Sukuk documents seek to reassure investors

Issuers of Islamic bonds are changing the language in documentation for new issues to reassure investors after a UAE company refused to redeem $700 million of maturing sukuk. In June, Dana Gas said it would not repay sukuk maturing in October because changes in the interpretation of Islamic finance during recent years had made the bonds “unlawful” in the UAE. Dana argues that its case, which involves a specific sukuk structure known as mudaraba, has no implication for the broad sukuk market. But its announcement worried many investors because of the risk that other Islamic bond issuers could use the same kind of argument to justify not paying debt. As a result, some issuers are now amending their documentation to preclude the use of an argument involving Shariah compliance to justify any refusal to redeem sukuk. For instance, the Saudi Arabia-based Islamic Corporation for the Development of the Private Sector (ICD) has included new clauses in its latest sukuk prospectus that explicitly waive any right to challenge the Shariah compliance of the deal. The company “shall not take any steps or bring any proceedings in any forum to challenge the Shariah compliance of the Programme Documents and the Transaction Documents,” reads the prospectus for the ICD’s sukuk program, dated Nov. 20. Similar language appeared in some sukuk from Indonesian firms predating the Dana case, but the ICD, a multilateral institution based in Jeddah, may influence the industry because of its role in advising countries in Africa and central Asia on introducing Islamic finance. Imam Qazi, partner and Islamic finance lead at law firm Foot Anstey in Britain, said sukuk issuers were aware that the Dana case could have implications for a wider range of transactions beyond mudaraba sukuk. “Financial institutions will be striving for clarity in their documents and from their Shariah scholars and legal advisers,” he said. Clauses seeking to reduce Shariah compliance risk in sukuk documentation have become normal in the global industry over recent months, said Mohamed Damak, global head of Islamic finance at credit rating agency Standard & Poor’s. But he added that the complexity of sukuk made it difficult to remove the risk entirely. “For the market to reach immunity to this type of risk, standardization is needed across the industry.” So far, the Dana case does not seem to have reduced investor demand for sukuk or affected prices in the secondary market. But the industry is also worried by the way in which the Dana case has underlined the possibility of contradictory rulings by courts in different countries, said Mohammed Khnifer, a debt capital markets senior associate at the Islamic Development Bank Group in Riyadh. Last month, Dana’s creditors won a victory when a London High Court ruled that the company’s challenges to the purchase undertaking behind the sukuk were unfounded and that the agreement was valid and enforceable. But the dispute is far from over because in addition to appealing the London ruling, Dana is fighting its case in a UAE court; UAE law governs the mudaraba agreement. A UAE hearing is scheduled for Dec. 25. In the wake of the Dana case, “sukuk holders and issuers will be now more inclined to rely heavily on English law and avoid local laws as much as possible with dollar-denominated issuance,” said Khnifer. Regulators in Bahrain and Malaysia, two major centers for Islamic finance, are working on Islamic corporate governance standards that address the potential for conflicting Shariah rulings and require more stringent monitoring of Shariah non-compliance risks. However, these standards apply to Islamic banks and insurance companies, not non-financial firms such as Dana.