The Curious Case of Bahrain Middle East Bank (BMB) Bahrain

Perhaps Somewhat Less Currently

Read the update here.  Massive losses at BMB, the bank is likely fatally wounded barring a miracle. 

An introductory note.  There is a financial group from Brunei that uses the acronym "BMB". This post is not about that group, but about the Bahrain Middle East Bank in Bahrain.

AA generally follows the bigger fish (admittedly a relative term) in the GCC.  But BMB caught my eye.

BMB is small bank not a financial force of any measure and has been “limping along” for years.

What’s interesting about it are two scandals, the last of which caused the Central Bank of Bahrain to come down with “both boots” on the Bank.

As well there appear to be some hints as the fate of the AlFawares Group of Kuwait which dropped from sight roughly two years ago.

2013 “Scandal”

In April 2013 BMB’s Board suddenly fired the bank’s CEO and CFO as well as some other officers.

For the first official word on the cause, let’s turn to note 5 from BMB’s 1Q13 interim financial statement.  Unfortunately, the copy online is a picture and so AA can’t cut and paste the text, but has laboriously copied it.

“Subsequent to the approval of the 31 December 2012 consolidated financial statements (the “consolidated financial statements”) by the Shareholders on 28 March 2013, the Board and new management team of the Bank have discovered certain transactions and balances which were not reported in the Bank’s consolidated financial statements. As the Board of Directors was not provided with complete information and documentation relevant to these transactions and balances; based on review of the underlying documentation for the transactions and balances and extensive evaluation, the Bank has concluded that assets and liabilities arising from these transactions, along with certain other assets and liabilities which were previously reported and accounted for as customer deposits under discretionary portfolio management program, should now be reported and accounted for as Bank’s assets and liabilities.  Furthermore, in line with the International Financial Reporting Standards, the Board and new management team have concluded that since key information was not available at the date of approval of the consolidated financial statements, the corresponding figures are not required to be restated.  As a result, the assets and liabilities of US$ 138,383 thousands and US$ 143,093 thousands respectively have been reported in the consolidated financial position of the Bank as at 31 March 2013."

Recognition of these assets and liabilities increased BMB’s balance sheet from USD 55.3 million to USD 190.5 million.

The major change on the liability side was in Deposits from Financial Institutions. As per note 10, some USD 124.078 million of that category was from “quasi-government interbank placements”.

The other increase USD 18.644 million in Borrowings was described as “a secured loan from financial institutions”.  That loan does not appear in the 2Q13 financials nor do some USD 25.7 million in Trading Securities.  AA presumes it was a “repo” like transaction.

In a statement dated 12 June 2013, BMB’s new CEO stated that based on the work of an “independent team of forensic experts” “it was discovered that during 2011, 2012, and Q1 2013 BMB was the subject of various unauthorized transactions, potentially involving fraudulent activities”.

So this was a multiyear activity, roughly coinciding with the tenure of the previous CEO.

BMB’s FY 2013 Annual Report provides additional details.

“2013 was a challenging year for BMB. In April 2013, the Board of Directors became aware that the Bank had potentially been the subject of a major fraud. The then Chief Executive Officer, Chief Financial Officer and a number of other senior staff at BMB were immediately suspended and the Board of Directors commissioned urgent internal and external investigations into the activities of the Bank and the then management team. These investigations uncovered a number of serious potentially criminal activities including the apparent misappropriation of significant funds. As a result a number of senior executives, including the then Chief Executive Officer and Chief Financial Officer, were dismissed. Official investigations relevant to these executives remain ongoing. As a result of prompt and decisive action substantially all misappropriated funds have been recovered by BMB. However, given the serious nature and magnitude of what took place, BMB has instigated criminal and civil legal proceedings against a number of parties. These matters are currently being investigated by the appropriate legal authorities in the Kingdom of Bahrain.  Throughout 2013 the Board and management carried out a full review of all external contractors, legal and professional advisers to the Bank. This has led to a number of changes and corrective measures and the application of a more rigorous approach to selecting and measuring the performance of third party contractors. BDO’s contract to act as Internal Auditor of BMB was terminated in May 2013. In September 2013, EY was appointed to replace KPMG as External Auditor of the Bank."

