The most significant industry trend to date this year has been the resurgence of the Islamic bond (sukuk) market. After a brief setback in 2010, funds raised through global sukuk issues in 2011 stood at $44.7bn in September. But sukuk issuance is still dominated by sovereigns from Asian and Gulf markets and remains concentrated in certain sectors. Four industry experts look at what needs to be done to encourage participation from corporates and facilitate issuances in a wider range of currencies.

Round_table_panel

The Panel

John Sandwick, a Geneva-based specialist in Islamic wealth and asset management

Waleed Al-Omar, director for the Middle East and north Africa region, Bank of London and the Middle East

Emad Al-Monayea, vice-chairman and CEO of Kuwait’s Liquidity House, a subsidiary of Kuwait Finance House

Mohammed Dawood, director of global capital financing at HSBC Amanah

Q: The sukuk market is still heavily weighted toward only a few issuing countries – but predominantly Malaysia, and 78% of all sovereign and quasi-sovereign issuances in 2010 – and 63% of cumulative amounts over 1996 to 2010 – originated from Malaysia. However, with investors now keen to avoid exposure to the eurozone and American debt crises and new Islamic funds located in the Gulf and south Asia proving stable, do you expect to see greater internationalisation of sukuk issuance and investment in the coming years?

John Sandwick: I believe we will very likely see a wave of sukuk issued from first the US and then Europe. There are thousands of bonds coming up to maturity in the coming 24 months in the US and in western Europe, among them bonds that are backed by solid investment-grade credits. These could easily be converted to sukuk if there was sufficient interest among origination teams at major banks.

We already know that there is more than $1000bn in assets in the global Islamic banking system. With not much more than $100bn in sukuk outstanding, one can already see a huge shortage in the supply of sukuk. If one were to say a ‘normal’ distribution of Islamic banking sector assets would be 40% into fixed-income instruments, then you can easily conclude immediate sukuk demand should be at least four times existing supply.

Waleed Al-Omar: It is important to note that most Malaysian sukuk are issued in local currency. Therefore in terms of the international sukuk market, the majority are issued from the Gulf Co-operation Council [GCC] region. It is likely that we will see an increase in issuance coming particularly from markets that have not been as active in the past, such as Europe and the US. 

Well-recognised names such as Goldman Sachs have recently announced sukuk issuance and it would not be surprising to see other names tap the sukuk market as capital is at a premium.

Emad Al-Monayea: After the recent US credit rating downgrade, we observed significant volatilities across the global financial market that affected every asset class – except to a certain degree, the good-quality sukuk.

Assuming an end to the Middle East uprising and given the number of GCC infrastructure projects in the pipeline, we should expect to see more sovereign and corporate sukuk issuances from the GCC, Turkey, Asia, the Commonwealth of Independent States and some African markets as well.

Mohammed Dawood: The outlook for sukuk is strong because of the high liquidity and more importantly, its performance. Sukuk have also outperformed comparable conventional bonds in the secondary market this year. Sukuk issuances will continue to be driven by markets that have sukuk-friendly laws – most of these markets are in Asia and the Middle East. New markets include Turkey, Kazakhstan, Jordan and Egypt. 

Q: In June this year, HSBC Middle East issued a benchmark $500m public sukuk – the first from an international bank. The issuance was oversubscribed by 3.5 times – proof that conventional banks can issue sukuk successfully. To date, sukuk issuance in the Middle East has been dominated by government-backed companies with significant exposures to real estate, financial services or oil and gas production. Do you expect to see greater issuance from regional-based conventional banks and corporates from a wider range of sectors in the future?

JS: One would like to think Saudi Arabia and the Gulf region in particular, but also north Africa and the [countries in the western part of the Middle East], would see common and frequent issuance of new corporate sukuk. Unfortunately there’s a good chance new-issue volumes will be small, and even if more than that, there’s still not going to be enough sukuk supply from the Arab world to fill demand for Islamic fixed-income securities. And the future of sukuk from the region will continue to be dominated by real estate, financial services and oil and gas, as these are natural areas for sukuk origination in these countries. 

One area I would like to see new sukuk activity would be related to consumer finance, in particular household white goods and automobile finance. Because of the normal shorter-term maturities of these sukuk they would be a very good introduction to longer-term sukuk from the mortgage sector. Sukuk backed by consumer asset pools would give buyers more experience in taking risk on rated portfolios, rather than the implied or explicit guarantees of a named corporate or sovereign borrower. 

WO: Yes, there will be an increase in conventional banks and businesses issuing sukuk. These institutions will not necessarily issue sukuk to grow their Islamic business but in order to access alternative funding streams and diversify their investor base. However, the fact that sukuk trades at a premium over conventional bonds – combined with the lack of international understanding and familiarity with sukuk – may limit growth.

