Total Sukuk issuance dropped by 15.3 per cent compared with the same period last year, reaching $44.2 billion compared with $52.2 billion first half of 2017. This drop was even more pronounced for foreign currency Sukuk issuance at 45 per cent, likely due to the absence of major issuances from the Gulf Cooperation Council (GCC) countries seen in 2017.
In the second half of 2018, S&P expects Sukuk issuance volumes will continue to be slowed by the global tightening of liquidity conditions as well as by lower financing needs of some GCC countries as a result of oil prices stabilising at higher levels.
The sharp increase in geopolitical risks in the Middle East will also likely weigh on investors' appetite. Meanwhile, inherent challenges related to the Sukuk market continue to drag on expansion of this market, although Malaysia will probably continue to support market growth, owning to its strong market foundations and government support for Islamic finance. Overall, S&P maintains its expectations for volume of issuance at $70 billion-$80 billion in 2018.
There are four main reasons that S&P expects the market will continue to lose steam:
The tightening of global liquidity that started in the first half of 2018 is likely to continue; the US Federal Reserve is expected hike its federal funds rate by another 50 basis points in the second half of 2018 after the two increases of the first half and that central banks of GCC countries will probably mirror such an increase due to the peg of their currencies with the US dollar. Overall, it is liely that the liquidity channelled to the Sukuk market from developed markets will reduce and become more expensive. Currently, European and US-based investors account generally for about one-quarter of Sukuk investment in terms of volume, while muted economic growth and declining lending activity in the GCC has shifted banks' focus to capital market activities in hopes of achieving higher yields than with cash and money market instruments.
The GCC countries' need for financing is reducing as liquidity conditions improve, thanks to higher oil prices, which are expected to remain at about $65 per barrel in 2018, and continued expenditure reduction by GCC countries since 2015. Overall, the gross commercial long-term debt issuance of GCC countries should decline by 15 per cent in 2018 from 2017.
By contrast, the repeal of the good and services tax in Malaysia without sufficient offsetting measures could result in higher fiscal deficit and financing needs for the country, further boosting its Sukuk issuance. In the first half of 2018, total Sukuk issuance in Malaysia increased by around 50 per cent compared with the same period last year, underpinned by higher government and corporate issuance.
Standard-setting bodies have made significant efforts to drive forward the standardisation of Sukuk, but there is still work to be done. Some market participants still think that standardisation is unrealistic and that it would be better to aim for harmonization and leave some flexibility for implementationCases similar to Dana Gas—where the issuer reportedly defaulted on its $700 million Sukuk on the basis that the instruments were no longer compliant with Shari’ah law—will act as regular wake-up calls and bring the standardisation debate back on the table.
Standardisation continues to be seen as an important topic and note that fixed-income investors tend to shy away from instruments with limited visibility on post-default resolution. Standardised Shari’ah requirements could prevent potential uncertainty on compliance after a transaction closes and is therefore key in helping investors better understand the risks involved.
Similarly, standard legal documentation provides clarity for investors on the recourse options available in the event of a default of a conventional bond. This is still lacking in Islamic finance. S&P recognises that the Islamic finance market has achieved a certain level of standardisation for the most common structures, while a few new instruments still need some refinement. Investors are asking for additional clarity on the risks related to the Murabahah-Mudarabah structure that is widely used in some jurisdictions. Standardisation for cross-broader Sukuk issuance is not only achievable but will also boost the volume of issuance. It will improve the attractiveness of the instrument to issuers by making the issuance process smoother and faster and by providing more clarity on the underlying risks.
The Dana Gas dispute raised several questions about the enforceability of the foreign judgments in the UAE. While the UK court ruled in favour of the investors, a local court in Sharjah ruled in favour of the company. Ultimately, in May 2018, Dana Gas reportedly reached a deal outside of court with the creditors committee of its Sukuk. While the recent drop in Sukuk issuance in the GCC is not attributed to the Dana Gas case, the underlying issue is possibly suppressing investors' appetite for GCC Sukuk.
Positively, S&P noted that since the dispute there have been a few changes in the legal documentation language for new Sukuk issuances, reportedly, to reduce the risk of such disputes occurring. Restructuring of debt is a common practice in the global capital market. However, additional rules and clarity around restructuring or resolution of Sukuk is needed for both issuers and investors. For the Islamic capital market, higher standardisation could help in setting these rules and achieving clarity.