http://www.gulf-times.com/site/topics/printArticle.asp?cu_no=2&item_no=328709&version=1&template_id=48&parent_id=28
Islamic bond problems herald due-diligence era
Publish Date: Friday,27 November, 2009, at 12:44 PM Doha Time
Reuters/London/Manama
Islamic bond defaults and the standstill requested for Dubai's Nakheel
will transform the market as investors demand more transparency and subject new
issues to forensic due diligence. Investors in real estate developer Nakheel
were stunned following the announcement on Wednesday that the company and its
owner state-run Dubai World would delay by at least six months repayment on
billions of dollars in debt.
Nakheel had a $3.5bn Islamic bond, the largest ever issued, maturing on
December 14, an obligation the market widely expected to be honoured. "If there
are lessons to be learned here, it is that due diligence is all important.
Compliance to Sharia in its structuring does not ensure the success of a sukuk
or of any product or business," said Yusuf Talal DeLorenzo, chief Sharia
officer at fund management company Shariah Capital.
The sukuk market was already jittery before the news from Dubai. Earlier
this month prominent Saudi business group Saad said it would miss the payment
of the second bi-annual coupon on its $650mn Golden Belt Sukuk Belt 1 Sukuk
domiciled in Bahrain.
In May Kuwait's Investment Dar said it defaulted on a $100mn sukuk.
In its simplest form sukuk are certificates proving ownership of an asset
but unlike bond holders, sukuk investors do not receive interest but rather
returns generated by the underlying assets pooled under special purpose
vehicles (SPV). The events have shaken the reputation of sukuk as safer and
more transparent than their conventional counterparts - just as the market was
recovering from a slump in 2008, with issuance up 40% in the first ten months
of the year. They also show that sukuk do not necessarily grant ownership of
the underlying assets, which would in theory make investors safe in case of
default.
"Clarity on the structure is essential. The Islamic finance industry must
do all it can to avoid accusations of mis-selling products," said a senior
industry figure, who spoke on condition on anonymity. The nature of the sukuk
also plays a role in where Islamic debt is ranked in debt restructuring
processes such as the ongoing ones at Saad and Investment Dar.
"It will be interesting to see whether the recovery value will be higher
than at the senior debt," Mohieddine Kronfol, managing director at Dubai asset
manager Algebra Capital, said of the Saad sukuk. Even when investors fully
understand the structure of the sukuk, it is not certain their ownership rights
will be reinforced, said an Islamic finance expert who declined to be named.
"The reality is that Middle Eastern property law is so weak that even
with asset-backed, people have little confidence in the success of that claim,"
the expert said, adding most investors did know the risks involved.
"All the rating agencies have never rated Middle Eastern sukuk in
reference to the assets, they only ever rated them in reference to the credit
rating of the sponsoring entity. They were rated as unsecured liability," he
said. A dramatic sell-off, although possible, looks improbable, according to
Indraj Mangat, a partner at law firm Eversheds' Islamic Finance Group. "The
defaults in the Gulf sukuk markets are more a reflection of the broader
economic difficulties in the Gulf than an indictment of sukuk per se. It is
possible that investors may judge sukuk on the defaults but that is like
throwing the baby out with the bath water," he said.
Investors however will become more discerning.
"Lending in the Gulf has often been based on the perceived value of the
family name of the borrower or its backers. The current announcement sees that
position being eroded, " said Amjad Hussain, head of banking and Islamic
finance, Middle East at law firm Eversheds. "The defaults in the Gulf will now
act as a catalyst for lenders to encourage them to adopt a more impartial and
diligence-led process. This is good for the long-term development of the Gulf
economies including on corporate governance-type issues," Mangat said.
[Non-text portions of this message have been removed]
