In what has been a difficult year for emerging markets (EM) fixed income, JAMIL MUFTI is of the view that the lack of issuance has helped support the Sukuk market as demand continues to outstrip supply. Adding to that is the low-beta nature of the Sukuk market due to the stickiness of buy and hold Islamic investors.
There have been a number of external shocks, most of which can be attributed to the anticipation of a rate rise in the US. The fear of a potential rate rise in the US has spooked market participants on both sides of the fence, investors and borrowers. On the supply side, issuers are worried about the uncertainty surrounded by the timing of a rate rise and the volatility arising from such an unknown variable. The demand side has been affected by apprehension toward EM fixed income while sovereign wealth funds of oil-exporting countries have reigned in cash as revenue from hydrocarbon sources decrease.
Review of 2015
There has been a preference to issue Sukuk in EM currencies recently as opposed to US dollars. This has been due to the appreciation in the US dolar versus the EM foreign exchange thereby inflating the hard currency debt load of EM issuers as their currencies weaken. In the GCC, there has also been a preference to tap the local loan market, a trend we have seen for some time now, as liquid banks are willing to lend at cheaper rates to regional institutions as the cost of capital remains low.
Staying on the subject of issuance, there has been an increase in ethical deals, with two issuers this year being World Bank-related: the International Finance Facility for Immunisation, which funds vaccinations, and the International Finance Corporation, which helps private sector development in developing countries. The IDB has also been a regular issuer over the years with no exception this year, issuing a five-year Sukuk, helping liquidity in the Sukuk market as well as funding various programs in developing Muslim countries.
Sovereigns have helped widen the scope of the Sukuk market. Last year, a number of debut issuances from non-Muslim nations – including the UK, South Africa, Luxembourg and Hong Kong – showed the investment community that Sukuk is a good way to diversify a borrower’s funding source and widen the investor base. In fact, Hong Kong tapped the market again this year, this time issuing a Wakalah structure which is not as asset-heavy as the Ijarah structure they used in last year’s issuance to provide a benchmark for corporates.
In terms of innovation within the Sukuk market this year, the Sukuk by Emirates Airlines stands out as it was the first Sukuk to be backed by an export credit agency (ECA), namely UK Export Finance. ECA-backed structures allow issuers with a low or no credit rating to receive a credit enhancement therefore lowering their borrowing costs.
As alluded to earlier, the Sukuk market has weathered the volatility in the markets this year and, at the time of writing, returned 2.23% as measured by the Dow Jones Sukuk Index, compared to a return of 1.31% for the Bloomberg Emerging Market Composite Bond Index. High-grade Sukuk have performed well due to a bid for safe haven assets as well as a positive credit move on the back of good sets of financial results out of the GCC, particularly the regional banks.
Preview of 2016
Although issuers have been apprehensive this year due to uncertainty surrounding a rate decision in the US, the Federal Open Market Committee (FOMC) has mentioned that the pace of hikes will be gradual which has flattened the rate curve and should help allay fears of tightening monetary policy hindering growth in the US and to a certain extent borrowers of US dollar debt. In fact, certain EM central bankers were reported to have said that the FOMC should hike sooner rather than later to dispel the volatility in the market. Sukuk issuance could see an increase next year as oil-exporting nations look for a bottom in the oil price weakness, at which point an increase in capital expenditure could be warranted. Also, GCC local rates have been slowly increasing recently, which should encourage issuers to tap the Sukuk market in order to diversify their funding base. As well as more issuances, there should be more clarity surrounding monetary policy in the US which could increase trading volumes as directional views are implemented.
The Sukuk market has grown a lot over the years but still remains a niche market. However, there are a number of ways in which to expand the depth of the market, with the key theme being education. The public should be informed about the availability of Islamic and ethical pension alternatives while issuers should be told of the wider investor base as conventional as well as Islamic investors can participate in Sukuk issuances.
The oil price weakness has slowed the GCC primary market somewhat, but the market has benefited from geographic diversification as issuances from Asia have helped to hedge to some degree the credit move from a lower oil price.