by Christopher W. Holton

As we reported earlier this month, the market for Shariah bonds is entering a new crisis as a result of an apparent default by Dana Gas:

Dana Gas is refusing to pay its creditors based on a new decision that its bond offering is no longer Shariah-compliant. This is an example of a moral hazard that does not exist in conventional finance.

A borrower refuses to pay, challenging the sharia-compliance of its bond

Ten years after sealing a landmark production deal with Iraqi Kurdistan, it is struggling to recover $900m it is owed by the autonomous region and the Egyptian government. So it faces a liquidity squeeze. That is not, however, why it says it wants to restructure $700m-worth of Islamic bonds maturing in October 2017. Rather, it says it has received legal advice that the bonds are no longer compliant with sharia—rules based on Islamic scripture.
The bonds were deemed compliant in 2013, but Dana cites evolution in the “interpretation” of Islamic financial instruments. It is seeking to have them declared invalid in a United Arab Emirates court.

There is no global standard or overarching authority for sharia compliance. Some countries, like Malaysia, have a central sharia board for finance. Others, including the UAE, do not, leaving issuers and investors to rely on the guidance of learned scholars to vet transactions. Inevitably, they sometimes disagree. Mohammed Khnifer of the Islamic Development Bank says some are “now trying to revisit the standards to make them more sharia-compliant”. Yet Dana’s request that a previous sharia ruling be reversed—and the looming default—are unprecedented.
Creditors are enraged. Dana Gas is proposing to exchange the sukuk for a new, sharia-compliant security that would confer rights to less than half of current profit rates, so that the company can focus on “cash preservation”. (Though, if sharia compliance was its only motive, nothing would prevent it from issuing new sukuk with the same economic value.)

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