Company shares as sukuk asset?
By Rushdi Siddiqui
Reuters recently reported that “Malaysia’s central bank has rejected Bimb’s proposal to secure the sukuk with shares of the company, which will need to identify an alternative asset for the exercise… Bimb last month proposed a 10-year Islamic bond, or sukuk, of 1.5 billion ringgit ($456.66 million) as part of a plan to acquire the 49 per cent stake it does not own in Bank Islam held by the Dubai Group and Tabung Haji.”
Sukuk has been issued where the underlying asset has been toll road revenue, aircraft leases, offshore oil drilling leases, mobile phone airtime, etc. Furthermore, a variety of sukuk includes convertible sukuk (to compliant company shares), exchangeable sukuk (another compliant company controlled by the sukuk-issuing company), perpetual sukuk (capital ratio), etc.
The regulator has to walk the fine line between encouraging Islamic capital market development with supporting compliant instruments and prudence, especially after Credit Crisis I (US subprime) and Credit Crisis II (eurozone sovereign debt).
It must be recalled that the derivatives market reached the size of $700 trillion, whilst the world economy was at $60 trillion. Hence, regulators conscious of maintaining the connection between offering instrument (abuse) and underlying (local) economy in an inter-connected capital markets.
Shares are asset?
According to Wikipedia, “a shareholder or stockholder is an individual or company that legally owns one or more shares of stock in a joint stock company… Shareholders are granted special privileges depending on the class of stock… and the right to a company’s assets during a liquidation of the company. However, shareholder’s rights to a company’s assets are subordinate to the rights of the company’s creditors.”
Thus, does the issue become “shareholders’ rights subordinated to creditors” for company shares secured to issue Sukuk?
Bank Negara prudence
The Malaysian central bank, Bank Negara Malaysia, was correct, on prudence, in rejecting Bimb’s proposal to secure sukuk issuance with the bank’s shares. As the Reuters story was lacking details, the rejection may be due to some of the following reasons:
1. Shares of an Islamic bank are generally illiquid (and smaller free float) compared to conventional counterpart publicly-listed bank, hence, an illiquid “holding” to an already illiquid instrument (attested by minimal secondary market trading volume for non-Murabaha sukuk)
2. What happens if the bank is acquired, taken private, stock-splits, issuance of additional shares, market sell-off, earnings declining due to non-performing loans and corresponding provisioning, or if it goes bankrupt? If the company goes bankrupt, the common stock holders would have the “residual assets of the company after discharge of all senior claims such as secured and unsecured debt”.
3. Now, assuming it was approved, what if the Shariah-compliant company, not Shariah-based like an Islamic bank, Takaful operator, Islamic Reit, violates one of the financial ratios (of the securities commission) at the review, and must removed from an Islamic index, what happens to the sukuk? Does it convert into a conventional bond, as the company is no longer Shariah-compliant? Will the “Islamic” holders of the paper need to sell immediately to continue being Islamic? Would clever lawyers be able to build in fail-safe mechanisms, but, will it make the sukuk, one, difficult to price/understand and, two, require a “fail-safe” premium?
4. Assuming it was approved, the 49 per cent would be in a trust, with corresponding responsibilities, would there be a conflict between sukuk holder and non-sukuk stock holders at AGMs, voting for directors, etc? Would the sukuk holders have some extra fiduciary duty, care and loyalty to the company?
Martin Whitman stated, “it can safely be stated that there does not exist any publicly-traded company where management works exclusively in the best interests of Opmi [Outside Passive Minority Investor] stockholders. Instead, there are both ‘communities of interest’ and ‘conflicts of interest’ between stockholders [principal] and management [agent]. This conflict is referred to as the principal/agent problem. It would be naive to think that any management would forego management compensation, and management entrenchment, just because some of these management privileges might be perceived as giving rise to a conflict of interest with Opmis.”
Conclusion
Islamic finance, as it matures and evolves and becomes cross border, will encounter both diminishing tailwinds and increasing headwinds. To address the headwinds, prudence may demand erring on side of caution to protect and preserve confidence and trust in this niche market, hence, with the regulators saying, “no, not yet as more research required”.
“A ship in harbour is safe — but that is not what ships are for.” — John A. Shedd.
The writer is co-founder and MD of Azka Capital, a private equity advisory firm focused on halal industry initiatives, and an advisor to Thomson Reuters on Islamic finance and the halal industry. Views expressed are his own.
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