Jan 17 2011
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Gulf sukuk issuance bounces back 61% following recessionary crisis
Sukuk issuance reaches $7bn
At the same time issuance of conventional bonds surged to record levels. The value of conventional bonds issued in the Gulf hit $15bn in 2009/10 compared to $12.9bn the year before, an increase of 16.3%.
Trowers & Hamlins says that the sukuk market was hit much harder by the credit crunch and global financial crisis than the conventional bond market in the Gulf.
Trowers & Hamlins says that, as well as facing these broader structural issues, many sukuk were primarily based on land values and/or revenues intended to flow from real estate and construction projects, an asset class and sector that lost much of its allure during the downturn, with Dubai particularly hard hit. Issuers are now looking for other asset classes which may form a suitable basis for sukuk and also reverting to "debt" (e.g. ijara) rather than equity based structures, such as musharaka.
"The crisis laid bare several misunderstandings about sukuk. Many investors assumed that sukuk came with a sovereign guarantee, or that if the issuer defaulted they would have an underlying asset as 'security' or that they (or their trustee) had sole recourse to such asset. The limitations of merely asset-based sukuk are now more widely understood."
"With restricted access to liquidity from banks, borrowers have been forced to access other sources of debt or capital. But with the cost of issuing sukuk now about 60% more expensive than bonds, corporates have largely turned to conventional debt."
He adds: "The market reached its nadir in 2009 but sentiment towards sukuk now appears to be recovering strongly. There is every reason to believe that demand for sukuk will eclipse its pre-credit crunch peak in the coming years."
According to the research by Trowers & Hamlins , however, the majority of sukuk issued over the past year were issued by banks and by sovereign or quasi-sovereign entities. Banks have been looking to raise fresh capital to repair or bolster their balance sheets. Many are expected to issue sukuk to meet the increased capital requirements of Basel III.
Trowers & Hamlins
, a combination of commercial or market-related factors led to steep falls in the price of sukuk:
During times of financial stress investors tend to avoid newer, complex and less tested forms of investment in favour of more traditional investments - a trend from which sukuk are more likely to suffer from than conventional bonds
Issuance of corporate sukuk and conventional bonds in the Gulf (US $bn)
Broader legal problems
Neale Downes says that the reputation of sukuk was hit by several high profile defaults. Investors had assumed that they would have security over or sole or first call on the assets on which the sukuk were based, but this confidence proved misplaced.
Explains Neale Downes: "The idea of taking possession of tangible assets on default, often real estate, made sukuk very attractive to investors. The reality has turned out very different, with sukuk investors having to form an orderly queue with other unsecured creditors of the originator."
"Subscribers to sukuk are meant to be part owners of assets so in theory, their credit and risk profiling should be based purely on an assessment of the value of and revenue generating potential of those assets, instead of just the paying ability and balance sheet of the company issuing the sukuk. In the absence of such a treatment and the ability properly to segregate those assets for the certificateholders, sukuk become little or no different from conventional corporate bonds."
The defaults have highlighted the disparities between English/Common law, by which nearly all sukuk documentation has been governed and civil law systems that prevail in most of the Gulf States calling into doubt the validity of:
the transfers of assets from the balance sheet of originators to issuer SPVs and
the trust arrangements upon which issuers hold assets for the benefit of their investors
The further interaction between English law, local laws and the Shari'ah (not law per se but a set of principles and teachings) adds a further level of complexity both when putting deals together and when later seeking to unwind or restructure such arrangements.
- Ends -
Trowers & Hamlins is an international and City law firm with 121 partners and over 700 staff. The firm has three offices across the UK and five offices in the Middle East (Abu Dhabi, Bahrain, Dubai, Cairo and Oman) as well as a co-operation agreement with two offices in Saudi Arabia and associations with firms in Syria and Jordan.
Trowers & Hamlins has been voted "Legal Firm of the Year" in this year's FDs' Excellence Awards. The award, supported by the CBI and by Real Business Magazine, is based on the results of a survey of 1,000 Finance Directors across the UK. Finance Directors polled commended Trowers & Hamlins for their "high quality" and "supportive" service.
Trowers & Hamlins received the award for outstanding contribution by a law firm to Islamic Financial Services at the 2010 Annual Sukuk Summit Awards. The Sukuk Summit Awards recognise excellence in the Islamic finance sector and are judged by industry experts from across the GCC, Europe and South East Asia.
Trowers & Hamlins is a limited liability partnership.
For more information, please contact:
Trowers & Hamlins
Tel: +973 17 515602 (Bahrain)
Paul Arvanitopoulos or Nick Mattison
Mattison Public Relations
Tel: +44 20 7645 3636 (London)
© Press Release 2011
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