Rafflesia Capital's Exchangeable Trust Certificates - Islamic Finance ...

Deals of the Year 2006 Handbook
Rafflesia Capital’s Exchangeable
Trust Certificates
On the 27 th September 2006, UBS Investment Bank
successfully launched and priced what is believed to be
the world’s first Shariah compliant exchangeable trust
certificates. The Sukuk, exchangeable into the equities
of Telekom Malaysia, were issued by Rafflesia Capital,
a Labuan (Malaysia) incorporated special purpose
company, for Khazanah Nasional, the investment arm of
the Government of Malaysia.
This was the largest ever exchangeable issue to come out
of Malaysia and the largest exchangeable issue out of
Asia – excluding Japan – in 2006. The offering comprised
US$750 million of periodic payment trust certifi cates (due
in 2011), upsized from the initial deal size of US$500 million
on the back of strong investor demand. The offering was
launched with a yield range of 5-year US dollar swap -32.5
bps to +42.5bps (equivalent to 4.925% to 5.675%) and a
premium of 17–20%, fi nally pricing at a tight 5.07% (swap
+3 basis points). The fi nal pricing was set at a yield of 5.07%
and a premium of 19%, which was above the mid-point of
the indicated range.
UNIQUE STRUCTURE
What was so remarkable about this transaction was its
unique and innovative structure – we believe this is the fi rst
Sukuk structure to be backed by Shariah compliant fi nancial
assets (equities of Telekom Malaysia). Previously, the Sukuk
market was predominantly comprised of Sukuk structured as
trust certifi cates, representing ownership of physical assets.
This meant that potential issuers with inadequate physical
assets – including holding companies and investment fi rms –
were excluded. This deal establishes a structural framework
so that these issuers can have access on the basis of their
Shariah compliant fi nancial assets.
Another challenging aspect of structuring this transaction
was designing the mechanism for payment of coupons on
the Sukuk, which were structured as premium redemption
instruments paying a coupon of 1.25%. Unlike the
redemption amount, which is guaranteed by Khazanah
Nasional pursuant to a Unilateral Purchase Undertaking,
the periodic Sukuk coupons could not be guaranteed and
had to be paid from the dividend income derived from the
equities of Telekom Malaysia. Investors’ concerns regarding
the uncertainty of coupon payments were addressed by
creating a sinking fund account for the benefi t of the
investors, wherein dividends from the underlying equities
were accumulated to ensure the availability of funds from
which to make payment of periodic coupons over the life
of the transaction.
COMMITMENT TO ISLAMIC FINANCE
The motivation of Khazanah Nasional for this deal was
to reinforce Malaysia’s reputation as an international
Islamic banking hub; to continue Malaysia’s tradition of
innovation in Islamic banking; and to tap into Middle
Eastern liquidity as an alternative funding source. Therefore,
a key performance indicator for Khazanah Nasional was
the acceptability of this structure to both conventional
and Islamic investors globally, and distribution of the Sukuk
to Middle Eastern fi nancial institutions. Given Malaysia’s
prominent commitment to the development of Islamic
fi nance, it was crucial that UBS Investment Bank structured
the transaction in a way that was both Shariah compliant
and priced at levels attractive to Islamic and conventional
investors.
EXTENSIVE PRE-MARKETING
Being the fi rst Shariah compliant exchangeable Sukuk, UBS
Investment Bank, along with representatives of the other
joint lead managers, undertook an extensive pre-marketing
exercise wherein selected Middle Eastern fi nancial institutions
in Kuwait, Qatar, the UAE and Bahrain were educated on
the various aspects of the Sukuk and encouraged to return
their feedback on the product features.
GREAT DEMAND
The groundbreaking nature of the deal combined with the
investor education conducted during the pre-marketing
phase motivated Islamic investors to buy in at below their
benchmark investment yield levels. The issue generated
demand in excess of US$3.2 billion, with over 100 investors
participating, implying a subscription level of 6.6 times the
base deal size. UBS Investment Bank generated 57% of this
US$3.2 billion demand. Approximately 44% of the Middle
East allocation was made to clients of UBS Investment
Bank.
SHARIAH COMPLIANCE OF TELEKOM
MALAYSIA
The Sukuk was structured as exchangeable trust certifi cates
representing the benefi cial ownership of the investors in
the underlying fi nancial assets (Telekom Malaysia equities).
It was therefore imperative from a Shariah compliance
perspective that Telekom Malaysia be Shariah compliant at
the time of issuance of the Sukuk and remain so throughout
the tenure of the Sukuk. For this purpose, the Shariah
advisors of the three joint lead managers approved the
following criteria for determining the Shariah compliance
of the company:
continued...
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Deals of the Year 2006 Handbook
Rafflesia Capital’s (continued...)
STRONG INTEREST
There was very strong interest from all groups of investors
globally; the allocation by investor type is shown below.
Allocation by investor type
Others
16%
ME Conv.
14%
Hedge Funds
33%
Source: UBS Investment Bank, September 2006
A designated calculation agent periodically applies the
above-mentioned tests to the relevant fi nancial statement
of Telekom Malaysia and forwards the results to a group
of three Shariah scholars appointed by Raffl esia Capital,
which issued the Sukuk, on behalf of Khazanah Nasional.
If there is a sustained breach of the Shariah compliance
tests, the Shariah scholars have the discretion to declare
Telekom Malaysia non-Shariah compliant, which gives the
investors the right to have their respective Sukuk redeemed
by Khazanah Nasional at an agreed price.
KEY TIMING
The timing of the transaction and its execution were key
factors to the success of the offering. Given the complexity
and objectives of the transaction, a detailed timetable was
prepared. Adequate time was factored in for investors to
understand the new structure and also assess the credit
quality of Khazanah. UBS Investment Bank conducted
continuous education and feedback sessions with Middle
Eastern investors to provide them with comfort. Investors
had a week to analyze the underlying asset and participate
in the transaction.
The result of this careful planning was signifi cant interest
and demand, not only from Islamic and Middle Eastern
investors, but also from conventional investors. The Fed
Funds rate was widely forecast to remain constant, with the
expectation that this would result in tightening of the swap
rates as a result of improving sentiments. Over the period
of the book building, the US dollar swap rates tightened by
around 25 basis points, which was fully captured in the fi nal
pricing to the benefi t of the issuer.
Islamic
14%
Outright
23%
Source: UBS Investment Bank, September 2006
Allocation was greatest among hedge funds, which were
allocated 33% of the offering; outright investment accounted
for 23% of allocation; and Islamic and conventional Middle
Eastern investors were each allocated approximately 14%
of the total issue size.
HIGHLY SUCCESSFUL
In the press the deal was unanimously perceived as a highly
successful offering. The Sukuk – and the UBS team in charge
of the transaction – gained a number of prestigious awards
in connection with the deal and it has also been nominated
for a number of other major awards to be announced
during the fi rst quarter of 2007.
UBS Islamic Finance Group is a
dedicated team of specialists
focused on the structuring and
execution of Shariah products,
giving customers access to innovative Shariah compliant
investments and services across a range of asset classes
including commodities, equities, fi xed income, foreign
exchange and alternative investments. For further
information please contact the UBS Islamic Finance
Group on: Islamic-fi nance@ubs.com.
www.islamicfinancenews.com
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