A decision by Dana Gas to declare its own Sharia-compliant bonds unlawful has baffled investors in the $2-trillion (Dh7.34 trillion) Islamic finance industry.
Sharjah-based Dana Gas said on Tuesday that it no longer considered its two Islamic bonds totalling $700 million issued four years ago as Sharia-compliant under the United Arab Emirates’ law. A court in Sharjah has since barred bondholders from taking any action against the company’s securities until it reviews Dana Gas’s application to declare its debt “unlawful and unenforceable.”
“As creditors we understand that this is a liquidity and a payment issue, not a solvency issue — but clearly the company is trying to squeeze sukukholders to the benefit of shareholders and that is a strategy that will end up hurting everybody down the road,” said Abdul Kadir Hussain, the head of fixed-income asset management at Arqaam Capital Ltd. Even if there were potential developments in Islamic finance that raised questions on the structure, “it is still a debt instrument and money they have borrowed,” he said.
The move comes after Dana Gas, which produces most of its energy in Egypt and Iraq, announced plans in May to restructure the debt, saying it needed to “focus on short to medium-term cash preservation.”
The company is owed about $1 billion from Egypt and the self-governed Kurdish region in northern Iraq. Dana Gas had about $298 million of cash on hand at the end of March.
What about the bondholders?
“This is pretty bad news for all sukuk investors as Dana Gas seeks to apply Sharia non-compliance as a rationale for restructuring discussions,” said Khalid Howladar, the founder of Acreditus, a risk and ratings-advisory firm.
Dana Gas plans to replace the current sukuk with four-year bonds paying “less than half of the current profit rates and without a conversion feature,” it said this week. The new profit payments will comprise a cash and payment-in-kind element, and the sukuk may be repaid either in whole, or in part at par, prior to its maturity without any penalty, the company said.
An ad hoc committee representing holders of the $700 million Islamic bonds said it won’t exchange the sukuk for new instruments at the proposed terms, which are “materially less favourable,” according to two people with knowledge of the matter and a statement seen by Bloomberg.
“Due to the evolution and continual development of Islamic financial instruments and their interpretation, the company has recently received legal advice that the sukuk in its present form is not Sharia-compliant and is therefore unlawful under UAE law,” Dana Gas said earlier this week.
A so-called mudarabah contract was used to structure the sukuk, which stipulates that the capital providers agree to share the profits between themselves and the entrepreneur at an agreed ratio or percentage.
A person familiar with the arguments the company will present said the structure isn’t legally sound because of the following characteristics:
Dana Gas’s sukuk structure was approved by Dar Al Shariah, a UAE-based firm that has also advised companies such as Citigroup Inc. and Emaar Properties PJSC, according to its website. Dar Al Shariah didn’t respond to emailed questions.
In the absence of a centralised national Sharia board, such as the regulatory body in Malaysia, Islamic borrowers seek the advice of trained scholars to approve contracts. Sharia law prohibits interest-based financial products and forbids investments in companies involved in activities considered unethical.
What’s at risk?
Other than Dana Gas’s sukuk, there are seven outstanding Islamic bonds issued by UAE borrowers that are based on mudarabah contracts, according to data compiled by Bloomberg. All are perpetual bonds, with the exception of DP World’s securities.
If the legal issue “is somehow contractual and specific to Dana, it shows how excessive sukuk complexity can expose inexperienced investors to additional risks upon default and argues strongly for regulated central Sharia boards to both build market confidence and transparency around this immature industry,” said Acreditus’s Howladar.
“Irrespective, the legal and Sharia opinions that are supporting this view should be made public by the regulators in the interests of market transparency,” he said.
Is this a first?
This isn’t the first time a company has sought to discredit its own Sharia facility. Investment Dar, a Kuwaiti company that was restructuring debt, contradicted its own scholars’ assessment and argued that a transaction with Beirut-based Blom Bank SAL breached Sharia principles because Dar “was taking deposits at interest,” it said in a court filing in 2009.
Not only was Investment Dar’s appeal thrown out of a UK court, but its own Sharia supervisory board barred it from using arguments based on Islamic law.
The Sharjah Federal Court of First Instance has issued an injunction while it considers Dana Gas’s application to have its Islamic bonds issued in 2013 “declared unlawful and unenforceable”, according to a company statement on Wednesday.
The injunction restrains institutions associated with the sukuk from taking any action inside or outside the UAE to enforce against any of the securities of the company and its affiliates until a final determination is made by the court, it said. Dana Gas was also granted an additional injunction from the commercial division of the High Court of Justice in the British Virgin Islands on June 13, according to another statement.
Initial hearing in the case in Sharjah has been scheduled for December 25. But the gas producer’s two securities, the $350-million 9 per cent ordinary certificates and the $350 million of 7 per cent bonds, mature in October.
Dana Gas said it won’t pay its next two profit distributions on July 31 and October 31, and that they will be accounted for as part of the new instrument.
Not paying coupons because the instrument is not Sharia-compliant is “something that has a much wider implication for the sukuk market in general,” said Hussain of Arqaam.
Dana Gas gets injunction from English court blocking claims
Dana Gas said on Sunday that it had obtained an injunction from the English High Court of Justice in London restraining holders of its $700 million of sukuk from taking any hostile action against the company in relation to the Islamic bonds.
Last week, the company obtained similar injunctions from the Sharjah Federal Court of First Instance in the United Arab Emirates and from the Commercial Division of the High Court of Justice in the British Virgin Islands.
The Abu Dhabi-listed energy company announced last week that its outstanding sukuk were not Sharia-compliant and were therefore unlawful and unenforceable in the UAE.
The company said it would therefore halt coupon payments on the sukuk, and proposed to its creditors exchanging the sukuk for new Islamic bonds with lower profit distributions.
A committee of sukuk holders said last week that the company’s decision to halt payments was a “repudiation” of the English law under which the instruments were issued.