FINANCIAL INSTITUTIONSENERGYINFRASTRUCTURE, MINING AND COMMODITIESTRANSPORTTECHNOLOGY AND INNOVATIONPHARMACEUTICALS AND LIFE SCIENCES

8th Annual Gulf Ship Finance ForumIslamic Finance and Bond Finance: alternatives or compliments to traditional finance

Mohammed ParachaAlex RoussosNorton Rose (Middle East) LLP7 March 2012

FINANCIAL INSTITUTIONSENERGYINFRASTRUCTURE, MINING AND COMMODITIESTRANSPORTTECHNOLOGY AND INNOVATIONPHARMACEUTICALS AND LIFE SCIENCES

ContentsToday we will look at:1. The relevance of Islamic finance in today’s global economy2. Basic principles of Shari’ah3. Principal structures used in Islamic finance4. Combining Islamic equity and conventional debt5. Accessing the capital markets6. Conventional bonds7. Convertible bonds8. Structured finance techniques9. Sukuk

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Why is it relevant? Growing demand for finance in many industrial sectors Islamic finance as a credible alternative source of funds Islamic finance needs tangible assets Islamic economic theory fully supports financing in many

industrial sectors where they add value and benefit to society Economic growth throughout the Muslim world Right deal, right place, right time…

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The starting point….. The Christian faith was not without its own warnings against unfair

behaviour in the commercial context:

– “If thou lend money to any of my people that is poor by thee, thou shalt not be to him as an usurer, neither shalt thou lay upon him usury” (Exodus 22:25)

– “Thou shalt not give him [they brother] thy money upon usury, nor lend him thy victuals for increase” (Leviticus 25:37)

– “He that putteth not out his money to usury, nor taketh reward against the innocent. He that doeth these things shall never be moved” (Psalm 15)

– “He that hath not given forth upon usury, neither hath taken any increase … he is just, he shall surely live” (Ezekiel 18:8-9)

Although it is probably true to say that such prescriptions do not now apply in the secular world of modern finance

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What is Shariah? Shariah - the principles of Islamic Law. Two main sources

– The Qur’an - the sacred book that records the word of God as revealed to the Prophet Muhammad (PBUH):

“… give up what remains of your demand for usury, if you are indeed believers. If you do not, take notice of war from Allah and His Apostle…” (Qur’an 2:278-279)“… God has permitted trade and forbidden interest…” (Qur’an 2:275)

– The Hadith - the body of documents that records the Sunnah (the practice) of the Prophet Muhammad (PBUH)

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The main rulings of Shariah in finance Riba - the prohibition against the charging of interest but it is

wider than this - usury or unjust enrichment

Gharar - uncertainty - there must be full disclosure (e.g. certainty as to the subject matter or price of a contract)

Maisir - speculation or gambling - “obtaining something without risk/hard effort”

Unethical Investment - certain products prohibited (e.g. alcohol, armaments, pork) and activities (e.g. gambling, entertainment, hotels)

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The key difference in practical terms

‘many products’

Bank Borrower

murabaha ijara

Istisna’a Istisna’a with ijara

‘one product’loan agreement

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Asset Murabaha based ship financing

Seller Financier

Customer

(1) $100

(2) Title

(3) Title (4) $110

Security

NB: 1. Fixed term contract2. Difficult to restructure3. Suits short term financing only4. Can be syndicated

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Commodity Murabaha ship financing

Vendor Financier Customer Third Party

Payment of purchase price

Payment of purchase pricePlus premium (deferred)

Payment of purchase price

Sale of commodity Sale of commoditySale of commodity

Acquisition of vessel/working capital

Funds utilisation

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Istisna’a or manufacturer financing

Financier Manufacturer

Customer

$100

Title

Title

Notes1. Allows finance to be provided for pre-

delivery or manufacturing process2. Late delivery can be problematic3. Security can be given4. Sale or lease at delivery?

$110 1st istisna’a

2nd istisna’a

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Ijara (finance lease) financing

Seller Financier

Customer

(2) Title

(3) Lease (4) Rent

(1) Purchase Price

Grant of options

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Istisna’a with forward ijara

Customer Financier

Financier Customer

Operator

(2) Title

(1) Procurement Agreement to build ship/stage payments

‘during construction’

Step 1:

Step 2:put option/purchase undertaking

(3) Head Lease

(4) Rental

(5) Sub Lease

call option/sale undertaking ‘post-construction’

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Combining Islamic equity & conventional debt

Financier

Lessee

SPV

Islamic Investor

LoanAgreement

$ Equity Contribution

Sub-lease

Option arrangements

Islamic Head Lease

DEBT EQUITY

Owner

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Accessing the capital markets Why tap the bond markets?

