By V L Srinivasan, Qatar Today Magazine
Sukuk are not only an established alternative source of
funding in the Gulf Cooperation Council (GCC) region and
the Asian markets but are also evoking considerable
interest in Europe, Africa and the CIS countries.
The first ever ringgit sukuk issuance was by Malaysia for
$33 million (QR120.12 million) in 1990, and the global
sukuk market crossed the $136 billion (QR495.04 billion)
mark in 2012. In fact the market has experienced a
compound annual growth rate (CAGR) of 27% in the past five
years.
However, the market witnessed a slump in 2013. In terms of
statistics, the Islamic bonds issued globally amounted to
$116 billion (QR422.24 billion) through 782 issues, a 15%
drop compared with 2012, through 728 issues.
The Malaysian sukuk market was particularly hit,
indicating that the sell-off in emerging market currencies
might have been driving the decline, whether or not that
was driven by concerns about the US Federal Reserve’s
decision-making regarding tapering asset
purchases.
What is interesting is that not only the Islamic nations
in the Middle East but even countries like Japan,
Australia, Ireland, France, the US, the UK, Luxembourg,
China, Morocco, Tunisia, South Africa, Nigeria, Senegal
and Kenya have become enamoured of the Sharia-compliant
bonds and want to tap into Islamic markets. All these
countries are looking to tap the sukuk market and are at
various stages of laying down the legal and regulatory
frameworks for Islamic finance.
British Prime Minister David Cameron, addressing the World
Islamic Economic Forum in London in October last year,
said his government would make a sukuk issue in 2014 for
£200 million (around QR1.2 billion), the first non-Muslim
sovereign entity to do so. “When Islamic finance is
growing 50% faster than traditional banking, and when
global Islamic investments are set to grow to £1.3
trillion (QR7.64 trillion) by 2014, we want to make sure a
big proportion of that new investment is made in Britain,”
he said.
In the East, Hong Kong has already passed an ordinance, in
July 2013, to create a “level playing field” for sukuk,
and in the US the Washington-based investment bank
Taylor-DeJongh has established a sukuk practice in order
to leverage the company’s energy and infrastructure
expertise and to develop sukuk finance solutions. The bank
is making an effort to offer Islamic financing in the
form of a security for US railcar operator Continental
Rail.
“The financing of infrastructure through sukuk, an Islamic
financing instrument that resembles asset-backed
securities, is beginning to mature and could contribute to
filling the investment gap that exists in infrastructure
markets, particularly in the US,” Taylor-DeJongh says in a
report entitled “Sukuk: Bridging the Gap”.
QInvest’s Head of Debt Capital Markets Hani Ibrahim says
the decline in sukuk issuances in 2013 was due to a slow
third quarter, which saw a decline in US dollar issuance
on the back of the emerging market fixed-income sell-off
during the same period.
However, the global sukuk market is expected to grow in
2014 as there are a number of new issuers looking at
sukuk, especially following recent reports on the topic
in the UK, Luxembourg and Hong Kong.
“We would expect that even the Qatari market will continue
to mature on the local currency side in the coming 12 to
24 months, given the continued issuance by QCB [Qatar
Central Bank] and the initiatives from the Qatar Exchange
to promote a domestic fixed-income market. On the US
dollar side, the active issuers are likely to be the
Islamic banks, although this will depend on the bank
liquidity position, which is currently very healthy,”
Ibrahim says.
Qatar accounted for a total of QR8.55 billion ($2.35
billion) of issuance between November 2013 and January
2014, with QR4 billion ($1.1 billion) coming from the
Qatar Central Bank and QR4.55 billion ($1.25 billion)
from the debut sukuk from Ooredoo.
When looking at the medium-term US dollar sukuk market,
the sukuk debut by Ooredoo was the only issuance from
Qatar, which accounted for 7% of the global medium-term
US dollar sukuk issued by value.
“The Ooredoo sukuk was a significant milestone for the
sukuk market given the innovative structure that was
applied, and being the first US dollar sukuk issued
globally using the airtime structure,” Ibrahim
says.
Growing sukuk players
Sharing Ibrahim’s views, Franklin Temple-ton Investments’
Chief Investment Officer (Global Sukuk and MENA Fixed
Income) Mohieddine Kronfol asserts that 2013 was a “very
healthy year” in terms of new issuers, new structures and
relative performance.