AA’s first thought when he read all this, particularly the bit about “quasi-governmental interbank placements”, was that a friendly government decided to help out BMB. Best guesses for that would be Kuwait (given the apparent shareholding by/related to Sh. Ali Khalifah Al Sabah) or Oman (given the then CEO’s prior roles with government institutions in Oman).

As a small bank with USD 30 million in equity, it would be very risky to place USD 140 million or so with the Bank.  However, by using a trust structure, all assets placed would be legally immune to any financial distress at BMB.

The Bank would enjoy the earnings from managing the discretionary account to increase its small income as well as develop a reputation in asset management as a potential new line of business.

So it appeared that the fraud was that certain members of senior management then appropriated these funds for their own use.

But there are some loose threads:

1. Once the assets were recovered why wasn’t the trust or discretionary account structure maintained/reinstated? If the documentation was deficient, then that could be corrected.
2. That suggests some sort of “problem” with the owner of the funds. What that is isn’t clear.
3. This would seem to pretty decisively counter AA’s initial thought that the provider of the funds was a Kuwaiti or Omani quasi-governmental body trying to help out either the major shareholder or the then CEO.
4. Also, as per point 3 in the “Key Audit Matters” section of the auditors’ report in BMB’s 2017 financials, it’s noted that in the category Due to Financial Institutions a “single bank in the region” is owed USD 127.4 million and “has been a depositor since September 2010.”
5. That certainly seems like a long time to keep one's funds with a bank. Why would that be?
6. Note that the descriptor does not include the phrase “quasi-governmental” as in the 1Q13 interim report.  Now it’s just a “single bank in the region.”  And the region is potentially very large, depending on the definition used.
7. You will no doubt note as AA did that this amount is some USD 3.3 million greater than the original amount recorded in 1Q2013. It seems strange that the regional financial institution would add such a small amount to the deposit.
8. Two possible explanations.  The deposit is not in USD but in another currency and the change is due to changes in the FX rate.  Or interest has been capitalized. Or both factors are present.  There's not enough information in the financials to determine the answer.

2018 - 2019 "Scandal"

A bit of history to set the stage.

Back in February 2014, AlFawares transferred 42.97% of its ownership stake in the bank to AN Investment W.L.L. a Bahraini company “controlled by the same shareholder as AlFawares Holding Company” as per page 22 of BMB’s 2013 FY AR.

As per records at the Bahraini MOICT (www.sijilat.bh) AN Investments CR 86835 was owned at least in 2016  by two sons of Sh. Ali AlKhalifah Al Sabah, former Minister of Finance and Oil Minister of the State of Kuwait. 

According to the MOICT website, on 26 December 2016, a request was filed to change the ownership of ANI to the names of three Turkish nationals: Huseyin Basaran (70%), Murat Solak (15%) and Ardases Saro Kavafyan (15%). This provides an indication that the sale of ANI to the Turkish three "amigos" probably took place in December 2016.

After a 26 March 2017 voluntary purchase of BMB shares and a subsequent rights offering later that year, ANI wound up owning some 81% of the bank.

Fast forward to 15 November 2018, BMB announced that its Board had met to approve September financials on 7 November but did not approve them due to the Central Bank of Bahrain putting forward “some observations that require resolution”.

In that same announcement, BMB noted that on 8 November 2018 the Central Bank of Bahrain issued a directive to the bank “restricting” the following:

1. Dealing with “specific Trade Finance related parties”.  From the Arabic we learn this means dealing with related parties to the bank in trade finance.
2. Interbank dealings with banks that are not licensed by the CBB.  The Arabic uses the term (مرخصة).  While this term is often used to mean “licensed”, AA suspects that BMB is not dealing with unlicensed banks in Bahrain, but this refers to banks elsewhere.  The CBB doesn’t license  banks in foreign jurisdictions, their own regulators, if any, do. Think of Citibank or NBAD.  However, it is likely that the CBB has set some guidelines as to which non-resident foreign banks Bahraini banks may deal with.  For example, it may forbid dealing with so-called “shell” banks, banks not licensed at all, or banks subject to international sanctions, etc.  So AA is reading (مرخصة) to mean banks outside Bahrain that the CBB does not allow Bahraini banks to deal with.
3. Making any new investments or credit.