EM: HSBC Middle East has built sufficient Islamic financial assets and sizeable activities, thereby it was able to create an Islamic sukuk that was segregated from conventional assets. In my opinion, other financial institutions with similar capabilities and proven assets will also be able to tap the sukuk market.

MD: We expect our sale to encourage other conventional banks with sizeable Islamic businesses to follow suit. In fact, First Gulf Bank’s recent sukuk attracted so much interest that it was 5.8 times oversubscribed, allowing the bank to raise the amount for issuance to $650m. Given that demand for sukuk products continues to outstrip supply, we expect corporates across the sectors to also use sukuk to raise funding.

Q: The universe of sukuk is much smaller than conventional bonds and, as a result, is dominated by buy-and-hold investors. The sukuk market needs more issuance, in varying maturities and currencies, with more secondary trading in order to be on a par with the conventional bond market. Apart from adopting globally accepted standards and structures for sukuk, what more can be done to encourage more issuance?

JS: We know the sukuk secondary market is in fact quite active. One boutique sukuk trading house claims it tracked about $7bn in global secondary market trading during one year, implying a 7% turnover on the then-outstanding $100bn in sukuk. 

First and foremost, governments everywhere should lead the way in issuing more sovereign or agency sukuk wherever possible. Major international banks that have sukuk origination teams should get off their chairs and start scouring Europe and North America, looking for investment-grade borrowers and explaining to them the abundant liquidity in the Islamic banking industry. 

WO: Generally speaking, the sukuk market has been more robust and less volatile than the conventional market since the onset of the global financial crisis in 2008. This performance has buoyed the secondary market. As more people recognise this, I would not be surprised to see more conventional investors enter the market and hence the idea of a 'purely buy-and-hold market' would vanish very quickly.

Progress is being made as borrowers become more aware of the liquidity available from investors in the GCC. Standardisation as you mention also allows for cheaper structuring and therefore more issuers become interested. There are still some obstacles to the issuance of sukuk which are preventing the market growing even faster, such as vagaries surrounding the underlying assets and structures. Sukuk need to be issued in a wider range of maturities and currencies in fixed and floating structures.

EM: Over the years, the global sukuk market has grown more than $160bn, which is certainly still very small compared with the outstanding conventional bond market. However, a centuries-old conventional bond market should not be compared with the only 10-years-old sukuk industry.

Structuring sukuk requires tremendous financial engineering. Developing commonly accepted structures that satisfy sharia constraints, supervisory regulators and risk appetite will attract a wider group of investors and help extend the tenor, as well as increasing the size and frequency of issuances.

MD: For more sukuk to be issued, governments need to have tax-friendly laws [so] that Islamic issuances will not be double-taxed. There also needs to be a greater diversity of investors, especially those who can invest over the longer term such as Islamic pension fund managers. Lastly, the connectivity between Middle East and Asia should be encouraged so that issuers can tap into the GCC liquidity and vice versa. It is important for these issues to be addressed so that the sukuk industry can achieve its full potential.

Q: What do you see as both the biggest challenge and the biggest opportunity in the global sukuk market industry today?

JS: There are highly skilled teams of investment bankers in Saudi Arabia, and also in Malaysia, London and elsewhere. Unfortunately, the management of these teams sometimes appear to lack the vision to execute more sukuk originations. They seem too focused on other areas of banking – in particular real estate projects, derivatives and private equity.

We cannot wait until local borrowers in Saudi Arabia, the Gulf and parts of south-east Asia bring sufficient new sukuk to market. We already have plenty of sources of new sukuk right under the noses of most bankers: North America and Europe. It takes only a few phone calls, a few flights, and a better integration of global bank networks to bring the skills of mostly Dubai and London-based sukuk origination teams to match the needs of qualified buyers. 

WO: It will be a challenge ensuring that more sukuk benchmarks are created by governments, not just in the GCC or Asia, but also in Europe. The biggest challenge is to spread the distribution of sukuk more widely to a global investor base who can be educated about their structures. In a sense, this is also the greatest opportunity because a large portion of the existing conventional debt market could be replaced with sukuk funding, which will more closely meet the preferences of Islamic issuers and investors, thereby allocating capital more efficiently.

EM: Enhancing the number and tradability of truly asset-backed sukuk remains the biggest challenge as well as the biggest opportunity.

MD: The biggest challenge is the lack of sharia-compliant assets to structure sukuk and alternative structures to help the sukuk market achieve size and scale. The biggest opportunity is its potential to become the dominant mode of funding in key Islamic finance markets.

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