AFTAB HASANManaging Director & CEO

Maritime Management Company (MMC)Dubai, U.A.E.

18th – 19th April 2010

‘Islamic Finance -  An emerging mode for Shipping Industry in current Economic

Scenario’

Presentation Outline

Introduction Islamic Finance Concepts Progress of Islamic Banking Islamic Ship Finance Market Islamic banks and financing opportunities Recent Deals Islamic Ship Finance Structures Brief Discussion on Sukuk Case Studies

Introduction

The current credit crisis has severely limited the appetite of conventional banks for pre-delivery financing of vessels under construction. This has resulted in a number of ship owners having to cancel or delay orders. The overall fall in freight rates and a general lack of liquidity means that conventional banks are not providing the finance required by ship-owners to upgrade or expand their fleets.

The credit crisis and shipbuilding

This scarcity of finance has led to The Chinese state owned Export-Import Bank of China (China EximBank) to take steps to fill the gap for Chinese shipbuilders (the Chinese are currently second for overall production behind South Korea). China EximBank are providing financing to Chinese shipyards and to the shipowners who are entering into shipbuilding contracts with them. For example, the New York-listed Overseas Shipholding Group has borrowed $389m to fund the construction of five tankers in a Chinese shipyard. This is China EximBank’s first deal with a US company. China EximBank is also providing loans of RMB 160 billion to China State Shipbuilding Corp (CSSC) and China Shipbuilding Industry Corp (CSIC), the two largest shipbuilding enterprises in China.Gao Zefeng, a senior credit manager with China EximBank, was quoted by the 21st Century Business Herald as saying “The (world’s) shipbuilding industry may face a financial gap of $300 billion in the next four years, with Chinese ship builders awaiting $60 billion to tide over the plight”.

Islamic Finance Concepts

• What Is Islamic Finance ?• The guiding principles for Islamically driven societies is a collective set of

rules and laws referred to as Shariah. Shariah Laws apply to all aspects of the Muslim's life, finance is no exception

• Prohibition of Riba “interest” interest is prohibited because in Islam all incomes must be determined by the supply of work effort associated by the factors of production. If money is lent for interest then capital is augmented without effort.

• Profit-Loss sharing Islam encourages Muslims to invest their money and become partners in order to share profits and risks of the business. However, due to commercial considerations, most of Islamic

• Banking products are structured so as to mirror the conventional risk and return profile

• Ethical Investing prohibits investment in sectors as gambling, alcohol, tobacco, arms industry, and pornography

Concept of Riba & Gharar

• Is it just “playing with words?” IMPORTANT! Riba is interest on money only!! Riba does not preclude a rate of return on investment. Islamic finance is sometimes said to be asset-based instead of

currency based. I.e., an investment is structured on ownership / exchange of assets,

money is just the payment mechanism.An Example is a home mortgage:

Western: Bank gives you money. You buy the house. You pay interest on the money.

Islamic: a musharakah arrangement. You and the bank buy the house together in partnership. You make payments that are partly rent and partly buyout of the bank.

Islamic: a murabaha arrangement. The bank buys the house and sells it to you on a deferred payment schedule.

Concept of Riba & Gharar

• The unacceptability of riba is not just because money has no intrinsic value. Rather, it is intended to avoid injustice and civil discord caused by one party (the lender) becoming unfairly enriched at the expense of another party (the borrower).

• Gharar Defined as “Preventable ambiguity or uncertainty.”Western derivatives not permitted.Subject of a contract must exist, must be specifiable and

measureable.Extends to the fairness and validity of a contract.Similar to our consumer protection laws.

Progress of Islamic Banking

Modern Islamic banking, as we know today, has evolved over the past four decades. From modest beginning, the overall industry has shown tremendous growth particularly since the late 1990s.

The three largest Islamic financial institutions are: Al Rajhi Bank in Saudi Arabia, Kuwait Finance House and Dubai Islamic Bank, which was also the first modern commercial Islamic bank formed in 1975.

