There were the heartbreakers, and then there were the Groundbreakers. The year 2008 was nothing short of a tumultuous ride, with the barely-there highs and the very-low lows. However, as they say in physics, every system has to experience entropy before it reaches equilibrium, and if the fiscal universe were to work the same way as the physical world, there definitely is hope that there will be redemption in the markets.

In this issue of Islamic Finance Asia, we honor those who were brave enough to go forth with their prodigious issuances amid uncertain markets, those resilient enough to weather the harshest storms, and more importantly, those clever enough to assure their investors that everything will, indeed, be all right. That in itself is groundbreaking.

Despite claims that the Islamic finance sector was isolated from the spill of bad debt and sour investments last year, mounting liquidity pressure and increasing costs of funding and borrowing saw a hefty drop in Sukuk issuances. Global Sukuk saw a 40% dip in 2008 to US$20 billion, from US$47 billion in 2007. The widening spreads on bond issuances had also affected deals due to mounting systemic risks, scarce liquidity, heightened credit risks (as proxied by credit ratings), and the fatwa by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) in February 2008 that a number of Sukuk structures are not Shariah compliant.

Furthermore, Dealogic data throughout 2006 to 2008 showed a gradual rise and fall in the number of Islamic deals closed, with the least in 2006; standing at 77, at a total value of US$8.5 billion, and then up by 23 to 100 deals in 2007, amounting to US$27.17 billion, and then a 6% dip to US$14.19 billion in 2008, with 94 deals closed.

However, 2008 saw more innovative structures, diversified investments and deals being closed at faster rates than ever before; signaling confidence in the Islamic capital markets and more educated investors. As at December last year, the top 30 deals in Asia involved Pakistani, Indonesian, Malaysian and some Japanese corporations. And that’s just in terms of the issuers.

These deals also breached unfamiliar terrain, crossing over into multinational jurisdictions — including Panama and the British Virgin Islands — and involved French banks and low-cost carriers. All these were closed before the year end, amid the crumbling economy and flailing investment giants.

It was on these bases that we selected the Groundbreakers of 2008. They are by no means the largest deals in the region, but those that we anticipate will push the industry forward the most. They are the year’s most innovative, speediest and revolutionary, be it in terms of regulation, investments or instruments.

The Islamic Finance Asia Groundbreakers were selected from more than 40 submissions from all over the globe, involving deals that were closed from the start right up to the end of the year in Asia. These deals also illustrate strong communication across the board among Islamic banks, with the deals’ lead arrangers comprising a myriad of banks from Asia and beyond. Banks such as Standard Chartered, Fortis Bank, Danareksa Sekuritas, Société Générale, BNP Paribas, and even the Irish arm of Landesbank Hessen-Thuringen Girozentraile, were in on the year’s deals.
Of those that did not make the top 10 — not that we were being frugal! — six are still significant, and deserve special mention. These are of significant volume, and firsts in their own right. They are UMW Toyota Capital’s US$308 billion Musharakah/Islamic medium-term notes program, Cagamas’ US$557.7 million Commodity Murabahah Sukuk, WCT Engineering’s US$83.02 million Sukuk Musharakah, Al-Aqar Capital’s US$83.02 million Sukuk Ijarah, Saudi Telecom Company’s (STC) US$450 million Structured Commodity Financing-I Term Finance Facility, and Olam International’s US$100 million Syndicated Dual Currency Murabahah.

The UMW Toyota, STC and Olam International deals were all noteworthy cross-border deals. The first is testament to the Japanese market opening up to Islamic finance, and highlights the flexibility of the Malaysian regulatory framework which allows issuers to issue Sukuk in any currency of their choice. The STC deal also showed growing Middle East investor confidence and was the largest corporate cross-border deal in Southeast Asia. Olam International’s deal was significant in its own right, being the first to originate from the nascent Singaporean Islamic market, and the first to be undertaken by a large-capital Singapore Exchange company.

The Cagamas deal is the largest corporate bond issue in ringgit, and the largest Sukuk commodity Murabahah in the Malaysian debt capital markets to date. The Sukuk was also successfully issued despite the relative inactivity in the market (the deal was launched in August), and completed within a few days of its launch.

Al-Aqar Capital REIT’s Sukuk Ijarah is the world’s first Islamic healthcare REIT and the world’s first listed Islamic REIT. It incorporates innovative measures which allow the Ijarah to take place, followed by the parallel commercial leases on assets. WCT Engineering’s deal represents the world’s first redeemable Sukuk Musharakah with detachable warrants. The deal was also rated a healthy ‘AA-’ by Malaysian Rating Corporation.

There was a good mix of issuers among the submissions we received, involving transportation, aviation, shipping and highway concessionaires; namely MRCB Southern Link, Projek Lebuhraya Utara Selatan (PLUS), Brunei Gas Carriers, Indosat, Bekasi Power, AirAsia and Westports Malaysia’s Sukuk Musharakah — with issuances well above US$100 million — signaling a new trend in Islamic finance investment, and deepening markets.

