Qatar’s $3.5 billion conventional bond issue may be the season’s most noteworthy Islamic finance deal. Malaysia, issuer of 75% of the world’s sukuk, has flexed even more muscle as it branches into the nascent Islamic finance market of neighboring Singapore. Anecdotally, these offerings are noteworthy; collectively, they may help ameliorate some high-profile setbacks for the industry.  The world sukuk market seems to have regained its footing. Thomson Reuters data show that global issuance from 2007-2009 dipped from $46.2 billion in 2007, to $39.6 billion in 2008, and back up to $46.3 billion in 2009. For the 12 months ending May 2010, sukuk issuance stands at $45.1 billion, with the summer’s major sukuk not yet included. 

But difficulties, if not outright defaults, have grabbed most of the Islamic finance headlines in the past year. From the controversial Nakheel sukuk, to the problems of Kuwait’s Investment Dar, to the recent IIG defaults, the industry has garnered considerable negative attention. If successful, however, Qatar’s offering may provide a template for a hybrid model employing both conventional and Islamic finance for a single big-ticket project.

Qatar’s approach in many ways mirrors that of the Dubai World subsidiary, Nakheel. Although Nakheel never technically defaulted on its sukuk, the uncertainty surrounding creditors’ rights in the enveloping Dubai World restructuring shed a harsh light on the underlying ijara model. The flamboyant developer of Dubai’s Palm and The World offshore real estate projects, Nakheel’s ijara structure securitized a revenue stream from a series of waterfront real estate rents. The structure was met with considerable opposition from some Islamic scholars.

While Nakheel’s prospectuses clearly articulated the risks, two fundamental issues gave investors pause. First, the trust certificates didn’t back any particular asset; the revenue stream was the asset itself. Second, and perhaps most worrisome, the government of Dubai did not announce an unconditional guarantee of the bonds.

The State of Qatar, arguably the world’s wealthiest nation on a per capita basis (See Westlaw Business Currents Qatar: Punching Above its Weight) has taken a different approach. The offering, a $1 billion, 3.5% bond payable 2015, coupled with a $2.5 billion, 5.0% bond payable 2020, is not a sukuk. The conventional offering, however, like Nakheel’s, does ultimately fund a cluster of real estate projects in Qatar.
Using a zero-interest qard (loan) transaction,1 Qatari Diar Real Estate Investment Company Q.S.C. (“Diar”), a real property investment company wholly-owned the Qatar Investment Authority (QIA), raises the funds that it then lends to the Barwa City project and two subsidiary projects, the Barwa Financial District and Barwa Commercial Avenue. (The a diagram of the Barwa qard structure can be seen at page 1 of the prospectus.) Bondholders are repaid as the Barwa projects return proceeds to the Issuer. 

The Qatar prospectus makes clear that bond holders will have no rights to the assets underlying the qard transaction. Moreover, the prospectus warns that Diar and the Barwa projects have no earning history. But the prospectus goes a step further; it explains information about Diar, Barwa and the subsidiaries has been limited because:

…the Bonds are unconditionally and irrevocably guaranteed as to the due and punctual payment of all amounts in respect thereof by the State and are being offered and sold based on the obligations of the State under the Guarantee and the credit of the State, and not on the credit of Diar, Barwa or the Barwa Project Subsidiaries. Accordingly, the information regarding the State contained in this Prospectus, and not the limited information regarding Diar, Barwa and the Barwa Project Subsidiaries, should form the basis of any decision to invest in the Bonds. (emphases added) 

The distinction between this and the Nakheel sukuk will not be lost on investors. Dubai World, while owned entirely by the Dubai government, nonetheless operates as a public corporation. Like any other corporation, a shareholder’s liability extends no farther than the value of the shares owned. Last fall’s Dubai World debt standstill announcement, however, awakened many investors to the limitations of their rights and remedies. By unconditionally guaranteeing $3.5 billion in trust certificates, markets will have to rely solely on the creditworthiness of one of the world’s wealthiest nations.