Product development framework based upon conventional experience, but refined to address the Islamic industry’s specific requirements to comply with Sharia principles

Industry bodies such as Accounting & Auditing Organization for Islamic Financial Institutions (AAOIFI) continue to make commendable efforts to formulate standards pertaining to accounting, auditing & reporting and compilation of Sharia standards.

Sharia scholars and forums such as Organization of the Islamic Conference (OIC) Fiqh Academy have made significant contributions to ensuring the balance between industry advancement and Sharia standards.

The Islamic Finance Market

1.3 billion - Worldwide Muslim population US$ 700 billion + - Estimated Sharia compliant assets. +15% - Annual growth rate of Islamic assets +300 - No. of Islamic Financial Institutions Product innovation - from simple to complex products & structures Support from - Governments & regulators worldwide No of players increasing - New Islamic FIs (such as Noor Islamic Bank & Al

Hilal Bank in UAE and Inma Bank in Saudi Arabia) as well as windows of conventional banks (such as SCB Saadiq and HSBC Amanah)

Islamic Ship Finance Market

• Growth Prospects• Many banks in the Middle East have experience of financing oil & energy

assets; financing forvessels such as crude & LNG carriers represented the next logical step

• Asset backed nature of vessel financing makes it naturally compatible with Sharia principles

• Ship finance offers Islamic banks a means of diversification as this as an asset class has been relatively less tapped.

• From a ship-owner perspective ‘Bareboat Charters’ fare well with Sharia principles

• Expansion in the number of specialists working in banks, law firms and shipping entities capable of dealing with the complexities of Sharia-compliant project / ship finance deals.

Islamic banks and financing

opportunities

It is into this gap that Islamic banks have moved, taking the opportunity to build market share. Islamic finance has been involved historically in the shipping industry since the 1970’s.Numerous shari’ah compliant funds have been established for investment in shipping by Islamic banks such as Kuwait Finance House and, most recently, Qinvest (the investment company of Qatar Islamic Bank). However, such involvement in the shipping industry has traditionally related to the acquisition or refinancing of existing vessels on a shari’ah compliant basis.

Shipbuilding is by its very nature an ideal industry for Islamic banks to finance and has traditional roots dating back to the early establishment of several Gulf Cooperation Council states such as Bahrain and the UAE. One of the principal reasons why Islamic finance has not penetrated the market as significantly as it could have done is the very favourable financing which has been offered by specialist conventional banks. A further factor for the lack of penetration is the shari’ah compliant structure for financing a shipbuilding, the Istisna’a. In an Istisna’a transaction the purchaser of the vessel legally changes from the shipowner with which the shipyard agrees terms to an Islamic bank. When the market was good the shipyard would use such transfer to renegotiate the contract price with the Islamic banks in their favour.

Recent Deals Islamic finance in the GCC is emerging as a credible alternative source of ship finance. In Decmber SFS Group Public Company, a Cyprus-based non-banking financial

institution and Malaysian subsidiaries of the Kuwait-based bank Kuwait Finance House had announced their partnership to set up a Global Shariah Shipping Fund, a private equity fund that aims to raise $150 million (Dh550m).

In November last year, QInvest (Qatar-based investment bank) and Fortis Bank Nederland signed a joint venture agreement and each committed $50m to the QInvest-Fortis Bank Nederland shipping fund, making it the world's first Shariah-compliant ship financing fund.

"A prime example would be the new shipping fund announced by Kuwait Finance House Malaysia," Davide Barzilai, Partner, Norton Rose, the London-based global law firm, told Emirates Business.

He said Islamic finance is going through a process of being more than a minor, niché sector of the wider banking market.

The Islamic finance market is well placed to take advantage of the scarcity of capital and funds such as the Fortis Nederlands/Qinvest junior ship finance fund are examples of future sources of finance over the coming years. However, he said, even though the GCC is the hub of Islamic finance, 2009 saw little interest from regional shipping companies leveraging Islamic finance.

