Euromoney, May 2015
IIFIM/GAVI – THE IMMUNISATION SUKUK US$500 million (Barwa, CIMB, NBAD, NCB, Stanchart; Allen & Overy, Slaughter and May)
Backers of Islamic finance often try to bracket their work with socially responsible investing: an argument that Shariah compliance is not only a sign that something avoids interest and alcohol and so forth, but actively contributes to a broader social good. That’s not always an easy claim to make, but this deal showed Islamic finance contributing in a useful way.
The International Finance Facility for Immunisation (IFFIm) is a multilateral created to provide predictable and long-term funding for Gavi, which seeks to bring health and immunization programmes to young children in 70 of the world’s poorest countries.
The idea of the sukuk was to raise funding, diversify the investor base, and create a benchmark in sukuk without compromising on the pricing available in the conventional world. It achieved this impressively, pricing at just 15 basis points over dollar three-month LIBOR, a rate 4 bps inside IFFIm’s previous three-year conventional bond, despite the deal size having been increased from a planned US$300 million. Moreover, since conventional funding had chiefly come from the west, the fact that 89% of the sukuk went to Middle Eastern and Asian investors was a useful diversification: in fact, 85% of the order book came from new, and primarily Islamic, investors. The diverse home bases of the bookrunners – Barwa from Qatar, CIMB from Malaysia, NBAD from Abu Dhabi, NCB from Saudi Arabia, and Standard Chartered as the multinational – illustrated the push for distribution into Islamic markets, and each had a role to play in obtaining regulatory approvals and favourable risk weightings at the local level.
Along the way, the deal became the largest ever sukuk al-Murabaha issue, as well as being the largest inaugural from a supranational. More to the point, deaths among children under the age of five have dropped by 28% since Gavi was created, and this facility will help it to continue this good work.
Hopefully – and this, really, is what puts it on our list – the IFFIm deal paves the way for more socially-responsible sukuk to be launched: surely, a segment of the market that would mesh very tightly with the principles that Islamic finance is supposed to represent.
SAUDI TELECOM – SAR2 billion sukuk programme
(JP Morgan, NCB, Stanchart, Saudi Fransi; also Allen & Overy, Clifford Chance)
The Saudi Telecom deal was an illustration of the growing sophistication both of Saudi Arabian borrowers and the markets within which they issue. Consider the fact that Saudi Electricity’s US$2.5 billion 10 and 30-year Reg S/144a sukuk doesn’t even make our list: scale and tenor like that from big Saudi Arabian borrowers is no longer remarkable.
There was a better case to include National Commercial Bank’s SAR5 billion tier 2 subordinated sukuk, a landmark deal: not the first subordinated sukuk from Saudi Arabia, but the one at the lowest price and with the highest order book, as well as being the largest ever bank issue from Saudi and the largest subordinated debt instrument from a bank in MENA, all of this despite being NCB’s debut in riyal debt markets. That was a highly successful and influential deal.
But we have opted to represent the Saudi sukuk markets with this issue from Saudi Telecom. Like everything else from Saudi these days, it could make a claim just on size, pricing and the sense of a landmark: it is the first debut riyal deal to go to 10 years, the first Saudi telco to access the debt markets, and the tightest ever pricing for a Saudi entity in 10-year funding, which creates a useful benchmark.
But it makes our list too for a point of structural innovation. So far, most corporate sukuk in Saudi have used a combination of Murabaha and Mudaraba, but where all of the work of the structure is in the Murabaha piece: this covers all the principal and profit payable under the sukuk. The Mudaraba, Clifford Chance explains (it and Allen & Overy were instrumental in this deal), “serves no real purpose other than to ensure that the sukuk are not solely based on debt and are therefore freely tradable.”
This deal did things a little differently, using the mudaraba part to service the coupon payment. Why does this matter? Well, the outcome of it is that investors are genuinely exposed to the performance risk of Saudi Telecom’s business. Given that Islamic finance is supposed to involve an equal sharing of risk among all parties, it makes it more clearly Shariah compliant, which matters more in Saudi Arabia than anywhere else. In creating a more risk-based Shariah structure, the deal not only returned to the principles of Islamic finance but also appealed to a lot more investors.
The introduction of risk brought additional structural requirements: in addition to the Murabaha, structured to provide capital protection, there was also something the lawyers call an available cash mechanic, which provides a form of cash collateral and “serves as an early warning signal if things are not going quite as planned,” Clifford Chance explains. This is the first time the structure has been tried; it combines the more risk-based approach with comfort for investors that what they’re investing in is consistent with market practice.
