Dana Gas has recently hit the headlines in the Islamic finance markets with its statement that it believes its own sukuk to not be Shariah-compliant, with proceedings underway in the High Court in London. In this article, we consider the relevance of this challenge to the sukuk market as a whole and in particular the UK.
Whilst sukuk structures are well known in certain parts of the world, knowledge within the UK is less developed so it is useful to begin with a brief explanation. Sukuk are Shariah-compliant trust certificates which (in very general terms) provide the holder with a shared beneficial ownership interest in specified underlying assets and in the profit deriving from them, and are often referred to in common parlance as ‘Islamic bonds’.
There are, however, a variety of legal structures that underpin the certificates and their use depends on multiple factors such as the type of underlying assets, tax considerations, whether title to the assets can be transferred, and even the legal system that the sukuk are to be governed by. The most popular sukuk structures relevant to this discussion are: (i) sukuk al-ijara, (ii) sukuk al-wakala, (iii) sukuk al- musharaka, and (iv) sukuk al-mudaraba.
- Sukuk al-ijara is the most popular sukuk structure (by volume) and operates on a sale and lease-back basis. This is the structure which was adopted in the UK Government’s sukuk issue in 2014, where the underlying assets (three government buildings) were sold and leased back and the sukuk-holders benefit from a share of the profit from the rental income that is generated.
- Sukuk al-wakala is a structure popular with financial institutions as the underlying assets can be a mix of investments and tangible assets. In this model an agent is appointed who manages the investments and/or assets and retains any profit produced over and above the agreed profit shared with the sukuk-holders.
- Sukuk al-musharaka is a joint-venture or partnership structure which is used to generate funds to realise the objectives of the joint venture with the sukuk-holders benefiting from a share of the resulting profit. This model has become less popular since the AAOIFI Statement in 2008 (discussed further below).
- Sukuk al-mudaraba is a partnership structure where one partner (the investment manager) manages the project/assets/investments contributed by the other partner to create a return which is shared in pre-agreed proportions. As with sukuk al-musharaka this model has become less popular since the AAOIFI Statement. This is the structure used in the contested Dana Gas sukuk.
In 2008 the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) issued a guidance statement on sukuk structures (the AAOIFI Statement). This statement was released following publication of a paper by Sheikh Taqi Usmani (the chairman of the AAOIFI Shariah Board) where he called into question the Shariah compliance of a number of sukuk structures (and in particular the provisions on the repurchase by the issuer of the assets on the maturity of the sukuk). The AAOIFI Statement set down a number of guidelines for certain types of sukuk (including sukuk al-mudaraba structures) going forward.
The Dana Gas sukuk
Dana Gas launched its sukuk in 2013 and issued US$425 million 9% ordinary certificates and US$425 million 7% exchangeable certificates, both of which are due to mature on 31st October 2017. On 13th June of this year Dana Gas issued a press release stating that following legal advice it considers that the structure of its sukuk is no longer Shariah compliant and the certificates are therefore unenforceable under UAE law. Following this, Dana Gas has stated that it would not be making the periodic profit payments due under the certificates on 31 July 2017 and 31 October 2017, it would be seeking a declaration of unlawfulness of the sukuk, and it has proposed to replace the sukuk with an alternative Shariah compliant instrument (although that proposal has since been withdrawn by Dana Gas).
Leaving aside any commercial considerations that may have influenced this decision, the stance taken by Dana Gas has raised an important question mark over the validity of existing sukuk al-mudaraba structures which are not in line with the AAOIFI Statement guidance.
What are the implications to the sukuk market and the UK Government sukuk?
Whilst the sukuk market has been understandably shaken by the Dana Gas sukuk it is important to note the following:
(i) The use of the sukuk al-mudaraba structure has been in decline since the AAOIFI Statement and therefore its importance in the marketplace has diminished (it is thought to constitute around 8% of the total current sukuk issuance).
(ii) The Dana Gas sukuk are issued out of the United Arab Emirates which do not have a central Shariah supervisory body, as compared to Malaysia which has its own central bank Shariah Supervisory Board and accounts for more than 60% of the global sukuk market.
What effect the Dana Gas case will have on the remainder of the sukuk market based on the al‑mudarabah structure will depend on its outcome, which remains to be seen. For the large majority of the market utilising different structures however, there is no reason to believe the impact will be severe even were the Dana Gas sukuk to be held non-compliant (which is far from certain).
As noted above, the UK Government sukuk adopted an ijara structure and in our view there should be no significant adverse implications for that sukuk issuance. Indeed, if the sukuk market as a whole weathers this storm successfully, as we would expect, that in itself could serve as a spur to further sukuk issuance by the UK Government or indeed the Scottish Government which is known to have considered the option of raising finance through a ‘tartan sukuk’.