Resilience is the word for 2021 because it implies hope, faith and possibilities. The global economic recovery continued in 2021 amid a resurging COVID-19 pandemic that poses unique policy challenges and requires strong multilateral effort. The situation became more concerning with the latest detection of a highly contagious new variant of the virus, causing lockdowns in certain part in the world and thus higher uncertainties affecting economic activities globally.
Central banks have injected massive amounts of liquidity into the system to support economies and to avoid a liquidity crisis. Extraordinary policy measures have eased financial conditions and supported the economy, helping to contain financial stability risks. With global inflation at the highest levels, supply chain disruptions and shortage in the labor market, regulators are expected to start tightening accommodative monetary policies next year.
Review of 2021
The COVID-19 pandemic has posed liquidity challenges for the Islamic financial industry. To deal with the crisis, central banks have introduced several measures for liquidity support to the banking sector including massive injections of cash, lowering reserve requirements, securities buying programs and accessibility of central bank credit lines (reverse repo). The first two measures helped both Islamic and conventional banks — however, the last two measures were hard to find for Islamic financial institutions.In that regard, the International Islamic Liquidity Management Corporation (IILM) hosted in June 2021 the 5th IILM Shariah Roundtable titled ‘Towards an Effective Shari’ah – Compliant Repo Market: Challenges and Alternatives’, focusing on the Shariah compliant repo market. The panelists clearly identified the need for an effective Islamic repo cross-border framework that will support the global financial need for Islamic short-term funding.
Meanwhile, the optimism that boosted markets earlier in 2021 has faded on growing concerns about the supply chain disruptions intensifying inflation concerns globally. The US’s inflation hit 6.8% in December 2021, the highest level since the last 40 years. To contain the surplus of liquidity in the US dollar, the Federal Reserve in November 2021 began tapering the pace of its monthly asset purchases by US$15 billion but held to its belief that high inflation would not require an urgent need to raise interest rates. The US regulator has changed its stance on calling the inflation transitory in its latest Federal Open Market Committee meeting in December 2021 and announced speeding up its tapering as well as potentially three rate hikes as early as 2022.
The Fed’s new hawkish decisions pushed investors to further park liquidity in high-quality short-term instruments which had a positive impact on the demand for IILM papers since the third quarter of 2021. This high demand has pushed the IILM profit rates on the regular tenors to their lowest since inception. The IILM has successfully stabilized its outstanding issuances in 2021 to US$3.51 billion, the highest volume of Sukuk ever, addressing the higher and various demand for high-quality assets from the institutions offering Islamic financial services.
In 2021, the IILM has thrived to fulfill its mandate of providing liquidity management instruments to the market by supplying an excess of US$14.12 billion across 36 Sukuk, the highest volume since inception. It became a frequent and stable issuer, constantly offering three different tenors monthly, namely one-month, three-month and six-month Sukuk. This accounted for 27% of the total global US dollar Sukuk issuances in 2021 and positioned the IILM as one of the top US dollar Sukuk issuers. The secondary market volume has risen to US$1.4 billion representing circa 10% of the total issuances in 2021.
Preview of 2022
After a year of record-breaking cash injections, the world’s big central banks are starting to ease off the stimulus pedal, forcing economies and financial markets to practice walking on their own again.
The Fed has been keeping its benchmark short-term interest rate anchored near zero since the start of the pandemic. Growing economic recovery and rising inflation pressure will be the main factors affecting the Fed’s decision to hike rates in 2022.
With investors anticipating interest rate hikes, more Sukuk issuers will likely turn to international markets to tap high investor demand and a sizeable liquidity pool. Total global Sukuk issuance for the end of 2021 is expected to hit a new record of around US$180 billion.
In addition, it has been stated that the one-week and two-month London Inter-Bank Offered Rate (LIBOR) will cease to be published from the 31st December 2021; whereas the one-month, three-month and six-month US LIBOR may continue until June 2023. It is imperative that in 2022, banks and financial institutions familiarize themselves with the Secured Overnight Financing Rate (or SOFR) and how it works with Islamic finance transactions. Islamic institutions continue to work together with Shariah scholars to consider other alternatives. The alternatives to LIBOR may not necessarily be problematic for conventional finance, but it remains more challenging for Islamic institutions.
It was in this perspective that the IILM in October 2021 co-hosted a virtual seminar titled ‘Global Benchmark Rate Reforms – Challenges & Solutions for Islamic Finance Industry’ with the International Islamic Financial Market and Bank Indonesia with regards to building the Islamic benchmark rates. The seminar’s purpose was to create awareness and highlight the challenges that LIBOR reform poses to Islamic financial product structures, transactions and related legal matters. The purpose was also to discuss the possibility of introducing an alternative to LIBOR.
Future developments will depend on the path of the health crisis, including whether the COVID-19 strains prove susceptible to vaccines or they will prolong the pandemic; the effectiveness of policy actions to limit persistent economic damage; the evolution of financial conditions and commodity prices; as well as the adjustment capacity of the economy. As higher uncertainties are surrounding the global economic outlook, the institutions offering Islamic financial services need more than ever a developed Islamic money market framework, which includes Islamic repo activity and enhanced availability of Islamic liquidity management solutions.
Looking ahead into the new year, the IILM will focus on developing its issuance program with new features as well as addressing the demand for more high-quality liquidity assets and longer tenors depending on market conditions. The IILM looks forward to attracting new investors to diversify its investor base and thus enhancing the liquidity for its Sukuk in the secondary market.
Hichem Bouqniss is the executive director of the International Islamic Liquidity Management Corporation (IILM). He can be contacted at [email protected]