The global Sukuk market remains an increasingly important segment of the global Islamic finance industry with Sukuk having established itself as a viable source of funding for general corporate purposes, sovereign budgetary and fiscal requirements, project finance, capital adequacy purposes, asset finance, short-term liquidity management and more.
The fact that issuers of Sukuk are able to increase liquidity and diversify their funding base by accessing pools of Islamic capital, while also remaining attractive to conventional investors who understand the product and are therefore able to invest in it, means that it remains an attractive financing option for many borrowers.
The industry has continued to develop and mature and we have seen increasing levels of innovation with the industry benefiting from the continued support of the more traditional market participants in developed Islamic markets, particularly in Southeast Asia and the Middle East, as well as from new market entrants.
Review of 2021
Despite 2020 being a difficult year across the globe, particularly following the effects of the global COVID-19 pandemic, it marked a record year for global Sukuk issuances with the value of global issuances reportedly hitting approximately US$175 billion.
Overall issuance levels in 2021 are not expected to reach the same record-breaking levels as in 2020 as fiscal deficits and other funding requirements reduce coming out of the pandemic and global oil prices remain high.
AAOIFI compliance in the UAE
One noticeable trend in the Middle East in particular this year has been a reduced number of Sukuk issuances as the market comes to terms with the effects of the direction by the UAE Higher Sharia Authority that any UAE licensed financial institution that participates in a Sukuk transaction in any capacity (whether as issuer, arranger, underwriter or investor) must ensure that such transaction is compliant with AAOIFI standards, including but not limited to the recent AAOIFI Standard 59 on the ‘Sale of Debt’ (Bai al-Dain).
The asset-based Sukuk product has rightly or wrongly always been viewed by market participants as akin to an ‘Islamic bond’ bearing the same fixed income characteristics as a conventional bond.
However, in order to make such transactions more compliant with some of the AAOIFI standards while maintaining the same fixed income characteristics desired by market participants, additional features have been structured into the transactions making an already complex product even more so.
In some instances, the gap between the resultant transactions and the fixed income features that are desired cannot be completely closed, leading to a departure of such Sukuk structures from the commercial profile of a traditional fixed income instrument.
This has had a significant impact on issuance levels where there would have been any involvement from UAE financial institutions.
One of the other trends worth mentioning over the past year has been the increasing relevance of environmental, social and governance (ESG) and sustainability principles to the Sukuk market. This is consistent with the overall momentum that ESG and sustainable financing has been gaining more generally among the global financial community.
Given the consistency between ESG and sustainability principles and Islamic finance as an ethical form of financing, as well as the increasing importance that the investment community has been placing on the deployment of capital in a more socially and environmentally conscious manner, it is perhaps not surprising to see this global trend continue to play out in the Sukuk market as well.
Preview of 2022
2022 will represent another interesting year for the Sukuk market in general. The funding
requirements of many issuers will be partly dictated by the way in which economies begin to recover from the effects of the global COVID-19 pandemic.
With a number of notable maturities expected in 2022, many of which will need to be refinanced, we expect 2022 to be another solid year for the Sukuk market, both in terms of domestic/local currency issuances as well as international cross-border issuances.
In the Middle East, it will be interesting to see how the market continues to adapt to the requirement to make transactions more consistent with the AAOIFI standards. At the time of writing, the market is far from settled.
There is a large disparity between investor demand for highly rated asset-based Sukuk transactions that continue to deliver fixed income-based returns and the level of issuance at present.
Whether investors continue to view many of these transactions as equivalent to a commercial bond in terms of its commercial profile or whether the additional transaction features being introduced to many of these deals to ensure AAOIFI compliance mean that either investor confidence in the product begins to wane completely and/or the pricing of such transactions make them undesirable from a commercial perspective remains to be seen.
We otherwise expect the trend toward Sukuk structures embracing more socially-aware investment to continue through 2022 and beyond as well. This is a theme that will become increasingly important to the global financial community going forward rather than something that can be expected to lose its appeal.
The increasing importance of the domestic and international capital markets to the global financial industry and the increasing appeal of Islamic finance are two factors that combine and will ensure the continued development of Sukuk markets across the globe.
While there may be occasional headwinds and factors in certain markets that may affect parts of the market on a temporary basis, we believe that the Sukuk markets as a whole will overcome all of these factors over time and the upward trajectory of the market in the long term looks set to continue.
Gregory Man is the global head of Islamic finance at Bird & Bird. He can be contacted at [email protected]