Apr 25 2012 |
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Goldman's sukuk induces ownership and liquidity risks
By Badri Ahmed
April 2012
Obviously, Goldman Sachs did not choose the most consensual structure. In the meantime, a lively debate has been sparked especially concerning the possible risks of non-Shari'ah compliance. These risks are not induced by the initial structure as it has been confirmed by Shari'ah Scholars, but by what this structure can potentially become.
This is a summary analysis to highlight three key concepts of the structure of Goldman Sachs 's Sukuk, namely: The type of structure, the liquidity, and the ownership of the Sukuk holders. This synthesis follows other articles[1] on the same subject and, it is not intended to be a definitive analysis, it could be supplemented by other experts or researchers in this field.
It is important, first, to specify the entities involved in the Sukuk structure, namely:
- Global Sukuk Company Limited (GSCL): Incorporated in the Cayman Islands. "Seller" in the Master Murabaha Agreement, Issuer of Murabaha trust certificates (Sukuk), and trustee.
Type of structure: Murabaha or Tawarruq[2]?
First and foremost, it is indeed a Sukuk Al-Murabaha structured type, according to a base prospectus filed with the Irish Stock Exchange. It is this structure which has been validated by the Shari'ah adviser[3] of the program. However, there is a high probability that this structure takes the form of Sukuk al-Tawarruq. Indeed, if the ownership of the underlying assets (commodities) is retained by GSI as a buyer, the Murabaha structure will be maintained. On the other hand, if the commodities are sold to a third party, then the structure will be classified as Tawarruq. This hypothesis is clearly stated in the prospectus: "the Purchaser may hold the Commodities as inventory or elect to sell the Commodities in the open market provided that where the Purchaser elects to sell the Commodities, it shall sell the Commodities to a third party buyer that is not the initial Supplier". Although opinions are diverse between Shari'ah Scholars on Tawarruq, it is not in any way the main problem. Assuming that some scholars agree that the Tawarruq be valid, allowing companies to meet liquidity needs, another issue of Shari'ah compliance appears at once, and thus it may that Shari'ah Scholars are of a consensus in disfavour of the structure. If the structure of Tawarruq is effective, then it is important to ask the following question:
Who will be the beneficiary of the flows of liquidity?
In this case, it is Goldman Sachs International (GSI), namely a conventional bank. It is important to note that, to date, Goldman Sachs has not developed Islamic banking, while, moreover, other banks such as Citigroup, HSBC, Standard Chartered, BNP Paribas or CIMB, have developed Islamic windows. Remember that conventional banks generally have a net banking Income composed of interest rates and speculation activities that clearly exceed the 5% allowed by the ratios of screening[4]. The next sentence of the prospectus "The net proceeds of each Series issued under the Program will be applied by the Trustee and GSI in the manner described in "Structure Overview - Murabaha Arrangements" and, in respect of GSI only, for its general corporate purposes and to meet its financing needs.[5]", based on a Tawarruq structure will not benefit the conventional banks, except in violation of the Shari'ah compliance.
In addition to liquidity and ownership risks that this structure induces, the Shari'ah risk, which does not exist a priori, is not only latent but entirely justified. This is a problem for all conventional financial institutions that choose a Sukuk Al-Murabaha type of structure. These difficulties are caused by this structure in particular, and do not apply to Sukuk in general.
However, there are some possible solutions to overcome these difficulties and to reassure investors. Amongst these are the following:
- Goldman Sachs should prove that this structure remains a Sukuk Al-Murabaha structure throughout the life of the contract until maturity. That is to say that the underlying assets (commodities), of Master Murabaha Agreement, must not under any circumstances be resold to a third party by GSI.
- Otherwise, the bank must prove that the objective is dedicated solely to finance Shari'ah compliant activities. And, as such, present the activities that will be funded, justify the existence of a dedicated information system, and also have separate accounts for tracing these transactions. This is to allow Islamic funds not be mixed with "non-Shari'ah compliant" activities.
