BWFF 3033 FINANCIAL MARKET AND INSTITUTION

A172 SECOND SEMESTER SESSION 2017/2018

GROUP C

GROUP ASSIGNMENT 2

EMIRATES AIRLINE: A BILLION-DOLLAR SUKUK-BOND ISSUE

PREPARED FOR:

DR. SHARMILAWATI BINTI SABKI

PREPARED BY:

NAME MATRIC NO

SARANYAH NADUNELINGEN 237565

HWONG BOH SIEN 239048

NAJUWA SYAKIRA BT MOHD DZULKEFLI 245357

NURUL NABILAH BT JAMIL 246632

NORFATIN SYAFIQA AZMA BT AZMAN 246636

KOMATHI SHANMUGAVELU 248300

SUBMISSION ON:

14 MAY 2018

1
Question 1 3

Question 2 6

Question 3 9

Question 4 10

Question 5 11

Question 6 12​-13

References 1​4

2
Question 1

What are the main issues in the given case study?

The main issue that has been discussed in the given case are on how the Emirates

Airline (EA) making decision to finance its purchase on new aircrafts. There were various

ways that EA has made to raise its brand and become one of the world's leading airline

companies with 60,000 employees, 200 aircrafts and flights to 140 destinations involving 70

countries on six continents and has been circulating flight services to 34 million passengers

and carrying 1.8 million tons cargo.

EA was established on March 1985 with the starting capital of $ 10 million and two

aircraft from Dubai’s royal family. After that, the EA developed a journey back and forth,

which began with flight to Bangkok, Hong Kong, Manila and Singapore. After being

developed and growing in Asia, the EA is stepping on a site to the European market, which

began operating to London, Frankfurt and Paris.

In a financial crisis incurred back in 2009, Dubai has experienced some major

problems due to a mismatch between the maturities of its assets and liabilities.

Government-related entities (GREs) with aggressive business strategies and fragile cash

flows relied on short term debt, leads to substantive financial difficulties. In order to solve

this issue, Dubai World asked for a restructuring of its debt worth of $26 billion so its

developer Nakheel announced a delay in the repayment of $4 billion sukuk.

First of all, sukuk is an Islamic investment certificate which is in other word called

Islamic bond. It has the same function as a conventional bond but because of interest is

prohibited in Islamic laws, a company or sukuk holder must be entitled to participate to the

performance of the underlying asset or business activity and has right on both profit and

losses resulting from the business activity. A key decision in engaging the lead managers is

3
whether to underwrite the issue or act on a best-effort basis. Underwriting involves

guaranteed placement of any remaining portion of the issue by any underwriting bank.

Islamic bonds are appear to be a significant asset class in the international markets.

In conjunction to that, Emirates Airline (EA) treasury department is struggling to

determine the best way to finance a new aircraft or planes in the coming year. Analysts was

unsure with the opinions whether to focus on repeating the sukuk issues, exploring other

types of sukuk bonds or rely on conventional financial arrangements.

Based on empirical results, EA raised $1.75 billion from issuing Islamic and

conventional bonds on March 12, 2013 and February 6, 2013. EA announced to issue a 10

years amortizing sukuk bond which matures in 2023 and has an amortizing structure for 5

years of average weighted life. This means that, sukuk will reduce in value of the bond

gradually over a period of time. Therefore, the full amount should be paid fully before the

final maturity date. This leads the arrangers release the initial profit rate guidance at a range

between 300 basis points to 350 basis points relative to five-year mid-swaps.

Besides, EA repaid a $550 million sukuk bond that used to pay back for the purchase

of plane in 2005. In 2013, on the other hand EA has to raise approximately $5 million to pay

for its existing aircraft orders. As a result, it only raised $1.75 billion from the issuance of

sukuk. In the sale of the 10-year amortizing sukuk bonds at a profit rate of 3.875 per cent

accounted for $1 billion and the maturity date is on March 19, 2023. The remaining $750

million came from the 12-year amortizing regular bonds at a coupon of 4.5 per cent and due

on February 6, 2025. The sukuk bonds yielded 0.486% (4.51% - 4.024%) basis point lower

profit than regular bonds yield.

The most concerning issues that attacked EA was the fluctuations in jet fuel and

currency exchange. Its debt obligations was mostly in AED (UAE dirhams) or US$. There

4
was also a small portion of debt obligation in Singapore dollars. Based on the consolidated

income statement. Although the revenue was increasing year by year but the net profit and

profit attributable to Emirates’ owner was fluctuating significantly. Therefore, it is difficult

for the EA to issue bonds between sukuk or conventional bonds to finance for new aircrafts

or planes in the coming year.

