The rise of sukuk

After a multi-year, crisis-induced lull, the sukuk market is back on the rise. But is it a realistic alternative to traditional bonds?
Islamic finance is emerging as an alternative to conventional funding, according to specialists

This year has seen a dramatic increase in sukuk issuance as a proportion of debt issuance.

Such structures are appealing for their simplicity and capture a public and regulatory mood that has swung decisively away from the complexity that characterised pre-crisis structures, even setting aside their ethical and religious dimension.

Sukuk have so far accounted for 65% of all issuance in the Middle East and North Africa in 2012, up from 21% last year and only 17% the year before, said Mohammed Al Tuwaijiri head of global banking and markets Middle East, North Africa (Mena) at HSBC. A key driver of this growth has been the number of conventional companies opting to issue sukuk, he said.

This puts the trajectory of sukuk growth firmly back on its pre-crisis course, after a faltering few years. Yet it is important to take these figures with a pinch of salt, said Douglas Johnson, CEO at Codexa Capital, a boutique investment bank focused on the Islamic crescent.

“The sukuk market is certainly growing dramatically but it remains a thin market, with total, global issuance this year limited compared to muni bond issuance in the US.” In such a constrained market, a single large issue — such as Qatar’s $4 billion, two-tranche deal in July can skew the numbers significantly, he said.

This illiquidity is a natural function of the youth of the market. “People say this market has been around for 40 years, and maybe that is true but in practice Islamic finance was barely a regional, let alone global, phenomenon in 1995,” said Johnson. “The catalyst for the growth of this market was the oil price surge in the 90s, and to some extent the repatriation of Arab money from the West following 9/11.”

The asset class needs to evolve over several business cycles before it can be a material alternative to the traditional bond market for sovereigns, let alone corporates, he added.

Investor concerns have arisen over the status of sukuk in a restructuring, but here, too, recent developments have helped alleviate concerns. A first wave of restructurings in 2010 culminated mostly with tenor extensions, and no haircuts. This year notable sukuk transactions like Global Investment House have been subjected to haircuts, providing clarity. It is no coincidence issuance levels have picked up since this uncertainty has been resolved.

There are a number of developmental watersheds that the market must reach before it can become a truly mainstream financing option — within the Gulf Cooperation Council (GCC) and beyond.

The first is for more issuers to come forward with jumbo, benchmark issues.

For now, the issuers that could do most to shower liquidity onto the market — the Gulf states — will not do so because they enjoy capital surpluses, said Johnson.

“GCC sovereigns need to focus on the development of the sukuk market as a policy imperative,” he said. The absence of benchmark issues makes it harder for other issuers, he explained, though the Jeddah Airport financing, effectively — though not technically — sponsored by Saudi Arabia, provided one of the closest things the market has seen to that benchmark, he said. “North African states, for example, would love to access this market, but (legal issues aside in some places) they can’t price a deal.”

However, with the Jeddah Airport financing, as well as Qatar’s $4 billion deal in July, there are at least signs that issuers understand the need for such issuance. If more come, ultimately the price premium between sukuk and traditional bonds would be reduced.

Standardise and innovate
This will partly be achieved by an increase in standardisation across products, speeding up the issuance process and removing the need for products to be individually approved by Shar’iah scholars. Yet paradoxically, there must be a conducive environment for invention and innovation of sukuk structures, said Badlisyah Abdul Ghani, CEO of CIMB Islamic. Without this, he warned, the sukuk market will eventually stagnate.

Governments could also encourage issuance through incentives for issuers and arrangers. “The most critical thing that any authority must do is to ensure cost efficiency and effectiveness in undertaking and trading sukuk through tax neutrality,” he said.

“The single most important factor that will take the sukuk market to its optimum potential in any jurisdiction would be the emplacement or enactment of an effective and comprehensive legislative, regulatory, legal and Shar’iah governance framework,” added Abdul Ghani. Once those watersheds are crossed the market can reach the next stage of its development, which may be a liquid secondary market.

As these developments occur in the coming months and years, issuers should flock to sukuk, not only for the favourable pricing on offer, but because it potentially reaches a broader pool of investors.

“Put simply, if you issue bonds only conventional accounts can buy them, but if you issue a sukuk conventional and Islamic accounts can both buy it,” said HSBC’s Al Tuwaijiri.

“Issuers are growing ever more comfortable with sukuk structures and it’s likely we’ll see new entrants to the market over the next few years.”

The differential between the price achievable with a sukuk is increasingly marginal, with supply still relatively limited and demand high, making such an issue more appealing. Meanwhile, the cost is declining. “The spread of the economic cost of doing Shar’iah-compliant financing compared to conventional has diminished,” said Al Tuwaijiri. Historically sukuk issuance took longer, and at greater cost, meaning there was little incentive to issue sukuk for non-Islamic companies.

Even socio-political events seem to be working in favour of a greater role for sukuk financing, “The events of the Arab Spring have brought to the fore the need for more government spending on infrastructure products,” said Al Tuwaijiri. “This will require at least some degree of international financing — and the sukuk markets will be key to this.”

There is already evidence of this, with Saudi Aramco Total Refining and Petrochemical, better known as Satorp, contemplating a project finance sukuk. Issuers are looking to fill the vacuum left by European banks that are no longer providing financing for such deals and sukuk could prove a good tool for unlocking that capital. “The spread of the economic cost of doing Shar’iah-compliant financing compared to conventional has diminished” Mohammed Al Tuwaijiri HSBC’s head of global banking and markets for MENA


This story first appeared in the October issue of FinanceAsia magazine

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