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.

Gulf Finance House - Draft Terms on New Sukuk = 23% Annual Return

 Choose Your Door Carefully.  Some Deals are Better than Others.

As you recall, GFH announced with great fanfare its plan to raise up to US$500 million in new capital.  If you don't, here's an earlier post.

I've just gotten a copy of the draft term sheet for the Sukuk from a reliable source.

First, a recitation of the terms:

1. Type - Convertible Murabaha Facility
2. Status - Senior Unsecured Debt
3. Maturity - 3.5 years
4. Profit Payment (aka Interest Rate) - Indicative 12% per annum!
5. Conversion Price - US$0.31 per share
6. Incentive Structure - If conversion election made before 31 December 2010, last 2.5 years Profit Payment in shares at US$0.31 conversion price.

Before the commentary, two very important caveats:

1. GFH's shareholders have not approved the issuance.  GFH's first OGM and EGM failed for lack of a quorum.  
2. The terms sheet is marked "indicative" meaning it's not binding, but rather serves as a basis for discussion/negotiation with potential investors. 
3. Nonetheless, these terms provide a window into what GFH's board and management believe will be necessary to secure investor interest.  In that regard, I'd note that the accompanying investor presentation (a future post will comment on that) states:  "Some commitments already received from Chairman, strategic investors, and related parties".  So you can be pretty sure that GFH has drawn on these disinterested parties to set market-based terms.

Now to the commentary.

1. Assuming a take and hold investor who does not elect conversion until after 31 December 2010, the promised return (IRR basis) is roughly 23% per annum. 
2. 12% of that return composed of cash (the "interest payments").   It's hard to see GFH earning sufficient returns to have much left for shareholders after the interest payment is made.
3. 11% of that from the discount on the shares (assuming the shareholders approve the 1:4  reverse split and GFH trades at 4 times its current US$0.125 per share.  A rather substantial dilution of existing shareholders.
4. The total promised return reflects the weak financial condition of the company when it has to offer essentially private equity like returns for its debt.  Of course, the actual return will depend on GFH's performance which may indicate a market judgment on the probability of such performance.
5. It also establishes what might be considered an "unfortunate" benchmark for GFH's debt issues. Particularly, when one considers this is apparently an early offer to potential investors.  And as we all know the first price in the suq is not the last.

International Investment Group - Update from Delegate on IIG Funding Sukuk (Hint: No Good News)

Deutsche Bank as the Delegate on the above transaction issued an announcement on Nasdaq Dubai advising that:

1. IIG had advised that it was awaiting ministerial approval of its new board so that they could vote to release the KPMG study to certificateholders who had signed a confidentiality agreement.
2. The Paying Agent advised it had not received the funds for the 12 October payment.
3. Certificateholders reminder of Dissolution Events and that they need to vote to accelerate.
4. That IIG has not honored the claim served under the Purchase Undertaking.
5. That the Delegate is not obliged to take actions unless indemnified to its satisfaction.  Apparently, it has not been.

The Future of Sukuk - Asa Fitch at The National

Asa Fitch over at The National has a piece on the sukuk market which you might find interesting.

Personally, I vote for a future.  As with any new financial instrument there is a bit of teething pain.  And the problems encountered today will lead to changes in structures  to correct defects.  As well, one can wish for a bit more investor intelligence though that is perhaps pushing the frontier of optimism a bit far.

International Investment Group: Defaults on Sukuk 2009 Financials Released

Today Deutsche Trustee Company, Delegate on the IIG Funding Limited Sukuk, announced on NasdaqDubai two further defaults on 10 July 2010:

1. First, IIG Funding did not pay the July 2010 Periodic Distribution Amount ("PDA" or "interest").   As you'll recall, the April PDA of US$3,353,062.50 was missed.   Since the Sukuk has a fixed interest rate (6.75% p.a.), the July PDA is the same amount meaning IIG has not paid a total of US$6,706,125.00 in PDAs.
2. Second, IIG (the parent and ultimate borrower) did not honour its Purchase Undertaking in the amount of US$152,467,782.23 representing principal of US$147,490,000 plus 100% of the unpaid PDA of US$4,977,782.22 on these amounts.  That is, 74.2274% thereof.

What is interesting is that Certificateholders did not dissolve the Trust for the April non payment under Article 13.  Rather they chose to use the Put Option under Article 6.5.   See Offering Circular here.   

What that means is that IIG was only obligated to Purchase the interests of those investors who exercised the Put Option (which had a one time exercise date of 10 July 2010).  Only 74.2274%. voted to exerecise the Option.  Technically, the remaining 25.773% of principal is not past due.  Those Certificateholders are in effect in a subordinate state.  Not a particularly wise position to be in. 

