too far but I do think we're much safer and I hope that it will not be in our lifetimes and I don't believe it will be," she said.

It's either a case of inadvertent investment advice or perhaps an indirect disclosure of health problems.

More likely the former. 

So it's an appropriate time to adjust your investment criteria to the side of more caution, if you haven't already given the new Administration in Washington..

Dana Gas Restructuring: Own Goal for Dana Gas

GOAL!!!!  (Sadly Own)

Without the Number Can't Tell If He's Management or an Advisor

DG’s maneuver—declaring the debt invalid, seeking court injunctions to restrict creditors’ rights, and apparently preferring UAE creditors with the Zora prepayment—is likely to have several effects. 

First, at the very least it will poison the initial phases of the restructuring negotiations. 

AA doesn’t understand why DG took this path. 

Unless completely somnolent, creditors were likely aware that they were not going to be repaid in full, though they were/are probably hoping for a significant “slice” of DG’s almost USD 300 million in cash to reduce outstandings. 

DG has a clearly compelling case that its ability to repay is restricted because its two main customers (95% of DG’s business) can’t or won’t honor their obligations in a timely fashion.  That allows DG to focus creditor anger away from itself to its customers.  

The creditors have limited opportunities to go on their own.  Additional security (more of those “current” receivables from the KRG and Egypt), a higher profit rate, tenor adjustments/principal amortization, etc. could probably secure a deal albeit with hard bargaining.    

Instead DG has in effect “declared war” on the Sukuk holders. 

Second, but that’s not all.  DG’s apparently half-baked strategy has caused it an even larger problem by creating more enemies who are likely allies for the creditors. 

Third parties whose interests are directly threatened by DG’s move are likely to oppose DG, providing ammunition to creditors in the courts.  Other third parties are likely to take positions that support the creditors, even if only indirectly. 

Instead of fighting battles with one adversary, DG has apparently though it wise to take on the “world”.

It’s hard to understand what DG are thinking, if indeed they are. 

A strategy like this is one that an obligor in a desperate situation adopts.  A very weak financial position, problems with ethics or legality that are about to emerge,  or an irrational set of creditors. 

If that's not the case, then the strategy is the result of some "clever boots" removing his shoes at the wrong moment during the decision process.

AA is not privy to insider information.

Third, but whatever the cause, it’s hard to see this turning out well for DG. It could "win" a pyrrhic victory or wind up on the pyre as the vanquished. 

• If DG’s Abu Yusuf legal arguments prevail, finding additional or new creditors is likely to be difficult.  Those few with an interest in providing future debt capital will probably seek to impose higher profit rates and enhanced protective terms – legal structure, collateral, etc.  That assumes that any such creditors will believe that legal structuring can create adequate defenses against an obligor who has clearly demonstrated disdain for contractual agreements.  
• If DG’s legal strategy collapses, creditors could well impose draconian terms on the company, e.g., a higher margin, additional collateral, shorter tenors, and a  requirement for a mandatory "sinking fund" or cashflow sweep. (More on this in a post to follow). Bond holders typically don't have the stomach or attention span to undertake these   In the worst case DG could wind up being managed for cashflow.  As I noted in my post about Global Investment House Kuwait, a creditor bent on principal recovery in an uncertain cashflow situation has little to no consideration for future growth of the firm. When creditors feel that an obligor cannot be trusted, that propensity is exacerbated. 

Dana Gas Restructuring: Almost Certain Winners

Well Almost Every Time

As promised earlier, some thoughts on potential winners and losers from Dana Gas’s “clever boots” maneuver.  Given AA's positive nature, let’s start this series of posts with the most likely winners. 

As with any restructuring, the most likely winners are the financial and legal advisors engaged by the obligor and the creditors as well as other firms that may be called upon to provide services, e.g.,  accounting firms, subject matter experts (here Shari'ah law and "Islamic" financial structuring), etc.  

Assuming payment of fees (particularly those owed by the obligor) there is a financial win for both sets of advisors.

But reputational risks remain until the restructuring is complete. And sometimes even after.

Did a financial advisor give bad advice that harmed its client and did news of that harm become public?  Sometimes an advisor makes a bone-headed demand. The other party’s advisor recognizes the mistake, prudently keeps silent itself and advises its client to do so. Its client reaps the benefit. 

Did a law firm miss a critical detail and a legal case went awry?  Did its pen make an unintentional slip in document drafting that resulted in unintended benefit to the other side?  Or did it miss an intentional attempt by the other party’s legal advisor to “redo” the termsheet through clever drafting?  As one of AA’s legal eagle friends notes when you’re on the benefit end you need to have a poker face.  When you’re on the receiving end of mischief intentional or otherwise, you need to have a sharp mind and loud voice. 

