Will Dubai Default Sink International Islamic Bonds Market?

Dubai's debt woes are bringing the world's attention to the Islamic finance, particularly the Islamic bonds known as sukuk. Sukuk are Sharia-compliant bonds that do not pay interest. Instead, the sukuk sellers pay the debt holders a share of the rent or capital gains from non-cash physical assets or share of the profits earned from businesses purchased with the money raised. Unfortunately for the Nakheel sukuk holders, the real estate bubble in Dubai that promised big gains from rents and sales has collapsed. And the Islamic bond holders are facing the possibility of a major default, resulting in a dramatic sell-off of sukuk in the last few weeks. According to Data Explorers, a company that tracks how much of a company's stock or bonds are out on loan, about 75% of institutions holding the sukuk sold their position between the end of August and the end of November. "It's an extraordinary sell-off in a bond so close to maturity, when there was no indication of a problem refinancing. The data suggests they had some information that it was a good time to sell," said Data Explorers managing director Julian Pittam.

Dubai's recent request for a debt standstill for Nakheel, one of its biggest state-owned companies, has raised the possibility of the largest Islamic bond or "sukuk" default on record, raising alarms in the global Islamic debt markets.

Nakheel, the Dubai developer behind many of the Emirate's high-profile projects, has to find $4bn to repay sukuk by the middle of this month, according to a report in Financial Times.

If Nakheel doesn't get creditors to agree to a stay on their claims, the Dubai company could be declared in default after Dec. 14, 2009. A group of the sukuk holders, including New York-based hedge-fund firm QVT Financial LP, have appointed London-based law firm Ashurst to represent them in the matter, says the Wall Street Journal.

A December 2006 report on the Nakheel sukuk sale in Euroweek, a trade publication for capital markets, said about 100 accounts bought the notes. Of those, more than half were banks. By geography, about 40% of the issue was placed in the Middle East and 40% in Europe.


Beginning modestly in 2000 with three sukuk issuers collectively worth US$336 million, the Sukuk bonds exceeded $75 billion last year. Issuance of sukuk - both in domestic and foreign currencies - has been quite common in some countries. The most active issuers of sukuk in the past year include Malaysia, the UAE, Saudi Arabia, Pakistan, Kuwait and Bahrain.

The potential Dubai default is likely to negatively affect nations in Asia and the Pacific region planning to raise money by offering sukuk. Indonesia, Pakistan and South Korea are planning to sell Islamic bonds offshore in separate offerings. Jakarta plans to sell up to $1 billion of global sukuk by the second quarter of 2010, according to people familiar with the situation. Pakistan, the only other Asian nation to have issued offshore Islamic bonds, has just $600 million outstanding from its 2005 sale. It is looking to raise $500 million in Islamic bonds next year.

The Karachi city government is preparing to issue $500 million in municipal sukuk by February, 2010, a Pakistan finance ministry official said in September this year.

South Korea is looking to sell what would be its first ever sukuk as it continues to refine its tax laws to facilitate issuance. It wants to attract capital from Islamic nations to diversify its funding sources and reduce its refinancing risks. The Korean government has been planning a road show in Malaysia and the United Arab Emirates.

Since the start of this year, $8.1 billion of Islamic bonds out of the Asian-Pacific region have priced, exceeding the $6.4 billion volume in the same period last year, according to data provider Dealogic.

Last year's global economic crisis brought attention to Islamic finance as an alternative for both Muslim and non-Muslim customers. In an article, the Vatican newspaper Osservatore Romano voiced its approval of Islamic finance. The Vatican paper wrote that banks should look at the rules of Islamic finance to restore confidence amongst their clients at a time of global economic crisis. “The ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service,” the Osservatore Romano said. “Western banks could use tools such as the Islamic bonds, known as sukuk, as collateral”. Sukuk may be used to fund the "car industry or the next Olympic Games in London,” the article said.

Investors have been attracted by Islamic banking's more conservative approach: Islamic law forbids banks from charging interest (though customers pay fees) and many scholars discourage investment in excessively leveraged companies. Though it currently accounts for just 1% of the global market, the Islamic finance industry's value is growing at around 15% a year, and could reach $4 trillion in five years, up from $500 billion today, according to a 2008 report from Moody's Investors Service.

The unfolding debt crisis in Dubai is the severest test yet of the short life of the Islamic debt markets. The process and the outcome of the ultimate resolution of the debt crisis in the tiny Gulf Emirate will have a lasting impact on the future of entire global Islamic finance.

Related Links:

Trillion Dollar Halal Business

Sukuk.me

South Asians Flee Dubai

Nakheel Saw Unusual Selling

Islamic Finance Structures 101: Mudarabah

Pessimism is the Ultimate Kufr

Nakheel Sukuk Saw Unusual Selling

July in Dubai

Comments

Mayraj said…
Islamic Finances uses as a tool what is known in US as lease financing. of course, the property bubble has hurt investors in it. But, lease finance can be used as a vehicle for financing in other ways as well. US reveals that in spades and the state of your location is a major user of this financing technique.
Riaz Haq said…
Pakistan ranks 8th in the world of Islamic Finance, according to a Guardian story. Here's an excerpt:

How it works

Islamic finance is all about sharing risk between financial institutions and the individuals that use them. To do that, the two parties are tied into a longer-term relationship with each other that is supposed to shift incentives and avoid cut and run financial deals.