Source : Business 24|7 (06/Jan/2010)

Islamic Ship Finance Structures

Consideration• Islamic Ship Finance can be generally broken down into two structures, each tailored to suit

the requirements of the transaction Structure # 1 : Existing Vessel• Existing vessel financing can be based on the sale & leaseback structure using the concept of

‘Ijara’• Wide acceptability amongst the various Sharia scholars & boards Structure # 2 : Istisna structure for New build Vessels

Structure # 3 : New build Vessels (under construction)• Financing structures for new build vessels mimic traditional Islamic Project Finance

structures• Structured as an Istisna (Arabic word literally meaning ‘procurement’ covering pre-

deliveryconstruction phase) and forward Ijara concept (for post-delivery period)

Obligor

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(Seller) (Lessee) (Service Agent)

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(3)Investment agency agreement

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Purchase and Lease of Assets 1. SPV formed for the purpose of arranging the facility. The SPV is to be administered by a Facility Agent.

2. SPV enters into a Purchase Agreement with the Obligor for purchase of existing and pre identified vessel (or vessels) (“Asset Pool”).

3. Participants and Facility Agent enter into an Investment Agency Agreement through which the Participants fund the Facility Agent to purchase the Asset Pool.

4. Once purchased, the SPV (acting through the Facility Agent) will enter into an Ijara (lease) Agreement to lease the Asset Pool to the Obligor for a period equal to the facility tenor against payment of rental consideration .

5. SPV enters into a Servicing Agency Agreement with the Obligor through which it appoints the Obligor as its Agent responsible for Major Maintenance & Structural Repair and the procurement of Insurance on the Asset Pool.

6. The Obligor also provides a Purchase Undertaking wherein it undertakes to purchase the Asset Pool from the SPV either at the end of the lease term or on the occurrence of an event of default. Structure # 1: Ijara Structure (for Existing Vessel)

Obligor (Lessee)

SPV Participants

Periodic Payments

Obligor (Lessee)

SPV

Participants

1 2

1 2

At Maturity

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Periodic Payments

1. Obligor makes periodic lease rental payments (“Rentals”) to the SPV during the lease term.Rentals can be fixed or floating rate(benchmarked to an index such as LIBOR).

2. Facility Agent distributes the Rentals to the Participant.

Amortizing Structure In case of an amortizing structure, the periodic

rentals shall comprise of the profitpayments and principal redemptions as per an agreed schedule.

Bullet Redemption In case of bullet repayment, the periodic rentals

shall consists of only profit payments except the last rental which will also include the Facility Amount.

At Maturity At maturity, SPV transfers back the Asset Pool to

the Obligor at an agreed price or a nominal amount. Hence ownership of the Asset Pool reverts back to the Obligor

Structure # 1: Ijara Structure (for Existing Vessel)

#2 Istisna’a structures for shipbuilding Istisna’a is a cash sales contract made against promised future delivery of

goods. Istisna’a may be derived from salam (a contract for the purchase of a commodity for deferred delivery in exchange for immediate payment according to specified conditions) but (1) under salam, deliverables are commodity like, (2) under Istisna’a, deliverables are manufactured and (3) under Istisna’a, unlike salam, interim or progress payments can be made.

A shipbuilding contract is an ideal agreement to be financed by means of an Istisna’a as it has all of the elements required to be shari’ah compliant. A shipbuilding contract can provide advantages over certain other types of contracts for manufactured property from the Islamic bank’s perspective.

For example, the asset manufactured (i.e. the ship) has a large secondary market in the event that the shipowner defaults under its obligations under the Istisna’a contract and the bank is required to take delivery of the vessel. In addition,the performance of the shipbuilder will typically be backed by refund guarantees from a financial institution whereby the instalments which have been paid for construction of the vessel will be refunded to the Islamic bank should the shipyard default in meeting its obligations. Finally, the shipbuilding industry also has the advantage of being able to provide the Islamic banks with the potential of additional third party export credit security in the form of insurance or a guarantee from institutions like China EximBank.

#2 Istisna’a structures for shipbuilding The shipowner will first reach an agreement with the shipyard on all of the

terms and conditions of the shipbuilding contract so that it is in final agreed form. An Islamic bank will then finance the construction of the vessel through the intermediary of the Istisna’a. The Islamic bank will enter into the pre-agreed shipbuilding contract on behalf of the shipowner and an Istisna’a agreement with the shipowner. The Istisna’a agreement will mirror the terms and conditions of the shipbuilding contract exactly but will also contain the additional terms and conditions of the credit relationship between the Islamic bank and the shipowner and the elements required for shari’ah compliance.

