The Asian Development Bank (ADB) has participated in its first shariah-compliant project financing for two wind farms in Sindh province, Pakistan. But the use of Islamic financial instruments was not ADB’s first option.
Though ADB has previously provided conventional debt alongside Islamic finance, this is the first time that all aspects have been shariah-compliant. ADB granted two partial credit guarantees worth up to $66 million to the Islamic Development Bank (IsDB), which then financed the project under an ijarah structure. A consortium of Pakistani banks provided the remainder via a musharakah structure with a term of 12 years.
TheFauji Foundation, which owns majority stakes in both projects, required all financing be obtained in compliance with shariah principles. Both projects were financed simultaneously with similar structures and documentation but with slightly different shareholders.
As multilateral development banks, ADB and IsDB operate according to operational parameters set out in their charters. In the case of IsDB, everything must be shariah compliant and certified by its Shariah Board.
But reconciling the two development banks’ charters was challenging. Ashraf Mohammed, assistant general counsel and practice leader of Islamic finance at ADB, told IFLR that the ADB had originally looked to a conventional loan structure through a special purpose vehicle (SPV).
The SPV would be set up between the international financiers and the project company, whereby ADB would provide a conventional loan to the SPV, IsDB would provide equity financing and the SPV would then provide shariah financing to the project company. However, the structure was not compliant with IsDB’s shariah guidelines.
Ultimately ADB and IsDB resorted to an innovative Islamic financing structure. IsDB provided the full amount of financing via an ijarah that was fully shariah-compliant. The ijarah was divided into a two-tranche structure in which ADB provided a 50 percent credit risk guarantee for one tranche so that IsDB and ADB equally share commercial and credit risk.
Shearman & Sterling partner Bill McCormack, who advised ADB and IsDB, said that the transaction required bespoke drafting of documentation for the guarantee and a counterindemnity by the company. Structuring intercreditor agreements related to decision-making and security sharing was also especially tricky, as they needed to ensure that voting rights and other entitlements reflected the banks’ exposure.
“The structure possibly points to analogous opportunities whereby commercial banks with funding issues could provide commercial guarantees or similar risk support to the likes of IsDB and ADB,” said McCormack.
As to whether ADB will utilise Islamic instruments in the future, Mohammed said that it would look at what clients need and respond accordingly. “It’s becoming a viable alternative to conventional finance, not just for conviction reasons but as an alternative asset class to conventional financial instruments,” he said.