The sukuk market saw the issuance of instruments that
covered the entire capital structure, from senior paper
with secured features (e.g. Dana Gas sukuk) to deeply
subordinated instruments in both the financial (e.g. Bank
Asya Tier 2 and ADIB Tier 1 sukuk) and non-financial (GEMS
perpetual sukuk) corporate spaces in 2013.
“It would be misleading to judge the health of the sukuk
market by looking at only one metric. Issuance volumes
were impacted by the Malaysian elections early in the year
(2013) and subsequently by the effect of Fed tapering on
primary markets everywhere, especially emerging markets
that bore the brunt of investors’ fears of the unwinding
of large capital flows. Compounded by Ramadan and a slow
summer, the third quarter was very quiet for sukuk, but
picked up robustly in September and carried through to the
end of the year,” Kronfol says.
Explaining the global trends in this market, Barwa Bank
CEO Steve Troop says that sukuk issues that were held back
in 2013, due to volatility in the financial markets,
should come through in 2014. US dollar issuers would also
look to take advantage of low rates ahead of anticipated
upward rate curve movement once current market unrest
settles. “Investment-grade US dollar issuers from the GCC
will take advantage of a 2014 issuance and the market will
see some sub-investment-grade paper come to market,” he
says.
An indication among the latest trends that the global
sukuk market is growing once again is that Malaysia-based
International Islamic Liquidity Management (IILM) has
already issued sukuk for $1.35 billion (QR4.91 billion) in
January and another $490 million (QR1.78 billion)
three-month Islamic bond in the last week of February this
year.
Even Malaysian sovereign wealth fund 1Malaysia Development
Berhad (1MDB) plans to sell $728.49 million (QR2.65
billion) worth of Islamic bonds around now to finance the
relocation of Malaysia’s defence units from land marked
for government development project Bandar
Malaysia.
According to a Zawya Islamic finance report, Malaysia
sold $79 billion (QR287.56 billion) in 2013 compared with
$100 billion (QR364 billion) in 2012. Nevertheless,
Malaysia represents the largest issuance – 68% of the
total amount of sukuk issued in 2013.
In the GCC, Saudi Arabia, the UAE and Qatar accounted for
95% of the total sukuk issuances in the region. Qatar took
sixth place with $2 billion (QR7.28 billion) worth of
issues in 2013, dropping a couple of notches from its
fourth place in 2012 with $5 billion (QR18.2 billion)
issuance.
Steve Troop says project Sukuk have not been active in the
region due to the current regional investor appetite in
terms of shorter tenors, and he doesn’t foresee any
material shift from that in 2014.
However, it is an area that needs to be developed as the
region, and particularly Qatar, pipelines material project
and infrastructure spend. “It would be very interesting
to see a government body support this type of project
Sukuk issuance in the region on a regular basis in order
to stimulate market activity and ultimately a supporting
liquidity pool,” Troop adds.
The future is optimistic
KPMG’s Partner (Audit and Advisory Services) in Bahrain
Mahesh Balasubramanian is optimistic that although there
was a decrease last year, sukuk issuances are in the
pipeline in 2014. “The primary reasons for the drop were
not attractive pricing but borrowers worrying about the
quantitative easing (QE) effect of the US Federal
Reserve,” he says.
Balasubramanian expects Qatar to have more sukuk issues to
support the large-scale infrastructure projects for the
FIFA World Cup in 2022. These activities and sovereign
spending are expected to drive the need for sukuk
issues.
“In the recent past, we have seen sukuk issued by Qatar
Islamic Bank (QIB), short-term treasury sukuk by QCB, and
Ooredoo Tamweel. This is expected to grow with the demand
for funding, and large corporates are also expected to
participate in this trend,” says Balasubramanian.
There is a lurking fear that some of the sukuk issuances
maturing this year may impact the economies of the
countries in the region. However, this would provide some
refinancing opportunities that could lead to more sukuk
issues. On the other hand, if no financing is required,
then investors will most probably look for reinvestment
opportunities, increasing the liquidity in the
market.
“As per IMF estimation, about $64 billion (QR232.96
billion) of debt held by Dubai and government-related
entities (GREs) will be due between 2014 and 2016. This is
a result of the restructuring carried out during the
financial crisis in 2008-09. Some of these sukuk requiring
restructuring, and the additional funding requirements
to support large-scale infrastructure development
projects, may have an impact on the economies as well as
be a driving force for the development activities,”
Balasubramanian says.
