LONDON, 6 December 2004 — In the last few weeks, Islamic finance has seen two landmark achievements in financing and the bond market which bankers stress underline the growing maturity of Islamic banks and the sector in mobilizing funds which hitherto were the exclusive domain of conventional banking.

In an era of high liquidity and a rapidly-growing demand for Islamic financing facilities, issuers, underwriters, and arrangers expect more such deals to come to the market, although in some cases certain concerns are being raised.

The landmark achievement in question is the record $2.35 billion Islamic bridge financing arranged in October 2004 for Ittihad Etisalat which was awarded the second GSM license in Saudi Arabia. This is by far the single largest Islamic financing facility to be arranged anywhere and sets a benchmark for other to follow.

“There is an unprecedented level of liquidity in the Middle East thanks largely to the high oil prices,” stresses one banker in London. “The fact that such a large deal has been done in the market entirely on an Islamic format does demonstrate that both Islamic and conventional banks are increasingly able to structure and participate in such deals.”

The deal comprised two tranches — a $1.6 billion tranche guaranteed by the sponsors and which is being used to finance the payment of the license fees and priced at a margin of LIBOR plus 50 basis points. The second tranche of $750 million is a non-recourse Murabaha tranche for financing the purchase of plant and equipment, for which contracts are still being negotiated and yet to be awarded.

This tranche is priced at a margin of LIBOR plus 112.5 basis points. The facility has a tenor of 12 months with a term-out option of six months.

“This is an issuer driven phenomenon. If issuers demand Islamic finance, then the Islamic and conventional banks can deliver that. This was evident in the bidding phase when two competing consortia had essentially committed $4.7 billion of market capacity in a hundred percent Islamic format,” explained the banker.

Islamic finance hitherto had been conspicuous in its absence especially in key sectors in the Middle East such as oil and gas; telecoms; and manufacturing. For instance, Islamic finance has never been accessed for various projects in Qatar’s massive North Fields Gas project; nor by Saudi Aramco and other such oil majors in the region.

The lone project financed part-Islamically has been the Equate I petrochemical plant in Kuwait. In November 2004, Kuwait Finance House (KFH) lead managed a further $300 million Islamic tranche for Equate II to finance a second olefins plant in Kuwait. KFH’s Bahrain subsidiary is also promoting the first privately-owned integrated petrochemical, power and water project in the region. It will be based in Bahrain.

A number of Islamic structured finance facilities have been arranged for power projects such as the Al-Hidd project in Bahrain and the Suwaibat project in Abu Dhabi.

The bond in question is the five-year $1 billion Sukuk (Islamic bond) issued by the Department of Civil Aviation on behalf of the Dubai government, and which is part of a $4.1 billion financing package for the development of Dubai International Airport, especially the construction of a new third terminal and two concourses.

It is once again by far the largest Sukuk to date; and according to one banker, “a landmark deal in terms of the size. It was priced at par with a coupon of 45 basis points over LIBOR.”

The Sukuk is unrated and is a direct obligation of the government of Dubai. It is secured on airport assets, in particular terminal one and the surrounding area.

Some concerns have been raised over valuation of assets, which were done by the Dubai government, instead of the involvement of independent valuers. Perhaps in this case where the Sukuk is essentially guaranteed by the government of Dubai, the effect was perceived to be marginal. But some analysts stress that it is the principle of independent valuation which is important. Not surprisingly, the uptake of the Sukuk was largely confined to Middle East banks (73 percent). European banks subscribed to only 16 percent. This is also due to the fact that the issue was unrated.

Others dismiss the concerns about valuation. “The transaction was oversubscribed from $750 million to over $1 billion, and involved the participation from the best Islamic banks and the best conventional banks in Islamic finance. The order book was in excess of $2 billion. The added value from an issuer perspective is that they have basically tapped the Islamic finance market to do a large benchmark-size issue even by conventional standards on an Islamic format; and got investors from the Middle East, Europe and Asia — just as one would expect in any conventional Eurobond transaction. This, despite that the Sukuk did not have a special official rating,” stresses one banker in London.