It said global issuance expanded for the fourth year in a row in 2012, growing 64 percent to about $138 billion, and expects another few strong years. Despite the growth spurt, the Sukuk market is still a small segment of the global fixed-income world. Largely dominating issuance are sovereign and sovereign-related issuers from Malaysia, and, to a lesser extent, from the countries of the Gulf Cooperation Council.
S&P believes that a number of banks, particularly, will come to market, needing to refinance their existing debt and seeking larger amounts to match the credit needs of their corporate clients, especially in project finance.
GCC banks that are Sukuk issuers – those in Saudi Arabia, Qatar, and the UAE – will increasingly turn to the market for funding sources, and perhaps in more innovative ways, not only because of the attractive market conditions but also to meet funding needs and increasingly stiff regulatory capital requirements. For example, in November 2012, Abu Dhabi Islamic Bank (not rated) issued a $1 billion perpetual Sukuk to strengthen its regulatory capital ratios. The Sukuk qualified as a Tier 1 instrument because the issue was deeply subordinated and senior only to ordinary shares. Investors snapped up the notes at 6.375 percent — compared with an initial float price of about 7 percent. Gulf banks issued $7.2 billion of Sukuk in 2012, of which $4 billion was issued by banks that S&P rates, up 55 percent from 2011.
Banks in Saudi Arabia and Qatar are set to increasingly issue debt in 2013 and 2014, including Sukuk, because of strong growth in lending that is outstripping deposit taking. In the UAE, where credit growth is stagnant, banks may continue to tap the debt markets to issue long-tenor paper to improve their long-term funding profiles.
Moreover, S&P believes the project finance sector will increasingly rely on Sukuk to fund transactions, taking advantage of the good market conditions. Infrastructure-related Sukuk, especially for transportation projects, increased to $6 billion in 2012 after two years of barely any issuance. Transportation represented 67 percent of all GCC issuance within the infrastructure segment in 2012.
Countries in the region, especially Saudi Arabia, will continue to favor issuing through their GREs rather than through the sovereign. For example, the Kingdom’s General Authority for Civil Aviation (not rated) issued SR15 billion (about $4.1 billion) to help fund the expansion of the Jeddah airport, and Saudi Aramco Total Refining Petrochemical Co. issued $1 billion of Sukuk to finance the development of the Jubail refinery.
Dubai’s GREs as well have a number of Sukuk transactions in the pipeline, though not to the exclusion of the recent sovereign 10-year $750 million Sukuk that the Dubai Department of Finance issued in January 2013, which was largely oversubscribed and priced at an attractive 3.875 percent.
Another example is the $1 billion Sukuk with a five-year tenor that Dubai Electricity and Water Authority (DEWA) issued in March 2013, which S&P views as significant for two reasons: It is the first foray by DEWA into US dollar-denominated Sukuk, and —the yield on this asset-based Sukuk is much lower, at a profit margin of 3 percent compared with the close to 6 percent yield on DEWA’s bond issuances of similar tenor two years ago. This issuance attracted a mixture of international and regional investors. The pricing reflects the appetite for investment-grade quality infrastructure issuance in the GCC. The transaction may set a benchmark for other strong credit quality GRE credits in the region.
The Asian and GCC Sukuk markets are becoming more interdependent as the number of cross-border transactions between the regions pick up, and because of increasing use of the Malaysian ringgit as preferred currency of choice. Both regions have relatively strong economies and are seeking huge amounts of capital to fund new infrastructure, support economic development and entice more private-sector investment.
Cross-border issuance will continue to gather steam, with Malaysia as the main benefactor, as in the past few years. Cross-border issuance means that an entity based in one country chooses to issue and market Sukuk in another country, and in all likelihood in that country’s currency. For instance, GCC-based entities have been crossing the figurative border with ringgit-denominated issues over the past few years, beginning with pioneering entities such as Abu Dhabi National Energy Co. PJSC, Bahrain-based Gulf Investment Corp., and National Bank of Abu Dhabi. Even though the amounts remain low, ringgit-denominated Sukuk issuance in the GCC has been steadily increasing, to $571 million in 2012 from $323 million in 2010.
More generally, last year’s non-Malaysian entities, such as China-based Noble Group Ltd. and the Development Bank of Kazakhstan, issued upward of $1.5 billion. The ringgit is becoming a growing, credible alternative to the US dollar for non-Malaysian issuers. Interestingly, issuance in the Malaysian currency by all issuers--domestic and foreign combined--actually exceeded those by Malaysian entities for the first time in 2012.
