As part of our country focus on South Africa this week, UWAIZ JASSAT walks us through the recent landmark issuance of the nation’s inaugural sovereign Sukuk, and explores its reception from investors as well as the potential for future issuance based on the initial success.
South Africa issued its first sovereign Sukuk for US$500 million this year. The amount is equivalent to a third of South Africa’s total foreign debt issuance for 2014 so far. The fact that the Sukuk program was four times oversubscribed is an indication of the enthusiasm of investors to participate in the issuance, which is likely to encourage the South African National Treasury to use this type of investment vehicle again in the future. The sovereign Sukuk provides South Africa with the opportunity for greater diversification in its funding base and has raised interest among state-owned enterprises to investigate Sukuk as an alternative funding mechanism in the medium to long-term.
Absa Islamic Banking believes that the potential for foreign Sukuk issued in South Africa is between US$1-1.5 billion with a tenor of five years and for domestic Sukuk about US$100-200 million with a tenor of three to seven years.
Analysis of the investor community locally and internationally indicates that a ZAR (South African rand) Sukuk is likely to be taken up 50-60% by South African Islamic institutional investors and 20-30% by South African conventional investors. The remaining approximately 20% would be taken up by international Islamic investors who have an appetite for ZAR and by international conventional investors which regularly participate in domestic ZAR auctions. A small percentage is likely to be taken up by South African high net worth individuals.
Core investors in a US$ Sukuk would be South Africa’s dedicated US, UK and European investor base which are active in South Africa’s Securities Exchange Control registered US$ issues as well as the Asian and Middle East investor base and international Islamic funds. The supporting investors would be South African Islamic and conventional investors who have offshore US$ accounts.
Absa estimates that the depth of the existing Islamic market is ZAR13-14 billion (US$1.16-1.25 billion), which is expected to grow as new products are introduced. The liquidity analysis conducted by Absa shows that the Islamic investor base is split evenly between banks and asset managers.
Anticipated growth in the ZAR Sukuk market is expected to be driven by overall growth in the Islamic financial market and an increase in assets under management and by the reallocation of assets from equities, cash, exchange traded funds and real estate into the fixed Sukuk market. The domestic investor base would include large, mid-sized and smaller investors as well as Islamic funds.
The Absa survey shows that among institutional clients, the level of understanding of the Sukuk market is still developing. Most institutional clients are aware of the Sukuk Ijarah structure and almost all see the development of the domestic Sukuk market as positive for South Africa. The domestic Sukuk market is expected to grow in both South Africa and other African territories. Institutional investors indicated that they would be likely to invest in domestic Sukuk via both conventional and Islamic funds. The majority of institutional investors indicated a preference for a domestic rather than a US$-based Sukuk. The most important factor in decisions to invest in Sukuk would be pricing and most investors would require the Sukuk to be rated. The tenor of the Sukuk was not seen as an important factor and the range of preferred ticket size was broad. Expectations were that a domestic Sukuk would be priced at a slight premium to conventional bond pricing.
Some sovereign Sukuk issuers have accessed both the international and domestic Sukuk markets, which have provided access for Islamic investors to both US$ and local currency-based Sukuk.
A ZAR Sukuk priced off the South African existing domestic bond curve is expected to have tenors ranging from two to eight years. A premium on yields may be required to compensate conventional investors for the structured nature of Sukuk and the generally lower levels of secondary market liquidity due to the buy and hold nature of the investor base. It is expected that South Africa would only require a pricing premium if targeting a larger issue size.
In summary, the benefits of a Sukuk market for South Africa would be additional liquidity instrument for Islamic banks, especially fully-fledged Islamic banks and the provision of a money market instrument for provident and pension funds which would deliver a much higher yield than current tools. It would also support growth in the short and long-term Takaful market by providing a high-yield investment avenue. Asset managers would be enabled in the development of both fixed income and balanced funds and it would also enable retail and institutional investors to produce higher yields. For issuers such as government, the Sukuk market offers a diversified form of funding, with credit rating being an important factor.
Uwaiz Jassat is the acting head of Islamic banking at Absa Islamic Banking. He can be contacted at
[email protected]
.