So, for example, sharia-compliant mortgages mean that the bank and the borrower share the risks of repayment rather than charging any form of interest. Similarly, Islamic bonds like the one announced by David Cameron today involve both parties owning the debt, rather than a simple promise to repay a loan.

Since it's Islamic, that also means that financial trading is off-limits for things that are forbidden even if no interest is charged - so investments can't be made in alcohol, tobacco, non-halal meat products such as pork, pornography or gambling companies.

You don't have to be Muslim to use Islamic financial services - a fact which has stimulated further interest in the sector. The Islamic Bank of Britain reported a 55% increase in applications for its savings accounts by non-Muslims last year after the Barclays rate-fixing scandal.

In numbers

275: The number of Islamic financial institutions in the world.
75: The number of countries where they have a presence.
US$1.357 trillion: The value of the global Islamic finance services industry by the end of 2011.
US$4 trillion: The projected value of the global Islamic finance services industry by 2020.
£200m: The value of the planned Islamic bond being unveiled by David Cameron today.
11th: The ranking of the UK (up 4 places from 2011) in the Global Islamic Finance Report which weighs up variables like the number of institutions involved in Islamic finance industry, the size of Islamic financial assets and the regulatory and legal infrastructure.

Glossary

bay 'al-mu'ajjal: Instant sale of an asset in return for a payment of money (made in full or by instalments) at a future date
gharar: Describes a risky or hazardous sale, where the details of the sale contract are unknown or uncertain
ijarah: Leasing contract
istisna': Refers to an agreement to sell a non-existent asset, which is to be manufactured or built according to the buyer's specifications and is to be delivered on a specified future date at a predetermined selling price.
mudarabah: Profit and loss-sharing
musharakah: Joint partnership
qard hasan: Interest-free financing
riba' : Usury
sharikat al-'aqd: Contractual partnership
sharika al-milk: Proprietary partnership
sukuk: Islamic bonds
tahawwut: Hedging
takaful: Islamic insurance
wadiah: Safe custody
wakala: Investor entrusts an agent to act on his behalf
zanniyyat: probabilistic evidence


http://www.theguardian.com/news/datablog/2013/oct/29/islamic-finance-for-beginners
Riaz Haq said…
A rally in Pakistan bonds bodes well for the world’s second-biggest Muslim nation as it prepares to sell global sukuk for the first time since 2005.

The government may issue $500 million of dollar Islamic notes by month-end, Finance Minister Ishaq Dar told reporters in Dubai on Nov. 8, reviving the sale initially scheduled for September. The yield on the nation’s conventional five-year U.S. currency debt sold in April dropped to a five-month low of 6.16 percent and Union Investment Privatfonds GmbH is predicting 6 percent for a similar-maturity sukuk.

Investors have sent the benchmark stock index to a record and the rupee to its strongest in more than two months as they focus back on the economy as Prime Minister Nawaz Sharif overcame pressure from opposition members to step down in August. Global sales of sukuk are heading for the worst fourth quarter since 2008, aggravating a shortage of Islamic securities that may support demand for Pakistan’s offering.

“The macroeconomic outlook of the country has vastly improved,” Vasseh Ahmed, chief investment officer of Faysal Asset Management Ltd., which oversees $85 million in Karachi, said in a Nov. 11 e-mail. “There is expected to be substantial interest owing to the lack of investment avenues for Islamic investors.”

Shrinking Sales

Worldwide sales of Islamic bonds dropped 81 percent this quarter to $2 billion from the previous three months, data compiled by Bloomberg show. Issuance climbed 11 percent in 2014 to $38.9 billion, trailing 2012’s record $46.8 billion total.

Pakistan tapped the international debt market in April for the first time since 2007. It sold $2 billion in total of 7.25 percent non-Shariah-compliant notes due in 2019 and 10-year 8.25 percent bonds whose yield was at a three-month low of 7.46 percent, data compiled by Bloomberg show. Demand exceeded the amount on offer by 14 times.

The nation has no global sukuk outstanding, only local-currency Shariah-compliant notes that were last issued in June.


A five-year note will pay from 6 percent to 6.5 percent and 10-year securities 7 percent to 7.5 percent, Mohammed Sohail, Karachi-based chief executive officer at Topline Securities Pakistan Ltd., said in a Nov. 11 e-mail.


---------
The South Asian nation’s foreign-exchange reserves totaled $14 billion in September, compared with $8.7 billion at end-2013, central bank data show. The fiscal deficit narrowed to 5.8 percent of gross domestic product in the 12 months through June, from 8.2 percent the previous year, according to official data on June 3.

‘Attractive Yield’

“The key factor will be the domestic political situation,” Sajjad Anwar, chief investment officer at NBP Fullerton Asset Management Ltd., which manages $456 million, said by phone on Nov. 11 from Karachi. “The economy is in better shape now and the response to the sukuk will be very encouraging.”