The US traditionally was the only alternative for issuers wanting to appeal to international investors, especially in countries where local currencies are pegged to the dollar such as the GCC countries, with shallow pools of domestic liquidity such as Indonesia, or with a short track record of Sukuk issuance – such as Turkey when it first tapped the market in a big way in 2011 and 2012. S&P forecast that ringgit-denominated issuance will continue to perform strongly, benefitting from, among other factors, Malaysia’s well-defined regulations and developed capital markets (both conventional and Islamic), large and diversified pool of investors, standardized Sukuk structures with available liquidity, as well as its status as a potential gateway to other fast-growing Asian economies such as Indonesia and China.
Future global growth of the Sukuk market, S&P believes, depends directly on greater liquidity and better price formation. Liquidity is tight because the market is still small and viewed as an alternative asset class. This situation is improving as larger and more frequent issues come to market, and as Sukuk gain greater acceptance as a mainstream debt instrument. The report noted the increasing number of Sukuk that are being rated and listed on international stock exchanges, with healthy competition by exchanges to attract issuers.
However, most Sukuk issued globally are not listed and remain over-the-counter instruments, and rated ones are the exception rather than the rule – although the absolute number of issuers seeking ratings is on the rise.
Listing Sukuk on organized markets and rating them not only bolsters liquidity, but also makes it easier for institutional investors to assess and manage these assets. Liquidity has so far grown slowly, partly because it is building in fragmented domestic pools. Malaysia’s success is partly explained by the existence of a well-functioning and credible debt capital market, which remains shallower in the GCC. Price formation has often proved difficult, even for listed Sukuk, because some of them trade infrequently. When trade is thin in a market, there are few prices and perhaps even no benchmarks, that is, weak price formation.
S&P further believes that sovereign issuance is critical for establishing benchmarks and facilitating price formation for private issuance. Since its infancy in the 1990s, the Sukuk market has experienced exponential growth, that is, until the financial crisis of 2008, which dampened investor appetite globally and across the board. Growth thereafter resumed when confidence returned, largely on the back of comparatively brighter economic prospects in emerging markets.
Islamic financial industry has the ability to overcome questions related to Shariah interpretation, standardization of Sukuk structures, and creditworthiness, plays directly into the globalization of the Sukuk market and its wider acceptance by international investors.
Two bodies are actively and increasingly helping in the development of sovereign Sukuk: the Islamic Development Bank (IDB) and the Malaysia-based International Islamic Liquidity Management Corp.
IDB invests in sovereign Sukuk, and issues Sukuk with the aim of providing low-cost funds to member countries. The IDB is the only Sukuk issuer that we rate AAA, through, notably, two programs for the finance of infrastructure projects: an $8 billion IDB Trust Services Ltd. global Sukuk and a MYR1 billion Tadamun Services Bhd. Sukuk geared to the Malaysian market. The IILM, founded in 2010 by central banks, monetary authorities, and multilateral organizations, seeks to play a vital role in developing much-needed short-term Shariah-compliant liquidity solutions for Islamic financial institutions.
The GCC and Asia will remain the key engines for growth of the Sukuk market in the coming 18-24 months. S&P sees new issuers, most probably sovereigns, though with modestly sized issues to test the waters and investors’ risk appetite.
Besides, S&P does not rule out the possibility that more African sovereigns will enter the market. Some African countries have been growing strongly over the past few years, and most have huge infrastructure investment needs.
So far, only two African sovereigns have come to the domestic market with Sukuk — Gambia and Sudan — but a number of them are considering either domestic or global issuance.
The rebound in Sukuk issuance from the GCC since 2011 is set to intensify, following muted years after the global financial crisis. Total Sukuk issuance in the Gulf increased to $24 billion in 2012. S&P projects that the region’s economic resilience, strong project pipeline, and regional refinancing needs could boost its issuance to match Malaysia’s over the long run. Although sovereign or sovereign-related entities are the main issuers, we believe private-sector entities may be able to ride the wave. Yields on GCC Sukuk appear to be consolidating at historic lows. Low interest rates worldwide and investors’ preference for the bond markets — over still-depressed equity markets — largely explain the trend. The tight yields also indicate continued strong investor demand for all manner of fixed-income products in the GCC.
source: Saudi Gazette