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Global debt goes Islamic
Despite a significant slowdown in the Islamic bond market, companies around the globe are turning to Islamic issuances amid a credit crunch that is paralysing lending markets. Now some corporations are adapting deals constructed to conventional specifications, in order to tap the riches on offer in the Gulf. Andrew White reports.
While markets in the us and Europe head for meltdown amid a slew of bank collapses and bailout schemes, attention is turning to the Islamic finance houses of the Middle East.
The Gulf's Sharia-compliant finance houses are obliged to conduct a closer scrutiny of assets they lend against than their conventional counterparts - many of whom have plunged into the subprime abyss as a result of ill-considered loans.
And with companies around the world now cut off from conventional lending streams, they are increasingly turning to the Islamic institutions of the Gulf to secure much-needed funding through Islamic bonds, or ‘Sukuk'.
"A lot of our clients are looking at the Middle East and at institutions in the Middle East to see if they can help with their business, and whether there are more opportunities for Western institutions to go into the Middle East and adopt Islamic standards," says Neil Miller, head of Islamic finance at international legal practice Norton Rose.
Moreover, in order to satisfy Sharia principles, conventional corporates are scrambling to adapt deals developed on a conventional basis.
The Gulf has the cash, and companies around the world are doing anything they can to gain access to those petrodollar billions - including reconfiguring transactions to avoid assets and structures deemed not to be Sharia-compliant.
"The arrangers are looking at if they can restructure their deals on a Sharia-compliant basis, or whether they can create a parallel investment opportunity fund or whatever it might be," says Miller. "So we're seeing that already and we're currently working on a number [of cases]."
The news will come as a boost to the Sukuk market, where growth had slowed in the first three quarters of 2009. Until this year Islamic bonds had been the fastest growing part of the global bond market. Its value had doubled every year since 2004 to $90bn worldwide at the end of 2007, and its position as a key pillar of the $1 trillion Islamic finance industry was unquestioned.
In the last two months alone Investment Corporation of Dubai, a state-owned holding company, said it will raise $5.6bn in a dual-currency loan, while Abu Dhabi National Energy Company borrowed $3.15bn to refinance debt, and Sorouh Real Estate, Abu Dhabi's third-biggest property company, sold $1.1bn of bonds.
However, 2008 has been a far from vintage year for Sukuk issuance, where banks sell debt by using assets to generate income equivalent to interest they would pay on conventional debt.
Total issuance worldwide stood at around $14bn in the eight months to August 31, 2008, down from around $23bn during the same period in 2007, according to ratings agency Standard & Poor's (S&P). What's more, analysts do not anticipate the market will pick up again before 2009.
"I think there's a natural hesitation because when you dig more deeply into the market you'll see a lot of the buyers of this paper are the Islamic windows of conventional banks," says Miller.
"The fact that they haven't got appetite at the moment has impacted the Islamic capital market exchange," he continues. "The linkage is partially because a lot of the arrangers of these instruments are conventional institutions acting in an Islamic capacity - for example, the two biggest arrangers of these instruments are Citi and HSBC."
Another factor in the slow progress of the Sukuk market has been the declaration by a group of influential Islamic scholars that most bonds fail to adhere to religious rules.
As with all Islamic financial instruments, the money cannot be used to finance gambling, guns or alcohol. However in February, the Bahrain-based Accounting & Auditing Organisation for Islamic Financial Institutions (AAOIFI) ruled that bonds don't meet religious requirements if they haven't transferred ownership of collateral to holders. About 85 percent of Sukuk failed this test, the board said.
"The industry is looking very closely at how it is going to do these deals in the future," says Miller. "In the current circumstances it's a hesitation rather than being symptomatic of anything more worrying, but the AAOIFI has caused the industry to reassess whether these instruments are moving away from Sharia fundamentals or whether they are permissible."
The credit squeeze and the religious edict have conspired to inspire nervousness among investors, and spreads have been hit hard. The HSBC-DIFX index of Sukuk has declined 0.7 percent this year, while the comparable conventional debt index has climbed over 1.3 percent.
Sukuk have on average yielded 320 basis points over US treasuries in 2008, while comparable conventional debt issued by Middle East borrowers has an average yield spread of 314 basis points.
"There's an element of bad synchronicity in the timing; had you had one of these on its own you wouldn't have seen so much hesitation," suggests Miller. "If there was no subprime crisis or credit crunch, people would have been looking at what the AAOIFI had to say, and then going out there much more confidently to work out what new structures could be created and how that would affect pricing."
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