x Abu Dhabi, UAEWednesday 17 January 2018

Nakheel alone cannot revive sukuks

The prospect of Nakheel repaying its US$3.5 billion (Dh12.85bn) Islamic bond on time may not be enough to revive the global sukuk market this year.

The prospect of Nakheel repaying its US$1.7 billion (Dh6.2bn) Islamic bonds on time may not be enough to revive the global sukuk market this year, IMF economists warn. Uncertainty over the level of protection for investors if the Dubai property unit had defaulted on its debt has shaken confidence in Islamic finance. Nakheel's payments are due this month and this year.

The concern stems from the lack of an effective regulatory framework for dealing with such scenarios, the IMF economists said. "Investor sentiment for sukuk issuances has been severely damaged from the Nakheel initial debt standstill and might halt the strong rebound of the sukuk market this year in the wake of continued uncertainty about investor protection," said the economists Heiko Hesse and Andreas Jobst, in an article for US financial analysis company Roubini Global Economics.

Lingering concern about Nakheel's sukuk repayment combined with debt defaults by two GCC companies has dampened investor enthusiasm for new Islamic bond issues in the region this year. Nakheel's parent company, the Dubai Government-controlled Dubai World, had asked in November for a six-month holiday on its debts, then put at $26bn. Dubai World's debt has since been revised to $24.8bn. In March, proposals were announced to repay fully and punctually investors in two sukuk issued by Nakheel, ruling out a possible default. The greater cost of insuring sovereign and quasi-sovereign debt has meant new sukuk issues in the region have almost dried up.

In contrast, total global sukuk issuance rose 114 per cent in the first quarter compared with the first three months of last year to reach $4.7bn, primarily driven by robust growth in Malaysia and Indonesia, according to data by NCB Capital. But many scholars and practitioners question whether the recent upswing in sukuk issuance is sustainable. Munawar Iqbal, an economics professor at Pakistan's International Islamic University, said the sukuk market would remain subdued until effective changes took place.

"The recent short-term recovery is only due to an excess in liquidity. I believe that the sector will remain under a dark cloud for some time unless real Sharia-compliant products are devised," Mr Iqbal said at a sukuk seminar in Dubai yesterday. He said confidence in the sector had remained shaken since the Islamic scholar Mohammad Taqi Usmani in 2008 said most sukuk were not Sharia-compliant. Such scepticism has been further aggravated by the recent sukuk defaults.

But while it still lacks standardisation, the industry most urgently needs financial experts who can combine knowledge of conventional finance and economics with Sharia expertise," Mr Iqbal said. "One of the greatest problems is the availability of financial engineers who know both," he said. Companies that have defaulted on sukuk payments since the global financial crisis include the Kuwaiti company The Investment Dar, which owns half of the luxury car maker Aston Martin; a subsidiary of Saudi Arabian conglomerate Saad Group; and the US oil and gas producer East Cameron Partners.

"The current controversy will raise expectations of enhanced transparency of sukuk structures as recent defaults have served as a poignant reminder of many risks that investors had not priced in before," said Mr Hesse and Mr Jobst. In future, potential creditors were likely to require more explicit guarantees from issuers of quasi-sovereign debt to encourage them to invest, they said. Nakheel's sukuk was explicitly guaranteed by Dubai World but not by the Dubai Government. But many investors believed the sukuk had the implicit backing of the Government.

The credit crisis disrupting Greece and the poor outlook for other heavily indebted European nations such as Portugal, Ireland, Italy and Spain was also weighing on the GCC sovereign sukuk market, said a report by NCB Capital, the largest investment bank in Saudi Arabia. "Uncertainty is likely to persist in the GCC debt capital markets for the time being as Dubai World seeks creditor approval for its debt restructuring proposals," Jarmo Kotilaine, the chief economist of NCB Capital, said in the report released last week.

In the medium term, the bank remained optimistic the GCC bond markets were on the road to recovery, Mr Kotilaine said. The lowering of spreads on domestic currency-denominated bonds would lead to better pricing, encouraging potential issuers to tap into the market. tarnold@thenational.ae uharnischfeger@thenational.ae