5
Question 2

Why is there a yield difference between the two issuance in these two different markets?

Is this due to difference in risk, investor clienteles, liquidity, seniority or something else?

In Emirates Airline’s case study, there are two types of issuance, which are Islamic

bonds (Sukuk) and conventional bonds. Sukuk or Islamic bonds, is a form of financing to

issuer that adhered to Islamic laws, the principles of Shari’ah. The face value of sukuk is

based on the market value of an underlying asset. Interest and speculation are prohibited in

Sukuk, however investors will get profit rate or share of profits from the underlying asset as

well as share for any loss incurred. Sukuk also gives the investor partial of asset ownership

which must be directly related to the purpose of financing with business activity on which the

transaction is based.

Conventional bonds are the long-term debt issuance to raise debt finance. The bond

price’s face value is based on issuer’s creditworthiness or credit rating. It is compulsory for

issuer to pay back the principle and interests upon the maturity date to the investors. Under

conventional bonds issuance, interest is the fixed income for investors. Besides, it does not

give investors share of assets ownership as it is a debt obligation from issuer to the investors.

Risk sharing elements also do not applicable under conventional bonds issuance. In general

way, the differences exist because of Sukuk is not being typical debt instruments and having

asset directly attached to it. Conventional bonds were tradable in conventional markets,

whereas not all Sukuk were tradable as it is depending on the type of Sukuk.

Based on the case study, Emirates Airline raised $1 billion from issuing Islamic bonds

(Sukuk) and $750 million from conventional bonds. The sale of 10-year amortizing Islamic

bonds at a profit rate of 3.875 per cent and 12-year amortizing conventional bonds at a

coupon of 4.5 per cent. The yield curve at issuance suggested these bonds should have similar

6
rates, however Sukuk bonds yielded 48.6 basis point lower profits than yield on conventional

bonds, which means Sukuk sold with a lower implied yield. In finance, the term yield refers

to the owner of a security will receive returns in form of cash. The term structure of interest

rates known as yield curve, is one of the common bond valuation method. It measures the

market’s expectation of future interest rates given the current market conditions. Yield curve

is also a plot of the yields on bonds with differing terms to maturity, yet similar in term of

risk, liquidity and tax considerations.

From the risk perspective, Sukuk has same risks as conventional bonds especially in

term of rate of return risk. For instance, fixed return on Sukuk unable to rise although the

market rate is increased, thus it can cause less earnings on Sukuk. However, rate of return

risk is not specifically unique to Sukuk as it is similarly to be found in conventional bonds.

Moreover, credit risk also arises in both conventional bonds and Sukuk issuance. Under

Sukuk issuance, the Shari’ah principles will limit the credit risk management instruments

available to investors. This is because Sukuk are issued in emerging markets where the

counterparties that possess less sophisticated risk management mechanism will have tendency

to default on their commitments. In fact, a risk that only face by Sukuk issuer is Shari’ah

compliance as if the underlying assets of Sukuk changed, it will cause Sukuk no longer be

Shari’ah compliant. In consequence, the certificate will be rendered null and void.

In relation to price, bond yields have inverse relationship with bonds’ price. When

current interest rates increase, the bond’s price will decrease as the bond is sold at discounted

price to attract more demands. So, it will lead to increase of bond yields or vice versa.

Besides, if demand for bonds rise, the price of bond increases and yield will decrease. There

is an issue on whether Sukuk and conventional bonds issuance will have same yield level,

7
ceteris paribus or not. Some sources stated Sukuk has higher yields or lower prices than

conventional bonds.

According to Reuters, the average yields for Sukuk issuance in Malaysia with the

most liquid Sukuk market are 8 bps higher than conventional counterparts. Market

practitioners provided that Sukuk are in greater demand than conventional bonds that lead to

higher price commanded by former, ceteris paribus. Moreover, as compared to 10-year Sukuk

bonds, 12-year conventional bonds are issued with longer maturity period that lead to high

risk, interest rate increase and increase the yields. In contrast, Sukuk issued by Emirates

Airline was at lower price of 99.331% and lower yield of 4.024% as compared to

conventional bonds price of 99.941% and yield of 4.51%. Thus, it makes the Sukuk a cheaper

source of financing for Emirates for purchasing its 30 new A380 aircrafts. In overall, the

yields between conventional bonds and Sukuk major affected by maturity term of 12 years

and 10 years respectively. It brings different level of risk that result in low or high interest

rates affect the price of bonds and yields.

8
Question 3

For this question only, assume this price differential is due to differences in investor

clienteles. Does this provide an opportunity that hedge fund managers could exploit? If

so, how exactly would they exploit this opportunity? If not, explain the market

impediment or friction that prevents hedge fund managers from acting on these price

differences.

