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Friday, 24 October 2014

Halal finance

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Islamic capital markets have seen dramatic recent growth, with 2007's total coming in at US$46.6bn compared with just US$336m in 2000. However, the sector has not been immune to the global banking crisis, with sukuk issuance expected to halve this year. Bakyt Azimkanov reports.

Ramadan ensured Islamic markets were muted during September but, before the onset of the latest chapter in the banking crisis at least, syndication desks were confident that issuers would gear back up for the fourth quarter.

"The post-Ramadan outlook for sukuk issuance looks healthy, with about US$20bn–$30bn in the pipeline globally and growing interest in the structure worldwide," according to Mohamed Damak, a Paris-based S&P analyst.

Islamic financing as it is now known is only 25 years old, despite an illustrious history dating back more than a thousands years. In recent years it has become a significant player on the financing scene: in its recent report, the International Monetary Fund (IMF) estimated global sukuk debt at US$200bn in outstanding, with almost 80% of primary sukuk issuance coming from corporates.

As recently as the end of 2007 outstanding sukuk global issuance stood at US$90bn, according to the IMF. Issuance of structured Islamic securities alone grew to nearly US$40bn in 2007, up from US$7bn in 2004.

Last year, around half of outstanding sukuk was originated in Asia – particularly Malaysia – with much of the remainder issued out of member states of the Gulf Co-operation Council – particularly Bahrain, the United Arab Emirates (UAE) and Saudi Arabia. Europe has a growing status in this area: the first Islamic deal in Europe was structured in London in 1985, since which time the City has also cemented its position as one of the global Islamic finance hubs.

Its growing status in international financing has seen commensurate growth in the popularity of Islamic instruments, and a number of platforms are being developed outside the Middle East. Western investors now make up to 80% of sukuk buyers. The International Islamic Financial Market (IIFM) predicts the pipeline for Islamic instruments will reach US$52bn globally in 2008. By mid-September nearly 30 deals – both Islamic and conventional – had been priced in the Middle East alone, worth a combined US$15.3bn.

This success has led to calls for further development, homogenisation and improvement of Sharia-compliant instruments. Such products are already available in all asset classes, from mudaraba loan facilities to ijara asset bonds and musharaka financing. There are around 15 different types of sukuk debt.

There has also been a proliferation of ethical investing, which Sharia-compliant instruments are well placed to serve. Sharia products serve non-Muslim ethical investors well, adhering to principles that satisfy a range of ethical sensibilities. There could even come a time when the majority of investable products are Sharia-compliant, to maximise their appeal, just as meat sold in non-Muslim butchers and restaurants is typically halal, said Jane Dellar, managing director at Bahrain Financial Services Development.

The scale of the opportunity is likely to attract more Islamic banks to the UK and Europe, as Muslims increasingly strive to adopt financial instruments that accord with their faith. There are already five FSA-licensed Islamic banks in London.

Western banks are also getting in on the act. Many have created dedicated teams, or even Islamic subsidiaries: among western banks the biggest market share of sukuk bond underwriting this year belongs to Calyon, HSBC, Citi and Standard Chartered Bank; Dubai Islamic Bank tops the Middle Eastern financials list, followed by the Emirates NBD.

Growth is now projected to move beyond traditional sukuk issuers, and to new markets. Credits in around 50 countries are planning to issue Islamic instruments.

Yet the first-ever decline in sukuk issuance, expected this year as the banking crisis continues, will be a set-back for the industry. Issuance could fall as much as 50% from 2007, according to studies in Malaysia. Last year saw sukuk issuance of around US$46.6bn – a 70% increase from 2006 – while only US$12.5bn sukuk was printed in the first eight months of this year, of which nearly US$6.5bn were sold internationally, annualising to US$18.75bn.

The world’s single biggest issuer of sukuk, Malaysia, has issued around US$5bn-equivalent of sukuk this year, 20% below last year's levels. The UAE printed US$4.9bn, while Saudi Arabia brought US$1.4bn to market – decreases of 50% and 75% respectively.

Doha Bank's decision to postpone its US$1bn sukuk deal left a bitter taste among UAE investors, amid fears that the global liquidity squeeze could harm the Sharia-compliant market.

What constitutes compliance?

Meanwhile, debate continues to rage about the exactly what does and does not constitute compliance with Sharia principles, underlining the need for improved standardisation of the sukuk certificates issued by scholars and Islamic financial structures. Disagreements over which definitions to use for the umbrella of Islamic Finance has led to large discrepancies in the estimations for total sukuk issuance and volumes. Yet so far this has not undermined demand for sukuk among Muslim or non-Muslim investors.