11 minutes later that same day a second announcement from BMB was published by the Bahrain Bourse that advised that the two directors representing AlFawares one of whom was Chairman of the Board had resigned on  7 November.

On November 22, BMB published another announcement stating that the CBB had issued “additional formal directions” on 15 November as follows:

1. The Board must resign immediately
2. The CEO and CFO must step down from their positions as the CBB does not consider them “fit and proper”.
3. The Bank must raise capital before year end
4. The Bank must stop dealing with specified related parties for trade finance
5. Further, as a result of identified violations and irregularities, the CBB is unable to comment on the bank’s 30 September financials.

Now you may be wondering as initially AA did why BMB’s announcements seem to be tardy.  On November 8, the Bahrain Bourse suspended trading pending release of the September financials. So timeliness of announcements wasn’t as critical as it would have been if BMB were still trading.

BMB’s AGM was held on 30 December.  According to the published minutes, shareholders holding 80.81% of shares were present.  This means that AN Investments was there.  Mr. Taqi al Alawi from the MOICT acted as Chairman.  A new slate of directors was elected.  None of them seem to have any relationship to ANI.  

The representative of ANI complained that the CBB had not approved Mr. Solak to serve as a director and demanded that the CBB should give this approval and that he should be elected as a director.  Mr. al Alawi noted the comment and proceeded.

To date BMB has not published its 3Q18 financials. And there has been complete radio silence from the Bank both on its website and the Bahrain Bourse.

So what are we to make of this?

From where AA sits, it appears that the CBB thinks this episode is more egregious than 2013. Or it has a "two strikes" rule:

1. The entire board was forced to resign. This indicates that the CBB believes that either (a) the Board was complicit in whatever irregularities occurred or (b) manifestly derelict in carrying out its functions.
2. The two AlFawares directors luckily resigned before the CBB’s directive requiring resignation of the board, thus avoiding the ignominy of being forced to resign by the CBB and possible impact on their eligibility for other board positions in Bahrain and elsewhere.  
3. Or perhaps it was more than luck.  Back when Iraq invaded Kuwait, foreign correspondents pulled their funding to Kuwaiti-owned banks in Bahrain.  Bahrain did not have the financial resources to support these banks.  A full-fledged banking crisis was on the offing.  Sh. Ali Al Khalifah then Minister of Finance of the State of Kuwait (in exile) provided the funding directly.  AA was told by his mentor that Bahrain never forgot that act.
4. The fact that the new board appears to have been chosen by the CBB with no apparent input from ANI investments also suggests (at least to AA) that the CBB assesses that the problem is not one of individual board members but an “institutional” one at the ANI level.
5. For the CBB to declare an officer of a bank as “not fit and proper” is a pretty damning assessment.
6. For the CBB to "fire" a board of directors as well.
7. For the CBB to not accept a person as a suitable candidate for the board of directors is a similar judgment.

At this point you’re probably thinking, AA what about AlFawares?  What have these scandals to do with AlFawares?  Probably nothing.

But BMB is entwined with AlFawares.  As mentioned at the beginning of this post, roughly two or so years ago, AlFawares’ star began to dim. 

Part of the problem seems to be that the members of the AlSabah family branch associated with AlFawares wound up on the wrong side of a family dispute in Kuwait -- not the Amir's side.

AA suspects there were also financial problems.  

AA has no doubt that like any typical Kuwaiti punter, AlFawares built its empire on OPM piled upon other OPM.   AA recalls reading in al Qabas that Gulf Bank was pursuing legal action against the group for unpaid debts.

As to concrete examples of financial difficulty we don’t have to look beyond BMB’s 2017 annual report.  In note 7 we see that BMB has fully provided the USD 3.533 million installment sales receivable which is guaranteed by AlFawares and two associated companies of AlFawares.

Clearly, if the guarantees were worth anything the Bank would have called them.

Additionally, it’s hard for AA to imagine that the CBB would tolerate provisioning if the guarantees had value. That the Bank has not called on the guarantees suggests they have very little value. 

The amount here is small. It is not a loan for USD 300 million but just USD 3 million.  That suggests that the three entities are in dire straits indeed.

