There has been talk aplenty of the importance of sovereign Sukuk, and almost every country with an interest in Islamic finance has claimed plans to originate. However, despite the vocal enthusiasm on almost every side, few countries actually seem to get around to an actual launch. Are they just paying lip service to the idea in order to boost the profile of their domestic Islamic finance sector and generate political mileage, or do genuinely good intentions simply sputter when faced with the realities of Sukuk issuance?
Close but no cigar
Numerous developing nations have shown interest in sovereign Sukuk to raise funds and boost the development of Islamic finance, but many of these have made enthusiastic announcements which subsequently fade quietly away. Jordan, Palestine, and Turkey have all expressed interest yet no Sukuk has as yet emerged. A number of African countries including Nigeria, Senegal, Kenya and Egypt have also announced plans to launch but these issuances will take considerable time to come to market (if they ever do) as most of these nations still need to put in place the necessary infrastructure and frameworks before they can issue, while Sudan’s planned US$300 million issuance was delayed in June this year. Tatarstan and Kazakhstan have both announced their intentions, but Kazakhstan has already delayed its issuance and although Tatarstan signed an MoU in January with Malaysia-based AmanahRaya and Kuwait Finance House Malaysia to develop its first Sukuk issuance, nothing has been heard from them in the subsequent three quarters. Even countries with relatively small Muslim populations like the Philippines, Malta and South Africa have jumped on the bandwagon with announcements of interest, which have subsequently fizzled out like damp squibs.
Europe has fared little better, with no significant government or quasi-government Sukuk issue since the EUR100 million (US$141 million) issue in 2004 by the German state of Saxony-Anhalt. France has made considerable noise but so far nothing concrete has emerged, although some market participants believe that because of its close links with north Africa and its large Muslim population, and its recent move to license Islamic banks and develop its Islamic finance sector, it is the best-placed European country to issue. However, France is fiercely secular and plans for developing Islamic finance have proved slow and problematic. The country is now thinking about promoting Islamic banking without using the term ‘Islamic’ in order to avoid religious sensitivities, which does not bode well for the successful development of Shariah compliant transactions. Plans for a EUR1 billion (US$1.41 billion) corporate Sukuk were announced in 2009 but delayed due to ‘technical challenges’ and no further news regarding Sukuk, corporate or sovereign, has been heard.
Twin peaks
In terms of European Sukuk, the UK and Luxembourg are the two front-runners. The UK has been considering sovereign Sukuk since 2007, and announced plans in 2010 for its first issuance which reached the final stages before being cancelled over fears that Sukuk did not represent value for money. A tense political climate in the run-up to elections, combined with concerns over a lack of demand after a weak uptake of two treasury bonds issued around the same time did not help the cause, and neither did slowing economic expansion and a considerable budget deficit. However, the Islamic finance community in London vehemently opposed the cancellation and there were mutterings that the government had never intended to issue, but instead used the announcement to promote itself as an Islamic finance hub and gain favour with its Muslim population. One banker called it: “A lot of dithering, dithering, dithering, and then nothing,” while Khalid Howladar (below), a senior credit analyst at Moody’s, suggested at the time that: “The UK’s initial drive to issue Sukuk was more politically and socially driven versus economic,” and that given the subsequent stresses on the economy, “such motives are now secondary to the need to raise funds efficiently”.
According to Roger Wedderburn-Day, a senior partner in international capital markets at Allen & Overy, the UK was upfront about its motives from the start. “The stated reasons for the UK issuing were always to encourage the development of the Islamic finance sector,” rather than for any economic motive, therefore an unfavorable economic environment understandably impacted the issuance.
Luxembourg, the other major Islamic finance center in Europe, recently deferred its plans for purportedly very different reasons. While the UK cited economic pressures the governor of Luxembourg’s central bank, Yves Mersch, in June this year said that the economy was in fact doing so well the government had no need of additional funds and therefore would not be issuing any imminent Sukuk. However, again there are rumors that other factors could be at play. Fernand Grulms, CEO of Luxembourg For Finance, has reportedly said that the sovereign Sukuk was in fact deferred because they could not find the right underlying assets.
Marc Theisen (top), the founder and senior partner of Theisen Law in Luxembourg, believes that there are numerous reasons why Luxembourg should launch “a small Sukuk – maybe US$100, 150, 200 million”. Sukuk launched this year in Malaysia and the Gulf have been significantly oversubscribed, suggesting high demand. A sovereign Sukuk would expand the field of fundraising available, and widen the investor space both for Muslims and non-Muslims interested in ethical investments – vital for Luxembourg, which has positioned itself as a hub for Shariah compliant investment vehicles. And importantly, he notes that the political motive is also there: “If you start something you must finish it 100%…and if you want to be a leader in Islamic finance you must at least seriously consider the opportunity of launching a Sukuk.” Theisen believes that “for the moment there is absolutely no chance – either in the UK or France – of a sovereign Sukuk,” but that “I would hope Luxembourg would be the first country in Europe to issue.” Given that it already has the necessary structures in place, it certainly looks like the most promising market in Europe at the moment.
Money makes the world go round
Yet despite the numerous motives cited, at the root of every delay or cancellation seems to lurk the same issue: cost. Sukuk origination (at least to start with) is unavoidably more expensive than conventional bonds, especially for countries that do not already have a well-developed Shariah compliant financial, tax, and legal infrastructure. Theisen explains that: “In Luxembourg it is the same problem as in England, as in France – issuing a sovereign Sukuk for the first time is expensive. Everything done in a Shariah compliant way is automatically a surplus cost. But if you launch a Sukuk you have to check so many legal and tax aspects. The launch especially of the first Sukuk is very expensive.” The start-up fees involved in setting up the necessary Shariah boards, regulatory requirements, auditing fees etc. are understandably offputting for governments struggling to haul their countries out of the recession.
Supply and demand
From the perspective of Sukuk as a source of political capital, it is obvious that a one-time issuance would be an expensive undertaking. Many have also expressed concern that the investor demand is not yet there to guarantee a successful issue. Theisen asks: “Do we have the investors in Europe yet? I don’t know, although I hope so. But will there be investors from the Gulf or from Malaysia – will they come to Luxembourg and invest in a Sukuk here? They have so many excellent opportunities in their own countries – do they really need to go abroad?”
However, given the volatile economic conditions, institutional and high net worth investors are seeking safe havens and sovereign Sukuk represent a secure, asset-backed investment. Although the global Sukuk market is currently dominated by sovereign issuances it is still a tiny market, with many new issuances coming from countries without high credit ratings, and in reality demand is likely to far exceed supply, especially for offerings from AAA-rated originators. Noripah Khamso (top), the CEO of CIMB-Principal Islamic Asset Management in Malaysia, said in June that she was baffled by the attitude of potential European originators as her company alone had over US$250 million to invest in sovereign Sukuk but could not find enough to invest in and is currently having to turn down new orders from clients due to a dearth of product.
For developing countries such as Egypt and Kazakhstan with high Muslim populations and a burgeoning Islamic finance sector, small Sukuk issuances represent a useful way to raise funds but can be understandably prohibitive in terms of cost and infrastructure. However, for highly-rated European countries a debut sovereign Sukuk could represent a long-term investment offering access to a wide market of hungry investors. For western economies keen for a bite at the Islamic finance pie, perhaps it is time to stop making excuses and put their money where their mouths are.