* First failure to redeem bond by a UAE company
* In past might have caused crisis; market now more mature
* Precedents exist for restructuring sukuk
* Deeper market makes investors less vulnerable to a default
* Yields on other sukuk continued to drop after Dana miss
By Bernardo Vizcaino
DUBAI, Nov 7 When a natural gas producing
company in the United Arab Emirates missed repaying a $920
million Islamic bond last week, it became the first UAE company
to fail to redeem a bond on time. But the region's debt market
Yields on some firms' outstanding Islamic bonds, known as
sukuk, dropped to fresh record lows as investors continued
pouring money into them. Other companies laid plans for new
issues of sukuk.
The incident underlined the extent to which the Gulf's
Islamic debt market, which is playing an increasingly important
role in funding companies, has strengthened in the past year.
Not long ago, a billion-dollar payment miss would have triggered
a crisis of confidence in the market; now, it is almost ignored.
"The market has matured enough to appreciate that this is
not a sukuk or Islamic finance issue but rather a credit issue,"
said Rizwan Kanji, debt capital markets partner at law firm King
& Spalding in Dubai.
"After the potential defaults a few years ago, the market's
reaction initially was that sukuk didn't work and as a
result the market reacted negatively. Fast forward three years
and we're in a similar scenario but the market has
reacted differently. You're not seeing the headlines screaming
that Islamic finance doesn't work."
Privately owned Dana Gas, headquartered in the
emirate of Sharjah, failed last Wednesday to repay its five-year
sukuk on maturity. The firm has been hit by delays in recovering
revenues from operations in Egypt and Iraq's Kurdistan.
Immediately after the payment miss, prices of Dana's sukuk
and shares plunged because of fears that its bond holders, who
include big foreign investment firms such as BlackRock
and Ashmore Group, might declare it in default, letting
them take legal action to liquidate assets backing the sukuk.
On Wednesday this week, Dana said it had reached an "in
principle" agreement with creditors to restructure the sukuk; it
would pay back part of the bond and issue two new sukuk to
finance the remaining amount. Details of the possible deal were
Although indebted firms in the UAE have restructured
billions of dollars of bank loans since Dubai's real estate
market crash in 2009-2010, no UAE company before Dana has failed
to repay a maturing bond, conventional or Islamic.
In the past, Dana's difficulties would have been seen as a
reminder of regulatory and legal risks in the Gulf's sukuk
market. Islamic finance was born in its modern form only in the
1970s, leaving courts and investors with relatively few
precedents to use when sukuk ran into trouble.
Because of Islam's ban on interest, sukuk are not pure debt
and do not pay conventional coupons; they pay returns earned by
real assets, which are temporarily leased to sukuk holders via
channels such as special-purpose vehicles. The complexity of
such structures can complicate restructuring talks.
A near-default on a $3.5 billion sukuk by Dubai's
state-owned property developer Nakheel in 2009 caused
the Islamic debt market to freeze up, partly because of
uncertainty over how the issue might be handled. Ultimately, the
sukuk was repaid with last-minute aid from the Abu Dhabi
Now, however, the regional market may have built up enough
experience with threatened defaults and restructurings to be
confident that they can be handled without damaging faith in the
Investment Dar, a Kuwaiti-based firm, defaulted on a $100
million sukuk in 2009; it eventually restructured it in 2011,
converting part of creditors' claims into equity in the company.
Saudi Arabia's Saad Group defaulted on its $650 million
Golden Belt sukuk in November 2009; the case is being heard in
Several Malaysian sukuk, including Ingress Sukuk Bhd,
Tracoma Holdings Bhd and Nam Fatt Corp, have defaulted since
January 2009; they have been dealt with by Malaysia's
well-developed legal framework in much the same way as defaults
on conventional bonds.
The most important factor supporting confidence in Gulf
sukuk may be the ballooning size of the market. As the euro zone
debt crisis made Western debt markets less attractive this year,
Islamic investors in the Gulf and southeast Asia poured money
into sukuk, triggering a record amount of new issues.
Globally, $109 billion worth of sukuk were issued in the
first nine months of 2012, up 69 percent from a year earlier,
with the rise driven primarily by Malaysia and Gulf governments,
according to research by Zawya, a Thomson Reuters company.
So far this year, $13.9 billion of dollar-denominated sukuk
have been issued in the Gulf Cooperation Council, comprising
Saudi Arabia, the UAE, Kuwait, Qatar, Oman and Bahrain. That is
almost double the $7.8 billion of conventional bonds issued - a
reversal of conventional finance's traditional dominance.
A report by credit rating agency Standard and Poor's last
month said the reliance of GCC companies and infrastructure
projects on sukuk could increase further in coming quarters.
With the sukuk market deepening, investors are better able
to spread their risks and less vulnerable to any single default.
This has helped to keep yields from rising on other sukuk
during the Dana debacle.
The yield on the $400 million, five-year sukuk issued by
private Dubai-based mall developer Majid Al Futtaim Holding in
January has fallen more than 1 percentage point
since the start of June; it continued to drop, falling 6 basis
points to 3.54 percent, after Dana missed its payment.
Five days after Dana's miss, Saudi Arabian dairy and food
producer Almarai Co said it would issue the second
tranche of a riyal-denominated sukuk programme to private
investors in coming months. It raised 1 billion riyals ($267
million) through the first tranche in March.
Chavan Bhogaita, head of the markets strategy unit at
National Bank of Abu Dhabi, said Dana was viewed by investors as
an isolated case which did not have implications for the sukuk
market or the corporate health of the UAE in general.
"It isn't a high-profile GRE (government-related entity) but
rather a stand-alone corporate that is going through some
financial distress - frankly, institutional investors appear to
be taking this in their stride," he said.
If Dana and its creditors fail to reach final agreement on
restructuring the sukuk, the dispute may be referred to an
arbitrator, said Nasser Al Osaiba, partner at Dubai-based law
firm Global Advocates and Legal Consultants.
If the case reaches the courts, it is likely to be resolved
in a British court rather than in the UAE court system, he
added. The Dana sukuk is listed on the London Stock Exchange,
though the gas production assets behind the sukuk are to be
handled under UAE law, according to the prospectus.
A September report by London-based investment firm Exotix
estimated a liquidation of Dana's sukuk assets could yield a
recovery value of 47 percent of par for investors. Such a poor
prospect may have deterred creditors from going after Dana's
assets and persuaded them to discuss restructuring the sukuk,
which might give them a better return over time.