AMLAK RESTRUCTURING (Allen & Overy, Clifford Chance) (UAE, about $2.7 billion)
Islamic finance needs to be a viable tool not only for capital raising, but for resolution and restructuring. It’s not as simple as it sounds, because of the requirement for an equal sharing of risk, which has to be observed throughout any corporate restructuring.
Amlak Finance is an Islamic mortgage provider in Dubai that ran into trouble during the global financial crisis and has been under restructuring advice since 2008. Why so long? Partly because the whole process has nearly 30 commercial participants and involved the restructuring of several different Islamic financing and deposit structures, including murabahas, mudarabas, and both bilateral and syndicated wakalas.
“One of the challenges of the restructuring was the need to right-size the balance sheet of Amlak Finance to reduce the total debt,” explains Allen & Overy, one of the lawyers on the deal alongside Clifford Chance. All participants converted part of their debt into an interest in a convertible contingent instrument, tied to a mudaraba arrangement through which participants will benefit from value growth in Amlak’s property portfolio over the life of the instrument. Any amount of the instrument that has not been redeemed by maturity can be converted into Amlak’s equity.
The whole lot – the facilities, the many creditors – are held together through a common terms agreement and intercreditor agreement. And the significance of it all, in the end, is a restructuring that has maintained exposure to potential gains, an equal sharing of risk, and Shariah compliance throughout a complicated and lengthy process. “The restructuring allowed a healthy equity position and gearing ratio for the company to meet all regulatory requirements, and to create a solid foundation for its recovery and future growth,” says Arif Alharm, Amlak Finance’s CEO. “We are very pleased.”
Malaysia Airports Holdings MR1 billion sukuk (HSBC, Citi, CIMB, Maybank)
Malaysia has always been a hub for Islamic finance innovation, and continues to be so. Many deals that came out of the country over the last year took the industry forward: Meximbank’s first dollar sukuk for an Eximbank; the Malaysian arm of Bank of Tokyo-Mitsubishi UFJ’s multicurrency programme that included the first yen sukuk in the global markets; AmIslamic’s groundbreaking bank capital issue; yet another innovative exchangeable from Khazanah – its sixth.
The one we highlight here was a RM1 billion sukuk from Malaysia Airports Holdings, the world’s first rated corporate perpetual sukuk.
The rating part of it was important because Malaysia Airports is among the highest rated issuers in the country and wanted to maintain the benefit of that rating in the pricing. A bigger institution than one might think, it operates and manages 39 airports in Malaysia, as well as three others in India and Turkey, and holds a (local) AAA rating. “The objective of issuing the perpetual subordinated sukuk,” explains Maybank, a bookrunner, “was to maintain MAH’s AAA corporate rating status and to avoid breaching its senior covenants.”
To do so, the sukuk was structured to achieve a 50% equity credit from the rating agencies; any other outcome would have pushed the issuer’s senior debt to a level that would have breached the AAA rating. It also received 100% equity classification for accounting purposes, which was important for the future since it avoids triggering any financial covenants. Despite this equity treatment, for MAH it represented cheaper equity funding than a share issue.
That’s fine for the issuer; but would it sell? It did, in force, with an order book passing RM5 billion by noon of December 3, the books having opened earlier that morning. The deal priced at 5.75%, below the bottom end of original guidance of 5.8%-6%, and participation was agreeably diverse, half of the deal going to asset managers and the remainder a mix of insurers, banks, corporates and high net worth individuals. “The transaction,” says CIMB, another bookrunner, “was a testimony to the increasing depth and maturity of the Malaysian fixed income markets, where investors are beginning to be more receptive towards structured finance transactions,” attracted by yield pick-up and reasonable credit protection.
Along the way, the deal became Malaysia’s first corporate perpetual sukuk.
Morocco Safi IPP (Mizuho, SMBC, BTMU, Mitsubshi UFJ, SG, Credit Agricole, BNP, UDB, Attijariwafa, BCP) (Clifford Chance)
Project finance lends itself extremely well to Islamic finance, since it’s very easy to satisfy the requirement for solid, tangible underpinnings to a financing when one is building a power plant or a highway. There were several of note in our period of review – others included the Al Sharkeya Sugar Manufacturing financing in Egypt, and the Wa’ad Al Shamal Phosphate financing in Saudi Arabia – but we highlight the Morocco Safi IPP, whose US$2.6 billion financing was completed in September. This project – labeled by the Moroccan state, with understated urgency, as “ultra-supercritical” – brought together GDF Suez, Nareva and Mitsui for a coal-fired independent power project near the port of Safi.