– wider pool of investors, more liquid– easier access to funding / potentially better pricing terms– long tenors– build relationships with banking community

Good match for ship financing where longer term funding may be required

Restrictions on bank lending following credit crisis

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Accessing the capital markets(1) Plain vanilla bonds

(i) Structures/methods of issuance– direct issuance by borrower– use of an SPV structure– stand-alone vs. medium term note programme– private placement vs. global offering– trustee vs. fiscal agency structure

(ii) Key parties– issuer/borrower– guarantor (typically encountered in SPV structure)– arrangers/lead managers/dealer group– trustee– paying agents– registrar– investors

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(iii) Key documents– prospectus/offering circular (including terms and conditions of the securities)– dealer/subscription agreement– trust deed– agency agreement– mandate letter

(iv) Key considerations for issuers– responsibility for offering document– the diligence process– reps/warranties and covenants in the dealer agreement and the terms and

conditions– no security required– ratings– listing and continuing obligations

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(2) Convertible bonds

(i) Key features and differences with plain vanilla bonds• What are convertible bonds?

– documentary and diligence process is much the same– however, main difference is that a CB allows the holder to convert the debt

to equity during a specified period in the future (the conversion period)• Examples of recent convertible bond issuances:

– USD150 million convertible bonds issued by Hanjin Shipping Co. Ltd in 2011

– USD110 million convertible bond issuance by Genco Shipping & Trading Limited in 2010

• determining the conversion price and the role of conversion price adjustment events

• offering document to contain disclosure on the company’s share capital and rights attaching to shares

• issuer call option and change of control provisions• key restrictions in doing a CB

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(ii) Advantages and disadvantages of issuing convertible bonds– from the issuer’s perspective

• comparatively cheap method of funding• funding now for equity issued later• relative ease and speed of issuance• lower repayment risk• but risks of no conversion and dilution

– from the investor’s perspective• allows investors to hedge their investment risk and collect coupon during the

life of the bonds• downside risk relating to drop in share value, inability to liquidate or inability

to convert

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(3) Sukuk Structures

Shariah–compliant bonds Key characteristics– asset-based instruments– must comply with laws of issuer’s and obligor’s jurisdictions, governing law, as

well as principles of Shariah– main structures encountered: Ijara, Mudaraba, Murabaha, Wakala– MT Venus Globy Sukuk example– the importance of obtaining a fatwa

• Documentation– diligence and disclosure similar to conventional debt– Islamic documentation in addition to capital markets documents

• Current market– liquidity and innovation

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“Venus Glory” Al Safeena Ijara Sukuk

$ Rent Sub-Charter

Owner

Venus Navigation Ltd.BVI

Intermediate Charterer

Venus Shipping SAPan

Sub-ChartererVela International

Marine Ltd

[Lib]

100% shares

Charitable Trust

Jersey

2nd Int. Charterer Assignment

2nd Mortgage

2nd Owner Assignment

2nd Accounts Deed

2nd Accounts Deed

Service Agency Ag.

Call and Put Options

Call Option

Security AssignmentAssignment of Mortgage

Head Charterer

Al Safeena I LimitedJersey SPC

Offering Memo. Sakk InstrumentSubscription Ag.

$ Investment

Agency & Trust Deed

Head Charter

Intermediate Charter

$ Investment & $ Rent

$ Rent

$ ProfitSukuk investors

Notes 1. Parting with possession and charging

for use (usufruct)2. Enables a floating rate to apply3. Rental values may vary4. Insurance & maintenance5. Call option granted in a separate

contract6. On exercising the call the Lessee can

make a final payment to acquire title to the asset

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(4) Structured finance Covered bonds: key characteristics– asset-backed securities assets, essentially comprising mortgages or other retail

or commercial loans– assets ring-fenced for investors in bankruptcy– can benefit from a credit rating which is higher than that of the issuer– used by shipping financiers e.g. HSH Norbank’s EUR 500 million covered bond

(June 2010)

Securitisation/off-balance sheet structured bonds– banks: true sale of shipping loans to offshore SPV which issues secured bonds– shipping companies: can use these structures to finance or re-finance vessels

or to securitise the cash flow generated by charter agreements (i.e. utilising the revenue stream). Title transferred to SPV which in turn issues the bonds. Bonds are secured over the vessels, earnings accounts, insurance policies and charter agreements.

– what a typical securitisation structure looks like:

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“Classic” true sale structure

Servicer

Obligors Originator Issuer Noteholders

Note Trustee

Liquidity Provider

Security Trustee

£ + deferred consideration

Hedge Provider

interest + principal

£

sale of pool of loans

£

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Conclusion

Significant opportunities for shipping companies and financiers

Bonds, convertibles, Sukuk, structured finance solutions all available to industry participants

Diversification necessary in current global economic conditions

Islamic finance and capital markets can complement traditional financing or independently fund the shipping industry

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Disclaimer

The purpose of this presentation is to provide information as to developments in the law. It does not contain a full analysis of the law nor does it constitute an opinion of Norton Rose (Middle East) LLP on the points of law discussed.

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