It has been a challenging year for both Islamic banking and the Islamic financial services sector, highlighted by continued uneven global economic growth and the ongoing regional geopolitical tensions. Regardless, many financial institutions are obligated to meet the revised capital structure. Therefore, SAUD AL NAFISI anticipates more Sukuk issuances by financial institutions in 2016.
The global Islamic financial services sector could face further pressure in terms of low demand for Sukuk issuance due to a combination of factors such as fall in oil prices, potential rise in global interest rates and contraction across global emerging markets. However, due to the gradual implementation of Basel III, many Islamic financial institutions are turning toward issuing Basel III compliant Sukuk instruments in order to meet the enhanced capital adequacy and liquidity standards. Further, there are a couple of maturities of Sukuk issued by financial institutions in 2015 and 2016 which will most likely be refinanced by a new Sukuk issuance.
Fitch Ratings said in a recent report that total new bonds and Sukuk (with a maturity of more than 18 months) from the GCC, Malaysia, Indonesia, Turkey, Singapore, Pakistan, Sri Lanka, and Taiwan declined 27% in the first half of 2015 from a year ago. Data for the first half of the year showed bonds were down 30% and Sukuk by 16%. In the second quarter of 2015, Sukuk accounted for 20% of total new issuance, marginally up from 18% in the second quarter of 2014. Global Sukuk issuance in July stood close to US$1.2 billion; however, over the year to the end of July, the overall issuance volume slipped by 20% as corporations reduced their borrowings. The sovereign issuance is down by 38% year to date, while quasi-sovereign issuance is down by 78%.
Global Sukuk issuance reached US$48.8 billion in the first nine months of 2015, down 40% from a year earlier after Malaysia’s central bank, Bank Negara Malaysia (BNM), the single largest issuer, decided to use other funding tools. In 2014, BNM alone issued about US$45 billion of Sukuk out of a total issuance of US$116.4 billion. As a result, S&P anticipates the total issuance to range between US$50 billion to US$60 billion by the end of 2015, a reduction of between 40% and 50% on last year.
BNM’s decision to stop issuing Sukuk and switch to other instruments leaves the door open to issuers such as the International Islamic Liquidity Management Corporation and the IDB to step up their issuance and provide the industry with liquidity, thereby contributing to the development of an Islamic yield curve. Aside from BNM’s decision, the market performed relatively well despite the decline in oil prices. By the 13th October, total Sukuk issuance reached US$52.4 billion, whereby 47% of the total issuance was from government institutions (266 issuances) and 31.4% comprised of financial institutions (109 issuances).
Increased borrowings by Middle Eastern banks are expected to continue into 2016 as financial institutions try to strengthen their balance sheets while regional liquidity drops amid low oil prices. Many financial institutions, such as Abu Dhabi Islamic Bank and Al Baraka, are planning to issue Sukuk mainly for debt-refinancing purposes. Financial institutions are now aiming to secure longer-term liquidity in the markets. The implementation of Basel III rules with their demands on banks to hold high-quality liquid assets will drive Sukuk growth. Financial institutions will also be looking to boost their Tier 1 and Tier 2 capital and we will see more Basel III-compliant Sukuk in the market.
A recent report suggests regional banks will need to raise around US$40 billion over the course of the next three to four years to satisfy capital requirements under Basel III. The implementation of the Basel III liquidity coverage ratio (LCR), for example, will be phased in progressively over several years across individual countries. For some countries, implementation began on the 1st January 2015 with a minimum LCR of 60% increasing by 10% a year to 100% by 2019. This graduated approach is designed to ensure that the LCR can be introduced without material disruption to the orderly strengthening of banking systems or the ongoing financing of economic activity. Financial institutions could also view Basel III as an opportunity to return to the Sukuk market or to step up their issuance.
Although Sukuk, like any other fixed rate instrument, will be affected by changes in the interest rate, massive infrastructure spending across the GCC and budget financing across several emerging Asian and African markets will continue to drive issuance. Moreover, the long-term growth and development of Sukuk will continue regardless of short-term market movements. As Islamic banking continues to grow at a faster rate than conventional banking, and therefore Islamic deposits and investments continue to grow, all this money will need to be placed and invested. Sukuk has become less complex and expensive for borrowers as the market gradually standardizes. And since Sukuk is an asset class which is now well developed and well understood globally, many financial institutions will continue to invest in Sukuk since Sukuk is viewed as an essential tool to mobilize funds.
Saud Al Nafisi is the investment officer in the Debt Capital Markets Department at KFH Capital. He can be contacted at [email protected].