Securitization is a structured product under both conventional and Islamic finance. Securitization is the process of pooling various assets into an SPV besides financing the acquisition of these pooled assets by the issuance of securities through the SPV. Hence, Islamic finance mimics conventional finance in defining securitization since most financial Islamic products are based on the concept of asset-backing. Another similarity is the parties’ involvement in the securitization process.
Nevertheless, there are two main differences. First, the underlying assets pool or portfolio should match the Islamic Shariah principles or the accepted Islamic financing schemes. Second, investors should have a share of ownership in the asset pool of the new SPV. In other words, investors participate in the securitization product based on a profit and loss generation mechanism rather than an interest rate as in conventional financing. Sukuk are considered the most common Islamic product used with securitization deals. So how did Islamic Sukuk securitization perform in 2020 especially in light of the COVID-19 outbreak? What is the contemplated outlook for Sukuk securitization in 2021?
Review of 2020
From a global perspective, the pandemic had a negative impact on conventional securitization deals. According to S&P’s global securitization report, new issuances of conventional securitization in 2020 are expected to record an aggregate of US$830 billion. If compared with 2020’s new issuance expectations prior to COVID-19, it should have recorded an amount of US$1.12 trillion. Hence, the pandemic resulted in a decline of around 26% in the global securitization market. The market of Islamic bonds or Sukuk is no different. As mentioned by Moody’s Investors Service last August, global issuance of Islamic bonds or Sukuk is expected in 2020 to record an aggregate of US$170 billion, representing a drop of 5% ending four consecutive years of annual growth.
It is worth mentioning that most of the Sukuk issuances in 2020 represent sovereign Sukuk issued by governments to support their balance sheets against the pandemic’s impact besides the major drop in oil prices. In other words, it is not a fully securitized product if compared with the conventional concept. Furthermore, if correlating the whole Sukuk market of US$170 billion to only the new issuances of conventional securitization of US$830 billion, Sukuk will represent around 20%.
This indicates that Sukuk securitization deals will witness a further drop than 5% in 2020 despite starting the current year with a positive outlook. This is evidenced by some Islamic market news detailing securitization programs launched prior to the pandemic. One example is the first asset-backed US$266 million Sukuk launched in Saudi Arabia last January.
The Sukuk proceeds were expected to be used to acquire real estate assets in Europe with a specific focus on Germany. Since then, few Sukuk securitization deals were conducted or announced except recently. Last September, KFH-Bahrain launched an Islamic securitization program offering local financial institutions and state-owned entities an opportunity to manage their liquidity positions and balance sheets through the issuance of a series of Sukuk Mudarabah.
Preview of 2021
According to expectations, the whole market of Islamic finance during 2020 will aggregate to around US$2.4 trillion. Such a decline is expected to continue during 2021. So what could Sukuk securitization expect in 2021? In line with international reports, the outlook is gloomy to some extent. But is there any window of opportunity?
In my humble opinion, to answer this question, we have to take into consideration two main pillars: LIBOR cancelation and the link of recourse concept with the issuance of credit ratings. Many issued Sukuk are referenced to the LIBOR rate which is expected to be canceled by the end of 2021 and replaced by the Secured Overnight Rate (SOFR).
It is worth mentioning that the SOFR rate is higher than LIBOR currently. Also, most Sukuk securitization embeds fixed cash flow streams. So what connects the two dots? Upon LIBOR’s cancelation, Sukuk will not be affected from a technical perspective since it is fixed and Islamic bonds are non-tradable.
Nevertheless, new Sukuk issuances in 2021 referencing LIBOR might result in investors refraining from subscribing to the Sukuk offering. In other words, an investor will be better off with a conventional income stream referenced to the SOFR rate than with an Islamic product tied with the fixed canceled LIBOR. An investor could mitigate this by engaging in a series of Islamic swaps.
The other main pillar is finding a Shariah compliance and legal opinion that allows embedding a recourse clause on the Sukuk issuer. This stems from the expectations of a global economy contraction that will result in a downward impact on most sovereign and corporate credit ratings.
By definition, Islamic finance entails the conventional securitization concept in most of its products. It has a real window of opportunity if stipulated on slim market dynamics by turning it around to its favor.
Samar Abuwarda is an experienced professional in structured transactions with multiple organizations in Egypt and internationally. She can be contacted at [email protected]