The sale of ANI to the three Turkish “amigos” is perhaps another sign of financial distress. Giving up one’s bank is a hard move.

Other indications that AlFawares is inactive or defunct are the disappearance of AlFawares Kuwait’s website.  On AlFawares Egypt’s website all the links are to pages under construction or dead-ends. You can’t really conduct business if the first thing a prospective client sees is that your website looks untended and untethered.

Does this mean that the good shaykhs from AlFawares are sleeping rough under an underpass on the First Ring Road somewhere?  

Not bloody likely.  Any Kuwaiti punter worth his salt has salted away money somewhere "safe" and "discreet" as Mubarak al-H is reported to have done.

Update Gulf One Investment Bank Bahrain

Last December while commenting on the ongoing woes of Dana Gas, I mentioned that there were other firms in even worse shape and cited Gulf One Investment Bank in Bahrain.

It’s time to take another look at G1 as AA ventures off his well worn path of larger institutions in Bahrain.

As per its 2018 annual report, G1 has extended its string of losses in 2018 to five years.

Over the period from FYE 2013 (its last profitable year) through FYE 2018, G1 has:

1. Lost (but not in the sense of misplaced) approximately USD 92 million in equity, a 69% drop from FYE 2013.  Driven primarily by cumulative net losses of some USD 82 million over the period.
2. Suffered a decline of approximately USD 79 million in investments, a 73% drop from FYE 2013. Driven primarily by USD 57 million cumulative net losses in Investment Income.

You can see the details in G1’s 2018 and 2017 Annual Report both on Page 8.

This is rather a dismal record.

But Gulf 1's Board is confident in the future as evidenced by these quotes from the MD&A section of the 2018 Annual Report.

“The Bank made important strides in 2018 towards repositioning its business on a sustainable path, including expanding its income-based business and realising value from its private equity portfolio. In particular, the Board has undertaken a critical review of the challenges facing the Bank and is now evaluating significant structural changes that would put the bank on a stronger footing without affecting the range of activities it currently undertakes.”

So far the important strides have yet to be reflected in the financials.

As to the critical review, лучше поздно, чем никогда.

And again.

“The bank’s journey towards the realization of the value of its private equity investment continues into 2019. This process will have a favourable impact on the Bank’s ability to grow its successful income generating investments to take the bank to profitability and growing shareholder value.”

With cumulative losses of some USD 57 million in investments the bank’s journey towards the realization of the value of its private equity portfolio would seem to a very long term journey.  It will take some rather incredible multiples to cover these losses and generate an appropriate return.  But then 千里之行，始於足下.

 A few other observations.

Regulatory Issues

It pays to read the auditors’ opinion carefully.  In the section “Report on Other Legal and Regulatory Requirements” tucked away in the third bullet point is the phrase “except for the matters discussed in note 1” we are not aware of any violations of ….

The violations in question are:

1. Accumulated losses exceed 50% of paid-up share capital.  Resolution can be by an increase of paid in capital (raise new capital) reduce paid in capital to offset the accumulated loses, or wind up the firm.I’m guessing that of the three shareholders would opt for the second – a capital reduction. If that option is chosen, then G1 would have a short respite, if losses were to continue at the levels of the past five years.
2. But there's a wrinkle that complicates this strategy. G1 has insufficient shareholders equity. Central Bank of Bahrain Rulebook Volume 1 LR-2.5.2B requires wholesale bank licensees to maintain minimum total shareholders’ equity of USD 100 million.

G1’s Board has decided to surrender their wholesale banking license in favor of Category 1 Investment Firm.  There are no set amounts for minimum capital required for this license.  Rather the firm and the CBB will agree an amount based on the firm’s business. 

As I noted in December, G1 has no borrowings. There are no deposits taken from other banks or from individuals or corporates.  Its miniscule USD 7 million in liabilities consist of internal accruals.

Shifting from a bank to an investment firm seems to make eminent sense.

Other signs of distress.

1. The last press release on G1’s website is from 2012.
2. The last weekly update if from 2014.
3. The last research bulletin is from 2013.

Unintended (?) Political Commentary from Gulf News on BREXIT

Has today’s Gulf News, the newspaper of record for the GCC, taken a stand on BREXIT in Sir Kim fashion?

