Despite a strong year for the Sukuk market in 2014, general market turbulence and the decision by the central bank of Malaysia to stop issuing Sukuk has led to a weaker than expected global Sukuk market in 2015 in terms of aggregate issuance. Despite continued uncertainty looking forward to 2016, DEBASHIS DEY feels there are some potential positives if current lower commodity prices instigate an increase in sovereign issuances and, separately, the continuing implementation of Basel III continues to have the potential to lift the Sukuk market in the medium term.
Review of 2015
As at June 2015, worldwide primary market issuance of Sukuk reached US$38.6 billion, down from the US$67.2 billion seen in the same period in 2014. This points to an expected Sukuk issuance total of no more than US$60 billion for 2015, a significant decline from the US$116.4 billion seen in 2014. In our view, there are three main causes for this decline as follows.
Oil prices: A continued drop in oil prices over the course of 2015 has had a disruptive economic effect on growth in core Sukuk markets which has also led to a decline in infrastructure-related financing.
Market uncertainty: The anticipation of a potential increase of interest rates by the US Federal Reserve and the turbulence in the global stock exchanges due to the collapse of the Chinese equity markets have led to a ‘wait and see’ attitude for many investors in Sukuk over the last several months.
Pullback by central bank of Malaysia: The central bank of Malaysia accounted for approximately 35% (about US$45 billion) of the total Sukuk issued in 2014. The decision by the central bank of Malaysia to cease issuing Sukuk in 2015 has thus far had a significant impact on the total global Sukuk issuance for the year to date.
Despite this, removing the effect of the central bank of Malaysia, global Sukuk markets only saw a small decrease in performance compared with 2014. In the end, 2015 looks to present a mixed picture as the lower than expected volume of issuance is offset by some positive signs such as the continued entry into the market of new issuers (including more debut sovereign issuance) and separately, the start of the implementation of Basel III is seen by many market participants as a good opportunity to return to the Sukuk market.
Preview of 2016
One key theme for the upcoming 2016 Sukuk market is uncertainty. The performance of the Sukuk market is inextricably linked to the health of Islamic economies and as we have seen from 2015, the headwinds caused by market uncertainty and lower oil prices will continue to present challenges going forward. Nevertheless, there are some potential positives for 2016 as follows:
Potential increase in sovereign and first time issuance: Many governments in the commodity-reliant GCC countries decided to initially withstand the economic effects of falling oil prices by tapping their fiscal reserves rather than increase debt levels. Given that experts predict a subdued commodities market in the near-to-medium turn, there is some indication from affected sovereigns that they may look to the capital markets to slow the depletion of their fiscal reserves. In addition, as the pricing gap between Sukuk and conventional counterparts continue to narrow, there is a renewed interest from new sovereign and other first-time issuers who are looking to broaden their investor base and tap into the traditionally liquid Islamic market. The latter half of 2015 has seen the first-ever issuance by Oman and the trend may continue into 2016.
Basel III to continue to buoy the market: Sukuk continue to play a role in addressing the liquidity and capital adequacy needs of Islamic banks as required by Basel III. The continuing lack of high-quality liquid assets in the Islamic finance space continues to pose a challenge to compliance with the liquidity coverage ratio mandated by Basel III. Moving forward, more Islamic banks and sovereigns are expected to issue Basel III compliant regulatory capital Sukuk which will further fuel the momentum in the global Sukuk market.
Despite a significant decline in 2015 and an uncertain 2016, the global Sukuk market continues to prove to be resilient. It is possible that the dip in issuance seen in 2015 is merely a correction of the inflated figures dominated by large scale issuance out of Malaysia in the past few years, rather than a sign of a global market decline generally. The growth of Islamic finance products (including Sukuk) continues to outpace their conventional counterparts and the continued growth of Sukuk in non-core markets bodes well for the industry in the medium to long term.