Alternative financing structures for the aviation industry Gregory Man Partner and Head of Debt Capital Markets (Middle East) Norton Rose Fulbright (Middle East) LLP October 4, 2016
Agenda • Introduction • Islamic Finance in perspective • What is Islamic Finance? • Introduction to Sukuk • Emirates ECA backed Sukuk • Future innovations 20
Muslim Demographics 21
Islamic Finance in perspective • Estimates of the current size of the Islamic Finance market range from [US]$1.66 trillion to [US]$2.1 trillion with expectations of market size to be [US]$3.4 trillion by end of 2018 • One of the fastest growing segment of the financial industry • Despite rapid growth, global Islamic finance market only represents around 1% of worldwide financial services industry • 1.6 billion Muslims (23% of the world’s population) • In 2015 it was reiterated that the world’s Muslim population will grow twice as fast as non- Muslim over the next three decades • Popularity in non-Muslim jurisdictions • Islamic finance is a credible alternative to conventional finance • Regulations changing globally to accommodate 22
What is Islamic Finance? • As practisedtoday, Islamic finance involves the application of Shari’a principles to financial activity of Muslims in the modern world • Traditional techniques and structures available for centuries, evolved and refined, within parameters of Islamic jurisprudence, to accommodatemodern financial institutions and modern banking • Applicable to range of financial products • Ethical form of financing that aims to create business activities that generate a fair and equitable profit from transactions that are backed by real assets • Often try to achieve similar commercial outcome to conventional financing • Requires an understanding of the Shari’a 23
What is the Shariah? Shariah is the religious law of Islam. It has two principal sources: • The Qur’an - the sacred book that records the word of God as revealed to the Prophet Muhammad (PBUH) “Oh you who believe! Fear Allah (God) and give up what remains of your demand for usury, if you are indeed believers. If you do not, take notice of war from Allah and His Apostle: but if you turn back, you shall have your capital sums: deal not unjustly, and you shall not be dealt with unjustly ” (Qur’an 278-279) • The Hadith - the body of documents that records the Sunnah (the practice or “life- example”) of the Prophet Muhammad (PBUH) 24
What is permissible? Halal Haram (Prohibited (Permissible) ) 25
The key prohibitions Interest ( Riba ) Unethical Speculation investments ( Maisir ) Key Uncertainty Unjust enrichment prohibitions ( Gharrar ) 26
The concept of riba • Probably the best known and biggest practical difference from conventional finance • Underlying concept stems from the nature of money in Islam – Money has no intrinsic value and is simply a means of facilitating trade – Money is not a commodity – Money can only be exchanged for the same at par value • There should be no charge for the use of money • Financial activities that are approved in Islam: – Trading and enterprise - the prohibition of riba does not preclude obtaining a rate of return on an investment or profit from a commercial venture – Taking security (including guarantees) – if it guards against negligence, willful wrongdoing or breach of contract of customers/partners • Islamic finance is sometimes said to be “asset based” as the trading of assets is often used to create obligations (where money is just the payment mechanism) 27
The basic difference* Conventional money Bank Client money + money (interest) Islamic Goods and Bank Client Services money * Courtesy of Sheikh Nizam Yaquby 28
Common Islamic financing structures The typical Islamic Financing structures • Goods Murabaha (cost-plus financing) • Tawarruq / Commodity Murabaha (murabaha financing through the use of a commodity) • Ijara /Ijara-waIqtina (leasing / leasing with a promise to sell) • Mudaraba (participation financing) • Musharaka(partnership / equity financing) • Wakala (agency) • Istisna’a (variation of murabaha that permits goods to be financed while under construction or manufacture) • Sukuk (Islamic bonds) 29