Are investors then stepping into more diverse territories such as shipping and aviation, and slowly exiting the declining real estate sector? Allan Redimerio, associate director of structured finance ratings at Standard & Poor’s, revealed: “This could potentially become an important sector for Islamic finance in the years to come, given the asset backing principle nature of this industry, and also because the industry is going through a difficult patch currently, with limited access to available conventional bank funding as a result.”

However, he added that some concerns to highlight include the depreciating assets involved (compared to real estate, which tends to appreciate in value over time), high maintenance costs and higher operational risks due to the moveable nature of the assets (as opposed to real estate, which is stagnant).

Will new structures and products arise from the rubble of 2008? Redimerio was candid: “The name of the game in the current economic climate is ‘back to basics’. In line with the current trend in the conventional finance markets, where investors are focusing more on simple plain vanilla structures, we expect issuance to be on simple and tried-and-tested structures in the Islamic finance market as well.”

Based on 2008’s submissions, this year is set to be a more exciting year for the industry in terms of issuances and structure innovation. Again, congratulations to the Groundbreakers of 2008, and here’s to an even more exhilarating 2009!

Government of Pakistan

We selected the Government of Pakistan’s three-year floating rate Sukuk Ijarah as one of our 10 Groundbreaking deals of 2008 as it marks many firsts in the landscape of Islamic finance and Asia. It is the first domestic Sukuk issue by the Pakistani government, and the largest program at PKR35.54 billion (US$452.16 million).

This is especially significant as the deal’s arrangers Standard Chartered (Pakistan) and Dubai Islamic Bank (Pakistan) were able to satisfy investors’ appetite and meet investors’ requirements within one week of its marketing exercise, despite the country’s economic and political volatility. Cornelius, Lane & Mufti was legal counsel for the deal, while a special purpose vehicle — the Pakistan Domestic Sukuk Company — was made trustee.

The Sukuk has completed two tranches, with the first issuance set at PKR6.5 billion (US$82.69 million) and sold to 14 primary dealers, and the second at PKR6 billion (US$76.33 million). The notes were benchmarked to six-month weighted average T-bill yields. It is the first Shariah compliant security by the Pakistani government which is reserve eligible, and also marks the first time the government was able to directly tap into Islamic funding.

The government’s recent sovereign rating downgrade had also made it difficult to access international capital markets for budgetary support, thus the offer was made for an alternative financial solution. The issuance has therefore enabled the Pakistani government to reduce its dependency on expensive foreign capital and borrow locally at more attractive rates.

On the challenges faced by the deal’s arrangers, Khalid Rashid, head of capital markets for Standard Chartered Pakistan, told Islamic Finance Asia: “Because it is the first domestic sovereign Sukuk by the Republic, there were of course some challenges, most of which involved guiding people and talking to different stakeholders, bringing everybody to a common playing ground and discussing the issues at hand and effectively getting the results. This is because there is no precedence for this transaction, and is in many ways blazing new grounds. But of course, we were able to overcome these issues. The success of the deal speaks for itself.”

Republic of Indonesia

The whole Islamic finance community was eagerly awaiting the Indonesian government’s rupiah-denominated Sukuk to pave the way for more government issuances as Indonesia, with its world’s largest Muslim population, is seen as somewhat of a barometer for the Muslim world.

The offering is an important development for Indonesia’s Islamic finance sector, which is why we deemed it Groundbreaking. With this issuance the country has gained more confidence in Islamic finance, and is currently gearing up for its foreign currency Sukuk which is due to be issued by the middle of this year.

The Sukuk, which was set at IDR4.7 trillion (US$409.05 million), was issued by Perusahaan Penerbit SBSN Indonesia (SBSN) on the 28th August 2008, and arranged by Mandiri Sekuritas, Danareksa Sekuritas and Trimegah Sekuritas. Marsinih Martoatmodjo Iskandar Kusdihardjo acted as legal counsel while the National Shariah Council an d the Council of Ulamas of Indonesia were Shariah advisors to the deal.

This first SBSN issuance used the Sukuk Ijarah sale and leaseback scheme with the government selling the beneficial title of the assets to a special purpose vehicle.

The investor breakdown for the deal was also incredibly diverse — banks (2.23%), foundations (3.36%), institutions (15.42%), insurance companies (50.75%), mutual funds (4.21%), pension funds (7.36%), retail (0.06%) and Islamic banks (16.6%). Net proceeds from the issuance were used for general funding purposes of the government.

Paka Capital

Khazanah Nasional’s US$550 million Islamic Exchangeable Bond was a Groundbreaker in its own right, having realized the potential of Islamic finance beyond its current geographical boundaries.