9
Question 4

Why were six different banks involved in this issuance? For simplicity, assume that the

banks equally split the issuance. Should the banks’ fees for their services differ between

the sukuk bond and the straight bond? If so, by how much and in which direction?

10
Question 5

The sukuk bond issued by EA is of the “wakala” variety (comparable to principle-agent

model), even though the largest block of sukuk bonds falls into the “ijara” category

(sale and lease back). Why did the company choose this structure? Is it right structure?

Why or why not?

Now, issuing sukuk bond is becoming the best way in Islamic financial market and it

also one of the attractive instrument to investor in term of competitive investment. The

company issued sukuk bond of the ‘’wakala’’ variety even though the largest block of sukuk

bonds fall into the ‘’ijara’’ category because it allowed the islamic and conventional investor

to access it significant liquidity pools without compromising risk return objective and it also

incurred the lower of financing cost is one of the reason why company issuing this sukuk

bond.

Besides, the sukuk bond issued by EA which is ‘’wakala’’ is the right structure. The

interest under this structure is prohibited under Islamic law and it also useful and important

for EA in term of underlying asset while sukuk entitled to proceed the performance of the

underlying asset.

This is because the previously EA issued the bond to raise the debt finance while the

bondholder were received the interest at the end of the contract before dividend and principal

but by using ‘’wakala’ it will received the profit return but it must be agreed by parties and

outset. By using this,if the company have any excess profit, it will kept as incentive fees. It

also comprise a broad range with the Shari’a compliant assets and the criteria of assets must

be approved by relevant Sharia board.

11
Question 6

How should EA finance its next batch of planes? What about the batch after that?

Recommend a financing roadmap for EA for its existing orders of A380 planes. Make

sure to consider the maturity choice of the firm as well.

Based on the case given, Emirate Airline should finance its next batch of planes by

repeating the sukuk issue. It is because when Emirate Airline keep repeating that sukuk issue

therefore the sukuk holder which is Emirate Airline itself will entitled to proceed the

performance of the underlying asset or business activity and also have a right to profit

resulting from their activity. Besides that, in our opinion Emirate Airline should repeating

this sukuk issue because before this they had been already doing this and as a result their fund

was raised in order to pay for its existing aircraft order.

According to the HSBC & NASDAQ DUBAI CORPORATE US DOLLAR SUKUK

INDEX (2013), average yield on global corporate sukuk have risen 46 basis points to 4.62

percent since the Fed said June 19 it might taper its asset-purchase programmes as early as

this year and the yield on Emirate $1bn sukuk which carries a 3.875 percent profit rate

increase 0.31 of percentage point in the period to 5 percent in Dubai . So, if Emirate Airline

continue repeating this sukuk issue therefore it will be easier for them to finance the next

batch of planes compared to try any different ways.

The another factor why Emirate Airlines should continue repeating this sukuk issue

because of their financing cost is lower compared to other. However, the best

recommendation that can be use to financing roadmap to Emirate Airline for their existing

order of A380 planes which is Emirate Airline itself should keep repeating the sukuk issue by

issuing that sukuk bond or also known as Islamic bond that consisted of “ijara (sale and lease

back concept)” or “murabaha (cost-plus financing)”.

12
 Emirate Airlines (EA) can proceed to continued issued sukuk bond as their announced

plan to issue US$1 billion of Islamic Bonds (Sukuk) on 11 March 2013 with maturity date of

10 years and also using similar rate to finance their next batch of planes. Here we can

conclude that, continue repeating sukuk issue is consider the best option that Emirate Airline

can take to finance its next batch of their planes itself.

13
References

1. “Five Important Differences Between Sukuk and Traditional Bonds.” Sukuk | Home

of the Global Sukuk Industry,

www.sukuk.com/education/important-differences-sukuk-traditional-bonds-2207/​.

2. “How Sukuk (Islamic Bonds) Differ from Conventional Bonds.” Dummies,

www.dummies.com/personal-finance/islamic-finance/how-sukuk-islamic-bonds-diffe

r-from-conventional-bonds/​.

3. Pettinger, Tejvan. “Factors That Determine Bond Yields.” Economics Help,

www.economicshelp.org/blog/5354/economics/factors-that-determine-bond-yields/​.

4. HSBC & NASDAQ DUBAI CORPORATE US DOLLAR SUKUK INDEX (2013),

“Emirates Airlines considers $4.5bn sukuk to pay for 21 aircraft”, Article of NUAE.

https://www.thenational.ae/uae/emirates-airline-considers-4-5bn-sukuk-to-pay-for-21-

aircraft-1.286101

14