The series of IFN Roadshows have highlighted a number of systemic issues across the whole of Islamic finance. Perhaps this comes as a bit of a surprise given the differences in the advancement of the local markets from Morocco to the Commonwealth of Independent States (CIS) region to Singapore and Bangladesh. Similar themes have arisen as the discussion around opportunities, and barriers, is remarkably consistent. What changing market trends will allow for new Sukuk issuers to emerge? Will new government-issued Sukuk drive innovation in the respective local markets? And will technology change the landscape for new issuers? Democratization means both new issuers and new investors — will conventional investors increase their exposure to Sukuk? The questions underpin much of the discussion across the entire series. DR SCOTT LEVY writes.
Every month sees more government initiatives to establish Sukuk as a funding mechanism. The capital markets exist specifically to provide global liquidity; the challenge is for new entrants in the market to establish a regular issuance of products. Introducing new domestic legislation to allow for Sukuk issuance has to go hand in hand with the government’s own fundraising initiatives to send a clear message to the domestic markets. Take Bangladesh as an example. The government’s first-ever Sukuk issuance in early 2021 is at odds with the central bank rules which prevent foreign capital investment via debt. This makes no sense; Sukuk are not debt and yet the central bank rules lag the capital market developments, creating discordance. Harmonizing the rules to allow for the fast-growing corporate market (or even domestic financial institutions) to tap the international Sukuk marketplace would be expected and yet this is pending. Government initiatives will bring some positive awareness to the global investor marketplace but it will take additional efforts to make an impact at the corporate and institutional levels.
Government policy support for issuing Sukuk is of course important. The real effort around what could be called ‘democratization’ comes from the enormous opportunities which are represented in providing capital to the real economy. With so many new entrants to the market already in 2021, quantifying the potential size of the growth of the market in 2021 is impossible. New mid-sized corporate issuers from Bangladesh, CIS, Morocco and Pakistan are all possible. The economies are solid; what it takes is some corporate issuers to drive a new agenda.
Fintech and blockchain continue to be hot topics but what is the role for businesses with this focus in increasing the global Sukuk issuance market? To be honest, it is too early to tell. It is early days for the businesses which have emerged in markets as diverse as Canada, the UK and across the GCC and Malaysia. The main problem is where are the issuers? Platforms which are proposing to offer a wider investment choice have to have a choice of investments. The barriers to entry remain and if the potential issuers are going to consider either a tech platform or traditional capital markets, the choice is easy. The biggest impact (for both job creation and market access) will be among mid-market corporates and financial institutions and established businesses looking for new liquidity.
Fintech companies will not be able to assist in issuing perpetual Sukuk to improve the balance sheet of mid-tier financial institutions. Blockchain will not help an established Bangladeshi corporate raise capital in the international marketplace. That being said, both technologies might be useful in accessing the retail pension market for Islamic investors, for example. The bulk of capital flows and the efficiency of the existing capital markets are more than sufficient to handle an explosion in demand of Sukuk issuance. The efficiency of current clearing and settlement arrangements (Euroclear and Clearstream to start) is not under threat (yet). To this end, it will be interesting to see where new platforms can attract capital from (most likely from high-end retail clients) but these take time to develop, have the hurdles of regulatory sandbox regimes to survive and the cost of acquisition of new clients is as yet unknown. At the end of the day, tapping into a global investor community has to be compliant with both old-school settlement systems as well as traditional investment due diligence, Fatwas and analysis of the underlying business. Technology will not change this. What will undoubtedly have an impact on improving Sukuk liquidity is expanding beyond the traditional financial institutions and limited mutual funds into a wider investment universe.
Sukuk issuers can — and have — benefit from a focus on the pure ethics of the transactions. There are examples in the market where conventional investors have invested in Sukuk issuers which have moved toward using terminology aligned with the United Nations Sustainable Development Goals (SDGs) and/or environmental, social and governance terminology. ‘Delabelization’, as it could be referred to, has been necessary for large segments of the conventional debt issuance spectrum post the global financial crisis. Public, not retail but even among professional investors, perception of SPVs or securitization has shifted. Conventional issuers have found alternative terms for traditional investment banking structures with remarkable ease.
Sukuk issuers should ensure that they align their proposition to the trendier terms associated with the SDGs. The ethical nature of the transaction is unarguable; however, conventional investors are not aware of the natural overlap between Shariah law and the SDGs in many aspects. As the weight of conventional money continues to search out investment opportunities, Sukuk issuers have already seen some early indications of the success of delabelization. To take this further, there is no reason why Sukuk issuers need to dedicate as much of their marketing material to the intricacies of the nature of the transaction (even as simple as a commodity Murabahah may confuse a conventional investor into thinking they are investing in commodities directly). The business and cash flows should stand on their own; coupled with an SDG angle, Sukuk issuers can penetrate the broader and deeper investment universe.
Most of the IFN Roadshows talked about potential. Even Singapore has not begun to capitalize on its market position. More governments are trying to set the pace for domestic markets by issuing Sukuk for the first time. The costs of issuance should continue to fall as technology and market opportunity create more efficiencies for new issuers. New markets and new investors should combine to increase the efficiency in the market and result in a subsequent reduction in cost. The cost of capital will not fall because new issuers will have a hard time benchmarking their offerings; there has only been one Bangladeshi corporate (the Deshbandhu Group) which issued a Sukuk facility but more should follow. And this is just the start as new providers and new technology (which could include some of the current new blockchain marketplaces) open new markets. Trends in the conventional debt capital markets can also bring positive lessons to new issuers.
As at the end of February 2021, institutional investors continue to accumulate ‘dry powder’ looking for the right mix of risk and return. Short-dated instruments are in short supply; issuers like the International Islamic Liquidity Management Corporation, Al Waseelah and the Central Bank of Bahrain should see increased competition for short-dated certificates. Assets like supply chain finance continue to consume capital but there is a shortage of issuers. Development banks which offer technical assistance should include more outcome-based support (not just drafting new laws but actually providing some support for local and international issuance). The COVID-19 crisis has increased globalization and flattened the market, with more capital connecting with more businesses on a broader basis than ever before. Who would have imagined doing a global roadshow for a US$250 million issuance? Video calling makes this possible.
The democratization of Sukuk issuance can bring systemic changes to many local markets as investors look at sustainability, ethical investing and most importantly, impact investing. The common positive theme across the IFN Roadshows shows how much interest there is. The opportunities for Sukuk issuance in 2021 and beyond are as bright as they have ever been.