With much of the buzz over new markets in the Islamic finance space centered around the emerging regions of Africa, Turkey, Indonesia and other up-and-coming industries, the vast potential of Russia and the Central Asian region can often be overlooked. But with the second landmark commodity Murabahah deal from leading Russian lender AK BARS Bank (ABB) launched in December last year, the market is ready to accelerate into a new gear. Islamic Finance news this week brings you a global exclusive from ABB and the players behind one of the most exciting deals to hit the Islamic industry in recent times.
On the 30th December 2013 ABB issued a US$100 million commodity Murabahah syndication, representing only the second deal in Russia since the bank launched the first ever Islamic finance transaction in the Commonwealth of Independent States (CIS) with its maiden US$60 million Murabahah deal in 2011, opening the doors to Islamic finance in Russia and the wider Central Asian region. Significantly oversubscribed and with a considerably broader and deeper investor base, Islamic Finance news is pleased to announce a deal that represents a very real move forward for Islamic finance in the region.
A landmark deal
Aydar Mukhametzyanov, the managing director of investment business and international banking at ABB, speaking exclusively to Islamic Finance news, confirms that: “It is another benchmark set. It shows that the interest in comparison to the previous transaction is significantly higher.”
Although Islamic finance is still in its developing stages for Russian borrowers, as they seek new sources of funding and look for new markets it is hoped that Shariah compliant products could become a regular tool for Russian institutions to access a more diverse investor base. “That is why the ABB deal is an excellent showcase,” explains Ivan Starcevic, Vice-President of Capital Markets origination at Citi, the exclusive documentation agent and joint mandated lead arranger and bookrunner along with Commerzbank and Emirates NBD. “It’s not only a very successful deal, but it’s a repeat transaction of an innovative structure for a Russian borrower. We really hope that this will set a precedent for more transactions from the region: coming as it does from a backdrop of strong and favorable market conditions and with a supportive broader banking market.”
A clear objective
However, ABB is a strong and successful bank in the region and despite the successful oversubscription, sourcing funding was perhaps less important in this transaction than building a strong Islamic book. What was interesting here was the use of a different structure to access a new pool of investors, as obviously the Russian market is already well known to the bank. According to Najam Khan, the head of corporate finance Middle East and Islamic finance at Commerzbank: “The management objective was to encourage Islamic finance.”
Ziad Qatami, vice-president of MENA debt markets and Islamic finance at Citigroup Global Markets, agrees: “The fundamental reason for using Islamic finance for this project was to grow the capabilities of the bank itself – to grow ABB’s own Islamic finance business.”
A core and concurrent feature of this objective is the concerted efforts which Russia has made over the last few years to build a relationship with the Middle East. “Russia opened direct contact with the GCC and Middle East markets about six years ago,” explains Mukhametzyanov. Both Russia (particularly Tatarstan where ABB is based, which has around a 55% Muslim majority) and the CIS region have strong Muslim populations and have recently seen their connection with the wider Muslim world, especially in the Middle East, maturing.
“It is important that the bridge that Government of Tatarstan and ABB have been trying to build over the last few years has finally started to pay off. There have been a huge number of investors coming in for Islamic finance conferences and summits, and now we see that the interest is strengthening and we are building a reputation,” he confirms. “We have done the first and now the second transaction and this bridge is hugely important; as previously there were no funds coming in from the Middle East region.”
Through building these relationships and attracting new funding, ABB is also working to diversify its liability base. While the bank is highly active on the US dollar, euro and ruble markets (with around US$1.1 billion outstanding in Eurobonds and around 15 billion in rubles) it is keen to increase its exposure to other regions and currencies. “We already know the dollar and ruble market very well and those investors know us very well. In this second Murabahah transaction, we wanted to identify a much broader range of Middle East and GCC investors towards Russian risk,” says Mukhametzyanov.
In this, the bank has been successful. Shibeer Ahmed, a partner at White & Case, the legal counsel for the issuer, told Islamic Finance news that: “ABB is becoming a regular borrower now in the international Islamic finance market. And while last time the transaction was driven predominantly by the Islamic Corporation for the Development of the Private Sector (ICD, an arm of the Islamic Development Bank (IDB) Group) this time it was driven by commercial banks and Islamic banks.”
This is a key point as it highlights not only that Islamic banks are increasingly interested in the sector, but that international commercial banks such as Commerzbank are also now back in the market for Shariah compliant deals. “For me that is very important,” explains Shibeer: “It is good to see interest from banks like Emirates NBD in the Russian market, and its also good to see that banks like Commerzbank and Citi are now back in the market arranging these sort of deals.”
