Although not hefty in numbers, convertible Sukuk has made its mark in the Islamic debt arena over the years via a handful of prominent issuances. Is this a trend that is set to grow, or will convertible Sukuk remain in barely-charted territory? NAZNEEN HALIM enquires.
In 2006, the Islamic bond market saw its first convertible Sukuk in the form of Ports, Customs & Free Zone Corporation (PCFC)’s US$3.5 billion Sukuk Musharakah, which paved the way for future issuances such as Khazanah Nasional’s US$750 million exchangeable Sukuk and Nakheel’s massive US$3.52 billion issuance.
PCFC’s convertible Sukuk Musharakah was the largest issuance to be listed on the Dubai International Financial Exchange at the time, and was a boost to investors’ confidence in the Gulf equity markets. It entitled investors to convert up to 30% of their equity shares of various PCFC entities in the event of future qualifying public offerings (QPO) within two years of the Sukuk issuance. Investors were also guaranteed a higher compensation should a QPO not transpire, or to exercise a “look-back option” buying them an extra 12 months to participate in a QPO after the Sukuk’s maturity.
However, in 2009, when the credit crisis enveloped the global economy, everything seemed to go pear-shaped in the Middle East market, with Sukuk being one of the hardest-hit sectors. Nakheel’s US$3.52 billion issuance was teetering on edge with restructuring on the cards, along with several other prominent Sukuk, shaking investor confidence in these debt issuances.
The market rebounded in 2010, with investors seeking safer havens in the Middle East and moving out of developed economies due to plunging yield prices and the successful restructuring of US$14.4 billion worth of Dubai World’s debt. Aldar Properties and Dana Gas, who had previously issued convertible Sukuk in 2007, saw the highest yield returns in 2010: with Aldar returning 13.6% as at the 30th June, and Dana Gas returning 8%. Dana Gas also saw a 23% gain in stock prices to AED0.81 in 2010, reducing losses previously experienced. Dana Gas’ Sukuk is due in October 2012, while Aldar’s Sukuk will mature in November this year.
After a lackadaisical 2010, 2011 has already seen one convertible Sukuk issuance out of Abu Dhabi by Aldar Properties for an amount not exceeding AED3.5 billion (US$952.8 million). The Sukuk, which was issued at the end of February, will see AED2.8 billion (US$762 million) be issued to Mubadala Development Company at a conversion rate equal to the market share price, not exceeding AED2.3, or less than AED1.75. Under the terms, the issuer is allowed to delay the conversion of any of the bonds up to December 2013, provided a minimum of AED2.105 billion (US$573 million) is converted in December 2011.
Despite this Anzal Mohammed, Islamic finance partner at Allen & Overy, who advised on the first convertible Sukuk out of Kuwait in 2007, believes that appetite for convertible Sukuk this year will be dismal, due to underperforming equity markets and a generally bleak investment sentiment.
“There has been a drop in interest in the convertible market because the equity market has not been performing at a particular level, especially here in the GCC. So with share prices dropping, you are unlikely to see huge demand for convertible instruments,” he said. Clarifying further, Mohammed added:
“From an economic perspective, if you have a depressed equity market, and investors are not necessarily keen on investing in equity, by definition, they will be less keen to invest in convertible Sukuk as well. From an investment division perspective, there is the same consideration as to whether they want to invest in equity or not, depending on the state of the equity market at that time, and what their perception is of the performance of the equity market over that period of time.”
The structure of a convertible Sukuk is such that the conversion of the trust certificates is contingent, and the identity of the company into whose shares the certificates convert are made known to investors before the option is exercised, therefore eliminating any sort of uncertainty. However, the possibility of a company issuing an IPO is relatively uncertain, thus adding to more structural complexities when the Shariah is involved. Mohammed also revealed: “From a legal perspective, there are the regulatory issues; shares and what the rules are, and approvals that you need. From a Shariah perspective, it centers very much on how you determine the payout itself. That is the key issue there, in the sense that you still have a purchase undertaking, but it is the mechanics of the receipt of shares as opposed to cash that is heavily considered.”
“Investors who are interested in convertible Sukuk always consider the state of the equity market. If share prices are unlikely to perform over a period of time, then they are unlikely to invest in a convertible Sukuk. I think we will need to see a return of the Sukuk market in general first, before we see a return to convertible issuances. But we may see the odd deal this year,” Mohammed concluded.