The nation, which is rated below investment grade at B- by Standard & Poor’s, is still likely to attract investor interest because of its higher yields. Qatar’s global Shariah-compliant debt due in 2023 yields 2.99 percent, while Malaysia’s 2021 sukuk pay 2.93 percent, according to data compiled by Bloomberg.

Pakistan has engaged in economic reforms to meet conditions of an International Monetary Fund bailout. The Washington-based lender said in a Nov. 8 statement that it will seek board approval to release $1.1 billion in loans in December. The reforms are “broadly on track” with growth forecast at 4.3 percent in the fiscal year ending June 2015, the fund said. GDP increased 4.1 percent in the last financial year.

“Pakistan is a very well known name to the sukuk investor community,” Union Investment’s Dergachev said in a Nov. 11 e-mail. “It still offers a very attractive yield compared to other sukuk issuers both in the sovereign and corporate space and that matters in a low-yield environment.”

http://www.bloomberg.com/news/2014-11-13/sharif-weathering-protest-revives-pakistan-plan-islamic-finance.html
Riaz Haq said…
From Wall Street Journal:

ISLAMABAD—Pakistan raised $1 billion through an Islamic bond issue on Wednesday, its first such issue in nearly a decade, in a bid to boost the country’s economy, finance ministry officials said.

The government initially planned to raise $500 million from the issue, but the bond was oversubscribed, with requests totaling $2.3 billion, the finance ministry said. Offers of $1 billion were accepted for a five-year maturity at a so-called profit rate, which is similar to a yield, of 6.75%.

The issue was part of Prime Minister Nawaz Sharif ’s ambitious plans to boost Pakistan’s economy, which include divestments and privatization of as many as 31 state-owned enterprises.

Finance Minister Ishaq Dar called the bond issue “a reflection of [the] international investor community’s [confidence] in the leadership of Prime Minister Nawaz Sharif and his economic policies.”

Officials on Thursday said the issue had added significance because of the abandoned sale of a part of the government’s stake in the country’s largest oil and gas business, due to poor investor response. That sale had been expected to raise $800 million, but investors tendered bids for only 52% of the shares on offer.

An Islamic bond, or Sukuk, doesn’t rely on interest, which is forbidden in Islam. Instead, the bonds are linked to assets and profits paid to investors based on revenue generated by the assets, or based on the investor’s part-ownership of the asset, depending on the bond’s arrangement.

“This [bond] issue has been very successful; It’s a big boost and a statement of trust from investors,” a senior finance ministry official said, requesting anonymity because he wasn’t authorized to speak to the media. “Our assessments proved correct: that investors were hungry for an Islamic bond.”

In a statement issued after the issue, Pakistan’s finance ministry said the profit rate of the $1 billion Islamic bond “compares favorably with the average weighted cost of comparable domestic debt of about 11%” and will result in annual savings worth 5 billion Pakistani rupees, or nearly $50 million, in debt servicing.

The ministry said the $1 billion proceeds from the bond issue will immediately go to the country’s central bank, which will help boost foreign exchange reserves. Pakistan had liquid foreign exchange reserves of $13.2 billion as of November 21, according to the State Bank of Pakistan. The government wants to increase reserves to $15 billion by the end of this year.

The International Monetary Fund is expected, pending a review by its executive board next month, to release a $1.1 billion tranche of a $6.6 billion loan to Pakistan.

http://online.wsj.com/articles/pakistan-issues-1-billion-of-bonds-1417113745
Riaz Haq said…
Pakistan's capital market regulator has published long-awaited rules for the issuance of sukuk, or Islamic bonds, as part of efforts to strengthen governance and broaden their appeal to investors.

The regulator first drafted the rules in October 2012, but efforts have accelerated under a five-year plan that authorities hope will double the industry's share of the banking sector to 20 percent by 2020.

The rules come at a time when issuance of corporate sukuk in Pakistan is gathering pace, helping broaden an Islamic capital market which in recent years has relied on the government for the bulk of such deals.

The current pipeline of sukuk includes utility K-Electric , which is planning a sukuk worth 22 billion rupees ($217 million), which would be Pakistan's largest corporate sukuk to date.

Pakistan Mobile Communications (Mobilink) and Bank Islami Pakistan also plan sukuk of their own.

Under the rules, sukuk will have to be structured to comply with standards of the Bahrain-based Accounting and Auditing Organisation for Islamic Finance Institutions (AAOIFI), as well as those set by the local regulator.

AAOIFI standards indicate how Islamic financial products should be structured; complying with the standards could increase the appeal of sukuk to investors by addressing consumer concerns about their religious authenticity.

The rules require issuers to conduct an annual audit to ensure the sukuk confirms to sharia requirements. Sukuk must also carry a credit rating not lower than triple BBB.

http://www.reuters.com/article/2015/02/10/pakistan-sukuk-rules-idUSL5N0VK00J20150210

Popular posts from this blog

Pakistani Women's Growing Particpation in Workforce

Project Azm: Pakistan to Develop 5th Generation Fighter Plane

Pakistan's Saadia Zahidi Leads World Economic Forum's Gender Parity Effort