A broad investor base
Starcevic confirms that as one of the bookrunners, Citi saw a much broader demand this time around. “The deal was well oversubscribed which attests to the success of the transaction, but we also expanded the investor base to investors from the Middle East and from Turkey as well.”
The original 2011 transaction was concluded by four institutions, while the 2013 transaction attracted almost three times this number with 11 banks involved including all four original players. “It was important for us to keep the Islamic buyers and Islamic dominance of this deal, and to build these relationships with the region,” says Mukhametzyanov. It is also important for us to diversify our partner base and encourage Islamic bank participation.”
From the composition of investors in this transaction it is clear that a wide range of institutions are interested – and not necessarily just Islamic institutions. “That in itself creates positive awareness,” points out Ziad. “We (Citigroup Global Markets} have had several discussions with borrowers who thought that you need to be an Islamic finance institution to be involved in this kind of facilities, but this deal will raise awareness and show that conventional financial institutions get to participate.”
Investors in the deal included Citi, Commerzbank, Emirates NBD, Amsterdam Trade Bank, Credit Europe Bank, the ICD, London Forfaiting Company, AKA Ausfuhrkredit, Banque de Commerce et de Placemement, J.P. Morgan and Ziraat Bankasi. This last is particularly interesting, being both a Turkish bank (state-owned and the second-largest in Turkey) and non-Islamic, although it is reportedly considering the launch of an Islamic bank. However, its participation highlights a significant feature of the CIS region’s Islamic aspirations: the positive influence of neighboring Turkey, with which it has longstanding and extensive historical links. “In fact,” points out Shibeer. “There’s no reason why a sovereign Sukuk shouldn’t happen in the region, especially now Turkey has done it. The countries that are active in the conventional debt finance market, who have access to the markets, and have the underlying assets – there’s no reason why they wouldn’t tap the Islamic market.”
It’s a two way street, however. There is strong interest from CIS governments to increase Islamic finance, especially as a lot of them have Turkic connections and Turkey is getting increasingly involved in the Islamic market. From the other side there is also interest from investors who are finally getting comfortable with the risk of these CIS countries, which are seeking to do investments and financing – but they need a push to get them into the market. And this needs to come from the development agencies as well as commercial banks. “Once they see the likes of the IDB doing deals, as the ICD did with the first ABB deal,” suggests Shibeer,“commercial banks will follow”.
Although in the first ABB transaction the ICD was a strong supporter, this time around the group stepped back to allow commercial banks to take the lead – a strong indicator of the renewed strength and corporate confidence in the transaction. Although ABB continues to have a close relationship with the IDB, Starcevic points out that: “The deal was initially anchored by the joint leads before being launched into broader syndication. Citi has very strong presence in that region and market, and being joined by Emirates NBD as one of the joint mandated lead arrangers and bookrunners, this gave the deal the additional flavor of being very well-supported regionally.”
However, as a key supporter of Islamic activity in the Russian and CIS region, the IDB has been and will continue to be the major driver of Islamic finance in the wider region. For example, in the GCC Islamic banks already have a lot of demand in their own region. In comparison if they go into the CIS they need to get comfortable with the risk, understand it and price it – and this takes time. “However for the IDB, it is its role to support infrastructure development in member states so it is more likely that they will get involved in that type of financing first, before commercial banks get involved,” says Shibeer.
This is all the more important because despite the success of the recent deal, Russia in fact has a number of structural and legislative impediments that could inhibit future Islamic finance transactions unless a major agency funds the first moves. While the first two ABB deals were both relatively straightforward commodity Murabahah transactions, Shibeer warns that: “Had it been an asset-backed Sukuk, we (White & Case) would have had to delve more deeply into Russian arrangements.” Because it was a commodity Murabahah deal, from a legal perspective the process was relatively simple and involved making sure the Russian tax authorities treated it as a loan financing and did not take into account the underlying Murabahah agreement, which would have triggered tax issues.
“In the future, there could be some structural issues that will have to be overcome. We would need to look carefully at the tax regime, especially for asset-backed Sukuk,” Shibeer explains. “I think what it will really come down to is if the companies can find the right assets that are available to do a Sukuk issuance; then you would have to do a very detailed due diligence on the taxation issues of doing a deal in Russia.”
However, the key players in the deal remain optimistic that the legislative challenges will not significantly inhibit the growth of Islamic finance. “Specifically in this region, ABB is showing that even with an existing conventional framework it is possible to do Islamic transactions, which is encouraging to show other people that it can be done,” comments Najam of Commerzbank. “The deal followed a normal, very well-known Shariah compliant format, and nothing unusual was required to make it successfully close. This showed that the region is doing things that are compatible with other regions, which is important.”