Some estimates suggest the issuance of Middle Eastern corporate bonds alone – both conventional and sukuk – could reach as much as US$50bn in the near future. In 2007 there was a 62% increase in such issuance from the GCC member states alone.

In January, the UAE’s currency – the dirham – became one of the settlement units of Clearstream and Euroclear, thus making it possible to print Eurodirham deals. To date, 13 international dirham-denominated deals have been brought to market: three sovereign deals, four each from corporates and financials as well as four securitisation sukuk transactions.

The dirham market is strong for two to five-year issues, according to one DCM manager, but Middle Eastern blue chips are looking beyond the Gulf to secure their financing needs. This year alone credits from the region have borrowed in American dollars, UAE dirham, Singaporean dollars, Malay ringgit, Saudi riyal, Swiss francs and Japanese yen. A Korean won deal is imminent. To date, roughly 35% of sukuk have been denominated in dirham, and 33% in ringgit, compared to 13% for the American dollar.

Malaysian banking has been especially heavily influenced by Islamic banking: it boasts outstanding sukuk worth US$45bn, with assets swelling by more than 150% in seven years. Islamic issues are expected to dominate the ringgit market as Malaysia hopes to fortify its position as the number one Islamic finance centre.

Japan Bank for International Co-operation's (JBIC) attempt to issue the first Japanese sukuk in Malaysian ringgit in July 2007 did not run smoothly, but JBIC is looking at the possibility of printing about US$200m–$300m, with the most likely market being Malaysia. Toyota Motor set up its first Islamic financing vehicle last May, while at least five borrowers from the UAE are looking to raise funds through a Samurai issue.

Interestingly, however, the Islamic bond market in the world's most populous Muslim country – Indonesia – is yet to flourish, but a recent bill is set to allow the government to roll out Islamic issues. In late August it priced its maiden Sharia-compliant domestic deal, worth Rp4.7trn, just below the target of Rp5trn. It has plans for a global deal soon.

Pakistan's rupee sukuk pipeline, on the other hand, is bulging. Islamic financing is projected to overtake the conventional debt market, according to one DCM manager in Karachi, because the vast majority of its population is Muslim, and increasingly enthusiastic about Sharia-compliant instruments. In September the sovereign printed its inaugural domestic rupee-denominated Rs6.5bn sukuk of Rs10bn planned. In January 2005, Pakistan brought a US$600m five-year international sukuk to market.

The global roundup

Other entities in Asia, such as Brunei, Thailand and China, have also expressed interest in printing sukuk. The Hong Kong Airport Authority and Singaporean Government are at various stages of selling Sharia-compliant deals.

In the CIS, Azerbaijan, Kazakhstan, the Kyrgyz Republic and Russia are also developing the legislative framework within which future issuance of Sharia-compliant instruments can flourish. Russian banks are now considering employing Islamic financing tools. "Reminiscent to the first securitisation deals in the country, someone has to pioneer the Islamic issuance for others to follow," said Lyudmila Khrapchenko, director for derivatives structuring at the Alfa-Bank.

African countries such as Algeria, Egypt, Libya, Morocco, Tunisia and Sudan are keen on future sukuk exercises. Gambia debuted with a US$166m sukuk deal, privately sold in the US in 2006.

In Europe, Turkey issued sukuk last year, though a platform has yet to be developed and strong secular policies are challenging the development of the Islamic banking sector. The Saxony-Anhalt Land of Germany already pioneered with sukuk in 2004, while France, Italy and Switzerland are also thinking about developing legislative platforms to issue Sharia-compliant instruments.

In the UK, economic secretary and City Minister, Kitty Ussher, said last June that "the government favoured a 'bill-like' sukuk programme which could be fully integrated with the conventional Treasury bill programme". Should the remaining barriers prove surmountable, a rolling programme of up to £2bn of bill-like sukuk issuance will be issued over time, she added. Some British credits, such as Tesco, have already printed offshore sukuk deals.

"To a large extent the Islamic markets are insulated from the US banking crisis as most assets were placed locally. The sovereign wealth funds could be hit harder, but we will never hear about that," said one banker in Dubai.

Summer, prolonged by Ramadan in September, led to a large backlog of sukuk deals, with more structuring questions to be raised by scholars. Issuance is likely to be off the near-term agenda, as players wait for calm waters, though there will be some opportunistic issuance during windows.

Even on the conventional side, central bank governors in Saudi Arabia, Qatar, UAE, Oman and Kuwait have all said the region's banks have escaped a serious hit from the American banking crisis. In late September the Central Bank of the UAE announced it will inject Dh50bn (US$13.6bn) to the banking sector to boost dampened liquidity.

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