During the formative years, the growth of the international Sukuk market primarily came from its traditional stronghold of the GCC and Malaysia. The product range and structures were also limited, aimed mainly at satisfying the financing needs of governments and corporates, and relying on the asset-based structures such as Ijarah (sale and leaseback). However, AHSAN ALI looks at three new trends that have emerged over the past few years which have taken the industry to a whole new level: (i) geographic diversification to new markets, including non-Muslim majority countries, (ii) expansion of product range beyond plain vanilla financing instruments and (iii) innovation in Shariah structuring to reduce reliance on asset-based structures.
For non-Muslim majority countries looking to make their first foray into the Sukuk marketplace, the year 2014 proved to be a breakthrough year, when the government of the Hong Kong Special Administrative Region of the People’s Republic of China, the UK government, the Grand Duchy of Luxembourg and the Republic of South Africa issued their inaugural sovereign Sukuk. While some of them wanted to position their countries as the hubs of Islamic finance just as they are hubs of conventional finance in their own rights, others wanted to access the growing pool of Islamic liquidity to diversify their sources of funding. The key outcome is that all of these nations have amended their legal, regulatory and taxation frameworks to accommodate Islamic finance in general and Sukuk structures in particular – which means that other quasi-sovereign and corporate entities from these countries can now tap the Sukuk market, confident in the knowledge that legal and taxation hurdles have been overcome.
These issuances have given prominence to the opportunities associated with issuing Sukuk for non-Muslim majority countries. Spurred by these issuances, many other sovereigns throughout the world are now looking to issue Sukuk for similar reasons and have been working with global Islamic industry bodies to make the necessary tax and legal amendments to their regulations to facilitate such issuances. This then opens the door for other semi-government, multinationals and large corporates within these countries to tap the Sukuk marketplace for their own funding requirements, from a new set of potential investors who have become more familiar with the language of Sukuk and Islamic banking and finance. Finally, there are new countries on either side, Muslim and non-Muslim majority countries, that have a local population requesting access to Islamic banking services. Furthermore, the importance of these frontier developments in the Sukuk marketplace stem from the fact that Sukuk issuances can play an important role in financing as most emerging markets require significant infrastructure investments in the next decade.
A natural extension of geographic diversification is the growth of the cross-border issuance market. Currently, the majority of cross-border issuances involve bringing issuers from around the world to issue in Malaysian ringgit, which is the largest local currency Sukuk market in the world. For example, Turkiye Finans, the Turkish participation bank, was the first issuer out of Turkey to issue in Malaysian ringgit, in what was the largest senior single tranche issuance by a foreign financial institution.
The second big theme in the growth of Sukuk market is the development of new product structures in line with the development in the conventional bond market. For most of the period from 2002 to 2012, a vast majority of the Sukuk issued mirrored the senior, unsecured debt structure of the plain vanilla conventional bond. However, from 2013 onwards, we have seen new products in the market such as project finance Sukuk, amortizing Sukuk, export credit agency-based Sukuk, bank capital Tier 1/Tier 2 instruments and corporate hybrid Sukuk having both equity and ‘debt’-like features.
Project finance Sukuk structures mirror the risk and cash flow of specific projects and therefore this development augurs well for the financing needs of infrastructure projects in many emerging nations around the world. Similarly, the first export credit agency-backed Sukuk issued by Emirates Airline in March 2015 was fully guaranteed by the Export Credits Guarantee Department of the UK government, which opens up a new market for both sovereigns and corporate entities to issue credit-enhanced instruments, targeting a new investor base and further widening the product suite in the Sukuk space.
Similarly, Tier 1 and Tier 2 bank capital instruments satisfy an increasingly important need for Islamic financial institutions to raise new capital for their ambitious growth targets while managing their capital ratios in compliance with new regulations such as Basel III. On the other hand, corporate hybrid Sukuk provides an innovative instrument for corporates to manage their leverage ratios without raising expensive equity.
A more recent global phenomenon is socially responsible investing or ethical investing, where Shariah compliant instruments should fit in naturally. In 2014, the International Finance Facility for Immunisation issued the first socially responsible and ethical Sukuk to support the immunization and vaccination programs of GAVI – the Vaccine Alliance. A natural extension of ethical investing is a ‘green’ Sukuk, where the use of proceeds would be for the purposes of satisfying specific critieria for such investments.
Innovation in Shariah structures
Traditionally, the Ijarah (sale and lease-back) or other 100% asset-based structures were the main Shariah structures used by market practitioners for creating the Sukuk, primarily as they were easy to understand by all involved, such as rating agencies, legal counsels, Shariah scholars and the investors themselves.
However, over the past years, we have seen increasing acceptance of asset-light structures as well as industry-specific structures. The main asset-light structure is based on the Wakalah concept, where the proportion of fixed assets required for structuring purposes is being substantially reduced to half or a third of the Sukuk amount by using a commodity Murabahah investment or other non-fixed assets such as services. The government of Malaysia’s Sukuk used a combination of Ijarah, sale of certain services and Murabahah investment, while the government of Indonesia’s Sukuk is based on completed assets plus projects under construction. Similarly, a popular structure in the Saudi local currency market is the Murabahah/Mudarabah structure, where part of the proceeds are utilized to invest in the (Shariah compliant) business of the issuer and part of it invested in commodity Murabahah. For bank capital Tier 1 issuance, usually a pure Mudarabah structure is used which aligns well with equity capital-like behavior of the instrument.
Industry-specific structures have been primarily used in the airline and the telecommunication industries. The ‘rights to travel’ structure is now a well-established structure for the airline industry, having been used for the Emirates, flyDubai and Garuda transactions. Similarly, the airtime structure based on mobile minutes or ‘airtime vouchers’ is a popular structure used by many telecommunication issuers – both in local currency and US dollar transactions. Going forward, this trend for structural innovation is expected to continue, as the Shariah scholars, rating agencies and investors become more familiar and well-versed with such innovative structures.
Though the first international Sukuk was issued as far back as 2002, up until 2012 the industry was primarily limited to the Islamic hubs in the GCC and Malaysia, with limited product reach and structures. The past three years have seen a major breakout, not only in terms of geographic expansion and cross-border issuance but also in terms of product range as well as Shariah structuring innovation. This bodes well for the long-term growth of the Sukuk market in particular, and also the Islamic finance industry in general.