Jan 22 The birth of three new sources of
sovereign sukuk - Britain, Luxembourg and Hong Kong - will
broaden the market in Islamic bonds, helping in a small way to
ease a shortage of top-rated paper that hurts the ability of
banks to manage their funds.
However, a full solution to the shortage probably depends on
a decision by Gulf Arab governments to boost their regular,
international issuance of sovereign sukuk - a policy which they
show no sign of adopting.
Issuance of sukuk has been rising rapidly in recent years;
global issues hit an all-time high of $134.3 billion in 2012,
before falling to $114.3 billion in 2013 as jitters about U.S.
monetary policy constrained sales of most kinds of debt.
Growth is expected to pick up again this year as the pool of
Islamic funds in the Gulf and southeast Asia continues to
expand. A Thomson Reuters study predicts issuance of $130
billion in 2014 and $237 billion in 2018.
But the international market still lacks a steady supply of
top-rated sukuk, which are available only from a small number of
sources such as the AAA-rated Islamic Development Bank
and the International Islamic Liquidity Management
Corp (IILM), rated a notch lower.
The IDB is expanding its London sukuk programme to $10
billion from $6.5 billion, has a 1 billion ringgit ($300
million) programme in Malaysia, and plans also to list sukuk in
Dubai. The IILM has $1.35 billion of outstanding sukuk and aims
to raise this as high as $2 billion.
The few other highly rated international issuers include
Qatar, rated AA by Standard & Poor's, which issued $4 billion of
sukuk in 2012 - the biggest U.S. dollar-denominated issue of
Islamic bonds ever.
While conventional banks around the world can invest in the
huge supplies of highly rated, interest-bearing sovereign bonds
issued by the United States, Germany, Britain, Japan and other
countries, Islamic banks cannot.
Governments in the Muslim world are often too rich to need
to issue large amounts of sukuk, as in the case of the Gulf oil
producers, or too financially constrained to be able to issue
much, as in North Africa. This makes it difficult - and
expensive - for Islamic banks to manage their balance sheets.
"There remains an acute shortage of high-quality sukuk in
the market, and as such this constrains the liquidity management
capabilities of Islamic banks," said Khalid Howladar, senior
credit officer at Moody's Investors Service.
That is why the emergence of new sovereign issuers of sukuk
is so important for Islamic finance. In October, Britain
revealed plans to sell sukuk as early as this year, seeking to
become the first sovereign outside the Muslim world to do so. It
is still rated AAA by S&P.
AAA-rated Luxembourg, which competes with London as an
Islamic financial centre, responded in early January by
presenting a draft bill to parliament that would permit its own
sovereign sukuk issuance.
A spokeswoman for Luxembourg's finance ministry said
approval of the bill would ultimately depend on the legislative
calendar, which was not yet known. But Luxembourg may be a step
ahead of London as its bill identifies three real estate assets
to back its sukuk; Britain has not yet released such details.
Luxembourg could come to market in a matter of months, a
source there said; it has a tested legal structure, a law
covering securitisation vehicles that was introduced in 2004 and
has been used by the Luxembourg-domiciled sukuk from the IILM.
Legal structures are crucial in the design of sukuk, as the
instruments can face heavy taxation because they involve
multiple transfers of the assets backing them.
Also this month, Hong Kong's AAA-rated government said it
hoped to raise funds with the territory's first sovereign
Islamic bond after the introduction of new laws.
"We hope that the bill will be passed as early as possible
to provide impetus to the development of a sukuk market in Hong
Kong," a spokesperson for the territory's Treasury told Reuters,
without giving a time frame.
Hong Kong would issue under an existing bond programme, and
it accumulated experience several years ago studying a proposal
for a sukuk issue by its airport authority which did not
materialise. It introduced tax legislation last year to
facilitate local issuance of sukuk.
All these factors would help speed up a Hong Kong deal, said
Davide Barzilai, partner and Asia Pacific head of Islamic
finance at law firm Norton Rose Fulbright in Hong Kong. He added
that the bill could be passed as early as the first quarter,
followed quickly by an issue.
"I don't think there is a new learning curve needed, they
have already done that. This is not a race, but as it happens we
(the three new sovereigns) are all moving at a similar pace."
Initial volumes from these centres will not be large,
however. Britain has said its first sukuk would be about 200
million pounds ($330 million), and would probably be a "one-off"
rather than the start of a regular programme. Luxembourg's bill
envisages a size equivalent to 200 million euros ($270 million).
These amounts are dwarfed by the tens of billions of dollars
worth of demand for highly rated sukuk expected from Islamic
banks and other investors in coming years.
Unfortunately for these investors, this demand does not look
likely to be satisfied by Gulf governments. Qatar now appears to
be focusing on developing its domestic debt market, issuing 11
billion riyals ($3 billion) of local currency sukuk to local
banks this month; its finance minister said in December that he
had no plan for international debt issuance in 2014.
Saudi Arabia's General Authority for Civil Aviation,
guaranteed by its AA minus-rated government, issued a massive
15.2 billion riyal ($4.05 billion) of sukuk last October, but
that was in its domestic market. The government has been paying
down its outstanding debt, which is very small, and has shown no
sign of issuing sovereign sukuk internationally.
With its huge cash reserves, the Abu Dhabi sovereign has
never issued sukuk and has not made public, international debt
issues its debut deal in 2009. Dubai has been relatively active
issuing sukuk, but has not sought a credit rating.
Nevertheless, the new sukuk issues from Britain, Luxembourg
and Hong Kong should benefit Islamic finance at the margin.
Barzilai said they would help some banks meet liquidity and
capital requirements under Basel III rules which will be phased
in around the world over the next few years.
"These issuances, depending on the currency, are a step in
creating a level playing field for Islamic banks," said Nigel
Denison, head of treasury and wealth management at Bank of
London and the Middle East.
Another benefit is a potential widening of the range of
currencies in which highly rated sukuk are denominated. The vast
majority of international issues have been in U.S. dollars, but
both Britain and Hong Kong plan local-currency deals, while
Luxembourg could issue in either euros or dollars.
At present there is next to no cross-border trade in highly
rated sukuk; primary dealers hold on to the IILM instruments
after auctions and there has been little if any secondary market
sales of them, said an official at one of the primary dealers.
An expanded flow of sovereign sukuk could move the industry
closer to a tipping point where liquidity is high enough for
secondary market trade to begin.
There is also the hope that sovereign issues from Britain,
Luxembourg and Hong Kong will be imitated by other new issuers
which want to attract funds from the Gulf and southeast Asia.
"Other European sovereigns may also follow the UK's lead,"
Private corporations in the West may look more closely at
sukuk, said Denison. "These transactions from the UK, Luxembourg
and Hong Kong will help create a more liquid market by meeting
the current demand, but will also raise awareness of sukuk and
attract more conventional issuers."