If they aren't already doing so, agencies like Bank Negara, MOF and MITI should be scrambling to get some advanced intelligence on the unfolding drama and start working with private sector Malaysian Islamic finance institutions to anticipate the legal issues that may start to question the entire jurisprudential basis that underpins and buttresses Islamic finance.
As the acknowledged global leader of Islamic finance, Malaysia needs to get ready to lead.
The debt crisis in Dubai is about to test one of the fastest-growing areas in banking — Islamic finance — and put the emirate’s own opaque judicial system on trial, according to bankers and experts in finance, The New York Times’s Heather Timmons reports.
Issuance of loans and bonds that comply with Shariah, or Islamic law, has skyrocketed in recent years, as oil-rich Middle East nations ramped up spending and the global credit crunch led debt investors into emerging markets.
But the unique terms of these instruments, which technically make lenders partners with borrowers, have never been tested in a downturn.
“There have been very few major defaults in this market,” said Zaher Barakat, a professor of Islamic finance at the Cass Business School in London. There are no consistent rules about who gets paid back first if a company defaults on Shariah-compliant debt, he said.
The Dubai government announced last week that it was asking creditors of Dubai World, the emirate’s flagship conglomerate, to grant a delay of up to six months on payments of Dubai World’s $59 billion in debt. The announcement took world markets by surprise and led briefly to fears of a ripple effect into other emerging markets.
Bankers and analysts estimate that 10 percent of Dubai’s $80 billion debt load complies with Shariah, which prohibits lenders from earning interest.
Most urgent, the $3.5 billion bond owed by Dubai World’s real estate subsidiary, Nakheel, is a Shariah-compliant bond. Nakheel is due to pay the bond back on Dec. 14. If it does not make the payment, it will be in default, which traditionally kicks off legal proceedings against a borrower. But no one really knows what could happen next.
Lawyers and bankers who helped to issue some of Dubai’s Shariah-complaint debt declined to be interviewed for this article and spoke only on condition that they not be identified. Most of Dubai’s government offices are closed until Thursday for the Id al-Adha holiday.
“No one has tested the legal system or the documentation,” said one lawyer who formerly was a top executive at a Dubai company.
Holders of Nakheel bonds probably “are going to argue that they are in the secured position on the underlying asset,” said one bank investor, who did not want to be identified. That means that bondholders could insist on being repaid before bank lenders, who traditionally would come first in a bankruptcy.
Abdulrahman al-Saleh, director general of Dubai’s Finance Department, said Monday that Dubai World was not guaranteed by the government, and the creditors would need to “bear some of the responsibility” for the company’s debt.
The Nakheel bond’s prospectus does not provide much clarity. In the case of a bankruptcy by Dubai World or Nakheel, bondholders have no guarantee of “repayment of their claims in full or at all,” the 237-page prospectus says in its section on risks. Under Dubai law, it says, no debt owed by the ruler or government can be recovered by taking possession of the government’s assets.
Bloomberg News reported Monday that Nakheel bondholders have formed a creditor group that represents more than 25 percent of the debt due Dec. 14, according to Ashurst, a London law firm that has been appointed legal adviser. The group is in the “process of considering its options,” Jo Shepherd, a spokeswoman for Ashurst, told Bloomberg News.
Global issuance of Shariah-compliant bonds and loans grew 40 percent in the first 10 months of 2009 from a year earlier, according to Moody’s Investors Services. The total amount of Shariah-compliant debt outstanding is estimated at about $1 trillion, more than doubling in 10 years.
The surge in Islamic finance has spawned hiring sprees at banks, a series of new financial indicators like the Dow Jones Islamic market index, and filled classrooms at schools that teach bankers how to structure these loans and bonds.
Hoping to appeal the Middle East’s huge sovereign wealth funds, even non-Islamic institutions have started to raise money using Islamic finance. In October, the British Treasury released regulatory guidance that analysts say will allow Britain to issue Shariah-compliant government debt in the near future. The same month, the World Bank became the first non-Islamic entity to issue Shariah-compliant bonds with a $100 million deal.
While Malaysia was traditionally the hub of Islamic finance, much of this new activity has been centered on Dubai, and foreign and local law firms and banks there helped the emirate raise much of its debt. Dubai even has a school that promises to turn students into trademarked “C.I.F.E.’s,” or “Certified Islamic Finance Executives.”
The uncertainty hanging over the Nakheel bond is exacerbated by the fact that Dubai’s courts have never handled a major bankruptcy of one of the government’s own companies. Unlike most of the other seven emirates, Dubai maintains a judiciary system that is separate from the United Arab Emirates Federal Judiciary Authority. The decisions of the Dubai courts, which are controlled by the emirate’s ruling family, can be fickle, say lawyers in the region.
Most important, in order to bring a court case against a government-owned or government-run entity, a corporation or individual needs to get permission — from the government.
The risk section of the Nakheel prospectus offers scant guidance here, as well. “Judicial precedents in Dubai have no binding effect on subsequent decisions,” it says, and court decision in Dubai are “generally not recorded.”
Perhaps unnecessarily, the document adds, “These factors create greater judicial uncertainty.”