Khazanah Nasional, the investment holding arm of the Malaysian government, had breached new markets in Hong Kong and China via the utilization of listed shares in the respective countries as the exchange property and underlying assets. The deal’s issuer was Paka Capital, and its obligor Khazanah Nasional.

This is the first Sukuk to offer Islamic investors exposure to China’s booming economy. The issuance’s underlying shares were the Ordinary Shares of Parkson Retail Group, which are listed on the Hong Kong Stock Exchange. Khazanah’s initial investment in Parkson was also monetized at over 900% its cost.

This is also the first exchangeable Sukuk to offer zero periodic payment, breaking away from the Middle Eastern preference of offering fixed income-like instruments with regular coupon payment.

Despite this, however, half of the deal’s investors originated from the Middle East. The issuance was also over-subscribed by 10 times its deal size of US$550 million, testament to investor confidence in the three economies — China, Hong Kong and Malaysia. This was also the speediest award submission that we received, seeing that the deal was launched overnight with bookbuilding done on an accelerated basis. The books closed three hours after opening with a record oversubscription.

The issuance had also gained listing across three jurisdictions —Labuan International Financial Ex-change, Hong Kong Stock Exchange and Dubai International Financial Exchange.

The Sukuk was also priced at the tightest end of the range, amid volatile markets a record LIBOR Swap minus 220basis points, the lowest yield USD Sukuk priced to date.

Commenting on the deal, Khazanah Nasional managing director Azman Mokhtar said: “The transaction is a wonderful testament to Malaysia’s and Khazanah’s credit and economic fundamentals at a turbulent time in the markets, when many countries and companies are afraid to tap international markets. Deals are being pulled out, and we have entered instead, and its 10 times oversubscription could not be a stronger endorsement.”

Brunei Gas Carriers

The Brunei Gas Carriers US$505 million shipbuilding deal for two LNG carriers was arranged by Standard Chartered, Fortis Bank, Société Genéralé and Brunei Investment & Commercial Bank.

Norton Rose and Watson Farley & Williams were the legal counsel to the arrangers and issuers respectively. The deal used a complex mixture of special purpose vehicles to engage in Istisna contracts to build the ships against the obligor’s forward lease.

It was the largest Islamic shipping transaction in Asia and involved complex sponsor support and chartering agreements which had to blend in with its Islamic structure. Again, a Groundbreaker in terms of innovation — having successfully tied in Islamic finance with the all-important, but commonly overlooked, industry of shipping. Some 90% of world trade is carried by the shipping industry, and this is definitely a lucrative market for future Islamic investments. Gervais Green, partner at Norton Rose, legal counsel to the deal’s arrangers, predicts more Islamic finance investments in shipping. He added that the project had closed before the current market conditions emerged, which had definitely been a great help.

In terms of the fluidity of the deal’s execution, Green was especially proud: “Essentially, it was a very well structured transaction. There were no difficulties faced.”

Projek Lintasan Shah Alam

The Projek Lintasan Shah Alam expressway project was another Groundbreaker in our books due to the deal’s innovative structure, being the first Sukuk to incorporate Ijarah, Mudarabah and Ijarah Mawsufah Fi Dhimmah for a project finance transaction.

The Sukuk Ijarah was set at RM330 million (US$94 million) and the Sukuk Mudarabah at RM415 million (US$118 million). RHB Islamic Bank and RHB Investment Bank were the deal’s joint principal advisor and lead arrangers. The deal’s grant concessionaire was the Malaysian government. The project, which involved the construction and development of a 14.7km highway with a three-lane dual carriageway, was funded through a debt-to-equity arrangement ratio of 55:45. On top of incorporating three complex structures within two issuances, the deal was also an effective cross-border transaction, having breached the gap between the Malaysian and Middle Eastern financial markets due to its ability to meet the GCC’s strict structuring guidelines.

The transaction was also successfully marketed in both the GCC and Malaysia, and had managed to break free from the common practice of using the highly debated form of financing of Bai Bithaman Ajil for project financing.

Armada Floating Solutions

How do you successfully assimilate into six separate jurisdictions which are not within geographic or economic proximity? Armada Floating Solutions floated in Malaysia, the British Virgin Islands, France, Panama, Singapore and the UK its US$48 million Islamic facility. The deal transcended international boundaries, and had to adhere to contract, corporate, Islamic financing and maritime laws all in one transaction.

Kuwait Finance House (Malaysia) acted as the deal’s arranger while Albar & Partners was the legal counsel for the arranger and financiers. Diaz Y Leon, Harneys Westwood & Riegels, Clifford Chance Europe and Wong Partnership were the foreign supporting legal counsel for the arrangers and financiers, representing Panama, the British Virgin Islands, France and Singapore respectively.

The collateral was subject, inter alia, to the laws of England, Malaysia, Singapore and Panama while the facility and financing documents are subject to the laws of Malaysia.