Presumably, the Certificateholders will vote again on a Dissolution - thus accelerating the entire principal and ensuring they are all on the same legal footing.  A failure by IIG to honour its Purchase Undertaking is another Article 13 Event of Dissolution. 

Anyone out there who has an explanation for this approach - that is, not voting straight away for Dissolution and accelerating all the Certificates - please post.  This seems a very perplexing approach.  The prudent passenger does not stay below deck on the Titanic after it has collided with the iceberg.

IIG has advised that it is unable to make the payment and referred to its engagement of KPMG to help it devise a restructuring plan. 

I'll post separately about IIG's 2009 financials.  As you might expect, they are not "pretty".

Sukuk Investors Need Protection? Or Just to Read the Prospectus

There's an interesting article in The National about the need for greater protections for investors in Sukuk.

“What good is it in the event of a default if you can’t have access to the underlying assets?” said Rifaat Abdel Karim, the secretary general of the Islamic Financial Services Board, a body based in Kuala Lumpur that sets standards for Sharia compliance. “As an investor you need to know what you get.”

Indeed, you need to know what you get.  That requires that you read the Offering Circular.

 

Every sukuk Offering Circular or Memorandum that I have read sets forth whether or not the investors have a collateral interest in the underlying asset.  Generally, legal issues (including ownership, enforcement and other risks) are set forth as well.

In TID's Global Sukuk I Offering Memorandum, the first Risk Factor (page 11) clearly states that  if there is a default,  the investors have no direct recourse to the underlying assets and have to rely on the obligor (TID) to repurchase the sukuk.  

In the Offering Memorandum for Saad's Golden Belt Sukuk, the second Risk Factor (page 24) also makes a similar statement.  As I've noted before, the potential for  a legal  challenge to the determination of the Periodic Rental Payment ("interest payment") is disclosed as are potential difficulties in enforcing rights. (pages 25 and 29).  The fact that the land remains registered in the name of Mr. AlSanea is noted on page 26.

For IIG's Sukuk, turn to Risk Factors (page 17) under Limited Recourse make a similar statement about access to the underlying assets as TID and Golden Belt.  Page 24 discusses that while the certificates are convertible to shares, the Company has not obtained shareholder consent or approval from the Kuwaiti authorities to issue new shares.

There's a very simple rule in finance.  Don't buy an investment if:

1. You're not capable of figuring out what you're buying.
2. And you don't want to hire a professional to help you.
3. Or you're capable, but just don't want to spend the time reading the Offering Memorandum and asking a few questions.

Golden Belt Sukuk #1 - Vote for Dissolution But Delegate to Take No Action

Citicorp as Delegate for the above transaction posted a notice on the BSE today that at least 25% of certificateholders had voted to dissolve the trust.  That in effect represents a sufficient vote to accelerate the maturity of the sukuk.  That means the issuer is obligated to pay.  As a shell company with no assets, the issuer will not be able to pay.  

At that point, Saad's purchase obligation will be triggered and the debt will become a direct unsecured liability of Saad.  

However, as pointed out in my earlier post, the certificateholders have no legal access to any real assets.  The land being "rented" in this transaction remains legally registered in Mr. Al Sanea's name.  So in effect they hold an unsecured obligation.  That means they will join the ranks of other Saad unsecured creditors - a large group both in terms of numbers of creditors and amount of debt.  That will enable them to take legal action against Saad.

So no guarantee of repayment.

One wrinkle, despite the vote, the Delegate does not have to take any action until it has been indemnified to its satisfaction.  Citicorp advises in the notice that it is not so indemnified.

I suspect the issue is certficateholder agreement to defray the not inconsiderable legal expenses associated with Citicorp taking action.  The issue is one of simple maths for the investors.  Will their ultimate recovery net of legal costs be positive?

International Investment Group Kuwait - Additional Background

Given the news item about IIG's problems, let's take a closer look at IIG.

In case it wasn't clear from the details in my previous post, IIG is a finance company in Kuwait that operates "in accordance with Islamic Shari'ah principles".   To quote further from its website:

At IIG, we firmly believe that Shari'ah principles and transparent corporate governance is essential to building and maintaining public trust. We at, IIG are guided by our values to maintain the highest level of integrity, treat everyone with dignity and respect, focus on our customers and demonstrate excellence in all we do.

And I think that quote quite nicely sets the stage for what follows.

Let's start with the Sukuk.  It is listed on NasdaqDubai where you can find a variety of documents including the Offering Circular.