Ziad agrees: “With more of these transactions we will see more awareness and increased involvement from regulatory bodies, who on a case by case basis might start developing a legal framework that will hopefully cover many other aspects of Islamic transactions.”
The ‘Stan’ supremacy
And while Russia may be lagging behind the times in terms of Islamic legislation, neighboring countries have not been as slow to the gate. Shibeer confirms that: “While there is some activity in Russia there is more activity in the ‘Stans’ as there is more Sukuk and product placement activity there. We have a couple of proposals out at the moment in the former Soviet republics.”
Kazakhstan, which has a population of almost 70% Muslims, introduced Islamic banking legislation in 2008 and in June 2012 the Development Bank of Kazakhstan issued a RM240 million (US$71.7 million) five-year ringgit-denominated Sukuk in the first tranche of a RM1.5 billion (US$448.6 million) Sukuk Murabahah program. Although activity stalled in recent years under the leadership of reportedly unenthusiastic central bank chief Grigori Marchenko, his replacement in October 2013 with deputy prime minister Kairat Kelimbetov is expected to once again kickstart its Islamic ambitions. Abu Dhabi-based Al Hilal Bank is already active in the country, while the IDB recently announced a new grant designed to catalyze the draft of a new and more specific Islamic banking law. The ICD in March 2013 also acquired a 35% stake in Zaman Bank and plans to convert it into an Islamic bank by this year; and also recently set up the country’s first Islamic leasing company with a paid-up capital of US$28 million. The ICD has also extended US$20 million for a real estate development project and committed US$40 million in financing for the SME sector in the country.
Azerbaijan is another key mover in the CIS, with a 93% Muslim population. The International Bank of Azerbaijan (IBA), the country’s biggest bank, is already working with national authorities on a draft Islamic banking law that it is hoped could be presented to parliament this year. Currently Shariah compliant products are only offered through an Islamic banking window of the IBA, but it plans to open four new branches this year and is also aiming to launch a stand-alone bank. “By the end of 2013 we will reach US$200 million of Islamic banking assets and with a goal for 2014 of around US$300-350 million,” said Behnam Gurbanzada, its director of Islamic banking, in a 2013 interview. The ICD is also active in Azerbaijan, and has established a leasing company and an investment company as well as extending lines of financing worth US$77 million to several local banks for SME funding.
The agency also recently established a leasing company in Tajikistan, and in Uzbekistan it has extended three lines of financing totaling US$133 million to local banks for SME lending, with US$78 million already successfully allocated. Currently the total ICD portfolio for the CIS region stands at US$227 million, with a further US$127.9 million in the pipeline for 2014.
All this contributes to what is undeniably an exciting new marketplace. But how soon before the fledgling industry takes full flight? Najam suggests that: “Although there is definitely a growing demand for deals out of the region, I think it’s a while yet before you will see a Russian entity using this as a vehicle, because they have access to sufficient amounts of liquidity anyway.” However, for the Central Asian countries it is more relevant. “It helps to diversify your investor base and enhance distribution capability. For Tatarstan I think it is very relevant; and I would expect other countries like Azerbaijan and Kazakhstan to follow suit. Islamic finance can be expected to grow more strongly in Central Asia than Moscow due to liquidity and diversification needs.”
However in the satellite CIS countries we can expect a lot more activity, with more firms flocking to market as they see the success of the ABB deal. “You will definitely see other financial institutions entering the market, you will see sovereigns possibly looking to tap the Sukuk market, and as these things happen and establish you will then also see more corporates. It will happen, but step by step,” confirms Najam. “The region is growing, and this transaction shows that there is investor appetite. I would not be surprised if ABB came to the market again, depending on its funding requirements.”
Shibeer agrees that: “When other institutions and corporates in the region see that you’ve got institutions willing to provide Islamic facilities for Russian entities, that will increase activity and generate interest among other corporates and institutions that may not otherwise have looked at Islamic finance as a possible source.” And for Russia specifically this is an important benchmark to have been set. “What we are seeing more and more from our investors in the region is more interest in what Russian borrowers are doing,” elaborates Starcevic. “This market will become more accessible to them. There is also the function of investors being liquid, looking for assets, which may come from beyond their immediate home region. So it will be interesting to see if some of the larger and more frequent borrowers like trade or larger oil and gas players look to access these markets. It will give access to a region that most foreign investors have not accessed before.”
In the wider region CIS region we are seeing more curiosity, activity and encouragement from banks than ever before: along with extensive pitching, marketing and education sessions. “We will certainly see more deals coming in and there is a lot of potential for these types of deals,” concludes Ziad. “Investors are interested and with the right approvals and groundwork in place we can expect a lot more from this region in the future.” – LM