• DG’s advisors are Houlihan Lokey (financial) and Squire Patton Boggs (legal) as per the Company’s 5 June 2017 press release. 
• Creditors have reportedly engaged Moelis (financial) and Weil, Gotshal & Manges (legal) as per Reuters.  

At present, advisor reputational risks are focused on the advisors being tagged whether rightly or wrongly with DG’s high risk and poorly thought out strategy.   More on that point to follow.      

Dana Gas: Why Did They Do It?

It's More Than Just Hot Air

I promised in my first post to write again on the winners and losers from Dana Gas’s maneuver.  A post from Arkad has temporarily derailed that plan.

What I’d like to offer today is some hopefully intelligent speculation on DG’s motive for declaring the outstanding certificates as “illegal under Shari’ah and thus unenforceable” and obtaining court injunctions against payment, particularly because these two steps are almost certainly going to poison the relationship with creditors which is critical in a restructuring.

Dana’s 13 June 2017 press release offers two potential explanations: 

• An outflowing of piety perhaps triggered by prayerful meditation during the holy month of Ramadan.  “As a result, a restructuring of the current Sukuk is necessary to ensure that it conforms to the relevant laws for the benefit of all stakeholders.”
• A desire to avoid repeat alleged damage to the company because “During the 2012 restructuring, representatives of Holders unnecessarily declared a Technical Default while negotiations were still ongoing, causing lasting harm.” 

The press seems to share AA’s view that piety is not the motive and has seized upon the second: prevention of a Technical Default. 

AA thinks there’s more to the story.    

Simply put this is a maneuver to stop the creditors from exercising their rights under the security agreement to gain time and increase DG’s negotiating leverage in the restructuring.  

According to Reuters, last Sunday Dana advised that it has obtained an injunction from the High Court of Justice Commercial Division in British Virgin Islands (BVI) and a restraining order from the High Court of Justice in England blocking creditors from taking “hostile” action in addition to the Sharjah Court injunction. 

Why were these steps taken and why are they significant?

• The BVI is “home” to DG’s affiliates who conduct business in Iraq in territory of the so-called Kurdistan Regional Government and in Egypt and whose shares are “security” for the Sukuk.  USD 300 million of Egyptian receivables owed to Dana Egypt also part of the security package.   A BVI injunction complicates an already difficult road for creditors to realize the collateral whose enforcement (but only the first step) is subject to the jurisdiction of the BVI. 
• The laws of England and Wales apply to key transaction documents as I pointed out in my earlier post in particular those documents under which certificate holders would quite justifiably call a default.  

Another sign that protecting assets is a key concern are the steps Dana Gas has taken to minimize its exposure to potential actions by other creditors acting under cross default clauses.  This limits potential collateral (secondary) damage (pun intended).  It also lessens Sukuk holders’ negotiating leverage by reducing/eliminating this threat.

The step also prefers UAE creditors.  A step not likely to be received well by Sukuk holders. 

Let’s let DG make this case by using quotes from the Directors’ Report in its 1Q2017 interim unaudited financials.  As customary, red boldface to distinguish AA’s “distinguished” comments. Black boldface to highlight particularly relevant statements by DG. 

“Subsequent to quarter end, in early May, the Company prepaid the Zora outstanding loan amounting to USD 60 million (AED 220 million) plus applicable interests/costs.”    DG’s 1Q2107 financials were signed 11 May by the auditors which means that the prepayment took place before that date.  AA would hope that creditors would ask if that was before or after the 3 May announcement that the Sukuk was going to be rescheduled. 

But it gets even better.

After announcing the prepayment, in the very next sentence DG states: 

“On 3 May 2017 the Company announced that, due to continued challenges it faces around cash collections and the resulting need to focus on short to medium term cash preservation, it will commence restructuring discussions with the holders of both its Sukuk dated 8 May 2013.”

According to DG’s 1Q2017 interim report note 11, as per contractual terms, USD 33 million of the Zora facility was not due for repayment until 2018.  Zora is located in the UAE and the lending syndicate is composed of UAE banks.      

As a side note, interest due on the Sukuk next month would be approximately USD 14 million.  Apparently, the USD 14 million are worth more than the USD 33 million prepayment to local banks –roughly 2.4x as valuable – when it comes to cash “preservation”.    