A few details on the US$200 million sukuk:

1. Maturity 10 July 2012.
2. Quarterly Periodic Distribution Amounts (every calendar quarter on the 10th) at 6.75 per cent per annum.
3. Mudarabah structure.
4. Principal repayment can be either in cash or IIG shares.  5,754.25 shares per US$10,000 of face value or approximately US$1.73 per share.  IIG currently trades at 44 Kuwaiti fils per share, roughly US$0.15.
5. As disclosed in IIG's 2008 annual report (the last issued), the sukuk is secured by  (a) available for sale investments (approximately KD0.4 million out of the total portfolio of KD17.5 million), composed predominantly of  unquoted shares, and (b) investments in affiliates (approximately KD54.3 million out the total portfolio of roughly KD76.6 million).
6. Kuwait Financial Centre ("Markaz") acts as security agent.
7. In the event that IIG Funding doesn't pay back, the certificateholders can call upon IIG to purchase the certificates at their nominal value plus "interest".  If IIG fails to pay, then the certificateholders can pursue the collateral through the Trustsee/Delegate.
8. Typical Dissolution Events ("Events of Default").
9. Upon the occurrence of a Dissolution Event, an early termination can be triggered by the positive vote of 25% of the certificateholders.  This accelerates the maturity of the sukuk.
10. Certificateholders have an individual right to "put" their certificates to the obligor (Section 6.5 a).  The voluntary put date is 10 July 2010.  An investor with a minimum of US$10 million can put the his certificates to IIG Funding for redemption.  So if one is an investor who wants to establish a legal right against IIG as a direct creditor but can't persuade other creditors to vote for an Early Dissolution, this could be the way out.  Of course, as noted above, the investor needs to have a minimum of US$10 million to tender.  Failure by IIG Funding to pay the put amounts would appear to trigger another Dissolution Event so certificateholders would get another vote.  The Delegate (Deutsche Bank) also has the right to take action without a vote, since the Trustee,  IIG Funding, has delegated its powers to do so to DB.

A few other things from the Offering Memorandum.

From Page 100  A Verbatim Quote on Shareholding

"IIG has been a publicly listed company since November 1997. The table below sets out information in relation to holdings of 2 per cent. or more in IIG’s shares as at 1 May 2007:

Shareholder	# of Shares	Percentage
Kuwait Clearing Company(1)	37,953,500	11.93%
Al Tawfeeq Company for  Investment Funds Ltd(3)	23,745,200	7.75%
IIG – portfolio holdings(2)	18,745,845	5.89%
Arab Banking Corporation (B.S.C.)	18,686,119	5.87%
IIG(4)	14,616,533	4.59%
Gulf Monetary Group	14,302,800	4.50%
Al Madar Finance & Investment Co.	11,721,250	3.86%
Grand (Real Estate)	7,370,680	2.32%

Notes:

(1) This company acts as a nominee for shares held on margin accounts to facilitate forward trading.

(2) These are shares held by IIG as portfolio investments for third parties, see ‘‘Businesses – Asset management’’.

(3) This company is part of the Al-Barakah Group in Saudi Arabia which was one of IIG’s founding  shareholders. IIG’s Vice Chairman also holds board and management positions with companies in this group.

(4) These are treasury shares. IIG is permitted to hold up to 10 per cent. of its paid up capital as treasury shares."

AA;  IIG owns 17.54% of Grand.

As of today, IIG lists the following as major shareholders as per the KSE.

1. Arab Banking Corporation 5.63%
2. AlBaraka Company for Development and Investment, 5.21%
3. Gulf Monetary Group Bahrain 8.2%  (Interestingly, on the BSE website it's noted that IIG owns 50.12% of GMG.  Investors Bank with 27.66% is the only other major shareholder shown).

Turning to  IIG's 2008 annual report (2009 is not yet released):

1. I didn't see IIG's investment in Gulf Monetary Group mentioned  in the 2008 financials so this must be a 2009 or 2010 event.
2. The term "related party" is used more frequently in IIG's annual report than the word "interesting" is used in this blog.   And that's not only interesting but also quite a record.  As per Note 22, some 38% of total assets are with related parties, including substantially all of the company's liquidity.  Note 6 states that IIG held KD71.2 million of collateral against the KD34.5 million in wakala and  murabaha payables. to related parties.  The nature of the collateral is not described.  As Note 22 assures, all related party transactions are approved by the shareholders at the annual general meeting.  Unclear if this is a retroactive approval.
3. There seems to be a significant amount of cross shareholding between IIG and its investments and other related parties. Grand, Gulf Monetary Group,  
4. One would expect no less in Kuwait, I suppose.  And equally one might make the argument that when you've got good business partners, whom you know and trust well, it's just natural to do more business with them.  And the same with investments. 

