Dubai debt to test laws of Islamic financing

Dubai debt to test laws of Islamic financing

New Delhi: The debt crisis in Dubai is about to test one of the fastest-growing areas in banking, Islamic finance, and put the city-state’s opaque judicial system on trial, according to bankers and experts in finance.

Many loans and bonds that comply with Shariah, or Islamic law, were issued in recent years by Dubai World, the investment arm of Dubai, and other Persian Gulf companies as oil-rich West Asian nations increased spending, and the global credit crisis fed debt investments in emerging markets.

But, because there have been few major defaults in this market, there is little precedent for arbitrating the unique terms of these instruments.

That is likely to create many legal issues for investors in Dubai World, which sent jitters through global markets by seeking to delay payments on $59 billion (Rs2.74 trillion) in debt.

Abdulrahman al-Saleh, director general of Dubai’s finance department, said on Monday that Dubai World was not guaranteed by the government, and the creditors would need to “bear some of the responsibility" for the its debt.

Shariah-compliant investments prohibit lenders from earning interest, and effectively place lenders and borrowers into a form of partnership. Yet there are no consistent rules about who gets repaid first if a company defaults on such debt, said Zaher Barakat, a professor of Islamic finance at Cass Business School in London. The first test of what that means for investors may happen around 14 December, when payments on a $3.5 billion Shariah-compliant bond owed by Dubai World’s real estate subsidiary, Nakheel, come due. If Nakheel defaults on its payment, legal proceedings may be initiated. It is unclear what may happen next.

Nakheel bondholders have formed a creditors’ group representing at least 25% of the outstanding debt, a legal adviser to the group said.

Holders of these bonds “are going to argue that they are in the secured position on the underlying asset," said one bank investor involved in the issuance of some of Dubai’s Shariah-compliant debt. That means that bondholders could insist on being repaid before banks, upending the traditional bankruptcy hierarchy.

“No one has tested the legal system or the documentation," a lawyer briefed on the situation said.