Zora was secured by a very robust security package as is typical project finance structure.  Lots of tripwires and potential pain for DG. 

“Project Security covers, commercial mortgage over mortgage-able Zora gas field project assets (onshore & offshore), assignment of rights under Gas Sales Purchase Agreements, assignment of all Dana Gas Exploration FZE bank accounts, assignment of Zora Project Insurance proceeds, Project performance Guarantees from Contractors & Irrevocable Letter of Credits from Sharjah Petroleum Council. Dana Gas PJSC has pledged the shares of Dana Gas Explorations FZE in favour of security agent. Dana Gas PJSC is also a Guarantor for the entire tenure of the term facility”

As noted elsewhere in the note there was also a cash sweep mechanism. 

Prepayment neatly resolves the issue of cross default for an income earning project in the UAE albeit small “beer” earnings compared to its Iraqi and Egyptian operations. 

Dana also repaid roughly 84% of the FYE 2016 USD 12.5 million outstanding murabaha facility from Mashrekbank Egypt again as per note 11 1Q2017 financials.  This facility was cash collateralized. 

UAE banks’ exposure to Dana is eliminated or reduced.  Dana has clearly “preferred” UAE creditors over the Sukuk holders, though one might argue that these are relatively small amounts when compared to the approximate USD 700 million outstanding on the Sukuk and removing these makes the restructuring less complicated. 

Some USD 25 million of debt remains for two sale/lease back transactions for DG Egypt (DGE):  (a) a building in Egypt and (b) spare parts/equipment acquired some years ago that have yet to be used as per note 25 c.  Perhaps DGE would welcome returning the latter to the lessor. 

In following posts I’ll pick up the promised discussion of winners and losers, well mostly losers, from DG’s "clever boots" maneuver. 

Dana Gas Sukuk: The Providential Detection

Violation of Shariah Caught Just in Time

You’ve probably been reading articles-such as this, or this or this-- on Dana Gas’s 13 June announcement that its existing U.S.$425,040,000 Exchangeable Certificates and U.S.$425,040,000 Ordinary Certificates due October 2017 (together the “Sukuk”) are no longer Shari’ah compliant and therefore “illegal” under U.A.E. law, requiring their restructuring. 

As a consequence, the company announced it will not make the July “profit” payment or the October principal repayment.  This discovery appears to have been made during Ramadan.  Perhaps (but not likely) as a result of the company’s prayerful reflections during the holy month grounded in its fastidious adherence to both Shari’ah and UAE law.  

That this providential “detection” was made one month before payments are required under the allegedly “illegal” agreement is no doubt one of those “remarkable coincidences” that occur from time to time in the finance.

Apparently further compelled by its probity and piety, the company sought and obtained an injunction from the Sharjah courts that prohibits payment.  The courts will hear arguments on the case 25 December, that is roughly two months after the October principal due date.

Just coincidentally this will allow the company to conduct restructuring discussions with the certificate holders which Dana Gas asked for on 3 May 2017 before it seems it became aware of the “violation” of Shari’ah.  Then its only stated concern focused on more mundane cashflow related problems. 

Note that it gave its “solemn” word to proceed not only in a “practical” and “sensible” manner but to “balance the interests of all stakeholders”.  This probably does not apply.

“Dana Gas PJSC (the "Company"), the Middle East's largest regional independent natural gas company today announces that, due to continued challenges it faces around cash collections and resulting need to focus on short to medium term cash preservation, it will commence restructuring discussions with holders of its Sukuk dated 8^th May 2013.  The Company will be addressing the way forward on the Sukuk, which has a maturity date of 31^st October 2017 in a practical manner that balances the interests of all stakeholders. The remaining profit payments will be addressed sensibly as part of the solution.”

As near as AA can tell, the detection occurred sometime after that date and 13 June.  It wasn’t mentioned in the June 5 2017 press release announcing the appointment of Houlihan Lokey as financial advisors and Squire Patton Boggs as legal advisors.

AA sincerely hopes that neither of these firms advocated this transparent bit of Abu Yusuf-efry.  “Abu Yusuf” Yacub Ibn Ibrahim Ibn Habib Ibn Saad Al-Ansari for those who don’t immediately recognize the reference.

In a 13 June 2017 press release Dana broke the news about Shari’ah non-compliance.  AA comments in red boldface.  We’ll step through the press release one paragraph at a time.

