Dana Gas sukuk move no impact on Malaysian bonds

Dana Gas PJSC’s application to have its US$700 million (RM3 billion) sukuk due in October this year to be declared unlawful and unenforceable has not affected sentiments in the Malaysian bond market.

In essence, Dana Gas is said to effectively attempt to reduce its finance cost by issuing lower yielding sukuk with fresh stamps of Shariah approval.
The issue, in the eyes of one research company, has raised a “key question” as to whether the precedent of revisiting the Shariah stamp of approval creates risk in excess of the risk associated with an equivalent piece of conventional finance.

On its part, Dana Gas said in a statement that the Sharjah Federal Court of First Instance in the United Arab Emirates (UAE) has issued an injunction pending determination of the company’s application to have its sukuk dated May 8, 2013, declared unlawful and unenforceable. The court has scheduled an initial hearing on Dec 25, 2017.

On June 13, 2017, the company was granted an additional injunction from the Commercial Division of the High Court of Justice in the British Virgin Islands.

Bond Pricing Agency Malaysia Sdn Bhd’s Meor Amri Meor Ayob, when contacted on the matter, told The Malaysian Reserve that the development has not impacted sentiments on the local bond market.

In a research report, Exotix Capital Ltd said the Dana Gas’ restructuring discussions have been ongoing since May and follow the company’s multi-year difficulty in collecting cash from quasi-sovereign counterparties in Egypt and the Kurdistan Region of Iraq (KRI).

The Sharjah-headquartered company has operations in the UAE, Egypt and KRI. The first and largest Middle East private-sector natural gas company was established in December 2005 and is listed on the Abu Dhabi Securities Exchange.

In a statement on June 13, Dana Gas said its initial proposal for restructuring the existing sukuk will be based on broad principles and terms that include exchanging the sukuk with a new enforceable, Shariah-compliant instrument. The instrument will have a tenure of four years, confer rights to profit distributions at less than half of the current profit rates and without a conversion feature.

The new instrument would represent a fundamental improvement to the current situation for bondholders as it would be enforceable and provide repayment to bondholders over time, according to the statement available on the company website.

As the company’s receivables and future damages payments may be unpredictable, Dana Gas has proposed to make prepayments under the new sukuk either in whole, or in part at par, prior to its maturity without any penalty, thus providing a path for early pay-down for bondholders.
Dana Gas said the next two distributions scheduled for July 31, 2017, and Oct 31, 2017, cannot be paid now that the existing sukuk is deemed unlawful, but will be accounted for as part of the new sukuk instrument.

In its research report entitled “Islamic finance risks raised by Dana Gas case” dated June 15, 2017, Exotix Capital posed some questions on the development as a test case for broad Islamic finance.

“How important is this precedent of reviewing Shariah compliance by a distressed borrower for the broad Islamic finance industry? The key question here is whether the precedent of revisiting the Shariah stamp of approval creates risk in excess of the risk associated with an equivalent piece of conventional finance (this question could apply not merely to sukuk, but to all other forms of Islamic finance),” said Exotix Capital.

“While posing this ‘baby and bathwater’ question, it is worth mentioning that there are many examples of distressed conventional bond borrowers engaging in aggressive or opportunistic negotiating positions (and, of course, many examples of default), which have resulted in higher future costs of borrowing for them rather than for the broad asset class.

“Sukuk, in practice, generally yield less than conventional bonds because of the technical factor that there is a surplus of cash in need of a Shariah-compliant return relative to the limited supply of sukuk issuers.

“Particularly, in the case of high yield, is there now a case for pricing sukuk more expensively than conventional bonds?”

It also raised the question whether such precedent of revisiting Shariah compliance poses greater risk of a loss of confidence and higher cost of capital in markets such as the Gulf Cooperation Council, Iran, Malaysia, Bangladesh, Jordan, Bahrain and Pakistan. All these markets have more than 10% of the overall banking assets made up by Islamic banking assets.

The report also raised the question if other UAE-based distressed companies may be emboldened to follow suit if Dana Gas receives a favourable judgement from the UAE court.

The fifth and final question raised in the report was: Does the jurisdiction of the sukuk become irrelevant, if a favourable ruling for the issuer is received in the jurisdiction where the assets underpinning the sukuk are located?

On the fifth point, it noted that in 2009, Kuwait’s Investment Dar Co KSC had argued its Islamic finance contract with Blom Bank SAL of Lebanon was not Shariah compliant in a UK court, which had set aside the argument.

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