“Rats” indeed!

AA has heard of rats leaving a sinking ship.

But not rats sinking the ship.

As to the news article itself, AA has his doubts.  A BofE official with the name Gertjan Vlieghe?  Not likely on PM Bojo's watch.

Analysis of DG Restructured Sukuk Terms - Amended

Lasciate ogne speranza, voi ch’intrate

It's a lot more than just a forum non conveniens 

at least for some folks

In this post we’ll take a look at how investors in DG’s restructured sukuk (the “Nile Delta Sukuk”) fared in the restructuring.

Are they better off?

Our primary source is the Nile Delta Listing Particulars.   Details on the previous sukuk “Dana Gas Sukuk” are here.

This post should be read in conjunction with the post on “DG Sukuk Restructuring - Lessons for Other Investors” (hereinafter “Lessons”) for a more extensive analysis of the replacement sukuk.

First, let’s go back almost two years when AA in his capacity as (الفاضي يعمل قاضي ) gave some sage advice to sukuk holders about elements they should incorporate in the restructured sukuk, if possible.

To wit:

1. Recast the legal agreements to reduce exposure to Abu Yusuf-y legal maneuvering by the obligor/issuer.
2. Get more collateral and take possession now rather than relying on the obligor to deliver it later.
3. Increase amortization via interim payments and a cash sweep.
4. Shorten up the tenor to keep pressure on the borrower.

Recast the Agreements

1. Well, agreements were recast.
2. As described ad nauseam in Lessons the sukuk holders’ legal position hasn’t really improved. 
3. In fact they may be worse off because the Listing Particulars state that the if the Trust Assets (Ijara assets) have not  been transferred and legally registered in the name of the Trustee, then the learned courts of Sharjah may characterize the sukuk not as a financing transaction but a Sale and Purchase agreement.
4. In which case, DG will be obliged to take possession of the assets and return for any monies paid, including interest payments (so-called Periodic Distributions).  This as you will recall is one of the bogus arguments that DG raised with the previous sukuk.  Now the sukuk holders appear to have signed on to this interpretation.
5. AA hopes if this situation comes to pass, the learned courts of Sharjah will NOT opine that the sukuks are a single transaction and include the interest from the year dot in their calculation.
6. As noted in Lessons, the Listing Particulars highlight the risk (lay out a legal strategy?) that this new “ijara” structure may be subject to challenge on what are simply technical matters and not changes in interpretation of Shari’ah compliance principles though the latter remain a risk.
7. As also outlined in that post, the risk of Abu Yusuf-ery remains, the sad result of a confluence of factors associated with so-called Shari’ah compliant transactions, exacerbated by the risk of having to litigate in the eminent courts of Sharjah.
8. Hint:  If you’re looking for Shari’ah compliant structures, AA suggests equity in a firm that does not engage in transactions contrary to Shari’ah. Or you might want to consider sovereign sukuk issuers who are expected to be less prone to employing Abu Yusuf or his “tricks”.

Obtain More Collateral and Take Possession

1. More described “security” was ostensibly obtained, including some promises of  future security arising from what might charitably be described as high unlikely events, e.g., sale of DG’s fine Egyptian assets or payment of an arbitration award by Iran.   
2. One would need an electron microscope to assess the practical impact on the sukuk holders’ security position of the additional collateral, including the (  في المشمش ) type.
3. AA recommended taking possession of security now rather than waiting to attempt to exercise rights after default.  That didn’t happen.  One sad example: the Ijara assets apparently have not been registered in the name of the Trustee. As noted in Lessons and above, that opens a potential loophole big enough for Donald Trump’s ego to pass through comfortably.