On the assumption that the "Sukuk Al-Murabaha" is maintained and only in this case, then the structure induces new risks namely: liquidity risk and risk of ownership.
Liquidity:
In fact, in an industry where operators are tending to move gradually towards "liquid" instruments, including the needs for asset-liability management (ALM), the structure chosen by Goldman Sachs is surprising. Indeed, this structure goes against the current trend, as Sukuk Al-Murabaha are, by nature, "illiquid" on the secondary market. The reasons for this "illiquidity" are numerous, not only due to the morphology of the market with demand greatly exceeding supply, but also due to the need for compliance with Shari'ah; raised by the international standards' of the AAOIFI[6]. According to the fore mentioned organization, the structure chosen by Goldman Sachs , based on a debt instrument (shahada al-dayn), does not allow such Sukuk to be traded on the secondary market. Otherwise, these transactions might be called "trade of debt" (bai' al-dayn) and so, at the same time, risk losing their compliance to Shari'ah. Therefore, subscribers will be in a position of investment such as "buy and hold" and this will be brought about by "obligation" rather than "determination".
There are ultimately some possible solutions to subscribers to transfer these Sukuk in a Shari'ah compliant way: The method known as the "portfolio proportion" based on the ratios of screening[7] and the "reallocation" on nominal value (par value). These solutions are framed by Islamic law, but could allow operators to find a new way out of their Sukuk, if the need arises.
Registered on the Irish Stock Exchange, it is noted that neither this Exchange nor Goldman Sachs are responsible for how these Sukuk will be traded on the secondary market. It is the responsibility of investors to trade these Sukuk in a Shari'ah compliant way.
However, this program will have the advantage of strengthening the trend towards diversification of the Sukuk market, in terms of types of contracts (Sukuk Al-Murabaha), in terms of geographic diversification of issuers (Western issuer) and currency of issuance (Multi-currency). Thus, this could allow operators to diversify their portfolios and, at the same time, diversify the nature of the associated risks.
Ownership of Sukuk holders:
Fitch assigned "A+ / F1+, Rating Watch Negative" for this program. According to this agency, the rating of these Sukuk can be enhanced either by the underlying assets, or any other type of collateral. This rating reflects the creditworthiness of Goldman Sachs group, Inc. (GSGI) as parent guarantor, and especially its credit quality.
Therefore, the Sukuk holders will not be considered as co-owners of the commodities. The ownership (of the commodities) is held at the completion of the Murabaha by GSI. Sukuk holders will only be considered as co-owners of the deferred payments made by GSI in favor of GSCL, throughout the life of the Sukuk.
However, GSGI will have to guarantee the GSI's obligations as a buyer, in the Master Murabaha Agreement, guaranteeing, among other things, the deferred payment to maturity. If cash flows are insufficient to fund the full periodic distribution, GSGI will provide additional funding to GSCL to enable the full payment to be made. These obligations are unconditional and irrevocable according to Fitch. In addition, these obligations will be considered pari passu with senior unsecured obligations of GSGI.
It is not to say that the additional funding (liquidity facility) corresponding to the obligations of GSGI must also be Shari'ah compliant.
Ignorance of these concepts may increase the risk of errors in some operations.
Conclusion:
However, it is important to note that the Islamic finance industry needs to strengthen its control of Shari'ah compliance throughout the life cycle of operations. The validation process a priori is no longer sufficient! The Shari'ah Scholars should take into account the importance of a posteriori Shari'ah audits, because a loss of Shari'ah compliance can result in reputational risk, including the Shari'ah Scholars who validate these structures.
The specific nature of this offer should encourage operators to have some discipline, prior to investment, to analyze the technical, legal and Shari'ah aspects to identify, measure and price associated risks.
About the Author
Badri AHMED is a senior consultant in Finance. He graduated from Paris-Dauphine University - France. E-mail: badri_a@hotmail.com- Source: Zawya by permission.
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