With around US$43 billion of Sukuk issuance year-to-date, the backdrop for the global Sukuk market remains supportive. Even though retail participation and retail product offerings are limited and still developing, institutional demand is strong and the current supply-demand imbalance is expected to persist. MOHIEDDINE KRONFOL discusses the role retail participation must play as Islamic capital markets develop.
Malaysia inaugurated its retail Sukuk in 2013, allowing retail investors the opportunity to fund the country’s mass rapid transit project and establish a direct channel for Malaysians to share in the economic growth of their nation. Will Malaysia be able to mobilize retail demand to the extent that it alters the structural demand for Sukuk and will other countries follow suit? Malaysia is once again leading the way and trying to transform Islamic capital markets to be more inclusive and has established another positive precedent, but global Sukuk markets remain at a relatively early stage of development and need more institutional participation, regulatory and legislative support and sustainable growth.
Forays into the retail Sukuk space have been limited to date and retail participation is still lacking in substance, though growing. Ventures into retail Sukuk took a significant leap forward with the first Indonesia retail Sukuk in 2009 and, more recently, with the Malaysian DanaInfra issuance.
Government-led initiatives are key to the development of retail participation in the demand for Sukuk, such as the framework for retail Sukuk developed by the Securities Commission Malaysia to facilitate greater retail participation; or more recently reforms to the Turkish pension system that allow participants to invest a portion of their assets in Sukuk.
In absolute terms, however, these initiatives remain discreet when viewed through the lens of a US$300 billion market (of accumulated Sukuk issued to date) growing at compound annual growth rates above 25%. It is also not very different from developed markets where retail bonds are limited in size and reach.
For instance, UK-listed companies have raised only GBP3 billion (US$4.53 billion) in the last three years by issuing retail bonds on the London Stock Exchange’s Order Book for Retail Bonds, launched in February 2010. For reference, according to the Bank of England, UK corporate bond issuance amounted to GBP41 billion (US$61.98 billion) in 2012 alone.
In Italy, in comparison, retail investors hold 11% of government debt. According to the World Bank, financial literacy, competitive distortions and distribution costs are generally the most important challenges to reaching sizeable volumes among retail investors. Distribution costs can also pose a major challenge in retail debt programs.
Beyond standardized and regulated retail Sukuk instruments, retail participation should be noticeable in local asset management industries, through mutual funds and listed exchange traded funds, for example. Unfortunately, in many Sukuk issuing countries, particularly those of the GCC, the regulatory framework for retail fund establishment and distribution is still under development and other initiatives that promote capital formation and savings also remain undeveloped.
The relatively low level of retail participation in the broader Sukuk space therefore is really a reflection of financial market development. Most Sukuk markets are in transition when it comes to their transparency, governance and legal frameworks. This is especially relevant for corporate Sukuk, which should arguably be left to professionally-managed institutions rather than individuals ill-equipped to deal with credit risk.
Islamic banks, funds and Takaful companies remain the natural audience. The lack of Islamic pension systems and the relative immaturity and almost total fragmentation of Islamic insurance and asset management industries, which in combination represent the most efficient channels for retail money into the Sukuk market, continue to inhibit the development of Islamic finance and keep the global Sukuk market dependent on conventional investors with significant diversity and scale. It is estimated that Islamic funds represent only 5% of total Islamic assets with two thirds of Islamic funds with less than US$100 million in assets under management and 50% of those with less than US$20 million.
Global Islamic banking assets with commercial banks grew to US$1.3 trillion in 2011 according to Ernst & Young, suggesting a compound annual growth rate of 19% over past four years and forecast to grow beyond the US$2 trillion mark as early as the end of 2014. With such remarkable growth, demand for Sukuk from treasuries and institutional investors is projected to keep expanding.
E&Y foresees a staggering US$600 billion in global Sukuk demand by 2015, implying an existing structural gap that is evidenced by the generally high level of oversubscription that accompanied recent primary issuances and the persistently competitive returns Sukuk generate relative to major fixed income sectors with significantly less volatility.
As we look ahead, we see continued growth, innovation and increased participation in the global Sukuk market. South Africa, Egypt, Nigeria, Tunisia, Morocco, Oman, as well as the UK and France and many others, have announced plans to issue Sukuk and develop their Islamic financial services infrastructure.
While retail participation strengthens the financial inclusion agenda and helps build a more stable and reliable investor base, developing and strengthening financial institutions, particularly non-bank financial institutions, and regulatory frameworks that support capital formation deserve the bulk of policymakers’ attention.
Mohieddine Kronfol is CIO of global Sukuk and MENA fixed income at Franklin Templeton Investments ME. He can be contacted at [email protected]
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