Sukuk - Bond or Equity A Profoundly Subversive Answer

Here's an extremely interesting and important article by Oliver Ali Agha, Managing Partner at Agha and Shamsi, and Claire Grainger, Partner of Head of Projects and Dispute Resolution at Agha and Shamsi.

Their central thesis is that Shari'ah compliant sukuks cannot be bonds or bond like instruments.   Shari'ah compliant sukuks are equity-like.  And so to refer to events of default or defaults is wrong.  Equity cannot default.  Therefore, sukuks can never default. 

These few simple statements embody a radically subversive thesis which demolishes the theoretical foundation of sukuk market as it currently exists by denying that there is an  Islamically acceptable from of traditional debt securities. 

This position is much more dangerous than law cases like BLOM v TID.  Posts on that topic here and here.  The latter represent attacks on implementation of aspects of the transaction while presupposing the structure is sound.  The former holds the structure itself is against the law (Shari'ah).  Under Agha and Grainger's thesis there is no "fix", no magic drafting that can achieve the goal of an "Islamic" debt instrument with bond-like features.

Some other observations.

1. Most of the sukuks I have seen do not meet AAOIFI's five tests. (outlined in the article)  Most fall down on the first. The Offering Memorandum are clear that the sukuk holders have no right in ownership of the underlying asset.  They do not own it during the transaction.  And  generally may not seize it if the obligor fails to perform.  Sukuk certificate holders have the right to the use or proceeds from the assets.  It seems to me that if I've leased you a piece of land which you've re-leased to me and I stop honoring the master lease contract, your recourse in a Shari'ah Court is not to take ownership of the land, but to sue me for the lost revenues. 
2. Sukuk are deliberately structured to be bond equivalents.   That is what the market appears to be demanding.  What Agha and Grainger are saying is that these instruments are not Shari'ah compliant.
3. From there it is not a giant leap to the conclusion that presenting these sukuk as Shari'ah compliant is fraud - on the part of the obligor, its financial advisors, and the Shari'ah boards.  The principle is crystal clear according to Agha and Grainger.
4. They make one other point which I don't follow.  "In reality, sukuk holders do have substantial remedies under Shari'ah: they are the beneficial owners of the underlying assets that would need to be excluded from the insolvency proceedings of the issuer."   Since the documentation I've seen explicitly states that the certificate holders do not own the assets, I 'm presuming they are referring to the hypothetical situation in which title transfer has taken place.
5. Without too great an intellectual leap, other debt like structures presented as Shari'ah compliant come under siege.

Dr. Mohammad Daud Bakar on Sukuk Structures

A brief analysis from a recognized Shari'a expert (Malaysian view) courtesy of Zawaya.

Islamic Legal Experts Discussion on Dubai, Dubai World and Nahkeel

 

Reuters presents a  short video streaming panel discussion among Islamic financing experts.    

I've included it here primarily because it contains some interesting comments, including something similar you may have read elsewhere about the "Implicit Guarantee".   

There is also an added cultural benefit.  Some rather interesting camera work.  Who would have thought of having the camera linger on water glass or a pencil during a discussion of Islamic financing?  Financial videos saved from being overly boring by a bit of avant garde framing.

Zawaya/Hawkamah Report on Sukuk

 

Zawaya and Hawkamah have teamed up to produce a 130 page report on the Sukuk market.  You can get your copy by registering here.

The report contains articles on a variety of topics as well as numerical analysis of the state of and trends in the Sukuk market by Ernst and Young.

One very interesting section is on the core weaknesses in the Sukuk market.  I think that is where the prudent investor should begin as understanding risk is the key to a good investment decision.  

One article in that section that caught my eye was a discussion by two attorneys from Vinson and Elkins on some of the legal issues associated with sukuk structures and default:

1. "In conventional finance and investment markets, the post-default path is well worn. For this reason, much of the process of structuring and documenting transactions, particularly in common law jurisdictions, accounts for the possibility of a worst case scenario. Precedents indicating what such a scenario may entail are readily available in the context of conventional transactions. The same cannot be said for Islamic transactions."
2. "Another factor contributing to the uncertainty surrounding post-default Sukuk is that many are subject to partially or wholly non-Shariah based legal regimes."

I had written earlier on this topic (here and here and here).  It seems we share some of the same legal concerns.