Increase Amortization, Add a Cash Sweep

1. The sukuk holders had a partial victory here.  The sukuk has been reduced to just under USD 400 million.
2. But only the down payment was mandatory.  The additional payment got DG a reduction in rate.  DG made both.
3. But as of now DG have no further obligations to make principal repayments until final maturity of the sukuk in October 2020.
4. To add insult to injury, DG won the right to pay dividends of 5.5% of paid in capital (roughly USD 95 million) a year with the only requirement that after payment of dividends DG maintain USD 100 million in cash and equivalents.
5. To spell it out, it doesn’t matter what DG’s cash flow or income is.  If DG has money in the bank, it can pay dividends of roughly USD 100 million a year as long as after payment it still has USD 100 million in the bank.  
6. A very key point: DG prepares "consolidated" financials that include assets and liabilities of investee companies, including Pearl Petroleum.  Legally, DG does not own these amounts and cannot use them.  
7. In the past I've focused on the Pearl Receivables.  Now it's time to look at Cash and Banks.  Note 15 to DG's FYE 2018 AR page 89 contains information on Current Assets of Pearl appearing on DG's balance sheet - some USD 131 million which would include Pearl cash and A/R.  
8. From the MD&A (page 36) we know that DG's share of Pearl A/R was some USD 18 million.  A rough estimate (note the double caveat here) then is that about USD 100 million of Cash on DG's balance sheet is likely to really be Pearl's cash.  Unless Pearl dividends this money to DG, DG cannot use it for sukuk repayment or other purposes.  
9. The key issue here is whether the dividends restriction is based on the cash appearing on DG's consolidated financials or its parent only financials (not disclosed in the AR).  
10. By AA’s calculation USD 100 million is 25% of the amount due at final maturity.  Of course DG cannot reduce its cash to zero if it is to remain a going concern. Equally it cannot use Pearl's cash for its operations or for debt service.  
11. DG's cash is USD 400 million in bank as per consolidated financials. And on a parent only basis, perhaps USD 300 million.  In either case, DG can pay away just under USD 200 million before final maturity.   
12. Leaving USD 200 million (consoldiated) or USD 100 million (estimated parent only).   50% of the final principal repayment, ignoring cash it must retain for operations. Or in the worst case 25% of the final payment.
13. That appears to leave sukuk holders in the position of hoping that DG can generate aggregate net cash of about USD 300 million during 2019 and the first 10 months of 2020 (consolidated basis) or USD 400 (million parent only).  That’s based on the assumption that DG would not reduce its cash to zero to make the final payment and probably needs to retain at least USD 100 million to assure ongoing operations.
14. If it does not generate that cash, then there will be another restructuring.  As outlined above, the sukuk holders have scant legal leverage.

Shorten the Tenor

1. Tenor was kept reasonably short.
2. While the sukuk holders’ legal and collateral position is weak, the short tenor does keep some pressure on DG.  The threat of another messy restructuring and resultant worsening of banking and public relations may provide some leverage on DG.
3. Perhaps, the sukuk holders just trod the path of a typical commercial bank restructuring.  The lenders know that the proposed terms are not economically based.  That is, the borrower will be unable to make the payments in the time frame given.  But the terms will “sell” back in the head office.  And when the maturity is missed, someone else will be charged with restructuring.
4. In any case the sukuk holders may be in for the financial equivalent of a “Zeno’s dichotomy paradox” restructuring.  Each time they restructure they’ll get half way to full repayment.  At some point, I suppose, the amount will be such that a write-off will be less costly than the professional fees associated with another restructuring.
5. AA gives sound advice or so he imagines.  But, clearly,  (اليد في الميّة مش زي اليد في لنار ). 
6. Sukuk holders probably did as well as they could.  In the desert any water will do.
7. The lesson is to avoid the desert if possible.  Sound advice as usual from AA but of little use to those already "invested" in Nile Delta.
8. A cautionary tale that shows the importance of (فكر في الخروج قبل الدخول )

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.

GFH 2017 Unexplained Pricing on USD 314.5 Million Share Issue - What Did We Learn About Transparency?

AA Promised a Rant and Here it Is

In an earlier post, I outlined what appears to be a discrepancy between the price at which GFH issued some 1,186,904,148 new shares in 2017 and the price that the Board requested shareholders approve and which they did approve at GFH’s 1 March 2017 EGM.

According to AA’s analysis, on average the shares were issued at USD 0.2505 per share (a 5% discount to par value) instead of the approved price of USD 0.953 per share.

AA could find no explanation from GFH for the discrepancy. So let us assume that the lower pricing is appropriate.  The fact that there is no disclosure suggest some serious shortcomings in disclosure.