A different perspective
Thomson Reuters Islamic Finance Gateway Community Leader
Blake Goud says there will be significantly larger sukuk
issuance by Qatar in 2014, which will be beneficial for
corporate issuers to use as a benchmark for new issues,
but that does not necessarily mean that increased volume
will come in 2014 because sukuk might be more expensive
than conventional bond issuance due to secondary market
illiquidity and additional costs.
Even Kronfol expects Qatar, which is behind the UAE in
terms of the size and diversity of its sukuk market, to
remain active in the domestic market (as the government
has announced that it will not tap the global debt market
in 2014) to support increasing liquidity at Qatar’s
Islamic banks, who themselves might issue sukuks. “Other
corporates might also opportunistically tap the sukuk
market for funding or refinancing needs,” Kronfol
says.
With regard to the prospects of sukuk in the GCC region,
Kronfol feels the conditions supporting the market remain
largely unaltered and constructive this year. “The region
should continue to benefit from increasing market
liquidity in the region and the probability that benchmark
interest rates will remain low for some time to come,
even as quantitative easing in the US fades. The GCC
continues to benefit from strong government finances,
abundant currency reserves and low correlation of GCC
sukuk to assets in other regions, and continued economic
growth,” Kronfol adds.
GCC focus
What makes sukuk occupy centre stage in the GCC region is
the financing requirement for various ongoing
infrastructure projects in countries like Qatar, the UAE
and Saudi Arabia.
Quoting an OECD report, the Malaysia International Islamic
Finance Centre says a whopping $71 trillion (QR258.44
trillion) will be needed for the infrastructure projects
to be executed around the world by 2030, and it is
estimated that the demand for sukuk will exceed $600
billion (QR2.18 trillion) by 2015, compared with a supply
of only $500 billion (QR1.82 trillion) at
present.
The market is witnessing a unique trend today where there
is a growing demand for sukuk issuances while the supply
is low. It is here that sukuk will play a key role in
bridging the $100 billion (QR364 billion) gap with many
countries trying to take advantage of the
situation.
These investments are required for investments in road,
rail, telecommunication, electricity and water
infrastructure, without taking into account seaports,
airports and social infrastructure. The amount represents
approximately 2.5% of global GDP to 2030.
The GCC, which is one of the key markets for sukuk
issuances, is expected to witness substantial
infrastructure investments during the decade 2010-2020,
with market estimates ranging from $535 billion (QR1.94
trillion) to about $2 trillion (QR7.28 trillion).
Saudi Arabia is expected to invest $80 billion (QR291.2
billion); Qatar has rolled out plans to spend $250 billion
(QR910 billion); Dubai, which will be hosting the
prestigious World Expo in 2020, will spend $8.1 billion
(QR29.48 billion); Abu Dhabi has committed a capital
expenditure of $90 billion (QR327.6 billion) till 2017;
and Oman will invest over $50 billion (QR182 billion) to
develop the transport, oil and gas and manufacturing and
industrial sectors.
So the GCC certainly seems primed for more sukuk issuance
if for no other reason than that the sukuk markets are
characterised by a significant excess in demand over
supply. The gap between supply and demand in sukuk
issuance is estimated at $229 billion (QR833.56 billion)
for 2014, up from $210 billion (QR764.4 billion) in 2013,
according to the Thomson Reuters Zawya Sukuk Perceptions
and Forecast Study 2014.
QInvest’s Ibrahim says: “Given the infrastructure plans
in countries like the UAE and Saudi Arabia, it is expected
that the GREs, banks and corporates of these countries
will issue sukuk in the near future. Sukuk is also a
natural choice for many issuers in the GCC as it takes
advantage of the abundant Islamic liquidity in the
market. The gap between demand and supply of sukuk is
expected to remain in the short term, and GCC issuers are
well positioned to capitalise on this dynamic.”
Balasubramanian too foresees a greater role being played
by the GCC in the development of the sukuk market in view
of the implementation of various infrastructure projects
in the region.
“With so many infrastructure projects under way, the
potential for sukuk funding can be expected to be
significant. The infrastructure financing gap is
estimated to be over $1.5 trillion (QR5.46 trillion) until
2022. The successful placement of a number of sukuk
structured for such projects in the past is a good
indicator for the marketability of the instruments, the
investor appetite, the confidence in sukuk and their
ability to successfully raise funds from a wider investor
base.
