The firm has initiated the first use in the Gulf States of a shari’a compliant funding mechanism that has some aspects in common with sukuk, a little known form of finance.

By Susan Kraemer

Why the CSP industry needs to know about these financing vehicles?

Geographically, because of its DNI requirements, CSP is wed to the world’s deserts. And with increasingly progressive climate policy in MENA nations like Morocco, the Islamic world is becoming central to CSP deployment.

Because of very strict moral limits that Islamic law puts on investment, there is a very large pool of potential investors in the region with an equally large pool of under-utilised sovereign capital.

In addition, the ethical investment movement globally could also find shari’a compliant finance attractive, due to its requirements that projects meet ethical standards or serve universally accepted notions of the public good.

So shari’a compliant finance could provide a very large new liquidity pool for infrastructure finance potentially available to develop the CSP pipeline.

Among Gulf nations fostering shari’a compliant sukuk financing, Bahrain has led the way, while Dubai, in the United Arab Emirates, has an announced the goal of becoming the global centre for sukuk among the Gulf States.

In 2014, the Dubai Supreme Energy Council (DSCE) signed an advisory service agreement with the World Bank under which they will collaborate on designing funding strategy for Dubai’s green investment program including green bonds and sukuk.

The UK, with regional ties, has begun to adjust its laws to allow sukuk to compete with conventional bonds.

How sukuk work

Like the tax equity finance familiar in the US, the investor owns a share of the asset, sukuk (the plural form of sakk, or ‘certificate’), which is asset-based financing, but based on Islamic law. Earnings come from the income generated by the asset, for example in the case of a CSP project, through a 25 year power contract with a utility.

Because the income is not from interest, this form of investment is compliant with Islamic law, which does not allow the earning of interest on money loaned.

The investor can expect to receive a portion of the earnings from cash generated once a physical asset is in operation, but also shares any risk if things go wrong.

As in bond financing, principle is paid at maturity, but unlike bond financing which has tax deductible interest earnings, in some jurisdictions, its periodic distributions are not tax deductible. The UK, Singapore and Luxembourg have moved to address this imbalance legislatively.

Unlike equity financing, the owner of sukuk doesn’t own part of the company, and cannot realistically sell off any sukuk if the project fails.

So there are risks.

Sukuk are subject to the same securities laws that apply to any other financing instruments available in each market. Bond markets in London, Luxembourg and Dublin have been the first Western markets to offer sukuk, but now the move is increasingly to the MENA region, which is why this kind of finance could be of interest to the CSP industry with its growing pipeline in the desert region.

Until recently sukuk have been very much an alternative. But interest in the model has been growing, and there are signs that it could become a mainstream financing option, if only because of who is interested in using it.

ACWA Power has not issued sukuk

Despite news stories that ACWA Power has issued sukuk financing, this is not the case.
ACWA Power has created a captive investment fund, Powervest. It is shari’a compliant, because the returns come from owning a share of a physical asset that will be used to provide a service, rather than from interest on money lent.

This is not sukuk, but it is shari’a compliant like sukuk.

Investors in Powervest will have the right - but not the obligation - of co-investing and co-owing new projects the firm develops, but will earn money from generating assets as a co-owner, not as a money lender. Under Islamic law, investors can invest in (and co-own) the assets developed by a company, but cannot lend money to the company itself.

Islam does not condone interest payment. Money must only be used as an exchange mechanism for other goods and services, not the payment of interest and the selling of debt for interest. Conventional bonds are forbidden because they represent a debt, and pay interest.

Wider investment pool, more efficient finance

“Shari’a compliant funding is another source of liquidity - in fact a very big source of liquidity” says ACWA Power CEO Paddy Padmanathan. “Investors who follow the Islamic faith will only invest in a manner consistent with the Islamic teaching and thus there is a fair amount of money out there looking for a home.”

The Powerfund’s investors include the Arab Petroleum Investment Corporation (APICORP), Public Investment Fund (PIF), Saudi Aramco Investment Management Company (SAIMCO), The Arab Investment Company (TAIC) and the Islamic Development Bank (IDB).

“Powervest will be used for equity investment to supplement our own equity capital. What it does do is allow us to use our own capital across more projects,” explains Padmanathan. “This is the first of its kind, in the GCC anyway, as it is a "captive" fund which will only invest in projects that ACWA Power develops.”

It is an efficient financing vehicle.

Unlike typical equity investing which is project by project, Powervest funds will continue to be available for ongoing project development “with terms and conditions broadly agreed one time - and not needing to be negotiated time and time again for each project - for us to bring along with minimum fuss and maximum efficiency.”

Sukuk better suits refinance

While Powervest enables future funding, the opposite holds for sukuk. “Sukuk, like bonds, are suited in the main to refinancing post-construction when the asset is in operation as we can then apply the funds in one lump,” explains Padmanathan.

“Otherwise the problem is that you will raise the money and hold it - incurring a significant carrying cost - and can then only progressively deploy it to pay construction cost as work gets completed. In a PV project where the construction duration is in months rather than years, this is a bit more manageable - although there is still a cost burden.”

“But in the case of CSP with a 30-plus month construction time frame, the carrying cost of that sukuk funding, collected up front and siting in a bank account doing nothing, makes it unaffordable.”

A series of smaller sukuk could be issued to cover incremental construction costs, but even that would introduce funding risk:

“What happens if a subsequent fund raising exercise does not give you the funds and you are left sitting with a half built plant, or what happens if by the time you go for the next round of funding the base interest rate has moved up?”

The need for financing innovation comes as ACWA Power is fast taking leadership in the CSP market, with 550 MW of projects awarded already in 2015, and 1,000 MW planned in the MENA region by year end. It won Noor I, and now Noor II and III, at Ouarzazate, in Morocco. In South Africa, it is developing the 50 MW Bokpoort trough project and the 100 MW Redstone tower project with SolarReserve.

While there are also advantages to sukuk - for refinance; what ACWA Power has designed is a funding vehicle that better enables future development, capturing the huge pool of potential investors seeking shari’a compliant investing, but with none of the limitations of sukuk.