What’s the future of SUKUK …

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.

“The Ooredoo sukuk issue 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.” Hani Ibrahim, Head of Debt Capital Markets, QInvest

Source: Qatar Today Magazine

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”.

“Over 2014, it is anticipated that sukuk issues held back in 2013 due to volatility in the financial marketsshould come through. USD issuers would also look to take advantage of low rates ahead of anticipated upward rate curve movement once current market unrest settles.  Investment-grade USD issuers from the GCC will take advantage of a 2014 issuance, and the market will see some sub-investment-grade paper come to market.”

Steve Troop
CEO, Barwa Bank

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.

Sovereigns make up  the lion’s share Sovereign issuers continued to dominate the sukuk landscape with QR276.64 billion worth of Islamic bonds, followed by corporate and quasi-sovereign issuers with QR112.84 billion and QR29.12 billion respectively in 15 countries. In comparison with the results of 2012, sovereign and quasi-sovereign issues declined by 18% and 60% respectively, while corporate issues increased by 34%. Governmental institutions remained the dominant sector in 2013, making up QR258.44 billion (61% of the total), followed by financial services at QR61.88 billion (11%) and power and utilities at QR32.76 billion (8%). The transport sector came fourth with QR21.84 billion, a downward move as it relinquished its 2012 third place ranking with QR54.6 billion. Around 85% or 753 sukuk issues were sold domestically, raking in QR356.72 billion, while the remaining QR65.52 billion were sold internationally through 29 deals.

“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 will remain active in the domestic market to support increasing liquidity of Qatar’s Islamic banks, which themselves might issue sukuk. Other corporates might also opportunistically tap the sukuk market for funding or refinancing needs following the example of Ooredoo’s debut sukuk in December 2013, a very welcome development for investors.” Mohieddine Kronfol, Chief Investment Officer (Global Sukuk, MENA Fixed Income),

Franklin Templeton Investments

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.

Qatar’s  credit growth to accelerate
Despite some headwinds, long-term prospects for the sukuk industry remain promising, as regulators continue to build and strengthen their frameworks to minimise barriers in the market and deepen liquidity, Standard & Poor’s Ratings Services says. In a report entitled “After A Mixed 2013, The Global Sukuk Market Looks Promising In 2014”, published last month, the rating agency says that despite a slowdown in credit growth in Qatar, largely due to administrative delays in certain projects in 2013, it expects credit growth to accelerate in 2014. “The Qatari Islamic banks continue to maintain strong credit growth, and we anticipate that they will become more active issuers of sukuk over the next few years,” the report says. The report also says that Malaysia has already benefited from a broad sukuk investor base and liquid debt market. So the increased interest from issuers, notably in the Middle East and Asia, in tapping the Malaysian ringgit and US dollar markets should continue over the next few years as Malaysia cements its leading position in the industry. “After a slowdown in 2013, with sukuk volumes declining by 13%, we anticipate that the sukuk industry will expand again in 2014, partly driven by corporate and infrastructure issuers in the Gulf,” says Standard & Poor’s credit analyst Samira Mensah, one of the authors of the report. 

“What’s more, total issuance will exceed $100 billion (QR364 billion) for the third year in a row if yields remain attractive for issuers. And, after weakening in 2013, we believe issuance could pick up again in Malaysia in 2014 as its investment programme resumes,” she adds.

Growing sukuk players
Sharing Ibrahim’s views, Franklin Templeton 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.

“The GCC market in particular will play a greater role. With a huge number of infrastructure projects planned, 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.”

Mahesh Balasubramanian
Partner, Audit and Advisory Services, KPMG

“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 relative 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.” Blake Goud, Community Leader, Thomson Reuters Islamic Finance Gateway

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.

“Malaysia’s domestic sukuk market will remain the largest for the near future, but it is unlikely that we will see a single sukuk capital emerge, given the fragmentation of investors and issuers across many different markets and time zones.” Khalid Howladar Senior Credit Officer, Moody’s Investors Service

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.

Key Growth Factors
Large pools of Muslim wealth and abundant liquidity
    Strong demand (still exceeds supply)
    Thriving Islamic funds industry
    Alternative source of funding
    Divergence from risky equity
    Safe haven, asset-backed/based
    Huge financing and refinancing requirements
    Drying up of syndicated loans market
    Adoption of Islamic finance by post-Arab Spring regimes
    Islamic banks less connected to Europe’s problems
    Islamic banks relatively more liquid

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.”

Leave a Reply