1. The growth of Islamic finance
The growth in appetite for syndications of Shariah compliant financing is consistent with the growth of Islamic finance generally. The catalyst for the Islamic finance boom is demand, founded on the requirement to obtain financing which complies with religious beliefs. In the syndicated bank markets, there is an increasingly active union between demand to tap Islamic liquidity (and possibly more competitive pricing) by accessing a wider funding base and the supply of Islamic finance. Liquidity is backed by increasing amounts of Islamic deposits and a growing number of Islamic financial institutions.
While Islamic financial institutions are precluded from participating in conventional loan syndicated financing, the opposite does not apply: conventional banks can (and frequently do) participate in Islamic syndicated deals. Aside from demand and supply dynamics, there is also profile to be gained — arguably higher profile than can be achieved with a conventional facility. While large loan transactions can make the headlines, the fact that a deal is Islamically structured or that a noteworthy corporate has taken Shariah compliant financing is often news by itself. A string of zeros after the deal size adds to the profile. For corporates looking to widen their investor base, therefore, there are very good tangible and intangible reasons to take a very close look at Islamic finance.
Raising funds through an Islamic syndication allows the corporate to diversify its funding sources; syndication opens up a wider distribution base. This paves the way for new relationships for the corporate and potentially gives access to more competitive and more numerous financing options. An increasing number of corporates are taking advantage of the competitive pricing and supply of liquidity offered by Islamic financing. However, many of the participants in Islamic syndications are not only Islamic financial institutions, but also a large number of conventional institutions, with or without Islamic windows, divisions or subsidiaries.
The growth in the demand for Islamic facilities has led to the development of a variety of Islamic financing structures — an evolution since the days when there were only vanilla Murabahah products — and to the widespread use of combined Islamic and conventional sources of finance. This chapter discusses contemporary Islamic and co-Islamic financing syndication transactions from a legal and structuring perspective.
2. Multisource financing
Conventional banks are not precluded from participating, and often do participate, in Islamic syndicated deals. Borrowers seek the advantages of multisource financing, particularly as regards pricing and funding diversity. As a result, the number of co-Islamic financing deals has been rising steadily and is likely to continue to increase now that Islamic financing is seen as a plausible financing source from the outset, rather than something to be utilized when there is a funding shortfall or, more generally, when there is a dip in emerging market sentiment from the commercial debt market.
The Gulf Cooperation Council (GCC) market has seen an increase in multisource Islamic deals where, in addition to a conventional tranche, there are several separate Islamic tranches. This phenomenon is due mainly to the lack of a centralized Shariah board system in the GCC providing for a binding and consistent interpretation of Shariah. As a result, different Shariah boards of different banks often have differing views or interpretations in relation to the same Islamic financing structure. The clearest example there is the divide in the GCC amongst Islamic financial institutions which accept commodity Murabahah financing and those which reject it (see the section on Murabahah below).
Attention needs to be given to how to structure each multisource transaction in order to cater for inter-creditor issues generally and to deal with the additional structural challenges that are specific to Islamic financings. Generally, inter-creditor issues, whether in respect of Islamic facilities or conventional facilities or both, fall into categories. These include who has a right to call a default and accelerate facilities, the order of disbursement of facilities and maturity of facilities, the order in which payments from the borrower are applied and restrictions on amendments and waivers, as well as voting powers generally. These issues need to be considered in light of the principle of equal treatment: conventional lenders will want to ensure that the Islamic banks do not acquire greater rights than those acquired by them, and vice versa.
There is the additional hurdle of satisfying the requirements of the Shariah boards involved without losing sight of the commercial deal. This involves: (i) satisfying the needs of conventional lenders without compromising on Shariah principles, (ii) reconciling the views of the different Shariah boards involved in the deal, and (iii) if the views of the different Shariah boards cannot be reconciled so as to get a single Islamic tranche, arranging separate Islamic tranches.
How the foregoing issues are dealt with in the documentation is key to a successful closing of any multisource financing deal. These inter-creditor considerations are usually covered in a common terms agreement. Alternatively, a facilities coordination agreement can be used to coordinate the rights and interests of the various parties involved.
The conventional wisdom is that borrowers, faced with multiple financiers, should avoid separate negotiations as far as possible and try to conduct negotiations by standardizing financing conditions. The much-used common terms agreement owes its origin to this rationale. The common terms agreement uses an integration approach. It is an agreement between all the parties, dealing with the representations, covenants and events of default, as well as specific inter-creditor issues. In addition to the common terms agreement there will be separate facility agreements for each tranche incorporating the provisions of the common terms agreement and otherwise setting out specific aspects of the facility (eg, the facility amount and utilization mechanics and such).
While conventional financiers will be limited only by their internal approval procedures, most importantly their credit committees, where Islamic financial institutions are involved, Shariah supervisory boards must also be satisfied that the financing arrangement is Shariah compliant. The Shariah is immutable and needs to be viewed accordingly by the parties involved. However, too often there is a lack of appreciation of this basic premise.
Changes to the provisions of a common terms agreement required for Shariah compliance reasons can lead to frustration for other parties. The common terms agreement can degenerate into a quagmire — the efficiency and speed sought by the integration approach of the common terms agreement can lead to opposite effects. One alternative used by the author on a number of co-Islamic financings with good results is the use of facilities coordination agreement in lieu of a common terms agreement.
The important distinction between a facilities coordination agreement compared to a common terms agreement is that a facilities coordination agreement does not seek to integrate the terms of the various financing sources, instead it seeks to coordinate them. A facilities coordination agreement is an agreement by all the parties involved in the financing. It deals with specific issues meriting coordination within the financing; the most important of which are pro rata utilization of the facilities involved, pro rata repayments and pro rata sharing provisions among the financiers. Otherwise, each facility is separate, including their representations and warranties, covenants and events of default. If there is security provided, then it is held by a common security trustee for each set of financiers. That security becomes enforceable when the security trustee is instructed accordingly. There may be an acceleration or enforcement of all of the facilities because, prior to issuing an acceleration notice or enforcement instruction, each set of financiers is obliged to give notice to the others. As default under one facility will lead to default on the others, each set of financiers can (and in all commercial probability will) accelerate if others elect to do so.
As each set of financiers is free to negotiate their own financing documents, Shariah issues should not materialize. The segregation of the Islamic financing documentation makes for an efficient means of ending up with a Shariah compliant financing arrangement, and avoids the risk of contagion whereby the Shariah compliant nature of the financing may be tainted by integrating common terms.
Rahail Ali is the global head of Islamic finance at Hogan Lovells. He can be contacted at
[email protected]
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