Guide 2007.indd - Islamic Finance News

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Guide 2007.indd - Islamic Finance News

Islamic Finance news Guide 2007

The Next Generation in Islamic Financing

By Arul Kandasamy

It is no coincidence that a pre-IPO structure has

been used for the two largest ever Sukuk (Nakheel

Development – US$3.52 billion and PCFC

Development – US$3.5 billion, both arranged by

Barclays Capital and Dubai Islamic Bank). It is a

unique structure that offers significant benefits to

both borrowers and investors. In fact, not only is

the Nakheel Development Sukuk the largest Sukuk

ever executed, it was one of the largest convertible

offerings ever executed globally.

The pre-IPO Sukuk has heralded a sea-change in investor

perception of the Sukuk instrument and has been the single

largest contributor to the growth of Sukuk issuance in 2006.

As can be seen from the table below, global Sukuk issuance

increased 120% from 2005 to 2006. Approximately 43%

of 2006 Sukuk issuance was made up of pre-IPO Sukuk

transactions.

Global Sukuk Issuance 2002-2007

The pre-IPO Sukuk is a relatively new instrument which

requires an arranger/lead manager who is at the cutting edge

of structuring technology. There is a need to combine the best

in fi nancing techniques with legal and Shariah structuring.

In particular, transaction structuring expertise and market

knowledge are key to being able to balance the requirements

of fi xed income (i.e. debt) investors with the requirements of

convertible (i.e. equity-oriented) investors. Barclays Capital

has successfully been able to leverage on its expertise in

structuring and distributing conventional fi nancing products

in the development and marketing of the pre-IPO Sukuk.

“The pre-IPO Sukuk has heralded a

sea-change in investor perception

of the Sukuk instrument and has

been the single largest contributor

to the growth of Sukuk issuance in

2006”

Depending on the particular needs of each borrower, a

number of different transaction structures can be used for a

pre-IPO Sukuk. As an example, the transaction structure used

for the Nakheel Development pre-IPO Sukuk is summarized

below.

Source: Bloomberg, January 2007

A pre-IPO Sukuk is a debt fi nancing instrument that provides

investors with an opportunity to take a view on the equity

markets before an IPO has taken place. During the lifetime

of the Sukuk, investors receive not only a fi xed income return,

similar to the one they would expect from a normal bond, but

also a guaranteed pre-allocation in shares to be issued in any

public offering (initial or secondary) that takes place during

the life of the issuance (defi ned as qualifi ed public offering

– QPO). This can happen either through the attribution of

subscription rights, or through a commitment of the company

to redeem in shares part of the instrument at the time of the

QPO. This allows investors to benefi t from the appreciation

of the shares, which usually takes place immediately after

the QPO. In this respect, a pre-IPO Sukuk has the risk/return

characteristics of a bond, but with an equity upside potential,

the value of which depends on the equity performance at the

time of the QPO.

continued...

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Page 35


Islamic Finance news Guide 2007

The Next Generation in Islamic Financing (continued...)

At the close of the transaction, Nakheel Development raised

US$3.52 billion by issuing trust certifi cates (Sukuk Ijarah)

to a diverse, global investor base. Proceeds of the Sukuk

issuance were used to purchase a long leasehold interest on

property at Dubai Waterfront (Sukuk assets) from Nakheel

Holdings 1 LLC. Nakheel Holdings 1 LLC then injected

capital into Nakheel Co., which is the corporate vehicle of

the Nakheel Group. Nakheel Development then leased the

Sukuk assets to Nakheel Holdings 2 LLC under a three-year

lease agreement. Rental from this lease agreement were

then upstreamed as returns to Sukuk holders. Pursuant to

the terms of a servicing agent agreement, Nakheel Holdings

2 LLC will be responsible for managing the Sukuk assets on

behalf of Nakheel Development.

The Sukuk size at launch was US$2.5 billion. Due to the

unique transaction structure and aggressive marketing of the

Sukuk, the transaction was well received in the global market,

with an order book that was oversubscribed nearly two times.

