One of the biggest constraints on sukuk market growth has been the product's lack of secondary liquidity. The market's mainstay investors – specialist sukuk funds and private wealth managers – tend to buy and hold, and are too small to trade in and out much. A more liquid market – which would in turn entice further investors – can only happen when bigger institutions become involved.
So far, there has been little progress in that direction, partly because specifically Islamic insurance (takaful) and reinsurance companies have not taken off. The big problem for such insurers, especially in the Gulf, has been that they have not offered an economic alternative to conventional insurance.
Thus, the Islamic bond and insurance markets have been developing somewhat separately. But both sectors might be able to make faster progress if they came together, in a mutually reinforcing way.
One point of connection between the markets is that every sukuk deal is backed by commercial assets of one kind or another – and all these assets, just like any others in business, are covered by insurance.
So far, the Islamic scholars that govern the sukuk market have not insisted that sukuk issuers use Islamic-compliant insurance for the assets in their deals. The sukuk sign-off forms contain a section where issuers are asked if they are using takaful, but the default setting has been to use conventional insurance.
There could now be a chance for more sukuk issuers to start using takaful – thanks, of all things, to developments in London.
Several large London insurance players are now interested in offering the same price to insure risks in either a conventional or a Shariah-compliant manner.
Moreover, the recent launch in the Lloyd's of London market of Cobalt Underwriting – hailed by various market sources as an important breakthrough – has provided a conduit for Shariah-compliant insurance and reinsurance. Cobalt specialises in helping businesses get the best pricing and spread their risk among suppliers of Islamic insurance.
Of course, London insurance is not the cheapest in the world – providers in other areas such as India or the Middle East might be able to offer cheaper rates. But when it comes to insuring the assets underlying big ticket Middle Eastern dollar sukuk, London insurance houses may be able to offer better credit ratings.
Whether sukuk scholars consider takaful necessary for a sukuk to be truly Shariah-compliant is of course entirely their own decision. But from a purely pragmatic point of view, a greater use of takaful by sukuk issuers could create two virtuous circles.
First, greater use of Islamic insurance would likely help its providers become more efficient and in due course offer better rates.
Second, Islamic finance as well could benefit. Insurance premiums paid to conventional insurers are of course invested in a wide variety of assets. Those paid to takaful providers must necessarily go into Shariah-compliant assets – including Islamic securities like sukuk. Islamic money market funds, in particular, might benefit, and in time become a deeper pool of demand for Islamic products.
Addressing the issue of insurance at an early stage in a deal could also amount to free due diligence, since insurers can arguably provide better intelligence than banks themselves on the risks associated with sukuk assets.
Rather than thinking of insurance as a box to be ticked once everything else is in place, those structuring sukuk deals could do a great service to the Islamic finance market by making it a priority.