Qatar’s is not the only significant issuance of the season, or the only hybrid. Khazanah, the investment holding arm of the Malaysian government added still another big offering to the roster, a S$1.5 billion sukuk (USD1.1 billion). The sukuk includes two series of trust certificates, one maturing in 2015 (S$600 million) and the other in 2020 (S$900 million). Islamic finance operates on the basis of predetermined profit, rather than interest. Ultimately, the deferred sale price for the series will be S$678,492,986.30 (2015) and S$1,235,525,547.93 (2020), representing returns for the bond holders at rates of 2.615 per annum for the 2015 series; 3.725 per annum for the 2020, respectively.

The sukuk’s hybrid structure pivots on a wakalah (agency) arrangement with two prescribed investment components. The first involves a commodity murabaha structure. By the terms of the offering, on the closing date (August 11, 2010), the Wakeel (agent) will invest $60 million in commodities for the 2015 series, and $90 million for the 2020 series. The remaining funds will be used to purchase shares in Shariah-compliant investments. According to the sukuk agreement, Shariah-compliant shares must comprise at least 51% of the total investment; commodities can make up no more than 49%.

The wakalah structure generated considerable controversy throughout the Islamic finance industry in 2009, when an English High Court effectively dismissed a Sharia-board’s fatwa (judgment) in Investment Dar Co. KSCC v Blom Developments Bank SAL, (Dec. 11, 2009). (See Westlaw Business Currents Not Quite Cricket: High Court Drops Islamic Finance Ball?)

The real significance of the sukuk, however, lies not in its size or complexity, but its listing. Already approved for listing on the Bursa Malaysia, the Khazanah sukuk has received approval in principle for listing on the Singapore Exchange Securities Trading Limited (SGT-ST). Malaysia remains unchallenged as the world’s leader in sukuk issuance. Singapore hopes with this issue to establish its own bona fides as an Islamic finance center. 

Reuters has reported that Singapore tax incentives helped drive the listing. The city-state at the tip of the Malay peninsula, while a financial services power, is a relative lightweight in the Islamic finance industry. By way of comparison, Singapore’s $56 million sukuk offerings for the past 12 months constitute less than 0.185% of Malaysia’s $30.708 billion.2 While the listing clearly signals a turning point for Singapore, for Malaysia, the offering could be perceived either as a splash into deeper pools of fresh capital or a vehicle to leverage its influence throughout the financial world. 

Predictably, Malaysia has had a busy summer. Cagamas Berhad, Malaysia’s national mortgage company, announced this month a, 230 million ringgit ($73 million) variable rate three-year sukuk commodity murabaha. A Cagamas press release describes the sukuk as its “largest ever rated, transferrable and tradeable variable rate Commodity Murabahah note issuance by a corporate in the Ringgit market to-date and is Cagamas’ maiden variable rate Sukuk issuance via its existing RM60 billion Islamic Commercial Papers and Medium Term Notes Programme.” This summer’s Cagamas offering follows a 300 million ringgit ($95 million) sukuk issued in May, and 500 million ringgit ($158 million) issue from April. The Malaysian government also launched a general purpose $1.25 billion sukuk earlier this summer. 

Bragging rights for the year’s biggest sukuk to date, however, remain with Abu Dhabi Investment Bank (ADIB). ADIB used a Cayman Islands vehicle in structuring a $5 billion sukuk musharakah. (See Westlaw Business Currents Sukuk Watch: Summer Offerings From Malaysia and Abu Dhabi Investment Bank.) 

Yet it’s a tiny $10 million sukuk from England may finally uncork what has been long reported as pent-up European demand. Innovative Industrial Technologies, a small industrial milling concern in Northern England, has reportedly issued the sukuk with a Dubai-based private equity firm as the sole buyer.

With more than half the year still to be counted, the rebounded global sukuk market provides a positive counterweight to several high-profile deals drag-on the Islamic finance industry. Malaysian hegemony shows no sign of erosion. Qatar, plowing its wealth into infrastructure through an Islamic loan, has backed its conventional bonds with the government’s full faith and credit, evidencing a ripening maturity for Islamic finance.