Within the spectrum of Islamic financial services (IFS), project financing has been one of the slower segments to develop. Historically, the reason for this has been the cost differential between conventional project financing and its sharia-compliant counterpart. In the past, conventional tenors also tended to be longer – up to 20 years for power and water projects – than those offered by Islamic financiers, due to the fact that Islamic banks tended to focus on retail deposits as a source of liquidity, while conventional lenders had access to a large array of longer-term bonds.
These dynamics have altered somewhat over the past decade. The financial crisis of 2008 brought the conventional and Islamic pricings much closer together, and the increasing popularity of sukuk (Islamic bonds), has granted Islamic financial institutions a much longer-term funding base. As a result, sharia financing is a growing force in the GCC, and Bahrain is playing a significant role in its development.
SIGNATURE PROJECTS: Of course there is nothing new about large-scale Islamic project financing in the region. In 1993 Saudi Arabia’s Ministry of Education raised $1.5bn using the istisna’a (type of sales contract) financing structure, arranged by the Al Rajhi Banking and Investment Corporation, to build 399 schools. The ministry paid 40 instalments on a quarterly basis and finally took possession of its new facilities in 2009.
In Bahrain some of the largest financing deals have featured Islamic components. Most artificial islands in the country were funded by Islamic finance. Durrat Al Bahrain and Diyar Al Muharraq were both originally built with finance from Kuwait Finance House, and most social housing on Diyar Al Muharraq continues to be funded by Islamic banks. Another notable project was the $1bn financing package arranged by BNP Paribas and HSBC for the state-owned Bahrain Petroleum Company (Bapco). The 2005 deal took six years to arrange due to protracted negotiations regarding government guarantees, but the final result was a multi-tranche package, which combined sharia-compliant financing with conventional and export credit agency portions. Furthermore, in 2016 nogaholding, the business development arm of the kingdom’s National Oil and Gas Authority, signed a $570m murabaha (type of Islamic sales contract) finance facility. The sharia-compliant package is its first syndicated debt facility and will be used to meet the group’s general purpose financing requirements, including the Bapco Modernisation Programme, a liquefied natural gas import terminal and the Bahrain gas plant project. A total of 10 local, regional and international institutions joined forces to provide the package. These included the Arab Banking Corporation, Ahli United Bank, Gulf International Bank, National Bank of Bahrain, Qatar Islamic Bank, BNP Paribas, HSBC and Bank of Tokyo-Mistubishi.
LOOKING AHEAD: Some inefficiencies continue to challenge the rate of expansion of Islamic project finance. There is still a large amount of legal documentation associated with sharia-compliant instruments, which can make transactions more expensive. But increasing standardisation in the form of central sharia boards and the activities of global standard-setters, such as the Bahrain-based Accounting and Auditing Organisation for Islamic Finance Institutions, have done much to iron out these bureaucratic wrinkles.
Looking ahead, it is possible that sukuk may play a larger role in the financing of new projects in Bahrain in the future. Traditionally, Islamic and conventional bonds have been ruled out of this role due to the difficulty of attracting subscribers. Institutional investors tend to seek project bonds with an “A” credit rating, which is hard to secure for greenfield projects, as they are often subject to delays and cost overruns. More recently, however, ways have been found to enhance the credit of project bonds and sukuk, through, for example, government equity contributions and guarantees, or by the financier shoring up the credit rating itself by extending a subordinated facility to the project company.
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