This is not simply an exercise in quibbling.  The difference in price had an immediate impact on dilution of the existing shareholders.  Had shares been issued at USD 0.953 each, GFH’s “old” shareholders to use Abdul Muhsin AdDarwiish’s happy turn of phrase would own some 88% of GFH.  Instead they own 61%. 

That in turn, leads AA to ask did shareholders understand the potential impact of dilution.  Was that impact sufficiently disclosed to them at time of approval? Was the significant change in price disclosed to them prior to conclusion of the transaction?  Were they asked to reaffirm their approval? Or otherwise consulted?  

You can read more details here. 

Let’s turn to the lessons AA thinks regulators, stock markets, shareholders, and GFH management should have learned from the share issuance. 

Dilution

1. If we take the EGM minutes as an accurate and complete account, then there was no discussion about the effect of dilution on current shareholders resulting from the issuance of a potential 3.4 billion of new shares.
2. Shareholders didn’t ask.
3. GFH’s Board did not raise the topic.
4. Perhaps, the Board are forgetful. If only they remembered, they would have raised it.
5. Perhaps, they forget they have a fiduciary duty to their shareholders. So they don’t feel a need to raise it.  The shareholders should look after themselves.
6. Whatever the case, it’s clear that the authorities need to establish a rule. You must tell your shareholders in writing what the proposal means.  If all the shares being offered are taken up, your shareholding will go from x% to y%. You must provide this document to them as part of the EGM package prior to the meeting.  And it must be clearly mentioned and discussed at the meeting.
7. External auditors should also be counseled that they have a fiduciary duty to the shareholders on matters like this, not a fiduciary duty to the board.  And that duty means they must bring up the topic if no one else does. One way to solve this issue so external auditors won't be shy out of concern about re-appointment is to make it a requirement that when dilution may occur, the external auditors are required by law to give a report.  
8. Representatives of the Central Bank, the Ministry of Commerce should be trained to make sure dilution is discussed, raising the topic if they have to. 
9. When the promised issue price is changed in a way that would increase dilution, as is the case here, It seems that the board at a very minimum needs to advise shareholders.  AA's minimum though would be a bit stricter to give shareholders a second vote at a second EGM.  Why? Because the change in price dramatically changed the shareholders' ownership interests in the company.

Disclosure

1. When there is new share issuance, details of the transaction need to be provided in writing to shareholders via a discussion in the annual report and a special disclosure on the exchanges where the company is listed.  Both ways.
2. The ludicrous two line “disclosure” given by GFH is completely inadequate.
3. Because of this it is clear that the authorities need to establish a rule requiring such a report and mandate its format and contents as issuers appear unable to determine what material information should be included. 
4. Data should include:  number of shares issued, class of shares, issue price per share allocated between par value and share premium. Gross proceeds, expenses, net proceeds.
5. If there are unusual accounting entries, e.g., the unexplained USD 24.3 million debit to the Capital Adjustment Account, these need to be explained in understandable language in financial statements.
6. Note 16 page 41 in GFH's 2017 AR has the following “explanation”: “Shares were issued to the subscribers resulting in increase in share capital by US$ 314,530 thousand. Excess over the par value of US$ 0.265 per share has been considered as share premium and reflected accordingly under share premium account (including transfer from capital adjustment account).”
7. That is not an adequate explanation.
8. And, no, management cannot hide behind the bogus excuse “the auditor made me do it”.  If the auditor is adamant that its language is unalterable, which seems unlikely. AA has never had a problem with auditors refusing to provide additional information. Then the management can explain in the MD and A in the AR. Or by  other means.
9. Frankly, the opaque language used in this note looks like a deliberate attempt to keep information from readers of the financials, to obfuscate the transaction, though it could also be the result of other deficiencies in aptitude or attitude.
10. How can a share premium be negative?  
11. Why is there a need to use the capital adjustment account? What on earth is being adjusted? 
12. If shares were issued at a discount, then that needs to be clearly and simply stated.
13. (شفافية) is not simply a word, or an expression of intent.
14.  It is proven by action – providing detailed, understandable information. 
15. Failure to do so is (خداع) in the worst case.  Or deficiencies in attitude or aptitude.  In either of these two cases one probably would be well advised to entrust one's money to other stewards.