“Based on current growth forecasts and increasing
liquidity in Islamic retail banks, Islamic financial
institutions will require at least $400 billion (QR1.45
trillion) of short-term, liquid securities for liquidity
and capital management by 2015. There are various
estimations and indications that the global sukuk demand
could be in excess of $600 billion (QR2.18 trillion) by
2015,” Balasubramanian adds.
With more infrastructure projects being undertaken
in Qatar and other countries in the GCC region, more
project-financing sukuk are likely to be issued in the
next couple of years.
“Like the Ruwais Power Company project bond or Emirates'
Enhanced Equipment Trust Certificates last year, we can
see large issuances of project-financing sukuk in 2014.
However, this will depend on primary market conditions
and banks’ appetite for such financing and the relative
cost of each for funding a given project,” Kronfol points
out.
Toppling Malaysia from top position?
Does all this mean Malaysia will be replaced by the GCC as
leader of the global sukuk market?
Moody’s Investors Service’s Senior Credit Officer Khalid
Howladar disagrees: “Malaysia’s domestic sukuk market will
remain the largest for the near future, but it is
unlikely that one will see a single sukuk capital emerge,
given the fragmentation of investors and issuers across
many different markets and time zones.
"GCC states are increasingly comfortable with sukuk
issuance, and their funding needs are increasing in step
with economic development plans. The prospects for the
sukuk market are very strong. However, there is still a
lot of complexity and opacity around the sector, so more
education and awareness is needed to ensure that the
ideals and benefits of Islamic finance are preserved and
delivered,” Howladar says.
Blake Goud too says there will not be an immediate shift
of global sukuk market leadership from Malaysia to the
GCC because the former market is significantly more liquid
than the latter. This liquidity is representative of the
greater development in that market.
“However, the GDP of the GCC countries is much larger
compared with Malaysia. Considering just the UAE, Qatar
and Saudi Arabia (the three largest GCC sukuk issuers),
there is $1.11 trillion (QR4.04 trillion) in GDP as of
2011 while that of Malaysia is $287 billion (QR1.04
trillion). So the potential in the GCC is much larger,
but it still needs to see greater development in debt
markets away from bank debt towards capital market
instruments like sukuk to realise the potential,” Goud
adds.
According to Balasubramanian, Asia will continue to
dominate sukuk issuance in the short term due to its deep
local-currency, fixed-income market, with Malaysia and
Indonesia being the driving forces in the region. “We are
also likely to see the GCC and Middle Eastern share in the
sukuk market get bigger, with heavy future funding for a
series of infrastructure projects planned, coupled with
greater participation from corporates in the sukuk
market,” he says.
With changes in market conditions in Europe due to the
ongoing financial crisis and regulations (Basel III
requirements), coupled with abundant liquidity in the
sukuk market, European entities may also take advantage of
the current favourable pricing prevailing in the sukuk
market, Balasubramanian adds.
Tapering impact
Will the ongoing quantitative easing policy of the US
affect the world sukuk market in 2014?
Though the idea of tapering was floated in May 2013,
sending bond yields up around the world and making it less
attractive to issue debt, GCC banks have largely escaped
the global liquidity crunch, as the region has only
limited dependency on foreign capital for its
funding.
“Also, the region had high credit spreads due to sovereign
ratings (the UAE, Bahrain etc.) until previous years,
leading to sukuk issues with attractive pricing and
substantial participation from regional investors (GCC
and Asia),” Balasubramanian points out.
Howladar feels that tapering would leave an impact, as
fund flows would come down or reverse from emerging
markets, which, in turn, would reduce the demand for
sukuk. “However, the prospects for the sukuk market are
very strong, given that many of the world’s
fastest-growing economies are Islamic. But there is still
a lot of complexity and opacity around the sector, so more
education and awareness is needed to ensure that the
ideals and benefits of Islamic finance are delivered,”
Howladar says.
Blake Goud adds: “Any changes to the Federal Reserve
policy are likely to affect world financial markets, and
sukuk would be no exception. A dramatic shift in the Fed’s
policy, particularly how it is transmitted through the
GCC countries that peg their currency with the US dollar,
could affect sukuk markets. The other factor is that the
large supply-demand imbalance could cushion some of the
impacts of a Fed policy move, but it will not insulate
sukuk from global and regional financial market
conditions.”