The purpose of the issue was to finance the acquisition of a floating production storage and off-loading vessel, the Armada Perkasa, and to finance the upgrading and refurbishment of the vessel, plus costs incurred in relation to the facility.

Mrcb Southern Link

MRCB Southern Link’s AA3-rated RM845 million (US$234.41 million) Senior Sukuk Istisna and A2-rated RM199 million (US$55.18 million) Junior Sukuk Istisna was our deal of choice as it marks the first and largest project financing transaction in the Malaysian market for 2008.

It is the first toll-road project financing employing an aggressive debt equity structure. Typically toll-road financing has a lower debt-equity ratio compared to independent power producers due to its traffic volume risk. This transaction had the highest debt-equity ratio achieved for a toll-road project financing, increasing the returns to its sponsors.

HSBC Amanah Malaysia and CIMB Investment Bank acted as the deal’s arrangers, while Adnan Sundra & Low was the legal counsel, with CIMB Trustees as trustee. The deal had also pioneered a new tax efficient structure in Malaysia by employing two special purpose vehicle (SPV) structures to segregate the concession company and fund-raising company, thus allowing the project to maximize its tax benefits.

Unlike other greenfield toll roads, traffic forecasts for this project were based on historical data reflecting actual volume as opposed to mere projections gauged on the development of surrounding areas.

A base case which was below the historical trend line growth levels was implemented, reflecting a strong debt servicing capability.

The Sukuk allows for prepayment flexibility based on certain spreads above the Malaysian government securities, reflective of market levels.

The highest possible ratings for a greenfield project were awarded by rating agencies despite the additional structuring required of the two SPV structures.

AirAsia

AirAsia’s US$336 million Shariah compliant French Single Investor leasing, arranged by BNP Paribas, Natixis Transport Finance, RHB Islamic, Bank Kerjasama Rakyat Malaysia and the Irish branch of Landesbank Hessen-Thuringen (Helaba), was one of the most innovative deals to come out of 2008.

The deal, advised by Norton Rose, Wong & Partners and Freshfields Bruckhaus Deringer, had utilized three currencies — euro, US dollar and Malaysian ringgit — under the Wakalah and Murabahah structures for the purchase of up to eight Airbus 320-200 aircraft.

It was also the first Islamic-French-Malaysian optimized transaction carried out. The deal bridged the gap between the airline and Islamic finance industries while providing a 100% cost-efficient finance structure for the issuers.

The Ijarah structure had allowed AirAsia’s capital and investment allowances to be preserved, while the flexible multi-currency structure allowed participation from foreign and Malaysian banks, thus diversifying AirAsia’s source of funding.

The 14-year tenor afforded for the lease is also longer that the traditional 10 to 12 years afforded by conventional aircraft financing and traditional Islamic structures, bringing its risk to a minimum.

Kamarudin Meranun, deputy group CEO of AirAsia, commented: “This unique structure has encouraged innovation and creativity in structuring Islamic products, and the development of aircraft financing in Malaysia.”

Tadamun Services

Standard Chartered Bank Malaysia, CIMB Investment Bank and RHB Islamic Bank acted as the arrangers and manager for the first Malaysian Ringgit Sukuk issuance by the Islamic Development Bank (IDB).

The Trust Certificates issued by Tadamun Services were set at RM1 billion (US$277.31 million), and seen its first issuance of RM300 million (US$83.19 million).

Zaid Ibrahim & Co acted as legal counsel for the arrangers, while CIMB Trustee was trustee to the deal.

This marks the first Ringgit-denominated issuance by the IDB, and the first Sukuk Musharakah by a multilateral development bank in Malaysia. It is also the first Malaysian Ringgit issuance to be afforded an ‘AAA’ rating by Standard & Poor’s.

For the issuance, IDB established a portfolio of assets, separate from any other of its assets in respect of the Trust Certificates. At least 51% of the portfolio comprised assets leased to IDB’s clients under the concepts of Ijarah, Murabahah and Istisna.

Apart from its many firsts, the deal’s other groundbreaking factor was the uptake of 43% of the issue by conventional investors, signaling confidence in the Islamic finance markets, the IDB and Malaysia all at once.

Noble Resources

In December 2008, Singapore-listed Noble Resources raised US$80 million in Hong Kong in a Murabahah deal arranged by HSBC Amanah. This was a significant deal in the mobilization of Hong Kong’s Islamic finance markets.

It was also the first Islamic deal syndicated in Hong Kong. Kuwait Finance House (Malaysia) participated in the transaction, with an uptake of US$20 million. The facility was raised to fund working capital for Noble Resources.

The deal is also seen as a market mover, seeing that the addition of Islamic finance as a new asset class in Hong Kong will add value to the territory as a thriving financial center and boost its position in Asia.