The shipbuilding contract will clearly state the specifications for the vessel, including the time frame for construction, clear milestones to be completed such as keel laying and launching together with a specific payment schedule for the completion of each milestone. All of these elements provide certainty as between the Islamic bank and the shipbuilder and the Islamic bank and the shipowner so that the Istisna’a will be fully shari’ah compliant in avoiding gharar (avoidable uncertainty). Any deductions to the contract price for late delivery which are included in the shipbuilding contract are permissible under shari’ah principles as the parties have an agreed delivery date and agreed deductions if it is not met (i.e. such deductions are not deemed a penalty which Islamic Shari’ah prohibits).

#2 Istisna’a structures for shipbuilding

On entry into the Istisna’a agreement with the Islamic bank the shipowner will pay a deposit (arboun) which represents its equity in the vessel. The deposit is then paid by the Islamic bank to the shipyard under the shipbuilding contract as the first instalment due and payable there under. As the vessel is constructed at the shipyard and additional stage payments are required these will be paid for by the Islamic bank. Upon completion of the vessel and delivery under the shipbuilding contract to the Islamic bank, the vessel will then be sold to the shipowner for a pre-agreed price under the Istisna’a agreement. This price will be higher than that paid by the Islamic bank so that it makes a profit on the financing. Alternatively, the Islamic bank may agree to refinance the transaction for the shipowner by taking delivery of the vessel itself and then leasing the vessel to the shipowner under an Ijarawa- iqtina’a (lease with an option to purchase) structure.

An Islamic bank will make its credit assessment on an Istisna’a agreement in much the same way as a conventional bank would in line with tenor, credit worthiness of the shipowner, relationship with the shipowner, quality of the shipyard and its export credit or refund guarantee backing, the type of vessel, strength of security and so on. The shipowner has an obligation to the Islamic bank under the Istisna’a agreement to purchase the vessel on completion and the bank can take a normal security package for this obligation including mortgages over collateral vessels, account charges, parent guarantees and so on.

Brief Discussion on Sukuk• The concept of Sukuk is based on the premise that any Islamic financing contract representing

ownership ina tangible asset can be bought or sold and hence can be securitized in the form of Tradable Securities.

• A Sukuk Represents:

-An undivided proportionate beneficial ownership interest in an asset or portfolio.

-The corresponding right to the Islamically acceptable income streams generated by the

asset/portfolio.• Sukuk Structure:

Sukuk can be structured in a number of ways, depending on the underlying assets and the business purpose. While most of the Sukuk issued to date have utilized Ijara structures based on real estate as the underlying asset, the Sukuks issued by Islamic banks and Finance Companies have used financial contracts as the underlying.

• In commercial terms, it works similar to a conventional bond in most characteristics such as trading, listing, rating etc. however, structured in a Sharia-compliant manner.

• Sukuk provide access to a vast and growing Islamic liquidity pool, in addition to the conventional debt capital market investor base.

• Structure is well established with growing number of sovereign and corporate issuances in the international market.

• Conventional investors in Europe and Far East are comfortable with Sukuk - as they consider it a par with conventional bond issuance

Case Studies

CASES

Brunei Gas Carriers US$ 505,000,000 . july 2008 Syndicated Islamic Ship Finance Facility Joint Primary Underwriter & Bookrunner,Joint Mandated Lead Arranger,

FacilityAgent & Islamic Finance Coordinator---Sadiq standard Chartered

GMMOS Group Inc. US$ 46,000,000 Syndicated Islamic Ship Finance Facility Joint Mandated Lead Arranger,Facility Agent & Account Bank --Sadiq

standard Chartered, August 2008

Ship Finance Facility for Brunei Gas Carriers (“BGC”)

Brunei Gas Carriers is an LNG vessel owner jointly owned by the Brunei Government, Shell and Mitsubishi, with long term charter arrangements with Brunei LNG (also jointly owned by the Brunei Government, Shell and Mitsubishi). Brunei LNG is a well-established, reputable LNG supplier with a 30-plus year track record of continuous LNG deliveries to large gas utility companies in Japan and Korea.

