Ethical Investment gif
restricted access to liquidity from banks, borrow- ers have been forced to access other sources of debt or capital. But with the cost of issuing sukuk now about 60% more ex- pensive than bonds, cor- porates 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 re- search by Trowers & Hamlins, however, the majority of sukuk issued over the past year were issued by banks and by sover- eign or quasi-sover- eign entities. Banks have been looking to raise fresh capi- tal to repair or bol- ster their balance sheets. Many are expected to issue sukuk to meet the increased capital requirements of Ba- sel III. According to Trowers & Hamlins, a combination of commercial or market-related factors led to steep falls in the price of sukuk:
$bn
18 16 14 12
10 8
6 4 2 0
5.12 5.13 0.96 0.98 2003-04 1.45 2.30
Conventional bonds Sukuk
Explains Neale Downes: “The idea of taking possession of tangible assets on default, often real estate, made sukuk very attrac- tive to investors. The reality has turned out very different, with sukuk investors having to form an orderly queue with other unse-
cured creditors of the originator.”
Issuance of corporate sukuk and conventional bonds in the Gulf (US $bn)
16.95 14.47 15.03 11.13 2004-05 2005-06 2006-07
“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 abili- ty and balance sheet of the company issu- ing the sukuk. In the absence of such a treatment and the ability properly to segregate those as- sets for the certifi- cate holders, sukuk become little or no different from con- ventional corporate bonds.”
12.86 11.20 6.97 4.34 2007-08 2008-09 2009-10
The defaults have highlighted the disparities between English/Common law, by which nearly all sukuk docu- mentation has been governed and civil law systems that prevail in most of the Gulf States calling into doubt the validity of:
• During times of financial stress investors tend to avoid newer, complex and less tested forms of in- vestment in favour of more traditional investments – a trend from which sukuk are more likely to suffer from than conventional bonds.
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 con- fidence proved misplaced.
• the transfers of assets from the balance sheet of originators to issuer SPVs and • the trust arrangements upon which issuers hold as- sets 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.
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2011 February Global Islamic Finance 53
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