Familiarity breeds content
This year marked a recovery for the Middle East sukuk market, with record issuances in the Islamic debt securities, the highest since 2007.
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In the first half of 2012, Middle East entities issued US$13bn of sukuk deals, an increase of 136% per cent compared with the whole of 2011 when US$5.5bn was raised, according to Dealogic. In fact, in the first six months of this year, Middle East companies have raised more than the combined value of issuances in 2010 and 2011 from sukuk sales.
The number of deals has also risen. In the first half there were 24 issuances, compared with just 13 last year. This averages more than 10 in each quarter, compared with an average of two deals per quarter since 2008.
“Sukuk remain the most heavily used source of financing for Middle East and North Africa entities,” said Mohammed Al Tuwaijiri, head of global banking and markets at HSBC Middle East and North Africa (Mena).
Across Mena, sukuk deals have accounted for 65% of all issuance so far this year, up from 21% in 2011 and 17% in 2010.
Investor interest in the Islamic finance sector appears to be at an all-time high since the credit crunch of 2008 that saw issuance decline.
With the eurozone debt crisis, increasing oil prices and high levels of deposits in the banking system, local investors have managed to build up large reserves of liquidity, which are now finding its way into the sukuk market.
Foreign and conventional investors have also turned their interest to sukuk as a way of diversifying their investments. These Islamic products are generally seen as a safer investment since they are backed by real assets. Following the 2008 real estate crash in Dubai, sukuk issuance and demand fell drastically, but interest has picked up this year and now an increasing number of sukuk deals are being placed abroad.
This increase in investor interest is also a result of higher yields than similarly rated assets elsewhere as seen earlier this year. The difference in price between sukuk and conventional bonds has evened out and the yield on sukuk issues has fallen to about 3% since August from about 4% according to the HSBC/Nasdaq Dubai sukuk index, making them more attractive to issuers. The volatile difference in pricing between the two instruments numbered 25bp–40bp earlier in the year, benefiting sukuk issuers, but the difference has shrunk to about 5bp–10bp shrinking the overall pricing advantage of sukuk deals.
A recent report by Ernst & Young’s Global Islamic Banking Centre of Excellence suggests that global demand for sukuk will grow three-fold from US$300bn to US$900bn by 2017. While Malaysia continues to dominate the sukuk market, Middle East entities are expected to help accelerate this growth. In the first half of this year, Malaysia accounted for 70.5% of total global sukuk issuance, followed by Saudi Arabia with 13.3% and the UAE with 6.2%.
As the Islamic banking industry grows and appetite for Sharia-compliant instruments rises with it, sukuk markets are expected to benefit. Demand is expected to come from Islamic financial institutions, fund managers and rich individuals.
Sukuk supply in the Mena region has grown by 6.1% despite no issuances in the first six months of this year.
The rise is down to the number of conventional companies opting to issue sukuk. Al Tuwaijiri identifies two reasons for this trend: “The pricing achieved by sukuk is more favourable, but second and more importantly, issuing sukuk increases the number of buyers that can invest.”
With conventional bonds, only conventional accounts can buy them, but one of the main advantages of sukuk is that both conventional and Islamic accounts can buy them.
“Historically, it was often thought that sukuk and conventional bonds simply co-existed, with Islamic companies opting for sukuk issuance, and conventional companies issuing bonds. This has changed,” said Al Tuwaijiri.
Confidence in the Gulf soared this year as three Dubai government bodies Jebel Ali Free Zone, Dubai International Finance Centre Investments and a unit of Dubai Holding managed to repay or refinance their debts. This marks a stark contrast to 2009 when fears over property developer Nakheel almost caused the Dubai government to default on a US$3.5bn sukuk issue.
In July Dubai enjoyed a confidence boost from Emaar Properties’ US$500bn seven-year Sukuk that attracted orders worth US$4.65bn from investors.