International Investment Group Kuwait Cures Payment Default

If you've been following the story, you know that on 11 January, IIG Funding Limited was to make a Periodic Distribution Payment (equivalent to interest under a conventional bond) of US$3,353,062.50 on its US$ 200 Million Trust Certificates "Sukuk Al Mudarabah" due 2012.

It did not.

At the time IIG (which is the source of the payment) advised it intended to pay on the 19th.

The payment was received on 20 January.

Under the terms of the Certificates a  three day delay in payment is grounds for the dissolution of the Trust.  Once the three days passes, even if IIG makes the payment as it did in this case, the Certificateholders have the right to dissolve the murabaha transaction.  A dissolution  is the same thing as an acceleration of a conventional bond:  IIG would be legally obliged to repay the Certificates in full - some US$200 million in principal plus any Periodic Distribution Payment ("interest") due.  

However, just as with a conventional bond, the Certificateholders must vote to exercise their right to accelerate payment. 

My guess is that they will not.

Golden Belt Sukuk 1 Management Advises Saad Group Not Responding to Info Requests

A disturbing disclosure on the Bahrain Stock Exchange today from Golden Belt Sukuk 1 management.

"Regular requests for various documents and information have been made by Golden Belt and the Delegate to Saad.  Saad has also been asked for money to pay various expenses of Golden Belt (which has no money of its own), including the BSE listing fees. Saad has neither acknowledged or responded to any of these inquiries."

One might understand an inability to provide money given that Maan's assets have been frozen.  It's harder to explain why information wouldn't be forthcoming.

Citibank is the Delegate on the transaction.   Golden Belt is managed by Ohad Trust.  Graham, is that your signature?

By the way it's not only the BSE listing that's in jeopardy if the company doesn't pay.  Golden Belt's Bahraini Commercial Registration (C.R. 65124-1) is up for renewal 9 May 2010.  And, as I've noted before, there's the very interesting fact that the registered owner of 99% of Golden Belt's shares is AlGosaibi Investment Company!

DIFC Guide to Issuing Sukuk

From the DIFC press release.

"The Dubai International Financial Centre Authority today announced the release of the “DIFC Sukuk Guide” - a comprehensive introduction to various sukuk structures, as well as legal and regulatory information on issuing sukuk from the DIFC and listing sukuk on NASDAQ Dubai."

Prepared by Clifford Chance, Amanie Consulting, the DFSA and the DIFC,  "The guide provides detailed descriptions of more than 10 sukuk structures, information on the history and current status of sukuk globally, an overview regarding the issuing and listing of sukuk in or from DIFC, and regulatory licensing in the district."

Here's the link to download a copy.

Sukuk Disclosure - NasdaqDubai

NasdaqDubai asked all of the issuers of listed sukuks the following questions:

1. Is the Issuer aware of any Price Sensitive Information concerning the Sukuk that has not been disclosed to the market?
 

2. Is the Issuer aware of any other Price Sensitive Information concerning any of the following (if applicable)?
a. The Issuer itself;
b. Any guarantees;
c. Covenants;
d. Cross Defaults;
e. Any restructuring plans;
f. Coupon Payments or Principal Payments;
g. Credit Rating changes;
h. Exposure to debt of other Dubai-based entities; and
i. Any other matter of a material nature required to be disclosed under the OSRs or Listing Rules.
 

3. Please confirm that the Issuer is in compliance with the Listing Rules and, in particular, the continuous disclosure obligations under Listing Rule 28.1.

Now, as we all know the financial crisis in the Gulf is over, but if there are some skeptical souls still out there you can check here.

If nothing eslse, you might want to see if your sukuk issuer responded.  Since the questions are rather routine, that bit of info might be quite telling.

The Investment Dar - Restructuring Update: Not So Good Times

6 December AlQabas has a fairly long article on recent developments.  See also this earlier post.  Also you can use the label The Investment Dar to see all other previous posts.

My following analysis is based on the working assumption that this report is basically correct.  I'm not in a position to make a final determination.  Bear that in mind as you read what follows.

60 second summary.  The restructuring agreement sounds like a financial Treaty of Versailles.  Draconian. It appears to me to be controlled liquidation based on expectations for less than a full recovery - probably with a large loss.  Perhaps up to 50% of the face amount of claims.