Brunei is the fourth largest crude oil and gas producer in the Asia Pacific region and the ninth largest LNG producer globally. It is also the third richest country in the Asia Pacific region on a GDP per capita basis. Being a predominantly Muslim country, the Brunei Government was keen to have the facility structured in accordance with Islamic financing principles, i.e. to be Sharia compliant.

Ship Finance Facility for Brunei Gas Carriers (“BGC”) Solution A best-in-class Sharia compliant solution under which the financing for the newbuild

LNG vessels was structured as an Istisna / Ijara (pre-delivery construction facility and forward lease). In this instance the challenge was a pre-delivery structural solution, which was overlaid on a robust security and cash flow structure that reflected the project-driven nature of the vessel financing.

Salient features of the structure were; Based on an Istisna structure with an underlying forward lease agreement. Islamic financiers appointed an SPV as Mudareb to carry out investment related

activities including the procurement of vessels Pursuant to an Istisna Agreement, SPV appoints another BGC SPV (the “Obligor”) to

procure the vessels Upon delivery, SPV will lease the vessels to the Obligor in consideration of rental payments

At the end of the lease period, the Obligor will purchase the vessels from SPV at a nominal price

Receivables in consideration of providing various services by BGC were credited into a collection account secured in favor of the financiers.

The vessels will be mortgaged to the financiers during the term of the facility.

Ship Finance Facility for GMMOS Group Inc. (“GMMOS”)

GMMOS Group Inc. is comprised of four well-established business divisions, which include Grandweld, the leading shipyard in the Gulf focusing on the Offshore Supply Vessel (OSV) segment; GMMOS Fabrication, an oil and gas specialized steel fabricator of pressure vessels and skid modules; Stanford Marine, a prominent OSV charter operator in the Gulf; and Gallagher, one of the largest mobile fleet operators in the UAE.

GMMOS has witnessed strong growth over the past few years across all its business divisions. This trend is expected to continue going forward, driven by sustained high oil prices, increased oil and gas-related spending, growth in the regional construction sector, and the overall economic growth in the region.

Ship Finance Facility for GMMOS Group Inc. (“GMMOS”) Solution The facility arranged by Standard Chartered Bank and Noor Islamic Bank is

aimed to finance Stanford Marine’s fleet renewal and expansion program. The facility provides a single facility financing to fund Stanford Marine’s refinancing needs as well as new-build and secondhand purchase plans. It is essentially three distinct facilities that are amalgamated into a single structure.

In addition, the facility is structured to comply with Sharia principles. Given that the facility is intended to fund a diverse portfolio of vessels, some of which are operating and others under construction, the Sharia structuring brought about a unique set of challenges, which were overcome through innovative solutions.

This financing was constructed for GMMOS to assist in the refinancing, construction and purchase of offshore service vessels to fund its acquisition programme. This was the first time that GMMOS had utilized an Islamic structure and they were keen to access this alternative form of liquidity, which is very prevalent in the Middle East. They are more likely to consider using the Islamic structure in the future now that they are comfortable with it.

Shipbuilding: A shari’ah compliant future?

We have seen an increasing number of Istisna’a structures within the shipbuilding industry and anticipate that this trend will continue for the foreseeable future even after conventional ship financing banks return to the market with greater liquidity. The appetite of the Islamic banks which have moved into the gap in this market is strong as the shipbuilding industry provides several advantages to other areas that the banks are involved in for construction financing. Likewise, the shipyards, once they are comfortable with the structure and not having a direct contract with the shipowner see the great advantages to them in having a bank as counterparty instead of being solely reliant upon the shipowners credit risk.

The shipowners also benefit from the greater choice of financiers willing to provide financing and in certain jurisdictions the Istisna’a structure can avoid issues which the shipowner would otherwise encounter with transfer or withholding tax. It is also encouraging from the perspective of Islamic banks returning more to the traditional roots of shari’ah compliance by entering into more compliant documentation like Istisna’a structures in industries, like shipping, which were historically financed in such ways in the GCC