Amid Dana debacle, Islamic finance seeks safeguards against illegality claims

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* Dana Gas case raises risk for sukuk investors
    * Some may now demand sharia assurances in documentation
    * Scholars endorsing sukuk may come under more scrutiny
    * Hiring model for scholars could change in long term
    * Dana case may be test for new UAE sharia authority

    By Bernardo Vizcaino and Liz LeeSYDNEY/KUALA LUMPUR, July 6 (Reuters) - The Islamic finance
industry is seeking ways to safeguard deals against challenges
to their religious permissibility, after a case in the United
Arab Emirates raised the risk that issuers of Islamic bonds
could refuse to redeem them after such a challenge.
    Bankers and lawyers say several mechanisms, new and old,
could address the problem, though it may be impossible to remove
the risk entirely.
    Legal provisions in contracts for financial instruments
could prevent their sharia-compliance from being questioned
after they are issued. Investors may also screen scholars who
certify instruments as sharia-compliant more carefully, and pay
more attention to what mechanisms, such as courts, exist to rule
on potential disputes.
    Last month, Sharjah-based Dana Gas <DANA.AD> declared it
would not make payments on $700 million of sukuk maturing this
October because Islamic finance standards had changed since the
instruments were issued four years ago.
    The change in standards meant the instruments were no longer
sharia-compliant and had become "unlawful" in the United Arab
Emirates, Dana argued. [ID:nL8N1JB5F9]
    This raised concern across the Islamic finance industry that
more companies could avoid redeeming sukuk by adopting the same
argument as Dana. The outcome of the Dana case, which is being
fought in British and UAE courts, could hurt liquidity and
growth in the global sukuk market, Moody's said.
    To try to avoid similar cases in future, investors may
demand  more detailed and restrictive language in sukuk
documentation. Such language already exists for some sukuk, but
it is not used consistently and is not standardised.
    "We foresee sukuk investors increasingly demanding sharia
assurances which could include a sharia undertaking in the form
of an explicit waiver of any defence of non-compliance," said
Mohammad Hasif Murad, investment manager at Aberdeen Islamic
Asset Management in Malaysia.
    Some issuers in Indonesia go further by stipulating that if
their sukuk cease to be sharia-compliant, they will be declared
in default, mature immediately and become repayable to
    Sukuk issued by Maybank Indonesia, BRI Syariah and Bank
Jambi include such clauses, according to Fitch Ratings. They all
used an investment management partnership structure known as
mudaraba, the same format employed by Dana.
    But early redemption is not fundamentally desirable for
issuers or investors, which may limit wide use of such clauses
in the Gulf region, said a Dubai-based partner of an
international law firm.
    Also, such clauses may not suffice against an issuer in
financial distress seeking to force a restructuring aggressively
or delay repayment, said the lawyer.
    "This is part of the risk that investors run in our region.
Such risk already tends to be priced into instruments issued out
of the Middle East."

    Investors may therefore cast a more watchful eye on the
groups of scholars who provide sharia endorsements for sukuk.
    "With this case, we will be more stringent when looking at
what are the pledges made, who are the sharia councils," said
Heddy Humaizi Hussain, director of institutional sales and
marketing at Kuala Lumpur-based financial firm Saturna.
    At present, sukuk issuers generally choose the scholars who
certify their instruments. Some analysts think that model could
eventually change under pressure from investors, if that is
necessary to maintain the credibility of Islamic finance.
    Issuers could be required to have an independent sharia
board that answers to directors and shareholders rather than to
management, said Sheikh Yusuf Talal DeLorenzo, a scholar with
over three decades of experience in Islamic finance.
    "Certainly in Muslim-majority jurisdictions this should be
the case, whether it's an airport authority, or a shipbuilder,
or a real estate developer," he said.
    Malaysia has succeeded in limiting disputes over sharia
compliance partly because it has country-level sharia boards
within its central bank and capital markets regulator. These
boards tend to create a national consensus on standards.
    In May, the UAE approved the formation of a high sharia
authority for Islamic banking and finance, which is expected to
set rules and a general framework for Islamic finance governance
and the issuance of sharia rulings.
    It is not yet known if the board will have influence over
the Dana case. But it could be instrumental in restoring
confidence in the UAE market, improving liquidity and reducing
costs, Dubai consultancy Acreditus said in a research note.
    "The Dana restructuring will be a critical and important
test for the Board," it predicted.

 (Editing by Andrew Torchia and Catherine Evans)
 ((Bernardo.Vizcaino@thomsonreuters.com; Telf: +61293218168;
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