Islamic finance is systemically important in many jurisdictions including the GCC and Malaysia and is growing in the wider regions of Middle East, Asia and even Africa, where there is significant potential and demand for infrastructure Islamic financing. In this article, BASHAR AL NATOOR takes a look at Sukuk infrastructure financing.
There is actually an infrastructure requirement that could be up to hundreds of billions of dollars a year in additional financing, with primarily young and growing populations and with investment requirements in infrastructure at the gauge of trillions in the years ahead.
However, in reality, 2015 has been no different to previous years in this area, where we have seen very limited activity in relevant regions’ infrastructure bond financing, let alone Islamic finance and Sukuk.
This can be largely attributed, especially in the GCC, to the reliance on government and the public sector to undertake such project funding, supported by high reserves and to a lesser extent banks as the traditional providers of easy debt finance for infrastructure projects.
Furthermore, infrastructure investment has inherent substantial investment risks due to the technical complexity of the projects, the long-term investment horizons and the typical size of the transactions. Regional factors also add to the uncertainty of the macroeconomic environment, regulatory reliability and political stability.
With the recent weakening in oil prices, declining sovereign reserves and liquidity in the financial systems in general, the equation could now change and infrastructure financing could receive an injection that could ignite expectations of GCC governments reverting to the market to seek alternative forms of funding for long-term infrastructure projects. This could include public-private partnerships (PPPs) that could be used to mobilize significant infrastructure investment needs in many sectors. With several banks withdrawing from this long-term business field or becoming more selective, Sukuk and bonds have become a viable option.
Infrastructure projects may eventually be a key source of Sukuk issuance due to their asset based or asset-backed nature, that in concept make it compatible to build highway networks, ports and other infrastructure projects.
By using Sukuk Istisnah (a form of financing under which a financier commissions the construction or manufacture of an asset) or Sukuk Ijarah (common form of Islamic project finance structures), this may make arranging deals simpler and potentially more attractive to investors, particularly as the structure is fairly compatible with traditional project finance. However, sovereigns may not be willing to adopt such structures if they risk losing control of the asset or if they do not have the necessary regulation and legislation allowing them to do so. This would result in more work to find an acceptable legal structure or the introduction of new regulations.
Although structures could be found, it would take longer to achieve and may see a slower take-up, especially as innovative structures would have to be approved by a Shariah board, which assesses compliance with Shariah. A transparent framework that investors, issuers and scholars are all comfortable with and which makes clear the rights of all the stakeholders should help attract a significantly wider investor base that would be needed for major infrastructure projects.
These challenges may lead to a longer time frame and higher costs than more established forms of infrastructure funding, at least until a standardized framework is established. However, several important trends could provide the necessary impetus for the development of infrastructure Sukuk. These include growing government support for Islamic finance, increasing acceptance of Sukuk and large investment and financing requirements in the GCC, Turkey, Asia and other emerging market projects.
As well as the G20’s initiative, other bodies are also taking steps that may help. These include the IDB’s and the Asian Development Bank’s reported efforts to provide technical assistance and credit guarantees to member countries that want to fund infrastructure projects and the IMF’s creation of a working group to build expertise in Sukuk.
Infrastructure long-term issuance could be a positive development for the wider Islamic finance industry as long-term Sukuk issuance can be particularly attractive to Islamic banks, Takaful companies and Islamic and regional investment funds that have been suffering from the limited long-tenor assets to match their long-tail liabilities and are well protected against inflation and less correlated with the financial market cycle. Some of the challenges for such institutions, however, include possible higher risk charges and their lack of experience with infrastructure investment.
In the GCC, with a less developed financial sector and regulations still being built for PPPs and Islamic finance, 2016 could be a promising year but not yet a quantum leap in Sukuk and bonds infrastructure financing. For the medium term, we still expect the GCC’s Sukuk and bond markets to continue to develop with issuance from the broader range of entities accessing capital market funding in the longer term.