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Hong Kong Shariah-Compliant Launch Sells

September 22, 2014

10-14-09 © kdgeislerHong Kong launched its first ever Islamic bond September 10. The issuance was a sukuk bond which, again, is just a way of saying that it is a Shariah-compliant instrument: that is, a bond that escapes the strictures of Islamic law as understood by the authorities in this matter.

For some background on what is or isn’t Shariah compliant, you might start here.

There exist a range of justifications, arguments for why a particular bond is compliant. Skeptics about the whole field, such as Muhammad Akram Khan, describe many of these justifications as “legal tricks.” In the case of the Hong Kong sukuk the relevant “trick” is what is known as the ijarah structure. This involves the creation of an operating lease that stand behind the sukuk documents.

In this case, the issuer is a special purpose vehicle created by the government of Hong Kong for this purpose. The SPE will use money from sale of the bonds to buy certain properties currently owned by that government. So Hong Kong’s SPE deals with Hong Kong and the buyers of the sukuk deal with the SPE. The government, which will continue to use these properties, as a five-year lessee, will pay an amount sufficient for the lessor in turn to pay the holders of the sukuk the contractually agreed-upon distributions. At the end of the term of the lease, the government will buy the assets back, thus providing the principal amount to the holders of the sukuk.

The key (for the definition of these bonds as sukuk) is that distributions made along the way are not the riba that the Koran forbids, so that pious Moslems can in good faith participate in this investment.

Ambition Achieved

The deal run by CIMB (of Malaysia),along with HSBC, the National Bank of Abu Dhabi and Standard Chartered Bank, was planned so as to offer investors 30 basis points above the five-year U.S. Treasuries. This was ambitious; a much tighter spread vis-à-vis U.S. Treasuries than is offered by the analogous notes outstanding from Singapore’s Temasek .

The actual sale of the bonds more than justified the ambition of the term sheet, pricing 9 basis points tighter than the term sheet’s figure, and then selling at a slightly tighter spread than that in the secondary markets.

All this establishes that there is a robust market for such bonds, and that governments will surely be encouraged to sell into that market. Indeed, Hong Kong changed its laws in March of this year in order to allow the government to engage in such transactions. On a related front, it changed its laws in July of last year to facilitate the sales of corporate Shariah-compliant instruments.

Yet the whole deal looks a lot like a conventional bond with some trimmings. It doesn’t warrant the starry-eyed language sometimes employed by the admirers of Shariah, who see it as, for example, the capitalism with a spiritual side or the application (as Mohammad Nejatullah Siddiqi has put it) of a “holistic view of human personality” to the world of finance. The contrast between such language and the prosaic reality of the Hong Kong deal is stark.

If I should declare that I will never eat duck, and then I simply re-name certain ducks “chickens” and eat them, then people who genuinely as a matter of principle refuse to eat duck may consider me a false friend. And those who have no objection to the eating of duck may think me a silly goose. If the re-naming process itself entails costs the whole thing may be an exercise in behavioral finance.

Big Numbers

Still, here are big numbers involved. The total value of sukuk issuance YTD (475 deals) comes to $88.9billion. Most issuances are still either from sovereigns or from quasi-sovereign entities. Corporate sukuk comes chiefly from Malaysia.

The numbers are big enough that Goldman Sachs wants to get into the act. Goldman backed off of a sukuk plan in 2011 under criticism that it wasn’t Shariah-compliant enough, in a game of “our Shariah experts are better than your Shariah experts.”

Goldman as an institution is nothing if not persistent, and it appears ready to try again. Whether you think of Shariah compliance as a powerful spiritual force, a marketing tool, or much-ado-about-nothing: Goldman’s next effort may reward careful study.