Sukuk: The epitome of ingenuity

Within the realm of Islamic finance, sukuk remains one of the most developed and more successful products that has earned the view by specialists as a vibrant and permanent funding source for borrowers from both the conventional and Islamic disciplines.

As Bank Negara’s governor, Tan Sri Dato’ Sri Dr Zeti Ahktar Aziz, stated in the welcoming address at this week’s Global Islamic Finance Forum in Kuala Lumpur, “the sukuk epitomises the very ingenuity in Islamic finance”.

“On the supply side it has drawn the participation from corporations, sovereigns and multilateral agencies. On the demand side, it has now become part of mainstream asset allocation strategies for investors seeking greater risk diversification,” he stated.

And the sukuk has achieved this with the greatest success in Malaysia, where it is viewed on par with conventional sources of funding.

Rafe Haneef, managing director of global markets at HSBC Amanah, pointed out during a panel discussion at yesterday’s GIFF that we’re experiencing a basic supply and demand scenario that is being driven by the more sophisticated investor pool following the sukuk.

“In Malaysia the secondary market trading is much more advanced because there are dedicated Islamic investors whose mandates are to invest in Islamic structures hence developing the need for Islamic papers,” said Syed Alwi Mohd Sultan of Standard Chartered Saadiq at a later discussion on the growth of the Islamic capital markets.

However, the same cannot be said for the frontier markets such as the UK, Russia, Australia or even the Gulf countries, which are all still very much in their infancy. As a result borrowers from these markets tend to be issuers of illiquid securities in markets that lack the depth to be viewed as a viable alternative for funding.

“To generate the growth needed the market has to be regulated,” said Nicholas Edmondes, partner at the law firm Trowers & Hamlins.

“If regulators [from frontier markets] were prepared to take a much more open and there was a firm level of regulatory support, then we would see much more depth in the market and liquid trading of the bonds,” added Edmondes.

But given the recent crisis in the Gulf, this is all easier said than done. Islamic finance structures had copped a lot of the criticisms linked to the property meltdown and since then investors have not been able to look at the sukuk with unequivocal certainty.

As such, outside of the bustling markets of Malaysia, it has been like paddling against the current for borrowers and advocates of Islamic finance. Sukuk notes are still being issued with a hefty premium relative to conventional bonds in order for borrowers to counter the perceived risks held by weary investors.

“The market is penalising sukuk purely out of a lack of awareness,” said Haneef.

And he was not alone in his view. Sultan also held the same opinion and provided a solution.

According to Sultan, a way of solving Shar’iah-associated risks is to encourage more AAA-rated corporations or sovereigns to come to market from frontier countries in order to stimulate trading and bring confidence back to investors.

In line with these views, Mohd Effendi Abdullah, head of Islamic markets at AmInvestment Bank, agreed that it was “important to establish the credit quality of the issuers” before delving into structure and price.

Nadim Khan, partner at Herbert Smith, suggested that regulators should look to defining a “situation where it is clear to investors and potential investors the implications of how the Shar’iah situation will play out in a dispute scenario”.

In Khan’s view, this would help drive the development of the sukuk markets in the frontier countries and, hence, further progress Islamic finance into a more global market and, quite possibly, one of the more robust alternatives to conventional financing.

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