Moody's: Dana Gas Shari'ah breach is credit negative for Sukuk investors
The English High Court of Justice had granted an injunction to restrain holders of UAE-based Dana Gas’ $700 million Mudharaba Sukuk from taking action against the company for halting coupon payments and proposing an exchange for a new Sukuk.
The company petitioned the court for the injunction after commencing legal proceedings in Sharjah courts on 13 June to have the Mudharaba Sukuk declared unlawful under UAE law because it does not comply with Shari'ah banking principles.
Dana Gas publicly stated on 13 June 2017 that it had "received legal advice that the Sukuk in its present form is not Shari'ah compliant and is therefore unlawful under UAE law" and that it had started court proceedings in the UAE to have the Sukuk declared unlawful and unenforceable. It has proposed restructuring the Sukuk "to ensure that it conforms to the relevant laws" and also to take into account "the Company's need to focus on short to medium term cash preservation". Sukuk distributions due on 31 July and 31 October “cannot be paid now that the existing Sukuk is deemed unlawful, but will be accounted for” as part of the restructured instrument, according to a statement by Dana Gas.
Despite very limited information regarding the structure’s legal and Shari'ah compliance, and what exactly the courts have thus far decided, if Dana Gas’ petitions are upheld by the Sharjah courts, it would trigger a standstill on the two upcoming contractual payments and an exchange with new securities carrying inferior terms and returns, a credit negative for the Dana Gas Sukuk investors.
The issue is also credit negative for Islamic finance in general and would likely diminish the liquidity and growth of the Sukuk market. The company, which is listed on Abu Dhabi Stock exchange, said that because of the Sukuk’s lack of Shari'ah compliance, a restructuring is necessary to ensure conformance to relevant laws. The company also assured all parties that no dissolution event or technical default has occurred, nor could one occur because of the unlawful nature of the Sukuk.
The company also advised that it will not pay the profit distribution due in July this year because of the Sukuk being unlawful. Although most investors regard the company’s announcement as a tactical move in its debt negotiations with lenders, a ruling in favour of Dana Gas would potentially send shockwaves among Islamic finance and Sukuk investors, even though Dana Gas’ lenders could still seek enforceability through other jurisdictions, depending on the documentation of the specific Sukuk in question.
Not distributing profits because the structure, which was previously considered Shari'ah-compliant, is now considered non-compliant and therefore unlawful would have wider implications on the Sukuk markets.
The implications include concerns about the legality of existing Sukuk and the effect on their issuers, the role and authority of Shari'ah boards, the responsibilities of the lead arrangers’ due diligence on the issuances, our approach to analysing Sukuk structures, and the liquidity of Sukuk markets.
Although Dana Gas is a small issuer in the UAE market, the credit implications of a court decision in its favour would test Sukuk regulatory and legal frameworks beyond Dana Gas as an issuer or the UAE as a jurisdiction. Dana Gas issued the Sukuk using the Al Mudharaba structure, a common structure used in Islamic finance.
Other companies in the UAE using a Mudharaba structure include Dubai Islamic Bank PJSC (Baa1 positive, ba31), Abu Dhabi Islamic Bank (A2 stable, ba1), Al Hilal Bank (A1 negative, ba2) and others. Although the price of the Dana Gas Sukuk tumbled following the company’s initial announcement on 13 June, the prices of other issuers were little changed.
There are currently nearly $411 billion in outstanding Sukuk. In terms of geographic distribution, Malaysia dominates the market with $215 billion (52 per cent) of Sukuk issued, followed by the Gulf Cooperation Council with $110 billion (27 per cent).