The Hong Kong government sold its inaugural $1 billion five-year sukuk on Wednesday, offering issuers an alternative funding source and investors an opportunity to put cash to work in a fast-growing asset class.
Hong Kong Sukuk 2014 — a special purpose vehicle fully owned by the government and established for issuing sharia-compliant securities in international markets — sold the Islamic bond, which obtained the tightest pricing ever seen from any Asia ex-Japan borrower.
“Hong Kong has created a new sukuk history,” said a source close to the deal. “Our biggest fear was that the sukuk product will only be attracted by corporates and countries from the Muslim world. What Hong Kong has shown is that it’s another financial product as long as it’s well-structured and well-distributed.”
The AAA-rated sukuk priced at 23bp above Treasuries, which is 7bp tighter than its initial price guidance of 30bp, according to a term sheet seen by FinanceAsia. The sharia-compliant note has a profit rate of 2.005%.
Although sources note that there were no clear apples-to-apples comparisons for Hong Kong’s 144A sukuk, the Republic of Korea and Singaporean investment company Temasek’s outstanding notes were used as close comparables. Their conventional offerings were trading at a G-spread of 48bp and 47bp respectively, indicating that Hong Kong’s Islamic bond priced half of those levels.
Additionally, Islamic Development Bank’s existing sukuk was also used as a comparable, and was trading at G-spread of 25bp prior to the announcement of Hong Kong’s Islamic bond, sources said.
In secondary markets, the sovereign’s sukuk continues to attract investors, tightening by 1bp to 2bp to trade at around 21bp above Treasuries, according to Bloomberg data.
Hong Kong's debut Islamic bond issue brings 2014’s sukuk volume to $21.8 billion globally, up 9.5% year-to-date, according to data from Thomson Reuters. The deal is the fourth-largest Islamic bond this year.
Investor-friendly structure
Given that Hong Kong has promoted the sukuk quite extensively, having executed a global roadshow on September 1, investors were able to familiarise themselves with the structure, commonly known in the Islamic world as the ijarah structure.
Ijarah is an operating lease whereby the bank will buy and lease equipment or property by the customer for an agreed rental fee. The agreement does not include a promise that the leased asset at the end of the lease term will be transferred to the lessee.
In the case of the Hong Kong government, the proceeds from the sukuk certificates will be used by the issuer to purchase certain properties currently owned by the government. Subsequent to the purchase, the borrower will enter into a lease agreement with the government.
Based on the terms of the agreement, the government will periodically pay an amount sufficient to fund distributions payable by the issuer to investors in the sukuk. At the end of the Islamic bond’s term, the government will purchase the lease assets at the exercise price, thus providing the principal amount payable by the issuer to certificate holders.
If the dissolution is triggered by a total loss event and the insurance proceeds are not sufficient to cover the amount payable by the issuer, the government will pay an amount equal to the shortfall.
“The ijarah structure is easy to explain and many investors are familiar with it,” said a source close to the deal. “Hong Kong wanted the least amount of resistance and wanted to market the story of Hong Kong and the role of Hong Kong in developing Islamic finance, rather than spending huge amount of time explaining the structure.”
Investor breakdown
The Hong Kong government’s sukuk received a total order book of $4.7 billion from more than 120 accounts, according to a source. Asian investors subscribed to 47% of the paper, followed by Middle Eastern investors with 36%, the US 11% and Europe 6%.
Financial institutions bought 55% of the notes, followed by public sector 30%, fund managers 11%, insurers 3% and private banks 1%.
Hong Kong’s proposed issuance comes in the wake of a law passed in March 2014 that allowed the government to issue sukuk under its existing Government Bond Programme.
Earlier, Hong Kong also amended its tax framework in July 2013 for common types of sukuk to facilitate sales of corporate Islamic debt. The tax law amendments removed additional profits tax and stamp duty charges incurred in issuing sukuk compared with conventional bonds.
Moody’s estimates that total sovereign sukuk outstanding account for more than 36% of the $296 billion of outstanding Islamic bonds as of July 2014. For sovereign sukuk, much of the growth occurred during the past three years, as annual issuance rose sharply from less than $15 billion in 2010 to $33 billion and $23 billion in 2012 and 2013, respectively.
HSBC and Standard Chartered were the joint global coordinators and bookrunners of Hong Kong’s Islamic bond. Other bookrunners include CIMB and National Bank of Abu Dhabi.
