Multiplying on the global stage

By Yadullah Ijtehadi

From being the flavour of the month, sukuk have quickly been elevated to become a viable long-term funding instrument for many of the Gulf's corporations.

This meteoric rise from being an alternative proposition to a mainstream reality has not gone unnoticed in the rest of the world, as international financial centres such as London, Tokyo and Hong Kong are altering their laws to accommodate sukuk and Islamic finance.

The German state of Saxony-Anhalt has already issued an AAA-rated five-year sukuk, while China, Japan and Thailand are reportedly planning to issue sovereign sukuk this year.

But for now the momentum is with the Gulf states.

This year alone, firms in the Gulf have raised $6.12 billion (or 61 per cent) in 22 issues of the total sukuk issued to date (June 15). Gulf corporates raised $18.72 billion, or 55 per cent, of all sukuk issued globally last year.

The rise of sukuk is part of a much bigger tide that has swept across the Gulf states. On the back of triple-digit oil prices, GCC sovereigns have now become one of the biggest exporters of capital globally, investing in high-profile blue chip companies, apart from emerging and developed markets.

These Gulf companies are seeking funds from the market to raise capital for their ambitious domestic and global expansion either in the form of public offerings, private placements, syndicated loans and bonds. All these options are in huge demand and sukuk are no exception.

Deustche Bank's outlook projects more prominence for the sukuk market going forward. "In our view, if we assume that only 10 per cent of the region's investment needs will be met by international sukuk issuance this would still imply a doubling of the existing international sukuk stock within two years, reaching close to $100 billion by 2010 ... we are starting to see the tip of the investment iceberg," says the bank in a report on sukuk.

Malaysia and the UAE remain the most active markets for sukuk, but many other markets also seem ripe for development.

Saudi Arabia, Kuwait and Qatar, among the Gulf states, and the UK, Pakistan and Indonesia all offer strong potential going forward. Malaysia, of course, remains a sukuk powerhouse, having raised 38 issues valued at $3.77 billion this year to date, but it remains decidedly focused on a ringgit-based, local audience.

So critical is the demand for funding in the Gulf that regional corporations are shrugging off the global credit crisis and the depreciating American dollar to issue domestic-currency denominated sukuk.

"The demand for domestic-denominated bonds remains high in the GCC at present as banks remain flush with local currency with limited assets to invest in," says Nish Popat, Director of Fixed Income at National Bank of Dubai. "In addition, the continued rumour of revaluation by various central banks continues to attract foreign money into the bonds. As long as speculation remains in the region concerning revaluation, demand for local currency bonds will remain high.

The dominance of the local currency-denominated sukuk finds its origins in the weakness of the US dollar, says Mohammad Damac, ratings specialist at Standard & Poors. "It also reflects some expectations that the GCC central banks will revise their exchange rate policy. Another reason is the widening of the credit spread in the market. We expect to see more sukuk issuances in local currency, although in the long run, the dollar should return as the currency of choice."

Seeking a yield curve

While the sukuk industry has risen quickly, it has not been without its short-term hiccups and long-term challenges. Apart from the fact that the market is not immune to the global credit crises, the industry faces a number of challenges to sustain growth, such as standarisation, structure harmonisation and the availability of expertise and human capital.

For example, the Gulf and Malaysian interpretation of sukuk differ greatly and there are concerns that it will lead to a fragmentation of the industry - if it has not already.

The handful of Islamic scholars also reflects the shallow talent pool available in the industry. According to a Forbes report, there are only 20 Sharia scholars who dictate Islamic finance. Lack of scholars is not the only problem. The sheer dearth of Islamic finance professionals also means that the industry has very little talent to pick from. These issues, if not addressed soon, could derail the sukuk gravy train.

On a macroeconomic level, sukuk issuance has been on the rise in the absence of an active monetary policy in the Gulf. Most Gulf currencies are pegged to the American dollar, making GCC monetary policies subservient to the Federal Reserve. The lack of monetary instruments in the Gulf central banks' arsenal has made the development of conventional bonds difficult, although not impossible.

Faisal Hijazi, business development analyst (structured finance - Middle East and Islamic finance) at Moody's, thinks Gulf governments are less likely to issue sukuk in the short to medium term, given the robustness of their fiscal and current account surpluses. "On the contrary, GCC governments with the rising fiscal surplus are gradually reducing their sovereign debt levels."

GCC governments, represented by central banks, could step up their monetary policy operations by issuing short term liquidity sukuk instruments, similar to the Central Bank of Bahrain (CBB) monetary instruments, CBB Sukuk and Al Salaam Sukuk programmes.

"Globally, I think the governments of Japan, Hong Kong and the UK more likely to issue sovereign sukuk much earlier," says Hijazi.

Indeed, the sukuk bug is not restricted to the Gulf. In June, Indonesia decided to remove taxes on sukuk issued by the government to make their offering more attractive to foreign investors.

Meanwhile, Japan Financial Services Agency (FSA) has submitted an amendment to the banking law to the Diet (Japanese parliament) which may allow Japanese banks to offer Islamic finance products through a subsidiary, according to media reports. Hong Kong, London and Singapore are also looking to leverage their financial services hub status to attract the Islamic finance market.

"I get a call virtually every day from companies in countries as diverse as South Korea, the United States and Brazil, looking to issue sukuk and tap into the liquidity in the Gulf," says the regional CEO of one of the largest international banks based out of DIFC.

It appears that sukuk have already gone global.