The suggestion can easily be made these days that sukuk as a borrowing and investing instrument is well and truly coming of age.
Certainly, there are many voices denoting that the Islamic variant on conventional fixed-income is establishing itself in the financial marketplace, tapping not only into the supposed relative safe-haven appeal of bond-related assets but also the regional and demographic drivers pertaining to the Sharia-compliant counterpart.
Notwithstanding that benchmark US Treasuries are beset by the vulnerability of the Fed’s quantitative easing strategy, there is a story behind the sukuk phenomenon that has gained traction.
As Malaysia’s starring role has faded somewhat this year in this respect, owing to the recent general election and surrounding political tensions, the Gulf seems by contrast to be straining at the leash.
As Michael Grifferty, President of the Gulf Bond and Sukuk Association, affirmed to me last week, “Supply is building, but still not quickly enough to keep up with demand in the region and elsewhere.”
Earlier this year Standard & Poor’s (S&P) documented the impressive global trend of last year, and predicted better things ahead, subject to the resolution of certain structural factors.
It told how sukuk has become mainstream, though still of modest dimension. Global issuance had grown for the fourth year running in 2012, by 64 per cent to about $138 billion. “We expect another strong few years,” the rating agency said. “Funding needs and infrastructural investments, combined with investor sentiment, are behind today’s momentum.”
In an update for Lancaster University’s Islamic Finance Bulletin last month, Paul-Henri Pruvost, analyst for S&P in Dubai, reiterated the message, despite the intervening uptick in bond yields, with the idea that “sukuk yields may now have reached a trough”.
Supportive GCC-Asian trade policies and the international search for yield will reinforce the attraction of GCC sukuk, he said, most notably to Asian investors. Cross-border transactions have grown, and the Malaysian ringitt has become a preferred currency, including for Gulf entities.
Banks needing to refinance existing debt and match the needs of corporate clients, particularly in project finance, will provide a further boost regionally, said S&P’s Pruvost. Sovereign and sovereign-related issuance will continue to shape the sukuk market, which will also see increased participation from frontier markets, notably in Africa.
Still, despite its greater acceptance, the future growth of the sukuk market might require assistance in terms of liquidity and price formation, he ventures. “Most sukuk globally are not listed and remain over-the-counter; and rated ones are the exception rather than the rule.” His pitch is that the industry must still answer questions as to Sharia interpretation, standardization of structures, and creditworthiness.
As for investors, economic research and strategy firm Arabia Monitor has offered “themes to ponder” from the experience of sukuk in recent years, noting that they have outperformed Mena conventional bonds this year to April.
Using detailed analysis, over the course of different market cycles and risk appetites, “sukuk have consistently showcased less volatile price movements than [have] emerging market bonds”.
The lesson from turbulent times is that “versatility pays”, and sukuk’s resilience is proven. Consequently, “we believe their performance offers opportunities under all market conditions, and especially in times of volatility.”
Clearly, sukuk are making a sizable impression, as doubtless will be restated at this week’s Islamic finance conference in Dubai, organized by Fleming Gulf.
As keynote speaker Harun Kapetanovic, adviser at Dubai’s Department of Economic Development, told me, “Islamic finance is consistently recording exponential growth figures. Strong sukuk growth in primary markets, with a globally diversified investor and issuer base, is one of the main drivers of [its] proliferation. This is testimony of the industry’s growing relevance in global financial markets.”
“Vibrant secondary markets will not only allow sukuk markets to develop further, but also play a key role in developing Islamic asset and fund management industries,” he asserts.
Given the apparent opportunities for market development, it’s no surprise that Dubai aspires to be at the forefront, whether by its institutions tapping international markets using sukuk structures, or the government seeking to furnish a welcoming, enabling environment.
The difference in sukuk in 2013
Sukuk issuance is down by some 20 per cent so far this year. Malaysia’s outturn declined by around one-third, year-on-year, through April. Yet the GCC’s was up 10 per cent.
The financial sector has been prominent, owing to the difficulty of raising capital from equity, and pending Basel III regulations, says Arabia Monitor. The Gulf’s pipeline, in the power & utilities sector especially, reflects robust government programmes and historically tight spreads, making financing “extremely attractive”.
As reported by Zawya, Paul Bateman, senior risk manager at Bank of London & Middle East, says that gently rising yields in sukuk this year have partly reflected the extension of durations as well as the use of subordinated issues.
“We are now seeing issuers easily place 10+ year paper in a market where a 5-year tenor used to be the norm,” itself a positive sign, he indicated.
Meanwhile, investors’ pursuit of yield has allowed banks to issue certificates benefiting capital adequacy ratios, such as Dubai Islamic Bank’s $1 billion perpetual sukuk in March, at 6.25 per cent, boosting Tier-1 capital.