What is a Sukuk? • Capital markets instrument sometimes called an Islamic “bond” • Trust certificate which represents an undivided beneficial ownership interest in an underlying asset/venture • To the extent that underlying assets generate a profit, profit can be distributed to certificate holders • Returns based on profits from assuming risk related to ownership • Profit payments can therefore not be guaranteed • Requirement for “tangibility” in order for Sukuk to be tradeable 30
Sukuk-al-ijara structure (lease structure) – acquisition finance Airline/Lessee Sale Purchase Rental Lease Undertaking Undertaking Payments Agreement SPV/Issuer/Lessor Purchase Price Airline Aircraft manufacturer “owner” Assignment Agreement Service Agency Agreement Title Principal & Sukuk Issuance Profit Proceeds Investors 31
Sukuk-al-manafa’a (usufruct structure) – corporate funding Emirates Third parties (as Obligor) Sale of Allotted Revenue Sale of Rights to Travel Exercise from Outstanding (materialised Price Rights to Rights to through sale of Travel Travel Sale of tickets Rights to Travel Appointment as Service (measured Emirates Agent Emirates SPV / Issuer in ATKMs) (as Agent) (as Seller) Revenue Purchase Price Principal & Issuance Sukuk Profit Proceeds Investors 32
Why did Emirates choose to do an ECA backed Sukuk? • First UK Export Finance backed Sukuk for aircraft financing • Largest ever capital markets offering in the aviation space with an Export Credit Agency guarantee • First Sukuk to be used to pre-fund the acquisition of aircraft • First ever Sukuk financing for 4 A380 aircraft • Regulation S and Rule 144A offering • Admitted to listing and trading on the London Stock Exchange and on NASDAQ Dubai 33
Investor base and geographies Geographies Investor Type 15% 29% 39% 47% 38% 32% Middle East and Asia Europe US Fund Managers 34
Annual Sukuk issuances 140 120 100 80 60 40 20 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 35
Emirates ECA backed Sukuk Emirates 11. Emirates Forward Lease of 12. Advanced Rental Aircraft and EK Service Agency 16. Actual Rental Agreement 31. Security 30. Security Lessor SPV 19. Aircraft 20. Aircraft Purchase Exercise Undertaking Price 29. Security ECA Security ECGD 10. Owner Forward Trustee Lease of Aircraft and Owner Service 13. Advance Agency Agreement 14. Delivery Rental 8. Issuance Period Periodic Proceeds Profit Distribution Secured 17. Actual Balance Amount Proceeds 24. Aircraft Sale Rental Account Undertaking Sale of Aircraft 9. Procurement Emirates Owner SPV Emirates 25. Aircraft Exercise Price Purchase Price for 28. ECGD Aircraft Guarantee Delivery of Aircraft 7. Issuance 23. ATKM 6. Declaration 15. Advance 22. ATKM 5. ATKM 4. Purchase Proceeds Purchase of Owner Rental Balance and Exercise Purchase of Rights to Undertaking Trust 18. Actual Rental Price Price Travel Rights to 21. Aircraft Exercise Travel Manufacturer Price 32. Security Trustee 27. Dissolution 26. Periodic 2. Issuance 3. Declaration Distribution Amounts / 1. Certificates Distribution Proceeds of Issuer Trust Partial Dissolution Amounts Amounts / Delivery Period Partial Distribution Notes Amounts / Aggregate Total Loss Dissolution Cash flow Certificateholders Amounts / Trust Property Asset flow Distribution Amount 36
Future innovations • Islamic EETCs – some structural challenges • Tax leasing structures – already utilise capital market products – could be adapted for Sukuk 37
International Canada Europe Calgary Québec Amsterdam Milan Montréal Toronto Athens Moscow Ottawa Brussels Munich Frankfurt Paris Hamburg Piraeus London Warsaw USA Central Asia Asia Austin Almaty Bangkok Dallas Beijing Denver Hong Kong Houston Jakarta* Los Angeles Shanghai Minneapolis Singapore New York Tokyo Pittsburgh- Southpointe Africa Middle East San Antonio Bujumbura** Abu Dhabi St Louis Australia Cape Town Bahrain Washington Casablanca Dubai Brisbane DC Melbourne Dar es Salaam Riyadh* Latin America Durban Perth Bogotá Harare** Sydney Caracas Johannesburg Rio de Janeiro Kampala** * associate office ** alliance 38
Contact details Gregory Man Partner, Head of debt capital markets (Middle East) Norton Rose Fulbright (Middle East) LLP Tel +971 4 369 6307 greg.man@nortonrosefulbright.com 39
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