slamic finance grew strongly in the first half of 2017. We witnessed numerous Sukuk issuances into the international markets, which commonly featured special purpose issuing vehicles domiciled in popular centers such as the Cayman Islands, Jersey and the Dubai International Financial Center (DIFC). Growth appears to have slowed somewhat during the second half, as oil prices remained consistently low and currencies of certain nations depreciated or were devalued. Some believe that the slow growth in Islamic finance is likely to continue into next year and possibly beyond.
Review of 2017
Notable Sukuk issuances by sovereigns, financial institutions and large corporates took place during the year. The Kingdom of SaudiArabia (KSA) had a spectacularly successful US$9 billion issuance of Sukuk into the international market, which was structured using a Cayman Islands subsidiary company. The prospectuses of KSA Sukuk Cayman Islands SPVs were also used in issuances of listed Sukuk by large GCC-based corporates such as Ezdan Holding Group, Dar Al-Arkan Real Estate Development Company and DAMAC. However, the issuing vehicles in these latter transactions were structured in the more customary manner as ‘orphan’ entities, with their shares held by a licensed trust company on a charitable trust and their management provided by independent directors. Labuan continues to be a popular issuer domicile for issuances out of Malaysia.
The trend from 2016 of GCC banks raising Tier 1 capital by way of Sukuk issuances in order to satisfy the stringent requirements of Basel III continued into 2017, with Warba Bank issuing US$250 million in perpetual Tier 1 capital certificates in March, followed by domestic private placement Sukuk issuances by Saudi Investment Bank and National Commercial Bank a few months later. Warba Bank utilized the customary Cayman Islands orphan issuing vehicle, but DIFC special purpose companies have also been a popular alternative for issuers of Tier 1 capital certificates.
In addition to Sukuk, there have been a significant number of GCC-based Islamic financial institutions forming Cayman Islands SPVs for hedging transactions in order to take advantage of that country’s netting-friendly legislation. The formation of these subsidiary companies is particularly useful for those Islamic banks situated in jurisdictions where the local laws do not recognize set-off and netting rights.
Preview of 2018
Despite the lack of reported activity by the aviation sector in the Islamic capital markets in 2017, we see this as a growing area for Islamic finance. Following Sukuk issuances by fly dubai, Emirates and Etihad in 2014, 2015 and 2016 respectively, we anticipate further airlines and/or aircraft lessors to tap into the Islamic capital markets in 2018 using similarly structured offshore SPVs as issuers. Several airlines and aircraft lessors are already transacting with Islamic banks that are offering Shariah compliant asset-financing products based on I jarah structures. This activity will most definitely continue into 2018, with such products using both on-balance sheet and off-balance sheet SPVs domiciled in centers such as the Cayman Islands, Ireland, the DIFC and the Abu Dhabi Global Market (ADGM) to acquire and hold the aircraft and act as limited recourse borrowers.
In terms of GCC financial institutions, as more of them become compliant with Basel III, one would expect that Tier 1 capital Sukuk issuances would become less frequent at least for a period of time. We do see the trend of GCC banks forming Cayman Islands SPVs for hedging purposes continuing into next year.
In terms of GCC corporates, a recent PwC study revealed that working capital performance has deteriorated for large corporates in certain regions of the GCC. We may witness an increase in issuances in the Islamic capital markets or simply an increased demand for Shariah compliant financing to ease pressure on liquidity. In either case, we anticipate that issuer/borrower vehicles will be formed for these purposes in popular centers such as the Cayman Islands, the British Virgin Islands and the DIFC that offer low-cost, English lawbased creditor-friendly legislative regimes, experienced judiciaries and political stability.
The considerable liquidity that remains in the market will drive the launch of new Shariah compliant funds by financial institutions and asset managers who wish to offer a diversified portfolio to their client base. These funds will likely continue to be based in offshore centers such as the Cayman Islands, Luxembourg and Jersey, each of which can offer an efficient and effective regulatory framework, a community of highly qualified professional advisors as well as a low (or no) tax regime.
The continued growth of the ADGM and its impact on Islamic finance will be interesting to watch next year, as ADGM SPVs may offer a viable alternative to SPVs formed in the DIFC and traditional offshore centers for use in Sukuk issuances and other Shariah compliant financing transactions.
One way in which offshore centers could advance Islamic finance (and possibly set themselves apart from other jurisdictions) would be to further evolve their legislation to accommodate Shariah compliant transactions and to address, for example, regulatory issues that arise in the structuring of Islamic finance transactions.
While there are contrasting views in the marketplace as to whether growth in Islamic finance will slow down or maintain its steady impressive pace next year, there remain much liquidity and interest in Shariah compliant investment and financing products. No matter the type of investment or product, the trend of using offshore jurisdictions as domiciles for investment and issuing vehicles in Islamic finance transactions will certainly continue.
Originally published by Islamic Finance News