Islamic religious prohibitions on guaranteed debt may be complicating negotiations to bail out Dubai World.
The market has recovered from the initial panic over a possible default on debt issued by Dubai World, and many are assuming that the United Arab Emirates will stand behind the bonds.
But under Islamic financing rules, creditors may be required to take a haircut. Guarantees on debt are prohibited by the shariah, which requires investors to accept risk in exchange for profits. Indeed, there were already questions about the legality of Dubai World’s debt arising from the principal guarantee of the bonds.
In recent years, there has been something of a backlash against some of the more aggressive types of Islamic financing, many of which have been structured to mirror Western bonds to make them more attractive to Western investors. Abu Dhabi, the UAE state expected to bail out Dubai World, may be hesitant to do anything that would be seen as disrupting the profit and loss sharing required by shariah.
“In that case, can it be that Dubai — perhaps under pressure from Abu Dhabi — is keen on a little burden-sharing of its own? This is especially so if one assumes legal proceedings held in the UAE would likely side with the views of the AAOIFI, potentially rendering Nakheel’s certificates unlawful and unenforceable,” Izabella Kaminska wrote at FT ALphaville.
Over the weekend, we spoke to a Wall Streeter who specialises in Islamic financing. He said that bond holders shouldn’t be too confident that they will be made whole. Indeed, he expects that the potential unenforceability of the bonds will be used by Dubai negotiators as a way of winning concessions from Western bondholders.
“I expect eventually there will be a move to support the Dubai credit but it may be costly for the creditors,” he said.