In January Saudi Arabia’s General Authority of Civil Aviation (GACA) issued the biggest ever single-tranche sukuk worth SR15bn (US$3.99bn), to fund Jeddah’s new King Abdul-Aziz International airport. The offer was three times oversubscribed despite being open to local investors only, highlighting the heightened interest among investors. The sukuk, guaranteed by the Ministry of Finance, has a 10-year tenor with a rate of 2.5%.
Saudi companies have continued to dominate with sukuk issuance from Saudi Electricity Company in March attracting orders of US$17.5bn for a sukuk worth US$1.75bn, Almarai, a local dairy company sold a SR1bn seven-year sukuk in the same month and petrochemicals company Sipchem issued a SR1.8bn sukuk while Banque Saudi Fransi announced a US$2bn sukuk programme in April.
All eyes will be on Saudi Basic Industries Corporation which gained approval from the Capital Market Authority in 2011 for US$5bn worth of sukuk issuance.
Not to be outdone by its large neighbour, the small state of Qatar beat GACA’s sukuk earlier in July with a US$4bn issuance of its own, becoming the biggest international sukuk transaction, bringing much liquidity to the market. The dual-tranche transaction attracted more than US$25bn from investors across the world, keen to buy into the country’s first issuance in nearly 10 years. The issue was oversubscribed six times and achieved significantly low rates of 2.09% and 3.24% for both the 5.5-year and 10.5-year tenures.
Middle East investors accounted for 58% of the five-year tranche, reflecting a wider trend for their interest in shorter debt. Generally Middle East buyers make up about half of sukuk investment in new issues.
European investors made up 20% of Qatar’s five-year tranche, Asia with 18% and US offshore investors at 4%. By investor type, banks took the lion’s share of Qatar’s new 2018, with 61%. Fund managers received 24%, private banks 7% and others 8%.
The 10-year tranche was distributed in similar fashion with 50% going to Middle East investors, 23% to Europe, 21% to Asia and US offshore accounts made up 6%. Banks took 54%, fund managers 33%, private banks 9% per cent and other investors took 4%.
Central Bank Local Issuances (CBLI), debt securities issued by GCC central banks in local currencies with maturities of less than one year also enjoyed a boost in the first half of this year. A total of US$13.8bn was raised by the central banks of Kuwait, Bahrain, Qatar and Oman during the first half of 2012. Kuwait’s Central Bank raised the most with US$6.5bn, more than 47% of the total CBLI through 14 issuances.
While many of the deals seen this year were those held over from 2011 as a result of the Arab Spring and general market uncertainty, the momentum is still strong. One of the biggest approved this year is a US$1.5bn sukuk programme from Qatar Islamic Bank.
“The growth of sukuk does not seem to show any signs of weakening any time soon. Issuers are growing ever more comfortable with sukuk structures and it is likely we will see new entrants to the market over the next few years,” said Al Tuwaijiri.
The Islamic finance market is set to enjoy a boost as both Egypt and Tunisia’s new Islamist governments seek to establish a robust a Sharia-compliant industry. Egypt is already laying the regulatory foundations for sukuk issuance, which could aid the country’s economy.
Demand vs issuance
Yet despite the recovery, there are still setbacks in the market. While issuers and investors have become more aware and comfortable with Islamic financing in general, demand outstrips the supply of new issuance.
“[The] absence of a global standardised sukuk trading platform open for all Islamic and conventional financial institutions is a major factor hindering growth,” said Ashar Nazim, Mena Islamic Finance Services Leader at Ernst & Young.
The call for standardisation across Islamic products is echoed by investors and issuers alike.
“The industry could benefit from standardisation across many products. For instance, when products are structured, they are built for a specific purpose and there are still no ‘standard’ Sharia-compliant products in the same way as there are conventional ones,” said Al Tuwaijiri.
Since each structure requires the approval of scholars in order to ensure it is Sharia-compliant, it can lengthen the time of the product issuance. Sukuk issuance platforms are also limited to a few Islamic institutions which also restricts the growth of the industry.
“The Islamic finance industry is still evolving, with new structures being introduced every other month. This means products can take more time to market than well-established conventional products,” said Al Tuwaijiri, but it seems investors have no problems with waiting.