Rating agencies, shoddy risk analysis, and sukuk
A recent article in the Wall Street Journal identifies the role played by rating agencies in perpetuating the credit boom that is currently imploding. The primary fault of investors, of course, is that they believed that credit ratings of new and unknown instruments, such as credit derivatives, are meaningful in any way. It is obvious that credit and asset-backed derivatives are signficantly different from the types of bonds that rating-agency experts are qualified to to assess (in terms of default risk).
In the case of sukuk, the silly bonds marketed as "Islamic" by rent-seekers, there are numerous legal risks that are very poorly understood, including by the lawyers and bankers who structure the instruments. The problem in this case is self-inflicted: the lawyers want to structure the instruments, e.g. lease-backed bonds or sukuk al-ijara, in such a way as to assure "Shari`a scholars" that bond-holders have material ownership of the underlying assets and receive "rent" rather than "interest". At the same time, they want to assure markets and rating agencies that the instruments are indistinguishable from conventional bonds, where the only mateiral risk is credit risk of the issuer. The rating agencies read the legalese and conclude that the lawyers are right: the "Islamic" structure is merely a fiction, and there is only credit risk. They give the sukuk the same credit rating they would give any other unsecured bond issued by the same entity (see, e.g. S&P's analysis of Qatar's Global Sukuk, where the rating was based on the soundness of the Qatari economy, without any significance lent to the asset ostensibly being leased back by the issuing SPV).
Unless and until we have a high-visibilty case of bankruptcy, we will not know with any certainty who owns what in the maze of SPVs that lawyers and structured financiers love to use. Until then, many will continue to line their pockets with legal, structuring, and advisory fees, as they congratulate themselves on "innovative Islamic products." What a shame!
In the case of sukuk, the silly bonds marketed as "Islamic" by rent-seekers, there are numerous legal risks that are very poorly understood, including by the lawyers and bankers who structure the instruments. The problem in this case is self-inflicted: the lawyers want to structure the instruments, e.g. lease-backed bonds or sukuk al-ijara, in such a way as to assure "Shari`a scholars" that bond-holders have material ownership of the underlying assets and receive "rent" rather than "interest". At the same time, they want to assure markets and rating agencies that the instruments are indistinguishable from conventional bonds, where the only mateiral risk is credit risk of the issuer. The rating agencies read the legalese and conclude that the lawyers are right: the "Islamic" structure is merely a fiction, and there is only credit risk. They give the sukuk the same credit rating they would give any other unsecured bond issued by the same entity (see, e.g. S&P's analysis of Qatar's Global Sukuk, where the rating was based on the soundness of the Qatari economy, without any significance lent to the asset ostensibly being leased back by the issuing SPV).
Unless and until we have a high-visibilty case of bankruptcy, we will not know with any certainty who owns what in the maze of SPVs that lawyers and structured financiers love to use. Until then, many will continue to line their pockets with legal, structuring, and advisory fees, as they congratulate themselves on "innovative Islamic products." What a shame!
posted by Mahmoud El-Gamal at 7:08 PM
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