To quote an appropriate song, this leaves TID:    بين شدو و حنيني وبكاء وانيني

Here's a rough translation of the AlQabas article.  My analysis/comments in blue italics:

First Principles

The proposal begins with an "open letter" to creditors encouraging them to approach the restructuring with a philosophy of justice and equal treatment for all parties. That there should be no spirit of one creditor trying to get its rights at the expense of another.  As well, no revenge (presumably against management) but a mutual co-operation to get out of the strait/predicament.  AA:  It's always nice to start with noble intentions.  The details of the Plan will show to what extent these are implemented.  And we will be able to get quite a precise understanding of any issues the creditors have with TID and its management as we step through these details.

Menu of Options (With a "tilt" to the desired outcome)

Then the three options are outlined as well as the reasons why only one of them makes sense.

1. Option 1 is the pursuit of legal claims.  Dismissed  as these will be very long and complicated steps, outcome uncertain, involve creditors paying legal expenses and consume a great deal of time.
2. Option 2 is wind-up/dissolution.  Dismissed as resulting in the destruction of the value of assets, the appointment of a liquidator (no control by banks over the process), as well as possible diversions.  AA:  Presumably the latter refers to the liquidator following his own procedures. and desires.  Those familiar with liquidations will recognize the worry that the liquidator's realization of assets may take longer than necessary, not result in the best sales price and incur extra expenses.  Lawyers, accountants and liquidators feast first in corporate dissolutions well before the creditors.  Note the key creditor issue: a concern about "control".  The Arabic says "Lack of any control by banks or investors".  We'll see that theme sounded more than once as we proceed.  Usually creditors want control when they have an issue with the way those in charge have exercised their powers.
   
3. Option 3 is the restructuring.   Done of course by mutual consent (AA:  Presumably the creditors made TID an offer it decided was wise not to refuse).  Rights of all creditors to be protected to the maximum extent.  AA:  I'm reading this that there is some doubt about a full recovery. And of course I've "read ahead" of you at this point so I know what's coming.   Banks and investors have "full control" to protect their rights.  AA: There's a sign of serious concern here.  An indication perhaps of strong dissatisfaction.  You'll recall the creditors asked and the Central Bank of Kuwait appointed a monitor to watch over things.  A step not taken at Global Investment House.  Certainly of implementation of corporate governance at TID and steps to protect the rights of creditors.  AA:  Apparently, the creditors see this as a needed change from the past.  

Basic Goals

The proposal then describes the basic goals of the restructuring.

1. First, the separation of the assets of the company and an orderly disposal thereof in a reasonable time to preserve asset values.  AA: Signs of a liquidation.  Asset realization to repay the debt.   Not cashflow from operations.
2. Second, the setting aside of a package of security (collateral) sufficient to protect against any situations resembling the current distressed situation. AA:  More signs of a liquidation.  And more indication of a lack of confidence.
   
3. Third, strengthening the corporate governance of TID and raising the level of transparency and disclosure vis-a-vis the creditors.   AA:  Not a ringing vote of confidence in TID management.
4. Fourth, additional measures to ensure that TID's liquidity is kept with creditors not with third parties.  AA:  This provides the creditors a right of set-off.  Presumably there will be sharing arrangements among the creditors to protect those who don't hold the deposits.  Another sign of lack of confidence in TID management.  And another indication that there is concern about ultimate recovery so the need to keep all assets under the control of the creditors.
   
5. Fifth, facilities and financial services able to be traded according to Islamic principles.   AA:  I'm guessing this is so those who want to get out early can - though they'll have to sell at a discount .
6. Sixth, justice for all creditors and investors by establishing the principle of equal treatment in payments.  

Quantum of Debt and Value of Assets

These two topics are the heart of the creditor decision process.  The higher the value of assets relative to the quantum of debt the less restrictive and onerous the terms of the restructuring.  And here we get confirmation of the basic problem the creditors think they face:  an asset value shortfall.

The Co-Ordinating Committee states there is KD1.220 billion of total debt (US$4.227 billion!) composed of KD 272 million in banks and wakala, KD586 million in various bi-lateral and collective loans, and KD 362 million in sukuk. (KD1 = US$3.50).

TID and its advisors estimate the value of the assets is between KD1.350 billion (short term) and KD1.650 billion long term.  AA:  Assuming these values, at the end of the process with any sort of interest payments, creditors and various other parties will leave little behind - another indication that liquidation is most likely.  TID's incentive is clearly to give a highest possible value in the hope that time will work in their favor.

On the other hand the creditors' and their advisors' view of asset values is different.  KD 600 million for a short term liquidation and KD 1.3 million for a long term liquidation.  The text indicates a 50% recovery rate.  AA:  Equally clearly no one on the creditor side wants to be proven wrong later if there is an asset shortfall.  So the bias is to lower values.  But the disparity here with TID's valuation is  large.  This indicates the strong possibility for less than a full recovery.  In fact a fairly substantial loss.  Hence, the need to control the process to try and extract maximum value.  Of course, anyone who's been involved in a creditor-led disposal of assets knows that creditors are not that much better than liquidators in realizing maximum values.

