Sukuk offerings witness 39% slowdown this year

Emirates Business 24/7 :Tight liquidity in the global and regional markets is responsible for the slowdown in the issuance of sukuk in 2008, which has seen a decline of more than 39 per cent in the first eight months of this year to $14 billion (Dh51.42bn), as opposed to $23bn registered in the same period last year.

Sukuk experts in the region have told Emirates Business that contrary to what has appeared in a section of the financial media, blaming comments about the Shariah-compliance of some sukuk by the Accounting and Auditing Organisation for Islamic Financial Institutions, it is the lack of liquidity – which has impacted other financial instruments as well – that is largely responsible for the lower number of sukuk.

"We need to be careful about reports attributing the fall in sukuk secondary market prices to the organisation's recent pronouncements," said Yavar Moini, Executive Director for Global Capital Markets at Morgan Stanley.

"The organisation's standards, whilst there to be respected, are not binding on any Islamic financial institution outside Bahrain. For example, all sukuk accounting is as per IFRS and not the organisation standards," he said. "Subsequent to the February pronouncement [by the organisation], there have been significant sukuk deals brought to market. These include Nakheel (Dh3.6bn), Aldar (Dh3.7bn), Tamweel (Dh1.1bn) and Tabreed (Dh1.7bn). Therefore, deals continue to be made."

Sheikh Muhammad Taqi Usmani, Chairperson of the organisation's advisory board, had in comments made late last year declared 85 per cent of sukuk to be un-Islamic. Later, the organisation issued a statement saying any financial product with a buyback clause was un-Islamic because this effectively eliminated the risk-sharing aspect of the investment, a necessary part of Shariah-compliance.

The organisation also declared that, in order to be considered Islamic, sukuk must be asset-backed, and not merely asset-based. It has come under a lot of heat recently owing to the unclear nature of the comments.

"Until we get clarity from the Islamic banking institutions and from the organisation itself, the market is bound to remain volatile. The comments from the organisation are a few months old but have been having an impact recently because they have been highlighted in the press. The Islamic banking community needs to formally address these issues and get investors comfortable," said Abdul Kadir Hussain, CEO, Mashreq Capital. "No scholar has ever stated that their views would be applied retroactively. Certain scholars are merely expressing a view of how they would like sukuk to be structured, going forward."

"We need to distinguish two types of activities: the primary issuance on the one side and the secondary market activity on the other side," said Giambattista Atzeni, Mena Strategic Business Development Manager for Global Corporate Trust at The Bank of New York Mellon. "In relation to the primary issuance, we think that the future activity will be linked to the pace of adjustment towards Shariah-compliant true-sale securitisations type of transactions. These deals are fully asset-backed and they represent certificates of ownership against tangible assets.

"These assets are effectively sold and registered to the certificate-holders and therefore investors accept a true 'profit and loss sharing' formula. We also believe that convertible sukuk will continue to support the activity on the primary issuance side. In particular, certain convertible structures, which were not criticised by the organisation, will represent a solution to the 'go public' trend within the GCC," said Atzeni.

"In relation to the secondary activity," he continued, "as accepted true asset-backed structures can be traded in the secondary markets, this could have a positive effect on the future activity."

Despite the positive outlook, Atzeni still had a word of caution to offer. "We may continue to experience a lack of liquidity caused by the credit crunch, the slow but eventual incorporation of accepted standards and a market infrastructure not fully capable to facilitate post-trading activity for these instruments," he said. "Most sukuk will be purchased to hold until the market stabilises/ evolves," he pointed out.

According to a recent report by Standard & Poor's, some issuers may have reconsidered how they structure their sukuk as a result of the organisation ruling, resulting in delays. The report maintains that most sukuk were issued in markets where liquidity is still abundant and/or appetite for Shariah-compliant instruments is high – namely the countries of the GCC and Malaysia.

Despite lower issuance compared to last year, S&P expects sukuk issuance will reach $20bn to $25bn this year given the good pipeline. Nevertheless, the borrowing costs of sukuk have been rising and pricing, while still attractive, is now dearer than earlier.

According to a Bloomberg report, as demand for Islamic bonds waned, yields rose to 2.94 percentage points more than the London Interbank Offered Rate (Libor), near a record and compared with 2.43 percentage points for an equivalent non-Islamic bond. The spread was 1.08 percentage points a year ago and about double that in February.

"Sukuk are repricing now because base rates in relation to Eibor and Sibor have risen considerably over the last quarter – in Eibor's case by 125bps," explained Moini.

"This is indicative of local currency beginning to dry up that has been caused by the level of borrowing done year-to-date in local currency and the unwinding of long only UAE dirham/ Saudi riyal currency position in the expectation of a revaluation," said Moini.

