We speak with Shibeer Ahmed, Head of Banking and Islamic Finance at Winston & Strawn about how borrowers can avoid these pitfalls and optimally structure a dual Islamic and conventional transaction.
Q. Assuming this is the first time that a company to sharia-compliant sources of finance, what should its first step (or first couple of steps) be?
As a starting point, in addition to agreeing the commercial terms and conditions with the Islamic banks (reflecting the position agreed with the conventional lenders), the company should also get an understanding of the Islamic financing structure which the Islamic banks are expecting to adopt for the Islamic facility. The structure for the Islamic facility will depend on a number of factors including, (i) the purpose for which the financing is required, i.e. whether it is for general company purposes or, for example, to develop a real estate asset, and (ii) whether the company owns tangible assets which it can use for the Islamic facility. The type of Islamic structure used will also depend on the Sharia board which will approve the financing. Some Sharia boards will only approve commodity Murabaha (or Tawarruq) financings in exceptional circumstances and even then only for very short tenors. A company wanting to utilise financing which is subject to approval by such Sharia boards will need to have a sufficient pool of tangible assets which can be used to underpin an asset based Islamic facility.
Q. When it comes to the documentation, what components typically need to be treated differently for conventional and Islamic banks?
Although the two facilities will be documented separately, the terms and conditions incorporated into the two sets of documents can be structured in a way that ensures that both sets of banks benefit from the same or very similar commercial terms. The documentation will need to ensure that both facilities rank as senior and the two syndicates share security on a pro rata and pari passu basis. In order to achieve this end, the two sets of banks will need to commit to set intercreditor and security sharing terms and conditions.
Q.Drawdown and payments can often work differently within the context of conventional and Islamic finance structures. Structurally, what can be done to ensure coherence under one framework?
A. It is possible to include provisions in the conventional and Islamic facility documents and in the intercreditor agreement requiring pro rata utilisation of the two facilities. The provisions will need to be structured so as avoid any Sharia compliance issues which may arise if conditionality is introduced into the Islamic facility documents. In the case of multiple utilisations under, for example, an Ijara financing, it will necessary to adopt a master and supplemental documentation structure, where the master forms of the purchase, Ijara and other Islamic facility documents are signed on financial close with each utilisation of the Islamic facility involving the execution of a package of agreed short form supplemental documents.
Q. Are there any particular areas of sensitivity which need to be dealt with in order get the two sets of banks to agree to a conventional and Islamic co-financing arrangement?
Below are some of the areas of sensitivity in relation to which both sets of banks will need to be comfortable.
Voting and decision making: In order to ensure parity between two sets of banks, it will be necessary for the exposure (based on the principal amount outstanding under the conventional facility and its equivalent amount under the Islamic facility) of the members of the two syndicates to be calculated on a consistent basis for the purposes of the voting and decision making process (whether this relates to granting consents and waivers to the company or to accelerating the facilities and taking enforcement action following a default) under the intercreditor agreement between the two syndicates.
Security sharing: This is a particularly sensitive area in the context of an Islamic financing which involves the use of the company’s assets, as in the case of an Islamic lease (or Ijara) financing. In an Ijara structure, the Islamic banks purchase an ownership interest in the relevant assets (e.g. real estate, vessel, industrial machinery, etc.) and lease that interest back to the company. On the face of it, having an ownership interest in the relevant assets provides the Islamic banks with a better position in relation to those assets compared with the conventional banks who may only have security over assets of the company. Appropriate provisions will need to be included in the intercreditor agreement to deal with this issue.
Some Sharia boards take the view that no amount of interest bearing debt can be secured against assets which are used to raise Islamic finance. This would mean that the conventional facility cannot be secured against the Islamic lease assets in the context of an Ijara financing. This matter will need to be discussed with the transaction Sharia board to agree an arrangement whereby: (i) the entire amount of the (conventional and Islamic) financing is secured against all the assets of the company; and (ii) the security agent can be instructed by the requisite percentage of the banks across the facilities to take enforcement action following a default.
Application of enforcement proceeds: From a Sharia compliance perspective, the Islamic banks will also need to ensure that, in the event of a sale of the Islamic facility assets following enforcement of the security, no amount of the liquidation proceeds of those assets is applied in payment of the conventional debt facility. This will require changes to the enforcement waterfall of payments to ensure that the interest element is, so far as possible, only paid from the liquidation proceeds of non-Islamic facility assets.
Shibeer Ahmed focuses his practice on project finance, banking and Islamic finance, regularly working on highly complex financings throughout the Middle East and internationally. He is the head of Winston & Strawn's Islamic Finance practice. Mr. Ahmed has advised a range of financial institutions, including commercial banks, Export Credit Agencies (ECAs), and development finance institutions, on complex multi-sourced project financings and Islamic financings. He has wide experience advising on corporate and sovereign Sukuk issuances. Mr. Ahmed has extensive experience across a range of sectors, including infrastructure, energy, petrochemicals, and oil & gas.