Aside from being the first multi-tranche cross-border Islamic financing into Morocco, and supporting a vital 1386 MW coal-fired power project with 18-year funding, this stood out for its financing mechanism, with a structured tranche provided by the Islamic Development Bank.
Normally, in an Islamic project financing, a procurement/forward lease structure is used – one sees at least half a dozen of these most years. But the Morocco deal (vitally, given pressures on funding) is a PPP, and this creates issues for Shariah compliance. Instead, a new structure was devised, combining an istisna’ arrangement with a wakala approach. This is the first time such a model has been used, and it will have applications for other PPP financings in the Islamic world.
It also helps to demonstrate the role that Islamic finance can play in Africa, which was one of the themes of the year (see also Dominic O’Neill’s article on Islamic finance on the continent). 2014 saw sukuk for the Republic of South Africa, with an inaugural US$500 million issue, and a local currency issue of CFA100 billion (about US$200 million) for the Republic of Senegal.
Nasdaq Dubai Murabaha platform (Emirates Islamic)
There has been an odd arrangement at work for Islamic financial institutions needing quick, liquid access to liquidity: they have been going not to some local market, nor to each other, but to the London Metal Exchange. It makes a certain amount of sense: the LME is a peerlessly liquid market for commodities which clearly fit the bill of Shariah compliance. But wouldn’t it be easier, and a greater show of faith in local markets, to transact in the Middle East?
That’s the premise behind Nasdaq Dubai’s new Murabaha platform, a collaboration between Nasdaq Dubai and Emirates Islamic, launched in April 2014.
The platform uses Shariah-compliant certificates that are traded on Nasdaq Dubai’s Central Securities Depository. The certificates are based on wakala investments such as sukuk from Emirates Islamic and other financial institutions. Islamic banks and finance companies can use those certificates to provide cash financing to customers; customers can buy and sell the certificates within minutes through Emirates Islamic Financial Brokerage. Some of these are small deals, a few thousand dirhams; some can run to many millions.
This is not the only way customers can get hold of murabaha, but it has several advantages over alternatives. One is price stability: unlike commodities or equities, these certificates have a fixed price (US$10) so that buy and sell prices are the same. The exchange is also relatively fast, big enough to cater not just for individuals but SMEs, has high liquidity – something of a rarity in Islamic finance – and avoids the need for an agency agreement with a separate Islamic bank. It’s also cost-effective, and everything is already certified as Shariah compliant.
So far, the platform has completed more than AED31 billion of transactions since its launch, with turnover increasing from AED1.88 billion in April 2014 to AED4.28 billion by February 2015. Aside from Emirates Islamic, other institutions are starting to join the platform, among them Sharjah Islamic Bank and Aafaq.
Wherever the system goes from here, it’s a sign of progress that it’s been attempted at all.
Jadwa private equity listings: Abdulmohsen Al-Hokair Group and Al Hammadi Company for Development and Investment.
These deals are recognized for what they say about Islamic finance as an avenue for effective private equity. The listings of Abdulmohsen Al-Hokair Group, a tourism and development company, and Al-Hammadi Company for Development & Investment, in June and July 2014, represented the culmination of many years of development anchored on Shariah principles. “These two transactions,” says Jadwa, “represented the culmination of partnerships that were rooted from the outset in best practice in Islamic finance.”
What does that mean, in practice? “In line with Islamic principles, Jadwa supported the owning families and [helped] the shareholder achieve their objectives by sharing responsibility and delivering honest counsel on advice, delivering on promises through partnership,” says the bank. That’s the point: a shared allocation of both responsibility and risk from the outset, which makes a lot of sense for new businesses attempting to start out. “Both families had indicated aspirations to go public from the outset of their engagement with Jadwa Investment, with the goal of ensuring the sustainability of their business for the benefit of future generations.”
The result, in the end, was a successful pair of IPOs. Abdulmohsen Al-Hokair’s deal was oversubscribed 11.7 times, Al-Hammadi’s over 12; both listed at the top of their valuation ranges, and performed exceptionally well once listed, each one hitting the maximum permitted daily increase of 10% several times over after launch. Again in keeping with shared responsibility and profit, Jadwa has retained a stake of over 20% in each post-offering.