"It's difficult to differentiate local and international investors, but sukuk prices have continued to come off, although some of that would be attributable to the market in general," said Hussain. "At the end of the day investing is a risk appetite call, and no capital markets are immune from risk perceptions, Islamic or non-Islamic."

"In a world where investors are becoming very risk averse, pricing for all securities will be impacted. What we are not likely to see in the Islamic space is the underlying credit weakness and rise in default risk that we are seeing elsewhere in global markets."

"No market can remain insulated from global trends," said Moini.

Atzeni agreed with their viewpoint.

"Within a globalised market, any instrument – whether Islamic or otherwise – would be affected by the financial squeeze."

"In addition to liquidity tightening, credit default swaps have widened at a sovereign level. This is being caused by the global credit crunch, a surfeit of borrowing by local issuers, a concentration of issuers related to real estate and corporate governance issues. As credit default swap levels rise, the cash market for sukuk revises its pricing. Therefore, there are both capacity and credit related issues causing sukuk spreads to widen," said Moini. "Traditionally, sukuk have been less liquid than conventional bonds so relatively small trades can significantly affect secondary market pricing. Therefore, we need to analyse secondary market trading volumes carefully," he said.

All experts that Emirates Business spoke to were bullish on the medium- and long-term future of Islamic finance in general and sukuk in particular.

"The vast majority of investors on the primary side are represented by international investors and they are generally less vulnerable to these types of verdicts," said Atzeni, referring to the organisation ruling. "International investors have a strong appetite in Middle Eastern corporates and are looking to gain more exposure in the GCC, therefore Sukuk represent a perfect solution for their investment needs. We expect a gradual pick up before the end of the year."

"The organisation ruling must have added to the uncertainty, however, we must remember that sukuk tend to be tightly held and are mostly placed with regional investors (referring specifically to straight debt as opposed to convertible sukuk). The regional investor base obviously has greater insight into the market and the instrument," said Moini, declining to predict the near-term volume.

Atzeni added: "We have reason to believe that Islamic products can potentially represent a solution or a safe harbour in these challenging times."

GCC to drive global sukuk market to $200b by 2010

Khaleej Times - Led by the UAE, the GCC is poised to play a key role in driving the global Islamic bond or sukuk market to a two-fold growth to an estimated $200 billion by 2010, banking industry sources said.

Sukuk issuance in the UAE is predicted by analysts to grow to Dh25-Dh30 billion this year as the market gained momentum after the uncertainty about dollar peg ended. The first half already registered Dh17 billion worth of new issues.

Islamic banking sources said with several new issues in the offing, about 70 per cent of the GCC's sukuks will be from UAE alone by next year. Malaysia currently accounts for almost 60 per cent of sukuk issue year to date. 'With the UAE driving the GCC sukuk market, there might be a shift in the ratio of sukuks between Malaysia and Middle East, in favour of this region,' they said.

According to a study done for the International Monetary Fund (IMF), a strong demand from Muslim countries and conventional global institutions for Shariah-principled bonds would boost the potential for sukuk despite the global credit crises. The total value of issued sukuks is likely to exceed $200 billion by 2010 from the current $100 billion said the IMF study titled 'Islamic Bond Issuance - What Sovereign Debt Managers Need to Know.' However, some critical constraints relating to continued legal uncertainty and regulatory divergences ought to be addressed, it said.

Although sukuk issuance slowed to $2.3 billion in first quarter 2008, the prevailing market uncertainty and the retrenchment of real estate exposures worldwide has created a significant backlog of planned issues, which could see a restoration over the course of this year, the report said.

Islamic finance experts in Dubai said GCC's fast growing Sukuk market is drawing global investors keener on less risky investment tool as well as an exposure to the region's currencies and equities markets.

'There is also the increasing prospects of Gulf-based pension funds and insurance industry looking at investing in sukuks as part of their investment strategy,' they said.

Sukuks issued worldwide totalled $47 billion in 2007, up 73 per cent, compared with about $25 billion in 2006 and $10 billion in 2005. The volume of sukuks issued in the Middle East, particularly the GCC countries, rose to 53 from 38 in 2007, industry watchers said. Worldwide, the total number of Sukuk issued was 207, compared with 199 in 2006 and 89 in 2005, according to the Islamic Finance Information Service (IFIS).

Despite fears that GCC also would be hit by the global credit crunch, Sukuks issued in the Gulf surged 17 per cent in 2007 to $17 billion. 'For international institutions, which account for more than 60 per cent of Sukuk investors, these Shariah-based bonds have been better than conventional bonds in terms of returns. They are also less risky investment vehicles as they offer a key advantage over conventional bonds because of the Islamic condition that all issues must have underlying physical collateral, a true asset-backed security. In addition, there has not been a single Sukuk default so far,' experts explained.

Experts said the UAE and the GCC will see more dollar sukuks in the coming months because the dollar link is no longer an issue after central bank governors maintained they will not revalue or depeg.