“The Company has scheduled a call with the Committee for later today during which the Company will cover the following points and set out an initial proposal for restructuring the existing Sukuk based on these broad principles and terms: Due to the evolution and continual development of Islamic financial instruments and their interpretation, the Company has recently received legal advice that the Sukuk in its present form is not Shari'a compliant and is therefore unlawful under UAE law. As a result, a restructuring of the current Sukuk is necessary to ensure that it conforms to the relevant laws for the benefit of all stakeholders.

• As a legal matter and AA claims no expertise in UAE law, it would seem that if Dana’s assertion is true (which AA doubts) the sukuk then would become a non-Shariah bond and that the legal concept of equity would require that Dana honor the debt as per the existing contractual terms.  There is no doubt that Dana borrowed the money (or more precisely restructured an earlier borrowing), agreed to the terms, and agreed not to challenge the legality of any of the transaction documents (more on that below).  Assuming Dana’s legal arguments are valid, one might expect Shari’ah scholars to “grandfather” this transaction which has a scant five months to run but forbid future such transactions.  But الله أعلم    
• Dana’s assertion raises or should raise concerns among certificateholders that Dana will cite future such “continual development” and declare the replacement sukuk no longer “halal” to justify its non-payment in 2021.  See more on that below. 
• Unlike The Investment Dar in its attempt to deny BLOM repayment, Dana has not alleged that the transaction was contrary to Shariah from inception, but has become so with the “evolution” of “interpretation” of Islamic financial instruments.  A neat way of not casting aspersions on the work of Dar al Shariah or Shaikh Hussain Hamed  Hassan  head of DAS Shariah Advisory Board.  AA hopes though that it will meet with the same stern rejection that TID did.   

"The Company therefore proposes to exchange the Sukuk with a new enforceable, Shari'a compliant instrument, which would have a tenor of four years, confer rights to profit distributions at less than half of the current profit rates and without a conversion feature.  Such new profit payments will comprise a cash and PIK element. " 

• Dana does not appear to have provided details on why the existing sukuk is “illegal”. 
• According to Reuters,  “a source with direct knowledge of the situation said the firm planned to argue the sukuk were not sharia-compliant because their repurchase price was fixed, the coupon was the result of interest-based not profit-based calculations, and the coupon paid out regardless of Dana's financial performance.”
• The terms outlined above by Dana seem to mirror those of the existing transaction, albeit less generous than the existing sukuk as well as eliminating the conversion feature  
• Given this is a second restructuring, credit risk has increased justifying a higher not a lower margin or profit share, absent of course of application of 2.280. 
• But put that aside. 
• If eating a ham sandwich is not halal, what makes eating one-half of the sandwich halal?  Or in other words, if the problem is a fixed rate, then how does a lower fixed rate solve the problem? 
• If profit-sharing payments must be based on profit, don’t PIK (payment in kind) payments imply the company has not really realized profit?  And if so, will “evolving” legal advice in 2021 result not only in refusal to repay principal but also “invalidate” all the PIK payments.

"The new instrument would represent a fundamental improvement to the current situation for Holders as it would be enforceable and would provide repayment to Holders over time."

• Since the courts have not ruled on this matter, this statement is an opinion by a party (Dana) which the less charitable of you out there might believe is not completely disinterested in this matter. 
• Sharjah and the UAE still recognize conventional non-Islamic finance.   Thus, the local courts may rule that while the transaction is no longer “Islamic”, it is a debt Dana owes according to the contract signed by the parties.  

"As the Company's receivables and future damages payments may be unpredictable, Dana Gas proposes to make prepayments under the new Sukuk either in whole, or in part at par, prior to its maturity without any penalty thus providing a path for early pay-down for the Holders." 

• AA would advise the certificateholders to demand a cash sweep to make such payments mandatory and not rely on the company's good faith  of which there is scant evidence so far.  

"The next two Distributions scheduled for 31 July 2017 and 31 October 2017 cannot be paid now that the existing Sukuk is deemed unlawful but will be accounted for as part of the new Sukuk instrument."

• As the courts have not ruled and given the very real possibility of conflicting opinions on Shariah as there is no single central authority, this is a mere assertion not a legal determination. 
• Certificateholders should treat it with the derision it so richly deserves. 

"During the 2012 restructuring, representatives of the Holders unnecessarily declared a Technical Default while negotiations were still ongoing, causing lasting harm.  The Company now assures all parties that no Dissolution Event nor Technical Default has taken place, nor indeed can take place due to the unlawful nature of the Sukuk.  While the Company is keen to reach a consensual agreement with the Holders, Dana Gas has a duty to protect the assets of the Company for the benefit of all stakeholders and will take action to fulfill this duty.”

