Sukuk costs to drop

Islamic bonds are set to get cheaper for issuers in the Gulf as growing demand for sukuk in the corporate sector spurs competition in the market, Standard & Poor's said on Tuesday.

Standard & Poor's said demand would likely be driven by Muslim countries as their capital markets developed and corporate borrowers sought a Sharia-compliant alternative to conventional debt.

"Past experience with debt instruments such as asset-backed securities, together with current market indicators, suggests that innovation and market demand for sukuk will continue to the extent that they evolve into a more commoditised asset class," said Mohammed Fayek, Standard & Poor's credit analyst.

"Furthermore, financial institutions will compete to capture this market segment and eventually narrow the pricing gap between sukuk and conventional instruments."

Standard & Poor's did not say how much the pricing gap would narrow or give a timeframe for this.

However, Standard & Poor's did caution that sukuk presented specific credit risks, particularly with regard to delays in scheduled payments, events of default, asset protection, structural issues and reporting standards.

The agency highlighted the GCC as one of the main regions driving growth in the Islamic bond market.

Listed sukuk on the Dubai International Financial Exchange (DIFX) amounted to about $16.1 billion at the end of 2007, up from $7.6 billion in 2006, it said.

Islamic bonds comply with the religion's ban on the receipt of interest, and returns derived from underlying physical assets, such as rent from real estate, are paid to bondholders.

Sukuk are usually more expensive for issuers than conventional bonds because it is a relatively new financial instrument and therefore issuers have to offer greater incentives to attract investors.

Sukuk's traditional base is in the banking and sovereign markets, but the growing interest in Sharia-compliant financial instruments has seen them expand into the corporate sector.

Recent action in the sukuk market includes the completion of a $875 million sukuk in early October by UAE-based Dana Gas, the announcement by another UAE firm, RAK Properties, that it intends to sell $2 billion of sukuk early this year, and Kuwaiti real estate firm Abyaar's announcement it will issue a $700 million sukuk early in 2008.

Islamic bond sales in Gulf countries could double to $50 billion in 2008 despite a global credit crunch, Morgan Stanley said in November.

Traditionally sukuk accounts for around 80% of all corporate bond issuances in the Gulf, but over the last year that share has been reduced to 57% with the growing popularity of conventional bonds, according to law firm Trowers & Hamlins.