Restructuring Conditions

1. Imposition of requirements for complete transparency and methods to ensure it.  AA:  Pretty clear why this is being hit.  And notice it is the first point.
2. No sale of any asset without the creditors' consent.  AA:  Completely understandable in a liquidation with insufficient assets to cover debts.
   
3. All asset sales on a sound basis (sahih), legally done, at market prices and not to related parties.   AA: That this point is raised speaks volumes about the creditors' impression of past practice. 
4. TID will not be permitted to dispose of any of its liquid assets without the knowledge of the Co-Ordinating Committee and the agreement of the "restructuring officer" (unclear if this is the CRO appointed by TID earlier or a new position).  AA:  No big surprise here.
   
5. Any amount to be distributed by TID goes to creditors first before management or shareholders.  AA:  No cash to grow/develop the business.  Pretty clear implication for the future of TID.
   
6. Co-Ordinating Committee has the right to refuse to agree the company's financials.  AA:  Again less than a vote of confidence in management.  They're not allowed any control over assets.  And now aren't even allowed to finalize financial reports.  Perhaps a hint of disputes over the long delayed 2008 fiscal report.  Or other concerns about the integrity and completeness of financials.

Small Creditors' Deal

To accomodate small creditors - defined as those with claims less than KD 3 million (US$10.5 million) - a special deal is offered:

1. 25% of claim amount paid quickly.
2. 50% of claim paid in second tranche.
3. 25% remaining along with other large creditors.

AA:  Gets the small creditors votes.  Recall there's no Chapter 11 in Kuwait so 100% agreement is required to close the restructuring.  Letting the small creditors out early is the price the bigger creditors have to reluctantly pay to maximize their own recovery. 

More Protective Conditions

As a prelude, there is a repetition of the argument that the restructuring will be quicker and more certain than legal proceedings.  It's noted that such proceedings will be complicated and take a long time to get the first level judgment which of course is automatically stayed when the losing party lodges an appeal.   But the deal has a legally enforceable fail-safe mechanism if the borrower fails to honor the restructuring plan.

1. Clear and strong condition that if the company fails the creditors will be entitled to take possession of all assets immediately to protect their rights.  AA:  To be incorporated into the restructuring agreement so exercise of the right can be immediate.
2. Complete transparency and the ability to track the Board to ensure that measures are being implemented.  AA:  We've seen this theme before.
   
3. Pledge of the assets for the loans effective so that court action is not required to enforce rights. AA:  The restructuring terms formalize the granting of collateral so that legal procedures in case of TID's subsequent failure will be more straightforward and simple.
   
4. Structuring the debt so that it is capable of being traded (according to Shari'ah principles) for those who want an early exit.  AA:  Some creditors just want out.  This gives others or new creditors the opportunity to acquire debt at a discount (probably a very steep discount).  Existing creditors can average down their cost base.  New creditors can hope to earn substantial returns.
   
5. The ability to study the assets of the company one by one and the opportunity to secure pledges on them.  AA:  Since this is a liquidation, this makes perfect sense.
   

Implementation

1. Creditors are asked to respond by 23 December with the goal of implementing the restructuring in February 2010.
2. Formation of 3 SPVs to which the Company's assets will be transfered:  real estate, shares, and foreign assets.  AA:  If you didn't see this as a liquidation before, this should be the final proof.  The SPVs will provide another layer of creditor protection in case of a need to seize the collateral.
   

Status of Acceptance

1. TID's Board and managment have agreed.  AA:  An offer they decided was wise not to refuse.  Can't imagine this was embraced with enthusiasm.
2. 80% of creditors have accepted (appears to be by number of creditors not volume of debt) and KD880 million by amount.   AA:  This may be the 66% percent referred to in my earlier post.  
3. The main remaining creditor is Investment Dar Bank which is reported to hold 27% of the debt.   And which is expected to agree shortly according to a source connected with TID.  AA:  I'm hoping this is IDB and its clients as 27% of the debt is KD 324 million which would appear to be an excessive credit concentration for a bank like IDB to have with anyone much less a related party.  You'll also recall the earlier post about Mustafa AlSalih's rumored resignation from IDB and Adeem which would appear to be related.

Status of Financials

The article quoting a source at TID states that the company will present its 2008 financials to the Central Bank of Kuwait either 6 or 7 December.  We'll see how long it takes the CBK to approve.