• Another assertion. 
• There is a very strong case for a default that’s default with a capital “D” not a “technical” default under transaction documents which are governed by English not local law which offer creditors a presumably easier path than the courts of Sharjah to call default.  And as outlined below default need not be called for a prospective (now) or actual (July) failure to pay.
• The Offering Memorandum  page 108 outlines  events of default.  Here are a quick three.   (a) “Non-payment”: either the Obligor or the Mudarib fails to pay any amount payable pursuant to any Transaction Document to which it is a party and/or either the Obligor or the Mudarib fails to pay any amount payable or deliver any shares pursuant to any Transaction Document to which it is a party within three days of the due date for payment or delivery thereof; or  (c) “Repudiation”: either the Obligor or the Mudarib repudiates or challenges the valid, legal, binding and enforceable nature of any or any part of a Transaction Document to which it is a party or does or causes to be done any act or thing evidencing an intention to repudiate or challenge the valid, legal, binding and enforceable nature of any Transaction Document to which it is a party; or (d) “Illegality”: at any time it is or will become unlawful for either the Obligor or the Mudarib to perform or comply with any or all of its obligations under the Transaction Documents to which it is a party, or any of the obligations of either the Obligor or the Mudarib under the Transaction Documents are not, or cease to be legal, valid, binding and enforceable;
• Dana has advised that it will not pay and has obtained a court injunction to engineer a legal obstacle to its payment.  The default under (a) will occur at the latest next month.    
• In refusing to pay and seeking the court injunction, it has repudiated the transaction documents (c) as of at least 13 June.  
• If on the other hand, its assertion that the transaction is illegal, then (d) is operative. By obtaining the injunction and applying for one in the BVI, the company is directly complicit in making its compliance with its obligations illegal.  It isn’t the Sharjah or UAE courts or a Shariah board which has initiated a legal action.  It is the company itself.
• Bond indentures generally have a lower threshold than syndicated loans for an instructing group – 25% is a typical number and that is reflected in the offering circular at least in respect of some transaction documents.  Thus, a relatively small number of certificateholders can call default.

In following post(s) I’ll take a look at the "winners" and "losers" of Dana’s “maneuver”.  The former will require much less comment than the latter, if any.

Global FX Code of Ethics: If You Have to State the Obvious, You Obviously Have a Real Problem

Annual Manifestation of the Free Market God at the AEA

Regular readers of this blog will have noticed that AA has little faith in the myth of the “self-regulating free market”.  Just last week  AA’s scant faith was confirmed yet again.

On 25 May the central bank-led Foreign Exchange Working Group (FXWG) in partnership with the private sector Market Participants Group (MPG) released a global code of conduct for the wholesale foreign exchange (FX) market.

The first principle of six in the Code is Ethics.  

This section of the Code calls on market participants to inter alia “strive for the highest ethical standards”, “the highest professional standards”, as well as “identify and address conflicts of interest”.

But let's let the Code "speak" for itself with AA using boldface to highlight key ideas

“Market Participants should:

• Act honestly in dealings with Clients and other Market Participants;
• Act fairly, dealing with Clients and other Market Participants in a consistent and appropriately transparent manner; and
• Act with integrity, particularly in avoiding and confronting questionable practices and behaviours.”

What this means in fewer words is that market participants should be honest and capable.

Two observations:

First, with reference to the “highest ethical standards” AA is at a loss to understand how being honest is an exemplar of “highest ethical standards”.  Are there ethical standards that allow one to be dishonest or act unfairly?  AA holds that being honest and acting fairly is like being pregnant.  One either is or is not.

Second, the six principles are not listed in alphabetical order.  Does the fact that ethics is placed first reflect an assessment by the FXWG and MPG (though perhaps the latter’s assessment is not as strong as the former’s) that there is a particular problem with ethics or more precisely a lack of ethics? If one has to make a point about what is self-evident, that seems to be an indication implication that practice is lacking.    

Does the need for promulgation of ethical standards refute the dogma of the self-regulating market?  If the market regulates itself, then such problems would be transitory and quickly remedied   

AA's parents and then AA himself spent a not inconsiderable sum on education, a good portion of which funded AA’s direct and indirect studies of economic dogma. 

It is an article of the Free Market faith that market forces driven by intense free market competition, act to indirectly compel ethical behavior among market participants.  Those who are unethical and act unfairly are displaced because customers flock to virtuous participants who act fairly and with high ethical standards.  This occurs even though the latter's salutary behaviour is motivated solely by the pursuit of profit not of virtue.  

That's the theory but this press release seems to confirm not the practice.