Innovation in Islamic finance, large-scale capital needs to fund infrastructure investments and a slump in traditional revenue streams among oil-exporting Islamic countries have spurred Sukuk issuance in the recent past. Sovereign Sukuk, which arrived in the global arena nearly two decades back, have firmly established a presence and account for the majority of Sukuk issuance. RAGHU MANDAGOLATHUR delves further.
Growth in Islamic finance underpinned by sovereign Sukuk issuance
Islamic finance has continued to prosper and gain prominence across the globe spurred by the adoption of socially responsible investing principles. The positive growth of Islamic finance has been fueled chiefly by the growth of Sukuk among others, and amid continued appetite from investors for alternative assets. Sukuk, an Islamic version of conventional bonds used to raise capital, have been the most popular instrument in Islamic finance.
Although Sukuk issuance accounts for a tiny fraction of the overall fixed income market, the market for Sukuk is growing fast. Global Sukuk issuance in 2018 was expected to be US$114.8 billion, almost flat from the value raised a year back.
The sustained volume in Sukuk issuance is primarily attributed to the preference of sovereigns to raise capital through various Sukuk structures. Sovereigns utilize Sukuk to raise capital for a variety of purposes including meeting budgetary needs, financing infrastructure development and debt/monetary management, among others.
Encouragingly, the investor base for Sukuk has also expanded with several sovereign, quasi-sovereign and financial institutions from Hong Kong, the UK, Malaysia, Indonesia, Pakistan, GCC countries, Turkey and Nigeria participating.
International Sukuk issuance is primarily concentrated in the Islamic markets of the Middle East (primarily GCC countries) and East Asian countries (Malaysia, Indonesia). Financial hubs such as Hong Kong, Luxembourg and the UK are also active players. Of the total issuance of US$114.8 billion in 2018, sovereign Sukuk accounted for 68% amounting to US$78.06 billion. Sovereign Sukuk issuance is set to rise on the back of higher fiscal deficits, Sukuk refinancing needs and sovereign commitments to deepen the Sukuk market in the coming years, and is expected to reach US$100 billion by 2020.
The first sovereign Sukuk issue was made in 2002 by Malaysia. Since then, the market has grown in size with active issuance from sovereigns across geographies. Malaysia is an active player in the sovereign Sukuk market and its overall outstanding long-term Sukuk issuance stands at US$84 billion.
Saudi Arabia is an emerging player and has recently taken to issuing international Sukuk. In 2017, Saudi Arabia had its inaugural international sovereign Sukuk issue, raising US$9 billion.
Opportunities and challenges
Sovereigns have adopted Sukuk as a preferred way to raise capital as the cost tends to be lower. Sukuk issuance has received wide investor interest, including from hedge funds which seek investments that are less correlated with conventional bonds, thus placing a premium on the issue. Additionally, the asset-backed nature of the Sukuk instrument has enabled certain issuers to market the Sukuk with a better/higher quality credit rating.
Overall, the broad investor base with significant interest and the asset-backed structure of the instrument have enabled sovereigns to raise capital at a lower cost than conventional bond issues.
However, the associated administrative costs, legal and accounting, along with an unfamiliarity with Islamic finance, have hindered the widespread adoption of Sukuk in non-Islamic markets. The illiquid nature of secondary markets for Sukuk also acts as a constraint leading to higher yields.
What needs to be done?
A conducive environment that places investor interest at the apex is critical for the Sukuk market to flourish.
Currently, the standards are set by multiple international Islamic standard-setting bodies such as the IFSB, AAOIFI and the International Islamic Financial Market (IIFM). While they have contributed to regularization and standardization leading to the introduction of a variety of Islamic products, it is to be noted that the adoption and adherence to these standards are purely voluntary.
Moreover, only a few jurisdictions have adopted them. The legal documentation pertaining to Sukuk structures is yet to be standardized and is subject to diverse interpretations. The legal tussle surrounding the Dana Gas Sukuk is a classic example in this regard.
To instill confidence among the various stakeholders, legal documentation surrounding Sukuk issues needs to be simplified and standardized. The development of global Sukuk standards is the need of the hour and will help to address the trust deficit issues among global investors.
Table 1: Selected international sovereign Sukuk issuances | ||||||
Country of issue | Issued year | Coupon | Yield to maturity | Maturity (years) | Instrument type | Amount issued (US$ million) |
Malaysia | 2017 | 4.8 | 4.5 | 20 | Murabahah | 3,546 |
Saudi Arabia | 2018 | 3.3 | N/A | 5 | Islamic Sukuk (Others) | 3,225 |
Qatar | 2019 | 4.3 | N/A | 5 | Ijarah | 1,099 |
Turkey | 2018 | 17.9 | 17 | 2 | Ijarah | 595 |
Nigeria | 2018 | 15.7 | N/A | 7 | Ijarah | 327 |
Bahrain | 2018 | 4.8 | 5.5 | 3 | Ijarah | 265 |
Source: Reuters |
Conclusion
The sovereign Sukuk market is likely to expand over the years underpinned by new issuers from both Islamic and non-Islamic countries. Supported by investor interest in asset-backed assets, the potential for Sukuk remains immense. The need for sovereigns to diversify their debt profile could also lead to growth.
However, to harness the true potential, challenges stemming from regulatory divergence and legal uncertainty need to be addressed. The establishment of global standards for Islamic issues to curb multiple interpretations of Shariah principles and the strict enforcement of contractual obligations could contribute to positive development.
Raghu Mandagolathur is the managing director of Marmore MENA Intelligence, a research house focused on conducting MENA-specific business, economic and capital market research. He can be contacted at [email protected].