Offshore centers have continued to be popular domiciles for the structuring of Islamic finance transactions in 2016. We have noticed a continued trend in the use of Cayman Islands (as well as the Dubai International Financial Center (DIFC)) SPVs, in particular for the issuance of Tier 1 capital Sukuk by GCC banks and to raise Shariah compliant financing in the aviation space. Uncertainty in the global economy and recent movements in the international markets may, however, impact upon the recent momentum of the strong growth of Islamic finance and how Islamic finance transactions may be structured over the next year and beyond.
Review of 2016
During 2016, we continued to witness a number of banks in the GCC raising Tier 1 capital by way of Sukuk issuances in order to satisfy the stringent requirements of the Basel III banking regulations. In 2015, the vehicles used for such issuances were most commonly incorporated in either the Cayman Islands or the DIFC, and this trend continued in 2016.
Over the year, we have seen a number of such issuances emanating out of Kuwait. Kuwait’s first Tier 1 capital Sukuk issuance occurred in May 2016 with Boubyan Bank’s issue of US$250 million-worth of Tier 1 capital certificates. Following on its heels was the issuance of a US$200 million perpetual additional Tier 1 Sukuk facility by Kuwait’s Ahli United Bank in October 2016. Both issuances were dual listed on NASDAQ Dubai and the Irish Stock Exchange. Boubyan Bank utilized a DIFC SPV as its issuing vehicle and Ahli United Bank’s Sukuk issuer was a Cayman Islands exempted company. Both issuing vehicles were (as is typically the case) set up as ‘orphan’ entities with their shares held in charitable trust by a licensed trust company and their management independent from the obligor. A third Kuwaiti bank, Warba Bank, recently announced its own proposed Tier 1 capital issuance, and we can reasonably expect similar announcements out of Kuwait and neighboring countries into 2017, utilizing similar Cayman Islands and DIFC structures.
Another area experiencing growth in the utilization of Islamic compliant SPV structures is the aviation sector. In 2015, Emirates issued close to US$1 billion in Sukuk to finance the acquisition of four A380 aircraft, and Garuda Indonesia had its inaugural international Sukuk issuance of US$500 million. Both of these transactions utilized a Cayman Islands entity as the issuing vehicle. Now in 2016, it was reported by Reuters that Etihad plans to issue a debut US dollar-denominated benchmark Sukuk and, if it follows recent issuances in the industry, it will also implement a similar SPV structure.
In addition to Sukuk, Cayman Islands companies have been widely used by airlines and aircraft lessors for the structuring of both Shariah compliant financings and equity investments to finance the acquisition of aircraft. In September 2016, International Airfinance Corporation (IAFC) reported that it had delivered three A330 Airbus aircraft to Saudi Arabian Airlines; this is out of a total 50 aircraft expected to be delivered to Saudia by the ALIF Fund. IAFC manages the ALIF Fund, a Shariah compliant aircraft leasing investment entity established with Airbus and the IDB as seed investors. The fund is incorporated as a Cayman Islands segregated portfolio company, the structure of which provides great flexibility by facilitating (through the use of different segregated portfolios) the financing of aircraft by various Shariah compliant means, including Ijarah financings and Sukuk.
Preview of 2017
Many have been surprised over recent events in the US, firstly by Republican Donald Trump’s victory as the president-elect of the US and, secondly by the rallying in the US stock markets just one day following the election. The US bond markets have been affected as well with yields on 10-year US Treasury rising sharply. According to Market Intelligence Center, this is largely a reaction to ‘Trump Trade’, Trump’s proposed protectionist trade plan and aggressive economic stimulus plan touted during his election campaign, which is anticipated to add supply to the Treasury bond market. Furthermore, the president-elect’s promises to cut taxes and increase spending are expected to lead to higher inflation in the US and a stronger US dollar.
Some analysts fear that these circumstances could result in reduced investments into emerging markets as investors are lured to the US and its offering of safer assets and greater returns. These fears have already materialized to some degree in certain Asian emerging markets, with Asian currencies falling in recent weeks.
So how might Trump’s new administration affect the offshore centers and the growth of Islamic finance? In terms of Islamic bonds, the Sukuk market does not necessarily follow the trends of the conventional bond markets. Higher yields in the US and a stronger US dollar may make it more challenging (and costly) to issue Sukuk (particularly US dollar-denominated Sukuk) to global investors, but there are many benefits to Islamic finance that will continue to make Sukuk investments very attractive.
As Sukuk are asset-based, many investors perceive it to be a safer investment than a conventional unsecured bond and one that is based on underlying assets and business practices that may be more ethical in nature. Islamic finance is generally seen to promote financial stability, as it is based on real assets and risk-sharing principles of Shariah. We witnessed this following the economic crisis of 2008 with Islamic banks faring much better than their conventional counterparts.
Notwithstanding any implications arising from the US markets, Islamic financial institutions will continue to seek Shariah compliant solutions for their customers and their own internal capital requirements and will do so using entities formed in jurisdictions such as the Cayman Islands, the British Virgin Islands, the DIFC, Labuan and Jersey. As mentioned previously, we should expect the continued use of such jurisdictions for Sukuk offerings in the Tier 1 capital space and to raise Islamic compliant financing for airlines and aircraft lessors. The trend of sovereign Sukuk issuance is also likely to continue as governments seek to fulfil their strategic policy goals for the development of Islamic finance; many of these issuances will likely be carried out through SPV structures. Furthermore, there will always be some appetite for investments into riskier emerging market assets, and jurisdictions such as the Cayman Islands and Jersey are well placed for the structuring of such investments through Shariah compliant investment funds.
One of the challenges moving forward will be to raise awareness of, and educate global investors on, the benefits of Islamic finance.
Conclusion
Notwithstanding the uncertainty in the market, there remains much liquidity as well as interest in Islamic finance, thus Shariah compliant structures will continue to remain attractive particularly to global investors seeking to diversify their portfolios. Offshore jurisdictions (such as the Cayman Islands), which offer a tax-neutral, low-cost environment and have enacted legislation to simplify structuring for Islamic financing transactions, will continue to remain popular domiciles for vehicles used in Islamic finance.
Manuela Belmontes is the partner at Maples & Calder. She can be contacted at [email protected].