This enabled Nakheel to upsize the transaction to US$3.52

billion and to price the Sukuk at LIBOR + 120 basis points

(bps) per annum, which was at the mid-point of marketing

price talk (LIBOR + 95 to LIBOR + 145 bps). Interestingly, due

to greater awareness from the investor base after the PCFC

Sukuk transaction, new investors (i.e. those not participating

in the PCFC Sukuk) accounted for 33% of the demand and

25% of the allocation in the Nakheel transaction. This was

a clear demonstration of increased investor demand for and

interest in Sukuk. Another key development was the large

number of orders received from investors in Europe and Asia

and as a consequence, the allocation of 40% of the Sukuk

to European investors and 13% of the Sukuk to investors in

Asia.

Nakheel Sukuk Allocation by Region

Asia

13%

Others

6%

preferential terms. Whilst this may seem like an expensive

option for the borrower to give, the borrower in fact benefi ts

through a lower cost of funding (the value of the option is

monetized through a reduction in the margin). In that respect,

the pre-IPO is a powerful fi nancing tool which offers a “win–

win” solution to all parties involved.

Issuer

Obligor

PCFC Sukuk

PCFC Development

(SPV)

Ports, Customs and Free

Zone Corporation

Nakheel Sukuk

Nakheel Development

(SPV)

Nakheel

Guarantor – Dubai World

Size US$3.5 billion US$3.52 billion

Closing Date January 2006 December 2006

Structure Musharakah Ijarah

Tenor 2 years 3 years

QPO Yield 7.125% (LIBOR +200

bps at launch)

6.345% p.a. (LIBOR + 120

bps at launch)

Non-QPO Yield 10.125% 6.345% + up to 2.00% p.a.

QPO Discount None 5%

Arrangers Barclays Capital and Dubai Islamic Bank

At Barclays Capital, we are confi dent that pre-IPO Sukuk will

form an integral part of future Sukuk issuance, particularly

in the GCC and South-East Asia, where there are a number

of unlisted, fast-growing or mature companies that want to

monetize today value that could be raised in the future via

an IPO.

The author is head

of Islamic Financing

Solutions at Barclays

Capital. He can be

contacted at: Dubai International Financial Centre, Level 9,

West Wing, The Gate Building, PO Box 506504, Dubai, UAE.

Tel: +971 4 362 1000 or +971 4 362 1013 (direct), Mob:

+971 50 553 2011, Fax: +971 4 362 1102.

Middle East

41%

Europe

40%

A key element of investor interest in a pre-IPO Sukuk relates

to the option investors have to participate in a future IPO on

Page 36

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Harness the energy

of our Islamic finance

& investment lawyers

Our lawyers assist clients with developing innovative Islamic

equivalents to capital protected funds and funds of funds,

call options (Bai Al-Arboon), convertible loans, leveraged

buy-outs, short selling and Sukuk backed-up by energy

(including renewable energy) assets in the U.S. and the EU.

Vinson & Elkins lawyers recently advised leading Islamic investment banks

with the following:

• US$180 million Sukuk backed by Gulf of Mexico assets, including an

overriding royalty interest and advised on Shari’ah compliance of related

hedges; named the 2006 Structured Finance Deal of the Year and USA

Deal of the Year, Islamic Finance News; Most Innovative Islamic Finance

Deal of the Year, Euromoney

• US$150 million variable rate, semi-annual return Islamic Musharaka

trust Sukuk (backed by assets consisting primarily of vehicles and

properties) for a Kuwait investment company

• US$200 million Sukuk transaction with proceeds used to finance a

Kuwait real estate development project

• US$150 million Shari’ah compliant private equity fund regulated by

the Bahrain Monetary Agency

For more information about V&E’s Islamic Finance & Investment practice,

please contact:

Ayman A. Khaleq (Dubai office)

akhaleq@velaw.com

+(971) 4.330.1800

Christopher B. Strong (Dubai office)

cstrong@velaw.com

+(971) 4.330.1800

Jeffrey E. Eldredge (London office)

jeldredge@velaw.com

+44 (0)20.7065.6000

Mark R. Spradling (Houston office)

mspradling@velaw.com

+1 (713) 758.2222

Vinson & Elkins LLP International Lawyers Austin Beijing Dallas Dubai Hong Kong

Houston London Moscow New York Shanghai Tokyo Washington www.velaw.com


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