Largely untested Islamic finance structures have, as we all know, been drawing unwanted scrutiny due to Dubai World’s recent debt-standstill antics.
However, that hasn’t stopped western corporates from adopting Islamic debt structures in a bid to raise much needed financing from alternative non-Western sources.
On November 19, General Electric became the first US corporate to issue an al-ijara Islamic bond — the $500m sukuk being marketed to investors in the Middle East, Asia and Europe. The industrial conglomerate reportedly saw strong demand for the issue, with orders coming in at under $1bn, according to bankers familiar with the deal.
On November 30th, GE listed the 2014-due bond on the Bursa Malaysia — one of the most developed sukuk markets in the world.
Helping matters along in terms of demand will certainly have been the sukuk’s al-ijara structure. According to Islamic finance experts this is seen as a shariah-compliant model in the eyes of the Bahrain-based Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) — unlike the now out-of-favour mudaraba and musharaka issues.
However, it also suggests the structure is similar to Dubai World’s infamous Nakheel al-ijara issue — which, of course, has revealed complexities all of its own.
Consequently, Blake Goud, over at the Sharing Risk blog, flags up some issues in terms of functionality in the event of default. As he states, lack of clarity might account for why the bond carries a 20 basis-premium over conventional debt:
It is unclear what this premium reflects, but it could be due to the relative lack of clarity about how sukuk function either in restructuring or default. The sukuk issuance comes 4 months after GE Capital ended its issuance of debt with a government backstop that began during the credit crisis. While GE Capital was a part of the Temporary Liquidity Guarantee Program, it issued $51 billion in long-term debt and $17 billion in commercial paper.
As we’ve not seen the prospectus we can’t really offer that much more guidance.
Nevertheless, we do imagine if there are concerns they must lie here — with the lack of a clear default precedent.
Goud, by the way, offers a great account of what Nakheek sukuk-holders might expect to get back following the Dubai World standstill. Above all, he stresses the issue is a “complicated financial product” and that Dubai laws do not indicate how investors might be treated or what recourse they can take.
Of course, in the case of the GE Capital sukuk we would imagine there is one important difference: recourse to the US legal system. And while there’s still no precedent for an al-ijara default in the United States, there is one for a musharaka structure in the case of the East Cameron ECP sukuk.
As explained in a paper by Tan Wan Yean, entitled Sukuk: Issues and the Way Forward (our emphasis):
The ECP Sukuk was launched in July 2006 in US to raise USD165.67 million, using the Musharakah structure12. It was a multiple-award wining sukuk which was once the spotlight of the media. In October 2008, East Cameron Gas Co. (“East Cameron”) filed for bankruptcy protection after its offshore Louisiana oil and gas wells failed to yield the expected returns, partly because of hurricane damage13. The issue in this case was whether the sukuk holders actually own a portion of the company’s oil and gas. In this relation, East Cameron argued that there had been no real transfer of ownership of production revenues, known as royalties, into a “special-purpose vehicle” formed to issue the sukuk. Instead, the company claimed the transaction was merely a loan secured on those royalties, implying that sukuk holders would have to share the royalties with other creditors in the event of liquidation.
Fortunately, the bankruptcy judge, Robert Summerhays J. rejected the company’s contention and ruled that the sukuk holders “invested in the sukuk certificates in reliance of the characterization of the transfer of the royalty interest as a true sale”14. The judge then gave East Cameron leave to find further arguments to support its case.
With that in mind, it will be interesting to see how the Nakheel debacle affects future al-ijara issues.
Related links:
The issue of shariah compliance and the Nakheel sukuk – FT Alphaville
What can Nakheel sukuk holders expect in a default? – Sharing Risk