Co-Ordinating Committee

I had made a point that the CC was largely invisible and had apparently not weighed in to support the restructduring.  The article concludes by saying that they have done so.  It also identifies the spokesman for the CC as Bader Abdullah Al Ali.  AA:  This is the name of the CEO at Gulf Investment House Kuwait.   Usually CEO's of creditors don't get involved in restructurings.  Usually most of the roles on committees are given to major creditors.  GIH is relatively small with some KD 59.9 million of shareholders' funds as per their 30 June 2009 financials.  I hope that GIH is holding a small amount of this paper.

DEWA US$2 Billion Sukuk 1Q 2010

Financial press reports that Dubai Electricity and Water Authority ("DEWA") is planning a bond and/or sukuk issue for 1Q 2010.

This source says that Citibank, Barclays and Dubai Islamic Bank have been tipped to do the deal.  Other market discussion is that the UK bank is Standard Chartered.  Perhaps both are involved?  Stan Chart had a major role in the syndicated loan earlier this year.

A bold move in the midst of a request for a standstill, particularly when DEWA is not a sovereign borrower as outlined below.

The sukuk/bond appears to be new money financing. That is, it is not designed to refinance a maturing obligation.  But rather to secure additional funding.

On 8 April 2009 DEWA announced the closing of a three-year US$2.2 billion equivalent syndicated "Islamic" refinancing loan at 300 basis points over Libor.  This  facility refinanced a one year  "Islamic" loan which had a margin a fraction of the replacement loan.  Later in May DEWA announced a thirteen-year ECA backed US$ 1 billion loan.   Both without a sovereign guarantee.

Also in June 2008 DEWA issued a five-year AED 3.2 billion (US$880 million) with Citi, Barclay and DIB as lead managers.  Again no sovereign guarantee.

From the Sukuk prospectus page 17:

"DEWA’s financial obligations are not guaranteed by the Government
Although DEWA is a wholly owned Government entity and also functions as a Government department providing an essential public utility, it is still an independent commercial enterprise and its financial obligations (including its financial obligations under the Transaction Documents) are not guaranteed by the Government. Therefore, DEWA’s ability to meet its financial obligations under the Transaction Documents, and consequently, the Issuer’s ability to pay Periodic Distribution Amounts and Dissolution Distribution Amounts to Certificateholders is solely dependent on DEWA’s  ability to fund such amounts from its business and operations."

In case you're still catching a glimpse of an implicit guarantee, here's an extract from Note 1 to DEWA's 2008 financials:

"Dubai Electricity and Water Authority (“DEWA” or “the Authority”) was incorporated on 1 January 1992 in the Emirate of Dubai by a decree (“the Original Decree”) issued by H.H., the Ruler of Dubai, effective 1 January 1992, as an independent public authority having status of a body corporate, and financially and administratively independent from the Government."

Just recently Fitch downgraded DEWA to BBB- based on an assessment that Government support cannot be counted on.

If you still see an implicit guarantee, AA suggests a visit to your opthalmologist is in order.

The question is what rate DEWA will have to pay on the new Sukuk.

As of today, Dubai Sovereign US$ Sukuks (DEWA is not Sovereign) are trading very roughly at a spread of 550 to 570 basis points with AED denominated issues somewhere around  80 to 100 basis points less.  Jebel Ali Free Zone (which is B+ note DEWA is BBB-) is trading at more than twice the Dubai Sovereign spread.  That suggests a range.  One would expect if priced today that logically DEWA a non Sovereign Dubai obligation would carry a higher rate than the Sovereign.  That implies something over  600 basis points. 

Some caveats:

1. As mentioned earlier, most bond markets (except US Governments) are thin.  Prices accordingly have less "precision" than in more liquid markets.  The GCC bond market is relatively anorexic compared to other thin markets.  The true test of a quote is when you try to hit it as screens do not trade institutions do. 
   
2. Pricing in 1Q 2010 will reflect (a) what has happened and how it has happened on the Dubai World restructuring of Nakheel and (b) macro economic factors/investor preference.
3. It's also important to remember that financial markets are not always logical. 
   

I wouldn't expect that market sentiment is going to improve that dramatically.  And probably not much progress is going to be made on the Nakheel restructuring with the various holidays coming.

Bankers and investors don't like uncertainty so I'd anticipate higher rather than lower prices.   DEWA has an ambitious capital spending program and constraining it will be more difficult than not building another 1 km tall sky scraper.  So it needs the money.  And Dubai does not have a lot of financing alternatives in the market.   The market knows this.