Of course, once a stock is listed, a whole new layer of responsibility for sharing risk and reward comes into play. Both IPOs came with a Shariah-compliant earnout structure, deferring a proportion of payments based upon achieving particular milestones laid out in the IPO over the next three years. “This serves to align interests among shareholders and Jadwa to strive toward a mutually beneficial goal,” says Jadwa. The bank also asked both families to retain proceeds of the listing within the companies, supporting future growth.
There should be a great deal of scope in Shariah-compliant private equity: after all, if a company starts out with those principles, it is a lot easier to maintain them than to try to turn something towards compliance later in its life. And it is not a new idea – Abraaj Capital launched an Islamic fundraising for private equity activity in 2006, though that involved much later-stage investment. If done properly, Islamic private equity that is there from the very start ought to show a fair split of risk and reward between bank, family and investor.
Lulu Hypermarket sale-leaseback (Al Rajhi Capital)
This small but interesting deal shows a useful approach to an important matter: Shariah-compliant methods for exiting large-scale commercial real estate developments in Saudi Arabia.
The Lulu Hypermarket is a shopping centre with 22,000 square metres of retail space in east Riyadh, built by the Al Mutlaq Group. It’s one of more than a hundred retail stores the LuLu Group operates around the Gulf.
Institutional investment in commercial real estate is in its infancy in Saudi Arabia, and highly fragmented; exit mechanisms, and the uncertainty around them, have been a key reason the market has not developed.
The Lulu deal, arranged by Al Rajhi Capital, involves a sale-leaseback structure that sets a new model in Saudi Arabia for developers to exit existing projects and redeploy the capital in new ones. The owners or users of the real estate assets are able to monetize the full amount of the project value, and can recycle the cash to fuel the future growth of the underlying sponsors, Al Rajhi says.
“The deal structure is very attractive to potential sellers as it helps generate cash equal to the full value of the properties while keeping intact the use of the facility by the seller for a long period of time,” the bank says. A first refusal mechanism gives the seller the option to buy back the property in future.
A structure like this, while not complicated, nevertheless opens the door for more investors – including individual investors – to participate in commercial real estate with the knowledge that they will be able to exit in due course, and that their counterparty will be an institution. And since commercial real estate is a buoyant and significant sector in Saudi Arabia, at a time when markets (equity at least) are opening up to international capital, it is a good time to be able to demonstrate a functional system for divestment.
Battersea Phase 3 (Standard Chartered, CIMB, Maybank, Norton Rose, Baker & McKenzie, Wong & Leow)
British real estate has long been a proving ground for Islamic finance outside of the Muslim world. It’s a combination of Middle Eastern appetite for high-quality London assets, and the fact that the legal environment is supportive of Shariah financing, and indeed of cross-border asset sales in general.
This year’s Islamic landmark in the British market involved the redevelopment of the Battersea Power Station on the south bank of the Thames. The iconic building is being redeveloped by Malaysian interests, and in October the financing was put together for Battersea Phase 3 Holding Company, a phase that will include mixed development of the site.
It is a vast overall project – the backers say it has a gross development value of £7.7 billion and will be completed over 12 years through seven separate phases – and not all of it will be funded Islamically, but it was clearly important to the three Malaysian partners to do part of it on a Shariah compliant basis. Two of them, Sime Darby and SP Setia, are well-known corporate names, but perhaps it is the third that is most interesting in this context: the Employees Provident Fund, the dominant Malaysian government pension fund, and the source of much of the initial capital for the Shariah-compliant asset managers who operate within the Malaysian International Islamic Financial Centre.
The £318.8 million Islamic tranche is the largest sterling syndicated Islamic facility Standard Chartered has ever closed (it was alongside CIMB and Maybank as mandated lead arrangers, bookrunners and joint coordinators), and demonstrated just how big a deal can now be financed through Islamic means even outside Islamic jurisdictions.
If it was just big, it wouldn’t have made our list; it also stands out for the fact that it was truly cross-border, with the jurisdictions of Malaysia, Jersey and the UK all involved. It had to provide a natural hedge against exchange rate movements, and to do so Islamically. It also fits the east-to-west pattern that is likely to be ever more prevalent in global trade and investment, and shows that in the Islamic world, it’s not just the Arabs who can make a splash in London top-end property.
The commodity murabaha structure is not everyone’s cup of tea – some think it doesn’t truly qualify for Shariah compliance – but that didn’t stop the facility being oversubscribed. It also bodes well for the financing of the many later phases of this project, and it would now be a huge surprise if a large chunk of those subsequent financings were not conducted on a Shariah-compliant basis.