How to structure shariah high-yield covenants

Author: | Published: 16 Sep 2010
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The Dar Al Arkan sukuk showed how a shariah-compliant transaction could be structured on conventional high-yield principles, opening up a new option for accessing Islamic markets. But covenants must be cautiously structured to make sure they apply to all facilities.

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“A typical high-yield package contains a whole raft of covenants, most of which will be applicable in a shariah-compliant financing such as sukuk,” said Mohammed Al-Sheikh, managing partner of Latham & Watkins’ Riyadh office in a web seminar on September 14.

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But where conflicts can arise is when making sure that all covenants and agreements apply equally across the whole deal, and not just to the conventional parts of the transaction. Particular care needs to be taken with covenants that limit indebtedness, and those that control permitted refinancing.

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“The covenant packages you see in European deals will not take into account murabaha, sukuk or wakhala arrangements,” said Al-Sheikh. “Because they are not simple loan arrangements but based on a return concept, they do not typically get picked up by the traditional definition of a loan.”

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Instead, standard covenants must be amended to make sure that shariah-compliant forms of financing do not fall outside their reach.

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Drafting is important on permitted refinancing too. As Al-Sheikh explained: “You have to make sure the permitted refinancing exemption is wide enough, and worded properly, to allow the refinancing of shariah financing and not just conventional arrangements.”

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Latham & Watkins advised the issuer, Dar Al-Arkan Real Estate Development Company, and a Linklaters team represented the joint lead managers.

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To listen to the web seminar ‘Islamic finance: the realities of debt’, please visit: http://www.brighttalk.com/webcast/22877

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